10-Q 1 sigi-9302012x10q.htm 10-Q
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2012
or
¨ 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: 001-33067
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 Offices) |  | (Zip Code)

(973) 948-3000
(Registrant’s Telephone Number, Including Area Code)
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No ¨
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x |  | Accelerated filer ¨
Non-accelerated filer ¨ |  | Smaller reporting company ¨

(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 Exchange Act).
Yes ¨ No x
As of September 30, 2012, there were 55,001,360 shares of common stock, par value $2.00 per share, outstanding.

Table of Contents

| SELECTIVE INSURANCE GROUP, INC. |
| Table of Contents |
|  | Page No.
PART I. FINANCIAL INFORMATION |
Item 1. | Financial Statements |
| Consolidated Balance Sheets as of September 30, 2012 (Unaudited) and December 31, 2011 | 1
| Unaudited Consolidated Statements of Income for the Quarter and Nine Months Ended September 30, 2012 and 2011 | 2
| Unaudited Consolidated Statements of Comprehensive Income for the Quarter and Nine Months Ended September 30, 2012 and 2011 | 3
| Unaudited Consolidated Statements of Stockholders’ Equity for the Nine Months Ended September 30, 2012 and 2011 | 4
| Unaudited Consolidated Statements of Cash Flow for the Nine Months Ended September 30, 2012 and 2011 | 5
| Notes to Unaudited Interim Consolidated Financial Statements | 6
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
| Forward-Looking Statements | 29
| Introduction | 29
| Critical Accounting Policies and Estimates | 30
| Financial Highlights of Results for Third Quarter 2012 and Nine Months 201 2 | 31
| Results of Operations and Related Information by Segment | 32
| Financial Condition, Liquidity, Short-term Borrowings, and Capital Resources | 49
| Ratings | 51
| Off-Balance Sheet Arrangements | 51
| Contractual Obligations, Contingent Liabilities, and Commitments | 52
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 52
Item 4. | Controls and Procedures | 52
PART II. OTHER INFORMATION
Item 1. | Legal Proceedings | 53
Item 1A. | Risk Factors | 53
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 54
Item 6. | Exhibits | 55
Signatures | 56

Table of Contents

PART I. FINANCIAL INFORMATION |

ITEM 1. FINANCIAL STATEMENTS |

SELECTIVE INSURANCE GROUP, INC. CONSOLIDATED BALANCE SHEETS |  | Unaudited |  |
($ in thousands, except share amounts) |  | September 30, 2012 |  | December 31, 2011
ASSETS |  |  |  |  |  |
Investments: |  |  |  |  |  |
Fixed maturity securities, held-to-maturity – at carrying value (fair value: $646,035 – 2012; $758,043 – 2011) |  | $ | 600,716 |  |  | 712,348 |
Fixed maturity securities, available-for-sale – at fair value (amortized cost: $3,091,740 – 2012; $2,766,856 – 2011) |  | 3,269,960 |  |  | 2,897,373 |
Equity securities, available-for-sale – at fair value (cost: $127,867 – 2012; $143,826 – 2011) |  | 155,577 |  |  | 157,355 |
Short-term investments (at cost which approximates fair value) |  | 184,878 |  |  | 217,044 |
Other investments |  | 122,081 |  |  | 128,301 |
Total investments |  | 4,333,212 |  |  | 4,112,421 |
Cash |  | 315 |  |  | 762 |
Interest and dividends due or accrued |  | 35,541 |  |  | 35,842 |
Premiums receivable, net of allowance for uncollectible accounts of: $3,684 – 2012; $3,768 – 2011 |  | 519,953 |  |  | 466,294 |
Reinsurance recoverables, net |  | 482,579 |  |  | 561,855 |
Prepaid reinsurance premiums |  | 138,785 |  |  | 147,686 |
Current federal income tax |  | 6,349 |  |  | 731 |
Deferred federal income tax |  | 91,916 |  |  | 119,486 |
Property and equipment – at cost, net of accumulated depreciation and amortization of: $167,052 – 2012; $160,294 – 2011 |  | 45,969 |  |  | 43,947 |
Deferred policy acquisition costs |  | 161,505 |  |  | 135,761 |
Goodwill |  | 7,849 |  |  | 7,849 |
Other assets |  | 55,968 |  |  | 52,835 |
Total assets |  | $ | 5,879,941 |  |  | 5,685,469 |
LIABILITIES AND STOCKHOLDERS’ EQUITY |  |  |  |  |  |
Liabilities: |  |  |  |  |  |
Reserve for losses and loss expenses |  | $ | 3,103,111 |  |  | 3,144,924 |
Unearned premiums |  | 1,017,076 |  |  | 906,991 |
Notes payable |  | 307,380 |  |  | 307,360 |
Accrued salaries and benefits |  | 124,662 |  |  | 119,297 |
Other liabilities |  | 203,334 |  |  | 148,569 |
Total liabilities |  | $ | 4,755,563 |  |  | 4,627,141 |
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: 98,014,074 – 2012; 97,246,711 – 2011 |  | 196,028 |  |  | 194,494 |
Additional paid-in capital |  | 267,527 |  |  | 257,370 |
Retained earnings |  | 1,131,115 |  |  | 1,116,319 |
Accumulated other comprehensive income |  | 85,011 |  |  | 42,294 |
Treasury stock – at cost (shares: 43,012,714 – 2012; 42,836,201 – 2011) |  | (555,303 | ) |  | (552,149 | )
Total stockholders’ equity |  | 1,124,378 |  |  | 1,058,328 |
Commitments and contingencies |  |  |  |  |  |
Total liabilities and stockholders’ equity |  | $ | 5,879,941 |  |  | 5,685,469 |

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.
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SELECTIVE INSURANCE GROUP, INC. UNAUDITED CONSOLIDATED STATEMENTS OF INCOME |  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands, except per share amounts) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Revenues: |  |  |  |  |  |  |  |  |  |  |  |
Net premiums earned |  | $ | 406,225 |  |  | 358,963 |  |  | $ | 1,177,266 |  |  | 1,065,886 |
Net investment income earned |  | 30,650 |  |  | 35,786 |  |  | 97,284 |  |  | 118,604 |
Net realized gains (losses): |  |  |  |  |  |  |  |  |  |  |  |
Net realized investment gains |  | 1,856 |  |  | 498 |  |  | 6,907 |  |  | 9,203 |
Other-than-temporary impairments |  | (921 | ) |  | (2,693 | ) |  | (1,218 | ) |  | (3,062 | )
Other-than-temporary impairments on fixed maturity securities recognized in other comprehensive income |  | (2,023 | ) |  | 150 |  |  | (2,241 | ) |  | (280 | )
Total net realized gains (losses) |  | (1,088 | ) |  | (2,045 | ) |  | 3,448 |  |  | 5,861 |
Other income |  | 1,085 |  |  | 1,365 |  |  | 7,129 |  |  | 6,744 |
Total revenues |  | 436,872 |  |  | 394,069 |  |  | 1,285,127 |  |  | 1,197,095 |
Expenses: |  |  |  |  |  |  |  |  |  |  |  |
Losses and loss expenses incurred |  | 272,251 |  |  | 305,958 |  |  | 813,060 |  |  | 829,719 |
Policy acquisition costs |  | 131,849 |  |  | 116,111 |  |  | 391,026 |  |  | 346,318 |
Interest expense |  | 4,725 |  |  | 4,559 |  |  | 14,148 |  |  | 13,675 |
Other expenses |  | 7,733 |  |  | 4,924 |  |  | 24,080 |  |  | 18,807 |
Total expenses |  | 416,558 |  |  | 431,552 |  |  | 1,242,314 |  |  | 1,208,519 |
Income (loss) from continuing operations before federal income tax |  | 20,314 |  |  | (37,483 | ) |  | 42,813 |  |  | (11,424 | )
Federal income tax expense (benefit): |  |  |  |  |  |  |  |  |  |  |  |
Current |  | (5,088 | ) |  | (20,001 | ) |  | 1,590 |  |  | (12,614 | )
Deferred |  | 7,128 |  |  | (164 | ) |  | 4,568 |  |  | (3,459 | )
Total federal income tax expense (benefit) |  | 2,040 |  |  | (20,165 | ) |  | 6,158 |  |  | (16,073 | )
Net income (loss) from continuing operations |  | $ | 18,274 |  |  | (17,318 | ) |  | $ | 36,655 |  |  | 4,649 |
Loss on disposal of discontinued operations, net of tax $(350) in Third Quarter and Nine Months 2011 |  | — |  |  | (650 | ) | — |  | — |  |  | (650 | )
Net income (loss) |  | 18,274 |  |  | (17,968 | ) |  | 36,655 |  |  | 3,999 |
Earnings per share: |  |  |  |  |  |  |  |  |  |  |  |
Basic net income (loss) from continuing operations |  | $ | 0.33 |  |  | (0.32 | ) |  | $ | 0.67 |  |  | 0.08 |
Basic net loss from disposal of discontinued operations |  | — |  |  | (0.01 | ) |  | — |  |  | (0.01 | )
Basic net income (loss) |  | $ | 0.33 |  |  | (0.33 | ) |  | $ | 0.67 |  |  | 0.07 |
Diluted net income (loss) from continuing operations |  | $ | 0.33 |  |  | (0.32 | ) |  | $ | 0.66 |  |  | 0.08 |
Diluted net loss from disposal of discontinued operations |  | — |  |  | (0.01 | ) |  | — |  |  | (0.01 | )
Diluted net income (loss) |  | $ | 0.33 |  |  | (0.33 | ) |  | $ | 0.66 |  |  | 0.07 |
Dividends to stockholders |  | 0.13 |  |  | 0.13 |  |  | 0.39 |  |  | 0.39 |

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.
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SELECTIVE INSURANCE GROUP, INC. UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME |  |  |  |
|  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Net income (loss) |  | $ | 18,274 |  |  | (17,968 | ) |  | $ | 36,655 |  |  | 3,999 |
Other comprehensive income, net of tax: |  |  |  |  |  |  |  |  |  |
Unrealized gains on investment securities: |  |  |  |  |  |  |  |  |  |
Unrealized holding gains arising during period |  | 23,803 |  |  | 9,564 |  |  | 41,777 |  |  | 28,521 |
Non-credit portion of other-than-temporary impairments recognized in other comprehensive income |  | 1,320 |  |  | (53 | ) |  | 1,633 |  |  | 336 |
Amortization of net unrealized gains on held-to-maturity securities |  | 537 |  |  | (432 | ) |  | (422 | ) |  | (2,013 | )
Less: reclassification adjustment for gains included in net income |  | (81 | ) |  | 1,239 |  |  | (3,056 | ) |  | (3,891 | )
Total unrealized gains on investment securities |  | 25,579 |  |  | 10,318 |  |  | 39,932 |  |  | 22,953 |
Defined benefit pension plans: |  |  |  |  |  |  |  |  |  |
Amortization of net actuarial loss included in net income |  | 904 |  |  | 678 |  |  | 2,712 |  |  | 2,114 |
Amortization of prior service cost included in net income |  | 24 |  |  | 24 |  |  | 73 |  |  | 73 |
Total defined benefit pension plans |  | 928 |  |  | 702 |  |  | 2,785 |  |  | 2,187 |
Other comprehensive income |  | 26,507 |  |  | 11,020 |  |  | 42,717 |  |  | 25,140 |
Comprehensive income (loss) |  | $ | 44,781 |  |  | (6,948 | ) |  | $ | 79,372 |  |  | 29,139 |

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.
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SELECTIVE INSURANCE GROUP, INC. UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY |  |
|  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011
Common stock: |  |  |  |  |  |
Beginning of year |  | $ | 194,494 |  |  | 192,725 |
Dividend reinvestment plan (shares: 68,640 – 2012; 74,777 – 2011) |  | 137 |  |  | 150 |
Stock purchase and compensation plans (shares: 698,723 – 2012; 607,059 – 2011) |  | 1,397 |  |  | 1,214 |
End of period |  | 196,028 |  |  | 194,089 |
Additional paid-in capital: |  |  |  |  |  |
Beginning of year |  | 257,370 |  |  | 244,613 |
Dividend reinvestment plan |  | 1,064 |  |  | 1,066 |
Stock purchase and compensation plans |  | 9,093 |  |  | 8,260 |
End of period |  | 267,527 |  |  | 253,939 |
Retained earnings: |  |  |  |  |  |
Beginning of year, as previously reported |  | 1,116,319 |  |  | 1,176,155 |
Add: Adjustment for the cumulative effect on prior years of applying retroactively the new method of accounting for deferred policy acquisition costs (Note 4) |  | — |  |  | (53,068 | )
Balance at beginning of year, as adjusted |  | 1,116,319 |  |  | 1,123,087 |
Net income |  | 36,655 |  |  | 3,999 |
Dividends to stockholders ($0.39 per share – 2012 and 2011) |  | (21,859 | ) |  | (21,579 | )
End of period |  | 1,131,115 |  |  | 1,105,507 |
Accumulated other comprehensive income: |  |  |  |  |  |
Beginning of year |  | 42,294 |  |  | 7,024 |
Other comprehensive income |  | 42,717 |  |  | 25,140 |
End of period |  | 85,011 |  |  | 32,164 |
Treasury stock: |  |  |  |  |  |
Beginning of year |  | (552,149 | ) |  | (549,408 | )
Acquisition of treasury stock (shares: 176,513 – 2012; 137,667 – 2011) |  | (3,154 | ) |  | (2,537 | )
End of period |  | (555,303 | ) |  | (551,945 | )
Total stockholders’ equity |  | $ | 1,124,378 |  |  | 1,033,754 |

Selective Insurance Group, Inc. 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.
The accompanying notes are an integral part of these unaudited interim consolidated financial statements.
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SELECTIVE INSURANCE GROUP, INC. UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOW |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011
Operating Activities |  |  |  |  |  |
Net income |  | $ | 36,655 |  |  | 3,999 |
Adjustments to reconcile net income to net cash provided by operating activities: |  |  |  |  |  |
Depreciation and amortization |  | 29,386 |  |  | 25,260 |
Loss on disposal of discontinued operations |  | — |  |  | 650 |
Stock-based compensation expense |  | 6,263 |  |  | 6,383 |
Undistributed losses (income) of equity method investments |  | 1,090 |  |  | (1,793 | )
Net realized gains |  | (3,448 | ) |  | (5,861 | )
Changes in assets and liabilities: |  |  |  |  |  |
Increase in reserves for losses and loss expenses, net of reinsurance recoverables |  | 37,463 |  |  | 100,584 |
Increase in unearned premiums, net of prepaid reinsurance and advance premiums |  | 119,269 |  |  | 67,816 |
Increase in net federal income taxes |  | (1,050 | ) |  | (9,426 | )
Increase in premiums receivable |  | (53,659 | ) |  | (63,764 | )
Increase in deferred policy acquisition costs |  | (25,744 | ) |  | (10,828 | )
Decrease in interest and dividends due or accrued |  | 721 |  |  | 1,943 |
Increase (decrease) in accrued salaries and benefits |  | 5,365 |  |  | (2,448 | )
Increase (decrease) in accrued insurance expenses |  | 299 |  |  | (6,772 | )
Other-net |  | 15,144 |  |  | 20,817 |
Net adjustments |  | 131,099 |  |  | 122,561 |
Net cash provided by operating activities |  | 167,754 |  |  | 126,560 |
Investing Activities |  |  |  |  |  |
Purchase of fixed maturity securities, available-for-sale |  | (676,408 | ) |  | (350,140 | )
Purchase of equity securities, available-for-sale |  | (41,004 | ) |  | (148,104 | )
Purchase of other investments |  | (9,050 | ) |  | (11,778 | )
Purchase of short-term investments |  | (1,231,519 | ) |  | (1,030,834 | )
Purchase of subsidiary |  | 255 |  |  | — |
Sale of subsidiary |  | 600 |  |  | 919 |
Sale of fixed maturity securities, available-for-sale |  | 92,170 |  |  | 85,773 |
Sale of short-term investments |  | 1,263,684 |  |  | 1,029,178 |
Redemption and maturities of fixed maturity securities, held-to-maturity |  | 91,665 |  |  | 138,907 |
Redemption and maturities of fixed maturity securities, available-for-sale |  | 297,980 |  |  | 95,951 |
Sale of equity securities, available-for-sale |  | 58,749 |  |  | 59,991 |
Distributions from other investments |  | 13,910 |  |  | 15,666 |
Sale of other investments |  | 1 |  |  | 16,357 |
Purchase of property and equipment |  | (9,382 | ) |  | (8,932 | )
Net cash used in investing activities |  | (148,349 | ) |  | (107,046 | )
Financing Activities |  |  |  |  |  |
Dividends to stockholders |  | (20,188 | ) |  | (19,863 | )
Acquisition of treasury stock |  | (3,154 | ) |  | (2,537 | )
Net proceeds from stock purchase and compensation plans |  | 2,586 |  |  | 2,718 |
Excess tax benefit (expense) from share-based payment arrangements |  | 904 |  |  | (190 | )
Net cash used in financing activities |  | (19,852 | ) |  | (19,872 | )
Net decrease in cash |  | (447 | ) |  | (358 | )
Cash, beginning of year |  | 762 |  |  | 645 |
Cash, end of period |  | $ | 315 |  |  | 287 |

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.
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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. Organization
Selective Insurance Group, Inc., through its subsidiaries, (collectively referred to as “we,” “us,” or “our”) offers standard and excess and surplus lines (“E&S”) property and casualty insurance products. Selective Insurance Group, Inc. (referred to as the “Parent”) was incorporated in New Jersey in 1977 and its main offices are located in Branchville, New Jersey. The Parent’s common stock is publicly traded on the NASDAQ Global Select Market under the symbol “SIGI.”
We report our business in two operating segments:

• | Insurance Operations, which sells property and casualty insurance products and services in both the standard and E&S markets; and

• | Investments, which invests the premiums collected by our insurance operations.

NOTE 2. Basis of Presentation
These interim unaudited consolidated financial statements (“Financial Statements”) include the accounts of the Parent and its subsidiaries, and 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”) regarding interim financial reporting. The preparation of the Financial Statements in conformity with GAAP requires us 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. All significant intercompany accounts and transactions between the Parent and its subsidiaries are eliminated in consolidation.
These Financial Statements reflect all adjustments that, in our opinion, are normal, recurring, and necessary for a fair presentation of our results of operations and financial condition. The Financial Statements cover the third quarters ended September 30, 2012 (“Third Quarter 2012”) and September 30, 2011 (“Third Quarter 2011”) and the nine-month periods ended September 30, 2012 ("Nine Months 2012") and September 30, 2011 ("Nine Months 2011"). The Financial Statements do not include all of the information and disclosures required by GAAP and the SEC for audited financial statements. Results of operations for any interim period are not necessarily indicative of results for a full year. Consequently, the Financial Statements should be read in conjunction with the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2011 (“2011 Annual Report”).
NOTE 3. Reclassification
Certain prior year amounts in these Financial Statements and related footnotes have been reclassified to conform to the current year presentation. Such reclassifications had no effect on our net income, stockholders’ equity, or cash flows.
NOTE 4. Adoption of Accounting Pronouncements
In October 2010, the FASB issued ASU 2010-26, Financial Services-Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (“ASU 2010-26”). ASU 2010-26 requires that only costs that are incremental or directly related to the successful acquisition of new or renewal insurance contracts are to be capitalized as a deferred acquisition cost. This includes, among other items, sales commissions paid to agents, premium taxes, and the portion of employee salaries and benefits directly related to time spent on acquired contracts. We adopted this guidance on January 1, 2012, with retrospective application and, as such, all historical data in this Form 10-Q has been restated to reflect the revised guidance.
The following tables provide select restated financial information:

Balance Sheet Information December 31, 2011 |  |  |  |  |  |
($ in thousands) |  | As Originally Reported |  | Effect of Change |  | As Adopted
Deferred policy acquisition costs |  | $ | 214,069 |  |  | (78,308 | ) |  | 135,761 |
Deferred federal income tax recoverable 1 |  | 92,078 |  |  | 27,408 |  |  | 119,486 |
Retained earnings |  | 1,167,219 |  |  | (50,900 | ) |  | 1,116,319 |

1 Included in the deferred federal income tax recoverable amount is an adjustment of $0.6 million reflecting the revaluation of a deferred tax asset acquired as part of the purchase of Mesa Underwriters Specialty Insurance Company ("MUSIC" ). For additional information, see Footnote 14, "Federal Income Taxes" below.
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Income Statement Information Quarter ended September 30, 2011 |  |  |  |  |  |
($ in thousands, except per share amounts) |  | As Originally Reported |  | Effect of Change |  | As Adopted
Policy acquisition costs |  | $ | 119,456 |  |  | (3,345 | ) |  | 116,111 |
Deferred federal income tax expense (benefit) |  | (1,335 | ) |  | 1,171 |  |  | (164 | )
Net income (loss) |  | (20,142 | ) |  | 2,174 |  |  | (17,968 | )
Net income (loss) per share: |  |  |  |  |  |  |  |  |
Basic |  | $ | (0.37 | ) |  | 0.04 |  |  | (0.33 | )
Diluted |  | (0.37 | ) |  | 0.04 |  |  | (0.33 | )

Income Statement Information Nine months ended September 30, 2011 |  |  |  |  |  |
($ in thousands, except per share amounts) |  | As Originally Reported |  | Effect of Change |  | As Adopted
Policy acquisition costs |  | $ | 346,729 |  |  | (411 | ) |  | 346,318 |
Deferred federal income tax expense (benefit) |  | (3,603 | ) |  | 144 |  |  | (3,459 | )
Net income (loss) |  | $ | 3,732 |  |  | 267 |  |  | 3,999 |
Net income (loss) per share: |  |  |  |  |  |
Basic |  | $ | 0.07 |  |  | — |  |  | 0.07 |
Diluted |  | 0.07 |  |  | — |  |  | 0.07 |

Cash Flow Information Nine months ended September 30, 2011 |  |  |  |  |  |
($ in thousands, except per share amounts) |  | As Originally Reported |  | Effect of Change |  | As Adopted
(Increase) decrease in deferred policy acquisition costs |  | $ | (10,417 | ) |  | (411 | ) |  | (10,828 | )
Increase (decrease) in net federal income taxes recoverable |  | (9,570 | ) |  | 144 |  |  | (9,426 | )

