SAFETY INSURANCE GROUP INC - Quarter Report: 2005 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 000-50070

SAFETY INSURANCE GROUP, INC.

(Exact name of registrant as specified in its charter)

Delaware		13-4181699
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

20 Custom House Street, Boston, Massachusetts 02110
(Address of principal executive offices including zip code)

(617) 951-0600
(Registrant’s telephone number, including area code)

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 ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ý No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No ý

As of November 3, 2005, there were 15,745,572 shares of common stock with a par value of $0.01 per share outstanding.

SAFETY INSURANCE GROUP, INC.

Table of Contents

		Page No.
PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements
	Consolidated Balance Sheets at September 30, 2005 (Unaudited) and December 31, 2004	3
	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2005 and 2004 (Unaudited)	4
	Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2005 and 2004 (Unaudited)	5
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2005 and 2004 (Unaudited)	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004 (Unaudited)	7
	Notes to Unaudited Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Executive Summary and Overview	15
	Critical Accounting Policies and Estimates	19
	Results of Operations – Three and Nine Months Ended September 30, 2005 and 2004	26
	Liquidity and Capital Resources	29
	Forward-Looking Statements	31

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	32

Item 4.	Controls and Procedures	33

PART II.	OTHER INFORMATION	33

Item 1.	Legal Proceedings	33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33

Item 3.	Defaults upon Senior Securities	33

Item 4.	Submission of Matters to a Vote of Security Holders	33

Item 5.	Other Information	33

Item 6.	Exhibits	33

SIGNATURE		34

EXHIBIT INDEX		35

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except share data)

	September 30,		December 31,
	2005		2004
	(Unaudited)
Assets
Investment securities available for sale:
Fixed maturities, at fair value (amortized cost: $692,872 and $650,159)	$	694,773	$	663,509
Equity securities, at fair value (cost: $2,057 and $1,037)	2,157		1,087
Total investment securities	696,930		664,596
Cash and cash equivalents	181,574		155,673
Accounts receivable, net of allowance for doubtful accounts	167,167		150,451
Accrued investment income	8,052		7,008
Receivable from reinsurers related to paid loss and loss adjustment expenses	21,595		18,980
Receivable from reinsurers related to unpaid loss and loss adjustment expenses	81,293		84,167
Prepaid reinsurance premiums	40,946		43,402
Deferred policy acquisition costs	49,763		42,919
Deferred income taxes	18,825		12,679
Equity and deposits in pools	49,775		23,678
Other assets	2,480		2,892
Total assets	$	1,318,400	$	1,206,445

Liabilities
Loss and loss adjustment expense reserves	$	455,813	$	450,897
Unearned premium reserves	376,119		337,786
Accounts payable and accrued liabilities	27,672		43,684
Taxes payable	4,570		3,509
Outstanding claims drafts	17,423		16,832
Payable to reinsurers	43,083		16,990
Payable for securities purchased	8,921		10,972
Capital lease obligations	321		485
Debt	19,956		19,956
Total liabilities	953,878		901,111

Commitments and contingencies (Note 7)

Shareholders’ equity
Common stock: $0.01 par value; 30,000,000 shares authorized; 15,743,472 and 15,500,052 shares issued and outstanding , respectively	157		155
Additional paid-in capital	119,015		114,070
Accumulated other comprehensive income, net of taxes	1,301		8,709
Retained earnings	244,049		182,400
Total shareholders’ equity	364,522		305,334
Total liabilities and shareholders’ equity	$	1,318,400	$	1,206,445

The accompanying notes are an integral part of these financial statements.

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

(Dollars in thousands, except per share and share data)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2004		2005		2004

Net earned premiums	$	157,521	$	149,473	$	470,451	$	439,983
Net investment income	7,939		6,866		23,051		20,322
Net realized gains on investments	58		712		454		1,316
Finance and other service income	4,322		4,098		12,268		11,698
Total revenue	169,840		161,149		506,224		473,319

Losses and loss adjustment expenses	89,748		103,282		293,720		320,209
Underwriting, operating and related expenses	36,769		36,209		113,335		106,649
Interest expenses	262		168		710		480
Total expenses	126,779		139,659		407,765		427,338

Income before income taxes	43,061		21,490		98,459		45,981
Income tax expense	12,586		6,313		30,236		14,154
Net income	$	30,475	$	15,177	$	68,223	$	31,827

Earnings per weighted average common share:
Basic	$	1.95	$	0.99	$	4.39	$	2.08
Diluted	$	1.92	$	0.98	$	4.29	$	2.06

Cash dividends paid per common share	$	0.18	$	0.12	$	0.42	$	0.32

Weighted average number of common shares outstanding:
Basic	15,630,838		15,318,862		15,552,128		15,283,000
Diluted	15,878,212		15,521,420		15,912,808		15,468,389

The accompanying notes are an integral part of these financial statements.

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

(Dollars in thousands)

					Accumulated			Promissory
					Other			Notes
			Additional		Comprehensive			Receivable						Total
	Common		Paid-in		Income/(Loss),			From			Retained			Shareholders’
	Stock		Capital		Net of Taxes			Management			Earnings			Equity

Balance at December 31, 2003	$	153	$	111,074	$	12,650		$	(34	)	$	144,177		$	268,020
Net income, January 1 to September 30, 2004											31,827			31,827
Payments on promissory notes from management								34						34
Other comprehensive loss, net of deferred federal income taxes					(2,819		)							(2,819		)
Exercise of options and unearned compensation on restricted stock, net of deferred federal income taxes	2		2,311											2,313
Dividends paid											(4,908		)	(4,908		)
Balance at September 30, 2004	$	155	$	113,385	$	9,831		$	—		$	171,096		$	294,467

Accumulated

Other

Additional

Comprehensive

Total

Common

Paid-in

Income/(Loss),

Retained

Shareholders’

Stock

Capital

Net of Taxes

Earnings

Equity

Balance at December 31, 2004

155

114,070

8,709

182,400

305,334

Net income, January 1 to September 30, 2005

68,223

Other comprehensive loss, net of deferred federal income taxes

(7,408

)

(7,408

)

Exercise of options and unearned compensation on restricted stock, net of deferred federal income taxes

4,490

4,492

Tax contingency reserve adjustment

455

Dividends paid

(6,574

)

(6,574

)

Balance at September 30, 2005

157

119,015

1,301

244,049

364,522

The accompanying notes are an integral part of these financial statements.

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

(Dollars in thousands)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004

Net income	$	30,475		$	15,177		$	68,223		$	31,827

Other comprehensive (loss) income, net of tax:
Change in unrealized holding gains, net of tax expense (benefit) of $(3,034), $4,387, $(3,830) and $(1,057)	(5,634		)	8,149			(7,113		)	(1,964		)
Reclassification adjustment for gains included in net income, net of tax benefit of $(20), $(249), $(159), and $(461)	(38		)	(463		)	(295		)	(855		)
Unrealized (losses) gains on securities available for sale	(5,672		)	7,686			(7,408		)	(2,819		)

Comprehensive income	$	24,803		$	22,863		$	60,815		$	29,008

The accompanying notes are an integral part of these financial statements.

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

	Nine Months Ended September 30,
	2005			2004
Cash flows from operating activities:
Net income	$	68,223		$	31,827
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization, net	6,318			5,927
Benefit for deferred income taxes	(2,157		)	(640		)
Gains on sale of fixed assets	—			(4		)
Net realized gains on investments	(454		)	(1,316		)
Changes in assets and liabilities:
Accounts receivable	(16,716		)	(25,859		)
Accrued investment income	(1,044		)	(356		)
Receivable from reinsurers	259			15,613
Prepaid reinsurance premiums	2,456			(11,779		)
Deferred policy acquisition costs	(6,844		)	(5,885		)
Other assets	(25,577		)	(17,897		)
Loss and loss adjustment expense reserves	4,916			48,744
Unearned premium reserves	38,334			60,309
Accounts payable and accrued liabilities	(16,012		)	(9,688		)
Payable to reinsurers	26,093			2,764
Other liabilities	3,310			(2,086		)
Net cash provided by operating activities	81,105			89,674

Cash flows from investing activities:
Fixed maturities purchased	(95,883		)	(83,158		)
Equity securities purchased	(1,252		)	—
Proceeds from sales of fixed maturities	41,540			91,854
Proceeds from maturities of fixed maturities	4,975			7,520
Proceeds from sales of equity securities	233			—
Fixed assets purchased	(610		)	(254		)
Proceeds from sales of fixed assets	—			4
Net cash (used for) provided by investing activities	(50,997		)	15,966

Cash flows from financing activities:
Payments on promissory notes from management	—			34
Proceeds from exercises of stock options	2,367			1,687
Dividends paid to shareholders	(6,574		)	(4,908		)
Net cash used for financing activities	(4,207		)	(3,187		)

Net increase in cash and cash equivalents	25,901			102,453
Cash and cash equivalents at beginning of year	155,673			26,284
Cash and cash equivalents at end of period	$	181,574		$	128,737

The accompanying notes are an integral part of these financial statements.

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

1. Basis of Presentation

The consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America (“GAAP”). GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates.

The consolidated financial statements include Safety Insurance Group, Inc. and its subsidiaries (the “Company”). The subsidiaries consist of Safety Insurance Company, Safety Indemnity Insurance Company, Thomas Black Insurance Agency, Inc. (“TBIA”), and RBS, Inc., TBIA’s holding company. All intercompany transactions have been eliminated. Prior period amounts have been reclassified to conform to the current period presentation.

The financial information as of September 30, 2005 and for the three and nine months ended September 30, 2005 and 2004 is unaudited; however, in the opinion of the Company, the information includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial condition and results of operations for the periods. These unaudited consolidated financial statements may not be indicative of financial results for the full year and should be read in conjunction with the audited financial statements included in the Company’s annual report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on March 16, 2005.

The Company is a leading provider of personal lines property and casualty insurance focused exclusively on the Massachusetts market. Its principal product line is private passenger automobile insurance, which accounted for 81.0% of its direct written premiums in 2004. The Company operates through its insurance company subsidiaries, Safety Insurance Company and Safety Indemnity Insurance Company.

2. New Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard No. (“FAS”) 123R (revised 2004), “Share-Based Payment”. This statement requires companies to measure and recognize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value. FAS 123R replaces FAS 123, “Accounting for Stock-Based Compensation”, and supersedes Accounting Principles Board No. (“APB”) 25, “Accounting for Stock Issued to Employees”. In April 2005, the SEC postponed the effective date of FAS 123R until the fiscal year beginning after June 15, 2005. The Company is currently evaluating the effects of FAS 123R.

