UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
   
þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 20072008
OR
   
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from                    to                    .
Commission file number 0-86411-33067
SELECTIVE INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)
   
New Jersey 22-2168890
(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.)
   
40 Wantage Avenue, Branchville, New Jersey 07890
(Address of Principal Executive Office) (Zip Code)
Registrant’s telephone number, including area code: (973) 948-3000
Securities registered pursuant to Section 12(b) of the Act:
   
Title of Each Class Name of Each Exchange on Which Registered
   
Common Stock, par value $2 per shareNASDAQ Global Select Market
7.5% Junior Subordinated Notes due September 27, 2066 New York Stock Exchange
Common Stock, par value $2 per shareNASDAQ Global Select Market
Preferred Share Purchase Rights
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
þ Yes      o No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
o Yes      þ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.
þ Yes     o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filerþ Accelerated filero Non-accelerated filero Smaller reporting companyo
  (Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
o Yes      þ No
The aggregate market value of the voting Commoncommon stock held by non-affiliates of the registrant, based on the closing price on the NASDAQ Global Select Market, was $1,393,617,821$960,558,610 on June 30, 2007.
2008. As of February 15, 2008,13, 2009, the registrant had outstanding 53,869,96752,699,262 shares of Common Stock.common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 20082009 Annual Meeting of Stockholders to be held on April 24, 200829, 2009 are incorporated by reference into Part III of this report.
 
 

 

 

 

SELECTIVE INSURANCE GROUP, INC.
Table of Contents
     
  Page No.
 
PART I.
    
     
Item 1. Business
  3 
     
Item 1A. Risk Factors
  2324 
     
Item 1B. Unresolved Staff Comments
  3238 
     
Item 2. Properties
  3238 
     
Item 3. Legal Proceedings
  3238 
     
Item 4. Submission of Matters to a Vote of Security Holders
  3238 
     
PART II.
    
     
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
  3339 
     
Item 6. Selected Financial Data
  3541 
     
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
  3743 
     
Forward-looking Statements
  3743 
     
Introduction
  3743 
     
Critical Accounting Policies and Estimates
  3743 
     
Financial Highlights of Results for Years Ended December 31, 2008, 2007, 2006, and 20052006
  4552 
     
Results of Operations and Related Information by Segment
  4653
Federal Income Taxes
72 
     
Financial Condition, Liquidity and Capital Resources
  60
Federal Income Taxes
6373 
     
Adoption of Accounting Pronouncements
  6377 
     
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
  6478 
     
Item 8. Financial Statements and Supplementary Data
  6782 
     
Consolidated Balance Sheets as of December 31, 20072008 and 20062007
  6883 
     
Consolidated Statements of Income for the Years Ended December 31, 2008, 2007, 2006 and 20052006
  6984 
     
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2008, 2007, 2006 and 20052006
  7085 
     
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007, 2006 and 20052006
  7186 
     
Notes to Consolidated Financial Statements
  7287 
     
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
  103123 
     
Item 9A. Controls and Procedures
  103123 
     
Item 9B. Other Information
  105125 
     
PART III.
    
     
Item 10. Directors, Executive Officers and Corporate Governance
  105125 
     
Item 11. Executive Compensation
  105125 
     
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
  105125 
     
Item 13. Certain Relationships and Related Transactions, and Director Independence
  105125 
     
Item 14. Principal Accountant Fees and Services
  105125
PART IV.
Item 15. Exhibits and Financial Statement Schedules
126 
     
 Exhibit 10.5e10.5f
 Exhibit 10.7a10.22a
 Exhibit 10.14b10.23e
 Exhibit 10.14c10.23f
 Exhibit 10.14d10.23g
Exhibit 10.23h
Exhibit 10.23i
 Exhibit 21
 Exhibit 23.1
 Exhibit 24.1
 Exhibit 24.2
 Exhibit 24.3
 Exhibit 24.224.4
 Exhibit 24.5
 Exhibit 24.6
 Exhibit 24.7
 Exhibit 24.8
 Exhibit 24.9
 Exhibit 24.10
 Exhibit 24.11
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 Exhibit 99.1

 

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PART I
Item 1. Business.
Overview
Selective Insurance Group, Inc., through its subsidiaries, (collectively knownreferred to as “Selective”“we” or “the Company”“our”) offers property and casualty insurance products and diversified insurance services and products. Selective Insurance Group, Inc. (referred to as the “Parent” or the “Parent Company”) was incorporated in New Jersey in 1977 and its main offices are located in Branchville, New Jersey. Selective Insurance Group, Inc.’s Common StockThe Parent’s common stock is publicly traded on the NASDAQ Global Select Market under the symbol “SIGI.”
Selective classifies itsWe classify our business into three operating segments:
 • Insurance Operations, which sells property and casualty insurance products and services primarily in 2122 states in the Eastern and Midwestern United States;U.S.;
 
 • Investments; and
 
 • Diversified Insurance Services, which provides human resource administration outsourcing (“HR Outsourcing”) products and services, and federal flood insurance administrative services.services (“Flood”).
Financial information about Selective’sour three operating segments is contained in this report in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8. “Financial Statements and Supplementary Data,” Note 12 to the consolidated financial statements, “Segment Information.”
Description of Operating Segment Products and Markets
Insurance Operations Segment
Selective’sOur Insurance Operations sell property and casualty insurance policies, which are contracts to cover losses for specified risks in exchange for premiums. Property insurance generally covers the financial consequences of accidental loss to the insured’s property. Property claims are generally reported and settled in a relatively short period of time. Casualty insurance generally covers the financial consequences of bodily injury and/or property damage to a third party as a result of the insured’s negligent acts, omissions, or legal liabilities. Casualty claims often take years to be reported and settled.
Selective’sOur Insurance Operations segment writes its property and casualty insurance products through seven insurance subsidiaries (“Insurance Subsidiaries”), which are listed on the following table together with their respective pooled financial strength ratings by A.M. Best Company, Inc. (“A.M. Best”), and state of domicile by which each is primarily regulated:
     
Insurance Subsidiaries A.M. Best Rating1 Domiciliary State
Selective Insurance Company of America (SICA)(“SICA”) “A+ (Superior)” New Jersey
Selective Way Insurance Company (SWIC)(“SWIC”) “A+ (Superior)” New Jersey
Selective Insurance Company of South Carolina (SICSC)(“SICSC”)2
 “A+ (Superior)” South CarolinaIndiana
Selective Insurance Company of the Southeast (SICSE)(“SICSE”)2
 “A+ (Superior)” North CarolinaIndiana
Selective Insurance Company of New York (SICNY)(“SICNY”) “A+ (Superior)” New York
Selective Insurance Company of New England (SICNE)(“SICNE”) “A+ (Superior)” Maine
Selective Auto Insurance Company of New Jersey (SAICNJ)(“SAICNJ”) “A+ (Superior)” New Jersey
1 With regard to an “A+” rating, A.M. Best uses its highest Financial Strength Rating of “Secure,” and a descriptor of “Superior,” which it defines as, “Assigned to companies that have, in our opinion, a superior ability to meet their ongoing obligations to policyholders.” OnlyApproximately 10% of commercial and personal insurance companies carry an “A+” or better rating from A.M. Best.
2Effective June 30, 2008, two of the Insurance Subsidiaries, SICSE and SICSC, changed their regulatory state of domicile from North Carolina and South Carolina, respectively, to Indiana.
In 2007,2008, A.M. Best, in its list of “Top 200 U.S. Property/Casualty Writers,Groups,” ranked Selectiveus the 4647th largest property and casualty group in the United StatesU.S. based on the combined net premiums written (“NPW”) for 2006.2007.

 

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Insurance Operations
Selective’sThe Insurance Operations segment derives substantially all of its revenues from insurance policy premiums. The Insurance Subsidiaries predominantly write annual policies, of which the associated premiums are defined as direct premium written. Direct premium written plus premium assumed from other carriers, less premium ceded to reinsurers is NPW. NPW is recognized as revenue as net premiums earned (“NPE”) ratably over the term of the insurance policy. Expenses related to the Insurance Operations fall into three categories: (i) losses associated with claims and various loss expenses incurred for adjusting claims; (ii) expenses related to the issuance of insurance policies, such as agent commissions, premium taxes, and other underwriting expenses, including employee compensation and benefits; and (iii) policyholder dividends.
Selective’sThe Insurance Subsidiaries are regulated by each of the states in which they do business. Each Insurance Subsidiary is required to file financial statements with such states, prepared in accordance with accounting principles prescribed by, or permitted by, such Insurance Subsidiary’s state of domicile (“Statutory Accounting Principles” or “SAP”). SAP have been promulgated by the National Association of Insurance Commissioners (“NAIC”) and adopted by the various states. Selective evaluatesWe evaluate and manage the performance of ourthe Insurance Subsidiaries in accordance with SAP. Incentive-based compensation to independent agents and employees is based on SAP results and our rating agencies use SAP information to evaluate our performance and for industry comparative purposes.
The underwriting performance of insurance companies is measured under SAP by four different ratios:
 1) Loss and loss expense ratio, which is calculated by dividing incurred loss and loss expenses by NPE;
 
 2) Underwriting expense ratio, which is calculated by dividing all expenses related to the issuance of insurance policies by NPW;
 
 3) Dividend ratio, which is calculated by dividing policyholder dividends by NPE; and
 
 4) Combined ratio, which is the sum of the loss and loss expense ratio, the underwriting expense ratio, and the dividend ratio.
A statutory combined ratio under 100% generally indicates an underwriting profit and a statutory combined ratio over 100% generally indicates an underwriting loss. The statutory combined ratio does not reflect investment income, federal income taxes, or other non-operating income or expense.
SAP differs in several ways from U.S. generally accepted accounting principles in the United States of America (“GAAP”), under which Selective iswe are required to report our financial results to the United States Securities and Exchange Commission (“SEC”). The most notable differences impacting our reported netbetween SAP and GAAP income are as follows:
 • Under SAP, Insurance Operations’ underwriting expenses are recognized when incurred; whereas under GAAP, underwriting expenses are deferred and amortized to expense over the life of the policy;
 
 • Under SAP, deferred taxes are recorded directly to surplus; whereas under GAAP, deferred taxes are recognized in our Consolidated Statements of Income as either a deferred tax expense or a deferred tax benefit;
•Under SAP, changes in the underwriting expense ratio is calculated using NPW as the denominator;fair value of our alternative investments, which are part of our other investment portfolio on our Consolidated Balance Sheets, are recorded directly to surplus; whereas NPE is used as the denominator under GAAP;GAAP, these fluctuations are recognized in income; and
 
 • Under SAP, the results of Selective’sour flood line of business are included in the income of the Insurance Operations segment, whereas under GAAP, these results are included within the income of Diversified Insurance Services segment.segment on our Consolidated Statements of Income.
Selective primarily usesThe most notable differences between SAP informationstatutory surplus and GAAP equity are as follows:
•The Insurance Operations’ underwriting expense item above results in a difference in statutory surplus and GAAP equity as a difference in expense recognition timing exists between SAP and GAAP;
•Under SAP, fixed maturity securities are carried at cost with no recognition of unrealized gains or losses in statutory surplus; whereas under GAAP, these securities are carried at market value with unrealized gains or losses recognized in equity;
•Under SAP, the recognition of deferred tax assets are limited to those that are expected to be realized within one year, or to the extent that we have a deferred tax liability or available carryback capabilities; whereas under GAAP, deferred tax assets are recognized based on a qualitative analysis of the temporary differences, past financial history, and future earning projections. A GAAP valuation allowance is required when it is determined that a gross deferred tax asset cannot be realized based on the “more likely than not” criteria.

4

Under SAP, a liability is recognized in an amount equal to monitorthe excess of the vested accumulated benefit obligation over the fair value of the pension plan assets with any changes in this balance not recognized in income being recognized in statutory surplus; whereas under GAAP, a liability is recognized in an amount equal to the excess of the projected benefit obligation over the fair value of the pension assets with any changes in this balance not recognized through income being recognized in equity as a component of other comprehensive income.
In addition to the above differences between SAP and manage its results of operations. Selective believesGAAP, the underwriting expense ratio is calculated using NPW as the denominator for SAP; whereas NPE is used as the denominator under GAAP.
We believe that providing SAP financial information for theour Insurance Operations segment helps itsour investors, agents, and customers better evaluate the underwriting success of Selective’sour insurance business.

4

The following table shows the statutory results of theour Insurance Operations segment for the last three completed fiscal years:
                        
 Year Ended December 31,  Year Ended December 31, 
(in thousands) 2007 2006 2005 
($ in thousands) 2008 2007 2006 
Insurance Operations Results
  
NPW $1,562,728 1,540,901 1,462,914  $1,492,938 1,562,728 1,540,901 
              
  
NPE $1,525,163 1,504,632 1,421,439  $1,504,387 1,525,163 1,504,632 
Losses and loss expenses incurred 997,230 958,741 902,557  1,011,700 997,230 958,741 
Net underwriting expenses incurred 494,944 482,657 449,569  471,629 494,944 482,657 
Policyholders’ dividends 7,202 5,927 5,688  5,211 7,202 5,927 
              
Underwriting profit $25,787 57,307 63,625  $15,847 25,787 57,307 
              
  
Ratios:
  
Losses and loss expense ratio  65.4% 63.7 63.5   67.2% 65.4 63.7 
Underwriting expense ratio  31.6% 31.3 30.7   31.7% 31.6 31.3 
Policyholders’ dividends ratio  0.5% 0.4 0.4   0.3% 0.5 0.4 
              
Combined ratio  97.5% 95.4 94.6   99.2% 97.5 95.4 
              
  
GAAP Combined ratio1
  98.9 % 96.1 95.1 
GAAP combined ratio1
  101.0% 98.9 96.1 
              
1 The “GAAP Combinedcombined ratio” excludes the flood line of business, which is included in the Diversified Insurance Services segment on a GAAP basis. The total Statutory Combinedstatutory combined ratio excluding flood was 99.9% in 2008, 98.2% in 2007, and 96.1% in 2006, and 95.3% in 2005.2006.
Historically, Selective has produced a lowerOur statutory combined ratio has been lower than the statutory combined ratio of the property and casualty insurance industry for seven of the past 10 years and has also outperformed the industry average for the past 10-yearduring that period by 2.32.6 points. The table below sets forth a comparison of certain Company and industry statutory ratios:ratios based on our operations in comparison to our industry:
                                                                    
 Simple            Simple                     
 Average of            Average of                     
 All Periods            All Periods                     
 Presented 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998  Presented 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 
Selective Ratios:(1)
 
Loss and loss expense  69.5% 65.4  63.7 63.5 65.3 70.3 72.3 74.3 75.7 74.4 70.2 
Underwriting expense 31.1 31.6  31.3 30.7 30.3 30.7 30.3 31.5 31.7 30.5 32.2 
Policyholders’ dividends 0.6 0.5  0.4 0.4 0.3 0.5 0.6 0.9 0.9 0.8 0.7 
Statutory combined ratio 101.2 97.5  95.4 94.6 95.9 101.5 103.2 106.7 108.2 105.7 103.2 
Growth (decline) in net premiums written 8.2 1.4 5.3 6.9 12.0 15.7 13.8 10.5 3.6 8.1 4.4 
Industry Ratios:(1) (2)
 
Our Ratios:1
 
Loss and loss expense 76.3 67.7  65.3 75.3 73.5 75.0 81.5 88.4 81.5 78.8 76.2  69.2 67.2 65.4 63.7 63.5 65.3 70.3 72.3 74.3 75.7 74.4 
Underwriting expense 26.3 27.2  26.2 25.4 24.9 24.6 25.1 26.5 27.4 27.9 27.7  31.0 31.7 31.6 31.3 30.7 30.3 30.7 30.3 31.5 31.7 30.5 
Policyholders’ dividends 0.9 0.6  0.9 0.5 0.5 0.5 0.6 0.8 1.4 1.3 1.7  0.6 0.3 0.5 0.4 0.4 0.3 0.5 0.6 0.9 0.9 0.8 
Statutory combined ratio 103.5 95.6  92.4 101.2 98.9 100.1 107.3 115.7 110.4 108.1 105.6  100.8 99.2 97.5 95.4 94.6 95.9 101.5 103.2 106.7 108.2 105.7 
Growth in net premiums written 4.9  (1.2) 3.9 0.0 4.4 9.7 15.1 8.5 4.7 1.9 1.8  7.3  (4.5) 1.4 5.3 6.9 12.0 15.7 13.8 10.5 3.6 8.1 
Selective Favorable (Unfavorable) to Industry:
 
Industry Ratios:1, 2
 
Loss and loss expense 76.4 77.0 67.7 65.4 75.3 73.5 75.0 81.5 88.4 81.5 78.8 
Underwriting expense 26.2 27.1 27.1 26.1 25.4 24.9 24.6 25.1 26.5 27.4 27.9 
Policyholders’ dividends 0.8 0.7 0.7 0.9 0.5 0.5 0.5 0.6 0.8 1.4 1.3 
Statutory combined ratio 2.3  (1.9)  (3.0) 6.6 3.0  (1.4) 4.1 9.0 2.2 2.4 2.4  103.4 104.7 95.6 92.4 101.2 98.9 100.1 107.3 115.7 110.4 108.1 
Growth (decline) in net premiums written 33 2.6 1.4 6.9 7.6 6.0  (1.3) 2.0  (1.1) 6.2 2.6 
Growth in net premiums written 4.7  (0.8)  (0.8) 4.0 0.0 4.4 9.7 15.1 8.5 4.7 1.9 
Favorable (Unfavorable) to Industry:
 
Statutory combined ratio 2.6 5.5  (1.9)  (3.0) 6.6 3.0  (1.4) 4.1 9.0 2.2 2.4 
Growth in net premiums written 2.6  (3.7) 2.2 1.3 6.9 7.6 6.0  (1.3) 2.0  (1.1) 6.2 
1.1 The ratios and percentages are based uponon SAP prescribed or permitted by state insurance departments in the states in which each company is domiciled. Effective January 1, 2001, Selectivewe adopted a codified set of statutory accounting principles, as required by the NAIC. These principles were not retroactively applied, but would not have had a material effect on the ratios presented above.
 
2.2 Source: A.M. Best. The industry ratios for 20072008 have been estimated by A.M. Best.

5

Lines of Business and Products
Selective’sOur Insurance Operations segment includesincludes: (i) commercial lines (“Commercial Lines”), which markets primarily to businesses and represents approximately 87%86% of Selective’sour NPW; and (ii) personal lines (“Personal Lines”), which markets primarily to individuals and represents approximately 13%14% of our NPW.

5

Commercial Lines
Commercial Lines underwrites and issues general liability (including excess coverage), commercial automobile, workers compensation, commercial property, business owners’ policy,policies, and bond risks through traditional insurance and alternative risk management products.
Personal Lines
Personal Lines underwrites and issues insurance policies for personal automobile, homeowners, and other various risks.risks, including excess and dwelling fire coverages.
Regional Geographic Market Focus
Selective’sOur Insurance Operations segment primarily focuses its marketing efforts and sells its products and services in the Eastern and Midwestern regions of the United States.U.S. Although still concentrated in coastal eastern states, this geographic diversification lessens Selective’sour exposure to regulatory, competitive, and catastrophic risk. The Insurance Operations segment does not conduct any business outside of the United States.U.S. The following table shows the principal states in which Selective writeswe write insurance business and the percentage of Selective’sour total NPW that such state represents for the last three fiscal years.
                        
 Year Ended December 31,  Year Ended December 31, 
Net Premiums Written 2007 2006 2005  2008 2007 2006 
New Jersey  30.0% 32.6  33.9    28.6% 30.0 32.6 
Pennsylvania 14.1 14.3  14.4   14.5 14.1 14.3 
New York 10.8 11.1  11.2   10.2 10.8 11.1 
Maryland 7.6 7.5  7.2   7.4 7.6 7.5 
Virginia 6.0 5.9  5.6   5.7 6.0 5.9 
Illinois 4.4 3.9  3.8   4.8 4.4 3.9 
North Carolina 4.0 3.8  3.8   4.0 4.0 3.8 
Georgia 3.5 3.2  3.1   3.7 3.5 3.2 
Indiana 3.5 3.1  2.8   3.7 3.5 3.1 
South Carolina 2.8 2.5  2.5   2.7 2.8 2.5 
Michigan 2.0 1.9  1.8   2.3 2.0 1.9 
Ohio 1.8 1.6  1.5   2.0 1.8 1.6 
Connecticut 1.7 1.4  1.3   1.7 1.7 1.4 
Rhode Island 1.3 1.3  1.2   1.4 1.3 1.3 
Delaware 1.2 1.3  1.4   1.1 1.2 1.3 
Wisconsin 1.2 1.1  1.1   1.1 1.2 1.1 
Minnesota 1.0 1.1  1.1  
Massachusetts 1.0 0.2 0.0 
Iowa 1.0 0.8 0.7 
Other states1
 3.1 2.4  2.3   3.1 3.1 2.8 
              
Total  100.0% 100.0  100.0    100.0% 100.0 100.0 
              
1 Other states and districts include, among others, Florida, Iowa, Kentucky, Minnesota, Missouri, Tennessee and Washington D.C.

6

Independent Insurance Agent Distribution Model
According to a study donepublished in 2008 by the Independent Insurance Agents and Brokers of America, in 2005,based on 2006 information, independent insurance agents and brokers wrote approximately 80% of commercial property and casualty insurance and approximately 36%35% of the personal lines insurance business in the United States.U.S. Independent agents are a significant force in overall insurance industry premium production, in large part because they represent more than one insurance company and, therefore, can provide insureds with a wider choice of commercial and personal property and casualty insurance products. As a result, Selective iswe are committed to the independent agency distribution channel and focuses itsfocus our primary strategy on building relationships with well-established, independent insurance agents, including efforts to assist in the hiring and training of producers. In addition, Selectivewe carefully monitorsmonitor each agent’s profitability, growth, financial stability, staff, and mix of business against plans that are developed annually with the agent. In developing annual plans with itsour independent insurance agents, Selective’sour field personnel and management spend considerable time meeting with agencies to: (i) advise them on Companyour developments; (ii) receive feedback on products and services; (iii) help agents increase market share;share through our market planning and leads program; (iv) consolidate more of their business utilizing Selective’sour technology advantages.advantages; and (v) offer them 24 hours a day, seven days a week service capabilities through our customer self-service initiative and our claims service center capabilities.
As of December 31, 2007, Selective’s2008, the Insurance Subsidiaries had entered into agency agreements with approximately 880940 independent insurance agents having approximately 1,800 storefronts pursuant to these agreements.1,850 storefronts. The agents are authorized to sell policies written by the Insurance Subsidiaries and are paid commissions pursuant to calculations and specific percentages stated in the agency agreement. Under the agency agreement, other than as provided by law, agents are not permitted to receive compensation for the business they place with Selectiveus from any insured or applicant for insurance other than Selective.insurance. The agency agreement provides for commissions to be paid based on a percentage of the premium written. SelectiveWe and itsour agents also negotiate other compensation arrangements, including supplemental commissions, based on the volume and underwriting results of the business the agent writes with Selective.us. In addition, each year selected agents are appointed to our President’s Club for their high standards in customer satisfaction, customer retention, sales, and profitability. Our President’s Club agencies receive benefits throughout the year, including access to top business consulting services and participation in company/agency strategic planning sessions, including an annual President’s Club trip.

6

Technology and Field Model Business Strategy
Selective usesWe use the service mark “High Tech“High-Tech x High TouchHigh-Touch = HT2®SM” to describe itsour business strategy for the Insurance Operations. “High Tech”“High-Tech” signifies the advanced technology that Selective useswe use to make it easy for: (i) independent insurance agents to transact and process business with Selective;us; and (ii) customers to access real-time information, manage their accounts and pay their bills through an on-lineonline customer portal that was established in September 2006. “High Touch”“High-Touch” signifies the close relationships that Selective haswe have with itsour independent insurance agents and customers as a result of itsour business model that places underwriters, claims representatives, technical or technology staff, and safety management representatives in the field near its agents and customers.
Technology
Selective seeksWe seek to transact as much of itsour business as possible through the use of technology and, in recent years, haswe have made significant investments in state-of-the-art information technology platforms, integrated systems, Internet-based applications, and predictive modeling initiatives to: (i) provide itsour independent agents and customers with access to accurate business information; (ii) provide an expanded platform through which our agent’s small business can be integrated seamlessly into our systems; (iii) provide our independent agents the ability to process business transactions from their offices and systems; and (iii)(iv) provide underwriters with targeted pricing tools to enhance profitability while growing the business. In 2007,2008, Applied Systems Client Network presented Selectiveus with the “2007“2008 Commercial Lines Interface Carrier of the Year Award” for promoting efficient communication between insurance carriers and independent agents. Applied Systems Client Network is a provider of automated solutions for property and casualty insurance agents. The award was given in recognition of Selective’s excellent work to implementour superior download and real-time interface technology with independent agents through itsour xSELerate® agency integration technology. Selective also received the 2007 Quantum Award from the AMS Users’ Group, another major provider of automated management solutions for agents, for creating technology that enables independent agents to make a quantum leap in productivity and profitability. This award was granted to Selective for increasing productivity and efficiency for its independent insurance agents through its xSELerate® agency integration technology. Additionally, Selective was recognized as a model carrier component by Celent, an IT consulting group, for its effective use of its xSELerate®technology.

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Selective manages its
We manage our information technology projects through a project management office (“PMO”). The PMO is staffed by certified individuals who apply methodologies to: (i) communicate project management standards; (ii) provide project management training and tools; (iii) review project status and cost; and (iv) provide non-technology project management consulting services to the rest of Selective. Selective’sthe organization. Our senior management meets monthly with the PMO to review all major projects and reportreceive reports on the status of other projects. Selective believesWe believe that the PMO is a factor in the success of itsour technology implementation and is a competitive advantage. Selective’sOur technology operations are located in Branchville, New Jersey; Glastonbury, Connecticut; and Sarasota, Florida. We also have an agreement with Satyam Computer Services Ltd. (“Satyam”) to provide supplemental staffing services to our information technology operation. Satyam is a consulting and information technology services company that is based in India. They provide approximately 25% of our total capacity for skilled technology resources, and we retain all management oversight of project and ongoing information technology production operations. We believe we would be able to manage an efficient transition to a new vendor and not experience a significant negative impact to our operations in the event that we no longer retain Satyam in their current capacity due to the financial issues they are currently experiencing.
Field Strategy
To support itsour independent agents, Selective employswe employ a field underwriting model and a field claims model that are supported by the homeCorporate office in Branchville, New Jersey, and sixfive regional branch offices (“Region”Regions”), which as of December 31, 20072008 were as follows:
   
Region Office Location
Great Lakes/Big RiverColumbus, Ohio
Heartland Carmel, Indiana
New Jersey Hamilton, New Jersey
Northeast Branchville, New Jersey
Mid-Atlantic Allentown, Pennsylvania and Hunt Valley, Maryland
Southern Charlotte, North Carolina

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During 2008, our Region structure was realigned from seven Regions to the above five Regions. As a result, we have ceased use of our Columbus, Ohio office.

As of December 31, 2007, Selective’s2008, our field force included:
 • 9897 Commercial Lines field underwriters, known as agency management specialists (“AMSs”). AMSs live and work in the geographic vicinity of Selective’sour appointed agents and generally work from offices in their homes. As a result of this close proximity and direct and regular interaction, AMSs are able to build strong relationships with agents.
 
 • 1114 Personal Lines territory managers (“TMs”) that work with AMSs and independent agents to advance production. Territory managersTMs build strong relationships with agents through direct and regular interaction, which better positions them to evaluate new business opportunities.
 
 • 1412 SRM account managers who, like AMSs, live and work in the geographic vicinity of their coverage territories.
•15 field technology employees. These employees work directly with agents, training and marketing Selective’sour technology systems likesuch as xSELerate® and SelectPLUS®. They also gather feedback from the agents to help improve Selective’sour technology to meet the needs of the agency force.agents’ needs.
 
 • 75 safety management specialists (“SMSs”). SMSs are located in the Regions and are responsible for surveying and assessing insured and prospective risks from a risk/safety standpoint, and for providing ongoing safety management services to certain insureds.
 
 • 149140 field claims adjusters, known as claim management specialists (“CMSs”). Like AMSs, CMSs live in the geographic vicinity of Selective’sour appointed agents and generally work from offices in their homes. CMSs, because of their geographic location, are able to conduct on-site inspections of losses and resolve claims faster, more accurately, and with higher levels of customer satisfaction. As a result, CMSs also obtain knowledge about potential exposures that they can share with AMSs.

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Underwriting
Selective seeksWe seek to underwrite a variety of insurance risks and divides itswe divide our markets into three segments:components:
 • Small business accounts with premiums less than $25,000 represent 52%56% of total direct premium written. During 2007, 30%2008, 33% of new small business was written through Selective’sour Internet-based One & Done® system’s automated underwriting templates;
 
 • Middle market business accounts with premiums greater than $25,000 but less than $250,000 represent 42%39% of total direct premium written. This business which cannot be written through the One & Done® system, is the primary focus of the AMSs; and
 
 • Large business accounts with annual premiums of approximately $250,000 or greater represent 6%5% of Selective’sour total direct premium written and are underwrittensupported by both our regional offices, who underwrite and issue these policies, and a specialized commercial lines unit,management group, Selective Risk Managers (“SRM”)., that is charged with handling account-specific issues, as well as developing strategic plans for enhancing our alternative risk transfer capabilities. Approximately 24% of the22% of the SRM premium includes alternative risk transfer mechanisms such as retrospective rating plans, self-insured group retention programs, or individual self-insured accounts.
Selective’sOur underwriting process requires communication and interaction among:
 • The independent agents and the AMSs, who identify product and market needs;
 
 • Selective’sOur strategic business units (“SBUs”), located in the home office, which are organized by customer and product type, and develop Selective’sour pricing and underwriting guidelines in conjunction with regions;
 
 • The Regions, which work with the SBUs to establish annual premium and pricing goals; and
 
 • The Actuarial Department, located in the home office, which assists in the determination of rate and pricing levels while also monitoring pricing and profitability.
SelectiveWe also hashave an underwriting service center (“USC”) located in Richmond, Virginia. The USC assists Selective’sour agents by servicing small to mid-sized business customers. During 2006, the USC became available to personal lines businessPersonal Lines customers of our New Jersey agents, with a rollout to Selective’sour remaining Personal Lines states during 2007.2008. At the USC, Selectiveour employees, who are licensed agents, respond to customer inquiries about insurance coverage, billing transactions, and other matters. The agent, as consideration for these services, receives a commission that is lower than the standard commission by approximately two points. Selective hasWe have found that the USC also provides additional opportunities to increase direct premiums written, as larger agencies seek insurance companies that have service center capabilities. Currently,As of December 31, 2008, the USC is servicing commercial linesCommercial Lines net premiums written of $70$63 million and personal linesPersonal Lines net premiums written of $33 million. The total $103$96 million serviced represents 7%6% of total net premiums written.NPW.

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Selective believesWe believe that a distinct advantage of itsour field underwriting model is its ability to provide a wide range of front-line safety management services focused on improving the policyholder’s safety and risk management programs, as expressed by its service mark “Safety Management: Solutions for a safer workplaceSM®”. Safety management services include: (i) risk evaluation and improvement surveys intended to evaluate potential exposures and provide solutions for mitigation; (ii) web-based safety management educational resources, including a large library of coverage-specific safety materials, videos and on-line courses, such as defensive driving and employee educational safety courses; (iii) thermographic infrared surveys aimed at identifying electrical hazards; and (iv) OSHA construction and general industry certification training. Risk improvement efforts for existing customers are designed to improve loss experience and policyholder retention through valuable ongoing consultative service. Selective’sOur safety management goal is to partner with itsour policyholders to identify and eliminate potential loss exposures.
Selective analyzes itsWe analyze our Insurance Operations segment’s underwriting profitability by line of business, account, product, agency, and other bases. Selective’sOur goal is to continue to underwrite the risks that it understandswe understand well and that, in aggregate, are profitable.
Field Claims Management
Effective, fair, and timely claims management is one of the most important customer services that Selective provideswe provide and one of the critical factors in achieving underwriting profitability. Selective’sOur claims practices emphasize the maintenance of timely and adequate claims reserves, and the cost-effective delivery of claims services by controlling losses and loss expenses. We have a claims service center (“CSC”), co-located with the USC, in Richmond, Virginia, that receives all first notices of loss from our insureds. The CSC is designed to reduce the loss settlement time on first- and third-party personal automobile claims and on first-party commercial lines automobile claims as well as to increase the usage of our discounts at body shops, glass repair shops, and car rental agencies. The CSC has expanded claim handling capabilities and, if necessary, is responsible for assigning claims to the appropriate Region for involvement by our CMSs, or for referring these claims to the corporate office for specialized handling. All workers compensation claims are directed from the CSC to the workers compensation claims unit of the applicable Region.

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CMSs are primarily responsible for investigating and settling a significant portion of our claims directly with policyholders and claimants. By promptly and personally investigating claims, CMSs are able to provide personal service and quickly resolve claims. CMSs also provide guidance on the handling of the claim until its final disposition. Selective also believesclaims that by visiting the site of the claim, and meeting face-to-face with the insured or claimant, the settlement will be more accurate.are within their jurisdiction to handle. In territories where there is insufficient claim volume to justify the placement of a CMS, or when a particular claim expertise is required, Selective useswe use independent adjusters to investigate and settleresolve claims. In addition, property liability claims that exceed established dollar thresholds are referred by the CMS to our general property adjusters for consultation and all environmental claims are referred by the CMS to our corporate environmental unit that specializes in the handling of these claims.
Selective hasWe have a centralized special investigations unit (“SIU”) that investigates potential insurance fraud and abuse, and supports efforts by regulatory bodies and trade associations to curtail the cost of fraud. The SIU adheres to uniform internal procedures to improve detection and takes action on potentially fraudulent claims. It is Selective’sour practice to notify the proper authorities of its findings. This practice sends a clear message that Selectivewe will not tolerate fraudulent activity committed against itus or itsour customers. The SIU also supervises anti-fraud training for CMSs and other employees, including AMSs.
Selective has a claims service center (“CSC”), co-located with the USC, in Richmond, Virginia. The CSC provides enhanced services to Selective’s policyholders, including immediate claim review, 24 hours a day, seven days a week. The CSC is also designed to reduce the loss settlement time on first-party automobile claims and increase the usage of Selective’s discounts at body shops, glass repair shops, and car rental agencies.
Net Loss and Loss Expense Reserves
Selective establishesWe establish loss and loss expense reserves that are estimates of amounts needed to pay claims and related expenses in the future for insured loss events that have already occurred. The process of estimating reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain. See “Critical Accounting Policies and Estimates” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” inof this Form 10-K for a full discussion regarding Selective’sour loss reserving process.
Selective’sOur loss and loss expense reserve development over the proceeding 10 years is shown on the following table.
Section I of the 10-year table shows the estimated liability that was recorded at the end of each of the indicated years for all current and prior accident year’s unpaid loss and loss expenses. The liability represents the estimated amount of loss and loss expenses for claims that were unpaid at the balance sheet date, including incurred but not reported (“IBNR”) reserves. In accordance with GAAP, the liability for unpaid loss and loss expenses is recorded in the balance sheet gross of the effects of reinsurance, with an estimate of reinsurance recoverables arising from reinsurance contracts reported separately as an asset. The net balance represents the estimated amount of unpaid loss and loss expenses outstanding as of the balance sheet date, reduced by estimates of amounts recoverable under reinsurance contracts.

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Section II of the table shows the re-estimated amount of the previously recorded net liability as of the end of each succeeding year. Estimates of the liability for unpaid loss and loss expenses are increased or decreased as payments are made and more information regarding individual claims and trends, such as overall frequency and severity patterns, becomes known. Section III of the table shows the cumulative amount of net loss and loss expenses paid relating to recorded liabilities as of the end of each succeeding year. Section IV of the table shows the re-estimated gross liability and re-estimated reinsurance recoverables through December 31, 2007.2008. Section V of the table shows the cumulative net (deficiency)/redundancy representing the aggregate change in the liability from the original balance sheet dates and the re-estimated liability through December 31, 2007.2008.

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This table does not present accident or policy year development data. Conditions and trends that have affected development of the reserves in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate redundancies or deficiencies based on this table.
                                                                   
($ in millions) 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007  1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 
I. Gross reserves for unpaid losses and loss expenses at December 31 $1,161.2 1,193.3 1,273.8 1,272.7 1,298.3 1,403.4 1,587.8 1,835.2 2,084.0 2,288.8 2,542.5 
Reinsurance recoverable on unpaid losses and loss expenses at December 31 $(124.2)  (140.5)  (192.0)  (160.9)  (166.5)  (160.4)  (184.6)  (218.8)  (218.2)  (199.7)  (227.8)
I.Gross reserves for unpaid losses and loss expenses at December 31 $1,193.3 1,273.8 1,272.7 1,298.3 1,403.4 1,587.8 1,835.2 2,084.0 2,288.8 2,542.5 2,641.0 
 
Reinsurance recoverables on unpaid losses and loss expenses at December 31 $(140.5)  (192.0)  (160.9)  (166.5)  (160.4)  (184.6)  (218.8)  (218.2)  (199.7)  (227.8)  (224.2)
 
Net reserves for unpaid losses and loss expenses at December 31 $1,037.0 1,052.8 1,081.8 1,111.8 1,131.8 1,243.1 1,403.2 1,616.4 1,865.8 2,089.0 2,314.7  $1,052.8 1,081.8 1,111.8 1,131.8 1,243.1 1,403.2 1,616.4 1,865.8 2,089.0 2,314.7 2,416.8 
  
II. Net Reserves estimated as of:II. Net Reserves estimated as of: II. Net Reserves estimated as of: 
One year later $1,034.5 1,044.2 1,080.7 1,125.5 1,151.7 1,258.1 1,408.1 1,621.5 1,858.5 2,070.2  $1,044.2 1,080.7 1,125.5 1,151.7 1,258.1 1,408.1 1,621.5 1,858.5 2,070.2 2,295.4 
Two years later 1,024.8 1,035.9 1,088.2 1,152.7 1,175.8 1,276.3 1,452.3 1,637.3 1,845.1  1,035.9 1,088.2 1,152.7 1,175.8 1,276.3 1,452.3 1,637.3 1,845.1 2,024.0 
Three years later 1,014.0 1,033.3 1,115.6 1,181.9 1,210.7 1,344.6 1,491.1 1,643.7  1,033.3 1,115.6 1,181.9 1,210.7 1,344.6 1,491.1 1,643.7 1,825.2 
Four years later 998.1 1,040.3 1,134.4 1,220.2 1,290.2 1,371.5 1,522.9  1,040.3 1,134.4 1,220.2 1,290.2 1,371.5 1,522.9 1,649.8 
Five years later 997.9 1,049.9 1,156.0 1,278.3 1,306.8 1,413.8  1,049.9 1,156.0 1,278.3 1,306.8 1,413.8 1,529.2 
Six years later 1,003.6 1,058.6 1,194.6 1,287.5 1,349.6  1,058.6 1,194.6 1,287.5 1,349.6 1,420.8 
Seven years later 1,011.6 1,090.0 1,203.2 1,325.5  1,090.0 1,203.2 1,325.5 1,357.6 
Eight years later 1,038.0 1,101.1 1,238.2  1,101.1 1,238.2 1,332.8 
Nine years later 1,045.2 1,135.4  1,135.4 1,243.5 
Ten years later  1,078.3  1,137.8 
Cumulative net redundancy (deficiency) $(41.3)  (82.6)  (156.5)  (213.7)  (217.8)  (170.8)  (119.7)  (27.3) 20.7 18.8  $(85.0)  (161.7)  (221.0)  (225.8)  (177.7)  (126.0)  (33.4) 40.6 65.0 19.3 
                                          
  
III. Cumulative amount of net reserves paid through:III. Cumulative amount of net reserves paid through: III. Cumulative amount of net reserves
paid through:		 
One year later $313.7 328.1 348.2 399.2 377.1 384.0 414.5 422.4 468.6 469.4  $328.1 348.2 399.2 377.1 384.0 414.5 422.4 468.6 469.4 579.4 
Two years later 531.1 537.5 600.3 649.1 627.3 653.3 691.4 729.5 775.0  537.5 600.3 649.1 627.3 653.3 691.4 729.5 775.0 841.3 
Three years later 665.5 703.8 767.5 815.3 807.2 836.3 903.7 942.4  703.8 767.5 815.3 807.2 836.3 903.7 942.4 1,026.9 
Four years later 760.8 797.1 870.8 930.9 926.9 966.2 1,033.5  797.1 870.8 930.9 926.9 966.2 1,033.5 1,101.0 
Five years later 812.2 856.1 933.6 1,002.4 1,003.3 1,044.6  856.1 933.6 1,002.4 1,003.3 1,044.6 1,128.4 
Six years later 849.7 892.2 974.6 1,046.3 1,053.8  892.2 974.6 1,046.3 1,053.8 1,110.0 
Seven years later 875.9 919.2 1,001.1 1,081.7  919.2 1,001.1 1,081.7 1,100.3 
Eight years later 894.7 937.1 1,029.0  937.1 1,029.0 1,115.9 
Nine years later 908.5 956.7  956.7 1,055.2 
Ten years later 922.5  979.2 
  
IV. Re-estimated gross liability $1,338.6 1,399.8 1,519.0 1,574.5 1,613.2 1,654.3 1,782.6 1,912.0 2,121.8 2,303.1  $1,405.2 1,526.1 1,583.0 1,620.5 1,658.1 1,783.6 1,913.1 2,099.3 2,256.5 2,528.8 
Re-estimated reinsurance recoverable $(260.3)  (264.4)  (280.8)  (249.0)  (263.6)  (240.4)  (259.6)  (268.3)  (276.7)  (232.9) 
 
Re-estimated reinsurance recoverables $(267.4)  (282.6)  (250.2)  (262.9)  (237.3)  (254.4)  (263.3)  (274.1)  (232.5)  (233.3) 
                     
                      
Re-estimated net liability $1,078.3 1,135.4 1,238.2 1,325.5 1,349.6 1,413.8 1,522.9 1,643.7 1,845.1 2070.2  $1,137.8 1,243.5 1,332.8 1,357.6 1,420.8 1,529.2 1,649.8 1,825.2 2,024.0 2,295.4 
                                          
V. Cumulative gross deficiency $(177.4)  (206.5)  (245.2)  (301.8)  (314.8)  (250.8)  (194.8)  (76.8)  (37.8)  (14.4) 
V. Cumulative gross redundancy (deficiency) $(211.9)  (252.3)  (310.4)  (322.2)  (254.7)  (195.8)  (77.9)  (15.3) 32.3 13.8 
                                          
Cumulative net redundancy (deficiency) $(41.3)  (82.6)  (156.5)  (213.7)  (217.8)  (170.8)  (119.7)  (27.3) 20.7 18.8  $(85.0)  (161.7)  (221.0)  (225.8)  (177.7)  (126.0)  (33.4) 40.6 65.0 19.3 
                                          
Note: Some amounts may not foot due to rounding.

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SelectiveWe experienced favorable prior year development in 2008, 2007, and 2006 of $19.3 million, $18.8 million and $7.3 million, respectively. In 2005, prior year adverse development was $5.1 million. The following paragraphs provide information regarding the overall favorable development in each of these calendercalendar years.

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Selective
We experienced overall favorable development in itsour loss and loss expense reserves totaling $19.3 million in 2008, which was primarily driven as follows:
•The workers compensation line of business experienced favorable prior year loss and loss expense reserve development of approximately $24 million, which was primarily driven by favorable development in accident years 2004 to 2006 as a result of the implementation of our multi-faceted underwriting strategy, higher budgeted medical trends, and the redesign and re-contracting of our managed care process, partially offset by adverse prior year development in accident year 2007 from higher severity.
•The general liability line of business experienced adverse prior year loss and loss expense reserve development of approximately $3 million reflecting normal volatility in this line of business.
•The remaining lines of business, which collectively contributed approximately $2 million of adverse development, do not individually reflect any significant trends related to prior year development.
We experienced overall favorable development in our loss and loss expense reserves totaling $18.8 million in 2007, which was primarily driven as follows:
 • The commercial automobile line of business experienced favorable prior year loss and loss expense reserve development of approximately $19 million, which was primarily driven by lower than expected severity in accident years 2004 through 2006.
 
 • The personal automobile line of business experienced favorable prior year development of approximately $10 million, due to lower than expected loss emergence for accident years 2005 and prior based on a revaluation of the impact of an adverse judicial ruling by the New Jersey Supreme Court to eliminate the application of the serious life impact standard to personal automobile cases under the verbal tort threshold of New Jersey’s Automobile Insurance Cost Reduction Act in 2005. This was partially offset by higher severity in accident year 2006.
 
 • The workers compensation line of business experienced favorable prior year development of approximately $4 million reflecting the implementation of a series of improvement strategies for this line in recent accident years partially offset by an increase in the tail factor related to medical inflation and general development trends.
 
 • The homeowners line of business experienced adverse prior year loss and loss expense reserve development of approximately $6 million driven by unfavorable trends in claims for groundwater contamination caused by the leakage of certain underground oil storage tanks.
 
 • The personal umbrellaexcess line of business experienced adverse prior year loss and loss expense reserve development of approximately $4 million in 2007, which was due to the impact of several significant losses on this small line.
 
 • The remaining lines of business, which collectively contributed approximately $4 million of adverse development, do not individually reflect any significant trends related to prior year development.
Selective’s 2006We experienced overall favorable development in our loss and loss expense reserve developmentreserves totaling $7.3 million in 2006, which was driven by the following:
 • The commercial automobile line of business experienced favorable prior year loss and loss expense reserve development of approximately $15 million, which was primarily driven by lower than expected severity in accident years 2004 and 2005.
 
 • The workers compensation line of business experienced favorable prior year development of approximately $4 million, which was driven, in part, by savings realized from changing medical and pharmacy networks outside New Jersey and re-contracting our medical bill review services.
 
 • The personal automobile line of business experienced favorable prior year development of approximately $9 million, due to lower than expected frequency.
 
 • The general liability line of business experienced adverse prior year loss and loss expense reserve development of approximately $15 million in 2006, which was largely driven by our contractor completed operations business and an increase in reserves for legal expenses.
 
 • The remaining lines of business, which collectively contributed approximately $6 million of adverse development, do not individually reflect significant prior year development.
During the course of 2005, Selective had analyzed certain negative trends in the workers compensation line of business and certain positive trends in the commercial automobile line of business. In the fourth quarter of 2005, Selective had accumulated sufficient evidence to change management’s best estimate of loss reserves for these lines. Accordingly, Selective took the following actions:
•Workers compensation reserves were increased by approximately $42 million to reflect rising medical cost trends that impacted accident years 2001 and prior.
•Commercial automobile reserves were decreased by approximately $48 million, primarily due to ongoing favorable severity trends in the 2002 through 2004 accident years.
•The general liability reserves adversely developed by approximately $14 million over the course of the year, which was driven mainly by our contractor completed operations business impacting accident years 2001 and prior, but partially offset by positive development in accident years 2002 through 2004.
The adverse judicial ruling by the New Jersey Supreme Court in the second quarter of 2005 that eliminated the application of the serious life impact standard to personal automobile bodily injury liability cases under the verbal tort threshold of the New Jersey Automobile Insurance Cost Reduction Act (“AICRA”) led to an increase in personal automobile reserves of approximately $10 million, of which $6 million represents adverse development from prior years.

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Thesignificant cumulative loss and loss expense reserve net deficiencies seen in the yearsbetween 1998 throughand 2003 are generally reflective of the soft market pricing in the industry during that time frame, which hit the lowest levels in 1999. The property and casualty insurance industry, as a whole, underestimated reserves and loss trends leading to intense pricing competition. Additionally, during 1999, Selectivewe significantly increased gross and ceded reserves by $37.5 million for prior accident years related to unlimited medical claims under personal injury protection provisions of personal automobile policies ceded to the Unsatisfied Claim and Judgment Fund in the State of New Jersey. Approximately 18% of the cumulative gross deficiency for years 1998 and prior stems from this increase.

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The following table reconciles losses and loss expense reserves under SAP and GAAP at December 31, as follows:
         
(in thousands) 2007  2006 
Statutory losses and loss expense reserves(1)
 $2,312,086    2,084,012  
Provision for uncollectible reinsurance  2,750    2,700  
Pension adjustment  72    2,619  
Other  (162)  (299)
       
         
GAAP losses and loss expense reserve – net  2,314,746    2,089,032  
Reinsurance recoverable on unpaid losses and loss expenses  227,801    199,738  
       
GAAP losses and loss expense reserves – gross $2,542,547    2,288,770  
         
($ in thousands) 2008  2007 
Statutory losses and loss expense reserves1
 $2,414,743   2,312,086 
Provision for uncollectible reinsurance  2,470   2,750 
Other  (432)  (90)
       
GAAP losses and loss expense reserves — net  2,416,781   2,314,746 
Reinsurance recoverables on unpaid losses and loss expenses  224,192   227,801 
       
GAAP losses and loss expense reserves — gross $2,640,973   2,542,547 
       
(1)1 Statutory losses and loss expense reserves are presented net of reinsurance recoverablerecoverables on unpaid losses and loss expenses.
Environmental Reserves
Reserves established for liability insurance include exposure to environmental claims, both asbestos and non-asbestos. Selective’s exposure to environmental liability is primarily due to: (i) policies written prior to the introduction of the absolute pollutions endorsement in the mid-1980’s; and (ii) underground storage tank leaks, mostly from New Jersey homeowners policies in recent years. Selective’sOur asbestos and non-asbestos environmental claims have arisen primarily from insured exposures in municipal government, small non-manufacturing commercial risks, and homeowners policies. The emergence of these claims is slow and highly unpredictable.
“Asbestos claims” are claims presented to Selectiveus in which bodily injury is alleged to have occurred as a result of exposure to asbestos and/or asbestos-containing products. In the past, we had been the insurer of various distributors of asbestos and/or asbestos-containing products but not manufacturers of such products. During the past two decades, the insurance industry has experienced the emergence and development of an increasing number of asbestos claims. At December 31, 2007,2008, asbestos claims constituted 89%86% of Selective’s 2,448our 2,362 environmental claims compared with 88%89% of Selective’s 2,575our 2,448 outstanding environmental claims at December 31, 2006.2007.
“Non-asbestos claims” are pollution and environmental claims alleging bodily injury or property damage presented, or expected to be presented to Selective,us, other than asbestos claims. These claims primarily include landfills and leaking underground storage tanks. In past years, landfill claims have accounted for a significant portion of Selective’sour environmental claim unit’s litigation costs. Over the past few years, Selective haswe have been experiencing adverse development in itsour homeowners line of business as a result of unfavorable trends in claims for groundwater contamination caused by leakage of certain underground heating oil storage tanks in New Jersey.
Selective refersWe refer all environmental claims to itsour centralized and specialized environmental claim unit. Environmental reserves are evaluated on a case-by-case basis. As cases progress, the ability to assess potential liability often improves. Reserves are then adjusted accordingly. In addition, each case is reviewed in light of other factors affecting liability, including judicial interpretation of coverage issues.
IBNR reserve estimation for environmental claims is difficult because, in addition to other factors, there are significant uncertainties associated with critical assumptions in the estimation process, such as average clean-up costs, third-party costs, potentially responsible party shares, allocation of damages, insurer litigation costs, insurer coverage defenses and potential changes to state and federal statutes. Moreover, normal historically-basedhistorically based actuarial approaches are difficult to apply because past environmental claims are not indicative of future potential environmental claims. In addition, while models can be applied, such models can produce significantly different results with small changes in assumptions. As a result, management doeswe do not calculate a specific environmental loss range. Historically, Selective’sour environmental claims have been significantly less volatile and uncertain than other competitors in the commercial lines industry. In part, this is due to the fact that Selective iswe are the primary insurance carrier on the majority of itsour environmental exposures, thus providing more certainty in itsour reserve position compared to the insurance marketplace.

 

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Reinsurance
In the ordinary course of their business, the Insurance Subsidiaries reinsure a portion of the risks that they underwrite in order to control exposure to losses and protect capital resources. Reinsurance also permits the Insurance Subsidiaries additional underwriting capacity by permitting them to accept larger risks and underwrite a greater number of risks without a corresponding increase in capital or surplus. For a premium paid by the Insurance Subsidiaries, reinsurers assume a portion of the losses ceded by the Insurance Subsidiaries. Selective usesWe use traditional forms of reinsurance and doesdo not use finite risk reinsurance. Amounts not reinsured are known as retention. The Insurance Subsidiaries use two types of reinsurancethe following to control exposure to losses:
 • Treaty reinsurance, in which certain types of policies are automatically reinsured without the need for approval by the reinsurer of the individual risks covered; and
 
 • Facultative reinsurance, in which an individual insurance policy or a specific risk is reinsured with the prior approval of the reinsurer. Facultative reinsurance is primarily used for policies with limits greater than the limits available under the reinsurance treaties.treaties; and
In addition to treaty and facultative reinsurance, the Insurance Subsidiaries are partially protected by the Terrorism Risk Insurance Act of 2002, which was modified and extended through December 31, 2014 via the Terrorism Risk Insurance Program Reauthorization Act of 2007. For further information regarding this legislation,•Protection provided under the Terrorism Risk Insurance Act of 2002, which was modified and extended through December 31, 2014 via the Terrorism Risk Insurance Program Reauthorization Act of 2007 (collectively referred to as “TRIA”). For further information regarding TRIA, see Item 1A. “Risk Factors” of this Form 10-K.
In addition, we are a servicing carrier in the “Write-Your-Own” (“WYO”) Program of the U.S. government’s National Flood Insurance Program (“NFIP”). This program allows participating property and casualty insurance companies to write and service the Standard Flood Insurance Policy in their own names for agreed upon fees, while ceding all of the premiums collected and losses incurred on these policies to the federal government.
Reinsurance does not legally discharge an insurer from its liability for the full-face amount of its policies, but it does make the reinsurer liable to the insurer to the extent of the reinsurance ceded. Reinsurance carries counterparty credit risk, which may be mitigated in certain cases by collateral such as letters of credit, trust funds, or funds withheld by the Insurance Subsidiaries. Selective attemptsWe attempt to mitigate the credit risk related to reinsurance by pursuing relationships with companies rated “A-” or higher in most circumstances and/or requiring collateral to secure reinsurance obligations. In addition, Selective employswe employ procedures to continuously review the quality of reinsurance recoverables and reserve for uncollectible reinsurance. SelectiveWe also may take actions, such as commutations, in cases of potential reinsurer default. Some of the Insurance Subsidiaries’ reinsurance contracts include provisions that give Selectiveus a contractual right to terminate and/or commute the reinsurers’ portion of the liabilities based on deterioration of the reinsurer’s rating or financial condition.
Reinsurance recoverable balances tend to fluctuate based on the underlying losses incurred by the Insurance Subsidiaries. If a severe catastrophic event occurs, reinsurance recoverable balances may increase significantly. The following table presents information regarding our reinsurance recoverable balancesrecoverables, including specific data on paid and unpaid claims were 22% of stockholders equity at December 31, 2007 compared to 19% at December 31, 2006. These balances, net of available collateral, were 18% of stockholders equity at December 31, 2007 compared to 15% at December 31, 2006. Federal or state sponsored pools, which Selective believes to have minimal default risk, represented approximately 44% at December 31, 2007 and 50% at December 31, 2006 of the uncollateralized reinsurance recoverable on paid and unpaid balance. The following are the fivethree largest individual uncollateralized reinsurance recoverables on paidbalances, excluding the two uncollateralized federal and unpaid balances:state pools also shown below:
                   
  As of: 12/31/07  As of: 12/31/06 
    Unsecured      Unsecured    
($ in thousands) Ratings: Recoverable on  % of  Recoverable on    
Reinsurer Name A.M. Best Paidand Unpaid  Total  Paid and Unpaid  % of Total 
                   
NJ Unsatisfied Claim Judgement Fund State pool $64,498   34% $65,624   39%
 
Munich Reinsurance America, Inc. “A+”  34,620   18%  30,776   18%
 
Hannover Ruckversicherungs AG “A”  18,014   9%  12,161   7%
 
Swiss Re America Corp. “A+”  14,434   8%  10,740   6%
 
National Flood Insurance Program Federal program  12,583   7%  14,823   9%
 
All Other Reinsurers  various  46,686   24%  32,346   21%
 
Total   $190,835      $166,470     
 
% of Shareholders Equity    18%      15%    
 
                 
  As of: 12/31/08  As of: 12/31/07 
  Recoverables  % of  Recoverables  % of 
  on Paid and  Stockholders’  on Paid and  Stockholders’ 
($ in thousands) Unpaid  Equity  Unpaid  Equity 
                 
Total Reinsurance Recoverables $230,705   26% $235,230   22%
Collateral1
  51,790   6%  44,233   4%
             
Net Unsecured Reinsurance Recoverables  178,915   20%  190,997   18%
                 
Federal and State Pools2:
                
NJ Unsatisfied Claim Judgment Fund  60,716   7%  64,498   6%
National Flood Insurance Program  23,291   3%  12,583   1%
Other  5,994   1%  6,154   1%
             
Total Federal and State Pools  90,001   10%  83,235   8%
             
                 
Remaining Unsecured Reinsurance Recoverables $88,914   10% $107,762   10%
             
                 
Munich Re Group (A.M. Best Rated “A+”) $21,354   2% $34,620   3%
Hannover Ruckversicherungs AG (A.M. Best Rated “A”)  17,347   2%  18,014   2%
Swiss Re Group. (A.M. Best Rated “A+”)  17,572   2%  14,434   1%
All Other Reinsurers  32,641   4%  40,694   4%
             
Total $88,914   10% $107,762   10%
             
1Includes letters of credit, trust funds, and funds withheld.
2Considered to have minimal risk of default.
Note:Some amounts may not foot due to rounding.

 

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We continually monitor the financial condition of our reinsurers and any potential impact on the recoverability of paid and unpaid claims from such reinsurers. For information surrounding our relationships with specific reinsurers, see the “Reinsurance” section of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” of this Form 10-K.
The table below summarizes the significant reinsurance treaties covering the Insurance Subsidiaries.
     
Treaty Reinsurance Coverage Terrorism Coverage
TRIA, Federal Statutory
Program		 See aboveItem 1A. “Risk Factors” of this Form 10-K for the description of TRIA. 85% of all TRIA certified losses above the retention. Selective’sOur retention for 20082009 is approximately $203$201 million. Current program covers both domestic and foreign terrorism. Terrorism acts related to the use of nuclear, biological, chemical or radioactive (“NBCR”) weapons are covered by TRIA provided that the Secretary of the Treasury certifies the event. Current program is set to expire on December 31, 2014. For further information regarding this legislationTRIA and our risks concerning terrorism exposure, see Item 1A. “Risk Factors” of this Form 10-K.
     
Property Excess of Loss $2328 million above a $2 million retention in two layers. Losses other than TRIA certified losses are subject to the following reinstatements and annual aggregate limits:

•     $8 million in excess of $2 million layer provides unlimited reinstatements, no annual aggregate limit; and

•     $15$20 million in excess of $10 million layer provides two reinstatements, $45 million in annual aggregate.three reinstatements.
 All NBCR losses are excluded regardless of whether or not they are certified under TRIA. For non-NBCR losses, the treaty distinguishes between acts certified under TRIA and those that are not.
The treaty provides annual aggregate limits for TRIA certified (other than NBCR) acts of $24 million for the first layer and $22.5$40 million for the second layer. Non-certified terrorism losses (other than NBCR) are subject to the normal limits under the treaty.
     
Property Catastrophe Excess of Loss 95% of $310 million above $40 million retention in three layers:

•     95% of losses in excess of $40 million up to $100 million;

•     95% of losses in excess of $100 million up to $200 million; and

•     95% of losses in excess of $200 million up to $350 million; andmillion.

The treaty provides one reinstatement per layer, $589.0 million in annual aggregate limit, net of Selective’sthe Insurance Subsidiaries’ co-participation.		 All nuclear, biological and chemical (NBC) losses are excluded regardless of whether or not they are certified under TRIA. TRIA losses related to foreign acts of terrorism are excluded from the treaty. Domestic terrorism is included regardless of whether it is certified under TRIA or not. Please see Item 1A. “Risk Factors” of this Form 10-K for further discussion regarding changes in TRIA.
     
Casualty Excess of Loss Casualty ExcessThe 1st layer of Loss program is structured in two treaties: Workers compensation only working layer treaty and all inclusive Casualty treaty, which provides coverage for all casualty lines including Workers compensation. Workers compensation losses have per occurrence coverage of $48$3 million in excess of $2 million retentionis covered at 65%. The 2nd through 5th layers are covered at 100% and additionalthe 6th layer of $40 million in excess of $50 million is covered at 75%. Losses other than terrorism losses are subject to the following reinstatements and annual aggregate limits:

•     65% of $3 million in excess of $2 million layer provides up to $2.0 million of per occurrence coverage net of co-participation with 22 reinstatements, $45 million net annual aggregate limit;

•     $7 million in excess of $5 million layer provides three reinstatements, $28 million annual aggregate limit;

•     $9 million in excess of $12 million layer provides two reinstatements, $27 million annual aggregate limit;

•     $9 million in excess of $21 million layer provides one reinstatement, $18 million annual aggregate limit;

•     $20 million in excess of $30 million layer provides one reinstatement, $40 million annual aggregate limit; and

•     75% of $40 million in excess of $50 million. All other casualty losses havemillion layer provides up to $30 million of per occurrence coverage net of co-participation with one reinstatement, $60 million in net annual aggregate limit.
 All NBCNBCR losses are excluded. All other losses stemming from the acts of terrorism are subject to the following reinstatements and annual aggregate limits:

Workers compensation only working layer
•     65% of $3 million in excess of $2 million layer provides two reinstatements for terrorism losses, $9 million annual aggregate limit;

Casualty treaty:
coverage of $45 million in excess of $5 million retention and additional coverage of 75% of $40 million in excess of $50 million. Losses other than TRIA certified losses are subject to the following reinstatements and annual aggregate limits:

Workers compensation only working layer of $3 million in excess of $2 million layer provides five reinstatements, $18 million annual aggregate limit;

Casualty treaty:
•    $7 million in excess of $5 million layer provides three reinstatements, $28 million annual aggregate limit;
•    $9 million in excess of $12 million layer provides two reinstatements, $27 million annual aggregate limit;
•    $9 million in excess of $21 million layer provides one reinstatement, $18 million annual aggregate limit; and
•    $20 million in excess of $30 million layer provides one reinstatement, $40 million annual aggregate limit.
•    75% of $40 million in excess of $50 million layer provides up to $30$2.0 million of per occurrence coverage net of co-participation with one reinstatement, $60four reinstatements for terrorism losses, $10 million in net annual aggregate limit.limit;

•     $7 million in excess of $5 million layer provides two reinstatements for terrorism losses, $21 million annual aggregate limit;

•     $9 million in excess of $12 million layer provides two reinstatements for terrorism losses, $27 million annual aggregate limit;

•     $9 million in excess of $21 million layer provides one reinstatement for terrorism losses, $18 million annual aggregate limit;

•     $20 million in excess of $30 million layer provides one reinstatement for terrorism losses, $40 million annual aggregate limit; and

•     75% of $40 million in excess of $50 million layer provides up to $30 million of per occurrence coverage net of co-participation with one reinstatement for terrorism losses, $60 million in net annual aggregate limit; andlimit.
National Workers Compensation Reinsurance Pool (“NWCRP”)100% quota share up to a maximum ceded combined ratio cap of 152%. Provides up to 5 points in pool participant insolvency assessment protection.Provides full terrorism coverage including NBCR.
     
Flood 100% reinsurance by the federal government’s National Flood Insurance Program Write Your Own program.WYO Program. None.
None

 

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Reinsurance Pooling Agreement
The Insurance Subsidiaries are parties to an inter-company reinsurance pooling agreement (“Pooling Agreement”). The purpose of the Pooling Agreement is to:
 • Pool or share proportionately the underwriting profit and loss results of property and casualty underwriting operations through reinsurance;
 
 • Prevent any Insurance Subsidiary from suffering undue loss;
 
 • Reduce administration expenses; and
 
 • Permit all of the Insurance Subsidiaries to obtain a uniform rating from A.M. Best.
Under the Pooling Agreement, all of the Insurance Subsidiaries mutually reinsure all insurance risks written by them pursuant to the respective percentage set forth opposite each Insurance Subsidiary’s name on the table below:
     
Insurance Subsidiary Respective Percentage 
SICA  49.5%
SWIC  21.0%
SICSC  9.0%
SICSE  7.0%
SICNY  7.0%
SAICNJ  6.0%
SICNE  0.5%
Insurance Regulation
General
Insurance companies are subject to supervision and regulation in the states in which they are domiciled and transact business. Such supervision and regulation relates to a variety of aspects of an insurance company’s business and financial condition. The primary public purpose of such supervision and regulation is to protect the insurer’s policyholders, not the insurer’s shareholders. The extent of regulation varies and generally is derived from state statutes that delegate regulatory, supervisory, and administrative authority to state insurance departments. Although the insurance industry is primarily regulated by individual states, federal initiatives can have an impact on the industry, such as the federal government’s enactment and extension of TRIA, the enforcement of economic and trade sanctions by the Office of Foreign Assets Control, and the proposal for an optional federal charter that would allow companies to choose between state regulation and national regulatory structure that would eliminate the need to comply with 51 sets of different regulations.
The Financial Services Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act (“GLB”), and related regulations govern, among other things, the privacy of consumer financial information. GLB limits disclosure by financial institutions of “nonpublic personal information” about individuals who obtain financial products or services for personal, family, or household purposes. GLB generally applies to disclosures to non-affiliated third parties, but not to disclosures to affiliates. Many states in which Selective operateswe operate have adopted laws that are at least as restrictive as GLB. Privacy of consumer financial information is an evolving area of regulation requiring continued monitoring to ensure continued compliance with GLB.
SelectiveWe cannot quantify the financial impact itwe would incur to satisfy revised or additional regulatory requirements that may be imposed in the future.
State Regulation
The regulatory authority of state insurance departments extends to such matters as insurer solvency standards, insurer and agent licensing, investment restrictions, payment of dividends and distributions, provisions for current losses and future liabilities, deposit of securities for the benefit of policyholders, restrictions on policy terminations, unfair trade practices, and approval of premium rates and policy forms. State insurance departments also conduct periodic examinations of the financial and business affairs of insurers and require insurers to file annual and other periodic reports relating to their financial condition. Regulatory agencies require that premium rates not be excessive, inadequate, or unfairly discriminatory. The Insurance Subsidiaries, consequently, must file all rates for commercial and personal insurance with the insurance department of each state in which they operate.

 

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All states have enacted legislation that regulates insurance holding company systems. Each insurance company in a holding company system is required to register with certain insurance supervisory agencies and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management, or financial condition of the insurers. Pursuant to these laws, the respective departments may: (i) examine Selectiveus and the Insurance Subsidiaries at any time; (ii) require disclosure or prior approval of material transactions of the Insurance Subsidiaries with any affiliate; and (iii) require prior approval or notice of certain transactions, such as dividends or distributions to Selective Insurance Group, Inc. (the “Parent”)the Parent from the Insurance Subsidiary domiciled in that state.
National Association of Insurance Commissioners (“NAIC”) Guidelines
The Insurance Subsidiaries are subject to statutory accounting principles and reporting formats established by the NAIC. The NAIC also promulgates model insurance laws and regulations relating to the financial and operational regulations of insurance companies, which includes the Insurance Regulatory Information System (“IRIS”). IRIS identifies 11 industry ratios and specifies “usual values” for each ratio. Departure from the usual values on four or more of the ratios can lead to inquiries from individual state insurance departments about certain aspects of the insurer’s business. The Insurance Subsidiaries have consistently met the majority of the IRIS ratio tests.
NAIC model laws and regulations are not usually applicable unless enacted into law or promulgated into regulation by the individual states. The adoption of certain NAIC model laws and regulations is a key aspect of the NAIC Financial Regulations Standards and Accreditation Program, which also sets forth minimum staffing and resource levels for all state insurance departments. All of the Insurance SubsidiariesSubsidiaries’ states of domicile, except New York, are accredited by the NAIC. Examinations conducted by, or along with, accredited states can be accepted by other states. The NAIC intends to create a nationwide regulatory network of accredited states.
The NAIC model laws and regulations are also intended to enhance the regulation of insurer solvency. These model laws and regulations contain certain risk-based capital requirements for property and casualty insurance companies designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. Risk-based capital is measured by the four major areas of risk to which property and casualty insurers are exposed: (i) asset risk; (ii) credit risk; (iii) underwriting risk; and (iv) off-balance sheet risk. Insurers with total adjusted capital that is less than two times their “Authorized Control Level,” as calculated pursuant to the NAIC model laws and regulations, are subject to different levels of regulatory intervention and action. Based upon the unaudited 20072008 statutory financial statements for the Insurance Subsidiaries, each Insurance Subsidiary’s total adjusted capital substantially exceeded two times their Authorized Control Level.
Investments Segment
Selective’sOur Investments segment operations are based primarily in Parsippany, New Jersey, while certain segments of the portfolio are managed by external investment portfolio managers. Like many other property and casualty insurance companies, we depend on income from our investment portfolio for a significant portion of our revenues and earnings. We are exposed to significant financial and capital markets risks, primarily relating to interest rates, credit spreads, equity price risks and the change in market value of our alternative investment portfolio. A decline in both income and our investment portfolio asset values could occur as a result of, among other things, a decrease in market liquidity, falling interest rates, decreased dividend payment rates, negative market perception of credit risk with respect to types of securities in our portfolio, a decline in the performance of the underlying collateral of our structured securities, reduced returns on our other investments, including our portfolio of alternative investments, or general market conditions.
Our investment philosophy includes setting certain return and risk objectives for itsour equity and fixed maturity portfolios. The return objective of theour equity portfolio is to meet or exceed a weighted-average benchmark of public equity indices. The primary return objective of theour fixed maturity portfolio is to maximize after-tax investment yield and income while balancing certain risk objectives.objectives with a secondary objective of meeting or exceeding a weighted-average benchmark of public fixed income indices. The risk objectives for allour portfolios are structured conservatively, focusingfocused on: (i) asset diversification; (ii) investment quality; (iii) liquidity, particularly to meet the cash obligations of the insurance operations;Insurance Operations; (iv) consideration of taxes; and (v) preservation of capital. 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 a “buy-and-hold” principle. Tactically, we also plan to further increase our portfolio allocation to Government and Agency holdings in the near-term in an effort to increase liquidity and capital preservation. At December 31, 2007, Selective’s2008, our investment portfolio consisted of $3,079.3$3,035.4 million (83%(86%) of fixed maturity securities, $274.7$134.7 million (7%(4%) of equity securities, $190.2$198.1 million (5%) of short-term investments, and $188.8$172.1 million (5%) of other investments.

17

Selective’s
While we have remained focused on our stated objectives, recently the fixed-income markets have been experiencing a period of extreme volatility, which has negatively impacted market liquidity conditions and increased the risk that issuers, or guarantors, of fixed maturity securities could default on principal and interest payments. Initially, the effects were focused on the subprime segment of the mortgage-backed securities market. However, this volatility has since spread, negatively impacting: (i) a broad range of mortgage-and asset-backed and other fixed income securities, including those rated investment grade; (ii) the U.S. and international credit and interbank money markets generally; and (iii) a wide range of financial institutions and markets, asset classes, and sectors. As a result, the market for fixed income securities has experienced decreased liquidity, increased price volatility, credit downgrade events, and increased probability of default. Securities that are less liquid are more difficult to value and may be hard to sell. As a result, investment quality has become increasingly more important given the extreme volatility in the fixed-income markets. Our fixed maturity portfolio is comprised primarily of highly rated securities, with almost 100% rated investment grade. The average rating of itsour fixed maturity securities is “AA+” by Standard & Poor’s Insurance Rating Services (“S&P”), their second highest credit quality rating. Selective expectsWe expect to continue to invest primarily in high quality, fixed maturity investments in order to reduce volatility of the portfolio and to maximize after-tax investment yield. However, the continuing market disruption has, in the short-term, kept us more focused on liquidity and capital preservation, at the expense of additional yield. The average duration of our fixed maturity portfolio, including short-term investments, was 3.5 years at December 31, 2008 and 3.9 years at December 31, 2007.
Domestic and international equity markets have also experienced heightened volatility and turmoil, with issuers (such as our company) exposed to the mortgage securities and credit markets particularly affected. As a result, we also took steps to limit our overall portfolio volatility by reducing our equity position by approximately $50 million. As noted above, our equity portfolio now represents only 4% of our total portfolio, which is down from 7% a year ago.
Additionally, our other investments include alternative investments in private limited partnerships that invest in various strategies such as private equity, mezzanine debt, distressed debt, and real estate. Our other investment strategy has historically provided additional yield with equity-like returns that were not significantly correlated to the S&P 500 index. The general volatility in the capital markets, the dislocation of the credit markets, and reduced values of financial assets globally has resulted in a negative return for this asset class during 2008; however, its total return outperformed the S&P 500 index by 2,700 basis points. As of December 31, 2008, these types of investments represented 5% of our total invested assets, which was consistent with prior year. Although our other investment asset class adds some earnings volatility, their continued outperformance of the S&P 500 index is expected to build more value for our shareholders over the long-term.
For further information regarding Selective’s interest rate sensitivity as well as otherour risks associated with itsthe overall investment portfolio, see Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” inand Item 1A. “Risk Factors” of this Form 10-K. The average duration of the fixed maturity portfolio, including short-term investments of $190.2 million at December 31, 2007 and $197.0 million at December 31, 2006, was 3.9 years at December 31, 2007 and 3.8 years at December 31, 2006.
Selective’s Investments segment operations are based primarily in Parsippany, New Jersey, while certain segments of the portfolio are managed by external money managers. For additional information about investments, see the sectionssection entitled, “Investments,” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8. “Financial Statements and Supplementary Data,” Note 4 to the consolidated financial statements.of this Form 10-K.

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Diversified Insurance Services Segment
Selective’sOur Diversified Insurance Services segment provides fee-based revenues that are expected to contribute to earnings, increase operating cash flow, and help mitigate potential volatility in insurance operating results. The Diversified Insurance Services segment is complementary to Selective’sour business model by sharing a common marketing or distribution system and creating new opportunities for independent agents to bring value-added services and products to their customers. In December 2005, Selective divested itself of its 100% ownership interest in CHN Solutions (Alta Services, LLC and Consumer Health Network Plus, LLC), which had historically been reported as part of the “Managed Care” component of the Diversified Insurance Services segment. For more information concerning the results of the Diversified Insurance Services segment for the last three fiscal years ended December 31, refer to Note 15, “Discontinued Operations” in Item 8. “Financial Statements and Supplementary Data” on this Form 10-K. The Diversified Insurance Services operation currently has two major components: (i) human resource administration outsourcing;HR Outsourcing; and (ii) flood insurance.Flood.
Human Resource AdministrationHR Outsourcing and Related Regulation
Human resource administration outsourcing (“HR Outsourcing”)Outsourcing products and services are sold by Selective HR Solutions, Inc. and its subsidiaries (“Selective HR”), which are headquartered in Sarasota, Florida. Selective HR’s customers are small businesses who generally have existing relationships with our independent insurance agents. Selective HR leverages these relationships by using independent insurance agents as its distribution channel for its products and services in the states where it operates. As a Professional Employer Organization (“PEO”), Selective HR enters into agreements with clients that establish a three-party relationship under which Selective HR and the client are co-employers of the employees who work at the client’s location (“worksite employees”). Selective HR’s 2008 operations have been adversely impacted by the economic downturn and the recent increase in unemployment in the U.S. These challenges are manifesting themselves through lower worksite lives and pressure on our State Unemployment Tax Authority (“SUTA”) margins as further discussed in the section entitled, “Diversified Insurance Services Segment,” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K. As of December 31, 2007,2008, Selective HR had approximately 25,11122,500 worksite employees, 39%34% of which are fromwere located in the state of Florida.