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). This guidance changes the wording used to describe the requirements in U.S. GAAP for measuring fair value and disclosing information about fair value measurements to improve consistency in the application and description of fair value between GAAP and International Financial Reporting Standards. ASU 2011-04 clarifies that the concepts of highest and best use and valuation premise in a fair value measurement are relevant only when measuring the fair value of nonfinancial assets, and are not relevant when measuring the fair value of financial assets or liabilities. In addition, ASU 2011-04 expands the disclosures for unobservable inputs for Level 3 fair value measurements, requiring quantitative and qualitative information to be disclosed related to: (i) the valuation processes used; (ii) the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs; and (iii) the use of a nonfinancial asset in a way that differs from the asset’s highest and best use. ASU 2011-04 was effective prospectively for interim and annual periods beginning after December 15, 2011. We have included the disclosures required by this guidance in our notes to the Financial Statements, where appropriate.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This standard eliminates the option to report other comprehensive income and its components in the statement of stockholders’ equity. Based on an amendment issued in December 2011, companies are not required to present separate line items on the income statement for reclassification adjustments out of accumulated other comprehensive income into net income, as would have been required under the initial ASU. This guidance, which is ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, is effective concurrently with ASU 2011-05. We have retroactively restated our financial statements in this Form 10-Q to comply with the presentation required under this accounting guidance.
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In September 2011, the FASB issued ASU 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment ("ASU 2011-08"), which simplifies the requirements to test goodwill for impairment. ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing events and circumstances, an entity determines that it is not more likely than not that the fair value of the reporting unit is less than the carrying amount, then performing the two-step impairment test is unnecessary. However, if the entity concludes otherwise, then it is required to perform the quantitative impairment test. ASU 2011-08 was effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, and early adoption was permitted. The adoption of this guidance did not impact our financial condition or results of operation.
In July 2012, the FASB issued ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment ("ASU 2012-02"), which reduces the cost and complexity of performing an impairment test for indefinite-lived intangible assets. This guidance permits an entity to first assess qualitative factors to determine whether it is more likely or not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform a quantitative impairment test. ASU 2012-02 was effective for annual and interim intangible impairment tests performed for fiscal years beginning on, or after, September 15, 2012, and early adoption was permitted. The adoption of this guidance did not impact our financial condition or results of operation.
NOTE 5. Statements of Cash Flow
Cash paid during the nine month periods ended September 30, 2012 and September 30, 2011 for interest and federal income taxes was as follows:

|  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011
Cash paid (received) during the period for: |  |  |  |  |  |
Interest |  | $ | 11,504 |  |  | 11,074 |
Federal income tax |  | 6,300 |  |  | (6,460 | )

NOTE 6. Investments
(a) The amortized cost, carrying value, unrealized and unrecognized holding gains and losses, and fair values of held-to-maturity (“HTM”) fixed maturity securities were as follows:

September 30, 2012 |  |  |  |  |  |  |  |  |  |  |  |
($ in thousands) |  | Amortized Cost |  | Net Unrealized Gains (Losses) |  | Carrying Value |  | Unrecognized Holding Gains |  | Unrecognized Holding Losses |  | Fair Value
Foreign government |  | $ | 5,292 |  |  | 232 |  |  | 5,524 |  |  | 72 |  |  | — |  |  | 5,596 |
Obligations of state and political subdivisions |  | 524,807 |  |  | 8,261 |  |  | 533,068 |  |  | 33,438 |  |  | (11 | ) |  | 566,495 |
Corporate securities |  | 49,532 |  |  | (957 | ) |  | 48,575 |  |  | 5,048 |  |  | — |  |  | 53,623 |
Asset-backed securities (“ABS”) |  | 7,211 |  |  | (1,152 | ) |  | 6,059 |  |  | 1,270 |  |  | — |  |  | 7,329 |
Commercial mortgage-backed securities (“CMBS”) |  | 8,758 |  |  | (1,268 | ) |  | 7,490 |  |  | 5,502 |  |  | — |  |  | 12,992 |
Total HTM fixed maturity securities |  | $ | 595,600 |  |  | 5,116 |  |  | 600,716 |  |  | 45,330 |  |  | (11 | ) |  | 646,035 |

December 31, 2011 |  |  |  |  |  |  |  |  |  |  |  |
($ in thousands) |  | Amortized Cost |  | Net Unrealized Gains (Losses) |  | Carrying Value |  | Unrecognized Holding Gains |  | Unrecognized Holding Losses |  | Fair Value
Foreign government |  | $ | 5,292 |  |  | 292 |  |  | 5,584 |  |  | — |  |  | (88 | ) |  | 5,496 |
Obligations of state and political subdivisions |  | 614,118 |  |  | 11,894 |  |  | 626,012 |  |  | 31,529 |  |  | (156 | ) |  | 657,385 |
Corporate securities |  | 64,840 |  |  | (2,189 | ) |  | 62,651 |  |  | 6,887 |  |  | — |  |  | 69,538 |
ABS |  | 8,077 |  |  | (1,469 | ) |  | 6,608 |  |  | 1,353 |  |  | (7 | ) |  | 7,954 |
CMBS |  | 14,455 |  |  | (2,962 | ) |  | 11,493 |  |  | 6,177 |  |  | — |  |  | 17,670 |
Total HTM fixed maturity securities |  | $ | 706,782 |  |  | 5,566 |  |  | 712,348 |  |  | 45,946 |  |  | (251 | ) |  | 758,043 |

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Unrecognized holding gains/losses of HTM securities are not reflected in the Financial Statements, as they represent fair value fluctuations from the later of: (i) the date a security is designated as HTM; or (ii) the date that an other-than-temporary impairment (“OTTI”) charge is recognized on an HTM security, through the date of the balance sheet. Our HTM securities had an average duration of 2.7 years as of September 30, 2012.
During Nine Months 2012, seven securities with a carrying value of $14.6 million and a net unrecognized gain position of $1.2 million were reclassified from an HTM designation to an available-for-sale (“AFS”) designation due to credit rating downgrades by Moody’s Investors Services ("Moody's"), Fitch Ratings, and Standard and Poor’s ("S&P") Financial Services. These unexpected rating downgrades raised significant concerns about the issuers’ credit worthiness, which changed our intention to hold these securities to maturity.
(b) The cost/amortized cost, unrealized gains (losses), and fair value of AFS securities were as follows:

September 30, 2012 |  |  |  |  |  |  |  |
($ in thousands) |  | Cost/ Amortized Cost |  | Unrealized Gains |  | Unrealized Losses |  | Fair Value
U.S. government and government agencies 1 |  | $ | 275,417 |  |  | 18,797 |  |  | — |  |  | 294,214 |
Foreign government |  | 28,819 |  |  | 1,664 |  |  | (191 | ) |  | 30,292 |
Obligations of states and political subdivisions |  | 737,985 |  |  | 46,524 |  |  | (8 | ) |  | 784,501 |
Corporate securities |  | 1,340,366 |  |  | 85,741 |  |  | (219 | ) |  | 1,425,888 |
ABS |  | 118,923 |  |  | 2,232 |  |  | (1 | ) |  | 121,154 |
CMBS 2 |  | 126,043 |  |  | 5,151 |  |  | (1,579 | ) |  | 129,615 |
Residential mortgage-backed securities (“RMBS”)3 |  | 464,187 |  |  | 20,359 |  |  | (250 | ) |  | 484,296 |
AFS fixed maturity securities |  | 3,091,740 |  |  | 180,468 |  |  | (2,248 | ) |  | 3,269,960 |
AFS equity securities |  | 127,867 |  |  | 27,921 |  |  | (211 | ) |  | 155,577 |
Total AFS securities |  | $ | 3,219,607 |  |  | 208,389 |  |  | (2,459 | ) |  | 3,425,537 |

December 31, 2011 |  |  |  |  |  |  |  |
($ in thousands) |  | Cost/ Amortized Cost |  | Unrealized Gains |  | Unrealized Losses |  | Fair Value
U.S. government and government agencies 1 |  | $ | 333,504 |  |  | 20,292 |  |  | — |  |  | 353,796 |
Foreign government |  | 33,687 |  |  | 1,042 |  |  | (556 | ) |  | 34,173 |
Obligations of states and political subdivisions |  | 578,214 |  |  | 44,491 |  |  | (46 | ) |  | 622,659 |
Corporate securities |  | 1,168,439 |  |  | 50,167 |  |  | (5,296 | ) |  | 1,213,310 |
ABS |  | 77,706 |  |  | 1,289 |  |  | (46 | ) |  | 78,949 |
CMBS 2 |  | 107,838 |  |  | 6,427 |  |  | (1,667 | ) |  | 112,598 |
RMBS 3 |  | 467,468 |  |  | 16,187 |  |  | (1,767 | ) |  | 481,888 |
AFS fixed maturity securities |  | 2,766,856 |  |  | 139,895 |  |  | (9,378 | ) |  | 2,897,373 |
AFS equity securities |  | 143,826 |  |  | 13,617 |  |  | (88 | ) |  | 157,355 |
Total AFS securities |  | $ | 2,910,682 |  |  | 153,512 |  |  | (9,466 | ) |  | 3,054,728 |

1 U.S. government includes corporate securities fully guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) with a fair value of $14.1 million at September 30, 2012 and $76.5 million at December 31, 2011.
2 CMBS includes government guaranteed agency securities with a fair value of $59.9 million at September 30, 2012 and $72.9 million at December 31, 2011.
3 RMBS includes government guaranteed agency securities with a fair value of $98.1 million at September 30, 2012 and $98.2 million at December 31, 2011.
Unrealized gains/losses of AFS securities represent fair value fluctuations from the later of: (i) the date a security is designated as AFS; or (ii) the date that an OTTI charge is recognized on an AFS security, through the date of the balance sheet. These unrealized gains and losses are recorded in accumulated other comprehensive income (“AOCI”) on the Consolidated Balance Sheets.
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(c) The following tables summarize, for all securities in a net unrealized/unrecognized loss position at September 30, 2012 and December 31, 2011, the fair value and gross pre-tax net unrealized/unrecognized loss by asset class and by length of time those securities have been in a net loss position:

September 30, 2012 |  | Less than 12 months |  | 12 months or longer
($ in thousands) |  | Fair Value |  | Unrealized Losses 1 |  | Fair Value |  | Unrealized Losses 1
AFS securities |  |  |  |  |  |  |  |  |  |  |  |
U.S. government and government agencies |  | $ | 520 |  |  | (1 | ) |  | — |  |  | — |
Foreign government |  | 2,805 |  |  | (190 | ) |  | — |  |  | — |
Obligations of states and political subdivisions |  | 1,327 |  |  | (8 | ) |  | — |  |  | — |
Corporate securities |  | 17,667 |  |  | (213 | ) |  | 3,997 |  |  | (6 | )
ABS |  | 1,299 |  |  | (1 | ) |  | — |  |  | — |
CMBS |  | 1,787 |  |  | (17 | ) |  | 12,080 |  |  | (1,562 | )
RMBS |  | 851 |  |  | (1 | ) |  | 5,503 |  |  | (249 | )
Total fixed maturity securities |  | 26,256 |  |  | (431 | ) |  | 21,580 |  |  | (1,817 | )
Equity securities |  | 4,649 |  |  | (211 | ) |  | — |  |  | — |
Subtotal |  | $ | 30,905 |  |  | (642 | ) |  | 21,580 |  |  | (1,817 | )

|  | Less than 12 months |  | 12 months or longer
($ in thousands) |  | Fair Value |  | Unrealized Losses 1 |  | Unrecognized Gains 2 |  | Fair Value |  | Unrealized Losses 1 |  | Unrecognized Gains 2
HTM securities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Obligations of states and political subdivisions |  | $ | 1,427 |  |  | (42 | ) |  | 37 |  |  | 1,331 |  |  | (57 | ) |  | 46 |
ABS |  | — |  |  | — |  |  | — |  |  | 2,876 |  |  | (884 | ) |  | 781 |
Subtotal |  | $ | 1,427 |  |  | (42 | ) |  | 37 |  |  | 4,207 |  |  | (941 | ) |  | 827 |
Total AFS and HTM |  | $ | 32,332 |  |  | (684 | ) |  | 37 |  |  | 25,787 |  |  | (2,758 | ) |  | 827 |

December 31, 2011 |  | Less than 12 months |  | 12 months or longer
($ in thousands) |  | Fair Value |  | Unrealized Losses 1 |  | Fair Value |  | Unrealized Losses 1
AFS securities: |  |  |  |  |  |  |  |  |  |  |  |
Foreign government |  | $ | 8,299 |  |  | (556 | ) |  | — |  |  | — |
Obligations of states and political subdivisions |  | 517 |  |  | (1 | ) |  | 1,740 |  |  | (45 | )
Corporate securities |  | 157,510 |  |  | (4,415 | ) |  | 14,084 |  |  | (881 | )
ABS |  | 15,808 |  |  | (14 | ) |  | 702 |  |  | (32 | )
CMBS |  | 4,822 |  |  | (48 | ) |  | 14,564 |  |  | (1,619 | )
RMBS |  | 29,803 |  |  | (625 | ) |  | 15,007 |  |  | (1,142 | )
Total fixed maturity securities |  | 216,759 |  |  | (5,659 | ) |  | 46,097 |  |  | (3,719 | )
Equity securities |  | 743 |  |  | (88 | ) |  | — |  |  | — |
Subtotal |  | $ | 217,502 |  |  | (5,747 | ) |  | 46,097 |  |  | (3,719 | )

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|  | Less than 12 months |  | 12 months or longer
($ in thousands) |  | Fair Value |  | Unrealized Losses 1 |  | Unrecognized Gains 2 |  | Fair Value |  | Unrealized Losses 1 |  | Unrecognized Gains 2
HTM securities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Obligations of states and political subdivisions |  | $ | 7,244 |  |  | (94 | ) |  | 78 |  |  | 9,419 |  |  | (519 | ) |  | 324 |
ABS |  | — |  |  | — |  |  | — |  |  | 2,816 |  |  | (1,009 | ) |  | 737 |
CMBS |  | — |  |  | — |  |  | — |  |  | 2,794 |  |  | (1,447 | ) |  | 761 |
Subtotal |  | $ | 7,244 |  |  | (94 | ) |  | 78 |  |  | 15,029 |  |  | (2,975 | ) |  | 1,822 |
Total AFS and HTM |  | $ | 224,746 |  |  | (5,841 | ) |  | 78 |  |  | 61,126 |  |  | (6,694 | ) |  | 1,822 |

1 | Gross unrealized losses include non-OTTI unrealized amounts and OTTI losses recognized in AOCI. In addition, this column includes remaining unrealized gain or loss amounts on securities that were transferred to an HTM designation in the first quarter of 2009 for those securities that are in a net unrealized/unrecognized loss position.

2 | Unrecognized gains represent fair value fluctuations from the later of: (i) the date a security is designated as HTM; or (ii) the date that an OTTI charge is recognized on an HTM security.

As evidenced by the table below, our net unrealized/unrecognized loss positions improved by $8.1 million as of September 30, 2012 compared to December 31, 2011 as follows:

($ in thousands) |  |
September 30, 2012 |  | December 31, 2011
Number of Issues | % of Market/Book | Unrealized Unrecognized Loss |  | Number of Issues | % of Market/Book | Unrealized Unrecognized Loss
46 |  | 80% - 99% | $ | 2,335 |  |  | 140 |  | 80% - 99% | $ | 10,166 |
1 |  | 60% - 79% | 243 |  |  | — |  | 60% - 79% | — |
— |  | 40% - 59% | — |  |  | 1 |  | 40% - 59% | 469 |
— |  | 20% - 39% | — |  |  | — |  | 20% - 39% | — |
— |  | 0% - 19% | — |  |  | — |  | 0% - 19% | — |
|  |  | $ | 2,578 |  |  |  |  |  | $ | 10,635 |

We have reviewed the securities in the tables above in accordance with our OTTI policy, as described in Note 2. “Summary of Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data.” of our 2011 Annual Report.
At September 30, 2012, we had 47 securities in an aggregate unrealized/unrecognized loss position of $2.6 million, $1.9 million of which have been in a loss position for more than 12 months. Securities with non-credit OTTI impairments comprised $1.2 million of the $1.9 million balance, including two securities that are currently experiencing immaterial interest payment shortfalls. These shortfalls have led to related credit OTTI impairments, one of which was recorded in Third Quarter 2012 and the other in the fourth quarter of 2011. The remainder of the securities in an unrealized loss position for over 12 months were, on average, 4% impaired compared to their amortized cost.
At December 31, 2011, we had 141 securities in an aggregate unrealized/unrecognized loss position of $10.6 million, $4.9 million of which had been in a loss position for more than 12 months. Non-credit OTTI impairments comprised $2.1 million of the $4.9 million balance, with the remainder related to securities that were, on average, 6% impaired compared to their amortized cost.
We do not have the intent to sell any securities in an unrealized/unrecognized loss position, nor do we believe we will be required to sell these securities, and therefore we have concluded that they are temporarily impaired as of September 30, 2012. This conclusion reflects our current judgment as to the financial position and future prospects of the entity that issued the investment security and underlying collateral. If our judgment about an individual security changes in the future, we may ultimately record a credit loss after having originally concluded that one did not exist, which could have a material impact on our net income and financial position in future periods.
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(d) Fixed maturity securities at September 30, 2012, 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 HTM fixed maturity securities at September 30, 2012:

($ in thousands) |  | Carrying Value |  | Fair Value
Due in one year or less |  | $ | 105,662 |  |  | 110,275 |
Due after one year through five years |  | 419,074 |  |  | 449,498 |
Due after five years through 10 years |  | 69,198 |  |  | 78,018 |
Due after 10 years |  | 6,782 |  |  | 8,244 |
Total HTM fixed maturity securities |  | $ | 600,716 |  |  | 646,035 |

Listed below are AFS fixed maturity securities at September 30, 2012:

($ in thousands) |  | Fair Value
Due in one year or less |  | $ | 362,970 |
Due after one year through five years |  | 1,904,084 |
Due after five years through 10 years |  | 930,177 |
Due after 10 years |  | 72,729 |
Total AFS fixed maturity securities |  | $ | 3,269,960 |

(e) The following table outlines a summary of our other investment portfolio by strategy and the remaining commitment amount associated with each strategy:

Other Investments |  | Carrying Value |  | September 30, 2012
($ in thousands) |  | September 30, 2012 |  | December 31, 2011 |  | Remaining Commitment
Alternative Investments |  |  |  |  |  |  |  |  |
Secondary private equity |  | $ | 28,883 |  |  | 30,114 |  |  | 8,153 |
Private equity |  | 24,743 |  |  | 21,736 |  |  | 3,883 |
Energy/power generation |  | 19,198 |  |  | 25,913 |  |  | 10,347 |
Distressed debt |  | 13,413 |  |  | 16,953 |  |  | 7,357 |
Real estate |  | 12,719 |  |  | 13,767 |  |  | 10,473 |
Mezzanine financing |  | 11,177 |  |  | 8,817 |  |  | 23,174 |
Venture capital |  | 7,651 |  |  | 7,248 |  |  | 400 |
Total alternative investments |  | 117,784 |  |  | 124,548 |  |  | 63,787 |
Other securities |  | 4,297 |  |  | 3,753 |  |  | 1,059 |
Total other investments |  | $ | 122,081 |  |  | 128,301 |  |  | 64,846 |

The carrying value of our other investments decreased by $6.2 million compared to year end 2011. The carrying value was impacted by distributions of $19.7 million, partially offset by income of $5.2 million and additional contributions of $8.3 million. These contributions included $5.4 million under our previously existing commitments and $2.5 million under two new alternative investment limited partnerships that we entered into during the second quarter of 2012. The remaining commitment on the two new mezzanine financing limited partnerships amounted to $7.9 million at September 30, 2012. The two new investments contain redemption restrictions and fund liquidation characteristics that are consistent with our other alternative investments. For a description of our seven alternative investment strategies, as well as information regarding redemption, restrictions, and fund liquidations, refer to Note 5. “Investments” in Item 8. “Financial Statements and Supplementary Data.” of our 2011 Annual Report.
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The following table sets forth aggregated summarized financial information for the partnerships in our alternative and other investments carried under the equity method of accounting. The last line of the table below reflects our share of the aggregate income, which is the portion included in our Financial Statements. As the majority of these investments report results to us on a quarter lag, the summarized financial statement information for the three and nine-month periods ended June 30, 2012, which are included in our Financial Statements as of September 30, 2012, is as follows:

Income Statement Information |  |  |  |  |  |  |  |
|  | Quarter ended June 30, |  | Nine Months ended June 30,
($ in millions) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Net investment income |  | 80.0 |  |  | 136.8 |  |  | 170.1 |  |  | 423.6 |
Realized gains (losses) |  | 19.6 |  |  | 710.6 |  |  | 1,004.9 |  |  | 873.6 |
Net change in unrealized (depreciation) appreciation |  | (117.1 | ) |  | (194.7 | ) |  | (551.1 | ) |  | 1,877.8 |
Net income |  | (17.5 | ) |  | 652.7 |  |  | 623.9 |  |  | 3,175.0 |
Selective’s insurance subsidiaries’ other investments income |  | 0.5 |  |  | 4.5 |  |  | 5.5 |  | 24.0 |

(f) At September 30, 2012, we had 30 fixed maturity securities, with a carrying value of $61.7 million, pledged as collateral for our outstanding borrowing with the Federal Home Loan Bank of Indianapolis (“FHLBI”). This borrowing, which has an outstanding principal balance of $58.0 million, is included in “Notes payable” on our Consolidated Balance Sheets. In accordance with the terms of our agreement with the FHLBI, we retain all rights regarding the collateral securities, which are included in the “U.S. government and government agencies,” “RMBS,” and “CMBS” classifications of our AFS fixed maturity securities portfolio.
(g) The components of net investment income earned were as follows:

|  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Fixed maturity securities |  | $ | 30,839 |  |  | 31,960 |  |  | 93,948 |  |  | 97,835 |
Equity securities |  | 1,268 |  |  | 1,197 |  |  | 3,785 |  |  | 2,299 |
Short-term investments |  | 36 |  |  | 28 |  |  | 103 |  |  | 123 |
Other investments |  | 497 |  |  | 4,453 |  |  | 5,460 |  |  | 23,994 |
Miscellaneous income |  | 41 |  |  | 41 |  |  | 105 |  |  | 88 |
Investment expenses |  | (2,031 | ) |  | (1,893 | ) |  | (6,117 | ) |  | (5,735 | )
Net investment income earned |  | $ | 30,650 |  |  | 35,786 |  |  | 97,284 |  |  | 118,604 |

Net investment income earned, before tax, decreased by $5.1 million in Third Quarter 2012 compared to Third Quarter 2011, and decreased by $21.3 million in Nine Months 2012 compared to Nine Months 2011. These decreases were primarily driven by lower income from alternative investments within our other investment portfolio of $3.5 million and $17.6 million in Third Quarter and Nine Months 2012, respectively. Our alternative investments, which are accounted for under the equity method, primarily consist of investments in limited partnerships, the majority of which report results to us on a one quarter lag. Interest income from our fixed maturity securities portfolio decreased by $1.1 million and $3.9 million for Third Quarter and Nine Months 2012, respectively, primarily due to lower reinvestment yields than in the prior year periods.
(h) The following tables summarize OTTI by asset type for the periods indicated:

Third Quarter 2012 |  |  |  |  |  |
($ in thousands) |  | Gross |  | Included in Other Comprehensive Income (“OCI”) |  | Recognized in Earnings
Fixed maturity securities |  |  |  |  |  |  |  |  |
ABS |  | $ | 36 |  |  | — |  |  | 36 |
CMBS |  | (1,504 | ) |  | (2,023 | ) |  | 519 |
Total fixed maturity securities |  | (1,468 | ) |  | (2,023 | ) |  | 555 |
Equity securities |  | 2,389 |  |  | — |  |  | 2,389 |
OTTI losses |  | $ | 921 |  |  | (2,023 | ) |  | 2,944 |

