SAFETY INSURANCE GROUP INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2005

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

For the transition period from to

Commission File Number: 000-50070

SAFETY INSURANCE GROUP, INC.

(Exact name of registrant as specified in its charter)

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

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

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o

As of May 9, 2005, there were 15,683,579 shares of common stock with a par value of $0.01 per share were outstanding.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Safety Insurance Group, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, except share data)

	March 31, 2005		December 31, 2004
	(Unaudited)
Assets
Investment securities available for sale:
Fixed maturities, at fair value (amortized cost: $668,744 and $650,159)	$	670,501	$	663,509
Equity securities, at fair value (cost: $2,014 and $1,037)	2,029		1,087
Total investment securities	672,530		664,596
Cash and cash equivalents	137,796		155,673
Accounts receivable, net of allowance for doubtful accounts	161,563		150,451
Accrued investment income	7,907		7,008
Receivable from reinsurers related to paid loss and loss adjustment expenses	20,309		18,980
Receivable from reinsurers related to unpaid loss and loss adjustment expenses	85,854		84,167
Prepaid reinsurance premiums	42,725		43,402
Deferred policy acquisition costs	47,252		42,919
Deferred income taxes	17,322		12,679
Equity and deposits in pools	27,791		23,678
Other assets	2,537		2,892
Total assets	$	1,223,586	$	1,206,445

Liabilities
Loss and loss adjustment expense reserves	$	462,302	$	450,897
Unearned premium reserves	364,890		337,786
Accounts payable and accrued liabilities	20,409		43,684
Taxes payable	5,352		3,509
Outstanding claims drafts	20,533		16,832
Payable to reinsurers	17,505		16,990
Payable for securities purchased	—		10,972
Capital lease obligations	431		485
Debt	19,956		19,956
Total liabilities	911,378		901,111

Commitments and contingencies (Note 7)

Shareholders’ equity
Common stock: $0.01 par value; 30,000,000 shares authorized; and 15,632,701 and 15,500,052 shares issued and outstanding	156		155
Additional paid-in capital	115,859		114,070
Accumulated other comprehensive income, net of taxes	1,152		8,709
Retained earnings	195,041		182,400
Total shareholders’ equity	312,208		305,334
Total liabilities and shareholders’ equity	$	1,223,586	$	1,206,445

The accompanying notes are an integral part of these financial statements

Safety Insurance Group, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
(Dollars in thousands, except per share and share data)

	Three Months Ended March 31,
	2005		2004

Net earned premiums	$	156,416	$	143,926
Net investment income	7,459		6,823
Net realized gains on investments	407		517
Finance and other service income	3,969		3,745
Total revenue	168,251		155,011

Losses and loss adjustment expenses	110,170		111,312
Underwriting, operating and related expenses	36,591		33,986
Interest expenses	223		153
Total expenses	146,984		145,451

Income before income taxes	21,267		9,560
Income tax expense	6,765		3,190
Net income	$	14,502	$	6,370

Earnings per weighted average common share:
Basic	$	0.94	$	0.42
Diluted	$	0.92	$	0.41

Cash dividends paid per common share	$	0.12	$	0.10

Weighted average number of common shares outstanding:
Basic	15,439,974		15,260,283
Diluted	15,742,717		15,417,307

The accompanying notes are an integral part of these financial statements

Safety Insurance Group, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity
(Unaudited)
(Dollars in thousands)

	Common Stock		Additional Paid-in Capital		Accumulated Other Comprehensive Income, Net of Taxes		Promissory Notes Receivable From Management			Retained Earnings			Total Shareholders’ Equity
Balance at December 31, 2003	$	153	$	111,074	$	12,650	$	(34	)	$	144,177		$	268,020
Net income, January 1 to March 31, 2004										6,370			6,370
Payments on promissory notes from management							34						34
Other comprehensive income, net of deferred federal income taxes					3,761								3,761
Exercise of options and unearned compensation on resrticted stock, net of deferred federal income taxes			58										58
Dividends paid										(1,526		)	(1,526		)
Balance at March 31, 2004	$	153	$	111,132	$	16,411	$	—		$	149,021		$	276,717

Common
Stock

Additional
Paid-in
Capital

Accumulated
Other
Comprehensive
Income,
Net of Taxes

Retained
Earnings

Total
Shareholders’
Equity

Balance at December 31, 2004

155

114,070

8,709

182,400

305,334

Net income, January 1 to March 31, 2005

14,502

Other comprehensive loss, net of deferred federal income taxes

(7,557

)

(7,557

)

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

1,789

1,790

Dividends paid

(1,861

)

(1,861

)

Balance at March 31, 2005

156

115,859

1,152

195,041

312,208

The accompanying notes are an integral part of these financial statements

Safety Insurance Group, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
(Unaudited)
(Dollars in thousands)

	Three Months Ended March 31,
	2005			2004

Net income	$	14,502		$	6,370

Other comprehensive (loss) income, net of tax:

Change in unrealized holding gains, net of tax (benefit) expense of $(3,927) and $2,206	(7,292		)	4,097

Reclassification adjustment for gains included in net income, net of tax benefit of $(143) and $(181)	(265		)	(336		)

Unrealized (losses) gains on securities available for sale	(7,557		)	3,761

Comprehensive income	$	6,945		$	10,131

The accompanying notes are an integral part of these financial statements

Safety Insurance Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)

