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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 September 30, 2009

 

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)

 

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 o 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 November 2, 2009, there were 15,051,435 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 September 30, 2009 and December 31, 2008 (Unaudited)

3

 

Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2009 and 2008 (Unaudited)

4

 

Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2009 and 2008 (Unaudited)

5

 

Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2009 and 2008 (Unaudited)

6

 

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008 (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

24

 

Critical Accounting Policies and Estimates

29

 

Results of Operations — Three and Nine Months Ended September 30, 2009 and 2008

37

 

Liquidity and Capital Resources

44

 

Forward-Looking Statements

46

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

46

 

 

 

Item 4.

Controls and Procedures

47

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

47

 

 

 

Item 1A.

Risk Factors

47

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

48

 

 

 

Item 3.

Defaults upon Senior Securities

48

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

48

 

 

 

Item 5.

Other Information

48

 

 

 

Item 6.

Exhibits

48

 

 

 

SIGNATURE

 

49

 

 

 

EXHIBIT INDEX

50

 



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(Unaudited)

(Dollars in thousands, except share data)

 

 

 

September 30,

 

December 31,

 

 

 

2009

 

2008

 

Assets

 

 

 

 

 

Investment securities available for sale:

 

 

 

 

 

Fixed maturities, at fair value (amortized cost: $989,753 and $929,836)

 

$

 1,026,818

 

$

 920,171

 

Equity securities, at fair value (cost: $9,645 and $8,419)

 

9,806

 

8,040

 

Short-term securities, at amortized cost which approximates fair value

 

 

82,928

 

Total investment securities

 

1,036,624

 

1,011,139

 

Cash and cash equivalents

 

73,698

 

60,451

 

Accounts receivable, net of allowance for doubtful accounts

 

148,353

 

138,792

 

Accrued investment income

 

10,027

 

9,957

 

Taxes recoverable

 

 

5,300

 

Receivable from reinsurers related to paid loss and loss adjustment expenses

 

9,773

 

10,835

 

Receivable from reinsurers related to unpaid loss and loss adjustment expenses

 

67,443

 

76,489

 

Ceded unearned premiums

 

14,688

 

21,620

 

Deferred policy acquisition costs

 

50,755

 

46,687

 

Deferred income taxes

 

1,780

 

18,986

 

Equity and deposits in pools

 

29,019

 

23,578

 

Other assets

 

13,105

 

13,983

 

Total assets

 

$

 1,455,265

 

$

 1,437,817

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Loss and loss adjustment expense reserves

 

$

 446,806

 

$

 467,559

 

Unearned premium reserves

 

302,223

 

289,695

 

Accounts payable and accrued liabilities

 

38,903

 

51,111

 

Taxes payable

 

367

 

 

Payable for securities purchased

 

15,710

 

 

Payable to reinsurers

 

14,397

 

8,291

 

Other liabilities

 

16,625

 

17,790

 

Total liabilities

 

835,031

 

834,446

 

 

 

 

 

 

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Common stock:  $0.01 par value; 30,000,000 shares authorized; 16,614,554 and 16,464,530 shares issued

 

166

 

165

 

Additional paid-in capital

 

143,527

 

140,261

 

Accumulated other comprehensive income (loss), net of taxes

 

24,197

 

(6,528

)

Retained earnings

 

502,056

 

476,989

 

Treasury stock, at cost; 1,564,548 and 232,013 shares

 

(49,712

)

(7,516

)

Total shareholders’ equity

 

620,234

 

603,371

 

Total liabilities and shareholders’ equity

 

$

 1,455,265

 

$

 1,437,817

 

 

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 share and per share data)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Net earned premiums

 

$

 133,059

 

$

 141,251

 

$

 399,715

 

$

 439,001

 

Net investment income

 

11,093

 

11,710

 

32,221

 

34,445

 

Net realized (losses) gains on investments

 

(20

)

(1,047

)

(337

)

1,056

 

Finance and other service income

 

4,197

 

4,584

 

12,578

 

13,597

 

Total revenue

 

148,329

 

156,498

 

444,177

 

488,099

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

82,280

 

87,702

 

261,555

 

274,650

 

Underwriting, operating and related expenses

 

42,061

 

43,130

 

122,681

 

132,069

 

Interest expenses

 

23

 

22

 

66

 

59

 

Total expenses

 

124,364

 

130,854

 

384,302

 

406,778

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

23,965

 

25,644

 

59,875

 

