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SAFETY INSURANCE GROUP INC - Quarter Report: 2011 June (Form 10-Q)

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended June 30, 2011

 

OR

 

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)

 

Not Applicable

(Former name or former address, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company 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 x

 

As of August 3, 2011, there were 15,187,777 shares of common stock with a par value of $0.01 per share outstanding.

 

 

 



Table of Contents

 

SAFETY INSURANCE GROUP, INC.

Table of Contents

 

 

 

Page

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

Consolidated Balance Sheets at June 30, 2011 (Unaudited) and December 31, 2010

3

 

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2011 and 2010 (Unaudited)

4

 

Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2011 and 2010 (Unaudited)

5

 

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2011 and 2010 (Unaudited)

6

 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010 (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

23

 

Results of Operations — Three and Six Months Ended June 30, 2011 and 2010

27

 

Liquidity and Capital Resources

31

 

Critical Accounting Policies and Estimates

33

 

Forward-Looking Statements

41

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

41

 

 

 

Item 4.

Controls and Procedures

42

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

42

 

 

 

Item 1A.

Risk Factors

42

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

42

 

 

 

Item 3.

Defaults upon Senior Securities

43

 

 

 

Item 4.

Removed and Reserved

43

 

 

 

Item 5.

Other Information

43

 

 

 

Item 6.

Exhibits

43

 

 

 

SIGNATURE

44

 

 

EXHIBIT INDEX

45

 

2



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except share data)

 

 

 

June 30,

 

December 31,

 

 

 

2011

 

2010

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Securities available for sale:

 

 

 

 

 

Fixed maturities, at fair value (amortized cost: $994,387 and $1,030,354)

 

$

1,033,321

 

$

1,063,237

 

Equity securities, at fair value (cost: $20,002 and $13,704)

 

21,446

 

14,624

 

Other invested assets, at cost, which approximates fair value

 

5,818

 

2,817

 

Total investments

 

1,060,585

 

1,080,678

 

Cash and cash equivalents

 

55,511

 

40,291

 

Accounts receivable, net of allowance for doubtful accounts

 

160,434

 

145,726

 

Receivable for securities sold

 

10,675

 

 

Accrued investment income

 

9,558

 

9,471

 

Taxes recoverable

 

11,719

 

5,061

 

Receivable from reinsurers related to paid loss and loss adjustment expenses

 

8,419

 

4,579

 

Receivable from reinsurers related to unpaid loss and loss adjustment expenses

 

52,475

 

53,147

 

Ceded unearned premiums

 

11,552

 

12,461

 

Deferred policy acquisition costs

 

57,979

 

52,824

 

Deferred income taxes

 

1,340

 

3,643

 

Equity and deposits in pools

 

13,308

 

19,971

 

Other assets

 

13,038

 

11,600

 

Total assets

 

$

1,466,593

 

$

1,439,452

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Loss and loss adjustment expense reserves

 

$

403,750

 

$

404,391

 

Unearned premium reserves

 

337,122

 

306,053

 

Accounts payable and accrued liabilities

 

39,286

 

54,239

 

Payable for securities purchased

 

10,532

 

 

Payable to reinsurers

 

7,296

 

5,571

 

Other liabilities

 

22,185

 

15,722

 

Total liabilities

 

820,171

 

785,976

 

 

 

 

 

 

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Common stock: $0.01 par value; 30,000,000 shares authorized; 16,915,032 and 16,795,504 shares issued

 

169

 

168

 

Additional paid-in capital

 

154,991

 

151,317

 

Accumulated other comprehensive income, net of taxes

 

26,246

 

21,972

 

Retained earnings

 

520,542

 

535,545

 

Treasury stock, at cost: 1,727,455 shares

 

(55,526

)

(55,526

)

Total shareholders’ equity

 

646,422

 

653,476

 

Total liabilities and shareholders’ equity

 

$

1,466,593

 

$

1,439,452

 

 

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

 

3



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

(Dollars in thousands, except per share data)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Net earned premiums

 

$

148,720

 

$

136,143

 

$

293,366

 

$

269,300

 

Net investment income

 

9,470

 

10,857

 

19,635

 

21,649

 

Net realized gains (losses) on investments

 

1,277

 

(178

)

858

 

(68

)

Finance and other service income

 

4,470

 

4,576

 

8,875

 

8,872

 

Total revenue

 

163,937

 

151,398

 

322,734

 

299,753

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

114,184

 

87,776

 

235,814

 

176,450

 

Underwriting, operating and related expenses

 

44,071

 

42,257

 

86,700

 

84,125

 

Interest expense

 

21

 

22

 

43

 

44

 

Total expenses

 

158,276

 

130,055

 

322,557

 

260,619

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

5,661

 

21,343

 

177

 

39,134

 

Income tax expense

 

1,576

 

6,254

 

45

 

11,271

 

Net income

 

$

4,085

 

$

15,089

 

$

132

 

$

27,863

 

 

 

 

 

 

 

 

 

 

 

Earnings per weighted average common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.27

 

$

1.00

 

$

0.01

 

$

1.85

 

Diluted

 

$

0.27

 

$

1.00

 

$

0.01

 

$

1.84

 

 

 

 

 

 

 

 

 

 

 

Cash dividends paid per common share

 

$

0.50

 

$

0.40

 

$

1.00

 

$

0.80

 

 

 

 

 

 

 

 

 

 

 

Number of shares used in computing earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

15,184,605

 

15,113,357

 

15,142,682

 

15,099,304

 

Diluted

 

15,198,804

 

15,130,393

 

15,159,513

 

15,116,127

 

 

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

 

4



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

(Dollars in thousands)

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Comprehensive

 

 

 

 

 

Total

 

 

 

Common

 

Paid-in

 

Income,

 

Retained

 

Treasury

 

Shareholders’

 

 

 

Stock

 

Capital

 

Net of Taxes

 

Earnings

 

Stock

 

Equity

 

Balance at December 31, 2009

 

$

166

 

$

144,814

 

$

18,866

 

$

506,301

 

$

(49,712

)

$

620,435

 

Net income, January 1 to June 30, 2010

 

 

 

 

 

 

 

27,863

 

 

 

27,863

 

Other comprehensive income, net of deferred federal income taxes

 

 

 

 

 

10,753

 

 

 

 

 

10,753

 

Unearned compensation on restricted stock, net of deferred federal income taxes

 

1

 

2,095

 

 

 

 

 

 

 

2,096

 

Exercise of options, net of federal income taxes

 

 

 

416

 

 

 

 

 

 

 

416

 

Dividends paid

 

 

 

 

 

 

 

(12,062

)

 

 

(12,062

)

Acquisition of treasury stock

 

 

 

 

 

 

 

 

 

(5,814

)

(5,814

)

Balance at June 30, 2010

 

$

167

 

$

147,325

 

$

29,619

 

$

522,102

 

$

(55,526

)

$

643,687

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Comprehensive

 

 

 

 

 

Total

 

 

 

Common

 

Paid-in

 

Income,

 

Retained

 

Treasury

 

Shareholders’

 

 

 

Stock

 

Capital

 

Net of Taxes

 

Earnings

 

Stock

 

Equity

 

Balance at December 31, 2010

 

$

168

 

$

151,317

 

$

21,972

 

$

535,545

 

$

(55,526

)

$

653,476

 

Net income, January 1 to June 30, 2011

 

 

 

 

 

 

 

132

 

 

 

132

 

Other comprehensive income, net of deferred federal income taxes

 

 

 

 

 

4,274

 

 

 

 

 

4,274

 

Unearned compensation on restricted stock, net of deferred federal income taxes

 

1

 

2,714

 

 

 

 

 

 

 

2,715

 

Exercise of options, net of federal income taxes

 

 

 

960

 

 

 

 

 

 

 

960

 

Dividends paid

 

 

 

 

 

 

 

(15,135

)

 

 

(15,135

)

Balance at June 30, 2011

 

$

169

 

$

154,991

 

$

26,246

 

$

520,542

 

$

(55,526

)

$

646,422

 

 

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

 

5



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

(Dollars in thousands)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net income

 

$

4,085

 

$

15,089

 

$

132

 

$

27,863

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Unrealized holding gains during the period, net of tax expense of $3,723, $3,368, $2,601, and $5,766

 

6,914

 

6,255

 

4,832

 

10,708

 

Reclassification adjustment for (gains) losses included in net income, net of tax (expense) benefit of ($447), $62, ($300), and $23

 

(830

)

116

 

(558

)

45

 

Unrealized gains on securities available for sale

 

6,084

 

6,371

 

4,274

 

10,753

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

10,169

 

$

21,460

 

$

4,406

 

$

38,616

 

 

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

 

6



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

132

 

$

27,863

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization, net

 

6,252

 

6,120

 

Provision (benefit) for deferred income taxes

 

1

 

(78

)

Net realized (gains) losses on investments

 

(858

)

68

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(14,708

)

(17,358

)

Accrued investment income

 

(87

)

349

 

Receivable from reinsurers

 

(3,168

)

7,396

 

Ceded unearned premiums

 

909

 

744

 

Deferred policy acquisition costs

 

(5,155

)

(5,451

)

Other assets

 

(393

)

(7,548

)

Loss and loss adjustment expense reserves

 

(641

)

(19,091

)

Unearned premium reserves

 

31,069

 

30,575

 

Accounts payable and accrued liabilities

 

(14,952

)

(20,699

)

Payable to reinsurers

 

1,725

 

3,738

 

Other liabilities

 

6,463

 

(4,243

)

Net cash provided by operating activities

 

6,589

 

2,385

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Fixed maturities purchased

 

(121,320

)

(128,337

)

Equity securities purchased

 

(10,360

)

(5,797

)

Other invested assets purchased

 

(3,060

)

 

Proceeds from sales and paydowns of fixed maturities

 

123,453

 

79,183

 

Proceeds from maturities, redemptions, and calls of fixed maturities

 

31,988

 

33,973

 

Proceed from sales of equity securities

 

4,166

 

2,079

 

Proceeds from sales of other invested assets

 

59

 

45

 

Fixed assets purchased

 

(2,051

)

(296

)

Net cash provided by (used for) investing activities

 

22,875

 

(19,150

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from stock options exercised

 

897

 

177

 

Excess tax benefits from stock options exercised

 

(6

)

37

 

Dividends paid to shareholders

 

(15,135

)

(12,062

)

Acquisition of treasury stock

 

 

(5,814

)

Net cash used for financing activities

 

(14,244

)

(17,662

)

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

15,220

 

(34,427

)

Cash and cash equivalents at beginning of year

 

40,291

 

74,470

 

Cash and cash equivalents at end of period

 

$

55,511

 

$

40,043

 

 

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

 

7



Table of Contents

 

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”).  The preparation of financial statements in conformity with 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, Safety Property and Casualty Insurance Company, Whiteshirts Asset Management Corporation (“WAMC”), and Whiteshirts Management Corporation, which is WAMC’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 June 30, 2011 and for the three and six months ended  June 30, 2011 and 2010 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 14, 2011.

 

The Company is a leading provider of personal lines property and casualty insurance focused primarily on the Massachusetts market.  The Company’s principal product line is private passenger automobile insurance, which accounted for 68.7% of its direct written premiums in 2010.  The Company operates through its insurance company subsidiaries, Safety Insurance Company, Safety Indemnity Insurance Company, and Safety Property and Casualty Insurance Company (together referred to as the “Insurance Subsidiaries”).

 

The Insurance Subsidiaries began writing private passenger automobile and homeowners insurance in New Hampshire during 2008 and began writing New Hampshire personal umbrella business during 2009.  For the six months ended June 30, 2011 and  2010, the Company wrote $2,462 and $1,191, respectively, in direct written premiums in New Hampshire.

 

2.  Recent Accounting Pronouncements

 

Accounting Standards Codification (“ASC”) 855, Subsequent Events, establishes principles and requirements for subsequent events.  ASC 855 was effective for interim and annual financial periods ending after June 15, 2009, and was applied prospectively.  In February 2010, the FASB issued updated guidance which amended the subsequent events disclosure requirements to eliminate the requirement for SEC filers to disclose the date through which it has evaluated subsequent events, clarify the period through which conduit bond obligors must evaluate subsequent events and refine the scope of the disclosure requirements for reissued financial statements.  The updated guidance was effective upon issuance.  The adoption of the guidance had no impact on the Company’s consolidated financial condition or results of operations.

 

In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06 (Topic 820), Improving Disclosures about Fair Value Measurements, which amends and clarifies existing guidance related to fair value measurements and disclosures.  This guidance requires new disclosures for (1) transfers in and out of Level 1 and Level 2 and reasons for such transfers; and (2) the separate presentation of purchases, sales, issuances and settlement in the Level 3 reconciliation.  It also clarifies guidance around disaggregation and disclosures of inputs and valuation techniques for Level 2 and Level 3 fair value measurements.  The Company adopted this guidance effective for quarter ended March 31, 2010, except for the new disclosures in the Level 3 reconciliation.  The Level 3 disclosures are effective for periods ending after December 15, 2010 and were implemented for year-end December 31, 2010.  The adoption of the guidance had no impact on the Company’s consolidated financial condition or results of operations.