18

Flood Insurance
Selective is a servicing carrier in the “Write-Your-Own” (“WYO”) Program of the United States government’s National Flood Insurance Program (“NFIP”). The WYO Program operates within the context of the NFIP, and is subject to its rules and regulations. The NFIP is administered by the Federal Emergency Management Agency (“FEMA”), which is part of the Department of Homeland Security. The WYO Program is a cooperative undertaking of the insurance industry and FEMA. The WYO Program allows participating property and casualty insurance companies to write and service the Standard Flood Insurance Policy in their own names, while ceding all of the premiums collected on these policies to the federal government. The companies receive an expense allowance, or servicing fee, for policies written and claims processed under the program, while the federal government retains responsibility for all underwriting losses. Selective is servicing approximately 299,000 flood policies under the NFIP through over 5,900 independent agents in 50 states and the District of Columbia.
Diversified Insurance Services Regulation
The companies within the Diversified Insurance Services segment are subject to certain laws and regulations. In particular, asAs a co-employer for some of its clients, Selective HR is subject to federal, state, and local laws and regulations relating to labor, tax, employment, employee benefits, and immigration matters. By contracting with its clients and creating a co-employer relationship with the worksite employees, Selective HR may be assuming certain contractual and legal obligations and responsibilities of an employer and could incur liability for violations of such laws and regulations, even if it was not actually responsible for the conduct giving rise to such liability. Some states in which Selective HR operates have already passed licensing or registration requirements for PEOs. These laws and regulations vary from state to state but generally provide for the monitoring of the fiscal responsibility of PEOs. Currently, many of these laws and regulations do not specifically address the obligations and responsibilities of co-employers. There can be no assurance that Selective HR will be able to satisfy new or revised laws and regulations.
Flood Insurance and Related Regulation
We are a servicing carrier in the WYO Program of the U.S. government’s NFIP. The NFIP is administered by the Federal Emergency Management Agency (“FEMA”), which is, in turn, part of the Department of Homeland Security. The WYO Program is a cooperative undertaking of the insurance industry and FEMA. The WYO Program allows participating property and casualty insurance companies to write and service the Standard Flood Insurance Policy in their own names, while ceding all of the premiums collected and losses incurred on these policies to the federal government. We receive the following amounts from the NFIP: (i) fees associated with servicing policy premium; and (ii) fees associated with the handling of claims. On June 1, 2008, the NFIP revised their fee structure associated with the handling of claims to provide for fees of 1% of direct premiums written, which are paid even in non-catastrophe years, coupled with fees equal to 1.5% of all incurred losses. Prior to June 1, 2008, we received claims handling fees equal to 3.3% of all incurred losses. Although these expenses could potentially change with future legislation, our servicing fee is currently 29.8% of direct premiums written. As of December 31, 2008, we served approximately 317,000 Flood policies under the NFIP through over 5,400 independent agents in 50 states and the District of Columbia.
The viability of the NFIP’s reinsurance program under the WYO Program is an essential component of Selective’sour Diversified Insurance Services operations. In 2005, the destruction caused by the active hurricane season stressedOn September 30, 2008, a law was passed to extend the NFIP with excessive levelsauthority to issue new policies, increase coverage on existing policies, and issue renewal policies until March 6, 2009. The NFIP currently has borrowing authority in the amount of flood losses. Selective continues$20.8 billion and has borrowed $17.3 billion through 2008. This amount is expected to rise as claims from Hurricane Ike continue to mature. The NFIP calculates that they will reach the borrowing limit in the first quarter of fiscal year 2010 and FEMA is currently seeking additional borrowings from Congress. We continue to monitor developments with the NFIP regarding its ability to pay claims in the event of another large-scale disaster. Congress controls the federal agency’s funding authority, which was exceeded after Hurricane Katrina, and is again nearing maximum capacity. Bills are pending in the House and Senate that could impact the NFIP. These bills contain substantial legislative changes and revisions to the NFIP and WYO Program, some of which may be favorable and some of which may be unfavorable for Selective. For additional information regarding regulation of flood insurance see Item 1A. “Risk Factors” of this Form 10-K.

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Competition
Selective facesWe face significant competition in both theour Insurance Operations and Diversified Insurance Services segments.
Property and casualty insurance is highly competitive on the basis of both price and service, and is extensively regulated by state insurance departments. In 2007, Selective was2008, we were ranked as the 4647th largest property and casualty group in the United StatesU.S. based on the 20062007 NPW, by A.M. Best in its list, “Top 200 U.S. Property/Casualty Writers.Groups.” The Insurance Operations compete with regional insurers, such as Cincinnati Financial Corporation and Harleysville Group, Inc., and national insurance companies, such as Liberty Mutual Group, Travelers Companies, Inc., The Hartford Financial Services Group, Inc., and Zurich. SelectiveZurich Financial Services Group. We also competescompete against direct writers of insurance coverage, including insurance offered through competitors’ internetInternet websites. These writers, such as GEICO and The Progressive Corporation, offer coverage primarily in personal lines, such as GEICO and Progressive.lines. Many of theseour competitors have greatermore customers and more financial and operating resources than Selective. Many of them alsowe do. As a result, they have more customers, which provide them withgreater scalability and more information regarding their risks and,which, with the use of statistical and computer models, may give them greater ability to make pricing and underwriting decisions. Purchasers of property and casualty insurance products do not always differentiate between insurance carriers and differences in coverage. The more significant competitive factors for most of Selective’sour insurance products are financial ratings, safety management, price, coverage terms, claims service, and technology. In addition, Selectivewe also facesface competition within each insurance agency that sells its insurance products as most of the agencies represent more than one insurance company.
With regard to theour Diversified Insurance Services segment, according to the most recent published information, Selective HR was ranked as the 1114th largest Professional Employer OrganizationPEO in a “Staffing Industry Report” published byStaffing Industry Analysts, Inc., based on 20052007 gross revenue. Based on 20062007 information, Selective’s Floodour flood line of business is the 7th largest WYO carrier for the NFIP based on information obtained from Statutory Annual Statements.statutory annual statements.
Please refer to Item 1A. “Risk Factors,” of this Form 10-K for a discussion of the factors that could impact Selective’sour ability to compete.

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Seasonality
Selective’sOur insurance business experiences modest seasonality with regard to premiums written. Due to the general timing of commercial policy renewals, premiums written are usually highest in January and July and lowest during the fourth quarter of the year. Although the writing of insurance policies experiences modest seasonality, the premiums related to these policies are earned consistently over the period of coverage. Losses and loss expenses incurred tend to remain consistent throughout the year, unless a catastrophe occurs from man-made or weather-related events such as hail, tornadoes, windstorms, hurricanes, and nor’easters.
Customers
No one customer or independent agency accounts for 10% or more of Selective’sour total revenue or the revenue of any one of itsour business segments.
Employees
At December 31, 2007, Selective2008, we had approximately 2,2002,000 employees, of which 2,0001,800 worked in the Insurance Operations and Investments segments and 200 worked in the Diversified Insurance Services segment.

 

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Executive Officers of the Registrant
The following table sets forth biographical information about Selective’sour Chief Executive Officer Executive Officers, and senior management,executive officers as of February 28, 2008:27, 2009:
   
Name, Age, Title Occupation Andand Background
Gregory E. Murphy 52, 53
Chairman, President, and
Chief Executive Officer
 
•     Chairman, President, and Chief Executive Officer of Selective, presentPresent position since May 2000

•     President, Chief Executive Officer, and Director, of Selective, May 1999 to May— 2000

•     President, Chief Operating Officer, and Director, of Selective, 1997 to May— 1999

•     Other senior executive, management, and operational positions, at Selective, since 1980

•     Certified Public Accountant (New Jersey) (Inactive)

•     Director, Newton Memorial Hospital Foundation, Inc., since 1999

•     Director, Property Casualty Insurers Association of America, since 2008

•     Director, Insurance Information Institute, since 2000

•     Trustee, the American Institute for CPCU (AICPCU) and the Insurance Institute of America (IIA), since June 2001

•     Graduate of Boston College (B.S. Accounting)

•     Harvard University (Advanced Management Program)
•    Certified Public Accountant (New Jersey) (Inactive)

  
Jamie Ochiltree III, 55
Senior Executive Vice
President, Insurance
Operations
•     Present position since February 2004 (scheduled retirement in March 2008)
•    VarietyM.I.T. Sloan School of executive positions, Selective, 1994 – February 2004
•    Miami University (B.A. Zoology)
•    Wharton School (Advanced Management Program)
   
Richard F. Connell 62, 63
Senior Executive Vice
President and
Chief
Administrative Officer
 
•     Present position since October 2007

•     Senior Executive Vice President and Chief Information Officer, August 2000 – OctoberSelective, 2006 — 2007

•     Executive Vice President and Chief Information Officer, AugustSelective, 2000 – January— 2006

•     Chief Technology Officer, Liberty Mutual, 1998 — 2000

•     Central Connecticut State University (B.S. Marketing)
   
Kerry A. Guthrie 50, 51
Executive Vice President
and
Chief Investment Officer
 
•     Present position since February 2005

•     Senior Vice President and Chief Investment Officer, Selective, August 2002 – February— 2005

•     Variety ofVarious investment positions, Selective, 1987 –— 2002

•     Chartered Financial Analyst

•     Certified Public Accountant (New Jersey) (Inactive)

•     Member, New York Society of Security Analysts

•     Siena College (B.S. Accounting)

•     Fairleigh Dickinson University (M.B.A. Finance)
   
Dale A. Thatcher 46, 47
Executive Vice President,
Chief Financial Officer and
Treasurer
 
•     Present position since February 2003

•     Senior Vice President, Chief Financial Officer and Treasurer, Selective, April 2000 – February— 2003

•     Certified Public Accountant (Ohio) (Inactive)

•     Chartered Property and Casualty Underwriter

•     Chartered Life Underwriter

•     Member, of the American Institute of Certified Public Accountants

•     Member, of the Ohio Society of Certified Public Accountants

•     Member, Financial Executives Initiative

•     Member, Insurance Accounting and Systems Association

•     University of Cincinnati (B.B.A. Accounting; M.B.A., Finance)

  
•     Harvard University (Advanced Management Program)

 

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Name, Age, Title Occupation Andand Background
Ronald J. Zaleski 53, 54
Executive Vice President and
Chief Actuary
 
•      Present position since February 2003

•     Senior Vice President and Chief Actuary, Selective, February 2000 – February- 2003
• Vice President and Chief Actuary, Selective, September 1999 – February— 2000

•     Fellow of Casualty Actuarial Society

•     Member, of the American Academy of Actuaries

•     Loyola College (B.A. Mathematics)
   
Victor Daley, 64Steven B. Woods, 49
Executive Vice President,
Human Resources
 
•     Present position since September 2005January 2009

•     Executive Vice President, Chief Administrative, and Human Resources, OfficerCorporate Affairs, Administration and Vice President, International for AmerUs Group, September 1995 – October 2004Crayola, LLC, 2000 — 2009
•    Providence College (B.S. Business Administration)
•    Roosevelt University (M.P.A.)
•    Harvard University (Advanced Management Program)

  
•     Southeastern Massachusetts University (B.S.)

Sharon R. Cooper, 46
Senior Vice President, Chief
Marketing and
Communications Officer
 
•     Present position since October 2007.
•    Vice President and Director of Communications, Selective, December 2000 – October 2007
•    Director of Media Relations, Allstate Insurance, 1996 – December 2000
•    Member, Society of Chartered Property and Casualty Underwriters
•Old Dominion University of Illinois (B.A. Broadcast Journalism)
•    Seton Hall (M.A. Strategic Communications and Leadership)(Ph.D., M.S.)
   
Michael H. Lanza 46, 47
Executive Vice President,
General Counsel, Corporateand
Secretary and Chief
Compliance Officer
 
•     Present position since JulyOctober 2007

•     Senior Vice President and General Counsel, Selective, 2004 - 2007

•     Corporate advisor and legal consultant, April 2003 – July— 2004

•     Executive Vice President &and Corporate Secretary, QuadraMed Corporation, a publicly-traded healthcare technology company, September 2000 – March— 2003

•     Member, Society of Corporate Secretaries and Corporate Governance Professionals

•     Member, National Investor Relations Institute

•     University of Connecticut (B.A.)

•     University of Connecticut School of Law (J.D.)
   
Mary T. Porter 52, 53
Executive Vice President,
Chief Claims Officer
 
•     Present position since October 2007

•     Senior Vice President, Director of Corporate Claims, JanuarySelective, 2007 - October 2007

•     Vice President, Group General Counsel, St. Paul Travelers, 1999 -— 2006

•     Assistant Vice President, Group Counsel USF&G, St. Paul Companies, 1993 — 1999

•     Private law practice in Washington, D.C.Member, Federation of Defense and Maryland, 1980 – 1993Corporate Counsel

•     Long Island University, C.W. Post College B.A,(B.A. Political ScienceScience)

•     George Washington University JD(J.D.)
   

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Name, Age, TitleOccupation And Background
John J. Marchioni 38, 39
Executive Vice President,
Chief Underwriting and
Field Operations
Officer
 
•     Present position since October 2008

•     Executive Vice President, Chief Field Operations Officer, Selective, 2007 — 2008

•     Senior Vice President, Director of Personal Lines, AugustSelective, 2005 – October— 2007

•     Vice President, Mercantile & Service SBU, July 2004 – AugustVarious insurance operations and government affairs positions, Selective, 1998 — 2005
•    Vice President, Director of Government Affairs, August 2002 – July 2004
•    Assistant Vice President, Government Affairs, August 2000 – July 2002
•    Government Affairs Specialist, January 1998 – July 2000

•     Chartered Property Casualty Underwriter (CPCU)

•     Princeton University (B.A. History)

•     Harvard University (Advanced Management Program)
Eduard J. Pulkstenis, 41
Executive Vice President,
Chief Underwriting Officer
•    Present position since October 2007
•    Senior Vice President, Chief Commercial Lines Underwriting Officer, July 2004 – October 2007
•    Vice President, Small Business, July 2003 – July 2004
•    Vice President, Director of Actuarial Pricing, March 2000 – July 2003
•    Managing Actuary, American International Group, October 1998 – February 2000
•    Various Actuarial positions, Selective, June 1988 – October 1998
•    Fellow of the Casualty Actuarial Society
•    Member of the American Academy of Actuaries
•    Member of the Society of Chartered Property Casualty Underwriters
•    Messiah College (B.A. Mathematics)
Charles A. Musilli, III, 49
Senior Vice President,
Northeast Region Manager
and Agency Development
•    Present position since October 2007
•    Senior Vice President, Chief Field Operations and Marketing Officer, June 2004 – October 2007
•    Senior Vice President, Selective Risk Managers, January 1997 – June 2004
•    Other management and operational positions at Selective from 1981 – 1984 and 1989 – 1997
•    Member, Society of Chartered Property and Casualty Underwriters
•    Rutgers University (B.A. Psychology)
Jeffrey F. Kamrowski, 43
Senior Vice President,
Business Services
•    Present position since October 2007
•    Other management and operational positions at Selective, since 1988
•    Member, Society of Chartered Property and Casualty Underwriters Hartwick College (B.S. Computer Information Science)
Daniel Bravo, 44
Senior Vice President,
Strategic Operations Group
•    Present position since October 2007
•    Senior Vice President of Knowledge Management (2005 – October 2007)
•    Vice President of Corporate Services Information Technology Services (2002 – 2005)
•    Operations Manager, Liberty Mutual Insurance (2000 – 2002)
•    Management Consultant for various consulting companies (1993 – 2000)
•    Babson College, MBA
•    Harvard University Extension School, Special Studies in Management Certificate
•    University of the Basque Country (Spain), (B.S. Economics)

 

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Information regarding Selective’s directors is included in the definitive Proxy Statement for the 2007 Annual Meeting of Stockholders to be held on April 24, 2008Information regarding our Board of Directors (the “Board”) is included in the definitive Proxy Statement for the 2009 Annual Meeting of Stockholders to be held on April 29, 2009 in “Information About Proposal 1, Election of Directors,” and is also incorporated by reference into Part III of this Form 10-K.
Available Information
Selective files itsWe file our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, and other required information with the SEC. The public may read and copy any materials on file with the SEC at the SEC’s Public Reference Room at 100 F Street N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site, www.sec.gov, that contains reports, proxy and information statements, and other information regarding issuers, including Selective,ourselves, that file electronically with the SEC.
Selective hasWe have a website, www.selective.com, through which itsour annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (“Exchange Act”) are available free of charge as soon as reasonably practicable after they are electronically filed with, or furnished to the SEC.

 

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Item 1A. Risk Factors
Certain risk factors exist that can have a significant impact on Selective’sour business, liquidity, capital resources, results of operations, and financial condition. The impact of these risk factors could also impact certain actions that Selective takeswe take as part of itsour long-term capital strategy including, but not limited to, contributing capital to subsidiaries in itsour Insurance Operations and Diversified Insurance Services segments, issuing additional debt and/or equity securities, repurchasing shares of the Parent’s common stock, (“Common Stock”), or increasingchanging stockholders’ dividends. The following list of risk factors is not exhaustive and others may exist. Selective operatesWe operate in a continually changing business environment and new risk factors emerge from time to time. Consequently, Selectivewe can neither predict such new risk factors nor assess the impact, if any, they might have on itsour business in the future.
Selective’sDifficult conditions in global capital markets and the economy may adversely affect our revenue and profitability and harm our business, and these conditions may not improve in the near future.
Our results of operations are materially affected by conditions in the global capital markets and the economy generally, in both the U.S. and abroad. As widely reported, financial markets in the U.S., Europe, and Asia have been experiencing extreme disruption from the second half of 2007 through 2008. Concerns over the availability and cost of credit, the U.S. mortgage market, a declining real estate market in the U.S., increased unemployment, volatile energy and commodity prices and geopolitical issues, among other factors, have contributed to increased volatility and diminished expectations for the economy and the financial and insurance markets going forward. These concerns have also led to declines in business and consumer confidence, which have precipitated an economic slowdown and fears of a sustained recession.
In addition, the fixed-income markets are experiencing a period of extreme volatility, which has negatively impacted market liquidity conditions and increased the risk that issuers, or guarantors, of fixed maturity securities will default on principal and interest payments. Initially, the effects were focused on the subprime segment of the mortgage-backed securities market. However, this volatility has since spread, negatively impacting: (i) a broad range of mortgage and asset-backed and other fixed income securities, including those rated investment grade; (ii) the U.S. and international credit and interbank money markets generally; and (iii) a wide range of financial institutions and markets, asset classes, and sectors. As a result, the market for fixed income securities has experienced decreased liquidity, increased price volatility, credit downgrade events, and increased probability of default. Securities that are less liquid are more difficult to value and may be hard to sell. Domestic and international equity markets have also been experiencing heightened volatility and turmoil, with issuers (such as our company) exposed to the mortgage securities and credit markets particularly affected. These factors and the continuing market disruption may have an adverse effect on our investment portfolio, revenues, and profit margins.
Factors such as consumer spending, business investment, government spending, the volatility and strength of the capital markets, and inflation, all affect the business and economic environment and, indirectly, the amount and profitability of our business. In an economic downturn characterized by higher unemployment, lower family income, lower corporate earnings, lower business investment, and lower consumer spending, the demand for insurance products could be adversely affected. In addition, we are impacted by the recent decrease in commercial and new home construction and home ownership in 2008 because 43% of NPW in our Commercial Lines business was generated through contractors business. Further unfavorable economic developments could adversely affect our earnings if our customers have less need for insurance coverage, cancel existing insurance policies, modify coverage or choose not to renew with us. These circumstances could have a material adverse effect on our business, results of operations and financial condition. Challenging economic conditions also may impair the ability of our customers to pay premiums as they come due. We are unable to predict the likely duration and severity of the current disruptions in financial markets and adverse economic conditions in the U.S. and other countries, which may have an adverse effect on us.

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We are also subject to the risk that the issuers, or guarantors, of fixed maturity securities we own may default on principal and interest payments due under the terms of the securities. At December 31, 2008, our fixed maturity securities portfolio represented approximately 86% of our total invested assets. Approximately 66% of our fixed maturity securities are state, municipality, or U.S. Government obligations. The occurrence of a major economic downturn (such as the current economy), acts of corporate malfeasance, widening credit spreads, budgetary deficits, or other events that adversely affect the issuers or guarantors of these securities could cause the value of our fixed maturity securities portfolio and our net income to decline and the default rate of our fixed maturity securities portfolio to increase. With economic uncertainty, credit quality of issuers or guarantors could be adversely affected and a ratings downgrade of the issuers or guarantors of the securities in our portfolio could also cause the value of our fixed maturity securities portfolio and our net income to decrease. For example, rating agency downgrades of monoline insurance companies during 2008 contributed to a decline in the carrying value and the market liquidity of our municipal bond investment portfolio. A reduction in the value of our investment portfolio could have a material adverse effect on our business, results of operations and financial condition. Levels of write down are impacted by our assessment of the impairment, including a review of the underlying collateral of structured securities, and our intent and ability to hold securities which have declined in value until recovery. If we determine to reposition or realign portions of the portfolio where we determine not to hold certain securities in an unrealized loss position to recovery, then we will incur an other-than-temporary impairment (“OTTI”) charge.
The current economic crisis has also raised the possibility of future legislative and regulatory actions, in addition to the recent enactment of the Emergency Economic Stabilization Act of 2008 (the “EESA”), which could further impact our business. We discuss government actions further in this section. We cannot predict whether or when such actions may occur, or what impact, if any, such actions could have on our business, results of operations and financial condition.
Our loss reserves may not be adequate to cover actual losses and expenses.
Selective isWe are required to maintain loss reserves for itsour estimated liability for losses and loss expenses associated with reported and unreported insurance claims for each accounting period. From time to time, Selective adjustswe adjust reserves and, if the reserves are inadequate, must increase itsour reserves. An increase in reserves: (i) reduces net income and stockholders’ equity for the period in which the deficiency in reserves is identified,identified; and (ii) could have a material adverse effect on Selective’sour results of operations, liquidity, financial condition, and financial strength and debt ratings. Selective’sOur estimates of reserve amounts are based on facts and circumstances of which it iswe are aware, including itsour expectations of the ultimate settlement and claim administration expenses, predictions of future events, trends in claims severity and frequency, and other subjective factors.factors relating to our insurance policies in force. There is no method for precisely estimating the ultimate liability for settlement of claims. Selective
We regularly reviews itsreview our reserving techniques and itsour overall amount of reserves. For more information regarding reserves, see the section entitled “Reserve for Losses and Loss Expenses” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K. The CompanyWe also reviews:review:
 • Information regarding each claim for losses, including potential extra-contractual liability,liabilities, or amounts paid in excess of the policy limits, which may not be covered by the Company’s reinsurance contracts;our contracts with reinsurers;
 
 • The Company’sOur loss history and the industry’s loss history;
 
 • Legislative enactments, judicial decisions and legal developments regarding damages;
 
 • Changes in political attitudes; and
 
 • Trends in general economic conditions, including inflation.
SelectiveIn addition to the above, we continue to manage our claims process in an effort to reduce claim cycle times and improve workflows. The initiatives undertaken in 2008 included: (i) claims automation; (ii) enhancement of claims quality and control; (iii) litigation management; (iv) enhancement of compliance and bill review; (v) enhancement of workers compensation review; and (vi) enhancement of salvage and subrogation review. As these initiatives are anticipated to accelerate the timing of reserve establishment, we ultimately expect lower loss costs to be realized through reduced legal and loss adjustment expenses. This acceleration will inflate our severity statistics in the near term, but we expect the longer-term benefit to be a more efficient management of the claims process.
We cannot be certain that the reserves it establisheswe establish are adequate or will be adequate in the future. For more information regarding reserves, see the section entitled “Reserve for Losses and Loss Expenses” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.
Selective is subjectAs a property and casualty insurer we are particularly vulnerable to a variety of operational risks which could have a material adverse impact on Selective’s business results.
Selective relies on complex financial models which have been developed internally and by third parties to analyze historical loss costs and pricing, trends in claim severity and frequency, the occurrence of catastrophe losses, and investment performance. Flaws in these financial models and/or faulty assumptions used by these financial models could lead to increased losses and loss reserving. Examples of these various models are Risk Management Solutions, the ALGO risk tool, and predictive modeling.
Catastrophiccatastrophic events.
Results of property and casualty insurers, such as our company, are subject to weather and other conditions. While one year may be relatively free of major weather occurrences or other disasters, another year may have numerous such events, causing results to be materially worse than other years. Selective’sThe Insurance Subsidiaries have experienced catastrophe losses and the Company expectswe expect them to experience such losses in the future.

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Various natural and man-made events can cause catastrophes, including, but not limited to,to; hurricanes, tornadoes, windstorms, earthquakes, hail, terrorism, explosions, severe winter weather, floods and fires, some of which may be related to climate changes. The frequency and severity of these catastrophes are inherently unpredictable. The extent of losses from a catastrophe is determined by the severity of the event and the total amount of insured exposures in the area affected by the event. Although catastrophes can cause losses in a variety of property and casualty lines, most of the catastrophe-related claims of Selective’sthe Insurance Subsidiaries historically have been related to commercial property and homeowners coverages. Selective’sOur property and casualty insurance business is concentrated geographically in the Eastern and Midwestern regions of the United States.U.S. New Jersey accountsaccounted for 30%29% of our total NPW during the Company’s total net premiums written.year ended December 31, 2008.
Selective’sThe Insurance Subsidiaries seek to reduce their exposure to catastrophe losses through the purchase of catastrophe reinsurance. Reinsurance, however, may prove inadequate if:
 • The modeling software usedwe use to analyze the Insurance Subsidiaries’ risk proves inadequate;results in an inadequate purchase of reinsurance by us;
 
 • A major catastrophic loss exceeds the reinsurance limit or the reinsurers’ financial capacity; or
 
 • The frequency of catastrophe losses result in the Insurance Subsidiaries exceeding their one reinstatement.
Continued deterioration in the public debt and equity markets, as well as in the private investment marketplace, could lead to investment losses, which may adversely affect our results of operations, financial condition and liquidity.
Like many other property and casualty insurance companies, we depend on income from our investment portfolio for a significant portion of our revenues and earnings. We are exposed to significant financial and capital markets risks, primarily relating to interest rates, credit spreads, equity price risks, and the changes in market value of our alternative investment portfolio. A decline could occur as a result of, among other things, a decrease in market liquidity, falling interest rates, decreased dividend payment rates, negative market perception of credit risk with respect to types of securities in our portfolio, a decline in the performance of the underlying collateral of our structured securities, reduced returns on our other investments, including our portfolio of alternative investments, or general market conditions.
Our notes payable and line of credit are subject to certain debt-to-capitalization restrictions and net worth covenants, which could also be impacted by a significant decline in investment values, and further OTTI charges could be necessary if there is a future significant decline in investment values. Depending on market conditions going forward, and in the event of extreme prolonged market events, such as the global credit crisis, we could incur additional realized and unrealized losses in future periods, which could have an adverse impact on our results of operations, financial condition, debt and financial strength ratings, and our ability to access capital markets as a result of realized losses, impairments and changes in unrealized positions.
Interest rate risk
Our exposure to interest rate risk relates primarily to the market price (and cash flow variability) associated with changes in interest rates. A rise in interest rates may decrease the fair value of our existing fixed maturity investments and declines in interest rates may result in an increase in the fair value of our existing fixed maturity investments. Our fixed income investment portfolio contains interest rate sensitive instruments, that may be adversely affected by changes in interest rates resulting from governmental monetary policies, domestic and international economic and political conditions, and other factors beyond our control. A rise in interest rates would increase the net unrealized loss position of the investment portfolio, offset by our ability to earn higher rates of return on funds reinvested and new investments. Conversely, a decline in interest rates would decrease the net unrealized loss position of the investment portfolio, offset by lower rates of return on funds reinvested and new investments. We seek to mitigate our interest rate risk associated with holding fixed maturity investments by monitoring and maintaining the average duration of our portfolio with a view toward achieving an adequate after-tax return without subjecting the portfolio to an unreasonable level of interest rate risk. Although we take measures to manage the economic risks of investing in a changing interest rate environment, we may not be able to mitigate the interest rate risk of our assets relative to our liabilities.
Equity price risk
Our primary exposure to equity risk relates to the potential adverse impact on our equity investments associated with volatility in equity market prices, decreased dividend payment rates, and reduced returns in certain of our other investments, which reduces our investment portfolio. 4%, or $134.7 million, of our total investment portfolio was equity securities and 5%, or $165.0 million, of our total investment portfolio was alternative investments as December 31, 2008. 49%, or $81.0 million, of our alternative investments were private equity investments (including secondary market), which represented 2% of our total investment portfolio as of December 31, 2008.

 

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We are also exposed to interest rate and equity risk based on the discount rate and expected long-term rate of return assumptions associated with our pension and other post-retirement benefit obligations. Sustained declines in long-term interest rates or equity returns likely would have a negative effect on the funded status of our pension plan. Even in the absence of a market downturn, we are exposed to substantial risk of loss due to market volatility.
The factors discussed above have resulted in significant realized and unrealized losses, including write downs for OTTI charges, in our equity and other investment portfolio. Any further decline in the market value of our equity and other investments would continue to reduce our revenue, stockholders’ equity, and policyholders’ surplus, which could impact our ability to issue additional insurance policies.
For more information regarding market, interest rate, credit, and equity price risk, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in this Form 10-K.
The property and casualty insurance industry is cyclical.
Historically, the results of the property and casualty insurance industry have experienced significant fluctuations due to competition, occurrence or severity of catastrophic events, levels of capacity, general economic conditions, interest rates, and other factors, suchfactors. Demand for insurance is influenced significantly by prevailing general economic conditions. The supply of insurance is related to prevailing prices, the levels of insured losses and the levels of industry surplus which, in turn, may fluctuate in response to changes in rates of return on investments being earned in the insurance industry. As a result, the insurance industry historically has been a cyclical industry characterized by periods of intense price competition due to excessive underwriting capacity as competition.well as periods when shortages of capacity permitted favorable premium levels. For example, the competitors pricing business below technical levels could force the Companyus to reduce itsour profit margin in order to protect itsour best business. Selective hasWe have experienced the following fluctuations in Commercial Lines premium pricing, excluding exposure (“pure price”), over the past several years:
•During 2007, pure price on Commercial Lines renewal business decreased 3.9%;
•During 2006, pure price on Commercial Lines renewal business decreased 1.7%;
•During 2005, pure price on Commercial Lines renewal business remained flat compared to 2004;
•From 2001 — 2004, pure price on Commercial Lines renewal business was increasing in a range from 4.3% to 12.6%; and
•For several years prior to 2001, Selective experienced decreases in pure price in our Commercial Lines operations.
     
Year Percentage Increase (Decrease) from Year to Year 
2008 (3.1)% 
2007 (3.9)% 
2006 (1.7)% 
2005 0% 
2001-2004 Increases ranging from 4.3% to 12.6%
As an example of pricing and loss trends on the statutory combined ratio, taking a pure price decline of 1.4% and removing the expense that directly varies with premium volume yields an adverse combined ratio impact of approximately 1 point, in addition to a claims inflation increase of 3%, will cause the loss and loss adjustment expense ratio to increase approximately 2 points, all else remaining equal. The combination of claims inflation and price decreases could raise the combined ratio approximately 3 points in this example, absent any initiatives targeted to address these trends.
The industry’s profitability also is affected by unpredictable developments, including:
 • Natural and man-made disasters;
 
 • Fluctuations in interest rates and other changes in the investment environment that affect investment returns;
 
 • Inflationary pressures (medical and economic) that affect the size of losses;
 
 • Judicial, regulatory, legislative, and legal decisions that affect insurers’ liabilities;
 
 • Changes in the frequency and severity of losses;
 
 • Pricing and availability of reinsurance in the marketplace; and
 
 • Weather-related impacts due to the effects of climate changes.
Selective competesAny of the above developments could cause the supply or demand for insurance to change, which could adversely affect our results of operations and financial condition.

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There can be no assurance that the actions of the U.S. Government, Federal Reserve and other governmental and regulatory bodies to try to stabilize the financial markets will achieve their intended effect.
In response to the financial crises affecting the banking system and financial markets, on October 3, 2008, President George Bush signed the EESA into law. Under the EESA, the U.S. Treasury has the authority to, among other things, purchase up to $700 billion of mortgage-backed and other securities from financial institutions to try to stabilize the financial markets. The EESA or similar legislation, as well as monetary or fiscal actions by the U.S. Federal Reserve Board or comparable authorities in other countries, may fail to stabilize the financial markets. These new forms of legislation and actions may have other consequences on financial factors, including interest rates, foreign exchange rates, and the markets for the financial instruments purchased and sold by the U.S. Department of Treasury pursuant to the EESA. These other consequences could materially affect our investments, results of operations and liquidity in ways that we cannot predict. The failure to effectively implement this legislation and related actions, or ineffectiveness of the legislation and actions, could result in a crisis of investor confidence in the U.S. economy and financial markets, which could increase constraints on the liquidity available in the banking system and financial markets and increase pressure on the price of our fixed income and equity portfolios. These results could materially and adversely affect our results of operations, financial condition, liquidity and the trading price of the Parent’s common stock.
In the event of future material deterioration in business conditions, we may need to raise additional capital or consider other transactions to manage our capital position and liquidity. However, since we are unable to predict the likely duration and severity of the current disruptions in the marketplace, we may find it difficult to raise capital, and if we do, we may be forced to incur a relatively high cost to obtain such capital.
Although we do not plan to participate in any of the EESA programs, it is possible that our competitors may, and those competitors may gain a competitive advantage by accessing funds through the EESA programs. Furthermore, it is possible that some companies, including competitors, may attempt to use the existing market volatility and enhanced market oversight as a platform for isolating poorly performing assets into separate stand-alone entities. There can be no assurance as to the effect that any such actions will have on our competitive position.
In addition, we are subject to extensive laws and regulations that are administered and enforced by a number of different governmental authorities and non-governmental self-regulatory agencies. In light of the current financial crisis, some of these authorities have implemented, or may in the future implement, new or enhanced regulatory requirements intended to restore confidence in financial institutions and reduce the likelihood of similar economic events in the future. These authorities may also seek to exercise their supervisory or enforcement authority in new or more robust ways. Such events could affect the way we conduct our business and manage our capital, and may require us to satisfy increased capital requirements. These developments, if they occurred, could materially affect our results of operations, financial condition and liquidity.
The Federal Deposit Insurance Corporation (“FDIC”) approved the Temporary Liquidity Guarantee Program (“TLGP”) on November 21, 2008. The program was designed to strengthen confidence and encourage liquidity in the banking system by guaranteeing newly issued senior unsecured debt of banks, thrifts, and certain holding companies, and by providing full coverage of non-interest bearing deposit transaction accounts, regardless of dollar amount. If we purchase securities guaranteed under the TLGP, and the program does not strengthen confidence or encourage liquidity in the marketplace, the carrying value of such securities in our investment portfolio could be adversely affected.
We are subject to the types of risks inherent in making alternative investments in private limited partnerships.
Our other investments include alternative investments in private limited partnerships that invest in various strategies such as private equity, mezzanine debt, distressed debt, and real estate. As of December 31, 2008, these types of investments represented 5% of our total invested assets. The amount and timing of income from these partnerships tends to be variable as a result of the performance and investment stage of the underlying investments. The timing of distributions from the partnerships, which depends on particular events relating to the underlying investments, as well as the partnerships’ schedules for making distributions and their need for cash, can be difficult to predict. As a result, the amount of income that we record from these investments can vary substantially from quarter to quarter. In addition, the general volatility in the capital markets, the dislocation of the credit markets, and reduced values of financial assets globally in the last half of 2008 has reduced investment income from these types of investments. Pursuant to the various limited partnership agreements of these partnerships, we are committed to potential future capital calls in the aggregate amount of approximately $120 million as of December 31, 2008.

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We are also subject to the risks arising from the fact that the determination of the fair value of these types of investments is inherently subjective. The general partner of each of these partnerships generally reports the change in the fair value of the interests in the partnership on a one quarter lag because of the nature of the underlying assets or liabilities. Since these partnerships’ underlying investments consist primarily of assets or liabilities for which there are no quoted prices in active markets for the same or similar assets, the valuation of interests in these partnerships are subject to a higher level of subjectivity and unobservable inputs than substantially all of our other investments. Pursuant to FASB Statement of Financial Accounting Standards No. 157,Fair Value Measurements(“FAS 157”), each of these general partners is required to determine fair value by the price obtainable for the sale of the interest at the time of determination. Valuations based on unobservable inputs are subject to greater scrutiny and reconsideration from one reporting period to the next and therefore, the changes in the fair value of these investments may be subject to significant fluctuations which could lead to significant decreases in their fair value from one reporting period to the next. Since we record our investments in these various partnerships under the equity method of accounting, any decreases in the valuation of these investments would negatively impact our results of operations.
The valuation of our investments include methodologies, estimations and assumptions which are subject to differing interpretations and could result in changes to investment valuations that may adversely affect our results of operations or financial condition.
Fixed maturity, equity and trading securities and short-term investments, which are reported at fair value on the consolidated balance sheet, represented the majority of our total cash and invested assets as of December 31, 2008. As required under accounting rules, we have categorized these securities into a three-level hierarchy, based on the priority of the inputs to the respective valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1), the next priority to quoted prices in markets that are not active or inputs that are observable either directly or indirectly, including quoted prices for similar assets or liabilities or in markets that are not active and other inputs that can be derived principally from, or corroborated by, observable market data for substantially the full term of the assets or liabilities (Level 2) and the lowest priority to unobservable inputs supported by little or no market activity and that reflect the reporting entity’s own assumptions about the exit price, including assumptions that market participants would use in pricing the asset or liability (Level 3). An asset or liability’s classification within the fair value hierarchy is based on the lowest level of significant input to its valuation. We generally use a combination of independent pricing services and broker quotes to price our investment securities. At December 31, 2008, approximately 13% and 87% of these securities represented Level 1 and Level 2, respectively. However, prices provided by independent pricing services and independent broker quotes can vary widely even for the same security. Rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of securities as reported within our consolidated financial statements and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on our financial condition and may result in an increase in non-cash OTTI charges.
The determination of the amount of impairments taken on our investments is highly subjective and could materially impact our results of operations or financial position.
The determination of the amount of impairments taken on our investments is based on our periodic evaluation and assessment of our investments and known and inherent risks associated with the various asset classes. Such evaluations and assessments are revised as conditions change and new information becomes available. Management updates its evaluations regularly and reflects changes in impairments as such evaluations are revised. There can be no assurance that our management has accurately assessed the level of impairments taken reflected in our financial statements. Furthermore, additional impairments may need to be taken in the future. Historical trends may not be indicative of future impairments.
An investment in a fixed maturity or equity security, is impaired if its fair value falls below its carrying value and the decline is considered to be other than temporary. We regularly review our entire investment portfolio for declines in value. If we believe that a decline in the value of a particular investment is temporary, we record the decline as an unrealized loss in accumulated other comprehensive income for those securities that are held as available for sale. If we believe the decline is other-than-temporary we write down the carrying value of the investment and record a realized loss in our consolidated statements of income. Management’s assessment of a decline in value includes current judgment as to the financial position and future prospects of the security issuer as well as our ability and intent to hold such security until a recovery could occur.

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Additionally, our management considers a wide range of factors about the security issuer and uses their best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations in the impairment evaluation process include, but are not limited to: (i) whether the decline appears to be issuer or industry specific; (ii) the relationship of market prices per share to book value per share at the date of acquisition and date of evaluation; (iii) the price-earnings ratio at the time of acquisition and date of evaluation; (iv) the financial condition and near-term prospects of the issuer, including any specific events that may influence the issuer’s operations; (v) the recent income or loss of the issuer; (vi) the independent auditors’ report on the issuer’s recent financial statements; (vii) the dividend policy of the issuer at the date of acquisition and the date of evaluation; (viii) any buy/hold/sell recommendations or price projections published by outside investment advisors; (ix) any rating agency announcements; (x) the length of time and the extent to which the fair value has been less than carrying value; and (xi) the stress testing of projected cash flows under various economic and default scenarios.
As of December 31, 2008, there were 401 securities in our portfolio in an unrealized loss position, including certain securities that were priced at a significant discount compared to our original cost due to uncertainties in the marketplace. Our gross unrealized losses on available-for-sale fixed maturity securities at December 31, 2008 were $160.2 million, pre-tax, in the aggregate and the component of gross unrealized losses for securities with a fair value of less than 85% of their amortized costs was approximately $122.7 million, pre-tax, at such date. Realized losses or impairments may have a material adverse impact on our results of operation and financial position.
A downgrade or a potential downgrade in our financial strength or credit ratings could result in a loss of business and could have a material adverse effect our financial condition and results of operations.
Insurance companies are subject to financial strength ratings issued by various Nationally Recognized Statistical Rating Organizations (“NRSROs”), based on factors relevant to policyholders. Ratings are not recommendations to buy, hold, or sell any of our securities. Higher ratings generally indicate financial stability and a strong ability to pay claims. We and the Insurance Subsidiaries currently maintain: (i) an A.M. Best financial strength rating of “A+” with a stable financial strength outlook; (ii) a S&P’s financial strength rating of “A+” with a negative outlook; (iii) a Fitch financial strength rating of “A+” with a stable outlook; and (iv) a Moody’s financial strength rating of “A2” with a stable outlook. A significant downgrade in ratings, from A.M. Best in particular, could: (i) affect our ability to write new business with customers, some of whom are required (under various third party agreements) to maintain insurance with a carrier that maintains a specified minimum rating; or (ii) be an event of default under our line of credit. Pursuant to our line of credit agreement with Wachovia Bank, National Association (“Line of Credit”), the Insurance Subsidiaries must maintain a financial strength rating by A.M. Best of at least “A-” (two levels below our current rating) at all times. A default under our Line of Credit could lead to acceleration of principal, which could trigger default provisions under certain of our other debt instruments and could negatively impact our ability to borrow in the future. As a result, any significant downgrade in ratings could have a material adverse effect our financial condition and results of operations.
In addition to financial strength ratings, various NRSROs also publish credit ratings for us. Credit ratings are indicators of a debt issuer’s ability to meet the terms of debt obligations in a timely manner and are important factors in our overall funding profile and ability to access certain types of liquidity. Currently, we maintain: (i) an A.M. Best long term issuer credit rating of “a-” with a stable long term credit outlook; (ii) a S&P’s long term local issuer credit rating of “BBB+” with a negative outlook; (iii) a Fitch long term issuer default rating of “A-” with a stable outlook; and (iv) a Moody’s Investor Service (“Moody’s) senior unsecured debt rating of “Baa2” with a stable outlook. Downgrades in our credit ratings could have a material adverse effect on our financial condition and results of operations in many ways, including making it more expensive for us to access capital markets. The Insurance Subsidiaries are also parties to the Pooling Agreement that allows them to obtain a uniform rating from A.M. Best. If one or more of the Insurance Subsidiaries suffered a ratings downgrade, the ability of the entire pool to maintain its uniform rating would be uncertain.
In view of the difficulties experienced recently by many financial institutions, including our competitors in the insurance industry, we believe it is possible that the external rating agencies: (i) will heighten the level of scrutiny that they apply to such institutions; (ii) will increase the frequency and scope of their reviews; and (iii) may adjust upward the capital and other requirements employed in their models for maintenance of certain rating levels. We cannot predict what actions rating agencies may take, or what actions we may take in response to the actions of rating agencies, which could adversely affect our business.

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We operate in a highly competitive environment which could adversely impact our results of operations and financial condition.
We compete with regional and national property and casualty insurance companies, including public and mutual companies, some of which do not use independent agents and write directly with insureds. Many of these competitors are larger than Selectiveus and have greater financial and operating resources, as well as greater information scale. The Internet has also emerged as a significant place of new competition, both from existing competitors and from new competitors. A new form of competition may enter the marketplace as some reinsurers may attempt to diversify their insurance risk by writing business in the primary marketplace. Because Selective sells itswe sell our coverages through independent insurance agents who also are agents of itsour competitors, the Company faceswe face competition within each of itsour appointed independent insurance agencies.
SelectiveWe also facesface competition, primarily in the commercial insurance market, from entities that self-insure their own risks. ManySome of Selective’sour customers and potential customers are examiningfrom time to time examine the benefits and risks of self-insuring as an alternative to traditional insurance. The ability to self-insure is generally only available to large risks. However, some small and mid-sized public entities do have the opportunity to partially self-insure through the use of risk pools or joint insurance funds.
New competition from these developments could cause the supply or demand for insurance to change, which could adversely affect Selective’sour results of operations and financial condition.
General economic conditions can adversely affect Selective’s business results and prospects.
Changes in general economic conditions can impact Selective’s business. For example, Selective’s contractor business represents 45%The occurrence of its insurance operations segment and is significantly impacted by changes in general economic conditions, including the downturn in the U.S. housing market. Other economic conditions impacting Selective’s business include, but, are not limited to, recessions; increases in corporate, municipal and/or consumer bankruptcies; changes in interest rate levels; a continued downturn in the U.S. housing market; changes in domestic and international laws, including tax laws and bankruptcy laws; intervention by governments in financial markets, including the imposition of limits on the ability of mortgagees to foreclose on defaulted mortgage loans; wars; and terroristany acts could adversely affect the performance of the Company’s insured and investment portfolios, possibly leading to increases in losses and loss reserves in the insured portfolio and decreases in the value of the investment portfolio and, therefore, the Company’s financial strength.

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Acts of terrorism not covered by, or exceeding, reinsurance limits.limits could have a material adverse affect on our results of operations and financial condition.
On November 26, 2002, theThe U.S. Terrorism Risk Insurance Act of 2002 legislation was signed into law. This legislation was(“TRIA”), as amended, in December 2005 and extended through December 31, 2007 throughestablished the Terrorism Risk Insurance ExtensionProgram (“TRIP”) which became effective on November 26, 2002 and was a three-year federal program effective through 2005. On December 22, 2005, President George Bush signed a bill extending TRIA for two more years, continuing TRIP through 2007. On December 26, 2007, President George Bush signed the Terrorism Risk Insurance Program Reauthorization Act of 2005 (collectively, these two acts will be referred to as “TRIA”). On December 18, 2007 TRIA was(“TRIPRA”) which further extended TRIP for seven more years until December 31, 2014. This revised legislation ends2014, and also eliminated the distinction between foreign and domestic acts of terrorism without increasing the level of damages necessaryterrorism. This seven-year period was designed to trigger the program ($100 million). This seven year period will provide the market with much-neededmuch needed stability.
TRIA requires sharing the risk of future losses from terrorism between private insurers and the federal government, and is applicable to almost all commercial lines of insurance. Insurance companies with direct commercial insurance exposure in the United StatesU.S., including our company, are required to participate in this program. TRIA rescinded all previously approved exclusions for terrorism. Policyholders forof non-workers compensation policies have the option to accept or decline the terrorism coverage Selective offerswe offer in itsour policies, or negotiate other terms. In 2007,2008, approximately 90% of Selective’sour commercial non-workers compensation policyholders purchased terrorism coverage. The terrorism coverage is mandatory for all workers compensation primary policies. In addition, 48%46%, or ten10 of the twenty-one22 primary states in which Selective writeswe write commercial property coverage, mandatemandated during 2008 the coverage of fire following an act of terrorism. These provisions apply to new policies written after enactment of TRIA. A terrorism act must be certified by the U.S. Secretary of Treasury in order to be covered by TRIA. Each participating insurance company will be responsible for paying out a certain amount in claims (a deductible) before federal assistance becomes available. This deductible, which iswas equal to approximately $200$201 million in 2008,2009, is based on a percentage of commercial lines direct earned premiums for lines subject to TRIA from the prior calendar year. For losses above an insurer’s deductible, the federal government will cover 85%, while the insurer contributes 15%. Although the provisions of TRIATRIPRA will serve to mitigate Selective’sour exposure in the event of a large-scale terrorist attack, the Company’sour deductible is substantial.
Selective’s investments support its operations and provide a significant portion of its revenues and earnings.
Like many other property and casualty insurance companies, Selective depends on income from its investment portfolio for a significant portion of its revenues and earnings. Any significant decline in the Company’s investment income as a result of falling interest rates, decreased dividend payment rates, reduced returns in the Company’s other investment portfolio, primarily from alternative investments, or general market conditions would have an adverse effect on its results. Fluctuations in interest rates cause inverse fluctuations in the market value of the Company’s debt portfolio. In addition, issuers of debt which the Company holds in its investment portfolio may default in its financial obligations as a result of insolvency, lack of liquidity, operational failure or other reasons. Any significant decline in the market value of its investments, excluding its held-to-maturity investments, would reduce the Company’s stockholders’ equity. A significant decline in the market value of its equity and other investments would also reduce its policyholders’ surplus, which could impact the Company’s ability to write additional premiums. In addition, Selective’s notes payable are subject to certain debt-to-capitalization restrictions, which could also be impacted by a significant decline in investment values. For more information see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in this Form 10-K.
Changes in tax laws impacting marginal tax rates and/or the preferred tax treatment of municipal obligations could adversely impact Selective’s business.
Tax legislation which imposes a “flat tax” or otherwise changes the tax preference of municipal obligations under current law could adversely affect the market value of municipal obligations. Forty-one percent of the Company’s investment portfolio is invested in tax-exempt municipal obligations; as such, the value of the investment portfolio could be adversely affected by any such legislation. Additionally, any such changes in tax law could reduce the difference between tax-exempt interest rates and taxable rates.
Selective may be adversely impacted by a change in its ratings.
Insurance companies are subject to financial strength ratings produced by external rating agencies, based upon factors relevant to policyholders. Ratings are not recommendations to buy, hold, or sell any of Selective’s securities. Higher ratings generally indicate financial stability and a strong ability to pay claims. A significant downgrade in ratings, from A.M. Best in particular, could: (i) affect Selective’s ability to write new business with customers, some of whom are required (under various third party agreements) to maintain insurance with a carrier that maintains a specified minimum rating; (ii) be an event of default under Selective’s line of credit; or (iii) make it more expensive for Selective to access capital markets.
SelectiveThe Parent is a holding company, and its subsidiaries may have a limited ability to declare dividends, and thus it may not have access to the cash that is needed to meet its cash needs.
Substantially all of Selective’sthe Parent’s operations are conducted through its subsidiaries. Restrictions on the ability of the Company’sits subsidiaries, particularly the Insurance Subsidiaries, to pay dividends or make other cash payments to the Parent may materially affect its ability to pay principal and interest on itsour indebtedness and dividends on its Common Stock.common stock.

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Under the terms of Selective’sour debt and line of credit agreements and financial solvency laws affecting insurers, the Company’sParent’s subsidiaries are permitted to incur indebtedness up to certain levels thatwhich may restrict or prohibit the making of distributions, the payment of dividends, or the making of loans by theits subsidiaries to the Parent. The CompanyWe cannot assure that the laws and agreements governing the current and future indebtedness of itsthe Parent’s subsidiaries will permit such subsidiaries to provide the Parent with sufficient dividends distributions, or loansdistributions to fund itsthe Parent’s cash needs. Sources of funds for the Insurance Subsidiaries primarily consist of premiums, investment income, and proceeds from sales and redemption of investments. Such funds are applied primarily to payment of claims, insurance operating expenses, income taxes and the purchase of investments, as well as dividends and other payments.

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The Insurance Subsidiaries may declare and pay dividends to the Parent only if they are permitted to do so under the insurance regulations of their respective state of domicile. All of the states in which the Insurance Subsidiaries are domiciled regulate the payment of dividends. Some states, including New Jersey, North Carolina, and South Carolina, require that Selective give notice is given to the relevant state insurance commissioner prior to itsour Insurance Subsidiary domiciled in that respective state declaring any dividends and distributions payable to the Parent. During the notice period, the state insurance commissioner may disallow all or part of the proposed dividend upon determination that: (i) the insurer’s surplus is not reasonable in relation to its liabilities and adequate to its financial needs and those of the policyholders, or (ii) in the case of New Jersey, the insurer is otherwise in a hazardous financial condition. In addition, insurance regulators may block dividends or other payments to affiliates that would otherwise be permitted without prior approval upon determination that, because of the financial condition of the insurance subsidiary or otherwise, payment of a dividend or any other payment to an affiliate would be detrimental to an insurance subsidiary’s policyholders or creditors. Selective’s Selective HR subsidiary may also declare and pay dividends, which are restricted by the operating needs of this entity as well as a professional employer organizationorganization’s licensing requirements to maintain a current ratio of at least 1:1.
SelectiveWe are subject to a variety of modeling risks which could have a material adverse impact on our business results.
We rely on complex financial models, such as predictive modeling, Risk Management Solutions, the ALGO risk tool and value-at-risk (“VaR”), which have been developed internally or by third parties to analyze historical loss costs and pricing, trends in claims severity and frequency, the occurrence of catastrophe losses, investment performance and portfolio risk. Flaws in these financial models and/or faulty assumptions used by these financial models, could lead to increased losses. For example, VaR is a method used by us to evaluate portfolio risk. VaR is a probabilistic method of measuring the potential loss in portfolio value over a given time period and for a given distribution of historical returns. Portfolio risk, as measured by VaR, is affected by four primary risk factors: asset concentration, asset volatility, asset correlation and systematic risk. While VaR models are relatively sophisticated, the quantitative market risk information generated is limited by the assumptions and parameters established in creating the related models. We believe that statistical models alone do not provide a reliable method of monitoring and controlling market risk. Therefore, such models are tools and do not substitute for the experience or judgment of senior management.
Our ability to reduce our exposure to risks depends on the availability and cost of reinsurance.
We transfer our risk exposure to other insurance and reinsurance companies through reinsurance arrangements. Through these arrangements, another insurer assumes a specified portion of our losses and loss adjustment expenses in exchange for a specified portion of the insurance policy premiums. While reinsurance agreements generally bind the reinsurance companies for the life of the business reinsured at generally fixed pricing, market conditions beyond our control determine the availability and cost of the reinsurance protection for new business. In certain circumstances, the price of reinsurance for business already reinsured may also increase. The availability, amount and cost of reinsurance depend on market conditions, which may vary significantly. Any decrease in the amount of our reinsurance will increase our risk of loss and any increase in the cost of reinsurance will, absent a decrease in the amount of reinsurance, reduce our earnings. Accordingly, we may be forced to incur additional expenses for reinsurance or may not be able to obtain sufficient reinsurance on acceptable terms, which could adversely affect our ability to write future business or result in the assumption of more risk with respect to those policies we issue.
In general, reinsurance does not relieve us of our direct liability to our policyholders, even when the reinsurer is liable to us. Accordingly, we bear credit risk with respect to our reinsurers. Reinsurers which we have contracted with may default in their obligations as a result of insolvency, lack of liquidity, operational failure or other reasons. We cannot provide assurance that our reinsurers will pay the reinsurance recoverables owed to us now or in the future or that they will pay these recoverables on a timely basis. For example, we maintain reinsurance relationships with certain subsidiaries of American International Group, Inc., which is currently party to a securities lending agreement with the Federal Reserve and was also given a line of credit by the Federal Reserve in order to meet its liquidity needs. Due to the uncertainty associated with casualty business, current reinsurance recoverables are subject to the credit risk of the reinsurers. The inability of any of our reinsurers to meet their financial obligations could materially and adversely affect our operations, as we remain primarily liable to our customers under the policies that we have insured.

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We depend on independent insurance agents and other third party service providers.
Selective marketsWe market and sells itssell our insurance products through independent, non-exclusive insurance agencies and brokers. Agents and brokers are not obligated to promote Selective’sour insurance products, and they may also sell the insurance products of the Company’sour competitors. As a result, Selective’sour business depends in part on the marketing and sales efforts of these agencies and brokers. As Selective diversifieswe diversify and expands itsexpand our business geographically, itwe may need to expand itsour network of agencies and brokers to successfully market itsour products. If these agencies and brokers fail to market Selective’sour products successfully, itsour business may be adversely impacted. Also, independent agents may decide to sell their businesses to banks, other insurance agencies, or other businesses. Agents with a Selectiveour appointment may decide to buy other agents. Changes in ownership of agencies or expansion of agencies through acquisition could adversely affect an agency’s ability to control growth and profitability, thereby adversely affecting Selective’sour business.
In addition to independent insurance agents, Selectivewe also reliesrely on third party service providers to conduct a portion of itsour premium audits, safety management services, and claims adjusting services. Selective’s HR Outsourcing business relies on third party service providers for products such as health coverage, flexible spending accounts, and 401(k) savings plans. If these third-partythird party service providers fail to perform their respective services and/or fail to provide their products successfully and/or accurately, Selective’sour business may be adversely impacted.
Selective isWe are heavily regulated in the states in which it operates.we operate and changes in regulation may reduce our profitability and limit our growth.
Selective isWe are subject to extensive supervision and regulation in the states in which the Insurance Subsidiaries transact insurance business. The primary purpose of insurance regulation is to protect individual policyholders and not shareholdersstockholders or other investors. Selective’sOur business can be adversely affected by regulations affecting property and casualty insurance companies. For example, laws and regulations can lead to mandated reductions in rates to levels that Selective doeswe do not believe are adequate for the risks it insures.we insure. Other laws and regulations limit the Company’sour ability to cancel or refuse to renew certain policies and require Selectiveus to offer coverage to all consumers. Changes in laws and regulations, or their interpretations, pertaining to insurance may also have an impact on Selective’sour business. Selective’sOur concentration of business may expose the Companyus to increased risks of regulatory matters in the states in which the Insurance Subsidiaries write insurance that could be greater than the risks the Companywe could be exposed to by transacting business in a greater number of geographic markets.

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Although the insurance industry is primarily regulated by individual states and the U.S. federal government does not directly regulate the business of insurance, federal initiatives, such as the NFIP, the proposed National Flood Insurance Program, theAct of 2007 (which would permit an optional federal charter andfor insurers), the proposed Free Choice Act (which would make it easier for workers to unionize), the Office of Foreign Assets Control, financial services regulation, privacy regulation and tort reform regulation can also impact the insurance industry.industry and our company. Proposals intended to control the cost and availability of healthcare services have been debated in the U.S. Congress and state legislatures. Although Selectivewe neither writeswrite health insurance nor assumesassume any healthcare risk, rules affecting healthcare services can affect workers compensation, commercial and personal automobile, liability, and other insurance that it doeswe do write. SelectiveWe cannot determine whether, or in what form, healthcare reform legislation may be adopted by the U.S. Congress or any state legislature. Selective also cannot determine the nature andlegislature or what effect, if any, that thesuch adoption of healthcare legislation or regulations, or changing interpretations, at the federal or state level would have on it.us as an insurer or as an employer. In addition, in view of recent events involving certain financial institutions, it is possible that the U.S. federal government will heighten its oversight of insurers such as us, including possibly through a federal system of insurance regulation. Proposals to create such a federal regulatory system for property and casualty insurers continue to be considered. We cannot predict whether these or other proposals will be adopted, or what impact, if any, such proposals or, if enacted, such laws, could have on our business, financial condition or results of operations.
ExamplesState laws in the U.S. grant insurance regulatory authorities broad administrative powers with respect to, among other things:
•Insurer solvency standards;
•Insurer and agent licensing;
•Investment restrictions;
•Payment of dividends and distributions;
•Provisions for current losses and future liabilities;
•Deposit of securities for the benefit of policyholders;
•Restrictions on policy terminations;
•Unfair trade practices; and
•Approval of premium rates and policy forms.

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Further specific examples of insurance regulatory risks include:
Automobile Insurance Regulation
In 1998, New Jersey instituted an Urban Enterprise Zone (“UEZ”) Program, which requires New Jersey auto insurers to have a market share in certain urban territories that is in proportion to their statewide market share. Due to mandated urban rate caps, the premiums on these UEZ policies are typically insufficient to cover losses. Although the law that imposed these urban rate caps was repealed in 1998, the caps continue to be enforced by the New Jersey Department of Banking and Insurance (“NJDOBI”). In an effort to mitigate this rate inadequacy, the NJDOBI implemented a new territorial rating structure in 2008.
From time to time, legislative proposals are passed and judicial decisions are rendered related to automobile insurance regulation that could adversely affect Selective’sour results of operations. For example, in 2005 a New Jersey Supreme Court decision eliminated the application of the serious life impact standard to personal automobile bodily injury liability cases under the verbal tort threshold of New Jersey’s Automobile Insurance Cost Reduction Act (“AICRA”).AICRA. This decision allows claimants to file lawsuits for non-economic damages without proving that the injuries sustained had a serious impact on their lives.
Workers Compensation Insurance Regulation
Because Selectivewe voluntarily writeswrite workers compensation insurance, it iswe are required by state law to support the involuntary market. Insurance companies that underwrite voluntary workers compensation insurance can either directly write involuntary coverage, which is assigned by state regulatory authorities, or participate in a sharing arrangement, where the business is written by a servicing carrier and the profits or losses of that serviced business are shared among the participating insurers. SelectiveWe currently participatesparticipate through a sharing arrangement in all states. State laws regulate not only the amounts and types of workers compensation benefits that must be paid to injured workers, but in some instances the premium rates that may be charged by us to insure businesses for those liabilities. For example, in approximately 16 states, except New Jersey, where it currently writes involuntary coverage directly.workers compensation insurance rates are set by the state insurance regulators and are adjusted periodically. Historically, monoline workers compensation business has been unprofitable whether written directly or handled through a sharing arrangement. Additionally, Selective iswe are required to provide workers compensation benefits for losses arising from acts of terrorism under itsour workers compensation policies. The impact of any terrorist act is unpredictable, and the ultimate impact on Selectiveus will depend upon the nature, extent, location, and timing of such an act. Any such impact on Selectiveus could be material.
Homeowners Insurance Regulation
Selective isWe are subject to regulatory provisions that are designed to address potential availability and/or affordability problems in the homeowners property insurance marketplace. Involuntary market mechanisms, such as the New Jersey Insurance Underwriting Association (“New Jersey FAIR Plan”), generally result in assessments against the Insurance Subsidiaries. The New Jersey FAIR Plan writes fire and extended coverage on homeowners for those individuals unable to secure insurance elsewhere. Insurance companies who voluntarily write homeowners insurance in New Jersey are assessed a portion of any deficit from the New Jersey FAIR Plan based on their share of the voluntary market. Similar involuntary plans exist in most other states where Selective operates.we operate.

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Certain coastal states have instituted, or are considering adopting, legislation or regulation to maintain or increase the availability of property insurance, particularly homeowners insurance, in those states. ForAs an example, in 2002 Florida combined its two high-risk insurance pools, the Windstorm and Joint Underwriting Association, to create Florida Citizens Property Insurance Corporation (“CPIC”). CPIC is a state-regulated association and historically has provided property insurance to policyholders unable to obtain coverage in the private insurance market. However, CPIC has evolved from market of last resort to become the state’s largest property insurer. In May 2007, a new insurance law passed in Florida expanding the role of CPIC and making its rates more competitive with the private market. Florida homeowners can now purchase coverage from CPIC if the rates for a policy from a private insurer are more than 15% higher than from a similar CPIC policy. CPIC can now also offer high-risk policyholders homeowners insurance as well as wind-only coverage in other parts of the state, which is driving homeowners rates down in the private market. In addition, effective January 1, 2008, an insurer writing homeowners insurance in another state, but not in Florida, may not continue to write private passenger automobile insurance in Florida unless such insurer is affiliated with an insurer writing homeowners insurance in Florida. At this time, none of Selective’s Insurance Subsidiaries write private passenger automobile insurance in Florida.
Certain other coastalcertain states, including certain states in which Selective’sthe Insurance Subsidiaries transact homeowners insurance business, are considering legislation requiring that insurers that write homeowners insurance in any geographic area of a state must write homeowners insurance in all geographic areas of that state. SelectiveWe cannot predict whether any such legislation or regulation will be enacted, and the ultimate impact on Selectiveus will depend upon the specifics of the legislation or regulation and the state or states that adopt any such legislation or regulation.
Credit Scoring Regulation
Selective usesWe use certain aspects of credit scores when evaluating individual risks. In June 2007, the United StatesU.S. Supreme Court interpreted the Fair Credit Reporting Act (“FCRA”) concerning the meaning of the term “adverse action” as it relates to an insurance carrier’s use of credit scoring when it quotes premium for a personal lines applicant or raises premium for an existing personal lines insured. This interpretation requires insurance carriers to notify policyholders and applicants when their credit reports are the basis for adverse action, such as a rate increase. An adverse action notification, according to the interpretation, would be required if a quoted rate is higher than it would have been in a credit neutral comparison, which compares the credit score-based ratescore based-rate against a credit score neutral rate.neutral-rate. The interpretation does not require an insurance carrier to inform all policyholders that their credit reports have been reviewed in the underwriting process or that the rate they have received is higher than the best possible rate of the carrier.

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In 2007, 31 states introduced 83 bills seeking to limit or completely restrict the use of credit scores on individuals. In addition,2008, the Federal Trade Commission produced(“FTC”) asked nine of the largest homeowners insurance companies to provide information it says will allow it to determine how consumer credit data is used by the companies in underwriting and rate setting. In addition, legislation was introduced that would amend the FCRA to prohibit personal lines property casualty insurers from utilizing credit information to underwrite a report in late 2007 statingpersonal lines policy if the FTC study concludes that insurers use of credit scores is an accurate predictor of risk and is not prejudicial to minority groups. Congress is expected to continue investigating this issue and many state legislatures and agencies will continue to monitor the impact credit scoring has on the insurance marketplace.information in underwriting “results in racial or ethnic discrimination or represents a proxy or proxy effect for race or ethnicity.”
Changes to regulation regarding the use of credit scores at either the federal or state level may impact the way in which the Company priceswe price business and/or notifiesnotify policyholders or applicants of adverse actions resulting from the use of these score.
Flood Insurance Regulation
The federal government’s NFIP programscores. However, the impact of such a change would apply similarly to all market participants that currently covers flooding caused by storm surge where water is pushed toward the shore by the force of the winds swirling around a storm. If this federal program is modified in an unfavorable manner, whereby flooding related to storm surge is no longer covered or is required to be covered by homeowners policies, such modification could have a material adverse effect on Selective’s Flood and/or Homeowners results. Legislation exists that may force policies to cover claims related to windstorm damage and could lower the fee paid by the NFIP to the servicing carrier. The current repayment of claims by the NFIP could also be restricted, with the current authorization expected to last only to 2009.utilize credit scores.
Regulation and Legislation of Agent Compensation
Selective’sThe Insurance Subsidiaries sell insurance products and services primarily through appointed independent insurance agents. Accordingly, Selective seekswe seek to compensate itsour agents consistent with market practices and pay commissions and other consideration for business agents place with Selective’sthe Insurance Subsidiaries. Selective discloses itsWe disclose our compensation practices in notices to all policyholders and on Selective’sour public website, while referring all specific questions about agent compensation to the agent that placed the business with Selective.

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Because Selective’s agents also generally represent several of Selective’s competitors, Selective’s primary marketing strategy is to:
•Develop close relationships with each agent by: (i) soliciting their feedback on products and services, (ii) advising them concerning company developments, and (iii) investing significant time with them professionally and socially; and,
•Develop with each agent, and then carefully monitor, annual goals regarding: (i) types and mix of risks placed with Selective, (ii) amounts of premium or numbers of policies placed with Selective, (iii) customer service levels, and (iv) profitability of business placed with Selective.
us.
At present, Selective believes itswe believe our agent compensation practices and disclosures meet current legal and regulatory requirements. Over the last twoIn recent years, however, certain state attorneys generalattorney generals have investigated and continue to investigate, various alleged anticompetitive practices engaged in by several insurance brokers and national insurance companies that compete with Selective.us. Some of these investigations, mainly related to insureds that are much larger than Selective’sour target customers, have resulted in consent orders under which brokers and several of Selective’sour competitors have left uncontested the attorneysattorney general’s allegations that some of their compensation arrangements may have caused certain brokers to clandestinely “steer” clients to specific insurers without sufficient disclosure to the client. The consent orders also have, to one degree or another, banned the use of such compensation arrangements by the offending brokers and insurers in several, but not all, lines of business.
Given the regulatory scrutiny of compensation arrangements with brokers to date, it is possible that compensation arrangements between insurers and independent agents will come under further review and will be the subject of public policy debate and possible legislative reform. Selective monitorsWe monitor these developments but cannot determine the nature or effect, if any, that such a public policy debate or possible legislative reform will have on itsour agent compensation practices or business.
Reinsurance Regulation
Florida, a state in which Selective doeswe do not write homeowners insurance recentlyor private passenger automobile insurance, passed legislation in 2008: (i) changing the funding and operation of the Florida state-sponsored insurer of last resort, Citizens Property Insurance Corporation, and the Florida Hurricane Catastrophe Fund (“FHCF”), which is the Florida state-sponsored reinsurance facility,facility; and (ii) prohibiting residential property insurers from including in rate calculations the additional costs of private reinsurance or loss exposure that duplicates FHCF coverage. In the short-term, such legislative action may increase overall private property reinsurance availability and reduce itsour costs outside of Florida. Should other states in which Selective writeswe write business enact similar legislation, it is possible that Selectivewe may not be able to include the costs of reinsurance that it deemswe deem appropriate in itsour rates. In such an event, Selectivewe may be forced, if permitted under applicable law, to exit certain markets. If not permitted to exit such markets, Selectivewe may face unfair competitive situations, where state-sponsored insurers implement rate freezes or decreases.
Selective’s ability to reduce its exposure toWe face risks depends onas a servicing carrier in the availability and costWYO Program of reinsurance.the U.S. government’s NFIP.
Selective transfers its risk exposure to other insurance and reinsurance companies through reinsurance arrangements. Through these arrangements, another insurer assumesWe are a specified portionservicing carrier in the WYO program of the Company’s lossesNFIP. Flood insurance is offered through the NFIP, which is managed by the Mitigation Division of FEMA under the U.S. Department of Homeland Security. On September 30, 2008, a law was passed to extend the NFIP authority to issue new policies, increase coverage on existing policies, and loss adjustment expenses in exchange for a specified portion of the insurance policy premiums.issue renewal policies until March 6, 2009. The availability, amount, and cost of reinsurance depend on market conditions, which may vary significantly. Any decreaseNFIP currently has borrowing authority established by Congress in the amount of Selective’s reinsurance will increase its risk$20.8 billion and, prior to Hurricane Ike in the third quarter of loss.
Selective also faces credit risk2008, had borrowed $17.3 billion from the U.S. Treasury. FEMA is currently seeking additional borrowings from the U.S. Treasury as the current limitation is expected to only last into the first quarter of 2010. We continue to monitor developments with respectthe NFIP.

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As a servicing carrier in the WYO program we receive an expense allowance, or servicing fee, for policies written and claims serviced under the WYO program. Effective June 1, 2008, the NFIP revised their claim servicing fee structure to reinsurance. In addition, reinsurersprovide for fees of 1% of direct premiums written, which are paid even in non-catastrophe years, coupled with fees equal to 1.5% of all incurred losses. Prior to June 1, 2008, we received claims handling fees equal to 3.3% of all incurred losses. Effective October 1, 2008, the Company has contracted with may default in their financial obligations as a result of insolvency, lack of liquidity, operational failureexpense allowance for servicing policies written was increased 0.1% to 29.8%. Any future changes to the fee structure or other reasons. The inability of anythe expenses incurred by us to adhere to additional regulatory requirements of the Company’s reinsurersWYO program could have an adverse effect on our operations.
While currently there are no active bills in Congress reforming the NFIP, we do expect to meet their financialsee legislative activity in 2009. It is possible that this federal program could be modified in an unfavorable manner having an adverse effect on our flood results, potentially affecting our continued participation in the program.
Changes in tax laws impacting marginal tax rates and/or the preferred tax treatment of municipal obligations could materially andadversely impact our business.
Tax legislation which changes the tax preference of municipal obligations under current law could adversely affect Selective’s operations,the market value of municipal obligations. At December 31, 2008, 48% of our investment portfolio was invested in tax-exempt municipal obligations; as such, the Company remains primarily liable to its customers undervalue of our investment portfolio could be adversely affected by any such legislation. Additionally, any such changes in tax law could reduce the policies that it has reinsured.difference between tax-exempt interest rates and taxable rates.
Class action litigation could affect Selective’sour business practices and financial results.
Selective’sOur industries have been the target of class action litigation in areas including the following:
 • After-market crash parts;
 
 • Urban homeowner insurance underwriting practices;
 
 • Credit scoring and predictive modeling pricing;
 
 • Investment disclosure;
 
 • Health maintenance organization practices;
 
 • Discounting and payment of personal injury protection claims; and
 
 • Shareholder class action suits.

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A change in Selective’sour market share in New Jersey could adversely impact the results of itsour private passenger automobile business.
New Jersey insurance regulations require New Jersey auto insurers to involuntarily write private passenger automobile insurance for individuals who are unable to obtain insurance in the voluntary market. These policies are priced according to a separate rating scheme that is established by the assigned risk plan and subject to approval by NJDOBI. The amount of involuntary insurance an insurer must write in New Jersey depends on the insurer’s statewide market share — the greater the market share, the more involuntary coverage the insurer is required to write. The underwriting of involuntary personal automobile insurance in New Jersey has been historically unprofitable. In addition to the assigned risk plan in New Jersey, there are ongoing attempts to address rate disparities between different geographic regions in the state, as well as judicial attempts to address limitations of lawsuits. In 2008, the NJDOBI implemented a new territorial rating structure to, in part, address the historical geographic subsidization. If our market share in New Jersey increases it could adversely impact the results of our private passenger automobile business if we are required to write more involuntary coverage.
Selective dependsWe depend on key personnel.
To a large extent, the success of Selective’sour businesses is dependent on itsour ability to attract and retain key employees, in particular itsour senior officers, key management, sales, information systems, underwriting, claims, HR Outsourcing, and corporate personnel. Competition to attract and retain key personnel is intense. While Selective haswe have employment agreements with a number of key managers, the Companywe generally doesdo not have employment contracts with itsour employees and cannot ensure that itwe will be able to attract and retain key personnel. In addition, Selective’sour workforce is older, with an average age of 47.45 as of December 31, 2008. Approximately 25%18% of Selective’sour workforce isas of December 31, 2008 was retirement eligible under Selective’sour retirement and benefit plans.