	Three Months Ended March 31,
	2005			2004
Cash flows from operating activities:
Net income	$	14,502		$	6,370
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization, net	2,017			1,849
Benefit for deferred income taxes	(574		)	(137		)
Gains on sale of fixed assets	—			(4		)
Net realized gains on investments	(407		)	(517		)
Changes in assets and liabilities:
Accounts receivable	(11,112		)	(14,773		)
Accrued investment income	(899		)	(532		)
Receivable from reinsurers	(3,016		)	2,693
Prepaid reinsurance premiums	677			(3,794		)
Deferred policy acquisition costs	(4,333		)	(3,992		)
Other assets	(3,588		)	19,891
Loss and loss adjustment expense reserves	11,405			17,734
Unearned premium reserves	27,104			36,362
Accounts payable and accrued liabilities	(23,275		)	(18,677		)
Payable to reinsurers	515			(18,596		)
Other liabilities	6,131			(882		)
Net cash provided by operating activities	15,147			22,995

Cash flows from investing activities:
Fixed maturities purchased	(43,422		)	(27,924		)
Equity securities purchased	(1,111		)	—
Proceeds from sales of fixed maturities	12,668			18,748
Proceeds from maturities of fixed maturities	—			5,000
Proceeds from sales of equity securities	134			—
Fixed assets purchased	(318		)	(101		)
Proceeds from sales of fixed assets	—			4
Net cash used for investing activities	(32,049		)	(4,273		)

Cash flows from financing activities:
Payments on promissory notes from management	—			34
Proceeds from exercise of stock options	886			53
Dividends paid to shareholders	(1,861		)	(1,526		)
Net cash used for financing activities	(975		)	(1,439		)

Net (decrease) increase in cash and cash equivalents	(17,877		)	17,283
Cash and cash equivalents at beginning of year	155,673			26,284

Cash and cash equivalents at end of period	$	137,796		$	43,567

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

Safety Insurance Group, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Dollars in thousands except per share and share data)

1. Basis of Presentation

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

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

The financial information as of March 31, 2005 and for the three months ended March 31, 2005 and 2004 is unaudited; however, in the opinion of the Company, the information includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial condition and results of operations for the periods. These unaudited consolidated financial statements may not be indicative of financial results for the full year and should be read in conjunction with the audited financial statements included in the Company’s annual report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on March 16, 2005.

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

2. New Accounting Pronouncements

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

3. Earnings Per Weighted Average Common Share

Basic earnings per weighted average common share (“EPS”) are calculated by dividing net income by the weighted average number of basic common shares outstanding during the period. Diluted EPS are calculated by dividing net income by the weighted average number of basic common shares outstanding and the net effect of potentially dilutive common shares. At March 31, 2005 and 2004, the Company’s potentially dilutive instruments consisted of common shares under option of 715,731 and 877,572, respectively, and common shares under restriction of 105,960 and 70,271, respectively.

	Three Months Ended March 31,
	2005		2004
Earnings per weighted average common share:
Basic	$	0.94	$	0.42
Diluted	$	0.92	$	0.41
Weighted average number of common shares outstanding:
Basic	15,439,974		15,260,283
Effect of dilutive securities:
Stock options	281,556		156,970
Restricted stock	21,187		54
Diluted	15,742,717		15,417,307

Diluted EPS excludes stock options with exercise prices greater than the average market price of the Company’s common stock during the periods because their inclusion would be anti-dilutive. The number of anti-dilutive stock options was 78,000 for the three months ended March 31, 2005. There were no such stock options during the three months ended March 31, 2004.

4. Stock-Based Compensation

On June 25, 2002, the Board adopted the 2002 Management Omnibus Incentive Plan (“the Incentive Plan”). The Incentive Plan provides for a variety of awards, including nonqualified stock options (“NQSOs”), stock appreciation rights and restricted stock (“RS”) awards. The maximum number of shares of common stock with respect to which awards may be granted under the Incentive Plan is 1,250,000. At March 31, 2005, there were 161,559 shares available for future grant. The Board 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 three months ended March 31, 2005 is as follows:

Number

Per Share

Type of Equity

of Awards

Exercise Price⁽¹⁾

Awarded

Effective Date

Granted

or Fair Value⁽²⁾

Vesting Terms

Expiration Date

NQSOs

March 16, 2005

78,000

35.23

⁽¹⁾

5 years, 20 annually

March 16, 2015

March 16, 2005

56,770

35.23

⁽²⁾

3 years, 30%-30%-40%

N/A

March 16, 2005

4,000

35.23

⁽²⁾

No vesting period⁽³⁾

N/A

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

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

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

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

	Three Months Ended March 31,
	2005				2004
	Shares Under Option		Weighted Average Exercise Price		Shares Under Option		Weighted Average Exercise Price
Outstanding at beginning of quarter	711,410		$	13.60	771,000		$	12.59
Granted during the quarter	78,000		$	35.23	111,000		$	18.50
Exercised during the quarter	(71,879	)	$	12.33	(4,428	)	$	12.00
Forfeited during the quarter	(1,800	)	$	16.19	—		—
Outstanding at end of quarter	715,731		$	16.08	877,572		$	13.34

The range of exercise prices on stock options outstanding under the Incentive Plan was $12.00 to $35.23 at March 31, 2005 and $12.00 to $18.50 at March 31, 2004.