 

In October 2010, the FASB issued ASU No. 2010-26 (Topic 944), Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, which updated guidance to address diversity in practice for the accounting of costs associated with acquiring or renewing insurance contracts.  This guidance modifies the definition of acquisition costs to specify that a cost be directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred.  The guidance also specifies that advertising costs only should be included as deferred acquisition costs if the direct-response advertising accounting criteria are met.  The new guidance is effective for reporting periods beginning after December 15, 2011 and should be applied prospectively, with retrospective application permitted.  The impact of adoption is not expected to be material to the Company’s consolidated financial condition and results of operations.

 

8



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

In May 2011, the FASB issued ASU No. 2011-04  (Topic 820), Fair Value Measurements, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (IFRS), which clarifies the application of existing fair value measurement and disclosure requirements and amends certain fair value measurement principles, requirements and disclosures.  To improve consistency in global application, changes in wording were made.  The guidance is to be applied prospectively for reporting periods beginning after December 15, 2011.  Early adoption is not permitted.  The impact of adoption is not expected to be material to the Company’s consolidated financial condition and results of operations.

 

In June 2011, the FASB issued ASU 2011-05 (Topic 220), Presentation of Comprehensive Income, which amends the presentation of comprehensive income and its components.  Under the new guidance, an entity has the option to present comprehensive income in a single continuous statement or in two separate but consecutive statements.  Both options require an entity to present reclassification adjustments for items reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of comprehensive income are presented.  The guidance is effective for reporting periods beginning after December 15, 2011 and is to be applied retrospectively.  Early adoption is permitted.  The impact of adoption is related to presentation only and will have no impact on the Company’s results of operations and financial position.

 

3.  Earnings per Weighted Average Common Share

 

Basic earnings per weighted average common share (“EPS”) is calculated by dividing net income by the weighted average number of basic common shares outstanding during the period including unvested restricted shares which are considered participating securities.  Diluted earnings per share amounts are based on the weighted average number of common shares including unvested restricted shares and the net effect of potentially dilutive common shares outstanding.  At June 30, 2011 and 2010, the Company’s potentially dilutive instruments were common shares under options of 126,100 and 206,580, respectively.

 

The following table sets forth the computation of basic and diluted EPS for the periods indicated.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net income as reported

 

$

4,085

 

$

15,089

 

$

132

 

$

27,863

 

Less dividends:

 

 

 

 

 

 

 

 

 

Distributed to common shareholders

 

7,466

 

5,928

 

14,869

 

11,840

 

Distributed to participating security holders

 

127

 

111

 

266

 

222

 

Total undistributed earnings

 

$

(3,508

)

$

9,050

 

$

(15,003

)

$

15,801

 

 

 

 

 

 

 

 

 

 

 

Undistributed earnings to common shareholders

 

$

(3,449

)

$

8,884

 

$

(14,742

)

$

15,511

 

Undistributed earnings to participating security holders

 

$

(59

)

$

166

 

$

(261

)

$

290

 

 

 

 

 

 

 

 

 

 

 

Net income available to common shareholders for basic and diluted earnings per share

 

$

4,085

 

$

15,089

 

$

132

 

$

27,863

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding

 

14,930,086

 

14,835,856

 

14,879,160

 

14,822,545

 

Common equivalent shares- restricted stock

 

254,519

 

277,501

 

263,522

 

276,759

 

Weighted average common and common equivalent shares outstanding used to calculate basic earnings per share

 

15,184,605

 

15,113,357

 

15,142,682

 

15,099,304

 

Common equivalent shares- stock options

 

14,199

 

17,036

 

16,831

 

16,823

 

Weighted average common and common equivalent shares outstanding used to calculate diluted earnings per share

 

15,198,804

 

15,130,393

 

15,159,513

 

15,116,127

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.27

 

$

1.00

 

$

0.01

 

$

1.85

 

Diluted earnings per share

 

$

0.27

 

$

1.00

 

$

0.01

 

$

1.84

 

 

Diluted EPS excludes stock options with exercise prices and exercise tax benefits greater than the average market price of the Company’s common stock during the period because their inclusion would be anti-dilutive.  There were no anti-dilutive stock options

 

9



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

for both the three and six months ended June 30, 2011.  There were 119,725 anti-dilutive stock options for both the three and six months ended June 30, 2010.

 

4.  Stock-Based Compensation

 

Management Omnibus Incentive Plan

 

Long-term incentive compensation is provided under the Company’s 2002 Management Omnibus Incentive Plan (“the Incentive Plan”) which provides for a variety of stock-based compensation awards, including nonqualified stock options, incentive stock options, stock appreciation rights and restricted stock (“RS”) awards.

 

The maximum number of shares of common stock with respect to which awards may be granted is 2,500,000. Shares of stock covered by an award under the Incentive Plan that are forfeited will again be available for issuance in connection with future grants of awards under the plan.  At June 30, 2011, there were 718,859 shares available for future grant.  The Board of Directors and the Compensation Committee intend to issue more awards under the Incentive Plan in the future.

 

A summary of stock based awards granted under the Incentive Plan during the six months ended June 30, 2011 is as follows:

 

Type of

 

 

 

Number of

 

Fair

 

 

 

Equity

 

 

 

Awards

 

Value per

 

 

 

Awarded

 

Effective Date

 

Granted

 

Share (1)

 

Vesting Terms

 

RS

 

March 9, 2011

 

68,637

 

$

47.35

 

3 years, 30%-30%-40%

 

RS

 

March 9, 2011

 

4,000

 

$

47.35

 

No vesting period (2)

 

RS

 

March 23, 2011

 

22,567

 

$

44.94

 

5 years, 20% annually

 

 


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

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

 

Accounting and Reporting for Stock-Based Awards

 

ASC 718, Compensation —Stock Compensation requires the Company to measure and recognize the cost of employee services received in exchange for an award of equity instruments.  The Company adopted ASC 718 effective January 1, 2006.  Under the provisions of ASC 718, share-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite service period (generally the vesting period of the equity grant).

 

As permitted by ASC 718, the Company elected the modified prospective transition method.  Under the modified prospective transition method, (i) compensation expense for share-based awards granted prior to January 1, 2006 is recognized over the remaining service period using the compensation cost calculated for pro forma disclosure purposes under ASC 718 as adjusted to incorporate forfeiture assumptions under ASC 718, and (ii) compensation expense for all share-based awards granted subsequent to December 31, 2005 is based on the grant date fair value estimated in accordance with the provisions of ASC 718.

 

Stock Options

 

The fair value of stock options used to compute net income and EPS for the three months ended June 30, 2010 and six months ended June 30, 2011 and 2010 is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Expected dividend yield

 

NA

 

1.68%

 

1.68%

 

1.36% - 1.68%

 

Expected volatility

 

NA

 

0.36

 

0.36

 

0.31 - 0.36

 

Risk-free interest rate

 

NA

 

4.76%

 

4.76%

 

4.35% - 4.76%

 

Expected holding period

 

NA

 

6.5 years

 

6.5 years

 

6.5 - 7 years

 

 

10



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

Expected dividend yield is the Company’s dividend yield on the measurement date and is based on the assumption that the current yield will continue in the future.  Expected volatility is based on historical volatility of the Company’s common stock as well as the volatility of a peer group of property and casualty insurers measured for a period equal to the expected holding period of the option.  The risk-free interest rate is based upon the yield on the measurement date of a zero-coupon U.S. Treasury bond with a maturity period equal to the expected holding period of the option.  The expected holding period is based upon the simplified method provided in SEC Staff Accounting Bulletin No. 107, Share-Based Payment, which utilizes the mid-points between the vesting dates and the expiration date of the option award to calculate the overall expected term.  There were no stock options granted during the three and six month periods ended June 30, 2011 and 2010.

 

The following table summarizes stock option activity under the Incentive Plan for the six months ended June 30, 2011.

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Shares

 

Weighted

 

Average

 

Aggregate

 

 

 

Under

 

Average

 

Remaining

 

Intrinsic

 

 

 

Option

 

Exercise Price

 

Contractual Term

 

Value

 

Outstanding at beginning of year

 

151,003

 

$

37.30

 

 

 

 

 

Exercised

 

(24,903

)

$

36.02

 

 

 

 

 

Outstanding at end of period

 

126,100

 

$

37.56

 

4.2 years

 

$

632

 

Exercisable at end of period

 

126,100

 

$

37.56

 

4.2 years

 

$

632

 

 

The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value, based upon the Company’s closing stock price of $42.04 on June 30, 2011, which would have been received by the option holders had all option holders exercised their options as of that date.  The range of exercise prices on stock options outstanding under the Incentive Plan was $13.30 to $42.85 at June 30, 2011 and $12.00 to $42.85 at June 30, 2010.  The total intrinsic value of options exercised during the six months ended June 30, 2011 and 2010 was $162 and $147, respectively.

 

A summary of the status of non-vested options as of June 30, 2011 is presented below.

 

 

 

 

 

Weighted Average

 

 

 

Number of

 

Grant Date

 

 

 

Shares

 

Exercise Price

 

Non-vested at beginning of year

 

23,945

 

$

42.85

 

Vested

 

(23,945

)

$

42.85

 

Non-vested at end of period

 

 

$

 

 

As of March 31, 2011, all compensation expense related to non-vested option awards had been recognized. Cash received from options exercised was $897 and $177 for the six months ended June 30, 2011 and 2010, respectively.

 

Restricted Stock

 

Restricted stock awarded to employees in the form of unvested shares is recorded at the market value of the Company’s common stock on the grant date and amortized ratably as expense over the requisite service period.

 

11



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

The following table summarizes restricted stock activity under the Incentive Plan during the six months ended June 30, 2011.

 

 

 

Shares

 

Weighted

 

 

 

Under

 

Average

 

 

 

Restriction

 

Fair Value

 

Outstanding at beginning of the year

 

301,501

 

$

35.13

 

Granted

 

95,204

 

$

46.78

 

Vested and unrestricted

 

(114,009

)

$

34.67

 

Forfeited

 

(579

)

$

37.75

 

Outstanding at end of period

 

282,117

 

$

39.24

 

 

As of June 30, 2011, there was $8,694 of unrecognized compensation expense related to non-vested restricted stock awards that is expected to be recognized over a weighted average period of 1.8 years.  The total fair value of the shares that were vested and unrestricted during the six months ended June 30, 2011 and 2010 was $3,953 and $3,782, respectively.  For the six months ended June 30, 2011 and 2010, the Company recorded compensation expense related to restricted stock of $1,461 and $1,322, net of income tax benefits of $787 and $712, respectively.

 

5.  Investments

 

The gross unrealized gains and losses on investments in fixed maturity securities, equity securities, including interests in mutual funds, and other invested assets were as follows for the periods indicated.

 

 

 

As of June 30, 2011

 

 

 

 

 

 

 

Gross Unrealized Losses (3)

 

 

 

 

 

Cost or

 

Gross

 

Non-OTTI

 

OTTI

 

Estimated

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gains

 

Losses

 

Losses (4)

 

Value

 

U.S. Treasury securities

 

$

90,798

 

$

306

 

$

(971

)

$

 

$

90,133

 

Obligations of states and political subdivisions

 

381,826

 

12,932

 

(1,351

)

 

393,407

 

Residential mortgage-backed securities (1)

 

232,720

 

16,493

 

(32

)

 

249,181

 

Commercial mortgage-backed securities

 

52,621

 

2,014

 

(11

)

 

54,624

 

Other asset-backed securities

 

14,360

 

797

 

 

 

15,157

 

Corporate and other securities

 

222,062

 

9,323

 

(566

)

 

230,819

 

Subtotal, fixed maturity securities

 

994,387

 

41,865

 

(2,931

)

 

1,033,321

 

Equity securities (2)

 

20,002

 

1,452

 

(8

)

 

21,446

 

Other invested assets

 

5,818

 

 

 

 

5,818

 

Totals

 

$

1,020,207

 

$

43,317

 

$

(2,939

)

$

 

$

1,060,585

 

 

12



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

 

 

As of December 31, 2010

 

 

 

 

 

 

 

Gross Unrealized Losses (3)

 

 

 

 

 

Cost or

 

Gross

 

Non-OTTI

 

OTTI

 

Estimated

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gains

 

Losses

 

Losses (4)

 

Value

 

U.S. Treasury securities

 

$

87,830

 

$

280

 

$

(1,841

)

$

 

$

86,269

 

Obligations of states and political subdivisions

 

436,082

 

12,014

 

(2,906

)

 

445,190

 

Residential mortgage-backed securities (1)

 

237,405

 

15,295

 

(39

)

 

252,661

 

Commercial mortgage-backed securities

 

61,259

 

2,332

 

 

 

63,591

 

Other asset-backed securities

 

16,543

 

862

 

 

 

17,405

 

Corporate and other securities

 

191,235

 

7,769

 

(883

)

 

198,121

 

Subtotal, fixed maturity securities

 

1,030,354

 

38,552

 

(5,669

)

 

1,063,237

 

Equity securities (2)

 

13,704

 

920

 

 

 

14,624

 

Other invested assets

 

2,817

 

 

 

 

2,817

 

Totals

 

$

1,046,875

 

$

39,472

 

$

(5,669

)

$

 

$

1,080,678

 

 


(1)  Residential mortgage-backed securities consists primarily of obligations of U.S. Government agencies including collateralized mortgage obligations issued, guaranteed and/or insured by the following issuers: Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA) and the Federal Home Loan Bank (FHLB).  The total of these fixed maturity securities was $232,720 and $237,335 at amortized cost and $249,181 and $252,592 at fair value as of June 30, 2011 and December 31, 2010, respectively.