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Selective facesWe face risks from technology-related failures.
Selective’sOur businesses are increasingly dependent on computer and Internet-enabled technology. The Company’sOur inability to anticipate or manage problems with technology associated with scalability, security, functionality, or reliability could adversely affect itsour ability to write business and service accounts, and could adversely impact itsour results of operations and financial condition.
Selective faces risks as a servicing carrier in the “Write-Your-Own” (“WYO”) Program of the United States government’s National Flood Insurance Program (“NFIP”).
Flood insurance is offered through the NFIP, which is managed by the Mitigation Division of FEMA under the U.S. Department of Homeland Security. In 2005, the destruction caused by the active hurricane season stressed the NFIP with flood losses currently estimated by FEMA to be in excess of $20 billion. Selective continues to monitor developments with the NFIP regarding its ability to pay claims in the event of another large-scale disaster. Congress controls the federal agency’s funding authority and future limitations in this funding could occur.
Effective October 1, 2006, the fee paid to Selective by the NFIP decreased 0.6 points to 30.2% of premiums written. This fee structure is still in place as of December 31, 2007. However, during 2008, the NFIP is expected to further decrease the fee 0.5 points to 29.7%. Further reductions in this rate could occur through legislative activity.
The current program is also being reevaluated to include a cap on claim fees paid by the NFIP. While the final outcome of this legislation is unknown, this cap could impact the ultimate claim fee the Company could receive in the event that there is a large catastrophe in an area in which Selective is geographically concentrated.
Selective facesWe face risks in the HR Outsourcing business.
Selective HR’s operations areHR is affected by numerous federal and state laws and regulations relating to employment matters, benefits plans, and taxes. In performing services for its clients, Selective HR assumes some obligations of an employer under these laws and regulations. Regulation in the HR Outsourcing business is constantly evolving, which could result in the modification of laws and regulations from time to time. SelectiveWe cannot predict what additional government initiatives, if any, affecting Selective HR’s businessHR may be promulgated in the future. Consequently, the Companywe also cannot predict whether Selective HR will be able to adapt to new or modified regulatory requirements or obtain necessary licenses and government approvals.
The severe downturn in the U.S. economy has particularly affected small businesses, which are the core of Selective is subjectHR’s customer base. Selective HR enters into agreements with these small businesses to establish a three-party relationship under which Selective HR and the compliance requirementssmall business are co-employers of the federal securities laws.
employees who work at the small business’ location (“worksite employees”). As these small businesses continue to feel the strain of liquidity issues, they may: (i) bring “in-house” the services that Selective HR provides to them; (ii) reduce their payrolls; or (iii) cease to continue their operations all together. The loss of these worksite employees will adversely affect Selective HR’s revenues. Furthermore, since Selective HR is subjectconsidered the co-employer of their clients’ employees, the rising unemployment rates in the U.S. will cause deterioration on Selective HR’s SUTA margins. This rise in unemployment rates, coupled with anticipated extensions of unemployment benefits, could put pressure on many states’ unemployment funds and is anticipated to extensive regulation under the federal securities laws as a registrant under the Securities Exchange Act of 1934, as amended. In the event Selective wasresult in future SUTA rate increases. We are unable to comply withpredict the federal securities laws,likely duration and severity of the Company would likely be unable to accesscurrent disruptions in financial markets and adverse economic conditions in the public capital markets, which would make it more difficult to raise necessary capital and/or increase the cost of capital. If Selective cannot obtain adequate capital on favorable terms or at all, the business, operating results and financial condition would be adversely affected.U.S.

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Selective employsWe employ anti-takeover measures that may discourage potential acquirers and could adversely affect the value of its Common Stock.the Parent common stock.
SelectiveThe Parent owns all of the shares of stock of itsthe Insurance Subsidiaries domiciled in the states of New Jersey, New York, North Carolina, South Carolina, and Maine.Subsidiaries. State insurance laws require prior approval by state insurance departments of any acquisition or control of a domestic insurance company or of any company that controls a domestic insurance company. Any purchase of 10% or more of Selective’sthe Parent’s outstanding Common Stockcommon stock would require prior action by all or some of the insurance commissioners of these states.the Insurance Subsidiaries’ states of domicile.
Other factors also may discourage, delay, or prevent a change of control of Selective,us, including, among others, provisions in the Company’sour certificate of incorporation (as amended), relating to:
 • Supermajority voting and fair price to Selective’sour business combinations;
•Staggered terms for Selective’s directors;
 
 • Supermajority voting requirements to amend the foregoing provisions;
•Selective’s stockholders’ rights plan; and
 
 • The ability of Selective’s board of directorsthe Board to issue “blank check” preferred stock.
The New Jersey Shareholders’ Protection Act provides that Selective,we, as a New Jersey corporation, may not engage in business combinations specified in the statute with a shareholder having indirect or direct beneficial ownership of 10% or more of the voting power of Selective’sthe Parent’s outstanding stock (an interested shareholder) for a period of five years following the date on which the shareholder became an interested shareholder, unless the business combination is approved by the board of directors of the corporation before the date the shareholder became an interested shareholder. In addition, Selectivewe may not engage at any time in any business combination with any interested shareholder other than: (i) a business combination approved by Selective’s board of directorsthe Board prior to the shareholder becoming an interested shareholder; (ii) a business combination approved by two-thirds of Selective’sour shareholders (other than the interested shareholder); or (iii) a business combination that satisfies certain price criteria. These provisions also could have the effect of depriving Selectiveour stockholders of an opportunity to receive a premium over the prevailing market price if a hostile takeover were attempted and may adversely affect the value of Selective’s Common Stock.the Parent’s common stock.

 

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Item 1B. Unresolved Staff Comments
None.
Item 2. Properties.
Selective’sOur main office is located in Branchville, New Jersey, on a site owned by a subsidiary with approximately 114 acres and 315,000 square feet of operational space. Selective leasesWe lease all of itsour other facilities. The principal office locations related to Selective’sour three business segments are described in the “Field Strategy,” “Investments Segment,” and “Human Resource Administration“HR Outsourcing” sections of Item 1. “Business.” Selective believes itsWe believe our facilities provide adequate space for itsour present needs and that additional space, if needed, would be available on reasonable terms.
Item 3. Legal Proceedings.
In the ordinary course of conducting business, Selective and its subsidiarieswe are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving the Insurance Subsidiaries as either: (a)either; (i) liability insurers defending or providing indemnity for third-party claims brought against insuredsinsureds; or (b)(ii) insurers defending first-party coverage claims brought against them. Selective accountsWe account for such activity through the establishment of unpaid loss and loss adjustment expense reserves. Selective’s management expectsWe expect that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to Selective’sour consolidated financial condition, results of operations, or cash flows.
From time-to-time,time to time, the Insurance Subsidiaries are also involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative state class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper reimbursement of medical providers paid under workers compensation and personal and commercial automobile insurance policies. The Insurance Subsidiaries are also from time-to-timetime to time involved in individual actions in which extra-contractual damages, punitive damages, or penalties are sought, such as claims alleging bad faith in the handling of insurance claims. Selective believesWe believe that it haswe have valid defenses to these cases. Selective’s management expectscases and expect that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to Selective’sour consolidated financial condition. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in certain matters could, from time-to-time,time to time, have a material adverse effect on Selective’sour consolidated results of operations or cash flows in particular quarterly or annual periods.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of 2007.2008.

 

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PART II
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
(a) Market Information
Selective’s Common Stock

The Parent’s common stock is traded on the NASDAQ Global Select Market under the symbol “SIGI.” The following table sets forth the high and low sales prices, as reported on the NASDAQ Global Select Market, for Selective’s Common Stockthe Parent’s common stock for each full quarterly period within the two most recent fiscal years:
                                
 2007 2006  2008 2007 
 High Low High Low  High Low High Low 
First Quarter $29.07 23.25 29.18 26.10  $27.03 20.78 29.07 23.25 
Second Quarter 27.87 25.27 28.23 25.38  26.22 18.74 27.87 25.27 
Third Quarter 27.33 19.04 28.02 24.89  30.40 17.81 27.33 19.04 
Fourth Quarter 25.41 20.84 29.10 25.95  26.49 16.33 25.41 20.84 
On February 22, 2008,20, 2009, the closing price of Selectivethe Parent’s common stock as reported on the NASDAQ Global Select Market was $24.40.$12.67.
(b) Holders
As of February 15, 2008,13, 2009, there were approximately 2,6512,555 holders of record of Selective’s Common Stock,the Parent’s common stock, including beneficial holders whose securities were held in the name of the registered clearing agency or its nominee.
(c) Dividends
Dividends on shares of Selective’s Common Stockthe Parent’s common stock are declared and paid at the discretion of the Board of Directors based on Selective’sour operating results, financial condition, capital requirements, contractual restrictions, and other relevant factors. The following table provides information on the dividends declared for each quarterly period within Selective’sour two most recent fiscal years:
                
Dividend per share 2007 2006  2008 2007 
First Quarter $0.12 $0.11  $0.13 $0.12 
Second Quarter 0.12 0.11  0.13 0.12 
Third Quarter 0.12 0.11  0.13 0.12 
Fourth Quarter 0.13 0.11  0.13 0.13 
Selective’sOur ability to declare dividends is restricted by covenants contained in our 8.87% senior notes that itwe issued on May 4, 2000 (“2000 Senior Notes”).2000. See Note 9 to the consolidated financial statements entitled, “Indebtedness.” All such covenants were met during 20072008 and 2006.2007. At December 31, 2007,2008, the amount available for dividends to holders of Selective’sour common shares under such restrictions was $336.0$302.6 million for the 20008.87% Senior Notes.
Selective’sOur ability to receive dividends, loans, or advances from itsthe Insurance Subsidiaries is subject to the approval and/or review of the insurance regulators in the respective domiciliary states of the Insurance Subsidiaries. Such approval and review is made under the respective domiciliary states’ insurance holding company acts, which generally require that any transaction between related companies be fair and equitable to the insurance company and its policyholders. Selective does not believeAlthough our dividends have historically been met with regulatory approval, there is no assurance that such restrictions materially limit the ability of the Insurance Subsidiaries to payfuture dividends to Selective now or in the foreseeable future. Selectivewill be approved given current market conditions. We currently expectsexpect to continue to pay quarterly cash dividends on shares of its Common Stockthe Parent’s common stock in the future.
(d) Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information about Selective’s Common Stockthe Parent’s common stock authorized for issuance under equity compensation plans as of December 31, 2007:2008:
                        
 (a) (b) (c)      (c) 
 Number of  Number of 
 securities remaining  (a)   securities remaining 
 Number of available for  Number of available for 
 securities to future issuance under  securities to be (b) future issuance under 
 be issued upon Weighted-average equity compensation  issued upon Weighted-average equity compensation 
 exercise of exercise price of plans (excluding  exercise of exercise price of plans (excluding 
 outstanding options, outstanding options, securities reflected  outstanding options, outstanding options, securities reflected in 
Plan Category warrants and rights warrants and rights in column (a))  warrants and rights warrants and rights column (a)) 
Equity compensation plans approved by security holders 1,241,153 $16.69  5,448,923(1) 1,158,847 $18.73  5,041,5121
(1)1 Includes 251,434116,873 shares available for issuance under Selective’sthe Employee Stock Purchase Savings Plan, 2,418,7542,641,471 shares available for issuance under Selective’sthe Stock Purchase Plan for Independent Insurance Agencies, and 2,283,168 shares available for issuance under the 2005 Omnibus Stock Plan, whichPlan. Future grants under this plan can be issued,made, among other things, as stock options, restricted stock units, or restricted stock awards, and 2,778,735 shares available for issuance under Selective’s Stock Purchase Plan for Independent Insurance Agencies.stock.

 

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(e) Performance Graph
The following chart, produced by Research Data Group, Inc., depicts Selective’sour performance for the period beginning December 31, 20022003 and ending December 31, 2007,2008, as measured by total stockholder return on the Company’s Common StockParent’s common stock compared with the total return of the NASDAQ Composite Index and a select group of peer companies.companies comprised of NASDAQ-listed companies in SIC Code 6330-6339, Fire, Marine, and Casualty Insurance.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Selective Insurance Group Inc., The NASDAQ Composite Index
And A Peer Group
*$100 invested on 12/31/02 in stock or index-including reinvestment of dividents. Fiscal year ending December 31.
Notwithstanding anything to the contrary set forth in any of Selective’sour previous filings under the Securities Act of 1933 or the Exchange Act that might incorporate future filings made by Selectiveus under those statutes, the preceding performance graph will not be incorporated by reference into any of those prior filings, nor will such graph be incorporated by reference into any future filings made by Selectiveus under those statutes.statutes except to the extent we specifically incorporate it by reference into any of such filings.
(f) Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The following table provides information regarding Selective’sour purchase of its own Common Stockthe Parent’s common stock in the fourth quarter of 2007:2008:
                 
          Total Number of  Maximum Number 
          Shares Purchased  of Shares that May Yet Be 
      Average Price  as Part of Publicly  Purchased Under the 
  Total Number of  Paid  Announced Plans  Announced Plans 
Period Shares Purchased1  per Share  or Programs2  or Programs2 
October 1-31, 2007  163,505  $24.27   —   3,519,300 
November 1-30, 2007  4,017   22.75   —   3,519,300 
December 1-31, 2007  10,619   24.07   —   3,519,300 
              
Total
  178,141  $24.22   —     
                 
          Total Number of  Maximum Number 
          Shares Purchased  of Shares that May Yet Be 
      Average Price  as Part of Publicly  Purchased Under the 
  Total Number of  Paid  Announced Plans  Announced Plans 
Period Shares Purchased1  per Share  or Programs2  or Programs2 
October 1-31, 2008  46,429  $23.46   —   1,748,766 
November 1-30, 2008  1,180   21.04   —   1,748,766 
December 1-31, 2008  12,375   21.76   —   1,748,766 
              
Total  59,984  $23.06   —   1,748,766 
1 During the fourth quarter of 2007, 174,0472008, 52,836 shares were purchased from employees in connection with the vesting of restricted stock and 4,0947,148 shares were purchased from employees in connection with stock option exercises. These repurchases were made in connection with satisfying tax withholding obligations with respect to those employees. These shares were not purchased as part of the publicly announced program. The shares that were purchased in connection with the vesting of restricted stock were purchased at the closing price on the dates of purchase. The shares purchased in connection with the option exercises were purchased at the current market prices of Selective’s Common Stockthe Parent’s common stock on the dates of the purchases.options were exercised.
 
2 On July 24, 2007, the Board of Directors authorized a new share repurchase program for up to 4 million shares, which expires on July 26, 2009. During the fourth quarter of 2007,2008, no shares were repurchased, leaving 3,519,3001,748,766 shares remaining to be purchased under the authorized program.

 

3440

Item 6. Selected Financial Data.
                     
Eleven-Year Financial Highlights1               
 
(All presentations are in accordance with               
GAAP unless noted otherwise, number of               
weighted average shares and dollars in               
thousands, except per share amounts) 2007  2006  2005  2004  2003 
Net premiums written $1,554,867   1,535,961   1,459,474   1,365,148   1,219,159 
Net premiums earned  1,517,306   1,499,664   1,418,013   1,318,390   1,133,070 
Net investment income earned  174,144   156,802   135,950   120,540   114,748 
Net realized gains (losses)
  33,354   35,479   14,464   24,587   12,842 
Diversified Insurance Services revenue from continuing operations2,3
  115,566   110,526   98,711   86,484   70,780 
Total revenues  1,846,228   1,807,867   1,671,012   1,553,624   1,335,056 
Underwriting profit (loss)  15,957   57,978   69,728   40,768   (25,252)
Diversified Insurance Services income (loss) from continuing operations2,3
  18,623   17,808   14,793   11,921   6,194 
Net income from continuing operations3
  146,498   163,574   147,452   127,177   64,375 
Total discontinued operations, net of tax3
  —   —   546   1,462   1,969 
Cumulative effect of change in account principle, net of tax  —   —   495   —   — 
Net income  146,498   163,574   148,493   128,639   66,344 
Comprehensive income  131,940   159,802   112,078   134,723   99,362 
Total assets  5,001,992   4,767,705   4,375,625   3,912,411   3,423,925 
Notes payable and debentures6
  295,067   362,602   339,409   264,350   238,621 
Stockholders’ equity  1,076,043   1,077,227   981,124   882,018   749,784 
Statutory premiums to surplus ratio4
  1.5   1.5   1.6   1.7   1.8 
Statutory combined ratio2,5
  97.5   95.4   94.6   95.9   101.5 
Combined ratio2,5
  98.9   96.1   95.1   96.9   102.2 
Yield on investment, before-tax  4.8   4.6   4.6   4.7   5.1 
Debt to capitalization  21.5   25.2   25.7   23.1   24.1 
Return on average equity  13.6   15.9   15.9   15.8   9.5 
                     
Per share data:                    
Net income from continuing operations3:
                    
Basic $2.80   2.98   2.72   2.38   1.23 
Diluted  2.59   2.65   2.33   2.01   1.07 
                     
Net income:                    
Basic $2.80   2.98   2.74   2.41   1.27 
Diluted  2.59   2.65   2.35   2.04   1.10 
                     
Dividends to stockholders $0.49   0.44   0.40   0.35   0.31 
                     
Stockholders’ equity $19.81   18.81   17.34   15.79   13.74 
                     
Price range of Common Stock:                    
High $29.07   29.18   29.64   22.98   16.50 
Low  19.04   24.89   20.88   15.86   10.91 
Close  22.99   28.65   26.55   22.12   16.18 
                     
Number of weighted average shares:                    
Basic  52,382   54,986   54,342   53,462   52,262 
Diluted  57,165   62,542   64,708   64,756   63,206 
Eleven-Year Financial Highlights1
                     
(All presentations are in accordance with               
GAAP unless noted otherwise, number of               
weighted average shares and dollars in               
thousands, except per share amounts) 2008  2007  2006  2005  2004 
Net premiums written $1,484,041   1,554,867   1,535,961   1,459,474   1,365,148 
Net premiums earned  1,495,490   1,517,306   1,499,664   1,418,013   1,318,390 
Net investment income earned  131,032   174,144   156,802   135,950   120,540 
Net realized (losses) gains  (49,452)  33,354   35,479   14,464   24,587 
Diversified Insurance Services revenue from continuing operations2,3
  116,346   115,566   110,526   98,711   86,484 
Total revenues  1,695,979   1,846,228   1,807,867   1,671,012   1,553,624 
Underwriting (loss) profit  (15,226)  15,957   57,978   69,728   40,768 
Diversified Insurance Services income (loss) from continuing operations2,3
  14,527   18,623   17,808   14,793   11,921 
Net income from continuing operations3
  43,758   146,498   163,574   147,452   127,177 
Total discontinued operations, net of tax3
  —   —   —   546   1,462 
Cumulative effect of change in account principle, net of tax  —   —   —   495   — 
Net income  43,758   146,498   163,574   148,493   128,639 
Comprehensive (loss) income  (136,741)  131,940   159,802   112,078   134,723 
Total assets  4,941,332   5,001,992   4,767,705   4,375,625   3,912,411 
Notes payable and debentures6
  273,878   295,067   362,602   339,409   264,350 
Stockholders’ equity  890,493   1,076,043   1,077,227   981,124   882,018 
Statutory premiums to surplus ratio4
  1.7   1.5   1.5   1.6   1.7 
Statutory combined ratio2,5
  99.2   97.5   95.4   94.6   95.9 
Combined ratio2,5
  101.0   98.9   96.1   95.1   96.9 
Yield on investment, before-tax  3.6   4.8   4.6   4.6   4.7 
Debt to capitalization  23.5   21.5   25.2   25.7   23.1 
Return on average equity  4.5   13.6   15.9   15.9   15.8 
   
Per share data:                    
Net income from continuing operations3:
                    
Basic $0.84   2.80   2.98   2.72   2.38 
Diluted  0.82   2.59   2.65   2.33   2.01 
                     
Net income:                    
Basic $0.84   2.80   2.98   2.74   2.41 
Diluted  0.82   2.59   2.65   2.35   2.04 
   
Dividends to stockholders $0.52   0.49   0.44   0.40   0.35 
   
Stockholders’ equity $16.84   19.81   18.81   17.34   15.79 
                     
Price range of Common Stock:                    
High $30.40   29.07   29.18   29.64   22.98 
Low  16.33   19.04   24.89   20.88   15.86 
Close  22.93   22.99   28.65   26.55   22.12 
                     
Number of weighted average shares:                    
Basic  52,104   52,382   54,986   54,342   53,462 
Diluted  53,319   57,165   62,542   64,708   64,756 
1.1 See the Glossary of Terms attached to this Form 10-K as Exhibit 99.1.
 
2.2 Flood business is included in statutory underwriting results in accordance with prescribed statutory accounting practices. On a GAAP basis only, flood servicing revenue and expense has been reclassified from underwriting results to Diversified Insurance Services.
 
3.3 See Item 8. “Financial Statements and Supplementary Data,” Note 15 to the consolidated financial statements and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the section entitled “Diversified Insurance Services Segment” for a discussion of discontinued operations and Item 8. “Financial Statements and Supplementary Data,” Note 12 to the consolidated financial statements for the components of of income. In 2002, we sold our ownership interest in PDA Software Services, Inc. and in 2005, we sold our ownership interest in CHN Solutions (Alta Services, LLC and Consumer Health Network Plus, LLC), both of which had historically been reported as components of the Diversified Insurance Services segment.

 

3541

                         
  2002  2001  2000  1999  1998  1997 
   1,053,487   925,420   843,604   811,677   748,873   717,618 
   988,268   883,048   821,265   799,065   722,992   676,268 
   103,067   96,767   99,495   96,531   99,196   100,530 
   3,294   6,816   4,191   29,377   (2,139)  6,021 
                         
   59,399   51,783   43,463   22,554   8,562   7,060 
   1,157,553   1,041,177   972,153   950,669   831,791   793,007 
   (38,743)  (60,638)  (65,122)  (54,147)  (24,986)  (3,022)
                         
   3,103   (3,819)  2,112   4,257   1,765   646 
   40,310   24,112   24,487   53,483   53,277   69,531 
   1,659   1,581   2,048   234   293   77 
                         
  —  —  —  —  —  — 
   41,969   25,693   26,535   53,717   53,570   69,608 
   59,366   24,405   49,166   16,088   78,842   105,931 
   3,016,335   2,673,721   2,590,903   2,507,545   2,432,168   2,306,191 
   262,768   156,433   163,634   81,585   88,791   96,559 
   652,102   591,160   577,797   569,964   607,583   565,316 
   1.9   1.8   1.7   1.6   1.5   1.5 
   103.2   106.7   108.2   105.7   103.2   100.1 
   103.9   106.9   107.9   106.8   103.6   100.3 
   5.4   5.4   5.8   5.6   5.7   6.0 
   28.7   21.0   22.1   12.5   13.2   14.6 
   6.8   4.4   4.6   9.1   9.1   13.4 
                         
   0.80   0.50   0.50   0.99   0.94   1.21 
   0.74   0.46   0.47   0.93   0.87   1.14 
                         
   0.83   0.53   0.54   0.99   0.94   1.21 
   0.77   0.49   0.51   0.94   0.87   1.14 
                         
   0.30   0.30   0.30   0.30   0.28   0.28 
                         
   12.26   11.58   11.46   10.73   10.65   9.66 
                         
   15.74   14.11   12.94   11.25   14.63   14.19 
   9.68   9.97   7.32   8.25   8.35   9.16 
   12.59   10.87   12.13   8.60   10.07   13.50 
                         
   50,602   49,166   49,814   54,162   56,960   57,818 
   55,990   52,848   53,144   57,754   60,824   61,850 
                       
 
 
 
2003		  2002  2001  2000  1999  1998 
 1,219,159   1,053,487   925,420   843,604   811,677   748,873 
 1,133,070   988,268   883,048   821,265   799,065   722,992 
 114,748   103,067   96,767   99,495   96,531   99,196 
 12,842   3,294   6,816   4,191   29,377   (2,139)
 
 		70,780   59,399   51,783   43,463   22,554   8,562 
 1,335,056   1,157,553   1,041,177   972,153   950,669   831,791 
 (25,252)  (38,743)  (60,638)  (65,122)  (54,147)  (24,986)
                       
 6,194   3,103   (3,819)  2,112   4,257   1,765 
 64,375   40,310   24,112   24,487   53,483   53,277 
 1,969   1,659   1,581   2,048   234   293 
 
 		—   —   —   —   —   — 
 66,344   41,969   25,693   26,535   53,717   53,570 
 99,362   59,366   24,405   49,166   16,088   78,842 
 3,423,925   3,016,335   2,673,721   2,590,903   2,507,545   2,432,168 
 238,621   262,768   156,433   163,634   81,585   88,791 
 749,784   652,102   591,160   577,797   569,964   607,583 
 1.8   1.9   1.8   1.7   1.6   1.5 
 101.5   103.2   106.7   108.2   105.7   103.2 
 102.2   103.9   106.9   107.9   106.8   103.6 
 5.1   5.4   5.4   5.8   5.6   5.7 
 24.1   28.7   21.0   22.1   12.5   13.2 
 9.5   6.8   4.4   4.6   9.1   9.1 
                       
                       
                       
 1.23   0.80   0.50   0.50   0.99   0.94 
 1.07   0.74   0.46   0.47   0.93   0.87 
                       
                       
 1.27   0.83   0.53   0.54   0.99   0.94 
 1.10   0.77   0.49   0.51   0.94   0.87 
                       
 0.31   0.30   0.30   0.30   0.30   0.28 
                       
 13.74   12.26   11.58   11.46   10.73   10.65 
                       
                       
 16.50   15.74   14.11   12.94   11.25   14.63 
 10.91   9.68   9.97   7.32   8.25   8.35 
 16.18   12.59   10.87   12.13   8.60   10.07 
                       
                       
 52,262   50,602   49,166   49,814   54,162   56,960 
 63,206   55,990   52,848   53,144   57,754   60,824 
4.4 Regulatory and rating agencies use the statutory premiums to surplus ratio as a measure of solvency, viewing an increase in the ratio as a possible increase in solvency risk. Management and analysts also view this ratio as a measure of the effective use of capital because, as the ratio increases, revenue per dollar of capital increases, indicating the possibility of increased returns or increased losses due to the effects of leverage.
 
5.5 Changes in both the GAAP and statutory combined ratios are viewed by management and analysts as indicative of changes in the profitability of underwriting operations. A ratio over 100% is indicative of an underwriting loss, and a ratio below 100% is indicative of an underwriting profit.
 
6.6 See Item 8. “Financial Statements and Supplementary Data,” Note 9 to the consolidated financial statements for a discussion of notes payable and debentures.

 

3642

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Forward-looking Statements
Certain statements in this report, including information incorporated by reference, are “forward-looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995 (“PSLRA”). The PSLRA provides a safe harbor under the Securities Act of 1933 and the Securities Exchange Act of 1934 for forward-looking statements. These statements relate to Selective’sour intentions, beliefs, projections, estimations or forecasts of future events or future financial performance and involve known and unknown risks, uncertainties and other factors that may cause Selective’sus or the industry’s actual results, levels of activity, or performance to be materially different from those expressed or implied by the forward-looking statements. In some cases, forward-looking statements may be identified by use of words such as “may,” “will,” “could,” “would,” “should,” “expect,” “plan,” “anticipate,” “target,” “project,” “intend,” “believe,” “estimate,” “predict,” “potential,” “pro forma,” “seek,” “likely” or “continue” or other comparable terminology. These statements are only predictions, and Selectivewe can give no assurance that such expectations will prove to be correct. Selective undertakesWe undertake no obligation, other than as may be required under the federal securities laws, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Factors that could cause Selective’sour actual results to differ materially from those Selective haswe have projected, forecasted or estimated in forward-looking statements are discussed in further detail in Item 1A. “Risk Factors.” These risk factors may not be exhaustive. Selective operatesWe operate in a continually changing business environment, and new risk factors emerge from time-to-time. Selectivetime to time. We can neither predict such new risk factors nor can Selectivewe assess the impact, if any, of such new risk factors on Selective’sour 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.
Introduction
Selective Insurance Group, Inc., (“Selective,” the “Company,” “we,” or “our”) offersWe offer property and casualty insurance products and diversified insurance services through itsour various subsidiaries. Selective classifies itsWe classify our businesses into three operating segments: (i) Insurance Operations; (ii) Investments; and (iii) Diversified Insurance Services.
The purpose of the 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. For convenience and reading ease, we have written the remainder of the MD&A in the first person plural.
In the MD&A, we will discuss and analyze the following:
• Critical Accounting Policies and Estimates;
 
• Financial Highlights of Results for years ended December 31, 2008, 2007, 2006, and 2005;2006;
 
• Results of Operations and Related Information by Segment;
•Federal Income Taxes;
 
• Financial Condition, Liquidity, and Capital Resources;
 
• Off-Balance Sheet Arrangements;
 
• Contractual Obligations and Contingent Liabilities and Commitments;
•Federal Income Taxes; and
 
• Adoption of Accounting Pronouncements.
Critical Accounting Policies and Estimates
We have identified the policies and estimates described below as critical to our business operations and the understanding of the results of our operations. Our preparation of the Consolidated Financial Statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our Consolidated Financial Statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates. Those estimates that were most critical to the preparation of the financial statementsConsolidated Financial Statements involved the following: (i) reserve for losses and loss expenses; (ii) deferred policy acquisition costs; (iii) pension and postretirementpost-retirement benefit plan actuarial assumptions; (iv) OTTI; (v) goodwill; and (iv) other-than-temporary investment impairments.(vi) reinsurance.

 

3743

Reserves for Losses and Loss Expenses
Significant periods of time can elapse between the occurrence of an insured loss, the reporting of the loss to the insurer, and the insurer’s payment of that loss. To recognize liabilities for unpaid losses and loss expenses, insurers establish reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported net losses and loss expenses. As of December 31, 2007,2008, we had accrued $2.5$2.6 billion of gross loss and loss expense reserves compared to $2.3$2.5 billion at December 31, 2006.2007.
How reserves are established
When a claim is reported to an insurance subsidiary, claims personnel establish a “case reserve” for the estimated amount of the ultimate payment. The amount of the reserve is primarily based upon a case-by-casecase by case evaluation of the type of claim involved, the circumstances surrounding each claim, and the policy provisions relating to the type of losses. The estimate reflects the informed judgment of such personnel based on their knowledge, experience, and general insurance reserving practices. Until the claim is resolved, these estimates are revised as deemed appropriate by the responsible claims personnel based on subsequent developments and periodic reviews of the case.
In addition to case reserves, we maintain estimates of reserves for losses and loss expenses incurred but not yet reported (“IBNR”).IBNR. Using generally accepted actuarial reserving techniques, we project our estimate of ultimate losses and loss expenses at each reporting date. The difference between: (i) projected ultimate loss and loss expense reserves and (ii) case loss reserves and loss expense reserves thereon are carried as the IBNR reserve. The actuarial techniques used are part of a comprehensive reserving process that includes two primary components. The first component is a detailed quarterly reserve analysis performed by our internal actuarial staff, which is managed independently from the operating units.In completing this analysis, the actuaries are required to make numerous assumptions, including, for example, the selection of loss development factors and the weight to be applied to each individual actuarial indication. These indications include paid and incurred versions for the following actuarial methodologies: loss development, Bornhuetter-Ferguson, Berquist-Sherman, and frequency/severity. Additionally, the actuaries must gather substantially similar data in sufficient volume to ensure the statistical credibility of the data. The second component of the analysis is the projection of the expected ultimate loss ratio for each line of business for the current accident year. This projection is part of our planning process wherein we review and update expected loss ratios each quarter. This review includes actual versus expected pricing changes, loss trend assumptions, and updated prior period loss ratios from the most recent quarterly reserve analysis.
In addition to the most recent loss trends, a range of possible IBNR reserves is determined annually and continually considered, among other factors, in establishing IBNR for each reporting period. Loss trends include, but are not limited to, large loss activity, environmental claim activity, large case reserve additions or reductions for prior accident years, and reinsurance recoverable issues. We also consider factors such as: (i) per claim information; (ii) company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the imposition of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. Based on the consideration of the range of possible IBNR reserves, recent loss trends, uncertainty associated with actuarial assumptions and other factors, IBNR is established and the ultimate net liability for losses and loss expenses is determined. Such an assessment requires considerable judgment given that it is frequently not possible to determine whether a change in the data is an anomaly until some time after the event. Even if a change is determined to be permanent, it is not always possible to reliably determine the extent of the change until some time later. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves because the eventual deficiency or redundancy is affected by many factors. The changes in these estimates, resulting from the continuous review process and the differences between estimates and ultimate payments, are reflected in the consolidated statements of income for the period in which such estimates are changed. Any changes in the liability estimate may be material to the results of operations in future periods.
Major trends by line of business creating additional loss and loss expense reserve uncertainty
The Insurance Subsidiaries are multi-state, multi-line property and casualty insurance companies and, as such, are subject to reserve uncertainty stemming from a variety of sources. These uncertainties are considered at each step in the process of establishing loss and loss expense reserves. However, as market conditions change, certain trends are identified that management believes create an additional amount of uncertainty. A discussion of recent trends, by line of business, that have been recognized by management follows:

 

3844

Workers Compensation
With $832 million, or 36%At December 31, 2008, our workers compensation line of our totalbusiness recorded reserves, net of reinsurance, at December 31, 2007, workers compensation isof $850 million, or 35% of our largest reserved line of business.total recorded reserves. In addition to the uncertainties associated with actuarial assumptions and methodologies described above, the workers compensation is the line of business most susceptible tocan be impacted by a variety of issues such as unexpected changes in medical services costs due to the length of time over which medical services are providedcost inflation, changes in overall economic conditions and the unpredictability of medical cost inflation.company specific initiatives. From 2005 through 2007,2008, we experienced an unusual amount of volatility associated with our workers compensation medical costs. In 2008 overall economic conditions were extremely unstable. Finally, in the past few years the company implemented a multi-faceted workers compensation strategy which incorporated knowledge management and predictive modeling initiatives. From 2005 through 2008, we had sufficient evidenceexperienced an unusual amount of greater than expected increasesvolatility in our workers compensation medical costs and raised our reserves in this line of business byprior year reserve development ranging from $42 million for accident years 2001 and prior. From 2006of adverse development in 2005 to 2007, our workers compensation medical$24 million of favorable development returned to a more normal level and as a result our reserves for prior accident years were reduced by the relatively moderate amount of $4 million in 2006 and $4 million in 2007.2008. Even though medical cost development returned to a more customary level in 2007 and 2008, the unusual amount of volatility over the pastprevious few years does create additional uncertainty. In addition, potential impacts from changing economic conditions and unforeseen expected results from our company-specific strategies are potential sources of additional uncertainty in the future. If the higher than historical increases in medical costs in 2005 were a just an anomaly, thendo not return and/or external economic conditions improve and/or our historical patterns are an appropriate basis forworkers compensation strategies exceed our future reserve projections. Ifexpectations, the result could be favorable development in the future. However, if higher medical trends return and continue on a longer term,and/or economic conditions remain poor and/or our historical patterns willinternal strategies are less effective than anticipated, the result could be less meaningful in predicting future loss costs and could result in significant adverse reserve development.development in the future.
General Liability
At December 31, 2007,2008, our general liability line of business had recorded reserves, net of reinsurance of $815$891 million, which represented 35%37% of our total net reserves. This line of business includes umbrellaexcess policies which provide additional limits above underlying automobile and general liability coverages. While favorableprior year development in 2007 for priorrecent years was minimal,has been relatively minor, two recent changes in our book of business relating to umbrellaexcess coverage could create additional volatility in our results: (i) we have grown the number of our commercial umbrellaexcess policies at a greater rate than the rest of our commercial lines of business; and (ii) we have raised the net retention of our reinsurance covering these policies.policies over the past several accident years. Both of these changes raise the average limits of losses that we retain on a net basis. While management has not identified any specific trends relating to additional reserve uncertainty, our increase in average net retention does create the potential for additional volatility in our reserves.
Commercial Automobile
At December 31, 2007,2008, our commercial automobile line of business had recorded reserves, net of reinsurance, of $330$346 million, which represented 14% of our total net reserves. This line of business has experienced only $0.4 million of favorable development in 2008 which is significantly less than the $19 million and $15 million it experienced in 2007 and 2006, respectively. The significant favorable prior year loss development in recent yearsfrom 2005 to 2007 was driven by a downward trend in large claims. The number of large claims has a high degree of volatility from year-to-yearyear to year and, therefore, requires a longer period before true trends are recognized and can be acted upon. We have experienced lower than expected severity in accident years 2002 through 2006,2005 which resultedhas not continued in favorable development in 2006 and 2007 of $15 million and $19 million, respectively. This result is driven by trends that are positively affecting the commercial auto insurance market in general, as well as by Selective specific initiatives such as: (i) the increase in lower hazard auto business as a percentage of our overall commercial auto book of business; (ii) a re-underwriting of our newest operating region; and (iii) a more proactive approach to loss prevention. At this time, the lower trend in large claims has leveled off andmost recent three accident years. While management has not identified any other recentspecific trends that would create significant reserve uncertainty forrelated to this line, the volatility of business.large claims does create additional uncertainty in our analysis for our most recent accident years.
General Liability and Commercial Automobile (Claims Initiatives Impact)
In addition to the line of business specific issues mentioned above, both of these lines of business have been impacted by a number of initiatives undertaken by our claims department which have resulted in the quicker development of case reserves. This change in the average level of case reserves increases the uncertainty in both the positive and negative directions in the short run, but the longer term benefit is a more refined management of the claims process.
Personal Automobile
At December 31, 2007,2008, our personal automobile line of business had recorded reserves, net of reinsurance, of $171$159 million, which represented 7% of our total net reserves. The majority of this business is written in New Jersey, where the judicial and regulatory environment has been subject to significant changes over the past few decades. The most recent change occurred in June 2005, when the New Jersey Supreme Court ruled that the serious life impact standard does not apply to the Automobile Insurance Cost Reduction Act (“AICRA”)AICRA limitation on lawsuit threshold. As a result of this decision, we increased reserves for this line of business by a net amount of $10 million, the majority of which was reflected in 2005 results. This recent judicial decision has increased the uncertainty surrounding our personal automobile reserves, particularly for accident years 2006 and 2007,through 2008, since much of the historical information used to make assumptions has been rendered less effective as a basis for projecting future results.

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Other Lines of Business
At December 31, 2007,2008, no other individual line of business had recorded reserves of more than $60$67 million, net of reinsurance. Management hasWe have not identified any recent trends that would create additional significant reserve uncertainty for these other lines of business.

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The following tables provide case and IBNR reserves for losses, reserves for loss expenses, and reinsurance recoverable on unpaid losses and loss expenses as of December 31, 20072008 and 2006:2007:
As of December 31, 2007
                         
                  Reinsurance    
                  Recoverable    
                  on Unpaid    
  Loss Reserves  Loss  Losses and    
As of December 31, 2008 Case  IBNR      Expense  Loss    
($ in thousands) Reserves  Reserves  Total  Reserves  Expenses  Net Reserves 
Commercial automobile $131,038   187,804   318,842   36,868   9,351   346,359 
Workers compensation  396,345   431,549   827,894   103,952   81,556   850,290 
General liability  203,487   538,591   742,078   185,434   36,978   890,534 
Commercial property  39,570   1,978   41,548   3,669   2,214   43,003 
Business owners’ policies  25,988   35,309   61,297   10,073   5,256   66,114 
Bonds  2,135   4,314   6,449   2,215   387   8,277 
Other  719   1,323   2,042   —   686   1,356 
                   
Total commercial lines  799,282   1,200,868   2,000,150   342,211   136,428   2,205,933 
                         
Personal automobile  123,964   62,141   186,105   35,239   62,699   158,645 
Homeowners  18,589   22,729   41,318   4,628   883   45,063 
Other  13,730   15,026   28,756   2,566   24,182   7,140 
                   
Total personal lines  156,283   99,896   256,179   42,433   87,764   210,848 
                   
Total $955,565   1,300,764   2,256,329   384,644   224,192   2,416,781 
                   
                                                
 Reinsurance    Reinsurance   
 Recoverable    Recoverable   
 on Unpaid    on Unpaid   
 Loss Reserves Loss Losses and    Loss Reserves Loss Losses and   
 Case IBNR Expense Loss   
As of December 31, 2007 Case IBNR Expense Loss   
($ in thousands) Reserves Reserves Total Reserves Expenses Net Reserves  Reserves Reserves Total Reserves Expenses Net Reserves 
Commercial automobile $117,299 188,294 305,593 36,236 12,255 329,574  $117,299 188,294 305,593 36,236 12,255 329,574 
Workers compensation 382,364 424,528 806,892 102,315 76,747 832,460  382,364 424,528 806,892 102,315 76,747 832,460 
General liability 198,636 500,806 699,442 162,098 46,434 815,106  198,636 500,806 699,442 162,098 46,434 815,106 
Commercial property 44,520 2,030 46,550 3,572 5,895 44,227  44,520 2,030 46,550 3,572 5,895 44,227 
Business owners’ policy 23,469 30,967 54,436 8,604 5,281 57,759 
Business owners’ policies 23,469 30,967 54,436 8,604 5,281 57,759 
Bonds 4,008 3,509 7,517 2,217 296 9,438  4,008 3,509 7,517 2,217 296 9,438 
Other 907 1,601 2,508 — 863 1,645  907 1,601 2,508 — 863 1,645 
                          
Total commercial lines 771,203 1,151,735 1,922,938 315,042 147,771 2,090,209  771,203 1,151,735 1,922,938 315,042 147,771 2,090,209 
  
Personal automobile 127,646 70,989 198,635 38,221 65,541 171,315  127,646 70,989 198,635 38,221 65,541 171,315 
Homeowners 17,889 21,227 39,116 4,511 944 42,683  17,889 21,227 39,116 4,511 944 42,683 
Other 7,479 14,404 21,883 2,201 13,545 10,539  7,479 14,404 21,883 2,201 13,545 10,539 
                          
Total personal lines 153,014 106,620 259,634 44,933 80,030 224,537  153,014 106,620 259,634 44,933 80,030 224,537 
                          
Total $924,217 1,258,355 2,182,572 359,975 227,801 2,314,746  $924,217 1,258,355 2,182,572 359,975 227,801 2,314,746 
                          
As of December 31, 2006
                         
                  Reinsurance    
                  Recoverable    
                  on Unpaid    
  Loss Reserves  Loss  Losses and    
  Case  IBNR      Expense  Loss    
($ in thousands) Reserves  Reserves  Total  Reserves  Expenses  Net Reserves 
Commercial automobile $104,490   180,937   285,427  $33,817   5,802   313,442 
Workers compensation  351,511   386,796   738,307   93,095   68,018   763,384 
General liability  154,807   448,474   603,281   139,714   34,882   708,113 
Commercial property  19,076   1,321   20,397   3,622   347   23,672 
Business owners’ policy  22,273   25,707   47,980   7,584   5,166   50,398 
Bonds  1,106   4,139   5,245   2,391   339   7,297 
Other  477   1,704   2,181   —   448   1,733 
                   
Total commercial lines  653,740   1,049,078   1,702,818   280,223   115,002   1,868,039 
                         
Personal automobile  127,051   81,663   208,714   42,849   68,196   183,367 
Homeowners  13,895   13,953   27,848   3,969   1,080   30,737 
Other  7,727   12,378   20,105   2,244   15,460   6,889 
                   
Total personal lines  148,673   107,994   256,667   49,062   84,736   220,993 
                   
Total $802,413   1,157,072   1,959,485  $329,285   199,738   2,089,032 
                   
Range of reasonable reserves
We established a range of reasonably possible reserves for net claims of approximately $2,267 million to $2,545 million at December 31, 2008 and of $2,180 million to $2,414 million at December 31, 2007 and of $1,977 million to $2,174 million at December 31, 2006.2007. A low and high reasonable reserve selection was derived primarily by considering the range of indications calculated using generally accepted actuarial techniques. Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting future events. Although this range reflects likely scenarios, it is possible that the final outcomes may fall above or below these amounts. Based on internal stochastic modeling, management feelswe feel that a reasonable estimate of the likelihood that the final outcome falls within the current range is approximately 70%75%. This range does not include a provision for potential increases or decreases associated with environmental reserves. Management’sOur best estimate is consistent with the actuarial best estimate. We do not discount to present value that portion of itsour loss reserves expected to be paid in future periods; however, the loss reserves take into account anticipated recoveries for salvage and subrogation claims.

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Sensitivity Analysis: Potential impact on reserve volatility due to changes in key assumptions
Our process to establish reserves includes a variety of key assumptions, including, but not limited to, the following:
 • The selection of loss development factors;
 
 • The weight to be applied to each individual actuarial indication;
 
 • Projected future loss trend; and
 
 • Expected ultimate loss ratios for the current accident year.

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The importance of any single assumption depends on several considerations, such as the line of business and the accident year. If the actual experience emerges differently than the assumptions used in the process to establish reserves, changes in our reserve estimate are possible and may be material to the results of operations in future periods. Set forth below is a discussion of the potential impact of using certain key assumptions that differ from those used in our latest reserve analysis. It is important to note that the following discussion considers each assumption individually, without any consideration of correlation between lines of business and accident years, and therefore, does not constitute an actuarial range. While the following discussion represents possible volatility from variations in key assumptions as identified by management, there is no assurance that the future emergence of our loss experience will be consistent with either our current or alternative set of assumptions. By the very nature of the insurance business, loss development patterns have a certain amount of normal volatility.
Workers Compensation
In addition to the normal amount of volatility, medical loss development factors for workers compensation are particularly sensitive to assumptions relating to medical inflation. Actual medical loss development factors could be significantly different than those which are selected from historical loss experience if actual medical inflation is materially different than what was observed in the past. In addition, workers compensation has been the focus of a multi-faceted underwriting strategy designed to significantly reduce the loss ratio over time. The combination of the sensitivity of workers compensation results to medical inflation and changes in underwriting could lead to actual experience emerging differently than the assumptions used in the process to establish reserves. In our judgment, it is possible that actual medical loss development factors could range from 6% below to 8% above those selected in our latest reserve analysis and expected loss ratios could range from 5% below to 3%7% above those selected in our latest reserve analysis. The combination of reducing the assumptions for medical loss development by 6% and the expected loss ratio by 5% could decrease our indicated workers compensation reserves by approximately $55$58 million for accident years 20062007 and prior. Alternatively, the combination of increasing the medical loss development factors by 8% and the expected loss ratio by 3%7% could increase our indicated workers compensation reserves by approximately $70 million.$81 million for accident years 2007 and prior.
General Liability
In addition to the normal amount of volatility, general liability loss development factors have greater uncertainty due to the complexity of the coverages and the possibly significant periods of time that can elapse between the occurrence of an insured loss, the reporting of the loss to the insurer, and the insurer’s payment of that loss. In our judgment, it is possible that general liability loss development factors could be +/- 6% from those actually selected in our latest reserve analysis. If the loss development assumptions were changed by +/- 6%, that would increase/decrease our indicated general liability reserves by approximately $80$92 million for accident years 20062007 and prior.
Commercial Automobile
In addition to the normal amount of volatility, our commercial automobile line of business has experiencedrealized significant favorable development in recent years.2005 to 2007, which leveled off to a minimal amount in 2008. This favorable development has beenwas driven in large part by a reduction in our bodily injury large loss experience. The actual number of large claims has a high degree of volatility from year-to-yearyear to year in terms of timing and therefore, requires a longer period of time before we would respondultimate final emergence. Even if ultimate large losses are ultimately consistent from year to this type of information. Under these circumstances, the difference between ayear, if they are identified at different times than previous years, traditional loss development method and the expected ultimate loss ratio is larger than usually expected. For this reason, the weight to be applied to each individualfactors may overstate or understate actuarial indication in this situation is another key assumption.indications. If the impacttiming of changing the weights to be applied to each actuarial indicationlarge losses is combined with the impact of possible changes to selected loss development factors of +/- 6%,significantly variable, it is our judgment that the possible impact to overallactual loss development factors could be +/- 6% different from those selected in our reserve review, which would increase/decrease our indicated commercial auto reserves could range fromby approximately $65$59 million reduction to approximately $40 million increase for accident years 20062007 and prior.
Claims Initiatives Impact on General Liability and Commercial Automobile
In addition to the line of business specific assumptions discussed above, a number of claims initiatives have increased average case reserves for both the general liability and commercial auto lines of business. This increase in case reserves causes larger differences between some indications than would normally be experienced. In our judgment, it is possible that the selections for these lines of business in our latest reserve review could increase by $57 million or decrease by $46 million depending on how various methodologies converge for these lines of business in accident years 2007 and 2008.

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Personal Automobile
In addition to the normal amount of volatility, the uncertainty of personal automobile loss development factors is greater than usual due to the number of judicial and regulatory changes in the New Jersey personal automobile market over the years. In our judgment, it is possible that personal auto bodily injury loss development factors could range from 5%4% below those actually selected in our latest reserve analysis to 4%3% above those selected in our latest reserve analysis. If the loss development assumptions were reduced by 5%4%, that would decrease our indicated personal automobile reserves by approximately $35$28 million for accident years 20062007 and prior. Alternatively, if the loss development factors were increased by 4%3%, that would increase our indicated personal automobile reserves by approximately $30 million.$21 million for accident years 2007 and prior.

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Current Accident Year
For the 20072008 accident year, the expected ultimate loss ratio by line of business is a key assumption. This assumption is based upon a large number of inputs that are assessed periodically, such as historical loss ratios, projected future loss trend, and planned pricing amounts. In our judgment, it is possible that the actual ultimate loss ratio for the 20072008 accident year could be +/-7% from the one selected in our latest reserve analysis for each of our four major long tailedlong-tailed lines of business. The table below summarizes the possible impact on our reserves of varying our expected loss ratio assumption by +/-7% by line of business for the 20072008 accident year.
Reserve Impact of Changing Current Year Expected Ultimate Loss Ratio Assumption
                
 If Assumption If Assumption  If Assumption Was If Assumption Was 
 Was Reduced Was Raised 
($ in millions) by 7% by 7% 
($in millions) Reduced by 7% Raised by 7% 
Workers Compensation  (22) 22   (21) 21 
General Liability  (29) 29   (28) 28 
Commercial Automobile Liability  (17) 17   (17) 17 
Personal Automobile Liability  (7) 7   (7) 7 
Prior year reserve development
In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, we review our reserve estimates on a regular basis as described above and make adjustments in the period that the need for such adjustment is determined. These reviews could result in the identification of information and trends that would require us to increase some reserves and/or decrease other reserves for prior periods and could also lead to additional increases in loss and loss adjustment expense reserves, which could materially adversely affecthave a material adverse effect our results of operations, equity, business, insurer financial strength, and debt ratings. In 2007,2008, we experienced favorable loss development in accident years 2002 through 2006 and prior of $61.7$46.2 million partially offset by unfavorable loss development in accident years 2001 and prioryear 2007 of $42.9$26.9 million, netting to total favorable prior year development of $18.8$19.3 million. In 2007, we experienced net favorable prior year development of $18.8 million, and in 2006, we experienced net favorable prior year development of $7.3 million, and in 2005, we experienced net adverse prior year development of $5.1 million. For further discussion on the prior year development in loss and loss expense reserves, see the discussion on “Net Loss and Loss Expense Reserves” in Item 1. “Business” and Note 8 of Item 8. “Financial Statements and Supplementary Data” inof this Form 10-K.
Asbestos and Environmental Reserves
Included in our loss and loss expense reserves are amounts for environmental claims, both asbestos and non-asbestos. Carried net loss and loss expense reserves for environmental claims were $44.1 million as of December 31, 2008 and $51.4 million as of December 31, 2007 and $46.5 million as of December 31, 2006. Our exposure to environmental liability is primarily due to policies written prior to the introduction of the absolute pollution exclusion endorsement in the mid-1980’s and underground storage tank leaks, mostly from New Jersey homeowners policies in recent years.2007. Our asbestos and non-asbestos environmental claims have arisen primarily from insured exposures in municipal government, small commercial risks, and homeowners policies. The emergence of these claims is slow and highly unpredictable. Over the past few years, we also experienced adverse development in itsour homeowners line of business as a result of unfavorable trends in claims for groundwater contamination caused by leakage of certain underground heating oil storage tanks in New Jersey. In addition, certain landfill sites are included on the National Priorities List (“NPL”) by the United States Environmental Protection Agency (“USEPA”). Once on the NPL, the USEPA determines an appropriate remediation plan for these sites. A landfill can remain on the NPL for many years until final approval for the removal of the site is granted from the USEPA. The USEPA also has the authority to re-open previously closed sites and return them to the NPL. We currently have reserves for several claims related to sites on the NPL. During 2008, 43 of our past and present insureds filed formal consent decrees with the New Jersey Department of Environmental Protection, resolving our largest landfill claim, which resulted in our payment of approximately $4.7 million on behalf of these insureds.
IBNR reserve estimation for environmental claims is often difficult because, in addition to other factors, there are significant uncertainties associated with critical assumptions in the estimation process, such as average clean-up costs, third-party costs, potentially responsible party shares, allocation of damages, insurer litigation costs, insurer coverage defenses, and potential changes to state and federal statutes.

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However, management iswe are not aware of any emerging trends that could result in future reserve adjustments. Moreover, normal historically-basedhistorically based actuarial approaches are difficult to apply because relevant history is not available. While models can be applied, such models can produce significantly different results with small changes in assumptions. As a result, management doeswe do not calculate a specific environmental loss range, as it believeswe believe it would not be meaningful.

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The table below summarizes the number of asbestos and non-asbestos claims outstanding at December 31, 2008, 2007, 2006, and 2005.2006. For additional information about our environmental reserves, see Item 1. “Business,” and Item 8. “Financial Statements and Supplementary Data,” Note 8 to the Consolidated Financial Statements.
Environmental Claims Activity
                        
 2007 2006 2005  2008 2007 2006 
Asbestos Related Claims(1)
 
Asbestos Related Claims1
 
Claims at beginning of year 2,273 2,089 3,025  2,177 2,273 2,089 
Claims received during year 114 358 276  124 114 358 
Claims closed during year(2)
  (210)  (174)  (1,212)
Claims closed during year2
  (264)  (210)  (174)
              
Claims at end of year 2,177 2,273 2,089  2,037 2,177 2,273 
              
Average gross loss settlement on closed claims $81 914 527  $32 81 914 
Gross amount paid to administer closed claims $51,868 66,710 230,340  $110,582 51,868 66,710 
Net survival ratio(3)
 16 20 16 
Net survival ratio3
 15 16 20 
  
Non-Asbestos Related Claims(1)
 
Non-Asbestos Related Claims1
 
Claims at beginning of year 302 293 285  271 302 293 
Claims received during year 108 111 154  269 108 111 
Claims closed during year(2)
  (139)  (102)  (146)
Claims closed during year2
  (215)  (139)  (102)
              
Claims at end of year 271 302 293  325 271 302 
              
Average gross loss settlement on closed claims $4,149 555 65,204  $14,803 4,149 555 
Gross amount paid to administer closed claims $62,874 26,321 1,717,746  $115,562 62,874 26,321 
Net survival ratio(3)
 14 9 7 
Net survival ratio3
 6 14 9 
(1)1 The number of environmental claims includes all multiple claimants who are associated with the same site or incident.
 
(2)2 Includes claims dismissed, settled, or otherwise resolved.
 
(3)3 The net survival ratio was calculated using a three-year average for net losses and expenses paid.
Deferred Policy Acquisition Costs
Policy acquisition costs, which include commissions, premium taxes, fees, and certain other costs of underwriting policies, are deferred and amortized over the same period in which the related premiums are earned. Deferred policy acquisition costs are limited to the estimated amounts recoverable after providing for losses and loss expenses that are expected to be incurred, based upon historical and current experience. Anticipated investment income is considered in determining whether a premium deficiency exists. The methods of making such estimates and establishing the deferred costs are continually reviewed, and any adjustments are made in the accounting period in which the adjustment arose. We measure the recoverability of deferred policy acquisition costs at the operating segment level. We had deferred policy acquisition costs of $212.3 million at December 31, 2008 compared to $226.4 million at December 31, 2007 compared to $218.1 million at December 31, 2006.2007.
Pension and PostretirementPost-retirement Benefit Plan Actuarial Assumptions
Our pension benefit and postretirementpost-retirement life benefit obligations and related costs are calculated using actuarial concepts, within the framework of Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions” (“SFAS 87”); and Statement of Financial Accounting Standards No. 106,“Employers’ Accounting for PostretirementPost-retirement Benefits Other thanPension” (“SFAS 106”), respectively. Two key assumptions, the discount rate and the expected return on plan assets, are important elements of expense and/or liability measurement. We evaluate these key assumptions annually. Other assumptions involve demographic factors such as retirement age, mortality, turnover, and rate of compensation increases.
The discount rate enables us to state expected future cash flow as a present value on the measurement date. The guideline for setting this rate is a high-quality long-term corporate bond rate. A higherlower discount rate decreasesincreases the present value of benefit obligations and decreasesincreases pension expense. We increaseddecreased our discount rate to 6.24% for 2008, from 6.50% for 2007 from 5.90% for 2006 to reflect market interest rate conditions. To determine the expected long-term rate of return on the plan assets, we consider the current and expected asset allocation, as well as historical and expected returns on each plan asset class. A lower expected rate of return on pension plan assets would increase pension expense. Our long-term expected return on plan assets was 8.00% in 2008 and 2007. We had a pension and post-retirement benefit plan obligation of $188.0 million at December 31, 2008 compared to $161.2 million at December 31, 2007.

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Our pension assets lost approximately 20% of their value in 2008 due to the volatility in the financial markets. As a result of this, coupled with the decrease in our pension discount rate, we recorded a charge to equity of approximately $38 million, after tax, as of December 31, 2008. In 2007, we recorded an equity increase of $5.7 million, after-tax, primarily due to an increase of our pension discount rate. In 2006, in relation to our adoption of Statement of Financial Accounting Standards No. 158, “Employers Accounting for Defined Benefit Pension and 2006.Other Post-retirement Plans — An amendment to FASB Statements No. 87, 88, 106, and 132(r),” we recorded a charge to equity of $13.7 million, after-tax, representing the recognition of the funded status of our plans. Changes in the related pension and postretirementpost-retirement benefit expense may occur in the future due to changes in these assumptions.
For additional information regarding our pension and postretirementpost-retirement benefit plan obligations, see Item 8. “Financial Statements and Supplementary Data,” Note 16(d) to the Consolidated Financial Statements.15(d) of this Form 10-K.

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Other-Than-Temporary Investment Impairments
An investment in a fixed maturity, or equity security that is available for sale and reported at fair value,or an other investment (i.e., an alternative investment), is impaired if its fair value falls below its book value and the decline is considered to be other than temporary. 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 temporary, we record the decline as an unrealized loss in accumulated other comprehensive income. If we believe the decline is “other-than-temporary,”other than temporary, we write down the carrying value of the investment and record a realized loss in our Consolidated Statements of Income. Management’sOur assessment of a decline in fair value includes current judgment as to the financial position and future prospects of the entity that issued the investment security. Broad changes in the overall market or interest rate environment generally will not lead to a write-down provided that management haswe have the ability and intent to hold such a security to maturity.
Our evaluation for other-than-temporary impairmentOTTI of a fixed maturity security or a short-term investment includes, but is not limited to, the evaluation of the following factors:
• Whether the decline appears to be issuer or industry specific;
 
• The degree to which an issuer is current or in arrears in making principal and interest payments on the fixed maturity security;
 
• The issuer’s current financial condition and ability to make future scheduled principal and interest payments on a timely basis;
 
• Stress testing of projected cash flows under various economic and default scenarios.
•Buy/hold/sell recommendations published by outside investment advisors and analysts;
 
• Relevant rating history, analysis and guidance provided by rating agencies and analysts;
•The length of time and the extent to which the fair value has been less than carrying value; and
 
• Our ability and intent to hold a security to maturity given interest rate fluctuations.
We perform impairment assessments for the structured securities included in our fixed maturity portfolio (including, but not limited to, commercial mortgaged-backed securities (“CMBS”), residential mortgaged-backed securities (“RMBS”), asset-backed securities (“ABS”), and collateralized debt obligations (“CDOs”)), comprising an evaluation of the underlying collateral of these structured securities. This assessment, although considering the length of time for which the security has been in an unrealized loss position, focuses on the performance of the underlying collateral under various economic and default scenarios which may involve subjective judgments and estimates determined by management. Considering various factors in our modeling of these structured securities, such as projected default rates, the nature and realizable value of the collateral, the ability of the security to make scheduled payments, historical performance and other relevant economic and performance factors, we determine if an impairment is other than temporary in circumstances where our projection of losses extends into the tranche of the security in which we are invested.
Our evaluation for other-than-temporary impairmentOTTI of an equity security, other investment, or a short-term investment includes, but is not limited to, the evaluation of the following factors:
• Whether the decline appears to be issuer or industry specific;
 
• The relationship of market prices per share to book value per share at the date of acquisition and date of evaluation;
 
• The price-earnings ratio at the time of acquisition and date of evaluation;
 
• The financial condition and near-term prospects of the issuer, including any specific events that may influence the issuer’s operations;
 
• The recent income or loss of the issuer;
 
• The independent auditors’ report on the issuer’s recent financial statements;
 
• The dividend policy of the issuer at the date of acquisition and the date of evaluation;
 
• Any buy/hold/sell recommendations or price projections published by outside investment advisors;
 
• Any rating agency announcements; and
 
• The length of time and the extent to which the fair value has been less than the carrying value.

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Our evaluation for OTTI of an other investment (i.e., an alternative investment) includes, but is not limited to, conversations with the management of the alternative investment concerning the following:
•The current investment strategy;
•Changes made or future changes to be made to the investment strategy;
•Emerging issues that may affect the success of the strategy; and
•The appropriateness of the valuation methodology used regarding the underlying investments.
In 2007,2008, we recorded ana pre-tax impairment charge of $4.9$53.1 million for two investments that we concluded were impaired for other than temporaryother-than-temporary declines in fair value. This charge was comprised of $41.7 million related to our fixed maturity securities, $6.6 million related to our equity securities, and $4.8 million related to our alternative investments. We recorded a pre-tax impairment charge of $4.9 million in 2007 and had no impairment charges during 2006. We recorded an impairment charge of $1.2 million in 2005 for one investment that we concluded was impaired for an other-than-temporary decline in value. For further information regarding the impairment charges, see the section entitled “Investments” in Item 7. “ Management’s“Management’s Discussion and Analysis of Financial Condition and Results of Operations.” of this Form 10-K.
Goodwill
Goodwill results from business acquisitions where the cost of assets acquired exceeds the fair value of those assets. We test goodwill for impairment annually, or more frequently if events or changes in circumstances indicate that goodwill may be impaired. Goodwill is allocated to the reporting units for the purposes of the impairment test. In the fourth quarter of 2008, we recorded a pre-tax impairment charge of $4.0 million for Selective HR as our near-term financial projections for this subsidiary were not sufficient to support its carrying cost. We did not record any impairments during 2007 2006 or 2005.2006.
Reinsurance
Reinsurance recoverablerecoverables on paid and unpaid losses and loss expenses represent estimates of the portion of such liabilities that will be recovered from reinsurers. Each reinsurance contract is analyzed to ensure that the transfer of risk exists to properly record the transactions in the financial statements. Amounts recoverable from reinsurers are recognized as assets at the same time and in a manner consistent with the paid and unpaid losses associated with the reinsurance policies. An allowance for estimated uncollectible reinsurance is recorded based on an evaluation of balances due from reinsurers and other available information. This allowance totaled $2.5 million at December 31, 2008 and $2.8 million at December 31, 2007. We continually monitor developments that may impact recoverability from our reinsurers and have available to us contractually provided remedies if necessary.

 

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Financial Highlights of Results for Years Ended December 31, 2008, 2007, 2006, and 200520061
                                        
 2007 2006  2008 2007 
($ in thousands, except per share amounts) 2007 2006 vs 2006 2005 vs 2005  2008 2007 vs. 2007 2006 vs. 2006 
  
Revenues $1,846,228 1,807,867  2% 1,671,012  8% $1,695,979 1,846,228  (8)% 1,807,867  2%
Net income before cumulative effect of change in accounting principle 146,498 163,574  (10) 147,998 11 
Net income 146,498 163,574  (10) 148,493 10  43,758 146,498  (70) 163,574  (10)
Diluted net income before cumulative effect of change in accounting principle per share 2.59 2.65  (2) 2.34 13 
Diluted net income per share 2.59 2.65  (2) 2.35 13  0.82 2.59  (68) 2.65  (2)
Diluted weighted-average outstanding shares 57,165 62,542  (9) 64,708  (3) 53,319 57,165  (7) 62,542  (9)
GAAP combined ratio  98.9% 96.1 2.8 pts 95.1 1.0 pts  101.0% 98.9 2.1pts 96.1 2.8pts
Statutory combined ratio  97.5% 95.4 2.1 94.6 0.8   99.2% 97.5 1.7 95.4 2.1 
Return on average equity  13.6% 15.9  (2.3) 15.9 —   4.5% 13.6  (9.1) 15.9  (2.3)
1 Refer to the Glossary of Terms attached to this Form 10-K as Exhibit 99.1 for definitions of terms used in this financial review, which exhibit is incorporated by reference.
Revenues
Revenues increasedNet income decreased in 20072008 compared to 20062007 and 20052006 primarily due to growth in net premiums earned (“NPE”) and net investment income earned.the following:
NPE growth contributed $17.6 million of the $38.4
•Net realized losses in our investment portfolio of $49.5 million, pre-tax, compared to net realized gains of $33.4 million in 2007 and $35.5 million in 2006. The losses in 2008 include non-cash OTTI charges of $53.1 million, as well as lower realized gains on our equity portfolio, due to continuing market volatility and unprecedented collateral deterioration across credit markets. In addition, certain equity securities were sold at a loss to take advantage of financial and tax planning strategies. For additional information on our realized losses, including OTTI charges, refer to the “Investments” section below.
Net realized gains in 2007 and 2006 reflect the sale of several equity positions which resulted in re-weighting various sector exposures. Partially offsetting the 2007 realized gains were pre-tax OTTI charges of $4.9 million. There were no OTTI charges in 2006.
•Net investment income earned of $131.0 million, pre-tax, in 2008 compared to $174.1 million in 2007 and $156.8 million in 2006. Reduced income levels in 2008 were primarily due to losses on our other investments portfolio, which includes alternative investments, as well as losses on our externally-managed equity trading portfolio. The lower returns on our alternative investments, compared to strong returns a year ago, resulted from the current volatility in the capital markets, the dislocation of the credit markets, and reduced values of financial assets globally. Although these assets resulted in a negative return for the year, they outperformed the S&P 500 by approximately 2,700 basis points in 2008. Our equity trading portfolio has experienced a reduction in fair value due to the continued sell off in the equity markets, as well as the collapse in commodity prices in the second half of 2008. For additional information on our other investment portfolio, which includes our alternative investments, as well as for information regarding our trading portfolio, refer to the “Investments” section below.
The increase in pre-tax net investment income earned in 2007 compared to 2006 is primarily attributable to a higher invested asset base, coupled with higher interest rates and strong returns from our other investment portfolio during the year.
•Underwriting losses of $15.2 million, pre-tax, in 2008 compared to underwriting gains of $16.0 million in 2007 and $58.0 million in 2006. The underwriting loss in 2008 reflects higher catastrophe losses and reduced NPE. Catastrophe losses increased by $16.8 million, to $31.7 million in 2008 driven by storm activity in the Southern and Midwestern states. NPE decreased by $21.8 million, or 1%, to $1.5 billion in 2008 reflecting pricing pressure stemming from a highly competitive insurance marketplace and the slowing economy. The following factors also contributed to the decline in revenue growth in 2007 compared to 2006 and $81.7 million to the $136.9 million in revenue growth in 2006 compared to 2005. The following factors contributed to the growth of NPE:
 • Direct new business written, excluding flood, ofdecreased $41.7 million to $310.6 million in 2008 compared to $352.3 million in 2007 compared to $310.0 million in 2006 and $300.5 million in 2005.2007.
 
 • Commercial lines renewal prices, including exposure, whichAudit and endorsement activity decreased by 0.3%$38.2 million to a net premium return to policyholders of $22.3 million in 2007 and increased in 2006 and 2005 by 2.2% and 3.5%, respectively.2008.
The above items were partially offset by (i) a slight reduction in commercial lines retention in 2007 compared to 2006 and 2005; (ii) a $17.9 million reduction in audit and endorsement premium activity in 2007 compared to 2006 and a $7.6 million reduction in 2006 compared to 2005 as a result of economic changes, especially in the construction industry; and (iii) decreases in NPE on our New Jersey personal automobile book of business attributable to the loss of a portion of our book that was repriced at higher pricing levels through our MATRIX® pricing system and subsequently did not renew. Our New Jersey personal automobile book of business experienced an 8% reduction in the number of cars insured at December 31, 2007 compared to December 31, 2006 and a 12% reduction in the number of cars from December 31, 2006 compared to December 31, 2005. Overall personal lines NPE was down 5% to $203.3 million in 2007 compared to $213.8 million in 2006. These premiums increased 2% in 2006 from $209.3 million in 2005.
Net investment income earned increased 11% in 2007 compared to 2006 and contributed $17.3 million to the $38.4 million revenue growth in 2007. In 2006, net investment income earned increased 15% compared to 2005 and contributed $20.9 million to the $136.9 million revenue growth in 2006. These increases are primarily attributable to a higher invested asset base, coupled with higher interest rates and strong returns from our other investment portfolio. The increase in our invested asset base is the result of operating cash flows of $386.3 million in 2007 and $393.1 million in 2006, as well as net proceeds of $96.8 million from our $100.0 million junior subordinated notes offering in the third quarter of 2006. These increases were partially offset by: (i) stock repurchases under our authorized stock repurchase program of 5.7 million shares during 2007 at a total cost of $143.3 million and 4.1 million shares during 2006 at a total cost of $110.1 million; and (ii) net share settlements of principal for $37.5 million in 2007 on our Senior convertible notes.
Net Income
Net income decreased in 2007 compared to 2006 due to increases in our GAAP combined ratio, resulting from lower pricing and higher claim severity, particularly in property losses, partially offset by profitability improvements in our workers compensation line of business and increases in net favorable prior year loss and loss expense development within our casualty lines of business. The reduction in our underwriting profit was partially offset by: (i) net investment income earned increases in 2007 as noted above; and (ii) decreases in federal income tax expense in 2007 compared to 2006, primarily attributable to lower underwriting income in our Insurance Operations segment, as explained above.
As a result of the various expense savings initiatives we implemented in 2008, net underwriting expenses incurred in 2008 were slightly lower than 2007. We acted early in 2008 to manage expenses with a workforce reduction initiative, changes to our agent commission programs, and the re-domestication of two of the Insurance Subsidiaries to Indiana. In addition to helping to manage expenses in 2008, these initiatives will continue to benefit expenses going forward.

 

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Net income increased in 2006 compared to 2005 due to growth in NPE, net investment income earned, and net realized gains as discussed above, partially offset by the reduction in our underwriting profit, resulting from increased property losses, including catastrophe losses, and increased underwriting expenses.
The decrease in pre-tax underwriting results in 2007 compared to 2006 is the result of lower pricing and higher claim severity, particularly property losses, partially offset by profitability improvements in our workers compensation line of business and increases in net favorable prior year loss and loss expense development within our casualty lines of business.
•A pre-tax goodwill impairment charge of $4.0 million related to Selective HR due to the fact that our near-term financial projections for this reporting unit were not sufficient to support its carrying value in light of current economic conditions. We did not record any goodwill impairments charges during 2007 or 2006.
The aforementioned pre-tax items resulted in a reduction in tax expense of $50.6 million in 2008 compared to 2007, resulting in a 2008 total tax benefit of $4.4 million compared to expenses of $46.3 million in 2007 and $56.9 million in 2006.
Results of Operations and Related Information by Segment
Insurance Operations
Our Insurance Operations segment writes property and casualty insurance business through the Insurance Subsidiaries primarily in 2122 states in the Eastern and Midwestern United States through seven insurance subsidiaries (the “Insurance Subsidiaries”). These Insurance Subsidiaries write businessU.S. through approximately 880940 independent insurance agencies. Our Insurance Operations segment consists of two components: (i) commercial lines (“Commercial Lines”),Lines, which markets primarily to businesses, and represents approximately 87%86% of net premiums written (“NPW”),NPW, and (ii) personal lines (“Personal Lines”),Lines, which markets primarily to individuals, and represents approximately 13%14% of NPW. The underwriting performances of these lines are generally measured by four different statutory ratios: (i) loss and loss expense ratio; (ii) underwriting expense ratio; (iii) dividend ratio; and (iv) combined ratio.
Summary of Insurance Operations
All Lines
                                        
 2007 2006  2008 2007 
($ in thousands) 2007 2006 vs. 2006 2005 vs. 2005  2008 2007 vs. 2007 2006 vs. 2006 
GAAP Insurance Operations Results:
  
NPW $1,554,867 1,535,961  1% 1,459,474  5% $1,484,041 1,554,867  (5)% 1,535,961  1%
                      
NPE 1,517,306 1,499,664 1 1,418,013 6  1,495,490 1,517,306  (1) 1,499,664 1 
Less:
  
Losses and loss expenses incurred 999,206 959,983 4 905,730 6  1,013,816 999,206 1 959,983 4 
Net underwriting expenses incurred 494,941 475,776 4 436,867 9  491,689 494,941  (1) 475,776 4 
Dividends to policyholders 7,202 5,927 22 5,688 4  5,211 7,202  (28) 5,927 22 
                      
Underwriting income $15,957 57,978  (72)% 69,728  (17)%
Underwriting (loss) income $(15,226) 15,957  (195)% 57,978  (72)%
                      
GAAP Ratios:
  
Loss and loss expense ratio  65.9% 64.0 1.9 pts 63.9 0.1 pts  67.8% 65.9 1.9pts 64.0 1.9pts
Underwriting expense ratio 32.5 31.7 0.8 30.8 0.9  32.9 32.5 0.4 31.7 0.8 
Dividends to policyholders ratio 0.5 0.4 0.1 0.4 —  0.3 0.5  (0.2) 0.4 0.1 
                      
Combined ratio 98.9 96.1 2.8 95.1 1.0  101.0 98.9 2.1 96.1 2.8 
                      
Statutory Ratios1:
  
Loss and loss expense ratio 65.4 63.7 1.7 63.5 0.2  67.2 65.4 1.8 63.7 1.7 
Underwriting expense ratio 31.6 31.3 0.3 30.7 0.6  31.7 31.6 0.1 31.3 0.3 
Dividends to policyholders ratio 0.5 0.4 0.1 0.4 —  0.3 0.5  (0.2) 0.4 0.1 
                      
Combined ratio1
  97.5% 95.4 2.1 pts 94.6 0.8 pts  99.2% 97.5 1.7pts 95.4 2.1pts
                      
1 The statutory ratios include Selective’sour flood line of business, which is included in the Diversified Insurance Services Segment on a GAAP basis and therefore excluded from the GAAP ratios. The total Statutory Combinedstatutory combined ratio excluding flood was 99.9% for 2008, 98.2% for 2007, and 96.1% for 2006,2006.
•NPW decreased in 2008 compared to 2007 as the result of the highly competitive insurance marketplace and 95.3% for 2005.the slowing economy. These factors were evidenced by: (i) our direct new business, which decreased $41.7 million to $310.6 million; (ii) a 3.1% decrease in Commercial Lines renewal pure pricing; and (iii) endorsement and audit activity which decreased $38.2 million.
As mentioned above, Commercial Lines renewal pure pricing in 2008 decreased 3.1% on renewal premiums, which we consider an achievement in the current competitive marketplace where many carriers are taking much larger rate decreases. Several commercial lines pricing studies indicate that, over the past 15 quarters, we have outperformed the industry, by as much as 6.5 points in the case of one survey. In addition, our Commercial Lines retention has remained relatively stable at 77% in 2008 compared to 78% in 2007 and 2006. In response to the highly competitive marketplace, our agents are actively managing our books of business by renewing accounts as much as 60 days in advance of the policy expiration date.