81,321

 

Income tax expense

 

6,941

 

7,286

 

15,992

 

22,987

 

Net income

 

$

 17,024

 

$

 18,358

 

$

 43,883

 

$

 58,334

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per weighted average common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

 1.11

 

$

 1.13

 

$

 2.80

 

$

 3.59

 

Diluted

 

$

 1.11

 

$

 1.12

 

$

 2.79

 

$

 3.58

 

 

 

 

 

 

 

 

 

 

 

Cash dividends paid per common share

 

$

 0.40

 

$

 0.40

 

$

 1.20

 

$

 1.20

 

 

 

 

 

 

 

 

 

 

 

Number of shares used in computing earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

15,296,221

 

16,309,712

 

15,694,500

 

16,260,696

 

Diluted

 

15,314,552

 

16,348,525

 

15,713,733

 

16,310,448

 

 

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

 

(Loss)/Income,

 

Retained

 

Treasury

 

Shareholders’

 

 

 

Stock

 

Capital

 

Net of Taxes

 

Earnings

 

Stock

 

Equity

 

Balance at December 31, 2007

 

$

162

 

$

134,224

 

$

4,453

 

$

432,746

 

$

(1,585

)

$

570,000

 

Net income, January 1 to September 30, 2008

 

 

 

 

 

 

 

58,334

 

 

 

58,334

 

Other comprehensive loss, net of deferred federal income taxes

 

 

 

 

 

(16,698

)

 

 

 

 

(16,698

)

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

 

3

 

4,953

 

 

 

 

 

 

 

4,956

 

Dividends paid

 

 

 

 

 

 

 

(19,517

)

 

 

(19,517

)

Acquisition of treasury stock

 

 

 

 

 

 

 

 

 

(2,444

)

(2,444

)

Balance at September 30, 2008

 

$

165

 

$

139,177

 

$

(12,245

)

$

471,563

 

$

(4,029

)

$

594,631

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Comprehensive

 

 

 

 

 

Total

 

 

 

Common

 

Paid-in

 

Income/(Loss),

 

Retained

 

Treasury

 

Shareholders’

 

 

 

Stock

 

Capital

 

Net of Taxes

 

Earnings

 

Stock

 

Equity

 

Balance at December 31, 2008

 

$

165

 

$

140,261

 

$

(6,528

)

$

476,989

 

$

(7,516

)

$

603,371

 

Net income, January 1 to September 30, 2009

 

 

 

 

 

 

 

43,883

 

 

 

43,883

 

Other comprehensive income, net of deferred federal income taxes

 

 

 

 

 

30,725

 

 

 

 

 

30,725

 

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

 

1

 

3,266

 

 

 

 

 

 

 

3,267

 

Dividends paid

 

 

 

 

 

 

 

(18,816

)

 

 

(18,816

)

Acquisition of treasury stock

 

 

 

 

 

 

 

 

 

(42,196

)

(42,196

)

Balance at September 30, 2009

 

$

166

 

$

143,527

 

$

24,197

 

$

502,056

 

$

(49,712

)

$

620,234

 

 

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

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

17,024

 

$

18,358

 

$

43,883

 

$

58,334

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) during the period, net of tax expense (benefit) of $8,744, $(5,052), $16,426, and $(8,621)

 

16,239

 

(9,382

)

30,506

 

(16,011

)

Reclassification adjustment for losses (gains) included in net income, net of tax expense (benefit) of $7, $367, $118 and $(369)

 

13

 

680

 

219

 

(687

)

 

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) on securities available for sale

 

16,252

 

(8,702

)

30,725

 

(16,698

)

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

33,276

 

$

9,656

 

$

74,608

 

$

41,636

 

 

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)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2009

 

2008

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

43,883

 

$

58,334

 

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

 

 

 

 

 

Depreciation and amortization, net

 

9,130

 

8,438

 

Provision (benefit) for deferred income taxes

 

662

 

(1,980

)

Net realized losses (gains) on investments

 

337

 

(1,056

)

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(9,561

)

(467

)

Accrued investment income

 

(70

)

627

 

Receivable from reinsurers

 

10,108

 

5,960

 

Ceded unearned premiums

 

6,932

 

4,814

 

Deferred policy acquisition costs

 

(4,068

)

(2,725

)

Other assets

 

(1,069

)

(10,132

)

Loss and loss adjustment expense reserves

 

(20,753

)

(13,529

)