(2)  Equity securities includes interests in mutual funds of $12,507 and $11,210 at cost and $13,062 and $11,699 at fair value as of June 30, 2011 and December 31, 2010, respectively, held to fund the Company’s executive deferred compensation plan.

(3)  Our investment portfolio included 64 and 80 securities in an unrealized loss position at June 30, 2011 and December 31, 2010, respectively.

(4) Amounts in this column represent other-than-temporary impairment (“OTTI”) recognized in accumulated other comprehensive income.

 

The amortized cost and the estimated fair value of fixed maturity securities, by maturity, are shown below for the period indicated.  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.

 

 

 

As of June 30, 2011

 

 

 

Amortized

 

Estimated

 

 

 

Cost

 

Fair Value

 

Due in one year or less

 

$

64,974

 

$

65,610

 

Due after one year through five years

 

230,781

 

240,224

 

Due after five years through ten years

 

242,956

 

251,054

 

Due after ten years through twenty years

 

119,858

 

121,470

 

Due after twenty years

 

36,117

 

36,001

 

Asset-backed securities

 

299,701

 

318,962

 

Totals

 

$

994,387

 

$

1,033,321

 

 

13



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

The gross realized gains (losses) on sales of fixed maturity and equity securities were as follows for the periods indicated.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Gross realized gains

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

$

1,254

 

$

366

 

$

1,577

 

$

608

 

Equity securities

 

31

 

 

102

 

 

Gross realized losses

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

(8

)

(537

)

(821

)

(669

)

Equity securities

 

 

(7

)

 

(7

)

Net realized gains (losses) on investments

 

$

1,277

 

$

(178

)

$

858

 

$

(68

)

 

Proceeds from maturities, redemptions and calls of fixed maturity securities were $30,731 and $361 for the three months ended June 30, 2011 and 2010, respectively.  Proceeds from maturities, redemptions and calls of fixed maturity securities were $31,988 and $33,973 for the six months ended June 30, 2011 and 2010, respectively.

 

In the normal course of business, the Company enters into transactions involving various types of financial instruments, including investments in fixed maturities and equity securities.  Investment transactions have credit exposure to the extent that a counter party may default on an obligation to the Company.  Credit risk is a consequence of carrying, trading and investing in securities.  To manage credit risk, the Company focuses on higher quality fixed income securities, reviews the credit strength of all companies in which it invests, limits its exposure in any one investment and monitors the portfolio quality, taking into account credit ratings assigned by recognized statistical rating organizations.

 

The following tables as of June 30, 2011 and December 31, 2010 present the gross unrealized losses included in the Company’s investment portfolio and the fair value of those securities aggregated by investment category.  The tables also present the length of time that they have been in a continuous unrealized loss position.

 

 

 

As of June 30, 2011

 

 

 

Less than 12 Months

 

12 Months or More

 

Total

 

 

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

 

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

U.S. Treasury securities

 

$

42,279

 

$

971

 

$

 

$

 

$

42,279

 

$

971

 

Obligations of states and political subdivisions

 

77,623

 

798

 

18,714

 

553

 

96,337

 

1,351

 

Residential mortgage-backed securities

 

15,635

 

25

 

221

 

7

 

15,856

 

32

 

Commercial mortgage-backed securities

 

2,839

 

11

 

 

 

2,839

 

11

 

Corporate and other securities

 

24,120

 

566

 

 

 

24,120

 

566

 

Subtotal, fixed maturity securities

 

162,496

 

2,371

 

18,935

 

560

 

181,431

 

2,931

 

Equity securities

 

440

 

8

 

 

 

440

 

8

 

Total temporarily impaired securities

 

$

162,936

 

$

2,379

 

$

18,935

 

$

560

 

$

181,871

 

$

2,939

 

 

 

 

As of December 31, 2010

 

 

 

Less than 12 Months

 

12 Months or More

 

Total

 

 

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

 

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

U.S. Treasury securities

 

$

38,318

 

$

1,841

 

$

 

$

 

$

38,318

 

$

1,841

 

Obligations of states and political subdivisions

 

109,883

 

2,490

 

7,325

 

416

 

117,208

 

2,906

 

Residential mortgage-backed securities

 

1,312

 

31

 

298

 

8

 

1,610

 

39

 

Corporate and other securities

 

27,736

 

883

 

 

 

27,736

 

883

 

Total temporarily impaired securities

 

$

177,249

 

$

5,245

 

$

7,623

 

$

424

 

$

184,872

 

$

5,669

 

 

14



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

As of June 30, 2011, we held insured investment securities of approximately $168,546, which represented approximately 15.9% of our total investments.  Approximately $55,898 of these securities are pre-refunded, meaning that funds have been set aside in escrow to satisfy the future interest and principal obligations of the bond.

 

The following table shows our insured investment securities that are backed by financial guarantors including pre-refunded securities as of June 30, 2011.  We do not have any direct investment holdings in a financial guarantee insurance company.

 

 

 

As of June 30, 2011

 

 

 

 

 

 

 

Exposure Net

 

 

 

 

 

Pre-refunded

 

of Pre-refunded

 

Financial Guarantor

 

Total

 

Securities

 

Securities

 

Municipal bonds

 

 

 

 

 

 

 

Ambac Assurance Corporation

 

$

23,606

 

$

8,557

 

$

15,049

 

Financial Guaranty Insurance Company

 

272

 

272

 

 

Assured Guaranty Municipal Corporation

 

72,310

 

34,587

 

37,723

 

National Public Finance Guaranty Corporation

 

68,375

 

12,482

 

55,893

 

Total municipal bonds

 

164,563

 

55,898

 

108,665

 

Other asset-backed securities

 

 

 

 

 

 

 

Ambac Assurance Corporation

 

3,983

 

 

3,983

 

Total other asset-backed securities

 

3,983

 

 

3,983

 

Total

 

$

168,546

 

$

55,898

 

$

112,648

 

 

The following table shows the Company’s insured investments by Moody’s rating where it is available both with and without the impact of the insurance guarantee as of June 30, 2011.

 

 

 

As of June 30, 2011

 

 

 

Rating

 

Rating

 

 

 

With

 

Without

 

Rating

 

Insurance

 

Insurance

 

Aaa

 

$

3,805

 

$

3,805

 

Aa1

 

20,509

 

20,509

 

Aa2

 

55,315

 

55,315

 

Aa3

 

53,439

 

45,193

 

A1

 

 

5,114

 

A2

 

4,945

 

4,945

 

A3

 

7,698

 

10,830

 

Baa1

 

272

 

272

 

Baa2

 

3,983

 

3,983

 

Total

 

$

149,966

 

$

149,966

 

 

Other-Than-Temporary Impairments

 

ASC 320, Investments — Debt and Equity Securities requires entities to separate an OTTI of a debt security into two components when there are credit related losses associated with the impaired debt security for which the Company asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis.  Under ASC 320, the amount of the OTTI related to a credit loss is recognized in earnings, and the amount of the OTTI related to other factors is recorded as a component of other comprehensive income (loss).  In instances where no credit loss exists but it is more likely than not that the Company will have to sell the debt security prior to the anticipated recovery, the decline in market value below amortized cost is recognized as an OTTI in earnings.  In periods after the recognition of an OTTI on debt securities, the Company accounts for such securities as if they had been purchased on the measurement date of the OTTI at an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings.  For debt securities for which OTTI was recognized

 

15



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

in earnings, the difference between the new amortized cost basis and the cash flows expected to be collected will be accreted or amortized into net investment income.

 

The Company holds no subprime mortgage debt securities.  All of the Company’s holdings in mortgage-backed securities are either U.S. Government or Agency guaranteed or are rated investment grade by either Moody’s or Standard & Poor’s.

 

The unrealized losses in the Company’s fixed income and equity portfolio as of June 30, 2011 were reviewed for potential other-than-temporary asset impairments.  The Company held no securities at June 30, 2011 with a material (20% or greater) unrealized loss for four or more consecutive quarters.  Specific qualitative analysis was also performed for any additional securities appearing on the Company’s “Watch List,” if any.  Qualitative analysis considered such factors as the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, changes to the rating of the security by a rating agency and the historical volatility of the fair value of the security.

 

The qualitative analysis performed by the Company concluded that the unrealized losses recorded on the investment portfolio at June 30, 2011 resulted from fluctuations in market interest rates and other temporary market conditions as opposed to fundamental changes in the credit quality of the issuers of such securities.  Therefore, decreases in fair values of the Company’s securities are viewed as being temporary.

 

During the six months ended June 30, 2011 and 2010 there was no significant deterioration in the credit quality of any of the Company’s holdings and no OTTI charges were recorded related to the Company’s portfolio of investment securities.  At June 30, 2011 and December 31, 2010, there were no amounts included in accumulated other comprehensive income related to securities which were considered by the Company to be other-than-temporarily impaired.

 

Based upon the qualitative analysis performed, the Company’s decision to hold these securities, the Company’s current level of liquidity and its positive operating cash flows, management believes it is more likely than not that it will not be required to sell any of its securities before the anticipated recovery in the fair value to its amortized cost basis.

 

Net Investment Income

 

The components of net investment income were as follows:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Interest on fixed maturity securities

 

$

9,698

 

$

11,123

 

$

20,096

 

$

22,187

 

Dividends on equity securities

 

42

 

56

 

85

 

98

 

Interest on other invested assets

 

45

 

3

 

90

 

6

 

Interest on cash and cash equivalents

 

12

 

16

 

23

 

32

 

Total investment income

 

9,797

 

11,198

 

20,294

 

22,323

 

Investment expenses

 

327

 

341

 

659

 

674

 

Net investment income

 

$

9,470

 

$

10,857

 

$

19,635

 

$

21,649

 

 

Fair Value Measurements

 

ASC 820, Fair Value Measurements and Disclosure provides a revised definition of fair value, establishes a framework for measuring fair value and expands financial statement disclosure requirements for fair value information.  Under ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exit price).  ASC 820  establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”).  The fair value hierarchy in ASC 820 prioritizes fair value measurements into three levels based on the nature of the inputs as follows:

 

Level 1 — Valuations based on quoted prices in active markets for identical assets and liabilities;

 

Level 2 — Valuations based on observable inputs that do not meet the criteria for Level 1, including quoted prices in inactive markets and quoted prices in active markets for similar, but not identical instruments; and

 

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Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

Level 3 — Valuations based on unobservable inputs.

 

Fair values for the Company’s fixed maturity securities are based on prices provided by its custodian bank and its investment manager.  Both the Company’s custodian bank and investment manager use a variety of independent, nationally recognized pricing services to determine market valuations.  If the pricing service cannot provide fair value determinations, the Company obtains non-binding price quotes from broker-dealers.  A minimum of two quoted prices is obtained for the majority of the Company’s available for sale fixed maturity securities in its investment portfolio.  The Company’s custodian bank is its primary provider of quoted prices from third-party pricing services and broker-dealers.  To provide reasonable assurance of the validity of each price or quote, a secondary third-party pricing service or broker-dealer quote is obtained from the Company’s investment manager.  An examination of the pricing data is then performed for each security.  If the variance between the primary and secondary price quotes for a security is within an accepted tolerance level, the quoted price obtained from the Company’s custodian bank is used in the financial statements for the security.  If the variance between the primary and secondary price quotes exceeds an accepted tolerance level, the Company obtains a quote from an alternative source, if possible, and documents and resolves any differences between the pricing sources.  In addition, the Company may request that its investment manager and its traders provide input as to which vendor is providing prices that its traders believe are reflective of fair value for the security.  Following this process, the Company may decide to value the security in its financial statements using the secondary or alternative source if it believes that pricing is more reflective of the security’s value than the primary pricing provided by its custodian bank.  The Company analyzes market valuations received to verify reasonableness, to understand the key assumptions used and their sources, and to determine an appropriate ASC 820 fair value hierarchy level based upon trading activity and the observability of market inputs.  Based on this evaluation and investment class analysis, each price is classified into Level 1, 2 or 3.

 

Fair values of instruments are based on (i) quoted prices in active markets for identical assets (Level 1), (ii) quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations in which all significant inputs are observable in active markets (Level 2) or (iii) valuations derived from valuation techniques in which one or more significant inputs are unobservable in the marketplace (Level 3).

 

The Company’s Level 1 securities consist of equity securities whose values are based on quoted prices in active markets for identical assets.  The Company’s Level 2 securities are comprised of available for sale fixed maturity securities whose fair value was determined using observable market inputs and a real estate investment trust equity investment whose fair value was determined using the trust’s net asset value obtained from its audited financial statements.  Fair values for securities for which quoted market prices were unavailable were estimated based upon reference to observable inputs such as benchmark interest rates, market comparables, and other relevant inputs.  Investments valued using these inputs include U.S. Treasury securities and obligations of U.S. Government agencies, obligations of international government agencies, obligations of states and political subdivisions, corporate securities, commercial and residential mortgage-backed securities, and other asset-backed securities.  Inputs into the fair value application that are utilized by asset class include but are not limited to:

 

·                  States and political subdivisions:  overall credit quality, including assessments of market sectors and the level and variability of sources of payment such as general obligation, revenue or lease; credit support such as insurance, state or local economic and political base, prefunded and escrowed to maturity covenants.