3. Earnings Per Weighted Average Common Share

Basic earnings per weighted average common share (“EPS”) are calculated by dividing net income by the weighted average number of basic common shares outstanding during the period. Diluted EPS are calculated by dividing net income by the weighted average number of basic common shares outstanding and the net effect of potentially dilutive common shares. At September 30, 2005 and 2004, the Company’s potentially dilutive instruments consisted of common shares under options of 586,560 and 753,512, respectively, and common shares under restriction of 105,960 and 70,271, respectively.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2004		2005		2004
Earnings per weighted average common share:
Basic	$	1.95	$	0.99	$	4.39	$	2.08
Diluted	$	1.92	$	0.98	$	4.29	$	2.06

Weighted average number of common shares outstanding:
Basic	15,630,838		15,318,862		15,552,128		15,283,000
Effect of dilutive securities:
Stock options	212,522		193,846		335,645		180,398
Restricted stock	34,852		8,712		25,035		4,991
Diluted	15,878,212		15,521,420		15,912,808		15,468,389

Diluted EPS excludes stock options with exercise prices greater than the average market price of the Company’s common stock during the period because their inclusion would be anti-dilutive. For the nine months ended September 30, 2005, there were 78,000 anti-dilutive stock options. There were no anti-dilutive stock options for the nine months ended September 30, 2004 and for the three months ended September 30, 2005, and 2004.

4. Stock-Based Compensation

On June 25, 2002, the Board adopted the 2002 Management Omnibus Incentive Plan (“the Incentive Plan”). The Incentive Plan provides for a variety of awards, including nonqualified stock options (“NQSOs”), stock appreciation rights and restricted stock (“RS”) awards. The maximum number of shares of common stock with respect to which awards may be granted under the Incentive Plan is 1,250,000. At September 30, 2005, there were 179,959 shares available for future grant. The Board and the Compensation Committee intend to issue more awards under the Incentive Plan in the future.

There were no grants made under the Incentive Plan during the three months ended September 30, 2005. A summary of stock-based awards granted under the Incentive Plan during the nine months ended September 30, 2005 is as follows:

		Number of	Per Share
Type of Equity		Awards	Exercise Price(1)			Expiration
Awarded	Effective Date	Granted	or Fair Value(2)		Vesting Terms	Date
NQSOs	March 16, 2005	78,000	35.23	(1)	5 years, 20% annually	March 16, 2015
RS	March 16, 2005	56,770	35.23	(2)	3 years, 30%, 30%, 40%	N/A
RS	March 16, 2005	4,000	35.23	(2)	No vesting period (3)	N/A

(1) The exercise price of the stock option grant is equal to the closing price of the Company’s common stock on the grant effective date.

(2) The fair value of the restricted stock grant is equal to the closing price of the Company’s common stock on the grant effective date.

(3) The shares cannot be sold, assigned, pledged, or otherwise transferred, encumbered or disposed of until the recipient is no longer a member of our Board of Directors.

The following table summarizes stock option activity under the Incentive Plan:

	Nine Months Ended September 30,
	2005				2004
	Shares		Weighted		Shares		Weighted
	Under		Average		Under		Average
	Option		Exercise Price		Option		Exercise Price
Outstanding at beginning of year	711,410		$	13.60	771,000		$	12.59
Granted during the period	78,000		35.23		121,000		18.74
Exercised during the period	(182,650	)	12.96		(134,888	)	12.50
Forfeited during the period	(20,200	)	23.01		(3,600	)	16.19
Outstanding at end of current quarter	586,560		16.35		753,512		13.58

The range of exercise prices on stock options outstanding under the Incentive Plan was $12.00 to $35.23 at September 30, 2005 and $12.00 to $21.40 at September 30, 2004.

The following table summarizes restricted stock activity under the Incentive Plan:

	Nine Months Ended September 30,
	2005				2004
	Shares		Weighted		Shares	Weighted
	Under		Average		Under	Average
	Restriction		Fair Value		Restriction	Fair Value
Outstanding at beginning of year	70,271		$	18.50	—	$	—
Granted during the period	60,770		35.23		70,271	18.50
Vested and unrestricted during the period	(21,081	)	18.50		—	—
Forfeited during the period	—		—		—	—
Outstanding at end of current quarter	109,960		27.75		70,271	18.50

The Company has adopted the accounting for the Incentive Plan under the recognition and measurement principles of APB 25, “Accounting for Stock Issued to Employees”, as allowed by FAS 123 and as amended by FAS 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”. No stock-based employee compensation cost related to stock options is reflected in net income, as all stock options granted under this plan had an exercise price equal to the market value of the underlying common stock on the effective date of grant.

The following table illustrates the effect on net income and EPS if the Company had applied the fair value recognition provisions of FAS 123 to these stock options.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
Net income, as reported	$	30,475		$	15,177		$	68,223		$	31,827
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects	(135		)	(119		)	(406		)	(337		)
Net income, proforma	$	30,340		$	15,058		$	67,817		$	31,490

Earnings per weighted average share:
Basic, as reported	$	1.95		$	0.99		$	4.39		$	2.08
Basic, pro forma	$	1.94		$	0.98		$	4.36		$	2.06
Diluted, as reported	$	1.92		$	0.98		$	4.29		$	2.06
Diluted, proforma	$	1.88		$	0.98		$	4.25		$	2.05

The fair value of stock options used to compute pro forma net income and earnings per share disclosures for the three and nine months ended September 30, 2005 and 2004 is the estimated fair value at grant effective date using the Black-Scholes option-pricing model with the following assumptions:

	Three and Nine Months Ended September 30,
	2005	2004
Dividend yield	1.36% - 2.52%	1.87% - 2.52%
Expected volatility	.20 - .31	.20 - .31
Risk-free interest rate	3.23% - 4.35%	3.23% - 4.07%
Expected holding period (in years)	7	7

5. Investments

The gross unrealized appreciation (depreciation) of investments in fixed maturities securities, including redeemable preferred stocks that have characteristics of fixed maturities, and equity securities, including interests in mutual funds, was as follows:

September 30, 2005

Gross

Estimated

Unrealized

Fair

Cost

Gains

Losses

Value

U.S. Treasury securities and obligations of U.S. Government agencies(1)

131,070

182

(2,189

)

129,063

Obligations of states and political subdivisions

322,420

5,362

(2,601

)

325,181

Asset-backed securities

100,437

456

(994

)

99,899

Corporate and other securities

138,945

2,846

(1,161

)

140,630

Subtotal, fixed maturity securities

692,872

8,846

(6,945

)

694,773

Equity securities

2,057

100

—

2,157

Totals

694,929

8,946

(6,945

)

696,930

(1) Obligations of U.S. Government agencies include collateralized mortgage obligations issued, guaranteed and/or insured by the following issuers: Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association (FNMA). The total of these fixed maturity securities was $122,902 at amortized cost and $120,921 at estimated fair value as of September 30, 2005. As such, the asset-backed securities presented exclude such issuers already presented under U.S. Treasury securities and obligations of U.S. Government Agencies.

The amortized cost and the estimated fair value of fixed maturity securities, by maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	September 30, 2005
	Amortized Cost		Fair Value
Due in one year or less	$	22,145	$	22,065
Due after one year through five years	155,366		155,099
Due after five years through ten years	207,800		210,591
Due after ten years through twenty years	64,950		65,591
Due after twenty years	19,272		20,607
Asset-backed securities	223,339		220,820
Totals	$	692,872	$	694,773

Gross gains of $66 and $777 and gross losses of $8 and $65 were realized on sales of fixed maturities for the three months ended September 30, 2005 and 2004, respectively. There were no realized gains or losses realized on sales of equity securities for the three months ended September 30, 2005 and 2004, respectively. Gross gains of $478 and $1,522 and gross losses of $25 and $206 were realized on sales of fixed maturities for the nine months ended September 30, 2005 and 2004, respectively. Gross gains of $1 and gross losses of $0 were realized on sales of equity securities for the nine months ended September 30, 2005. There were no realized gains or losses on the sale of equity securities for the nine months ended September 30, 2004. Proceeds from fixed maturities maturing were $4,975 and $7,520 for the nine months ended September 30, 2005 and 2004, respectively.

The following tables illustrate the gross unrealized losses included in the Company’s investment portfolio and the fair value of those securities aggregated by investment category. The table also illustrates the length of time that they have been in a continuous unrealized loss position.

September 30, 2005

Less than 12 Months

12 Months or More

Total

Unrealized

Fair Value

Losses

Fair Value

Losses

Fair Value

Losses

U.S. Treasury securities and obligations of U.S. Government agencies

63,810

620

53,778

1,569

117,588

2,189

Obligations of states and political subdivisions

56,622

796

91,759

1,805

148,381

2,601

Asset-backed securities

52,481

677

15,667

317

68,148

994

Corporate and other securities

49,379

654

17,419

507

66,798

1,161

Total temporarily impaired securities

222,292

2,747

178,623

4,198

400,915

6,945

The Company’s investment portfolio included 172 securities in an unrealized loss position at September 30, 2005. The Company’s methodology of assessing other-than-temporary impairment is based upon analysis of each security as of the balance sheet date and considers various factors including the length of time and the extent to which fair value has been less than the cost, the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for recovery of its costs.

During the three and nine months ended September 30, 2005 and 2004, there was no significant deterioration in the credit quality of any of the Company’s holdings and no other-than-temporary impairment charges were recorded related to the Company’s portfolio of investment securities.

As of September 30, 2005, the Company’s fixed income securities portfolio was comprised entirely of investment grade securities as defined by Moody’s Investor Services, Inc., Standard and Poor’s, and the Securities Valuation Office of the National Association of Insurance Commissioners.

Net Investment Income

The components of net investment income were as follows:

	Three Months Ended, September 30,				Nine Months Ended, September 30,
	2005		2004		2005		2004
Interest and dividends on fixed maturities	$	6,951	$	6,818	$	20,873	$	20,552
Dividends on equity securities	8		—		19		—
Interest on cash and cash equivalents	1,252		297		2,957		521
Total investment income	8,211		7,115		23,849		21,073
Investment expenses	272		249		798		751
Net investment income	$	7,939	$	6,866	$	23,051	$	20,322

6. Loss and Loss Adjustment Expense (“LAE”) Reserves

The following table sets forth a reconciliation of beginning and ending reserves for losses and LAE, as shown in the Company’s consolidated financial statements for the periods indicated:

	Nine Months Ended September 30,
	2005			2004
Reserves for losses and LAE, beginning of year	$	450,897		$	383,551
Less reinsurance recoverable on unpaid losses and LAE	(84,167		)	(73,539		)
Net reserves for losses and LAE, beginning of year	366,730			310,012
Incurred losses and LAE, related to:
Current year	321,182			322,458
Prior years	(27,462		)	(2,249		)
Total incurred losses and LAE	293,720			320,209
Paid losses and LAE related to:
Current year	171,289			168,022
Prior years	114,641			110,981
Total paid losses and LAE	285,930			279,003
Net reserves for losses and LAE, end of current quarter	374,520			351,218
Plus reinsurance recoverables on unpaid losses and LAE	81,293			81,077
Reserves for losses and LAE, end of current quarter	$	455,813		$	432,295

At the end of each period, the reserves were re-estimated for all prior accident years. Primarily due to an improvement in Commonwealth Automobile Reinsurers (“CAR”) results, the Company’s prior year reserves decreased by $27,462 and $2,249 for the nine months ended September 30, 2005 and 2004, respectively. The decrease in prior year reserves during the 2005 period resulted from re-estimations of prior year ultimate loss and LAE liabilities and is composed of reductions of $18,212 in CAR assumed reserves and $9,250 in the Company’s automobile reserves. It is not appropriate to extrapolate future favorable or unfavorable development of reserves from this past experience.