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 •Personal lines premiums grew 4% in 2008 compared to 2007 as we successfully received approval for rate increases during the year and have plans to implement additional rate increases in 2009. Partially offsetting our rate increases in this book of business was the disruption caused by the elimination of rate caps that had been in place while our MATRIXSM pricing system was implemented for our personal automobile business in New Jersey. This disruption was evidenced by car counts in New Jersey, which decreased by approximately 6,000 to approximately 65,000 at year-end 2008. As we further transition our entire Personal Lines book into MATRIXSM, we could see some modest downward pressure on retention which currently stands at a strong 81%.
 NPW increased in 2007 compared to 2006, and in 2006 compared to 2005. Premium growth in 2007 compared to 2006 is attributable todriven by increases in direct new business written, excluding flood, of 14%, to $352.3 million for 2007 compared to 2006 partially offset byby: (i) commercial linesCommercial Lines renewal pricing, including exposure, which decreased by 0.3%pure price decrease of 3.9% in 2007; (ii) a slight reduction in commercial lines retention in 2007 compared to 2006 and 2005;Commercial Lines retention; (iii) ana $17.9 million reduction in audit and endorsement premium activity in 2007 compared to 2006 and a $7.6 million reduction in 2006 compared to 2005 as a result of economic changes, especially in the construction industry;activity; and (iv) a decline in NPW for our New Jersey personal automobile business of $12.6 million, to $80.1 million, for 2007 compared to 2006 driven by a reduction in the number of New Jersey personal automobiles that we insure, primarily as a result of repricing at higher levels through our MATRIX®SM pricing system.
•As the result of decreased NPW over the last 12 months, NPE declined in 2008 compared to 2007. There was a slight increase in NPE in 2007 compared to 2006 reflecting the 2007 increases in NPW discussed above.
•The increase in the GAAP loss and loss expense ratio in 2008 compared to 2007 reflects higher catastrophe losses related to 2008 storm activity primarily in our Midwestern and Southern regions. Total catastrophe losses for the year added $31.7 million, or 2.1 points, to losses in 2008. For 2007, catastrophe losses added $14.9 million, or 1.0 point, to losses. In 2008, net favorable prior year loss and loss expense development, driven primarily by our workers compensation line of business, was flat at approximately $19 million, or 1.3 points, compared to approximately $19 million, or 1.2 points, in 2007 driven by our commercial automobile line of business.
 
   Premium growth in 2006 compared to 2005 is attributable to increases in direct new business written, excluding flood, of 3% to $310.0 million for 2006 compared to 2005 coupled with Commercial Lines renewal pricing increases, including exposure, of 2.2% in 2006. Partially offsetting these items is a decline in NPW for our New Jersey personal automobile business of $14.6 million to $92.7 million for 2006 compared to 2005 as a result of the highly competitive marketplace.
•NPE increased slightly in 2007 compared to 2006 and increased in 2006 compared to 2005 reflecting increases in NPW discussed above.

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•The 1.9 point increase in the GAAP loss and loss expense ratio in 2007 compared to 2006 wasis primarily attributable to lower pricing on our Commercial and Personal Lines business, as well as increases in property losses and overall higher loss costs in 2007 compared to 2006. The increases in property losses were driven by higher non-catastrophe losses for 2007 compared to 2006. These increases to the GAAP loss and loss expense ratio were partially offset byby: (i) improved profitability in our workers compensation line of business,business; and (ii) net favorable prior year loss and loss expense development within our casualty lines of business of approximately $19 million in 2007, compared to approximately $7 million in 2006. The GAAP
While loss activity is part of the normal volatility in our property lines of business, we continue to manage our claims process in an effort to reduce our loss and loss expense ratioratio. To that end, we have instituted a number of initiatives that are focused on best practices in 2006 remained comparable with the 2005 ratio.following areas:
•Claims automation;
 
 • The increases in the GAAP underwriting expense ratio in 2007 compared to 2006Enhancement of claims quality and 2005 was primarily attributable to increases in underwriting expenses that outpaced premium growth in the comparable periods. Increased labor expenses drove the increase in expense dollars for 2007 and 2006. For additional information regarding our initiatives in the management of the underwriting expense ratio, see the outlook section below and Note 22, “Subsequent Events” in Item 8. “Financial Statements and Supplementary Data” of this Form 10-K.
Insurance Operations Outlook
Historically, the results of the property and casualty insurance industry have experienced significant fluctuations due to high levels of competition, economic conditions, interest rates, loss cost trends, and other factors. During 2007, the industry experienced low levels of catastrophe losses and a softening market characterized by accelerated competition, leading to pricing deterioration in the primary insurance market that was worse than originally anticipated. We expect this trend to continue into 2008. The average forecast, according to the “U.S. Property/Casualty — Review & Preview” from A.M. Best (the “Forecast”) dated January 28, 2008, calls for negative growth in NPW of 0.6% in 2008. This is in addition to the estimated negative growth in NPW of 1.2% for 2007 discussed in the Forecast and results from an across-the-board softening in the personal and commercial lines pricing environments, a weakening economy, leakage of premium to government operated reinsurers and strong interest in alternative forms of risk transfer, including various forms of self insurance, captives, and catastrophe bonds. The 2008 NPW forecast, if accurate, would represent the first decline in total industry annual premiums since 1943. As a result, we may need to reduce our pricing, which could lead to a decrease in margins in order to retain our best business. Accelerated competition in the marketplace, coupled with low premium growth rates, has also led to an increased interest in merger and acquisition activity within the industry. The Forecast also indicates an increase in the expected statutory combined ratio in 2008 compared to the 2007 expectation, indicating that underwriting performance in the industry, although still profitable, is deteriorating.
We believe that future profitability may be impacted by higher loss trends, which are characterized by changes in frequency, severity, and pricing deterioration. When renewal pure price increases are declining and loss costs trend higher, a market cycle shift occurs. General inflation and, notably, medical inflation, can drive up loss costs and lead to higher industry-wide statutory combined ratios. We believe it is critical to have a clearly defined plan to improve risk selection and mitigate higher frequency and severity trends during market cycles. Some of the tools we use to lower frequency and severity are knowledge management, predictive modeling, safety management, managed care, and enhanced claims review. Although it is uncertain at this time whether our initiatives will offset macro pricing and loss trends, we have outperformed the industry’s loss and loss adjustment expense ratio by 6.8 points, on average, over the past 10 years.
Considering the current environment, in the upcoming year, we anticipate pricing discipline and expense management to be key factors in the generation of strong underwriting results. As part of our expense management initiative, in February 2008, we announced a reduction in our workforce of approximately 80 positions, including the immediate displacement of 60 employees and the elimination of 20 open positions. We anticipate these changes to have a related one-time pre-tax cost of approximately $4 million in the first quarter of 2008 and annualized pre-tax savings of approximately $8 million. In addition, we are implementing targeted changes to agency commissions that will maintain highly competitive awards for agents who produce the strongest results for us, while reducing commissions where our historically higher payments have not generated an appropriate level of profitable growth. The changes will bring our program more in line with the competition; however, commissions on 87% of our direct premiums written will not be affected, and the supplemental commission program that rewards our most profitable growth agencies does not change. We feel the changes will bring our program more in line with the competition. These commission revisions are expected to generate annualized pre-tax savings of approximately $8.0 million, and are targeted for rollout in most states in July 2008.

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Even in this competitive market, we believe that the strategies we have implemented will allow us to continue to profitably grow our business based on strong agency relationships and our unique field-based model. To this end, we have developed market-planning tools that are allowing us to strategically appoint additional independent agencies as well as agency management specialists (“AMSs”) in under-penetrated territories, with classes of business that we know historically have been profitable. Through the end of 2007, the Insurance Subsidiaries’ total agency count increased to approximately 880, up from 770 at last year-end, serviced by approximately 100 field-based AMSs who make hands-on underwriting decisions in agents’ offices on a daily basis.
We back the “high touch” component of our business model with technology that allows agents and the Insurance Subsidiaries’ field teams to input business seamlessly into our systems, while also allowing them to select and price accounts at optimal levels through predictive modeling. Technology that allows for the seamless placement of business into our systems includes our One & Done® small business system and our xSELerate® straight-through processing system. Premiums of $250,000 per workday were processed through our One & Done® small business system in 2007, up 42% from 2006. We have set a multi-year small business growth target of $350,000 in One & Done® business per work day, and in 2008 our efforts will be centered on: (i) better managing price points and scale; (ii) implementing a more comprehensive marketing and branding strategy; and (iii) updating the distribution model to address multiple agent and customer needs.
We also continue to pursue our organic growth strategy. Effective July 1, 2007, we entered our 21st primary state, Massachusetts, for Commercial Lines only and wrote approximately $3.8 million of new business in 2007. In 2008, we have plans to expand our footprint to Tennessee. We also have expanded Personal Lines into Rhode Island, Minnesota, and Iowa, states that are already within our existing Commercial Lines footprint. In addition to our organic growth strategy, we are taking note of opportunities that marketplace competition may be creating and would not rule out making an opportunistic acquisition.
Based on our expense management programs along with technology investments, ongoing underwriting improvements, our assessment of current loss cost and pricing trends, and other areas of strategic focus, we are providing 2008 earnings guidance in the range of $2.20 to $2.40 per diluted share. Our guidance is based on the following assumptions: (i) a statutory combined ratio of 98% and a GAAP combined ratio of 100%; (ii) after-tax catastrophe losses of $14.4 million; (iii) growth in after-tax investment income of 3%, including a 10% pre-tax yield on alternative investments, included in “Other investments” on the Consolidated Balance Sheets; (iv) Diversified Insurance Services revenue growth of 5% with a return on revenue of 10%; and (v) diluted weighted average shares of 52.5 million, which includes the expectation of repurchasing 3.5 million shares over the course of the year.
Review of Underwriting Results by Line of Business
Commercial Lines
Commercial Lines
                     
          2007      2006 
($ in thousands) 2007  2006  vs. 2006  2005  vs. 2005 
GAAP Insurance Operations Results:
                    
NPW $1,350,798   1,318,873   2%  1,258,632   5%
                
NPE  1,314,002   1,285,876   2   1,208,666   6 
Less:
                    
Losses and loss expenses incurred  838,577   811,326   3   748,548   8 
Net underwriting expenses incurred  426,118   405,141   5   378,759   7 
Dividends to policyholders  7,202   5,927   22   5,688   4 
                
Underwriting income $42,105   63,482   (34)  75,671   (16)
                
GAAP Ratios:
                    
Loss and loss expense ratio  63.8%  63.1   0.7   61.9   1.2 
Underwriting expense ratio  32.5%  31.5   1.0   31.3   0.2 
Dividends to policyholders ratio  0.5%  0.5   —   0.5   — 
                
Combined ratio  96.8%  95.1   1.7   93.7   1.4 
                
Statutory Ratios:
                    
Loss and loss expense ratio  63.4%  62.9  0.5 pts  61.8  1.1 pts
Underwriting expense ratio  32.0%  31.6   0.4   31.3   0.3 
Dividends to policyholders ratio  0.5%  0.5   —   0.5   — 
                
Combined ratio  95.9%  95.0   0.9   93.6   1.4 
                

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•NPW increased in 2007 compared to 2006 and 2005. Premium growth in 2007 was attributable to increases in direct new business written of $36.4 million to $313.3 million for 2007 compared to 2006 partially offset by: (i) a slight reduction in retention for 2007 compared to 2006 and 2005; (ii) decreases in audit and endorsement premium activity of $11.5 million and $6.3 million, respectively; and, (iii) renewal price decreases, including exposure of 0.3% in 2007 reflecting the competitive pressure on our renewal book of business.
Premium growth in 2006 as compared to 2005 was attributable to increases in direct new business of $14.1 million to $276.9 million coupled with renewal price increases, including exposure, of 2.2% in 2006.control;
 
 • NPE increased reflecting increasesLitigation management;
•Enhancement of compliance and bill review;
•Enhancement of workers compensation review; and
•Enhancement of salvage and subrogation review.
As these initiatives are anticipated to accelerate the timing of reserve establishment, we ultimately expect lower loss costs to be realized through reduced legal and loss adjustment expenses. This acceleration inflates our severity statistics in NPW as discussed above.the near term, but we expect the longer-term benefit to be a refined management of the claims process.
 
 • The GAAP loss and lossunderwriting expense ratio increased 0.7 points in 20072008 compared to 2006 and 1.2 points in 2006 compared to 2005,2007 primarily due to: (i) lower pricing on our commercial bookas the result of business; and, (ii) increases in property losses. Included in total property losses were catastrophe losses that decreased $3.6the pre-tax restructuring charge of $5.0 million, or 0.3 points, related to $12.0 millionreductions in 2007 compared to 2006 and increased $11.8 million or 0.9 points to $15.6 million in 2006 compared to 2005. The GAAP loss and lossour workforce during 2008. Absent this charge, the expense ratio increases wereremained relatively flat, reflecting a 1% decrease in NPE partially offset by:by lower overall underwriting expenses year over year. These reduced expenses are the result of lower expected payments of profit-based incentives to our agents and employees, reflecting lower NPW and underwriting results during 2008, and benefits realized from our cost containment initiatives including: (i) underwriting improvements relatedtargeted changes to our agency commission program implemented in July 2008 and expected to generate annual savings of $7 million, pre-tax; (ii) our workforce reductions during 2007 and 2008, expected to generate annual savings of $7 million, pre-tax; and (iii) the implementationre-domestication of our long-term strategies; and, (ii) favorable prior year loss and loss expense development within our workers compensation and commercial auto linestwo of business.the Insurance Subsidiaries effective June 30, 2008, to achieve operational efficiencies with an anticipated pre-tax savings of $2 million annually.

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  For 2007, net favorable prior year loss and loss expense development within our casualty lines of business amounted to approximately $20 million, or 1.5 points, compared to approximately $2 million in 2006, or 0.1 points, and minimal prior year loss and loss expense development in 2005.
• The increase in the GAAP underwriting expense ratio in 2007 compared to 2006 and 2005 was attributable to increases in underwriting expenses that outpaced premium growth. These underwriting expense increases were driven by higher labor costs. For additional information regarding
Insurance Operations Outlook
Historically, the results of the property and casualty insurance industry have experienced significant fluctuations due to competition, economic conditions, interest rates, loss cost trends, and other factors. Since 2006, the industry has been experiencing a softening market under which both personal and commercial lines pricing are declining. In its report entitled, “U.S. Property/Casualty — Review & Preview”, A.M. Best increased its projection for the property and casualty industry-wide combined ratio for 2008 to 104.7% up from its initial projection of 98.6%, with commercial and personal lines projected to end the year at 106.5% and 103.3%, respectively. The initial projections for these lines were 97.5% and 99.5%, respectively.
During 2008, the Insurance Operations segment outperformed both A.M. Best’s projection of 104.7% and an industry-wide projection of 104.8% by Fitch Ratings (“Fitch”), provided in their report entitled “Review and Outlook for 2008 and 2009,” with a statutory combined ratio of 99.2% for the year. Our Commercial Lines business reported a statutory combined ratio of 98.5% and our Personal Lines business reported a statutory combined ratio of 103.7% for the year. In an effort to write profitable business in the current commercial and personal lines market conditions, we have implemented a clearly defined plan to improve risk selection and mitigate higher frequency and severity trends to complement our strong agency relationships and unique field-based model.
In addition, our focus in 2008 included the following:
•Efforts to manage expenses with a workforce reduction initiative, changes to our agent commission programs, and the re-domestication of two of the Insurance Subsidiaries to Indiana. In addition to helping to manage our expense ratios this year, the ongoing impact of these initiatives will continue to benefit expenses going forward. While the cost-savings generated by these efforts are recognized immediately on a statutory basis, they are recognized on a GAAP basis over a 12-month period, thereby somewhat delaying their impact.
•Claims management initiative with a focus on best practices in the areas of: (i) claims automation; (ii) enhancement of claims quality and control; (iii) litigation management; (iv) enhancement of compliance and bill review; (v) enhancement of workers compensation review; and (vi) enhancement of salvage and subrogation review.
•Sales management efforts including our market planning tools and leads program. Our market planning tools allow us to identify and strategically appoint additional independent agencies in and hire AMSs for underpenetrated territories. During 2008, the Insurance Subsidiaries independent agency count grew by approximately 60, bringing our total agency count to approximately 940. These independent insurance agencies are serviced by approximately 100 field-based AMSs who make hands-on underwriting decisions on a daily basis.
•Technology that allows agents and our field teams to input business seamlessly into our systems, including our One & Done® small business system and our xSELerate® straight-through processing system. Premiums of approximately $273,000 per workday were processed through our One & Done® small business system during 2008, up 9% from the same period in 2007.
•Organic expansion including entering our 22nd state, Tennessee, in June 2008. In the first seven months of operations in this state, we wrote premium of $5.5 million. In addition, we wrote $14.6 million of premium in Massachusetts during 2008, our first full year of operations in this state.
Commercial lines pricing continued to soften in 2008, although there were early signs of rate stabilization as the year wore on. Our commercial lines pure renewal pricing decreased 3.1% for the year, which we consider an achievement when viewed in conjunction with our retention, which remained relatively stable at 77% compared to last year. In the current competitive marketplace, where many carriers are taking larger rate decreases in order to grow their revenues, our cycle management tools that we have in place performed as they were intended; they protected us from writing business that we believe will be unprofitable. As many of our competitors have more financial and operating resources than we do, they have greater scalability and more information regarding their risks which, coupled with the use of statistical and computer models, may give them a greater ability to make pricing and underwriting decisions. We believe that while the short-term downside of the use of our cycle management tools was a 5% decline in NPW for the year, over the longer run, by accepting this short-term decline, we will be in a better position to return to targeted return on equity levels.
Looking forward into 2009, Fitch is projecting an industry-wide statutory combined ratio of 104.0% for the year, reflecting their belief that underwriting results will not improve significantly as premiums are projected to grow by less than 1% due to premium rate declines. In addition, Fitch anticipates that underwriting results will be adversely impacted by higher expense ratios and less favorable reserve development, offset by a return to historical average catastrophe loss experience.

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Considering the ongoing impact of the 3.1% decrease in commercial lines pure renewal pricing in 2008, coupled with anticipated normal loss cost trends, we have provided guidance for 2009 that includes a GAAP combined ratio below 103.5% and a statutory combined ratio below 102.5%, both of which reflect catastrophe losses of 1.4 points.
Review of Underwriting Results by Line of Business
Commercial Lines
                     
          2008      2007 
($ in thousands) 2008  2007  vs. 2007  2006  vs. 2006 
                
GAAP Insurance Operations Results:
                    
NPW $1,270,856   1,350,798   (6)%  1,318,873   2%
                
NPE  1,285,547   1,314,002   (2)  1,285,876   2 
Less:
                    
Losses and loss expenses incurred  852,697   838,577   2   811,326   3 
Net underwriting expenses incurred  421,536   426,118   (1)  405,141   5 
Dividends to policyholders  5,211   7,202   (28)  5,927   22 
                
Underwriting income $6,103   42,105   (86)%  63,482   (34)%
                
GAAP Ratios:
                    
Loss and loss expense ratio  66.3%  63.8   2.5pts  63.1   0.7pts
Underwriting expense ratio  32.8%  32.5   0.3   31.5   1.0 
Dividends to policyholders ratio  0.4%  0.5   (0.1)  0.5   — 
                
Combined ratio  99.5%  96.8   2.7   95.1   1.7 
                
Statutory Ratios:
                    
Loss and loss expense ratio  65.9%  63.4   2.5   62.9   0.5 
Underwriting expense ratio  32.2%  32.0   0.2   31.6   0.4 
Dividends to policyholders ratio  0.4%  0.5   (0.1)  0.5   — 
                
Combined ratio  98.5%  95.9   2.6pts  95.0   0.9pts
                
•NPW decreased in 2008 compared to 2007 and 2006 due to the highly competitive insurance marketplace and the slowing economy. These factors were evidenced by: (i) Commercial Lines direct new business that decreased $46.1 million to $267.2 million; (ii) a 3.1% decrease in renewal pure pricing; and (iii) endorsement and audit activity that decreased $37.7 million.
As mentioned above, Commercial Lines renewal pure pricing in 2008 decreased 3.1% on renewal premiums, which we consider an achievement in the current competitive marketplace, especially when viewed in conjunction with our retention, which remained relatively flat at 77% during the year. In response to the highly competitive marketplace, our agents are actively managing our books of business by renewing accounts as much as 60 days in advance of the policy expiration date.
NPW increased in 2007 compared to 2006, driven by increases in direct new business of $36.4 million, to $313.3 million, partially offset by: (i) renewal pure price decreases of 3.9%; (ii) a slight reduction in retention; and (iii) decreases in audit and endorsement premium activity of $11.5 million and $6.3 million, respectively.
•As the result of decreased NPW over the last 12 months, NPE declined in 2008 compared to 2007. There was a slight increase in NPE in 2007 compared to 2006 reflecting the 2007 increases in NPW discussed above.
•The increase in the GAAP loss and loss expense ratio in 2008 compared to 2007 reflects higher catastrophe losses related to 2008 storm activity primarily in our Midwestern and Southern regions and a reduction in favorable prior year loss and loss expense development of approximately $6 million, from approximately $20 million, or 1.5 points in 2007 to approximately $14 million, or 1.1 points in 2008. Total catastrophe losses for the year added $27.0 million, or 2.1 points, to losses in 2008. For 2007, catastrophe losses added $12.0 million, or 0.9 points, to losses. The favorable prior year development in 2008 was driven by improvement in our workers compensation line of business, while the prior year development in 2007 was driven by lower than expected severity on our commercial automobile line of business.

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The increase in the GAAP loss and loss expense ratio in 2007 compared to 2006 is primarily attributable to lower pricing on our commercial book of business as well as increases in property losses. Included in property losses were catastrophe losses that decreased $3.6 million, or 0.3 points, to $12.0 million in 2007 compared to $15.6 million in 2006. These increases were partially offset by net favorable prior year loss and loss expense development, primarily in our commercial automobile line of business, that amounted to approximately $20 million, or 1.5 points in 2007, compared to approximately $2 million, or 0.1 points, of net favorable prior year loss and loss expense development in 2006.
•The GAAP underwriting expense ratio seeincreased in 2008 compared to 2007 primarily as the outlook section belowresult of the pre-tax restructuring charge of $4.4 million, or 0.3 points, related to reductions in our workforce during 2008. Absent this charge, the expense ratio remained flat, reflecting a decrease in NPE partially offset by lower overall underwriting expenses year over year. These reduced expenses are the result of lower expected payments of profit-based incentives to our agents and Note 22, “Subsequent Events”employees, reflecting lower NPW and underwriting results during 2008, and benefits realized from our cost containment initiatives including: (i) targeted changes to our agency commission program implemented in Item 8. “Financial StatementsJuly 2008; (ii) our workforce reductions during 2007 and Supplementary Data”2008; and (iii) the re-domestication of this Form 10-K.two of the Insurance Subsidiaries effective June 30, 2008, to achieve operational efficiencies.
The increase in the GAAP underwriting expense ratio in 2007 compared to 2006 was attributable to increases in underwriting expenses that outpaced premium growth. These underwriting expense increases were driven by higher labor costs.
The following is a discussion on our most significant commercial lines of business:
Commercial AutomobileGeneral Liability
                                        
 2007 2006  2008 2007 
($ in thousands) 2007 2006 vs. 2006 2005 vs. 2005  2008 2007 vs. 2007 2006 vs. 2006 
  
Statutory NPW $319,176 319,710  —% 325,048  (2)% $393,012 420,388  (7)% 413,381  2%
Statutory NPE 315,259 319,921  (1) 320,080 —  396,066 410,024  (3) 402,745 2 
Statutory combined ratio  88.1% 88.1 — pts 74.4 13.7 pts  102.0% 98.8 3.2pts 96.5 2.3pts
% of total statutory commercial NPW  23% 24 26   31% 31 31 
Our continued strong performance in this line is the result of underwriting and pricing improvements over the last several years. We have implemented targeted rate decreases on the best accounts to grow this profitable line of business. The policy count onNPW for this line of business increased 8%decreased in 2008 compared to 2007, primarily due to: (i) a decrease in direct voluntary new business premiums of $15.7 million, or 17%; (ii) a renewal pure price decrease of 2.0%; and (iii) a decrease in our audit and endorsement premiums of $17.7 million, to a return premium of $7.8 million. As of December 31, 2008, approximately 58% of our premium is subject to audit whereby actual exposure units (usually sales or payroll) are compared to estimates and a return premium or additional premium transaction occurs. In 2007, NPW increased compared to 2006, driven bywith a direct voluntary new policy count increases of 18%. In 2006, as compared to 2005, policy counts increased 6% driven by new policy count increases of 4%. However, renewal prices, including exposure, decreased 2.9% in 2007 compared to a decrease of 1.1% in 2006 and anbusiness increase of 0.4% in 2005, which has put pressure on NPW and NPE. Lower severity trends have resulted in favorable prior year statutory loss and loss expense development of approximately $19 million in 2007 compared to $15 million in 2006 and $48 million in 2005.
General Liability
                     
          2007      2006 
($ in thousands) 2007  2006  vs. 2006  2005  vs. 2005 
                     
Statutory NPW $420,388   413,381   2%  382,172   8%
Statutory NPE  410,024   402,745   2   363,713   11 
Statutory combined ratio  98.8%  96.5  2.3 pts  97.5  (1.0) pts
% of total statutory commercial NPW  31%  31       30     

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Total policy counts in14%. In this line of business, we are experiencing the highest level of competition in our middle market and large account business. Despite this competition, overall policy counts increased 5% in 2008 compared to 2007 and 9% in 2007 compared to 2006, and 7%reflecting moderate growth in 2006 compared to 2005. Newour small account business, which we define as policies with premiums inless than $25,000. Retention on this line of business increased 14% for 2007was 74% in 2008 compared to 2006 and 1% for 2006 compared to 2005. Evidence of the softening market is illustrated in our renewal pricing for this line which, including exposure, decreased 1.1% in 2007 compared to increases of 1.5% in 2006 and 3.0% in 2005. Continuing evidence of the softening market is illustrated by retention that decreased slightly to 75% in 2007 compared toand 77% in 2006 and 76% in 2005.2006.
Pricing pressure, coupled with higher loss costs, continues to put pressure on profitability in this line of business. However, we continue to concentrate on our long-term strategy to improve profitability, which focuses on: (i) contractor growth in business segments with lower completed operations exposures; and (ii) contractor and subcontractor underwriting guidelines to minimize losses.

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Workers Compensation
                                        
 2007 2006  2008 2007 
($ in thousands) 2007 2006 vs. 2006 2005 vs. 2005  2008 2007 vs. 2007 2006 vs. 2006 
  
Statutory NPW $336,189 325,008  3% 309,584  5% $303,783 336,189  (10)% 325,008  3%
Statutory NPE 325,657 314,221 4 293,311 7  308,618 325,657  (5) 314,221 4 
Statutory combined ratio  101.6% 108.4 (6.8) pts 124.1 (15.7) pts  96.1% 101.6 (5.5)pts 108.4 (6.8)pts
% of total statutory commercial NPW  25% 25 25   24% 25 25 
Our multi-facetedNPW for this line of business decreased in 2008 compared to 2007, primarily as the result of: (i) competitive pressure from monoline carriers willing to write workers compensation strategy, which incorporatespolicies, mainly on the upper end of our knowledge managementmiddle market business and predictive modelingour large account business that led to a direct voluntary new business premium decrease of $17.0 million, or 21%; (ii) a decrease in audit and endorsement premium of $15.5 million; and (iii) renewal pure price decreases of 2.1% in 2008. Retention decreased one point to 78% partially due to initiatives has enabled us to retain and write more of the best accounts, leading to 2007 increases in total policy counts of 9% compared to 2006 and 6% in 2006 compared to 2005. Direct new voluntary policy premiums increased 28% for 2007 compared to 2006 and 30% for 2006 compared to 2005. At the same time, these initiativesthat have allowed us to target price increases for our worst performing business, which contributed to the decrease in our retention in 2007 to 79% from 80% in 2006 and 81% in 2005, thereby improving the profitabilityquality of our retained business. Policy counts increased by 5% in 2008 compared to 2007 as we are writing more, smaller premium policies.
In 2007, NPW for this line increased from 2006, reflecting a 28% increase in direct new voluntary policy premiums. As in 2008, retention decreased one point in 2007 compared to 2006, while policy counts increased 9%.
The improvement in the statutory combined ratio of this line of5.5 points in 2008 compared to 2007 and 6.8 points in 2007 compared to 2006 and 15.7reflects: (i) favorable prior year development of approximately $23 million, or 7.6 points, in 20062008 compared to 2005 reflects not only$3 million, or 0.8 points, in 2007 and $2 million, or 0.7 points in 2006; and (ii) the ongoing progress resulting from our improvement initiative including the executionuse of our workers compensation strategies, but alsobusiness analytics tools enabling us to price and retain our best accounts, coupled with the impact of medical trends that have returned to a more normalized level, and the redesign and recontracting of our managed care process. The prior year development in 2008 reflects favorable development in accident years 2004 to 2006, as a result of our improvement initiatives on this line as mentioned above, partially offset by adverse development in the 2007 accident year driven by higher than expected severity.
Commercial Automobile
                     
          2008      2007 
($ in thousands) 2008  2007  vs. 2007  2006  vs. 2006 
   
Statutory NPW $300,391   319,176   (6)%  319,710   —%
Statutory NPE  307,388   315,259   (2)  319,921   (1)
Statutory combined ratio  99.7%  88.1   11.6pts  88.1   —pts
% of total statutory commercial NPW  23%  23       24     
NPW for this line of business decreased in 2008 compared to 2007, while it remained flat in 2007 compared to 2006. The 2008 decrease was primarily driven by: (i) lower direct voluntary new business premiums, which were $52.3 million in 2008, down $9.2 million, or 15% from 2007; and (ii) renewal pure price decreases of 5.0%. In managing our pure price decreases in 2008, we lost only one point in retention and ended the year at 79% compared to 80% in 2007. Pure price decreases on this line were 5.4% in 2007 and 4.1% in 2006 while retention was 80% and 81%, respectively. As with the general liability line of business, we are experiencing the highest level of competition in our middle market and large account business, while our small account business, which we define as policies with premiums less than $25,000, experienced moderate growth. Overall policy counts for this line increased 5% in 2008 compared to 2007. In 2007, as compared to 2006, policy counts increased 8%.
The increase in the statutory combined ratio in 2008 compared to 2007 for the commercial automobile line is primarily due to: (i) favorable prior year statutory development in 2007 of $3approximately $19 million attributabledue to improved severity trends; (ii) physical damage losses that were $6.2 million, or 2.3 points, higher in 2008; and (iii) pure price decreases as discussed above.

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Commercial Property
                     
          2008      2007 
($ in thousands) 2008  2007  vs. 2007  2006  vs. 2006 
   
Statutory NPW $194,550   198,903   (2)%  188,839   5%
Statutory NPE  196,189   190,681   3   182,351   5 
Statutory combined ratio  92.9%  92.7   0.2pts  82.1   10.6pts
% of total statutory commercial NPW  15%  15       14     
NPW for this line of business decreased in 2008 compared to 2007 driven by a new business premium decrease of $2.4 million, or 5%, coupled with a one point reduction in retention to 76%, and renewal pure pricing that decreased 4.1%. Partially offsetting these strategies, partially offset by anitems is a 6% increase in the tail factor relatedpolicy counts in 2008 compared to medical inflation and general development trends. Favorable prior year statutory development of approximately $2 million in 2006 was driven, in part, by savings realized from changing medical and pharmacy networks outside of New Jersey and re-contracting our medical bill review services. Adverse prior year statutory development of $40 million in 2005 was primarily the result of adverse loss trends, specifically in medical costs in the 2001 and prior accident years, which warranted an increase in management’s best estimates within the loss range.
Commercial Property
                     
          2007      2006 
($ in thousands) 2007  2006  vs. 2006  2005  vs. 2005 
                     
Statutory NPW $198,903   188,839   5%  176,764   7%
Statutory NPE  190,681   182,351   5   168,281   8 
Statutory combined ratio  92.7%  82.1   10.6 pts  69.5   12.6 pts
% of total statutory commercial NPW  15%  14       14     
Net premiums written2007. NPW for this line of business increased in 2007 compared to 2006 and 2005 due to increases in total policy counts of 11% in 2007 compared to 2006 and 9%2006. Partially offsetting the 2007 increase were renewal pure price decreases of 5.9% during the year.
The statutory combined ratio remained relatively flat in 20062008 as compared to 2005. Stable retention2007, despite increased catastrophe losses of approximately 81% over$11.9 million, or 5.9 points, to $22.6 million related to storm activity in our Southern and Midwestern regions, including the past three years has also ledeffects of Hurricane Ike, which added $6.6 million, or 3.4 points, to an increase in net premiums written. NPW growth wasthe combined ratio for the year. These catastrophes were partially offset by renewal prices, including exposure, which decreased 0.4%a decrease in non-catastrophe property losses, reflecting normal volatility inherent in this line of business.
Although profitable, the increased statutory ratio in 2007 compared to increases of 2.1% infrom 2006 and 2.8% in 2005.
Although still profitable, the higher statutory combined ratio for commercial property reflects lower pricing and increased property losses especially in comparisoncompared to the unusually low experience in 2006. The increase in property losses appears to be part of the normal variability in this line and2007 was primarily the result of an increase in the severity of losses, mainly attributable to flood events and electrical fires. For 2007,As opposed to the increased catastrophe losses in 2008, catastrophes decreased $2.5 million to $10.7 millionin 2007 compared to 2006, however, for 2006, catastrophe losses increased $10.4 million to $13.2 million compared to 2005.2006.

 

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Personal Lines
Personal Lines
                     
          2008      2007 
($ in thousands) 2008  2007  vs. 2007  2006  vs. 2006 
GAAP Insurance Operations Results:
                    
NPW $213,185   204,069   4%  217,088   (6)%
                
NPE  209,943   203,304   3   213,788   (5)
Less:
                    
Losses and loss expenses incurred  161,119   160,629   —   148,657   8 
Net underwriting expenses incurred  70,153   68,823   2   70,635   (3)
                
Underwriting loss $(21,329)  (26,148)  18%  (5,504)  (375)%
                
GAAP Ratios:
                    
Loss and loss expense ratio  76.7%  79.0   (2.3)pts  69.5   9.5pts
Underwriting expense ratio  33.5%  33.9   (0.4)  33.1   0.8 
                
Combined ratio  110.2%  112.9   (2.7)  102.6   10.3 
                
Statutory Ratios1:
                    
Loss and loss expense ratio  75.7%  78.2   (2.5)  68.5   9.7 
Underwriting expense ratio  28.0%  29.7   (1.7)  29.7   — 
                
Combined ratio  103.7%  107.9   (4.2)pts  98.2   9.7pts
                
                     
          2007      2006 
($ in thousands) 2007  2006  vs. 2006  2005  vs. 2005 
GAAP Insurance Operations Results:
                    
NPW $204,069   217,088   (6)%  200,842   8%
                
NPE  203,304   213,788   (5)  209,347   2 
Less:
                    
Losses and loss expenses incurred  160,629   148,657   8%  157,182   (5)%
Net underwriting expenses incurred  68,823   70,635   (3)  58,108   22 
                
Underwriting loss $(26,148)  (5,504)  (375)  (5,943)  7 
                
GAAP Ratios:
                    
Loss and loss expense ratio  79.0%  69.5   9.5 pts  75.1   (5.6) pts
Underwriting expense ratio  33.9%  33.1   0.8   27.8   5.3 
                
Combined ratio  112.9%  102.6   10.3   102.9   (0.3)
                
Statutory Ratios1:
                    
Loss and loss expense ratio  78.2%  68.5   9.7 pts  73.4   (4.9) pts
Underwriting expense ratio  29.7%  29.7   —   27.2   2.5 
                
Combined ratio  107.9%  98.2   9.7   100.6   (2.4)
                
1 The statutory ratios include Selective’sour flood line of business, which is included in the Diversified Insurance Services Segmentsegment on a GAAP basis and therefore excluded from the GAAP ratios. The total Statutory Combinedstatutory combined ratio excluding flood was 108.7% for 2008, 113.0% for 2007, and 102.9% for 2006.
•The increase in NPW in 2008 compared to 2007 is primarily due to the impact of rate actions that became effective during the year. These rate actions resulted in an overall rate increase of 7.7% in Personal Lines, comprised of 11.1% in our personal automobile line of business and 1.1% in our homeowners line of business. Specific to our New Jersey personal automobile business, we have received rate increases of 6.8% effective in May 2008 and 6.5% effective in October 2008.
Our rate increases were partially offset by a decline in retention of approximately one point, to 81%, on our overall Personal Lines book. In addition, the number of automobiles that we insure in New Jersey decreased by approximately 6,000, to 65,000 cars, at December 31, 2008.
NPW decreased in 2007 compared to 2006. Excluding the impact from the cancellation of the New Jersey Homeowners’ Quota Share Treaty, which increased 2006 NPW by $11.3 million, NPW decreased 1% in 2007 compared to 2006. This modest 1% decrease was driven by the implementation of our MATRIXSM pricing system, which caused a dislocation in our New Jersey personal automobile line of business as renewal policies were repriced at higher levels. Partially offsetting this decrease were increases in our personal automobile business outside of New Jersey of $5.4 million, to $50.0 million, coupled with increases in our homeowners business of $4.5 million, to $65.4 million, in 2007.
•The fluctuations in NPE reflect the fluctuations in NPW as discussed above.
•The improvement in the GAAP loss and 105.0 % for 2005.loss expense ratio in 2008 compared to 2007 is primarily driven by the 3% increase in NPE, coupled with favorable prior year development in our casualty lines of approximately $5 million, or 2.2 points, in 2008, compared to unfavorable prior year development of approximately $1 million, or 0.4 points, in 2007. The 2008 development reflected a better quality of business being written through our MATRIXSM pricing system, coupled with normal volatility, while the 2007 development included the impact of unfavorable trends in groundwater contamination caused by the leakage of certain underground oil storage tanks in our homeowners line of business. This improvement in the loss and loss expense ratio was partially offset by increases in: (i) catastrophe losses of $1.9 million, to $4.7, million in 2008; and (ii) non-catastrophe property losses of $4.5 million, to $56.5 million, in 2008.

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The deterioration in the GAAP loss and loss expense ratio in 2007 compared to 2006 was primarily driven by decreased pricing in our New Jersey personal automobile line of business coupled with the following:
•An increase of $6.7 million in non-catastrophe property losses in 2007 compared to 2006.
•Unfavorable prior year development in our casualty lines of $1 million in 2007 compared to favorable prior year development of $6 million in 2006. The unfavorable development in 2007 reflects: (i) higher severity in accident year 2006 for our personal automobile line of business; (ii) adverse prior year development due to unfavorable trends in claims for groundwater contamination caused by the leakage of certain underground oil storage tanks in our homeowners line of business; and (iii) several significant losses in our personal excess line of business, partially offset by lower than expected loss emergence for accident years prior to 2006. The favorable prior year development in 2006 primarily related to lower than expected frequency in personal automobile claims.
NPW decreased
The deterioration in the 2007 loss and loss expense ratio was partially offset by a reduction in catastrophe losses of $2.2 million, to $2.9 million, in 2007.
•The GAAP underwriting expense ratio improved in 2008 compared to 2007 primarily due to costs associated with the reorganization of the Personal Lines department in May of 2007, which reduced the staffing level by 31 employees and, added 0.6 points to the underwriting expense ratio in 2007. The deterioration in the GAAP underwriting expense ratio in 2007 compared to 2006 was primarily attributable to overhead costs that have outpaced premiums earned.
We continue to focus on improving our Personal Lines results and continue to diligently take steps in 2007 comparedthat regard. The significant rate increases that we achieved in 2008 will generate an additional $15 million in annual premium. In addition, we have more rate increases planned in 2009 that are expected to 2006 after increasinggenerate approximately $9 million in 2006 compared to 2005. Excluding the impact from the cancellationadditional premium, including 21 anticipated rate increases of the New Jersey Homeowners’ Quota Share Treaty (“Quota Share Treaty”), which increased 2006 NPW by $11.3 million, NPW decreased 1% in 2007 compared to 2006 and increased 2% in 2006 compared to 2005.
The remaining decrease in NPW in 2007 compared to 2006 was primarily driven by a decline in NPW3% or more. In December of 2008, we implemented territory rate changes for our New Jersey personal automobile business of $12.6 million to $80.1 million in 2007. This resulted from a reduction in thebusiness. The number of New Jersey personal automobiles that we insure, primarily driven by repricing at higher levels through our MATRIX® pricing system. Partially offsetting this decrease were increases in our personal automobile business outside of New Jersey of $5.4 million to $50.0 million coupled with increases in our homeowners business of $4.5 million to $65.4 million in 2007.
The New Jersey personal automobile market has been impacted by the introduction of new companies writing businessterritories in the state with rating plans that allow themwas increased from 40 to price accounts competitively without the legacy issue of repricing existing accounts through filed rate increases. Our60 and, as we move into these new Personal Lines rating plan was approved by the New Jersey Department of Banking and Insurance (“NJDOBI”) and was implemented in August 2006. Our new plan allows us to better evaluate and price risks, which will help us to profitably competeterritories for new business in our agencies. We have moved our entire existing renewal inventory into our new pricing and tiering structure in New Jersey, which has caused a dislocation in this book of business, due to the repricing of certain business at higher levels, some of which did not renew. As annualprice increases or decreases in any given year are capped at 20%10%. We anticipate having the majority of the price adjustments reflected in our renewal book by year-end 2010, and we believe the NJDOBI,new territory rates will provide more adequate pricing in territories that have historically not been profitable for us.
In early 2009, we expect improvements to materialize over a three-year period. We continue to focus on increasing new business production within and outside of New Jersey through this advanced pricing methodology. In our continuing efforts to improve our existing book of automobile business, we have implemented average renewal rate increases of 13.1% in Pennsylvania effective August 1, 2007, and 8.5% in Maryland effective September 1, 2007. These changes applied to business written prior to thewill be completing implementation of our MATRIX®SM program. In 2008, we are taking steps to continue to improve our automobile business by filing further rate increases of 7% in New Jersey, which is targetedpricing system for May, 7% in Pennsylvania, targeted for July, and 6% in Maryland, targeted for August. The New Jersey change applies to all business, and the other changes apply to business originally written prior to the implementation of our MATRIX® program. Such rate increases were necessary, as these states have regulatory restrictions on moving the renewal book into our new pricing methodology and the previous rates did not yield sufficient profitability.

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Excluding the impact of the one-time benefit received from the cancellation of the Quota Share Treaty, NPW increased 2% in 2006 compared to 2005. This increase reflects the retention of homeowners business that had previously been ceded under the treaty coupled with an increase in direct homeowners premiums written of 6% in 2006 compared to 2005, partially offset by a decrease in our personal automobile business of $16.6 million to $137.4 million. NPW on our personal automobile line of business decreased in 2006 as a result of the ongoing competition in the New Jersey personal automobile marketplace coupled with our rating plans that were not competitive through the first half of the year due to a historically restrictive rating environment.
The fluctuations in NPE reflect the fluctuations in NPW as discussed above.
The deterioration in the GAAP loss and loss expense ratio in 2007 compared to 2006 was primarily driven by decreased pricing in our New Jersey personal automobile line of business coupled with the following:
An increase of $6.7 million in non-catastrophe property losses in 2007 compared to 2006.
Unfavorable prior year development in our casualty lines of $1 million in 2007 compared to favorable prior year development of $6 million in 2006. The unfavorable development in 2007 reflects (i) higher severity in accident year 2006 for our personal automobile line of business; (ii) adverse prior year development due to unfavorable trends in claims for groundwater contamination caused by the leakage of certain underground oil storage tanks in our homeowners line of business; and, (iii) several significant losses inbusiness. Through this system, we are able to better manage our personal umbrella line of business, partially offsetcoastal exposure by lower than expected loss emergence for accident years prior to 2006. In 2006, the favorable prior year development primarily related to lower than expected frequency in personal automobile claims.
pricing risks at levels that we believe are more adequate.
This deterioration in the loss and loss expense ratio was partially offset by a reduction in catastrophe losses of $2.2 million, to $2.9 million in 2007.
The improvement in the 2006 GAAP loss and loss expense ratio was driven by the reserving actions taken in 2005 in light of a New Jersey Supreme Court decision that eliminated the application of the serious life impact standard to personal automobile cases under the verbal tort threshold of New Jersey’s Automobile Insurance Cost Reduction Act (“AICRA”) and resulted in an increase to our reserves of $13.0 million in the second quarter of 2005. The implementation of AICRA, and our rating and tiering actions had enabled us to achieve profitability in the New Jersey personal automobile line of business over the two years prior to the ruling. However, factoring higher expected claim costs into our New Jersey personal automobile excess profits calculation eliminated $5.5 million of excess profits reserves in the second quarter of 2005.
The deterioration in the GAAP underwriting expense ratio in 2007 compared to 2006 and 2005 was primarily attributable to overhead costs that have outpaced premiums earned. In addition, costs associated with the reorganization of the Personal Lines department in May of 2007, which reduced the staffing level by 31 employees, added 0.6 points to the underwriting expense ratio in 2007.
We have also implemented a three-part profit improvement plan that will focus on returning Personal Lines to profitability by the end of 2009. To decrease costs associated with writing policies and servicing claims, we plan to: (i) utilize the full capability of our MATRIX® pricing system, along with widening the One & Done® pipeline to maximize the cost savings that are associated with these policies; (ii) roll out our knowledge management initiatives to the Personal Lines operation in May 2008; and, (iii) move additional claims to our centrally located claims department to cut down on costs incurred for claims handling.

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Reinsurance
We have reinsurance contracts that cover both property and casualty business. We use traditional forms of reinsurance and do not utilize finite risk reinsurance. Our contractsAvailable reinsurance can be segregated into the following key categories:
 • Property Reinsurance–- includes our Property Excess of Loss treaty purchased for protection against large individual property losses and our Property Catastrophe treaty purchased to provide protection for the overall property portfolio against severe catastrophic events. Facultative reinsurance is also used for property risks that are in excess of our treaty capacity.
 • Casualty Reinsurance–- purchased to provide protection for both individual large casualty losses and catastrophic casualty losses involving multiple claimants or insureds. Facultative reinsurance is also used for casualty risks that are in excess of our treaty capacity.
•Terrorism Reinsurance- available as a federal backstop related to terrorism losses as provided under the TRIA. For further information regarding this legislation, see Item 1A. “Risk Factors” of this Form 10-K.
•Flood Reinsurance- as a servicing carrier in the WYO Program, we receive a fee for writing flood business, for which the related premiums and losses are ceded to the federal government.
 • Other Reinsurance–- includes smaller treaties, such as our Surety and Fidelity Excess of Loss and our Equipment Breakdown Coverage treaties, which do not fall within the categories above.
Additional information regarding the terms and related coverage associated with each of our categories of reinsurance can be found in Item 1. “Business” of this Form 10-K.

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We regularly reevaluate our overall reinsurance program and try to develop the most effective ways to manage our risk. Our analysis is based on a comprehensive process that includes periodic analysis of modeling results, aggregation of exposures, exposure growth, diversification of risks, limits written, projected reinsurance costs, financial strength of reinsurers and projected impact on earnings and statutory surplus. We strive to balance sometimesometimes opposing considerations of reinsurer credit quality, price, terms, and our appetite for retaining a certain level of risk.
Terrorism Reinsurance
In addition to treaty and facultative reinsurance, the Insurance Subsidiaries are partially protected by the Terrorism Risk Insurance Act of 2002, which was modified and extended through December 31, 2014 via the Terrorism Risk Insurance Program Reauthorization Act of 2007. For further information regarding this legislation, see Item 1A. “Risk Factors” of this Form 10-K.
Property Reinsurance
The Property Catastrophe treaty renewed effective January 1, 20082009 with a 15% reduction7.8% increase in premium. The current treaty providesstructure remains the same providing per occurrence coverage for 95% of $310.0 million in excess of $40.0 million retention compared to 95% of $335.0 million in excess of $40.0 million retention under the expiring treaty.retention. The annual aggregate limit net of our co-participation is $589.0 millionmillion.
In 2008, we managed our hurricane exposures through the implementation of a Catastrophe (“CAT”) strategy initiative. It focused on policies with high Annual Average Loss (“AAL”) to premium ratios which were targeted for increases in deductibles and premium, and in certain cases non-renewals. The strategy led to the implementation of a variety of underwriting system tools that provide CAT management information to the underwriters for a more granular portfolio management of our property book of business. The July 2008 modeling results included a 4.4% reduction in gross AAL, while insured values increased 3.5% when compared to $636.5 million forJune 2007, clearly showing that the expiring treaty. strategy has taken hold.
We continue to assess our property catastrophe exposure aggregations, modeled results and effects of growth on our property portfolio and strive to manage our exposure to individual large events balanced against the cost of reinsurance protection.
The following table presents Risk Management Solutions, Inc.’s (“RMS”) v.7.0v.8.0 modeled hurricane losses based on the Insurance Subsidiaries’ property book of business as of June 30, 2007:July 1, 2008:
                        
 Historical Basis Near Term Basis 
                         Net Losses Net Losses 
($ in thousands) Historic Basis Stochastic Basis  as a as a 
 Net Losses Net Losses 
 Gross as a Percent Gross as a Percent 
Occurrence Exceedence Losses Net of 12/31/07 Losses Net of 12/31/07  Gross Losses Net Percent of Gross Losses Net Percent of 
Probability RMS v.7.0 Losses1 Equity RMS v.7.0 Losses1 Equity  RMS v.8.0 Losses1 Equity2 RMS v.8.0 Losses1 Equity2 
  
4.00% (1 in 25 year event ) $49,277  26,874   2 % $69,947  28,823   3%
2.00% (1 in 50 year event) 100,670  31,702  3  134,532  34,057  3 
1.00% (1 in 100 year event) 190,897  37,977  4  244,445  41,015  4 
4.0% (1 in 25 year event) $48,695 26,820  3% $68,994 28,733  3%
2.0% (1 in 50 year event) 99,455 31,604 4 132,327 33,903 4 
1.0% (1 in 100 year event) 185,855 37,626 4 235,608 40,537 5 
0.40% (1 in 250 year event) 400,631  79,637  7  485,837  135,021  13  377,497 64,600 7 455,380 115,224 13 
1 Losses are after tax and include applicable reinstatement premium.
2Equity as of December 31, 2008
RMS v.7.0v.8.0 allows modeling based on the long termlong-term averages (historic view) and modeling based on a five year projectionnear-term view that includes an assumption of elevated hurricane activity in the North Atlantic Basin in the short to medium term (stochastic view).medium-term. Results of both models are provided above for select probabilities. Our current catastrophe program provides protection for a 1 in 209225 year event, or an event with 0.5 %0.4% probability according to the RMS v.7.0v8.0 historic model, and for a 1 in 159171 year event, or an event with 0.6% probability according to RMS v.7.0 stochasticv.8.0 near term model.
The Property Excess of Loss treaty was renewed on July 1, 2008 and is effective through June 30, 2009, with a $28.0 million limit in excess of a $2.0 million retention, compared to the prior treaty of $23.0 million limit in excess of a $2.0 million retention.
•The per-occurrence cap on the first layer of this treaty was $24.0 million in both the current and expiring treaty and the per occurrence cap on the second layer was increased to $40.0 million from $22.5 million, bringing the total per-occurrence limit for the program to $64.0 million compared to the $46.5 million limit in the expiring treaty.
•The annual aggregate limit for the second $20.0 million in excess of $10.0 million layer was also increased, by an additional reinstatement, to $80.0 million. The first layer continues to have unlimited reinstatements.
•Consistent with the prior year contract, all NBCR losses are excluded from the Property Excess of Loss treaty. Terrorism (excluding NBCR) and per-occurrence aggregate limits were increased to $64.0 million from $46.5 million.

 

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The retention and limit under our Property Excess of Loss treaty renewed July 1, 2007, remained the same at $23.0 million in excess of $2.0 million. Consistent with prior year contract, all nuclear, biological, chemical and radioactive reaction (“NBCR”) losses are excluded from the Property Excess of Loss treaty. Terrorism (excluding NBCR) and per occurrence aggregate limits remain at $46.5 million.
Casualty Reinsurance
The Casualty Excess of Loss program was renewed effective July 1, 2007, with no changes to the expiring structure. The total program currently provides the following coverage:
Workers compensation only treaty, covering up to $3.0 million in excess of $2.0 million per occurrence;
All Casualty Lines Excess of Loss treaty (“Casualty Treaty”) coveringwas restructured effective July 1, 2008 into one treaty encompassing all casualty lines, including workers compensation. This treaty expires on June 30, 2009. As a result, the Workers Compensation Only treaty was not renewed at July 1, 2008. The current program provides the following coverage:
•The first layer was expanded from a workers compensation only layer to now include all lines, which significantly reduces uncertainty surrounding losses in that layer. This layer provides coverage up to 65% of $3.0 million in excess of a $2.0 million retention.
•The next four layers provide coverage up to 100% of $45.0 million in excess of a $5.0 million retention.
•The sixth layer provides coverage up to 75% of $40.0 million in excess of a $50.0 million retention.
•Consistent with the prior year, the Casualty Treaty excludes nuclear, biological, chemical, and radiological terrorism losses. Annual aggregate terrorism limits, net of co-participation including a $40.0 million in excess of $50.0 million layer, is $175.8 million for all losses.
The cost of the second through sixth layers of this treaty have decreased 2% to $10 million. On a fiscal year basis, the ceded premium for the entire casualty program will be approximately $10 million above the expiring premium due to the significant extension in coverage. The overall impact of the restructured program will be to improve insurance operations by about $2.0 million with lower investment income being offset due to higher ceded premium. In addition, we expect reduced volatility in our results as the first layer of this treaty was expanded to cover all lines of business, including workers compensation, up to $45.0 million, inour excess of $5.0 million per occurrence; and
Additional layer to the Casualty Treaty covering all casualty business, including workers compensation, up to 75% of $40.0 million in excess of $50 million.
The total coverage for workers compensation claims continues to be $78.0 million per occurrence and $75.0 million per occurrence for casualty claims other than workers compensation, net of our co-participation in the $40.0 million in excess of $50.0 million layer.lines.
Other Reinsurance
Our Surety and Fidelity Excess of Loss treaty was renewed effective January 1, 2008,2009, with essentially no changes in coverage and a 2.5% increasean 11.4% decrease in estimated ceded premium due to an increasea decrease in projected subject premium offset by a decreaseand an increase in the rate.
Effective January 1, 2008,2009, we entered into a newrenewed the NWCRP treaty which covers our participation in the involuntary National Council on Compensation Insurance (NCCI) pool, a residual workers compensation market. The NWCRP treaty provides 100% Quota Share coverage, including terrorism coverage, for the 2009 and 2008 underwriting yearyears, assumed business assumed from the NCCI and has an aggregate combined ratio limit of approximately 152% and 142%., respectively for each of the underwriting years. The 2009 treaty is placed with twothree carriers both ratedwith ratings of “A” or “A+” by A. M. Best and we expectBest. Due to cede $6.0 millionour decision to participate in premiumthe New Jersey residual workers compensation market through the NCCI in 2008.2009, the treaty now covers this state. We believe that the continued protection provided within this treaty for residual market business will beis especially beneficial given current market conditions and the expected deterioration in the experience of the NCCI pool.
Counter-Party Credit Risk
During the second half of 2008, AIG entered into agreements with the U.S. Treasury Department and the Federal Reserve that include both ongoing financing facilities and one-time transactions designed to address AIG’s liquidity issues. As we maintain reinsurance relationships with the following AIG subsidiaries through three currently in-force treaties, we closely monitor developments regarding AIG’s liquidity concerns: (i) The Hartford Steam Boiler Inspection and Insurance Company (“HSB”), (ii) National Union Fire Insurance Company, and (iii) Transatlantic Reinsurance Company (collectively referred to as the “AIG Subsidiaries”). On December 22, 2008, AIG announced the sale of the HSB Group, Inc., HSB’s parent, to Munich Re Group.
The AIG Subsidiaries are rated “A” by A.M. Best and National Union Fire Insurance Company and Transatlantic Reinsurance Company have S&P credit ratings of “A+” as of December 31, 2008. Uncollateralized reinsurance recoverables on paid and unpaid loss and loss adjustment expenses, including IBNR losses, amounted to $2.3 million at year-end 2008, representing 1.3%, of our total uncollateralized reinsurance recoverables and less than one percent of our stockholders’ equity. Some of the reinsurance arrangements that the AIG Subsidiaries participate in involve upper layers of casualty business (known as “clash layers”) for which historical experience does not exist. Due to the uncertainty associated with casualty business, and specifically losses reaching those clash layers, current reinsurance recoverables from AIG Subsidiaries may change materially in the event of a significant loss event well in excess of our historical levels. As we continually monitor developments that may impact our prospects for recovery from the AIG Subsidiaries, we are prepared to avail ourselves of certain contractually provided remedies available to us if we determine it to be appropriate.

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In early 2009, the “A+” financial strength rating of Swiss Reinsurance Company and its similarly rated subsidiaries (collectively referred to as “Swiss Re”), was placed under review by A.M. Best with negative implications. Swiss Re is currently one of our top five reinsurance groups. A.M. Best placed Swiss Re’s ratings under review due to the announcement of planned actions to initiate several asset de-risking and capital strengthening initiatives, including an anticipated capital infusion agreement with Berkshire Hathaway, Inc. of approximately $2.6 billion. This comes after Swiss Re’s announcement of an expected net loss for fiscal year 2008 and a fourth quarter decline of its capital balance of approximately $4 to $5 billion as of December 31, 2008. A.M. Best had previously assigned a negative outlook to Swiss Re’s ratings due to concerns that the continuing turmoil in the financial markets could further erode their capital position and negatively impact earnings in 2009. As of December 31, 2008, Swiss Re’s uncollateralized reinsurance recoverables on paid and unpaid loss and loss adjustment expenses, including IBNR losses, amounted to $17.6 million, representing 20%, of our total uncollateralized reinsurance recoverables and approximately 2% of our stockholders’ equity.
Investments
Our investment portfolio consists primarilyresults have been significantly affected by conditions in the global capital markets and the overall economy, in both the U.S. and abroad. As widely reported, financial markets in the U.S., Europe, and Asia have been experiencing extreme disruption since the second half of fixed maturity investments (83%), but also contains equity securities (7%), short-term investments (5%),2007. Concerns over the availability and cost of credit, the U.S. mortgage market, a declining global real estate market, increased unemployment, volatile energy and commodity prices and geopolitical issues, among other investments (5%). factors, have contributed to increased volatility and diminished expectations for the economy and the financial markets going forward. These concerns have led to declines in business and consumer confidence, which have precipitated an economic slowdown and fears of a sustained recession. These factors have had, and could continue to have, an adverse effect on our investment portfolio.
Our investment philosophy includes setting certain return and risk objectives for ourthe fixed maturity and equity portfolios. The primary return objective of our fixed maturity portfolio return objective is to maximize after-tax investment yield and income while balancing certain risk objectives.risk. A secondary objective is to meet or exceed a weighted-average benchmark of public fixed income indices. The equity portfolio return objective of the equity portfolio is to meet or exceed a weighted-average benchmark of public equity indices. The risk objective forAlthough yield and income generation remain the key drivers to our entire portfolioinvestment strategy, our overall philosophy is to ensure thatinvest with a long-term horizon along with a “buy-and-hold” principle. Tactically, we also plan to further increase our portfolio allocation to government and agency holdings in the near-term in an effort to increase liquidity and capital preservation.
For additional information regarding market risk related to our investment portfolio, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” of this Form 10-K.
The following table presents information regarding our investment portfolio:
                     
          2008      2007 
($ in thousands) 2008  2007  vs. 2007  2006  vs. 2006 
Total invested assets $3,540,309   3,733,029   (5)%  3,596,102   4%
Net investment income — before tax  131,032   174,144   (25)  156,802   11 
Net investment income — after tax  105,039   133,669   (21)  121,460   10 
Net realized (losses) gains — before tax  (49,452)  33,354   (248)  35,479   (6)
Net realized (losses) gains — after tax  (32,144)  21,680   (248)  23,061   (6)
Effective tax rate  19.8%  23.2   (3.4)pts  22.5   0.7pts
Annual after-tax yield on fixed maturity securities  3.6   3.6   —   3.5   0.1 
Annual after-tax yield on investment portfolio  2.9   3.6   (0.7)  3.6   — 
Total Invested Assets
Our investment portfolio totaled $3.5 billion at December 31, 2008, a decrease of 5% compared to $3.7 billion at December 31, 2007. The decrease in invested assets was primarily due to unrealized portfolio losses from decreasing financial asset values as a result of the volatile financial markets in 2008. Our investment portfolio consists primarily of fixed maturity investments are structured(86%), but also contains equity securities (4%), short-term investments (5%), and other investments (5%). While we consider our investment portfolio to be conservative and well-diversified, all asset classes proved to be closely correlated in a year of unprecedented financial turmoil. Despite the recent financial crisis, we continue to strive to structure our portfolio conservatively focusingwith a focus on: (i) asset diversification; (ii) investment quality; (iii) liquidity, particularly to meet the cash obligations of the insurance operations;our Insurance Operations segment; (iv) consideration of taxes; and (v) preservation of capital.
Our investment returns for the last three years are as follows:
                     
          2007      2006 
($ in thousands) 2007  2006  vs. 2006  2005  vs. 2005 
Net investment income – before tax $174,144    156,802    11%  135,950    15%
Net investment income – after tax $133,669    121,460    10%  104,840    16%
Total invested assets  3,733,029    3,596,102    4%  3,245,545    11%
Effective tax rate  23.2 %  22.5    0.7pts   22.9    (0.4) pts 
Annual after-tax yield on investment portfolio  3.6 %  3.6    — pts   3.5    0.1 pts 

 

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Fixed maturity, equity, trading securities and short-term investments are reported at fair value on the Consolidated Balance Sheets in accordance with the January 1, 2008 adoption of FAS 157. As required under GAAP, these fair values are categorized into a three-level hierarchy, based on the priority of the inputs to the respective valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1), the next priority to quoted prices in markets that are not active or inputs that are observable either directly or indirectly, including quoted prices for similar assets or liabilities or in markets that are not active and other inputs that can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities (Level 2) and the lowest priority to unobservable inputs supported by little or no market activity and that reflect the reporting entity’s own assumptions about the exit price, including assumptions that market participants would use in pricing the asset or liability (Level 3). An asset or liability’s classification within the fair value hierarchy is based on the lowest level of significant input to its valuation. We generally use a combination of independent pricing services and broker quotes to price our investment securities. At December 31, 2008 all of our securities are priced using Level 1 or Level 2 inputs. For additional information see Note 6 of Item 8. “Financial Statements and Supplementary Data” of this Form 10-K.
Despite the current credit crisis, our portfolio has an average S&P rating of “AA+.” The following table presents the Moody’s and S&P ratings of our fixed maturities portfolios:
         
  December 31,  December 31, 
Rating 2008  2007 
Aaa/AAA  52%  69%
Aa/AA  34%  16%
A/A  10%  9%
Baa/BBB  4%  6%
Ba/BB or below  <1%  <1%
       
Total  100%  100%
       
The shift in the percentage of securities rated “AAA” to those rated “AA” since December 31, 2007 is primarily due to downgrades of monoline insurers, which have adversely impacted the ratings on our municipal bond and ABS portfolios. At December 31, 2008, municipal securities with insurance enhancement represented 27% of our fixed maturity securities portfolio and the average credit rating of the underlying securities was “AA-” compared to 28% and a rating of “AA-” at December 31, 2007. High credit quality continues to be a cornerstone of our investment strategy, as almost 100% of the fixed maturity securities in our portfolio are investment grade. At December 31, 2008, non-investment grade securities (below “BBB-”) represented less than 1%, or approximately $16.7 million, of our fixed maturity portfolio compared to less than 1% or approximately $10.0 million at December 31, 2007. Nonetheless, the current credit crisis is expected to increase the possibility of certain fixed maturity securities being downgraded to non-investment grade over time.
The following table details the top ten state exposures of the municipal bond portion of our fixed maturity securities at December 31, 2008:
                 
State Exposures of Municipal Bonds General  Special  Fair  Credit 
($ in thousands) Obligation  Revenue  Value  Rating 
Texas $100,607   101,638   202,245  AA+ 
Florida  18,085   90,702   108,787  AA 
Arizona  16,195   81,208   97,403  AA+ 
Washington  46,930   47,957   94,887  AA+ 
New York  —   90,874   90,874  AA+ 
Illinois  35,137   43,930   79,067  AA+ 
Georgia  41,244   34,233   75,477  AA+ 
Ohio  24,221   44,833   69,054  AA+ 
Colorado  41,569   25,820   67,389  AA+ 
Other  233,149   577,810   810,959  AA+ 
             
  $557,137   1,139,005   1,696,142  AA+ 
              
Advanced refunded/escrowed to maturity bonds          62,982     
                
Total         $1,759,124     
                
Net Investment Income
The decrease in net investment income, before tax, of $43.1 million for 2008 compared to 2007 was due to: (i) decreased returns of $31.9 million on the alternative investment portion of our other investments portfolio; and (ii) $8.1 million of reductions in the fair value of our equity trading portfolio due to the sell off in the equity markets, as well as the collapse in commodity prices in the second half of 2008. The increase in net investment income, before tax, of $17.3 million for 2007 compared to 2006 was primarily the result of increased fixed maturity income due to higher invested assets and increased income of approximately $7.0 million from certain alternative investments within our “Other investments”other investments category. Growth in net investment income, before tax, of $20.9 million for 2006 compared to 2005 was primarily attributable to the increase in our investment portfolio as well as increased income of $4.0 million in alternative investment income and $1.0 million in dividend income. Our investment portfolio totaled $3.7 billion at December 31, 2007, an increase of 4% compared to $3.6 billion at December 31, 2006. The increase in invested assets was due to substantial cash flows from operations of $386.3 million in 2007, $393.1 million in 2006 and $406.8 million in 2005. Cash flows from operations in 2007 were partially offset by cash outflows of: (i) $143.3 million related to treasury stock repurchases under our authorized program; (ii) $37.5 million related to principal payments on our senior convertible notes; and (iii) $18.3 million related to principal payments on our 8.87% and 8.63 senior notes. Debt offerings in September 2006 and November 2005 added approximately $96.8 million and $98.4 million in assets, respectively, in 2006 and 2005.
We continue to maintain a conservative, diversified investment portfolio, with fixed maturity investments representing 83% of invested assets. Sixty-nine percent (69%) of our fixed maturities portfolio is rated “AAA” while the portfolio has an average rating of “AA+,” S&P’s second highest credit quality rating. High credit quality continues to be a cornerstone of our investment strategy, as evidenced by the fact that almost 100% of the fixed maturities are investment grade. At December 31, 2007 and 2006, non-investment grade securities (below “BBB-“) represented less than 1%, or approximately $10 million, of our fixed maturity portfolio. Our mortgage backed securities portfolio totaled $697.9 million at December 31, 2007, with an average credit rating of “AA+.” Selective has no significant sub-prime mortgage exposure. Prior to investing in mortgage-backed securities, we analyze, among other credit factors, each transaction’s FICO credit score and loan to value ratio. For additional information regarding our fixed investment income portfolio, see Exhibit 99.1 of Form 8-K dated January 23, 2008 and Exhibit 99.2 of Form 8-K dated February 12, 2008. For additional information regarding market risk related to our investment portfolio, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” of this Form 10-K.
The following table presents the Moody’s and S&P ratings of our fixed maturities portfolio:
         
Rating 2007  2006 
Aaa/AAA  69%    73%  
Aa/AA  16%    17%  
A/A  9%    7%  
Baa/BBB  6%    3%  
Ba/BB or below  <1%    <1%  
       
Total  100%    100%  
       
Our fixed maturity investment strategy is to make security purchases that are attractively priced in relation to perceived credit risks. We manage the interest rate risk associated with holding fixed maturity investments by monitoring and maintaining the average duration of the portfolio with a view toward achieving an adequate after-tax return without subjecting the portfolio to an unreasonable level of interest rate risk. We invest our fixed maturities portfolio primarily in intermediate-term securities to limit the overall interest rate risk of fixed maturity investments. Generally, the Insurance Subsidiaries have a duration mismatch between assets and liabilities. The duration of the fixed maturity portfolio, including short-term investments, is 3.9 years while the Insurance Subsidiaries’ liabilities have a duration of 3.4 years. The current duration of our fixed maturities is within our historical range and is monitored and managed to maximize yield and limit interest rate risk. The duration mismatch is managed with a laddered maturity structure and an appropriate level of short-term investments that avoids liquidation of available-for-sale fixed maturities in the ordinary course of business. Liquidity is always a consideration when buying or selling securities, but because of the high quality and active market for the majority of securities in our investment portfolio, the securities sold have not diminished the overall liquidity of our portfolio. Our normal liquidity requirements have historically been met by operating cash flow from our Insurance Operations and Diversified Insurance Services segments. We expect our liquidity requirements in the future to be met by these sources of funds or, if necessary, the issuance of debt and equity securities, as well as borrowings from our credit facility. Managing investment risk by adhering to these strategies is intended to protect the interests of our stockholders and the policyholders of our Insurance Subsidiaries, while enhancing our financial strength and underwriting capacity.

 

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Our alternative investments, which primarily consist of investments in limited partnerships, report results to us on a one quarter lag. Therefore the 2008 after-tax loss of $8.2 million reflects the performance for the majority of these investments through September 30, 2008. The general volatility in the capital markets, the dislocation of the credit markets, and reduced asset values globally has resulted in a negative return for this asset class during 2008. In addition, the majority of our limited partnerships adopted FAS 157 during 2008. We believe this has led to increased volatility in the period-to-period changes in the fair values associated with the underlying assets of these partnerships which are now based on current exit values. Unlike available for sale securities, our limited partnerships are accounted for under the equity method of accounting, with changes in the valuation of these investments being reflected in net investment income as opposed to other comprehensive income. Additional losses on these securities are expected to be reported in the first quarter of 2009 considering the volatility in the marketplace during the fourth quarter of 2008. Although our alternative investments add some earnings volatility, their continued outperformance of the S&P 500 is expected to build more value for our shareholders over the long-term. During 2008, our alternative investment total return outperformed the S&P 500 by 2,700 basis points.
As of December 31, 2008, these types of investments represented only 5% of our total invested assets, which was consistent with prior year. In addition to the capital that we have already invested to date, we are contractually obligated to invest up to an additional $119.5 million in these alternative investments through commitments that expire at various dates through 2023. The following table details the six core strategies of our alternative investment portfolio and the remaining commitment amount associated with each strategy:
         
Alternative Investment Strategies Carrying  Remaining 
($ in millions) Value  Commitment 
Private Equity $56.9   36.0 
Distressed Debt  29.8   5.2 
Secondary Market  24.1   27.7 
Real Estate  23.4   20.0 
Mezzanine Financing  23.1   28.1 
Venture Capital  5.9   2.5 
Other  1.8   — 
       
Total $165.0   119.5 
       
Due to the current market turmoil, there is uncertainty regarding reduced investment income in the future as a result of, among other things, falling interest rates, decreased dividend payment rates, and reduced returns on our other investments, including our portfolio of alternative investments.
Realized Gains and Losses
Realized gains and losses are determined on the basis of the cost of specific investments sold and are credited or charged to income. Also included in realized gains and losses are write-downs for non-cash OTTI charges. The following table summarizes our net realized gains and losses by investment type:
The following table summarizes our net realized gains by investment type:
             
($ in thousands) 2008  2007  2006 
Held-to-maturity fixed maturities            
Gains $27   —   16 
Losses  (2)  —   — 
Available-for-sale fixed maturities            
Gains  1,777   445   2,460 
Losses  (55,961)  (7,150)  (6,756)
Available-for-sale equity securities            
Gains  34,582   50,254   43,542 
Losses  (21,290)  (9,359)  (3,783)
Available-for-sale other investments            
Gains  1,356   847   — 
Losses  (9,941)  (1,683)  — 
          
Total net realized (losses) gains $(49,452)  33,354   35,479 
          

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Our realized losses within the available-for-sale fixed maturity securities, equity securities, and other investments increased in 2008 as compared to 2007 and 2006. This is the primary result of non-cash OTTI charges of $53.1 million in 2008 compared to $4.9 million in 2007. During 2006, we did not recognize any realized losses from OTTI charges. An investment in a fixed maturity or equity security, that is available for sale and reported at fair value, is impaired if its fair value falls below its book value and the decline is considered to be other than temporary. The OTTI framework under existing accounting literature specifies that a write-down be to fair value, which is defined as the then current exit value despite the fact that certain fixed maturity securities may still have contractual cash flows that support a value higher than such exit value, but below the company’s cost basis. 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 temporary, we record the decline as an unrealized loss in accumulated other comprehensive income. If we believe the decline is other than temporary, impairment charges. Our Investments segment included netwe write down the carrying value of the investment and record a realized gains beforeloss in our Consolidated Statements of Income. In addition, during 2008, we sold certain fixed maturity securities that were in an unrealized loss position immediately prior to their sale. These sales resulted from our financial and tax planning strategies. Furthermore, in the early portion of $33.42008, we took steps to limit our overall portfolio volatility by reducing our equity position by approximately $50 million.
In 2008, our non-cash OTTI charges of $53.1 million consisted of: (i) $41.7 million in 2007, compared to $35.5fixed maturity securities associated with RMBSs, CMBSs, ABSs, and corporate bonds; and (ii) $11.4 million in 2006, and $14.5 million in 2005. The realized gains were principally from the sale of equity securities. Net realized gains in 2007securities and 2006 reflectalternative investments. As part of our determination that these securities were other-than-temporarily impaired, we considered factors such as: (i) the salefinancial condition and near-term prospects of severalthe issuer; and (ii) our ability and intent to hold these securities through their recovery periods. For further details regarding our policy with respect to assessing OTTI, see the “Critical Accounting Policies and Estimates” section above.
The fixed maturity non-cash OTTI charges of $41.7 million for 2008 consist of the following:
•$15.1 million of RMBS and CMBS charges. These charges related to declines in the related cash flows of the collateral, based on our assumptions of the expected default rates and the value of the collateral, and accordingly, we do not believe it is probable that we will receive all contractual cash flows.
•$16.4 million of ABS charges. These charges related to issuer-specific credit events that revolved around the performance of the underlying collateral, which had materially deteriorated; however, none of which were bankruptcy related. In general, these securities were experiencing increased conditional default rates and expected loss severities, and as a result, our stress test scenarios were indicating less of a margin to absorb losses going forward. Although some of these securities were insured or guaranteed by monoline bond guarantors, downgrades have reduced our confidence in their ability to perform in the event of default. In addition, credit support for these securities has also begun to erode, thereby further increasing the potential for eventual loss.
•$10.2 million associated with corporate bond charges. These charges were due to issuer-specific events, primarily related to two Icelandic bank debt securities, on which the banks were placed in receivership.
The non-cash OTTI charges on the equity positions which resulted in re-weighting various sector exposures. Realized gains were partially offset by realized losses,and alternative investments of $11.4 million consisted of:
•$6.6 million from six equity securities related to the sharp sell off in the global equity markets stemming from the mortgage and credit crisis, which led to concerns that both U.S. and global economic growth would slow in the near future.
•$4.8 million on two alternative investments directly related to a security held in their portfolio that had considerable unrealized losses because of the severe volatility in the current financial markets and the dramatic market sell off, specifically in commodity prices.
Despite the most significant losses are discussed below. We maintainissues surrounding the securities above, we believe that we have a high quality and liquid investment portfolio and theportfolio. The sale of the securities that resulted inproduced net realized gains, or impairment charges that produced realized losses, did not change the overall liquidity of the investment portfolio. Our general philosophy for sales of securities generally is to reduce our exposure to securities and sectors based upon economic evaluations or ifand when the fundamentals for that security or sector have deteriorated. We typically have a long investment time horizon and ourthe turnover is low, which has resulted in many securities accumulating large unrealized gains.low. Every purchase or sale is made with the intent of improving future investment returns.
The following table summarizes our net realized gains by investment type:
             
($ in thousands) 2007  2006  2005 
Held-to-maturity fixed maturities            
Gains $—   16   106 
Available-for-sale fixed maturities            
Gains  445   2,460   1,468 
Losses  (7,150)  (6,756)  (4,196)
Available-for-sale equity securities            
Gains  50,254   43,542   21,149 
Losses  (9,359)  (3,783)  (4,063)
Available-for-sale other investments            
Gains  847   —   — 
Losses  (1,683)  —   — 
          
Total net realized gains $33,354   35,479   14,464 
          
Realized losses within the available-for-sale fixed maturity securities increased in 2007 as compared to 2006 and 2005. This is primarily the result of other than temporary impairment charge associated with two commercial real estate collateralized debt obligations (“CDO”) for $4.9 million. During the second half of 2007, the market for lower-rated commercial mortgage-backed securities (“CMBS”) saw severe contagion effects from the sub-prime mortgage crisis. CMBS spreads, particularly subordinated tranche CMBS, widened dramatically over the course of the second half of the year. As a result, CDOs in general have become extremely dislocated and difficult to value as the market spreads between bid and ask prices are very wide, even for CDOs that do not have any sub-prime asset backed exposure. At this time, there have been no credit defaults or rating downgrades on CDOs in our portfolio. However, given the severe lack of liquidity currently being experienced in the marketplace, it is difficult to value certain securities and, as a result, we recorded an other than temporary impairment charge on two commercial real estate CDOs in 2007. During 2006, Selective had not recognized any realized losses from other than temporary charges, whereas during 2005 Selective had recorded $1.2 million in realized losses related to other than temporary charges.
The dislocation in the sub-prime mortgage sector had also extended more broadly into both the credit and equity markets in early August 2007. These events adversely affected quantitative strategies that use factor-based models to identify incorrectly priced securities, and produced widespread de-leveraging and unprecedented negative returns to all standard quantitative factors in the U.S. during early August. With the increased uncertainty and risk of the equity markets at that time, we had hedged our direct exposure to the S&P 500 by investing in an exchange-traded fund (“ETF”). The fund was set up to perform inversely to the S&P 500 Index at a 2:1 ratio. Through this action, we had protected $90 million of our equity capital base. While the investment limited the upside of the equity portfolio, we believed that this strategy was appropriate during this period of extreme market uncertainty. As a result of the aggressive actions by the Federal Reserve to lower the federal funds rate later in the third quarter, improvements were seen in the equity markets leading us to sell our interest in the ETF.  This sale resulted in a $4.3 million realized loss in the third quarter of 2007.
In light of the market conditions, we also decided to dispose of one of our other investments, a global quantitative market-neutral equity hedge fund, primarily due to its undifferentiated model and greater than anticipated volatility. This disposition resulted in a $1.7 million realized loss and is reflected in the available-for-sale other investment category in the table above.