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Third Quarter 2011 |  |  |  |  |  |
($ in thousands) |  | Gross |  | Included in OCI |  | Recognized in Earnings
Fixed maturity securities |  |  |  |  |  |  |  |  |
ABS |  | $ | 543 |  |  | 493 |  |  | 50 |
CMBS |  | (184 | ) |  | (316 | ) |  | 132 |
RMBS |  | 22 |  |  | (27 | ) |  | 49 |
Total fixed maturities |  | 381 |  |  | 150 |  |  | 231 |
Equity securities |  | 2,312 |  |  | — |  |  | 2,312 |
OTTI losses |  | $ | 2,693 |  |  | 150 |  |  | 2,543 |

Nine Months 2012 |  |  |  |  |  |
($ in thousands) |  | Gross |  | Included in OCI |  | Recognized in Earnings
Fixed maturity securities |  |  |  |  |  |  |  |  |
ABS |  | $ | 98 |  |  | — |  |  | 98 |
CMBS |  | (1,396 | ) |  | (2,023 | ) |  | 627 |
RMBS |  | (44 | ) |  | (218 | ) |  | 174 |
Total fixed maturity securities |  | (1,342 | ) |  | (2,241 | ) |  | 899 |
Equity securities |  | 2,560 |  |  | — |  |  | 2,560 |
OTTI losses |  | $ | 1,218 |  |  | (2,241 | ) |  | 3,459 |

Nine Months 2011 |  |  |  |  |  |
($ in thousands) |  | Gross |  | Included in OCI |  | Recognized in Earnings
Fixed maturity securities |  |  |  |  |  |  |  |  |
Obligations of state and political subdivisions |  | $ | 17 |  |  | — |  |  | 17 |
Corporate securities |  | 244 |  |  | — |  |  | 244 |
ABS |  | 543 |  |  | 493 |  |  | 50 |
CMBS |  | (370 | ) |  | (974 | ) |  | 604 |
RMBS |  | 316 |  |  | 201 |  |  | 115 |
Total fixed maturities |  | 750 |  |  | (280 | ) |  | 1,030 |
Equity securities |  | 2,312 |  |  | — |  |  | 2,312 |
OTTI losses |  | $ | 3,062 |  |  | (280 | ) |  | 3,342 |

The majority of the OTTI charges in Third Quarter and Nine Months 2012 reflect charges on securities in our high dividend yield strategy equity portfolio that we intend to sell. OTTI charges in Third Quarter and Nine Months 2011 were primarily related to certain securities in the same portfolio that we did not believe would recover in the near term.
The following tables set forth, for the periods indicated, credit loss impairments on fixed maturity securities for which a portion of the OTTI charge was recognized in OCI, and the corresponding changes in such amounts:

|  | Quarter ended September 30,
($ in thousands) |  | 2012 |  | 2011
Balance, beginning of period |  | $ | 6,775 |  |  | 14,024 |
Addition for the amount related to credit loss for which an OTTI was not previously recognized |  | — |  |  | — |
Reductions for securities sold during the period |  | — |  |  | — |
Reductions for securities for which the amount previously recognized in OCI was recognized in earnings because of intention or potential requirement to sell before recovery of amortized cost |  | — |  |  | — |
Reductions for securities for which the entire amount previously recognized in OCI was recognized in earnings due to a decrease in cash flows expected |  | — |  |  | — |
Additional increases to the amount related to credit loss for which an OTTI was previously recognized |  | 519 |  |  | 207 |
Accretion of credit loss impairments previously recognized due to an increase in cash flows expected to be collected |  | — |  |  | — |
Balance, end of period |  | $ | 7,294 |  |  | 14,231 |

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|  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011
Balance, beginning of period |  | $ | 6,602 |  |  | 17,723 |
Addition for the amount related to credit loss for which an OTTI was not previously recognized |  | — |  |  | — |
Reductions for securities sold during the period |  | — |  |  | — |
Reductions for securities for which the amount previously recognized in OCI was recognized in earnings because of intention or potential requirement to sell before recovery of amortized cost |  | — |  |  | — |
Reductions for securities for which the entire amount previously recognized in OCI was recognized in earnings due to a decrease in cash flows expected |  | — |  |  | (3,954 | )
Additional increases to the amount related to credit loss for which an OTTI was previously recognized |  | 692 |  |  | 462 |
Accretion of credit loss impairments previously recognized due to an increase in cash flows expected to be collected |  | — |  |  | — |
Balance, end of period |  | $ | 7,294 |  |  | 14,231 |

(i)The components of net realized gains, excluding OTTI charges, were as follows:

|  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
HTM fixed maturity securities |  |  |  |  |  |  |  |  |  |  |  |
Gains |  | $ | 40 |  |  | — |  |  | 195 |  |  | 9 |
Losses |  | (90 | ) |  | (200 | ) |  | (196 | ) |  | (522 | )
AFS fixed maturity securities |  |  |  |  |  |  |  |  |  |  |  |
Gains |  | 2,168 |  |  | 698 |  |  | 2,941 |  |  | 3,052 |
Losses |  | (262 | ) |  | (5 | ) |  | (379 | ) |  | (12 | )
AFS equity securities |  |  |  |  |  |  |  |  |  |  |  |
Gains |  | — |  |  | 5 |  |  | 4,775 |  |  | 6,676 |
Losses |  | — |  |  | — |  |  | (428 | ) |  | — |
Short-term investments |  |  |  |  |  |  |  |  |  |  |  |
Losses |  | — |  |  | — |  |  | (2 | ) |  | — |
Other investments |  |  |  |  |  |  |  |
Gains |  | — |  |  | — |  |  | 1 |  |  | — |
Total other net realized investment gains |  | 1,856 |  |  | 498 |  |  | 6,907 |  |  | 9,203 |
Total OTTI charges recognized in earnings |  | (2,944 | ) |  | (2,543 | ) |  | (3,459 | ) |  | (3,342 | )
Total net realized gains |  | $ | (1,088 | ) |  | (2,045 | ) |  | 3,448 |  |  | 5,861 |

Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold. Of the $6.9 million in net realized investment gains in Nine Months 2012, $4.3 million was related to the sale of AFS equity securities due to a rebalancing of our equity portfolio. Net realized investment gains in Nine Months 2011 of $9.2 million included the impact of reallocating our AFS equity securities into our high-dividend yield strategy. This reallocation generated net realized gains of $6.7 million.
Proceeds from the sale of AFS securities were $55.0 million and $150.9 million in Third Quarter and Nine Months 2012 and $22.0 million and $145.8 million in Third Quarter and Nine Months 2011.
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NOTE 7. Fair Value Measurements
The following table presents the carrying amounts and estimated fair values of our financial instruments as of September 30, 2012 and December 31, 2011:

|  | September 30, 2012 |  | December 31, 2011
($ in thousands) |  | Carrying Amount |  | Fair Value |  | Carrying Amount |  | Fair Value
Financial Assets |  |  |  |  |  |  |  |  |  |  |  |
Fixed maturity securities: |  |  |  |  |  |  |  |  |  |  |  |
HTM |  | $ | 600,716 |  |  | 646,035 |  |  | 712,348 |  |  | 758,043 |
AFS |  | 3,269,960 |  |  | 3,269,960 |  |  | 2,897,373 |  |  | 2,897,373 |
Equity securities, AFS |  | 155,577 |  |  | 155,577 |  |  | 157,355 |  |  | 157,355 |
Short-term investments |  | 184,878 |  |  | 184,878 |  |  | 217,044 |  |  | 217,044 |
Receivable for proceeds related to sale of Selective HR Solutions (“Selective HR”) |  | 2,799 |  |  | 2,799 |  |  | 3,212 |  |  | 3,212 |
Financial Liabilities |  |  |  |  |  |  |  |  |  |  |  |
Notes payable: |  |  |  |  |  |  |  |  |  |  |  |
7.25% Senior Notes |  | 49,911 |  |  | 62,201 |  |  | 49,908 |  |  | 51,111 |
6.70% Senior Notes |  | 99,469 |  |  | 102,169 |  |  | 99,452 |  |  | 113,195 |
7.50% Junior Notes |  | 100,000 |  |  | 100,200 |  |  | 100,000 |  |  | 100,360 |
2.90% borrowings from FHLBI |  | 13,000 |  |  | 13,667 |  |  | 13,000 |  |  | 13,759 |
1.25% borrowings from FHLBI |  | 45,000 |  |  | 45,663 |  |  | 45,000 |  |  | 44,629 |
Total notes payable |  | $ | 307,380 |  |  | 323,900 |  |  | 307,360 |  |  | 323,054 |

The techniques used to value our financial assets are as follows:

• | For valuations of a large portion of our equity securities portfolio as well as U.S. Treasury notes held in our fixed maturity securities portfolio, we receive prices from an independent pricing service that are based on observable market transactions. We validate these prices against a second external pricing service, and if established market value comparison thresholds are breached, further analysis is performed, in conjunction with our external investment managers, to determine the price to be used. These securities are classified as Level 1 in the fair value hierarchy.

• | For approximately 95% of our fixed maturity securities portfolio, we utilize a market approach, using primarily matrix pricing models prepared by external pricing services. Matrix pricing models use mathematical techniques to value debt securities by relying on the securities relationship to other benchmark quoted securities, and not relying exclusively on quoted prices for specific securities, as the specific securities are not always frequently traded. As a matter of policy, we consistently use one pricing service as our primary source and secondary pricing services if prices are not available from the primary pricing service. In conjunction with our external investment portfolio managers, fixed maturity securities portfolio pricing is reviewed for reasonableness in the following ways: (i) comparing positions traded directly by the external investment portfolio managers to prices received from the third-party pricing services; (ii) comparing the primary vendor pricing to other third-party pricing services as well as benchmark indexed pricing; (iii) comparing market value fluctuations between months for reasonableness; and (iv) reviewing stale prices. If further analysis is needed, a challenge is sent to the primary pricing service for review and confirmation of the price. In addition to the tests described above, management also selects a sample of prices for a comparison to a secondary price source. Historically, we have not experienced significant variances in prices, and therefore, we have consistently used our primary pricing service. These prices are typically Level 2 in the fair value hierarchy.

• | For the small portion of our fixed maturity securities portfolio that we cannot price using our primary service, we typically use non-binding broker quotes. These prices are from various broker/dealers that utilize bid or ask prices, or benchmarks to indices, in measuring the fair value of a security. For the small portion of non-public equity securities that we hold, we typically receive prices from a third party pricing service or through statements provided by the security issuer. In conjunction with our external investment portfolio managers, these fair value measurements are reviewed for reasonableness. This review typically includes an analysis of price fluctuations between months with variances over established thresholds being analyzed further. These prices are generally classified as Level 3 in the fair value hierarchy, as the inputs cannot be corroborated by observable market data.

• | Short-term investments are carried at cost, which approximates fair value. Given the liquid nature of our short-term investments, we generally validate their fair value by way of active trades within approximately one week of the financial statement close. These securities are classified as Level 1 in the fair value hierarchy.

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• | Our investments in other securities in our other investments portfolio are generally accounted for under the equity method.

• | The fair value of the receivable for proceeds related to the 2009 sale of Selective HR is estimated using a discounted cash flow analysis, which includes our judgment regarding future worksite life generation and retention assumptions. These assumptions are derived based on our historical experience modified to reflect current and anticipated future trends. Proceeds related to the sale are scheduled to be received over a 10-year period based on the ability of the purchaser to retain and generate new worksite lives though our independent agency distribution channel. We have concluded that these proceeds are not directly related to the operations of Selective HR since we have no continuing involvement with the operations of this company and have no continuing cash flows other than these proceeds. This receivable is classified as Level 3 in the fair value hierarchy.

The techniques used to value our financial liabilities are as follows:

• | The fair values of the 7.25% Senior Notes due November 15, 2034, the 6.70% Senior Notes due November 1, 2035, and the 7.50% Junior Subordinated Notes due September 27, 2066 are based on quoted market prices. These prices are typically Level 1 in the fair value hierarchy.

• | The fair value of the 2.90% and 1.25% borrowings from the FHLBI are estimated using a discounted cash flow analysis based on a current borrowing rate provided by the FHLBI consistent with the remaining term of the borrowing. These prices are typically Level 2 in the fair value hierarchy.

The following tables provide quantitative disclosures of our financial assets that were measured at fair value at September 30, 2012 and December 31, 2011:

September 30, 2012 |  |  |  | Fair Value Measurements Using
($ in thousands) |  | Assets Measured at Fair Value at 9/30/12 |  | Quoted Prices in Active Markets for Identical Assets/ Liabilities (Level 1)1 |  | Significant Other Observable Inputs (Level 2)1 |  | Significant Unobservable Inputs (Level 3)
Description |  |  |  |  |  |  |  |  |  |  |  |
Measured on a recurring basis: |  |  |  |  |  |  |  |  |  |  |  |
U.S. government and government agencies 2 |  | $ | 294,214 |  |  | 130,435 |  |  | 143,804 |  |  | 19,975 |
Foreign government |  | 30,292 |  |  | — |  |  | 30,292 |  |  | — |
Obligations of states and political subdivisions |  | 784,501 |  |  | — |  |  | 784,501 |  |  | — |
Corporate securities |  | 1,425,888 |  |  | — |  |  | 1,423,005 |  |  | 2,883 |
ABS |  | 121,154 |  |  | — |  |  | 113,835 |  |  | 7,319 |
CMBS |  | 129,615 |  |  | — |  |  | 114,904 |  |  | 14,711 |
RMBS |  | 484,296 |  |  | — |  |  | 484,296 |  |  | — |
Total AFS fixed maturity securities |  | 3,269,960 |  |  | 130,435 |  |  | 3,094,637 |  |  | 44,888 |
Equity securities |  | 155,577 |  |  | 151,970 |  |  | — |  |  | 3,607 |
Short-term investments |  | 184,878 |  |  | 184,878 |  |  | — |  |  | — |
Receivable for proceeds related to sale of Selective HR |  | 2,799 |  |  | — |  |  | — |  |  | 2,799 |
Total assets |  | $ | 3,613,214 |  |  | 467,283 |  |  | 3,094,637 |  |  | 51,294 |

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December 31, 2011 |  |  |  | Fair Value Measurements Using
($ in thousands) |  | Assets Measured at Fair Value at 12/31/11 |  | Quoted Prices in Active Markets for Identical Assets/Liabilities (Level 1)1 |  | Significant Other Observable Inputs (Level 2)1 |  | Significant Unobservable Inputs (Level 3)
Description |  |  |  |  |  |  |  |  |  |  |  |
Measured on a recurring basis: |  |  |  |  |  |  |  |  |  |  |  |
U.S. government and government agencies 2 |  | $ | 353,796 |  |  | 126,475 |  |  | 205,580 |  |  | 21,741 |
Foreign government |  | 34,173 |  |  | — |  |  | 34,173 |  |  | — |
Obligations of states and political subdivisions |  | 622,659 |  |  | — |  |  | 622,659 |  |  | — |
Corporate securities |  | 1,213,310 |  |  | — |  |  | 1,210,707 |  |  | 2,603 |
ABS |  | 78,949 |  |  | — |  |  | 78,949 |  |  | — |
CMBS |  | 112,598 |  |  | — |  |  | 112,244 |  |  | 354 |
RMBS |  | 481,888 |  |  | — |  |  | 481,888 |  |  | — |
Total AFS fixed maturity securities |  | 2,897,373 |  |  | 126,475 |  |  | 2,746,200 |  |  | 24,698 |
Equity securities |  | 157,355 |  |  | 157,355 |  |  | — |  |  | — |
Short-term investments |  | 217,044 |  |  | 217,044 |  |  | — |  |  | — |
Receivable for proceeds related to sale of Selective HR |  | 3,212 |  |  | — |  |  | — |  |  | 3,212 |
Total assets |  | $ | 3,274,984 |  |  | 500,874 |  |  | 2,746,200 |  |  | 27,910 |

1 | There were no transfers of securities between Level 1 and Level 2.

2 | U.S. government includes corporate securities fully guaranteed by the FDIC.

The following table provides a summary of the changes in the fair value of securities measured using Level 3 inputs and related quantitative information for Nine Months 2012:

Nine Months 2012 |  |  |  |  |  |  |  |  |  |  |  |  |  |
($ in thousands) |  | Government |  | Corporate |  | ABS |  | CMBS |  | Equity |  | Receivable for Proceeds Related to Sale of Selective HR |  | Total
Fair value, December 31, 2011 |  | $ | 21,741 |  |  | 2,603 |  |  | — |  |  | 354 |  |  | — |  |  | 3,212 |  |  | 27,910 |
Total net (losses) gains for the period included in: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
OCI 1 |  | 121 |  |  | 121 |  |  | 20 |  |  | 517 |  |  | — |  |  | — |  |  | 779 |
Net income 2,3 |  | (149 | ) |  | — |  |  | — |  |  | 4 |  |  | — |  |  | 187 |  |  | 42 |
Purchases |  | — |  |  | — |  |  | 7,299 |  |  | 5,611 |  |  | — |  |  | — |  |  | 12,910 |
Sales |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Issuances |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Settlements |  | (1,738 | ) |  | (629 | ) |  |  |  |  | (22 | ) |  | — |  |  | (600 | ) |  | (2,989 | )
Transfers into Level 3 |  | — |  |  | 788 |  |  | — |  |  | 8,247 |  |  | 3,607 |  |  | — |  |  | 12,642 |
Transfers out of Level 3 |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Fair value, September 30, 2012 |  | $ | 19,975 |  |  | 2,883 |  |  | 7,319 |  |  | 14,711 |  |  | 3,607 |  |  | 2,799 |  |  | 51,294 |

1 Amounts are reported in “Unrealized holding gains arising during period” on the Consolidated Statements of Comprehensive Income.
2 Amounts are reported in “Net realized gains (losses)” for realized gains and losses and “Net investment income earned” for amortization of securities on the Consolidated Statements of Income.
3 Amounts are reported in “Other income” for the receivable related to the sale of Selective HR on the Consolidated Statements of Income, and are related to interest accretion on the receivable.
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As discussed above, the fair value of our Level 3 fixed maturity securities are typically obtained through non-binding broker quotes, which we review for reasonableness. In Nine Months 2012, fixed maturity securities with an aggregate fair value of $44.9 million were measured using Level 3 inputs. This amount includes securities with a fair value of $9.0 million that were transferred into Level 3 during the year. These transfers were primarily related to securities that had been previously priced using Level 2 inputs, but due to the availability and nature of the pricing used at the valuation dates, are priced using Level 3 inputs at September 30, 2012. In addition, a portion of these transfers relate to securities that had previously been classified as HTM, and therefore not measured at fair value, for which available pricing at September 30, 2012 used Level 3 inputs.
Equity securities with a fair value of $3.6 million were transferred into Level 3 during Nine Months 2012, driven primarily by the nature of the quotes used at the valuation date. We review the fair values received on these non-publicly traded equity securities for reasonableness.
The remaining measurement using Level 3 inputs relates to the receivable from the sale of Selective HR. This security is measured using unobservable inputs, the most significant of which is our assumption regarding the retention of business. If this assumption were to change by +/- 10%, the value of the receivable would increase/decrease by approximately $0.1 million.
The following table provides a summary of the changes in the fair value of securities measured using Level 3 inputs in 2011:

2011 |  |  |  |  |  |  |  |  |  |
($ in thousands) |  | Government |  | Corporate |  | CMBS |  | Receivable for Proceeds Related to Sale of Selective HR |  | Total
Fair value, December 31, 2010 |  | $ | — |  |  | — |  |  | 185 |  |  | 5,002 |  |  | 5,187 |
Total net (losses) gains for the period included in: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
OCI 1 |  | — |  |  | — |  |  | 507 |  |  | — |  |  | 507 |
Net income 2,3 |  | — |  |  | — |  |  | (322 | ) |  | (638 | ) |  | (960 | )
Purchases |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Sales |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Issuances |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Settlements |  | — |  |  | — |  |  | (16 | ) |  | (1,152 | ) |  | (1,168 | )
Transfers into Level 3 |  | 21,741 |  |  | 2,603 |  |  | — |  |  | — |  |  | 24,344 |
Transfers out of Level 3 |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Fair value, December 31, 2011 |  | $ | 21,741 |  |  | 2,603 |  |  | 354 |  |  | 3,212 |  |  | 27,910 |

1 Amounts are reported in “Other net unrealized gains on investment securities, net of deferred income tax” on the Consolidated Statements of Stockholders’ Equity in our 2011 Annual Report.
2 Amounts are reported in “Net realized gains (losses)” for realized gains and losses and “Net investment income earned” for amortization for the CMBS securities on the Consolidated Statements of Income in our 2011 Annual Report.
3 Amounts are reported in either “Loss on disposal of discontinued operations, net of tax” or “Other income” for the receivable related to the sale of Selective HR on the Consolidated Statements of Income in our 2011 Annual Report. Amounts in “Loss on disposal of discontinued operations, net of tax” related to charges to reduce the fair value of our receivable, and amounts in “Other income” related to interest accretion on the receivable in our 2011 Annual Report.
The transfers of the government and corporate securities into Level 3 classification at December 31, 2011 were primarily the result of broker-priced securities being transferred from an HTM to an AFS designation in 2011.
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The following tables provide quantitative information regarding our financial assets and liabilities that were disclosed at fair value at September 30, 2012:

September 30, 2012 |  |  |  | Fair Value Measurements Using
($ in thousands) |  | Assets/ Liabilities Disclosed at Fair Value at 9/30/12 |  | Quoted Prices in Active Markets for Identical Assets/ Liabilities (Level 1) |  | Significant Other Observable Inputs (Level 2) |  | Significant Unobservable Inputs (Level 3)
Financial Assets |  |  |  |  |  |  |  |  |  |  |  |
HTM: |  |  |  |  |  |  |  |  |  |  |  |
Foreign government |  | $ | 5,596 |  |  | — |  |  | 5,596 |  |  | — |
Obligations of states and political subdivisions |  | 566,495 |  |  | — |  |  | 566,495 |  |  | — |
Corporate securities |  | 53,623 |  |  | — |  |  | 48,731 |  |  | 4,892 |
ABS |  | 7,329 |  |  | — |  |  | 5,846 |  |  | 1,483 |
CMBS |  | 12,992 |  |  | — |  |  | 12,992 |  |  | — |
Total HTM fixed maturity securities |  | $ | 646,035 |  |  | — |  |  | 639,660 |  |  | 6,375 |
Financial Liabilities |  |  |  |  |  |  |  |  |  |  |  |
Notes payable: |  |  |  |  |  |  |  |  |  |  |  |
7.25% Senior Notes |  | $ | 62,201 |  |  | 62,201 |  |  | — |  |  | — |
6.70% Senior Notes |  | 102,169 |  |  | 102,169 |  |  | — |  |  | — |
7.50% Junior Notes |  | 100,200 |  |  | 100,200 |  |  | — |  |  | — |
2.90% borrowings from FHLBI |  | 13,667 |  |  | — |  |  | 13,667 |  |  | — |
1.25% borrowings from FHLBI |  | 45,663 |  |  | — |  |  | 45,663 |  |  | — |
Total notes payable |  | $ | 323,900 |  |  | 264,570 |  |  | 59,330 |  |  | — |

