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

[July 31, 2014]

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

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


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

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

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

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

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

Securities and Exchange Commission ("SEC").

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

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

Financial Highlights of Results for Second Quarter and Six Months 2014 and Second Quarter and Six Months 20131 Quarter ended June 30, Six Months ended June 30, ($ and shares in thousands, except per share Change Change amounts) 2014 2013 % or Points 2014 2013 % or Points Generally Accepted Accounting Principles ("GAAP") measures: Revenues $ 506,849 468,945 8 % $ 1,015,920 928,894 9 % Pre-tax net investment income 36,774 34,003 8 72,308 66,873 8 Pre-tax net income 39,521 36,201 9 64,605 63,534 2 Net income 29,341 27,122 8 47,315 48,430 (2 ) Diluted net income per share 0.51 0.48 6 0.83 0.86 (3 ) Diluted weighted-average outstanding shares 57,260 56,616 1 57,215 56,530 1 GAAP combined ratio 97.8 % 98.9 (1.1 ) pts 99.4 98.0 1.4 pts Statutory combined ratio2 97.5 % 97.7 (0.2 ) 99.2 97.3 1.9 Return on average equity 9.7 % 9.7 - 7.9 8.8 (0.9 ) Non-GAAP measures: Operating income3 $ 26,390 23,773 11 % $ 39,673 43,897 (10 ) % Diluted operating income per share3 0.46 0.42 10 0.70 0.78 (10 ) Operating return on average equity3 8.7 % 8.5 0.2 pts 6.6 8.0 (1.4 ) pts 1 Refer to the Glossary of Terms attached to our 2013 Annual Report as Exhibit 99.1 for definitions of terms used in this Form 10-Q.

2 The statutory combined ratio for Six Months 2013 included 0.7 points related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

3 Operating income is used as an important financial measure by us, analysts, and investors, because the realization of investment gains and losses on sales in any given period is largely discretionary as to timing. In addition, these realized investment gains and losses, as well as OTTI that are charged to earnings and the results of discontinued operations, could distort the analysis of trends. See below for a reconciliation of operating income to net income in accordance with GAAP. Operating return on average equity is calculated by dividing annualized operating income by average stockholders' equity.

The following table reconciles operating income and net income for the periods presented above: Quarter ended June 30, Six Months ended June 30, ($ in thousands, except per share amounts) 2014 2013 2014 2013 Operating income $ 26,390 23,773 39,673 43,897 Net realized gains, net of tax 2,951 3,349 7,642 5,530 Loss on disposal of discontinued operations, net of tax - - - (997 ) Net income $ 29,341 27,122 47,315 48,430 Diluted operating income per share $ 0.46 0.42 0.70 0.78 Diluted net realized gains per share 0.05 0.06 0.13 0.10 Diluted net loss from disposal of discontinued operations per share - - - (0.02 ) Diluted net income per share $ 0.51 0.48 0.83 0.86 28-------------------------------------------------------------------------------- Table of Contents Over the long term, we target a return on average equity that is three points higher than our cost of capital, or 12%, excluding the impact of realized gains and losses, which is referred to as operating return on average equity. Our operating return on average equity and contribution by component for Second Quarter 2014 and Six Months 2014 and the comparable prior year periods are as follows: Operating Return on Average Equity Quarter ended June 30, Six Months ended June 30, 2014 2013 2014 2013 Standard Insurance Operations 2.2 % 1.6 % 0.4 % 2.2 % E&S Insurance Operations - % (0.6 )% 0.1 % (0.2 )% Investments 9.1 % 9.2 % 9.0 % 9.2 % Other (2.6 )% (1.7 )% (2.9 )% (3.2 )% Total 8.7 % 8.5 % 6.6 % 8.0 % Our operating return on average equity in Second Quarter 2014 and Six Months 2014 reflects GAAP combined ratios of 97.8% and 99.4%, compared to 98.9% and 98.0% in the same periods a year ago. Increased favorable prior year casualty reserve development and the impact of renewal pure price increases drove the improvement in operating return on average equity in the quarter, despite increased levels of catastrophe and non-catastrophe property losses. On a year-to-date basis, the increase in property losses resulted in an increase in the combined ratio and a corresponding decline in operating return on average equity compared to Six Months 2013. Further descriptions of the variances for the quarter and year-to-date periods are as follows: • Catastrophe losses for Second Quarter 2014 and Six Months 2014 were $27.2 million, or 5.9 points, and $61.6 million, or 6.7 points, respectively, compared to $19.6 million, or 4.6 points, and $21.2 million, or 2.5 points, in the respective prior year periods. The majority of these catastrophe losses were attributed to extreme weather events in the first quarter of 2014, which brought freezing temperatures and snowstorms to our 22-state standard lines footprint, coupled with hail, tornadoes, and wind events in Second Quarter 2014.

• Non-catastrophe property losses in Second Quarter 2014 and Six Months 2014 were at some of the highest levels that we have experienced in recent years. The impact varied by line but, for both standard lines and E&S, non-catastrophe property losses for Second Quarter 2014 and Six Months 2014 were approximately $73.0 million, or 15.7 points, and $164.4 million, or 17.9 points, respectively. Non-catastrophe losses for the quarter and year-to-date periods were both about 4 points higher than the same periods last year. These non-catastrophe property losses were primarily the result of fires, roof collapses, and water damage, which were often related to the weather events experienced throughout our footprint states in both Second Quarter 2014 and Six Months 2014.

• Renewal pure price increases of 7.6% were achieved in full-year 2013, which are currently earning in at 6.9% in Second Quarter 2014 and 7.1% in Six Months 2014. This earned rate is above the loss cost trend of approximately 3%. After taking into account the incremental expenses associated with the additional premium, the net benefit to the combined ratio is approximately 2.5 points for both periods.

• Favorable prior year casualty development in Second Quarter 2014 and Six Months 2014 was $17.5 million, or 3.8 points, and $31.5 million, or 3.5 points, respectively, compared to favorable prior year casualty development of $2 million, or 0.5 points, and $4 million, or 0.4 points, in Second Quarter 2013 and Six Months 2013, respectively. We experienced stable workers compensation trends in the quarter and year-to-date periods, with no development either favorable or unfavorable. The level of releases in Second Quarter and Six Months 2014 were driven by improving claim trends within our general liability line of business for the 2012 and prior accident years.

Also contributing to Six Months 2014 Insurance Operations results, was the March 2014 sale of the renewal rights to our self-insured group, or "SIG," book of pooled public entity business, which contributed $8 million to other income, reducing the combined ratio by 0.9 points. Although we did not solicit buyers, we decided to sell this very small and specialized book of business when the opportunity presented itself because it had significant production outside of our standard lines footprint, and proved difficult to grow. We, however, have retained our substantial individual risk public entity book of business and we will continue to look for opportunities to grow it.

The remaining fluctuation in our Second Quarter 2014 operating return on average equity compared to Second Quarter 2013 was driven by higher long-term employee compensation expense associated with our performance relative to our peer group and fluctuations in our stock price. This item is captured within the "Other" component in the table above.

29-------------------------------------------------------------------------------- Table of Contents The following table provides a quantitative foundation for analyzing our overall Insurance Subsidiaries' underwriting results: All Lines Quarter ended June 30, Six Months ended June 30, Change Change % or % or ($ in thousands) 2014 2013 Points 2014 2013 Points GAAP Insurance Operations Results: Net premiums written ("NPW") $ 479,823 462,177 4 % $ 956,573 912,301 5 % Net premiums earned ("NPE") 463,625 426,252 9 920,120 847,192 9 Less: Loss and loss expense incurred 297,795 279,594 7 618,341 549,443 13 Net underwriting expenses incurred 154,197 141,194 9 293,923 279,038 5 Dividends to policyholders 1,549 981 58 2,787 2,067 35 Underwriting gain $ 10,084 4,483 125 % $ 5,069 16,644 (70 ) % GAAP Ratios: Loss and loss expense ratio 64.2 % 65.6 (1.4 ) pts 67.2 % 64.9 2.3 pts Underwriting expense ratio 33.3 33.1 0.2 31.9 32.9 (1.0 ) Dividends to policyholders ratio 0.3 0.2 0.1 0.3 0.2 0.1 Combined ratio 97.8 98.9 (1.1 ) 99.4 98.0 1.4 Statutory Ratios: Loss and loss expense ratio1 64.2 65.6 (1.4 ) 67.2 64.9 2.3 Underwriting expense ratio1 33.0 31.9 1.1 31.7 32.2 (0.5 ) Dividends to policyholders ratio 0.3 0.2 0.1 0.3 0.2 0.1 Combined ratio1 97.5 % 97.7 (0.2 ) pts 99.2 % 97.3 1.9 pts 1 Statutory ratios for Six Months 2013 included 0.2 points in the loss and loss expense ratio, 0.5 points in the underwriting ratio, and 0.7 points in the combined ratio related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

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

NPE increases in Second Quarter 2014 and Six Months 2014 were consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2014 compared to the twelve-month period ended June 30, 2013.