·                  Corporate fixed maturities: overall credit quality, the establishment of a risk adjusted credit spread over the applicable risk free yield curve for discounted cash flow valuations; assessments of the level of industry economic sensitivity, company financial policies, indenture restrictive covenants, and/or security and collateral.

·                  Residential mortgage-backed securities, U.S. agency pass-throughs, collateralized mortgage obligations (“CMOs”), non U.S. agency CMOs:  estimates of prepayment speeds based upon historical prepayment rate trends, underlying collateral interest rates, original weighted average maturity, vintage year, borrower credit quality characteristics, interest rate and yield curve forecasts, U.S. government support programs, tax policies, and delinquency/default trends.

·                  Commercial mortgage-backed securities:  overall credit quality, including assessments of the level and variability of credit support and collateral type such as office, retail, or lodging, predictability of cash flows for the deal structure, prevailing economic market conditions.

·                  Other asset-backed securities:  overall credit quality, estimates of prepayment speeds based upon historical trends and characteristics of underlying loans, including assessments of the level and variability of collateral, revenue generating agreements, area licenses agreements, product sourcing agreements and equipment and property leases.

·                  Real estate investment trust (“REIT”): net asset value per share derived from member ownership in capital venture to which a proportionate share of independently appraised net assets is attributed.

 

All unadjusted estimates of fair value for our fixed maturities priced by the pricing services as described above are included in the amounts disclosed in Level 2.

 

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Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

In order to ensure the fair value determination is representative of an exit price (consistent with ASC 820), the Company’s procedures for validating quotes or prices obtained from third-parties include, but are not limited to, obtaining a minimum of two price quotes for each fixed maturity security if possible, as discussed above, the periodic testing of sales activity to determine if there are any significant differences between the market price used to value the security as of the balance sheet date and the sales price of the security for sales that occurred around the balance sheet date, and the periodic review of reports provided by its investment manager regarding those securities with ratings changes and securities placed on its “Watch List.” In addition, valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by the Company’s external investment manager, whose investment professionals are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price (consistent with ASC 820).

 

The Company’s entire available for sale portfolio was priced based upon quoted market prices or other observable inputs as of June 30, 2011.  There were no significant changes to the valuation process during the six months ending June 30, 2011.  As of June 30, 2011 and December 31, 2010, no quotes or prices obtained were adjusted by management.  All broker quotes obtained were non-binding.

 

The following tables summarize the Company’s total fair value measurements for available for sale investments for the periods indicated.

 

 

 

As of June 30, 2011

 

 

 

Total

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

U.S. Treasury securities

 

$

90,133

 

$

 

$

90,133

 

$

 

Obligations of states and political subdivisions

 

393,407

 

 

393,407

 

 

Residential mortgage-backed securities

 

249,181

 

 

249,181

 

 

Commercial mortgage-backed securities

 

54,624

 

 

54,624

 

 

Other asset-backed securities

 

15,157

 

 

15,157

 

 

Corporate and other securities

 

230,819

 

 

230,819

 

 

Equity securities

 

21,446

 

16,318

 

5,128

 

 

Total investment securities

 

$

1,054,767

 

$

16,318

 

$

1,038,449

 

$

 

 

 

 

As of December 31, 2010

 

 

 

Total

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

U.S. Treasury securities

 

$

86,269

 

$

 

$

86,269

 

$

 

Obligations of states and political subdivisions

 

445,190

 

 

445,190

 

 

Residential mortgage-backed securities

 

252,661

 

 

252,661

 

 

Commercial mortgage-backed securities

 

63,591

 

 

63,591

 

 

Other asset-backed securities

 

17,405

 

 

17,405

 

 

Corporate and other securities

 

198,121

 

 

198,121

 

 

Equity securities

 

14,624

 

14,624

 

 

 

Total investment securities

 

$

1,077,861

 

$

14,624

 

$

1,063,237

 

$

 

 

There were no transfers between Level 1 and Level 2 during the three and six months ended June 30, 2011 and 2010.

 

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Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

The following tables summarize the changes in the Company’s Level 3 fair value measurements for the periods indicated.

 

 

 

Three Months Ended June 30,

 

 

 

2011

 

2010

 

 

 

Level 3

 

Level 3

 

 

 

Fair Value

 

Fair Value

 

 

 

Securities

 

Securities

 

Balance at April 1

 

$

 

$

2,506

 

Net gains and losses included in earnings

 

 

 

Net gains included in other comprehensive income

 

 

676

 

Purchases and sales

 

 

 

Transfers in (out) of Level 3

 

 

 

Balance at June 30

 

$

 

$

3,182

 

Amount of total losses included in earnings attributable to the change in unrealized losses related to assets still held at June 30

 

$

 

$

 

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

 

 

Level 3

 

Level 3

 

 

 

Fair Value

 

Fair Value

 

 

 

Securities

 

Securities

 

Balance at January 1

 

$

 

$

2,504

 

Net gains and losses included in earnings

 

 

 

Net gains included in other comprehensive income

 

 

678

 

Purchases and sales

 

 

 

Transfers in (out) of Level 3

 

 

 

Balance at June 30

 

$

 

$

3,182

 

Amount of total losses included in earnings attributable to the change in unrealized losses related to assets still held at June 30

 

$

 

$

 

 

Transfers in and out of Level 3 are attributable to changes in the ability to observe significant inputs in determining fair value exit pricing.  As noted in the tables above, no transfers were made in or out of Level 3 during the three and six months ended June 30, 2011 and 2010.

 

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Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

6.   Loss and Loss Adjustment Expense Reserves

 

The following table sets forth a reconciliation of beginning and ending reserves for losses and loss adjustment expenses (“LAE”), as shown in the Company’s consolidated financial statements for the periods indicated.

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

Reserves for losses and LAE at beginning of year

 

$

404,391

 

$

439,706

 

Less receivable from reinsurers related to unpaid losses and LAE

 

(53,147

)

(64,874

)

Net reserves for losses and LAE at beginning of year

 

351,244

 

374,832

 

Incurred losses and LAE, related to:

 

 

 

 

 

Current year

 

254,661

 

199,008

 

Prior years

 

(18,847

)

(22,558

)

Total incurred losses and LAE

 

235,814

 

176,450

 

Paid losses and LAE related to:

 

 

 

 

 

Current year

 

143,512

 

106,607

 

Prior years

 

92,271

 

82,894

 

Total paid losses and LAE

 

235,783

 

189,501

 

Net reserves for losses and LAE at end of period

 

351,275

 

361,781

 

Plus receivable from reinsurers related to unpaid losses and LAE

 

52,475

 

58,834

 

Reserves for losses and LAE at end of period

 

$

403,750

 

$

420,615

 

 

At the end of each period, the reserves were re-estimated for all prior accident years. The Company’s prior year reserves decreased by $18,847 and $22,558 for the six months ended June 30, 2011 and 2010, respectively, and resulted from re-estimations of prior years ultimate loss and LAE liabilities.  The decrease in prior years reserves during the 2011 period is primarily composed of reductions of $14,289 in the Company’s retained automobile reserves and $2,580 in the Company’s retained homeowners reserves.  The decrease in prior year reserves during the 2010 period is primarily composed of reductions of $15,679 in the Company’s retained automobile reserves, $3,080 in reserves assumed from Commonwealth Automobile Reinsurers (“CAR”), and $3,037 in the Company’s retained homeowners reserves.

 

The Company’s private passenger automobile line of business prior year reserves decreased by $12,419 for the six months ended June 30, 2011.  The decrease was primarily due to improved retained private passenger results of $11,168 for the accident years 2005 through 2009.  The Company’s private passenger automobile line of business prior year reserves decreased by $15,498 for the six months ended June 30, 2010.  The decrease was primarily due to improved retained private passenger results of $11,582 for accident years 2005 through 2009, and improved assumed CAR results for the private passenger automobile pool of $2,124 for accident years 2007 through 2009.  The improved retained private passenger results were primarily due to fewer incurred but not yet reported claims than previously estimated and better than previously estimated severity on the Company’s established bodily injury and property damage case reserves.  The improved CAR results were due primarily to improved CAR private passenger loss ratios as published and reported by the CAR Loss Reserving Committee.

 

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, if estimates of the ultimate resolutions of those proceedings are revised, liabilities related to those proceedings could be adjusted in the near term.

 

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

 

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Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

expenses of the Insolvency Fund in connection with an insolvent insurer.  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

 

On August 14, 2008, the Company entered into an Amended and Restated Revolving Credit Agreement (the “New Credit Agreement”) with RBS Citizens, NA (“RBS Citizens”).  The New Credit Agreement amended and restated the terms of the Company’s existing Revolving Credit Agreement with RBS Citizens prior to its expiration date of August 17, 2008.  The New Credit Agreement extends the maturity date to August 14, 2013 and provides a $30,000 revolving credit facility with an accordion feature allowing for future expansion of the committed amount up to $50,000.  Loans under the credit facility bear interest at the Company’s option at either (i) the LIBOR rate plus 1.25% per annum or (ii) the higher of RBS Citizens prime rate or 0.5% above the federal funds rate plus 1.25% per annum.  Interest only is payable prior to maturity.

 

The Company’s obligations under the credit facility are secured by pledges of its assets and the capital stock of its operating subsidiaries.  The credit facility is guaranteed by the Company’s non-insurance company subsidiaries.  The credit facility contains covenants including requirements to maintain minimum risk based capital ratios and statutory surplus of Safety Insurance Company as well as limitations or restrictions on indebtedness, liens, and other matters.  Among other covenants, the credit facility restricts the Company’s payment of dividends (i) if a default under the credit facility is continuing or would result therefrom or (ii) in an amount in excess of 50% of the Company’s prior year’s net income, as determined in accordance with GAAP.  As of June 30, 2011, the Company was in compliance with all such covenants. In addition, the credit facility includes customary events of default, including a cross-default provision permitting the lenders to accelerate the facility if the Company (i) defaults in any payment obligation under debt having a principal amount in excess of $10,000 or (ii) fails to perform any other covenant permitting acceleration of all such debt.

 

The Company had no amounts outstanding on its credit facility at June 30, 2011 and December 31, 2010.  The credit facility commitment fee included in interest expenses was computed at a rate of 0.25% on the $30,000 commitment at June 30, 2011 and 2010.

 

9. Income Taxes

 

Federal income tax expense for the six months ended June 30, 2011 and 2010 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.

 

The Company believes that the positions taken on its income tax returns for open tax years will be sustained upon examination by the Internal Revenue Service (“IRS”).  Therefore, the Company has not recorded a liability under ASC 740, Income Taxes.

 

During the six months ended June 30, 2011, there were no material changes to the amount of the Company’s unrecognized tax benefits or to any assumptions regarding the amount of its ASC 740 liability.

 

As of June 30, 2011 and December 31, 2010, the Company was no longer subject to examination of its U.S. federal tax returns for years prior to 2007.  The Company is not currently under examination by the IRS.

 

10. Share Repurchase Program

 

On August 3, 2007, the Board of Directors approved a share repurchase program of up to $30,000 of the Company’s outstanding common shares.  On March 19, 2009, the Board of Directors increased this existing share repurchase program by authorizing repurchase of up to $60,000 of the Company’s outstanding common shares.  On August 4, 2010, the Board of Directors again increased the existing share repurchase program by authorizing repurchase of up to $90,000 of the Company’s outstanding common shares.  Under the program, the Company may repurchase shares of its common stock for cash in public or private transactions, in the open market or otherwise.  The timing of such repurchases and actual number of shares repurchased will depend on a variety of factors including price, market conditions and applicable regulatory and corporate requirements.  The program does not require the Company to repurchase any specific number of shares and it may be modified, suspended or terminated at any time without prior notice.

 

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Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

There was no activity under the program during the six months ended June 30, 2011.  During the six months ended June 30, 2010, the Company purchased 162,907 shares of its common shares on the open market under the program at a cost of $5,815.  As of June 30, 2011 and December 31, 2010, the Company had purchased 1,727,455 shares on the open market at a cost of $55,526.

 

11. Subsequent Events

 

The Company has evaluated subsequent events for recognition or disclosure in the consolidated financial statements filed on Form 10-Q with the SEC and no events have occurred that require recognition or disclosure.

 

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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” below 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 (“Safety Indemnity”), Safety Property and Casualty Insurance Company (“Safety P&C”), Whiteshirts Asset Management Corporation (“WAMC”), and Whiteshirts Management Corporation, which is WAMC’s holding company.

 

We are a leading provider of private passenger automobile insurance in Massachusetts.  In addition to private passenger automobile insurance (which represented 68.7% of our direct written premiums in 2010), we offer a portfolio of other insurance products, including commercial automobile (10.4% of 2010 direct written premiums), homeowners (16.8% of 2010 direct written premiums), dwelling fire, umbrella and business owner policies (totaling 4.1% of 2010 direct written premiums).  Operating exclusively in Massachusetts and New Hampshire through our insurance company subsidiaries, Safety Insurance, Safety Indemnity, and Safety P&C (together referred to as the “Insurance Subsidiaries”), we have established strong relationships with independent insurance agents, who numbered 783 in 939 locations throughout Massachusetts and New Hampshire during 2010. We have used these relationships and our extensive knowledge of the Massachusetts market to become the second largest private passenger automobile and the third largest commercial automobile insurance carrier in Massachusetts, capturing an approximate 11.7% and 11.9% share, respectively, of the Massachusetts private passenger and commercial automobile markets in 2011, according to the Commonwealth Automobile Reinsurers (“CAR”) Cession Volume Analysis Report of June 23, 2011, 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 report as automobile exposures.

