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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 June 30, 2014

 

OR

 

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

 

For the transition period from                  to                 

 

Commission File Number: 000-50070

 

SAFETY INSURANCE GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

13-4181699

(State or other jurisdiction of incorporation or organization)

 

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

 

20 Custom House Street, Boston, Massachusetts 02110

(Address of principal executive offices including zip code)

 

(617) 951-0600

(Registrant’s telephone number, including area code)

 

Not Applicable

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

 

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

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer x

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

As of August 5, 2014, there were 15,006,136 shares of common stock with a par value of $0.01 per share outstanding.

 

 

 



Table of Contents

 

SAFETY INSURANCE GROUP, INC.

Table of Contents

 

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

Consolidated Balance Sheets at June 30, 2014 (Unaudited) and December 31, 2013

 

3

 

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2014 and 2013 (Unaudited)

 

4

 

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2014 and 2013 (Unaudited)

 

5

 

Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2014 and 2013 (Unaudited)

 

6

 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013 (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

 

20

 

Results of Operations — Three and Six Months Ended June 30, 2014 and 2013

 

22

 

Liquidity and Capital Resources

 

26

 

Critical Accounting Policies and Estimates

 

28

 

Forward-Looking Statements

 

35

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

 

36

 

 

 

 

Item 4.

Controls and Procedures

 

36

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

37

 

 

 

 

Item 1A.

Risk Factors

 

37

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

37

 

 

 

 

Item 3.

Defaults upon Senior Securities

 

37

 

 

 

 

Item 4.

Mine Safety Disclosures

 

37

 

 

 

 

Item 5.

Other Information

 

37

 

 

 

 

Item 6.

Exhibits

 

37

 

 

 

 

SIGNATURE

 

38

 

 

 

 

EXHIBIT INDEX

 

39

 



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except share data)

 

 

 

June 30,

 

December 31,

 

 

 

2014

 

2013

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Securities available for sale:

 

 

 

 

 

Fixed maturities, at fair value (amortized cost: $1,075,650 and $1,087,232)

 

$

1,111,248

 

$

1,104,957

 

Equity securities, at fair value (cost: $84,974 and $83,134)

 

97,540

 

91,871

 

Other invested assets

 

7,552

 

5,748

 

Total investments

 

1,216,340

 

1,202,576

 

Cash and cash equivalents

 

37,740

 

55,877

 

Accounts receivable, net of allowance for doubtful accounts

 

191,149

 

169,304

 

Receivable for securities sold

 

660

 

1,320

 

Accrued investment income

 

9,813

 

10,329

 

Taxes recoverable

 

566

 

709

 

Receivable from reinsurers related to paid loss and loss adjustment expenses

 

11,943

 

4,588

 

Receivable from reinsurers related to unpaid loss and loss adjustment expenses

 

58,823

 

60,346

 

Ceded unearned premiums

 

18,649

 

17,900

 

Deferred policy acquisition costs

 

69,110

 

63,388

 

Deferred income taxes

 

 

3,984

 

Equity and deposits in pools

 

22,655

 

18,733

 

Other assets

 

15,475

 

16,403

 

Total assets

 

$

1,652,923

 

$

1,625,457

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Loss and loss adjustment expense reserves

 

$

457,789

 

$

455,014

 

Unearned premium reserves

 

403,638

 

370,583

 

Accounts payable and accrued liabilities

 

52,685

 

66,508

 

Payable for securities purchased

 

6,554

 

13,327

 

Payable to reinsurers

 

12,958

 

7,094

 

Deferred income taxes

 

3,752

 

 

Other liabilities

 

11,846

 

17,744

 

Total liabilities

 

949,222

 

930,270

 

 

 

 

 

 

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Common stock: $0.01 par value; 30,000,000 shares authorized; 17,288,504 and 17,207,929 shares issued

 

173

 

172

 

Additional paid-in capital

 

173,177

 

170,391

 

Accumulated other comprehensive income, net of taxes

 

31,306

 

17,200

 

Retained earnings

 

582,880

 

567,792

 

Treasury Stock, at cost: 2,279,570 and 1,819,547 shares

 

(83,835

)

(60,368

)

Total shareholders’ equity

 

703,701

 

695,187

 