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

	Three Months Ended March 31,
	2005				2004
	Shares Under Restriction		Weighted Average Fair Value		Shares Under Restriction	Weighted Average Fair Value
Outstanding at beginning of quarter	70,271		$	18.50	—	—
Granted during the quarter	60,770		$	35.23	70,271	$	18.50
Vested and unrestricted during the quarter	(21,081	)	$	18.50	—	—
Forfeited during the quarter	—		—		—	—
Outstanding at end of quarter	109,960		$	27.75	70,271	$	18.50

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

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

	Three Months Ended March 31,
	2005			2004
Net income, as reported	$	14,502		$	6,370
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects	(143		)	(100		)
Net income, pro forma	$	14,359		$	6,270

Earnings per weighted average share:
Basic, as reported	$	0.94		$	0.42
Basic, pro forma	$	0.93		$	0.41
Diluted, as reported	$	0.92		$	0.41
Diluted, pro forma	$	0.91		$	0.41

The fair value of stock options used to compute pro forma net income and earnings per share disclosures for the three months ended March 31, 2005 and 2004 is the estimated fair value at grant effective date using the Black-Scholes option-pricing model with the following assumptions:

	Three Months Ended March 31,
	2005	2004
Dividend yield	1.36% - 2.52%	1.95 - 2.52%
Expected volatility	0.20 - 0.31	0.20 - 0.28
Risk-free interest rate	3.23% - 4.35%	3.23 - 4.07%
Expected holding period (in years)	7	7

5. Investments

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

March 31, 2005

Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Estimated
Fair Value

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

119,280

435

(2,171

)

117,544

Obligations of states and political subdivisions

324,674

5,170

(3,492

)

326,352

Asset-backed securities

94,749

681

(1,042

)

94,388

Corporate and other securities

130,041

3,159

(983

)

132,217

Subtotal, fixed maturity securities

668,744

9,445

(7,688

)

670,501

Equity securities

2,014

)

2,029

Totals

670,758

9,467

(7,695

)

672,530

(1) Obligations of U.S. Government agencies include collateralized mortgage obligations issued, guaranteed and/or insured by the following issuers: Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association (FNMA). The total of these fixed maturity securities was $115,806 at amortized cost and $114,069 at estimated fair value as of March 31, 2005. As such, the asset-backed securities presented exclude such issuers already presented under U.S. Treasury securities and obligations of U.S. Government Agencies.

The amortized cost and the estimated fair value of fixed maturity securities, by maturity, at March 31, 2005 are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	March 31, 2005
	Amortized Cost		Fair Value
Due in one year or less	$	20,455	$	20,493
Due after one year through five years	140,907		140,874
Due after five years through ten years	198,256		200,990
Due after ten years through twenty years	79,189		79,079
Due after twenty years	19,382		20,608
Asset-backed securities	210,555		208,457
Totals	$	668,744	$	670,501

Gross gains of $411 and $561 and gross losses of $5 and $44 were realized on sales of fixed maturities for the three months ended March 31, 2005 and 2004, respectively. Gross gains of $1 were realized on the sales of equity securities for the three months ended March 31, 2005. There were no realized gains or losses on the sale of equity securities for the three months ended March 31, 2004. Proceeds from fixed maturities maturing were $0 and $5,000 for the three months ended March 31, 2005 and 2004, respectively.

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

March 31, 2005

Less than 12 Months

12 Months or More

Total

Fair
Value

Unrealized
Losses

Fair
Value

Unrealized
Losses

Fair Value

Unrealized
Losses

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

80,545

1,793

7,796

378

88,341

2,171

Obligations of states and political subdivisions

94,000

1,725

61,492

1,767

155,492

3,492

Asset-backed securities

59,218

876

7,549

166

66,767

1,042

Corporate and other securities

47,981

925

1,460

49,441

990

Total temporarily impaired securities

281,744

5,319

78,297

2,376

360,041

7,695

The Company’s investment portfolio included 142 securities in an unrealized loss position at March 31, 2005. The Company’s methodology of assessing other-than-temporary impairment is based upon analysis of each security as of the balance sheet date and considers various factors including the length of time and the extent to which fair value has been less than the cost, the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, and the Company’s intent to hold the investment for a period of time sufficient to allow for recovery of its costs.

During the three months ended March 31, 2005 and 2004, there was no significant deterioration in the credit quality of any of the Company’s holdings and no other-than-temporary impairment charges were recorded related to the Company’s portfolio of investment securities.

As of March 31, 2005, the Company’s fixed income securities portfolio was comprised entirely of investment grade securities as defined by Moody’s Investor Services, Inc., Standard and Poor’s, and the Securities Valuation Office of the National Association of Insurance Commissioners.