Due to the nature of the risks that the Company underwrites and has historically underwritten, management does not believe that it has an exposure to asbestos or environmental pollution liabilities.

7. Commitments and Contingencies

Various claims, generally incidental to the conduct of normal business, are pending or alleged against the Company from time to time. In the opinion of management, based in part on the advice of legal counsel, the ultimate resolution of such claims will not have a material adverse effect on the Company’s consolidated financial statements. However, liabilities related to those proceedings could be established in the near term if estimates of the ultimate resolutions of those proceedings are revised.

Massachusetts law requires that insurers licensed to do business in Massachusetts participate in the Massachusetts Insurers Insolvency Fund (“Insolvency Fund”). Members of the Insolvency Fund are assessed a proportionate share of the obligations and expenses of the Insolvency Fund in connection with an insolvent insurer. Although the Company has not received written notice regarding 2005 actions to be taken by the Insolvency Fund, based upon existing knowledge that a reimbursement of prior year assessments has been approved by the Board of Directors of the Insolvency Fund, the Company reduced its estimated potential assessments to $0 for the nine months ended 2005, which resulted in a reduction to underwriting expenses of $1,300 for the three months ended September 30, 2005. On November 1, 2004, the Company received notice of assessments from the Insolvency Fund related to prior year losses amounting to $2,538, which it fully expensed over the nine months ended September 30, 2004, and which resulted in an addition of $815 to underwriting expenses during the three months ended September 30, 2004.

It is anticipated that there will be additional assessments from time to time relating to various insolvencies. Although the timing and amounts of any future assessments are not known, based upon existing knowledge, management’s opinion is that such future assessments will not have a material effect upon the financial position of the Company.

8. Debt

Concurrent with the closing of the Company’s November 27, 2002 initial public offering, the Company obtained a new $30,000 revolving credit facility. Bank of America was the lender under this credit facility. Under an agreement effective on June 17, 2005, Bank of America assigned the $30,000 credit facility to Citizens Bank of Massachusetts. Under a June 17, 2005 amendment to the credit facility, the maturity date was extended to June 17, 2008. Other terms of the revolving credit facility remain unchanged.

9. Income Taxes

Federal income tax expense for the nine months ended September 30, 2005 and 2004 has been computed using estimated effective tax rates. These rates are revised, if necessary, at the end of each successive interim period to reflect the current estimates of the annual effective tax rates.

During the quarter ended September 30, 2005, an examination of the Company’s federal income tax returns for the tax periods ended December 31, 2003, 2002, and 2001 by the Internal Revenue Service (“IRS”) was completed. The Company recorded a $1,616 tax benefit representing a reduction in federal income tax reserves for tax years 2001 through 2003, resulting from a settlement reached with the IRS in August 2005. Of this total tax benefit, $455 was recorded as an increase to additional paid-in capital and $1,161 was recorded as a reduction to income tax expense for the three and nine months ended September 30, 2005.

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our accompanying consolidated financial statements and notes thereto, which appear elsewhere in this document. In this discussion, all dollar amounts are presented in thousands, except share and per share data.

The following discussion contains forward-looking statements. We intend statements which are not historical in nature to be, and are hereby identified as “forward-looking statements” to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In addition, the Company’s senior management may make forward-looking statements orally to analysts, investors, the media and others. This safe harbor requires that we specify important factors that could cause actual results to differ materially from those contained in forward-looking statements made by or on behalf of us. We cannot promise that our expectations in such forward-looking statements will turn out to be correct. Our actual results could be materially different from and worse than our expectations. See “Forward-Looking Statements” on page 31 for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.

Executive Summary and Overview

In this discussion, “Safety” refers to Safety Insurance Group, Inc. and “our Company,” “we,” “us” and “our” refer to Safety Insurance Group, Inc. and its consolidated subsidiaries. Our subsidiaries consist of Safety Insurance Company (“Safety Insurance”), Safety Indemnity Insurance Company, Thomas Black Insurance Agency, Inc. (“TBIA”) and RBS, Inc., TBIA’s holding company.

We are a leading provider of private passenger automobile insurance in Massachusetts. In addition to private passenger automobile insurance (which represented 81.0% of our direct written premiums in 2004), we offer a portfolio of other insurance products, including commercial automobile (10.4% of 2004 direct written premiums), homeowners (7.2% of 2004 direct written premiums), dwelling fire, umbrella and business owner policies. Operating exclusively in Massachusetts through our insurance company subsidiaries, Safety Insurance and Safety Indemnity Insurance Company (together referred to as the “Insurance Subsidiaries”), we have established strong relationships with 556 independent insurance agents in 659 locations throughout Massachusetts. We have used these relationships and our extensive knowledge of the Massachusetts market to become the second largest private passenger automobile insurance carrier in Massachusetts, capturing an approximate 11.3% share of the Massachusetts private passenger automobile market in 2005, according to the Commonwealth Automobile Reinsurers (“CAR”) Cession Volume Analysis Report of November 1, 2005, based on automobile exposures. These statistics total, for each vehicle insured, the number of months during the year insurance for that vehicle is in effect, to arrive at an aggregate number of car-months for each insurer; this aggregate number, divided by 12, equals the insurer’s number of car-years, a measure we refer to in this discussion as automobile exposures.

Massachusetts Automobile Insurance Market

We are subject to the extensive regulation of the private passenger automobile insurance industry in Massachusetts, which represented 81.0% of our direct written premiums in 2004. Owners of registered automobiles in Massachusetts are required to maintain minimum automobile insurance coverages. We are required to participate in a state-mandated reinsurance program run by CAR to which we cede certain unprofitable risks and from which we are allocated a portion of the overall losses. As a servicing carrier of CAR, we are required to issue a policy to all qualified applicants. This program operates at an underwriting deficit. This deficit is allocated among every Massachusetts automobile insurance company, including us, based on a complex formula that takes into consideration a company’s voluntary market share, the rate at which it cedes business to CAR, and the company’s utilization of a credit system CAR has designed to encourage carriers to reduce their use of CAR. In addition, based on our market share, we are assigned certain licensed producers by CAR that have been unable to obtain a voluntary contract with another insurer. We call these agents Exclusive Representative Producers, or ERPs.

On April 29, 2004, the Governor of Massachusetts (the “Governor”) announced the formation of a bipartisan task force charged with reviewing potential changes to the Massachusetts personal automobile insurance system that, according to the Governor’s announcement, “will open the door to more competition, move to a rate-setting system that is more in line with the rest of the country, examine the costs and benefits of our current “no fault” claims process, crack down on fraud and eliminate the subsidy that good drivers pay for bad drivers.” The Governor also announced “that the Division of Insurance has taken the first steps toward reform by pushing for changes in the distribution of losses generated by high-risk drivers.” As a result, in a letter to CAR dated April 29, 2004, the Massachusetts Insurance Commissioner (the “Commissioner”) directed CAR to materially change

the operation of the residual market in Massachusetts, including the formula by which CAR’s deficit is allocated and the manner in which policies produced by ERPs are assigned to insurers.

On December 31, 2004, the Commissioner approved new rules for CAR, which became effective on January 1, 2005 (the “Approved Rules”). On January 14, 2005, we filed, on Form 8-K, an estimate of the financial impact the Approved Rules may have on us and we stated that a lawsuit had been filed in Suffolk Superior Court by Commerce Insurance Company against the Commissioner that seeks an order permanently enjoining implementation and/or enforcement of the Approved Rules. Certain ERPs, Arbella Mutual Insurance Company and the Center for Insurance Research intervened as plaintiffs and CAR intervened as a defendant in this lawsuit. On June 20, 2005, the Massachusetts Superior Court ruled that the Commissioner lacked the statutory authority to implement the Approved Rules and ordered them vacated. As a result, the Approved Rules will not go into effect. The Commissioner has appealed the decision of the Massachusetts Superior Court. On October 26, 2005, the Massachusetts Supreme Judicial Court agreed to take direct appellate review of the Commissioner’s appeal. At the present time, we are unable to predict whether the Commissioner’s appeal will be approved.

CAR annually approves the rules that set the value of credits and the cost to cede business. On March 9, 2005, CAR approved rules for the operation of the residual market for 2005 (the “2005 Rules”). CAR filed the 2005 Rules with the Commissioner on March 29, 2005, and a hearing to consider the 2005 Rules was held on May 31, 2005. The 2005 Rules revise the value of credits based on the actual rate subsidies contained in the Commissioner’s rate decision, and reduce the cost for ceding high loss ratio ERP business to CAR. The 2005 Rules would reduce the penalty in the current rules for ceding high loss ratio ERP business to CAR, and would therefore result in a reduction of the expense we incur because of our disproportionate share of high loss ratio ERP business. On September 20, 2005, the Commissioner disapproved the 2005 Rules, and requested CAR to resubmit new rules. On October 5, 2005, CAR approved and filed with the Commissioner rules for the operation of the residual market for 2005 (the “Revised 2005 Rules”) that revise the value of credits based on the actual rate subsidies contained in the Commissioner’s rate decision, and do not reduce the cost for ceding high loss ratio ERP business to CAR. The Revised 2005 Rules would not reduce the penalty in the current rules for ceding high loss ratio ERP business to CAR, and would therefore not result in a reduction of the expense we incur because of our disproportionate share of high loss ratio ERP business. According to CAR Bulletin 809 issued November 7, 2005, the Revised 2005 Rules became effective as no public hearing was requested by any interested party and the Revised 2005 Rules were not disapproved by the Commissioner within thirty days of the submission.

On June 15, 2005, CAR approved rules to modify the ERP subscription relief process, making the reassignment of ERP exposures from an oversubscribed servicing carrier more timely and responsive, while enhancing equity in the ERP distribution for all servicing carriers (the “ERP Subscription Rules”). Also, the current practice of two and three-party agreements between ERPs and servicing carriers would be prohibited. On September 30, 2005, the Commissioner approved the ERP Subscription Rules, and instructed CAR to complete, within 60 days, a redistribution of all ERPs that will establish for all servicing carriers overall parity in the quantity and quality of their ERP exposures. We expect that the redistribution of ERPs will eliminate our disproportionate share of high loss ratio ERP business, and would therefore result in a reduction of the expense we incur because of our disproportionate share of high loss ratio ERPs. However, it is possible that other servicing carriers or ERPs could bring challenges, with regards to the redistribution of ERPs, and as a result there can be no assurances that our expenses will be reduced.