 

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The following tables present the period of time that securities sold at a loss were continuously in an unrealized loss position prior to sale:
                        
                         2008 2007 2006 
Period of time in an 2007 2006 2005  Fair Fair Fair   
Unrealized loss position Fair Fair Fair    Value on Realized Value on Realized Value on Realized 
 Value on Realized Value on Realized Value on Realized 
($ in millions) Sale Date Loss Sale Date Loss Sale Date Loss  Sale Date Loss Sale Date Loss Sale Date Loss 
Fixed maturities:  
0 – 6 months $29.0  0.7  94.9  1.5  67.1  1.4  
7 – 12 months 31.6  0.4  76.6  2.5  32.4  0.7  
0 - 6 months $40.4 8.3 29.0 0.7 94.9 1.5 
7 - 12 months 11.4 0.6 31.6 0.4 76.6 2.5 
Greater than 12 months 10.2  0.2  35.8  1.5  33.0  1.1   9.4 3.6 10.2 0.2 35.8 1.5 
                          
Total fixed maturities 70.8  1.3  207.3  5.5  132.5  3.2   61.2 12.5 70.8 1.3 207.3 5.5 
                          
Equity Securities:  
0 – 6 months 60.0  8.8  15.5  3.1  11.2  1.8  
7 – 12 months 1.6  0.4  3.2  0.7  3.6  1.0  
0 - 6 months 30.1 13.4 60.0 8.8 15.5 3.1 
7 - 12 months 3.8 0.6 1.6 0.4 3.2 0.7 
Greater than 12 months 0.4  0.2  —  —  0.7  0.1   1.6 0.7 0.4 0.2 — — 
                          
Total equity securities 62.0  9.4  18.7  3.8  15.5  2.9   35.5 14.7 62.0 9.4 18.7 3.8 
                          
Other investments:  
0 – 6 months 5.3  1.7  —  —  —  —  
7 – 12 months —  —  —  —  —  —  
0 - 6 months 9.0 4.3 5.3 1.7 — — 
7 - 12 months — — — — — — 
Greater than 12 months —  —  —  —  —  —   — — — — — — 
                          
Total other investments 5.3  1.7  —  —  —  —   9.0 4.3 5.3 1.7 — — 
                          
Total $138.1  12.4  226.0  9.3  148.0  6.1   $105.7 31.5 138.1 12.4 226.0 9.3 
                          
During 2008, we sold certain securities that were in an unrealized loss position immediately prior to their sale. These sales resulted from our financial and tax planning strategies.
Unrealized Losses
The following table summarizes the aggregate fair value and gross pre-tax unrealized loss recorded in our accumulated other comprehensive income, by asset class and by length of time, for all available-for-sale securities that have continuously been in an unrealized loss position at December 31, 20072008 and December 31, 2006:2007:
                
                 2008 2007 
Period of time in an 2007 2006  Gross Gross 
Unrealized loss position Gross Gross  Fair Unrealized Fair Unrealized 
 Fair Unrealized Fair Unrealized 
($ in millions) Value Loss Value Loss  Value Loss Value Loss 
Fixed maturities:  
0 – 6 months $219.2  8.0  376.6  1.7  
7 – 12 months 188.6  11.6  107.6  0.7  
0 - 6 months $402.2 18.1 219.2 8.0 
7 - 12 months 375.8 53.4 188.6 11.6 
Greater than 12 months 340.5  5.7  705.8  10.1   232.8 88.7 340.5 5.7 
                  
Total fixed maturities 748.3  25.3  1,190.0  12.5   1,010.8 160.2 748.3 25.3 
                  
Equities:  
0 – 6 months 25.7  1.1  7.8  0.2  
7 – 12 months 1.1  0.4  —  —  
0 - 6 months 53.4 14.3 25.7 1.1 
7 - 12 months 7.7 4.4 1.1 0.4 
Greater than 12 months —  —  0.4  0.2   — — — — 
                  
Total equity securities 26.8  1.5  8.2  0.4   61.1 18.7 26.8 1.5 
                  
Other:  
0 – 6 months —  —  6.9  0.1  
7 – 12 months —  —  —  —  
0 - 6 months 4.5 1.5 — — 
7 - 12 months — — — — 
Greater than 12 months —  —  —  —   — — — — 
                  
Total other securities —  —  6.9  0.1   4.5 1.5 — — 
                  
Total $775.1  26.8  1,205.1  13.0   $1,076.4 180.4 775.1 26.8 
                  
Although overall interest rates decreased in 2007, the unrealizedUnrealized losses for fixed maturity securities, equities, and other investments increased in 2008 as compared to 2007, primarily due primarily to the credit stress andwhich caused credit spreads to widen, dislocation in the capital markets, along with inflation worriesconcerns, and general uncertainty about the U.S. economy in general caused fixed maturities credit spreads to widen.economy. As of December 31, 2007,2008, there are 240were 401 securities in our portfolio in an unrealized loss position. Broadposition, including certain securities that were priced at a significant discount compared to cost due to the uncertainties in the marketplace. However, broad changes in the overall market or interest rate environment generally do not lead to impairment charges.charges and, therefore, based on our analyses, which includes our review of the credit worthiness of the issuers, coupled with our ability and intent to hold the securities throughout their anticipated recovery periods, none of these securities are considered other-than-temporarily impaired.

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We have reviewed the securities in the table above in accordance with our OTTI policy, which is discussed in Note 2, “Summary of Significant Accounting Policies,” above. In performing our OTTI impairment analysis for asset-backed, agency mortgage-backed, and non-agency mortgage backed securities, which represented $109.8 million of the $160.2 million of gross unrealized losses at December 31, 2008 on fixed maturity securities reflected in the table above, we estimated future cash flows for each security based upon our best estimate of future delinquencies, loss severity, and prepayments. The resulting cash flows were reviewed to determine whether we anticipate receiving all of the originally scheduled cash flows. Projected credit losses were compared to the current level of credit enhancement to determine whether the security is expected to experience losses during any future period and therefore become other-than-temporarily impaired. Based on this cash flow testing, we have determined that the decline in fair value of the non-agency mortgage-backed securities presented in the table above is not attributable to credit quality, but to a significant widening of interest rate spreads across market sectors related to the continued illiquidity and uncertainty of the markets. As we have the ability and intent to hold these investments until a fair value recovery or until maturity, we do not consider these securities to be other-than-temporarily impaired as of December 31, 2008. It is possible that the underlying loan collateral of these securities will perform at a level worse than our expectations, which may lead to adverse changes in cash flows on these securities and potential future OTTI losses. Events that may trigger material declines in fair values for these securities include, but are not limited to, the deterioration of credit metrics, significantly higher levels of default and severity of losses on the underlying collateral, or further illiquidity.
In performing our OTTI analysis for corporate debt securities, we analyzed the general market condition of each industry, particularly the financial services sector, as well as the geographic area of the issuer given the current economic environment. In addition, we look for evidence of significant deterioration in the issuer’s credit worthiness. We have determined that the decline in fair value of $30.1 million of corporate securities in an unrealized loss position at December 31, 2008 to be attributed to the current volatile market conditions and not to the credit worthiness of any individual issuer. We have the ability and intent to hold these securities until a fair value recovery or until maturity and do not consider these securities to be other-than-temporarily-impaired.
The following tables present information for AFS fixed maturity securities regarding the severity of unrealized losses and, for those securities with a fair value of less than 85% of their amortized cost, information regarding the duration of the unrealized loss position as of December 31, 2008:
         
Fair Value as a Percentage of Amortized Cost Unrealized  Fair 
($ in millions) (Loss) Gain  Value 
85% but less than 100% of amortized cost $(37.5)  820.3 
75% or more but less than 85% of amortized cost  (21.9)  84.4 
Less than 75% of amortized cost  (100.8)  106.1 
       
Gross unrealized losses on fixed maturity securities  (160.2)  1,010.8 
Gross unrealized gains on fixed maturity securities  71.1   2,023.5 
       
Net unrealized losses on fixed maturity securities $(89.1)  3,034.3��
       
         
  75% or more    
  but less than  Less than 
  85% of  75% of 
Duration of Unrealized Loss Position Amortized  Amortized 
($ in millions) Cost  Cost 
0 - 3 months $(18.4)  (31.4)
4 - 6 months  (2.3)  (14.2)
7 - 9 months  —   (11.3)
10 - 12 months  (1.2)  (32.6)
Greater than 12 months  —   (11.3)
       
Gross unrealized losses $(21.9)  (100.8)
       

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The following table presents information regarding securities in our portfolio with the five largest unrealized balances as of December 31, 2008:
             
  Cost/       
2008 Amortized  Fair  Unrealized 
($ in thousands) Cost  Value  Losses 
Countrywide Home Loans $10,078   2,096   (7,982)
Banc of America Alternative Loan  9,657   3,516   (6,141)
TBW Mortgage Backed Pass Through  9,996   4,122   (5,874)
GS Mortgage Securities Corp II  9,620   4,378   (5,242)
JP Morgan Alternative Loan  11,496   6,424   (5,072)
The following table presents information regarding our available-for-sale fixed maturities that were in an unrealized loss position at December 31, 20072008 by contractual maturity:
                
Contractual Maturities Amortized Fair  Amortized Fair 
($ in millions) Cost Value  Cost Value 
One year or less $91.7  90.1   $94.5 83.6 
Due after one year through five years 373.4  365.0   554.1 476.0 
Due after five years through ten years 233.7  223.2   443.7 395.1 
Due after ten years through fifteen years 40.2  36.9   48.6 43.0 
Due after fifteen years 34.6  33.1   30.1 13.1 
          
Total $773.6  748.3   $1,171.0 1,010.8 
          
In February 2009, we transferred $1.6 billion of our AFS securities to a held-to-maturity designation as we had determined that we have the ability and the intent to hold these securities as an investment until maturity or call. Of the $1.6 billion in AFS securities transferred, $1.3 billion consist of state and political subdivision obligations and $0.3 billion in U.S. Government and government agency obligations, corporate, mortgage-backed and asset-backed securities. In total, the securities transferred had a net unrealized gain of approximately $8 million.
Investment Outlook
The global credit markets dislocation brought on by the crisis of confidence, widespread risk aversion, and on-going de-leveraging, took hold of the economy. Economic weakness, as evidenced by declines in residential home values, the sharp sell off in the equity markets, reduced consumer spending, and increased unemployment rates has created economic uncertainty. The passage of government legislation (i.e., the Troubled Asset Relief Program or “TARP”) and the recent coordinated efforts by central banks around the globe to restore investor confidence may have some positive impacts on the debt markets, or at least may provide some liquidity back-stop mechanisms. Nonetheless, early signs of the aggressive measures taken by central banks and governments may prove to have measurably offset a much greater financial shock. However, we expect 2009 to be a challenging year for the U.S. and global economy. The capital markets will most likely remain volatile throughout the year.
Our overall philosophy is to invest with a long-term horizon along with yield and income as our key drivers. In the near-term, we plan to tactically maintain a higher level of liquidity in the fixed income portfolio by continuing to build a higher allocation to government and agency holdings, considering that liquidity and capital preservation are strategically important in our asset allocation until more stable conditions become apparent. Recession risk is rising in relation to the municipal credit market, but we continue to focus on sound credit quality combined with liquidity, value and yield. Other investment opportunities such as high-quality corporate bonds, agency RMBS, equipment leases, credit cards, and CMBS also remain.
The second half of 2009 may bring some economic relief as efforts by central banks plus extraordinary fiscal policy initiatives take hold in the U.S., China, the Middle East, and Japan. President Obama’s administration’s stimulus program is designed to stem some of the economic weakness associated with credit restraint. Until a more favorable outlook for earnings becomes apparent, an improvement of access to credit for corporations and consumers occurs, home prices stabilize, and an indication that the market has priced in the macro deterioration and is refocusing on company fundamentals, we will continue our defensive equity investment strategy (consumer staples and healthcare stocks) and focus on high-quality stocks with the ability to grow their dividend in 2009 as these stocks have historically outperformed when profit growth has decelerated.

 

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Investment Outlook
As we look forward, we see a number of risks that could contribute to an extended period of uncertainty and volatility in the financial markets. Recession fears abound and negative economic predictions are increasingly more common. We foresee no stabilizing signs in the U.S. housing market. Declining home prices are seemingly already affecting retail sales and other consumer discretionary spending. A return to a more normally functioning housing market may not truly occur until the securitization markets start to properly function again. We are encouraged by signs pointing to a possible mortgage refinance wave that could occur in 2008 as interest rates and mortgage rates have declined. However, we believe the post-credit bubble effects will continue to keep volatility high in the financial markets for some time. Another concern is whether a financial market malaise will result in a global recession. Given the surge in prices of oil and other commodities, pricing inflation also remains a risk.
Our fixed income focus will be to seek high quality securities to reduce portfolio volatility and to maximize after–tax investment yield. This will entail maintaining a fairly elevated level of new purchase allocations to municipal securities, as they present attractive relative value on a taxable equivalent yield basis. Volatility, downgrades, and a lack of market liquidity in ABS and CMBS may also present some interesting opportunities in those sectors, as new issue volumes are expected to be down by well over 25% or more by some estimates. The volatility in this sector is not expected to end soon as leveraged positions in structured bonds are unwound. Nonetheless, we expect that further Federal Reserve rate cuts may certainly aid the markets in 2008; although additional cuts could further weaken the U.S. dollar, which could have a far-reaching negative impact in the U.S. financial markets.
Considering all the volatility in the equity market, we are even more cautious now than we were in late 2007. We will continue to manage through this period of uncertainty by investing in companies with more defensive characteristics, such as solid free cash flow, exposure to secular growth themes, strong balance sheets and reasonable valuations. Other considerations are favorable long-term corporate performance and attractive relative historical valuations.
Our outlook for theour alternative investment strategy continues to be positive, overparticularly relative to other traditional asset classes of stocks, bonds, and cash. Although investors with available capital in these difficult markets are finding assets for sale at very attractive terms, we continue to be cautious with our investments in this sector due to the longer-term. Inmark-to-market pressures that have resulted in the near term, we expectdecline in value of all financial assets globally as well as the fact that the current credit crisis will continue to slowkeep the pace of merger and acquisitions,acquisition activity well below normal. However, long-term, we believe the current marketplace creates a favorable investment environment as risk has been re-priced and financial discipline will eventually be restored to the financial markets.
Nonetheless, as 2009 progresses, the commitment to invest for diversification across a large number of sectors and individual security positions remains intact. We remain optimistic that in the near future, credit fundamentals will slowly begin to once again be reflected in security evaluations and hence, start to bolster performance as fundamentals gain recognition over pressure from mark-to-market issues related to blanket forced selling. However, there continues to be the potential buyers no longerfor additional OTTI charges in 2009 and furthermore, due to the continued uncertain financial market conditions we have accessdecided not to large quantities of debt with favorable credit terms. This will reduce the return that many private equity sponsors have been able to realize over the past few years. Therefore, we expect a slowdown in deal activity and a reduction in distributions to private equity investors.provide investment income guidance for 2009.
Diversified Insurance Services Segment
The Diversified Insurance Services operations includeconsist of two core functions: (i) human resource administration outsourcing (“HR Outsourcing”);Outsourcing; and (ii) flood insurance. We believe these operations are in markets that continue to offer growth opportunities. During 2007,2008, these operations provided a contribution of $0.22$0.18 per diluted share, compared to $0.19$0.22 per diluted share in 2006.2007. Contributions from the Diversified Insurance Services segment, particularly the flood business, continue to provide some mitigation of insurance pricing cycles and the adverse impact that catastrophe losses have on our Insurance Operations segment. We evaluate the performance of these operations based on several measures, including, but not limited to, results of operations in accordance with GAAP, with a focus on our return on revenue (net income divided by revenues). The results for this segment’s continuing operations are as follows:
                        
For the Year Ended December 31,        
($ in thousands) 2007 2006 2005  2008 2007 2006 
HR Outsourcing
  
Revenue $59,109 63,322 60,227  $53,147 59,109 63,322 
Pre-tax profit (loss) 3,993 4,810 3,793 
Pre-tax (loss) profit  (781) 3,993 4,810 
Flood Insurance
  
Revenue 47,842 41,522 34,320  52,943 47,842 41,522 
Pre-tax profit 10,360 10,167 9,060  10,646 10,360 10,167 
Other
  
Revenue 8,615 5,682 4,164  10,256 8,615 5,682 
Pre-tax profit 4,270 2,831 1,940  4,662 4,270 2,831 
Total
  
Revenue from continuing operations 115,566 110,526 98,711 
Pre-tax profit from continuing operations 18,623 17,808 14,793 
After-tax profit from continuing operations 12,355 11,848 9,844 
Revenue 116,346 115,566 110,526 
Pre-tax profit 14,527 18,623 17,808 
After-tax profit 9,606 12,355 11,848 
After-tax return on revenue  10.7%  10.7%  10.0%  8.3%  10.7%  10.7%

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HR Outsourcing
HR Outsourcing revenue declined in 2007 compared to 2006 and 2005, primarily as a result of a reduction in worksite lives. As of December 31, 2007, our worksite lives were down 7% to 25,111 compared to 26,952 as of December 31, 2006 and 23,974 as of December 31, 2005, resulting from recent economic trends as well as the sale, in the third quarter of 2007, of two large HR Outsourcing clients to companies that manage their payroll and human resources activities in-house. The increase in worksite lives in 2006 compared to 2005 is mainly due to the unveiling of the new marketing strategy and a new agent commission structure for our human resources outsourcing product during the first quarter of 2006. We refer to this product as our employer protection program (“EPP”), which is designed to assist business owners in managing the risk of employer-related liabilities.
Pre-tax profit decreased in our HR Outsourcing business in 2007 compared to 2006 mainly due to pricing pressure on our workers compensation product and the reduced level of worksite lives as mentioned above. In the fourth quarter of 2007, we reduced our internal workforce at this operation by 11% to better align expenses with production. Pre-tax profit increased in 2006 compared to 2005 mainly due to higher margins, particularly on our workers compensation business, and an increase in our number of worksite lives as mentioned above.
•HR Outsourcing revenue declined in 2008 compared to 2007 and 2006, primarily as a result of the economic downturn as evidenced by reduced payrolls at existing clients, referred to as “client change.” In total, new worksite lives decreased more than 30% in 2008 compared to 2007 and client change decreased four times more in 2008 than in 2007. Also, as a result of the economic downturn, there were fewer new business start-ups and therefore less opportunity to increase our worksite lives relative to these businesses. As of December 31, 2008, Selective HR’s worksite lives were down 10% to 22,520 compared to 25,111 as of December 31, 2007 and 26,952 as of December 31, 2006.
•Pre-tax profit decreased in our HR Outsourcing business in 2008 compared to 2007 mainly due to a pre-tax goodwill impairment charge of $4.0 million taken in the fourth quarter of 2008 reflecting near-term financial projections that are not sufficient to cover the carrying value of this reporting unit, coupled with the reduced level of worksite lives as mentioned above. Pre-tax profit decreased in 2007 compared to 2006 primarily due to pricing pressure on our workers compensation products as well as a reduced level of worksite lives.
Flood Insurance
Our Flood revenues are primarily derived from two activities: (i) fees associated with servicing policy premium; and (ii) fees associated with handling claims. Revenue increases of 15% in 2007 compared to 2006 and 21% in 2006 compared to 2005 were mainly attributable toOn June 1, 2008, the increase in servicing flood premium in force, which increased 19% to $141.9 million at December 31, 2007 compared to 2006 and 27% to $119.2 million at December 31, 2006 compared to 2005. The increases in premiums were not fully realized in revenues as the fee paid to us by the National Flood Insurance Program (“NFIP”) decreased 0.6 points to 30.2% from 30.8%, which was effective for the NFIP’s fiscal year beginning on October 1, 2006. ThisNFIP revised their fee structure is still in place as of December 31, 2007. The fee arrangement for 2008 is still under review. In addition, our revenues associated with the handling floodof claims were $1.6 millionto provide for fees of 1% of direct premiums written, which are paid even in 2007 comparednon-catastrophe years, coupled with fees equal to $1.8 million in 2006 and $3.6 million in 2005.1.5% of all incurred losses. Prior to June 1, 2008, we received claims handling fees equal to 3.3% of all incurred losses.

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The fluctuations in pre-tax profit, which increased $0.2 million in 2007 compared to 2006 and increased $1.1 million in 2006 compared to 2005, were driven by the revenue items noted above.
In December 2005, we divested ourselves of our 100% ownership in CHN Solutions (Alta Services, LLC and Consumer Health Network Plus, LLC), which had historically been reported as part of the managed care component of the Diversified Insurance Services segment. These companies were sold for approximately $16 million in proceeds at an after-tax net loss of approximately $2.6 million. For further information regarding this divestiture, see Note 15 in Item 8. “Financial Statements and Supplementary Data” of this Form 10-K.
Revenue increases of 11% in 2008 compared to 2007 and 15% in 2007 compared to 2006 were mainly attributable to the level of servicing Flood premium in force, which increased 16%, to $165.2 million, at December 31, 2008 compared to 2007 and 19%, to $141.9 million, at December 31, 2007 compared to 2006. In addition, our revenues associated with handling Flood claims were $2.5 million in 2008 compared to $1.6 million in 2007 and $1.8 million in 2006, primarily driven by claims associated with Hurricane Ike and the Midwestern flooding in 2008. The increases in premiums, and as a result the corresponding fees associated with servicing policy premium, were partially offset by a reduction in the fee paid to us by the NFIP of 0.5 points, to 29.7% effective June 1, 2008, prior to a 0.1 point increase to 29.8%, effective October 1, 2008.
•The fluctuations in pre-tax profit, which increased $0.3 million in 2008 compared to 2007 and increased $0.2 million in 2007 compared to 2006, were driven by the revenue items noted above.
Diversified Insurance Services Outlook
Our
We expect sales for our HR Outsourcing products primarily the EPP, offer an additional revenue stream for our independent agents. Since unveiling the EPP during the first quarter 2006, agents have gained a better understanding of the HR Outsourcing product. Despite this, consistent with trends in the professional employer industry that are pointing to flat to negative growth in worksite lives and the current economy, we expect our client sales to continue to be difficult. We also have two issues in Florida, where we derive 29% of our co-employer service fees. First, the economy is struggling and, second, workers compensation rates have been reduced by the regulators by 18.4% for 2008, after a 15.7% rate decrease that was effective January 1, 2007 for voluntary industrial classes. Consequently, we only expect marginal growthdifficult, considering current economic conditions, especially in the numberstate of worksite lives during 2008.Florida. In addition, we expect SUTA margins to deteriorate as increased unemployment claims, coupled with the extension of unemployment benefits, are putting pressure on many states’ unemployment funds and are anticipated to result in future rate increases.
The viability of the NFIP’s reinsurance program under the “Write-Your-Own” (“WYO”)WYO Program is an essential component of our Diversified Insurance ServicesFlood operations. In 2005, the destruction caused by the active hurricane season stressedAs a result of current economic conditions, we expect growth rates in the NFIP with excessiveprogram to be lower than historical levels reflecting the sluggish real estate and construction marketplace. On September 30, 2008, a law was passed to extend the NFIP authority to issue new policies, increase coverage on existing policies, and issue renewal policies until March 6, 2009. The NFIP currently has borrowing authority in the amount of flood losses.$20.8 billion and, prior to Hurricane Ike in the third quarter of 2008, had borrowed $17.3 billion. FEMA is currently seeking additional borrowings from Congress as the current limitation is expected to only last into the first quarter of 2010. We continue to monitor developments with the NFIP regarding itsour ability to pay claims considering these funding limitations. For additional discussion associated with the NFIP program, see Item 1A. “Risk Factors” of this Form 10-K.
Federal Income Taxes
The following table presents our taxable income, pre-tax financial statement income, and net deferred tax asset:
             
($ in millions) 2008  2007  2006 
Current taxable income $71.2   157.1   151.5 
Pre-tax financial statement income  39.4   192.8   220.5 
Net deferred tax asset  146.8   22.4   15.4 
Total federal income tax benefit was $4.4 million in 2008 compared to federal income tax expense of $46.3 million in 2007 and $56.9 million in 2006. The effective tax rate for 2008 was (11.1)% compared to 24.0% for 2007 and 25.8% for 2006. Our effective tax rate differs from the federal corporate rate of 35% primarily as a result of tax-advantaged investment income. For a reconciliation of our effective tax rate to the statutory rate of 35%, see Note 14, “Federal Income Tax” in Item 8. “Financial Statement and Supplementary Data” of this Form 10-K.
We have a net deferred tax asset of $146.8 million at December 31, 2008 compared with a deferred tax asset of $22.4 million at December 31, 2007. This change is primarily due to a reduction in unrealized gains in our investment portfolio, coupled with an unrealized pension charge reflecting a decrease in the event of another large-scale disaster. Congress controls the federal agency’s funding authority, which was exceeded after Hurricane Katrina,discount rate used to value our pension liability and is again nearing maximum capacity. Bills are pendinga reduction in the House and Senate that could impact the NFIP. These bills contain substantial legislative changes and revisionspension assets due to the NFIP and WYO Program, some of which may be favorable and some of which may be unfavorable for us. It is uncertain, at present, what the net impact to us may be if the legislation is passed. During 2008, the NFIP also is expected to further decrease the fee paid to us by 0.5 points to 29.7%, which could put some pressure on future margin levels. The current program is also being reevaluated to include a cap on claim fees paid by the NFIP. While the final outcome of this legislation is unknown, this cap could impact the ultimate claim fee that we receive in the event that there is a large catastrophe in an area in which we are geographically concentrated.market volatility.

 

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Financial Condition, Liquidity and Capital Resources
Capital resources and liquidity represent our overall financial strength andreflect 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
Liquidity isWe manage liquidity with a measure of our ability to generatefocus on generating sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. Given the current market turmoil and credit crisis, we are carefully monitoring our liquidity in all entities of the organization. We have taken a number of steps to help ensure our continued liquidity, including the diversification of banking partners to enable business continuity in case of a disruption with a particular bank and the diversification of money market fund managers.
Our cash and short-term investmentsinvestment position remained relatively flatwas $216.8 million at December 31, 2008 and $198.6 million at December 31, 2007 compared to $203.5 million at2007. At December 31, 2006. 2008 and 2007, these balances included approximately $60 million and $65 million, respectively, at the Parent, $138 million and $126 million, respectively, at the Insurance Subsidiaries and $19 million and $8 million, respectively, at our Diversified Insurance Services companies. We continually evaluate our liquidity levels in the light of market conditions and, given recent financial market volatility, we are maintaining higher than usual cash and short-term investment balances. All short-term investments are maintained in NAIC-approved AAA-rated money market funds.
Sources of cash for the Parent currently consist of dividends from ourits subsidiaries and borrowings under its line of credit, which are subject to compliance with specified debt covenants as discussed below. Historically, the issuance of stock and debt and equity securities as well ashas been a potential source of cash for the saleParent. However, due to the current conditions in these marketplaces, our access to them is limited at this time. The Insurance Subsidiaries are the primary source of Common Stock under our employee and agent stock purchase plans. However, our abilitydividends to receivethe Parent. Based on the 2008 unaudited statutory financial statements, the Insurance Subsidiaries are permitted to pay approximately $101.6 million in ordinary dividends from our subsidiaries is restricted.to the Parent in 2009. Dividends from ourthe Insurance Subsidiaries, which in 2008 amounted to $77.0 million, are subject to the approval and/or review of the insurance regulators in thetheir respective domiciliary states of the Insurance Subsidiaries under insurance holding company acts, and are generally payable only from earned surplus as reported in the statutory annual statements of those subsidiaries as of the preceding December 31. Based on the 2007 unaudited statutory financial statements, the Insurance Subsidiaries are permitted to pay to Selective Insurance Group, Inc. ordinary31st. Although our dividends in the aggregate amount of approximately $139.4 million in 2008.have historically been met with regulatory approval, there is no assurance that future dividends will be approved given current market conditions. For additional information regarding dividend restrictions, refer to Note 9, “Indebtedness” and Note 10, “Stockholders’ Equity” in Item 8. “Financial Statements and Supplementary Data”Data.” of this Form 10-K.
OurThe Insurance Subsidiaries generate cash flowsto fund the dividends to the Parent primarily fromthrough 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. To provideWhile current market conditions have limited the liquidity while maintaining consistent investment performance, we ladderin our fixed maturity investments so thatregarding sales, our laddered portfolio, in which some issues are always approaching maturity andmaturing, continues to provide a source of predictable cash flowflows for claim payments in the ordinary course of business. The duration of the fixed maturity portfolio, including short-term investments, was 3.93.5 years as of December 31, 2007,2008, while the liabilities of ourthe Insurance Subsidiaries have a duration of 3.43.7 years. In addition, the Insurance Subsidiaries purchase reinsurance coverage for protection against any significantly large claims or catastrophes that may occur during the year.
We have a syndicated line of credit agreement with Wachovia Bank, National Association as administrative agent. Under this agreement, we have accessIn addition to a $50 million credit facility, which can be increased to $75 million withdividends received from the consent of all lending parties. At December 31, 2007, no balances were outstanding under this credit facility.
Insurance Subsidiaries, the Parent also receives dividends from Selective HR Solutions (“Selective HR”), our HR Outsourcing business, generates cash flows from its operations.HR. Dividends from Selective HR are restricted by theits operating needs of this entity as well asand a professional employer organization licensing requirements torequirement that it maintain a current ratio of at least 1:1. The current ratio, which Selective HR generally maintains just above 1:1, provides an indication of a company’s ability to meet its short-term obligations, and is calculated by dividing current assets by current liabilities. Selective HR provided the Parent with dividends to Selective Insurance Group, Inc. of $3.0 million in 2008 and $4.1 million in 2007.
The Parent can also borrow under its $50 million line of credit, which is contingent upon the satisfaction of certain agreed-upon debt covenants, as outlined below, and is syndicated among the following five banks: (i) Wachovia Bank N.A., a subsidiary of Wells Fargo & Company, as administrative agent; (ii) JP Morgan Chase Bank, N.A.; (iii) State Street Bank and Trust Company; (iv) Branch Banking and Trust Company; and (v) TD Bank, National Association (formerly known as Commerce Bank, N.A.). This line can be increased to $75 million with the consent of all lending parties. We continue to monitor current news regarding the banking industry, in general, and our lending partners, in particular, as, according to the syndicated line of credit agreement, the lenders are not joint and severally liable with regards to other lenders’ commitment under the agreement. At December 31, 2008, no balances were outstanding under this credit facility and, since inception, only one draw down was made on the facility. This draw down, which occurred in 2007 was for $6.0 million and $4.2 million in 2006.was outstanding for slightly more than a month.

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In order to have access to draw down on the line of credit, we are required, per the syndicated line of credit agreement, to comply with certain restrictive covenants. Some of the significant covenants are as follows:
•Our consolidated net worth, calculated per the syndicated line of credit agreement, must be equal to or greater than the required minimum consolidated net worth, as calculated per the syndicated line of credit agreement. In accordance with the calculations in the agreement, at December 31, 2008 our consolidated net worth was $890.5 million and the required minimum consolidated net worth was $882.0 million.
•Our consolidated debt to total capitalization ratio, as calculated per the syndicated line of credit agreement, cannot exceed 30.0% at any point in time. At December 31, 2008 our consolidated debt to capitalization ratio was 23.6%.
•The Insurance Subsidiaries must maintain a financial strength rating by A.M. Best of at least “A-” at all times. Throughout 2008, our A.M. Best financial strength rating was continuously “A+.”
•In addition to the above requirements, the syndicated line of credit agreement contains a cross-default provision that provides that the line of credit will be in default if the Company fails to comply with any condition, covenant or agreement (including payment of principal and interest when due on any debt with an aggregate principal amount of at least $5.0 million), which causes, or permits, the acceleration of principal.
In addition to subsidiary dividends and borrowings under the line of credit, the Parent has traditionally been able to issue equity and debt securities to meet liquidity needs. However, due to the current restricted nature of the debt and equity markets, we believe that our access to them is limited at this time.
Dividends on shares of our Common Stockthe Parent’s common stock are declared and paid at the discretion of ourthe Board of Directors based on our operating results, financial condition, capital requirements, contractual restrictions, and other relevant factors. Our ability to declare dividends is restricted by covenants contained in the notes payable we issued on May 4, 2000 (the “2000 Senior Notes”). , of which $24.6 million was outstanding as of December 31, 2008. Some of the significant covenants are as follows:
•Our tangible net worth, as calculated per the note purchase agreement, must be equal to or greater than the required consolidated tangible net worth minimum as computed per the note purchase agreement. In accordance with our calculations as of our December 31, 2008, our tangible net worth was $1.5 billion and the consolidated tangible net worth minimum equaled $541.2 million.
•Our consolidated debt, as computed per the note purchase agreement, must be less than or equal to 30% of our consolidated capitalization, as calculated per the note purchase agreement. As of our December 31, 2008, our consolidated debt to consolidated capitalization ratio was 15.2%.
•At any time during the most recent quarter, our consolidated debt, as calculated per the note purchase agreement, must be less than or equal to 40% of our consolidated capitalization, as calculated per the note purchase agreement. During the fourth quarter, our consolidated debt to consolidated capitalization ratio, as calculated per the note purchase agreement, did not exceed 15.6%.
•The aggregate amount of all restricted payments, as defined in the note purchase agreement, must not exceed the restricted payment limitation as defined in the note purchase agreement. As of our December 31, 2008 analysis performed, the restricted payment limitation was calculated to be approximately $869.9 million and our aggregate amount of all restricted payments through December 31, 2008 was $567.3 million.
All such covenants were met during 20072008 and 2006.2007. For further information regarding our notes payable, see Note 9, “Indebtedness,” included in Item 8. “Financial Statements and Supplementary Data” of this Form 10-K.
At December 31, 2007,2008, the amount available for dividends to holders of our Common Stock,the Parent’s common stock, in accordance with the restrictions of the 2000 Senior Notes, was $336.0$302.6 million. On January 30, 2007,Our ability to meet our Board of Directors declared a two-for-one stock split ofinterest and principal repayment obligations on our Common Stock, in the form of a share dividend of one additional share of Common Stock for each outstanding share of Common Stock (the “Share Dividend”). The Share Dividend was paid on February 20, 2007 to stockholders of record as of the close of business on February 13, 2007. The effect of the Share Dividend has been recognized retroactively in all share and per share data,debt, as well as the capital stock account balances, in the accompanying Consolidated Financial Statements, Notes to Consolidated Financial Statements and supplemental financial data. Book value per share increased to $19.81 as of December 31, 2007 compared to $18.81 as of December 31, 2006. Ourour ability to continue to pay dividends to our stockholders, is also dependent in large part on the ability of ourthe Insurance Subsidiaries and the subsidiaries in our Diversified Insurance Services segmentSelective HR to pay dividends. Restrictions on the ability of ourthese subsidiaries, particularly the Insurance Subsidiaries, to declare and pay dividends, could materially affect our ability to pay principalservice our debt and interest on indebtedness andpay dividends on Common Stock.

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We have historically met our liquidity requirements through dividends from our subsidiaries and by issuing debt and equity securities. We expect to meet our liquidity requirements by these sources in the future. The Insurance Subsidiaries have historically met their liquidity requirements from insurance premiums and investment income. These items have historically provided more than sufficient funds to pay losses, operating expenses, and dividends.common stock.
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 December 31, 2007,2008, we had stockholders’ equity of $1,076.0$890.5 million and total debt of $295.1 million. In addition, we have an irrevocable trust valued at $13.2$273.9 million, which equates to provide for the repaymenta debt-to-capital ratio of notes having maturities in 2008.23.5%.

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Our cash requirements include, but are not limited to, principal and interest payments on senior convertible notes, various notes payable and convertible subordinated debentures, dividends to stockholders, payment of claims, the purchasepayment of investmentscommitments 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 titledentitled “Contractual Obligations and Contingent Liabilities and Commitments.”
As active capital managers, 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 a 25% debt-to-capital ratio and a premiums to surpluspremiums-to-surplus ratio sufficient to maintain an “A+” (Superior) financial strength A.M. Best rating for ourthe Insurance Subsidiaries. Based on our analysis and market conditions, we may take a variety of actions, including, but not limited to, contributing capital to our subsidiaries in our Insurance Operations and Diversified Insurance Services segments, issuing additional debt and/or equity securities, repurchasing shares of our Common Stock, orthe Parent’s common stock, and increasing stockholders’ dividends. The following are a few examples of capital management actions we have taken during 2007:
On March 8, 2007, Selective Insurance Group, Inc. entered into a written trading plan under Rule 10b5-1 under the Securities Exchange Act of 1934 (“Trading Plan”) with a broker to facilitate the purchase of our Common Stock. Rule 10b5-1 allows a company to purchase its shares at times when it ordinarily would not be in the market because of self-imposed trading blackout periods, such as the time preceding its quarterly earnings releases.
On July 24, 2007, the Board of Directors authorized a new stock repurchase program for up to 4 million shares, which expires on July 26, 2009.
In 2007,During 2008, we repurchased approximately 5.71.8 million shares for $143.3 millionof the Parent’s common stock under our previous and currentauthorized share repurchase programs.
program at a cost of $40.5 million. As of December 31, 2008, there were 1.7 million shares remaining under the current repurchase authorization that extends through July 26, 2009. With market conditions as they currently exist, we have added liquidity at the Insurance Subsidiary levels and do not anticipate additional buybacks currently under this program. As mentioned above, the debt and equity markets are currently operating in a restricted manner, which may make accessing the markets more difficult than usual. 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.
On October 23, 2007, the Board of Directors declared, for stockholders of recordBook value per share decreased to $16.84 as of November 15,December 31, 2008, from $19.81 as of December 31, 2007, primarily driven by the impact of: (i) unrealized losses on our investment portfolio, which amounted to a dividendreduction in book value of $0.13 per share,$2.70; and (ii) an 8% increase fromunrealized pension charge, which amounted to a reduction in book value of $0.72, reflecting a decrease in the previous quarter, which was paid on December 3, 2007.
Indiscount rate used to value our pension liability, as well as the fourth quarterimpact of 2007, we called for redemption the remaining Senior Convertible Notes that were scheduledlower pension assets due to mature on September 24, 2032. For additional information regarding the settlement of this debt, see Note 9, “Indebtedness” in Item 8. “Financial Statements and Supplementary Data” of this Form 10-K.
market volatility.
Off-Balance Sheet Arrangements
At December 31, 20072008 and, December 31, 2006,2007, we did not have any relationships with unconsolidated entities or financial partnerships, such as 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 financing, liquidity, market, or credit risk that could arise if we had engaged in such relationships.

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Contractual Obligations and Contingent Liabilities and Commitments
As discussed in “Net Loss and Loss Expense Reserves” in Item 1. “Business.” of this Form 10-K, we maintain case reserves and estimates of reserves for losses and loss expenses incurred but not yet reported (“IBNR”),IBNR, in accordance with industry practice. Using generally accepted actuarial reserving techniques, we project our estimate of ultimate losses and loss expenses at each reporting date. Included within the estimate of ultimate losses and loss expenses are case reserves, which are analyzed on a case-by-case basis by the type of claim involved, the circumstances surrounding each claim, and the policy provisions relating to the type of losses. The difference between: (i) projected ultimate loss and loss expense reserves; and (ii) case loss reserves and loss expense reserves thereon are carried as the IBNR reserve. A range of possible reserves is determined annually and considered in addition to the most recent loss trends and other factors in establishing reserves for each reporting period. Based on the consideration of the range of possible reserves, recent loss trends and other factors, IBNR is established and the ultimate net liability for losses and loss expenses is determined. Such an assessment requires considerable judgment given that it is frequently not possible to determine whether a change in the data is an anomaly until sometime after the event. Even if a change is determined to be permanent, it is not always possible to reliably determine the extent of the change until sometime later. As a result, there is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves because the eventual deficiency or redundancy is affected by many factors.
Given that the loss and loss expense reserves are estimates as described above and in more detail under the “Critical Accounting Policies and Estimates” section of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Form 10-K, the payment of actual losses and loss expenses is generally not fixed as to amount or timing. Due to this uncertainty, financial accounting standards prohibit us from discounting these reserves to their present value. Additionally, estimated losses as of the financial statement date do not consider the impact of estimated losses from future business. Therefore, the projected settlement of the reserves for net loss and loss expenses will differ, perhaps significantly, from actual future payments.

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The informationprojected paid amounts in the “Contractual Obligations” table below relating to loss and loss expense payments is presented in accordance with reporting requirements of the SEC. These projected paid amounts by year are estimates based on past experience, adjusted for the effects of current developments and anticipated trends, and include considerable judgment. There is no precise method for evaluating the impact of any specific factor on the projected timing of when loss and loss expense reserves will be paid and as a result, the timing and amounts of the actual payments will be affected by many factors. Care must be taken to avoid misinterpretation by those unfamiliar with this information or familiar with other data commonly reported by the insurance industry. As was noted above, for further information regarding the uncertainty associated with loss and loss expense reserves see the “Critical Accounting Policies and Estimates” section of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.
Our future cash payments associated with contractual obligations pursuant to operating leases for office space and equipment, senior convertible notes, convertible subordinated debentures, notes payable, interest on debt obligations, and loss and loss expenses as of December 31, 20072008 are summarized below:
                     
Contractual obligations Payment due by period 
      Less than  1-3  3-5  More than 
($ in millions) Total  1 year  years  years  5 years 
Operating leases $25.3    8.6    10.5    4.5    1.7  
Senior convertible notes  8.7    8.7    —    —    —  
Notes payable1
  286.9    12.3    24.6    —    250.0  
Interest on debt obligations  731.2    20.6    37.8    35.6    637.2  
                
Subtotal $1,052.1    50.2    72.9    40.1    888.9  
                     
Gross loss and loss expense payments  2,542.5    655.5    846.7    395.8    644.5  
Ceded loss and loss expense payments  227.8    47.9    52.4    28.4    99.1  
                
Net loss and loss expense payments  2,314.7    607.6    794.3    367.4    545.4  
                     
                
Total $3,366.8    657.8    867.2    407.5    1,434.3  
                
1Selective has an irrevocable trust to provide for the repayment of certain debt obligations with a market value of $13.2 million as of December 31, 2007.
                     
  Payment due by period 
Contractual obligations     Less than  1-3  3-5  More than 
($ in millions) Total  1 year  years  years  5 years 
Operating leases $25.9   9.4   11.5   4.3   0.7 
Notes payable  274.6   12.3   12.3   —   250.0 
Interest on debt obligations  710.5   19.4   36.2   35.6   619.3 
                
Subtotal $1,011.0   41.1   60.0   39.9   870.0 
                     
Gross loss and loss expense payments  2,641.0   675.4   853.3   419.7   692.6 
Ceded loss and loss expense payments  224.2   46.5   50.2   26.5   101.0 
                
Net loss and loss expense payments  2,416.8   628.9   803.1   393.2   591.6 
                
                     
Total $3,427.8   670.0   863.1   433.1   1,461.6 
                
See “Liquidity” section of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K for a discussion of our syndicated line of credit agreement.

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At December 31, 2007,2008, we also have contractual obligations that expire at various dates through 20222023 that may require us to invest up to an additional $129.8$119.5 million in alternative investments. There is no certainty that any such additional investment will be required. 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 18,17, “Related Party Transactions” included in Item 8. “Financial Statements and Supplementary Data” of this Form 10-K.
Ratings
We are rated by major rating agencies, which provideissue opinions ofon 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, which currently rates uswas reaffirmed in the second quarter of 2008 as “A+ (Superior),” their second highest of fifteen ratings, and hasratings. We have been rated “A” or higher by A.M. Best for the past 75 years, with our current rating of “A+ (Superior)” being in place for 46the last 47 consecutive years. The financial strength reflected by our A.M. Best rating is a competitive advantage in the marketplace and influences where independent insurance agents place their business. A downgrade from A.M. Best, could: (i) 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; (ii) be an event of default under our line of credit; or (iii) make it more expensive for us to access capital markets. In the third quarter of 2007,

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Our ratings by other major rating agencies are as follows:
•S&P Insurance Rating Services — Our “A+” financial strength rating was reaffirmed in the third quarter of 2008 and our outlook was revised from “stable” to “negative.” Our financial strength rating reflects our strong competitive position in the core Mid-Atlantic market, coupled with our strong operating performance, capitalization and financial flexibility. Our outlook was revised due to recent lower underwriting results, including results in our personal lines operations, our capital management strategy, and our geographic concentration in the Mid-Atlantic region.
•Moody’s — Our “A2” financial strength rating was reaffirmed in the third quarter of 2008, citing our strong regional franchise with good independent agency support, along with our conservative balance sheet, moderate financial leverage, and consistent profitability. At the same time, Moody’s revised our outlook from “positive” to “stable” reflecting an increasingly competitive commercial lines market and continued weakness in our personal lines book of business.
•Fitch Ratings — Our “A+” rating was reaffirmed in the second quarter of 2008, citing our consistently favorable operating results, disciplined underwriting culture, conservative balance sheet, strong independent agency relationships, and improved diversification through our continued efforts to reduce our concentration in New Jersey.
Our S&P’s Insurance Rating Services (“S&P”) reaffirmed our&P financial strength rating of “A+.” S&P’s reaffirmation citesand our strong competitive position with close ties to our agents, strong operating performance, very strong operating company capitalization, and good financial flexibility. During the third quarter of 2006, Moody’s elevated their outlook regarding Selective to “positive.” The financial strength of our insurance business has been rated, “A2” by Moody’s since 2001 and “A+” by Fitch Ratings since 2004. Our Moody’s and S&P financial strength ratingsrating affect our ability to access capital markets, andmarkets. In addition, our interest rate under our line of credit varies based upon Selective Insurance Group Inc.’son the Parent’s debt ratings from Moody’sS&P and S&P. Moody’s.
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. We review our financial debt agreements for any potential rating triggers that could dictate a material change in terms if our credit ratings were to change.
Federal Income Taxes
The following table presents our taxable income, pre-tax financial statement income, and net deferred tax (liability) asset:
             
($ in millions) 2007  2006  2005 
Current taxable income from continuing operations $157.1   151.5   167.6 
Pre-tax financial statement income from continuing operations  192.8   220.5   202.8 
Net deferred tax asset (liability)  22.4   15.4   (5.7)
Total federal income tax expense was $46.3 million in 2007 compared to $56.9 million in 2006 and $55.3 million in 2005. The effective tax rate for 2007 was 24.0% compared to 25.8% for 2006 and 27.3% for 2005. Our effective tax rate differs from the federal corporate rate of 35% primarily as a result of tax-advantaged investment income. The decline in underwriting profits and the resulting higher ratio of net investment income to total book income before tax contributed to the 1.8% decrease in the effective tax rate from 2006 to 2007. The 1.5% decrease in the effective tax rate from 2005 to 2006 is mainly attributable to the increase in the tax advantaged securities within our investment portfolio and the settlement of an IRS audit.
We have a net deferred tax asset of $22.4 million at December 31, 2007 compared with a deferred tax asset of $15.4 million at December 31, 2006. This change is primarily due to temporary differences relating to the conversion and redemption of the convertible debt, the deferred impact of underwriting results and a reduction in unrealized gains in the investment portfolio offset by pension and accelerated depreciation.
Adoption of Accounting Pronouncements
For information concerning the adoption of accounting pronouncements and new accounting pronouncements that have been issued but not yet adopted, see Note 3, “Adoption of Accounting Pronouncements” in Item 8. “Financial Statements and Supplementary Data.” Note 3 to the Consolidated Financial Statements.of this Form 10-K.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market RiskRisk.
Market Risk
The fair value of Selective’sour assets and liabilities are subject to market risk, primarily interest rate, credit riskspreads, and equity price risk related to Selective’sour investment portfolio as well as the change in market value of our alternative investment portfolio. Selective’sOur investment portfolio is comprised of securities categorized as available for sale, or held to maturity, and trading in accordance with the Statement of Financial Accounting Standards No. 115, “AccountingAccounting for Certain Investments in Debt and Equity Securities”, issued by the Financial Accounting Standards Board (“FAS 115”), with no investment in securities categorized as trading. Selective does. We do not hold derivative or commodity investments. Foreign investments are made on a limited basis, and all fixed maturity transactions are denominated in U.S. currency. Selective hasWe have minimal foreign currency fluctuation risk on certain equity securities.
Selective’sOur investment philosophy includes setting certain return objectives relating to the equity and fixed maturity portfolios as well as risk objectives relating to the overall portfolio. The return objective of theour equity portfolio is to meet or exceed a weighted-average benchmark of public equity indices. The primary return objective of theour fixed maturity portfolio is to maximize after-tax investment yield and income while balancing certain risk objectives, with a secondary objective of meeting or exceeding a weighted-average benchmark of public fixed income indices. The risk objectives for allour portfolios are to ensure investments are being structured conservatively, focusing on: (i) asset diversification; (ii) investment quality; (iii) liquidity, particularly to meet the cash obligations of the insurance operations; (iv) consideration of taxes; and (v) preservation of capital. 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 a “buy-and-hold” principle. We also plan to further increase our portfolio allocation to government and agency holdings in the near-term in an effort to increase liquidity and capital preservation. As of December 31, 2007,2008, the mix of Selective’sour investment portfolio was 83%86% fixed maturity securities, 7%4% equity securities, 5% short-term investments, and 5% other investments.
During 2007, portions ofWe manage our investment portfolio were adversely affected by events and developmentsto mitigate risks associated with various financial market scenarios. We will, however, take prudent risk to enhance our overall long-term results while managing a conservative, well-diversified investment portfolio to support our underwriting activities. Unfortunately, in the capital markets, including decreaseda year of unprecedented market liquidity for certain invested assets, market perception of increased credit risk with respectturmoil, all asset classes proved to the types of securities held in Selective’s portfolio, and the corresponding credit spread-widening with respect to our invested assets.be closely correlated.
Interest Rate Risk
In connection with the Insurance Subsidiaries, Selective investswe invest in interest rate sensitiverate-sensitive securities, mainly fixed maturity securities. Selective’sOur fixed maturity portfolio is comprised of primarily investment grade (investments receiving S&P or an equivalent rating of BBB- or above) corporate securities, U.S. government and agency securities, municipal obligations, and mortgage-backed securities. Selective’sOur strategy to manage interest rate risk is to purchase intermediate-term fixed maturity investments that are attractively priced in relation to perceived credit risks. Selective’sOur fixed maturity securities include both available-for-sale and held-to-maturity securities in accordance with FAS 115. Fixed maturity securities that are not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity. Those fixed maturity securities that Selective haswe have the ability and positive intent to hold to maturity are classified as held-to-maturity and carried at amortized cost.
Selective generally manages itsOur exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. A rise in interest rates may decrease the fair value of our existing fixed maturity investments and declines in interest rates may result in an increase in the fair value of our existing fixed maturity investments. However, new and reinvested money used to purchase fixed maturity securities would benefit from rising interest rates and would be negatively impacted by falling interest rates. Our fixed income investment portfolio contains interest rate sensitive instruments that may be adversely affected by changes in interest rates resulting from governmental monetary policies, domestic and international economic and political conditions, and other factors beyond our control. We seek to mitigate our interest rate risk associated with its portfolio ofholding fixed maturity investments by monitoring and maintaining the average duration of theour portfolio which allows Selective to achievewith a view toward achieving an adequate yieldafter-tax return without subjecting the portfolio to an unreasonable level of interest rate risk. Increases and decreases in prevailing interest rates generally translate, respectively, into decreases and increases in fair values of fixed maturity investments. Fair values of interest rate sensitive instruments also may be affected by the credit worthiness of the issuer, prepayment options, relative values of other investments, the liquidity of the instrument, and other general market conditions. At December 31, 2007, 95%2008, 97% of Selective’sour fixed maturity portfolio (excluding short-term investments) had a maturity of 10 years or less, and the average duration was 4.23.8 years. Based on itsour fixed maturity securities asset allocation and security selection process, Selective believeswe believe that itsour fixed maturity portfolio is not overly prone to prepayment or extension risk. Although we take measures to manage the economic risks of investing in a changing interest rate environment, we may not be able to mitigate the interest rate risk of our assets relative to our liabilities.

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Selective uses
We use interest rate sensitivity analysis to measure the potential loss or gain in future earnings, fair values, or cash flows of market sensitive fixed maturity securities and preferred stock.securities. The sensitivity analysis hypothetically assumes aan instant parallel 200 basis point shift in interest rates up and down in 100 basis point increments within one year from the date of the Consolidated Financial Statements. Selective usesWe use fair values to measure itsthe potential loss.
This analysis is not intended to provide a precise forecast of the effect of changes in market interest rates and equity prices on Selective’sour income or stockholders’ equity. Further, the calculations do not take into account any actions Selectivewe may take in response to market fluctuations.

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The following table presents the sensitivity analysis of each component of market risk as of December 31, 2007:2008:
                                        
 2007  2008 
 Interest Rate Shift in Basis Points  Interest Rate Shift in Basis Points 
($ in millions) -200 -100 0 100 200  -200 -100 0 100 200 
Fair value of fixed maturity securities portfolio 3,340.9 3,210.2 3,079.5 2,951.0 2,822.5  3,361.1 3,193.5 3,035.5 2,892.2 2,761.3 
Fair value change 261.4 130.7 —  (128.5)  (257.0) 325.6 158.0 —  (143.3)  (274.2)
Fair value change from base (%)  8.5%  4.2%  —%  (4.2)%  (8.3)%  10.7%  5.2% —%  (4.7)%  (9.0)%
Going forward, the impact of market risk on our portfolio and our stockholders’ equity is partially mitigated by the fact that in early 2009, we transferred $1.6 billion of our AFS securities to a held-to-maturity designation. Of this $1.6 billion, $1.3 billion is comprised of state and political subdivision obligations and $0.3 billion is comprised of U.S. government, government agency obligations, and corporate, mortgage-backed and asset-backed securities. In total, the securities transferred had a net unrealized gain of approximately $8 million.
Credit Risk
CreditDuring 2008, the economy was impacted by the dislocation of the credit markets brought on by the crisis of confidence, widespread risk aversion, and ongoing de-leveraging. We experienced increased credit risk with respect to the types of securities held in our portfolio and our invested assets were negatively affected by widening the credit spread. However, credit quality of theour fixed maturity portfolio continues to remain high, with the weightedan average creditS&P rating of the portfolio at “AA+.” This is primarily due to the large allocation of the fixed income portfolio to highly-rated and high quality Municipal bonds, Agency RMBS, and government and agency obligations. Exposure to non-investment grade bonds remains at a low absolute level, composing less than 1% of the total fixed maturity portfolio. SelectiveWe only has threehave ten non-investment grade rated securities in the portfolio with a fair value of $10.1$16.7 million and an unrealized loss of $0.3$13.9 million. As

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The following table summarizes the fair values, unrealized gain (loss) balances, and the weighted average credit qualities of our AFS fixed maturity securities at December 31, 2008 and December 31, 2007:
                         
  December 31, 2008  December 31, 2007 
  Fair  Unrealized  Credit  Fair  Unrealized  Credit 
($ in millions) Value  Gain (Loss)  Quality  Value  Gain (Loss)  Quality 
AFS Fixed Maturity Portfolio:
                        
U.S. government obligations1
 $252.2   16.6  AAA  179.7   6.9  AAA
State and municipal obligations  1,758.0   18.6  AA+  1,611.1   17.6  AA+
Corporate securities  366.5   (22.9)  A   487.1   7.9   A 
Mortgaged-backed-securities  596.2   (86.1) AA+  697.9   (7.3) AA+
ABS  61.4   (15.3) AA  97.7   (1.5) AA+
                   
Total AFS portfolio $3,034.3   (89.1) AA+  3,073.5   23.6  AA+
                   
                         
State and Municipal Obligations:
                        
General obligations $574.1   16.2  AA+  521.5   7.3  AA+
Special revenue obligations  1,183.9   2.4  AA+  1,089.6   10.3  AA+
                   
Total state and municipal obligations $1,758.0   18.6  AA+  1,611.1   17.6  AA+
                   
                         
Corporate Securities:
                        
Financial $101.0   (13.1)  A+   183.6   1.6   A+ 
Industrials  67.7   (2.1)  A-   86.0   2.0   A- 
Utilities  47.6   (0.8)  A   49.9   1.5   A 
Consumer discretion  33.9   (1.5)  A-   46.7   1.4   A- 
Consumer staples  42.0   0.5   A   36.8   0.1   A+ 
Healthcare  22.7   0.7   A+   26.7   0.7   A+ 
Materials  13.2   (3.7) BBB+  17.1   0.1   A- 
Energy  19.1   (0.2)  A-   18.1   0.3   A 
Information technology  10.1   (1.9) BBB  12.3   0.3  BBB
Telecommunications services  9.2   (0.8)  A-   9.9   (0.1)  A- 
                   
Total corporate securities $366.5   (22.9)  A   487.1   7.9   A 
                   
                         
Mortgaged-backed securities :
                        
Agency CMBS $72.9   2.8  AAA  50.2   1.2  AAA
Non-agency CMBS  154.3   (34.8) AAA  234.2   (5.8) AA+
Agency RMBS  245.5   4.2  AAA  221.8   2.2  AAA
Non-agency RMBS  74.3   (28.4) AA+  119.4   (1.9) AA+
Alternative-A (“Alt-A”) RMBS  49.2   (29.9) AA+  72.3   (3.0) AAA
                   
Total mortgaged-backed-securities $596.2   (86.1) AA+  697.9   (7.3) AA+
                   
                         
ABS:
                        
ABS $59.3   (15.1) AA+  76.5   (1.3) AA+
Alt-A ABS  0.9   —   B   19.2   (0. 2) AAA
Sub-prime ABS2
  1.2   (0.2)  A   2.0   —  AAA
                   
Total ABS $61.4   (15.3) AA  97.7   (1.5) AA+
                   
1U.S. government includes corporate securities fully guaranteed by the FDIC.
2We define sub-prime exposure as exposure to direct and indirect investments in non-agency residential mortgages with average FICO® scores below 650.
To manage and mitigate exposure, we perform analyses on mortgage-backed securities both at the time of purchase and as part of the ongoing portfolio evaluation. This analysis includes review of average FICO® scores, loan-to-value ratios, geographic spread of the assets securing the bond, delinquencies in payments for the underlying mortgages, gains/losses on sales, stress testing of projected cash flows under various economic and default scenarios, as well as other information that aids in determination of the health of the underlying assets. We also consider 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.
Our fixed maturity investment strategy is to make security purchases that are attractively priced in relation to perceived credit risks. We manage the interest rate risk associated with holding fixed maturity investments by monitoring and maintaining the average duration of the portfolio to achieve an adequate after-tax return without subjecting the portfolio to an unreasonable level of interest rate risk. We invest the fixed maturities portfolio primarily in intermediate-term securities to limit the overall interest rate risk of fixed maturity investments. The duration of the fixed maturity portfolio as of December 31, 2007, no single fixed maturity security is rated below “BB.”
However, Selective’s investment portfolio includes certain classes of assets, such as Residential Asset Backed Securities (“RABS”) and Residential Mortgage Backed Securities (“RMBS”), which have been affected by the current market conditions related2008, including short-term investments, was 3.5 years compared to the sub-prime crisis.liability duration of approximately 3.7 years for the Insurance Subsidiaries. The RMBS and RABS portfolio represents 14% of our total fixed maturity portfolio and consists entirely of investment grade securities with 96%current duration of the portfolio rated “AAA”fixed maturities is within our historical range and only 1% rated “A” or below. Agency securities backed by various federal agencies represent approximately 50%is monitored and managed to maximize yield and limit interest rate risk. We manage the slight duration mismatch between our assets and liabilities with a laddered maturity structure and an appropriate level of Selective’s RMBS and RABS. Loanshort-term investments to Value (“LTV”) ratios and FICO score statistics are important in our initial as well as ongoing analysisavoid liquidation of this portfolio. 99% of the non-agency securities have current LTV ratios of 80% and below and 94% have FICO scores above 700 with only 1% where FICO scores are below 650. In addition, we have no sub-prime reset riskavailable-for-sale fixed maturities in the RMBS or RABS portfolio. Despite the portfolio’s high quality, current market conditions reduced the liquidityordinary course of the RMBS and RABS securities, which in turn resulted in some volatility in their fair value. As of December 31, 2007, Selective’s RMBS and RABS portfolio has a fair value of $440.6 million with unrealized losses of $3.8 million. Selective continuesbusiness.

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We continue to evaluate underlying credit quality within this portfolio and believesbelieve that current fair value fluctuations are reflective of temporary market dislocation. As long term,long-term, income-oriented investors, Selective remainswe remain comfortable with the credit risk in these securities.
Residual effects of the current market conditions may also affect other parts of Selective’s portfolio; such as bonds and equity investments in financial institutions and certain other invested assets. For example, as of December 31, 2007, the market value of Selective’s Commercial Mortgage Backed Securities (“CMBS”) portfolio is $284.4 million with unrealized losses of $4.6 million. The CMBS portfolio makes up 9% of our total fixed maturity portfolio and consists primarily of highly rated securities with 92% of CMBS securities rated above “A” and only 2% rated below investment grade as of December 31, 2007. In addition, agency securities backed by various federal agencies represent approximately 17% of Selective’s CMBS portfolio.
During 2007, our RMBS, RABS, and CMBS portfolios experienced no ratings downgrades which is in part a result of the high credit quality of the underlying collateral and stringent pre-purchase analysis and due diligence. Based on Selective’s fixed maturity portfolio asset allocation and security selection process, Selective believes that its fixed maturity portfolio is not overly prone to significant credit risk and Selective does not believe that the fair value fluctuations noted above will result in material changes to the value of our overall invested assets.
Equity Price Risk
Selective’sOur equity securities are classified as available for sale and trading in accordance with FAS 115. The Company’sOur equity securities portfolio is exposed to equity price risk arising from potential volatility in equity market prices. Selective attemptsWe attempt to minimize the exposure to equity price risk by maintaining a diversified portfolio and limiting concentrations in any one company or industry. The sensitivity analysis hypothetically assumes a 20% change in equity prices up and down in 10% increments at December 31, 2007. In the analysis, Selective includes investments in equity securities. The following table presents the hypothetical increases and decreases in 10% increments in market value of the equity portfolio as of December 31, 2007:2008:
                                                
 2007  Change in Equity Values in Percent 
($ in millions) -30% -20% -10% 0% 10% 20% 30% 
Fair value of AFS equity portfolio 92.5 105.7 118.9 132.1 145.3 158.5 171.7 
Fair value change  (39.6)  (26.4)  (13.2) — 13.2 26.4 39.6 
 Change in Equity Values in Percent  
 -20% -10% 0% 10% 20% 
Fair value of equity portfolio 219.8 247.2 274.7 302.2 329.6 
Fair value of equity trading portfolio 1.7 2.0 2.3 2.6 2.9 3.2 3.5 
Fair value change  (54.9)  (27.5) — 27.5 54.9   (0.9)  (0.6)  (0.3) — 0.3 0.6 0.9 

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In addition to our equity securities, we invest in certain other investments that are also subject to price risk. Our other investments include alternative investments in private limited partnerships that invest in various strategies such as private equity, mezzanine debt, distressed debt, and real estate. As of December 31, 2008, these types of investments represented 5% of our total invested assets. These investments are subject to the risks arising from the fact that the determination of their value is inherently subjective. The general partner of each of these partnerships usually reports the change in the value of the interests in the partnership on a one quarter lag because of the nature of the underlying assets or liabilities. Since these partnerships’ underlying investments consist primarily of assets or liabilities for which there are no quoted prices in active markets for the same or similar assets, the valuation of interests in these partnerships are subject to a higher level of subjectivity and unobservable inputs than substantially all of our other investments. Pursuant to FAS 157, each of these general partners are required to determine fair value by the price obtainable for the sale of the interest at the time of determination. Valuations based on unobservable inputs are subject to greater scrutiny and reconsideration from one reporting period to the next and therefore, the changes in the fair value of these investments may be subject to significant fluctuations which could lead to significant decreases in their fair value from one reporting period to the next. Since we record our investments in these various partnerships under the equity method of accounting, any decreases in the valuation of these investments would negatively impact our results of operations.

Indebtedness
(a) Long-Term Debt. As of December 31, 2007, Selective2008, the Parent had outstanding long-term debt of $295.1$273.9 million that mature as shown on the following table:
                        
 2007  2008 
 Year of Carrying Fair  Year of Carrying Fair 
(in thousands) Maturity Amount Value 
($ in thousands) Maturity Amount Value 
Financial liabilities
  
Notes payable:  
8.87% Senior Notes Series B 2010 36,900  37,990   2010 $24,600 $25,592 
7.25% Senior Notes 2034 49,891  52,080   2034 49,895 42,221 
6.70% Senior Notes 2035 99,360  90,000   2035 99,383 72,000 
7.50% Junior Subordinated Notes 2066 100,000  85,000   2066 100,000 59,680 
          
Total notes payable 286,151  265,070   $273,878 $199,493 
Senior convertible notes 2032 8,740  13,853  
Convertible subordinated debentures 2008 176  1,143  
     
The weighted average effective interest rate for Selective’sthe Parent’s outstanding long-term debt is 7.26%7.29%. SelectiveThe Parent is not exposed to material changes in interest rates because the interest rates are fixed on its long-term indebtedness.
(b) Short-Term Debt. During 2007, Selective had a syndicatedThe Parent can borrow under its $50 million line of credit, agreement withwhich is contingent upon the satisfaction of certain agreed-upon debt covenants, and is syndicated among the following five banks: (i) Wachovia Bank N.A., a subsidiary of Wells Fargo & Company, as administrative agent; (ii) JP Morgan Chase Bank, N.A.; (iii) State Street Bank and Trust Company; (iv) Branch Banking and Trust Company; and (v) TD Bank, National Association (formerly known as administrative agent. Under this agreement, Selective has access to a $50 million credit facility, whichCommerce Bank, N.A.). This line can be increased to $75 million with the consent of all lending parties. Selective accessed $6 million fromWe continue to monitor current news regarding the banking industry in general, and our lending partners in particular, as, according to the syndicated line of credit agreement, the lenders are not joint and severally liable with regards to the total commitment under the agreement. The Parent did not access the facility during 20072008 and, as such, at the London Interbank Offered Rate. At December 31, 2007, there were2008, no balances outstanding under the facility.were outstanding.

 

6681

Item 8. Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Selective Insurance Group, Inc.:
We have audited the accompanying consolidated balance sheets of Selective Insurance Group, Inc. and its subsidiaries as of December 31, 20072008 and 2006,2007, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2007.2008. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedules I to VI.V. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Selective Insurance Group, Inc. and its subsidiaries as of December 31, 20072008 and 2006,2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007,2008, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in Note 2 to the Consolidated Financial Statements, in 2006 the Company changed its definition of cash equivalents for presentation in the statement of cash flows and, in 2005, changed its method of accounting for share-based payments.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Selective Insurance Group, Inc.’s internal control over financial reporting as of December 31, 2007,2008, based on criteria established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 27, 20082009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
New York, New York
February 27, 20082009

 

6782

Consolidated Balance Sheets
                
December 31,   
(in thousands, except share amounts) 2007 2006 
ASSETS Investments:
 
Fixed maturity securities, held-to-maturity – at amortized cost
(fair value: $5,927 – 2007; $10,073 – 2006)		 $5,783 9,822 
Fixed maturity securities, available-for-sale – at fair value
(amortized cost: $3,049,913 – 2007; $2,916,884 – 2006)		 3,073,547 2,937,100 
Equity securities, available-for-sale – at fair value
(cost of: $160,390 – 2007; $157,864 – 2006)		 274,705 307,376 
Consolidated Balance Sheets
December 31,
($ in thousands, except share amounts)		 2008 2007 
 
ASSETS
 
Investments:
 
Fixed maturity securities, held-to-maturity — at amortized cost (fair value: $1,178 — 2008; $5,927 — 2007) $1,163 5,783 
Fixed maturity securities, available-for-sale — at fair value (amortized cost: $3,123,346 — 2008; $3,049,913 — 2007) 3,034,278 3,073,547 
Equity securities, available-for-sale — at fair value (cost of: $125,947 — 2008; $160,390 — 2007) 132,131 274,705 
Short-term investments (at cost which approximates fair value) 190,167 197,019  198,111 190,167 
Equity securities, trading — at fair value 2,569 — 
Other investments 188,827 144,785  172,057 188,827 
          
Total investments (Note 4) 3,733,029 3,596,102  3,540,309 3,733,029 
Cash and cash equivalents 8,383 6,443  18,643 8,383 
Interest and dividends due or accrued 36,141 34,846  36,538 36,141 
Premiums receivable, net of allowance for uncollectible accounts of: $3,905 – 2007; $3,229 – 2006 496,363 458,452 
Other trade receivables, net of allowance for uncollectible accounts of: $244 – 2007; $255 – 2006 21,875 21,388 
Premiums receivable, net of allowance for uncollectible accounts of: $4,237 — 2008; $3,905 — 2007 480,894 496,363 
Other trade receivables, net of allowance for uncollectible accounts of: $299 — 2008; $244 — 2007 19,461 21,875 
Reinsurance recoverable on paid losses and loss expenses 7,429 4,693  6,513 7,429 
Reinsurance recoverable on unpaid losses and loss expenses (Note 7) 227,801 199,738  224,192 227,801 
Prepaid reinsurance premiums (Note 7) 82,182 69,935  96,617 82,182 
Current federal income tax 4,235 468 
Current federal income tax (Note 14) 26,327 4,235 
Deferred federal income tax (Note 14) 22,375 15,445  146,801 22,375 
Property and Equipment – at cost, net of accumulated depreciation and amortization of: $117,832 – 2007; $103,660 – 2006 58,561 59,004 
Deferred policy acquisition costs (Note 2i) 226,434 218,103 
Goodwill (Note 2j) 33,637 33,637 
Property and Equipment — at cost, net of accumulated depreciation and amortization of: $132,609 — 2008; $117,832 — 2007 51,697 58,561 
Deferred policy acquisition costs (Note 2j) 212,319 226,434 
Goodwill (Note 2k, 12) 29,637 33,637 
Other assets 43,547 49,451  51,384 43,547 
          
Total assets $5,001,992 4,767,705  $4,941,332 5,001,992 
          
  
LIABILITIES AND STOCKHOLDERS’ EQUITY
  
Liabilities:
  
Reserve for losses (Note 8) $2,182,572 1,959,485  $2,256,329 2,182,572 
Reserve for loss expenses (Note 8) 359,975 329,285  384,644 359,975 
Unearned premiums 841,348 791,540  844,334 841,348 
Senior convertible notes (Note 9) 8,740 57,413  — 8,740 
Notes payable (Note 9) 286,151 304,424  273,878 286,151 
Commissions payable 60,178 54,814  48,560 60,178 
Accrued salaries and benefits 88,079 94,560  147,050 88,079 
Other liabilities 98,906 98,957  96,044 98,906 
          
Total liabilities 3,925,949 3,690,478  4,050,839 3,925,949 
          
  
Stockholders’ Equity:
  
Preferred stock of $0 par value per share:  
Authorized shares: 5,000,000; no shares issued or outstanding  
Common stock of $2 par value per share:  
Authorized shares: 360,000,000 (Note 10) 
Issued: 94,652,930 – 2007; 91,562,266 – 2006 189,306 183,124 
Authorized shares: 360,000,000 (Note 10)
Issued: 95,263,508 — 2008; 94,652,930 — 2007		 190,527 189,306 
Additional paid-in capital 192,627 153,246  217,195 192,627 
Retained earnings 1,105,946 986,017  1,128,149 1,105,946 
Accumulated other comprehensive income (Note 5) 86,043 100,601 
Treasury stock – at cost (shares: 40,347,894 – 2007; 34,289,974 – 2006)  (497,879)  (345,761)
Accumulated other comprehensive (loss) income (Note 5)  (100,666) 86,043 
Treasury stock — at cost (shares: 42,386,921 — 2008; 40,347,894 — 2007)  (544,712)  (497,879)
          
Total stockholders’ equity (Notes 10 and 11) 1,076,043 1,077,227  890,493 1,076,043 
          
Commitments and contingencies (Notes 19 and 20) 
Commitments and contingencies (Notes 18 and 19) 
 
Total liabilities and stockholders’ equity $5,001,992 4,767,705  $4,941,332 5,001,992 
          
See accompanying notes to consolidated financial statements.