Total liabilities and shareholders’ equity

 

$

1,652,923

 

$

1,625,457

 

 

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

 

3



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

(Dollars in thousands, except per share data)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Net earned premiums

 

$

178,150

 

$

169,550

 

$

354,120

 

$

335,989

 

Net investment income

 

9,909

 

9,727

 

20,482

 

20,114

 

Net realized gains on investments

 

379

 

140

 

399

 

542

 

Finance and other service income

 

4,508

 

4,584

 

9,032

 

9,152

 

Total revenue

 

192,946

 

184,001

 

384,033

 

365,797

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

108,550

 

106,976

 

229,438

 

219,121

 

Underwriting, operating and related expenses

 

54,418

 

51,467

 

107,825

 

101,565

 

Interest expense

 

23

 

21

 

45

 

43

 

Total expenses

 

162,991

 

158,464

 

337,308

 

320,729

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

29,955

 

25,537

 

46,725

 

45,068

 

Income tax expense

 

8,532

 

7,478

 

13,177

 

13,025

 

Net income

 

$

21,423

 

$

18,059

 

$

33,548

 

$

32,043

 

 

 

 

 

 

 

 

 

 

 

Earnings per weighted average common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

1.40

 

$

1.17

 

$

2.19

 

$

2.09

 

Diluted

 

$

1.40

 

$

1.17

 

$

2.18

 

$

2.08

 

 

 

 

 

 

 

 

 

 

 

Cash dividends paid per common share

 

$

0.60

 

$

0.60

 

$

1.20

 

$

1.20

 

 

 

 

 

 

 

 

 

 

 

Number of shares used in computing earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

15,271,200

 

15,380,053

 

15,307,808

 

15,359,983

 

Diluted

 

15,352,692

 

15,421,300

 

15,379,199

 

15,389,236

 

 

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

 

4



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

(Dollars in thousands)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net income

 

$

21,423

 

$

18,059

 

$

33,548

 

$

32,043

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) during the period, net of tax expense (benefit) of $3,881, ($10,082), $7,735, and ($12,470)

 

7,207

 

(18,724

)

14,365

 

(23,159

)

Reclassification adjustment for gains included in net income, net of tax expense of ($132), ($49), ($140), and ($190)

 

(246

)

(91

)

(259

)

(352

)

Unrealized gains (losses) on securities available for sale

 

6,961

 

(18,815

)

14,106

 

(23,511

)

 

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

 

$

28,384

 

$

(756

)

$

47,654

 

$

8,532

 

 

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

 

5



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, 2012

 

$

170

 

$

163,041

 

$

43,356

 

$

543,361

 

$

(55,569

)

$

694,359

 

Net income, January 1 to June 30, 2013

 

 

 

 

 

 

 

32,043

 

 

 

32,043

 

Other comprehensive income, net of deferred federal income taxes

 

 

 

 

 

(23,511

)

 

 

 

 

(23,511

)

Restricted share awards issued

 

1

 

187

 

 

 

 

 

 

 

188

 

Recognition of employee share-based compensation, net of deferred federal income taxes

 

 

 

2,364

 

 

 

 

 

 

 

2,364

 

Exercise of options, net of federal income taxes

 

1

 

2,165

 

 

 

 

 

 

 

2,166

 

Dividends paid and accrued

 

 

 

 

 

 

 

(18,452

)

 

 

(18,452

)

Acquisition of treasury stock

 

 

 

 

 

 

 

 

 

(4,799

)

(4,799

)

Balance at June 30, 2013

 

$

172

 

$

167,757

 

$

19,845

 

$

556,952

 

$

(60,368

)

$

684,358

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Comprehensive

 

 

 

 

 

Total

 

 

 

Common

 

Paid-in

 

Income,

 

Retained

 

Treasury

 

Shareholders’

 

 

 

Stock

 

Capital

 

Net of Taxes

 

Earnings

 

Stock

 

Equity

 

Balance at December 31, 2013

 

$

172

 

$

170,391

 

$

17,200

 

$

567,792

 

$

(60,368

)

$

695,187

 

Net income, January 1 to June 30, 2014

 

 

 

 

 

 

 

33,548

 

 

 

33,548

 

Other comprehensive loss, net of deferred federal income taxes

 

 

 