On June 1, 2005, the Governor filed legislation that would introduce more competition into the Massachusetts automobile insurance marketplace, reduce rates for good drivers, target fraud and excessive personal injury costs, and allow insurers rate flexibility. At this time we are unable to predict whether the Governor’s legislation will be approved.

Each year, the Commissioner sets maximum premium rates that may be charged and minimum commissions that must be paid to agents for private passenger automobile insurance. The Commissioner announced on December 15, 2004, a 1.7% statewide average private passenger automobile insurance rate decrease for 2005, compared to a 2.5% increase for 2004. Coinciding with the 2005 rate decision, the Commissioner also approved a 10.9% commission rate agents receive for selling private passenger automobile insurance, as a percentage of premiums, compared to a commission rate of 10.5% in 2004. The Commissioner will set the average rate for 2006 after a hearing in which the Automobile Insurers Bureau, the Attorney General, and the State Rating Bureau (which is a department within the Massachusetts Division of Insurance) are parties. On August 11, 2005, the Automobile Insurers Bureau proposed an average 0.1% rate decrease for 2006. The Attorney General has recommended a decrease of 18.0%, and the State Rating Bureau has proposed a decrease of 5.4%. The Commissioner has not yet set the average premium rate for 2006. We expect the Commissioner to make this decision by December 15, 2005.

While state-mandated average maximum private passenger automobile insurance rates decreased 1.7% for 2005, our average premium per automobile exposure in the nine months ended September 30, 2005 increased from the nine months ended September 30, 2004 by approximately 0.4%. This increase was primarily the result of purchases of new automobiles by our insureds. We believe that the continued benefits of our rate pursuit initiative, which validates insured rating classifications and discount eligibility, contributed to the increase in our average premiums received per automobile exposure. The table below shows average Massachusetts-mandated private passenger automobile premium rate changes and changes in our average premium per automobile exposure from 1996-2005.

Massachusetts Private Passenger Rate Decisions

	State Mandated		Safety Change in
	Average Rate		Average Premium per
Year	Change (1)		Automobile Exposure (2)
2005	-1.7	%	0.4	%
2004	2.5	%	6.1	%
2003	2.7	%	6.9	%
2002	0.0	%	5.2	%
2001	-8.3	%	0.0	%
2000	0.7	%	7.4	%
1999	0.7	%	10.9	%
1998	-4.0	%	2.8	%
1997	-6.2	%	-5.1	%
1996	-4.5	%	-7.7	%

(1) Source: Commissioner rate decisions for 1996 - 2005.

(2) Source: Safety Insurance.

Statutory Accounting Principles

Our results are reported in accordance with GAAP, which differ from amounts reported in accordance with statutory accounting principles (“SAP”) as prescribed by insurance regulatory authorities. Specifically, under GAAP:

• Policy acquisition costs such as commissions, premium taxes and other variable costs incurred in connection with writing new and renewal business are capitalized and amortized on a pro rata basis over the period in which the related premiums are earned, rather than expensed as incurred, as required by SAP.

• Certain assets are included in the consolidated balance sheets whereas, under SAP, such assets are designated as “nonadmitted assets” and charged directly against statutory surplus. These assets consist primarily of premium receivables that are outstanding over 90 days, federal deferred tax assets in excess of statutory limitations, furniture, equipment, leasehold improvements and prepaid expenses.

• Amounts related to ceded reinsurance are shown gross as prepaid reinsurance premiums and reinsurance recoverables, rather than netted against unearned premium reserves and loss and loss adjustment expense reserves, respectively, as required by SAP.

• Fixed maturities securities, which are classified as available-for-sale, are reported at current market values, rather than at amortized cost, or the lower of amortized cost or market, depending on the specific type of security, as required by SAP.

• Equity securities are reported at quoted market values, which may differ from the National Association of Insurance Commissioners market values as required by SAP.

• The differing treatment of income and expense items results in a corresponding difference in federal income tax expense. Changes in deferred income taxes are reflected as an item of income tax benefit or expense, rather than recorded directly to surplus as regards policyholders, as required by SAP. Admittance testing may result in a charge to unassigned surplus for non-admitted portions of deferred tax assets. Under GAAP reporting, a valuation allowance may be recorded against the deferred tax asset and reflected as an expense.

Insurance Ratios

The property and casualty insurance industry uses the combined ratio as a measure of underwriting profitability. The combined ratio is the sum of the loss ratio (losses and loss adjustment expenses incurred as a percent of net earned premiums) plus the expense ratio (underwriting expenses as a percent of net written premiums, if calculated on a SAP basis, or net earned premiums, if calculated on a GAAP basis). The combined ratio reflects only underwriting results, and does not include income

from investments or finance and other service income. Underwriting profitability is subject to significant fluctuations due to competition, catastrophic events, weather, economic and social conditions and other factors.

Our SAP insurance ratios are outlined in the following table.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2004		2005		2004
Statutory Ratios
Loss ratio	57.0	%	69.1	%	62.4	%	72.7	%
Expense ratio	23.4	%	24.0	%	23.3	%	22.9	%
Combined ratio	80.4	%	93.1	%	85.7	%	95.6	%

Under GAAP, the loss ratio is computed in the same manner as under SAP, but the expense ratio is determined by matching underwriting expenses to the period over which net premiums were earned, rather than to the period that net premiums were written.

Our GAAP insurance ratios are outlined in the following table.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2004		2005		2004
GAAP ratios
Loss ratio	57.0	%	69.1	%	62.4	%	72.8	%
Expense ratio	23.3	%	24.2	%	24.1	%	24.2	%
Combined ratio	80.3	%	93.3	%	86.5	%	97.0	%

Stock-Based Compensation

On June 25, 2002, the Board adopted the 2002 Management Omnibus Incentive Plan (“the Incentive Plan”). The Incentive Plan provides for a variety of awards, including nonqualified stock options (“NQSOs”), stock appreciation rights and restricted stock (“RS”) awards. The maximum number of shares of common stock with respect to which awards may be granted under the Incentive Plan is 1,250,000. At September 30, 2005 there were 179,959 shares available for future grant. The Board and the Compensation Committee intend to issue more awards under the Incentive Plan in the future. Grants made under the Incentive Plan during the nine months ended September 30, 2005 are as follows:

		Number of	Per Share
Type of Equity		Awards	Exercise Price(1)			Expiration
Awarded	Effective Date	Granted	or Fair Value(2)		Vesting Terms	Date
NQSOs	March 16, 2005	78,000	35.23	(1)	5 years, 20% annually	March 16, 2015
RS	March 16, 2005	56,770	35.23	(2)	3 years, 30%, 30%, 40%	N/A
RS	March 16, 2005	4,000	35.23	(2)	No vesting period (3)	N/A

(1) The exercise price of the stock option grant is equal to the closing price of the Company’s common stock on the grant effective date.

(2) The fair value of the restricted stock grant is equal to the closing price of the Company’s common stock on the grant effective date.

(3) The shares cannot be sold, assigned, pledged, or otherwise transferred, encumbered or disposed of until the recipient is no longer a member of our Board of Directors.

Reinsurance

We reinsure with other insurance companies a portion of our potential liability under the policies we have underwritten, thereby protecting us against an unexpectedly large loss or a catastrophic occurrence that could produce large losses, primarily in our homeowners line of business. As of January 1, 2005 our catastrophe reinsurance provides gross per occurrence reinsurance coverage up to $250,000. As of September 30, 2005 our catastrophe reinsurance protects us in the event of a “415-year storm” (that is, a storm of a severity expected to occur once in a 415-year period). Swiss Re, our primary reinsurer, maintains an A.M.

Best rating of “A+” (Superior). All of our other reinsurers have an A.M. Best rating of “A” (Excellent) or better except for Montpelier Re and Endurance Re which are rated “A-” (Excellent). We are a participant in CAR, a state-established body that runs the residual market reinsurance programs for both private passenger and commercial automobile insurance in Massachusetts under which premiums, expenses, losses and loss adjustment expenses on ceded business are shared by all insurers writing automobile insurance in Massachusetts. We also participate in the Massachusetts Property Insurance Underwriting Association in which premiums, expenses, losses and loss adjustment expenses on homeowners business that cannot be placed in the voluntary market are shared by all insurers writing homeowners insurance in Massachusetts. As of September 30, 2005, we had no material amounts recoverable from any reinsurer, excluding the residual markets described above.

On March 10, 2005, our Board of Directors adopted a resolution that prohibits Safety from purchasing finite reinsurance without approval by the Board. To date, the Company has never purchased a finite reinsurance contract.

Effects of Inflation

We do not believe that inflation has had a material effect on our consolidated results of operations, except insofar as inflation may affect interest rates.

Critical Accounting Policies and Estimates

Loss and Loss Adjustment Expense Reserves

Significant periods of time can elapse between the occurrence of an insured loss, the reporting to us of that loss and our final payment of that loss. To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities. Our reserves represent estimates of amounts needed to pay reported and unreported losses and the expenses of investigating and paying those losses, or loss adjustment expenses. Every quarter, we review our previously established reserves and adjust them, if necessary.

When a claim is reported, claims personnel establish a “case reserve” for the estimated amount of the ultimate payment. The amount of the reserve is primarily based upon an evaluation of the type of claim involved, the circumstances surrounding each claim and the policy provisions relating to the loss. The estimate reflects the informed judgment of such personnel based on general insurance reserving practices and on the experience and knowledge of the claims person. During the loss adjustment period, these estimates are revised as deemed necessary by our claims department based on subsequent developments and periodic reviews of the cases.

In accordance with industry practice, we also maintain reserves for estimated losses incurred but not yet reported (“IBNR”). IBNR reserves are determined in accordance with commonly accepted actuarial reserving techniques on the basis of our historical information and experience. We review and make adjustments to incurred but not yet reported reserves quarterly.

When reviewing reserves, we analyze historical data and estimate the impact of various loss development factors, such as our historical loss experience and that of the industry, trends in claims frequency and severity, our mix of business, our claims processing procedures, legislative enactments, judicial decisions, legal developments in imposition of damages, and changes and trends in general economic conditions, including the effects of inflation. A change in any of these factors from the assumption implicit in our estimate can cause our actual loss experience to be better or worse than our reserves, and the difference can be material. There is no precise method, however, for evaluating the impact of any specific factor on the adequacy of reserves, because the eventual development of reserves is affected by many factors.