Unearned premium reserves

 

12,528

 

1,344

 

Accounts payable and accrued liabilities

 

(12,210

)

(11,980

)

Payable to reinsurers

 

6,106

 

15,370

 

Other liabilities

 

(1,082

)

(679

)

Net cash provided by operating activities

 

40,873

 

52,339

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Fixed maturities purchased

 

(140,971

)

(108,209

)

Equity securities purchased

 

(4,708

)

(5,147

)

Proceeds from sales, paydowns and calls of fixed maturities

 

82,829

 

123,316

 

Proceeds from maturities of fixed maturities

 

10,022

 

21,156

 

Proceeds from sales of equity securities

 

3,164

 

3,135

 

Proceeds from maturities of short-term securities

 

82,996

 

 

Fixed assets purchased

 

(217

)

(5,223

)

Net cash provided by investing activities

 

33,115

 

29,028

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds and excess tax benefits from exercise of stock options

 

271

 

2,065

 

Dividends paid to shareholders

 

(18,816

)

(19,517

)

Acquisition of treasury stock

 

(42,196

)

(2,444

)

Net cash used for financing activities

 

(60,741

)

(19,896

)

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

13,247

 

61,471

 

Cash and cash equivalents at beginning of year

 

60,451

 

46,311

 

Cash and cash equivalents at end of period

 

$

73,698

 

$

107,782

 

 

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 September 30, 2009 and for the three and nine months ended September 30, 2009 and 2008 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 13, 2009.

 

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 71.7% of its direct written premiums in 2008. The Company operates through its insurance company subsidiaries, Safety Insurance Company, Safety Indemnity Insurance Company and Safety Property and Casualty Company (together referred to as the “Insurance Subsidiaries”).

 

The Company has evaluated subsequent events since the date of these consolidated financial statements through the issuance date of November 5, 2009.

 

2.  Recent Accounting Pronouncements

 

In June 2009, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Codification (“ASC”) 105, Generally Accepted Accounting Principles (prior authoritative literature - Statement of Financial Accounting Standard (“FAS”) No.168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles).  ASC 105 is now the single source of authoritative nongovernmental GAAP. ASC 105 reorganizes the thousands of GAAP pronouncements into roughly 90 accounting topics and displays them using a consistent structure. Also included is relevant SEC guidance organized using the same topical structure in separate sections. ASC 105 was effective for financial statements issued for reporting periods that end after September 15, 2009.  As of September 30, 2009, all of the Company’s disclosures in its consolidated financial statements are now referenced in accordance with ASC 105. The implementation of ASC 105 did not have an impact on the Company’s consolidated results of operations or financial position as it does not change authoritative guidance.

 

ASC 820, Fair Value Measurements and Disclosures (prior authoritative literature - FAS No.157, Fair Value Measurements) defines fair value, sets out a framework for measuring fair value and requires additional disclosures about fair value measurements.  This standard applies to fair value measurements already required or permitted by existing standards and was effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company adopted ASC 820 on January 1, 2008.  The adoption of ASC 820 did not have an impact on the Company’s consolidated results of operations or financial position. See Note 5, “Investments,” for further information regarding the Company’s investments and fair value measurements.

 

ASC 825, Financial Instruments (prior authoritative literature - FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115) permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent unrealized gains and losses on items

 

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)

 

for which the fair value option has been elected will be reported in earnings. ASC 825 was effective for fiscal years beginning after November 15, 2007. The Company has chosen not to elect the fair value option permitted by this statement.

 

ASC 260 , Other Presentation Matters —Participating Securities and the Two Class Method (prior authoritative literature - Emerging Issues Task Force 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities) addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting.   ASC 260 requires that such instruments that hold unforfeitable rights to dividends or dividend equivalents, regardless of whether paid or unpaid, should be considered participating securities and accordingly, should be included in the calculation of earnings per share (“EPS”) under the two-class method instead of the treasury stock method.  Under the Company’s employee incentive compensation plan, restricted stock grantees have unforfeitable rights to dividends before the vesting period and are therefore, participating securities and treated as a separate class of securities in calculating earning per share.  The Company adopted ASC 260 effective January 1, 2009, and has since used the two-class method to calculate earnings per share. In accordance with the adoption provisions of ASC 260, all prior period earnings per share data has been adjusted retroactively to conform to the provisions of ASC 260.  For the nine months ended September 30, 2008 basic EPS was reduced by $0.05 cents per share and diluted EPS was reduced by $0.04 cents per share from previously disclosed amounts. For the three months ending September 30, 2008, basic EPS was reduced by $0.01 and diluted EPS was reduced by $0.02 from previously disclosed amounts.