The combined ratios for both Second Quarter 2014 and Six Months 2014 were primarily driven by property results, renewal pure price increases, and favorable prior year casualty development, as discussed above.

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

Although A.M. Best is continuing to maintain its negative outlook for the commercial lines market reflecting "the uncertainty around loss-reserve development and continued low profit margins driven by low investment yields," it anticipates a 99.9% statutory combined ratio for 2014, driven by: (i) a more normal level of catastrophe losses; (ii) less favorable loss-reserve development; and (iii) loss trends that are partially offset by lower pricing.

For personal lines, A.M. Best maintains a stable outlook in the coming year reflecting ongoing stability of the auto line and successful carriers continuing to enhance the granularity of their home pricing models.

30-------------------------------------------------------------------------------- Table of Contents In its financial review issued on July 14, 2014, A.M. Best noted that increased catastrophe and weather-related claims led to an increase in losses for the U.S.

property and casualty industry in the first quarter of 2014, causing underwriting and net income to decline compared with last year's results. Losses related to the polar vortex account for much of this increase. Overall, catastrophe losses accounted for 3.4 points on the combined ratio, a substantial increase over the 2.1-point impact in the first quarter of last year. Despite these increased losses, the industry posted another quarter of profitable underwriting, producing a combined ratio of 96.4% for the first quarter of 2014, up from 92.7% for the first quarter of 2013.

In early 2012, we laid out a three-year plan to achieve overall annual renewal pure price increases of 5% to 8%. We achieved 6.0% in Six Months 2014, including 6.1% in our Standard Commercial Lines, 6.2% in our Standard Personal Lines, and 3.7% in our E&S Lines. The 7.6% overall renewal pure price increase in 2013 translated into earned price increases of 7.1% in Six Months 2014, which is above loss cost trends of approximately 3%. The 6% overall renewal pure price increase that we expect to achieve in 2014 is also above loss cost trends, and will continue to add to profitability in 2015.

Our Insurance Subsidiaries reported statutory combined ratios, excluding catastrophes, of 91.6% for Second Quarter 2014 and 92.5% for Six Months 2014, which are in line with our stated full-year 2014 goal of 92%. The catastrophe losses in Second Quarter 2014 of $27 million added 5.9 points to our statutory combined ratio, and the catastrophe losses in Six Months 2014 of $61.6 million added 6.7 points to our statutory combined ratio. This increased level of catastrophe losses was related to extreme winter weather in the first quarter of 2014 and Midwest storms in Second Quarter 2014.

The yield on the 10-year U.S. Treasury Notes fell by 50 basis points in Six Months 2014, but as the overall portfolio yield approaches the yield of new purchases, we have begun to see a declining rate of pressure on the yield of the existing portfolio. The continued low interest rate environment has several significant impacts on our business, some of which are beneficial and some of which present a challenge to us. The benefits include lower inflation rates that suppress loss trends, as well as reduce our cost of capital. However, the interest rate environment presents a significant challenge in generating after-tax return on our investment portfolio.

Given the results we have achieved in Six Months 2014, including the level of catastrophe losses we have incurred and the overall renewal pure price increases we have achieved, we currently expect to generate: • A full-year combined ratio of 92% excluding catastrophe losses and assuming no additional prior year casualty reserve development; • Five points of catastrophe losses for the year, which is one point higher than our previous guidance; • Renewal pure price increases of approximately 6% on an overall company basis, at the low end of our previous estimate of 6%-7%; • After-tax investment income of approximately $100 million; and • Weighted-average shares of approximately 57.4 million.

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

Quarter ended June 30, Six Months ended June 30, Change Change % or % or ($ in thousands) 2014 2013 Points 2014 2013 Points GAAP Insurance Operations Results:NPW $ 442,041 429,511 3 % $ 888,729 851,255 4 % NPE 429,051 396,205 8 853,310 787,086 8 Less: Loss and loss expense incurred 275,395 258,520 7 576,061 509,251 13 Net underwriting expenses incurred 141,986 129,936 9 270,331 256,925 5 Dividends to policyholders 1,549 981 58 2,787 2,067 35 Underwriting gain $ 10,121 6,768 50 % $ 4,131 18,843 (78 ) % GAAP Ratios: Loss and loss expense ratio 64.2 % 65.2 (1.0 ) pts 67.5 % 64.7 2.8 pts Underwriting expense ratio 33.0 32.9 0.1 31.7 32.6 (0.9 ) Dividends to policyholders ratio 0.4 0.2 0.2 0.3 0.3 - Combined ratio 97.6 98.3 (0.7 ) 99.5 97.6 1.9 Statutory Ratios: Loss and loss expense ratio1 64.2 65.3 (1.1 ) 67.5 64.7 2.8 Underwriting expense ratio1 32.7 31.5 1.2 31.4 31.9 (0.5 ) Dividends to policyholders ratio 0.4 0.2 0.2 0.3 0.3 - Combined ratio1 97.3 % 97.0 0.3 pts 99.2 % 96.9 2.3 pts 1 Statutory ratios for Six Months 2013 included 0.2 points in the loss and loss expense ratio, 0.5 points in the underwriting ratio, and 0.7 points in the combined ratio related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

The improvements in NPW in Second Quarter and Six Months 2014 compared to Second Quarter and Six Months 2013 include the following: Quarter ended June 30, Quarter ended June 30, 2014 2013 Renewal Renewal Pure Price Pure Price ($ in millions) Increase Retention Increase Retention Standard Commercial Lines 5.9 % 82 % 7.2 % 83 % Standard Personal Lines 6.5 82 8.3 87 Six Months ended June Six Months ended June 30, 2014 30, 2013 Renewal Renewal Pure Price Pure Price ($ in millions) Increase Retention Increase Retention Standard Commercial Lines 6.1 % 82 % 7.3 % 82 % Standard Personal Lines 6.2 82 8.4 86 32-------------------------------------------------------------------------------- Table of Contents The decrease in the Standard Personal Lines retention was driven by targeted actions that we have taken to reduce our exposure to certain coverages that have historically been less profitable for us. Excluding the impact of these targeted actions, retention remains strong and comparable to last year.

NPE increases in Second Quarter and Six Months 2014 were consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2014 compared to the twelve-month period ended June 30, 2013.