Net Investment Income

The components of net investment income were as follows:

	Three Months Ended March 31,
	2005		2004

Interest and dividends on fixed maturities	$	6,973	$	6,985
Dividends on equity securities	2		—
Interest on cash and cash equivalents	745		89
Total investment income	7,720		7,074
Investment expenses	261		251
Net investment income	$	7,459	$	6,823

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

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

	Three Months Ended March 31,
	2005			2004
Reserves for losses and LAE, beginning of year	$	450,897		$	383,551
Less reinsurance recoverable on unpaid losses and LAE	(84,167		)	(73,539		)
Net reserves for losses and LAE, beginning of year	366,730			310,012
Incurred losses and LAE, related to:
Current year	118,498			111,312
Prior years	(8,328		)	—
Total incurred losses and LAE	110,170			111,312
Paid losses and LAE related to:
Current year	44,371			41,603
Prior years	56,081			54,934
Total paid losses and LAE	100,452			96,537
Net reserves for losses and LAE, end of quarter	376,448			324,787
Plus reinsurance recoverables on unpaid losses and LAE	85,854			76,498
Reserves for losses and LAE, end of quarter	$	462,302		$	401,285

At the end of each period, the reserves were re-estimated for all prior accident years. Primarily due to an improvement in Commonwealth Automobile Reinsurers (“CAR”) results, prior year reserves decreased by $8,328 for the three months ended March 31, 2005. This decrease in prior year reserves resulted from re-estimations of prior accident years ultimate loss and LAE liabilities which resulted in reductions of $6,328 in CAR assumed reserves and $2,000 in the Company’s automobile reserves. The reserves for all prior accident years were unchanged for the three months ended March 31, 2004. Conditions and trends that have affected development of the loss and LAE reserves in the past may not necessarily occur in the future.

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.

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

The following discussion contains forward-looking statements. We intend statements which are not historical in nature to be, and are hereby identified as “forward-looking statements” to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In addition, the Company’s senior management may make forward-looking statements orally to analysts, investors, the media and others. This safe harbor requires that we specify important factors that could cause actual results to differ materially from those contained in forward-looking statements made by or on behalf of us. We cannot promise that our expectations in such forward-looking statements will turn out to be correct. Our actual results could be materially different from and worse than our expectations. See “Forward-Looking Statements” on page 23 for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.

Executive Summary and Overview

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

We are a leading provider of private passenger automobile insurance in Massachusetts. In addition to private passenger automobile insurance (which represented 81.0% of our direct written premiums in 2004), we offer a portfolio of other insurance products, including commercial automobile (10.4% of 2004 direct written premiums), homeowners (7.2% of 2004 direct written premiums), dwelling fire, umbrella and business owner policies. Operating exclusively in Massachusetts through our insurance company subsidiaries, Safety Insurance and Safety Indemnity Insurance Company (together referred to as the “Insurance Subsidiaries”), we have established strong relationships with 556 independent insurance agents in 659 locations throughout Massachusetts. We have used these relationships and our extensive knowledge of the Massachusetts market to become the second largest private passenger automobile insurance carrier in Massachusetts, capturing an approximate 11.0% share of the Massachusetts private passenger automobile market in 2004, according to the CAR Cession Volume Analysis Report of March 1, 2005, based on automobile exposures. These statistics total, for each vehicle insured, the number of months during the year insurance for that vehicle is in effect, to arrive at an aggregate number of car-months for each insurer; this aggregate number, divided by 12, equals the insurer’s number of car-years, a measure we refer to in this discussion as automobile exposures.

Massachusetts Automobile Insurance Market

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

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

On December 31, 2004, the Commissioner approved new rules for CAR, which became effective on January 1, 2005 (the “Approved Rules”). The Approved Rules replace CAR with an assigned insurance plan, the “Massachusetts Assigned Insurance Plan” (the “MAIP”), similar to those employed in 42 other states. The Approved Rules consist of two parts. One part applies to the operation of the MAIP, which will be phased in during 2006 and 2007 and which will fully replace CAR beginning January 1, 2008. The MAIP will provide for random and equitable distribution to companies of risks unable to obtain insurance in the voluntary market. The second part of the Approved Rules consists of a series of transition rules that are scheduled to take effect in 2005, 2006 and 2007.

On January 14, 2005, we filed, on Form 8-K, an estimate of the financial impact the Approved Rules may have on us and we stated that a lawsuit had been filed in Suffolk Superior Court by Commerce Insurance Company against the Commissioner that seeks an order permanently enjoining implementation and/or enforcement of the Approved Rules. Certain ERPs, Arbella Mutual Insurance Company and the Center for Insurance Research have intervened as plaintiffs and CAR has intervened as a defendant in this lawsuit. On February 1, 2005 the Court issued an order approving a motion by the ERP plaintiffs that stayed the Approved Rules pending a final decision in this lawsuit. The Plaintiffs have moved for Judgment on the Pleadings and a hearing on that motion was held in the Superior Court on May 2, 2005. Safety has joined with several other insurance companies and insurance industry trade associations in filing an amicus curiae brief in support of the Approved Rules. At the present time, we are unable to predict the outcome of the litigation surrounding the Approved Rules.

CAR annually approves the rules that set the value of credits and the cost to cede business. On March 9, 2005, CAR approved rules for the operation of the residual market for 2005 (the “2005 Rules”). CAR filed the 2005 Rules with the Commissioner on March 29, 2005, after CAR obtained an order from the Superior Court confirming that the stay of the Approved Rules did not prevent CAR from filing the 2005 Rules with the Commissioner. Commerce Insurance Company, Arbella Mutual Insurance Company, and Plymouth Rock Assurance Corporation have requested a public hearing in accordance with provisions of CAR’s Plan of Operation and the Commissioner has scheduled a hearing to consider the 2005 Rules on May 31, 2005. The 2005 Rules revise the value of credits based on the actual rate subsidies contained in the Commissioner’s rate decision, and reduce the cost for ceding high loss ratio ERP business to CAR. The 2005 Rules would reduce the penalty in the current rules for ceding high loss ratio ERP business to CAR, and would therefore result in a reduction of the expense we incur because of our disproportionate share of high loss ratio ERP business. At the present time, we are unable to predict whether the Commissioner will approve the 2005 Rules.