NOTE 8. Reinsurance
The following table contains a listing of direct, assumed, and ceded reinsurance amounts for premiums written, premiums earned, and losses and loss expenses incurred. For more information concerning reinsurance, refer to Note 8. “Reinsurance” in Item 8. “Financial Statements and Supplementary Data.” in our 2011 Annual Report.

|  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Premiums written: |  |  |  |  |  |  |  |  |  |  |  |
Direct |  | $ | 520,943 |  |  | 453,768 |  |  | 1,504,429 |  |  | 1,324,705 |
Assumed |  | 17,976 |  |  | 22,575 |  |  | 44,712 |  |  | 29,765 |
Ceded |  | (88,401 | ) |  | (79,511 | ) |  | (252,888 | ) |  | (221,300 | )
Net |  | $ | 450,518 |  |  | 396,832 |  |  | 1,296,253 |  |  | 1,133,170 |
Premiums earned: |  |  |  |  |  |  |  |  |  |  |  |
Direct |  | $ | 474,055 |  |  | 425,231 |  |  | 1,389,373 |  |  | 1,257,087 |
Assumed |  | 18,595 |  |  | 7,626 |  |  | 49,683 |  |  | 18,866 |
Ceded |  | (86,425 | ) |  | (73,894 | ) |  | (261,790 | ) |  | (210,067 | )
Net |  | $ | 406,225 |  |  | 358,963 |  |  | 1,177,266 |  |  | 1,065,886 |
Losses and loss expenses incurred: |  |  |  |  |  |  |  |  |  |  |  |
Direct |  | $ | 327,883 |  |  | 638,219 |  |  | 881,537 |  |  | 1,204,586 |
Assumed |  | 13,970 |  |  | 5,977 |  |  | 35,039 |  |  | 13,549 |
Ceded |  | (69,602 | ) |  | (338,238 | ) |  | (103,516 | ) |  | (388,416 | )
Net |  | $ | 272,251 |  |  | 305,958 |  |  | 813,060 |  |  | 829,719 |

Direct premium written ("DPW") increases in both Third Quarter and Nine Months 2012 were attributable to our newly acquired E&S business, higher new business, and higher renewal premiums reflecting increases in renewal pure price in our standard insurance operations.
Direct premium earned increases in Third Quarter and Nine Months 2012 were consistent with the fluctuation in DPW for the twelve-month period ended September 30, 2012 as compared to the twelve-month period ended September 30, 2011.
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Assumed premiums written for Third Quarter 2012 decreased compared to the same period last year as E&S business, which was previously written through a reinsurance agreement, is now written by one of our ten insurance subsidiaries ("Insurance Subsidiaries"). A fronting arrangement was in place during the second half of 2011 to write E&S business that we acquired through the purchase of a renewal book of business in August 2011. Assumed E&S premiums from this renewal book continued until April 2012, when our recently-acquired Insurance Subsidiary, MUSIC, became the direct writer of this business. Increases in assumed premiums earned in Third Quarter and Nine Months 2012 compared to the prior year periods were driven by the E&S premiums.
Direct losses and loss expenses incurred were significantly impacted by decreases in flood losses that are ceded under the NFIP program, as well as decreases in catastrophe losses of $57.9 million, to $9.6 million, in Third Quarter 2012 and $65.7 million, to $46.7 million, in Nine Months 2012, compared to the prior year periods. Flood losses decreased absent the significant flooding that was experienced in 2011 as a result of Tropical Storm Lee and, to a lesser extent, Hurricane Irene. As the flood losses are fully ceded under the NFIP program, the reduction in the direct losses and loss expenses drive the corresponding decrease in our ceded losses. The ceded premiums and losses related to our involvement with the NFIP, in which all of our Flood premiums, losses, and loss expenses are ceded to the NFIP, are as follows:

National Flood Insurance Program |  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Ceded premiums written |  | $ | (58,923 | ) |  | (55,198 | ) |  | (171,172 | ) |  | (158,777 | )
Ceded premiums earned |  | (53,222 | ) |  | (50,256 | ) |  | (157,895 | ) |  | (147,111 | )
Ceded losses and loss expenses incurred |  | $ | (32,702 | ) |  | (301,725 | ) |  | (24,534 | ) |  | (331,604 | )

NOTE 9. Segment Information
We have historically classified our operations into two segments, the disaggregated results of which are reported to and used by senior management to manage our operations:

• | Insurance Operations, which is 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; and

• | Investments, which is evaluated based on net investment income and net realized gains and losses.

In Nine Months 2012, we began writing E&S business through our newly-acquired subsidiary, MUSIC. This business has not met the quantitative thresholds for individual segment reporting, and as our E&S operations share various economic, regulatory, and production-related characteristics with our standard market insurance products, we have aggregated their results into our Insurance Operations segment for reporting purposes.
In computing the results of each segment, we do not make adjustments for interest expense, net general corporate expenses, or federal income taxes. We do not maintain separate investment portfolios for the segments, and therefore, do not allocate assets to the segments.
The following summaries present revenue (net investment income and net realized gain (loss) on investments in the case of the Investments segment) and pre-tax income for the individual segments:
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Revenue by Segment |  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Insurance Operations: |  |  |  |  |  |  |  |  |  |  |  |
Net premiums earned: |  |  |  |  |  |  |  |  |  |  |  |
Commercial automobile |  | $ | 72,758 |  |  | 70,174 |  |  | $ | 214,782 |  |  | 209,042 |
Workers compensation |  | 65,592 |  |  | 63,497 |  |  | 198,064 |  |  | 189,878 |
General liability |  | 93,763 |  |  | 87,479 |  |  | 276,538 |  |  | 255,717 |
Commercial property |  | 52,197 |  |  | 48,051 |  |  | 151,945 |  |  | 144,121 |
Business owners’ policies |  | 17,749 |  |  | 16,663 |  |  | 51,872 |  |  | 49,555 |
Bonds |  | 4,713 |  |  | 4,727 |  |  | 14,076 |  |  | 14,219 |
Other |  | 27,648 |  |  | 1,772 |  |  | 59,619 |  |  | 6,889 |
Total commercial lines |  | 334,420 |  |  | 292,363 |  |  | 966,896 |  |  | 869,421 |
Personal automobile |  | 38,295 |  |  | 37,371 |  |  | 113,648 |  |  | 111,522 |
Homeowners |  | 29,919 |  |  | 25,923 |  |  | 86,685 |  |  | 75,538 |
Other |  | 3,591 |  |  | 3,306 |  |  | 10,037 |  |  | 9,405 |
Total personal lines |  | 71,805 |  |  | 66,600 |  |  | 210,370 |  |  | 196,465 |
Total net premiums earned |  | 406,225 |  |  | 358,963 |  |  | 1,177,266 |  |  | 1,065,886 |
Miscellaneous income |  | 1,009 |  |  | 1,255 |  |  | 6,904 |  |  | 6,413 |
Total Insurance Operations revenues |  | 407,234 |  |  | 360,218 |  |  | 1,184,170 |  |  | 1,072,299 |
Investments: |  |  |  |  |  |  |  |  |  |  |  |
Net investment income |  | 30,650 |  |  | 35,786 |  |  | 97,284 |  |  | 118,604 |
Net realized investment (losses) gains |  | (1,088 | ) |  | (2,045 | ) |  | 3,448 |  |  | 5,861 |
Total investment revenues |  | 29,562 |  |  | 33,741 |  |  | 100,732 |  |  | 124,465 |
Total all segments |  | 436,796 |  |  | 393,959 |  |  | 1,284,902 |  |  | 1,196,764 |
Other income |  | 76 |  |  | 110 |  |  | 225 |  |  | 331 |
Total revenues |  | $ | 436,872 |  |  | 394,069 |  |  | $ | 1,285,127 |  |  | 1,197,095 |

Income from Continuing Operations before Federal Income Tax |  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Insurance Operations: |  |  |  |  |  |  |  |  |  |  |  |
Commercial lines underwriting |  | $ | (6,359 | ) |  | (36,512 | ) |  | $ | (30,367 | ) |  | (66,150 | )
Personal lines underwriting |  | 7,220 |  |  | (28,267 | ) |  | 2,903 |  |  | (45,329 | )
Underwriting income (loss), before federal income tax |  | 861 |  |  | (64,779 | ) |  | (27,464 | ) |  | (111,479 | )
GAAP combined ratio |  | 99.8 | % |  | 118.0 | % |  | 102.3 | % |  | 110.5 | %
Statutory combined ratio |  | 98.4 | % |  | 116.4 | % |  | 101.2 | % |  | 109.6 | %
Investments: |  |  |  |  |  |  |  |  |  |  |  |
Net investment income |  | $ | 30,650 |  |  | 35,786 |  |  | $ | 97,284 |  |  | 118,604 |
Net realized investment (losses) gains |  | (1,088 | ) |  | (2,045 | ) |  | 3,448 |  |  | 5,861 |
Total investment income, before federal income tax |  | 29,562 |  |  | 33,741 |  |  | 100,732 |  |  | 124,465 |
Total all segments |  | 30,423 |  |  | (31,038 | ) |  | 73,268 |  |  | 12,986 |
Interest expense |  | (4,725 | ) |  | (4,559 | ) |  | (14,148 | ) |  | (13,675 | )
General corporate and other expenses |  | (5,384 | ) |  | (1,886 | ) |  | (16,307 | ) |  | (10,735 | )
Income (loss) from continuing operations before federal income tax |  | $ | 20,314 |  |  | (37,483 | ) |  | $ | 42,813 |  |  | (11,424 | )

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NOTE 10. Retirement Plans
The following tables show the costs of the Retirement Income Plan for Selective Insurance Company of America (“Retirement Income Plan”) and the retirement life insurance component (“Retirement Life Plan”) of the Selective Insurance Company of America Welfare Benefits Plan. For more information concerning these plans, refer to Note 16. “Retirement Plans” in Item 8. “Financial Statements and Supplementary Data.” of our 2011 Annual Report.

|  | Retirement Income Plan Quarter ended September 30, |  | Retirement Life Plan Quarter ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Components of Net Periodic Benefit Cost: |  |  |  |  |  |  |  |  |  |  |  |
Service cost |  | $ | 2,154 |  |  | 1,894 |  |  | — |  |  | — |
Interest cost |  | 3,230 |  |  | 3,087 |  |  | 73 |  |  | 77 |
Expected return on plan assets |  | (3,547 | ) |  | (3,482 | ) |  | — |  |  | — |
Amortization of unrecognized prior service cost |  | 38 |  |  | 38 |  |  | — |  |  | — |
Amortization of unrecognized net loss |  | 1,383 |  |  | 1,039 |  |  | 8 |  |  | 4 |
Net periodic cost |  | $ | 3,258 |  |  | 2,576 |  |  | 81 |  |  | 81 |

|  | Retirement Income Plan Nine Months ended September 30, |  | Retirement Life Plan Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Components of Net Periodic Benefit Cost: |  |  |  |  |  |  |  |  |  |  |  |
Service cost |  | $ | 6,462 |  |  | 6,241 |  |  | — |  |  | — |
Interest cost |  | 9,690 |  |  | 9,397 |  |  | 221 |  |  | 230 |
Expected return on plan assets |  | (10,641 | ) |  | (10,445 | ) |  | — |  |  | — |
Amortization of unrecognized prior service cost |  | 113 |  |  | 113 |  |  | — |  |  | — |
Amortization of unrecognized net loss |  | 4,149 |  |  | 3,239 |  |  | 23 |  |  | 13 |
Net periodic cost |  | $ | 9,773 |  |  | 8,545 |  |  | 244 |  |  | 243 |

Weighted-Average Expense Assumptions for the years ended December 31: |  |  |  |  |  |  |  |  |  |
Discount rate |  | 5.16 | % |  | 5.55 |  | 5.16 | % |  | 5.55
Expected return on plan assets |  | 7.75 | % |  | 8.00 |  | — |  |  | —
Rate of compensation increase |  | 4.00 | % |  | 4.00 |  | — |  |  | —

We presently anticipate contributing $8.6 million to the Retirement Income Plan in 2012, $7.1 million of which has been funded as of September 30, 2012.
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NOTE 11. Comprehensive Income
The components of comprehensive income, both gross and net of tax, for Third Quarter 2012 and 2011 are as follows:

Third Quarter 2012 |  |  |  |  |  |
($ in thousands) |  | Gross |  | Tax |  | Net
Net income |  | $ | 20,314 |  |  | 2,040 |  |  | 18,274 |
Components of OCI: |  |  |  |  |  |  |  |  |
Unrealized gains on securities: |  |  |  |  |  |  |  |  |
Unrealized holding gains during the period |  | 36,620 |  |  | 12,817 |  |  | 23,803 |
Portion of OTTI recognized in OCI |  | 2,031 |  |  | 711 |  |  | 1,320 |
Amortization of net unrealized gains on HTM securities |  | 827 |  |  | 290 |  |  | 537 |
Reclassification adjustment for gains included in net income |  | (125 | ) |  | (44 | ) |  | (81 | )
Net unrealized gains |  | 39,353 |  |  | 13,774 |  |  | 25,579 |
Defined benefit pension and post-retirement plans: |  |  |  |  |  |  |  |  |
Reversal of amortization items: |  |  |  |  |  |  |  |  |
Net actuarial loss |  | 1,391 |  |  | 487 |  |  | 904 |
Prior service cost |  | 38 |  |  | 14 |  |  | 24 |
Defined benefit pension and post-retirement plans |  | 1,429 |  |  | 501 |  |  | 928 |
Comprehensive income |  | $ | 61,096 |  |  | 16,315 |  |  | 44,781 |

Third Quarter 2011 |  |  |  |  |  |
($ in thousands) |  | Gross |  | Tax |  | Net
Net loss |  | $ | (38,483 | ) |  | (20,515 | ) |  | (17,968 | )
Components of OCI: |  |  |  |  |  |  |  |  |
Unrealized gains on securities: |  |  |  |  |  |  |  |  |
Unrealized holding gains during the period |  | 14,712 |  |  | 5,148 |  |  | 9,564 |
Portion of OTTI recognized in OCI |  | (81 | ) |  | (28 | ) |  | (53 | )
Amortization of net unrealized gains on HTM securities |  | (664 | ) |  | (232 | ) |  | (432 | )
Reclassification adjustment for gains included in net income |  | 1,907 |  |  | 668 |  |  | 1,239 |
Net unrealized gains |  | 15,874 |  |  | 5,556 |  |  | 10,318 |
Defined benefit pension and post-retirement plans: |  |  |  |  |  |  |  |  |
Reversal of amortization items: |  |  |  |  |  |  |  |  |
Net actuarial loss |  | 1,043 |  |  | 365 |  |  | 678 |
Prior service cost |  | 38 |  |  | 14 |  |  | 24 |
Defined benefit pension and post-retirement plans |  | 1,081 |  |  | 379 |  |  | 702 |
Comprehensive loss |  | $ | (21,528 | ) |  | (14,580 | ) |  | (6,948 | )

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The components of comprehensive income, both gross and net of tax, for Nine Months 2012 and 2011 are as follows:

Nine Months 2012 |  |  |  |  |  |
($ in thousands) |  | Gross |  | Tax |  | Net
Net income |  | $ | 42,813 |  |  | 6,158 |  |  | 36,655 |
Components of OCI: |  |  |  |  |  |  |  |  |
Unrealized gains on securities: |  |  |  |  |  |  |  |  |
Unrealized holding gains during the period |  | 64,273 |  |  | 22,496 |  |  | 41,777 |
Portion of OTTI recognized in OCI |  | 2,512 |  |  | 879 |  |  | 1,633 |
Amortization of net unrealized gains on HTM securities |  | (649 | ) |  | (227 | ) |  | (422 | )
Reclassification adjustment for gains included in net income |  | (4,702 | ) |  | (1,646 | ) |  | (3,056 | )
Net unrealized gains |  | 61,434 |  |  | 21,502 |  |  | 39,932 |
Defined benefit pension and post-retirement plans: |  |  |  |  |  |  |  |  |
Reversal of amortization items: |  |  |  |  |  |  |  |  |
Net actuarial loss |  | 4,172 |  |  | 1,460 |  |  | 2,712 |
Prior service cost |  | 113 |  |  | 40 |  |  | 73 |
Defined benefit pension and post-retirement plans |  | 4,285 |  |  | 1,500 |  |  | 2,785 |
Comprehensive income |  | $ | 108,532 |  |  | 29,160 |  |  | 79,372 |

Nine Months 2011 |  |  |  |  |  |
($ in thousands) |  | Gross |  | Tax |  | Net
Net (loss) income |  | $ | (12,424 | ) |  | (16,423 | ) |  | 3,999 |
Components of OCI: |  |  |  |  |  |  |  |  |
Unrealized gains on securities: |  |  |  |  |  |  |  |  |
Unrealized holding gains during the period |  | 43,878 |  |  | 15,357 |  |  | 28,521 |
Portion of OTTI recognized in OCI |  | 517 |  |  | 181 |  |  | 336 |
Amortization of net unrealized gains on HTM securities |  | (3,097 | ) |  | (1,084 | ) |  | (2,013 | )
Reclassification adjustment for gains included in net income |  | (5,986 | ) |  | (2,095 | ) |  | (3,891 | )
Net unrealized gains |  | 35,312 |  |  | 12,359 |  |  | 22,953 |
Defined benefit pension and post-retirement plans: |  |  |  |  |  |  |  |  |
Reversal of amortization items: |  |  |  |  |  |  |  |  |
Net actuarial loss |  | 3,252 |  |  | 1,138 |  |  | 2,114 |
Prior service cost |  | 113 |  |  | 40 |  |  | 73 |
Defined benefit pension and post-retirement plans |  | 3,365 |  |  | 1,178 |  |  | 2,187 |
Comprehensive loss |  | $ | 26,253 |  |  | (2,886 | ) |  | 29,139 |

The balances of, and changes in, each component of AOCI (net of taxes) as of September 30, 2012 are as follows:

September 30, 2012 |  | Net Unrealized Gain (Loss) |  |  |  |
($ in thousands) |  | OTTI Related |  | HTM Related |  | All Other |  | Defined Benefit Pension and Post-Retirement Plans |  | Total Accumulated OCI
Balance, December 31, 2011 |  | $ | (3,500 | ) |  | 4,622 |  |  | 96,125 |  |  | (54,953 | ) |  | 42,294 |
Changes in component during period |  | 1,633 |  |  | (1,249 | ) |  | 39,548 |  |  | 2,785 |  |  | 42,717 |
Balance, September 30, 2012 |  | $ | (1,867 | ) |  | 3,373 |  |  | 135,673 |  |  | (52,168 | ) |  | 85,011 |

Note 12. Commitments and Contingencies
At September 30, 2012, we had contractual obligations that expire at various dates through 2022 to invest up to an additional $64.8 million in alternative and other investments. There is no certainty that any such additional investment will be required.
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Note 13. Litigation
In the ordinary course of conducting business, we are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving our ten 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. We account for such activity through the establishment of unpaid loss and loss adjustment expense reserves. We 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 our consolidated financial condition, results of operations, or cash flows.
Our Insurance Subsidiaries are also from time-to-time involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative 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. Our Insurance Subsidiaries also are involved from time-to-time 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. We believe that we have valid defenses to these cases. We 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 our 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, have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.
Note 14. Federal Income Taxes
A reconciliation of federal income tax on pre-tax earnings from continuing operations at the corporate rate to the effective tax rate is as follows:

|  | Unaudited, |  | Unaudited,
|  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Tax at statutory rate of 35% |  | $ | 7,110 |  |  | (13,119 | ) |  | 14,985 |  |  | (3,998 | )
Tax-advantaged interest |  | (3,311 | ) |  | (3,477 | ) |  | (9,970 | ) |  | (10,964 | )
Dividends received deduction |  | (313 | ) |  | (361 | ) |  | (826 | ) |  | (587 | )
Interim period tax rate adjustment 1 |  | (1,476 | ) |  | (3,250 | ) |  | 1,304 |  |  | — |
Other |  | 30 |  |  | 42 |  |  | 665 |  |  | (524 | )
Federal income tax expense (benefit) from continuing operations |  | $ | 2,040 |  |  | (20,165 | ) |  | 6,158 |  |  | (16,073 | )

1 During Third Quarter 2011, we recorded year-to-date taxes using the actual effective tax rate as opposed to the estimated full-year effective tax rate that was used in previous quarters.
As part of our acquisition of MUSIC in December 2011, we recorded a net operating loss deferred tax asset of $4.8 million, which was valued based on preliminary information that was available at the time of closing. In Third Quarter 2012, final information became available and this deferred tax asset was re-valued at $4.2 million, a decrease of $0.6 million. The Consolidated Balance Sheet as of December 31, 2011 has been restated to reflect this purchase price adjustment with a corresponding increase to the re-valued covenant not to compete.
Note 15. Statutory Financial Information and Restrictions on Dividends and Transfers of Funds
In Third Quarter 2012, we formed two new Insurance Subsidiaries, Selective Casualty Insurance Company (“SCIC”) and Selective Fire and Casualty Insurance Company (“SFCIC”). These New Jersey-domiciled subsidiaries are expected to begin writing premium in 2013 and have been included in our reinsurance pooling agreement as of July 1, 2012. See the “Reinsurance” section of Item 2. “Management's Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-Q for additional information regarding the change to our pooling agreement.
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In Third Quarter 2012, Selective Insurance Company of America ("SICA") received approval from the New Jersey Department of Banking and Insurance to pay an extraordinary dividend of $134.0 million to the Parent. This dividend, along with a portion of the ordinary dividends received, was used by the Parent as follows: (i) $74.4 million and $31.9 million respectively, to capitalize SCIC and SFCIC; (ii) $13.3 million to provide additional capitalization of our recently-acquired Insurance Subsidiary, MUSIC; and (iii) $19.5 million to further capitalize Selective Insurance Company of New England. In addition to the extraordinary dividend, the Insurance Subsidiaries provided $45.7 million in ordinary dividends to the Parent in Nine Months 2012. The following table provides data regarding all Insurance Subsidiary dividends paid in 2012:

Dividends |  |  |  |  |  |  |  |
|  | 2012 |  | Nine Months ended September 30, 2012
($ in millions) |  | Maximum Ordinary Dividend 1 |  | Ordinary Dividends Paid |  | Extraordinary Dividends Paid |  | Total Dividends Paid
SICA |  | $ | 50.7 |  |  | 28.7 |  | 2 | 134.0 |  |  | 162.7 |
Selective Way Insurance Company ("SWIC") |  | 22.2 |  |  | 12.5 |  |  | — |  |  | 12.5 |
Selective Insurance Company of South Carolina ("SICSC") |  | 9.1 |  |  | 0.8 |  |  | — |  |  | 0.8 |
Selective Insurance Company of the Southeast ("SICSE") |  | 6.9 |  |  | 0.5 |  |  | — |  |  | 0.5 |
Selective Insurance Company of New York ("SICNY") |  | 7.3 |  |  | 1.6 |  |  | — |  |  | 1.6 |
Selective Insurance Company of New England ("SICNE") |  | 1.4 |  |  | 1.0 |  |  | — |  |  | 1.0 |
Selective Auto Insurance Company of New Jersey ("SAICNJ") |  | 6.0 |  |  | 0.6 |  |  | — |  |  | 0.6 |
Total |  | $ | 103.6 |  |  | 45.7 |  |  | 134.0 |  |  | 179.7 |