Management determines the Company’s loss and LAE reserves estimate based upon the work of the Company’s actuaries and management’s own assessment of reasonable reserves. A reasonable estimate is derived primarily by considering a range of indications calculated by the Company’s actuaries using generally accepted actuarial techniques. Our key assumptions are the ultimate frequency and severity of claims, based upon the most recent ten years of claims reported to the Company and the data CAR reports to us to calculate our share of the residual market, as of the date of the applicable balance sheet. For each accident year and each coverage within a line of business our actuaries calculate reserve ranges using actuarial techniques such as:

• Paid Loss Indications: This method projects ultimate loss estimates based upon extrapolations of historic paid loss trends. This method tends to be used on short tail lines such as automobile physical damage.

• Incurred Loss Indications: This method projects ultimate loss estimates based upon extrapolations of historic incurred loss trends. This method tends to be used on long tail lines of business such as automobile liability and homeowner’s liability.

• Bornhuetter-Ferguson Indications: This method projects ultimate loss estimates based upon extrapolations of an expected amount of IBNR, which is added to current incurred losses or paid losses. This method tends to be used on small, immature, or volatile lines of business, such as our BOP and umbrella lines of business.

• Bodily Injury Code Indications: This method projects ultimate loss estimates for our private passenger and commercial automobile bodily injury coverage based upon extrapolations of the historic number of accidents and the historic number of bodily injury claims per accident. Projected ultimate bodily injury claims are then segregated into expected claims by type of injury (e.g. soft tissue injury vs. hard tissue injury) based on past experience. An ultimate severity, or average paid loss amounts, is estimated based upon extrapolating historic trends. Projected ultimate loss estimates using this method are the aggregate of estimated losses by injury type.

Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting future events. It is possible that the final outcome may fall above or below these amounts as a result of a number of factors, including immature data, sparse data, or significant growth in a line of business. Using these methodologies our actuaries established a range of reasonable possible estimations for net reserves of approximately $338,123 to $384,462 as of September 30, 2005. In general, the low and high values of the ranges represent reasonable minimum and maximum values of the indications based on the techniques described above. The following table presents the recorded reserves and the range of estimations by line of business for net loss and LAE reserves as of September 30, 2005.

Range of Net Reserves for Losses and LAE

Line of Business	Low			Recorded			High
Private Passenger Auto	$	260,205		$	286,226		$	291,164
Commercial Auto	45,111			49,719			53,831
Homeowners	26,160			30,869			31,348
All Other	6,647			7,706			8,119
Total	$		338,123	$		374,520	$	384,462

The Company’s net loss and LAE reserves, based on management’s best estimate, were set at $374,520 as of September 30, 2005. For our private passenger and commercial auto lines of business we recorded reserves slightly higher than the mid-point of the range due to our stable long-term trends in frequency and severity. For our homeowners and all other lines of business, due to the relatively short time we have been writing these lines of business, and the resulting immature data available for our analysis, we recorded reserves closer to the high of the range of projections.

The following table presents information by line of business for our net reserves for losses and LAE as of September 30, 2005.

Net Reserves for Losses and LAE

Line of Business	Direct less Ceded		Assumed		Net
Private Passenger Auto	$	206,753
CAR assumed Private Passenger			$	79,473
Net Private Passenger Auto					$	286,226
Commercial Auto	34,760
CAR assumed Commercial Auto			14,959
Net Commercial Auto					49,719
Homeowners	21,722
FAIR Plan assumed Homeowners			9,147
Net Homeowners					30,869
All Other	7,706				7,706
Total Net Reserves for Losses and LAE	$	270,941	$	103,579	$	374,520

CAR Loss and Loss Adjustment Expense Reserves

We are a participant in CAR and assume a significant portion of losses and LAE on business ceded by the industry participants to CAR. We estimate reserves for assumed losses and LAE that have not yet been reported to us by CAR. Our estimations are based upon the same factors we use for our own reserves, plus additional factors due to the nature of and the information we receive from CAR.

The CAR deficit, which consists of premium ceded to CAR less CAR losses and LAE, is allocated amongst every automobile insurance company writing business in Massachusetts based on a complex formula (the “Participation Ratio”) that takes into consideration a company’s voluntary market share, the amount of business it cedes to CAR and credits the company earns under a system CAR has designed to encourage carriers to voluntarily write business in selected under-priced classes and territories.

We receive a Settlement of Balances report from CAR that reports our share of CAR premium, losses and LAE, on a lagged basis, 75 days after the end of every quarter. CAR-published financial data is always at least one quarter behind the financial data we report. For example, when we reported our financial results for the year ended December 31, 2004, we had nine months of reported 2004 CAR financial data, and we had to estimate what CAR would report to us for the last three months of the year.

We receive our final calendar year Participation Ratio report from CAR eight months after the end of that year, and thus we have to estimate for six quarters our share of the CAR deficit. For example, for the year ended December 31, 2004 we had to estimate our 2004 policy year CAR Participation Ratio beginning with the first quarter of 2004 through the second quarter of 2005.

Because of the lag in CAR estimates, and in order to try to validate to the extent possible the information CAR does provide, we must try to estimate the effects of the actions of our competitors in order to establish our Participation Ratio. Before final Participation Ratios are available, we estimate the size of CAR and the resulting deficit, based on historical analysis of CAR results, and estimations of our competitors’ current cession strategies. Even after our final Participation Ratio is available from CAR, we must continue to estimate the size of CAR, and the resulting deficit based upon data published by CAR and our own continuing analysis. As a result, changes in our reserves for CAR may continue to occur until all claims are finally settled. The Loss Reserving Committee at CAR meets 70 days after the end of each quarter to estimate the CAR deficit for all active policy years and publishes estimations, which we use to estimate our share of the deficit. The estimation that CAR calculates is based on data it collects from 19 servicing carriers which settle, reserve and report claims using a variety of methods. Any delays or errors in the collection of this data could have a significant impact on the accuracy of CAR’s estimations.

Although we rely to a significant extent in setting our reserves on the information CAR provides, we are cautious in our use of that information, both because of the delays described above and because the CAR estimates incorporate data CAR receives from all the other CAR servicing carriers in Massachusetts. We do not have direct access to that data or firsthand knowledge of how those carriers are currently conducting their operations. As a result, we are cautious in recording CAR reserves for the calendar years that we have to estimate our Participation Ratio and these reserves are subject to significant judgments and estimates.

Sensitivity Analysis

Establishment of appropriate reserves is an inherently uncertain process. There can be no certainty that currently established reserves based on our key assumptions regarding frequency and severity in our lines of business, or our assumptions regarding our share of the CAR loss will prove adequate in light of subsequent actual experience. To the extent that reserves are inadequate and are strengthened, the amount of such increase is treated as a charge to earnings in the period that the deficiency is recognized. To the extent that reserves are redundant and are released, the amount of the release is a credit to earnings in the period the redundancy is recognized. For the nine months ended September 30, 2005 a 1 percentage-point change in the loss and LAE ratio would result in a change in reserves of $4,705. Each 1 percentage point change in the loss and loss expense ratio would have a $3,058 effect on net income, or $0.19 per diluted share.

Our assumptions assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for establishing our reserves. Our key assumptions could have a reasonable possible range of plus or minus 5 percentage-points for each estimation. The following sensitivity tables present information for each of our primary lines of business on the effect each 1 percentage-point change in each of our key assumptions on unpaid frequency and severity could

have on our direct minus ceded loss and LAE reserves and net income for the nine months ended September 30, 2005. In evaluating the information in the table, it should be noted that a 1 percentage-point change in a single assumption would change estimated reserves by 1 percentage-point. A 1 percentage-point change in both our key assumptions would change estimated reserves within a range of plus or minus 2 percentage-points.

	-1 Percent						+1 Percent
	Change in			No Change in			Change in
	Frequency			Frequency			Frequency
Private Passenger Automobile Direct minus Ceded Loss and LAE Reserves
-1 Percent Change in Severity
Estimated increase (decrease) in reserves	$	(4,135	)	$	(2,068	)	$	—
Estimated increase (decrease) in net income	2,688			1,344			—
No Change in Severity
Estimated increase (decrease) in reserves	(2,068		)	—			2,068
Estimated increase (decrease) in net income	1,344			—			(1,344		)
+1 Percent Change in Severity
Estimated increase (decrease) in reserves	—			2,068			4,135
Estimated increase (decrease) in net income	—			(1,344		)	(2,688		)

Commercial Automobile Direct minus Ceded Loss and LAE Reserves
-1 Percent Change in Severity
Estimated increase (decrease) in reserves	(695		)	(348		)	—
Estimated increase (decrease) in net income	452			226			—
No Change in Severity
Estimated increase (decrease) in reserves	(348		)	—			348
Estimated increase (decrease) in Net Income	226			—			(226		)
+1 Percent Change in Severity
Estimated increase (decrease) in reserves	—			348			695
Estimated increase (decrease) in net income	—			(226		)	(452		)

Homeowners Direct minus Ceded Loss and LAE Reserves
-1 Percent Change in Severity
Estimated increase (decrease) in reserves	(434		)	(217		)	—
Estimated increase (decrease) in net income	282			141			—
No Change in Severity
Estimated increase (decrease) in reserves	(217		)	—			217
Estimated increase (decrease) in net income	141			—			(141		)
+1 Percent Change in Severity
Estimated increase (decrease) in reserves	—			217			434
Estimated increase (decrease) in net income	—			(141		)	(282		)

All Other Direct minus Ceded Loss and LAE Reserves
-1 Percent Change in Severity
Estimated increase (decrease) in reserves	(154		)	(77		)	—
Estimated increase (decrease) in net income	100			50			—
No Change in Severity
Estimated increase (decrease) in reserves	(77		)	—			77
Estimated increase (decrease) in net income	50			—			(50		)
+1 Percent Change in Severity
Estimated increase (decrease) in reserves	—			77			154
Estimated increase (decrease) in net income	—			(50		)	(100		)

Our estimated share of CAR loss and LAE reserves is based on assumptions about our Participation Ratio, the size of CAR, and the resulting deficit (similar assumptions apply with respect to the FAIR Plan). Our assumptions assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for establishing our CAR reserves. Our assumptions could have a reasonable possible range of plus or minus 5 percentage-points for each estimation. The following sensitivity table presents information of the effect each 1 percentage-point change in our assumptions on our share of reserves for CAR and other residual markets could have on our assumed loss and LAE reserves and net income for the nine months ended September 30, 2005. In evaluating the information in the table, it should be noted that a 1 percentage-point change in our assumptions would change estimated reserves by 1 percentage-point.

