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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 March 31, 2011

 

OR

 

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

 

For the transition period from             to             

 

Commission File Number: 000-50070

 

SAFETY INSURANCE GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

13-4181699

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

20 Custom House Street, Boston, Massachusetts 02110

(Address of principal executive offices including zip code)

 

(617) 951-0600

(Registrant’s telephone number, including area code)

 

Not Applicable

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

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes 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 May 5, 2011, there were 15,182,962 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 March 31, 2011 (Unaudited) and December 31, 2010

3

 

Consolidated Statements of Operations for the Three Months Ended March 31, 2011 and 2010 (Unaudited)

4

 

Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2011 and 2010 (Unaudited)

5

 

Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2011 and 2010 (Unaudited)

6

 

Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010 (Unaudited)

7

 

Notes to Unaudited Consolidated Financial Statements

8

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

Executive Summary and Overview

27

 

Critical Accounting Policies and Estimates

31

 

Results of Operations — Three Months Ended March 31, 2011 and 2010

40

 

Liquidity and Capital Resources

48

 

Forward-Looking Statements

51

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

51

 

 

 

Item 4.

Controls and Procedures

52

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

53

 

 

 

Item 1A.

Risk Factors

53

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

53

 

 

 

Item 3.

Defaults upon Senior Securities

53

 

 

 

Item 4.

Removed and Reserved

53

 

 

 

Item 5.

Other Information

53

 

 

 

Item 6.

Exhibits

53

 

 

SIGNATURE

54

 

 

EXHIBIT INDEX

55

 



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except share data)

 

 

 

March 31,

 

December 31,

 

 

 

2011

 

2010

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Securities available for sale:

 

 

 

 

 

Fixed maturities, at fair value (amortized cost: $994,137 and $1,030,354)

 

$

1,023,661

 

$

1,063,237

 

Equity securities, at fair value (cost: $14,902 and $13,704)

 

16,398

 

14,624

 

Other invested assets, at cost, which approximates fair value

 

3,348

 

2,817

 

Total investments

 

1,043,407

 

1,080,678

 

Cash and cash equivalents

 

55,428

 

40,291

 

Accounts receivable, net of allowance for doubtful accounts

 

146,878

 

145,726

 

Receivable for securities sold

 

7,539

 

 

Accrued investment income

 

8,985

 

9,471

 

Taxes recoverable

 

8,949

 

5,061

 

Receivable from reinsurers related to paid loss and loss adjustment expenses

 

4,306

 

4,579

 

Receivable from reinsurers related to unpaid loss and loss adjustment expenses

 

52,168

 

53,147

 

Ceded unearned premiums

 

12,478

 

12,461

 

Deferred policy acquisition costs

 

54,598

 

52,824

 

Deferred income taxes

 

4,595

 

3,643

 

Equity and deposits in pools

 

13,591

 

19,971

 

Other assets

 

13,252

 

11,600

 

Total assets

 

$

1,426,174

 

$

1,439,452

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Loss and loss adjustment expense reserves

 

$

396,732

 

$

404,391

 

Unearned premium reserves

 

318,944

 

306,053

 

Accounts payable and accrued liabilities

 

38,075

 

54,239

 

Payable to reinsurers

 

4,594

 

5,571

 

Other liabilities

 

25,275

 

15,722

 

Total liabilities

 

783,620

 

785,976

 

 

 

 

 

 

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Common stock:  $0.01 par value; 30,000,000 shares authorized; 16,908,517 and 16,795,504 shares issued

 

169

 

168

 

Additional paid-in capital

 

153,700

 

151,317

 

Accumulated other comprehensive income, net of taxes

 

20,162

 

21,972

 

Retained earnings

 

524,049

 

535,545

 

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

 

(55,526

)

(55,526

)

Total shareholders’ equity

 

        642,554

 

653,476

 

Total liabilities and shareholders’ equity

 

$

1,426,174

 

$

1,439,452

 

 

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

 

3



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

(Dollars in thousands, except per share data)

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Net earned premiums

 

$

144,646

 

$

133,157

 

Net investment income

 

10,165

 

10,792

 

Net realized (losses) gains on investments

 

(419

)

110

 

Finance and other service income

 

4,405

 

4,296

 

Total revenue

 

158,797

 

148,355

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

121,630

 

88,674

 

Underwriting, operating and related expenses

 

42,629

 

41,868

 

Interest expense

 

22

 

22

 

Total expenses

 

164,281

 

130,564

 

 

 

 

 

 

 

(Loss) income before income taxes

 

(5,484

)

17,791

 

Income tax (benefit) expense

 

(1,530

)

5,017

 

Net (loss) income

 

$

(3,954

)

$

12,774

 

 

 

 

 

 

 

(Loss) earnings per weighted average common share:

 

 

 

 

 

Basic

 

$

(0.26

)

$

0.85

 

Diluted

 

$

(0.26

)

$

0.85

 

 

 

 

 

 

 

Cash dividends paid per common share

 

$

0.50

 

$

0.40

 

 

 

 

 

 

 

Number of shares used in computing (loss) earnings per share:

 

 

 

 

 

Basic

 

15,100,293

 

15,085,096

 

Diluted

 

15,100,293

 

15,102,105

 

 

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

 

4



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

(Dollars in thousands)

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Comprehensive

 

 

 

 

 

Total

 

 

 

Common

 

Paid-in

 

Income,

 

Retained

 

Treasury

 

Shareholders’

 

 

 

Stock

 

Capital

 

Net of Taxes

 

Earnings

 

Stock

 

Equity

 

Balance at December 31, 2009

 

$

166

 

$

144,814

 

$

18,866

 

$

506,301

 

$

(49,712

)

$

620,435

 

Net income, January 1 to March 31, 2010

 

 

 

 

 

 

 

12,774

 

 

 

12,774

 

Other comprehensive income, net of deferred federal income taxes

 

 

 

 

 

4,382

 

 

 

 

 

4,382

 

Exercise of options, net of federal income taxes

 

 

 

185

 

 

 

 

 

 

 

185

 

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

 

1

 