Each year, the Commissioner sets maximum premium rates that may be charged and minimum commissions that must be paid to agents for private passenger automobile insurance. The Commissioner announced on December 15, 2004 a 1.7% statewide average private passenger automobile insurance rate decrease for 2005, compared to a 2.5% increase for 2004. Coinciding with the 2005 rate decision, the Commissioner also approved a 10.9% commission rate agents receive for selling private passenger automobile insurance, as a percentage of premiums, compared to a commission rate of 10.5% in 2004.

While state-mandated average maximum private passenger automobile insurance rates decreased 1.7% for 2005, our average premium per automobile exposure in the three months ended March 31, 2005 increased from the three months ended March 31, 2004 by approximately 0.7%. This increase was primarily the result of purchases of new automobiles by our insureds. We believe that the continued benefits of our rate pursuit initiative, which validates insured rating classifications and discount eligibility, contributed to the increase in our average premiums received per automobile exposure. The table below shows average Massachusetts-mandated private passenger automobile premium rate changes and changes in our average premium per automobile exposure from 1996-2005.

Massachusetts Private Passenger Rate Decisions

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

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

⁽²⁾ Source: Safety Insurance.

Statutory Accounting Principles

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

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

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

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

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

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

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

Insurance Ratios

The property and casualty insurance industry uses the combined ratio as a measure of underwriting profitability. The combined ratio is the sum of the loss ratio (losses and loss adjustment expenses incurred as a percent of net earned premiums) plus the expense ratio (underwriting expenses as a percent of net written premiums, if calculated on a SAP basis, or net earned premiums, if calculated on a GAAP basis). The combined ratio reflects only underwriting results, and does not include income from investments or finance and other service income. Underwriting profitability is subject to significant fluctuations due to competition, catastrophic events, weather, economic and social conditions and other factors.

Our SAP insurance ratios are outlined in the following table:

	For the Three Months Ended March 31,
SAP Ratios:	2005		2004
Loss Ratio	70.4	%	77.3	%
Expense Ratio	22.0		21.3
Combined Ratio	92.4	%	98.6	%

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

Our GAAP insurance ratios are outlined in the following table:

	For the Three Months Ended March 31,
GAAP Ratios:	2005		2004
Loss Ratio	70.4	%	77.3	%
Expense Ratio	23.4		23.6
Combined Ratio	93.8	%	100.9	%

Stock-Based Compensation

Type of Equity
Awarded

Effective Date

Number of
Awards
Granted

Per Share
Exercise price⁽¹⁾or fair value⁽²⁾

Vesting Terms

Expiration Date

NQSOs

March 16, 2005

78,000

35.23

⁽¹⁾

5 years, 20 annually

March 16, 2015

March 16, 2005

56,770

35.23

⁽²⁾

3 years, 30%-30%-40%

N/A

March 16, 2005

4,000

35.23

⁽²⁾

No vesting period⁽³⁾

N/A

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

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

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

Reinsurance

We reinsure with other insurance companies a portion of our potential liability under the policies we have underwritten, thereby protecting us against an unexpectedly large loss or a catastrophic occurrence that could produce large losses, primarily in our homeowners line of business. As of January 1, 2005 our catastrophe reinsurance provides gross per occurrence reinsurance coverage up to $250,000. This catastrophe reinsurance protects us in the event of a “426-year storm” (that is, a storm of a severity expected to occur once in a 426-year period). Swiss Re, our primary reinsurer, maintains an A.M. Best rating of “A+” (Superior). All of our other reinsurers have an A.M. Best rating of “A” (Excellent) or better. We are a participant in CAR, a state-established body that runs the residual market reinsurance programs for both private passenger and commercial automobile insurance in Massachusetts under which premiums, expenses, losses and loss adjustment expenses on ceded business are shared by all insurers writing automobile insurance in Massachusetts. We also participate in the Massachusetts Property Insurance Underwriting Association in which premiums, expenses, losses and loss adjustment expenses on homeowners business that cannot be placed in the voluntary market are shared by all insurers writing homeowners insurance in Massachusetts. As of March 31, 2005, we had no material amounts recoverable from any reinsurer, excluding the residual markets described above.

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

Effects of Inflation

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

Critical Accounting Policies

Loss and Loss Adjustment Expense Reserves.

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

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

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

When reviewing reserves, we analyze historical data and estimate the impact of various loss development factors, such as our historical loss experience and that of the industry, trends in claims frequency and severity, our mix of business, our claims processing procedures, legislative enactments, judicial decisions, legal developments in imposition of damages, and changes and trends in general economic conditions, including the effects of inflation. A change in any of these factors from the assumption implicit in our estimate can cause our actual loss experience to be better or worse than our reserves, and the difference can be material. There is no precise method, however, for evaluating the impact of any specific factor on the adequacy of reserves, because the eventual development of reserves is affected by many factors. Establishment of appropriate reserves is an inherently uncertain process, and currently established reserves may not prove adequate in light of subsequent actual experience. To the extent that reserves are inadequate and are strengthened, the amount of such an 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. We do not discount reserves.