	-1 Percent			No		+1 Percent
	Change in			Change in		Change in
	Estimation			Estimation		Estimation
CAR Assumed Private Passenger Automobile
Estimated increase (decrease) in reserves	$	(795	)	$	—	$	795
Estimated increase (decrease) in net income	517			—		(517		)
CAR Assumed Commercial Automobile
Estimated increase (decrease) in reserves	(150		)	—		150
Estimated increase (decrease) in Net Income	97			—		(97		)
FAIR Plan Assumed Homeowners
Estimated increase (decrease) in reserves	(91		)	—		91
Estimated increase (decrease) in Net Income	59			—		(59		)

Reserve Development Summary

The changes we have recorded in our reserves in the past illustrate the uncertainty of estimating reserves. Primarily due to an improvement in CAR results, the Company’s prior year reserves decreased by $27,462 and $2,249 for the nine months ended September 30, 2005 and 2004, respectively. The decrease in prior year reserves during the 2005 period resulted from re-estimations of prior year ultimate loss and LAE liabilities and is composed of a reduction of $18,212 in CAR assumed reserves and a reduction of $9,250 in the Company’s automobile reserves. It is not appropriate to extrapolate future favorable or unfavorable development of reserves from this past experience.

The following table presents information by line of business for prior year development of our net reserves for losses and LAE for the nine months ended September 30, 2005. Each accident year represents all claims for an annual calendar accounting period in which loss events occurred, regardless of when the losses are actually reported, booked or paid. Our financial statements reflect the aggregate results of the current and all prior accident years.

Prior Year Net Loss and LAE Reserve Development Summary

Accident	Private Passenger			Commercial
Year	Automobile			Automobile			Homeowners			All Other			Total
1995 & Prior	$	(29	)	$	—		$	—		$	—		$	(29	)
1996	(99		)	—			—			—			(99		)
1997	(1		)	—			—			—			(1		)
1998	15			(1		)	—			—			14
1999	(341		)	(58		)	(50		)	—			(449		)
2000	(25		)	17			9			(3		)	(2		)
2001	(6		)	26			(225		)	(6		)	(211		)
2002	(2,140		)	(87		)	(547		)	(10		)	(2,784		)
2003	(3,096		)	(390		)	(602		)	(3		)	(4,091		)
2004	(19,371		)	(1,876		)	1,245			192			(19,810		)
All Prior Years	$	(25,093	)	$	(2,369	)	$	(170	)	$	170		$	(27,462	)

The table above reflects all of our business. To further clarify the effects of changes in our reserve estimates for CAR and other residual markets, the next two tables break out the information in the table above by source of the business (i.e., non-

residual market vs. residual market). The following table presents information by line of business for prior year development of direct minus ceded reserves for losses and LAE for the nine months ended September 30, 2005; that is, all our reserves except for business ceded or assumed from CAR and other residual markets.

Prior Year Direct minus Ceded Loss and LAE Reserve Development Summary

	Retained			Retained
Accident	Private Passenger			Commercial			Retained			Retained
Year	Automobile			Automobile			Homeowners			All Other			Total
1995 & Prior	$	(29	)	$	—		$	—		$	—		$	(29	)
1996	(99		)	—			—			—			(99		)
1997	(1		)	—			—			—			(1		)
1998	15			(1		)	—			—			14
1999	(341		)	(58		)	(50		)	—			(449		)
2000	(25		)	17			9			(3		)	(2		)
2001	(6		)	26			(225		)	(6		)	(211		)
2002	(1,586		)	(67		)	(547		)	(10		)	(2,210		)
2003	767			(264		)	(602		)	(3		)	(102		)
2004	(6,036		)	(1,562		)	1,245			192			(6,161		)
All Prior Years	$	(7,341	)	$	(1,909	)	$	(170	)	$	170		$	(9,250	)

The following table presents information by line of business for prior year development of reserves assumed from CAR and other residual markets for losses and LAE for the nine months ended September 30, 2005.

Prior Year Assumed Loss and LAE Reserve Development Summary

	CAR Assumed			CAR Assumed
Accident	Private Passenger			Commercial			FAIR Plan
Year	Automobile			Automobile			Homeowners		All Other		Total
1995 & Prior	$	—		$	—		$	—	$	—	$	—
1996	—			—			—		—		—
1997	—			—			—		—		—
1998	—			—			—		—		—
1999	—			—			—		—		—
2000	—			—			—		—		—
2001	—			—			—		—		—
2002	(554		)	(20		)	—		—		(574		)
2003	(3,863		)	(126		)	—		—		(3,989		)
2004	(13,335		)	(314		)	—		—		(13,649		)
All Prior Years	$	(17,752	)	$	(460	)	$	—	$	—	$	(18,212	)

Our private passenger automobile line of business prior year reserves decreased by $25,093 for the nine months ended September 30, 2005. The decrease was primarily due to improved assumed CAR results for the private passenger automobile pool for the 2004 accident year of $13,335 and for the 2003 accident year of $3,863. The improved CAR results were due primarily to improved CAR private passenger loss ratios for 2004 and 2003 as published and reported by the CAR Loss Reserving Committee at the August 31, 2005 meeting, as compared to the published results at the December 1, 2004 meeting. In addition, we reduced our private passenger automobile reserves for the 2002 and 2004 accident years by $1,586 and $6,036, respectively, primarily due to better than previously estimated severity on our established bodily injury case reserves during 2005.

Our commercial automobile line of business prior year reserves decreased by $2,369 for the nine months ended September 30, 2005. The decrease was primarily due to more favorable commercial automobile bodily injury severity than previously estimated on our established case reserves during 2005.

Our Homeowners line of business prior year reserves decreased by $170 for the nine months ended September 30, 2005. The decrease was primarily due to better than previously estimated severity on property reserves on our established case reserves for 2002 and 2003 of $547 and $602, respectively, offset by increased severity on our established case reserves for 2004 of $1,245.

In estimating all our loss reserves, including CAR, we follow the guidance prescribed by Statement of Financial Accounting Standards (“FAS”) No. 60, “Accounting and Reporting by Insurance Enterprises” and FAS No. 113, “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.”

For further information, see “Results of Operations - Losses and Loss Adjustment Expenses.”

Other-Than-Temporary Impairments.

We use a systematic methodology to evaluate declines in market values below cost or amortized cost of our investments. This methodology ensures that we evaluate available evidence concerning any declines in a disciplined manner.

In our determination of whether a decline in market value below amortized cost is an other-than-temporary impairment, we consider and evaluate several factors and circumstances including the issuer’s overall financial condition, the issuer’s credit and financial strength ratings, a weakening of the general market conditions in the industry or geographic region in which the issuer operates, a prolonged period (typically six months or longer) in which the fair value of an issuer’s securities remains below our amortized cost, our ability and intent to hold these investments for a period of time sufficient to allow for recovery of our costs, and any other factors that may raise doubt about the issuer’s ability to continue as a going concern.

We record other-than-temporary impairments as realized losses, which serve to reduce net income and earnings per share. We record temporary losses as unrealized losses, which do not impact net income and earnings per share but reduce other comprehensive net income. The risks inherent in our assessment of other-than-temporary impairments include the risk that market factors may differ from our expectations, or that the credit assessment could change in the near term, resulting in a charge to earnings.

For further information, see “Results of Operations - Net Realized Investment Losses.”

Results of Operations

The following table shows certain of our selected financial results.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2004		2005		2004

Direct premiums written	$	161,159	$	154,772	$	514,390	$	496,906
Net premiums written	156,863		151,489		511,241		488,514
Net earned premiums	157,521		149,473		470,451		439,983
Net investment income	7,939		6,866		23,051		20,322
Net realized gains on investments	58		712		454		1,316
Finance and other service income	4,322		4,098		12,268		11,698
Total revenue	169,840		161,149		506,224		473,319
Losses and loss adjustment expenses	89,748		103,282		293,720		320,209
Underwriting, operating and related expenses	36,769		36,209		113,335		106,649
Interest expenses	262		168		710		480
Total expenses	126,779		139,659		407,765		427,338
Income before income taxes	43,061		21,490		98,459		45,981
Income tax expense	12,586		6,313		30,236		14,154
Net income	$	30,475	$	15,177	$	68,223	$	31,827

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004

Direct Written Premiums. Direct written premiums for the three months ended September 30, 2005 increased by $6,387, or 4.1%, to $161,159 from $154,772 for the comparable 2004 period. Direct written premiums for the nine months ended September 30, 2005 increased by $17,484, or 3.5%, to $514,390 from $496,906 for the comparable 2004 period. The 2005 increase occurred primarily in our personal automobile line, which experienced a 0.4% increase in average written premium and a 2.5% increase in written exposures. In addition, our commercial automobile line’s average written premium decreased by 0.7%, which was more than offset by a 7.3% increase in written exposures, and our homeowners line’s average written premium increased by 7.0%, which was partly offset by a 3.0% decrease in written exposures.

Net Written Premiums. Net written premiums for the three months ended September 30, 2005 increased by $5,374, or 3.5%, to $156,863 from $151,489 for the comparable 2004 period. Net written premiums for the nine months ended September 30, 2005 increased by $22,727, or 4.7%, to $511,241 from $488,514 for the comparable 2004 period. These increases were primarily due to the factors that increased direct written premiums combined with a decrease in premiums ceded to CAR.

Net Earned Premiums. Net earned premiums for the three months ended September 30, 2005 increased by $8,048, or 5.4%, to $157,521 from $149,473 for the comparable 2004 period. Net earned premiums for the nine months ended September 30, 2005 increased by $30,468, or 6.9%, to $470,451 from $439,983 for the comparable 2004 period. These increases were primarily due the factors that increased direct written premiums combined with a decrease in premiums ceded to CAR.

Net Investment Income. Net investment income for the three months ended September 30, 2005 was $7,939 compared to $6,866 for the comparable 2004 period. Net investment income for the nine months ended September 30, 2005 was $23,051 compared to $20,322 for the comparable 2004 period. Average cash and investment securities (at cost) increased by $107,541, or 15.0%, to $826,787 for the nine months ended September 30, 2005 from $719,246 for the nine months ended September 30, 2004 due primarily to a $89,251 increase in average cash and cash equivalents. Net effective annualized yield on the investment portfolio decreased to 3.7% during the nine months ended September 30, 2005 from 4.0% during 2004 due to management’s investment strategy to shorten the portfolio duration, shift to higher rated securities, and increase tax-exempt holdings. Our duration decreased to 3.2 years at September 30, 2005 from 3.4 years at December 31, 2004.

Net Realized Gains on Investments. Net realized gains on investments was $58 for the third quarter of 2005 compared to $712 for the third quarter of 2004. Net realized gains on investments decreased to $454 for the nine months ended September 30, 2005 from $1,316 for the comparable 2004 period.