1,109

 

 

 

 

 

 

 

1,110

 

Dividends paid

 

 

 

 

 

 

 

(6,024

)

 

 

(6,024

)

Balance at March 31, 2010

 

$

167

 

$

146,108

 

$

23,248

 

$

513,051

 

$

(49,712

)

$

632,862

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Comprehensive

 

 

 

 

 

Total

 

 

 

Common

 

Paid-in

 

Income,

 

Retained

 

Treasury

 

Shareholders’

 

 

 

Stock

 

Capital

 

Net of Taxes

 

Earnings

 

Stock

 

Equity

 

Balance at December 31, 2010

 

$

168

 

$

151,317

 

$

21,972

 

$

535,545

 

$

(55,526

)

$

653,476

 

Net loss, January 1 to March 31, 2011

 

 

 

 

 

 

 

(3,954

)

 

 

(3,954

)

Other comprehensive loss, net of deferred federal income taxes

 

 

 

 

 

(1,810

)

 

 

 

 

(1,810

)

Exercise of options, net of federal income taxes

 

 

 

736

 

 

 

 

 

 

 

736

 

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

 

1

 

1,647

 

 

 

 

 

 

 

1,648

 

Dividends paid

 

 

 

 

 

 

 

(7,542

)

 

 

(7,542

)

Balance at March 31, 2011

 

$

169

 

$

153,700

 

$

20,162

 

$

524,049

 

$

(55,526

)

$

642,554

 

 

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 March 31,

 

 

 

2011

 

2010

 

Net (loss) income

 

$

(3,954

)

$

12,774

 

 

 

 

 

 

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

Unrealized holding (losses) gains during the period, net of tax (benefit) expense of ($1,121) and $2,398

 

(2,082

)

4,453

 

Reclassification adjustment for losses (gains) included in net income, net of tax benefit (expense) of $147 and ($39)

 

272

 

(71

)

 

 

 

 

 

 

Unrealized (losses) gains on securities available for sale

 

(1,810

)

4,382

 

 

 

 

 

 

 

Comprehensive (loss) income

 

$

(5,764

)

$

17,156

 

 

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)

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Cash flows from operating activities:

 

 

 

 

 

Net (loss) income

 

$

(3,954

)

$

12,774

 

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

 

 

 

 

 

Depreciation and amortization, net

 

3,167

 

3,104

 

Provision for deferred income taxes

 

22

 

178

 

Gains on sale of fixed assets

 

 

(4

)

Net realized losses (gains) on investments

 

419

 

(110

)

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(1,152

)

(3,937

)

Accrued investment income

 

486

 

125

 

Receivable from reinsurers

 

1,252

 

3,664

 

Ceded unearned premiums

 

(17

)

313

 

Deferred policy acquisition costs

 

(1,774

)

(2,168

)

Other assets

 

1,349

 

(1,460

)

Loss and loss adjustment expense reserves

 

(7,659

)

(9,266

)

Unearned premium reserves

 

12,891

 

13,618

 

Accounts payable and accrued liabilities

 

(16,163

)

(24,462

)

Payable to reinsurers

 

(977

)

394

 

Other liabilities

 

9,553

 

(1,467

)

Net cash used for operating activities

 

(2,557

)

(8,704

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Fixed maturities purchased

 

(22,472

)

(97,256

)

Equity securities purchased

 

(4,207

)

(3,239

)

Other invested assets purchased

 

(560

)

 

Proceeds from sales and paydowns of fixed maturities

 

48,190

 

45,452

 

Proceeds from maturities, redemptions and calls of fixed maturities

 

1,257

 

33,612

 

Proceed from sales of equity securities

 

3,082

 

800

 

Proceeds from sales of other invested assets

 

29

 

23

 

Fixed assets purchased

 

(749

)

(146

)

Proceeds from sales of fixed assets

 

 

4

 

Net cash provided by (used for) investing activities

 

24,570

 

(20,750

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from stock options exercised

 

685

 

50

 

Excess tax benefits from stock options exercised

 

(19

)

18

 

Dividends paid to shareholders

 

(7,542

)

(6,024

)

Net cash used for financing activities

 

(6,876

)

(5,956

)

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

15,137

 

(35,410

)

Cash and cash equivalents at beginning of year

 

40,291

 

74,470

 

Cash and cash equivalents at end of period

 

$

55,428

 

$

39,060

 

 

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 March 31, 2011 and for the three months ended March 31, 2011 and 2010 is unaudited; however, in the opinion of the Company, the information includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial condition and results of operations for the periods. These unaudited consolidated financial statements may not be indicative of financial results for the full year and should be read in conjunction with the audited financial statements included in the Company’s annual report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on March 14, 2011.

 

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

 

The Insurance Subsidiaries began writing private passenger automobile and homeowners insurance business in New Hampshire during 2008 and began writing New Hampshire personal umbrella business during 2009.  For the three months ended March 31, 2011 and 2010, the Company wrote $973 and $441, respectively, in direct written premiums in New Hampshire.

 

2.  Recent Accounting Pronouncements

 

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

 

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

 

8



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

In October 2010, the FASB issued updated guidance to address diversity in practice for the accounting of costs associated with acquiring or renewing insurance contracts.  This guidance modifies the definition of acquisition costs to specify that a cost be directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred.  The guidance also specifies that advertising costs only should be included as deferred acquisition costs if the direct-response advertising accounting criteria are met.  The new guidance is effective for reporting periods beginning after December 15, 2011 and should be applied prospectively, with retrospective application permitted.  The Company is in the process of evaluating the impact of adoption on its consolidated financial conditions and results of operations.

