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

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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.                                            38

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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;   

<p>• 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 %                                             39

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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 %                                             40

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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                                                        Weighted                               Weighted                                                        Average                                Average                             Fair        Unrealized      Credit       Fair       Unrealized     Credit ($ in millions)             Value       Gain (Loss)    Quality      Value      Gain (Loss)    Quality AFS Fixed Maturity Portfolio: U.S. government obligations1             $   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 ABS3                     0.7               -        D            0.7              -        D Sub-prime ABS2, 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.                                            41

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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                                                                  Unrealized Gain                                                                     (Loss) in                                                                    Accumulated         Total        Weighted                                                  Unrecognized         Other

Unrealized/ Average

                           Fair        Carry      Holding Gain     Comprehensive     Unrecognized     Credit ($ in millions)          Value        Value         (Loss)           Income         Gain (Loss)     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                                              42

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  Table of Contents  December 31, 2011                                                                                             Total        Weighted                                                    Unrecognized                          Unrealized/     Average                           Fair        Carry        Holding Gain      Unrealized Gain     Unrecognized     Credit ($ in millions)          Value        Value           (Loss)          (Loss) in AOCI     Gain (Loss)     Quality HTM Portfolio: Foreign government obligations            $    5.5         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

                                                                      Ratings     Ratings                                                                         With      without ($ in thousands)                                      Fair Value     Insurance   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.                                           43

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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

                                                                                     Weighted                              General Obligation                                      Average                                                          Special        Fair          Credit ($ in thousands)             Local          State        Revenue        Value        Quality 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:

<pre>September 30, 2012 Government ($ in millions) Corporate Securities 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 A1 1 Total credit rating of Eurozone exposure excludes equity securities. 44

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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 $4.3 million.  Other Investments As of September 30, 2012, other investments represented 3% of our total invested assets. The following table outlines a summary of our other investment portfolio by strategy and the remaining commitment amount associated with each strategy:  Other Investments                                                                                Remaining                                                               Carrying Value                    Commitment                                                                                                September 30, ($ in thousands)                                 September 30, 2012      December 31, 2011         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.                                           45

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  Net Investment Income The components of net investment income earned were as follows:                                                                                Nine Months ended                                          Quarter ended September 30,             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:                                                                                  Nine Months ended                                              Quarter ended September 30,          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                                            46

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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:                                                                                   Nine Months ended                                              Quarter ended September 30,            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                       Unrealized        Number of                 

Unrealized

Issues % of Market/Book Unrecognized Loss Issues % of Market/Book 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.                                           47

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Table of Contents 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: Amortized Fair ($ in thousands) Cost 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:

                                           Amortized      Fair ($ in thousands)                            Cost       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          Nine Months ended                                                 September 30,            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                                         49

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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          Actual as of                                         September 30, 2012     September 30, 2012 Consolidated net worth                     $812 million           $1.1 billion Statutory surplus                   Not less than $750 million    $1.1 billion Debt-to-capitalization ratio1           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."                                         50

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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.                                          51

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Table of ContentsContractual 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.