 

6883

Consolidated Statements of Income
                        
Years Ended December 31,    
(in thousands, except per share amounts) 2007 2006 2005 
Consolidated Statements of Income
Years Ended December 31,
($ in thousands, except per share amounts)		 2008 2007 2006 
Revenues:
  
Net premiums written $1,554,867 1,535,961 1,459,474  $1,484,041 1,554,867 1,535,961 
Net increase in unearned premiums and prepaid reinsurance premiums  (37,561)  (36,297)  (41,461)
Net decrease (increase) in unearned premiums and prepaid reinsurance premiums 11,449  (37,561)  (36,297)
              
Net premiums earned 1,517,306 1,499,664 1,418,013  1,495,490 1,517,306 1,499,664 
Net investment income earned 174,144 156,802 135,950  131,032 174,144 156,802 
Net realized gains 33,354 35,479 14,464 
Net realized (losses) gains  (49,452) 33,354 35,479 
Diversified Insurance Services revenue 115,566 110,526 98,711  116,346 115,566 110,526 
Other income 5,858 5,396 3,874  2,563 5,858 5,396 
              
Total revenues 1,846,228 1,807,867 1,671,012  1,695,979 1,846,228 1,807,867 
              
  
Expenses:
  
Losses incurred 829,524 791,955 730,618  845,656 829,524 791,955 
Loss expenses incurred 169,682 168,028 175,112  168,160 169,682 168,028 
Policy acquisition costs 497,229 478,339 437,894  490,040 497,229 478,339 
Dividends to policyholders 7,202 5,927 5,688  5,211 7,202 5,927 
Interest expense 23,795 21,411 17,582  20,508 23,795 21,411 
Diversified Insurance Services expenses 96,943 92,718 83,918  97,819 96,943 92,718 
Goodwill impairment 4,000 — — 
Other expenses 29,095 28,979 17,416  25,199 29,095 28,979 
              
Total expenses 1,653,470 1,587,357 1,468,228  1,656,593 1,653,470 1,587,357 
              
  
Income from continuing operations, before federal income tax 192,758 220,510 202,784 
Income before federal income tax 39,386 192,758 220,510 
              
  
Federal income tax expense (benefit):
  
Current 43,046 66,717 60,130  22,293 43,046 66,717 
Deferred 3,214  (9,781)  (4,798)  (26,665) 3,214  (9,781)
              
Total federal income tax expense 46,260 56,936 55,332 
       
 
Net income from continuing operations 146,498 163,574 147,452 
       
 
Income from discontinued operations, net of tax: $1,712 – 2005 — — 3,180 
Loss on disposal of discontinued operations, net of tax $(1,418) – 2005 — —  (2,634)
       
Total discontinued operations, net of tax — — 546 
       
 
Net income before cumulative effect of change in accounting principle 146,498 163,574 147,998 
       
 
Cumulative effect of change in accounting principle, net of tax — — 495 
Total federal income tax (benefit) expense  (4,372) 46,260 56,936 
              
  
Net income $146,498 163,574 148,493  43,758 146,498 163,574 
        
 
Earnings per share:
  
Basic net income from continuing operations $2.80 2.98 2.72 
Basic net income from discontinued operations — — 0.01 
Basic cumulative effect of change in accounting principle — — 0.01 
       
Basic net income $2.80 2.98 2.74  $0.84 2.80 2.98 
       
 
Diluted net income from continuing operations $2.59 2.65 2.33 
Diluted net income from discontinued operations — — 0.01 
Diluted cumulative effect of change in accounting principle — — 0.01 
        
Diluted net income $2.59 2.65 2.35  $0.82 2.59 2.65 
        
 
Dividends to stockholders $0.49 0.44 0.40  $0.52 0.49 0.44 
See accompanying notes to consolidated financial statements.

 

6984

Consolidated Statements of Stockholders’ Equity
                                                
Years Ended December 31,    
(in thousands, except per share amounts) 2007 2006 2005 
Consolidated Statements of Stockholders’ Equity
Years Ended December 31,
($ in thousands, except per share amounts)		 2008 2007 2006 
Common stock:
  
Beginning of year $183,124 173,085 169,872  $189,306 183,124 173,085 
Dividend reinvestment plan (shares: 78,762 – 2007; 64,072 – 2006; 63,914 – 2005) 158 128 128 
Convertible debentures (shares: 2,074,067 – 2007; 3,999,128 – 2006; 72,872 – 2005) 4,148 7,998 146 
Stock purchase and compensation plans (shares: 937,835 – 2007; 956,520 – 2006; 1,469,562 – 2005) 1,876 1,913 2,939 
Dividend reinvestment plan (shares: 81,200 — 2008; 78,762 — 2007; 64,072 — 2006) 162 158 128 
Convertible debt (shares: 45,759 — 2008; 2,074,067 — 2007; 3,999,128 — 2006) 92 4,148 7,998 
Stock purchase and compensation plans (shares: 483,619 — 2008; 937,835 — 2007; 956,520 — 2006) 967 1,876 1,913 
              
End of year 189,306 183,124 173,085  190,527 189,306 183,124 
              
  
Additional paid-in capital:
  
Beginning of year 153,246 71,638 57,356  192,627 153,246 71,638 
Dividend reinvestment plan 1,708 1,604 1,441  1,677 1,708 1,604 
Convertible debentures 9,806 51,249 113 
Convertible debt 645 9,806 51,249 
Stock purchase and compensation plans 27,867 28,755 12,728  22,246 27,867 28,755 
              
End of year 192,627 153,246 71,638  217,195 192,627 153,246 
              
  
Retained earnings:
  
Beginning of year 986,017 847,687 721,483  1,105,946 986,017 847,687 
Cumulative-effect adjustment due to adoption of FAS 159, net of deferred income tax effect of $3,344 6,210 
Net income 146,498 146,498 163,574 163,574 148,493 148,493  43,758 43,758 146,498 146,498 163,574 163,574 
Dividends to stockholders ($0.49 per share –2007; $0.44 per share – 2006; $0.40 per share – 2005)  (26,569)  (25,244)  (22,289) 
Dividends to stockholders ($0.52 per share — 2008; $0.49 per share — 2007; $0.44 per share — 2006)  (27,765)  (26,569)  (25,244) 
              
End of year 1,105,946 986,017 847,687  1,128,149 1,105,946 986,017 
              
  
Accumulated other comprehensive income:
 
Accumulated other comprehensive (loss) income:
 
Beginning of year 100,601 118,121 154,536  86,043 100,601 118,121 
Other comprehensive (loss) income, (decrease) increase in: 
Net unrealized gains on investment securities, Net of deferred income tax effect of $(10,925) – 2007; $(2,031) – 2006; $(19,608) – 2005  (20,289)  (20,289)  (3,772)  (3,772)  (36,415)  (36,415)
Defined benefit pension plans, net of deferred income tax effect of $3,086 – 2007; $(7,403) – 2006 (Note 16d) 5,731 5,731  (13,748) — — — 
Cumulative-effect adjustment due to adoption of FAS 159, net of deferred income tax effect of $(3,344)  (6,210) 
Other comprehensive (loss) income, (increase) decrease in: 
Net unrealized gains on investment securities, Net of deferred income tax effect of $(76,831) — 2008; $(10,925) — 2007; $(2,031) — 2006  (142,685)  (142,685)  (20,289)  (20,289)  (3,772)  (3,772)
Defined benefit pension plans, net of deferred income tax effect of $(20,362) — 2008; $3,086 — 2007; $(7,403) — 2006  (37,814)  (37,814) 5,731 5,731  (13,748) — 
                          
End of year 86,043 100,601 118,121   (100,666) 86,043 100,601 
              
Comprehensive income 131,940 159,802 112,078 
Comprehensive (loss) income  (136,741) 131,940 159,802 
              
  
Treasury stock:
  
Beginning of year  (345,761)  (229,407)  (206,522)   (497,879)  (345,761)  (229,407) 
Acquisition of treasury stock (shares: 6,057,920 – 2007; 4,335,622 – 2006; 896,218 – 2005)  (152,118)  (116,354)  (22,885) 
Acquisition of treasury stock (shares: 2,039,027 — 2008; 6,057,920 — 2007; 4,335,622 — 2006)  (46,833)  (152,118)  (116,354) 
              
End of year  (497,879)  (345,761)  (229,407)   (544,712)  (497,879)  (345,761) 
              
  
Unearned stock compensation and notes receivable from stock sales:
 
Beginning of year — —  (14,707) 
Unearned stock compensation — — — 
Reclassification of unearned stock compensation — — 14,641 
Amortization of deferred compensation expense and amounts received on notes — — 66 
       
End of year — — — 
       
Total stockholders’ equity $1,076,043 1,077,227 981,124  $890,493 1,076,043 1,077,227 
              
The Company also has authorized, but not issued, 5,000,000 shares of preferred stock without par value of which 300,000 shares have been designated Series A junior preferred stock without par value.
See accompanying notes to consolidated financial statements.

 

7085

Consolidated Statements of Cash Flows
                        
Years Ended December 31,    
(in thousands) 2007 2006 2005 
Consolidated Statements of Cash Flows
Years Ended December 31,
($ in thousands)		 2008 2007 2006 
 
Operating Activities
  
Net income $146,498 163,574 148,493  $43,758 146,498 163,574 
              
  
Adjustments to reconcile net income to net cash provided by operating activities:
  
Depreciation and amortization 29,139 25,684 21,380  28,552 29,139 25,684 
Stock-based compensation expense 20,992 14,524 11,361  17,215 20,992 14,524 
Net realized gains  (33,354)  (35,479)  (14,464)
Deferred tax 3,214  (9,781)  (4,798)
Loss on disposition of discontinued operations — — 2,634 
Undistributed losses (income) of equity method investments 13,753  (4,281)  (3,511)
Net realized losses (gains) 49,452  (33,354)  (35,479)
Deferred tax (benefit) expense  (26,665) 3,214  (9,781)
Unrealized loss on trading securities 8,129 — — 
Debt conversion inducement — 2,117 —  — — 2,117 
Cumulative effect of change in accounting principle, net of tax — —  (495)
Impairment of goodwill 4,000 — — 
  
Changes in assets and liabilities:
  
Increase in reserves for losses and loss expenses, net of reinsurance recoverable on unpaid losses and loss expenses 227,749 223,231 249,356  102,100 227,749 223,231 
Increase in unearned premiums, net of prepaid reinsurance and advance premiums 38,346 35,708 41,430 
(Decrease) increase in net federal income tax payable  (3,767)  (2,761) 585 
Increase in premiums receivable  (37,911)  (11,232)  (35,785)
Increase in other trade receivables  (487)  (4,835)  (6,534)
Increase in deferred policy acquisition costs  (8,331)  (13,271)  (17,915)
Increase (decrease) in unearned premiums, net of prepaid reinsurance and advance premium  (10,766) 38,346 35,708 
Increase in net federal income tax recoverable  (22,092)  (3,767)  (2,761)
Decrease (increase) in premiums receivable 15,469  (37,911)  (11,232)
Decrease (increase) in other trade receivables 2,414  (487)  (4,835)
Decrease (increase) in deferred policy acquisition costs 14,115  (8,331)  (13,271)
Increase in interest and dividends due or accrued  (1,331)  (2,280)  (4,632)  (431)  (1,331)  (2,280)
(Increase) decrease in reinsurance recoverable on paid losses and loss expenses  (2,736)  (144) 1,292 
(Decrease) increase in accrued salaries and benefits  (3,266) 5,385 17,953 
Increase (decrease) in accrued insurance expenses 6,370  (1,566) 11,582 
Decrease (increase) in reinsurance recoverable on paid losses and loss expenses 916  (2,736)  (144)
Increase (decrease) in accrued salaries and benefits  (3,100)  (3,266) 5,385 
(Decrease) increase in accrued insurance expenses  (15,880) 6,370  (1,566)
Purchase of trading securities  (6,587) — — 
Sale of trading securities 21,002 — — 
Other, net 5,163 4,181  (14,605) 5,819 9,444 7,692 
              
Net adjustments 239,790 229,481 258,345  197,415 239,790 229,481 
              
Net cash provided by operating activities 386,288 393,055 406,838  241,173 386,288 393,055 
              
  
Investing Activities
  
Purchase of fixed maturity securities, available-for-sale  (580,864)  (801,647)  (779,212)  (587,430)  (580,864)  (801,647)
Purchase of equity securities, available-for-sale  (148,569)  (52,429)  (47,645)  (70,651)  (148,569)  (52,429)
Purchase of other investments  (80,147)  (71,486)  (26,789)  (53,089)  (80,147)  (71,486)
Purchase of short-term investments  (2,198,362)  (2,290,937)  (1,907,686)  (2,204,107)  (2,198,362)  (2,290,937)
Net proceeds from sale of subsidiary — 376 14,785  — — 376 
Sale of fixed maturity securities, available-for-sale 102,613 306,044 181,279  152,655 102,613 306,044 
Sale of short-term investments 2,205,194 2,279,055 1,821,231  2,196,162 2,205,194 2,279,055 
Redemption and maturities of fixed maturity securities, held-to-maturity 4,051 3,635 27,616  4,652 4,051 3,635 
Redemption and maturities of fixed maturity securities, available-for-sale 319,118 187,608 209,377  294,342 319,118 187,608 
Sale of equity securities, available-for-sale 187,259 108,382 54,487  102,313 187,259 108,382 
Proceeds from other investments 40,115 8,350 9,975  26,164 40,115 8,350 
Purchase of property and equipment  (14,511)  (18,670)  (9,558)  (8,083)  (14,511)  (18,670)
              
Net cash used in investing activities  (164,103)  (341,719)  (452,140)  (147,072)  (164,103)  (341,719)
              
  
Financing Activities
  
Dividends to stockholders  (24,464)  (22,831)  (19,908)  (25,804)  (24,464)  (22,831)
Acquisition of treasury stock  (152,118)  (116,354)  (22,885)  (46,833)  (152,118)  (116,354)
Proceeds from issuance of notes payable, net of issuance costs — 96,263 99,310  — — 96,263 
Principal payments of notes payable  (18,300)  (18,300)  (24,000)  (12,300)  (18,300)  (18,300)
Net proceeds from stock purchase and compensation plans 8,609 11,560 11,919  8,222 8,609 11,560 
Excess tax benefits from share-based payment arrangements 3,484 3,903 3,783  1,628 3,484 3,903 
Borrowings under line of credit agreement 6,000 — —  — 6,000 — 
Repayment of borrowings under line of credit agreement  (6,000) — —  —  (6,000) — 
Debt conversion inducement —  (2,117) —  — —  (2,117)
Principal payments of senior convertible notes  (37,456) — — 
Proceeds received on notes receivable from stock sales — — 66 
Principal payments of convertible debt  (8,754)  (37,456) — 
              
Net cash (used in) provided by financing activities  (220,245)  (47,876) 48,285 
Net cash used in financing activities  (83,841)  (220,245)  (47,876)
              
Net increase in cash and cash equivalents 1,940 3,460 2,983  10,260 1,940 3,460 
Cash and cash equivalents, beginning of year 6,443 2,983 —  8,383 6,443 2,983 
              
Cash and cash equivalents, end of year $8,383 6,443 2,983  $18,643 8,383 6,443 
              
  
Supplemental Disclosures of Cash Flows Information
  
Cash paid during the year for:  
Interest $25,311 21,391 16,984  $20,647 25,311 21,391 
Federal income tax 43,809 65,575 57,476  42,750 43,809 65,575 
Supplemental schedule of non-cash financing activity:  
Conversion of convertible debentures 12,066 58,534 258  169 12,066 58,534 
See accompanying notes to consolidated financial statements.

 

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Notes to Consolidated Financial Statements
December 31, 2008, 2007, 2006, and 20052006
Note 1 Organization
Selective Insurance Group, Inc., through its subsidiaries, (collectively knownreferred to as “Selective”“we” or “our”) offers property and casualty insurance products and diversified insurance services and products. Selective Insurance Group, Inc. (referred to as the “Parent” or the “Parent Company”) was incorporated in New Jersey in 1977 and its main offices are located in Branchville, New Jersey. Selective Insurance Group, Inc.’s Common StockThe Parent’s common stock is publicly traded on the NASDAQ Global Select Market under the symbol “SIGI.”
Selective classifies itsWe classify our business into three operating segments:
Insurance Operations, which sells property and casualty insurance products and services primarily in 21 states in the Eastern and Midwestern United States;
•Insurance Operations, which sells property and casualty insurance products and services primarily in 22 states in the Eastern and Midwestern U.S.;
•Investments; and
•Diversified Insurance Services, which provides human resource administration outsourcing (“HR Outsourcing”) products and services, and federal flood insurance administrative services (“Flood”).
Investments; and
Diversified Insurance Services, which provides human resource administration outsourcing products and services, and federal flood insurance administrative services.
Note 2 Summary of Significant Accounting Policies
(a) Principles of Consolidation
The accompanying consolidated financial statements (“Financial Statements”), which include the accounts of Selective,we have been prepared in conformity with: (i) U.S. generally accepted accounting principles (“GAAP”); and (ii) the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). All significant intercompany accounts and transactions are eliminated in consolidation.
(b) Use of Estimates
The preparation of theour Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported financial statement balances, as well as the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.
(c) Reclassifications
Certain amounts in our prior years’ consolidated financial statements and related footnotes have been reclassified to conform to the 2008 presentation. Such reclassifications had no effect on our net income or stockholders’ equity.
(d) Investments
Fixed maturity securities are comprised ofmay include bonds, redeemable preferred stocks, and mortgage-backedmortgage and asset-backed securities. Fixed maturity securities classified as available for saleavailable-for-sale are reported at fair value. Those fixed maturity securities that Selective haswe have the ability and positive intent to hold to maturity are classified as held-to-maturity and are carried at amortized cost. The amortized cost of debtfixed maturity securities is adjusted for amortization of premiums and accretion of discounts over the expected life of the security using the effective interest method. Premiums expected and discounts arising from the purchase of mortgage-backed securities are amortized over the expected life of the security based on future principal payments, and considering prepayments. These prepayments are estimated based upon historical and projected cash flows. Prepayment assumptions are reviewed annually and adjusted to reflect actual prepayments and changes in expectations. Future amortization of any premium and/or discount is also adjusted to reflect the revised assumptions. Interest income, as well as amortization and accretion, is included in “Net investment income earned.”earned” on our Consolidated Statements of Income. The amortized cost of fixed maturity securities is written down to fair value when a decline in value is considered to be other than temporary. See the discussion below on realized investment gains and losses for a description of the accounting for impairments. Unrealized gains and losses on fixed maturities classified as available-for-sale, net of tax are included in accumulated other comprehensive income (loss) (“AOCI”).
Equity securities which are classified as available for sale, are comprised ofavailable-for-sale, may include common stocks and non-redeemable preferred stocks and are carried at fair value. Dividend income on these securities is included in “Net investment income earned.” The associated unrealized gains and losses, net of tax are included in AOCI. The cost of equity securities is written down to fair value when a decline in value is considered to be other than temporary. See the discussion below on realized investment gains and losses for a description of the accounting for impairments. Certain equity securities managed by an external portfolio manager are classified as trading securities and are carried at fair value. Trading securities are recorded at fair value with subsequent changes in fair value recognized in net investment income.

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Short-term investments are comprised ofmay include certain money market instruments, savings accounts, commercial paper, other debt issues purchased with a maturity of less than one year, and variable rate demand notes. These investments are carried at cost, which approximates fair value. The associated income is included in “Net investment income earned.”

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Other investments are comprised ofmay include alternative investments and other miscellaneous securities. Alternative investments are accounted for using the equity method. Selective’sOur share of distributed and undistributed net income from alternative investments is included in “Net investment income earned.” Investments in other miscellaneous securities are generally carried at estimated fair value, because Selective’sour interests are so minor that it exerciseswe exercise virtually no influence over operating and financial policies. Selective’spolicies of the investees. Our distributed share of net income from other miscellaneous investments is included in “Net investment income earned.” Any changes in estimated fair value associated with these other miscellaneous investments are recorded as an unrealized gain or loss, of which these items, net of tax, are included in AOCI.
Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold and are credited or charged to income. Also included in realized gains and losses are write-downs for other than temporaryother-than-temporary impairment (“OTTI”) charges.
When the fair value of any investment is lower than its cost, an assessment is made to determine if the decline is other than temporary. If the decline is deemed to be other than temporary, the investment is written down to fair value, which approximates the price at which a market participant would be willing to transact at (i.e., the exit price), and the amount of the write-down is charged to income as a realized loss. The fair value of the investment becomes its new cost basis. Selective’sOur assessment for other-than-temporary impairmentOTTI of fixed maturity securities and short-term investments, includes, but is not limited to, the evaluation of the following factors:
Whether the decline appears to be issuer or industry specific;
•Whether the decline appears to be issuer or industry specific;
•The degree to which an issuer is current or in arrears in making principal and interest payments on the fixed maturity securities in question;
•The issuer’s current financial condition and its ability to make future scheduled principal and interest payments on a timely basis;
•Stress testing of projected cash flows under various economic and default scenarios;
•Buy/hold/sell recommendations published by outside investment advisors and analysts;
•Relevant rating history, analysis and guidance provided by rating agencies and analysts; and
•Our ability and intent to hold a security to maturity given interest rate fluctuations.
We perform impairment assessments for the structured securities included in our fixed maturity portfolio (including, but not limited to, commercial-mortgage-backed securities in question;
The issuer’s current financial condition(“CMBS”), residential-mortgage-backed securities (“RMBS”), asset-backed securities (“ABS”), and its ability to make future scheduled principal and interest payments on a timely basis;
Buy/hold/sell recommendations published by outside investment advisors and analysts;
Relevant rating history, analysis and guidance provided by rating agencies and analysts;
Thecollateralized debt obligations (“CDOs”), comprising an evaluation of the underlying collateral of these structured securities. This assessment, although considering the length of time and the extent tofor which the fair valuesecurity has been less than carrying value;in an unrealized loss position, focuses on the performance of the underlying collateral under various economic and
Our default scenarios which may involve subjective judgments and estimates determined by management. Considering various factors in our modeling of these structured securities, such as projected default rates, the nature and realizable value of the collateral, the ability and intent to hold aof the security to maturity given interest rate fluctuations.
make scheduled payments, historical performance, and other relevant economic and performance factors, we determine if an impairment is other than temporary in circumstances where our projection of losses extends into the tranche of the security in which we are invested.
Evaluation for other-than-temporary impairmentOTTI of equity securities other investments, and short-termother investments includes, but is not limited to, the following factors:
•Whether the decline appears to be issuer or industry specific;
•The relationship of market prices per share to book value per share at the date of acquisition and date of evaluation;
•The price-earnings ratio at the time of acquisition and date of evaluation;
•The financial condition and near-term prospects of the issuer, including any specific events that may influence the issuer’s operations;
•The recent income or loss of the issuer;
•The independent auditors’ report on the issuer’s recent financial statements;
•The dividend policy of the issuer at the date of acquisition and the date of evaluation;
•Any buy/hold/sell recommendations or price projections published by outside investment advisors;
•Any rating agency announcements; and
•The length of time and the extent to which the fair value has been less than carrying value.

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Whether the decline appears to be issuer or industry specific;
The relationship of market prices per share to book value per share at the date of acquisition and date of evaluation;
The price-earnings ratio at the time of acquisition and date of evaluation;
The financial condition and near-term prospects of the issuer, including any specific events that may influence the issuer’s operations;
The recent income or loss of the issuer;
The independent auditors’ report on the issuer’s recent financial statements;
The dividend policy of the issuer at the date of acquisition and the date of evaluation;
Any buy/hold/sell recommendations or price projections published by outside investment advisors;
Any rating agency announcements; and
The length of time and the extent to which the fair value has been less than carrying value.
(d)(e) Fair Values of Financial Instruments
On January 1, 2008, we adopted FASB Statement of Financial Accounting Standards No. 157,Fair Value Measurements(“FAS 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosure about fair value measurements. The impact of the adoption of FAS 157 did not have a material impact on our results of operations or financial condition.
The following methods and assumptions are used in estimating the fair value of financial instruments:
(1) Investments: FairThe fair values forof our investment portfolio are generated using various valuation techniques. For valuations of securities in our equity portfolio and U.S. Treasury notes held in our fixed maturity portfolio, we utilize a market approach, wherein we use quoted prices in an active market for identical assets. The source of these prices is an external pricing service, which we validate against other external pricing sources.
For the majority of our fixed maturity portfolio and several non-publicly traded equity securities, are based onwe also utilize a market prices from independentapproach, using primarily matrix pricing models prepared by external pricing services. We validate these prices against other external pricing sources in order to determine the fair market value of the positions, as well as to determine their placement within the fair value hierarchy (Level 1, Level 2, or Level 3) as defined in FAS 157. For disclosures required by FAS 157, refer to Note 6, “Fair Values of Financial Instruments.”
Short-term investments are carried at cost, which approximates fair value. Our investmentinvestments in other miscellaneous securities are generally accounted for at fair value based on net asset value.
(2) Indebtedness: The fair valuevalues of the convertible subordinated debentures, the 1.6155% Senior Convertible Notes due September 24, 2032, the 7.25% Senior Notes due November 15, 2034, the 6.70% Senior Notes due November 1, 2035, and the 7.5% Junior Subordinated Notes due September 27, 2066, are based on quoted market prices. The fair value of the 8.63% Senior Notes due May 4, 2007 and 8.87% Senior Notes due May 4, 2010 wereis estimated using a cash flow analysis based upon Selective’sour current incremental borrowing rate for the remaining term of the loans.loan.
See Note 6 for a summary table of the fair value and related carrying amounts of financial instruments.

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(e)(f) Allowance for Doubtful Accounts
Selective estimatesWe estimate an allowance for doubtful accounts on itsour premiums and other trade receivables. The allowance for premiums and other trade receivables is based on historical write-off percentages adjusted for the effects of current and anticipated trends.
(f)(g) Share-Based Compensation
Effective January 1, 2005, Selective adopted Financial Accounting Standards Board (“FASB”) StatementShare-based compensation consists of Financial Accounting Standards No. 123 (Revised 2004), “Share-Based Payment” (“FAS 123R”), which replaces FASB Statement No. 123 “Accounting for Stock Based Compensation” (“FAS 123”) and supersedes Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”). FAS 123R applies to all share-based payment transactions in which an entity acquires goods or services by issuing (or offering to issue) its shares, share units, share options, or other equity instruments. FAS 123R requires that theThe cost resulting from all share-based payment transactions beare recognized in the consolidated financial statements, based on the fair value of such instruments at the grant date over the requisite service period. The requisite service period is typically the lesser of the vesting period or the period of time from the grant date to the date of retirement eligibility. The expense recognized for share-based awards, which, in some cases, contain performance criteria, is based on the number of shares/units expected to be issued at the end of the performance period.
In adopting FAS 123R, Selective applied the modified prospective application method, which did not have a material effect on: (i) income before cumulative effect of change in accounting principle in 2005; or (ii) basic or diluted earnings per share before cumulative effect of change in accounting principle in 2005. At adoption, Selective recognized a cumulative effect of change in accounting principle resulting in a net income benefit of $0.5 million, which corresponded to the requirement of estimating forfeitures at the date of grant. FAS 123R also eliminated the presentation of the contra-equity account, “Unearned Stock Compensation” from the face of the Consolidated Balance Sheets, resulting in a reclassification of $14.7 million to “Additional Paid-in Capital.”
(g)(h) Reinsurance
Reinsurance recoverable on paid and unpaid losses and loss expenses represent estimates of the portion of such liabilities that will be recovered from reinsurers. Generally, amounts recoverable from reinsurers are recognized as assets at the same time and in a manner consistent with the paid and unpaid losses associated with the reinsured policies. An allowance for estimated uncollectible reinsurance is recorded based on an evaluation of balances due from reinsurers and other available information.
(h)(i) Property and Equipment
Property and equipment used in operations, including certain costs incurred to develop or obtain computer software for internal use, are capitalized and carried at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, which range up to 40 years.

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(i)
(j) Deferred Policy Acquisition Costs
Policy acquisition costs directly related to the writing of insurance policies are deferred and amortized over the life of the policies. These costs include labor costs, commissions, premium taxes and assessments, boards, bureaus and dues, travel, and other underwriting expenses incurred in the acquisition of premium. The deferred policy acquisition costs are limited to the sum of unearned premiums and anticipated investment income less anticipated losses and loss expenses, policyholder dividends and other expenses for maintenance of policies in force. SelectiveWe regularly conductsconduct reviews for potential premium deficiencies. There were no premium deficiencies for any of the reported years as the sum of the anticipated losses and loss expenses, policyholder dividends, and other expenses did not exceed the related unearned premium and anticipated investment income. The investment yields assumed in the premium deficiency assessment for each reporting period, which are based upon the Company’sour actual average investment yield before-taxbefore tax as of the calculation date on September 30, were 4.1% for 2008, 4.6% for 2007 and 4.4% for 2006 and 2005.2006. Deferred policy acquisition costs amortized to expense were $454.8 million for 2008, $460.2 million for 2007, and $443.3 million for 2006, and $400.6 million for 2005.2006.
(j)(k) Goodwill
Goodwill results from business acquisitions where the cost of assets/liabilities acquired exceeds the fair value of those assets/liabilities. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that goodwill may be impaired. Goodwill is allocated to the reporting units for the purposes of the impairment test. Selective did not record any impairments during 2007, 2006 or 2005.

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(k)(l) Reserves for Losses and Loss Expenses
Reserves for losses and loss expenses are made up of both case reserves and reserves for claims incurred but not yet reported (“IBNR”). Case reserves result from claims that have been reported to theour seven insurance subsidiaries (the “Insurance Subsidiaries”) and are estimated at the amount of ultimate payment. IBNR reserves are established based on generally accepted actuarial techniques. Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting future events. In applying generally accepted actuarial techniques, Selectivewe also considersconsider a range of possible loss and loss adjustment expense reserves in establishing IBNR.
The internal assumptions considered by Selectiveus in the estimation of the IBNR amounts for both environmental and non-environmental reserves at Selective’sour reporting dates are based on: (i) an analysis of both paid and incurred loss and loss expense development trends; (ii) an analysis of both paid and incurred claim count development trends; (iii) the exposure estimates for reported claims; (iv) recent development on exposure estimates with respect to individual large claims and the aggregate of all claims; (v) the rate at which new environmental claims are being reported; and (vi) patterns of events observed by claims personnel or reported to them by defense counsel. External factors identified by Selectiveus in the estimation of IBNR for both environmental and non-environmental IBNR reserves include: (i) legislative enactments; (ii) judicial decisions; (iii) legal developments in the determination of liability and the imposition of damages; and (iv) trends in general economic conditions, including the effects of inflation. Adjustments to IBNR are made periodically to take into account changes in the volume of business written, claims frequency and severity, the mix of business, claims processing, and other items that are expected by management to affect Selective’sour reserves for losses and loss expenses over time.
By using both individual estimates of reported claims and generally accepted actuarial reserving techniques, Selective estimateswe estimate the ultimate net liability for losses and loss expenses. While the ultimate actual liability may be higher or lower than reserves established, Selective believeswe believe the reserves to be adequate. Any changes in the liability estimate may be material to the results of operations in future periods. Selective doesWe do not discount to present value that portion of itsour loss reserves expected to be paid in future periods; however, theour loss reserves include anticipated recoveries for salvage and subrogation claims.
Reserves are reviewed for adequacy on a periodic basis. As part of the periodic review, Selective considerswe consider the range of possible loss and loss expense reserves, determined at the beginning of the year, in evaluating reserve adequacy. When reviewing reserves, Selective analyzeswe analyze historical data and estimatesestimate the impact of various factors such as: (i) per claim information; (ii) Selectiveour and industrythe industry’s historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the imposition of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. ThereHowever, there is no precise method however, for subsequently evaluating the impact of any specific factor on the adequacy of reserves because the eventual deficiency or redundancy is affected by many factors. Based upon such reviews, Selective believeswe believe that the estimated reserves for losses and loss expenses are adequate to cover the ultimate cost of claims. The changes in these estimates, resulting from the continuous review process and the differences between estimates and ultimate payments, are reflected in the consolidated statements of income for the period in which such estimates are changed.

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(l)
(m) Revenue Recognition
Selective’s seven insurance subsidiaries’The Insurance Subsidiaries’ net premiums written include direct insurance policy writings plus reinsurance assumed and estimates of premiums earned but unbilled on the workers compensation and general liability lines of insurance, less reinsurance ceded. Premiums written are recognized as revenue over the period that coverage is provided using the semi-monthly pro-rata method. Unearned premiums and prepaid reinsurance premiums represent that portion of premiums written that are applicable to the unexpired terms of policies in force.
Selective HR Solutions (“Selective HR”), our human resource administration outsourcing operation,operations, reports revenues on a net basis for the amount billed to clients for worksite employee salaries, wages and certain payroll-related taxes less amounts paid to worksite employees and taxing authorities for these salaries, wages and taxes. All feesFees that have the potential for a margin are included in revenue on a gross basis and all amounts that have no margin but are simply pass through amounts collected from the client and passed on to the employee or appropriate taxing authorities are presented on a net basis. Specifically, gross wages, Federal Insurance Contributions Act (“FICA”) tax and Federal Unemployment Tax (“FUTA”) are included on a net basis whereas administration fees, state unemployment taxes, health fees and workers compensation fees are included on a gross basis. Selective HR accounts for its revenues using the accrual method of accounting. Under the accrual method of accounting, Selective HR recognizes its revenues ratably over the payroll period as worksite employees perform their services at the clients’ worksites.

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(m)(n) Dividends to Policyholders
Selective establishesWe establish reserves for dividends to policyholders on certain policies, most significantly workers compensation policies. These dividends are based on the policyholders’ loss experience. The dividend reserves are established based on past experience, adjusted for the effects of current developments and anticipated trends. The expense for these dividends is recognized over a period that begins at policy inception and ends with the payment of the dividend. Selective doesWe do not issue policies that entitle the policyholder to participate in the earnings or surplus of the Insurance Subsidiaries.
(n)(o) Federal Income Tax
Selective usesWe use the asset and liability method of accounting for income taxes. Deferred federal income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax basis of Selective’s assets and liabilities. A valuation allowance is established when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period of enactment.
(o)(p) Cash and Cash Equivalents
Cash and cash equivalents are comprised of cash and certain money market accounts that are used as part of the Company’sour daily cash management.
(p)(q) Leases
Selective hasWe have various operating leases for office space and equipment. Rental expense for such leases is recorded on a straight-line basis over the lease term. If a lease has a fixed and determinable escalation clause, or periods of rent holidays, the difference between rental expense and rent paid is included in “Other liabilities” as deferred rent in the Consolidated Balance Sheets.
Note 3 Adoption of Accounting Pronouncements
On January 1, 2007, Selective adopted Financial Accounting Standards No. 155,Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140(“FAS 155”). Under the guidance contained in FAS 155, companies are required to evaluate interests in securitized financial assets to identify whether such interests are freestanding derivatives or hybrid financial instruments that contain an embedded derivative. During the fourth quarter of 2006, the Financial Accounting Standards Board (“FASB”) recommended a narrow scope exception for securitized interests if: (i) the securitized interest itself has no embedded derivative (including interest rate related derivatives) that would be required to be accounted for separately other than an embedded derivative that results solely from the embedded call options in the underlying financial assets; and (ii) the investor does not control the right to accelerate the settlement. The adoption of FAS 155 did not have a material impact on the results of operations or financial condition of Selective during 2007.
On January 1, 2007, Selective adopted the provisions of FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109(“FIN 48”). FIN 48 calls for a two-step process to evaluate tax positions based on the recognition, derecognition, and measurement of benefits related to income taxes. The process begins with an initial assessment of whether a tax position, based on its technical merits and applicability to the facts and circumstances, will “more-likely-than-not” be sustained upon examination, including related appeals or litigation. The “more-likely-than-not” threshold is defined as having greater than a 50% chance of being realized upon settlement. Tax positions that are “more-likely-than-not” sustainable are then measured to determine how much of the benefit should be recorded in the financial statements. This determination is made by considering the probabilities of the amounts that could be realized upon effective settlement. Each tax position is evaluated individually and must continue to meet the threshold in each subsequent reporting period or the benefit will be derecognized. A position that initially failed to meet the “more-likely-than-not” threshold should be recognized in a subsequent period if: (i) a change in facts and circumstances results in the position’s ability to meet the threshold; (ii) the issue is settled with the taxing authority; or (iii) the statute of limitations expires. Selective has analyzed its tax positions in all federal and state jurisdictions in which it is required to file income tax returns for all open tax years. The open tax years for the federal returns are 2003 though 2006. The Internal Revenue Service completed a limited scope examination of tax year 2003 and 2004 that resulted in a favorable adjustment of $1.1 million. Selective did not have any unrecognized tax benefits as of January 1, 2007. Selective believes its tax positions will be sustained on audit and does not anticipate any adjustments that will result in a material change to its financial position. As a result, there was no material change in Selective’s liability for unrecognized tax benefits.

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In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157,Fair Value Measurements(“FAS 157”). FAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosure about fair value measurements. It applies to other pronouncements that require or permit fair value, however, it does not require any new fair value measurements. FAS 157 is effective for fiscal years beginning after November 15, 2007. Selective will apply FAS 157 to its invested assets portfolio beginning in the first quarter of 2008. This application will require the Company to classify the fair values of its investments into three different categories, each of which requires varying levels of disclosure in the financial statements beginning in the first quarter of 2008. The adoption of this statement is not expected to have a material impact on Selective’s results of operations or financial condition.
In February 2007, the FASB issued Financial Accounting Standards No. 159,The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115(“FAS 159”), which provides companies with an option to report selected financial assets and liabilities at fair value (“fair value option”). FAS 159 requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of a company’s choice to use fair value on its earnings. FAS 159 also requires companies to display the fair value of those assets and liabilities for which a company has chosen to use fair value on the face of the balance sheet. Selective adopted FAS 159 on January 1, 2008 and has made the fair value option election as it relates to a portfolio of equity securities currently being managed by one outside manager. The impact of making this election is not expected to be material to the Consolidated Financial Statements.
In June 2007, the Emerging Issues Task Force (“EITF”) of the FASBFinancial Accounting Standards Board (“FASB”) issued EITF Issue No. 06-11,Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards(“EITF 06-11”). EITF 06-11 requires that the tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity classified nonvested equity shares, nonvested equity share units, and outstanding equity share options be recognized as an increase to additional paid-in capital. This EITF is06-11 was effective on a prospective basis beginning with dividends declared in fiscal years beginning after December 15, 2007.2007, and we adopted it in the first quarter of 2008. The adoption of this EITF is06-11 did not expected to have a material impact on Selective’sour results of operations or financial condition.
In May 2008, FASB issued Statement of Financial Accounting Standards No. 162,The Hierarchy of Generally Accepted Accounting Principles,(“FAS 162”) which identifies the sources of generally accepted accounting principles and provides a framework, or hierarchy, for selecting the principles to be used in preparing U.S. GAAP financial statements for non-governmental entities. FAS 162 makes the GAAP hierarchy explicitly and directly applicable to preparers of financial statements, a step that recognizes preparers’ responsibilities for selecting the accounting principles for their financial statements. The hierarchy of authoritative accounting guidance did not change current practice but has assisted in facilitating the FASB’s plan to designate as authoritative its forthcoming codification of accounting standards. FAS 162 was effective November 15, 2008 and did not have an impact on our existing accounting policies.

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In May 2008, the FASB issued Statement of Financial Accounting Standards No. 163,Accounting for Financial Guarantee Insurance Contracts — an interpretation of FASB Statement No. 60(“FAS 163”). FAS 163 applies to financial guarantee insurance and reinsurance contracts that are: (i) issued by enterprises that are included within the scope of FASB Statement of Financial Accounting Standards No. 60,Accounting and Reporting by Insurance Enterprises(“FAS 60”); and (ii) not accounted for as derivative instruments. FAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The adoption of FAS 163 is not expected to have an impact on our results of operations or financial condition.
In May 2008, the FASB issued FSP No. APB 14-1,Accounting for Convertible Debt Instruments that may be Settled in Cash upon Conversion (Including Partial Cash Settlement)(“FSP 14-1”). FSP 14-1 applies to convertible debt instruments that, by their stated terms, may be completely or partially settled in cash (or other assets) upon conversion, unless the embedded conversion option is required to be separately accounted for as a derivative under FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities. FSP 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. We are currently evaluating the applicability of FSP 14-1 to our operations.
In June 2008, the FASB issued FSP No. EITF 03-6-1,Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities(“FSP 03-6-1”). FSP 03-6-1 addresses the treatment of unvested share-based payment awards containing nonforfeitable rights to dividends or dividend equivalents in the calculation of earnings per share and is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. We are currently evaluating the impact of FSP 03-6-1 on our calculation of earnings per share.
In December 2008, the FASB issued FSP FAS 132(R)-1 (“FSP FAS 132(R)-1”) which amends FASB Statement No. 132 (revised 2003),Employers’ Disclosures about Pensions and Other Post-retirement Benefits, to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. The FSP requires employers of public and nonpublic entities to disclose more information about the following:
•How investment allocation decisions are made (including investment policies and strategies, as well as the company’s strategy for funding the benefit obligations);
•The major categories of plan assets, including cash and cash equivalents; equity securities (segregated by industry type, company size, or investment objective); debt securities (segregated by those issued by national, state, and local governments); corporate debt securities; asset-backed securities; structured debt; derivatives (segregated by the type of underlying risk in the contract); investment funds (segregated by type of fund); and real estate;
•Fair-value measurements, and the fair-value techniques and inputs used to measure plan assets similar to the requirements set forth under FAS 157 (i.e.: Level 1, 2 & 3); and
•Significant concentrations of risk within plan assets.
The disclosure requirements are effective for years ending after December 15, 2009.
In January 2009, FASB issued FASB Staff Position (“FSP”) EITF 99-20-1 (“FSP 99-20-1��) which amends the other-than-temporary impairment guidance in EITF Issue No. 99-20,Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets, (“EITF 99-20”) to be consistent with that contained in Statement of Financial Accounting Standards No. 115,Accounting for Certain Investments in Debt and Equity Securities(“FAS 115”). Under the previously existing guidance in EITF 99-20, a company was required to use market participant assumptions about future cash flows. This requirement could not be overcome by management’s judgment as to the probability of collecting all projected cash flows. On the contrary, FAS 115 does not require exclusive reliance on market participant assumptions about future cash flows and instead management is permitted to use reasonable judgment when considering the probability of collection of all future cash flows due in determining whether an OTTI charge exists. FSP 99-20-1, which was effective for reporting periods ending after December 15, 2008, did not have a material impact on our operations.

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Note 4 Investments
(a) Net unrealized (losses) gains on investments included in other comprehensive income by asset class at December 31, are as follows:
                        
(in thousands) 2007 2006 2005 
($ in thousands) 2008 2007 2006 
Fixed maturity securities $23,634 20,216 26,290  $(89,068) 23,634 20,216 
Equity securities 114,315 149,512 152,717   (3,370) 114,315 149,512 
Other investments 6,758 6,193 2,717   (1,478) 6,758 6,193 
              
Total net unrealized gains 144,707 175,921 181,724 
Deferred income tax expense  (50,647)  (61,572)  (63,603)
Total net unrealized (losses) gains  (93,916) 144,707 175,921 
Deferred income tax benefit (expense) 32,871  (50,647)  (61,572)
Cumulative effect adjustment due to adoption of FAS 159, net of tax 6,210 — — 
              
Net unrealized gains, net of deferred income tax $94,060 114,349 118,121 
Net unrealized (losses) gains, net of deferred income tax $(54,835) 94,060 114,349 
              
Decrease in net unrealized gains, net of deferred income tax expense $(20,289)  (3,772)  (36,415) $(148,895)  (20,289)  (3,772)
              
(b) The amortized cost, estimated fair values, and unrealized gains (losses) of held-to-maturity fixed maturity securities at December 31, 20072008 and 2006,2007, respectively, were as follows:
2007
                 
2008 Amortized  Unrealized  Unrealized  Fair 
($ in thousands) Cost  Gains  Losses  Value 
Obligations of states and political subdivisions $1,146   71   (58)  1,159 
Mortgage-backed securities  17   2   —   19 
             
Total held-to-maturity fixed maturity securities $1,163   73   (58)  1,178 
             
                                
 Amortized Unrealized Unrealized Fair 
(in thousands) Cost Gains Losses Value 
2007 Amortized Unrealized Unrealized Fair 
($ in thousands) Cost Gains Losses Value 
Obligations of states and political subdivisions $5,759 143 — 5,902  $5,759 143 — 5,902 
Mortgage-backed securities 24 1 — 25  24 1 — 25 
                  
Total held-to-maturity fixed maturity securities $5,783 144 — 5,927  $5,783 144 — 5,927 
                  
2006
                 
 Amortized  Unrealized  Unrealized  Fair 
(in thousands) Cost  Gains  Losses  Value 
Obligations of states and political subdivisions $9,792   250   —   10,042 
Mortgage-backed securities  30   1   —   31 
             
Total held-to-maturity fixed maturity securities $9,822   251   —   10,073 
             

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(c) The cost/amortized cost, estimated fair values, and unrealized gains (losses) of available-for-sale securities at December 31, 20072008 and 2006,2007, respectively, were as follows:
2007
                 
  Cost/          
2008 Amortized  Unrealized  Unrealized  Fair 
($ in thousands) Cost  Gains  Losses  Value 
U.S. government and government agencies1
 $235,540   16,611   —   252,151 
Obligations of states and political subdivisions  1,739,349   38,863   (20,247)  1,757,965 
Corporate securities  389,386   7,277   (30,127)  366,536 
Asset-backed securities  76,758   6   (15,346)  61,418 
Mortgage-backed securities  682,313   8,332   (94,437)  596,208 
             
Available-for-sale fixed maturity securities  3,123,346   71,089   (160,157)  3,034,278 
Available-for-sale equity securities  125,947   24,845   (18,661)  132,131 
             
Total available-for-sale securities $3,249,293   95,934   (178,818)  3,166,409 
             
                                
 Cost/     Cost/       
 Amortized Unrealized Unrealized Fair 
(in thousands) Cost Gains Losses Value 
U.S. government and government agencies $172,795 7,365  (448) 179,712 
2007 Amortized Unrealized Unrealized Fair 
($ in thousands) Cost Gains Losses Value 
U.S. government and government agencies1
 $156,605 7,092  (397) 163,300 
Obligations of states and political subdivisions 1,593,587 21,274  (3,646) 1,611,215  1,593,587 21,274  (3,646) 1,611,215 
Corporate securities 479,169 10,923  (3,017) 487,075  479,169 10,923  (3,017) 487,075 
Asset-backed securities 99,184 698  (2,197) 97,685  117,029 395  (2,796) 114,628 
Mortgage-backed securities 705,178 8,685  (16,003) 697,860  703,523 9,261  (15,455) 697,329 
                  
Available-for-sale fixed maturity securities 3,049,913 48,945  (25,311) 3,073,547  3,049,913 48,945  (25,311) 3,073,547 
Available-for-sale equity securities 160,390 115,742  (1,427) 274,705  160,390 115,742  (1,427) 274,705 
                  
Total available-for-sale securities $3,210,303 164,687  (26,738) 3,348,252  $3,210,303 164,687  (26,738) 3,348,252 
                  
2006
1U.S. government includes corporate securities fully guaranteed by the Federal Deposit Insurance Corporation (“FDIC”).

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  Cost/       
  Amortized  Unrealized  Unrealized  Fair 
(in thousands) Cost  Gains  Losses  Value 
U.S. government and government agencies $195,725   4,379   (794)  199,310 
Obligations of states and political subdivisions  1,736,865   14,488   (7,704)  1,743,649 
Corporate securities  295,964   6,676   (1,059)  301,581 
Asset-backed securities  50,319   205   (103)  50,421 
Mortgage-backed securities  638,011   7,011   (2,883)  642,139 
             
Available-for-sale fixed maturity securities  2,916,884   32,759   (12,543)  2,937,100 
Available-for-sale equity securities  157,864   149,895   (383)  307,376 
             
Total available-for-sale securities $3,074,748   182,654   (12,926)  3,244,476 
             
(d) The following tables summarize, for all securities in an unrealized loss position at December 31, 20072008 and December 31, 2006,2007, the aggregate fair value and gross pre-tax unrealized loss recorded in Selective’s accumulated other comprehensive income,our AOCI by asset class and by length of time those securities have been in an unrealized loss position:
2007
                         
  Less than 12 months  12 months or longer  Total 
2008 Fair  Unrealized  Fair  Unrealized  Fair  Unrealized 
($ in thousands) Value  Losses  Value  Losses  Value  Losses 
U.S. government and government agencies $—   —   —   —   —   — 
Obligations of states and political subdivisions  354,615   (11,565)  128,130   (8,682)  482,745   (20,247)
Corporate securities  162,339   (20,109)  30,087   (10,018)  192,426   (30,127)
Asset-backed securities  42,142   (7,769)  15,336   (7,577)  57,478   (15,346)
Agency mortgage-backed securities  2,910   (8)  6,092   (1,241)  9,002   (1,249)
Non-agency mortgage-backed securities  178,235   (28,095)  90,937   (65,093)  269,172   (93,188)
                   
Total fixed maturity securities  740,241   (67,546)  270,582   (92,611)  1,010,823   (160,157)
Equity securities  61,147   (18,661)  —   —   61,147   (18,661)
Other investments  4,528   (1,478)  —   —   4,528   (1,478)
                   
Total securities in a temporary unrealized loss position $805,916   (87,685)  270,582   (92,611)  1,076,498   (180,296)
                   
                                                
 Less than 12 months 12 months or longer Total  Less than 12 months 12 months or longer Total 
 Fair Unrealized Fair Unrealized Fair Unrealized 
(in thousands) Value Losses Value Losses Value Losses 
2007 Fair Unrealized Fair Unrealized Fair Unrealized 
($ in thousands) Value Losses Value Losses Value Losses 
U.S. government and government agencies $10,816  (53) 10,028  (395) 20,844  (448) $3,461  (1) 10,028  (396) 13,489  (397)
Obligations of states and political subdivisions 73,136  (651) 225,766  (2,995) 298,902  (3,646) 73,136  (651) 225,766  (2,995) 298,902  (3,646)
Corporate securities 82,599  (2,843) 12,303  (174) 94,902  (3,017) 82,599  (2,843) 12,303  (174) 94,902  (3,017)
Asset-backed securities 37,696  (2,181) 3,484  (16) 41,180  (2,197) 55,222  (2,656) 13,205  (140) 68,427  (2,796)
Mortgage-backed securities 201,505  (13,895) 90,919  (2,108) 292,424  (16,003)
Agency mortgage-backed securities 31,176  (374) 23,916  (110) 55,092  (484)
Non-agency mortgage-backed securities 160,158  (13,098) 57,282  (1,873) 217,440  (14,971)
                          
Total fixed maturity securities 405,752  (19,623) 342,500  (5,688) 748,252  (25,311) 405,752  (19,623) 342,500  (5,688) 748,252  (25,311)
Equity securities 26,780  (1,427) — — 26,780  (1,427) 26,780  (1,427) — — 26,780  (1,427)
             
Total securities in a temporary unrealized loss position $432,532  (21,050) 342,500  (5,688) 775,032  (26,738) $432,532  (21,050) 342,500  (5,688) 775,032  (26,738)
                          
2006
                         
  Less than 12 months  12 months or longer  Total 
  Fair  Unrealized  Fair  Unrealized  Fair  Unrealized 
(in thousands) Value  Losses  Value  Losses  Value  Losses 
U.S. government and government agencies $43,873   (108)  46,264   (686)  90,137   (794)
Obligations of states and political subdivisions  320,851   (1,623)  455,970   (6,081)  776,821   (7,704)
Corporate securities  45,694   (279)  29,965   (780)  75,659   (1,059)
Asset-backed securities  9,863   (29)  3,425   (74)  13,288   (103)
Mortgage-backed securities  63,954   (380)  170,171   (2,503)  234,125   (2,883)
                   
Total fixed maturity securities  484,235   (2,419)  705,795   (10,124)  1,190,030   (12,543)
Equity securities  7,763   (223)  374   (160)  8,137   (383)
Other investments  6,913   (87)  —   —   6,913   (87)
                   
Total securities in a temporary unrealized loss position $498,911   (2,729)  706,169   (10,284)  1,205,080   (13,013)
                   

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Unrealized losses for fixed maturity securities, equities, and other investments increased in 2008 as compared to 2007, primarily due to the volatile nature of the securities marketplace driven by the credit stress and resulting widening credit spreads, the dislocation in the capital markets, and inflation concerns. An atmosphere of economic uncertainty was created by declines in residential home values, the sharp sell off in the equity markets, reduced consumer spending, and increased unemployment rates. Our investment portfolio was adversely affected by these events, which included decreased market liquidity for certain invested assets, increased credit risk with respect to the type of securities held in our portfolio, and the corresponding widening of credit spreads with respect to our invested assets. These effects were evidenced by an increase in unrealized losses of $153.6 million as compared to the prior year. At December 31, 2008, we held 355 fixed maturity securities, 45 equity securities, and one other investment security in an unrealized loss position. At December 31, 2007, Selectivewe held (i) 231 fixed maturity securities with a fair value of $748.3 million in an unrealized loss position of $25.3 million; (ii) 9and nine equity securities in an unrealized loss position, with a fair value of $26.8 million and an unrealized loss of $1.4 million. Of these 240positions.
We have reviewed the securities 10 had fair values less than 85% of their cost basis. The remaining 230 securities had fair values between 86% and 99% of their cost basis. Selective believes the decline in the fair valuetable above in accordance with our OTTI policy, which is discussed in Note 2, “Summary of allSignificant Accounting Policies,” above. The overall S&P credit quality rating of our fixed maturity securities is “AA+” and these securities are performing according to be temporary.their contractual terms. The assessment of whether a decline in value is temporary includes Selective’sour current judgment as to the financial position and future prospects of the entity that issued the investment security. Broad changes in the overall market or interest rate environment generally will not lead to a write-down, provided that management has the ability and intent to hold a security to maturity. If Selective’sour judgment about an individual security changes in the future, Selectivewe may ultimately record a realized loss after having originally concluded that the decline in value was temporary, which could have a material impact on Selective’sour net income and financial position in future periods. Currently, except for securities for which an impairment loss has been recognized, Selective haswe have the ability and intent to hold all securities in an unrealized loss position until their anticipated recovery.

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Although overall interest rates decreased
In performing our OTTI impairment analysis for asset-backed, agency mortgage-backed, and non-agency mortgage backed securities, which in 2007,total were in an unrealized loss position of $109.8 million at December 31, 2008, we estimated future cash flows for each security based upon our best estimate of future delinquencies, loss severity, and prepayments. The resulting cash flows were reviewed to determine whether we anticipate receiving all of the unrealizedoriginally scheduled cash flows. Projected credit losses for fixed maturity securities increased due primarilywere compared to the current level of credit stressenhancement to determine whether the security is expected to experience losses during any future period and dislocationtherefore become other-than-temporarily impaired. Based on this cash flow testing, we have determined that the decline in fair value of these structured securities presented in the capital markets, along with inflation worriestable above is not attributable to credit quality, but to a significant widening of interest rate spreads across market sectors related to the continued illiquidity and uncertainty aboutof the U.S. economy in general caused fixed maturities credit spreadsmarkets. As we have the ability and intent to widen. Athold these investments until a fair value recovery or until maturity, we do not consider these securities to be other-than-temporarily impaired as of December 31, 2007, there were 2402008. It is possible that the underlying loan collateral of these securities will perform at a level worse than our expectations, which may lead to adverse changes in cash flows on these securities and potential future other-than-temporary impairment losses. Events that may trigger material declines in fair values for these securities include, but are not limited to, the deterioration of credit metrics, significantly higher levels of default and severity of losses on the underlying collateral, or further illiquidity.
In performing our OTTI analysis for corporate debt securities, we analyzed the general market condition of each industry, particularly the financial services sector, as well as the geographic area of the issuer given the current economic environment. In addition, we look for evidence of significant deterioration in the issuer’s credit worthiness. We have determined that the decline in fair value of $30.1 million of corporate securities in an unrealized loss position. Broad changes inposition at December 31, 2008 to be attributed to the overallcurrent volatile market conditions and not to the creditworthiness of any individual issuer. We have the ability and intent to hold these securities until a fair value recovery or interest rate environment generallyuntil maturity and do not leadconsider these securities to impairment charges. During 2007 Selective recorded an other than temporary impairment charge associated with two commercial real estate collateralized debt obligations (“CDO”) for $4.9 million. During the second half of 2007, the market for lower-rated commercial mortgage-backedbe other-than-temporarily-impaired.
The following table presents information regarding securities (“CMBS”) saw severe contagion effects from the sub-prime mortgage crisis. CMBS spreads, particularly subordinated tranche CMBS, widened dramatically over the course of the second half of the year. As a result, CDOs in general have become extremely dislocated and difficult to value as the market spreads between bid and ask prices are very wide, even for CDOs that do not have any sub-prime asset backed exposure. At this time, there have been no credit defaults or rating downgrades on CDOs in our portfolio. However, givenportfolio with the severe lackfive largest unrealized balances as of liquidity currently being experienced in the marketplace, it is difficult to value certain securities and, as a result, we recorded an other than temporary impairment charge on two commercial real estate CDOs in 2007. During 2006, Selective had not recognized any realized losses from other than temporary charges, whereas during 2005 Selective had recorded $1.2 million in realized losses related to other than temporary charges.December 31, 2008:
             
  Cost/       
2008 Amortized  Fair  Unrealized 
($ in thousands) Cost  Value  Losses 
Countrywide Home Loans $10,078   2,096   (7,982)
Banc of America Alternative Loan  9,657   3,516   (6,141)
TBW Mortgage Backed Pass Through  9,996   4,122   (5,874)
GS Mortgage Securities Corp II  9,620   4,378   (5,242)
JP Morgan Alternative Loan  11,496   6,424   (5,072)
(e) The amortized cost and estimated fair value of fixed maturity securities at December 31, 2007,2008, by contractual maturity are shown below. Mortgage-backed securities are included in the maturity tables using the estimated average life of each security. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Listed below are held-to-maturity fixed maturity securities:
                
(in thousands) Amortized Cost Fair Value 
($ in thousands) Amortized Cost Fair Value 
Due in one year or less $4,391 4,455  $960 902 
Due after one year through five years 1,049 1,056  17 19 
Due after five years through ten years 343 416  186 257 
          
Total held-to-maturity fixed maturity securities $5,783 5,927  $1,163 1,178 
          
Listed below are available-for-sale fixed maturity securities:
                
(in thousands) Amortized Cost Fair Value 
($ in thousands) Amortized Cost Fair Value 
Due in one year or less $252,754 252,595  $307,101 298,473 
Due after one year through five years 1,409,716 1,423,983  1,550,191 1,508,154 
Due after five years through ten years 1,238,010 1,249,664  1,164,534 1,147,842 
Due after ten years through fifteen years 98,609 97,592  71,400 66,681 
Due after fifteen years 50,824 49,713  30,120 13,128 
          
Total available-for-sale fixed maturity securities $3,049,913 3,073,547  $3,123,346 3,034,278 
          
(f) Certain investments were on deposit with various state regulatory agencies to comply with insurance laws and had carryingfair values of $26.8 million as of December 31, 2008 and $26.0 million as of December 31, 2007 and $25.3 million as of December 31, 2006.2007.

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(g) Selective isWe are not exposed to significant concentrations of credit risk within itsour investment portfolio. The largest investment in the securities of any one issuer was $26.0 million at December 31, 2008 and $16.0 million at December 31, 20072007. In addition, the sector exposure of our available-for-sale fixed maturity securities breaks down as follows: (i) 58% in state and $19.3 million at December 31, 2006.municipal obligations; (ii) 12% in corporate securities, 28% of which are in the financial services industry sector; (iii) 12% in residential-mortgage-backed securities RMBS; (iv) 8% in U.S. government obligations; (v) 8% in commercial-mortgage-backed securities CMBS; and (vi) 2% in asset-backed securities ABS.

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(h) Other investments include the following at December 31:
                
(in thousands) 2007 2006 
($ in thousands) 2008 2007 
Alternative investments $156,618 93,880  $165,017 156,618 
Other securities 32,209 50,905  7,040 32,209 
          
Total other investments $188,827 144,785  $172,057 188,827 
          
The decrease of other investments of $16.8 million for 2008 compared to 2007 was primarily due to the decrease of $25.2 million in other securities resulting from the sale of one international investment fund for $11.5 million and another large capital growth fund for $5.0 million. We sold these securities to reduce our equity exposure in the current volatile market. Additionally, the decrease in the fair value of our other securities led to a reduction in the carrying value of these securities.
Our alternative investment portfolio of $165.0 million in 2008 primarily utilizes six different strategies consisting of $56.9 million in private equity, $29.8 million in distressed debt, $24.1 million in secondary private equity, $23.4 million in real estate, $23.1 million in mezzanine financing, and $5.9 in venture capital. At December 31, 2007, Selective has2008, we have contractual obligations that expire at various dates through 20222023 to further invest up to $129.8$119.5 million in alternative investments. There is no certainty that any such additional investment will be required.
(i) The components of net investment income earned were as follows:
                        
(in thousands) 2007 2006 2005 
($ in thousands) 2008 2007 2006 
Fixed maturity securities $140,383 128,771 117,987  $146,555 140,383 128,771 
Equity securities 8,626 9,898 8,873 
Equity securities, dividend income 5,603 8,626 9,898 
Trading securities, change in fair value  (8,129) — — 
Short-term investments 8,563 7,806 2,749  4,252 8,563 7,806 
Other investments 21,828 13,746 8,579   (12,336) 21,828 13,746 
              
 179,400 160,221 138,188  135,945 179,400 160,221 
Investment expenses  (5,256)  (3,419)  (2,238)  (4,913)  (5,256)  (3,419)
              
Net investment income earned $174,144 156,802 135,950  $131,032 174,144 156,802 
              
The decrease in net investment income, before tax, of $43.1 million for 2008 compared to 2007 was due to: (i) decreased returns of $31.9 million on the alternative investment portion of our other investments portfolio; and (ii) $8.1 million of reductions in the fair value of our equity trading portfolio due to the sell off in the equity markets, as well as the collapse in commodity prices in 2008.
The general volatility in the capital markets, the dislocation of the credit markets, and reduced asset values globally has resulted in a negative return for our alternative investments, which primarily consist of investments in limited partnerships, during 2008. In addition, the majority of these limited partnerships adopted FAS 157 during 2008; the result of which we believe has led to increased volatility in the period to period changes in the fair values associated with the underlying assets of these partnerships as fair values are now based on current exit values. As we account for these investments under the equity method of accounting, any changes in the valuation of these limited partnerships are reflected in net investment income as opposed to other comprehensive income.
Due to the current market turmoil, there is uncertainty regarding reduced investment income in the future as a result of, among other things, falling interest rates, decreased dividend payment rates, or reduced returns on our other investments, including our portfolio of alternative investments, which are reported on a one-quarter lag.

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(j) The components of net realized (losses) gains (losses) were as follows:
                        
(in thousands) 2007 2006 2005  2008 2007 2006 
Held-to-maturity fixed maturity securities  
Gains $— 16 106  $27 — 16 
Losses  (2) — — 
Available-for-sale fixed maturity securities  
Gains 445 2,460 1,468  1,777 445 2,460 
Losses  (7,150)  (6,756)  (4,196)  (55,961)  (7,150)  (6,756)
Available-for-sale equity securities  
Gains 50,254 43,542 21,149  34,582 50,254 43,542 
Losses  (9,359)  (3,783)  (4,063)  (21,290)  (9,359)  (3,783)
Available-for-sale other investments 
Other investments 
Gains 847 — —  1,356 847 — 
Losses  (1,683) — —   (9,941)  (1,683) — 
              
Total net realized gains $33,354 35,479 14,464 
Total net realized (losses) gains $(49,452) 33,354 35,479 
              
Proceeds from the sale of available-for-saleavailable for sale securities and other investments were $255.0 million during 2008, $289.9 million during 2007, and $414.4 million during 2006,2006. The shift from realized gains of $33.4 million in 2007 to realized losses of $49.5 million in 2008 is due primarily to OTTI. An investment in a fixed maturity or equity security, that is available for sale and $235.8 millionreported at fair value, is impaired if its fair value falls below its book value and the decline is considered to be other than temporary. In addition, during 2005. There was $4.9 million2008, we sold certain fixed maturity securities that were in an unrealized loss position immediately prior to their sale. These sales resulted from our financial and tax planning strategies. Furthermore, in the early portion of 2008 we also took steps to limit our overall portfolio volatility by reducing our equity position by approximately $50 million.
Increases in realized losses of our available for sale fixed maturity securities of $48.8 million was primarily due to non-cash OTTI charges of $41.7 million for 2008 which consisted of:
•$15.1 million of RMBS and CMBS charges. These charges related to declines in the related cash flows of the collateral, based on our assumptions of the expected default rates and the value of the collateral, and accordingly, we do not believe it is probable that we will receive all contractual cash flows.
•$16.4 million of ABS charges. These charges related to issuer-specific credit events that revolved around the performance of the underlying collateral, which had materially deteriorated; however, none of which were bankruptcy related. In general, these securities were experiencing increased conditional default rates and expected loss severities, and as a result, our stress test scenarios were indicating less of a margin to absorb losses going forward. Although some of these securities were insured or guaranteed by monoline bond guarantors, downgrades have reduced our confidence in their ability to perform in the event of default. In addition, credit support for these securities has also begun to erode, thereby further increasing the potential for eventual loss.
•$10.2 million associated with corporate bond charges. These charges were due to issuer-specific events, primarily related to two Icelandic bank debt securities, on which the banks were placed in receivership.
The fixed maturity non-cash OTTI charge for 2007 consisted of $4.9 million associated with two commercial real estate CDOs. These charges were due to the two other than temporary impairment charges mentioned above. There were nosevere contagion effects from the sub-prime mortgage crisis. CMBS spreads, particularly subordinated tranche CMBS, widened dramatically over the course of the second half of 2007. As a result, CDOs in general had become extremely dislocated and difficult to value as the market spreads between bid and ask prices became very wide, even for CDOs that did not have any sub-prime asset backed exposure. During 2006, we did not recognize any realized losses from other than temporary impairment charges in 2006 and there were $1.2 millionOTTI charges.
The increase in realized losses on available for sale equity securities of $11.9 million is primarily due to non-cash OTTI charges of $6.6 million from other than temporary impairmentsix equity securities, including $1.5 million related to an externally managed trading portfolio. These securities were written down due to the fact that we lack the intent to hold these securities through their anticipated recovery period as we do not control day-to-day trading decisions for this portfolio. These charges related to the sharp sell off in 2005.the global equity markets stemming from the mortgage and credit crisis, which led to concerns that both U.S. and global economic growth would slow in the near future.
Other investment realized losses increased $8.3 million primarily due to non-cash OTTI charges of $4.8 million on two alternative investments. These charges were directly related to a security held in their portfolio that had considerable unrealized losses because of the severe volatility in the current financial markets and the dramatic market sell off, specifically in commodity prices. Additionally, we sold one international investment fund which resulted in losses of $2.5 million.

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Note 5 Other Comprehensive (Loss) Income
The components of comprehensive (loss) income, both gross and net of tax, for 2006, 2005,2008, 2007, and 20042006 are as follows:
2007
             
2008         
($ in thousands) Gross  Tax  Net 
Net Income $39,386   (4,372)  43,758 
          
Components of other comprehensive loss:            
Unrealized losses on securities:
            
Unrealized holding losses during the period  (268,993)  (94,148)  (174,845)
Add: Reclassification adjustment for losses included in net income  49,477   17,317   32,160 
Net unrealized losses  (219,516)  (76,831)  (142,685)
Defined benefit pension plans:
            
Net actuarial loss  (60,272)  (21,095)  (39,177)
Prior service credit  1,985   695   1,290 
Reversal of amortization items:            
Net actuarial loss  136   47   89 
Prior service credit  (25)  (9)  (16)
          
Defined benefit pension plans, net  (58,176)  (20,362)  (37,814)
          
Comprehensive loss $(238,306)  (101,565)  (136,741)
          
             
(in thousands) Gross  Tax  Net 
Net Income $192,758   46,260   146,498 
          
Components of other comprehensive income:            
Unrealized gains on securities:
            
Unrealized holding gains during the period  2,140   749   1,391 
Less: Reclassification adjustment for gains included in net income  (33,354)  (11,674)  (21,680)
          
Net unrealized losses  (31,214)  (10,925)  (20,289)
Defined benefit pension plans:
            
Net actuarial gain  8,003   2,801   5,202 
Reversal of amortization items:            
Net actuarial loss  696   244   452 
Prior service cost  118   41   77 
          
Defined benefit pension plans, net  8,817   3,086   5,731 
          
Comprehensive income $170,361   38,421   131,940 
          

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2006
             
2007         
($ in thousands) Gross  Tax  Net 
Net Income $192,758   46,260   146,498 
          
Components of other comprehensive income:            
Unrealized gains on securities:
            
Unrealized holding gains during the period  2,140   749   1,391 
Less: Reclassification adjustment for gains included in net income  (33,354)  (11,674)  (21,680)
Net unrealized losses  (31,214)  (10,925)  (20,289)
Defined benefit pension plans:
            
Net actuarial gain  8,003   2,801   5,202 
Reversal of amortization items:            
Net actuarial loss  696   244   452 
Prior service cost  118   41   77 
          
Defined benefit pension plans, net  8,817   3,086   5,731 
          
Comprehensive income $170,361   38,421   131,940 
          
                        
(in thousands) Gross Tax Net 
2006       
($ in thousands) Gross Tax Net 
Net Income $220,510 56,936 163,574  $220,510 56,936 163,574 
              
Components of other comprehensive income:  
Unrealized gains on securities: 
Unrealized holding gains during the period 29,676 10,387 19,289  29,676 10,387 19,289 
Previous unrealized gains currently realized in net income  (35,479)  (12,418)  (23,061)  (35,479)  (12,418)  (23,061)
              
Net unrealized losses  (5,803)  (2,031)  (3,772) $(5,803)  (2,031)  (3,772)
              
Comprehensive income $214,707 54,905 159,802  214,707 54,905 159,802 
              
2005
             
(in thousands) Gross  Tax  Net 
Net Income $204,386   55,893   148,493 
          
Components of other comprehensive income:            
Unrealized holding gains during the period  (41,666)  (14,583)  (27,083)
Previous unrealized gains currently realized in net income  (14,357)  (5,025)  (9,332)
          
Net unrealized losses  (56,023)  (19,608)  (36,415)
          
Comprehensive income $148,363   36,285   112,078 
          
Note 6 Fair Values of Financial Instruments
On January 1, 2008, we adopted FASB Statement of Financial Accounting Standards No. 159,The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115(“FAS 159”). FAS 159 provides companies with an option to report selected financial assets and liabilities at fair value (“fair value option”). We elected to apply the fair value option to certain securities that were being managed by an external manager at the time of adoption. The securities for which we elected the fair value option were previously held as available-for-sale securities and are now classified as trading securities.

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The following table provides information regarding the reclassification and corresponding cumulative-effect adjustment on retained earnings resulting from the initial application of FAS 159 for this portfolio:
             
  Pre-Adoption  Impact of  Post-Adoption 
  Carrying/Fair  Fair Value  Carrying/Fair 
  Value at  Election  Value at 
($ in thousands) January 1, 2008  Adoption  January 1, 2008 
Equity securities:            
Available-for-sale securities $274,705   (25,113)  249,592 
Trading securities  —   25,113   25,113 
          
Total equity securities $274,705   —   274,705 
          
             
      Accumulated    
      Other    
  Retained  Comprehensive    
($ in thousands) Earnings  Income  Total 
Beginning balance at January 1, 2008 $1,105,946   86,043   1,191,989 
Pre-tax cumulative effect of adoption of fair value option  9,554   (9,554)  — 
Deferred tax impact  (3,344)  3,344   — 
          
Adjusted beginning balance at January 1, 2008 $1,112,156   79,833   1,191,989 
          
The following table presents the carrying amounts and estimated fair values of Selective’sour financial instruments as of December 31, 20072008 and 2006:2007:
                                
 2007 2006  2008 2007 
 Carrying Fair Carrying Fair  Carrying Fair Carrying Fair 
(in thousands) Amount Value Amount Value 
($ in thousands) Amount Value Amount Value 
Financial assets
  
Fixed maturity securities:  
Held-to-maturity $5,783 5,927 9,822 10,073  $1,163 1,178 5,783 5,927 
Available-for-sale 3,073,547 3,073,547 2,937,100 2,937,100  3,034,278 3,034,278 3,073,547 3,073,547 
Equity securities 274,705 274,705 307,376 307,376 
Equity securities: 
Available-for-sale 132,131 132,131 274,705 274,705 
Trading 2,569 2,569 — — 
Short-term investments 190,167 190,167 197,019 197,019  198,111 198,111 190,167 190,167 
Other securities 32,209 32,209 50,905 50,905  7,040 7,040 32,209 32,209 
  
Financial liabilities
  
Notes payable: 
8.63% Senior Notes Series A — — 6,000 6,023 
Notes payable: 1
 
8.87% Senior Notes Series B 36,900 37,990 49,200 49,885  24,600 25,592 36,900 37,990 
7.25% Senior Notes 49,891 52,080 49,887 56,010  49,895 42,221 49,891 52,080 
6.70% Senior Notes 99,360 90,000 99,337 99,455  99,383 72,000 99,360 90,000 
7.50% Junior Notes 100,000 85,000 100,000 102,760  100,000 59,680 100,000 85,000 
                  
Total notes payable 286,151 265,070 304,424 314,133  273,878 199,493 286,151 265,070 
Senior convertible notes 8,740 13,853 57,413 105,727  — — 8,740 13,853 
Convertible subordinated debentures 176 1,143 765 6,190  — — 176 1,143 
1Our notes payable are subject to certain debt covenants which were met in their entirety in 2008 and 2007. For further discussion regarding the debt covenants, refer to Note 9, “Indebtedness.”
Selective’sOur carrying amounts shown in the table are included in the Consolidated Balance Sheets. The convertible subordinated debentures are included in “Other liabilities” on the Consolidated Balance Sheets. Alternative investments are not included in the table above as they are not financial instruments.

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See Note 2(d)2(e) for the methods and assumptions we used by Selective in estimating the fair values of itsour financial instruments. The following table provides quantitative disclosures regarding fair value measurements of our invested assets:

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      Fair Value Measurements at 12/31/08 Using 
      Quoted Prices in  Significant    
  Assets  Active Markets  Other  Significant 
  Measured at  for Identical  Observable  Unobservable 
($ in thousands) Fair Value at  Assets  Inputs  Inputs 
Description 12/31/08  (Level 1)  (Level 2)  (Level 3) 
Trading securities:                
Equity securities $2,569   2,569   —   — 
Available-for-sale securities:                
Fixed maturity securities  3,034,278   94,811   2,939,467   — 
Equity securities  132,131   132,131   —   — 
Short-term investments  198,111   198,111   —   — 
Other investments  7,040   —   7,040   — 
             
Total $3,374,129   427,622   2,946,507   — 
             

Investment income associated with the above invested assets is included in net investment income in the Consolidated Income Statement, including unrealized gains and losses on our trading securities. In 2008, net investment income included $8.1 million of reductions in fair value, respectively, representing the change in market value on our trading securities. The portion of trading losses for the period that relates to the trading securities still held at December 31, 2008 is $2.0 million.
Fair values in the above table were generated using various valuation techniques. For valuations of securities in our equity portfolio and U.S. Treasury notes held in our fixed maturity portfolio, we utilized a market approach, wherein we used quoted prices in an active market for identical assets (i.e., Level 1 prices). The source of our Level 1 prices for these securities was an external pricing service, which we validated against other external pricing sources.
For the majority of our fixed maturity portfolio and several non-publicly traded equity securities, we also utilized a market approach, using primarily matrix pricing prepared by external pricing services. We validate these prices against other external pricing sources in order to determine the fair value of the positions, as well as to determine their placement within the fair value hierarchy (Level , Level 2, or Level 3) as defined in FAS 157.
Note 7 Reinsurance
Selective’sOur consolidated financial statements reflect the effects of assumed and ceded reinsurance transactions. Assumed reinsurance refers to the acceptance of certain insurance risks that other insurance entities have underwritten. Ceded reinsurance involves transferring certain insurance risks (along with the related written and earned premiums) that Selective haswe have underwritten to other insurance companies that agree to share these risks. The primary purpose of ceded reinsurance is to protect Selectiveour company from potential losses in excess of the amount it is prepared to accept.
The Insurance Subsidiaries remain liable to policyholders to the extent that any reinsurer becomes unable to meet itsour contractual obligations. Selective evaluatesWe evaluate and monitorsmonitor the financial condition of itsour reinsurers under voluntary reinsurance arrangements to minimize itsour exposure to significant losses from reinsurer insolvencies. On an ongoing basis, Selective reviewswe review amounts outstanding, length of collection period, changes in reinsurer credit ratings and other relevant factors to determine collectibility of reinsurance recoverables. The allowance for reinsurance recoverables on paid and unpaid losses and loss expenses was $2.5 million at December 31, 2008 and $2.8 million at December 31, 2007 and $3.2 million at December 31, 2006.2007.
A trust fund in the amount of $32.5 million at December 31, 2008 and $31.6 million at December 31, 2007 and $30.4 million at December 31, 2006 securing a portion of the liabilities ceded to Munich Reinsurance America, Inc. is held for the benefit of Selective.our benefit. Amounts ceded to Munich Reinsurance America, Inc., which is rated “A+” by A.M. Best, exceeding the available trust fund, represent 8% or $22.4 million as of December 31, 2008 and 13% or $36.0 million as of December 31, 2007 and 14% or $32.1 million as of December 31, 2006 of Selective’sour consolidated prepaid reinsurance premiums and loss recoverable balances not secured by trust funds, letters of credit or funds withheld (collateral). In addition, approximately 55%62% of Selective’sour consolidated prepaid reinsurance premiums and net reinsurance recoverable balances not secured by collateral are ceded to two state or federally sponsored pools. SelectiveWe ceded $60.7 million as of December 31, 2008 and $64.5 million as of December 31, 2007 and $65.6 million as of December 31, 2006 to New Jersey Unsatisfied Claims Judgment Fund. SelectiveWe also ceded $111.5 million as of December 31, 2008 and $88.0 million as of December 31, 2007 and $78.9 million as of December 31, 2006 to the National Flood Insurance Program (“NFIP”).
Under Selective’sour reinsurance arrangements, which are prospective in nature, reinsurance premiums ceded are recorded as prepaid reinsurance and amortized over the remaining contract period in proportion to the reinsurance protection provided, or recorded periodically, as per the terms of the contract, in a direct relationship to the gross premium recording. Reinsurance recoveries are recognized as gross losses are incurred.