 

ASC 320, Investments — Debt and Equity Securities (prior authoritative literature - FASB Staff Position (“FSP”) FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments) requires entities to separate an other-than-temporary impairment of a debt security into two components when there are credit related losses associated with the impaired debt security for which management 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.  The amount of the other-than-temporary impairment related to a credit loss is recognized in earnings, and the amount of the other-than-temporary impairment related to other factors is recorded in other comprehensive loss.  ASC 320 is required to be adopted for periods ending after June 15, 2009. The Company adopted ASC 320 effective for its interim reporting period ending June 30, 2009.   The adoption of ASC 320 did not have an impact on the Company’s consolidated results of operations or financial position.  For further information, see Note 5, “Investments.”

 

ASC 825, Financial Instruments (prior authoritative literature FSP FAS 107-1 and Accounting Principles Board 28-1, Interim Disclosures about Fair Value of Financial Instruments) requires disclosures about fair value of financial instruments in interim and annual financial statements and is effective for periods ending after June 15, 2009. The Company adopted ASC 825 effective for its interim reporting period ending June 30, 2009, and its adoption did not have an impact on the Company’s consolidated financial condition or results of operations.  For further information, see Note 5, “Investments.”

 

ASC 820, Fair Value Measurements and Disclosures (prior authoritative literature FSP FAS 157-4, Determining Fair Value When Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that are Not Orderly ) expands certain disclosure requirements and is effective for periods ending after June 15, 2009. The Company adopted ASC 820 effective for its interim period ending June 30, 2009, and its adoption did not have an impact on the Company’s consolidated financial condition or results of operations.

 

ASC 855, Subsequent Events (prior authoritative literature FAS No. 165, Subsequent Events) establishes principles and requirements for subsequent events. ASC 855 is effective for interim and annual financial periods ending after June 15, 2009, and shall be applied prospectively. See Note 1 for the date through which the Company evaluated subsequent events.

 

3.  Earnings per Weighted Average Common Share

 

Basic earnings per weighted average common share 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 September 30, 2009 and 2008, the Company’s potentially dilutive instruments were common shares under options of 225,003, and 242,866, respectively.

 

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)

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net income as reported

 

$

 17,024

 

$

 18,358

 

$

 43,883

 

$

 58,334

 

Less dividends:

 

 

 

 

 

 

 

 

 

Distributed to common shareholders

 

6,026

 

6,441

 

18,509

 

19,270

 

Distributed to participating security holders

 

111

 

94

 

307

 

247

 

Total undistributed earnings

 

$

 10,887

 

$

 11,823

 

$

 25,067

 

$

 38,817

 

 

 

 

 

 

 

 

 

 

 

Undistributed earnings to common shareholders

 

$

 10,694

 

$

 11,656

 

$

 24,643

 

$

 38,305

 

Undistributed earnings to participating security holders

 

$

 193

 

$

 167

 

$

 424

 

$

 512

 

 

 

 

 

 

 

 

 

 

 

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

 

$

 17,024

 

$

 18,358

 

$

 43,883

 

$

 58,334

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding

 

15,017,392

 

16,079,387

 

15,428,696

 

16,046,111

 

Common equivalent shares - restricted stock

 

278,829

 

230,325

 

265,804

 

214,585

 

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

 

15,296,221

 

16,309,712

 

15,694,500

 

16,260,696

 

Common equivalent shares - stock options

 

18,331

 

38,813

 

19,233

 

49,752

 

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

 

15,314,552

 

16,348,525

 

15,713,733

 

16,310,448

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

 1.11

 

$

 1.13

 

$

 2.80

 

$

 3.59

 

Diluted earnings per share

 

$

 1.11

 

$

 1.12

 

$

 2.79

 

$

 3.58

 

 

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 167,925 anti-dilutive stock options for both the three and nine months ended September 30, 2009.  There were 168,925 anti-dilutive stock options for both the three and nine months ended September 30, 2008.

 

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 September 30, 2009 there were 920,434 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.