 

The Insurance Subsidiaries began writing private passenger automobile and homeowners insurance in New Hampshire during 2008 and personal umbrella business during 2009.  During the six months ended June 30, 2011 and 2010, we wrote $2,462 and $1,191, respectively, in direct written premiums in New Hampshire.

 

Recent Trends and Events

 

·                  We experienced $16,697 of catastrophe losses in our automobile and property lines for the quarter ended June 30, 2011 as a result of the unusual tornado outbreaks and severe weather across Western and Central Massachusetts which occurred on June 1, 2011.

·                  A reassessment of our catastrophe and severe weather losses which occurred during the quarter ended March 31, 2011 resulted in an additional $5,353 of losses recorded during the quarter ended June 30, 2011.

·                  We increased our Massachusetts private passenger automobile rates 3.9% effective May 15, 2011.

·                  We increased our Massachusetts homeowners rates 7.5% effective August 15, 2011.

 

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Massachusetts Automobile Insurance Market

 

We have been subject to extensive regulation in the private passenger automobile insurance industry in Massachusetts, which represented 68.7% of our direct written premiums in 2010.  Owners of registered automobiles in Massachusetts are required to maintain minimum automobile insurance coverage.  Prior to April 1, 2008, the Commissioner of Insurance (the “Commissioner”) had fixed and established the maximum rates that could be charged for private passenger automobile insurance.  Prior to April 1, 2008, as a servicing carrier of CAR, we were required to issue a policy to all qualified applicants.  In addition, based on our market share prior to April 1, 2009, we had been assigned certain licensed producers by CAR that were unable to obtain a voluntary contract with another insurer.  We call these agents Exclusive Representative Producers, or ERPs.

 

On July 16, 2007, the Commissioner issued two decisions that significantly changed how private passenger automobile insurance was regulated in Massachusetts.  In the first decision, the Commissioner approved and set a time table for the implementation of new CAR rules pursuant to which the reinsurance program run by CAR was replaced with an assigned risk plan, the Massachusetts Automobile Insurance Plan (“MAIP”).  Under these new rules, as of April 1, 2009 we are no longer assigned ERPs and instead, we are assigned individual policies by CAR.  The MAIP began with business effective on or after April 1, 2008 for new business and those risks that had 10 or more Safe Driver Points.  Beginning April 1, 2009, all business was eligible for MAIP except those risks that have no violations or accidents in the preceding three year period (so called “Clean in three” risks).  The last policy effective date on which any risk could be ceded to CAR was March 31, 2009.

 

In the second decision referenced above, the Commissioner announced that the Commissioner would not fix and establish the maximum premium rates that can be charged for private passenger automobile insurance policies issued or renewed after April 1, 2008.  In a letter accompanying the decision, the Commissioner stated that in place of the “fixed and established” system, the Commissioner would institute a system that introduces competitive pricing to the Massachusetts private passenger automobile insurance market, which the Commissioner described as “managed competition” (“Managed Competition”).  On October 5, 2007, the Commissioner issued regulation that describes the technical details of Managed Competition.

 

The Commissioner has also issued a number of bulletins addressing issues related to the implementation of Managed Competition.

 

On May 27, 2010, the Massachusetts Office of the Attorney General (the “AG”) issued proposed regulations that would have applied to the sale, marketing, claims processing, rating, and underwriting of private passenger automobile insurance offered or provided in the Commonwealth of Massachusetts.  The proposed regulations described various acts by insurers and insurance producers which would be considered to be unfair trade practices under Massachusetts’ unfair trade practices act.  The AG held two public hearings on the proposed regulations in June 2010.  In April 2011, the AG announced that although she continues to believe that additional consumer protections are necessary regarding automobile insurance, the proposed regulations will not be promulgated as proposed.  No other regulations have been proposed at this time.

 

CAR runs a reinsurance pool for commercial automobile policies and, beginning January 1, 2006, CAR implemented a Limited Servicing Carrier Program (“LSC”) for ceded commercial automobile policies.  CAR approved Safety Insurance and five other servicing carriers through a Request for Proposal to process ceded commercial automobile business, which was spread equitably among the six servicing carriers.  In 2010 CAR reduced the number of servicing carriers to four, and CAR has approved Safety Insurance and three other servicing carriers effective July 1, 2011 to continue the program.  Subject to the Commissioner’s review, CAR sets the premium rates for commercial automobile policies reinsured through CAR and this reinsurance pool can generate an underwriting result that is a profit or deficit based upon CAR’s rate level.  This underwriting result is allocated among every Massachusetts commercial automobile insurance company, including us, based on a company’s commercial automobile voluntary market share.

 

CAR also runs a reinsurance pool for Taxi, Limousine and Car Service risks (the “Taxi/Limo Program”).  On April 25, 2007, Safety Insurance submitted through a Request for Proposal a bid to process a portion of the Taxi/Limo Program.  CAR approved Safety Insurance as one of the two servicing carriers for this program beginning January 1, 2008, and CAR has again approved Safety Insurance beginning January 1, 2011 as one of the two servicing carriers.

 

During 2009, we increased our private passenger automobile rates an average of 2.6% in a series of rate filings during the year.  We began using three rating tiers effective April 1, 2009.  We filed and were approved for a 0.3% rate decrease effective June 1, 2009 and a 2.9% rate increase effective October 1, 2009.  We filed and were approved for a rate increase of 0.4% and began using four rating tiers effective January 1, 2010.  A Companion Policy Client Tier, which is policyholders who have an other than private passenger automobile policy with us, receives a rate decrease of 2.5% from our filed base rates.  A Loyal Automobile Client Tier, which is policyholders who have been insured with us for two or more years, receives our filed base rates.  A New Insurance Client Tier, which is policyholders with twelve or more months of continuous coverage or who qualify for a multi-car discount, receives a rate increase of 2.5% from our filed base rates.  A New Policyholder Tier, which is policyholders who do not qualify for the other

 

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three tiers, receives MAIP rates.  We filed and were approved for a 1.9% increase in our private passenger automobile rates effective April 19, 2010 and we filed and were approved for a 0.5% decrease in those rates effective June 15, 2010.  In addition, we filed and have been approved for a 3.9% increase in our private passenger automobile rates effective May 15, 2011.  Our rates include a 13.0% commission rate for agents.  Our direct written premiums increased by 8.1% in 2010 primarily as a result of increased exposures and average written premium per exposure in our private passenger and homeowner lines of business.

 

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 and other expenses as a percent of net earned premiums, 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 GAAP insurance ratios are outlined in the following table.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

GAAP ratios:

 

 

 

 

 

 

 

 

 

Loss ratio

 

76.8

%

64.5

%

80.4

%

65.5

%

Expense ratio

 

29.6

 

31.0

 

29.6

 

31.2

 

Combined ratio

 

106.4

%

95.5

%

110.0

%

96.7

%

 

Stock-Based Compensation

 

Long-term incentive compensation is provided under the our 2002 Management Omnibus Incentive Plan (the “Incentive Plan”) which provides for a variety of stock-based compensation awards, including nonqualified stock options, incentive stock options, stock appreciation rights and restricted stock (“RS”) awards.

 

The maximum number of shares of common stock with respect to which awards may be granted is 2,500,000.  Shares of stock covered by an award under the Incentive Plan that are forfeited will again be available for issuance in connection with future grants of awards under the plan. At June 30, 2011, there were 718,859 shares available for future grant. The Board of Directors and the Compensation Committee intend to issue more awards under the Incentive Plan in the future.

 

A summary of stock based awards granted under the Incentive Plan during the six months ended June 30, 2011 is as follows:

 

Type of

 

 

 

Number of

 

Fair

 

 

 

Equity

 

 

 

Awards

 

Value per

 

 

 

Awarded

 

Effective Date

 

Granted

 

Share (1)

 

Vesting Terms

 

RS

 

March 9, 2011

 

68,637

 

$

47.35

 

3 years, 30%-30%-40%

 

RS

 

March 9, 2011

 

4,000

 

$

47.35

 

No vesting period (2)

 

RS

 

March 23, 2011

 

22,567

 

$

44.94

 

5 years, 20% annually

 

 


(1)   The fair value per share of the restricted stock grant is equal to the closing price of our common stock on the grant date.

(2)   The shares cannot be sold, assigned, pledged, or otherwise transferred, encumbered or disposed of until the recipient is no longer a member of the 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. We use various software products to measure our exposure to catastrophe losses and the probable maximum loss to us for catastrophe losses such as hurricanes.  The models include estimates for our share of the catastrophe losses generated in the residual market for property insurance by the Massachusetts Property Insurance Underwriting Association (“FAIR Plan”).  In the aftermath of Hurricane Katrina in 2005, the reinsurance market has seen from the various software modelers, increases

 

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in the estimate of damage from hurricanes in the southern and northeast portions of the United States due to revised estimations of increased hurricane activity and increases in the estimation of demand surge in the periods following a significant event.  We continue to adjust our reinsurance programs as a result of the changes to the models.  As of January 1, 2011, we have purchased four layers of excess catastrophe reinsurance providing $505,000 of coverage for property losses in excess of $30,000 up to a maximum of $535,000.  Our reinsurers co-participation is 85.0% of $50,000 for the 1st layer, 85.0% of $80,000 for the 2nd layer, 80.0% of $250,000 for the 3rd layer, and 80.0% of $125,000 for the 4th layer. As a result of the changes to the models, and our revised reinsurance program, our catastrophe reinsurance in 2011 protects us in the event of a “125-year storm” (that is, a storm of a severity expected to occur once in a 125-year period).  Swiss Re, our primary reinsurer, maintains an A.M. Best rating of “A” (Excellent).  Most of our other reinsurers have an A.M. Best rating of “A” (Excellent) however in no case is a reinsurer rated below “A-” (Excellent).  Our losses from the June 1, 2011 tornado outbreaks and storms in Massachusetts have been less than our retention to date.

 

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 FAIR Plan 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. The FAIR Plan has grown dramatically over the past few years as insurance carriers have reduced their exposure to coastal property. The FAIR Plan’s exposure to catastrophe losses increased and as a result, the FAIR Plan decided to buy reinsurance to reduce their exposure to catastrophe losses.  On July 1, 2011, the FAIR Plan purchased $1,000,000 of catastrophe reinsurance for property losses in excess of $200,000.  At June 30, 2011, we had no material amounts recoverable from any reinsurer, excluding $44,681 recoverable from CAR.

 

On March 10, 2005, our Board of Directors adopted a resolution that prohibits Safety from purchasing finite reinsurance (reinsurance that transfers only a finite or limited amount of risk to the reinsurer) 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.

 

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Results of Operations

 

Three and Six Months Ended June 30, 2011 Compared to Three and Six Months Ended June 30, 2010

 

The following table shows certain of our selected financial results.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Direct written premiums

 

$

173,130

 

$

160,383

 

$

337,214

 

$

314,489

 

Net written premiums

 

$

167,825

 

$

153,531

 

$

325,344

 

$

300,619

 

Net earned premiums

 

$

148,720

 

$

136,143

 

$

293,366

 

$

269,300

 

Net Investment income

 

9,470

 

10,857

 

19,635

 

21,649

 

Net realized gains (losses) on investments

 

1,277

 

(178

)

858

 

(68

)

Finance and other service income

 

4,470

 

4,576

 

8,875

 

8,872

 

Total revenue

 

163,937

 

151,398

 

322,734

 

299,753

 

Loss and loss adjustment expenses

 

114,184

 

87,776

 

235,814

 

176,450

 

Underwriting, operating and related expenses

 

44,071

 

42,257

 

86,700

 

84,125

 

Interest expenses

 

21

 

22

 

43

 

44

 

Total expenses

 

158,276

 

130,055

 

322,557

 

260,619

 

Income before income taxes

 

5,661

 

21,343

 

177

 

39,134

 

Income tax expense

 

1,576

 

6,254

 

45

 

11,271

 

Net income

 

$

4,085

 

$

15,089

 

$

132

 

$

27,863

 

Earnings per weighted average common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.27

 

$

1.00

 

$

0.01

 

$

1.85

 

Diluted

 

$

0.27

 

$

1.00

 

$

0.01

 

$

1.84

 

Cash dividends paid per common share

 

$

0.50

 

$

0.40

 

$

1.00

 

$

0.80

 

 

Direct Written Premiums.  Direct written premiums for the quarter ended June 30, 2011 increased by $12,747, or 7.9%, to $173,130 from $160,383 for the comparable 2010 period.  Direct written premiums for the six months ended June 30, 2011 increased by $22,725, or 7.2% to $337,214 from $314,489 for the comparable 2010 period.  The 2011 increases occurred primarily in our personal automobile and homeowners lines, which experienced increases of 2.8% and 2.3%, respectively, in average written premium per exposure and increases of 2.9% and 14.2%, respectively, in written exposures for the six months ended June 30, 2011 from the comparable 2010 period.  The increase in homeowners exposures is primarily the result of our pricing strategy of offering account discounts to policyholders who insure both an automobile and home with us.