The GAAP loss and loss expense ratio decreased 1.0 points in Second Quarter 2014 compared to Second Quarter 2013 driven by: (i) renewal pure price increases that exceed our projected loss cost trends; and (ii) favorable prior year casualty reserve development. This was partially offset by higher non-catastrophe property losses and an increased level of catastrophe losses. Quantitative information regarding the property losses and the reserve development is as follows: Quarter ended June 30, 2014 Quarter ended June 30, 2013 Impact on Impact on Loss and Loss Expense Loss and Loss Loss and Loss Expense Loss and Loss Change in ($ in millions) Incurred Expense Ratio Incurred Expense Ratio RatioCatastrophe losses $ 25.5 5.9 pts $ 17.1 4.3 pts 1.6 pts Non-catastrophe property losses 67.5 15.7 50.2 12.7 3.0 Favorable prior year casualty reserve development (17.5 ) (4.1 ) (4.0 ) (1.0 ) (3.1 ) The GAAP loss and loss expense ratio increased 2.8 points in Six Months 2014 compared to Six Months 2013 driven by: (i) an increased level of catastrophe losses; and (ii) higher non-catastrophe property losses. This was partially offset by favorable prior year casualty reserve development and renewal pure price increases that exceed our projected loss cost trends. Quantitative information regarding the property losses and the reserve development is as follows: Six Months ended June 30, 2014 Six Months ended June 30, 2013 Impact on Impact on Loss and Loss Expense Loss and Loss Loss and Loss Expense Loss and Loss Change in ($ in millions) Incurred Expense Ratio Incurred Expense Ratio Ratio Catastrophe losses $ 59.7 7.0 pts $ 18.3 2.3 pts 4.7 pts Non-catastrophe property losses 153.7 18.0 110.9 14.1 3.9 Favorable prior year casualty reserve development (31.5 ) (3.7 ) (6.0 ) (0.8 ) (2.9 ) The breakdown of favorable prior year casualty reserve development in our Standard Insurance Operations by line of business is as follows: Favorable/(Unfavorable) Prior Year Casualty Reserve Development Quarter ended June 30, Six Months ended June 30, ($ in millions) 2014 2013 2014 2013 General liability $ 14.0 5.0 $ 25.0 9.0 Commercial automobile 4.0 - 4.0 - Workers compensation - (3.0 ) - (11.0 ) Businessowners' policies (2.5 ) 3.0 (1.5 ) 6.0 Homeowners - - - 2.0 Personal automobile 2.0 (1.0 ) 4.0 - Total favorable prior year casualty reserve development $ 17.5 4.0 $ 31.5 6.0 Favorable impact on loss ratio 4.1 pts 1.0 pts 3.7 pts. 0.8 pts.

Favorable prior year casualty reserve development of $17.5 million in Second Quarter 2014 and $31.5 million in Six Months 2014 was primarily driven by improving claim trends for the 2007 through 2012 accident years on our general liability line of business coupled with stable workers compensation trends in 2014. Included in this net favorable prior year casualty reserve development is unfavorable development in the 2009 accident year in our businessowners' policies line of business.

33-------------------------------------------------------------------------------- Table of Contents The improvement in the GAAP underwriting expense ratio in Six Months 2014 compared to Six Months 2013 was primarily driven by the income generated from the first quarter 2014 sale of the renewal rights to our SIG book of pooled public entity business for $8 million, or 0.9 points. For additional information regarding the sale, see Note 8. "Segment Information" in Item 1.

"Financial Statements." of this Form 10-Q.

The statutory underwriting expense ratio increased 1.2 points in Second Quarter 2014 compared to Second Quarter 2013 partially due to an increase in commissions to our agents. This increase, which was due to the mix of NPW, coupled with higher supplemental commissions to agents, was recognized immediately on a statutory basis, but was deferred and amortized on a GAAP basis.

Review of Underwriting Results by Line of Business Standard Commercial Lines Quarter ended June 30, Six Months ended June 30, Change Change % or % or ($ in thousands) 2014 2013 Points 2014 2013 Points GAAP Insurance Operations Results: NPW $ 363,860 350,651 4 % $ 743,210 703,840 6 % NPE 354,507 322,657 10 703,948 640,502 10 Less: Loss and loss expense incurred 216,532 201,316 8 459,171 404,455 14 Net underwriting expenses incurred 120,723 110,617 9 229,917 218,135 5 Dividends to policyholders 1,549 981 58 2,787 2,067 35 Underwriting gain $ 15,703 9,743 61 % $ 12,073 15,845 (24 ) % GAAP Ratios: Loss and loss expense ratio 61.1 % 62.4 (1.3 ) pts 65.2 % 63.1 2.1 pts Underwriting expense ratio 34.1 34.3 (0.2 ) 32.7 34.1 (1.4 ) Dividends to policyholders ratio 0.4 0.3 0.1 0.4 0.3 0.1 Combined ratio 95.6 97.0 (1.4 ) 98.3 97.5 0.8 Statutory Ratios: Loss and loss expense ratio1 61.1 62.4 (1.3 ) 65.2 63.1 2.1 Underwriting expense ratio1 34.0 32.9 1.1 32.2 33.2 (1.0 ) Dividends to policyholders ratio 0.4 0.3 0.1 0.4 0.3 0.1 Combined ratio1 95.5 % 95.6 (0.1 ) pts 97.8 % 96.6 1.2 pts 1 Statutory ratios for Six Months 2013 included 0.2 points in the loss and loss expense ratio, 0.5 points in the underwriting ratio, and 0.7 points in the combined ratio related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all employees eligible to participate in the plans after March 31, 2016.

The increase in NPW in Second Quarter and Six Months 2014 compared to Second Quarter and Six Months 2013 is primarily the result of the following: Quarter ended June 30, Six Months ended June 30, ($ in millions) 2014 2013 2013 2012 Retention 82 % 83 82 % 82 Renewal pure price increases 5.9 7.2 6.1 7.3 NPE increases in Second Quarter and Six Months 2014 were consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2014 compared to the twelve-month period ended June 30, 2013.

34-------------------------------------------------------------------------------- Table of Contents The GAAP loss and loss expense ratio decreased 1.3 points in Second Quarter 2014 compared to Second Quarter 2013 driven by: (i) renewal pure price increases that averaged 6.1% in Six Months 2014 and 7.6% in full-year 2013, the earning of which exceeds our projected loss cost trend by approximately 3 points; and (ii) favorable prior year casualty reserve development. These were partially offset by the following: (i) an increased level of catastrophe losses; and (ii) higher non-catastrophe property losses. Quantitative information regarding the property losses and the reserve development is as follows: Quarter ended June 30, 2014 Quarter ended June 30, 2013 Impact on Losses Impact on ($ in millions) Losses Incurred Loss Ratio Incurred Loss Ratio Change in Ratio Catastrophe losses $ 12.8 3.6 pts $ 9.2 2.8 pts 0.8 pts Non-catastrophe property losses 43.6 12.3 27.9 8.6 3.7 Favorable prior year casualty reserve development (15.5 ) (4.4 ) (5.0 ) (1.5 ) (2.9 ) The GAAP loss and loss expense ratio increased 2.1 points in Six Months 2014 compared to Six Months 2013 driven by: (i) an increased level of catastrophe losses; and (ii) higher non-catastrophe property losses. These losses were partially offset by the following: (i) renewal pure price increases that averaged 6.1% in Six Months 2014 and 7.6% in full-year 2013, the earning of which exceeds our projected loss cost trend by approximately 3 points; and (ii) favorable prior year casualty reserve development. Quantitative information regarding the property losses and the reserve development are as follows: Six Months ended June 30, 2014 Six Months ended June 30, 2013 Impact on Losses Impact on ($ in millions) Losses Incurred Loss Ratio Incurred Loss Ratio Change in Ratio Catastrophe losses $ 38.7 5.5 pts $ 9.9 1.6 pts 3.9 pts Non-catastrophe property losses 102.4 14.5 64.8 10.1 4.4 Favorable prior year casualty reserve development (27.5 ) (3.9 ) (4.5 ) (0.7 ) (3.2 ) The improvement in the GAAP and statutory underwriting expense ratios in Six Months 2014 compared to Six Months 2013 was primarily driven by the income generated from the renewal rights sale of our SIG book of business for $8 million, or 1.1 points, in the first quarter of 2014. For additional information regarding the sale, see Note 8. "Segment Information" in Item 1. "Financial Statements." of this Form 10-Q.

The statutory underwriting expense ratio increased 1.1 points in Second Quarter 2014 compared to Second Quarter 2013 partially due to an increase in commissions to our agents. This increase was driven by: (i) the mix of NPW, specifically lower workers compensation NPW, which has a lower commission rate than our other lines of business; and (ii) higher supplemental commission to agents. These amounts are recognized immediately on a statutory basis, but are deferred and amortized on a GAAP basis.