The gross unrealized appreciation (depreciation) of investments in fixed maturity securities, including redeemable preferred stocks that have characteristics of fixed maturities, and equity securities, including interests in mutual funds, was as follows:

September 30, 2005

Gross

Estimated

Unrealized

Fair

Cost

Gains

Losses

Value

U.S. Treasury securities and obligations of U.S. Government agencies(1)

131,070

182

(2,189

)

129,063

Obligations of states and political subdivisions

322,420

5,362

(2,601

)

325,181

Asset-backed securities

100,437

456

(994

)

99,899

Corporate and other securities

138,945

2,846

(1,161

)

140,630

Subtotal, fixed maturity securities

692,872

8,846

(6,945

)

694,773

Equity securities

2,057

100

—

2,157

Totals

694,929

8,946

(6,945

)

696,930

As of September 30, 2005, our portfolio of fixed maturity investments was comprised entirely of investment grade corporate fixed maturity securities, U.S. government and agency securities and asset-backed securities (i.e., all our securities received a rating assigned by Moody’s Investors Service, Inc. of Baa or higher, except the few securities not rated by Moody’s which received S&P ratings of AA/A or higher, as well as a rating assigned by the Securities Valuation Office of the National Association of Insurance Commissioners of 1 or 2).

The composition of our fixed income security portfolio by Moody’s rating was as follows:

	September 30, 2005
	Fair Value		Percent
U.S. Government and Government Agency Fixed Income Securities	$	129,063	18.6	%
Aaa/Aa	434,994		62.6	%
A	85,588		12.3	%
Baa	45,128		6.5	%
Total	$	694,773	100.0	%

Ratings are assigned by Moody’s, or the equivalent, as discussed above. Such ratings are generally assigned upon the issuance of the securities and are subject to revision on the basis of ongoing evaluations. Ratings in the table are as of the date indicated.

In our determination of other-than-temporary impairments, we consider several factors and circumstances including the issuer’s overall financial condition, the issuer’s credit and financial strength ratings, a weakening of the general market conditions in the industry or geographic region in which the issuer operates, a prolonged period (typically six months or longer) in which the fair value of an issuer’s securities remains below our amortized cost, our ability and intent to hold these investments for a period of time sufficient to allow for recovery of our costs, and any other factors that may raise doubt about the issuer’s ability to continue as a going concern.

Other-than-temporary impairments are recorded as realized losses, which serve to reduce net income and earnings per share. Temporary losses are recorded as unrealized losses, which do not impact net income and earnings per share but reduce other comprehensive net income. The risks inherent in the assessment of other-than-temporary impairments include the risk that market factors may differ from our expectations; we may decide to subsequently sell a security for unforeseen business needs; or the credit assessment could change in the near term, resulting in a charge to earnings.

The following table illustrates the gross unrealized losses included in the Company’s investment portfolio and the fair value of those securities, aggregated by investment category. The table also illustrates the length of time that they have been in a continuous unrealized loss position as of September 30, 2005.

September 30, 2005

Less than 12 Months

12 Months or More

Total

Unrealized

Fair Value

Losses

Fair Value

Losses

Fair Value

Losses

U.S. Treasury securities and obligations of U.S. Government agencies

63,810

620

53,778

1,569

117,588

2,189

Obligations of states and political subdivisions

56,622

796

91,759

1,805

148,381

2,601

Asset-backed securities

52,481

677

15,667

317

68,148

994

Corporate and other securities

49,379

654

17,419

507

66,798

1,161

Total temporarily impaired securities

222,292

2,747

178,623

4,198

400,915

6,945

The unrealized losses recorded on the fixed maturity investment portfolio at September 30, 2005 resulted from fluctuations in market interest rates as opposed to fundamental changes in the credit quality of the issuers of such securities. Therefore, these decreases in values are viewed as being temporary as we have the intent and ability to retain such investments for a period of time sufficient to allow for recovery in market value.

Of the $6,945 gross unrealized losses as of September 30, 2005, $4,790 relates to fixed maturity obligations of states and political subdivisions and U.S. government agencies. The remaining $2,155 of gross unrealized losses relates primarily to holdings of investment grade asset-backed, corporate and other fixed maturity securities.

Finance and Other Service Income. Finance and other service income includes revenues from premium installment charges, which we recognize when earned. Finance and other service income increased by $224, or 5.5%, to $4,322 for the third quarter of 2005 from $4,098 for the comparable 2004 period. Finance and other service income increased by $570, or 4.9%, to $12,268 for the nine months ended September 30, 2005 from $11,698 for the comparable 2004 period. This resulted from increases in premium installment billing fees primarily due to growth in the number of policies.

Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses incurred during the third quarter of 2005 decreased by $13,534, or 13.1%, to $89,748 from $103,282 for the comparable 2004 period. Losses and loss adjustment expenses incurred during the nine months ended September 30, 2005 decreased by $26,489, or 8.3%, to $293,720 from $320,209 for the comparable 2004 period. Our GAAP loss ratio for the third quarter of 2005 decreased to 57.0% from 69.1% for the comparable 2004 period. Our GAAP loss ratio for the nine months ended September 30, 2005 decreased to 62.4% from 72.8% for the comparable 2004 period. Our GAAP loss ratio excluding loss adjustment expenses for the third quarter of 2005 decreased to 50.2% from 62.4% for the comparable 2004 period. Our GAAP loss ratio excluding loss adjustment expenses for the nine months ended September 30, 2005 decreased to 55.6% from 65.9% for the comparable 2004 period. The loss ratio improved as a result of a decrease in personal and commercial automobile bodily injury claim frequency, $18,212 of favorable loss development in CAR prior year results, and $9,250 of favorable loss development in our personal automobile line of business for the nine months ended September 30, 2005 compared to $3,248 of favorable loss development in CAR prior year results, $2,001 of favorable loss development in our homeowners line of business, and $3,000 of adverse loss development in our personal automobile line of business for the comparable 2004 period.

Underwriting, Operating and Related Expenses. Underwriting, operating and related expense for the third quarter of 2005 increased by $560, or 1.5%, to $36,769 from $36,209 for the comparable 2004 period. Underwriting, operating and related expense for the nine months ended September 30, 2005 increased by $6,686, or 6.3%, to $113,335 from $106,649 for the comparable 2004 period. Our GAAP expense ratios for the third quarter of 2005 decreased to 23.3% from 24.2% for the comparable 2004 period. Our GAAP expense ratios for the nine months ended September 30, 2005 decreased to 24.1% from 24.2% for the comparable 2004 period.

Although we have not received written notice from the Massachusetts Insurers Insolvency Fund (“Insolvency Fund”) regarding 2005 actions to be taken by the Insolvency Fund, based upon existing knowledge that a reimbursement of prior year assessments has been approved by the Board of Directors of the Insolvency Fund, we reduced our estimated potential assessments to $0 for 2005, which resulted in a reduction to underwriting expenses of $1,300 for the three months ended September 30, 2005 compared to additional underwriting expenses related to assessments of $825 and $2,538 for the three and nine months ended September 30, 2004.

Interest Expenses. Interest expense for the third quarter of 2005 was $262 compared to $168 for the comparable 2004 period. Interest expense for the nine months ended September 30, 2005 was $710 compared to $480 for the comparable 2004 period.

Income Tax Expense. Our effective tax rate was 29.2% and 29.4% for the third quarter of 2005 and 2004, respectively. Our effective tax rate was 30.7% and 30.8% for the nine months ended September 30, 2005 and 2004, respectively. These effective rates were lower than the statutory rate of 35% primarily due to adjustments for tax-exempt investment income and a $1,161 tax benefit recorded as a reduction to income tax expense for the three and nine months ended September 30, 2005. This tax benefit represents a reduction in federal income tax reserves for tax years 2001 through 2003 during the third quarter of 2005 upon completion of an examination of the Company’s federal income tax returns for the tax periods ended December 31, 2003, 2002, and 2001 by the Internal Revenue Service.

Net Income. Net income for the third quarter of 2005 increased by $15,298, or 100.8%, to $30,475 from $15,177 for the comparable 2004 period. Net income for the nine months ended September 30, 2005 increased by $36,396, or 114.4%, to $68,223 from $31,827 for the comparable 2004 period. This increase was primarily due to the increase in premiums and decrease in the loss ratio, as discussed above.

Liquidity and Capital Resources

As a holding company, Safety’s assets consist primarily of the stock of our direct and indirect subsidiaries. Our principal source of funds to meet our obligations and pay dividends to shareholders, therefore, is dividends and other permitted payments from our subsidiaries, principally Safety Insurance. Safety is the borrower under our credit facilities.

Safety Insurance’s sources of funds primarily include premiums received, investment income and proceeds from sales and redemptions of investments. Safety Insurance’s principal uses of cash are the payment of claims, operating expenses and taxes, the purchase of investments and payment of dividends to Safety.

Net cash provided by operating activities was $81,105 and $89,674 during the nine months ended September 30, 2005 and 2004, respectively. Our operations typically generate substantial positive cash flows from operations as most premiums are received in advance of the time when claim and benefit payments are required. These positive operating cash flows are expected to continue to meet our liquidity requirements.

Net cash used for investing activities was $50,997 during the nine months ended September 30, 2005 compared to $15,966 of cash provided by investing activities during the nine months ended September 30, 2004. This was primarily the result of greater sales of fixed maturities in 2004.

Net cash used for financing activities was $4,207 and $3,187 during the nine months ended September 30, 2005 and 2004, respectively, primarily from dividends paid to shareholders in excess of proceeds from stock option exercises.

Credit Facility

Concurrent with the closing of our November 27, 2002 intial public offering (“IPO”) and repayment of the old credit facility, Safety obtained a new $30,000 revolving credit facility. Safety borrowed the entire $30,000 under this credit facility at the closing of the IPO and paid down the balance to $19,956 on December 5, 2002 with the approximately $10,000 net proceeds from the exercise of the underwriter’s over-allotment option for 900,000 shares of our common stock. Loans under the credit facility bear interest at our option at either (i) the LIBOR

rate plus 1.5% per annum or (ii) the higher of Citizens Bank of Massachusetts’ prime rate or 0.5% above the federal funds rate plus 1.5% per annum. Interest only is payable prior to maturity. The obligations of Safety under the credit facility are secured by pledges of the assets of Safety and the capital stock of Safety’s operating subsidiaries. The credit facility is guaranteed by the non-insurance company subsidiaries of Safety. The credit facility contains covenants including requirements to maintain minimum risk based capital ratios and statutory surplus of Safety Insurance as well as limitations or restrictions on indebtedness, liens, dividends, and other matters. As of September 30, 2005, we were in compliance with all such covenants.

Bank of America was the lender under this credit facility. Under an agreement effective on June 17, 2005, Bank of America assigned the $30,000 credit facility to Citizens Bank of Massachusetts. The credit facility was due and payable at maturity on November 27, 2005, which was three years from the closing of the IPO. Under a June 17, 2005 amendment to the credit facility, the maturity date was extended to June 17, 2008. Other terms of the revolving credit facility remain unchanged.