 

3.  (Loss) Earnings per Weighted Average Common Share

 

Basic (loss) earnings  per weighted average common share (“EPS”) is calculated by dividing net income by the weighted average number of basic common shares outstanding during the period including unvested restricted shares which are considered participating securities.  Diluted (loss) 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 March 31, 2011 and 2010, the Company’s potentially dilutive instruments were common shares under options of 133,194 and 212,375, 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 March 31,

 

 

 

2011

 

2010

 

Net (loss) income as reported

 

$

(3,954

)

$

12,774

 

Less dividends:

 

 

 

 

 

Distributed to common shareholders

 

7,403

 

5,912

 

Distributed to participating security holders

 

139

 

112

 

Total undistributed earnings

 

$

(11,496

)

$

6,750

 

 

 

 

 

 

 

Undistributed earnings to common shareholders

 

$

(11,288

)

$

6,626

 

Undistributed earnings to participating security holders

 

$

(208

)

$

124

 

 

 

 

 

 

 

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

 

$

(3,954

)

$

12,774

 

 

 

 

 

 

 

Weighted average number of common shares outstanding

 

14,827,668

 

14,809,087

 

Common equivalent shares - restricted stock

 

272,625

 

276,009

 

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

 

15,100,293

 

15,085,096

 

Common equivalent shares - stock options

 

 

17,009

 

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

 

15,100,293

 

15,102,105

 

 

 

 

 

 

 

Basic (loss) earnings per share

 

$

(0.26

)

$

0.85

 

Diluted (loss) earnings per share

 

$

(0.26

)

$

0.85

 

 

For the three months ended March 31, 2011, all 133,194 common shares under options were not included in the computation of EPS because their inclusion would be anti-dilutive.  For the three months ended March 31, 2010, there were 119,725 anti-dilutive common shares under options not included in the computation of EPS because their exercise prices were greater than the average market price of common stock for the period.

 

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)

 

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 March 31, 2011, there were 718,280 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.

 

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)

 

A summary of stock based awards granted under the Incentive Plan during the three months ended March 31, 2011 is as follows:

 

Type of

 

 

 

Number of

 

Fair

 

 

 

Equity

 

 

 

Awards

 

Value per

 

 

 

Awarded

 

Effective Date

 

Granted

 

Share (1)

 

Vesting Terms

 

RS

 

March 9, 2011

 

68,637

 

$

47.35

 

3 years, 30%-30%-40%

 

RS

 

March 9, 2011

 

4,000

 

$

47.35

 

No vesting period (2)

 

RS

 

March 23, 2011

 

22,567

 

$

44.94

 

5 years, 20% annually

 

 


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

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

 

Accounting and Reporting for Stock-Based Awards

 

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

 

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

 

Stock Options

 

The fair value of stock options used to compute net income and EPS for the three months ended March 31, 2011 and 2010 is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Expected dividend yield

 

1.68%

 

1.36% - 1.68%

 

Expected volatility

 

0.36

 

0.31 - 0.36

 

Risk-free interest rate

 

4.76%

 

4.35% - 4.76%

 

Expected holding period

 

6.5 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 months ended March 31, 2011 and 2010.

 

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)

 

The following table summarizes stock option activity under the Incentive Plan for the three months ended March 31, 2011.

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Shares

 

Weighted

 

Average

 

Aggregate

 

 

 

Under

 

Average

 

Remaining

 

Intrinsic

 

 

 

Option

 

Exercise Price

 

Contractual Term

 

Value

 

Outstanding at beginning of year

 

151,003

 

$

37.30

 

 

 

 

 

Exercised

 

(17,809

)

$

38.45

 

 

 

 

 

Outstanding at end of period

 

133,194

 

$

37.15

 

4.4 years

 

$

1,194

 

Exercisable at end of period

 

133,194

 

$

37.15

 

4.4 years

 

$

1,194

 

 

The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value, based upon the Company’s closing stock price of $46.11 on March 31, 2011, which would have been received by the option holders had all option holders exercised their options as of that date.  The range of exercise prices on stock options outstanding under the Incentive Plan was $13.30 to $42.85 at March 31, 2011 and $12.00 to $42.85 at March 31, 2010.  The total intrinsic value of options exercised during the three months ended March 31, 2011 and 2010 was $136 and $62, respectively.

 

A summary of the status of non-vested options as of March 31, 2011 is presented below.

 

 

 

 

 

Weighted Average

 

 

 

Number of

 

Grant Date

 

 

 

Shares

 

Exercise Price

 

Non-vested at beginning of year

 

23,945

 

$

42.85

 

Vested

 

(23,945

)

$

42.85

 

Non-vested at end of period

 

 

 

 

 

As of March 31, 2011, all compensation expense related to non-vested option awards had been recognized.  Cash received from options exercised was $685 and $50 for the three months ended March 31, 2011, and 2010, respectively.

 

Restricted Stock

 

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

 

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 following table summarizes restricted stock activity under the Incentive Plan during the three months ended March 31, 2011.

 

 

 

Shares

 

Weighted

 

 

 

Under

 

Average

 

 

 

Restriction

 

Fair Value

 

Outstanding at beginning of the year

 

301,501

 

$

35.13

 

Granted

 

95,204

 

$

46.78

 

Vested and unrestricted

 

(114,009

)

$

34.67

 

Outstanding at end of period

 

282,696

 

$

39.24

 

 

As of March 31, 2011, there was $9,782 of unrecognized compensation expense related to non-vested restricted stock awards that is expected to be recognized over a weighted average period of 1.9 years.  The total fair value of the shares that were vested and unrestricted during the three months ended March 31, 2011 and 2010 was $3,953 and $3,782, respectively.  For the three months ended March 31, 2011 and 2010, the Company recorded compensation expense related to restricted stock of $768 and $681, net of income tax benefits of $414 and $367, 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 March 31, 2011

 

 

 

 

 

 

 

Gross Unrealized Losses (3)

 

 

 

 

 

Cost or

 

Gross

 

Non-OTTI

 

OTTI

 

Estimated

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gains

 

Losses

 

Losses (4)

 

Value

 

U.S. Treasury securities

 

$

85,773

 

$

224

 

$

(1,973

)

$

 

$

84,024

 

Obligations of states and political subdivisions

 

407,030

 

10,587

 

(2,447

)

 

415,170

 

Residential mortgage-backed securities (1)

 

222,527

 

14,394

 

(26

)

 

236,895

 

Commercial mortgage-backed securities

 

57,073

 

1,907

 