 

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)

 

A summary of stock based awards granted under the Incentive Plan during the nine months ended September 30, 2009 is as follows:

 

Type of

 

 

 

Number of

 

Fair

 

 

 

Equity

 

 

 

Awards

 

Value per

 

 

 

Awarded

 

Effective Date

 

Granted

 

Share (1)

 

Vesting Terms

 

RS

 

March 9, 2009

 

95,953

 

$

 28.66

 

3 years,  30%-30%-40%

 

RS

 

March 9, 2009

 

4,000

 

$

 28.66

 

No vesting period (2)

 

RS

 

March 19, 2009

 

38,046

 

$

 33.24

 

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 our Board of Directors.

 

Accounting and Reporting for Stock-Based Awards

 

 ASC 718, Compensation —Stock Compensation (prior authoritative literature FAS 123R (revised 2004), Share-Based Payment) 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 earnings per share for the three and nine month periods ended September 30, 2009 and 2008 is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Expected dividend yield

 

1.36% - 1.87%

 

1.36% - 2.52%

 

1.36% - 2.16%

 

1.36% - 2.52%

 

Expected volatility

 

0.31 - 0.36

 

0.20 - 0.36

 

0.28 - 0.36

 

0.20 - 0.36

 

Risk-free interest rate

 

3.82% - 4.76%

 

3.23% - 4.76%

 

3.23% - 4.76%

 

3.23% - 4.76%

 

Expected holding period

 

6.5 - 7 years

 

6.5 - 7 years

 

6.5 - 7 years

 

6.5 - 7 years

 

 

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 nine month periods ended September 30, 2009 and 2008.

 

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 stock option activity under the Incentive Plan for the nine months ended September 30, 2009.

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Shares

 

Weighted

 

Average

 

Aggregate

 

 

 

Under

 

Average

 

Remaining

 

Intrinsic

 

 

 

Option

 

Exercise Price

 

Contractual Term

 

Value

 

Outstanding at beginning of year

 

238,666

 

$

 33.66

 

 

 

 

 

Forfeited

 

(1,000

)

$

 42.85

 

 

 

 

 

Exercised

 

(12,663

)

$

 15.75

 

 

 

 

 

Outstanding at end of period

 

225,003

 

$

 34.63

 

5.6 years

 

$

 917

 

Exercisable at end of period

 

164,513

 

$

 32.18

 

5.4 years

 

$

 917

 

 

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based upon the Company’s closing stock price of $32.92 on September 30, 2009, 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 $12.00 to $42.85 at September 30, 2009 and 2008. The total intrinsic value of options exercised during the nine months ended September 30, 2009 and 2008 was $217 and $2,127, respectively.

 

A summary of the status of non-vested options as of September 30, 2009, is presented below.

 

 

 

 

 

Weighted Average

 

 

 

Number of

 

Grant Date

 

 

 

Shares

 

Exercise Price

 

Non-vested at beginning of year

 

118,035

 

$

 37.06

 

Vested

 

(56,545

)

$

 32.47

 

Forfeited

 

(1,000

)

$

 42.85

 

Non-vested at end of period

 

60,490

 

$

 41.26

 

 

As of September 30, 2009, there was $556 of unrecognized compensation expense related to non-vested option awards that is expected to be recognized over a weighted average period of 1.0 years.

 

Cash received from options exercised was $199 and $1,352 for the nine months ended September 30, 2009, and 2008, 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.

 

The following table summarizes restricted stock activity under the Incentive Plan during the nine months ended September 30, 2009.

 

 

 

Shares

 

Weighted

 

 

 

Under

 

Average

 

 

 

Restriction

 

Fair Value

 

Outstanding at beginning of the year

 

246,325

 

$

 38.77

 

Granted

 

137,999

 

$

 29.92

 

Vested and unrestricted

 

(84,857

)

$

 40.20

 

Forfeited

 

(638

)

$

 36.57

 

Outstanding at end of period

 

298,829

 

$

 34.28

 

 

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 September 30, 2009, there was $7,358 of unrecognized compensation expense related to non-vested restricted stock awards that is expected to be recognized over a weighted average period of 1.5 years.  The total fair value of the shares that were vested and unrestricted during the nine months ended September 30, 2009 and 2008 was $3,412 and $2,733, respectively.  For the nine months ended September 30, 2009 and 2008, the Company recorded compensation expense related to restricted stock of $1,875 and $1,673 net of income tax benefits of $1,009 and $901, respectively.