 

Net Written Premiums.  Net written premiums for the quarter ended June 30, 2011 increased by $14,294, or 9.3%, to $167,825 from $153,531 for the comparable 2010 period.  Net written premiums for the six months ended June 30, 2011 increased by $24,725, or 8.2%, to $325,344 from $300,619 for the comparable 2010 period.  The 2011 increase was primarily due to the factors that increased direct written premiums.

 

Net Earned Premiums.  Net earned premiums for the quarter ended June 30, 2011 increased by $12,577, or 9.2%, to $148,720 from $136,143 for the comparable 2010 period.  Net earned premiums for the six months ended June 30, 2011 increased by $24,066, or 8.9%, to $293,366 from $269,300 for the comparable 2010 period.  The 2011 increase was primarily due to the factors that increased direct written premiums.

 

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Table of Contents

 

The effect of reinsurance on net written and net earned premiums is presented in the following table.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Written Premiums

 

 

 

 

 

 

 

 

 

Direct

 

$

173,130

 

$

160,383

 

$

337,214

 

$

314,489

 

Assumed

 

4,530

 

3,347

 

8,697

 

6,940

 

Ceded

 

(9,835

)

(10,199

)

(20,567

)

(20,810

)

Net written premiums

 

$

167,825

 

$

153,531

 

$

325,344

 

$

300,619

 

 

 

 

 

 

 

 

 

 

 

Earned Premiums

 

 

 

 

 

 

 

 

 

Direct

 

$

155,481

 

$

143,204

 

$

306,952

 

$

283,066

 

Assumed

 

4,000

 

3,569

 

7,890

 

7,788

 

Ceded

 

(10,761

)

(10,630

)

(21,476

)

(21,554

)

Net earned premiums

 

$

148,720

 

$

136,143

 

$

293,366

 

$

269,300

 

 

Net Investment Income.  Net investment income for the quarter ended June 30, 2011 decreased by $1,387, or 12.8%, to $9,470 from $10,857 for the comparable 2010 period.  Net investment income for the six months ended June 30, 2011 decreased by $2,014, or 9.3%, to $19,635 from $21,649 for the comparable 2010 period.  The 2011 decrease primarily resulted from lower short-term interest rates and ongoing maintenance of short duration to protect the portfolio from rising interest rates.  Net effective annualized yield on the investment portfolio decreased to 3.5% for the quarter ended June 30, 2011 from 4.1% for the comparable 2010 period.  Net effective annualized yield on the investment portfolio decreased to 3.6% for the six months ended June 30, 2011 from 4.1% for the comparable 2010 period.  Our duration was 3.7 years at June 30, 2011, up from 3.3 years at December 31, 2010.

 

Net Realized Gains (Losses) on Investments.  Net realized gains on investments were $1,277 for the quarter ended June 30, 2011 compared to net realized losses of $178 for the comparable 2010 period.  Net realized gains on investments were $858 for the six months ended June 30, 2011 compared to net realized losses of $68 for the comparable 2010 period.

 

The gross unrealized gains and losses on investments in fixed maturity securities, equity securities, including interests in mutual funds, and other invested assets were as follows:

 

 

 

As of June 30, 2011

 

 

 

 

 

 

 

Gross Unrealized Losses (3)

 

 

 

 

 

Cost or

 

Gross

 

Non-OTTI

 

OTTI

 

Estimated

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gains

 

Losses

 

Losses (4)

 

Value

 

U.S. Treasury securities

 

$

90,798

 

$

306

 

$

(971

)

$

 

$

90,133

 

Obligations of states and political subdivisions

 

381,826

 

12,932

 

(1,351

)

 

393,407

 

Residential mortgage-backed securities (1)

 

232,720

 

16,493

 

(32

)

 

249,181

 

Commercial mortgage-backed securities

 

52,621

 

2,014

 

(11

)

 

54,624

 

Other asset-backed securities

 

14,360

 

797

 

 

 

15,157

 

Corporate and other securities

 

222,062

 

9,323

 

(566

)

 

230,819

 

Subtotal, fixed maturity securities

 

994,387

 

41,865

 

(2,931

)

 

1,033,321

 

Equity securities (2)

 

20,002

 

1,452

 

(8

)

 

21,446

 

Other invested assets

 

5,818

 

 

 

 

5,818

 

Totals

 

$

1,020,207

 

$

43,317

 

$

(2,939

)

$

 

$

1,060,585

 

 


(1) Residential mortgage-backed securities consists primarily of obligations of U.S. Government agencies including collateralized mortgage obligations and mortgage-backed securities guaranteed and/or insured by the following issuers: Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA) and the Federal Home Loan Bank (FHLB).  The total of these fixed maturity securities was $232,720 at amortized cost and $249,181 at fair value as of June 30, 2011.

 

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(2)  Equity securities includes interests in mutual funds of $12,507 at cost and $13,062 at fair value as of June 30, 2011 held to fund the Company’s executive deferred compensation plan.

(3)  Our investment portfolio included 64 securities in an unrealized loss position at June 30, 2011.

(4)  Amounts in this column represent other-than-temporary impairments recognized in accumulated other comprehensive income.

 

We continue to hold no subprime mortgage debt securities.  All of our holdings in mortgage-backed securities are either U.S. Government or Agency guaranteed or are rated investment grade by either Moody’s or Standard & Poor’s.

 

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

 

 

 

As of June 30, 2011

 

 

 

Estimated

 

 

 

 

 

Fair Value

 

Percent

 

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

 

$

347,416

 

33.6

%

Aaa/Aa

 

458,173

 

44.3

 

A

 

102,713

 

9.9

 

Baa

 

62,993

 

6.1

 

Ba

 

326

 

 

Not rated

 

61,700

 

6.1

 

Total

 

$

1,033,321

 

100.0

%

 

As of June 30, 2011, 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, with the exception of two securities which represented less than 0.6% of our total investment in fixed income securities.  All of our securities received a rating assigned by Moody’s of Ba or higher, except the few securities not rated by Moody’s, all except one of which are rated investment grade by Standard & Poor’s.  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.

 

The following table illustrates the gross unrealized losses included in our 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 June 30, 2011.

 

 

 

As of June 30, 2011

 

 

 

Less than 12 Months

 

12 Months or More

 

Total

 

 

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

 

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

U.S. Treasury securities

 

$

42,279

 

$

971

 

$

 

$

 

$

42,279

 

$

971

 

Obligations of states and political subdivisions

 

77,623

 

798

 

18,714

 

553

 

96,337

 

1,351

 

Residential mortgage-backed securities

 

15,635

 

25

 

221

 

7

 

15,856

 

32

 

Commercial mortgage-backed securities

 

2,839

 

11

 

 

 

2,839

 

11

 

Corporate and other securities

 

24,120

 

566

 

 

 

24,120

 

566

 

Subtotal, fixed maturity securities

 

162,496

 

2,371

 

18,935

 

560

 

181,431

 

2,931

 

Equity securities

 

440

 

8

 

 

 

440

 

8

 

Total temporarily impaired securities

 

$

162,936

 

$

2,379

 

$

18,935

 

$

560

 

$

181,871

 

$

2,939

 

 

As of June 30, 2011, we held insured investment securities of approximately $168,546, which represented approximately 15.9% of our total investments.  Approximately $55,898 of these securities are pre-refunded, meaning that funds have been set aside in escrow to satisfy the future interest and principal obligations of the bond.

 

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The following table shows our insured investment securities that are backed by financial guarantors including pre-refunded securities as of June 30, 2011.  We do not have any direct investment holdings in a financial guarantee insurance company.

 

 

 

As of June 30, 2011

 

 

 

 

 

 

 

Exposure Net

 

 

 

 

 

Pre-refunded

 

of Pre-refunded

 

Financial Guarantor

 

Total

 

Securities

 

Securities

 

Municipal bonds

 

 

 

 

 

 

 

Ambac Assurance Corporation

 

$

23,606

 

$

8,557

 

$

15,049

 

Financial Guaranty Insurance Company

 

272

 

272

 

 

Assured Guaranty Municipal Corporation

 

72,310

 

34,587

 

37,723

 

National Public Finance Guaranty Corporation

 

68,375

 

12,482

 

55,893

 

Total municipal bonds

 

164,563

 

55,898

 

108,665

 

Other asset-backed securities

 

 

 

 

 

 

 

Ambac Assurance Corporation

 

3,983

 

 

3,983

 

Total other asset-backed securities

 

3,983

 

 

3,983

 

Total

 

$

168,546

 

$

55,898

 

$

112,648

 

 

The following table shows our insured investments by Moody’s rating where it is available both with and without the impact of the insurance guarantee as of June 30, 2011.

 

 

 

As of June 30, 2011

 

 

 

Rating

 

Rating

 

 

 

With

 

Without

 

Rating

 

Insurance

 

Insurance

 

Aaa

 

$

3,805

 

$

3,805

 

Aa1

 

20,509

 

20,509

 

Aa2

 

55,315

 

55,315

 

Aa3

 

53,439

 

45,193

 

A1

 

 

5,114

 

A2

 

4,945

 

4,945

 

A3

 

7,698

 

10,830

 

Baa1

 

272

 

272

 

Baa2

 

3,983

 

3,983

 

Total

 

$

149,966

 

$

149,966

 

 

We reviewed the unrealized losses in our fixed income and equity portfolio as of June 30, 2011 for potential other-than-temporary asset impairments.  We held no debt securities at June 30, 2011 with a material (20% or greater) unrealized loss for four or more consecutive quarters.  Specific qualitative analysis was performed for securities appearing on our “Watch List,” if any.  Qualitative analysis considered such factors as the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, changes to the rating of the security by a rating agency and the historical volatility of the fair value of the security.

 

Of the $2,939 gross unrealized losses as of June 30, 2011, $2,322 relates to obligations of U.S. Treasuries, states and political subdivisions.  The remaining $617 of gross unrealized losses relates primarily to holdings of investment grade asset-backed, corporate, other fixed maturity and equity securities.

 

The unrealized losses recorded on the investment portfolio at June 30, 2011 resulted from fluctuations in market interest rates and other temporary market conditions as opposed to fundamental changes in the credit quality of the issuers of such securities.  Given our current level of liquidity, the fact that we do not intend to sell these securities, and that it is more likely than not that we will not be required to sell these securities prior to recovery of the cost basis of these securities, these decreases in values are viewed as being temporary.

 

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During the six months ended June 30, 2011 and 2010, there was no significant deterioration in the credit quality of any of our holdings and no other-than-temporary impairment (“OTTI”) charges were recorded related to our portfolio of investment securities.

 

For information regarding fair value measurements of our investment portfolio, refer to Item 1-Financial Statements, Note 5, Investments, of  this Form 10-Q.

 

Finance and Other Service Income.  Finance and other service income includes revenues from premium installment charges, which we recognize when earned, and other miscellaneous income and fees.  Finance and other service income decreased by $106, or 2.3%, to $4,470 for the quarter ended June 30, 2011 from $4,576 for the comparable 2010 period.  Finance and other service income increased by $3, or 0.1%, to $8,875 for the six months ended June 30, 2011 from $8,872 for the comparable 2010 period.

 

Losses and Loss Adjustment Expenses.  Losses and loss adjustment expenses incurred for the quarter ended June 30, 2011 increased by $26,408, or 30.1%, to $114,184 from $87,776 for the comparable 2010 period.  Losses and loss adjustment expenses incurred for the six months ended June 30, 2011 increased by $59,364, or 33.6%, to $235,814 from $176,450 for the comparable 2010 period.  Our GAAP loss ratio for the quarter ended June 30, 2011 increased to 76.8% from 64.5% for the comparable 2010 period.  Our GAAP loss ratio for the six months ended June 30, 2011 increased to 80.4% from 65.5% for the comparable 2010 period.  The June 1, 2011 severe weather and tornado outbreaks across Western and Central Massachusetts caused extensive damage and as a result, we experienced $16,697 of catastrophe losses in our automobile and property lines for the quarter ended June 30, 2011 compared to no catastrophe losses for the comparable 2010 period.  Further, a reassessment of our catastrophe and severe weather losses which occurred during the quarter ended March 31, 2011 resulted in an additional $5,353 of losses recorded during the quarter ended June 30, 2011.  Included in the six months ended June 30, 2011 pre-tax results is $40,668 attributable to catastrophic weather event losses compared to $9,439 for the comparable 2010 period.  Our GAAP loss ratio excluding loss adjustment expenses for the quarter ended June 30, 2011 increased to 67.8% from 54.9% for the comparable 2010 period.  Our GAAP loss ratio excluding loss adjustment expenses for the six months ended June 30, 2011 increased to 70.8% from 56.1% for the comparable 2010 period.  Total prior year favorable development included in the pre-tax results for the quarter and six months ended June 30, 2011 was $9,185 and $18,847, respectively, compared to prior years favorable development of $10,018 and $22,558, respectively, for the comparable 2010 periods.

 

Underwriting, Operating and Related Expenses.  Underwriting, operating and related expenses for the quarter ended June 30, 2011 increased by $1,814, or 4.3%, to $44,071 from $42,257 for the comparable 2010 period.  Underwriting, operating and related expense for the six months ended June 30, 2011 increased by $2,575, or 3.1%, to $86,700 from $84,125 for the comparable 2010 period. Our GAAP expense ratios for the quarter ended June 30, 2011 decreased to 29.6 % from 31.0% for the comparable 2010 period. Our GAAP expense ratios for the six months ended June 30, 2011 decreased to 29.6 % from 31.2% for the comparable 2010 period.