(1

)

 

58,979

 

Other asset-backed securities

 

14,998

 

678

 

 

 

15,676

 

Corporate and other securities

 

206,736

 

7,277

 

(1,096

)

 

 

212,917

 

Subtotal, fixed maturity securities

 

994,137

 

35,067

 

(5,543

)

 

1,023,661

 

Equity securities (2)

 

14,902

 

1,499

 

(3

)

 

16,398

 

Other invested assets

 

3,348

 

 

 

 

3,348

 

Totals

 

$

1,012,387

 

$

36,566

 

$

(5,546

)

$

 

$

1,043,407

 

 

14



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

 

 

As of December 31, 2010

 

 

 

 

 

 

 

Gross Unrealized Losses (3)

 

 

 

 

 

Cost or

 

Gross

 

Non-OTTI

 

OTTI

 

Estimated

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gains

 

Losses

 

Losses (4)

 

Value

 

U.S. Treasury securities

 

$

87,830

 

$

280

 

$

(1,841

)

$

 

$

86,269

 

Obligations of states and political subdivisions

 

436,082

 

12,014

 

(2,906

)

 

445,190

 

Residential mortgage-backed securities (1)

 

237,405

 

15,295

 

(39

)

 

252,661

 

Commercial mortgage-backed securities

 

61,259

 

2,332

 

 

 

63,591

 

Other asset-backed securities

 

16,543

 

862

 

 

 

17,405

 

Corporate and other securities

 

191,235

 

7,769

 

(883

)

 

198,121

 

Subtotal, fixed maturity securities

 

1,030,354

 

38,552

 

(5,669

)

 

1,063,237

 

Equity securities (2)

 

13,704

 

920

 

 

 

14,624

 

Other invested assets

 

2,817

 

 

 

 

2,817

 

Totals

 

$

1,046,875

 

$

39,472

 

$

(5,669

)

$

 

$

1,080,678

 

 


(1)  Residential mortgage-backed securities consists primarily of obligations of U.S. Government agencies including collateralized mortgage obligations and mortgage-backed securities guaranteed and/or insured by the following issuers: Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA) and the Federal Home Loan Bank (FHLB).  The total of these fixed maturity securities was $222,514 and $237,335 at amortized cost and $236,882 and $252,592 at fair value as of March 31, 2011 and December 31, 2010, respectively.

(2)  Equity securities includes interests in mutual funds of $12,407 and $11,210  at cost and $13,032 and $11,699 at fair value as of March  31, 2011 and December 31, 2010, respectively, held to fund the Company’s executive deferred compensation plan.

(3)  The Company’s investment portfolio included 84 and 80 securities in an unrealized loss position at March 31, 2011 and December 31, 2010, respectively.

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

 

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 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 March 31, 2011

 

 

 

Amortized

 

Estimated

 

 

 

Cost

 

Fair Value

 

Due in one year or less

 

$

98,906

 

$

99,635

 

Due after one year through five years

 

271,767

 

279,878

 

Due after five years through ten years

 

231,374

 

235,274

 

Due after ten years through twenty years

 

88,587

 

88,414

 

Due after twenty years

 

8,905

 

8,909

 

Asset-backed securities

 

294,598

 

311,551

 

Totals

 

$

994,137

 

$

1,023,661

 

 

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)

 

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

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Gross realized gains

 

 

 

 

 

Fixed maturity securities

 

$

323

 

$

242

 

Equity securities

 

71

 

 

Gross realized losses

 

 

 

 

 

Fixed maturity securities

 

(813

)

(132

)

Net realized (losses) gains on investments

 

$

(419

)

$

110

 

 

Proceeds from maturities, redemptions and calls of fixed maturity securities were $1,257 and $33,612 for the three months ended March 31, 2011 and 2010, respectively.

 

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

 

17



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 March 31, 2011 and December 31, 2010 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 the securities have been in a continuous unrealized loss position.

 

 

 

As of March 31, 2011

 

 

 

Less than 12 Months

 

12 Months or More

 

Total

 

 

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

 

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

U.S. Treasury securities

 

$

36,190

 

$

1,973

 

$

 

$

 

$

36,190

 

$

1,973

 

Obligations of states and political subdivisions

 

85,451

 

2,062

 

6,095

 

385

 

91,546

 

2,447

 

Residential mortgage-backed securities

 

1,221

 

19

 

266

 

7

 

1,487

 

26

 

Commercial mortgage-backed securities

 

2,480

 

1

 

 

 

2,480

 

1

 

Corporate and other securities

 

37,033

 

1,096

 

 

 

37,033

 

1,096

 

Subtotal fixed maturity securities

 

162,375

 

5,151

 

6,361

 

392

 

168,736

 

5,543

 

Equity securities

 

441

 

3

 

 

 

441

 

3

 

Total temporarily impaired securities

 

$

162,816

 

$

5,154

 

$

6,361

 

$

392

 

$

169,177

 

$

5,546

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2010

 

 

 

Less than 12 Months

 

12 Months or More

 

Total

 

 

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

 

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

U.S. Treasury securities

 

$

38,318

 

$

1,841

 

$

 

$

 

$

38,318

 

$

1,841

 

Obligations of states and political subdivisions

 

109,883

 

2,490

 

7,325

 

416

 

117,208

 

2,906

 

Residential mortgage-backed securities

 

1,312

 

31

 

298

 

8

 

1,610

 

39

 

Corporate and other securities

 

27,736

 

883

 

 

 

27,736

 

883

 

Total temporarily impaired securities

 

$

177,249

 

$

5,245

 

$

7,623

 

$

424

 

$

184,872

 

$

5,669

 

 

As of March 31, 2011, the Company held insured investment securities of approximately $226,111 which represented approximately 21.7% of the Company’s total investment portfolio.  Approximately $66,254 of these securities are pre-refunded, meaning that funds have been set aside in escrow to satisfy the future interest and principal obligations of the bond.

 

The following table shows the Company’s insured investment securities that are backed by financial guarantors including pre-refunded securities as of March 31, 2011.  The Company does not have any direct investment holdings in a financial guarantee insurance company.