 

5.  Investments

 

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

 

 

 

As of September 30, 2009

 

 

 

 

 

 

 

Gross Unrealized Losses (3)

 

 

 

 

 

Cost or

 

Gross

 

Non-OTTI

 

OTTI

 

Estimated

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gains

 

Losses

 

Losses

 

Value

 

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

 

$

319,268

 

$

13,873

 

$

(152

)

$

 

$

332,989

 

Obligations of states and political subdivisions

 

477,327

 

21,533

 

(258

)

 

498,602

 

Asset-backed securities (1)

 

93,958

 

931

 

(3,403

)

 

91,486

 

Corporate and other securities

 

99,200

 

4,791

 

(250

)

 

103,741

 

Subtotal, fixed maturity securities

 

989,753

 

41,128

 

(4,063

)

 

1,026,818

 

Equity securities (2)

 

9,645

 

161

 

 

 

9,806

 

Totals

 

$

999,398

 

$

41,289

 

$

(4,063

)

$

 

$

1,036,624

 

 

 

 

As of December  31, 2008

 

 

 

 

 

 

 

Gross Unrealized Losses (3)

 

 

 

 

 

Cost or

 

Gross

 

Non-OTTI

 

OTTI

 

Estimated

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gains

 

Losses

 

Losses

 

Value

 

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

 

$

288,598

 

$

8,532

 

$

(244

)

$

 

$

296,886

 

Obligations of states and political subdivisions

 

498,339

 

9,414

 

(6,132

)

 

501,621

 

Asset-backed securities (1)

 

77,656

 

 

(17,122

)

 

60,534

 

Corporate and other securities

 

65,243

 

420

 

(4,533

)

 

61,130

 

Subtotal, fixed maturity securities

 

929,836

 

18,366

 

(28,031

)

 

920,171

 

Equity securities (2)

 

8,419

 

 

(379

)

 

8,040

 

Short term securities

 

82,928

 

 

 

 

82,928

 

Totals

 

$

1,021,183

 

$

18,366

 

$

(28,410

)

$

 

$

1,011,139

 

 

(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), Federal National Mortgage Association (FNMA) and Small Business Administration (SBA). The total of these fixed maturity securities was $307,808 and $286,100 at amortized cost and $321,378 and $294,064 at fair value as of September 30, 2009 and December 31, 2008, respectively. As such, the asset-backed securities presented exclude such issuers already presented under U.S. Treasury securities and obligations of U.S. Government Agencies.

(2)  Equity securities consist solely of interests in mutual funds held to fund the Company’s executive deferred compensation plan.

(3)  The Company’s investment portfolio included 64 and 161 securities in an unrealized loss position at September 30, 2009 and December 31, 2008, respectively.

 

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 amortized cost and the estimated fair value of fixed maturity securities, by maturity, are shown below for the periods 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 September 30, 2009

 

As of December 31, 2008

 

 

 

Amortized

 

Estimated

 

Amortized

 

Estimated

 

 

 

Cost

 

Fair Value

 

Cost

 

Fair Value

 

Due in one year or less

 

$

41,317

 

$

42,050

 

$

10,572

 

$

10,678

 

Due after one year through five years

 

239,365

 

250,150

 

245,457

 

249,425

 

Due after five years through ten years

 

163,426

 

172,270

 

153,520

 

154,817

 

Due after ten years through twenty years

 

130,630

 

136,110

 

143,278

 

138,225

 

Due after twenty years

 

13,249

 

13,374

 

13,252

 

12,428

 

Asset-backed securities

 

401,766

 

412,864

 

363,757

 

354,598

 

Totals

 

$

989,753

 

$

1,026,818

 

$

929,836

 

$

920,171

 

 

The gross realized (losses) gains on sales of fixed maturity, short-term, and equity securities were as follows for the periods indicated:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Gross realized gains

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

$

151

 

$

123

 

$

151

 

$

2,251

 

Equity securities

 

 

 

 

 

Short term securities

 

 

 

1

 

 

Gross realized losses

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

(171

)

(1,052

)

(171

)

(1,077

)

Equity securities

 

 

(118

)

(318

)

(118

)

Short term securities

 

 

 

 

 

Net realized (losses) gains on investments

 

$

(20

)

$

(1,047

)

$

(337

)

$

1,056

 

 

Proceeds from fixed maturities maturing were $4,700 and $3,481 for the three months ended September 30, 2009 and 2008, respectively. Proceeds from fixed maturities maturing were $10,022 and $21,156 for the nine months ended September 30, 2009 and 2008, 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.