The changes we have recorded in our reserves in the past illustrate the uncertainty of estimating reserves. Primarily due to an improvement in CAR results, our prior year reserves decreased by $8,328 for the three months ended March 31, 2005 as compared to no change for the three months ended March 31, 2004. This decrease in our prior year reserves resulted from re-estimations of prior year accident year ultimate loss and LAE liabilities and is composed of a reduction of $6,328 in CAR assumed reserves and a decrease of $2,000 in our automobile reserves. It is not appropriate to extrapolate future favorable or unfavorable development of reserves from this past experience.

For further information, see “Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations: Results of Operations - Losses and Loss Adjustment Expenses.”

Other-Than-Temporary Impairments.

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

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

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

For further information, see “Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations: Results of Operations - Net Realized Investment Losses.”

Results of Operations

The following table shows certain of our selected financial results:

	For the Three Months Ended March 31,
	2005		2004

Direct written premiums	$	185,775	$	180,583
Net written premiums	184,198		176,494
Net earned premiums	156,416		143,926
Net investment income	7,459		6,823
Net realized gains on investments	407		517
Finance and other service income	3,969		3,745
Total revenue	168,251		155,011
Losses and loss adjustment expenses	110,170		111,312
Underwriting, operating and related expenses	36,591		33,986
Interest expenses	223		153
Total expenses	146,984		145,451
Income before income taxes	21,267		9,560
Income tax expense	6,765		3,190
Net income	$	14,502	$	6,370

THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THREE MONTHS ENDED MARCH 31, 2004

Direct Written Premiums. Direct written premiums for the first quarter of 2005 increased by $5,192, or 2.9%, to $185,775 from $180,583 for the comparable 2004 period. The 2005 increase occurred primarily in our personal automobile line, which experienced a 0.7% increase in average written premium and a 2.0% increase in written exposures. In addition, our commercial automobile line’s average written premium decreased by 1.8%, which was more than offset by a 9.8% increase in written exposures. Our homeowners line average written premium increased by 8.9%, which was partly offset by a 4.6% decrease in written exposures.

Net Written Premiums. Net written premiums for the first quarter of 2005 increased by $7,704, or 4.4%, to $184,198 from $176,494 for the comparable 2004 period primarily due to the factors that increased direct written premiums.

Net Earned Premiums. Net earned premiums for the first quarter of 2005 increased by $12,490, or 8.7%, to $156,416 from $143,926 for the comparable 2004 period. This was primarily due to the factors that increased direct written premiums.

Net Investment Income. Net investment income for the first quarter of 2005 was $7,459 compared to $6,823 for the comparable 2004 period. Average cash and investment securities (at amortized cost) increased by $111,611, or 16.2%, to $802,226 at March 31, 2005 from $690,615 for the comparable 2004 period due primarily to a $111,809 increase in average cash and cash equivalents. Net effective annualized yield on the investment portfolio decreased to 3.7% during the first quarter of 2005 from 4.0% during the comparable 2004 period due to management’s investment strategy to shift to higher rated securities and increase tax-exempt holdings. Our duration increased slightly to 3.5 years at March 31, 2005 from 3.4 years at March 31, 2004.

Net Realized Gains on Investments. Net realized gains on investments decreased to $407 for the first quarter of 2005 from $517 for the comparable 2004 period.

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

March 31, 2005

Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Estimated
Fair Value

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

119,280

435

(2,171

)

117,544

Obligations of states and political subdivisions

324,674

5,170

(3,492

)

326,352

Asset-backed securities

94,749

681

(1,042

)

94,388

Corporate and other securities

130,041

3,159

(983

)

132,217

Subtotal, fixed maturity securites

668,744

9,445

(7,688

)

670,501

Equity securities

2,014

)

2,029

Totals

670,758

9,467

(7,695

)

672,530

As of March 31, 2005, our portfolio of fixed maturity investments was comprised entirely of investment grade corporate fixed maturity securities, U.S. government and agency securities and asset-backed securities (i.e., all our securities received a rating assigned by Moody’s Investors Service, Inc. of Baa or higher, except the few securities not rated by Moody’s which received S&P ratings of AA/A or higher, as well as a rating assigned by the Securities Valuation Office of the National Association of Insurance Commissioners of 1 or 2).

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

	March 31, 2005
	Fair Value		Percent
U.S. Government and Government Agency Fixed Income Securities	$	117,545	17.5	%
Aaa/Aa	427,975		63.9
A	78,696		11.7
Baa	46,285		6.9
Total	$	670,501	100.0	%

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

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

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

The following table illustrates the gross unrealized losses included in the Company’s investment portfolio and the fair value of those securities, aggregated by investment category. The table also illustrates the length of time that they have been in a continuous unrealized loss position as of March 31, 2005.

March 31, 2005

Less than 12 Months

12 Months or More

Total

Fair Value

Unrealized
Losses

Fair Value

Unrealized
Losses

Fair Value

Unrealized
Losses

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

80,545

1,793

7,796

378

88,341

2,171

Obligations of states and political subdivisions

94,000

1,725

61,492

1,767

155,492

3,492

Asset-backed securities

59,218

876

7,549

166

66,767

1,042

Corporate and other securities

47,981

925

1,460

49,441

990

Total temporarily impaired securities

281,744

5,319

78,297

2,376

360,041

7,695

The unrealized losses recorded on the fixed maturity investment portfolio at March 31, 2005 resulted from fluctuations in market interest rates as opposed to fundamental changes in the credit quality of the issuers of such securities. Therefore, these decreases in values are viewed as being temporary as we have the intent and ability to retain such investments for a period of time sufficient to allow for recovery in market value.