The following is a discussion of our most significant standard Commercial Lines of business and their respective statutory results: General Liability Quarter ended June 30, Six Months ended June 30, Change Change % or % or ($ in thousands) 2014 2013 Points 2014 2013 Points Statutory NPW $ 118,176 110,232 7 % $ 237,680 219,637 8 % Direct new business 19,839 20,859 (5 ) 39,674 40,640 (2 ) Retention 82 % 82 - pts 82 % 82 - pts Renewal pure price increases 7.2 % 8.7 (1.5 ) 7.4 % 8.7 (1.3 ) Statutory NPE $ 111,591 99,766 12 % $ 220,409 197,469 12 % Statutory combined ratio 80.7 % 94.9 (14.2 ) pts 80.7 % 95.4 (14.7 ) pts % of total statutory standard Commercial Lines NPW 32 % 31 32 % 31 The growth in NPW and NPE for our general liability business in Second Quarter and Six Months 2014 reflects renewal pure price increases and strong retention.

35-------------------------------------------------------------------------------- Table of Contents The statutory combined ratio improvement for Second Quarter and Six Months 2014 was driven by renewal pure price increases of 7.2% and 7.4%, respectively, that continue to outpace loss cost trends on this line as well as the following: Quarter ended June 30, 2014 Quarter ended June 30, 2013 Impact on Impact on Combined Change ($ in millions) (Benefit) Expense Combined Ratio (Benefit) Expense Ratio Points Favorable prior year casualty reserve development $ (14.0 ) (12.5 ) pts $ (5.0 ) (5.0 ) pts (7.5 ) pts Six Months ended June 30, 2014 Six Months ended June 30, 2013 Impact on Impact on Change ($ in millions) (Benefit) Expense Combined Ratio (Benefit) Expense Combined Ratio Points Favorable prior year casualty reserve development $ (25.0 ) (11.3 ) pts $ (9.0 ) (4.6 ) pts (6.7 ) pts Sale of SIG renewal rights (2.1 ) (0.9 ) - - (0.9 ) Retirement Income Plan curtailment charge - - 1.4 0.7 (0.7 ) Favorable prior year casualty reserve development in Second Quarter and Six Months 2014 was driven by improving claim trends for the 2012 and prior accident years; whereas favorable prior year casualty reserve development in Second Quarter 2013 and Six Months 2013 was driven by the 2009 through 2011 accident years.

Commercial Automobile Quarter ended June 30, Six Months ended June 30, Change Change % or % or ($ in thousands) 2014 2013 Points 2014 2013 Points Statutory NPW $ 87,413 84,254 4 % $ 176,535 166,126 6 % Direct new business 13,679 16,166 (15 ) 28,485 31,070 (8 ) Retention 82 % 82 - pts 82 % 82 - pts Renewal pure price increases 5.8 % 7.0 (1.2 ) 6.0 % 7.0 (1.0 ) Statutory NPE $ 83,472 76,706 9 % $ 165,688 151,053 10 % Statutory combined ratio 93.5 % 95.3 (1.8 ) pts 94.2 % 96.6 (2.4 ) pts % of total statutory standard Commercial Lines NPW 24 % 24 24 % 24 The growth in NPW and NPE for our commercial automobile business in Second Quarter and Six Months 2014 reflects renewal pure price increases and strong retention.

The statutory combined ratio improvements for Second Quarter 2014 and Six Months 2014 were impacted by the following: Quarter ended June 30, 2014 Quarter ended June 30, 2013 Impact on Impact on Combined ($ in millions) (Benefit) Expense Combined Ratio (Benefit) Expense Ratio Change Points Catastrophe losses $ 1.4 1.7 pts $ (0.3 ) (0.4 ) pts 2.1 pts Favorable prior year casualty reserve development (4.0 ) (4.8 ) - - (4.8 ) Six Months ended June 30, 2014 Six Months ended June 30, 2013 Impact on Impact on Change ($ in millions) (Benefit) Expense Combined Ratio (Benefit) Expense Combined Ratio Points Catastrophe losses $ 1.5 0.9 pts $ (0.9 ) (0.6 ) pts 1.5 pts Favorable prior year casualty reserve development (4.0 ) (2.4 ) - - (2.4 ) Sale of SIG renewal rights (1.5 ) (0.9 ) - - (0.9 ) Retirement Income Plan curtailment charge - - 1.0 0.6 (0.6 ) 36-------------------------------------------------------------------------------- Table of Contents Favorable prior year casualty development in Second Quarter 2014 and Six Months 2014 was driven by the 2008 through 2012 accident years, partially offset by unfavorable prior year casualty development in the 2013 accident year.

Workers Compensation Quarter ended June 30, Six Months ended June 30, Change Change % or % or ($ in thousands) 2014 2013 Points 2014 2013 Points Statutory NPW $ 65,210 68,589 (5 ) % $ 141,181 143,994 (2 ) % Direct new business 11,069 14,813 (25 ) 24,727 28,692 (14 ) Retention 81 % 81 - pts 81 % 82 (1 ) pts Renewal pure price increases 5.7 % 7.6 (1.9 ) 5.3 % 7.8 (2.5 ) Statutory NPE $ 68,992 64,855 6 % $ 138,405 130,939 6 % Statutory combined ratio 112.1 % 118.3 (6.2 ) pts 108.8 % 118.6 (9.8 ) pts % of total statutory standard Commercial Lines NPW 18 % 20 19 % 20 Second Quarter and Six Months 2014 NPW decreased compared to Second Quarter and Six Months 2013 due to a decrease in direct new business. In addition, this line is beginning to be impacted by the sale of the SIG book of business in the first quarter of 2014. The reduction in NPW as a result of this sale was 0.6% for Second Quarter 2014 and 0.3% for Six Months 2014. Although not substantial during the current quarter and year-to-date periods, the reduction in NPW will become more significant as the year progresses, with the greatest impact expected in the third quarter, due to the seasonality of these premiums.

NPE increases in Second Quarter and Six Months 2014 were consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2014 compared to the twelve-month period ended June 30, 2013.

While we continue to view workers compensation in the context of an overall account, we remain very focused on improving this competitive line of business through both underwriting and claims initiatives. We achieved renewal pure price increases of 5.7% in Second Quarter 2014 and 5.3% in Six Months 2014. We are applying all the underwriting tools we have to move pricing higher and write the best risks. In addition, we have centralized the handling of lost-time and medical-only workers compensation claims alongside our strategic case management unit to create integration around our core strategy of early identification, escalation, and mitigation of potentially high-risk claims. We have supplemented our claims expertise within our strategic case management unit with the addition of medical specialists, including nurse practioners and a physician consultant.

The improvement in the statutory combined ratio was primarily attributable to the following: Quarter ended June 30, 2014 Quarter ended June 30, 2013 Impact on Impact on Combined Combined Change ($ in millions) (Benefit) Expense Ratio (Benefit) Expense Ratio Points Unfavorable prior year casualty reserve development $ - - pts $ 3.5 5.0 pts (5.0 ) pts Six Months ended June 30, 2014 Six Months ended June 30, 2013 Impact on Impact on (Benefit) Combined Change ($ in millions) (Benefit) Expense Combined Ratio Expense Ratio Points Unfavorable prior year casualty reserve development $ - - pts $ 10.5 8.1 pts (8.1 ) pts Sale of SIG renewal rights (1.5 ) (1.1 ) - - (1.1 ) Retirement Income Plan curtailment charge - - 1.2 0.9 (0.9 ) Second Quarter 2013 and Six Months 2013 unfavorable prior year casualty reserve development was primarily driven by development on the 2012 accident year. In addition, Six Months 2013 was also impacted by a single large claim prior to 2003.

37-------------------------------------------------------------------------------- Table of Contents Commercial Property Quarter ended June 30, Six Months ended June 30, Change Change ($ in % or % or thousands) 2014 2013 Points 2014 2013 Points Statutory NPW $ 62,630 59,193 6 % $ 126,726 116,953 8 % Direct new business 13,271 14,396 (8 ) 27,766 28,781 (4 ) Retention 81 % 82 (1 ) pts 81 % 81 - pts Renewal pure price increases 4.0 % 5.0 (1.0 ) 4.8 % 5.3 (0.5 ) Statutory NPE $ 61,226 54,937 11 % $ 121,412 108,352 12 % Statutory combined ratio 101.7 % 80.9 20.8 pts 116.4 % 83.7 32.7 pts % of total statutory standard Commercial Lines NPW 17 % 17 17 % 17 NPW and NPE increased in Second Quarter and Six Months 2014 compared to Second Quarter and Six Months 2013 primarily due to renewal pure price increases and strong retention.