 

 

 

As of March 31, 2011

 

 

 

 

 

 

 

Exposure Net

 

 

 

 

 

Pre-refunded

 

of Pre-refunded

 

Financial Guarantor

 

Total

 

Securities

 

Securities

 

Municipal bonds

 

 

 

 

 

 

 

Ambac Assurance Corporation

 

$

31,931

 

$

15,423

 

$

16,508

 

Financial Guaranty Insurance Company

 

266

 

266

 

 

Assured Guaranty Municipal Corporation

 

89,027

 

34,734

 

54,293

 

National Public Finance Guaranty Corporation

 

100,921

 

15,831

 

85,090

 

Total municipal bonds

 

222,145

 

66,254

 

155,891

 

Other asset-backed securities

 

 

 

 

 

 

 

Ambac Assurance Corporation

 

3,966

 

 

3,966

 

Total other asset-backed securities

 

3,966

 

 

3,966

 

Total

 

$

226,111

 

$

66,254

 

$

159,857

 

 

18



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 investments by Moody’s rating where it is available both with and without the impact of the insurance guarantee as of March 31, 2011.

 

 

 

As of March 31, 2011

 

 

 

Rating

 

Rating

 

 

 

With

 

Without

 

Rating

 

Insurance

 

Insurance

 

Aaa

 

$

3,831

 

$

3,831

 

Aa1

 

28,837

 

28,837

 

Aa2

 

64,920

 

64,920

 

Aa3

 

75,836

 

66,950

 

A1

 

11,851

 

11,851

 

A2

 

10,903

 

16,660

 

A3

 

7,359

 

10,488

 

Baa1

 

266

 

266

 

Baa2

 

3,966

 

3,966

 

Total

 

$

207,769

 

$

207,769

 

 

Other-Than-Temporary Impairments

 

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

 

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

 

The unrealized losses in the Company’s fixed income and equity portfolio as of March 31, 2011 were reviewed for potential other- than-temporary asset impairments.  The Company held no securities at March 31, 2011 with a material (20% or greater) unrealized loss for four or more consecutive quarters.  Specific qualitative analysis was also performed for any additional securities appearing on the Company’s “Watch List,” if any.  Qualitative analysis considered such factors as the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, changes to the rating of the security by a rating agency and the historical volatility of the fair value of the security.

 

The qualitative analysis performed by the Company concluded that the unrealized losses recorded on the investment portfolio at March 31, 2011 resulted from fluctuations in market interest rates and other temporary market conditions as opposed to fundamental changes in the credit quality of the issuers of such securities.  Therefore, decreases in fair values of the Company’s securities are viewed as being temporary.

 

19



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

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

 

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

 

Net Investment Income

 

The components of net investment income were as follows:

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

Interest and dividends on fixed maturities

 

$

10,398

 

$

11,064

 

Dividends on equity securities

 

43

 

42

 

Interest on other invested assets

 

45

 

3

 

Interest on cash and cash equivalents

 

11

 

16

 

Total investment income

 

10,497

 

11,125

 

Investment expenses

 

332

 

333

 

Net investment income

 

$

10,165

 

$

10,792

 

 

Fair Value Measurements

 

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

 

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

 

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

 

Level 3 — Valuations based on unobservable inputs.

 

Fair values for the Company’s fixed maturity securities are based on prices provided by its custodian bank and its investment manager.  Both the Company’s custodian bank and investment manager use a variety of independent, nationally recognized pricing services to determine market valuations.  If the pricing service cannot provide fair value determinations, the Company obtains non-binding price quotes from broker-dealers.  A minimum of two quoted prices is obtained for the majority of our available for sale 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 its financial statements for the security.  If the variance between the primary and secondary price quotes

 

20



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

exceeds an accepted tolerance level, the Company obtains a quote from an alternative source, if possible, and documents and resolves any differences between the pricing sources.  In addition, the Company may request that its investment manager and its traders provide input as to which vendor is providing prices that its traders believe are reflective of fair value for the security. Following this process, the Company may decide to value the security in its financial statements using the secondary or alternative source if it believes that pricing is more reflective of the security’s value than the primary pricing provided by its custodian bank.  The Company analyzes market valuations received to verify reasonableness, to understand the key assumptions used and their sources, and to determine an appropriate ASC 820 fair value hierarchy level based upon trading activity and the observability of market inputs.  Based on this evaluation and investment class analysis, each price is classified into Level 1, 2 or 3.

 

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

 

The Company’s Level 1 securities consist of equity securities whose values are based on quoted prices in active markets for identical assets.  The Company’s Level 2 securities are comprised of our available for sale fixed maturity 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. Investments valued using these inputs include U.S. Treasury securities and obligations of U.S. Government agencies, obligations of international government agencies, obligations of states and political subdivisions, corporate securities, commercial and residential mortgage-backed securities, and other asset-backed securities.  Inputs into the fair value application that are utilized by asset class include but are not limited to:

 

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

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

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

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

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

 

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

 

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

 

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Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

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

 

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

 

 

 

As of March 31, 2011

 

 

 

Total

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

U.S. Treasury securities

 

$

84,024

 

$

 

$

84,024

 

$

 

Obligations of states and political subdivisions

 

415,170

 

 

415,170

 

 

Residential mortgage-backed securities

 

236,895

 

 

236,895

 

 

Commercial mortgage-backed securities

 

58,979

 

 

58,979

 

 

Other asset-backed securities

 

15,676

 

 

15,676

 

 

Corporate and other securities

 

212,917

 

 

212,917

 

 

Equity securities

 

16,398

 

16,398

 

 

 

Totals

 

$

1,040,059

 

$

16,398

 

$

1,023,661

 

$

 

 

 

 

As of December 31, 2010

 

 

 

Total

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

U.S. Treasury securities

 

$

86,269

 

$

 

$

86,269

 

$

 

Obligations of states and political subdivisions

 

445,190

 

 

445,190

 

 

Residential mortgage-backed securities

 

252,661

 

 

252,661

 

 

Commercial mortgage-backed securities

 

63,591

 

 

63,591

 

 

Other asset-backed securities

 

17,405

 

 

17,405

 

 

Corporate and other securities

 

198,121

 

 

198,121

 

 

Equity securities

 

14,624

 

14,624

 

 

 

Totals

 

$

1,077,861

 

$

14,624

 

$

1,063,237

 

$

 

 

There were no transfers between Level 1 and Level 2 during the three months ended March 31, 2011.