 

Interest Expenses.  Interest expense for the quarter ended June 30, 2011 was $21, compared to $22 for the comparable 2010 period. Interest expense for the six months ended June 30, 2011 was $43, compared to $44 for the comparable 2010 period.  The credit facility commitment fee included in interest expense for both the three and six months ended June 30, 2011 and 2010 was $19 and $37, respectively.

 

Income Tax Expense.  Our effective tax rate was 27.8% and 29.3% for the quarters ended June 30, 2011 and 2010, respectively. Our effective tax rate was 25.4% and 28.8% for the six months ended June 30, 2011 and 2010, respectively.  These effective rates were lower than the statutory rate of 35.0% primarily due to adjustments for tax-exempt investment income.

 

Net Income.  Net income for the quarter ended June 30, 2011 was $4,085 compared to $15,089 for the comparable 2010 period.  Net income for the six months ended June 30, 2011 was $132 compared to $27,863 for the comparable 2010 period.  The decreases in net income for the three and six months ended June 30, 2011 from the comparable 2010 periods were primarily attributable to the increases in losses and loss adjustment expenses, 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 facility.

 

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.

 

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Net cash provided by operating activities was $6,589 and $2,385 during the six months ended June 30, 2011 and 2010, respectively.  Our operations typically generate 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 provided by investing activities during the six months ended June 30, 2011 was $22,875 as sales, paydowns, calls and maturities of fixed maturity and equity securities exceeded purchases of fixed maturity and equity securities.  Net cash used for investing activities during the six months ended June 30, 2010 was $19,150 as fixed maturities and equity securities purchases exceeded sales, paydowns, calls and maturities of fixed maturity and equity securities.

 

Net cash used for financing activities was $14,244 and $17,662 during the six months ended June 30, 2011 and 2010, respectively.  Net cash used for financing activities is primarily comprised of dividend payments to shareholders.

 

Credit Facility

 

On August 14, 2008, we entered into an Amended and Restated Revolving Credit Agreement (the “New Credit Agreement”) with RBS Citizens, NA (“RBS Citizens”).  The New Credit Agreement amended and restated the terms of our existing Revolving Credit Agreement with RBS Citizens prior to its expiration date of August 17, 2008.  The New Credit Agreement extends the maturity date to August 14, 2013 and provides a $30,000 revolving credit facility with an accordion feature allowing for future expansion of the committed amount up to $50,000.  Loans under the credit facility bear interest at the Company’s option at either (i) the LIBOR rate plus 1.25% per annum or (ii) the higher of RBS Citizens prime rate or 0.5% above the federal funds rate plus 1.25% per annum.  Interest only is payable prior to maturity.

 

Our obligations under the credit facility are secured by pledges of our assets and the capital stock of our operating subsidiaries.  The credit facility is guaranteed by our non-insurance company subsidiaries. The credit facility contains covenants including requirements to maintain minimum risk based capital ratios and statutory surplus of Safety Insurance Company as well as limitations or restrictions on indebtedness, liens, and other matters. Among other covenants, the credit facility restricts the Company’s payment of dividends (i) if a default under the credit facility is continuing or would result therefrom or (ii) in an amount in excess of 50% of our prior year’s net income, as determined in accordance with GAAP.  As of June 30, 2011, we were in compliance with all such covenants. In addition, the credit facility includes customary events of default, including a cross-default provision permitting the lenders to accelerate the facility if the Company (i) defaults in any payment obligation under debt having a principal amount in excess of $10,000 or (ii) fails to perform any other covenant permitting acceleration of all such debt.

 

We had no amounts outstanding on our credit facility at June 30, 2011 and December 31, 2010.  The credit facility commitment fee included in interest expenses was computed at an annual rate of 0.25% on the $30,000 commitment at June 30, 2011 and 2010.

 

Regulatory Matters

 

Our insurance company’s 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, together with other distributions made 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, 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 2010, the statutory surplus of Safety Insurance was $582,432, and its net income for 2010 was $51,560.  As a result, a maximum of $58,243 is available in 2011 for such dividends without prior approval of the Commissioner.  During the six months ended June 30, 2011, Safety Insurance recorded dividends to Safety of $12,300.

 

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 February 15, 2011, our Board approved and declared a quarterly cash dividend on our common stock of $0.50 per share, or $7,542, which was paid on March 15, 2011 to shareholders of record on March 1, 2011.  On May 4, 2011, our Board approved and

 

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declared a quarterly cash dividend of $0.50 per share, or $7,593, which was paid on June 15, 2011 to shareholders of record on June 1, 2011.  On August 3, 2011, our Board approved and declared a quarterly cash dividend on our common stock of $0.50 per share which will be paid on September 15, 2011 to shareholders of record on September 1, 2011.  We plan to continue to declare and pay quarterly cash dividends in 2011, depending on our financial position and the regularity of our cash flows.

 

On August 3, 2007, our Board approved a share repurchase program of up to $30,000 of the Company’s outstanding common shares.  On March 19, 2009, our Board increased this existing share repurchase program by authorizing repurchase of up to $60,000 of the Company’s outstanding common shares. On August 4, 2010, our Board again increased the existing share repurchase program by authorizing repurchase of up to $90,000 of the Company’s outstanding common shares.  Under the program, we may repurchase shares of our common stock for cash in public or private transactions, in the open market or otherwise.  The timing of such repurchases and actual number of shares repurchased will depend on a variety of factors including price, market conditions and applicable regulatory and corporate requirements.  The program does not require us to repurchase any specific number of shares and may be modified, suspended or terminated at any time without prior notice.  As of June 30, 2011 and December 31, 2010, the Company had purchased 1,727,455 of its common shares on the open market under the program at a cost of $55,526.  There was no activity under the program during the six months ended June 30, 2011.  During the six months ended June 30, 2010, the Company purchased 162,907 shares of its common shares on the open market under the program at a cost of $5,815.

 

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 ASC 460, Guarantees.  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.

 

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.  When a claim is closed with or without a payment, the difference between the case reserve and the settlement amount creates a reserve deficiency if the payment exceeds the case reserve or a reserve redundancy if the payment is less than the case reserve.

 

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.  In addition, IBNR reserves can also be expressed as the total loss reserves required less the case reserves on reported claims.

 

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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 our loss and LAE reserves estimate based upon the analysis of our actuaries.  A reasonable estimate is derived by selecting a point estimate within a range of indications as calculated by our actuaries using generally accepted actuarial techniques. The key assumption in most actuarial analysis is that past patterns of frequency and severity will repeat in the future, unless a significant change in the factors described above takes place.  Our key factors and resulting 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 the ultimate losses incurred.  Our total reserves are the difference between the ultimate losses incurred and the cumulative loss and loss adjustment payments made to date.  Our IBNR reserves are calculated as the difference between our total reserves and the outstanding case reserves at the end of the accounting period.  To determine ultimate losses, our actuaries calculate a range of indications and select a point estimation using such actuarial techniques 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, is an appropriate basis for predicting our ultimate losses, total reserves and resulting IBNR reserves.  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 reasonably possible estimations for net reserves of approximately $319,512 to $361,628 as of June 30, 2011.  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. Our selected point estimate of net loss and LAE reserves based upon the analysis of our actuaries was $351,275 as of June 30, 2011.

 

The following tables present the point estimation of the recorded reserves and the range of estimations by line of business for net loss and LAE reserves as of June 30, 2011.  We have recorded reserves closer to the high end of the ranges of our projections.

 

Line of Business

 

Low

 

Recorded

 

High

 

Private passenger automobile

 

$

206,422

 

$

223,921

 

$

230,260

 

Commercial automobile

 

38,398

 

43,839

 

44,090

 

Homeowners

 

50,521

 

57,362

 

59,211

 

All other

 

24,171

 

26,153

 

28,067

 

Total

 

$

319,512

 

$

351,275

 

$

361,628

 

 

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The following table presents our total net reserves and the corresponding case reserves and IBNR reserves for each line of business as of June 30, 2011.

 

Line of Business

 

Case

 

IBNR

 

Total

 

Private passenger automobile

 

$

230,974

 

$

(13,527

)

$

217,447

 

CAR assumed private passenger auto

 

4,975

 

1,499

 

6,474

 

Commercial automobile

 

28,739

 

3,685

 

32,424

 

CAR assumed commercial automobile

 

7,294

 

4,121

 

11,415

 

Homeowners

 

45,535

 

7,234

 

52,769

 

FAIR Plan assumed homeowners

 

2,371

 

2,222

 

4,593

 

All other

 

18,201

 

7,952

 

26,153

 

Total net reserves for losses and LAE

 

$

338,089

 

$

13,186

 

$

351,275

 

 

Our IBNR reserves consist of our estimate of the total loss reserves required less our case reserves.  The IBNR reserves for CAR assumed private passenger and commercial automobile business are 23.2% and 36.1%, respectively, of our total reserves for CAR assumed private passenger and commercial automobile business as of June 30, 2011 due to the reporting delays in the information we receive from CAR, as described further in the section on CAR Loss and Loss Adjustment Expense Reserves.  Our IBNR reserves for FAIR Plan assumed homeowners are 48.4% of our total reserves for FAIR Plan assumed homeowners at June 30, 2011 due to similar reporting delays in the information we receive from FAIR Plan.  Our IBNR reserves for private passenger automobile have decreased due to the favorable development of case reserves in recent years.

 

The following table presents information by line of business for our total net reserves and the corresponding retained (i.e. direct less ceded) reserves and assumed reserves as of June 30, 2011.

 

Line of Business

 

Retained

 

Assumed

 

Net

 

Private passenger automobile

 

$

217,447

 

 

 

 

 

CAR assumed private passenger automobile

 

 

 

$

6,474

 

 

 

Net private passenger automobile

 

 

 

 

 

$

223,921

 

Commercial automobile

 

32,424

 

 

 

 

 

CAR assumed commercial automobile

 

 

 

11,415

 

 

 

Net commercial automobile

 

 

 

 

 

43,839

 

Homeowners

 

52,769

 

 

 

 

 

FAIR Plan assumed homeowners

 

 

 

4,593

 

 

 

Net homeowners

 

 

 

 

 

57,362

 

All other

 

26,153

 

 

26,153

 

Total net reserves for losses and LAE

 

$

328,793

 

$

22,482

 

$

351,275

 

 

CAR Loss and Loss Adjustment Expense Reserves

 

We are a participant in CAR and assume a 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 portion of reserves based upon CAR estimates for private passenger automobile line of business has declined substantially over time as a result of the institution of the MAIP and phase-out of the private passenger automobile CAR reinsurance pool on April 1, 2009, as described elsewhere in this report.

 

The CAR deficit, which consists of premium ceded to CAR less CAR losses and LAE, is allocated among 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, seventy-five 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, 2010, we had nine

 

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months of reported 2010 CAR financial data, and we had to estimate and record as IBNR reserves 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, 2009 we had to estimate our 2009 policy year CAR Participation Ratio beginning with the first quarter of 2009 through the second quarter of 2010.

 

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’ 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 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 for which 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 six months ended June 30, 2011, a 1 percentage-point change in the loss and LAE ratio would result in a change in reserves of $2,934.  Each 1 percentage-point change in the loss and loss expense ratio would have had a $1,907 effect on net income, or $0.13 per diluted share.

 

Our assumptions consider that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for establishing our reserves.  Our individual key assumptions could each have a reasonable possible range of plus or minus 5 percentage-points for each estimation, although there is no guarantee that our assumptions will not have more than a 5 percentage point variation.  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 retained (i.e., direct minus ceded) loss and LAE reserves and net income for the six months ended June 30, 2011.  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.