The increase in the statutory combined ratio in Second Quarter and Six Months 2014 compared to the same prior year periods was due to the following: Quarter ended June 30, 2014 Quarter ended June 30, 2013 Change (Benefit) Impact on (Benefit) Impact on % or ($ in millions) Expense Combined Ratio Expense Combined Ratio Points Catastrophe losses $ 10.1 16.5 pts $ 7.7 14.0 pts 2.5 pts Non-catastrophe property losses 26.2 42.7 13.3 24.3 18.4 Six Months ended June 30, 2014 SixMonths ended June 30, 2013 Change Impact on (Benefit) Impact on % or ($ in millions) (Benefit) Expense Combined Ratio Expense Combined Ratio Points Catastrophe losses $ 29.0 23.9 pts $ 9.5 8.8 pts 15.1 pts Non-catastrophe property losses 62.6 51.5 34.0 31.3 20.2 Sale of SIG renewal rights (1.4 ) (1.1 ) - - (1.1 ) Retirement Income Plan curtailment charge - - 0.8 0.7 (0.7 ) 38-------------------------------------------------------------------------------- Table of Contents Standard Personal Lines Quarter ended June 30, Six Months ended June 30, Change Change % or % or ($ in thousands) 2014 2013 Points 2014 2013 Points GAAP Insurance Operations Results: NPW $ 78,181 78,860 (1 ) % $ 145,519 147,415 (1 ) % NPE 74,544 73,548 1 149,362 146,584 2 Less: Loss and loss expense incurred 58,863 57,204 3 116,890 104,796 12 Net underwriting expenses incurred 21,263 19,319 10 40,414 38,790 4 Underwriting (loss) gain $ (5,582 ) (2,975 ) (88 ) % $ (7,942 ) 2,998 (365 ) % GAAP Ratios: Loss and loss expense ratio 79.0 % 77.8 1.2 pts 78.3 % 71.5 6.8 pts Underwriting expense ratio 28.5 26.2 2.3 27.0 26.5 0.5 Combined ratio 107.5 104.0 3.5 105.3 98.0 7.3 Statutory Ratios: Loss and loss expense ratio1 79.0 77.9 1.1 78.3 71.6 6.7 Underwriting expense ratio1 27.1 25.0 2.1 27.0 26.0 1.0 Combined ratio1 106.1 % 102.9 3.2 pts 105.3 % 97.6 7.7 pts 1 Statutory ratios for Six Months 2013 included 0.1 points in the loss and loss expense ratio, 0.5 points in the underwriting ratio, and 0.6 points in the combined ratio related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all employees eligible to participate in the plans after March 31, 2016.

The decreases in NPW for both the quarter and year-to-date periods were primarily driven by a marginal decrease in new business and lower retention compared to the same periods a year ago. Partially offsetting these decreases were renewal pure price increases. Quantitative information regarding these items is as follows: Quarter ended June 30, Six Months ended June 30, ($ in millions) 2014 2013 2014 2013 New Business $ 9.7 10.8 $ 17.7 20.8 Retention 82 % 87 82 % 86 Renewal pure price increase 6.5 8.3 6.2 8.4 The decrease in retention was driven by targeted actions that we have taken to reduce our exposure to certain coverages that have historically been less profitable for us. Excluding the impact of these targeted actions, retention remains strong and comparable to last year.

NPE increases in Second Quarter and Six Months 2014 compared to Second Quarter and Six Months 2013, are consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2014 compared to the twelve-month period ended June 30, 2013.

The variance in the loss and loss expense ratios was driven by storms and fires, resulting in: (i) an increased level of catastrophe losses; and (ii) higher non-catastrophe property losses. Partially offsetting these losses were renewal pure price increases of 6.2% for Six Months 2014, and 7.8% for full-year 2013, the earning of which exceeds our projected loss cost trend for the casualty component of our Personal Lines. Quantitative information regarding the property losses are as follows: 39-------------------------------------------------------------------------------- Table of Contents Quarter ended June 30, 2014 Quarter ended June 30, 2013 Impact on Loss and Loss Impact on Loss and Loss Expense Loss and Loss Expense Loss and Loss ($ in millions) Incurred Expense Ratio Incurred Expense Ratio Change in Ratio Catastrophe losses $ 12.7 17.1 pts $ 7.9 10.7 pts 6.4 pts Non-catastrophe property losses 24.0 32.1 22.3 30.3 1.8 Flood claims handling fees (1.0 ) (1.3 ) (1.3 ) (1.7 ) 0.4 (Favorable)/unfavorable prior year casualty development (2.0 ) (2.7 ) 1.0 1.2 (3.9 ) Six Months ended June 30, 2014 Six Months ended June 30, 2013 Impact on Impact on Loss and Loss and Loss Loss and Loss Loss Loss and Loss Expense Expense Expense Expense ($ in millions) Incurred Ratio Incurred Ratio Change in Ratio Catastrophe losses $ 21.0 14.1 pts $ 8.4 5.7 pts 8.4 pts Non-catastrophe property losses 51.3 34.4 46.1 31.4 3.0 Flood claims handling fees (1.6 ) (1.0 ) (2.8 ) (1.9 ) 0.9 Favorable prior year casualty development (4.0 ) (2.7 ) (1.5 ) (1.2 ) (1.5 ) Favorable prior year casualty reserve development in Second Quarter 2014 and Six Months 2014 was driven by the 2009 through 2013 accident years on our personal auto line of business. Unfavorable prior year casualty reserve development in Second Quarter 2013 was driven by accident years prior to 2003, whereas favorable prior year casualty reserve development in Six Months 2013 was due to the 2010 and 2011 accident years in our homeowners line of business.

The increase in the GAAP and statutory underwriting expense ratios were driven by higher supplemental commissions to agents. In addition, the statutory underwriting expense ratio had a one-time favorable premium tax ruling on our Flood business of 1.5 points in Second Quarter 2013 and 0.8 points in Six Months 2013.

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

Quarter ended June 30, Six Months ended June 30, Change Change % or % or ($ in thousands) 2014 2013 Points 2014 2013 Points GAAP Insurance Operations Results: NPW $ 37,782 32,666 16 % $ 67,844 61,046 11 % NPE 34,574 30,047 15 66,810 60,106 11 Less: Loss and loss expense incurred 22,400 21,074 6 42,280 40,192 5 Net underwriting expenses incurred 12,211 11,258 8 23,592 22,113 7 Underwriting (loss) gain $ (37 ) (2,285 ) 98 % $ 938 (2,199 ) 143 % GAAP Ratios: Loss and loss expense ratio 64.8 % 70.1 (5.3 ) pts 63.3 % 66.9 (3.6 ) pts Underwriting expense ratio 35.3 37.5 (2.2 ) 35.3 36.8 (1.5 ) Combined ratio 100.1 107.6 (7.5 ) 98.6 103.7 (5.1 ) Statutory Ratios: Loss and loss expense ratio 65.0 70.3 (5.3 ) 63.4 66.9 (3.5 ) Underwriting expense ratio 34.9 36.5 (1.6 ) 35.4 35.7 (0.3 ) Combined ratio 99.9 % 106.8 (6.9 ) pts 98.8 % 102.6 (3.8 ) pts 40-------------------------------------------------------------------------------- Table of Contents The improvement in the combined ratio in Second Quarter and Six Months 2014 was driven by the following: • Significant underwriting actions that we have implemented to improve profitability, including achieving renewal pure price increases of 2.7% in Second Quarter 2014 and 3.7% in Six Months 2014.

• No prior year casualty reserve development in 2014 compared to unfavorable prior year casualty reserve development of $2.0 million, or 6.5 points, in Second Quarter 2013 and $2.5 million, or 4.1 points, in Six Months 2013.

• Catastrophe losses of 4.9 points in Second Quarter 2014 compared to 8.5 points in Second Quarter 2013 and 2.8 points in Six Months 2014 compared to 4.8 points in Six Months 2013.