 

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

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

 

 

Level 3

 

Level 3

 

 

 

Fair Value

 

Fair Value

 

 

 

Securities

 

Securities

 

Balance at January 1

 

$

 

$

2,504

 

Net gains and losses included in earnings

 

 

 

Net gains included in other comprehensive income

 

 

2

 

Purchases and sales

 

 

 

Transfers in (out) of Level 3

 

 

 

Balance at March 31

 

$

 

$

2,506

 

Amount of total losses included in earnings attributable to the change in unrealized losses related to assets still held at March 31

 

$

 

$

 

 

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Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

Transfers in and out of Level 3 are attributable to changes in the ability to observe significant inputs in determining fair value exit pricing. As noted in the table above, no transfers were made in or out of Level 3 during the three months ended March 31, 2011 and 2010.

 

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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)

 

6.   Loss and Loss Adjustment Expense 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,

 

 

 

2011

 

2010

 

Reserves for losses and LAE at beginning of year

 

$

404,391

 

$

439,706

 

Less reinsurance recoverable on unpaid losses and LAE

 

(53,147

)

(64,874

)

Net reserves for losses and LAE at beginning of year

 

351,244

 

374,832

 

Incurred losses and LAE, related to:

 

 

 

 

 

Current year

 

131,292

 

101,214

 

Prior years

 

(9,662

)

(12,540

)

Total incurred losses and LAE

 

121,630

 

88,674

 

Paid losses and LAE related to:

 

 

 

 

 

Current year

 

64,824

 

43,083

 

Prior years

 

63,486

 

50,617

 

Total paid losses and LAE

 

128,310

 

93,700

 

Net reserves for losses and LAE at end of period

 

344,564

 

369,806

 

Plus reinsurance recoverables on unpaid losses and LAE

 

52,168

 

60,634

 

Reserves for losses and LAE at end of period

 

$

396,732

 

$

430,440

 

 

At the end of each period, the reserves were re-estimated for all prior accident years.  The Company’s prior year reserves decreased by $9,662 and $12,540 for the three months ended March 31, 2011 and 2010, respectively, and resulted from re-estimations of prior years ultimate loss and LAE liabilities.  The decrease in prior years reserves during the 2011 period is primarily composed of reductions of $7,298 in the Company’s retained automobile reserves and $1,250 in the Company’s retained homeowners reserves.  The decrease in prior year reserves during the 2010 period is primarily composed of reductions of $8,832 in the Company’s retained automobile reserves, $1,879 in the Company’s retained homeowners reserves, and $1,391 in reserves assumed from Commonwealth Automobile Reinsurers (“CAR”).

 

The Company’s private passenger automobile line of business prior year reserves decreased by $6,292 for the three months ended March 31, 2011.  The decrease was primarily due to improved retained private passenger results of $5,121 for accident years 2006 through 2009.  The Company’s private passenger automobile line of business prior year reserves decreased by $8,497 for the three months ended March 31, 2010.  The decrease was primarily due to improved retained private passenger results of $7,190 for accident years 2005 through 2009, and improved assumed CAR results for the private passenger automobile pool of $898 for accident years 2007 through 2009.  The improved retained private passenger results were primarily due to fewer incurred but not yet reported claims than previously estimated and better than previously estimated severity on the Company’s established bodily injury and property damage case reserves.  The improved CAR results were due primarily to improved CAR private passenger loss ratios as published and reported by the CAR Loss Reserving Committee.

 

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

 

7.  Commitments and Contingencies

 

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

 

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Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

Massachusetts law requires that insurers licensed to do business in Massachusetts participate in the Massachusetts Insurers Insolvency Fund (“Insolvency Fund”).  Members of the Insolvency Fund are assessed a proportionate share of the obligations and expenses of the Insolvency Fund in connection with an insolvent insurer.  It is anticipated that there will be additional assessments from time to time relating to various insolvencies.  Although the timing and amounts of any future assessments are not known, based upon existing knowledge, management’s opinion is that such future assessments will not have a material effect upon the financial position of the Company.

 

8.  Debt

 

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

 

The Company’s obligations under the credit facility are secured by pledges of its assets and the capital stock of its operating subsidiaries.  The credit facility is guaranteed by the Company’s non-insurance company subsidiaries.  The credit facility contains covenants including requirements to maintain minimum risk based capital ratios and statutory surplus of Safety Insurance Company as well as limitations or restrictions on indebtedness, liens, and other matters.  Among other covenants, the credit facility restricts the Company’s payment of dividends (i) if a default under the credit facility is continuing or would result therefrom or (ii) in an amount in excess of 50% of the Company’s prior year’s net income, as determined in accordance with GAAP.  As of March 31, 2011, the Company was in compliance with all such covenants.  In addition, the credit facility includes customary events of default, including a cross-default provision permitting the lenders to accelerate the facility if the Company (i) defaults in any payment obligation under debt having a principal amount in excess of $10,000 or (ii) fails to perform any other covenant permitting acceleration of all such debt.

 

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

 

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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)

 

9. Income Taxes

 

Federal income tax expense for the three months ended March 31, 2011 and 2010 has been computed using estimated effective tax rates.  These rates are revised, if necessary, at the end of each successive interim period to reflect the current estimates of the annual effective tax rates.

 

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

 

During the three months ended March 31, 2011, there were no material changes to the amount of the Company’s unrecognized tax benefits or to any assumptions regarding the amount of its ASC 740 liability.

 

As of March 31, 2011 and December 31, 2010, the Company was no longer subject to examination of its U.S. federal tax returns for years prior to 2006.  The Company is not currently under examination by the IRS.