Of the $7,695 gross unrealized losses as of March 31, 2005, $5,663 relates to fixed maturity obligations of states and political subdivisions and U.S. government agencies. The remaining $2,032 of gross unrealized losses relates primarily to holdings of investment grade asset-backed, corporate and other fixed maturity securities.

Finance and Other Service Income. Finance and other service income includes revenues from premium installment charges, which we recognize when earned. Finance and other service income increased $224, or 6.0%, to $3,969 for the first quarter of 2005 from $3,745 for the comparable 2004 period. This resulted from increases in premium installment billing fees primarily due to growth in the number of policies.

Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses incurred for the first quarter of 2005 decreased $1,142, or 1.0%, to $110,170 from $111,312 for the comparable 2004 period. Our GAAP loss ratio for the first quarter of 2005 decreased to 70.4% from 77.3% for the comparable 2004 period. Our GAAP loss ratio excluding loss adjustment expenses for the first quarter of 2005 decreased to 63.0% from 69.9% for the comparable 2004 period. The 2005 loss ratio improved as a result of $8,328 in favorable loss development composed primarily of a reduction of $6,328 in CAR prior year results. Also contributing to the improvement was lower severity in our automobile lines of business, partially offset by increased frequency due to worse winter weather in Massachusetts.

Underwriting, Operating and Related Expenses. Underwriting, operating and related expense for the first quarter of 2005 increased by $2,605, or 7.7%, to $36,591 from $33,986 for the comparable 2004 period. Our GAAP expense ratios for the first quarter of 2005 decreased slightly to 23.4% from 23.6% for the comparable 2004 period.

Interest Expenses. Interest expense for the first quarter of 2005 was $223 compared to $153 for the comparable 2004 period.

Income Tax Expense. Our effective tax rates were 31.8% and 33.4% for the first quarter of 2005 and 2004, respectively. These effective rates were lower than the statutory rate of 35% primarily due to adjustments for tax-exempt investment income.

Net Income. Net income for the first quarter of 2005 increased by $8,132, or 127.7%, to $14,502 from $6,370 for the comparable 2004 period. This increase was primarily due to the increase in premiums and decrease in the loss ratio, as discussed above.

Liquidity and Capital Resources

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

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

Net cash provided by operating activities was $15,147 and $22,995 during the first quarters of 2005 and 2004, respectively. Our operations typically generate substantial positive cash flows from operations as most premiums are received in advance of the time when claim and benefit payments are required. These positive operating cash flows are expected to continue to meet our liquidity requirements.

Net cash used for investing activities was $32,049 and $4,273 during the first quarters of 2005 and 2004, respectively, primarily from purchases of fixed maturities in excess of sales of fixed maturities.

Net cash used for financing activities was $975 and $1,439 during the first quarters of 2005 and 2004, respectively, primarily from dividends paid to shareholders in excess of proceeds from stock option exercises.

Credit Facility

Concurrent with the closing of our IPO and repayment of the old credit facility, Safety obtained a new $30,000 revolving credit facility. Bank of America is the lender under this credit facility. Safety borrowed the entire $30,000 under this credit facility at the closing of the IPO and paid down the balance to $19,956 on December 5, 2002 with the approximately $10,000 net proceeds from the exercise of the underwriter’s over-allotment option for 900,000 shares of our common stock. Loans under the credit facility bear interest at our option at either (i) the LIBOR rate plus 1.50% per annum or (ii) the higher of Bank of America’s prime rate or 0.50% above the federal funds rate plus 1.50% per annum. The credit facility is due and payable at maturity on November 27, 2005, which is three years from the closing of the IPO. Interest only is payable prior to maturity. The obligations of Safety under the credit facility are secured by pledges of the assets of Safety and the capital stock of Safety’s operating subsidiaries. The credit facility is guaranteed by the non-insurance company subsidiaries of Safety. The credit facility contains covenants including requirements to maintain minimum risk based capital ratios and statutory surplus of Safety Insurance as well as limitations or restrictions on indebtedness, liens, dividends, and other matters. As of March 31, 2005, we were in compliance with all such covenants.

Regulatory Matters

Our insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of the Commissioner. The Massachusetts statute limits the dividends an insurer may pay in any twelve-month period, without the prior permission of the Commissioner, to the greater of (i) 10% of the insurer’s surplus as of the preceding December 31 or (ii) the insurer’s net income for the twelve-month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices. Our insurance company subsidiaries may not declare an “extraordinary dividend” (defined as any dividend or distribution that, 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 Massachusett’s 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 2004, the statutory surplus of Safety Insurance was $278,161, and its net income for 2004 was $42,251. As a result, a maximum of $42,251 is available in 2005 for such dividends without prior approval of the Division. During the first quarter of 2005, Safety Insurance recorded dividends to Safety of $2,256.

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 17, 2005, our Board approved a quarterly cash dividend on our common stock of $0.12 per share, or $1,861, which was paid on March 15, 2005. We plan to continue to declare and pay quarterly cash dividends in 2005, depending on our financial position and the regularity of our cash flows.