These benefits were partially offset by increased non-catastrophe property losses in Second Quarter 2014 and Six Months 2014 compared to the same periods last year.

Reinsurance: Standard Insurance Operations Reinsurance Treaties and Arrangement We have successfully completed negotiations of our July 1, 2014 Standard Insurance Operations excess of loss treaties with some enhancements in terms and conditions and the same structure as the expiring treaties as follows: Property Excess of Loss The property excess of loss treaty ("Property Treaty") continues to provide $38.0 million of coverage in excess of a $2.0 million retention: • The per occurrence cap on the total program is $84.0 million.

• The first layer continues to have unlimited reinstatements. The annual aggregate limit for the $30.0 million in excess of $10.0 million second layer is $120.0 million.

• The Property Treaty continues to exclude nuclear, biological, chemical, and radiological terrorism losses.

Casualty Excess of Loss The casualty excess of loss treaty ("Casualty Treaty") continues to provide $88.0 million of coverage in excess of a $2.0 million retention: • The first through sixth layers provide coverage for 100% of up to $88.0 million in excess of a $2.0 million retention.

• The Casualty Treaty excludes nuclear, biological, chemical, and radiological terrorism losses, with the annual aggregate terrorism limits increased to $208.0 million from $201.0 million.

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

Total Invested Assets ($ in thousands) June 30, 2014 December 31, 2013 Change % Total invested assets $ 4,739,099 4,583,312 3 % Unrealized gain - before tax 144,877 79,236 83 Unrealized gain - after tax 94,169 51,504 83 The increase in our investment portfolio compared to year-end 2013 was primarily due to: (i) cash flows provided by operating activities of $72.7 million; and (ii) an increase in pre-tax unrealized gains of $65.6 million. These gains were driven by increases in the market value of our fixed income securities portfolio as interest rates decreased during Six Months 2014.

During Six Months 2014, interest rates on the 10-year U.S. Treasury Note fell by 50 basis points. This decline in interest rates increased the unrealized gain position on our fixed income securities portfolio. The average after-tax yield on our purchases of fixed income securities was 2.3% during Second Quarter 2014.

The interest rate environment over the past several years has put pressure on the existing investment yield of the portfolio, as new and reinvested money has been redeployed at lower rates. However, as the overall portfolio yield approaches the yield of new purchases, we have begun to see a declining rate of pressure on the yield of the existing portfolio.

We structure our portfolio conservatively with a focus on: (i) asset diversification; (ii) investment quality; (iii) liquidity, particularly to meet the cash obligations of our insurance operations segments; (iv) consideration of taxes; and (v) preservation of capital. We believe that we have a high quality and liquid investment portfolio. The breakdown of our investment portfolio is as follows: June 30, 2014 December 31, 2013 U.S. government obligations 3 % 4 Foreign government obligations 1 1 State and municipal obligations 30 28 Corporate securities 38 39 Mortgage-backed securities ("MBS") 15 15 Asset-backed securities ("ABS") 3 3 Total fixed income securities 90 90 Equity securities 4 4 Short-term investments 4 4 Other investments 2 2 Total 100 % 100 42-------------------------------------------------------------------------------- Table of Contents Fixed Income Securities The average duration of the fixed income securities portfolio as of June 30, 2014 was 3.6 years, including short-term investments, compared to the Insurance Subsidiaries' liability duration of approximately 3.8 years. The current duration of the fixed income securities portfolio is within our historical range, and is monitored and managed to maximize yield while managing interest rate risk at an acceptable level. We are experiencing continued pressure on the yields within our fixed income securities portfolio, as higher yielding bonds that are either maturing or have been sold are being replaced with lower yielding bonds that are currently available in the marketplace. We manage liquidity with a laddered maturity structure and an appropriate level of short-term investments to avoid liquidation of available-for-sale ("AFS") fixed income securities in the ordinary course of business. We typically have a long investment time horizon, and every purchase or sale is made with the intent of maximizing risk-adjusted investment returns in the current market environment while balancing capital preservation.

Our fixed income securities portfolio had a weighted average credit rating of "AA-" as of June 30, 2014. The following table presents the credit ratings of this portfolio: Fixed Income Security Rating June 30, 2014 December 31, 2013 Aaa/AAA 16 % 15 Aa/AA 45 45 A/A 25 26 Baa/BBB 13 13 Ba/BB or below 1 1 Total 100 % 100 43-------------------------------------------------------------------------------- Table of Contents The following table summarizes the fair value, unrealized gain (loss) balances, and the weighted average credit qualities of our AFS fixed income securities at June 30, 2014 and December 31, 2013: June 30, 2014 December 31, 2013 Weighted Weighted Average Fair Unrealized Average Credit Fair Unrealized Credit ($ in millions) Value Gain (Loss) Quality Value Gain (Loss) Quality AFS Fixed Income Portfolio: U.S. government obligations $ 158.8 9.3 AA+ 173.4 10.1 AA+ Foreign government obligations 28.0 1.0 AA- 30.6 0.8 AA- State and municipal obligations 1,107.1 27.0 AA+ 951.6 5.2 AA Corporate securities 1,782.6 52.4 A- 1,734.9 27.0 A ABS 132.2 0.7 AAA 140.9 0.5 AAA MBS 681.5 7.8 AA+ 684.1 (4.0 ) AA+ Total AFS fixed income portfolio $ 3,890.2 98.2 AA- 3,715.5 39.6 AA- State and Municipal Obligations: General obligations $ 528.0 12.4 AA+ 472.0 2.6 AA+ Special revenue obligations 579.1 14.6 AA 479.6 2.6 AA Total state and municipal obligations $ 1,107.1 27.0 AA+ 951.6 5.2 AA Corporate Securities: Financial $ 550.7 16.1 A 534.1 11.7 A Industrials 140.6 5.3 A- 135.1 3.7 A- Utilities 156.4 3.8 BBB+ 146.5 (0.3 ) A- Consumer discretionary 204.9 7.0 A- 190.6 2.7 A- Consumer staples 171.5 4.8 A 171.9 3.0 A Healthcare 167.8 5.4 A 168.5 3.1 A Materials 109.3 3.5 BBB+ 101.2 1.4 A- Energy 108.1 2.8 A- 93.7 0.9 A- Information technology 116.0 1.8 A+ 121.2 (0.6 ) A+ Telecommunications services 50.4 1.5 BBB+ 64.7 1.0 BBB+ Other 6.9 0.4 AA+ 7.4 0.4 AA+ Total corporate securities $ 1,782.6 52.4 A- 1,734.9 27.0 A ABS: ABS $ 131.8 0.7 AAA 140.4 0.4 AAA Sub-prime ABS1 0.4 - D 0.5 0.1 D Total ABS 132.2 0.7 AAA 140.9 0.5 AAA MBS: Government guaranteed agency commercial mortgage-backed securities ("CMBS") $ 23.7 0.6 AA+ 30.0 0.9 AA+ Other agency CMBS 10.8 (0.1 ) AA+ 9.1 (0.3 ) AA+ Non-agency CMBS 138.0 1.6 AA+ 132.2 (1.5 ) AA+ Government guaranteed agency residential MBS ("RMBS") 41.8 1.2 AA+ 55.2 1.4 AA+ Other agency RMBS 422.9 3.6 AA+ 411.5 (5.1 ) AA+ Non-agency RMBS 40.1 0.8 A- 41.4 0.6 A- Alternative-A ("Alt-A") RMBS 4.2 0.1 A 4.7 - A Total MBS $ 681.5 7.8 AA+ 684.1 (4.0 ) AA+ 1Subprime ABS consists of one security whose issuer is currently expected by rating agencies to default on its obligations. We define sub-prime exposure as exposure to direct and indirect investments in non-agency residential mortgages with average FICO® scores below 650.