 

10. Share Repurchase Program

 

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

 

No share purchases were made by the Company under the program during the quarters ended March 31, 2011 and March 31, 2010.  As of March 31, 2011 and December 31, 2010, the Company had purchased 1,727,455 shares on the open market at a cost of $55,526.

 

11. Subsequent Events

 

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

 

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Table of Contents

 

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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

 

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

 

Executive Summary and Overview

 

In this discussion, “Safety” refers to Safety Insurance Group, Inc. and “our Company,” “we,” “us” and “our” refer to Safety Insurance Group, Inc. and its consolidated subsidiaries.  Our subsidiaries consist of Safety Insurance Company (“Safety Insurance”), Safety Indemnity Insurance Company (“Safety Indemnity”), Safety Property and Casualty Insurance Company (“Safety P&C”), Whiteshirts Asset Management Corporation (“WAMC”), and Whiteshirts Management Corporation, which is WAMC’s holding company.

 

We are a leading provider of private passenger automobile insurance in Massachusetts.  In addition to private passenger automobile insurance (which represented 68.7% of our direct written premiums in 2010), we offer a portfolio of other insurance products, including commercial automobile (10.4% of 2010 direct written premiums), homeowners (16.8% of 2010 direct written premiums), dwelling fire, umbrella and business owner policies (totaling 4.1% of 2010 direct written premiums).  Operating exclusively in Massachusetts and New Hampshire through our insurance company subsidiaries, Safety Insurance, Safety Indemnity, and Safety P&C (together referred to as the “Insurance Subsidiaries”), we have established strong relationships with independent insurance agents, who numbered 783 in 939 locations throughout Massachusetts and New Hampshire during 2010. We have used these relationships and our extensive knowledge of the Massachusetts market to become the second largest private passenger automobile and the third largest commercial automobile insurance carrier in Massachusetts, capturing an approximate 11.4% and 10.7% share, respectively, of the Massachusetts private passenger and commercial automobile markets in 2010, according to the Commonwealth Automobile Reinsurers (“CAR”) Cession Volume Analysis Report of March 3, 2011, based on automobile exposures. These statistics total, for each vehicle insured, the number of months during the year insurance for that vehicle is in effect, to arrive at an aggregate number of car-months for each insurer; this aggregate number, divided by 12, equals the insurer’s number of car-years, a measure we refer to in this report as automobile exposures.

 

The Insurance Subsidiaries began writing private passenger automobile and homeowners insurance business in New Hampshire during 2008 and personal umbrella business during 2009.  During the three months ended March 31, 2011 and 2010, we wrote $973 and $441, respectively, in direct written premiums in New Hampshire.

 

Massachusetts Automobile Insurance Market

 

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

 

On July 16, 2007, the Commissioner issued two decisions that significantly changed how private passenger automobile insurance was regulated in Massachusetts.  In the first decision, the Commissioner approved and set a time table for the implementation of new CAR rules pursuant to which the reinsurance program run by CAR was replaced with an assigned risk plan, the Massachusetts Automobile Insurance Plan (“MAIP”).  Under these new rules, as of April 1, 2009 we are no longer

 

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Table of Contents

 

assigned ERPs and instead, we are assigned individual policies by CAR.  The MAIP began with business effective on or after April 1, 2008 for new business and those risks that had 10 or more Safe Driver Points.  Beginning April 1, 2009, all business was eligible for MAIP except those risks that have no violations or accidents in the preceding three year period (so called “Clean in three” risks).  The last policy effective date on which any risk could be ceded to CAR was March 31, 2009.

 

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

 

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

 

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

 

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

 

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

 

During 2009, we increased our rates an average of 2.6% in a series of rate filings during the year.  We began using three rating tiers effective April 1, 2009.  We filed and were approved for a 0.3% rate decrease effective June 1, 2009 and a 2.9% rate increase effective October 1, 2009.  We filed and were approved for a rate increase of 0.4% and began using four rating tiers effective January 1, 2010.  A Companion Policy Client Tier, which is policyholders who have an other than private passenger automobile policy with us, receives a rate decrease of 2.5% from our filed base rates.  A Loyal Automobile Client Tier, which is policyholders who have been insured with us for two or more years, receives our filed base rates.  A New Insurance Client Tier, which is policyholders with twelve or more months of continuous coverage or who qualify for a multi-car discount, receives a rate increase of 2.5% from our filed base rates.  A New Policyholder Tier, which is policyholders who do not qualify for the other three tiers, receives MAIP rates.  We filed and were approved for a 1.9% increase in our rates effective April 19, 2010 and we filed and were approved for a 0.5% decrease in our rates effective June 15, 2010.  In addition, we filed and have been approved for a 3.9% increase in our rates effective May 15, 2011.  Our rates include a 13.0% commission rate for agents.  Our direct written premiums increased by 8.1% in 2010 primarily as a result of increased exposures and average written premium per exposure in our private passenger and homeowner lines of business.

 

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Table of Contents

 

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, which in general reflect a liquidating, rather than going concern concept of accounting.  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 “non admitted assets,” and charged directly against statutory surplus.  These assets consist primarily of premium receivables that are outstanding over ninety 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 of ceded unearned 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 fair 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.

·                  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 and other expenses as a percent of net earned premiums, calculated on a GAAP basis).  The combined ratio reflects only underwriting results and does not include income from investments or finance and other service income.  Underwriting profitability is subject to significant fluctuations due to competition, catastrophic events, weather, economic and social conditions, and other factors. 

 

Our GAAP insurance ratios are outlined in the following table.

 

 

 

Three Months Ended March 31,

 

 

 

2011

 

2010

 

GAAP ratios:

 

 

 

 

 

Loss ratio

 

84.1

%

66.6

%

Expense ratio

 

29.5

 

31.4

 

Combined ratio

 

113.6

%

98.0

%

 

Stock-Based Compensation

 

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

 

The maximum number of shares of common stock with respect to which awards may be granted is 2,500,000.  Shares of stock covered by an award under the Incentive Plan that are forfeited will again be available for issuance in connection with future grants of awards under the plan.  At March 31, 2011, there were 718,280 shares available for future grant.  The Board of Directors and the Compensation Committee intend to issue more awards under the Incentive Plan in the future.