1 Based on December 31, 2011 statutory data.
2 SICA's ordinary dividends paid in the 12-month period ended September 30, 2012 were $50.7 million.
As of September 30, 2012, the Parent has stand-alone retained earnings of $1.1 billion. Of this amount, $1.0 billion is related to investments in our Insurance Subsidiaries and Parent company issued debt. As referenced in the table above, the Insurance Subsidiaries have the ability to provide for approximately $104 million in annual ordinary dividends to the Parent; however, as regulated entities, these dividends are subject to certain restrictions as is further discussed below. In addition to the restrictions on the Insurance Subsidiaries, there are also restrictions on the Parent company's issued debt, which is further discussed in Note 10, “Indebtedness” in Item 8. "Financial Statements and Supplementary Data" of our 2011 Annual Report. The remaining $87 million of retained earnings is not restricted, and is primarily comprised of Parent company investments and cash that could be used to fund debt interest payments, of which approximately $7 million is due in the fourth quarter of 2012, with the remainder available to fund dividend payments to shareholders. If necessary, the Parent company also has other potential sources of liquidity that could provide for additional funding of its stockholder dividends, which include common stock and debt issuances.
As noted above, the restriction on our net assets and retained earnings is predominantly driven by our Insurance Subsidiaries' ability to pay dividends to the Parent under applicable law and regulations. Under the insurance laws of the domiciliary states of the Insurance Subsidiaries, New Jersey, Indiana, and New York, an insurer can potentially make an ordinary dividend payment if its statutory surplus following such dividend is reasonable in relation to its outstanding liabilities, is adequate to its financial needs, and the dividend does not exceed the insurer's unassigned surplus. In general, New Jersey defines an ordinary dividend as a dividend whose fair market value, together with other dividends made within the preceding 12 months, is less than the greater of 10% of the insurer's statutory surplus as of the preceding December 31, or the insurer's net income (excluding capital gains) for the 12-month period ending on the preceding December 31. Indiana's ordinary dividend calculation is consistent with New Jersey's, except that it does not exclude capital gains from net income. In general, New York defines an ordinary dividend as a dividend whose fair market value, together with other dividends made within the preceding 12 months, is less than the lesser of 10% of the insurer's statutory surplus, or 100% of adjusted net investment income. New Jersey and Indiana require notice of the declaration of any ordinary 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 dividend is not appropriate given the above considerations. New York does not require notice of ordinary dividends. Dividend payments exceeding ordinary dividends are referred to as extraordinary dividends and require review and approval by the applicable domiciliary insurance regulatory authority prior to payment.
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The following table provides statutory data for each of our Insurance Subsidiaries after consideration of the dividends paid in Nine Months 2012, along with other surplus activities in the normal course of business:

|  | Unassigned Surplus |  | Statutory Surplus |  | Statutory Net Income
($ in millions) |  | September 30, 2012 |  | December 31, 2011 |  | September 30, 2012 |  | December 31, 2011 |  | Nine Months ended September 30, 2012 |  | Nine Months ended September 30, 2011
SICA |  | $ | 261.9 |  |  | 360.7 |  |  | $ | 385.6 |  |  | 507.4 |  |  | 47.4 |  |  | 5.1 |
SWIC |  | 179.6 |  |  | 169.1 |  |  | 223.2 |  |  | 221.7 |  |  | 7.1 |  |  | 2.8 |
SICSC |  | 72.2 |  |  | 65.5 |  |  | 93.4 |  |  | 90.5 |  |  | 2.6 |  |  | (1.9 | )
SICSE |  | 51.6 |  |  | 46.8 |  |  | 71.2 |  |  | 69.3 |  |  | 1.6 |  |  | (1.5 | )
SICNY |  | 47.4 |  |  | 43.0 |  |  | 74.7 |  |  | 73.3 |  |  | 2.1 |  |  | (1.0 | )
SICNE |  | 2.9 |  |  | 3.8 |  |  | 32.7 |  |  | 14.3 |  |  | (3.6 | ) |  | 0.2 |
SAICNJ |  | 9.1 |  |  | 5.6 |  |  | 59.9 |  |  | 60.1 |  |  | 1.6 |  |  | (1.1 | )
MUSIC |  | (12.5 | ) |  | (15.4 | ) |  | 56.0 |  |  | 39.9 |  |  | (6.5 | ) |  | N/A |
SCIC |  | (1.6 | ) |  | N/A |  |  | 72.9 |  |  | N/A |  |  | (11.2 | ) |  | N/A |
SFCIC |  | (0.6 | ) |  | N/A |  |  | 31.3 |  |  | N/A |  |  | (4.8 | ) |  | N/A |
Total |  | $ | 610.0 |  |  | 679.1 |  |  | $ | 1,100.9 |  |  | 1,076.5 |  |  | 36.3 |  |  | 2.6 |

In addition to the Insurance Subsidiaries' ability to provide dividends to the Parent company, our two Indiana-domiciled Insurance Subsidiaries have approved intercompany lending agreements with the Parent that provide for additional lending capacity of $18.0 million after considering that borrowings under these lending agreements are restricted to 10% of the admitted assets of these respective subsidiaries.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 report our business in two operating segments:

• | Insurance Operations, which sells property and casualty insurance products and services; and

• | Investments, which invests the premiums collected by our insurance operations.

Our Insurance Operations offers Commercial Lines and Personal Lines market insurance products through our ten insurance subsidiaries, which include the following:

• | Nine subsidiaries that write standard Commercial Lines and Personal Lines business. Two of these subsidiaries, Selective Casualty Insurance Company and Selective Fire and Casualty Insurance Company, were created in the second quarter of 2012. These subsidiaries are expected to begin writing premium in 2013 and have been included in our reinsurance pooling agreement as of July 1, 2012. See the “Reinsurance” section below for details regarding the pooling change.

• | One subsidiary that writes excess and surplus lines ("E&S") business. We purchased this subsidiary, Mesa Underwriters Specialty Insurance Company ("MUSIC"), in December 2011. This acquisition complimented our August 2011 purchase of the renewal rights to an E&S book of business, as MUSIC is licensed to write E&S business in all 50 states and the District of Columbia.

Our ten insurance subsidiaries are collectively referred to as the “Insurance Subsidiaries”. For additional information regarding our acquisition of MUSIC, refer to Note 13. “Business Combinations” in Item 8. “Financial statements and Supplementary Data.” of our Annual Report on Form 10-K for the year ended December 31, 2011 (“2011 Annual Report”).
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. Consequently, investors should read the MD&A in conjunction with the consolidated financial statements in our 2011 Annual Report.
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In the MD&A, we will discuss and analyze the following:

• | Critical Accounting Policies and Estimates;

• | Financial Highlights of Results for the third quarter ended September 30, 2012 ("Third Quarter 2012") and the nine-month period ended September 30, 2012 ("Nine Months 2012");

• | 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.

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 losses and loss expenses; (ii) deferred policy acquisition costs; (iii) premium audit; (iv) pension and post-retirement benefit plan actuarial assumptions; (v) other-than-temporary investment impairments; and (vi) 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 2011 Annual Report, pages 47 through 56.
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Financial Highlights of Results for Third Quarter 2012 and Nine Months 2012 1

|  | Quarter ended September 30, |  |  |  |  |  | Nine Months ended September 30, |  |  |  |
(Shares and $ in thousands, except per share amounts) |  | 2012 |  | 2011 |  | Change % or Points |  |  |  | 2012 |  | 2011 |  | Change % or Points |  |
GAAP measures: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Revenues |  | $ | 436,872 |  |  | 394,069 |  |  | 11 |  |  | % |  | 1,285,127 |  |  | 1,197,095 |  |  | 7 |  |  | %
Pre-tax net investment income |  | 30,650 |  |  | 35,786 |  |  | (14 | ) |  |  |  | 97,284 |  |  | 118,604 |  |  | (18 | ) |  |
Pre-tax net income (loss) |  | 20,314 |  |  | (38,483 | ) |  | 153 |  |  |  |  | 42,813 |  |  | (12,424 | ) |  | 445 |  |  |
Net income (loss) |  | 18,274 |  |  | (17,968 | ) |  | 202 |  |  |  |  | 36,655 |  |  | 3,999 |  |  | 817 |  |  |
Diluted net income (loss) per share |  | 0.33 |  |  | (0.33 | ) |  | 200 |  |  |  |  | 0.66 |  |  | 0.07 |  |  | 843 |  |  |
Diluted weighted-average outstanding shares |  | 55,862 |  |  | 54,183 |  |  | 3 |  |  |  |  | 55,717 |  |  | 55,172 |  |  | 1 |  |  |
GAAP combined ratio |  | 99.8 | % |  | 118.0 | % |  | (18.2 | ) |  | pts |  | 102.3 | % |  | 110.5 |  |  | (8.2 | ) |  | pts
Statutory combined ratio |  | 98.4 | % |  | 116.4 | % |  | (18.0 | ) |  |  |  | 101.2 | % |  | 109.6 |  |  | (8.4 | ) |  |
Return on average equity |  | 6.6 | % |  | (6.9 | )% |  | 13.5 |  |  |  |  | 4.5 | % |  | 0.5 |  |  | 4.0 |  |  |
Non-GAAP measures: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Operating income (loss)2 |  | $ | 18,982 |  |  | (15,989 | ) |  | 219 |  |  | % |  | 34,414 |  |  | 839 |  |  | 4,002 |  |  | %
Diluted operating income (loss) per share 2 |  | 0.34 |  |  | (0.30 | ) |  | 213 |  |  |  |  | 0.62 |  |  | 0.01 |  |  | 6,100 |  |  |
Operating return on average equity 2 |  | 6.9 | % |  | (6.2 | )% |  | 13.1 |  |  | pts |  | 4.2 | % |  | 0.1 | % |  | 4.1 |  |  | pts

1 | Refer to the Glossary of Terms attached to our 2011 Annual Report as Exhibit 99.1 for definitions of terms used in this Form 10-Q.

2 | Operating income is used as an important financial measure by us, analysts, and investors, because the realization of investment gains and losses on sales in any given period is largely discretionary as to timing. In addition, these realized investment gains and losses, as well as other-than-temporary impairments (“OTTI”) that are charged to earnings and the results of discontinued operations could distort the analysis of trends. See below for a reconciliation of operating income to net income in accordance with U.S. generally accepted accounting principles (“GAAP”). Operating return on average equity is calculated by dividing annualized operating income by average stockholders’ equity.

Revenue increased in both the quarter and year-to-date periods, reflecting higher premium from our Insurance Operations, partially offset by reductions in net investment income. Premium increases were attributable to our newly-acquired E&S business, as well as standard Commercial Lines and Personal Lines renewal pure price increases and higher retention. See the Insurance Operations discussion below for additional information.
The improvement in pre-tax and after-tax net income in both Third Quarter and Nine Months 2012 compared to last year was driven primarily by an improvement in catastrophe losses. These pre-tax losses decreased by $57.9 million, to $9.6 million, in Third Quarter 2012 and by $65.7 million, to $46.7 million, in Nine Months 2012, compared to the prior year periods. Partially offsetting these underwriting improvements were lower returns on the alternative investment portion of our other investments portfolio.
The following table reconciles operating income and net income for the periods presented above:

|  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands, except per share amounts) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Operating income (loss) |  | $ | 18,982 |  |  | (15,989 | ) |  | $ | 34,414 |  |  | 839 |
Net realized (losses) gains, net of tax |  | (708 | ) |  | (1,329 | ) |  | 2,241 |  |  | 3,810 |
Loss on disposal of discontinued operations, net of tax |  | — |  |  | (650 | ) |  | — |  |  | (650 | )
Net income (loss) |  | $ | 18,274 |  |  | (17,968 | ) |  | $ | 36,655 |  |  | 3,999 |
Diluted operating income (loss) per share |  | $ | 0.34 |  |  | (0.30 | ) |  | $ | 0.62 |  |  | 0.01 |
Diluted net realized (losses) gains per share |  | (0.01 | ) |  | (0.02 | ) |  | 0.04 |  |  | 0.07 |
Diluted net loss from disposal of discontinued operations per share |  | — |  |  | (0.01 | ) |  | — |  |  | (0.01 | )
Diluted net income (loss) per share |  | $ | 0.33 |  |  | (0.33 | ) |  | $ | 0.66 |  |  | 0.07 |

The variances in operating income are reflective of the results discussed above.
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Results of Operations and Related Information by Segment
Insurance Operations
Our standard Commercial Lines and Personal Lines market insurance products and services are sold primarily in 22 states in the Eastern and Midwestern U.S. through approximately 1,100 independent insurance agencies. Our recent E&S business acquisitions provide us the opportunity to write contract binding authority E&S business in all 50 states and the District of Columbia through approximately 100 wholesale agents.
Our Insurance Operations segment consists of two components: (i) Commercial Lines, which markets primarily to businesses and represents approximately 82% of net premiums written (“NPW”); and (ii) Personal Lines, which markets primarily to individuals and represents approximately 18% of NPW. Our E&S operations write exclusively commercial lines of business, and for purposes of this MD&A, this business is included within Commercial Lines. The underwriting performance of these lines is generally measured by four different statutory ratios: (i) the loss and loss expense ratio; (ii) the underwriting expense ratio; (iii) the dividend ratio; and (iv) the combined ratio.

Summary of Insurance Operations |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
All Lines |  | Quarter ended September 30, |  |  |  |  |  | Nine months ended September 30, |  |  |  |
($ in thousands) |  | 2012 |  | 2011 |  | Change % or Points |  |  |  | 2012 |  | 2011 |  | Change % or Points |  |
GAAP Insurance Operations Results: |  |  |  |  |  |  |  |  |  |  |  |  |  |
NPW |  | $ | 450,518 |  |  | 396,832 |  |  | 14 |  |  | % |  | 1,296,253 |  |  | 1,133,170 |  |  | 14 |  |  | %
Net premiums earned (“NPE”) |  | 406,225 |  |  | 358,963 |  |  | 13 |  |  |  |  | 1,177,266 |  |  | 1,065,886 |  |  | 10 |  |  |
Less: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Losses and loss expenses incurred |  | 272,251 |  |  | 305,958 |  |  | (11 | ) |  |  |  | 813,060 |  |  | 829,719 |  |  | (2 | ) |  |
Net underwriting expenses incurred |  | 132,428 |  |  | 116,728 |  |  | 13 |  |  |  |  | 388,841 |  |  | 343,843 |  |  | 13 |  |  |
Dividends to policyholders |  | 685 |  |  | 1,056 |  |  | (35 | ) |  |  |  | 2,829 |  |  | 3,803 |  |  | (26 | ) |  |
Underwriting gain (loss) |  | $ | 861 |  |  | (64,779 | ) |  | 101 |  |  | % |  | (27,464 | ) |  | (111,479 | ) |  | 75 |  |  | %
GAAP Ratios: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loss and loss expense ratio |  | 67.0 | % |  | 85.2 |  |  | (18.2 | ) |  | pts |  | 69.1 |  |  | 77.8 |  |  | (8.7 | ) |  | pts
Underwriting expense ratio |  | 32.6 |  |  | 32.5 |  |  | 0.1 |  |  |  |  | 33.0 |  |  | 32.3 |  |  | 0.7 |  |  |
Dividends to policyholders ratio |  | 0.2 |  |  | 0.3 |  |  | (0.1 | ) |  |  |  | 0.2 |  |  | 0.4 |  |  | (0.2 | ) |  |
Combined ratio |  | 99.8 |  |  | 118.0 |  |  | (18.2 | ) |  |  |  | 102.3 |  |  | 110.5 |  |  | (8.2 | ) |  |
Statutory Ratios: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loss and loss expense ratio |  | 66.9 |  |  | 85.1 |  |  | (18.2 | ) |  |  |  | 69.0 |  |  | 77.8 |  |  | (8.8 | ) |  |
Underwriting expense ratio |  | 31.3 |  |  | 31.0 |  |  | 0.3 |  |  |  |  | 32.0 |  |  | 31.4 |  |  | 0.6 |  |  |
Dividends to policyholders ratio |  | 0.2 |  |  | 0.3 |  |  | (0.1 | ) |  |  |  | 0.2 |  |  | 0.4 |  |  | (0.2 | ) |  |
Combined ratio |  | 98.4 | % |  | 116.4 |  |  | (18.0 | ) |  | pts |  | 101.2 |  |  | 109.6 |  |  | (8.4 | ) |  | pts

NPW increases in both Third Quarter and Nine Months 2012 compared to the prior year periods were attributable to our newly acquired E&S business coupled with higher renewal premiums in our standard Insurance Operations, reflecting increases in renewal pure price and strong retention. In addition, new business contributed to the NPW increase in Nine Months 2012 compared to Nine Months 2011. The following provides quantitative information regarding these premium fluctuations:

|  | Quarter ended September 30, |  | Nine months ended September 30,
($ in millions) |  | 2012 |  | 2011 |  | 2012 |  | 2011
E&S premiums |  | $ | 29.8 |  |  | 8.4 |  |  | 83.9 |  |  | 8.4 |
Standard Insurance Operations new business |  | $ | 69.2 |  |  | 70.3 |  |  | 222.9 |  |  | 198.8 |
Standard Insurance Operations retention |  | 85 | % |  | 84 | % |  | 84 | % |  | 83 | %
Standard Commercial Lines renewal pure price increases |  | 6.6 | % |  | 2.7 | % |  | 6.0 | % |  | 2.7 | %
Standard Personal Lines renewal pure price increases |  | 6.9 | % |  | 5.9 | % |  | 6.1 | % |  | 6.3 | %

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NPE increases in Third Quarter and Nine Months 2012 were consistent with the fluctuation in NPW for the twelve-month period ended September 30, 2012 as compared to the twelve-month period ended September 30, 2011.
The GAAP loss and loss expense ratio improved in the quarter and year-to-date periods as catastrophe losses were lower than the historic level we experienced last year, which included significant storms, such as Hurricane Irene and Tropical Storm Lee. The following tables provide quantitative information regarding catastrophe losses:

|  | Quarter ended September 30, |  |  |  | Nine months ended September 30, |
|  | Catastrophe Losses |  | Impact to |  |  |  | Catastrophe Losses |  | Impact to |
($ in millions) |  | Incurred |  | Loss Ratio |  |  |  | Incurred |  | Loss Ratio |
2012 | $ | 9.6 |  | 2.4 |  | pts |  | $ | 46.7 |  | 4.0 | pts
2011 |  | 67.5 |  | 18.8 |  |  |  |  | 112.4 |  | 10.5 |

In addition, favorable prior year development on our casualty lines was $7 million, or 1.7 points, in Third Quarter 2012 compared to $10 million, or 2.7 points, in Third Quarter 2011. Favorable prior year casualty development was $16 million, or 1.3 points, in Nine Months 2012 compared to $19 million, or 1.8 points, in Nine Months 2011.
Insurance Operations Outlook
A.M. Best Company ("A.M. Best") noted in their October financial review that the industry's underwriting and operating performance improved substantially in the first half of 2012 as a result of lower catastrophe losses, which accounted for 6.0 pointsof the industry's combined ratio of 101.0%, compared to 12.7 points of catastrophe losses in the first half of 2011. In addition, rate increases and exposure growth drove increases in NPW and NPE. This improvement in the industry's results is expected to continue through 2012, particularly in light of the reduction in catastrophe-related losses through September. The industry still faces obstacles associated with prolonged challenging market conditions, the persistently slow economic recovery, expectations for sustained low investment yields, and investment market volatility. Our Insurance Operations segment reported statutory combined ratios of 98.4% and 101.2% for Third Quarter and Nine Months 2012, respectively, as compared to 116.4% and 109.6% in Third Quarter and Nine Months 2011, respectively. Similar to the industry, we experienced lower catastrophe losses this year compared to the historic level of catastrophe losses that we experienced last year.
A.M. Best continues to maintain its negative outlook on the commercial lines sector as widespread significant pricing improvements have not yet materialized. A recent report from the Commercial Lines Insurance Pricing Survey showed that industry pricing increased by 6.0% during the second quarter of 2012. While industry pricing continues to improve, we completed our 14 th consecutive quarter of Commercial Lines renewal pure price increases with 6.6% in Third Quarter 2012. Our Commercial Lines retention continues to be strong at 83%, which is a one-point increase compared to the prior year period. For Nine Months 2012, Commercial Lines renewal pure price increases were 6%, coupled with strong policy retention, demonstrating the overall strength of the relationships that we have with our independent agents in very competitive market conditions and slow economic times.
The personal lines market continues to provide more pricing power and A.M. Best has continued to maintain a stable outlook for the sector, citing that capitalization will continue to be strong and rating actions will generally be affirmations. Our Personal Lines operations continue to experience NPW growth driven by ongoing rate increases that went into effect over the past several years. Personal Lines renewal pure price increases for Third Quarter and Nine Months 2012 averaged 6.9% and 6.1%, respectively, while retention remained strong at 87% and 86%. Strong property results and favorable prior year development, as well as the ongoing pure price increases that we have achieved contributed to a Personal Lines statutory combined ratio of 88.8% in Third Quarter 2012 and 98.4% for Nine Months 2012.
Given our results through Nine Months 2012, we expect to generate a full-year statutory combined ratio of approximately 101.5% and a full-year combined ratio of approximately 102.5% under U.S. generally accepted accounting principles ("GAAP"), both of which include a full-year catastrophe loss assumption of approximately 3.5 points. These combined ratios do not include any assumptions for additional reserve development, favorable or unfavorable. Investment income is expected to be approximately $100 million, after tax, given the alternative investment portfolio performance and the low interest rate environment. Weighted average shares at year-end 2012 are expected to be approximately 55.6 million.
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Review of Underwriting Results by Line of Business
Commercial Lines