 

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)

 

The following tables as of September 30, 2009 and December 31, 2008 illustrate 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 illustrate the length of time that they have been in a continuous unrealized loss position.

 

 

 

As of September 30, 2009

 

 

 

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 and obligations of U.S. Government agencies

 

$

23,057

 

$

116

 

$

667

 

$

36

 

$

23,724

 

$

152

 

Obligations of states and political subdivisions

 

255

 

 

18,448

 

258

 

18,703

 

258

 

Asset-backed securities

 

 

 

49,523

 

3,403

 

49,523

 

3,403

 

Corporate and other securities

 

1,987

 

9

 

6,422

 

241

 

8,409

 

250

 

Subtotal, fixed maturity securities

 

25,299

 

125

 

75,060

 

3,938

 

100,359

 

4,063

 

Equity securities

 

 

 

 

 

 

 

Total temporarily impaired securities

 

$

25,299

 

$

125

 

$

75,060

 

$

3,938

 

$

100,359

 

$

4,063

 

 

 

 

As of December 31, 2008

 

 

 

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 and obligations of U.S. Government agencies

 

$

4,300

 

$

9

 

$

9,770

 

$

235

 

$

14,070

 

$

244

 

Obligations of states and political subdivisions

 

116,605

 

4,524

 

32,220

 

1,608

 

148,825

 

6,132

 

Asset-backed securities

 

24,036

 

7,876

 

36,498

 

9,246

 

60,534

 

17,122

 

Corporate and other securities

 

21,503

 

931

 

16,307

 

3,602

 

37,810

 

4,533

 

Subtotal, fixed maturity securities

 

166,444

 

13,340

 

94,795

 

14,691

 

261,239

 

28,031

 

Equity securities

 

2,458

 

353

 

33

 

26

 

2,491

 

379

 

Total temporarily impaired securities

 

$

168,902

 

$

13,693

 

$

94,828

 

$

14,717

 

$

263,730

 

$

28,410

 

 

As of September 30, 2009, the Company held insured investment securities of approximately $315,945, which represented approximately 30.5% of the Company’s total investment portfolio. Approximately $37,039 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.

 

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)

 

The following table shows the Company’s insured investment securities that are backed by financial guarantors including pre-refunded securities as of September 30, 2009.   The Company does not have any direct investment holdings in a financial guarantee insurance company.

 

 

 

As of September 30, 2009

 

 

 

 

 

 

 

Exposure Net

 

 

 

 

 

Pre-refunded

 

of Pre-refunded

 

Financial Guarantor

 

Total

 

Securities

 

Securities

 

Municipal bonds

 

 

 

 

 

 

 

Ambac Assurance Corporation

 

$

48,077

 

$

8,472

 

$

39,605

 

Financial Guaranty Insurance Company

 

279

 

279

 

 

Financial Security Assurance, Inc.

 

112,784

 

19,493

 

93,291

 

National Public Finance Guaranty Corporation

 

147,499

 

8,795

 

138,704

 

 

 

308,639

 

37,039

 

271,600

 

Other asset-backed securities

 

 

 

 

 

 

 

Ambac Assurance Corporation

 

3,592

 

 

3,592

 

Financial Guaranty Insurance Company

 

2,394

 

 

2,394

 

Syncora Corporation (XL Capital Assurance)

 

1,320

 

 

1,320

 

 

 

7,306

 

 

7,306

 

Total

 

$

315,945

 

$

37,039

 

$

278,906

 

 

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 September 30, 2009.

 

 

 

As of September 30, 2009

 

 

 

Rating

 

Rating

 

 

 

With

 

Without

 

Rating

 

Insurance

 

Insurance

 

Aaa

 

$

4,007

 

$

4,007

 

Aa1

 

10,656

 

10,656

 

Aa2

 

33,338

 

33,338

 

Aa3

 

141,977

 

83,335

 

A1

 

51,063

 

85,868

 

A2

 

23,267

 

36,286

 

A3

 

23,184

 

27,712

 

Baa1

 

279

 

279

 

Baa2

 

3,592

 

3,592

 

Ba2

 

 

6,290

 

 

 

$

291,363

 

$

291,363

 

 

Other-Than-Temporary Impairments

 

ASC 320, Investments — Debt and Equity Securities (prior authoritative literature - FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments ) requires entities to separate an other-than-temporary impairment (“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. Prior to April 1, 2009, the Company had to determine whether it had the intent and ability to hold the investment for a sufficient period of time for the value to recover. When the analysis of the above factors resulted in the Company’s conclusion that declines in market values were other-than-temporary, the cost of the securities was written down to market value and the reduction in value was reflected as a realized loss.

