Statutory Financial Information, Capital Requirements, and Restrictions on Dividends and Transfers of Funds

(a) Statutory Financial Information

The Insurance Subsidiaries prepare their statutory financial statements in accordance with accounting principles prescribed or permitted by the various state insurance departments of domicile. Prescribed statutory accounting principles include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (“NAIC"). Permitted statutory accounting principles encompass all accounting principles that are not prescribed; such principles differ from state to state, may differ from company to company within a state and may change in the future. The Insurance Subsidiaries do not utilize any permitted statutory accounting principles that materially affect the determination of statutory surplus, statutory net income, or risk-based capital (“RBC”). As of December 31, 2012, the various state insurance departments of domicile have adopted the March 2012 version of the NAIC Accounting Practices and Procedures manual in its entirety, as a component of prescribed or permitted practices.

The following table provides statutory data for each of our Insurance Subsidiaries:



	State of Domicile	Unassigned Surplus					Statutory Surplus		Statutory Net Income
($ in millions)		2012			2011		2012	2011	2012	2011	2010
SICA	New Jersey	$	246.2		360.7		369.9	507.4	29.8	15.2	55.4
Selective Way Insurance Company ("SWIC")	New Jersey	167.6			169.1		211.2	221.7	10.1	7.8	6.2
Selective Insurance Company of South Carolina ("SICSC")	Indiana	70.1			65.5		91.4	90.5	2.8	0.7	7.3
Selective Insurance Company of the Southeast ("SICSE")	Indiana	50.1			46.8		69.7	69.3	1.6	0.3	5.2
Selective Insurance Company of New York ("SICNY")	New York	45.3			43.0		72.6	73.3	2.7	1.5	6.9
Selective Insurance Company of New England ("SICNE")	New Jersey	2.7			3.8		32.5	14.3	0.6	0.3	0.8
Selective Auto Insurance Company of New Jersey ("SAICNJ")	New Jersey	7.6			5.6		45.9	46.3	1.5	0.7	5.1
Mesa Underwriters Specialty Insurance Company ("MUSIC")	New Jersey	(14.9		)	(15.4	)	53.6	39.9	0.9	—	—
Selective Casualty Insurance Company ("SCIC")	New Jersey	(2.2		)	—		72.2	—	0.2	—	—
Selective Fire and Casualty Insurance Company ("SFCIC")	New Jersey	(0.9		)	—		31.1	—	0.2	—	—
Total		$	571.6		679.1		1,050.1	1,062.7	50.4	26.5	86.9

(b) Capital Requirements

The Insurance Subsidiaries are required to maintain certain minimum amounts of statutory surplus to satisfy their various state insurance departments of domicile. RBC requirements for property and casualty insurance companies are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. The Insurance Subsidiaries combined total adjusted capital exceeded the authorized control level RBC, as defined by the NAIC, by 3.9 :1 based on their 2012 statutory financial statements. The negative unassigned surplus balance for MUSIC existed prior to our acquisition of this company in 2011. This company, as well as the two newly formed subsidiaries, SCIC and SFCIC have not generated sufficient net income as of yet to offset negative surplus items, such as non-admitted assets.

The Parent pays dividends to stockholders from funds available at the holding company level. As of December 31, 2012, the Parent had a $68 million investment portfolio available to fund future dividends and interest payments. This portfolio is not subject to any regulatory restrictions whereas the Company's consolidated retained earnings of $1.1 billion is predominately restricted due to the regulation associated with our Insurance Subsidiaries. In 2013, the Insurance Subsidiaries have the ability to provide for $106.2 million in annual dividends to the Parent; however, as regulated entities these dividends are subject to certain restrictions as is further discussed below. The Parent also has available to it other potential sources of liquidity, such as: (i) borrowings from our Indiana-domiciled Insurance Subsidiaries; (ii) debt issuances; and (iii) common stock issuances. Borrowings from SISE and SISC are governed by approved intercompany lending agreements with the Parent that provide for additional capacity of $22 million as of December 31, 2012 after considering that borrowings under these lending agreements are restricted to 10% of the admitted assets of these respective subsidiaries. For additional restrictions on the Parent's debt, see Note 10, "Indebtedness" in this Form 10-K.

Insurance Subsidiaries Dividend Restrictions

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.

In 2012, SICA received approval from the New Jersey Department of Banking and Insurance to pay extraordinary dividends of $141.1 million to the Parent. The following table provides quantitative data regarding all Insurance Subsidiaries' dividends paid to the Parent in 2012:



Dividends		Twelve Months ended December 31, 2012
($ in millions)	State of Domicile	Ordinary Dividends Paid		Extraordinary Dividends Paid	Total Dividends Paid
SICA	New Jersey	$	28.7	141.1	169.8
SWIC	New Jersey	20.5		—	20.5
SICSC	Indiana	0.8		—	0.8
SICSE	Indiana	0.5		—	0.5
SICNY	New York	2.9		—	2.9
SICNE	New Jersey	1.0		—	1.0
SAICNJ	New Jersey	0.6		—	0.6
MUSIC	New Jersey	—		—	—
SCIC	New Jersey	—		—	—
SFCIC	New Jersey	—		—	—
Total		$	55.0	141.1	196.1

These dividends were used as follows:



($ in millions)	2012
Capitalization of newly-formed Insurance Subsidiaries:
SCIC	$	74.4
SFCIC	31.9
Additional capitalization of existing Insurance Subsidiaries:
SICNE	19.5
MUSIC	13.3
Debt service, shareholder dividends and general operating purposes	57.0
Total	$	196.1

Based on the 2012 statutory financial statements, the maximum ordinary dividends that can be paid to the Parent by the Insurance Subsidiaries in 2013 are as follows:



		2013
($ in millions)	State of Domicile	Maximum Ordinary Dividends Paid
SICA	New Jersey	$	37.0
SWIC	New Jersey	21.1
SICSC	Indiana	9.1
SICSE	Indiana	7.0
SICNY	New York	7.3
SICNE	New Jersey	3.2
SAICNJ	New Jersey	5.8
MUSIC	New Jersey	5.4
SCIC	New Jersey	7.2
SFCIC	New Jersey	3.1
Total		$	106.2