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

We have received no inquiries from the Commissioner, the Massachusetts Attorney General, or any other government agency relative to how we conduct our contingent commissions and profit sharing programs.

Off-Balance Sheet Arrangements

We have no material obligations under a guarantee contract meeting the characteristics identified in paragraph 3 of Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements, Including Indirect Guarantees of Indebtedness of Others”. We have no material retained or contingent interests in assets transferred to an unconsolidated entity. We have no material obligations, including contingent obligations, under contracts that would be accounted for as derivative instruments. We have no obligation, including contingent obligations, arising out of a variable interest in an unconsolidated entity held by, and material to, us, where such entity provides financing, liquidity, market risk or credit risk support to, or engages in leasing, hedging or research and development services with us. We have no direct investments in real estate and no holdings of mortgages secured by commercial real estate. Accordingly, we have no material off-balance sheet arrangements.

Contractual Obligations

We have obligations to make future payments under contracts and credit-related financial instruments and commitments. At March 31, 2005, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:

	Payments Due by Period
	No Stated Maturity		Within One Year		Two to Three Years		Four to Five Years		After Five Years		Total
Loss and LAE reserve⁽¹⁾	$	462,302	N/A		N/A		N/A		N/A		$	462,302
Debt	—		$	19,956	$	—	$	—	$	—	19,956
Capital lease obligations	—		233		198		—		—		431
Operating leases	—		2,883		5,846		2,318		—		11,047
Total contractual obligations	$	462,302	$	23,072	$	6,044	$	2,318	$	—	$	493,736

⁽¹⁾ We cannot reasonably estimate the future payments due by year as our loss and LAE reserves do not have contractual maturity dates and the timing of future payments and final settlement of claims is subject to significant uncertainty.

There was no material change in any of our contractual obligations outside the ordinary course of our business during the three months ended March 31, 2005. Our loss and loss adjustment expense reserves, debt and capital lease obligations are currently reflected in our March 31, 2005 and 2004 balance sheets under GAAP.

Forward-Looking Statements

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

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

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

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

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

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

Forward-looking statements are not guarantees of future performance. By their nature, forward-looking statements are subject to risks and uncertainties. There are a number of factors, many of which are beyond our control, that could cause actual future conditions, events, results or trends to differ significantly and/or materially from historical results or those projected in the forward-looking statements. These factors include but are not limited to the competitive nature of our industry and the possible adverse effects of such competition. Although a number of national insurers that are much larger than we are do not currently compete in a material way in the Massachusetts private passenger automobile market, if one or more of these companies decided to aggressively enter the market it could have a material adverse effect on us. Other significant factors include conditions for business operations and restrictive regulations in Massachusetts, the possibility of losses due to claims resulting from severe weather, the possibility that the Approved Rules are successfully appealed by Commerce or one or more of our other competitors, the possibility that the Commissioner may approve future Rule changes that change the operation of the residual market, our possible need for and availability of additional financing, and our dependence on strategic relationships, among others, and other risks and factors identified from time to time in our reports filed with the SEC, such as those set forth under the caption “Risk Factors” in our prospectus in the registration statement on Form S-1 filed with the SEC on November 22, 2002.

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

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

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

Market Risk. Market risk is the risk that we will incur losses due to adverse changes in market rates and prices. We have exposure to market risk through our investment activities and our financing activities. Our primary market risk exposure is to changes in interest rates. We 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 maximize the total after-tax return on all of our investments. An important strategy that we employ to achieve this goal is to try to hold enough in cash and short-term investments in order to avoid liquidating longer-term investments to pay claims.

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

	As of March 31, 2005
	-100 Basis Point Change		No Change		+100 Basis Point Change
Estimated fair value	$	698,395	$	670,501	$		641,327
Estimated increase (decrease) in fair value	$	27,894	—		$	(29,174		)

An important market risk for all of our outstanding long-term debt is interest rate risk. We continue to monitor the interest rate environment and to evaluate refinancing opportunities as maturity dates approach. With respect to floating rate debt, we are also exposed to the effects of changes in prevailing interest rates. At March 31, 2005 we had $19,956 of debt outstanding under our credit facility at a variable rate of 4.3%. A 2.0% change in the prevailing interest rate on our variable rate debt would result in interest expense fluctuating approximately $400 for 2005, assuming that all of such debt is outstanding for the entire year.

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

Item 4. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

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

Changes in Internal Control over Financial Reporting

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

Part II. OTHER INFORMATION

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

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

Item 3. Defaults upon Senior Securities - None.

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

Item 5. Other Information - None.

Item 6. Exhibits - The exhibits are contained herein as listed in the Exhibit Index on page 26.

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: May 10, 2005

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

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

		Page No.
PART I.	FINANCIAL INFORMATION

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

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Executive Summary and Overview	14
	Critical Accounting Policies	17
	Results of Operations - Three Months Ended March 31, 2005 and 2004	19
	Liquidity and Capital Resources	22
	Forward-Looking Statements	23

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	24

Item 4.	Controls and Procedures	25

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	25

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25

Item 3.	Defaults upon Senior Securities	25

Item 4.	Submission of Matters to a Vote of Security Holders	25

Item 5.	Other Information	25

Item 6.	Exhibits	25

SIGNATURE		25

EXHIBIT INDEX		26

Exhibit Number		Description

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

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

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

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

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