 

16



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

Effective 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.

 

As of September 30, 2009, with the exception of one security which represented 0.1% of the Company’s total investment in fixed income securities, the Company’s fixed income securities portfolio was comprised entirely of investment grade corporate fixed maturity securities, U.S. Government and Agency securities, states and political subdivision securities, and asset-backed securities (i.e., all securities received a rating assigned by Moody’s Investors Service, Inc. of Baa or higher, except the few securities not rated by Moody’s.)  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 Aaa.

 

The unrealized losses in the Company’s fixed income portfolio as of September 30, 2009 were reviewed for potential permanent asset impairments.  The Company obtained specific qualitative analysis regarding certain debt securities held at September 30, 2009 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 our “Watch List.” 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 fixed maturity investment portfolio at September 30, 2009 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 three and nine months ended September 30, 2009, there was no significant deterioration in the credit quality of any of the Company’s holdings.  During the three and nine months ended September 30, 2008, there was a significant deterioration in the issuer’s financial condition of one of Company’s holdings, American International Group, Inc.  Accordingly in the third quarter of 2008, the Company recorded an other-than-temporary impairment charge of $1,032 for this security.  The Company sold this security during the quarter ended September 30, 2009 and recognized an additional loss of $14.

 

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.

 

ASC 320, Investments — Debt and Equity Securities (prior authoritative literature - FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments) requires that the Company record, as of the beginning of the interim period of adoption, a cumulative effect adjustment to reclassify the noncredit component of a previously recognized OTTI from retained earnings to other comprehensive income (loss). At September 30, 2009 and December 31, 2008, there were no amounts included in accumulated other comprehensive income related to securities which were considered by the Company to be permanently impaired.

 

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Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

Net Investment Income

 

The components of net investment income were as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Interest and dividends on fixed maturities

 

$

11,351

 

$

11,467

 

$

32,843

 

$

34,168

 

Dividends on equity securities

 

38

 

79

 

109

 

201

 

Interest on short-term securities

 

3

 

 

74

 

 

Interest on cash and cash equivalents

 

47

 

492

 

198

 

1,072

 

Total investment income

 

11,439

 

12,038

 

33,224

 

35,441

 

Investment expenses

 

346

 

328

 

1,003

 

996

 

Net investment income

 

$

11,093

 

$

11,710

 

$

32,221

 

$

34,445

 

 

Fair Value Measurements

 

ASC 820, Fair Value Measurements and Disclosure (prior authoritative literature - FAS157, Fair Value Measurements) 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

 

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 custodian bank and the 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 fixed maturity securities in the Company’s 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 Company’s 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 their traders provide input as to which vendor is providing prices that their 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.

 

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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 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 securities whose fair value was determined using observable market inputs. 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.  On January 1 and September 30, 2009, the Company’s Level 3 securities consisted of one asset-backed security whose price was based solely on a single broker quote which was deemed to be obtained through unobservable inputs.

 

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 the Company’s “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).

 

Approximately 99.8% of the Company’s portfolio was priced based upon quoted market prices or other observable inputs as of September 30, 2009.  There were no significant changes to the valuation process during the third quarter of 2009.

 

As of September 30, 2009 and December 31, 2008, no quotes or prices obtained were adjusted by management.  All broker quotes obtained were non-binding.

 

The following tables summarize our total fair value measurements and the fair value measurements based on Level 3 inputs for investments for the periods indicated.

 

 

 

As of September 30, 2009

 

 

 

Total

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

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

 

$

332,989

 

$

 

$

332,989

 

$

 

Obligations of states and political subdivisions

 

498,602

 

 

498,602

 

 

Asset-backed securities

 

91,486

 

 

89,092

 

2,394

 

Corporate and other securities

 

103,741

 

 

103,741

 

 

Equity securities

 

9,806

 

9,806

 

 

 

Total investment securities

 

$

1,036,624

 

$

9,806

 

$

1,024,424

 

$

2,394

 

 

 

 

As of December 31, 2008

 

 

 

Total

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

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

 

$

296,886

 

$

 

$

296,886

 

$

 

Obligations of states and political subdivisions

 

501,621

 

 

501,621

 

 

Asset-backed securities

 

60,534

 

 

58,692