44-------------------------------------------------------------------------------- Table of Contents The following tables provide information regarding our held-to-maturity ("HTM") fixed income securities and their credit qualities at June 30, 2014 and December 31, 2013: June 30, 2014 Unrealized Gain (Loss) in Accumulated Total Weighted Unrecognized Other Unrealized/ Average Fair Carry Holding Gain Comprehensive Unrecognized Credit ($ in millions) Value Value (Loss) Income ("AOCI") Gain (Loss) Quality HTM Fixed Income Portfolio: Foreign government obligations $ 5.5 5.4 0.1 0.1 0.2 AA+ State and municipal obligations 346.7 330.8 15.9 2.9 18.8 AA Corporate securities 24.5 21.5 3.0 (0.3 ) 2.7 A+ ABS 3.3 2.7 0.6 (0.6 ) - AAA MBS 5.5 4.5 1.0 (0.5 ) 0.5 AAA Total HTM fixed income portfolio $ 385.5 364.9 20.6 1.6 22.2 AA State and Municipal Obligations: General obligations $ 110.6 105.9 4.7 1.5 6.2 AA Special revenue obligations 236.1 224.9 11.2 1.4 12.6 AA Total state and municipal obligations $ 346.7 330.8 15.9 2.9 18.8 AA Corporate Securities: Financial $ 2.3 1.9 0.4 (0.1 ) 0.3 A- Industrials 7.0 5.9 1.1 (0.1 ) 1.0 A+ Utilities 13.7 12.2 1.5 (0.1 ) 1.4 A+ Consumer discretionary 1.5 1.5 - - - AA Total corporate securities $ 24.5 21.5 3.0 (0.3 ) 2.7 A+ ABS: ABS $ 0.8 0.8 - - - AA Alt-A ABS 2.5 1.9 0.6 (0.6 ) - AAA Total ABS $ 3.3 2.7 0.6 (0.6 ) - AAA MBS: Non-agency CMBS $ 5.5 4.5 1.0 (0.5 ) 0.5 AAA Total MBS $ 5.5 4.5 1.0 (0.5 ) 0.5 AAA 45-------------------------------------------------------------------------------- Table of Contents December 31, 2013 Total Weighted Unrecognized Unrealized/ Average Fair Carry Holding Gain Unrealized Gain Unrecognized Credit ($ in millions) Value Value (Loss) (Loss) in AOCI Gain (Loss) Quality HTM Portfolio: Foreign government obligations $ 5.6 5.4 0.2 0.1 0.3 AA+ State and municipal obligations 369.8 352.2 17.6 4.0 21.6 AA Corporate securities 30.3 27.8 2.5 (0.3 ) 2.2 A ABS 3.4 2.8 0.6 (0.6 ) - AA+ MBS 7.9 4.7 3.2 (0.9 ) 2.3 AA- Total HTM portfolio $ 417.0 392.9 24.1 2.3 26.4 AA State and Municipal Obligations: General obligations $ 118.5 113.1 5.4 2.0 7.4 AA Special revenue obligations 251.3 239.1 12.2 2.0 14.2 AA Total state and municipal obligations $ 369.8 352.2 17.6 4.0 21.6 AA Corporate Securities: Financial $ 7.3 6.8 0.5 (0.1 ) 0.4 BBB+ Industrials 7.8 6.8 1.0 (0.2 ) 0.8 A+ Utilities 13.2 12.2 1.0 - 1.0 A+ Consumer discretionary 2.0 2.0 - - - AA Total corporate securities $ 30.3 27.8 2.5 (0.3 ) 2.2 A ABS: ABS $ 0.9 0.9 - - - A Alt-A ABS 2.5 1.9 0.6 (0.6 ) - AAA Total ABS $ 3.4 2.8 0.6 (0.6 ) - AA+ MBS: Non-agency CMBS $ 7.9 4.7 3.2 (0.9 ) 2.3 AA- Total MBS $ 7.9 4.7 3.2 (0.9 ) 2.3 AA- 46-------------------------------------------------------------------------------- Table of Contents The sector composition and credit quality of our municipal bonds did not significantly change from December 31, 2013. For details regarding our special revenue bond sectors and additional information regarding credit risk and our management of MBS exposure, see Item 7A. "Quantitative and Qualitative Disclosures About Market Risk." of our 2013 Annual Report.

The following table details the top 10 state exposures of the municipal bond portion of our fixed income securities portfolio at June 30, 2014: State Exposures of Municipal Bonds Weighted General Obligation Average Special Fair Credit ($ in thousands) Local State Revenue Value % of Total Quality New York $ 9,854 - 109,187 119,041 8% AA+ Texas1 57,750 5,812 54,741 118,303 8% AA+ Washington 39,628 6,912 43,399 89,939 6% AA+ Florida - 15,479 50,340 65,819 5% AA Arizona 8,062 1,003 54,865 63,930 4% AA California 8,873 - 40,809 49,682 4% AA Colorado 31,723 - 16,712 48,435 3% AA- Missouri 16,015 10,138 19,196 45,349 3% AA+ North Carolina 13,079 8,275 22,998 44,352 3% AA Ohio 8,365 19,104 14,927 42,396 3% AA+ Other 170,146 139,726 319,588 629,460 43% AA 363,495 206,449 746,762 1,316,706 90% AA Pre-refunded/escrowed to maturity bonds 52,757 15,878 68,437 137,072 10% AA+ Total $ 416,252 222,327 815,199 1,453,778 100% AA % of Total Portfolio 29 % 15 % 56 % 100 % 1 Of the $58 million in local Texas general obligation bonds, $28 million represents investments in Texas Permanent School Fund bonds, which are considered to have lower risk as a result of the bond guarantee program that supports these bonds.

A portion of our municipal bonds contain insurance enhancements. The following table provides information regarding these insurance-enhanced securities as of June 30, 2014: Insurers of Municipal Bond Securities Ratings Ratings with without ($ in thousands) Fair Value Insurance Insurance National Public Finance Guarantee Corporation, a subsidiary of MBIA, Inc. $ 185,126 AA- AA- Assured Guaranty 138,553 AA AA- Ambac Financial Group, Inc. 58,848 AA AA Other 10,575 AA A+ Total $ 393,102 AA AA- Equity Securities Our equity securities portfolio was 4% of invested assets as of both June 30, 2014 and December 31, 2013, while the value of this portfolio increased modestly to $211.3 million from $192.8 million over the same time period. During Six Months 2014, we rebalanced our high dividend yield strategy holdings within this portfolio, generating purchases of $111.8 million and sales of securities that had an original cost of $99.6 million.

47-------------------------------------------------------------------------------- Table of Contents Unrealized/Unrecognized Losses Our net unrealized/unrecognized loss positions improved by $38.7 million, to $13.3 million, as of June 30, 2014 compared to December 31, 2013. The majority of this improvement was in our fixed income securities portfolio.

The following table presents amortized cost and fair value information for our AFS fixed income securities that were in an unrealized loss position at June 30, 2014 by contractual maturity: Amortized Fair ($ in thousands) Cost Value Unrealized Loss One year or less $ 393 378 15 Due after one year through five years 256,800 253,974 2,826 Due after five years through ten years 559,252 548,852 10,400 Due after ten years 3,461 3,401 60 Total $ 819,906 806,605 13,301 The following table presents amortized cost and fair value information for our HTM fixed income securities that were in an unrealized/unrecognized loss position at June 30, 2014 by contractual maturity: Amortized Fair ($ in thousands) Cost Value Unrecognized/Unrealized Loss One year or less $ 1,484 1,482 2 Due after one year through five years 2,515 2,496 19 Total $ 3,999 3,978 21 We have reviewed the securities in the tables above in accordance with our OTTI policy, which is discussed in Note 2. "Summary of Significant Accounting Policies" in Item 8. "Financial Statements and Supplementary Data." of our 2013 Annual Report. We have concluded that these securities were temporarily impaired as of June 30, 2014 and December 31, 2013. For additional information regarding the unrealized/unrecognized losses in our AFS and HTM portfolios, see Note 5.

"Investments" in Item 1. "Financial Statements." of this Form 10-Q.

Other Investments As of June 30, 2014, other investments of $106.1 million represented 2% of our total invested assets. In addition to the capital that we have already invested to date, we are contractually obligated to invest up to an additional $52.7 million in our other investments portfolio through commitments that currently expire at various dates through 2026. For a description of our seven alternative investment strategies, as well as redemption, restrictions, and fund liquidations, refer to Note 5. "Investments" in Item 8. "Financial Statements and Supplementary Data." of our 2013 Annual Report.