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(in thousands) 2007 2006 2005 
($ in thousands) 2008 2007 2006 
Premiums written:
  
Direct $1,723,083 1,660,177 1,572,180  $1,686,742 1,723,083 1,660,177 
Assumed 29,165 33,916 44,843  22,051 29,165 33,916 
Ceded  (197,381)  (158,132)  (157,549)  (224,752)  (197,381)  (158,132)
              
Net $1,554,867 1,535,961 1,459,474  $1,484,041 1,554,867 1,535,961 
              
  
Premiums earned:
  
Direct $1,671,510 1,619,009 1,523,205  $1,679,105 1,671,510 1,619,009 
Assumed 30,930 36,009 43,464  26,703 30,930 36,009 
Ceded  (185,134)  (155,354)  (148,656)  (210,318)  (185,134)  (155,354)
              
Net $1,517,306 1,499,664 1,418,013  $1,495,490 1,517,306 1,499,664 
              
  
Losses and loss expenses incurred:
  
Direct $1,083,601 1,021,133 1,001,762  $1,112,261 1,083,601 1,021,133 
Assumed 22,595 28,344 38,689  17,852 22,595 28,344 
Ceded  (106,990)  (89,494)  (134,721)  (116,297)  (106,990)  (89,494)
              
Net $999,206 959,983 905,730  $1,013,816 999,206 959,983 
              
Assumed premiums and losses decreased in 2008 compared to 2007 and from 2007 compared to 2006 primarily due to reduction in mandatory and voluntary pool assumptions while assumed losses decreased primarily due to a reduction in mandatory pool assumptions. Ceded writtenpremiums increased in 2008 compared to 2007, primarily due to increases in flood premiums that are 100% ceded to the NFIP. Ceded premiums increased in 2007 compared to 2006 primarily due to increases in flood premiums that are 100% ceded to the NFIP and the termination of the New Jersey Homeowners Property 75% Quota Share Treaty that resulted in a return of premium of $11.3 million in the first quarter of 2006, previously ceded to this treaty and still unearned as of December 31, 2005. IncreaseThe increase in ceded loss and loss adjustment expenses incurred of $17.5$9.3 million in 2007 compared to 2006 is primarily a result of an increase in losses ceded to the NFIP, offset by a decrease in large loss activity from the excess of loss treaties. Ceded loss and loss adjustment expenses incurred increased $17.5 million in 2007 as compared to 2006 primarily as a result of an increase in large loss activity from the excess of loss treaties which was offset by decreases in losses ceded to the NFIP.
The flood ceded premiums and losses are as follows:
                        
(in thousands) 2007 2006 2005 
($ in thousands) 2008 2007 2006 
Ceded premiums written $(143,404)  (120,003)  (93,660) $(166,649)  (143,404)  (120,003)
Ceded premiums earned  (132,041)  (106,214)  (85,276)  (153,883)  (132,041)  (106,214)
Ceded losses and loss expenses incurred  (48,698)  (56,653)  (108,729)  (87,829)  (48,698)  (56,653)
Counter-Party Credit Risk
During 2008, certain reinsurers with whom we do business have: (i) experienced liquidity concerns; or (ii) have been downgraded or placed on ratings review by one or more rating agencies. Some of the reinsurance arrangements that these reinsurers participate in involve upper layers of casualty business (known as “clash layers”) for which historical experience does not exist. Due to the uncertainty associated with casualty business, and specifically losses reaching those clash layers, current reinsurance recoverables from our reinsurers may change materially in the event of a significant loss event well in excess of our historical levels. The ability of our reinsurers to reimburse us for their portion of future losses may become uncertain in the event of significant financial deterioration of these reinsurers.

 

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Note 8 Reserves For Losses and Loss Expenses
The table below provides a roll-forwardroll forward of reserves for losses and loss expenses for beginning and ending reserve balances:
                        
(in thousands) 2007 2006 2005 
($ in thousands) 2008 2007 2006 
Gross reserves for losses and loss expenses, at beginning of year $2,288,770 2,084,049 1,835,217  $2,542,547 2,288,770 2,084,049 
Less: reinsurance recoverable on unpaid loss and loss expenses, at beginning of year 199,738 218,248 218,772  227,801 199,738 218,248 
              
Net reserves for losses and loss expenses, at beginning of year 2,089,032 1,865,801 1,616,445  2,314,746 2,089,032 1,865,801 
              
Incurred losses and loss expenses for claims occurring in the:  
Current year 1,018,050 967,272 900,658  1,033,124 1,018,050 967,272 
Prior years  (18,844)  (7,289) 5,072   (19,308)  (18,844)  (7,289)
              
Total incurred losses and loss expenses 999,206 959,983 905,730  1,013,816 999,206 959,983 
              
Paid losses and loss expenses for claims occurring in the:  
Current year 304,121 268,173 233,969  332,430 304,121 268,173 
Prior years 469,371 468,579 422,405  579,351 469,371 468,579 
              
Total paid losses and loss expenses 773,492 736,752 656,374  911,781 773,492 736,752 
              
Net reserves for losses and loss expenses, at end of year 2,314,746 2,089,032 1,865,801  2,416,781 2,314,746 2,089,032 
Add: Reinsurance recoverable on unpaid loss and loss expenses, at end of year 227,801 199,738 218,248  224,192 227,801 199,738 
              
Gross reserves for losses and loss expenses at end of year $2,542,547 2,288,770 2,084,049  $2,640,973 2,542,547 2,288,770 
              
The net loss and loss expense reserves increased by $102.0 million in 2008, $225.7 million in 2007, and $223.2 million in 2006, and $249.4 million in 2005.2006. The loss reserves include anticipated recoveries for salvage and subrogation claims, which amounted to $55.9 million for 2008, $52.3 million for 2007, and $49.6 million for 2006, and $46.5 million in 2005.2006. The changes in the net loss and loss expense reserves were the result of growth in exposures, anticipated loss trends, changes in reinsurance retentions, as well as normal reserve development inherent in the uncertainty in establishing reserves for losses and loss expenses. As additional information is collected in the loss settlement process, reserves are adjusted accordingly. These adjustments are reflected in the consolidated statements of income in the period in which such adjustments are recognized. These changes could have a material impact on the results of operations of future periods when the adjustments are made.
In 2008, we experienced favorable loss development of $19.3 million, which was primarily driven by favorable loss development in accident years 2002 through 2006 of $54.2 million partially offset by unfavorable loss development in accident year 2007 Selectiveof $26.9 million as well as unfavorable development in accident years 2001 and prior of $8.0 million. The main driver of this development was favorable prior year development in our workers compensation line of business, partially offset by adverse prior year development in the general liability line of business. Workers compensation experienced favorable prior year development of $24 million primarily driven by favorable development in accident years 2004 to 2006 as a result of the implementation of improvement strategies for this line, partially offset by adverse prior year development in accident year 2007. Prior year development for the commercial automobile line of business was only minimally favorable reflecting the leveling off of improvements in severity trends. Partially offsetting the favorable loss development, the general liability line of business experienced adverse prior year development of approximately $3 million reflecting normal volatility in this line of business. The remaining lines of business, which collectively contributed approximately $2 million of adverse development, do not individually reflect any significant trends related to prior year development.

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In 2007, we experienced favorable loss development in accident years 2002 through 2006 of $61.7 million partially offset by unfavorable loss development in accident years 2001 and prior of $42.9 million, netting to total favorable prior year development of $18.8 million. This development was primarily driven by favorable prior year development in Selective’sour commercial automobile, personal automobile, and workers compensation lines of business partially offset by adverse development in itsour homeowners and personal umbrellaexcess lines of business. The commercial automobile line of business experienced favorable prior year loss and loss expense reserve development of approximately $19 million, which was primarily driven by lower than expected severity in accident years 2004 through 2006. The personal automobile line of business experienced favorable prior year development of approximately $10 million, due to lower than expected loss emergence for accident years 2005 and prior, partially offset by higher severity in accident year 2006. The workers compensation line of business experienced favorable prior year development of approximately $4 million reflecting the implementation of a series of improvement strategies for this line in recent accident years partially offset by an increase in the tail factor related to medical inflation and general development trends. The homeowners line of business experienced adverse prior year loss and loss expense reserve development of approximately $6 million driven by unfavorable trends in claims for groundwater contamination caused by the leakage of certain underground oil storage tanks. The personal umbrellaexcess line of business experienced adverse prior year loss and loss expense reserve development of approximately $4 million in 2007, which was due to the impact of several significant losses on this small line. The remaining lines of business, which collectively contributed approximately $4 million of adverse development, do not individually reflect any significant trends related to prior year development.
SelectiveWe experienced favorable development in itsour loss and loss expense reserves totaling $7.3 million in 2006, which was primarily driven by favorable prior year development in itsour commercial automobile, workers compensation, and personal automobile lines of business partially offset by adverse development in itsour general liability line of business. The commercial automobile line of business experienced favorable prior year loss and loss expense reserve development of approximately $15 million, which was primarily driven by lower than expected severity in accident years 2004 and 2005. The workers compensation line of business experienced favorable prior year development of approximately $4 million, which was driven, in part, by savings realized from changing medical and pharmacy networks outside of New Jersey and re-contracting our medical bill review services. The personal automobile line of business experienced favorable prior year development of approximately $9 million, due to lower than expected frequency. The general liability line of business experienced adverse prior year loss and loss expense reserve development of approximately $15 million in 2006, which was largely driven by Selective’s contractorour contractors completed operations business and an increase in reserves for legal expenses. The remaining lines of business, which collectively contributed approximately $6 million of adverse development, do not individually reflect significant prior year development.

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Selective experienced adverse development in its loss and loss expense reserves totaling $5.1 million in 2005. Through internal actuarial reviews, Selective analyzed certain negative trends in the workers compensation line of business and certain positive trends in the commercial automobile line of business. In the fourth quarter of 2005, Selective had sufficient evidence accumulated to move management’s best estimate of loss reserves for these lines. Accordingly, workers compensation reserves were increased by approximately $42 million to reflect rising medical cost trends that impacted accident years 2001 and prior. At the same time, commercial automobile reserves were decreased by approximately $48 million, primarily due to ongoing favorable severity trends in the 2002 through 2004 accident years. In addition, the general liability reserves adversely developed by approximately $14 million over the course of the year, which was driven mainly by our contractor completed operations business impacting accident years 2001 and prior, but partially offset by positive development in accident years 2002 through 2004. Also in 2005, Selective increased personal automobile reserves by approximately $10 million, of which $6.0 million was attributable to prior year development due to the adverse judicial ruling by the New Jersey Supreme Court in the second quarter of 2005 that eliminated the application of the serious life impact standard to personal automobile bodily injury liability cases under the verbal tort threshold of the New Jersey Automobile Insurance Cost Reduction Act (“AICRA”). The reserving action was based on an analysis of claim files and loss experience pre- and post-AICRA, which resulted in an increase to New Jersey personal automobile loss projections.
Reserves established for liability insurance written primarily in the general liability line of business, continue to reflectinclude exposure to environmental claims, both asbestos and non-asbestos. These claims have arisen primarily under older policies containing exclusions for environmental liability which certain courts,from insured exposures in interpreting such exclusions, have determined do not bar such claims.municipal government, small non-manufacturing commercial risk, and homeowners policies. The emergence of these claims is slow and highly unpredictable. Since 1986, policies issued by the Insurance Subsidiaries have contained a more expansive exclusion for losses related to environmental claims. There are significant uncertainties in estimating Selective’sour exposure to environmental claims (for both case and IBNR reserves) resulting from lack of historical data, long reporting delays, uncertainty as to the number and identity of claimants and complex legal and coverage issues. Legal issues that arise in environmental cases include federal or state venue, choice of law, causation, admissibility of evidence, allocation of damages and contribution among joint defendants, successor and predecessor liability, and whether direct action against insurers can be maintained. Coverage issues that arise in environmental cases include the interpretation and application of policy exclusions, the determination and calculation of policy limits, the determination of the ultimate amount of a loss, the extent to which a loss is covered by a policy, if at all, the obligation of an insurer to defend a claim and the extent to which a party can prove the existence of coverage. Courts have reached different and sometimes inconsistent conclusions on these legal and coverage issues. Selective doesWe do not discount to present value that portion of itsour loss reserves expected to be paid in future periods.
At December 31, 2007, Selective’s2008, our reserves for environmental claims amounted to $58.7$51.5 million on a gross basis (including case reserves of $26.1$20.3 million and IBNR reserves of $32.6$31.2 million) and $51.4$44.1 million on a net basis (including case reserves of $22.6$16.7 million and IBNR reserves of $28.8$27.4 million). There are a total of 2,4482,362 environmental claims, including multiple claimants who are associated with the same site or incident. Of these, 2,1772,037 are asbestos related, of which 1,1501,321 are with seven insureds in the wholesale and/or retail of plumbing, electrical, and other building supplies with related case reserves of $3.1$4.9 million. During 2007, 2102008, 264 asbestos claims were closed, which accounted for approximately $0.1 million of the total asbestos paid of $1.2$1.4 million. The total case reserves for asbestos related claims amounted to $6.8$6.4 million on a gross and net basis. About 6970 of the total environmental claims involve six landfill sites. The landfill sites account for case reserves of $11.8$7.8 million on a gross and net basis, and include reserves for several sites that are currently listed on the National Priorities List. The remaining claims, which account for $7.5$6.1 million of case reserves on a gross and $4.0$2.5 million on a net basis, involve leaking underground heating oil storage tanks and other latent environmental exposures.

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The following table details our exposures to various environmental claims:
                
 2007  2008 
($ in millions) Gross Net  Gross Net 
Asbestos $15.0  13.7   $14.3 13.0 
Landfill sites 21.2  17.7   20.1 16.2 
Other* 22.5  20.0  
Other1
 17.1 14.9 
          
Total $58.7  51.4   $51.5 44.1 
          
*1 Consists of leaking underground storage tanks, and other latent environmental exposures.

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IBNR reserve estimation is often difficult because, in addition to other factors, there are significant uncertainties associated with critical assumptions in the estimation process such as average clean-up costs, third-party costs, potentially responsible party shares, allocation of damages, insurer litigation costs, insurer coverage defenses and potential changes to state and federal statutes. Moreover, normal historically based actuarial approaches are difficult to apply because relevant history is not available. In addition, while models can be applied, such models can produce significantly different results with small changes in assumptions.
The following table provides a roll-forwardroll forward of gross and net environmental incurred losses and loss expenses and related reserves thereon:
                                                
 2007 2006 2005  2008 2007 2006 
(in thousands) Gross Net Gross Net Gross Net 
($ in thousands) Gross Net Gross Net Gross Net 
Asbestos
  
Reserves for losses and loss expenses at the beginning of year $14,164 12,863 13,113 11,813 10,602 9,302  $14,955 13,655 14,164 12,863 13,113 11,813 
Incurred losses and loss expenses 1,943 1,845 2,083 1,327 3,703 3,702  672 579 1,943 1,845 2,083 1,327 
Less losses and loss expenses paid  (1,152)  (1,053)  (1,032)  (277)  (1,192)  (1,191)
Less: losses and loss expenses paid  (1,358)  (1,265)  (1,152)  (1,053)  (1,032)  (277)
                          
Reserves for losses and loss expenses at the end of year $14,955 13,655 14,164 12,863 13,113 11,813  $14,269 12,969 14,955 13,655 14,164 12,863 
                          
  
Non-Asbestos
  
Reserves for losses and loss expenses at the beginning of year $36,547 33,615 32,513 30,013 31,674 29,174  $43,741 37,716 36,547 33,615 32,513 30,013 
Incurred losses and loss expenses 10,496 7,128 7,357 6,534 3,716 2,834  3,222 2,754 10,496 7,128 7,357 6,534 
Less losses and loss expenses paid  (3,302)  (3,027)  (3,323)  (2,932)  (2,877)  (1,995)
Less: losses and loss expenses paid  (9,717)  (9,346)  (3,302)  (3,027)  (3,323)  (2,932)
                          
Reserves for losses and loss expenses at the end of year $43,741 37,716 36,547 33,615 32,513 30,013  $37,246 31,124 43,741 37,716 36,547 33,615 
                          
  
Total Environmental Claims
  
Reserves for losses and loss expenses at the beginning of year $50,711 46,478 45,626 41,826 42,276 38,476  $58,696 51,371 50,711 46,478 45,626 41,826 
Incurred losses and loss expenses 12,439 8,973 9,440 7,861 7,419 6,536  3,894 3,333 12,439 8,973 9,440 7,861 
Less losses and loss expenses paid  (4,454)  (4,080)  (4,355)  (3,209)  (4,069)  (3,186)  (11,075)  (10,611)  (4,454)  (4,080)  (4,355)  (3,209)
                          
Reserves for losses and loss expenses at the end of year $58,696 51,371 50,711 46,478 45,626 41,826  $51,515 44,093 58,696 51,371 50,711 46,478 
                          
BasedDuring 2008, 43 of our past and present insureds filed formal consent decrees with the New Jersey Department of Environmental Protection, resolving our largest landfill claim, which resulted in our payment of approximately $4.7 million on its aggregate reserve for net losses and loss expenses at December 31, 2007, Selective does not expect that liabilities associated with environmental and non-environmental claims will have a materially adverse impact on its future liquidity, financial position and resultsbehalf of operations. However, given the complexity of coverage and other legal issues, and the significant assumptions used in estimating such exposures, actual results could significantly differ from Selective’s current estimates.these insureds.
Note 9 Indebtedness
(a) Notes Payable
(1) On September 25, 2006, we issued $100 million aggregate principal amount of 7.5% Junior Subordinated Notes due 2066 (“Junior Notes”). The Junior Notes will pay interest, subject to our right to defer interest payments for up to 10 years, on March 15, June 15, September 15, and December 15 of each year, beginning December 15, 2006, and ending on September 27, 2066. On or after September 26, 2011, the Junior Notes may be called at any time, in whole or in part, at their aggregate principal amount, together with any accrued and unpaid interest. The net proceeds of $96.8 million from the issuance were used for general corporate purposes. There are no attached financial debt covenants to which we are required to comply in regards to the Junior Notes.

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(2) On November 3, 2005, we issued $100 million of 6.70% Senior Notes due 2035. These notes were issued at a discount of $0.7 million resulting in an effective yield of 6.754% and pay interest on May 1 and November 1 each year commencing on May 1, 2006. Net proceeds of approximately $50 million were used to fund an irrevocable trust to provide for certain payment obligations in respect of our outstanding debt. The remainder of the proceeds were used for general corporate purposes. The agreements covering these notes contain a standard default cross-acceleration provision that provides the 6.70% Senior Notes will enter a state of default upon the failure to pay principal when due or upon any event or condition that results in an acceleration of principal of any other debt instrument in excess of $10 million which we have outstanding concurrently with the 6.70% Senior Notes. There are no attached financial debt covenants to which we are required to comply in regards to these notes.
(3) On November 15, 2004, we issued $50 million of 7.25% Senior Notes due 2034. These notes were issued at a discount of $0.1 million, resulting in an effective yield of 7.27% and pay interest on May 15 and November 15 each year. We contributed $25.0 million of the bond proceeds to the Insurance Subsidiaries as capital. The remainder of the proceeds were used for general corporate purposes. The agreements covering these notes contain a standard default cross-acceleration provision that provides the 7.25% Senior Notes will enter a state of default upon the failure to pay principal when due or upon any event or condition that results in an acceleration of principal of any other debt instrument in excess of $10 million which we have outstanding concurrently with the 7.25% Senior Notes. There are no attached financial debt covenants to which we are required to comply in regards to these notes.
(4) On May 4, 2000, we entered into a $30.0 million and a $61.5 million note purchase agreement with various private lenders covering the 8.63% and 8.87% Senior Notes, respectively. During 2007, the principal amount of the 8.63% Senior Notes was paid in full. We have paid $36.9 million in principal to date, in addition to accrued interest thereon, for the 8.87% Senior Notes. Principal payments of $12.3 million are required annually through May 4, 2010. The unpaid principal amount of the 8.87% Senior Notes, which was $24.6 million at December 31, 2008 and $36.9 million at December 31, 2007, accrues interest and is payable semiannually on May 4 and November 4 of each year, until the principal is paid in full. The agreements covering these notes contain a standard default cross-acceleration provision that provides the 8.87% Senior Notes will enter a state of default upon the failure to pay principal when due or upon any event or condition that results in an acceleration of principal, the election of directors to the Board, or a mandatory repurchase of any other debt instrument in excess of $1 million which we have outstanding concurrently with the 8.87% Senior Notes. In addition to the above cross-acceleration provision covenants, the note purchase agreement covering the 8.87% Senior Notes also contains financial debt covenants that are reviewed quarterly. They include, but are not limited to, a limitation on indebtedness, restricted ability to declare dividends, and net worth maintenance. All of the covenants were met during 2008 and 2007. At December 31, 2008, the amount available for dividends to stockholders under such restrictions was $302.6 million for the 8.87% Senior Notes.
(b) Short-Term Debt
On August 11, 2006, the Parent entered into a syndicated line of credit agreement, which is contingent upon the satisfaction of certain agreed upon debt covenants, as outlined below, and is syndicated among the following five banks: (i) Wachovia Bank N.A., a subsidiary of Wells Fargo & Company, as administrative agent; (ii) JP Morgan Chase Bank, N.A.; (iii) State Street Bank and Trust Company; (iv) Branch Banking and Trust Company; and (v) TD Bank, National Association (formerly known as Commerce Bank, N.A.). This line can be increased to $75 million with the consent of all lending parties. According to the syndicated line of credit agreement, the lenders are not joint and severally liable with regards to the total commitment under the agreement. The Parent did not access the facility during 2008 and there were no balances outstanding under the line of credit as of December 31, 2008 or December 31, 2007.
In order to have access to draw down on the line of credit, we are required, per the syndicated line of credit agreement, to comply with certain restrictive covenants. Some of the significant covenants are as follows:
•Our consolidated net worth, as calculated per the syndicated line of credit agreement, must be equal to or greater than the required minimum consolidated net worth, as calculated per the syndicated line of credit agreement. In accordance with the calculations in the agreement, at December 31, 2008 our consolidated net worth was $890.5 million and the required minimum consolidated net worth was $882 million.
•Our consolidated debt to total capitalization ratio, as calculated per the syndicated line of credit agreement, cannot exceed 30.0% at any point in time. At December 31, 2008 our consolidated debt to capitalization ratio was 23.6%.
•The Insurance Subsidiaries must maintain a financial strength rating by A.M. Best of at least “A-” at all times. Throughout 2008, our A.M. Best financial strength rating was continuously “A+”.
•In addition to the above requirements, the syndicated line of credit agreement contains a cross-default provision that provides that the line of credit will be in default if the Company fails to comply with any condition, covenant or agreement (including payment of principal and interest when due on any debt with an aggregate principal amount of at least $5.0 million), which causes, or permits, the acceleration of principal.

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(c) Senior Convertible Notes
In 2002, Selectivewe issued $305 million aggregate principal amount of 1.6155% senior convertible notes (“Convertible Notes”), due September 24, 2032, at a discount of 61.988% resulting in an effective yield of 4.25%. Selective recorded gross proceeds of $116.0 million along with $3.2 million of deferred charges, which were amortized over the life of the Convertible Notes, in connection with debt issuance costs. Approximately $72.0 million of the net proceeds were used to fund an irrevocable trust, which provided for certain payment obligations in respect of Selective’s outstanding debt obligations through 2005. Selective also paid a $40.0 million capital contribution to its Insurance Subsidiaries with the remainder of the net proceeds.
The Convertible Notes were redeemable by Selectivethe Parent in whole or in part, at any time on or after September 24, 2007, at a price equal to the sum of the issue price, plus the call premium, if any, plus accrued original issue discount and accrued and unpaid cash interest, if any, on such Convertible Notes to the applicable redemption date.
During 2006, $58.5 million of the principal balance was redeemed through an induced conversion that resulted in (i) the issuance of 3,996,306 shares of stock; (ii) additional expensestock and the recognition of $2.1 million in expense representing the incremental consideration in connection with the transactions; and (iii) a $1.5 million equity charge representingtransactions. During 2007, the related unamortized debt costs.
During the first ten months of 2007,remaining principal balance was settled as follows: (i) $21.7 million of the principal balance was voluntarily presented for conversion, $11.2 million of which was settled through the issuance of 765,903 shares, with the remaining $10.5 million net-share settled resulting in the issuance of 235,220 shares.
During the last two months of 2007, the remainingshares; and (ii) $35.7 million of the Convertible Notes werewas called for redemption, of whichwith the final $8.7 million settledsettling in January 2008. The Company net-share settled the majority of these notes, which had been voluntarily presented for conversion prior to redemption, and as a result, issuedredemptions were net-share settled resulting in the issuance of 905,052 shares.

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(b) Notes Payable
(1) On September 25, 2006, Selective issued $100 million aggregate principal amount of 7.5% Junior Subordinated Notes due 2066 (“Junior Notes”). The Junior Notes will pay interest, subject to Selective’s right to defer interest payments for up to 10 years, on March 15, June 15, September 15, and December 15 of each year, beginning December 15, 2006, and ending on September 27, 2066. At anytime on or after September 26, 2011, the Junior Notes may be called by Selective at any time, in whole or in part, at their aggregate principal amount, together with any accrued and unpaid interest. The net proceeds of $96.8 million from the issuance were used for general corporate purposes.
(2) On November 3, 2005, Selective issued $100 million of 6.70% Senior Notes due 2035. These notes were issued at a discount of $0.7 million resulting in an effective yield of 6.754% and pay interest on May 1 and November 1 each year commencing on May 1, 2006. Net proceeds of approximately $50 million were used to fund an irrevocable trust to provide for certain payment obligations in respect of Selective’s outstanding debt. The remainder of the bond proceeds were used for general corporate purposes.
(3) On November 15, 2004, Selective issued $50 million of 7.25% Senior Notes due 2034. These notes were issued at a discount of $0.1 million, resulting in an effective yield of 7.27% and pay interest on May 15 and November 15 each year. The Parent contributed $25.0 million of the bond proceeds to the Insurance Subsidiaries as capital. The remainder of the proceeds were used for general corporate purposes.
(4) On May 4, 2000, Selective entered into a $30.0 million and a $61.5 million note purchase agreement with various private lenders covering the 8.63% and 8.87% Senior Notes, respectively. As of December 31, 2007, the principal amount of the 8.63% Senior Notes has been paid in full. Selective has paid $24.6 million in principal to date, in addition to accrued interest thereon, for the 8.87% Senior Notes. Principal payments of $12.3 million are required annually through May 4, 2010. The unpaid principal amount of these Senior Notes, which was $36.9 million at December 31, 2007 and $49.2 million at December 31, 2006, accrues interest and is payable semiannually on May 4 and November 4 of each year, until the principal is paid in full.
The note purchase agreement covering the 8.87% Senior Notes contains restrictive business covenants that are reviewed quarterly. They include, but are not limited to, a limitation on indebtedness, restricted ability to declare dividends, and net worth maintenance. All of the covenants were met during 2007 and 2006. At December 31, 2007, the amount available for dividends to stockholders under such restrictions was $336.0 million for the 2000 senior notes.
(c)(d) Convertible Subordinated Debentures
The Convertible Subordinated Debentures (the “Debentures”) were issued under an Indenture dated December 29, 1982, (the “1982 Indenture”) in the principal amount of $25.0 million, bearing interest at a rate of 8.75% per annum, which iswas payable on the unpaid principal semiannually on January 1 and July 1 in each year to holders of record at the close of business on the preceding December 15 and June 15, respectively. The Debentures arewere convertible into Common Stockcommon stock at an effective conversion price of $3.54 per share. The 1982 Indenture requires Selectiverequired us to retire, through the operation of a mandatory sinking fund, 5% of the original $25.0 million aggregate principal amount of the debentures on or before December 31 of each year from 1993 through 2006. Voluntary conversions have satisfied this obligation in its entirety.
On January 2, 2008, the Debentures matured and were settled through the issuance of 45,759 shares of the Parent’s common stock along with an insignificant cash payment. The principal amount of the Debentures, which was $0.2 million at December 31, 2007, and $0.8 million at December 31, 2006, is included in “Other liabilities” on the Consolidated Balance Sheets. On January 2, 2008, the Debentures matured and were settled through the issuance of 45,763 shares of Selective’s Common Stock along with an insignificant cash payment.
(d) Short-Term Debt
On August 11, 2006, Selective entered into a syndicated line of credit agreement with Wachovia Bank, National Association, as administrative agent. Under this agreement, Selective has access to a $50.0 million revolving credit facility, which can be increased to $75.0 million with the consent of all lending parties. The agreement will expire on August 11, 2011. Interest rates on borrowings under the credit facility are based on either London Interbank Offered Rate or the higher of the prime rate and adjusted federal funds rate. Selective accessed $6.0 million from the facility during 2007 at the London Interbank Offered Rate. At December 31, 2007, there were no balances outstanding under the line of credit. Prior to this time, Selective had revolving lines of credit with State Street Corporation of $20.0 million and Wachovia Bank, National Association, of $25.0 million which expired during the third quarter of 2006.

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Note 10 Stockholders’ Equity
As of December 31, 2008, we had 9.9 million shares reserved for various stock compensation and purchase plans, retirement plans, dividend reinvestment plans and convertible debt offerings. As part of our ongoing capital management strategy, we repurchase the Parent’s stock from time to time. The following table provides information regarding the purchase of the Parent’s common stock during the 2006-2008 reporting periods:
                 
  Shares Purchased  Cost of Shares Purchased  Shares Purchased  Cost of Shares Purchased 
  in Connection with  in Connection with  as Part of Publicly  as Part of Publicly 
($ in thousands) Restricted stock Vestings  Restricted stock Vestings  Announced Plans  Announced Plans 
Period and Stock Option Exercises  and Stock Option Exercises  or Programs  or Programs 
2008  268,493  $6,290   1,770,534  $40,543 
2007  354,456  $8,813   5,703,464  $143,305 
2006  228,914  $6,237   4,106,708  $110,117 
The maximum number of shares that may yet be purchased under our authorized stock repurchase program is 1.7 million. This program is scheduled to expire on July 26, 2009.
On January 30, 2007, the Board of Directors (the “Board”) of Selective Insurance Group, Inc.the Parent declared a two-for-one stock split of Selective’s Common Stock,the Parent’s common stock, par value $2.00 per share in the form of a share dividend of one additional share of Common Stockthe Parent’s common stock for each outstanding share of Common Stockthe Parent’s common stock issued by Selectiveus (the “Share Dividend”). The Share Dividend was paid on February 20, 2007 to shareholders of record as of the close of business on February 13, 2007. The effect of the Share Dividend has been recognized retroactively in 2006 and 2005 share and per share data, as well as the capital stock account balances, in the accompanying Consolidated Financial Statements, Notes to Consolidated Financial Statements and supplemental financial data.

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As of December 31, 2007, Selective had an additional 12.5 million shares reserved for various stock compensation and purchase plans, retirement plans, dividend reinvestment plans and convertible debt offerings. As part of its ongoing capital management strategy, Selective repurchases its own stock. The following table provides information regarding Selective’s purchase of its own Common Stock during the 2005-2007 reporting periods:
                 
($ in thousands)          
  Shares Purchased  Cost of Shares Purchased  Shares Purchased  Cost of Shares Purchased 
  in connection with  in connection with  as Part of Publicly  as Part of Publicly 
  Restricted stock Vestings  Restricted stock Vestings  Announced Plans  Announced Plans 
Period and Stock Option Exercises  and Stock Option Exercises  or Programs  or Programs 
2007  354,456  $8,813   5,703,464  $143,305 
2006  228,914  $6,237   4,106,708  $110,117 
2005  225,690  $6,557   670,528  $16,327 
The maximum number of shares that may yet be purchased under Selective’s authorized stock repurchase program is 3.5 million. This program is scheduled to expire on July 26, 2009.
Selective’sOur ability to declare and pay dividends on its Common Stockthe Parent’s common stock is affected by the ability of its subsidiariesthe Insurance Subsidiaries to declare and pay dividends to the parent holding company.Parent. The dividends from Selective HR are restricted by the operating cash flows of this entity, as well as professional employer organization licensing requirements to maintain a current ratio of at least 1:1. The dividends from the Insurance Subsidiaries are subject to the regulatory limitations of the states in which the Insurance Subsidiaries are domiciled: New Jersey, New York, North Carolina, South Carolina,Indiana, or Maine. Based on the unaudited 20072008 statutory financial statements, the maximum ordinary dividends that can be paid to Selectiveour parent company by the Insurance Subsidiaries in 20082009 are:
        
($ in millions)   ($ in millions) 
Selective Insurance Company of America $84.5  $51.5 
Selective Way Insurance Company 25.7  20.8 
Selective Insurance Company of South Carolina 11.3  9.4 
Selective Insurance Company of the Southeast 9.0  8.7 
Selective Insurance Company of New York 7.5  6.7 
Selective Insurance Company of New England 1.3  1.3 
Selective Auto Insurance Company of New Jersey 0.1  3.2 
      
Total $139.4  $101.6 
      
The statutory capital and surplus of the Insurance Subsidiaries in excess of these ordinary dividend amounts must remain with the Insurance Subsidiaries in the absence of the approval of a request for an extraordinary dividend. In each such jurisdiction, domestic insurers are prohibited from paying “extraordinary dividends” without approval of the insurance commissioner of the respective state. Additionally, New Jersey North Carolina, and South CarolinaIndiana require notice of the declaration of any ordinary or extraordinary dividend distribution. During the notice period, the relevant state regulatory authority may disallow all or part of the proposed dividend if it determines that the insurer’s surplus, with regard to policyholders, is not reasonable in relation to the insurer’s outstanding liabilities and adequate for itsour financial needs.

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Note 11 Preferred Share Purchase Rights Plan
On February 2, 1999, Selective’sthe Board of Directors (the “Board”) approved the Amended and Restated Rights Agreement (the “Rights Agreement”). This agreement expired on February 2, 2009. Under the previously existing Rights Agreement, the right to purchase one-halfone half of one two-hundredth (or one four-hundredth) of a share of Selective’sthe Parent’s Series A Junior Preferred Stock (each, a “Preferred Share”) at an exercise price of $80 (each, a “Right” and collectively, the “Rights”) iswas attached to each share of Selective’s Common Stock.the Parent’s common stock. The Right iswas exercisable 10 days after an announcement that a person or group hashad acquired 15% or more of Selective’sthe Parent’s outstanding Common Stockcommon stock (an ���Acquiring“Acquiring Person”) or 10 business days after a person or group commencescommenced or announcesannounced its intent to make a tender offer that would resulthave resulted in such person or group becoming an Acquiring Person. If a person or group becomesbecame an Acquiring Person, each Right willwould entitle the holder, other than an Acquiring Person, to purchase such number of one-halfone half of one two-hundredths of a Preferred Share, as set forth in the Rights certificate (the “Rights Amount”), at a price of $80 per one-halfone half of one two-hundredstwo-hundredths of a Preferred Share.
If Selective iswe were acquired in a merger, or 50% or more of itsour assets arewere sold (each a “Triggering Transaction”), each holder of a Right, other than an Acquiring Person, willwould have had the right to receive, for an exercise price of $80, such number of shares of Common Stockcommon stock of the Principal Party (as defined in the Rights Agreement) equal to $80 multiplied by the Rights Amount, divided by 50% of the current per-share market price of the Common Stockcommon stock of the Principal Party on the consummation date of the Triggering Transaction.
Selective’sThe Board may,could have, after a person or group becomesbecame an Acquiring Person, but before an Acquiring Person acquiresacquired 50% or more of Selective’sthe Parent’s outstanding Common Stock, exchangecommon stock, exchanged all or part of the outstanding Rights, other than the Rights of an Acquiring Person, for Selective’s Common Stock,the Parent’s common stock, at an exchange ratio of one (1) share of Common Stockthe Parent’s common stock per Right. TheUnder the previously existing Rights Agreement, the Rights were scheduled to expire at the earliest of: (i) the close of business on February 2, 2009; (ii) the time at which Selective’sthe Board of Directors redeemsredeemed all of the outstanding Rights at a redemption price of $0.01 per Right before an announcement that a person or group hashad become an Acquiring Person; or (iii) the time at which the Rights arewere exchanged for shares of Selective’s Common Stockthe Parent’s common stock as described above.

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Note 12 Segment Information
Selective hasWe have classified itsour operations into three segments, the disaggregated results of which are reported to and used by senior management to manage Selective’sour operations:
Insurance Operations, which are evaluated based on statutory underwriting results (net premiums earned, incurred losses and loss expenses, policyholders dividends, policy acquisition costs, and other underwriting expenses), and statutory combined ratios;
•Insurance Operations, which are evaluated based on statutory underwriting results (net premiums earned, incurred losses and loss expenses, policyholders dividends, policy acquisition costs, and other underwriting expenses), and statutory combined ratios;
•Investments, which are evaluated based on net investment income and net realized gains and losses; and
•Diversified Insurance Services (Flood and HR Outsourcing), which, because they are not dependent on insurance underwriting cycles, are evaluated based on several measures including, but not limited to, results of operations in accordance with GAAP, with a focus on return on revenues (net income divided by revenues).
Investments, which are evaluated based on net investment income and net realized gains and losses; and
Diversified Insurance Services (federal flood insurance administrative services and human resource administration outsourcing products and servicing), which, because they are not dependent on insurance underwriting cycles, are evaluated based on several measures including, but not limited to, results of operations in accordance with GAAP, with a focus on return on revenues (net income divided by revenues).
Selective doesWe do not aggregate any of itsour operating segments. TheOur Insurance Operations and Diversified Insurance Services segments share a common marketing or distribution system and create new opportunities for independent insurance agents to bring value-added services and products to their customers. Selective’sOur commercial and personal lines property and casualty insurance products, flood insurance, and human resource administration outsourcing products are sold through independent insurance agents.
In December 2005, Selective divested itself of its 100% ownership interest in CHN Solutions (Alta Services, LLC and Consumer Health Network Plus, LLC), which had historically been reported as part of the “Managed Care” component of the Diversified Insurance Services segment. For additional information regarding this divestiture, see Note 15, “Discontinued Operations.” Selective’s remainingOur goodwill balance by operating segment is as follows:
                
(in thousands) 2007 2006 
($ in thousands) 2008 2007 
Diversified Insurance Services goodwill $25,788 25,788   $21,788 25,788 
Insurance Operations goodwill 7,849 7,849   7,849 7,849 
          
Total goodwill $33,637 33,637   $29,637 33,637 
          

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Due to the economic deterioration that occurred during 2008 in the U.S., our near-term financial projections for our HR Outsourcing reporting unit were not sufficient to support its carrying value. As a result, in the fourth quarter of 2008, a pre-tax goodwill impairment loss of $4.0 million was recognized for this reporting unit. We calculated the fair value of that reporting unit utilizing an income approach as defined under FAS 157 (i.e. expected present value of future cash flows). We did not record any goodwill impairment charges during 2007 or 2006.

Selective’sOur Insurance Operations and Diversified Insurance Services segments are subject to certain geographic concentration. Approximately 30%29% of net premiums written are related to insurance policies written in New Jersey and 29%25% of Selective HR’s co-employer service fees are related to business in Florida. For additional information regarding the states that the Company’sgenerate our remaining revenues, are generated from, see the section entitled “Regional Geographic Market Focus” in Item 1. “Business,” from this Form 10-K.
Selective and its subsidiariesWe also provide services to each other in the normal course of business. These transactions totaled $13.8 million in 2008, $17.8 million in 2007, and $19.3 million in 2006, and $19.4 million in 2005.2006. These transactions were eliminated in all consolidated statements. In computing the results of each segment, Selective doeswe do not make adjustments for interest expense, net general corporate expenses, or federal income taxes. Selective doesWe do not maintain separate investment portfolios for the segments and therefore, does not allocate assets to the segments.

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The following summaries present revenues from continuing operations (net investment income and net realized gains on investments in the case of the Investments segment) and pre-tax income from continuing operations for the individual segments:
Revenue by segment
             
Revenue by segment         
Years ended December 31,         
($ in thousands) 2008  2007  2006 
Insurance Operations:
            
Net premiums earned:            
Commercial automobile $307,388   315,259   319,921 
Workers compensation  308,618   325,636   314,174 
General liability  396,066   410,024   402,745 
Commercial property ��196,189   190,681   182,351 
Business owners’ policies  57,858   52,677   48,500 
Bonds  18,831   19,036   17,466 
Other  597   689   719 
          
Total Commercial Lines  1,285,547   1,314,002   1,285,876 
          
Personal automobile  132,845   132,944   146,737 
Homeowners  68,088   62,280   59,334 
Other  9,010   8,080   7,717 
          
Total personal lines  209,943   203,304   213,788 
          
Total net premiums earned  1,495,490   1,517,306   1,499,664 
          
Miscellaneous income  2,560   5,795   5,390 
          
Total Insurance Operations revenues  1,498,050   1,523,101   1,505,054 
Investments:
            
Net investment income  131,032   174,144   156,802 
Net realized (losses) gains on investments  (49,452)  33,354   35,479 
          
Total investment revenues  81,580   207,498   192,281 
Diversified Insurance Services:
            
HR Outsourcing  53,147   59,109   63,322 
Flood  52,943   47,842   41,522 
Other  10,256   8,615   5,682 
          
Total Diversified Insurance Services revenues  116,346   115,566   110,526 
          
Total all segments
  1,695,976   1,846,165   1,807,861 
          
Other income  3   63   6 
          
Total revenues
 $1,695,979   1,846,228   1,807,867 
          
             
(in thousands) 2007  2006  2005 
Insurance Operations:
            
Commercial automobile net premiums earned $315,259   319,921   320,080 
Workers compensation net premiums earned  325,636   314,174   293,268 
General liability net premiums earned  410,024   402,745   363,513 
Commercial property net premiums earned  190,681   182,351   168,282 
Business owners’ policy net premiums earned  52,677   48,500   46,708 
Bonds net premiums earned  19,036   17,466   16,026 
Other net premiums earned  689   719   789 
          
Total commercial lines net premiums earned  1,314,002   1,285,876   1,208,666 
 
Personal automobile net premiums earned  132,944   146,737   164,805 
Homeowners net premiums earned  62,280   59,334   37,706 
Other net premiums earned  8,080   7,717   6,836 
          
Total personal lines net premiums earned  203,304   213,788   209,347 
 
Miscellaneous income  5,795   5,390   3,768 
          
Total insurance operations revenues  1,523,101   1,505,054   1,421,781 
 
Investments:
            
Net investment income  174,144   156,802   135,950 
Net realized gains on investments  33,354   35,479   14,464 
          
Total investment revenues  207,498   192,281   150,414 
 
Diversified Insurance Services:
            
Human resource administration outsourcing  59,109   63,322   60,227 
Flood insurance  47,842   41,522   34,320 
Other  8,615   5,682   4,164 
          
Total diversified insurance services revenues from continuing operations  115,566   110,526   98,711 
          
Total all segments
  1,846,165   1,807, 861   1,670,906 
          
Other income  63   6   106 
          
Total revenues from continuing operations
 $1,846,228   1,807,867   1,671,012 
          
             
Income before federal income tax         
Years Ended December 31,         
($ in thousands) 2008  2007  2006 
Insurance Operations:
            
Commercial lines underwriting income $6,103   42,105   63,482 
Personal lines underwriting loss  (21,329)  (26,148)  (5,504)
          
Underwriting income, before federal income tax  (15,226)  15,957   57,978 
          
GAAP combined ratio  101.0%  98.9   96.1 
          
Statutory combined ratio  99.2%  97.5   95.4 
          
Investments:
            
Net investment income  131,032   174,144   156,802 
Net realized (losses) gains on investments  (49,452)  33,354   35,479 
          
Total investment income, before federal income tax  81,580   207,498   192,281 
          
Diversified Insurance Services:
            
Income before federal income tax  14,527   18,623   17,808 
          
Total all segments
  80,881   242,078   268,067 
          
Interest expense  (20,508)  (23,795)  (21,411)
General corporate expenses  (20,987)  (25,525)  (26,146)
          
 
Income before federal income tax
 $39,386   192,758   220,510 
          

 

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Income or (loss) from continuing operations before federal income tax by segment:
             
(in thousands) 2007  2006  2005 
Insurance Operations:
            
Commercial lines underwriting income $42,105   63,482   75,671 
Personal lines underwriting loss  (26,148)  (5,504)  (5,943)
          
Underwriting income, before federal income tax  15,957   57,978   69,728 
GAAP combined ratio  98.9 %  96.1   95.1 
Statutory combined ratio  97.5 %  95.4   94.6 
             
Investments:
            
Net investment income  174,144   156,802   135,950 
Net realized gains on investments  33,354   35,479   14,464 
          
Total investment income, before federal income tax  207,498   192,281   150,414 
          
             
Diversified Insurance Services:
            
Income from continuing operations, before federal income tax  18,623   17,808   14,793 
          
             
Total all segments
  242,078   268,067   234,935 
Interest expense  (23,795)  (21,411)  (17,582)
General corporate expenses  (25,525)  (26,146)  (14,569)
          
             
Income from continuing operations, before federal income tax
 $192,758   220,510   202,784 
          
Note 13 Earnings per Share


The following table provides a reconciliation of the numerators and denominators of the basic and diluted earnings per share (“EPS”) computations of net income for the year ended:
2007
             
2008 Income  Shares  Per Share 
($ in thousands, except per share amounts) (Numerator)  (Denominator)  Amount 
Basic EPS:            
Net income available to common stockholders $43,758   52,104   0.84 
             
Effect of dilutive securities:            
Restricted stock  —   727     
Restricted stock units  —   53     
Stock options  —   247     
Deferred shares  —   188     
           
             
Diluted EPS:            
Income available to common stockholders and assumed conversions $43,758   53,319   0.82 
          
                        
 Income Shares Per Share 
(in thousands, except per share amounts) (Numerator) (Denominator) Amount 
2007 Income Shares Per Share 
($ in thousands, except per share amounts) (Numerator) (Denominator) Amount 
Basic EPS:  
Net income available to common stockholders $146,498 52,382 2.80  $146,498 52,382 2.80 
  
Effect of dilutive securities:  
Restricted stock — 1,158  — 1,158 
8.75% convertible subordinated debentures 25 128  25 128 
4.25% senior convertible notes 1,268 2,931  1,268 2,931 
Stock options — 385  — 385 
Deferred shares — 181  — 181 
          
  
Diluted EPS:  
Income available to common stockholders and assumed conversions $147,791 57,165 2.59  $147,791 57,165 2.59 
              
During the fourth quarter of 2007, the remaining $46.6 million principal balance of Selective’s Senior Convertible Notes that were scheduled to mature on September 24, 2032 were either voluntarily converted or mandatorily redeemed, with the final $8.7 million settled in January 2008. These activities resulted in the issuance of approximately 1.2 million shares as well as the elimination of approximately 3.2 million common stock equivalents. The full impact on the weighted average shares for these transactions was not realized during 2007, because the transactions occurred during the fourth quarter of the year. For additional information regarding these transactions, see Note 9, “Indebtedness.”
             
2006 Income  Shares  Per Share 
($ in thousands, except per share amounts) (Numerator)  (Denominator)  Amount 
Basic EPS:            
Net income available to common stockholders $163,574   54,986   2.98 
             
Effect of dilutive securities:            
Restricted stock  —   1,264     
8.75% convertible subordinated debentures  43   216     
4.25% senior convertible notes  2,170   5,334     
Stock options  —   566     
Deferred shares  —   176     
           
             
Diluted EPS:            
Income available to common stockholders and assumed conversions $165,787   62,542   2.65 
          
2006
             
  Income  Shares  Per Share 
(in thousands, except per share amounts) (Numerator)  (Denominator)  Amount 
Basic EPS:            
Net income available to common stockholders $163,574   54,986   2.98 
             
Effect of dilutive securities:            
Restricted stock  —   1,264     
8.75% convertible subordinated debentures  43   216     
4.25% senior convertible notes  2,170   5,334     
Stock options  —   566     
Deferred shares  —   176     
           
             
Diluted EPS:            
Income available to common stockholders and assumed conversions $165,787   62,542   2.65 
          

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2005
             
  Income  Shares  Per Share 
(in thousands, except per share amounts) (Numerator)  (Denominator)  Amount 
Basic EPS:            
Net income from continuing operations $147,452   54,342  $2.72 
Net income from discontinued operations  546   54,342   0.01 
Cumulative effect of change in accounting principle  495   54,342   0.01 
           
Net income available to common stockholders $148,493   54,342  $2.74 
          
             
Effect of dilutive securities:            
Restricted stock  —   1,318     
8.75% convertible subordinated debentures  45   224     
4.25% senior convertible notes  3,203   7,916     
Stock options  —   726     
Deferred shares  —   182     
           
            
             
Diluted EPS:            
Income from continuing operations $150,700   64,708  $2.33 
Net income from discontinued operations  546   64,708   0.01 
Cumulative effect of change in accounting principle  495   64,708   0.01 
           
Income available to common stockholders and assumed conversions $151,741   64,708  $2.35 
          
            
Note 14 Federal Income Tax
(a) A reconciliation of federal income tax on pre-tax earnings at the corporate rate to the effective tax rate is as follows:
                        
(in thousands) 2007 2006 2005 
($ in thousands) 2008 2007 2006 
Tax at statutory rate of 35% $67,465 77,178 70,974  $13,785 67,465 77,178 
Tax-advantaged interest  (19,246)  (17,911)  (14,334)  (18,946)  (19,246)  (17,911)
Dividends received deduction  (1,213)  (2,019)  (2,152)  (922)  (1,213)  (2,019)
Non qualified deferred compensation 1,563  (351)  (73)
Other  (746)  (312) 844  148  (395)  (239)
              
Federal income tax expense $46,260 56,936 55,332 
Federal income tax (benefit) expense $(4,372) 46,260 56,936 
              

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(b) The tax effects of the significant temporary differences that give rise to deferred tax assets and liabilities are as follows:
                
(in thousands) 2007 2006 
($ in thousands) 2008 2007 
Deferred tax assets:  
Net loss reserve discounting $96,697 93,466  $95,444 96,697 
Net unearned premiums 53,158 50,553  52,297 53,158 
Employee Benefits 8,736 10,695 
Employee benefits 27,556 8,736 
Long-term incentive compensation plans 11,518 10,575  12,347 11,518 
Unrealized loss on available-for-sale securities 29,527 — 
Temporary investment write-downs 12,811 1,712 
Other 7,020 5,052  9,088 5,308 
          
Total deferred tax assets 177,129 170,341  239,070 177,129 
          
  
Deferred tax liabilities:  
Deferred policy acquisition costs 79,249 76,333  74,156 79,249 
Unrealized gains on available-for-sale securities 50,648 61,572  — 50,648 
Accelerated depreciation and amortization 14,510 8,434  12,777 14,510 
Other 10,347 8,557  5,336 10,347 
          
Total deferred tax liabilities 154,754 154,896  92,269 154,754 
          
Net deferred federal income tax asset $22,375 15,445  $146,801 22,375 
          
Based on Selective’sour federal tax loss carryback availability, expected levels of pre-tax financial statement income and federal taxable income, Selective believeswe believe it is more likely than not that the existing deductible temporary differences will reverse during periods in which Selective generateswe generate net federal taxable income or hashave adequate federal carryback availability. As a result, Selective haswe have no valuation allowance recognized for federal deferred tax assets.assets at December 31, 2008. In addition, at December 31, 2007, we had no similar valuation allowances recognized.
Stockholders’ equity reflects tax benefits related to compensation expense deductions for stock options exercised of $18.6 million at December 31, 2008, $17.0 million at December 31, 2007, and $13.5 million at December 31, 2006.
In accordance with FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109(“FIN 48”), we have analyzed our deferred tax positions in all open tax years, which as of December 31, 2008 were 2005, 2006, and $9.6 million at2007. Based on this analysis, we do not have unrecognized tax benefits as of December 31, 2005.

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Note 15 Discontinued Operations
2008. We believe our tax positions will more likely than not be sustained upon examination, including related appeals or litigation. In December 2005, Selective divested itself of its 100% ownership interest in CHN Solutions (Alta Services, LLC and Consumer Health Network Plus, LLC), whichthe event we had historically been reported as part of the “Managed Care” component of the Diversified Insurance Services segment. Selective sold its interest in CHN Solutions for proceeds of $16.4 million, which produced an after tax loss of $2.6 million. This loss, which is net of a tax benefit of $1.4 million, is included in discontinued operations on the Consolidated Statements of Income. Also included in discontinued operations on the Consolidated Statements of Income are after tax profits of $3.2 million in 2005 from the operations of CHN Solutions prior to divestiture. Taxes on these operating profits amounted to $1.7 million in 2005.
As part of the divestiture, Selective’s Insurance Subsidiaries entered into an agreement with the buyer, wherein Selective’s Insurance Subsidiaries have agreed to continue to use the managed care services of CHN Solutions in processing claims for its workers compensation and automobile policies issued by the Insurance Subsidiaries in the State of New Jersey. This agreement is effective until December 2010 and can be terminated by either party for the following reasons: (i) breach of contract; (ii) insolvency; or (iii) a change in control. In addition, Selective’s Insurance Subsidiaries can terminate the agreement if the buyer fails toposition that did not meet the performance standards as outlinedmore likely than not criteria, any tax, interest, and penalties incurred related to such a position would be reflected in the agreement.
Selective has reclassified prior period amounts“Federal income tax expense” on the consolidated statements of income to present the operating results of CHN Solutions as a discontinued operation.our Consolidated Income Statement.
Operating results, as well as the loss on disposition, from discontinued operations are as follows:
     
(in thousands) 2005 
Net revenue $25,791 
Pre-tax profit  4,893 
After-tax profit  3,180 
Loss on disposition, net of tax  (2,634)
Note 1615 Retirement Plans
(a) Retirement Plan for NonemployeeNon-employee Directors
SelectiveWe terminated, effective December 31, 1997, a nonqualified defined benefit retirement income plan for non-employee Directors. The estimated accrued costs for this plan were not material. As part of the termination, the present value of each Director’s future benefits, as of that date, was converted into units based on the fair value of Selective Common Stock.the Parent’s common stock. The original termination called for the cash value of these units based upon the fair value of Selective Common Stockthe Parent’s common stock on retirement date to be distributed to each Director, or at each Director’s election, over a period of fifteen years after such retirement. On May 8, 2002, the stockholders approved the conversion of the units issued under the termination plan into shares of Selective Common Stock.the Parent’s common stock. All of the shares issued under this conversion have been deferred by the participants for receipt upon retirement, or at each Director’s election, over a period of no more than five years after such retirement. These deferred shares, which are currently being held in accounts on behalf of each Director, are credited with cash dividends along with interest on those dividends. The adoption of FAS 123RFASB Statement No. 123 (revised 2004) on January 1, 2005 resulted in a reclassification of $1.3 million to “Additional paid-in capital” on the Consolidated Balance Sheet for these deferred shares. The amount reflected in “Additional paid-in capital” for these deferred shares was $1.0 million at December 31, 20072008 and $1.1$1.0 million at December 31, 2006.2007.

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(b) Retirement Savings Plan
Selective Insurance Company of America (“SICA”) offers a voluntary defined contribution 401(k) retirement savings plan to employees who meet eligibility requirements. Participants, other than highly compensated employees as defined by the IRS, can contribute up to 50% of their defined compensation to the Retirement Savings Plan. Highly compensated employees are limited to 8% of their defined compensation. Contributions by participants are matchedWe match 65% by Selectiveof participant contributions up to a maximum of 7% of defined compensation. Effective January 1, 2006, the Selective Insurance Retirement Savings Plan (“Retirement Savings Plan”) was amended to include additional enhanced matching contributions and non-elective contributions for otherwise eligible employees who, because of a date of hire after December 31, 2005, are not eligible for the Retirement Income Plan for Selective Insurance Company of America (“Retirement Income Plan”). For those employees, following one year of service, Selective matches,we match, dollar for dollar, up to 2% of the employee’s base pay contributions. In addition, Selective makeswe make non-elective contributions to the Retirement Savings Plan equal to 2% of the employee’s base pay effective with the first pay following one year of service.

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The Retirement Savings Plan allows employees to make voluntary contributions to a number of diversified investment options, as well as Selective’s Common Stock,the Parent’s common stock, on a before and/or after-tax basis. Shares of Selective’s Common Stockthe Parent’s common stock issued under this plan were 27,920 during 2008, 29,214 during 2007, and 21,472 during 2006, and 29,572 during 2005.2006. The number of shares of Selective’s Common Stockthe Parent’s common stock available to be purchased under the Retirement Savings Plan was 1,516,9541,489,034 at December 31, 2007.2008.
TwoThree additional defined contribution plans arewere maintained by Selective HR in 2008, which does not participate in Selective’sSICA’s defined contribution plan. The maximum allowable employee contribution to these plans is 75% of defined compensation. The contributions of highly compensated employees may be further restricted in accordance with the plan terms. At year end, Selective HR maintains only one defined contribution plan.
In all plans, employees age 50 or older who are contributing the maximum may also make additional contributions not to exceed the additional amount permitted by the IRS.
Employer contributions for all the plans amounted to $6.4 million in 2008, $5.4 million in 2007, and $4.4 million in 2006, and $4.0 million in 2005.2006.
(c) Deferred Compensation Plan
SelectiveSICA offers a nonqualified deferred compensation plan (“Deferred Compensation Plan”) to a group of management or highly compensated employees (the “Participants”) as a method of recognizing and retaining such employees. The Deferred Compensation Plan provides the Participants the opportunity to elect to defer receipt of specified portions of compensation and to have such deferred amounts treated as ifdeemed to be invested in specified investment options. A Participant in the Deferred Compensation Plan may elect to defer compensation or awards to be received from Selective,our company, including up to: (i) 50% of annual base salary; (ii) 100% of incentive compensation;annual bonus; and/or (iii) a percentage of other compensation as otherwise designated by the Administrator of the Deferred Compensation Plan.
In addition to the deferrals elected by the Participants, Selective may choose at any time to make discretionary contributions on a consistent basis to the deferral accounts of all Participants in its sole discretion. No discretionary contributions were made in 2007, 2006, or 2005. Selectivewe may also choose to make matching contributions to the deferral accounts of some or all Participants to the extent a Participant did not receive the maximum matching contribution permissible under Selective’sour Retirement Savings Plan due to limitations under the Internal Revenue Code or the Retirement Savings Plan. We may also choose at any time to make discretionary contributions to the deferral account of any Participant in our sole discretion. No discretionary contributions were made in 2008, 2007, or 2006.
SelectiveWe contributed $0.2 million in 2008 and $0.1 million in 2007 and 2006 and $0.4 million in 2005 to the Deferred Compensation Plan.
(d) Retirement Income and PostretirementPost-retirement Plans
Selective’sThe Retirement Income Plan is a noncontributory defined benefit retirement income plan covering all SICA employees who meet eligibility requirements. Selective’sThe funding policy provides that payments to the pension trust shall be equal to the minimum funding requirements of the Employee Retirement Income Security Act, plus additional amounts that the Board of Directors of Selective Insurance Company of America, the plan sponsor, may approve from time to time.  For entrants into

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The Retirement Income Plan was amended as of July 1, 2002, to provide for different calculations based on service with the company as of that date. Monthly benefits payable under the Retirement Income Plan on or after July 1, 2002, the monthly retirement benefits beginningand Supplemental Excess Retirement Plan at normal retirement were decreased to 1.2% from 2.0%age are computed by adding two calculations: (i) 2% of “average monthly base salary” (based on the monthly average of the participant’s compensation for the 60 months out of the most recent 120 months of employment preceding the participant’s termination of employment for which the employee’s base salary is the highest) less 1 3/7% of a social security benefit multiplied by the number of years of benefit service through June 30, 2002 (up to a maximum of 35 years); and, (ii) 1.2% of average monthly compensation as defined.  Also, for all Retirement Income Plan participants, earlybase salary (as described above) multiplied by the number of years of benefit service after June 30, 2002. The earliest retirement eligibility begins atage is age 55 with 10 years of service or when the sumattainment of a participant’s age70 points (age plus years of service equalsservice). For a participant who retires at least 70.the earliest retirement age, the Retirement Income Plan’s early reduction factors are 6 2/3% per year for the first five years and 3 1/3% for the next five years and the reduction is actuarially equivalent for the years earlier than age 55. At retirement, participants receive monthly pension payments and may choose among four joint and survivor payment options.
Effective January 1, 2006, the Retirement Income Plan was amended to eliminate eligibility for plan participation by employees first hired on or after January 1, 2006. If otherwise qualified, these employees will, however, be eligible for enhanced matching and non-elective Selective contributions from SICA under the Retirement Savings Plan as discussed above.

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SelectiveSICA also provides life insurance benefits (postretirement(post-retirement benefits) for retired employees.  Substantially all of Selective’s employees may becomewho terminate employment and meet the age and service requirements to otherwise be eligible for these benefits if they reach retirement age while working for Selective and meet a minimum of 10 years of eligibility service.  Those individualsbenefit under the Retirement Income Plan (referred to as “Retirees”). Retirees who retired prior to January 1, 1991 receive life insurance coverage which decreases over ten years to a current ultimate value of up to approximately $70,000 per retiree. Those individuals who retired on or after January 1, 1991, through December 31, 2001, receive life insurance coverage in an amount equal to 50% of their annual salary amount in effect at the end of their active career to a maximum benefit of $100,000.  Those individuals retiring on or after January 1, 2002, through December 31, 2004, receive life insurance coverage in an amount equal to 50% of their annual salary amount in effect at the end of their active career to a maximum benefit of $35,000.  Those individuals retiring on or after January 1, 2005, through December 31, 2007, receive life insurance coverage in an amount equal to 50% of their active life insurance coverage in effect at the end of their active career to a maximum benefit of $35,000.  Those individuals retiringterminated employment with SICA on or after January 1, 2008 thatwho have attained age 60 by December 31, 2007 will receive life insurance coverage in an amount equal to 50% of their active life insurance coverage in effect aton the end of their active careerdate the Retiree terminates employment with SICA to a maximum benefit of $35,000. All other individuals retiringRetirees who terminated employment with SICA on or after January 1, 2008 will receive life insurance coverage in an amount equal to $10,000. Retirees who terminated employment with SICA prior to January 1, 2008 are eligible for a maximum life insurance benefit, depending upon the Retiree’s date of termination ranging from $35,000 to $100,000. The estimated cost of these benefits is accrued over the working lives of those employees expected to qualify for such benefits.
                 
  Retirement Income Plan  Postretirement Plan 
(in thousands) 2007  2006  2007  2006 
Change in Benefit Obligation:
                
Benefit obligation, beginning of year $149,943   148,137   8,610   7,554 
Service cost  7,454   7,345   317   339 
Interest cost  8,963   8,061   495   472 
Actuarial (gains) losses  (11,265)  (10,310)  (275)  488 
Benefits paid  (3,743)  (3,290)  (261)  (243)
Special termination benefits  900   —   100   — 
             
Benefit obligation, end of year $152,252   149,943   8,986   8,610 
             
                 
Change in Fair Value of Assets:
                
Fair value of assets, beginning of year $135,911   121,785   —   — 
Actual return on plan assets (net of expenses)  7,555   13,194   —   — 
Contributions by the employer to funded plans  8,200   4,150   —   — 
Contributions by the employer to unfunded plans  72   72   —   — 
Benefits paid  (3,743)  (3,290)  —   — 
             
Fair value of assets, end of year $147,995   135,911   —   — 
             
                 
Funded status
 $(4,257)  (14,032)  (8,986)  (8,610)
             
                 
Amounts Recognized in the Consolidated Balance Sheet:
                
Liabilities  (4,257)  (14,032)  (8,986)  (8,610)
             
Net pension liability, end of year $(4,257)  (14,032)  (8,986)  (8,610)
             
                 
Amounts Recognized in the Accumulated Other Comprehensive Income:
                
Prior service cost (credit) $776   926   (235)  (267)
Net actuarial loss  11,543   19,967   250   525 
             
Total $12,319   20,893   15   258 
             
                 
Other Information as of December 31:
                
Accumulated benefit obligation $128,524   125,005   —   — 
                 
Information for Pension Plans with an Accumulated Benefit Obligation in Excess of Plan Assets as of December 31:
                
Projected benefit obligation $3,957   3,836   —   — 
Accumulated benefit obligation  2,771   2,658   —   — 
                 
Weighted-Average Liability Assumptions as of December 31:
                
Discount rate  6.50 %  5.90   6.50   5.90 
Rate of compensation increase  4.00 %  4.00   4.00   4.00 

 

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  Retirement Income Plan  Postretirement Plan 
(in thousands) 2007  2006  2005  2007  2006  2005 
Components of Net Periodic Benefit Cost and Other Amounts Recognized in Other Comprehensive Income:
                        
 
Net Periodic Benefit Cost:
                        
Service cost $7,454   7,345   6,911   317   339   384 
Interest cost  8,963   8,061   7,502   495   472   392 
Expected return on plan assets  (11,092)  (9,753)  (9,286)  —   —   — 
Amortization of unrecognized prior service cost (credit)  150   150   150   (32)  (32)  (32)
Amortization of unrecognized actuarial loss  696   1,682   1,198   —   25   — 
Special termination benefits  900   —   —   100   —   — 
                   
Net periodic cost $7,071   7,485   6,475   880   804   744 
                   
                         
Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income:
                        
Net actuarial gain  (7,728)  —   —   (275)  —   — 
Reversal of amortization of net actuarial loss  (696)  —   —   —   —   — 
Reversal of amortization of prior service (cost)/credit  (150)  —   —   32   —   — 
                   
Total recognized in other comprehensive income  (8,574)  —   —   (243)  —   — 
                   
Total recognized in net periodic benefit cost and other comprehensive income $(1,503)  7,485   6,475   637   804   744 
                   
The funded status of these plans was recognized in the Consolidated Balance Sheets for 2008 and 2007, the details of which are as follows:
                 
  Retirement Income Plan  Post-retirement Plan 
($ in thousands) 2008  2007  2008  2007 
Change in Benefit Obligation:
                
Benefit obligation, beginning of year $152,252   149,943   8,986   8,610 
Service cost  6,966   7,454   122   317 
Interest cost  10,039   8,963   473   495 
Plan amendments  —   —   (1,985)  — 
Actuarial losses (gains)  15,352   (11,265)  364   (275)
Benefits paid  (4,268)  (3,743)  (316)  (261)
Special termination benefits  —   900   —   100 
             
Benefit obligation, end of year $180,341   152,252   7,644   8,986 
             
                 
Change in Fair Value of Assets:
                
Fair value of assets, beginning of year $147,995   135,911   —   — 
Actual return on plan assets, net of expenses  (32,689)  7,555   —   — 
Contributions by the employer to funded plans  6,145   8,200   —   — 
Contributions by the employer to unfunded plans  75   72   —   — 
Benefits paid  (4,268)  (3,743)  —   — 
             
Fair value of assets, end of year $117,258   147,995   —   — 
             
                 
Funded status
 $(63,083)  (4,257)  (7,644)  (8,986)
             
                 
Amounts Recognized in the Consolidated Balance Sheet:
                
Liabilities  (63,083)  (4,257)  (7,644)  (8,986)
             
Net pension liability, end of year $(63,083)  (4,257)  (7,644)  (8,986)
             
                 
Amounts Recognized in Accumulated Other Comprehensive (Loss) Income:
                
Prior service cost (credit) $626   776   (2,045)  (235)
Net actuarial loss  71,315   11,543   614   250 
             
Total $71,941   12,319   (1,431)  15 
             
                 
Other Information as of December 31:
                
Accumulated benefit obligation $152,744   128,524   —   — 
                 
Information for Pension Plans with an Accumulated Benefit Obligation in Excess of Plan Assets as of December 31:
                
Projected benefit obligation $180,341   3,957   —   — 
Accumulated benefit obligation  152,744   2,771   —   — 
                 
Weighted-Average Liability Assumptions as of December 31:
                
Discount rate  6.24%  6.50   6.24   6.50 
Rate of compensation increase  4.00%  4.00   4.00   4.00 

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  Retirement Income Plan  Post-retirement Plan 
($ in thousands) 2008  2007  2006  2008  2007  2006 
Components of Net Periodic Benefit Cost and Other Amounts Recognized in Other Comprehensive Loss (Income):
                        
                         
Net Periodic Benefit Cost:
                        
Service cost $6,966   7,454   7,345   122   317   339 
Interest cost  10,039   8,963   8,061   473   495   472 
Expected return on plan assets  (11,867)  (11,092)  (9,753)  —   —   — 
Amortization of unrecognized prior service cost (credit)  150   150   150   (175)  (32)  (32)
Amortization of unrecognized actuarial loss  136   696   1,682   —   —   25 
Special termination benefits  —   900   —   —   100   — 
                   
Net periodic cost $5,424   7,071   7,485   420   880   804 
                   
                         
Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Loss (Income):
                        
Net actuarial loss (gain)  59,908   (7,728)  —   364   (275)  — 
Prior service credit  —   —   —   (1,985)  —   — 
Reversal of amortization of net actuarial loss  (136)  (696)  —   —   —   — 
Reversal of amortization of prior service (cost) credit  (150)  (150)  —   175   32   — 
                   
Total recognized in other comprehensive loss (income)  59,622   (8,574)  —   (1,446)  (243)  — 
                   
                         
Total recognized in net periodic benefit cost and other comprehensive loss (income) $65,046   (1,503)  7,485   (1,026)  637   804 
                   
In the second quarter of 2007, Selectivewe restructured itsour personal lines department. As part of this restructuring, an early retirement enhancement option was offered to eligible employees. The present value of the enhancement to be made in conjunction with this early retirement option iswas equal to $0.9 million for the Retirement Income Plan and $0.1 million for the PostretirementPost-retirement Plan.
The amortization of prior service cost related to the Retirement Income Plan and PostretirementPost-retirement Plan is determined using a straight-line amortization of the cost over the average remaining service period of employees expected to receive benefits under the Plans.
The estimated net actuarial loss and prior service cost for the Retirement Income Plan that will be amortized from accumulated other comprehensive (loss) income into net periodic benefit cost during the 2008 fiscal year are $0.1$4.5 million and $0.2 million, respectively. The estimated net actuarial loss and prior service costcredit for the Postretirement Plan that will be amortized from accumulated other comprehensive (loss) income into net periodic benefit cost during the 2008 fiscal year are $0 and $(32,000) respectively.is $0.2 million.
                                                
 Retirement Income Plan Postretirement Plan  Retirement Income Plan Post-retirement Plan 
(in thousands) 2007 2006 2005 2007 2006 2005 
($ in thousands) 2008 2007 2006 2008 2007 2006 
Weighted-Average Expense Assumptions for the years ended December 31:
  
Discount rate  5.90 % 5.50 5.75 5.90 5.50 5.75   6.50% 5.90 5.50 6.50 5.90 5.50 
Expected return on plan assets  8.00 % 8.00 8.00 — — —   8.00% 8.00 8.00 — — — 
Rate of compensation increase  4.00 % 4.00 4.00 4.00 4.00 4.00   4.00% 4.00 4.00 4.00 4.00 4.00 
                
 Retirement Postretirement 
(in thousands) Income Plan Plan 
($ in thousands) Retirement Income Plan Post-retirement Plan 
Benefits Expected to be Paid in Future
  
Fiscal Years:  
2008 4,197 288 
2009 4,670 299  $5,493 324 
2010 5,163 310  5,936 355 
2011 5,711 323  6,523 372 
2012 6,532 336  7,179 390 
2013-2017 45,398 1,937 
2013 7,965 409 
2014-2018 53,681 2,316 
The funded status was recognized in the consolidated balance sheet for 2007 and 2006.

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Selective’sOur measurement date was December 31, 20072008 and itsour expected return on plan assets was 8.0%, which was based primarily on the Retirement Income Plan’s long-term historical returns. Selective’sOur expected return is supported by itsapproximates our actual 9.0%7.4% annualized return achieved since plan inception for all plan assets. In addition to the plan’s historical returns, Selective considerswe consider long-term historical rates of return on the respective asset classes. SelectiveWe presently anticipatesanticipate contributing $4.2$8.0 million to the Retirement Income Plan in 20082009, none of which represents minimum required contribution amounts, and hashave kept itsour expected return on plan assets at 8.0% after examining recent market conditions and trends.