 

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-1 Percent

 

No

 

+1 Percent

 

 

 

Change in

 

Change in

 

Change in

 

 

 

Frequency

 

Frequency

 

Frequency

 

Private passenger automobile retained loss and LAE reserves

 

 

 

 

 

 

 

-1 Percent Change in Severity

 

 

 

 

 

 

 

Estimated decrease in reserves

 

$

(4,349

)

$

(2,174

)

$

 

Estimated increase in net income

 

2,827

 

1,413

 

 

No Change in Severity

 

 

 

 

 

 

 

Estimated (decrease) increase in reserves

 

(2,174

)

 

2,174

 

Estimated increase (decrease) in net income

 

1,413

 

 

(1,413

)

+1 Percent Change in Severity

 

 

 

 

 

 

 

Estimated increase in reserves

 

 

2,174

 

4,349

 

Estimated decrease in net income

 

 

(1,413

)

(2,827

)

 

 

 

 

 

 

 

 

Commercial automobile retained loss and LAE reserves

 

 

 

 

 

 

 

-1 Percent Change in Severity

 

 

 

 

 

 

 

Estimated decrease in reserves

 

(648

)

(324

)

 

Estimated increase in net income

 

421

 

211

 

 

No Change in Severity

 

 

 

 

 

 

 

Estimated (decrease) increase in reserves

 

(324

)

 

324

 

Estimated increase (decrease) in net income

 

211

 

 

(211

)

+1 Percent Change in Severity

 

 

 

 

 

 

 

Estimated increase in reserves

 

 

324

 

648

 

Estimated decrease in net income

 

 

(211

)

(421

)

 

 

 

 

 

 

 

 

Homeowners retained loss and LAE reserves

 

 

 

 

 

 

 

-1 Percent Change in Severity

 

 

 

 

 

 

 

Estimated decrease in reserves

 

(1,055

)

(528

)

 

Estimated increase in net income

 

686

 

343

 

 

No Change in Severity

 

 

 

 

 

 

 

Estimated (decrease) increase in reserves

 

(528

)

 

528

 

Estimated increase (decrease) in net income

 

343

 

 

(343

)

+1 Percent Change in Severity

 

 

 

 

 

 

 

Estimated increase in reserves

 

 

528

 

1,055

 

Estimated decrease in net income

 

 

(343

)

(686

)

 

 

 

 

 

 

 

 

All other retained loss and LAE reserves

 

 

 

 

 

 

 

-1 Percent Change in Severity

 

 

 

 

 

 

 

Estimated decrease in reserves

 

(523

)

(262

)

 

Estimated increase in net income

 

340

 

170

 

 

No Change in Severity

 

 

 

 

 

 

 

Estimated (decrease) increase in reserves

 

(262

)

 

262

 

Estimated increase (decrease) in net income

 

170

 

 

(170

)

+1 Percent Change in Severity

 

 

 

 

 

 

 

Estimated increase in reserves

 

 

262

 

523

 

Estimated decrease in net income

 

 

(170

)

(340

)

 

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 consider that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for establishing our CAR reserves.  Each of our assumptions could have a reasonably possible range of plus or minus 5 percentage-points for each estimation.

 

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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 six months ended June 30, 2011.  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

 

+1 Percent

 

 

 

Change in

 

Change in

 

 

 

Estimation

 

Estimation

 

CAR assumed private passenger automobile

 

 

 

 

 

Estimated (decrease) increase in reserves

 

$

(65

)

$

65

 

Estimated increase (decrease) in net income

 

42

 

(42

)

CAR assumed commercial automobile

 

 

 

 

 

Estimated (decrease) increase in reserves

 

(114

)

114

 

Estimated increase (decrease) in net income

 

74

 

(74

)

FAIR Plan assumed homeowners

 

 

 

 

 

Estimated (decrease) increase in reserves

 

(46

)

46

 

Estimated increase (decrease) in net income

 

30

 

(30

)

 

Reserve Development Summary

 

The changes we have recorded in our reserves in the past illustrate the uncertainty of estimating reserves.  Our prior year reserves decreased by $18,847, and $22,558 during the six months ended June 30, 2011 and 2010, respectively.

 

The following table presents a comparison of prior year development of our net reserves for losses and LAE for the six months ended June 30, 2011 and 2010.  Each accident year represents all claims for an annual 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.

 

 

 

Six Months Ended June 30,

 

Accident Year

 

2011

 

2010

 

2001 & prior

 

$

47

 

$

(572

)

2002 

 

(135

)

(182

)

2003 

 

(375

)

(857

)

2004 

 

(739

)

(1,076

)

2005 

 

(1,926

)

(2,696

)

2006 

 

(3,140

)

(4,364

)

2007 

 

(3,365

)

(4,926

)

2008 

 

(6,037

)

(4,629

)

2009 

 

(2,094

)

(3,256

)

2010 

 

(1,083

)

 

All prior years

 

$

(18,847

)

$

(22,558

)

 

The decreases in prior years reserves during the six months ended June 30, 2011 and 2010 resulted from re-estimations of prior year ultimate loss and LAE liabilities.The 2011 decrease is primarily composed of reductions of $14,289 in our retained automobile reserves and $2,580 in our retained homeowners reserves.  The 2010 decrease is primarily composed of reductions of $15,679 in our retained automobile reserves, $3,080 in CAR assumed reserves and $3,037 in our retained homeowners reserves.

 

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The following table presents information by line of business for prior year development of our net reserves for losses and LAE for the six months ended June 30, 2011.

 

 

 

Private Passenger

 

Commercial

 

 

 

 

 

 

 

Accident Year

 

Automobile

 

Automobile

 

Homeowners

 

All Other

 

Total

 

2001 & prior

 

$

148

 

$

(101

)

$

 

$

 

$

47

 

2002 

 

(134

)

(1

)

 

 

(135

)

2003 

 

(270

)

(105

)

 

 

(375

)

2004 

 

(521

)

(166

)

(52

)

 

(739

)

2005 

 

(1,521

)

(404

)

(1

)

 

(1,926

)

2006 

 

(1,974

)

(161

)

(768

)

(237

)

(3,140

)

2007 

 

(2,018

)

(654

)

(693

)

 

(3,365

)

2008 

 

(3,608

)

(830

)

(891

)

(708

)

(6,037

)

2009 

 

(2,435

)

(195

)

268

 

268

 

(2,094

)

2010 

 

(86

)

(142

)

(847

)

(8

)

(1,083

)

All prior years

 

$

(12,419

)

$

(2,759

)

$

(2,984

)

$

(685

)

$

(18,847

)

 

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 retained reserves for losses and LAE for the six months ended June 30, 2011; that is, all our reserves except for business ceded or assumed from CAR and other residual markets.

 

 

 

Retained

 

Retained

 

 

 

 

 

 

 

 

 

Private Passenger

 

Commercial

 

Retained

 

Retained

 

 

 

Accident Year

 

Automobile

 

Automobile

 

Homeowners

 

All Other

 

Total

 

2001 & prior

 

$

148

 

$

(101

)

$

 

$

 

$

47

 

2002 

 

(134

)

(1

)

 

 

(135

)

2003 

 

(240

)

(100

)

 

 

(340

)

2004 

 

(493

)

(151

)

(51

)

 

(695

)

2005 

 

(1,494

)

(374

)

 

 

(1,868

)

2006 

 

(1,906

)

(108

)

(751

)

(237

)

(3,002

)

2007 

 

(1,978

)

(511

)

(672

)

 

(3,161

)

2008 

 

(3,532

)

(723

)

(843

)

(708

)

(5,806

)

2009 

 

(2,258

)

(134

)

441

 

268

 

(1,683

)

2010 

 

1

 

(200

)

(704

)

(8

)

(911

)

All prior years

 

$

(11,886

)

$

(2,403

)

$

(2,580

)

$

(685

)

$

(17,554

)

 

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The following table presents information by line of business for prior year development of reserves assumed from residual markets for losses and LAE for the six months ended June 30, 2011.

 

 

 

CAR Assumed

 

CAR Assumed

 

 

 

 

 

 

 

Private Passenger

 

Commercial

 

FAIR Plan

 

 

 

Accident Year

 

Automobile

 

Automobile

 

Homeowners

 

Total

 

2001 & prior

 

$

 

$

 

$

 

$

 

2002 

 

 

 

 

 

2003 

 

(30

)

(5

)

 

(35

)

2004 

 

(28

)

(15

)

(1

)

(44

)

2005 

 

(27

)

(30

)

(1

)

(58

)

2006 

 

(68

)

(53

)

(17

)

(138

)

2007 

 

(40

)

(143

)

(21

)

(204

)

2008 

 

(76

)

(107

)

(48

)

(231

)

2009 

 

(177

)

(61

)

(173

)

(411

)

2010 

 

(87

)

58

 

(143

)

(172

)

All prior years

 

$

(533

)

$

(356

)

$

(404

)

$

(1,293

)

 

Our private passenger automobile line of business prior year reserves decreased by $12,419 for the six months ended June 30, 2011.  The decrease was primarily due to improved retained private passenger results of $11,168 for the accident years 2005 through 2009 The improved retained private passenger results were primarily due to fewer IBNR claims than previously estimated and better than previously estimated severity on our established bodily injury and property damage case reserves.

 

Our commercial automobile line of business prior year reserves decreased by $2,759 for the six months ended June 30, 2011 due primarily to fewer IBNR claims than previously estimated.

 

Our retained homeowners line of business prior year reserves decreased by $2,580 for the six months ended June 30, 2011.  Our FAIR Plan homeowners reserve decreased by $404 for the six months ended June 30, 2011.

 

In estimating all our loss reserves, including CAR, we follow the guidance prescribed by Accounting Standards Codification (“ASC”) 944, Financial Services-Insurance.

 

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 fair 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 fair value below amortized cost is an other-than-temporary impairment (“OTTI”), 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, and any other factors that may raise doubt about the issuer’s ability to continue as a going concern.

 

ASC 320, Investments — Debt and Equity Securities requires entities to separate an OTTI of a debt security into two components when there are credit related losses associated with the impaired debt security for which the Company asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis.  Under ASC 320, the amount of the OTTI related to a credit loss is recognized in earnings, and the amount of the OTTI related to other factors is recorded as a component of other comprehensive income (loss).  In instances where no credit loss exists but it is more likely than not that the Company will have to sell the debt security prior to the anticipated recovery, the decline in market value below amortized cost is recognized as an OTTI in earnings.  In periods after the recognition of an OTTI on debt securities, the Company accounts for such securities as if they had been purchased on the measurement date of the OTTI at an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings.  For debt securities for which OTTI was recognized in earnings, the difference between the new amortized cost basis and the cash flows expected to be collected will be accreted or amortized into net investment income.

 

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For further information, see “Results of Operations: Net Realized Gains (Losses) on Investments.”

 

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;

·                  Descriptions of assumptions underlying or relating to any of the foregoing; and

·                  Future performance of credit markets.

 

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, the possibility that existing insurance-related laws and regulations will become further restrictive in the future, 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.  Refer to Part I, Item 1A — Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2010.

 

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 use both fixed and variable rate debt as sources of financing.  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

 

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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 table shows the interest rate risk of our investments in fixed maturities, measured in terms of fair value (which is equal to the carrying value for all our fixed maturity securities).

 

 

 

-100 Basis

 

 

 

+100 Basis

 

 

 

Point Change

 

No Change

 

Point Change

 

As of June 30, 2011

 

 

 

 

 

 

 

Estimated fair value

 

$

1,074,431

 

$

1,033,321

 

$

989,182

 

Estimated increase (decrease) in fair value

 

$

41,110

 

$

 

$

(44,139

)

 

With respect to floating rate debt, we are exposed to the effects of changes in prevailing interest rates.  At June 30, 2011, we had no debt outstanding under our credit facility.  Assuming the full utilization of our current available credit facility, a 2.0% increase in the prevailing interest rate on our variable rate debt would result in interest expense increasing approximately $600 for 2011, assuming that all of such debt is outstanding for the entire year.

 

In addition, in the current market environment, our investments can also contain liquidity risks.

 

Equity Risk.  Equity risk is the risk that we will incur economic losses due to adverse changes in equity prices.  Our exposure to changes in equity prices results from our holdings of common stock and mutual funds held to fund the executive deferred compensation plan.  We continuously evaluate market conditions and we expect in the future to purchase additional equity securities.  We principally manage 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 (“CEO”) and Chief Financial Officer (“CFO”), 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 by us in the reports that we file or submit under the Exchange Act 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 CEO and CFO, as appropriate, 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 1A.  Risk Factors

 

There have been no subsequent material changes from the risk factors previously disclosed in the Company’s 2010 Annual Report on Form 10-K.

 

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds (Dollars in thousands)

 

On August 3, 2007, the Board approved a share repurchase program of up to $30,000 of the Company’s outstanding common shares.  On March 19, 2009, the Board increased this existing share repurchase program by authorizing repurchase of up to $60,000 of the Company’s outstanding common shares. On August 4, 2010, our Board again increased the existing share repurchase program by authorizing repurchase of up to $90,000 of the Company’s outstanding common shares.  Under the program, we may repurchase shares of our common stock for cash in public or private transactions, in the open market or otherwise.  The timing of such

 

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Table of Contents

 

repurchases and actual number of shares repurchased will depend on a variety of factors including price, market conditions and applicable regulatory and corporate requirements.  The program does not require us to repurchase any specific number of shares and may be modified, suspended or terminated at any time without prior notice.  There was no activity under this repurchase program for the six months ended June 30, 2011.

 

Item 3.   Defaults upon Senior Securities - None.

 

Item 4.   Removed and Reserved.

 

Item 5.  Other Information - None.

 

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

 

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Table of Contents

 

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: August 8, 2011

 

 

 

 

 

 

By:

/s/ WILLIAM J. BEGLEY, JR.

 

 

William J. Begley, Jr.

 

 

Vice President, Chief Financial Officer and Secretary

 

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Table of Contents

 

SAFETY INSURANCE GROUP, INC.

 

EXHIBIT INDEX

 

Exhibit

 

 

Number

 

Description

 

 

 

11.0

 

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)

101

 

The following materials from Safety Insurance Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011 formatted in eXtensible Business Reporting Language (“XBRL”): (i) Consolidated Statements of Income for the three and six months ended June 30, 2011 and 2010; (ii) Consolidated Balance Sheets at June 30, 2011 and December 31, 2010; (iii) Consolidated Statements of Shareholders’ Equity for the six months ended June 30, 2011 and 2010; (iv) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2011 and 2010; (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010, and (vi) related notes to these financial statements, tagged as blocks of text. (2)

 


(1)  Not included herein as the information is included as part of this Form 10-Q, Item 1 - Financial Statements, Note 3, Earnings per Weighted Average Common Share.

(2)  Included herein.

 

45