Commercial Lines |  | Quarter ended September 30, |  |  |  |  |  | Nine months ended September 30, |  |  |  |
($ in thousands) |  | 2012 |  | 2011 |  | Change % or Points |  |  |  | 2012 |  | 2011 |  | Change % or Points |  |
GAAP Insurance Operations Results: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
NPW |  | $ | 371,082 |  |  | 323,696 |  |  | 15 |  |  | % |  | 1,074,466 |  |  | 927,335 |  |  | 16 |  |  | %
NPE |  | 334,420 |  |  | 292,363 |  |  | 14 |  |  |  |  | 966,896 |  |  | 869,421 |  |  | 11 |  |  |
Less: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Losses and loss expenses incurred |  | 227,531 |  |  | 229,119 |  |  | (1 | ) |  |  |  | 662,732 |  |  | 641,504 |  |  | 3 |  |  |
Net underwriting expenses incurred |  | 112,563 |  |  | 98,700 |  |  | 14 |  |  |  |  | 331,702 |  |  | 290,264 |  |  | 14 |  |  |
Dividends to policyholders |  | 685 |  |  | 1,056 |  |  | (35 | ) |  |  |  | 2,829 |  |  | 3,803 |  |  | (26 | ) |  |
Underwriting loss |  | $ | (6,359 | ) |  | (36,512 | ) |  | 83 |  |  | % |  | (30,367 | ) |  | (66,150 | ) |  | 54 |  |  | %
GAAP Ratios: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loss and loss expense ratio |  | 68.0 | % |  | 78.4 |  |  | (10.4 | ) |  | pts |  | 68.5 | % |  | 73.8 |  |  | (5.3 | ) |  | pts
Underwriting expense ratio |  | 33.7 |  |  | 33.7 |  |  | — |  |  |  |  | 34.3 |  |  | 33.4 |  |  | 0.9 |  |  |
Dividends to policyholders ratio |  | 0.2 |  |  | 0.4 |  |  | (0.2 | ) |  |  |  | 0.3 |  |  | 0.4 |  |  | (0.1 | ) |  |
Combined ratio |  | 101.9 |  |  | 112.5 |  |  | (10.6 | ) |  |  |  | 103.1 |  |  | 107.6 |  |  | (4.5 | ) |  |
Statutory Ratios: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loss and loss expense ratio |  | 67.9 |  |  | 78.2 |  |  | (10.3 | ) |  |  |  | 68.5 |  |  | 73.8 |  |  | (5.3 | ) |  |
Underwriting expense ratio |  | 32.4 |  |  | 32.1 |  |  | 0.3 |  |  |  |  | 33.0 |  |  | 32.4 |  |  | 0.6 |  |  |
Dividends to policyholders ratio |  | 0.2 |  |  | 0.4 |  |  | (0.2 | ) |  |  |  | 0.3 |  |  | 0.4 |  |  | (0.1 | ) |  |
Combined ratio |  | 100.5 |  |  | 110.7 |  |  | (10.2 | ) |  | pts |  | 101.8 |  |  | 106.6 |  |  | (4.8 | ) |  | pts

Commercial Lines NPW increases in both Third Quarter and Nine Months 2012 were attributable to our newly acquired E&S business coupled with higher renewal premiums in our standard Insurance Operations. In addition, new business in our standard Commercial Lines increased by 15%, or $24.5 million, in Nine Months 2012 compared to Nine Months 2011. The following provides quantitative information regarding these premium fluctuations:

|  | Quarter ended September 30, |  | Nine months ended September 30,
($ in millions) |  | 2012 |  | 2011 |  | 2012 |  | 2011
E&S premiums |  | $ | 29.8 |  |  | 8.4 |  |  | 83.9 |  |  | 8.4 |
Standard Commercial Lines direct new business |  | 56.1 |  |  | 57.5 |  |  | 184.6 |  |  | 160.1 |
Standard Commercial Lines retention |  | 83 | % |  | 82 | % |  | 82 | % |  | 80 | %
Standard Commercial Lines renewal pure price increases |  | 6.6 | % |  | 2.7 | % |  | 6.0 | % |  | 2.7 | %

NPE increases in Third Quarter and Nine Months 2012 compared to Third Quarter and Nine Months 2011 are consistent with the fluctuation in NPW for the twelve-month period ended September 30, 2012 as compared to the twelve-month period ended September 30, 2011.
The GAAP loss and loss expense ratio improved in the quarter and year-to-date periods, as catastrophe losses were lower than the historic level we experienced last year, which included significant storms such as Hurricane Irene and Tropical Storm Lee. The following table provides quantitative information regarding catastrophe losses:

|  | Third Quarter |  |  |  | Nine Months Ended
($ in millions) |  | Catastrophe Losses Incurred |  | Impact to Loss and Loss Expense Ratio |  |  |  | Catastrophe Losses Incurred |  | Impact to Loss and Loss Expense Ratio |
2012 | $ | 7.7 |  |  | 2.3 | pts |  | $ | 30.3 |  |  | 3.1 | pts
2011 |  | 39.6 |  |  | 13.5 |  |  |  | 70.4 |  |  | 8.1 |

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The following is a discussion of our most significant standard market commercial lines of business:
General Liability

|  | Quarter ended September 30, |  |  |  |  |  | Nine months ended September 30, |  |  |  |
($ in thousands) |  | 2012 |  | 2011 |  | Change % or Points |  |  |  | 2012 |  | 2011 |  | Change % or Points |  |
Statutory NPW |  | 106,020 |  |  | 95,187 |  |  | 11 |  |  | % |  | 305,870 |  |  | 274,422 |  |  | 11 |  | %
Direct new business |  | 16,737 |  |  | 16,907 |  |  | (1 | ) |  |  |  | 53,050 |  |  | 45,036 |  |  | 18 |  |
Retention |  | 83 | % |  | 81 | % |  | 2 |  |  | pts |  | 81 | % |  | 79 | % |  | 2 |  | pts
Renewal pure price increases |  | 7.2 | % |  | 3.3 | % |  | 3.9 |  |  |  |  | 6.8 | % |  | 3.7 | % |  | 3.1 |  |
Statutory NPE |  | 93,763 |  |  | 87,478 |  |  | 7 |  |  | % |  | 276,538 |  |  | 255,717 |  |  | 8 |  | %
Statutory combined ratio |  | 100.4 | % |  | 95.9 |  |  | 4.5 |  |  | pts |  | 101.0 | % |  | 99.7 |  |  | 1.3 |  | pts
% of total statutory commercial NPW |  | 29 | % |  | 29 |  |  |  |  |  |  | 28 | % |  | 30 |  |  |  |  |

NPW increased in the quarter and year-to-date periods this year compared to the prior year periods, which is evidenced by continued improvements in pricing in the general liability line, coupled with increased retention. Nine Months 2012 NPW was favorably impacted by higher new business, as well as audit and endorsement premium of $6.0 million compared to $0.6 million in Nine Months 2011.
The statutory combined ratio for the general liability line was positively impacted by renewal pure price increases that have outpaced loss trends in both Third Quarter and Nine Months 2012. The 2011 combined ratios also reflect favorable prior year development of $6 million, or 6.9 points, in Third Quarter 2011 and $9 million, or 3.7 points, in Nine Months 2011. This 2011 favorable prior year development was driven by the 2005 through 2009 accident years, partially offset by adverse development in the 2010 accident year.
Workers Compensation

|  | Quarter ended September 30, |  |  |  |  |  | Nine months ended September 30, |  |  |  |
($ in thousands) |  | 2012 |  | 2011 |  | Change % or Points |  |  |  | 2012 |  | 2011 |  | Change % or Points |  |
Statutory NPW |  | 66,320 |  |  | 64,269 |  |  | 3 |  |  | % |  | 206,272 |  |  | 198,742 |  |  | 4 |  |  | %
Direct new business |  | 8,535 |  |  | 11,330 |  |  | (25 | ) |  |  |  | 33,905 |  |  | 34,495 |  |  | (2 | ) |  |
Retention |  | 83 | % |  | 80 | % |  | 3 |  |  | pts |  | 81 | % |  | 79 | % |  | 2 |  |  | pts
Renewal pure price increases |  | 8.5 | % |  | 3.6 | % |  | 4.9 |  |  |  |  | 8.0 | % |  | 3.4 | % |  | 4.6 |  |  |
Statutory NPE |  | 65,592 |  |  | 63,497 |  |  | 3 |  |  | % |  | 198,064 |  |  | 189,878 |  |  | 4 |  |  | %
Statutory combined ratio |  | 115.9 | % |  | 114.2 |  |  | 1.7 |  |  | pts |  | 113.1 | % |  | 117.7 |  |  | (4.6 | ) |  | pts
% of total statutory commercial NPW |  | 18 | % |  | 20 |  |  |  |  |  |  | 19 | % |  | 21 |  |  |  |  |

Growth in NPW in the workers compensation line in Third Quarter and Nine Months 2012 compared to last year was primarily attributable to renewal pure price increases and retention improvements, partially offset by lower new business. NPW also benefited by audit and endorsement premium of $4.1 million and $12.5 million in Third Quarter and Nine Months 2012, compared to $1.6 million and $3.5 million in Third Quarter and Nine Months 2011, respectively.
On a year-to-date basis, the improvement in the statutory combined ratio is due to adverse prior year development in 2011 of $7 million, or 3.7 points as compared to 2012, which had no development. This development was driven by the 2010 accident year. In addition, in Nine Months 2012, renewal pure price increases have outpaced loss trends.
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Commercial Automobile

|  | Quarter ended September 30, |  |  |  |  |  | Nine months ended September 30, |  |  |  |
($ in thousands) |  | 2012 |  | 2011 |  | Change % or Points |  |  |  | 2012 |  | 2011 |  | Change % or Points |  |
Statutory NPW |  | 80,725 |  |  | 76,031 |  |  | 6 |  |  | % |  | 231,475 |  |  | 220,500 |  |  | 5 |  |  | %
Direct new business |  | 12,040 |  |  | 12,527 |  |  | (4 | ) |  |  |  | 39,466 |  |  | 34,687 |  |  | 14 |  |  |
Retention |  | 84 | % |  | 82 | % |  | 2 |  |  | pts |  | 82 | % |  | 81 | % |  | 1 |  |  | pts
Renewal pure price increases |  | 5.6 | % |  | 1.7 | % |  | 3.9 |  |  |  |  | 4.9 | % |  | 1.4 | % |  | 3.5 |  |  |
Statutory NPE |  | 72,758 |  |  | 70,173 |  |  | 4 |  |  | % |  | 214,782 |  |  | 209,042 |  |  | 3 |  |  | %
Statutory combined ratio |  | 95.7 | % |  | 95.9 |  |  | (0.2 | ) |  | pts |  | 96.1 | % |  | 93.5 |  |  | 2.6 |  |  | pts
% of total statutory commercial NPW |  | 22 | % |  | 23 |  |  |  |  |  |  | 22 |  |  | 24 |  |  |  |  |

NPW increased on the commercial automobile line of business in both Third Quarter and Nine Months 2012 compared to the same periods last year driven by increases in renewal pure price and improved retention. In addition, on a year-to-date basis, new business contributed to the premium increase.
The statutory combined ratio for the commercial automobile line for Nine Months 2012 was impacted by lower favorable casualty prior year development compared to the same period last year. Prior year favorable casualty development was as follows:

• | 2012: $2.0 million, or 2.7 points, in Third Quarter 2012 and $5 million, or 2.1 points, in Nine Months 2012 driven by the 2006 and 2007 accident years; and

• | 2011: $2.0 million, or 2.9 points, in Third Quarter 2011 and $10 million, or 4.8 points, in Nine Months 2011 driven by accident years 2006 through 2010.

In Nine Months 2012, the impact of lower prior year favorable development was partially offset by renewal pure price increases that have outpaced loss trends.
Commercial Property

|  | Quarter ended September 30, |  |  |  |  |  | Nine months ended September 30, |  |  |  |
($ in thousands) |  | 2012 |  | 2011 |  | Change % or Points |  |  |  | 2012 |  | 2011 |  | Change % or Points |  |
Statutory NPW |  | 62,259 |  |  | 55,725 |  |  | 12 |  |  | % |  | 168,481 |  |  | 153,105 |  |  | 10 |  |  | %
Direct new business |  | 12,577 |  |  | 11,032 |  |  | 14 |  |  |  |  | 38,624 |  |  | 29,320 |  |  | 32 |  |  |
Retention |  | 83 | % |  | 80 | % |  | 3 |  |  | pts |  | 81 | % |  | 79 | % |  | 2 |  |  | pts
Renewal pure price increases |  | 4.9 | % |  | 1.8 | % |  | 3.1 |  |  |  |  | 4.2 | % |  | 1.5 | % |  | 2.7 |  |  |
Statutory NPE |  | 52,197 |  |  | 48,051 |  |  | 9 |  |  |  |  | 151,945 |  |  | 144,121 |  |  | 5 |  |  |
Statutory combined ratio |  | 81.3 | % |  | 148.1 |  |  | (66.8 | ) |  | pts |  | 93.7 | % |  | 121.8 |  |  | (28.1 | ) |  | pts
% of total statutory commercial NPW |  | 17 | % |  | 17 |  |  |  |  |  |  | 16 | % |  | 17 |  |  |  |  |

NPW increased in both Third Quarter and Nine Months 2012 compared to the same periods in 2011 primarily due to: (i) growth in new business; (ii) increases in retention; and (iii) renewal pure price increases.
The statutory combined ratio for the commercial property line improved in both the quarter and year-to-date periods this year as a result of lower catastrophe losses than in 2011. Catastrophe losses were $2.2 million, or 4.2 points, in Third Quarter 2012 compared to $32.1 million, or 66.9 points, in Third Quarter 2011. Catastrophe losses were $18.0 million, or 11.8 points, in Nine Months 2012 compared to $57.0 million, or 39.6 points, in Nine Months 2011.
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Personal Lines

Personal Lines |  | Quarter ended September 30, |  |  |  |  |  | Nine months ended September 30, |  |  |  |
($ in thousands) |  | 2012 |  | 2011 |  | Change % or Points |  |  |  | 2012 |  | 2011 |  | Change % or Points |  |
GAAP Insurance Operations Results: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
NPW |  | $ | 79,436 |  |  | 73,136 |  |  | 9 |  |  | % |  | 221,787 |  |  | 205,835 |  |  | 8 |  |  | %
NPE |  | 71,805 |  |  | 66,600 |  |  | 8 |  |  |  |  | 210,370 |  |  | 196,465 |  |  | 7 |  |  |
Less: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Losses and loss expenses incurred |  | 44,720 |  |  | 76,839 |  |  | (42 | ) |  |  |  | 150,328 |  |  | 188,215 |  |  | (20 | ) |  |
Net underwriting expenses incurred |  | 19,865 |  |  | 18,028 |  |  | 10 |  |  |  |  | 57,139 |  |  | 53,579 |  |  | 7 |  |  |
Underwriting gain (loss) |  | $ | 7,220 |  |  | (28,267 | ) |  | 126 |  |  | % |  | 2,903 |  |  | (45,329 | ) |  | 106 |  |  | %
GAAP Ratios: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loss and loss expense ratio |  | 62.3 | % |  | 115.4 |  |  | (53.1 | ) |  | pts |  | 71.5 | % |  | 95.8 |  |  | (24.3 | ) |  | pts
Underwriting expense ratio |  | 27.6 |  |  | 27.0 |  |  | 0.6 |  |  |  |  | 27.1 |  |  | 27.3 |  |  | (0.2 | ) |  |
Combined ratio |  | 89.9 |  |  | 142.4 |  |  | (52.5 | ) |  |  |  | 98.6 |  |  | 123.1 |  |  | (24.5 | ) |  |
Statutory Ratios: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loss and loss expense ratio |  | 62.3 |  |  | 115.2 |  |  | (52.9 | ) |  |  |  | 71.5 |  |  | 95.7 |  |  | (24.2 | ) |  |
Underwriting expense ratio |  | 26.5 |  |  | 26.2 |  |  | 0.3 |  |  |  |  | 26.9 |  |  | 27.1 |  |  | (0.2 | ) |  |
Combined ratio |  | 88.8 | % |  | 141.4 |  |  | (52.6 | ) |  | pts |  | 98.4 | % |  | 122.8 |  |  | (24.4 | ) |  | pts

Personal Lines NPW increased in Third Quarter and Nine Months 2012 compared to Third Quarter and Nine Months 2011 primarily due to:

• | Renewal pure price increases were 6.9% and 6.1% in Third Quarter and Nine Months 2012, respectively; and

• | Retention of 87% in Third Quarter 2012 and 86% in Nine Months 2012, which was relatively flat from the same periods last year.

NPE increases in Third Quarter and Nine Months 2012, compared to the same periods last year, are consistent with the fluctuation in NPW for the 12-month period ended September 30, 2012 as compared to the 12-month period ended September 30, 2011.
The Personal Lines GAAP loss and loss expense ratio improved in the quarter and year-to-date periods as catastrophe losses were lower than the historic level we experienced last year. The following tables provide quantitative information regarding catastrophe losses:

Personal Lines |  | Quarter ended September 30, |  |  |  | Nine months ended September 30, |
($ in millions) |  | Catastrophe Losses Incurred |  | Impact to Loss and Loss Expense Ratio |  |  |  | Catastrophe Losses Incurred |  | Impact to Loss and Loss Expense Ratio |
2012 | $ | 1.8 |  |  | 2.6 |  | pts |  | $ | 16.4 |  |  | 7.8 |  | pts
2011 |  | 27.9 |  |  | 41.9 |  |  |  |  | 42.0 |  |  | 21.4 |  |

The reduction in the Personal Lines loss and loss expense ratio was also reflective of a decrease in non-catastrophe property losses of $7.7 million, or 13.6 points, and $12.1 million, or 8.1 points, in Third Quarter and Nine Months 2012, respectively, compared to the prior year periods.
In addition, we have taken steps to address the overall profitability of our Personal Lines business by implementing age of roof restrictions and certain deductible changes, particularly in the homeowners line. We have also achieved renewal pure price increases of 7.9% and 6.9% in Third Quarter 2012 and Nine Months 2012, respectively, on the homeowners line. On the personal automobile line, we have achieved renewal pure price increases of 5.9% and 5.5% in Third Quarter 2012 and Nine Months 2012, respectively.
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Reinsurance
We use reinsurance to protect our capital resources and insure us against losses on property and casualty risks that we underwrite. We use two main reinsurance vehicles: (i) a reinsurance pooling agreement among our Insurance Subsidiaries ("Pooling Agreement") in which each company agrees to share in premiums and losses based on certain specified percentages; and (ii) reinsurance contracts and arrangements with third parties that cover various policies that our Insurance Operations issue to insureds.
Pooling Agreement
The primary purposes of the Pooling Agreement are the following:

• | Pool or share proportionately the underwriting profit and loss results of property and casualty insurance underwriting operations through reinsurance;

• | Prevent any of our Insurance Subsidiaries from suffering undue loss;

• | Reduce administration expenses; and

• | Permit all of the Insurance Subsidiaries to obtain a uniform rating from A.M. Best.

Effective July 1, 2012, the Pooling Agreement was amended to add two newly-formed insurance companies, Selective Casualty Insurance Company and Selective Fire and Casualty Insurance Company. Under the Pooling Agreement, as of September 30, 2012, the following Insurance Subsidiaries mutually reinsured 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
Selective Insurance Company of America ("SICA") | 32.0%
Selective Way Insurance Company ("SWIC") | 21.0%
Selective Insurance Company of South Carolina ("SICSC") | 9.0%
Selective Insurance Company of the Southeast ("SICSE") | 7.0%
Selective Insurance Company of New York ("SICNY") | 7.0%
Selective Casualty Insurance Company ("SCIC")(1) | 7.0%
Selective Auto Insurance Company of New Jersey ("SAICNJ") | 6.0%
Mesa Underwriters Specialty Insurance Company ("MUSIC") | 5.0%
Selective Insurance Company of New England ("SICNE") | 3.0%
Selective Fire and Casualty Insurance Company ("SFCIC")(1) | 3.0%

(1) Anticipated to begin writing business on January 1, 2013.
Reinsurance Treaties and Arrangement
We successfully completed negotiations of our July 1, 2012 excess of loss treaties with highlights as follows:
Property Excess of Loss
The property excess of loss treaty (“Property Treaty”) was renewed with the following terms:

• | Per risk coverage of $38.0 million in excess of a $2.0 million retention; an increase of $10.0 million from the prior treaty term of $28.0 in excess of $2.0 million.

• | Per occurrence cap on the total program of $84.0 million, an increase of $20.0 million from the prior treaty term of $64.0 million;

• | The first layer continues to have unlimited reinstatements. The annual aggregate limit for the second $30.0 million in excess of $10.0 million layer, increased to $120.0 million from $80.0 million; and

• | Consistent with the prior year treaty, the Property Treaty excludes nuclear, biological, chemical, and radiological terrorism losses.

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Casualty Excess of Loss
The casualty excess of loss treaty (“Casualty Treaty”) was renewed with substantially the same terms as the expiring treaty providing the following per occurrence coverage:

• | The first through the sixth layers provide coverage for 100% of up to $88.0 million in excess of a $2.0 million retention, consistent with the prior year treaty;

• | Consistent with the prior year, the Casualty Treaty excludes nuclear, biological, chemical, and radiological terrorism losses; and

• | Annual aggregate terrorism limits remain the same as the prior year treaty at $201.0 million.