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Selective’s 2007
Our 2008 discount rate used to value the liability is 6.5%6.24% for both the Retirement Income Plan and Postretirementthe Post-retirement Plan. SelectiveWe determined the most appropriate discount rate in comparison to our expected pay-outpay out patterns of the plans’ obligations.
Assets of the Retirement Income Plan shall be invested to ensure that principal is preserved and enhanced over time. In addition, the Retirement Income Plan is expected to perform above average relative to comparable funds without assuming undue risk, and to add value through active management. Selective’sOur return objective is to meet or exceed the returns of the plan’s policy index, which is the return the plan would have earned if the assets were invested according to the target asset class weightings and earned index returns. The plan’s allocated target and ranges by investment categories are as follows:
         
Investment Category Target  Range 
Equity  44%  40-5035-53%
Alternative investments  27%  22-3220-34%
Fixed Income  29%  21-37%
Additionally, the portfolio may not contain more than 5% of the portfolio value invested in any one security or issuer, regardless of the number of differing issues, except for U.S. Treasury and agency obligations, as well as sovereign debt issues rated A through AAA. The use of leverage is prohibited and the fund managers are prohibited from investing in certain types of securities.
The weighted average asset allocation by percentage of the Retirement Income Plan at December 31 is as follows:
                
 2007 2006  2008 2007 
Equity securities and funds  40% 49    34% 40 
Fixed income securities and funds 28 27   34 28 
Alternative investments 30 21   31 30 
Cash and short-term investments 2 3   1 2 
          
Total  100% 100    100% 100 
          
The Retirement Income Plan had no investments in the Common StockParent’s common stock as of the Company at December 31, 20072008 and 2006.2007.
Note 1716 Share-Based Payments
The following is a brief description of each of Selective’sour share-based compensation plans:
2005 Omnibus Stock Plan
The Selective Insurance Group, Inc.Parent’s 2005 Omnibus Stock Plan (“Stock Plan”) was adopted and approved by the Board of Directors effective as of April 1, 2005, and approved by stockholders’stockholders on April 27, 2005. With the Stock Plan’s approval, no further grants are available under the: (i) Selective InsuranceParent’s Stock Option Plan III, as amended (“Stock Option Plan III”); (ii) Selective Insurance Group, Inc.Parent’s Stock Option Plan for Directors, as amended (“Stock Option Plan for Directors”); or (iii) Selective Insurance Group, Inc.Parent’s Stock Compensation Plan for Nonemployee Directors, as amended (“Stock Compensation Plan for Nonemployee Directors”), but awards outstanding under these plans and the Selective Insurance Group, Inc. Stock Option Plan II, as amended (“Stock Option Plan II”), under which future grants ceased being available on May 22, 2002, shall continue in effect according to the terms of those plans and any applicable award agreements.
Under the Stock Plan, the Board of Directors’Board’s Salary and Employee Benefits Committee (“SEBC”) may grant stock options, stock appreciation rights (“SARs”), restricted stock, restricted stock units (“RSUs”), phantom stock, stock bonuses, and other awards in such amounts and with such terms and conditions as it shall determine, subject to the provisions of the Stock Plan. Each award granted under the Stock Plan (except unconditional stock bonuses and the cash component of Director compensation) shall be evidenced by an agreement containing such restrictions as the SEBC may, in its sole discretion, deem necessary or desirable and which are not in conflict with the terms of the Stock Plan. The maximum exercise period for an option grant under this plan is ten years from the date of the grant. During 2008, we granted, net of forfeitures, 382,521 RSUs, and experienced net restricted stock forfeitures of 45,240 shares. During 2007 Selective issued,and 2006 we granted, net of forfeitures, 478,862 and 309,218 shares of restricted shares, 309,218 restricted shares during 2006 and 8,750 during 2005. Selectivestock, respectively. We also granted options to purchase 191,568 shares during 2008, 158,435 shares during 2007, and 88,940, shares during 2006 and 2,500 shares during 2005.2006. As of December 31, 2007, 2,691,5992008, 2,724,227 shares of Selective’s Common Stockthe Parent’s common stock remain available for issuance pursuant to outstanding stock options and restricted stock awards granted under the Stock Plan.
During the vesting period, dividend equivalent units (“DEUs”) are earned on the RSUs. The DEUs are reinvested in the Parent’s common stock at fair value on each dividend payment date. During 2008, 8,667 DEUs were accrued in relation to the RSUs granted. The DEUs are subject to the same vesting period and conditions set forth in the award agreement for the RSUs.

 

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Cash Incentive Plan
The Selective Insurance Group, Inc.Parent’s Cash Incentive Plan (“Cash Incentive Plan”) was adopted and approved by the Board of Directors effective March 1, 2006 and approved by stockholders on April 27, 2005. Under the Cash Incentive Plan, the Board of Directors’Board’s SEBC may grant cash incentive units in such amounts and with such terms and conditions as it shall determine, subject to the provisions of the Cash Incentive Plan. The initial dollar value of these grants will be adjusted to reflect the percentage increase or decrease in the total shareholder return on the Common Stock of SelectiveParent’s common stock over a specified performance period. In addition, for certain grants, the number of units granted will be adjusted to reflect Selective’sour performance on specified indicators as compared to targeted peer companies. Each award granted under the Cash Incentive Plan shall be evidenced by an agreement containing such restrictions as the SEBC may, in its sole discretion, deem necessary or desirable and which are not in conflict with the terms of the Cash Incentive Plan. During 2007, Selective2008, we issued, net of forfeitures, 48,890 cash units, 38,681 cash units during 2007, and 79,384 cash units net of forfeitures.during 2006.
Stock Option Plan II
As of December 31, 2007, 548,6822008, 416,242 shares of Selective’s Common Stockthe Parent’s common stock remain available for issuance pursuant to outstanding stock options and restricted stock awards granted under Stock Option Plan II, under which future grants ceased being available on May 22, 2002. Under Stock Option Plan II, employees were granted qualified and nonqualified stock options, with or without stock appreciation rights (“SARs”),SARs, and restricted or unrestricted stock: (i) at not less than fair value on the date of grant and (ii) subject to certain vesting periods as determined by the SEBC. Restricted stock awards also could be subject to the achievement of performance objectives as determined by the SEBC. The maximum exercise period for an option grant under this plan is ten years from the date of the grant. There were no forfeitures under this plan in 2008 and 2007, and forfeitures in 2006 and 2005 amounted to 984 restricted shares and 13,600 restricted shares respectively.shares.
During the vesting period, dividends are earned on the restricted shares and held in escrow subject to the same vesting period and conditions set forth in the award agreement. Effective September 3, 1996, dividends earned on the restricted shares were reinvested in Selective’s Common Stockthe Parent’s common stock at fair value. SelectiveWe issued, net of forfeitures, 539255 restricted shares from the DRPDividend Reinvestment Plan (“DRP”) reserves during 2008, 539 restricted shares during 2007, and 346 restricted shares during 2006, and 5,892 restricted shares during 2005.2006.
Stock Option Plan III
As of December 31, 2007,2008, there were 458,930427,288 shares of Selective’s Common Stockthe Parent’s common stock available for issuance pursuant to outstanding stock options and restricted stock awards granted under Stock Option Plan III, under which future grants ceased being available with the approval of the Stock Plan. Under Stock Option Plan III, employees were granted qualified and nonqualified stock options, with or without SARs, and restricted or unrestricted stock: (i) at not less than fair value on the date of grant and (ii) subject to certain vesting restrictions determined by the SEBC. Restricted stock awards also could be subject to achievement of performance objectives as determined by the SEBC. The maximum exercise period for an option grant under this plan is ten years from the date of the grant. Under Stock Option Plan III, Selective granted options to purchase 211,326 shares without SARs during 2005.
Selective also granted 626,216We experienced restricted stock forfeitures of 21,532 shares during 2005, and experienced forfeitures of2008, 25,128 shares during 2007 and 61,446 shares during 2006 and 48,030 shares during 2005.2006. During the vesting period, dividends earned on restricted shares are reinvested in Selective’s Common Stockthe Parent’s common stock at fair value. SelectiveWe issued, net of forfeitures, 11,6941,017 restricted shares from the DRP reserves during 2008, 11,694 restricted shares during 2007, and 24,446 restricted shares during 2006, 27,042 restricted shares during 2005.2006.
Stock Option Plan for Directors
As of December 31, 2007, 420,0002008, 372,000 shares of Selective’s Common Stockthe Parent’s common stock were available for issuance pursuant to outstanding stock option awards under the Stock Option Plan for Directors, under which future grants ceased being available with the approval of the Stock Plan. All non-employee directors participated in this plan and automatically received an annual nonqualified option to purchase 6,000 shares of Common Stockthe Parent’s common stock at not less than fair value on the date of grant, which was on March 1. Options under this plan vested on the first anniversary of the grant and must be exercised by the tenth anniversary of the grant. Under the Stock Option Plan for Directors, Selective granted 66,000 options during 2005.
Stock Compensation Plan for Non-employee Directors
As of December 31, 2007,2008, there were 95,250 shares of the Common StockParent’s common stock available for issuance pursuant to outstanding stock option awards under the Stock Compensation Plan for Non-employee Directors, under which future grants ceased being available with the approval of the Stock Plan. Under the Stock Compensation Plan for Non-employee Directors, Directors could elect to receive a portion of their annual compensation in shares of Selective’s Common Stock. Selective issued 21,838 shares during 2005 under this plan.the Parent’s common stock.

 

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Employee Stock Purchase Savings Plan
Under Selective’sour Employee Stock Purchase Savings Plan (“ESPP”), there were 251,434116,873 shares of Common Stockthe Parent’s common stock available for purchase as of December 31, 2007.2008. The ESPP is available to all employees who meet the plan’s eligibility requirements. The ESPP provides for the issuance of options to purchase shares of Common Stock.common stock. The purchase price is the lower of: (i) 85% of the closing market price at the time the option is granted or (ii) 85% of the closing price at the time the option is exercised. Shares are generally issued on June 30 and December 31 of each year. Under the ESPP, Selectivewe issued 108,062134,561 shares to employees during 2008, 108,062 shares during 2007, and 88,310 shares during 2006, 88,758 shares during 2005.2006.
Agent Stock Purchase Plan
On April 26, 2006, Selective’sour stockholders approved the Selective Insurance Group, Inc. Stock Purchase Plan for Independent Insurance Agencies (“Agent Plan”). This plan replaced the previous agent purchase plan under which no further purchases could be made as of July 1, 2006. Under the Agent Plan, there were 2,778,7352,641,471 shares of Common Stockcommon stock available for purchase as of December 31, 2007.2008. The Agent Plan provides for quarterly offerings in which independent insurance agencies and certain eligible persons associated with the agencies with contracts with the Insurance Subsidiaries can purchase Selective’s Common Stockthe Parent’s common stock at a 10% discount with a one year restricted period during which the shares purchased cannot be sold or transferred. Collectively, under the current and prior plans, Selectivewe issued shares to agents in the amount of 137,264 in 2008, 157,375 in 2007 and 153,478 in 2006 and 158,856 in 2005 and charged to expense $0.3 million in 2008, and $0.4 million in both 2007 2006, and 2005,2006, with a corresponding income tax benefit of $0.1 million in each year.
A summary of the stock option transactions under Selective’sour share-based payment plans is as follows:
                 
          Weighted    
      Weighted  Average    
      Average  Remaining  Aggregate 
  Number  Exercise  Contractual  Intrinsic Value 
  of shares  Price  Life in Years  ($ in thousands) 
Outstanding at December 31, 2006  1,250,036  $14.99         
Granted 2007  158,435   26.37         
Exercised 2007  165,054   13.12         
Forfeited or expired 2007  2,264   14.02         
               
                 
Outstanding at December 31, 2007  1,241,153  $16.69   5.22  $7,821 
             
Exercisable at December 31, 2007  1,075,096  $15.13   4.66  $8,453 
             
                 
          Weighted    
      Weighted  Average    
      Average  Remaining  Aggregate 
  Number  Exercise  Contractual  Intrinsic Value 
  of shares  Price  Life in Years  ($ in thousands) 
Outstanding at December 31, 2007  1,241,153  $16.69         
Granted 2008  191,568   24.02         
Exercised 2008  233,614   11.24         
Forfeited or expired 2008  40,260   24.40         
             
                 
Outstanding at December 31, 2008  1,158,847  $18.73   5.50  $6,047 
             
Exercisable at December 31, 2008  954,094  $17.40   4.79  $6,047 
             
The total intrinsic value of options exercised was $2.8 million at December 31, 2008, $1.9 million at December 31, 2007, and $6.1 million at December 31, 2006, and $7.4 million at December 31, 2005.2006.
A summary of the restricted stock and RSU transactions under Selective’sour share-based payment plans is as follows:
         
      Weighted 
      Average 
  Number  Grant Date 
  of shares  Fair Value 
         
Unvested restricted stock awards at January 1, 2007  1,864,478  $19.49 
Granted 2007  493,416   27.30 
Vested 2007  908,847   17.41 
Forfeited 2007  39,682   22.66 
       
Unvested restricted stock awards at December 31, 2007  1,409,365  $23.47 
       
         
      Weighted 
      Average 
  Number  Grant Date 
  of shares  Fair Value 
Unvested restricted stock and RSU awards at January 1, 2008  1,409,365  $23.47 
Granted 2008  406,454   23.11 
Vested 2008  605,081   20.77 
Forfeited 2008  90,705   25.03 
       
         
Unvested restricted stock and RSU awards at December 31, 2008  1,120,033  $24.67 
       
As of December 31, 2007,2008, total unrecognized compensation cost related to nonvestednon-vested restricted stock and RSU awards granted under Selective’sour stock plans was $9.5$6.6 million. That cost is expected to be recognized over a weighted-average period of 1.61.5 years. The total fair value of restricted stock and RSU vested was $14.2 million for 2008, $22.7 million for 2007, and $11.7 million for 2006, and $10.9 million for 2005.2006. In connection with the restricted stock vestings, the total fair value of the DRP shares that also vested was $0.6 million during 2008, $1.1 million during 2007, and $0.9 million during 2006, and $1.0 million during 2005.2006.

 

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At December 31, 2007,2008, the liability recorded in connection with Selective’sour Cash Incentive Plan was $9.4$13.2 million. The fair value of the liability is re-measured at each reporting period through the settlement date of the awards, which is three years from the date of grant.grant based on an amount expected to be paid. A Monte Carlo simulation is performed to determine the fair value of the cash incentive units that, in accordance with the Cash Incentive Plan, are adjusted to reflect Selective’sour performance on specified indicators as compared to targeted peer companies. The remaining cost associated with the cash incentive units is expected to be recognized over a weighted average period of 1.21.6 years. During 2008, 2007, and 2006, no cash incentive unit payments were made.
In determining expense to be recorded for stock options granted under Selective’sour share-based compensation plans, the fair value of each option award is estimated on the date of grant using the Black Scholes option valuation model (“Black Scholes”). The following are the significant assumptions used in applying Black Scholes: (i) risk-free interest rate, which is the implied yield currently available on U.S. Treasury zero-coupon issues with an equal remaining term; (ii) expected term, which is based on historical experience of similar awards; (iii) dividend yield, which is determined by dividing the expected per share dividend during the coming year by the grant date stock price; and (iv) expected volatility, which is based on the volatility of Selective’sthe Parent’s stock price over a historical period comparable to the expected term. In applying Black Scholes, Selective useswe use the weighted average assumptions illustrated in the following table:
                                                
 Employee Stock Purchase Plan All Other Option Plans  Employee Stock Purchase Plan All Other Option Plans 
 2007 2006 2005 2007 2006 2005  2008 2007 2006 2008 2007 2006 
Risk-free interest rate  5.11%  4.78%  2.94%  4.67%  4.55%  3.99 %  2.77%  5.11%  4.78%  2.97%  4.67%  4.55%
Expected term 6 months 6 months 6 months  6 years 6 years 7 years  6 months 6 months 6 months 6 years 6 years 6 years 
Dividend yield  1.7%  1.6%  1.6%  1.8%  1.5%  1.7 %  2.5%  1.7%  1.6%  2.2%  1.8%  1.5%
Expected volatility  17%  19%  27%  23%  25%  26 %  38%  17%  19%  25%  23%  25%
The expense recorded for restricted stock awards and stock compensation for non-employee directors is determined using the number of awards granted and the grant date fair value.value and is amortized over the requisite service period.
The weighted-average fair value of options and stock, including restricted stock and RSUs granted per share for Selective’sthe Parent’s stock plans, during 2008, 2007, 2006, and 20052006 is as follows:
                        
 2007 2006 2005  2008 2007 2006 
Stock options $7.02 8.01  6.57   $5.43 7.02 8.01 
Restricted stock 27.30 28.46  22.57  
Restricted stock and RSUs 23.11 27.30 28.46 
Directors’ stock compensation plan 25.57 26.87  23.54   22.70 25.57 26.87 
Employee stock purchase plan (ESPP):  
Six month option 1.47 1.58  1.59   2.02 1.47 1.58 
15% of grant date market value 3.72 4.19  3.50   2.83 3.72 4.19 
              
Total ESPP 5.19 5.77  5.09   4.85 5.19 5.77 
Agent stock purchase plan:  
Discount of grant date market value $2.40 2.71  2.45   $2.24 2.40 2.71 
              
Share-based compensation expense charged against net income before tax was $20.6$16.9 million atfor the year ended December 31, 20072008 with a corresponding income tax benefit of $6.8$5.5 million. Share-based compensation expense that was charged against net income before tax was $20.6 million for the year ended December 31, 2007 and $20.1 million atfor the year ended December 31, 2006 with a corresponding income tax benefit of $6.8 million and $6.7 million. As part of the 2005 divestiture of CHN Solutions, unvested restricted stock awards were modified, resulting in a cash payment of $1.0 million, in lieu of issuing shares. In addition, accelerated share based compensation of $0.4 million as of December 31, 2005 after tax, is included in “Loss on disposal of discontinued operations, net of tax” on the Consolidated Statements of Income. See Note 15, “Discontinued Operations,” for additional information regarding the divestiture.respectively.
Note 1817 Related Party Transactions
In August 1998, certain officers of Selectiveour company purchased stock on the open market with proceeds advanced by Selective.us. These officers gave Selectiveour company promissory notes totaling $1.8 million. The promissory notes bear interest at 2.5% and are secured by the purchased shares of Selective’s Common Stock.the Parent’s common stock. The promissory notes are full recourse and subject to certain employment requirements. The principal amount outstanding, which is scheduled to be fully repaid in 2009, was $0.1 million at December 31, 2008 and $0.2 million at December 31, 2007 and December 31, 2006.2007. The outstanding balances are reflected in “Other assets” on the Consolidated Balance Sheets.
William M. Rue, a Director of Selective Insurance Group, Inc.,the Parent, is President of, and owns more than 10% of the equity of, Chas. E. Rue & Sons, Inc. t/a Rue Insurance, a general independent insurance agency (“Rue Insurance”). Rue Insurance is an appointed independent agent of Selective’sthe Insurance Subsidiaries and Selective HR, on terms and conditions similar to those of our other Selective agents. Rue Insurance also places insurance for Selective’sour business operations. Selective’sOur relationship with Rue Insurance has existed since 1928.

 

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The following is a summary of transactions with Rue Insurance:
 • Rue Insurance placed insurance policies with Selective’sthe Insurance Subsidiaries. Direct premiums written associated with these policies waswere $8.3 million in 2008, $9.9 million in 2007, and $9.5 million in 2006, and $10.2 million in 2005.2006. In return, Selective’sthe Insurance Subsidiaries paid commissions to Rue Insurance of $1.7 million in 2008 and 2007 and $1.9 million in 2006 and 2005.2006.
 
 • Rue Insurance placed human resource outsourcing contracts with Selective HR resulting in revenues to Selective HR of approximately $79,000 in 2008, $69,000 in 2007, and $62,000 in 2006, and $64,000 in 2005.2006. In return, Selective HR paid commissions to Rue Insurance of $12,000 in 2008, $15,000 in 2007, and $14,000 in 2006, and $15,000 in 2005.2006.
 
 • Rue Insurance placed insurance coverage for Selectiveus with non-Selectiveother insurance companies for which Rue Insurance was paid commission pursuant to its agreements with those carriers. SelectiveWe paid premiums for such insurance coverage of $0.5 million in 2008, 2007, $0.5 million in 2006, and $0.6 million in 2005.2006.
 
 • SelectiveWe paid reinsurance commissions of $0.2 million in 2008, 2007 2006, and 20052006 to PL, LLC. PL, LLC is an insurance fund administrator of which Rue Insurance owns 26.67%33.33% and which places reinsurance through a Selectivean Insurance Subsidiary.
In 2005, a private foundation, The Selective Group Foundation (the “Foundation”), was established by Selectiveus under Section 501(c)(3) of the Internal Revenue Code. The Board of Directors of the Foundation is comprised of certain Selective Insurance Group, Inc.some of the Parent’s officers. SelectiveWe made contributions to the Foundation in the amount of $0.5 million in 2008, $0.4 million in 2007 and $0.5 million in 2005. Nono donations were made to the Foundation in 2006.
Note 1918 Commitments and Contingencies
(a) Selective purchasesWe purchase annuities from life insurance companies to fulfill obligations under claim settlements which provide for periodic future payments to claimants. As of December 31, 2007, Selective2008, we had purchased such annuities in the amount of $10.3$9.5 million for settlement of claims on a structured basis for which Selective iswe are contingently liable. To Selective’sour knowledge, none of the issuers of such annuities have defaulted in their obligations thereunder.
(b) Selective hasWe have various operating leases for office space and equipment. Such lease agreements, which expire at various times, are generally renewed or replaced by similar leases. Rental expense under these leases amounted to $11.9 million in 2008, $11.2 million in 2007, and $9.6 million in 2006, and $10.0 million in 2005.2006. See Note 2(p)2(q) for information on Selective’sour accounting policy regarding leases.
In addition, certain leases for rented premises and equipment are non-cancelable, and liability for payment will continue even though the space or equipment may no longer be in use.
At December 31, 2007,2008, the total future minimum rental commitments under non-cancelable leases were $25.3$25.9 million and such yearly amounts are as follows:
        
($ in millions)   ($ in millions) 
2008 $8.6 
2009 6.0  $9.4 
2010 4.5  7.0 
2011 2.9  4.5 
2012 1.6  2.4 
After 2012 1.7 
2013 1.9 
After 2013 0.7 
      
Total minimum payment required $25.3  $25.9 
      
(c) At December 31, 2007, Selective has2008, we have contractual obligations that expire at various dates through 20222023 to invest up to an additional $129.8$119.5 million in alternative investments. There is no certainty that any such additional investment will be required. For additional information regarding these investments, see item (h) of Note 4, “Investments.”
Note 2019 Litigation
In the ordinary course of conducting business, Selective and its subsidiarieswe are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving Selective’s seven insurance subsidiaries (the “Insurance Subsidiaries”)the Insurance Subsidiaries as either (a) liability insurers defending or providing indemnity for third-party claims brought against insureds or (b) insurers defending first-party coverage claims brought against them. Selective accountsus. We account for such activity through the establishment of unpaid loss and loss adjustment expense reserves. Selective’s management expectsWe expect that the ultimate liability, if any, with respect to such ordinary-courseordinary course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to Selective’sour consolidated financial condition, results of operations, or cash flows.

 

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The Insurance Subsidiaries are also from time-to-timetime to time involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative state class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper reimbursement of medical providers paid under workers compensation and personal and commercial automobile insurance policies. The Insurance Subsidiaries are also from time-to-timetime to time involved in individual actions in which extra-contractual damages, punitive damages, or penalties are sought, such as claims alleging bad faith in the handling of insurance claims. Selective believesWe believe that it haswe have valid defenses to these cases. Selective’sOur management expects that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to Selective’sour consolidated financial condition. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in certain matters could, from time-to-time,time to time, have a material adverse effect on Selective’sour consolidated results of operations or cash flows in particular quarterly or annual periods.
Note 2120 Statutory Financial Information
The Insurance Subsidiaries prepare their statutory financial statements in accordance with accounting principles prescribed or permitted by the various state insurance departments of domicile. Prescribed statutory accounting principles include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (“NAIC”). Permitted statutory accounting principles encompass all accounting principles that are not prescribed; such principles differ from state to state, may differ from company to company within a state and may change in the future. The Insurance Subsidiaries do not utilize any permitted statutory accounting principles that materially affect the determination of statutory surplus, statutory net income, or risk-based capital. As of December 31, 20052008 the various state insurance departments of domicile have adopted the NAIC Accounting Practices and Procedures manual, version as of March 2007,2008, in its entirety, as a component of prescribed or permitted practices.
Selective’sThe combined statutory capital and surplus of the Insurance Subsidiaries was $1,034.3$884.4 million (unaudited) in 2007,2008, and $1,030.1$1,034.3 million in 2006. Selective’s2007. The combined statutory net income of the Insurance Subsidiaries was $167.6$104.3 million (unaudited) in 2008, $167.6 million in 2007, and $164.2 million in 2006, and $140.2 million in 2005.2006.
The Insurance Subsidiaries are required to maintain certain minimum amounts of statutory surplus to satisfy their various state insurance departments of domicile. These risk-based capital (“RBC”) requirements for property and casualty insurance companies are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. Based upon the Insurance Subsidiaries 2007Subsidiaries’ 2008 unaudited statutory financial statements, their combined total adjusted capital exceeded the authorized control level RBC by 5.0:4.4:1, as defined by the NAIC.
Note 2221 Subsequent Event
In February 2008, Selective announced2009, we transferred $1.6 billion of our AFS securities to a reductionheld-to-maturity designation. In accordance with FAS 115, we are required at each balance sheet date to reassess the classification designation of each security we hold. The reclassification of these securities is permitted as we have appropriately determined that we have the ability and the intent to hold these securities as an investment until maturity or call. When a security is transferred from AFS to held-to-maturity, the difference between its par value and fair value at the date of transfer is amortized as a yield adjustment in its workforceaccordance with FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases. The fair value at the date of transfer, adjusted for subsequent amortization, becomes the security’s amortized cost basis as required by FAS 115. The unrealized holding gain or loss at the date of transfer is retained in other comprehensive income and in the carrying value of the held-to maturity securities. Of the $1.6 billion in AFS securities transferred, $1.3 billion consist of state and political subdivision obligations and $0.3 billion in U.S. government, government agency obligations, and corporate, mortgage-backed and asset-backed securities. In total, the securities transferred had a net unrealized gain of approximately 80 positions, including the immediate displacement of 60 employees and the elimination of 20 open positions. Selective anticipates these changes will have a related one-time pre-tax cost of approximately $4 million in the first quarter of 2008. In addition, Selective is implementing targeted changes to agency commissions that will maintain highly competitive awards for agents who produce the strongest results, while reducing commissions where historically higher payments have not generated an appropriate level of profitable growth. The changes will bring Selective’s program more in line with the competition; however, commissions on 87% of direct premiums written will not be affected, and the supplemental commission program that rewards the most profitable growth agencies does not change and is targeted for rollout in most states in July 2008.$8 million.

 

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Note 2322 Quarterly Financial Information1
                                                                
(unaudited, in thousands, First Quarter Second Quarter Third Quarter Fourth Quarter 
(unaudited, $ in thousands, First Quarter Second Quarter Third Quarter Fourth Quarter 
except per share data) 2007 2006 2007 2006 2007 2006 2007 2006  2008 2007 2008 2007 2008 2007 2008 2007 
Net premiums written $417,185 431,989 404,923 395,621 409,523 401,426 323,236 306,925  $389,840 417,185 387,229 404,923 400,541 409,523 306,431 323,236 
Net premiums earned 380,013 370,157 376,351 374,755 378,260 377,572 382,682 377,180  381,273 380,013 375,089 376,351 372,510 378,260 366,618 382,682 
Net investment income earned 39,863 36,002 40,642 37,390 43,674 38,891 49,965 44,519  37,866 39,863 38,515 40,642 36,134 43,674 18,517 49,965 
Net realized gains 11,243 7,367 13,148 14,487 2,814 3,948 6,149 9,677 
Net realized gains (losses) 1,515 11,243 1,923 13,148  (22,577) 2,814  (30,313) 6,149 
Diversified Insurance Services revenues 29,178 27,278 30,677 27,550 29,331 29,284 26,380 26,415  29,799 29,178 30,064 30,677 30,481 29,331 26,002 26,380 
Diversified Insurance Services net income 2,903 2,359 4,019 2,754 3,075 3,943 2,358 2,791 
Net income 37,252 39,978 35,886 41,996 37,119 38,056 36,240 43,543 
Other comprehensive income (loss)  (3,139)  (12,571)  (23,774)  (30,119) 13,534 34,921  (1,178) 3,997 
Underwriting (loss) profit  (1,452) 9,717  (3,251)  (145)  (5,738) 5,122  (4,785) 1,263 
Diversified Insurance Services income (loss) before federal income tax 4,285 4,367 4,939 6,069 5,687 4,661  (384) 3,526 
Net income (loss) 20,503 37,252 28,651 35,886 8,992 37,119  (14,388) 36,240 
Other comprehensive (loss) income  (26,628)  (3,139)  (37,935)  (23,774)  (46,289) 13,534  (69,647)  (1,178)
                                  
Comprehensive income 34,113 27,407 12,112 11,877 50,653 72,977 35,062 47,540 
Net income per share: 4
 
Comprehensive (loss) income  (6,125) 34,113  (9,284) 12,112  (37,297) 50,653  (84,035) 35,062 
Net income (loss) per share:
 
Basic 0.68 0.75 0.69 0.77 0.72 0.69 0.70 0.79  0.39 0.68 0.55 0.69 0.17 0.72  (0.28) 0.70 
Diluted 0.62 0.64 0.64 0.68 0.66 0.63 0.67 0.72  0.38 0.62 0.54 0.64 0.17 0.66  (0.28) 0.67 
Dividends to stockholders2,4
 0.12 0.11 0.12 0.11 0.12 0.11 0.13 0.11 
Price range of common stock:3,4
 
Dividends to stockholders2
 0.13 0.12 0.13 0.12 0.13 0.12 0.13 0.13 
Price range of common stock:3
 
High 29.07 29.18 27.87 28.23 27.33 28.02 25.41 29.10  27.03 29.07 26.22 27.87 30.40 27.33 26.49 25.41 
Low 23.25 26.10 25.27 25.38 19.04 24.89 20.84 25.95  20.78 23.25 18.74 25.27 17.81 19.04 16.33 20.84 
The addition of all quarters may not agree to annual amounts on the consolidated financial statements due to rounding.
1.1 Refer to the Glossary of Terms attached to this Form 10-K as Exhibit 99.1.
 
2.2 See Note 9(b) and Note 10 to the consolidated financial statements for a discussion of dividend restrictions.
 
3.3 These ranges of high and low prices of Selective’s Common Stock,the Parent’s common stock, as reported by the NASDAQ Global Select Market, represent actual transactions. All price quotations do not include retail markups, markdowns and commissions. The range of high and low prices for Common Stockcommon stock for the period beginning January 2, 20082009 and ending February 22, 200820, 2009 was $20.78$23.28 to $24.92.
4.All per share amounts in 2006 have been restated to give retroactive effect to the two-for-one stock split distributed on February 20, 2007 to shareholders of record as of February 13, 2007. See Note 10 to the consolidated financial statements for a discussion of the stock split.$12.33.

 

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Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures
Selective’sOur management, with the participation of itsour Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Selective’sour disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, Selective’sour Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, Selective’sour disclosure controls and procedures are: (i) effective in recording, processing, summarizing, and reporting information on a timely basis that Selective iswe are required to disclosed in the reports that it fileswe file or submitssubmit under the Exchange Act; and (ii) effective in ensuring that information that Selective iswe are required to disclose in the reports that it fileswe file or submitssubmit under the Exchange Act is accumulated and communicated to Selective’sour management, including itsour Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
Selective’s
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) is a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by the company’s board of directors,Board, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
 • Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company;
 
 • Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
 
 • Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Selective’sOur management assessed the effectiveness of Selective’sour internal control over financial reporting as of December 31, 2007.2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) inInternal Control-Integrated Framework.
Based on its assessment, Selective’sour management believes that, as of December 31, 2007, Selective’s2008, our internal control over financial reporting is effective.
No changes in Selective’sour internal control over financial reporting (as such term is defined in Rule 13a-15(f) of the Exchange Act) occurred during the fourth quarter of 20072008 that materially affected, or are reasonably likely to materially affect, Selective’sour internal control over financial reporting.

 

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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Selective Insurance Group, Inc.:
We have audited Selective Insurance Group, Inc.’s and subsidiaries’ (“the Company”) internal control over financial reporting as of December 31, 2007,2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on Selective Insurance Group, Inc.’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Selective Insurance Group, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007,2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Selective Insurance Group, Inc. and subsidiaries as of December 31, 20072008 and 2006,2007, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2007,2008, and our report dated February 27, 20082009 expressed an unqualified opinion on those consolidated financial statements. Our report refers to a change in accounting principle regarding the definition of cash equivalents in 2006 and a change in the method of accounting for share-based payments in 2005.
/s/ KPMG LLP
New York, New York
February 27, 20082009

 

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Item 9B. Other InformationInformation.
There is no other information that was required to be disclosed in a report on Form 8-K during the fourth quarter of 20072008 that Selectivewe did not report.
PART III
Because Selectivewe will file a Proxy Statement within 120 days after the end of the fiscal year ending December 31, 2007,2008, this Annual Report on Form 10-K omits certain information required by Part III and incorporates by reference certain information included in the Proxy Statement.
Item 10. Directors, Executive Officers and Corporate Governance.
Information regarding Selective’sour executive officers appears in Item 1. “Business” of this Form 10-K under “Management.” Information about Selective’s directorsthe Board and all other matters required to be disclosed in Item 10. “Directors, and Executive Officers of the Registrant”and Corporate Governance” appears under “Election of Directors” in the Proxy Statement. That portion of the Proxy Statement is hereby incorporated by reference.
Section 16(a) Beneficial Ownership Reporting Compliance
Information about compliance with Section 16(a) of the Exchange Act appears under “Section 16(a) Beneficial Ownership Reporting Compliance” in the “Election of Directors” section of the Proxy Statement and is hereby incorporated by reference.
Item 11. Executive Compensation.
Information about compensation of Selective’sour named executive officers appears under “Executive Compensation” in the “Election of Directors” section of the Proxy Statement and is hereby incorporated by reference. Information about compensation of Selective’s directorsthe Board appears under “Director Compensation” in the “Election of Directors” section of the Proxy Statement and is hereby incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information about security ownership of certain beneficial owners and management appears under “Security Ownership of DirectorsManagement and Executive Officers”Certain Beneficial Owners” in the “Election of Directors” section of the Proxy Statement and is hereby incorporated by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Information about certain relationships and related transactions, and director independence appears under “Certain Relationships and Related Transactions” in the “Election of Directors” section of the Proxy Statement and is hereby incorporated by reference.
Item 14. Principal Accountant’sAccountant Fees and Services
Information about the fees and services of Selective’sour principal accountants appears under “Audit Committee Report” and “Fees of Independent Auditors”Public Accountants” in the “Ratification of Appointment of Independent Public Accountants” section of the Proxy Statement and is hereby incorporated by reference.

 

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PART IV
Item 15. Exhibits and Financial Statement Schedules.
(a)(a) The following documents are filed as part of this report:
(1)(1) Financial Statements:
The consolidated financial statements of the Company listed below are included in Item 8. “Financial Statements and Supplementary Data.”
   
  Form 10-K
  Page
Consolidated Balance Sheets as of December 31, 20072008 and 2006
2007		 6883
   
Consolidated Statements of Income for the Years ended December 31, 2008, 2007 2006 and 2005
2006		 6984
   
Consolidated Statements of Stockholders’ Equity for the Years ended December 31, 2008, 2007 2006 and 2005
2006		 7085
   
Consolidated Statements of Cash Flows for the Years ended December 31, 2008, 2007 2006 and 2005
2006		 7186
   
Notes to Consolidated Financial Statements, December 31, 2008, 2007 2006 and 2005
2006		 72
87
(2)(2) Financial Statement Schedules:
The financial statement schedules, with Independent Auditors’ Report thereon, required to be filed are listed below by page number as filed in this report. All other schedules are omitted as the information required is inapplicable, immaterial, or the information is presented in the consolidated financial statements or related notes.
       
    Form 10-K
    Page
Schedule I
 Condensed Financial Information of Registrant at December 31, 20072008 and 2006,2007 and for the years ended December 31, 2008, 2007 2006 and 20052006.  109129
       
Schedule II
 Allowance for Uncollectible Premiums and Other Receivables for the years ended December 31, 2008, 2007 2006 and 20052006.  112132
       
Schedule III
 Summary of Investments — Other than Investments in Related Parties at December 31, 20072008.  113133
       
Schedule IV
 Supplementary Insurance Information for the years ended December 31, 2008, 2007 2006 and 20052006.  114134
       
Schedule V
 Reinsurance for the years ended December 31, 2008, 2007 2006 and 20052006.  117
137
(3)(3) Exhibits:
The exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index, which is incorporated by reference and immediately precedes the exhibits filed with or incorporated by reference in this Form 10-K.

 

106126

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
SELECTIVE INSURANCE GROUP, INC.
 
SELECTIVE INSURANCE GROUP, INC.
      
By: /s/ Gregory E. MurphyFebruary 28, 2008
   February 27, 2009
Gregory E. Murphy   
Chairman of the Board, President and Chief Executive Officer   
      
By: /s/ Dale A. ThatcherFebruary 28, 2008
   February 27, 2009
Dale A. Thatcher   
Executive Vice President, Chief Financial Officer and Treasurer   
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
      
By: /s/ Gregory E. MurphyFebruary 28, 2008
   February 27, 2009
Gregory E. Murphy  
Chairman of the Board, President and Chief Executive Officer  
 
     
*
Paul D. Bauer		   February 28, 2008
Paul D. Bauer27, 2009
Director  
*February 28, 2008
W. Marston Becker
Director
*February 28, 2008
A. David Brown
Director
*February 28, 2008
John C. Burville
Director
*February 28, 2008
William M. Kearns, Jr.
Director  
     
*
W. Marston Becker		   February 28, 200827, 2009
Director
    
Joan M. Lamm-Tennant
*
A. David Brown
February 27, 2009
Director  
*
John C. Burville
February 27, 2009
Director
*
William M. Kearns, Jr.
February 27, 2009
Director
*
Joan M. Lamm-Tennant
February 27, 2009
Director  

 

107127

     
*
S. Griffin McClellan III		   February 28, 200827, 2009
Director  
S. Griffin McClellan III
Director  
     
*
Michael J. Morrissey		   February 28, 2008
Ronald L. O’Kelley27, 2009
Director  
*February 28, 2008
John F. Rockart
Director  
     
*
Ronald L. O’Kelley		   February 28, 2008
William M. Rue27, 2009
Director   
     
*
William M. Rue		   February 28, 200827, 2009
Director
    
*
J. Brian Thebault
  February 27, 2009
Director  
      
* By: /s/ Michael H. LanzaFebruary 28, 2008
   February 27, 2009
Michael H. Lanza  
Attorney-in-fact  

 

108128

SCHEDULE I
SELECTIVE INSURANCE GROUP, INC.
(Parent Corporation)
Balance Sheets
         
  December 31, 
(in thousands, except share amounts) 2007  2006 
Assets
        
Fixed maturity securities, available-for-sale — at fair value1
(cost: $14,006 - 2007; $47,612 - 2006)
 $13,980   47,470 
Short-term investments  64,492   115,332 
Cash  81   71 
Investment in subsidiaries  1,271,494   1,253,392 
Current federal income tax  18,453   14,842 
Deferred federal income tax  12,347   9,220 
Other assets  5,979   9,267 
       
Total assets $1,386,826   1,449,594 
       
         
Liabilities and Stockholders’ Equity
        
Liabilities:
        
Senior convertible notes $8,740   57,413 
Notes payable  286,151   304,424 
Other liabilities  15,892   10,530 
       
Total liabilities  310,783   372,367 
       
         
Stockholders’ equity:
        
Preferred stock of $0 par value per share:        
Authorized shares: 5,000,000; no shares issued or outstanding        
Common stock of $2 par value per share:        
Authorized shares: 360,000,000        
Issued: 94,652,930 - 2007; 91,562,266 - 2006  189,306   183,124 
Additional paid-in capital  192,627   153,246 
Retained earnings  1,105,946   986,017 
Accumulated other comprehensive income  86,043   100,601 
Treasury stock — at cost (shares: 40,347,894 - 2007; 34,289,974 - 2006)  (497,879)  (345,761)
       
Total stockholders’ equity  1,076,043   1,077,227 
       
Total liabilities and stockholders’ equity $1,386,826   1,449,594 
       
1As part of its notes payable issuance in 2005, Selective Insurance Group, Inc. established an irrevocable trust for the benefit of senior note holders with a market value of approximately $13.2 million as of December 31, 2007 to provide for certain payment obligations in respect to its outstanding debt.
         
  December 31, 
($ in thousands, except share amounts) 2008  2007 
Assets
        
Fixed maturity securities, available-for-sale — at fair value (cost: $1,542 — 2008; $14,006 — 2007) $1,535   13,980 
Short-term investments  60,208   64,492 
Cash  —   81 
Investment in subsidiaries  1,081,229   1,271,494 
Current federal income tax  14,225   18,453 
Deferred federal income tax  14,014   12,347 
Other assets  5,575   5,979 
       
Total assets $1,176,786   1,386,826 
       
         
Liabilities and Stockholders’ Equity
        
Liabilities:
        
Senior convertible notes $—   8,740 
Notes payable  273,878   286,151 
Other liabilities  12,415   15,892 
       
Total liabilities  286,293   310,783 
       
 
Stockholders’ Equity:
        
Preferred stock of $0 par value per share:        
Authorized shares: 5,000,000; no shares issued or outstanding        
Common stock of $2 par value per share:        
Authorized shares: 360,000,000
Issued: 95,263,508 — 2008; 94,652,930 — 2007		  190,527   189,306 
Additional paid-in capital  217,195   192,627 
Retained earnings  1,128,149   1,105,946 
Accumulated other comprehensive (loss) income  (100,666)  86,043 
Treasury stock — at cost (shares: 42,386,921 — 2008; 40,347,894 — 2007)  (544,712)  (497,879)
       
Total stockholders’ equity  890,493   1,076,043 
       
Total liabilities and stockholders’ equity $1,176,786   1,386,826 
       
Information should be read in conjunction with the Notes to Consolidated Financial Statements of Selective Insurance Group, Inc. and its subsidiaries in Item 8. “Financial Statements and Supplementary Data” of the Company’s Form 10-K.

 

109129

SCHEDULE I (continued)
SELECTIVE INSURANCE GROUP, INC.
(Parent Corporation)
Statements of Income
                        
 Year ended December 31,  Year ended December 31, 
(in thousands) 2007 2006 2005 
($ in thousands) 2008 2007 2006 
Revenues:
  
Dividends from subsidiaries $142,743 111,829 40,950  $79,124 142,743 111,829 
Net investment income earned 3,529 4,652 2,299  1,206 3,529 4,652 
Net realized (losses) gains —  (164) 130 
Net realized losses — —  (164)
Other income 63 6 106  3 63 6 
              
Total revenues 146,335 116,323 43,485  80,333 146,335 116,323 
              
  
Expenses:
  
Interest expense 23,795 21,411 17,582  20,508 23,795 21,411 
Other expenses 25,588 26,152 14,509  20,990 25,588 26,152 
              
Total expenses 49,383 47,563 32,091  41,498 49,383 47,563 
              
Income from continuing operations before federal income tax and equity in undistributed income of subsidiaries 96,952 68,760 11,394 
 
Income before federal income tax 38,835 96,952 68,760 
              
  
Federal income tax benefit:
  
Current  (14,969)  (11,433)  (8,877)  (12,611)  (14,969)  (11,433)
Deferred  (861)  (3,833)  (881)  (1,106)  (861)  (3,833)
              
Total federal income tax benefit  (15,830)  (15,266)  (9,758)  (13,717)  (15,830)  (15,266)
              
Net income from continuing operations before equity in undistributed income of subsidiaries, net of tax 112,782 84,026 21,152 
 
Net income before equity in (loss)/undistributed income of subsidiaries, net 52,552 112,782 84,026 
              
  
Equity in undistributed income of subsidiaries, net of tax 33,716 79,548 126,300 
Dividends from discontinued operations, net of tax — — 3,180 
Loss on disposal of discontinued operations, net of tax — —  (2,634)
       
Total discontinued operations, net of tax — — 546 
       
 
Net income before cumulative effective of change in accounting principle 146,498 163,574 147,998 
 
Cumulative effect of change in accounting principle, net of tax — — 495 
       
Equity in (loss)/undistributed income of subsidiaries, net of tax  (341) 33,716 79,548 
Dividends in excess of subsidiaries’ current year earnings  (8,453) — — 
        
        
Net income $146,498 163,574 148,493  $43,758 146,498 163,574 
              
Information should be read in conjunction with the Notes to Consolidated Financial Statements of Selective Insurance Group, Inc. and its subsidiaries in Item 8, “Financial Statements and Supplementary Data” of the Company’s Form 10-K.

130

SCHEDULE I (continued)
SELECTIVE INSURANCE GROUP, INC.
(Parent Corporation)
Statements of Cash Flows
             
  Year ended December 31, 
($ in thousands) 2008  2007  2006 
Operating Activities:
            
Net income $43,758   146,498   163,574 
          
             
Adjustments to reconcile net income to net cash provided by operating activities:
            
Equity in loss/(undistributed income) of subsidiaries, net of tax  341   (33,716)  (79,548)
Dividends in excess of subsidiaries’ current year income  8,453   —   — 
Stock-based compensation expense  17,215   20,992   14,524 
Deferred income tax benefit  (1,106)  (861)  (3,833)
Debt conversion inducement  —   —   2,117 
Net realized losses  —   —   164 
Amortization — other  269   1,306   (554)
             
Changes in assets and liabilities:
            
Increase in accrued salaries and benefits  —   —   5,818 
Decrease (increase) in net federal income tax recoverable  4,228   (3,611)  (3,262)
Other, net  (7,105)  4,208   (4,481)
          
Net adjustments  22,295   (11,682)  (69,055)
          
Net cash provided by operating activities  66,053   134,816   94,519 
          
             
Investing Activities:
            
Purchase of fixed maturity securities, available-for-sale  —   —   (15,000)
Sale of fixed maturity securities, available-for-sale  —   —   23,167 
Redemption and maturities of fixed maturity securities, available-for-sale  12,463   33,619   6,009 
Purchase of short-term investments  (363,827)  (381,775)  (386,912)
Sale of short-term investments  368,111   432,615   356,771 
Capital contribution to subsidiaries  —   —   (32,100)
Distributions of capital by subsidiaries  960   980   1,493 
          
Net cash provided (used) in investing activities  17,707   85,439   (46,572)
          
             
Financing Activities:
            
Dividends to stockholders  (25,804)  (24,464)  (22,831)
Acquisition of treasury stock  (46,833)  (152,118)  (116,354)
Proceeds from issuance of notes payable, net of issuance costs  —   —   96,263 
Principal payment on note payable  (12,300)  (18,300)  (18,300)
Net proceeds from stock purchase and compensation plans  8,222   8,609   11,560 
Excess tax benefits from share-based payment arrangements  1,628   3,484   3,903 
Borrowings under line of credit agreement  —   6,000   — 
Repayment of borrowings under line of credit agreement  —   (6,000)  — 
Debt conversion inducement  —   —   (2,117)
Principal payments of convertible debt  (8,754)  (37,456)  — 
          
Net cash used in financing activities  (83,841)  (220,245)  (47,876)
          
Net (decrease) increase in cash  (81)  10   71 
Cash, beginning of year  81   71   — 
          
Cash, end of year $—   81   71 
          
Information should be read in conjunction with the Notes to Consolidated Financial Statements of Selective Insurance Group, Inc. and its subsidiaries in Item 8. “Financial Statements and Supplementary Data” of the Company’s Form 10-K.

 

110131

SCHEDULE I (continued)
SELECTIVE INSURANCE GROUP, INC.
(Parent Corporation)
Statements of Cash Flows
             
  Year ended December 31, 
(in thousands) 2007  2006  2005 
Operating Activities:
            
Net income $146,498   163,574   148,493 
          
             
Adjustments to reconcile net income to net cash provided by operating activities:
            
Equity in undistributed income of subsidiaries, net of tax  (33,716)  (79,548)  (127,405)
Stock-based compensation expense  20,992   14,524   11,361 
Loss on disposition of discontinued operations  —   —   2,634 
Deferred income tax  (861)  (3,833)  (881)
Debt conversion inducement  —   2,117   — 
Net realized losses/(gains)  —   164   (130)
Amortization — other  1,306   (554)  (211)
Cumulative effect of change in accounting principle, net of tax  —   —   (495)
             
Changes in assets and liabilities:
            
Increase in accrued salaries and benefits  —   5,818   — 
Increase in net federal income tax recoverable  (3,611)  (3,262)  (1,290)
Other, net  4,208   (4,481)  3,126 
          
Net adjustments  (11,682)  (69,055)  (113,291)
          
Net cash provided by operating activities  134,816   94,519   35,202 
          
             
Investing Activities:
            
Purchase of fixed maturity securities, available-for-sale  —   (15,000)  (53,692)
Sale of fixed maturity securities, available-for-sale  —   23,167   19,344 
Redemption and maturities of fixed maturity securities, available-for-sale  33,619   6,009   8,716 
Sale of subsidiary  —   —   14,785 
Purchase of short-term investments  (381,775)  (386,912)  (273,491)
Sale of short-term investments  432,615   356,771   209,365 
Capital contribution to subsidiaries  —   (32,100)  (12,530)
Dividend in excess of subsidiary’s income  980   1,493   4,016 
          
Net cash used in investing activities  85,439   (46,572)  (83,487)
          
             
Financing Activities:
            
Dividends to stockholders  (24,464)  (22,831)  (19,908)
Acquisition of treasury stock  (152,118)  (116,354)  (22,885)
Proceeds from issuance of notes payable, net of issuance costs  —   96,263   99,310 
Principal payment on note payable  (18,300)  (18,300)  (24,000)
Net proceeds from stock purchase and compensation plans  8,609   11,560   11,919 
Excess tax benefits from share-based payment arrangements  3,484   3,903   3,783 
Borrowings under line of credit agreement  6,000   —   — 
Repayment of borrowings under line of credit agreement  (6,000)  —   — 
Debt conversion inducement  —   (2,117)  — 
Principal payments of senior convertible notes  (37,456)  —   — 
Proceeds received on notes receivable from stock sale  —   —   66 
          
Net cash (used in) provided by financing activities  (220,245)  (47,876)  48,285 
          
Net increase in cash  10   71   — 
Cash, beginning of year  71   —   — 
          
Cash, end of year $81   71   — 
          
Information should be read in conjunction with the Notes to Consolidated Financial Statements of Selective Insurance Group, Inc. and its subsidiaries in Item 8. “Financial Statements and Supplementary Data” of the Company’s Form 10-K.

111

SCHEDULE II
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
ALLOWANCE FOR UNCOLLECTIBLE PREMIUMS AND OTHER RECEIVABLES
Years ended December 31, 2008, 2007 2006 and 20052006
             
(in thousands) 2007  2006  2005 
Balance, January 1 $6,656   8,085   8,242 
Additions  3,625   2,955   6,120 
Deletions1
  (3,382)  (4,384)  (6,277)
          
Balance, December 31 $6,899   6,656   8,085 
          
1The 2005 deletion amount includes $493 related to the December 2005 divestiture of Selective’s 100% ownership interest in CHN Solutions (Alta Services, LLC and Consumer Health Network Plus, LLC). For additional information regarding this divestiture, see Item 8. “Financial Statements and Supplementary Data,” Note 15 to the Consolidated Financial Statements in the Company’s Form 10-K
             
($ in thousands) 2008  2007  2006 
Balance, January 1 $6,899   6,656   8,085 
Additions  4,283   3,625   2,955 
Deletions  (4,176)  (3,382)  (4,384)
          
Balance, December 31 $7,006   6,899   6,656 
          

 

112132

SCHEDULE III
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 20072008
                        
Type of investment Amortized Cost Fair Carrying  Amortized Cost Fair Carrying 
(in thousands) or Cost Value Amount 
($ in thousands) or Cost Value Amount 
Fixed maturity securities:
  
Held-to-maturity:  
Obligations of states and political subdivisions $5,759 5,902 5,759  $1,146 1,159 1,146 
Mortgage-backed securities 24 25 24  17 19 17 
              
Total fixed maturity securities, held-to-maturity 5,783 5,927 5,783  1,163 1,178 1,163 
              
Available-for-sale:  
U.S. government and government agencies 172,795 179,713 179,713  235,540 252,151 252,151 
Obligations of states and political subdivisions 1,593,587 1,611,215 1,611,215  1,739,349 1,757,965 1,757,965 
Corporate securities 479,169 487,075 487,075  389,386 366,536 366,536 
Asset-backed securities 99,184 97,684 97,684  76,758 61,418 61,418 
Mortgage-backed securities 705,178 697,860 697,860  682,313 596,208 596,208 
              
Total fixed maturity securities, available-for-sale 3,049,913 3,073,547 3,073,547  3,123,346 3,034,278 3,034,278 
              
  
Equity securities, available-for-sale:
 
Common stocks: 
Equity securities
 
Available for sales: 
Banks, trust and insurance companies 4,834 11,606 11,606  3,147 5,658 5,658 
Industrial, miscellaneous and all other 155,556 263,099 263,099  122,800 126,473 126,473 
              
Total equity securities, available-for-sale 160,390 274,705 274,705 
Total available-for-sale 125,947 132,131 132,131 
Trading securities 2,569 2,569 2,569 
       
Total equity securities 128,516 134,700 134,700 
       
        
Short-term investments 190,167 190,167  198,111 198,111 
Other investments 158,180 188,827  173,534 172,057 
          
Total investments $3,564,433 3,733,029  $3,624,670 3,540,309 
          

 

113133

SCHEDULE IV
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
Year ended December 31, 2008
                                     
                          Amortization       
  Deferred  Reserve              Losses  of deferred       
  policy  for losses      Net  Net  and loss  policy  Other  Net 
  acquisition  and loss  Unearned  premiums  investment  expenses  acquisition  operating  premiums 
($ in thousands) costs  expenses1  premiums  earned  income2  incurred3  costs4  expenses4  written 
Insurance Operations Segment $212,319   2,640,973   844,334   1,495,490   —   1,013,816   454,826   42,074   1,484,041 
Investments Segment  —   —   —   —   81,580   —   —   —   — 
                            
Total $212,319   2,640,973   844,334   1,495,490   81,580   1,013,816   454,826   42,074   1,484,041 
                            
1Includes “Reserve for losses” and “Reserve for loss expenses” on the Consolidated Balance Sheets.
2Includes “Net investment income earned” and “Net realized (losses) gains” on the Consolidated Statements of Income.
3Includes “Losses incurred” and “Loss expenses incurred” on the Consolidated Statements of Income.
4The total of “Amortization of deferred policy acquisition costs” of $454,826, and “Other operating expenses” of $42,074 reconciles to the Consolidated Statement of Income as follows:
     
Policy acquisition costs $490,040 
Dividends to policyholders  5,211 
Other income5
  (2,560)
Other expenses5
  4,209 
    
Total $496,900 
    
5In addition to amounts related to the Insurance Operations segment, “Other income” and “Other expense” on the Consolidated Statements of Income includes holding company income and expense amounts of $3 and $20,990, respectively.

134

SCHEDULE IV (continued)
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
Year ended December 31, 2007
                                     
                          Amortization       
  Deferred  Reserve              Losses  of deferred       
  policy  for losses      Net  Net  and loss  policy  Other  Net 
  acquisition  and loss  Unearned  premiums  investment  expenses  acquisition  operating  premiums 
(in thousands) costs  expenses1  premiums  earned  income2  incurred3  costs4  expenses4  written 
Insurance Operations Segment $226,434   2,542,547   841,348   1,517,306   —   999,206   460,167   41,976   1,554,867 
Investments Segment  —   —   —   —   207,498   —   —   —   — 
                            
Total $226,434   2,542,547   841,348   1,517,306   207,498   999,206   460,167   41,976   1,554,867 
                            
1 Includes “Reserve for losses” and “Reserve for loss expenses” on the Consolidated Balance Sheet.Sheets.
 
2 Includes “Net investment income earned” and “Net realized (losses) gains” on the Consolidated Income Statement.Statements of Income.
 
3 Includes “Losses incurred” and “Loss expenses incurred” on the Consolidated Income Statement.Statements of Income.
 
4 The total of “Amortization of deferred policy acquisition costs” of $460,167, and “Other operating expenses” of $41,977 reconciles to the Consolidated Statements of Income Statement as follows:
     
Policy acquisition costs $497,229 
Dividends to policyholders  7,202 
Other income5
  (5,795)
Other expenses5
  3,507 
    
Total $502,143 
    
     
Policy acquisition costs $497,229 
Dividends to policyholders  7,202 
Other income  (5,795)
Other expenses  3,507 
    
Total $502,143 
    
In addition to amounts related to the Insurance Operations segment, “Other income” and “Other expense” on the Consolidated Income Statement includes holding company income and expense amounts of $63 and $25,588, respectively.
5In addition to amounts related to the Insurance Operations segment, “Other income” and “Other expense” on the Consolidated Statements of Income includes holding company income and expense amounts of $63 and $25,588, respectively.

 

114135

SCHEDULE IV (continued)
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
Year ended December 31, 2006
                                                                        
 Amortization      Amortization     
 Deferred Reserve Losses of deferred      Deferred Reserve Losses of deferred     
 policy for losses Net Net and loss policy Other Net  policy for losses Net Net and loss policy Other Net 
 acquisition and loss Unearned premiums investment expenses acquisition operating premiums  acquisition and loss Unearned premiums investment expenses acquisition operating premiums 
(in thousands) costs expenses1 premiums earned income2 incurred3 costs4 expenses4 written 
($ in thousands) costs expenses1 premiums earned income2 incurred3 costs4 expenses4 written 
Insurance Operations Segment $218,103 2,288,770 791,540 1,499,664 — 959,983 443,300 38,403 1,535,961  $218,103 2,288,770 791,540 1,499,664 — 959,983 443,300 38,403 1,535,961 
Investments Segment — — — — 192,281 — — — —  — — — — 192,281 — — — — 
                                      
Total $218,103 2,288,770 791,540 1,499,664 192,281 959,983 443,300 38,403 1,535,961  $218,103 2,288,770 791,540 1,499,664 192,281 959,983 443,300 38,403 1,535,961 
                                      
1 Includes “Reserve for losses” and “Reserve for loss expenses” on the Consolidated Balance Sheet.Sheets.
 
2 Includes “Net investment income earned” and “Net realized (losses) gains” on the Consolidated Income Statement.Statements of Income.
 
3 Includes “Losses incurred” and “Loss expenses incurred” on the Consolidated Income Statement.Statements of Income.
 
4 The total of “Amortization of deferred policy acquisition costs” of $443,300 and “Other operating expenses” of $38,404$38,403 reconciles to the Consolidated Statements of Income Statement as follows:
     
Policy acquisition costs $478,339 
Dividends to policyholders  5,927 
Other income5
  (5,390)
Other expenses5
  2,827 
    
Total $481,703 
    
     
Policy acquisition costs $478,339 
Dividends to policyholders  5,927 
Other income  (5,390)
Other expenses  2,827 
    
Total $481,703 
    
In addition to amounts related to the Insurance Operations segment, “Other income” and “Other expense” on the Consolidated Income Statement includes holding company income and expense amounts of $6 and $26,152, respectively.
5In addition to amounts related to the Insurance Operations segment, “Other income” and “Other expense” on the Consolidated Statements of Income includes holding company income and expense amounts of $6 and $26,152, respectively.

 

115136

SCHEDULE IV (continued)
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
Year ended December 31, 2005
                                     
                          Amortization       
  Deferred  Reserve              Losses  of deferred       
  policy  for losses      Net  Net  and loss  policy  Other  Net 
  acquisition  and loss  Unearned  premiums  investment  expenses  acquisition  operating  premiums 
(in thousands) costs  expenses1  premiums  earned  income2  incurred3  costs4  expenses4  written 
Insurance Operations Segment $204,832   2,084,049   752,465   1,418,013   —   905,730   400,613   41,942   1,459,474 
Investments Segment  —   —   —   —   150,414   —   —   —   — 
                            
Total $204,832   2,084,049   752,465   1,418,013   150,414   905,730   400,613   41,942   1,459,474 
                            
1Includes “Reserve for losses” and “Reserve for loss expenses” on the Consolidated Balance Sheet.
2Includes “Net investment income earned” and “Net realized gains” on the Consolidated Income Statement.
3Includes “Losses incurred” and “Loss expenses incurred” on the Consolidated Income Statement.
4The total of “Amortization of deferred policy acquisition costs” of $400,613 and “Other operating expenses” of $41,942 reconciles to the Consolidated Income Statement as follows:
     
Policy acquisition costs $437,894 
Dividends to policyholders  5,688 
Other income  (3,769)
Other expenses  2,742 
    
Total $442,555 
    
In addition to amounts related to the Insurance Operations segment, “Other income” and “Other expense” on the Consolidated Income Statement includes holding company income and expense amounts of $105 and $14,674, respectively.

116

SCHEDULE V
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
REINSURANCE
Years ended December 31, 2008, 2007 2006 and 20052006
                                        
 % of  % of 
 Assumed Ceded Amount  Assumed Ceded Amount 
 Direct from Other to Other Assumed  Direct from Other to Other Assumed 
(in thousands) Amount Companies Companies Net Amount to Net 
($ in thousands) Amount Companies Companies Net Amount to Net 
2008
 
Premiums earned: 
Accident and health insurance $80 — 80 — — 
Property and liability insurance 1,679,025 26,703 210,238 1,495,490  2%
           
Total premiums earned 1,679,105 26,703 210,318 1,495,490  2%
           
 
2007
  
Premiums earned:  
Accident and health insurance $80 — 80 — —  $80 — 80 — — 
Property and liability insurance 1,671,430 30,930 185,054 1,517,306  2% 1,671,430 30,930 185,054 1,517,306  2%
                      
Total premiums earned $1,671,510 30,930 185,134 1,517,306  2% $1,671,510 30,930 185,134 1,517,306  2%
                      
  
2006
  
Premiums earned:  
Accident and health insurance $509 — 476 33 —  $509 — 476 33 — 
Property and liability insurance 1,618,500 36,009 154,878 1,499,631  2% 1,618,500 36,009 154,878 1,499,631  2%
                      
Total premiums earned $1,619,009 36,009 155,354 1,499,664  2% $1,619,009 36,009 155,354 1,499,664  2%
                      
 
2005
 
Premiums earned: 
Accident and health insurance $120 — — 120 — 
Property and liability insurance 1,523,085 43,464 148,656 1,417,893  3%
           
Total premiums earned $1,523,205 43,464 148,656 1,418,013  3%
           

 

117137

EXHIBIT INDEX
   
Exhibit  
Number  
3.1 Restated Certificate of Incorporation of Selective Insurance Group, Inc., dated August 4, 1977, as amended (incorporated by reference to Exhibit 3.1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006,2007, File No. 1-33067)001-33067).
   
3.2 By-Laws of Selective Insurance Group, Inc., effective October 24, 2006 (incorporated by reference herein to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed October 24, 2006, File No. 001-33067).
   
4.1Indenture dated December 29, 1982, between Selective Insurance Group, Inc. and Midlantic National Bank, as Trustee, relating to the Company’s 8 3/4% Subordinated Convertible Debentures due 2008 (incorporated by reference herein to Exhibit 4.3 to the Company’s Registration Statement on Form S-3 No. 2-80881).
4.2 Indenture dated as of September 24, 2002, between Selective Insurance Group, Inc. and National City Bank, as Trustee, relating to the Company’s 1.6155% Senior Convertible Notes due September 24, 2032 (incorporated by reference herein to Exhibit 4.1 of the Company’s Registration Statement on Form S-3 No. 333-101489).
   
4.34.2 Indenture, dated as of November 16, 2004, between Selective Insurance Group, Inc. and Wachovia Bank, National Association, as Trustee, relating to the Company’s 7.25% Senior Notes due 2034 (incorporated by reference herein to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed November 18, 2004, File No. 0-8641).
   
4.44.3 Indenture, dated as of November 3, 2005, between Selective Insurance Group, Inc. and Wachovia Bank, National Association, as Trustee, relating to the Company’s 6.70% Senior Notes due 2035 (incorporated by reference herein to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed November 9, 2005, File No. 0-8641).
   
4.5Amended and Restated Rights Agreement, dated as of February 2, 1999, between Selective Insurance Group, Inc. and Wells Fargo, National Association, as Successor to First Chicago Trust Company of New York, as Rights Agent (incorporated by reference herein to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed February 4, 1999, File No. 0-8641).
4.5aCertificate of Adjustment, dated February 20, 2007, to the Amended and Restated Rights Agreement (incorporated by reference herein to Exhibit 4.2 to the Company’s Form 8-A filed February 20, 2007, File No. 001-33067).
4.64.4 Registration Rights Agreement, dated as of November 16, 2004, between Selective Insurance Group, Inc. and Keefe, Bruyette & Woods, Inc. (incorporated by reference herein to Exhibit 4.2 of the Company’s Current Report on Form 8-K filed November 18, 2004, File No. 0-8641)001-33067).
   
4.74.5 Registration Rights Agreement, dated as of November 3, 2005, between Selective Insurance Group, Inc. and Keefe, Bruyette & Woods, Inc. (incorporated by reference herein to Exhibit 4.2 of the Company’s Current Report on Form 8-K filed November 9, 2005, File No. 0-8641)001-33067).
   
4.84.6 Form of Junior Subordinated Debt Indenture between Selective Insurance Group, Inc. and U.S. Bank National Association (incorporated by reference herein to Exhibit 4.3 of the Company’s Registration Statement on Form S-3 No. 333-137395).

118

   
Exhibit
Number
4.94.7 First Supplemental Indenture, dated as of September 25, 2006, between Selective Insurance Group, Inc. and U.S. Bank National Association, as Trustee, relating to the Company’s 7.5% Junior Subordinated Notes due 2066 (incorporated by reference herein to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed September 27, 2006, File No. 0-8641).
   
10.1 Selective Insurance Supplemental Pension Plan, effective as ofAs Amended and Restated Effective January 1, 19892005 (incorporated by reference herein to Exhibit 10.1 of the Company’s Registration StatementQuarterly Report on Form S-4,10-Q for the quarter ended September 30, 2008, File No. 333-129927)001-33067).
   
10.2 Selective Insurance Company of America Deferred Compensation Plan effective July 1, 2002(2005) (incorporated by reference herein to Exhibit 99.110.1 of the Company’s Registration StatementCurrent Report on Form S-8,8-K filed September 21, 2007, File No. 333-97799)001-33067).
   
10.3 Selective Insurance Stock Option Plan II, as amended (incorporated by reference herein to Exhibit 10.13b to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999, File No. 0-8641).

138

 
Exhibit
Number  
10.3a Amendment to the Selective Insurance Stock Option Plan II, as amended, effective as of July 26, 2006 (incorporated by reference herein to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, File No. 0-8641).
   
10.4 Selective Insurance Stock Option Plan III (incorporated by reference herein to Exhibit A to the Company’s Definitive Proxy Statement for its 2002 Annual Meeting of Stockholders filed with the Securities and Exchange Commission on April 1, 2002)2002, File No. 0-8641).
   
10.4a Amendment to the Selective Insurance Stock Option Plan III, effective as of July 26, 2006 (incorporated by reference herein to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, File No. 0-8641).
   
10.5 Selective Insurance Group, Inc. 2005 Omnibus Stock Plan (incorporated by reference herein to Appendix A of the Company’s Definitive Proxy Statement for its 2005 Annual Meeting of Stockholders filed with the Securities and Exchange Commission on April 6, 2005)2005, File No. 0-8641).
   
10.5a Amendment to the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan (incorporated by reference herein to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, File No. 0-8641).
   
10.5b Amendment No. 2 to the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan (incorporated by reference herein to Exhibit 10.5b of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, File No. 0-8641).
   
10.5c Amendment No. 3 to the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan (incorporated by reference herein to Exhibit 10.5c of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, File No. 0-8641).
   
10.5d Amendment No. 4 to the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Amendment (incorporated by reference herein to Exhibit 10.5d of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, File No. 0-8641)001-33067).
   
*10.5e Amendment No. 5 to the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Amendment (incorporated by reference herein to Exhibit 10.5e of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, File No. 0-8641)001-33067).
*10.5fAmendment No. 6 to the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Amendment.
   
10.6 Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Stock Option Agreement (incorporated by reference herein to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File No. 0-8641).

119

 
Exhibit
Number  
10.7 Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Director Restricted Stock Agreement (incorporated by reference herein to Exhibit 10.8 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, File No. 0-8641).
   
*10.7a10.8 Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Director Restricted Stock Unit Agreement (incorporated by reference herein to Exhibit 10.7a of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, File No. 0-8641)001-33067).
   
10.810.9 Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Director Stock Option Agreement (incorporated by reference herein to Exhibit 10.9 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, File No. 0-8641).
   
10.910.10 Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Restricted Stock Agreement (incorporated by reference herein to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File No. 0-8641).

139

   
10.10Exhibit
Number
10.11 Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Restricted Stock Agreement (incorporated by reference herein to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File No. 0-8641).
   
10.1110.12Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Restricted Stock Unit Agreement (incorporated by reference herein to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed February 4, 2008, File No. 001-33067).
10.13Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Restricted Stock Unit Agreement (incorporated by reference herein to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed February 4, 2008, File No. 001-33067).
10.14 Selective Insurance Group, Inc. 2005 Omnibus Stock Plan Automatic Director Stock Option Agreement (incorporated by reference herein to Exhibit 2 of the Company’s Definitive Proxy Statement for its 2005 Annual Meeting of Stockholders filed with the Securities and Exchange Commission on April 6, 2005)2005, File No. 0-8641).
   
10.1210.15 Deferred Compensation Plan for Directors (incorporated by reference herein to Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-8641).
   
10.1310.16 Selective Insurance Group, Inc. Employee Stock Purchase Savings Plan (incorporated by reference herein to Exhibit 10.6 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-8641).
   
10.13a10.16a Amendment to the 1987 Employee Stock Purchase Savings Plan, effective May 2, 1997, (incorporated by reference herein to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, File No. 0-8641).
   
10.1410.17 Selective Insurance Group, Inc. Cash Incentive Plan (incorporated by reference herein to Appendix B to the Company’s Definitive Proxy Statement for its 2005 Annual Meeting of Stockholders filed with the Securities and Exchange Commission on April 6, 2005)2005, File No. 0-8641).
   
10.14a10.17a Amendment No. 1 to the Selective Insurance Group, Inc. Cash Incentive Plan (incorporated by reference herein to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File No. 0-8641).
   
*10.14b10.17b Amendment No.��2 to the Selective Insurance Group, Inc. Cash Incentive Plan (incorporated by reference herein to Exhibit 10.14b of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, File No. 0-8641)001-33067).
   
*10.14c10.18 Selective Insurance Group, Inc. Cash Incentive Plan Cash Incentive Unit Award Agreement (incorporated by reference herein to Exhibit 10.14c of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, File No. 0-8641)001-33067).
   
*10.14d10.19 Selective Insurance Group, Inc. Cash Incentive Plan Cash Incentive Unit Award Agreement (incorporated by reference herein to Exhibit 10.14d of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, File No. 0-8641)001-33067).

120

   
Exhibit
Number
10.1510.20 Selective Insurance Group, Inc. Stock Purchase Plan for Independent Insurance Agencies, effective July 1, 2006 (incorporated by reference herein to Appendix A of the Company’s Definitive Proxy Statement for its 2006 Annual Meeting of Stockholders filed with the Securities and Exchange Commission on March 28, 2006)2006, File No. 0-8641).
   
10.15a10.20a Amendment No. 1 to the Selective Insurance Group, Inc. Stock Purchase Plan for Independent Insurance Agencies (incorporated by reference to Exhibit 10.15a of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, File No. 1-33067)001-33067).

140

Exhibit
Number
10.20bAmendment No. 2 to the Selective Insurance Group, Inc. Stock Purchase Plan for Independent Insurance Agencies (incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, File No. 001-33067).
   
10.1610.21 Selective Insurance Group, Inc. Stock Option Plan for Directors (incorporated by reference herein to Exhibit B of the Company’s Definitive Proxy Statement for its 2000 Annual Meeting of Stockholders filed with the Securities and Exchange Commission on March 31, 2000)2000, File No. 0-8641).
   
10.16a10.21a Amendment to the Selective Insurance Group, Inc. Stock Option Plan for Directors, as amended, effective as of July 26, 2006, (incorporated by reference herein to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, File No. 0-8641).
   
10.1710.22 Selective Insurance Group, Inc. Stock Compensation Plan for Nonemployee Directors, as amended (incorporated by reference herein to Exhibit A to the Company’s Definitive Proxy Statement for its 2000 Annual Meeting of Stockholders filed with the Securities and Exchange Commission on March 31, 2000)2000, File No. 0-8641).
   
10.18*10.22aAmendment to Selective Insurance Group, Inc. Stock Compensation Plan for Nonemployee Directors, as amended.
10.23 Employment, Termination and Severance Agreements.
   
10.18a10.23a Employment Agreement between Selective Insurance Group, Inc.Company of America and Gregory E. Murphy, dated as of April 26, 2006December 23, 2008 (incorporated by reference herein to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed April 28, 2006,December 30, 2009, File No. 0-8641)001-33067).
   
10.18b10.23b Employment Agreement between Selective Insurance Group, Inc.Company of America and Jamie Ochiltree, III,Dale A. Thatcher, dated as of August, 1, 2006December 23, 2008 (incorporated by reference herein to Exhibit 10.610.2 to the Company’s QuarterlyCurrent Report on Form 10-Q for the quarter ended June8-K filed December 30, 2006,2008, File No. 0-8641)001-33067).
   
10.18c10.23c Employment Agreement between Selective Insurance Group, Inc.Company of America and Dale A. Thatcher,Richard F. Connell, dated as of August 1, 2006December 23, 2008 (incorporated by reference herein to Exhibit 10.910.3 to the Company’s QuarterlyCurrent Report on Form 10-Q for the quarter ended June8-K filed December 30, 2006,2008, File No. 0-8641)001-33067).
   
10.18d10.23d Employment Agreement between Selective Insurance Group, Inc.Company of America and Richard F. Connell,Kerry A. Guthrie, dated as of August 1, 2006December 30, 2008 (incorporated by reference herein to Exhibit 10.710.4 to the Company’s QuarterlyCurrent Report on Form 10-Q for the quarter ended June8-K filed December 30, 2006,2008, File No. 0-8641)001-33067).
   
10.18e*10.23e TerminationEmployment Agreement between Selective Insurance Company of America and Michael H. Lanza, dated as of July 27, 2004 (incorporated by reference herein to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, File No. 0-8641).December 23, 2008.
   
10.18f*10.23f Employment Agreement amongbetween Selective Insurance Company of America Selective Insurance Group, Inc. and Victor N. Daley,John J. Marchioni, dated as of September 26, 2005 (incorporated by reference to Exhibit 10.18m of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, File No. 0-8641).23, 2008.
   
10.18g*10.23g Employment Agreement between Selective Insurance Group, Inc.Company of America and Kerry A. Guthrie,Mary T. Porter, dated as of August 1, 2006 (incorporated by reference herein to Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, File No. 0-8641).December 23, 2008.
*10.23hEmployment Agreement between Selective Insurance Company of America and Steven B. Woods, dated as of February 20, 2009.
*10.23iEmployment Agreement between Selective Insurance Company of America and Ronald J. Zaleski, dated as of December 23, 2008.

 

121141

   
Exhibit  
Number  
10.18hEmployment Agreement between Selective Insurance Group, Inc. and Ronald J. Zaleski, dated as of August 1, 2006 (incorporated by reference herein to Exhibit 10.10 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, File No. 0-8641).
10.1910.24 Credit Agreement among Selective Insurance Group, Inc., the Lenders Named Therein and Wachovia Bank, National Association, as Administrative Agent, dated as of August 11, 2006 (incorporated by reference herein to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed August 16, 2006, File No. 0-8641)001-33067).
   
*21 Subsidiaries of Selective Insurance Group, Inc.
   
*23.1 Consent of KPMG LLP.
   
*24.1 Power of Attorney of Paul D. Bauer.
   
*24.2 Power of Attorney of W. Marston Becker.
   
*24.3 Power of Attorney of A. David Brown.
   
*24.4 Power of Attorney of John C. Burville.
   
*24.5 Power of Attorney of William M. Kearns, Jr.
   
*24.6 Power of Attorney of Joan M. Lamm-Tennant.
   
*24.7 Power of Attorney of S. Griffin McClellan III.
   
*24.8 Power of Attorney of Ronald L. O’Kelley.Michael J. Morrissey.
   
*24.9 Power of Attorney of John F. Rockart.Ronald L. O’Kelley.
   
*24.10 Power of Attorney of William M. Rue.
   
*24.11 Power of Attorney of J. Brian Thebault.
   
*31.1 Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002.
   
*31.2 Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002.
   
*32.1 Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002.
   
*32.2 Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002.
   
*99.1 Glossary of Terms.
* Filed herewith.

 

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