 

A summary of stock based awards granted under the Incentive Plan during the three months ended March 31, 2011 is as follows:

 

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Table of Contents

 

Type of

 

 

 

Number of

 

Fair

 

 

 

Equity

 

 

 

Awards

 

Value per

 

 

 

Awarded

 

Effective Date

 

Granted

 

Share (1)

 

Vesting Terms

 

RS

 

March 9, 2011

 

68,637

 

$

47.35

 

3 years, 30%-30%-40%

 

RS

 

March 9, 2011

 

4,000

 

$

47.35

 

No vesting period (2)

 

RS

 

March 23, 2011

 

22,567

 

$

44.94

 

5 years, 20% annually

 

 


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

(2)   The shares cannot be sold, assigned, pledged, or otherwise transferred, encumbered or disposed of until the recipient is no

longer a member of 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.  We use various software products to measure our exposure to catastrophe losses and the probable maximum loss to us for catastrophe losses such as hurricanes.  The models include estimates for our share of the catastrophe losses generated in the residual market for property insurance by the Massachusetts Property Insurance Underwriting Association (“FAIR Plan”).  In the aftermath of Hurricane Katrina in 2005, the reinsurance market has seen from the various software modelers, increases in the estimate of damage from hurricanes in the southern and northeast portions of the United States due to revised estimations of increased hurricane activity and increases in the estimation of demand surge in the periods following a significant event.  We continue to adjust our reinsurance programs as a result of the changes to the models and the number of homes we write.  As of January 1, 2011, our catastrophe reinsurance provides gross per occurrence reinsurance coverage up to $535,000.  As a result of the changes to the models, and our revised reinsurance program, our catastrophe reinsurance in 2011 protects us in the event of a “125-year storm” (that is, a storm of a severity expected to occur once in a 125-year period).  Swiss Re, our primary reinsurer, maintains an A.M. Best rating of “A” (Excellent).  Most of our other reinsurers have an A.M. Best rating of “A” (Excellent) however in no case is a reinsurer rated below “A-” (Excellent).

 

We are a participant in CAR, a state-established body that runs the residual market reinsurance programs for both private passenger and commercial automobile insurance in Massachusetts under which premiums, expenses, losses and loss adjustment expenses on ceded business are shared by all insurers writing automobile insurance in Massachusetts.  We also participate in the FAIR Plan in which premiums, expenses, losses and loss adjustment expenses on homeowners business that cannot be placed in the voluntary market are shared by all insurers writing homeowners insurance in Massachusetts.  The FAIR Plan has grown dramatically over the past few years as insurance carriers have reduced their exposure to coastal property.  The FAIR Plan’s exposure to catastrophe losses increased and as a result, the FAIR Plan decided to buy reinsurance to reduce their exposure to catastrophe losses.  On July 1, 2010, the FAIR Plan purchased $1,000,000 of catastrophe reinsurance for property losses in excess of $200,000.  At March 31, 2011, we had no material amounts recoverable from any reinsurer, excluding $43,953 recoverable from CAR.

 

On March 10, 2005, our Board of Directors adopted a resolution that prohibits Safety from purchasing finite reinsurance (reinsurance that transfers only a finite or limited amount of risk to the reinsurer) without approval by the Board.  To date, the Company has never purchased a finite reinsurance contract.

 

Effects of Inflation

 

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

 

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Critical Accounting Policies and Estimates

 

Loss and Loss Adjustment Expense Reserves.

 

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

 

When a claim is reported, claims personnel establish a “case reserve” for the estimated amount of the ultimate payment.  The amount of the reserve is primarily based upon an evaluation of the type of claim involved, the circumstances surrounding each claim and the policy provisions relating to the loss.  The estimate reflects the informed judgment of such personnel based on general insurance reserving practices and on the experience and knowledge of the claims person.  During the loss adjustment period, these estimates are revised as deemed necessary by our claims department based on subsequent developments and periodic reviews of the cases.  When a claim is closed with or without a payment, the difference between the case reserve and the settlement amount creates a reserve deficiency if the payment exceeds the case reserve or a reserve redundancy if the payment is less than the case reserve.

 

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

 

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

 

Management determines our loss and LAE reserves estimate based upon the analysis of our actuaries.  A reasonable estimate is derived by selecting a point estimate within a range of indications as calculated by our actuaries using generally accepted actuarial techniques.  The key assumption in most actuarial analysis is that past patterns of frequency and severity will repeat in the future, unless a significant change in the factors described above takes place. Our key factors and resulting assumptions are the ultimate frequency and severity of claims, based upon the most recent ten years of claims reported to the Company, and the data CAR reports to us to calculate our share of the residual market, as of the date of the applicable balance sheet.  For each accident year and each coverage within a line of business our actuaries calculate the ultimate losses incurred. Our total reserves are the difference between the ultimate losses incurred and the cumulative loss and loss adjustment payments made to date.  Our IBNR reserves are calculated as the difference between our total reserves and the outstanding case reserves at the end of the accounting period.  To determine ultimate losses, our actuaries calculate a range of indications and select a point estimation using such actuarial techniques as:

 

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

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

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

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

 

Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting our ultimate losses, total reserves and resulting IBNR reserves.  It is possible that the final

 

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outcome may fall above or below these amounts as a result of a number of factors, including immature data, sparse data, or significant growth in a line of business.  Using these methodologies, our actuaries established a range of reasonably possible estimations for net reserves of approximately $310,005 to $352,138 as of March 31, 2011.  In general, the low and high values of the ranges represent reasonable minimum and maximum values of the indications based on the techniques described above.  Our selected point estimate of net loss and LAE reserves based upon the analysis of our actuaries was $344,564 as of March 31, 2011.

 

The following table presents the point estimation of the recorded reserves and the range of estimations by line of business for net loss and LAE reserves as of March 31, 2011.  We have recorded reserves closer to the high end of the ranges of our projections.

 

Line of Business