Investments
Our investment philosophy includes certain return and risk objectives for the fixed maturity, equity, and other investment portfolios. The primary fixed maturity securities 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 maturity securities indices. Within the equity portfolio, the high dividend yield equities strategy is designed to generate consistent dividend income while maintaining a minimal tracking error to the Standard & Poor’s (“S&P”) 500 Index. Additional equity security strategies are focused on meeting or exceeding strategy specific benchmarks of public equity indices. 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 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) |  | September 30, 2012 |  | December 31, 2011 |  | Change %
Total invested assets |  | $ | 4,333,212 |  |  | 4,112,421 |  |  | 5 | %
Unrealized gain – before tax |  | 211,047 |  |  | 149,612 |  |  | 41 |
Unrealized gain – after tax |  | 137,181 |  |  | 97,248 |  |  | 41 |

The increase in our investment portfolio compared to year-end 2011 was driven primarily by: (i) operating cash flows generated from Insurance Operations; and (ii) valuation improvements on securities in our available-for-sale (“AFS”) portfolio. The cash generated from our Insurance Operations in Nine Months 2012 was used to invest primarily in corporate securities within our fixed maturity securities 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 segment; (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:

|  | September 30, 2012 |  | December 31, 2011
U.S. government obligations |  | 7 | % |  | 9 | %
Foreign government obligations |  | 1 |  |  | 1 |
State and municipal obligations |  | 30 |  |  | 30 |
Corporate securities |  | 34 |  |  | 31 |
Mortgage-backed securities (“MBS”) |  | 14 |  |  | 15 |
Asset-backed securities (“ABS”) |  | 3 |  |  | 2 |
Total fixed maturity securities |  | 89 |  |  | 88 |
Equity securities |  | 4 |  |  | 4 |
Short-term investments |  | 4 |  |  | 5 |
Other investments |  | 3 |  |  | 3 |
Total |  | 100 | % |  | 100 | %

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Fixed Maturity Securities
The average duration of the fixed maturity securities portfolio as of September 30, 2012 was 3.5 years compared to the Insurance Subsidiaries’ liability duration of approximately 3.8 years. The current duration of the fixed maturity 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 our yields within our fixed maturity securities portfolio, as higher yielding bonds that are either maturing or have been sold are being replaced with the 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 AFS fixed maturity 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. In Third Quarter 2012, we increased purchases of highly-rated municipal bonds, structured securities, and investment-grade corporate bonds due to attractive risk adjusted return opportunities in those sectors.
Our fixed maturity securities portfolio had a weighted average credit rating of “AA-” as of September 30, 2012. The following table presents the credit ratings of our fixed maturity securities portfolio:

Fixed Maturity Security Rating |  | September 30, 2012 |  | December 31, 2011
Aaa/AAA |  | 15 | % |  | 14 | %
Aa/AA |  | 49 |  |  | 52 |
A/A |  | 24 |  |  | 24 |
Baa/BBB |  | 10 |  |  | 9 |
Ba/BB or below |  | 2 |  |  | 1 |
Total |  | 100 | % |  | 100 | %

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The following table summarizes the fair value, unrealized gain (loss) balances, and the weighted average credit qualities of our AFS fixed maturity securities at September 30, 2012 and December 31, 2011

|  | September 30, 2012 |  | December 31, 2011
($ in millions) |  | Fair Value |  | Unrealized Gain (Loss) |  | Weighted Average Credit Quality |  | Fair Value |  | Unrealized Gain (Loss) |  | Weighted Average Credit Quality
AFS Fixed Maturity Portfolio: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. government obligations 1 |  | $ | 294.2 |  |  | 18.8 |  |  | AA+ |  | 353.8 |  |  | 20.3 |  |  | AA+
Foreign government obligations |  | 30.3 |  |  | 1.5 |  |  | AA- |  | 34.2 |  |  | 0.5 |  |  | AA
State and municipal obligations |  | 784.5 |  |  | 46.5 |  |  | AA |  | 622.7 |  |  | 44.4 |  |  | AA
Corporate securities |  | 1,425.9 |  |  | 85.5 |  |  | A |  | 1,213.3 |  |  | 44.9 |  |  | A
Mortgage-Backed Securities ("MBS") |  | 613.9 |  |  | 23.7 |  |  | AA |  | 594.5 |  |  | 19.2 |  |  | AA
ABS |  | 121.2 |  |  | 2.2 |  |  | AAA |  | 78.9 |  |  | 1.2 |  |  | AAA
Total AFS fixed maturity portfolio |  | $ | 3,270.0 |  |  | 178.2 |  |  | AA- |  | 2,897.4 |  |  | 130.5 |  |  | AA-
State and Municipal Obligations: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
General obligations |  | $ | 344.7 |  |  | 22.4 |  |  | AA+ |  | 282.6 |  |  | 22.1 |  |  | AA+
Special revenue obligations |  | 439.8 |  |  | 24.1 |  |  | AA |  | 340.1 |  |  | 22.3 |  |  | AA
Total state and municipal obligations |  | $ | 784.5 |  |  | 46.5 |  |  | AA |  | 622.7 |  |  | 44.4 |  |  | AA
Corporate Securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial |  | $ | 433.4 |  |  | 22.7 |  |  | A |  | 379.0 |  |  | 3.7 |  |  | A
Industrials |  | 97.1 |  |  | 8.3 |  |  | A |  | 86.9 |  |  | 6.1 |  |  | A-
Utilities |  | 111.7 |  |  | 6.5 |  |  | BBB+ |  | 75.6 |  |  | 3.5 |  |  | BBB+
Consumer discretionary |  | 130.5 |  |  | 9.1 |  |  | BBB+ |  | 104.3 |  |  | 4.9 |  |  | BBB+
Consumer staples |  | 160.6 |  |  | 9.4 |  |  | A |  | 137.3 |  |  | 6.9 |  |  | A
Healthcare |  | 179.2 |  |  | 11.4 |  |  | A+ |  | 145.0 |  |  | 8.3 |  |  | AA-
Materials |  | 72.1 |  |  | 4.8 |  |  | A- |  | 66.5 |  |  | 2.5 |  |  | A-
Energy |  | 90.6 |  |  | 5.0 |  |  | A- |  | 77.9 |  |  | 3.3 |  |  | A-
Information technology |  | 93.4 |  |  | 3.9 |  |  | A |  | 74.3 |  |  | 2.6 |  |  | A
Telecommunications services |  | 45.9 |  |  | 3.0 |  |  | BBB+ |  | 50.9 |  |  | 1.5 |  |  | BBB+
Other |  | 11.4 |  |  | 1.4 |  |  | AA+ |  | 15.6 |  |  | 1.6 |  |  | AA+
Total corporate securities |  | $ | 1,425.9 |  |  | 85.5 |  |  | A |  | 1,213.3 |  |  | 44.9 |  |  | A
MBS: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Government guaranteed agency Commercial Mortgage-Backed Securities ("CMBS") |  | $ | 59.9 |  |  | 2.9 |  |  | AA+ |  | 72.9 |  |  | 5.0 |  |  | AA+
Non-agency CMBS |  | 68.5 |  |  | 0.7 |  |  | AA- |  | 39.7 |  |  | (0.3 | ) |  | A-
Other agency CMBS |  | 1.2 |  |  | — |  |  | AA+ |  | — |  |  | — |  |  | N/A
Government guaranteed agency residential MBS ("RMBS") |  | 98.1 |  |  | 5.0 |  |  | AA+ |  | 98.2 |  |  | 4.7 |  |  | AA+
Other agency RMBS |  | 334.2 |  |  | 13.9 |  |  | AA+ |  | 339.1 |  |  | 10.8 |  |  | AA+
Non-agency RMBS |  | 45.5 |  |  | 1.1 |  |  | A- |  | 37.1 |  |  | (1.0 | ) |  | BBB
Alternative-A (“Alt-A”) RMBS |  | 6.5 |  |  | 0.1 |  |  | AA+ |  | 7.5 |  |  | — |  |  | AA+
Total MBS |  | $ | 613.9 |  |  | 23.7 |  |  | AA |  | 594.5 |  |  | 19.2 |  |  | AA
ABS: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
ABS |  | $ | 119.9 |  |  | 2.2 |  |  | AAA |  | 77.5 |  |  | 1.3 |  |  | AAA
Alt-A ABS 3 |  | 0.7 |  |  | — |  |  | D |  | 0.7 |  |  | — |  |  | D
Sub-prime ABS 2, 3 |  | 0.6 |  |  | — |  |  | D |  | 0.7 |  |  | (0.1 | ) |  | D
Total ABS |  | $ | 121.2 |  |  | 2.2 |  |  | AAA |  | 78.9 |  |  | 1.2 |  |  | AAA

1 | U.S. government obligations include corporate securities fully guaranteed by the Federal Deposit Insurance Corporation (“FDIC”).

2 | We define sub-prime exposure as exposure to direct and indirect investments in non-agency residential mortgages with average FICO® scores below 650.

3 | Alt-A ABS and subprime ABS each consist of one security whose issuer is currently expected by rating agencies to default on its obligations.

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The following tables provide information regarding our held-to-maturity (“HTM”) fixed maturity securities and their credit qualities at September 30, 2012 and December 31, 2011:

September 30, 2012 |  |  |  |  |  |  |  |  |  |  |  |
($ in millions) |  | Fair Value |  | Carry Value |  | Unrecognized Holding Gain (Loss) |  | Unrealized Gain (Loss) in Accumulated Other Comprehensive Income |  | Total Unrealized/ Unrecognized Gain (Loss) |  | Weighted Average Credit Quality
HTM Portfolio: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Foreign government obligations |  | $ | 5.6 |  |  | 5.5 |  |  | 0.1 |  |  | 0.2 |  |  | 0.3 |  |  | AA+
State and municipal obligations |  | 566.5 |  |  | 533.1 |  |  | 33.4 |  |  | 8.3 |  |  | 41.7 |  |  | AA
Corporate securities |  | 53.6 |  |  | 48.5 |  |  | 5.1 |  |  | (1.0 | ) |  | 4.1 |  |  | A
MBS |  | 13.0 |  |  | 7.5 |  |  | 5.5 |  |  | (1.3 | ) |  | 4.2 |  |  | AA-
ABS |  | 7.3 |  |  | 6.1 |  |  | 1.2 |  |  | (1.1 | ) |  | 0.1 |  |  | A
Total HTM portfolio |  | $ | 646.0 |  |  | 600.7 |  |  | 45.3 |  |  | 5.1 |  |  | 50.4 |  |  | AA
State and Municipal Obligations: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
General obligations |  | $ | 184.4 |  |  | 174.9 |  |  | 9.5 |  |  | 4.3 |  |  | 13.8 |  |  | AA
Special revenue obligations |  | 382.1 |  |  | 358.2 |  |  | 23.9 |  |  | 4.0 |  |  | 27.9 |  |  | AA
Total state and municipal obligations |  | $ | 566.5 |  |  | 533.1 |  |  | 33.4 |  |  | 8.3 |  |  | 41.7 |  |  | AA
Corporate Securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial |  | $ | 15.7 |  |  | 14.2 |  |  | 1.5 |  |  | (0.8 | ) |  | 0.7 |  |  | BBB+
Industrials |  | 17.0 |  |  | 15.4 |  |  | 1.6 |  |  | (0.2 | ) |  | 1.4 |  |  | A
Utilities |  | 15.4 |  |  | 13.6 |  |  | 1.8 |  |  | (0.1 | ) |  | 1.7 |  |  | A+
Consumer discretionary |  | 3.5 |  |  | 3.3 |  |  | 0.2 |  |  | 0.1 |  |  | 0.3 |  |  | AA
Materials |  | 2.0 |  |  | 2.0 |  |  | — |  |  | — |  |  | — |  |  | BBB
Total corporate securities |  | $ | 53.6 |  |  | 48.5 |  |  | 5.1 |  |  | (1.0 | ) |  | 4.1 |  |  | A
MBS: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Non-agency CMBS |  | $ | 13.0 |  |  | 7.5 |  |  | 5.5 |  |  | (1.3 | ) |  | 4.2 |  |  | AA-
Total MBS |  | $ | 13.0 |  |  | 7.5 |  |  | 5.5 |  |  | (1.3 | ) |  | 4.2 |  |  | AA-
ABS: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
ABS |  | $ | 4.9 |  |  | 4.4 |  |  | 0.5 |  |  | (0.3 | ) |  | 0.2 |  |  | BBB+
Alt-A ABS |  | 2.4 |  |  | 1.7 |  |  | 0.7 |  |  | (0.8 | ) |  | (0.1 | ) |  | AAA
Total ABS |  | $ | 7.3 |  |  | 6.1 |  |  | 1.2 |  |  | (1.1 | ) |  | 0.1 |  |  | A

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December 31, 2011 |  |  |  |  |  |  |  |  |  |  |  |
($ in millions) |  | Fair Value |  | Carry Value |  | Unrecognized Holding Gain (Loss) |  | Unrealized Gain (Loss) in AOCI |  | Total Unrealized/ Unrecognized Gain (Loss) |  | Weighted Average Credit Quality
HTM Portfolio: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Foreign government obligations |  | $ | 5.5 |  |  | 5.6 |  |  | (0.1 | ) |  | 0.3 |  |  | 0.2 |  |  | AA+
State and municipal obligations |  | 657.4 |  |  | 626.0 |  |  | 31.4 |  |  | 11.9 |  |  | 43.3 |  |  | AA
Corporate securities |  | 69.5 |  |  | 62.6 |  |  | 6.9 |  |  | (2.2 | ) |  | 4.7 |  |  | A
MBS |  | 17.7 |  |  | 11.5 |  |  | 6.2 |  |  | (3.0 | ) |  | 3.2 |  |  | AA-
ABS |  | 7.9 |  |  | 6.6 |  |  | 1.3 |  |  | (1.4 | ) |  | (0.1 | ) |  | A
Total HTM portfolio |  | $ | 758.0 |  |  | 712.3 |  |  | 45.7 |  |  | 5.6 |  |  | 51.3 |  |  | AA
State and Municipal Obligations: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
General obligations |  | $ | 214.8 |  |  | 205.3 |  |  | 9.5 |  |  | 6.3 |  |  | 15.8 |  |  | AA
Special revenue obligations |  | 442.6 |  |  | 420.7 |  |  | 21.9 |  |  | 5.6 |  |  | 27.5 |  |  | AA
Total state and municipal obligations |  | $ | 657.4 |  |  | 626.0 |  |  | 31.4 |  |  | 11.9 |  |  | 43.3 |  |  | AA
Corporate Securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial |  | $ | 20.7 |  |  | 18.5 |  |  | 2.2 |  |  | (1.5 | ) |  | 0.7 |  |  | A-
Industrials |  | 20.3 |  |  | 17.8 |  |  | 2.5 |  |  | (0.7 | ) |  | 1.8 |  |  | A
Utilities |  | 15.4 |  |  | 13.7 |  |  | 1.7 |  |  | (0.1 | ) |  | 1.6 |  |  | A+
Consumer discretionary |  | 5.9 |  |  | 5.6 |  |  | 0.3 |  |  | 0.1 |  |  | 0.4 |  |  | AA-
Consumer staples |  | 5.1 |  |  | 5.0 |  |  | 0.1 |  |  | — |  |  | 0.1 |  |  | A
Materials |  | 2.1 |  |  | 2.0 |  |  | 0.1 |  |  | — |  |  | 0.1 |  |  | BBB
Total corporate securities |  | $ | 69.5 |  |  | 62.6 |  |  | 6.9 |  |  | (2.2 | ) |  | 4.7 |  |  | A
MBS: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Non-agency CMBS |  | $ | 17.7 |  |  | 11.5 |  |  | 6.2 |  |  | (3.0 | ) |  | 3.2 |  |  | AA-
Total MBS |  | $ | 17.7 |  |  | 11.5 |  |  | 6.2 |  |  | (3.0 | ) |  | 3.2 |  |  | AA-
ABS: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
ABS |  | $ | 5.6 |  |  | 5.0 |  |  | 0.6 |  |  | (0.5 | ) |  | 0.1 |  |  | BBB+
Alt-A ABS |  | 2.3 |  |  | 1.6 |  |  | 0.7 |  |  | (0.9 | ) |  | (0.2 | ) |  | AAA
Total ABS |  | $ | 7.9 |  |  | 6.6 |  |  | 1.3 |  |  | (1.4 | ) |  | (0.1 | ) |  | A

A portion of our AFS and HTM municipal bonds contain insurance enhancements. The following table provides information regarding these insurance-enhanced securities as of September 30, 2012:

Insurers of Municipal Bond Securities |  |  |  |  |  |
($ in thousands) |  | Fair Value |  | Ratings With Insurance |  | Ratings without Insurance
National Public Finance Guarantee Corporation, a subsidiary of MBIA, Inc. |  | $ | 306,863 |  |  | AA- |  | AA-
Assured Guaranty |  | 194,420 |  |  | AA |  | AA
Ambac Financial Group, Inc. |  | 87,900 |  |  | AA- |  | AA-
Other |  | 9,387 |  |  | AA |  | AA
Total |  | $ | 598,570 |  |  | AA- |  | AA-

To manage and mitigate exposure, we perform analysis on MBS 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, evaluations of projected cash flows, as well as other information that aids in determination of the health of the underlying assets. We also consider the overall credit environment, economic conditions, total projected return on the investment, and overall asset allocation of the portfolio in our decisions to purchase or sell structured securities.
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The following table details the top 10 state exposures of the municipal bond portion of our fixed maturity securities portfolio at September 30, 2012:

State Exposures of Municipal Bonds |  |  |  |  |  |  |  |
|  | General Obligation |  | Special Revenue |  | Fair Value |  | Weighted Average Credit Quality
($ in thousands) |  | Local |  | State |  |  |
Texas |  | $ | 84,555 |  |  | 1,126 |  |  | 52,624 |  |  | 138,305 |  |  | AA+
Washington |  | 46,052 |  |  | 7,270 |  |  | 49,327 |  |  | 102,649 |  |  | AA
New York |  | 3,678 |  |  | — |  |  | 74,947 |  |  | 78,625 |  |  | AA+
Arizona |  | 2,466 |  |  | — |  |  | 62,510 |  |  | 64,976 |  |  | AA
Florida |  | — |  |  | 6,226 |  |  | 55,105 |  |  | 61,331 |  |  | AA-
Colorado |  | 31,371 |  |  | 1,756 |  |  | 21,905 |  |  | 55,032 |  |  | AA-
Illinois |  | 20,324 |  |  | — |  |  | 25,857 |  |  | 46,181 |  |  | AA-
Ohio |  | 13,338 |  |  | 7,070 |  |  | 22,734 |  |  | 43,142 |  |  | AA
North Carolina |  | 13,923 |  |  | 3,760 |  |  | 24,313 |  |  | 41,996 |  |  | AA
Missouri |  | 16,975 |  |  | — |  |  | 21,229 |  |  | 38,204 |  |  | AA+
Other |  | 114,601 |  |  | 107,180 |  |  | 359,588 |  |  | 581,369 |  |  | AA
|  | 347,283 |  |  | 134,388 |  |  | 770,139 |  |  | 1,251,810 |  |  | AA
Pre-refunded/escrowed to maturity bonds |  | 35,298 |  |  | 12,050 |  |  | 51,838 |  |  | 99,186 |  |  | AA+
Total |  | $ | 382,581 |  |  | 146,438 |  |  | 821,977 |  |  | 1,350,996 |  |  | AA

There has been recent concern regarding the stress on state and local governments emanating from declining revenues, large unfunded liabilities, and entrenched cost structures. We are comfortable with the quality, composition, and diversification of our $1.4 billion municipal bond portfolio. Our municipal bond portfolio is very high quality with an average AA rating and is well laddered with 39% maturing within three years, and another 31% maturing between three and five years. The weightings of the municipal bond portfolio are: (i) 61% of high-quality revenue bonds that have dedicated revenue streams; (ii) 28% of local general obligation bonds; and (iii) 11% of state general obligation bonds. In addition, approximately 7% of the municipal bond portfolio has been pre-refunded, meaning assets have been placed in trust to fund the maturity of the bonds. Our largest state exposure is to Texas, at 10% excluding the impact of pre-refunded bonds. Of the $85 million in local Texas general obligation bonds, $34 million represents investments in Texas Permanent School Fund bonds, which are considered to be of lower risk.
The sector composition and credit quality of our special revenue bonds did not significantly change from December 31, 2011. For details regarding our special revenue bond sectors and additional information regarding credit risk associated with our portfolio, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.” of our 2011 Annual Report.
Our top Eurozone exposures as of September 30, 2012 were as follows:

September 30, 2012 |  |  |  |  |  |  |  |
($ in millions) |  | Corporate Securities |  | Government Securities |  | Equity Securities |  | Total Exposure
Country: |  |  |  |  |  |  |  |  |  |  |  |
Netherlands |  | $ | 9.2 |  |  | — |  |  | — |  |  | 9.2 |
Luxembourg |  | 8.5 |  |  | — |  |  | — |  |  | 8.5 |
Germany |  | — |  |  | 5.6 |  |  | — |  |  | 5.6 |
France |  | 2.7 |  |  | — |  |  | — |  |  | 2.7 |
Ireland |  | — |  |  | — |  |  | 1.5 |  |  | 1.5 |
Total |  | $ | 20.4 |  |  | 5.6 |  |  | 1.5 |  |  | 27.5 |
Average Credit Rating |  | A- |  |  | AA+ |  |  | N/A |  |  | A 1 |

1 | Total credit rating of Eurozone exposure excludes equity securities.

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Uncertainty about the ability of certain sovereign issuers to fully repay their debt triggered significant turbulence in global financial markets in 2011 and continues to cause market volatility in 2012. The sovereign debt crisis has been particularly concentrated in the Eurozone, and a number of member countries have been repeatedly downgraded by the major ratings agencies. The crisis has placed strains on the stability of the Euro currency, as the European Central Bank struggled to supply liquidity to member nations and their banks. As of September 30, 2012, we had no direct exposure to issuers domiciled in Italy, Greece, Portugal, or Spain, four of the more economically troubled nations in the Eurozone. In Third Quarter 2012, we significantly reduced our Eurozone exposures for proceeds of $44.2 million and net realized gains of $0.4 million. We do not own any derivative exposures such as credit default swaps. Outside of the effect foreign economies have on the underlying investments, we have minimal exposure to Euro depreciation or appreciation.
Equity Securities
Our equity securities portfolio was 4% of invested assets as of September 30, 2012, a consistent level compared to year-end 2011. Dividend income increased by 65% in Nine Months 2012 compared to Nine Months 2011 due to our 2011 transition into a high-dividend yield equities strategy. In Nine Months 2012, we rebalanced our holdings within this portfolio, generating net proceeds of $17.8 million with net realized gains of $4.3 million.
Other Investments
As of September 30, 2012, other investments represented 3% of our total invested assets. The following table outlines a summary of our other investment portfolio by strategy and the remaining commitment amount associated with each strategy:

Other Investments |  | Carrying Value |  | Remaining Commitment
($ in thousands) |  | September 30, 2012 |  | December 31, 2011 |  | September 30, 2012
Alternative Investments: |  |  |  |  |  |
Secondary private equity |  | $ | 28,883 |  |  | 30,114 |  |  | 8,153 |
Private equity |  | 24,743 |  |  | 21,736 |  |  | 3,883 |
Energy/power generation |  | 19,198 |  |  | 25,913 |  |  | 10,347 |
Distressed debt |  | 13,413 |  |  | 16,953 |  |  | 7,357 |
Real estate |  | 12,719 |  |  | 13,767 |  |  | 10,473 |
Mezzanine financing |  | 11,177 |  |  | 8,817 |  |  | 23,174 |
Venture capital |  | 7,651 |  |  | 7,248 |  |  | 400 |
Total alternative investments |  | 117,784 |  |  | 124,548 |  |  | 63,787 |
Other securities |  | 4,297 |  |  | 3,753 |  |  | 1,059 |
Total other investments |  | $ | 122,081 |  |  | 128,301 |  |  | 64,846 |

In addition to the capital that we have already invested to date, we are contractually obligated to invest up to an additional $64.8 million in these alternative and other investments through commitments that currently expire at various dates through 2022. For a description of our seven alternative investment strategies outlined above, as well as redemption, restrictions, and fund liquidations, refer to Note 5. “Investments” in Item 8. “Financial Statements and Supplementary Data.” of our 2011 Annual Report. In addition, for information on current year activity, refer to Note 6. "Investments" in Item 1. "Financial Statements" of this Form 10-Q.
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Net Investment Income
The components of net investment income earned were as follows:

|  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
Fixed maturity securities |  | $ | 30,839 |  |  | 31,960 |  |  | 93,948 |  |  | 97,835 |
Equity securities |  | 1,268 |  |  | 1,197 |  |  | 3,785 |  |  | 2,299 |
Short-term investments |  | 36 |  |  | 28 |  |  | 103 |  |  | 123 |
Other investments |  | 497 |  |  | 4,453 |  |  | 5,460 |  |  | 23,994 |
Miscellaneous income |  | 41 |  |  | 41 |  |  | 105 |  |  | 88 |
Investment expenses |  | (2,031 | ) |  | (1,893 | ) |  | (6,117 | ) |  | (5,735 | )
Net investment income earned – before tax |  | 30,650 |  |  | 35,786 |  |  | 97,284 |  |  | 118,604 |
Net investment income tax expense |  | (7,156 | ) |  | (8,810 | ) |  | (23,305 | ) |  | (30,083 | )
Net investment income earned – after tax |  | 23,494 |  |  | 26,976 |  |  | 73,979 |  |  | 88,521 |
Effective tax rate |  | 23.3 | % |  | 24.6 | % |  | 24.0 | % |  | 25.4 | %
Annual after-tax yield on fixed maturity securities |  |  |  |  |  |  | 2.5 |  |  | 2.8 |
Annual after-tax yield on investment portfolio |  |  |  |  |  |  | 2.3 |  |  | 3.0 |