48-------------------------------------------------------------------------------- Table of Contents Net Investment Income The components of net investment income earned for the indicated periods were as follows: Quarter ended June 30, Six Months ended June 30, ($ in thousands) 2014 2013 2014 2013 Fixed income securities $ 33,781 30,298 64,809 60,387 Equity securities 1,736 1,874 3,185 3,081 Short-term investments 14 29 33 81 Other investments 3,553 3,869 8,771 7,471 Investment expenses (2,310 ) (2,067 ) (4,490 ) (4,147 ) Net investment income earned - before tax 36,774 34,003 72,308 66,873 Net investment income tax expense (9,353 ) (8,303 ) (18,401 ) (16,334 ) Net investment income earned - after tax $ 27,421 25,700 53,907 50,539 Effective tax rate 25.4 % 24.4 25.4 24.4 Annualized after-tax yield on fixed income securities 2.4 2.3 2.3 2.4 Annualized after-tax yield on investment portfolio 2.3 2.3 2.3 2.3 Net investment income before tax increased in Second Quarter and Six Months 2014 compared to the same periods last year primarily due to higher income from our fixed income securities, driven by an increase in the size of this portfolio, which more than offset the lower yield earned this year compared to last.

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

We typically have a long investment time horizon, and every purchase or sale is made with the intent of maximizing risk-adjusted investment returns in the current market environment while balancing capital preservation. Total net realized gains amounted to $4.5 million in Second Quarter 2014 and $11.8 million in Six Months 2014, and $5.2 million and $8.5 million in the same periods a year ago. These amounts included $0.4 million and $1.4 million in OTTI charges in Second Quarter and Six Months 2014, and $0.6 million and $2.5 million in Second Quarter and Six Months 2013, respectively.

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

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

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

Federal Income Taxes The following table provides information regarding federal income taxes from continuing operations: Quarter ended June 30, Six Months ended June 30, ($ in million) 2014 2013 2014 2013 Federal income tax expense from continuing operations $ 10.2 9.1 17.3 15.6 Effective tax rate 26 % 25 27 24 Despite lower pre-tax net income in Six Months 2014 compared to Six Months 2013, federal income tax expense, as well as the effective tax rate have increased year over year. This increase is driven by our expectation of relatively higher full-year insurance operations results in 2014. We are required, through accounting rules, to record each quarter's taxes at the expected annual effective tax rate regardless of the relative magnitude of the individual components within any one quarter.

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

Liquidity We manage liquidity with a focus on generating sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. Our cash and short-term investment position of $168 million at June 30, 2014 was comprised of $30.8 million at Selective Insurance Group, Inc. (the "Parent") and $137.2 million at the Insurance Subsidiaries. Short-term investments are generally maintained in "AAA" rated money market funds approved by the National Association of Insurance Commissioners. The Parent continues to maintain a fixed income security investment portfolio containing high-quality, highly-liquid government and corporate fixed income securities to generate additional yield.

This portfolio amounted to $60 million at June 30, 2014 compared to $56 million at December 31, 2013.

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

We currently anticipate the Insurance Subsidiaries will pay approximately $57.5 million in total dividends to the Parent in 2014. Cash dividends of $28.8 million were paid in Six Months 2014. As of December 31, 2013, our allowable ordinary maximum dividend was approximately $127 million for 2014.

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

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

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

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

The Parent's Line of Credit agreement permits collateralized borrowings by the Indiana Subsidiaries from the FHLBI so long as the aggregate amount borrowed does not exceed 10% of the respective Indiana Subsidiary's admitted assets from the preceding calendar year. Admitted assets amounted to $542.4 million for SICSC and $414.9 million for SICSE as of December 31, 2013, for a borrowing capacity of approximately $96 million. As our outstanding borrowing with the FHLBI is currently $58 million, the Indiana Subsidiaries have the ability to borrow approximately $38 million more until the Line of Credit borrowing limit is met, of which $30 million could be loaned to the Parent under lending agreements approved by the Indiana Department of Insurance. Similar to the Line of Credit agreement, these lending agreements limit borrowings by the Parent from the Indiana Subsidiaries to 10% of the admitted assets of the respective Indiana Subsidiary. For additional information regarding the Parent's Line of Credit, refer to the section below entitled "Short-term Borrowings." The Insurance Subsidiaries also generate liquidity through insurance float, which is created by collecting premiums and earning investment income before losses are paid. The period of the float can extend over many years. Our investment portfolio consists of maturity dates that are laddered to continually provide a source of cash flows for claims payments in the ordinary course of business. The duration of the fixed income securities portfolio including short-term investments was 3.6 years as of June 30, 2014, while the liabilities of the Insurance Subsidiaries have a duration of 3.8 years. In addition, the Insurance Subsidiaries purchase reinsurance coverage for protection against any significantly large claims or catastrophes that may occur during the year.

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

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

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

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

The Line of Credit provides the Parent with an additional source of short-term liquidity. The interest rate on our Line of Credit varies and is based on, among other factors, the Parent's debt ratings. The Line of Credit expires on September 26, 2017. There were no balances outstanding under the Line of Credit at June 30, 2014 or at any time during Six Months 2014.

The Line of Credit agreement contains representations, warranties, and covenants that are customary for credit facilities of this type, including, without limitation, financial covenants under which we are obligated to maintain a minimum consolidated net worth, minimum combined statutory surplus, and maximum ratio of consolidated debt to total capitalization, as well as covenants limiting our ability to: (i) merge or liquidate; (ii) incur debt or liens; (iii) dispose of assets; (iv) make certain investments and acquisitions; and (v) engage in transactions with affiliates.

The table below outlines information regarding certain of the covenants in the Line of Credit: Actual as of Required as of June 30, 2014 June 30, 2014 Consolidated net worth $830 million $1.2 billion Statutory surplus Not less than $750 million $1.3 billion Debt-to-capitalization ratio1 Not to exceed 35% 24.3% A.M. Best financial strength rating A- A 1 Calculated in accordance with the Line of Credit agreement.

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 June 30, 2014, we had statutory surplus of $1.3 billion, GAAP stockholders' equity of $1.2 billion, and total debt of $392.3 million, which equates to a debt-to-capital ratio of approximately 24.1%.

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

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

Book value per share increased to $21.96 as of June 30, 2014, from $20.63 as of December 31, 2013, due to $0.84 in net income coupled with a $0.76 increase in unrealized gains on our investment portfolio. These items were partially offset by $0.26 in dividends to our shareholders.

Ratings We are rated by major rating agencies that issue opinions on our financial strength, operating performance, strategic position, and ability to meet policyholder obligations. We believe that our ability to write insurance business is most influenced by our rating from A.M. Best. In Second Quarter 2014, A.M. Best reaffirmed our rating of "A (Excellent)," their third highest of 13 financial strength ratings, with a "stable" outlook. The rating reflects our strong risk-adjusted capitalization, disciplined underwriting focus, increasing use of predictive modeling technology, strong independent retail agency relationships, and consistently stable loss reserves. We have been rated "A" or higher by A.M. Best for the past 84 years. A downgrade from A.M. Best to a rating below "A-" is an event of default under our Line of Credit and could affect our ability to write new business with customers and/or agents, some of whom are required (under various third-party agreements) to maintain insurance with a carrier that maintains a specified A.M. Best minimum rating.

Ratings by other major rating agencies are as follows: • Fitch Ratings ("Fitch") - Our "A+" rating was reaffirmed in Second Quarter 2014, citing our improved underwriting results, strong independent agency relationships, solid loss reserve position, and enhanced diversification through continued efforts to reduce our concentration in New Jersey.

Our outlook has been revised to stable reflecting operating earnings-based interest coverage that showed improvement in 2013.

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

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

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

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

Off-Balance Sheet Arrangements At June 30, 2014 and December 31, 2013, we did not have any material relationships with unconsolidated entities or financial partnerships, such entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any material financing, liquidity, market, or credit risk that could arise if we had engaged in such relationships.

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

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

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

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