Regulatory Matters

Our insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of the Commissioner. The Massachusetts statute limits the dividends an insurer may pay in any twelve-month period, without the prior permission of the Commissioner, to the greater of (i) 10% of the insurer’s surplus as of the preceding December 31 or (ii) the insurer’s net income for the twelve-month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices. Our insurance company subsidiaries may not declare an “extraordinary dividend” (defined as any dividend or distribution that, within the preceding twelve months, exceeds the limits established by Massachusetts statute) until thirty days after the Commissioner has received notice of the intended dividend and has not objected. As historically administered by the Commissioner, this provision requires the Commissioner’s prior approval of an extraordinary dividend. Under Massachusetts law, an insurer may pay cash dividends only from its unassigned funds, also known as earned surplus, without the approval of the Commissioner and the insurer’s remaining surplus must be both reasonable in relation to its outstanding liabilities and adequate to its financial needs. At year-end 2004, the statutory surplus of Safety Insurance was $278,161, and its net income for 2004 was $42,251. As a result, a maximum of $42,251 is available in 2005 for such dividends without prior approval of the Commissioner. During the nine months ended September 30, 2005, Safety Insurance recorded dividends to Safety of $7,936.

The maximum dividend permitted by law is not indicative of an insurer’s actual ability to pay dividends, which may be constrained by business and regulatory considerations, such as the impact of dividends on surplus, which could affect an insurer’s ratings or competitive position, the amount of premiums that can be written and the ability to pay future dividends.

On November 3, 2005, our Board approved a quarterly cash dividend on our common stock of $0.18 per share, payable on December 15, 2005 to shareholders of record on December 1, 2005. On August 18, 2005, our Board approved a quarterly cash dividend on our common stock of $0.18 per share, or $2,832, which was paid on September 15, 2005. On May 19, 2005, our Board approved a quarterly cash dividend on our common stock of $0.12 per share, or $1,881, which was paid on June 15, 2005. On February 17, 2005, our Board approved a quarterly cash dividend on our common stock of $0.12 per share, or $1,861, which was paid on March 15, 2005. We plan to continue to declare and pay quarterly cash dividends in 2006, depending on our financial position and the regularity of our cash flows.

Management believes that the current level of cash flow from operations provides us with sufficient liquidity to meet our operating needs over the next 12 months. We expect to be able to continue to meet our operating needs after the next 12 months from internally generated funds. Since our ability to meet our obligations in the long term (beyond such twelve-month period) is dependent upon such factors as market changes, insurance regulatory changes and economic conditions, no assurance can be given that the available net cash flow will be sufficient to meet our operating needs. We expect that we would need to borrow or issue capital stock if we needed additional funds, for example, to pay for an acquisition or a significant expansion of our operations. There can be no assurance that sufficient funds for any of the foregoing purposes would be available to us at such time.

Off-Balance Sheet Arrangements

We have no material obligations under a guarantee contract meeting the characteristics identified in paragraph 3 of Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements, Including Indirect Guarantees of Indebtedness of Others”. We have no material retained or contingent interests in assets transferred to an unconsolidated entity. We have no material obligations, including contingent obligations, under contracts that would be accounted for as derivative instruments. We have no obligations, including contingent obligations, arising out of a variable interest in an unconsolidated entity held by, and material to, us, where such entity provides financing, liquidity, market

risk or credit risk support to, or engages in leasing, hedging or research and development services with us. We have no direct investments in real estate and no holdings of mortgages secured by commercial real estate. Accordingly, we have no material off-balance sheet arrangements.

Contractual Obligations

We have obligations to make future payments under contracts and credit-related financial instruments and commitments. At September 30, 2005, certain long-term aggregate contractual obligations and credit-related commitments are as follows:

Within

Two to

Three to

More Than

One Year

Three Years

Five Years

Total

Loss and LAE Reserves

223,348

200,558

27,349

4,558

455,813

Debt

—

19,956

—

19,956

Capital lease obligations

223

—

321

Operating leases

2,886

5,918

802

—

9,606

Total contractual obligations

226,457

226,530

28,151

4,558

485,696

As of September 30, 2005, the Company had loss and LAE reserves of $455,813, reinsurance recoverables of $81,293 and net loss and LAE reserves of $374,520. Our loss and LAE reserves are estimates as described in more detail under “Critical Accounting Policies and Estimates”. The specific amounts and timing of obligations related to case reserves, IBNR reserves and related LAE reserves are not set contractually, and the amounts and timing of these obligations are unknown. Nonetheless, based upon our cumulative claims paid over the last ten years, the Company estimates that its loss and LAE reserves will be paid in the period shown above. While management believes that historical performance of loss payment patterns is a reasonable source for projecting future claims payments, there is inherent uncertainty in this estimated projected settlement of loss and LAE reserves, and as a result these estimates will differ, perhaps significantly, from actual future payments. Our operations typically generate substantial positive cash flows from operations as most premiums are received in advance of the time when claim and benefit payments are required. These positive operating cash flows are expected to continue to meet our liquidity requirements, including any unexpected variations in the timing of claim settlements.

Forward-Looking Statements

Forward-looking statements might include one or more of the following, among others:

• Projections of revenues, income, earnings per share, capital expenditures, dividends, capital structure or other financial items;

• Descriptions of plans or objectives of management for future operations, products or services;

• Forecasts of future economic performance, liquidity, need for funding and income; and

• Descriptions of assumptions underlying or relating to any of the foregoing.

Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “aim,” “projects,” or words of similar meaning and expressions that indicate future events and trends, or future or conditional verbs such as “will,” “would,” “should,” “could,” or “may”. All statements that address expectations or projections about the future, including statements about the Company’s strategy for growth, product development, market position, expenditures and financial results, are forward-looking statements.

Forward-looking statements are not guarantees of future performance. By their nature, forward-looking statements are subject to risks and uncertainties. There are a number of factors, many of which are beyond our control, that could cause actual future conditions, events, results or trends to differ significantly and/or materially from historical results or those projected in the forward-looking statements. These factors include but are not limited to the competitive nature of our industry and the possible adverse effects of such competition. Although a number of national insurers that are much larger than we are do not currently compete in a material way in the Massachusetts private passenger automobile market, if one or more of these companies decided to aggressively enter the market it could have a material adverse effect on us. Other significant factors include conditions for business operations and restrictive regulations in Massachusetts, the possibility of losses due to claims resulting from severe weather, the possibility that the Commissioner may approve future Rule changes that change the operation of the residual market, our possible need for and availability of additional financing, and our dependence on strategic relationships, among others, and

other risks and factors identified from time to time in our reports filed with the SEC, such as those set forth under the caption “Risk Factors” in our prospectus in the registration statement on Form S-1 filed with the SEC on November 22, 2002.

Some other factors, such as market, operational, liquidity, interest rate, equity and other risks, are described elsewhere in this Quarterly Report on Form 10-Q. Factors relating to the regulation and supervision of our Company are also described or incorporated in this report. There are other factors besides those described or incorporated in this report that could cause actual conditions, events or results to differ from those in the forward-looking statements.

Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. We do not undertake any obligation to update publicly or revise any forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.

Item 3. Quantitative and Qualitative Information about Market Risk (Dollars in thousands)

Market Risk. Market risk is the risk that we will incur losses due to adverse changes in market rates and prices. We have exposure to market risk through our investment activities and our financing activities. Our primary market risk exposure is to changes in interest rates. We may use both fixed and variable rate debt as sources of financing; at present all of our debt is at variable rates. We have not entered, and do not plan to enter, into any derivative financial instruments for trading or speculative purposes.

Interest Rate Risk. Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. Our exposure to interest rate changes primarily results from our significant holdings of fixed rate investments and from our financing activities. Our fixed maturity investments include U.S. and foreign government bonds, securities issued by government agencies, obligations of state and local governments and governmental authorities, corporate bonds and asset-backed securities, most of which are exposed to changes in prevailing interest rates.

We manage our exposure to risks associated with interest rate fluctuations through active review of our investment portfolio by our management and Board and consultation with third-party financial advisors. As a general matter, we do not attempt to match the durations of our assets with the durations of our liabilities, and the majority of our liabilities are “short tail.” Our goal is to maximize the total after-tax return on all of our investments. An important strategy that we employ to achieve this goal is to try to hold enough in cash and short-term investments in order to avoid liquidating longer-term investments to pay claims.

Based upon the results of interest rate sensitivity analysis, the following tables show the interest rate risk of our investments in fixed maturities, including preferred stocks with characteristics of fixed maturities, measured in terms of fair value (which is equal to the carrying value for all our fixed maturity securities).

	As of September 30, 2005
	-100 Basis				+100 Basis
	Point Change		No Change		Point Change
Estimated fair value	$	722,135	$	694,773	$	667,314
Estimated increase (decrease) in fair value	27,362		—		(27,459		)

An important market risk for all of our outstanding long-term debt is interest rate risk. We continue to monitor the interest rate environment and to evaluate refinancing opportunities as maturity dates approach. With respect to floating rate debt, we are also exposed to the effects of changes in prevailing interest rates. At September 30, 2005 we had $19,956 of debt outstanding under our credit facility at a variable rate of 5.7%. A 2.0% change in the prevailing interest rate on our variable rate debt would result in interest expense fluctuating approximately $400 for 2005, assuming that all of such debt is outstanding for the entire year.

Equity Risk. Equity risk is the risk that we will incur economic losses due to adverse changes in equity prices. In the past, our exposure to changes in equity prices primarily resulted from our holdings of common stocks, mutual funds and other equities. While we have in the past held common equity securities in our investment portfolio, presently we hold none, except for interests in mutual funds to fund the executive deferred compensation plan. We continuously evaluate market conditions and we expect in the future to purchase equity securities. We principally managed equity price risk through industry and issuer diversification and asset allocation techniques.

Item 4. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on that evaluation, our CEO and CFO have concluded that our disclosure controls and procedures are adequate and effective and ensure that all information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and that information required to be disclosed in such reports is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II. OTHER INFORMATION

Item 1. Legal Proceedings - Please see “Item 1 – Financial Statements - Note 7, Commitments and Contingencies.”

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds - None.

Item 3. Defaults upon Senior Securities - None.

Item 4. Submission of Matters to a Vote of Security Holders - None.

Item 5. Other Information - None.

Item 6. Exhibits - The exhibits are contained herein as listed in the Exhibit Index on page 35.

SIGNATURE

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.

	SAFETY INSURANCE GROUP, INC. (Registrant)

Date: November 9, 2005

	By:	/s/ WILLIAM J. BEGLEY, JR.

		William J. Begley, Jr.
		Vice President, Chief Financial Officer and Secretary

SAFETY INSURANCE GROUP, INC.

EXHIBIT INDEX

Exhibit Number		Description

11		Statement re: Computation of Per Share Earnings. (1)

31.1		CEO Certification Pursuant to Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (2)

31.2		CFO Certification Pursuant to Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (2)

32.1		CEO Certification Pursuant to U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (2)

32.2		CFO Certification Pursuant to U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (2)

(1) Not included herein as the information can be calculated from the face of the Consolidated Statements of Operations (see page 4).

(2) Included herein.