Net investment income earned, before tax, decreased by $5.1 million in Third Quarter 2012 compared to Third Quarter 2011, and decreased by $21.3 million in Nine Months 2012 compared to Nine Months 2011. These decreases were primarily driven by lower income from alternative investments within our other investment portfolio of $3.5 million and $17.6 million in Third Quarter and Nine Months 2012, respectively. Our alternative investments, which are accounted for under the equity method, primarily consist of investments in limited partnerships, the majority of which report results to us on a one quarter lag. Interest income from our fixed maturity securities portfolio also decreased by $1.1 million and $3.9 million for Third Quarter and Nine Months 2012, respectively, primarily due to lower reinvestment yields then in prior periods.
Realized Gains and Losses
Realized Gains and Losses (excluding OTTI)
Realized gains and losses, by type of security excluding OTTI charges, are determined on the basis of the cost of specific investments sold and are credited or charged to income. The components of net realized gains were as follows:

|  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
HTM fixed maturity securities |  |  |  |  |  |  |  |
Gains |  | $ | 40 |  |  | — |  |  | 195 |  |  | 9 |
Losses |  | (90 | ) |  | (200 | ) |  | (196 | ) |  | (522 | )
AFS fixed maturity securities |  |  |  |  |  |  |  |  |  |  |  |
Gains |  | 2,168 |  |  | 698 |  |  | 2,941 |  |  | 3,052 |
Losses |  | (262 | ) |  | (5 | ) |  | (379 | ) |  | (12 | )
AFS equity securities |  |  |  |  |  |  |  |  |  |  |  |
Gains |  | — |  |  | 5 |  |  | 4,775 |  |  | 6,676 |
Losses |  | — |  |  | — |  |  | (428 | ) |  | — |
Short-term investments |  |  |  |  |  |  |  |  |  |  |  |
Losses |  | — |  |  | — |  |  | (2 | ) |  | — |
Other Investments |  |  |  |  |  |  |  |
Gains |  | — |  |  | — |  |  | 1 |  |  | — |
Total other net realized investment gains |  | 1,856 |  |  | 498 |  |  | 6,907 |  |  | 9,203 |
Total OTTI charges recognized in earnings |  | (2,944 | ) |  | (2,543 | ) |  | (3,459 | ) |  | (3,342 | )
Total net realized gains |  | (1,088 | ) |  | (2,045 | ) |  | 3,448 |  |  | 5,861 |

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Our general philosophy for sales of securities is to reduce our exposure to securities and sectors based upon 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.
For additional discussion regarding realized gains and losses, see Note 6. “Investments” in Item 1. “Financial Statements” of this Form 10-Q.
Other-than-Temporary Impairments
The following table provides information regarding our OTTI charges recognized in earnings:

|  | Quarter ended September 30, |  | Nine Months ended September 30,
($ in thousands) |  | 2012 |  | 2011 |  | 2012 |  | 2011
AFS securities |  |  |  |  |  |  |  |  |  |
Obligations of state and political subdivisions |  | $ | — |  |  | — |  |  | — |  |  | 17 |
Corporate securities |  | — |  |  | — |  |  | — |  |  | 244 |
ABS |  | 36 |  |  | 50 |  |  | 98 |  |  | 50 |
CMBS |  | 519 |  |  | 132 |  |  | 627 |  |  | 604 |
RMBS |  | — |  |  | 49 |  |  | 174 |  |  | 115 |
Total AFS securities |  | 555 |  |  | 231 |  |  | 899 |  |  | 1,030 |
Equity securities |  | 2,389 |  |  | 2,312 |  |  | 2,560 |  |  | 2,312 |
Total OTTI charges recognized in earnings |  | $ | 2,944 |  |  | 2,543 |  |  | 3,459 |  |  | 3,342 |

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 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 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 OTTI methodology, see Note 2. “Summary of Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data.” of our 2011 Annual Report.
Unrealized/Unrecognized Losses
As evidenced by the table below, our unrealized/unrecognized loss positions improved by $8.1 million as of September 30, 2012 compared to December 31, 2011 as follows:

($ in thousands) |  |
September 30, 2012 |  | December 31, 2011
Number of Issues | % of Market/Book | Unrealized Unrecognized Loss |  | Number of Issues | % of Market/Book | Unrealized Unrecognized Loss
46 | 80% - 99% | $ | 2,335 |  |  | 140 | 80% - 99% | $ | 10,166 |
1 | 60% - 79% | 243 |  |  | — | 60% - 79% | — |
— | 40% - 59% | — |  |  | 1 | 40% - 59% | 469 |
— | 20% - 39% | — |  |  | — | 20% - 39% | — |
— | 0% - 19% | — |  |  | — | 0% - 19% | — |
|  | $ | 2,578 |  |  |  |  | $ | 10,635 |

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” in Item 8. “Financial Statements and Supplementary Data.” of our 2011 Annual Report. We have concluded that these securities are temporarily impaired as of September 30, 2012. For additional information regarding the unrealized/unrecognized losses between our AFS and HTM portfolios, see Note 6. “Investments,” in Item 1. “Financial Statements” of this Form 10-Q.
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Contractual Maturities
The following table presents amortized cost and fair value information for our AFS fixed maturity securities that were in an unrealized loss position at September 30, 2012 by contractual maturity:

($ in thousands) |  | Amortized Cost |  | Fair Value
One year or less |  | $ | 8,850 |  |  | 8,225 |
Due after one year through five years |  | 24,328 |  |  | 22,914 |
Due after five years through ten years |  | 10,883 |  |  | 10,768 |
Due after ten years |  | 6,023 |  |  | 5,929 |
Total |  | $ | 50,084 |  |  | 47,836 |

The following table presents amortized cost and fair value information for our HTM fixed maturity securities that were in an unrealized/unrecognized loss position at September 30, 2012 by contractual maturity:

($ in thousands) |  | Amortized Cost |  | Fair Value
One year or less |  | $ | 573 |  |  | 571 |
Due after one year through five years |  | 5,180 |  |  | 5,063 |
Total |  | $ | 5,753 |  |  | 5,634 |

Investments Outlook
According to the Bureau of Economic Analysis, real gross domestic product increased at a 1.3% annual rate in the second quarter of 2012 compared to a 1.8% increase for 2011. For the first eight months of the year, the unemployment rate held within a range of 8.1% to 8.3%. The September report from the Bureau of Labor Statistics reported a drop in this rate to 7.8%, although the broader measure of total unemployed, which includes marginally-attached workers and those employed part-time for economic reasons, held steady from the August report at 14.7%. The risk factors that cause concern have remained consistent during the year, namely slower global growth rates, sovereign debt stability, U.S. fiscal uncertainty in this election year, and inflation expectations. Volatility in equity and bond markets declined during Third Quarter 2012. The Federal Reserve continues to maintain (and, in fact, reiterated) its commitment to an accommodative monetary policy while fixed maturity securities yields remain low. The Federal Reserve Chairman has indicated that low interest rates may persist until 2015, and the continuing challenge for the fixed income portfolio is to maintain credit quality while overcoming the spread between maturing assets and the reinvestment rate available. For each 25 basis point decline in after-tax portfolio yield, return on equity declines by roughly 100 basis points, all else being equal.
Our fixed maturity securities portfolio strategy remains focused on maintaining sufficient liquidity while maximizing yield within acceptable risk tolerances. We will continue to invest in high quality instruments, including additions to investment grade corporate bonds and municipal fixed income securities with diversified maturities to manage incremental interest rate risk, and may opportunistically invest in below investment grade to take advantage of risk adjusted return opportunities.
The allocation to a high dividend yield equities strategy is being maintained, and has improved diversification in the equities portfolio while providing additional yield. The strategy is relatively sector-neutral, provides broad based exposure to the domestic equity market and provides attractive current income yields.
Our current outlook for alternative investments remains positive and private markets continue to offer attractive risk adjusted returns.
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Federal Income Taxes
The following table provides information regarding federal income taxes from continuing operations:

| Quarter ended September 30, | Nine Months ended September 30
($ in million) | 2012 |  | 2011 | 2012 |  | 2011
Federal income expense (benefit) from continuing operations | $ | 2.0 |  |  | (20.2 | ) | 6.2 |  |  | (16.1 | )
Effective tax rate | 10 | % |  | 54 |  | 14 |  |  | 141 |

The increases in federal income tax expense in Third Quarter and Nine Months 2012 were primarily due to an improvement in underwriting results as compared to last year, partially offset by decreases in net investment income. For a reconciliation of the federal corporate tax rate to our effective tax rate, see Note 14. "Federal Income Taxes" in Item 1. "Financial Statements" of this Form 10-Q.
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 both the short-term and long-term cash requirements of our business operations. Our cash and short-term investment position was $185.2 million at September 30, 2012, primarily comprised of $24.1 million at Selective Insurance Group, Inc. (the “Parent”) and $161.1 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.
Sources of cash for the Parent have historically consisted of dividends from the Insurance Subsidiaries, borrowings under lines of credit and the Federal Home Loan Bank of Indianapolis (“FHLBI”) through our Indiana-domiciled Insurance Subsidiaries' (“Indiana Subsidiaries”) loan agreements, 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 paying approximately $196 million in total dividends to the Parent in 2012, of which $179.7 million was paid through Third Quarter 2012, including an extraordinary cash and property dividend of approximately $134 million that was paid to the Parent from SICA in Third Quarter 2012. This dividend, along with a portion of the ordinary dividends, was used as follows: (i) $74.4 million and $31.9 million, respectively, to further capitalize the formation of two additional New Jersey-domiciled insurance companies, SCIC and SFCIC; (ii) $13.3 million to provide additional capitalization of our recently-acquired Insurance Subsidiary, MUSIC; and (iii) $19.5 million to further capitalize SICNE, an Insurance Subsidiary that was re-domesticated from Maine to New Jersey in the second quarter of 2012. Our allowable maximum ordinary dividend is approximately $108 million.
Any dividends to the Parent continue to be subject to the approval and/or review of the insurance regulators in the respective domiciliary states 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. 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 6. “Stockholders' Equity and Other Comprehensive Income (Loss)” in Item 8. “Financial Statements and Supplementary Data.” of our 2011 Annual Report.
The Parent had no private or public issuances of stock or debt during 2012 and there were no borrowings under its $30 million line of credit (“Line of Credit”). The Indiana Subsidiaries' membership in the FHLBI provides these companies 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. The Parent's Line of Credit agreement permits collateralized borrowings by the Indiana Subsidiaries from the FHLBI as long as the aggregate amount borrowed does not exceed 10% of the respective Indiana Subsidiary's admitted assets from the preceding calendar year. For additional information regarding the Parent's Line of Credit, refer to the section below entitled “Short-term Borrowings.” All borrowings from the FHLBI are required to be secured by certain investments. For additional information regarding the required collateral, refer to Note 6, “Investments” in Item 1. “Financial Statements” of this Form 10-Q. The Indiana Department of Insurance has approved lending agreements from each of the Indiana Subsidiaries to the Parent for up to 10% of the admitted assets of the respective Indiana Subsidiary. At September 30, 2012, the outstanding borrowings of the Indiana Subsidiaries from the FHLBI were $58 million. The Indiana Subsidiaries have the ability to borrow an additional $26 million
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from the FHLBI, as total borrowings are limited to 10% of admitted assets of the Indiana Subsidiaries under our line of credit, as explained above. In addition, pursuant to the lending agreements between the Indiana Subsidiaries and the Parent, additional borrowings by the Parent from the Indiana Subsidiaries are limited to approximately $18 million.
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 well-laddered to continually provide a source of cash flows for claims payments in the ordinary course of business. The duration of the fixed maturity securities portfolio, excluding short-term investments, was 3.5 years as of September 30, 2012, while the liabilities of the Insurance Subsidiaries have a duration of approximately 3.8 years. In addition, the Insurance Subsidiaries purchase reinsurance coverage for protection against any significantly large claims or catastrophes that may occur during the year.
The liquidity generated from the sources discussed above is used, among other things, to pay dividends to our shareholders. Dividends on shares of the Parent's common stock are declared and paid at the discretion of the Board of Directors based on our operating results, financial condition, capital requirements, contractual restrictions, and other relevant factors.
Our ability to meet our interest and principal repayment obligations on our debt, as well as our ability to continue to pay dividends to our stockholders is dependent on liquidity at the Parent coupled with the ability of the Insurance Subsidiaries to pay dividends, if necessary, and/or the availability of other sources of liquidity to the Parent. Our next principal repayments of $13 million and $45 million are due in 2014 and 2016, respectively. 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 the Parent's ability to service its 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 June 13, 2011 with a borrowing capacity of $30 million, which can be increased to $50 million with the approval of both lending parties. This Line of Credit provides the Parent an additional source of short-term liquidity, if needed. The interest rate on our Line of Credit varies and is based on the Parent's debt ratings. The Line of Credit expires on June 13, 2014. There were no balances outstanding under this credit facility as of September 30, 2012 or at any time during 2012.
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 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:

| Required as of September 30, 2012 | Actual as of September 30, 2012
Consolidated net worth | $812 million | $1.1 billion
Statutory surplus | Not less than $750 million | $1.1 billion
Debt-to-capitalization ratio 1 | Not to exceed 35% | 19.8%
A.M. Best financial strength rating | Minimum of 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 September 30, 2012, we had statutory surplus and GAAP stockholders' equity of $1.1 billion. We had total debt of $307.4 million at September 30, 2012, which equates to a debt-to-capital ratio of 21.5%.
Our cash requirements include, but are not limited to, principal and interest payments on various notes payable and 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.”
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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 our subsidiaries in our Insurance Operations, issuing additional debt and/or equity securities, repurchasing shares of the Parent's common stock, and increasing stockholders' dividends.
Our capital management strategy is intended to protect the interests of the policyholders of the Insurance Subsidiaries and our stockholders, while enhancing our financial strength and underwriting capacity.
Book value per share increased to $20.44 as of September 30, 2012, from $19.45 as of December 31, 2011, primarily driven by: (i) an increase in unrealized gains on our investment portfolio, which led to an increase in book value per share of $0.73; and (ii) net income, which led to an increase in book value per share of $0.67. Partially offsetting these increases was the $0.39 in dividends paid 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 and Company ("A.M. Best"). In the second quarter of 2012, A.M. Best lowered our rating to “A (Excellent),” their third highest of 15 ratings, with a “stable” outlook. The change resulted from their assessment of our operating performance over the most recent five-year period relative to the commercial casualty composite index despite recognizing that recent performance has been negatively impacted by record catastrophic and weather-related losses. They cited solid risk-adjusted capitalization, disciplined underwriting focus, increasing use of predictive modeling technology, and our strong independent agency relationships in support of the “A (Excellent)” rating. We have been rated “A” or higher by A.M. Best for the past 82 years. A downgrade from A.M. Best to a rating below “A-” 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; or (ii) be an event of default under our Line of Credit.
Ratings by other major rating agencies are as follows:

• | Standard and Poors' Rating Services (“S&P”) - Our “A” financial strength rating was reaffirmed in Third Quarter 2012 by S&P, which cited our strong competitive position in Mid-Atlantic markets, financial flexibility, and relationships with independent agents. Our outlook was revised to “negative” reflecting a modest decline in available capital and increased charges for underwriting risk, asset risk, and property catastrophe exposure as measured by Standard & Poor's capital adequacy model.

• | Moody's Investor Service (“Moody's”) - Moody's cited our strong regional franchise with established independent agency support, along with good risk adjusted capitalization and moderate financial leverage in support of our financial strength rating of “A2” with a stable outlook. Their outlook reflects the expectation that we will continue to employ our technologically-based risk management process to identify and manage underperforming segments, while maintaining pricing discipline and reserve adequacy.

• | Fitch Ratings - Our “A+” rating and outlook of stable was reaffirmed in the second quarter of 2012, citing our disciplined underwriting culture, conservative balance sheet with very good capitalization and reserve strength, strong independent agency relationships, and improved diversification through our continued efforts to reduce our concentration in New Jersey.

Our S&P and Moody's financial strength ratings affect our ability to access capital markets. 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 September 30, 2012 and December 31, 2011, 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.
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Contractual Obligations, Contingent Liabilities, and Commitments
Our future cash payments associated with loss and loss expense reserves, contractual obligations pursuant to operating leases for office space and equipment, and notes payable have not materially changed since December 31, 2011. We expect to have the capacity to repay and/or refinance these obligations as they come due.
At September 30, 2012, we had contractual obligations that expire at various dates through 2022 that may require us to invest up to an additional $64.8 million in alternative and other 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. “Related Party Transactions” included in Item 8. “Financial Statements and Supplementary Data.” of our 2011 Annual Report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the information about market risk set forth in our 2011 Annual Report.
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our 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 (“Exchange Act”)), as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are: (i) effective in recording, processing, summarizing, and reporting information on a timely basis that we are required to disclose in the reports that we file or submit under the Exchange Act; and (ii) effective in ensuring that information that we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. No changes in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) of the Exchange Act) occurred during Third Quarter 2012 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the ordinary course of conducting business, we are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving our 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. We account for such activity through the establishment of unpaid loss and loss adjustment expense reserves. We 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 our consolidated financial condition, results of operations, or cash flows.
Our Insurance Subsidiaries are also from time-to-time involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative 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. Our Insurance Subsidiaries are also involved from time-to-time 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. We believe that we have valid defenses to these cases. We 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 our 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, have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.
ITEM 1A. RISK FACTORS
Certain risk factors exist that can have a significant impact on our business, liquidity, capital resources, results of operations, and financial condition. The impact of these risk factors could also impact certain actions that we take as part of our long-term capital strategy including, but not limited to, contributing capital to our subsidiaries in our Insurance Operations, issuing additional debt and/or equity securities, repurchasing shares of our common stock, or changing stockholders’ dividends. We operate in a continually changing business environment and new risk factors emerge from time-to-time. Consequently, we can neither predict such new risk factors nor assess the impact, if any, they might have on our business in the future. There have been no material changes from the risk factors disclosed in Item 1A. “Risk Factors.” in our 2011 Annual Report other than as discussed below.
We face risks regarding our flood business because of uncertainties regarding the funding of the National Flood Insurance Program (“NFIP”).
Selective is the sixth largest insurance group participating in the write-your-own (“WYO”) arrangement of the NFIP, which is managed by the Mitigation Division of the Federal Emergency Management Agency ("FEMA") in the U.S. Department of Homeland Security. For WYO participation, Selective receives an expense allowance, or servicing fee, for policies written and claims serviced. As of September 30, 2012, the expense allowance was 30.4% and the servicing fee was a combination of 1% of direct written premiums and 1.5% of incurred losses. Effective October 1, 2012, the expense allowance changed to 30.7% and the servicing fee is 0.9% of direct written premiums and 1.5% of incurred losses.
The NFIP is funded by Congress. This past July, the President signed a law extending the National Flood Insurance Program until September 30, 2017. In addition to the much needed extension, the law increases the annual limitation on flood premium increases from 10% to 20%; requires a four-year phase-in to actuarial rates for pre-Flood Insurance Rate Map (FIRM) properties; increases the minimum annual deductibles for pre-FIRM properties; and allows for installment plans to pay premiums. The legislation directs the FEMA to develop a storm model to better define “wind” versus “water” claims and the responsibility of payment between the NFIP and private insurers. In addition, the law directs FEMA to re-examine WYO compensation. These changes, and specifically potential changes in compensation of WYO carriers, may impact the financial viability of our participation of the program.
As a WYO carrier, we are required to follow certain NFIP procedures when administering flood policies and claims. Some of these requirements may be different from our normal business practices and may present a reputational risk to our brand. Insurance companies are regulated by states, however, NFIP is a federal program and there may be instances where requirements placed on WYO carriers by NFIP are not consistent with the regulations of a particular state. Consequently, we have the risk that our regulator's position may conflict with NFIP's position on the same issue.
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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 on our financial condition and results of operations.
Our financial strength ratings are as follows:

NRSRO | Financial Strength Rating | Outlook
A.M. Best and Company | “A” | Stable
S&P | “A” | Negative
Moody's Investor Service | “A2” | Stable
Fitch Ratings | “A+” | Stable

A significant rating downgrade, particularly from A.M. Best, 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 with Wells Fargo Bank, National Association (“Line of Credit”). The Line of Credit requires our Insurance Subsidiaries to maintain an A.M. Best rating of at least “A-” (one level below our current rating) and a default could lead to acceleration of any outstanding principal. Such an event also could trigger default provisions under certain of our other debt instruments and negatively impact our ability to borrow in the future. As a result, any significant downgrade in our financial strength ratings could have a material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings.
NRSROs also rate our long-term debt creditworthiness. Credit ratings indicate the ability of debt issuers to meet debt obligations in a timely manner and are important factors in our overall funding profile and ability to access certain types of liquidity. Our current credit ratings are as follows:

NRSRO | Credit Rating | Long Term Credit Outlook
A.M. Best and Company | “bbb+” | Stable
S&P | “BBB” | Negative
Moody's Investor Service | “Baa2” | Stable
Fitch Ratings | “BBB+” | Stable

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 to access capital markets.
Because of the difficulties experienced by many financial institutions during the recent credit crisis, including insurance companies, and the public criticism of NRSROs, we believe it is possible that the NRSROs: (i) will heighten their level of scrutiny of financial 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 maintaining certain rating levels. We cannot predict possible actions NRSROs may take regarding their ratings that could adversely affect our business or the possible actions we may take in response to any such action.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table provides information regarding our purchases of our common stock in Third Quarter 2012:

Period |  | Total Number of Shares Purchased 1 |  | Average Price Paid per Share |  | Total Number of Shares Purchased as Part of Publicly Announced Programs |  | Maximum Number of Shares that May Yet Be Purchased Under the Programs
July 1 – 31, 2012 |  | — |  |  | $ | — |  |  | — |  |  | — |
August 1 – 31, 2012 |  | 2,214 |  |  | 17.71 |  |  | — |  |  | — |
September 1 – 30, 2012 |  | 679 |  |  | 19.03 |  |  | — |  |  | — |
Total |  | 2,893 |  |  | $ | 18.02 |  |  | — |  |  | — |

1 | During Third Quarter 2012, 2,893 shares were purchased from employees in connection with the vesting of restricted stock units. These repurchases were made to satisfy tax withholding obligations and/or option costs with respect to those employees. These shares were not purchased as part of any publicly announced program. The shares that were purchased in connection with the vesting of restricted stock units were purchased at fair market value as defined in the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan As Amended and Restated Effective as of May 1, 2010.

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Item 6. EXHIBITS
(a) Exhibits:

Exhibit No. |  |
* 11 |  | Statement Re: Computation of Per Share Earnings.
* 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.
** 101.INS |  | XBRL Instance Document.
** 101.SCH |  | XBRL Taxonomy Extension Schema Document.
** 101.CAL |  | XBRL Taxonomy Extension Calculation Linkbase Document.
** 101.LAB |  | XBRL Taxonomy Extension Label Linkbase Document.
** 101.PRE |  | XBRL Taxonomy Extension Presentation Linkbase Document.
** 101.DEF |  | XBRL Taxonomy Extension Definition Linkbase Document.

* Filed herewith.
** Furnished and not filed herewith.
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SIGNATURES
Pursuant to the requirements 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.
Registrant

By: /s/ Gregory E. Murphy | October 25, 2012
Gregory E. Murphy |
Chairman of the Board, President and Chief Executive Officer |
By: /s/ Dale A. Thatcher | October 25, 2012
Dale A. Thatcher |
Executive Vice President and Chief Financial Officer |
(principal accounting officer and principal financial officer) |

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