 

 

14,106

 

 

 

 

 

14,106

 

Restricted share awards issued

 

1

 

217

 

 

 

 

 

 

 

218

 

Recognition of employee share-based compensation, net of deferred federal income taxes

 

 

 

2,418

 

 

 

 

 

 

 

2,418

 

Exercise of options, net of federal income taxes

 

 

 

151

 

 

 

 

 

 

 

151

 

Dividends paid and accrued

 

 

 

 

 

 

 

(18,460

)

 

 

(18,460

)

Acquisition of treasury stock

 

 

 

 

 

 

 

 

 

(23,467

)

(23,467

)

Balance at June 30, 2014

 

$

173

 

$

173,177

 

$

31,306

 

$

582,880

 

$

(83,835

)

$

703,701

 

 

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

 

6



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

 

 

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

33,548

 

$

32,043

 

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

 

 

 

 

 

Depreciation and amortization, net

 

6,602

 

7,273

 

Provision for deferred income taxes

 

140

 

225

 

Net realized gains on investments

 

(399

)

(542

)

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(21,845

)

(23,506

)

Accrued investment income

 

516

 

221

 

Receivable from reinsurers

 

(5,832

)

(10,847

)

Ceded unearned premiums

 

(749

)

(1,544

)

Deferred policy acquisition costs

 

(5,722

)

(5,086

)

Other assets

 

(3,529

)

3,347

 

Loss and loss adjustment expense reserves

 

2,775

 

8,754

 

Unearned premium reserves

 

33,055

 

34,092

 

Accounts payable and accrued liabilities

 

(13,823

)

(16,943

)

Payable to reinsurers

 

5,864

 

4,964

 

Other liabilities

 

(5,978

)

2,647

 

Net cash provided by operating activities

 

24,623

 

35,098

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Fixed maturities purchased

 

(113,200

)

(96,797

)

Equity securities purchased

 

(7,372

)

(24,922

)

Other invested assets purchase

 

(1,770

)

 

Proceeds from sales and paydowns of fixed maturities

 

92,726

 

85,978

 

Proceeds from maturities, redemptions, and calls of fixed maturities

 

23,248

 

20,705

 

Proceed from sales of equity securities

 

6,310

 

3,445

 

Fixed assets purchased

 

(1,006

)

(2,038

)

Net cash used for investing activities

 

(1,064

)

(13,629

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from stock options exercised

 

147

 

2,224

 

Excess tax benefit (expense) from stock options exercised

 

4

 

(59

)

Dividends paid to shareholders

 

(18,380

)

(18,430

)

Acquisition of treasury stock

 

(23,467

)

(4,799

)

Net cash used for financing activities

 

(41,696

)

(21,064

)

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(18,137

)

405

 

Cash and cash equivalents at beginning of year

 

55,877

 

35,383

 

Cash and cash equivalents at end of period

 

$

37,740

 

$

35,788

 

 

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.

 

The financial information as of June 30, 2014 and for the three and six months ended June 30, 2014 and 2013 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, results of operations, and cash flows for the periods.  These unaudited interim 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 17, 2014.

 

The Company is a leading provider of property and casualty insurance focused primarily on the Massachusetts market.  The Company’s principal product line is automobile insurance.  The Company operates through its insurance company subsidiaries, Safety Insurance Company, Safety Indemnity Insurance Company, and Safety Property and Casualty Insurance Company (together referred to as the “Insurance Subsidiaries”).

 

The Insurance Subsidiaries began writing private passenger automobile and homeowners insurance in New Hampshire during 2008, personal umbrella insurance in New Hampshire during 2009, and commercial automobile insurance in New Hampshire during 2011.

 

2.  Recent Accounting Pronouncements

 

On May 28, 2014, the FASB issued as final, ASU 2014-09, Revenue from Contracts with Customers (Topic 606) which supersedes virtually all existing revenue recognition guidance under GAAP. The update’s core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The update is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2016 and prohibits early adoption. The update allows for the use of either the retrospective or modified retrospective approach of adoption. The impact of adoption to the Company’s consolidated financial condition and results of operations is currently being evaluated.

 

In February 2013, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. ASU 2013-02 requires entities to present in either a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source and the income statement line items affected by the reclassification. Items not required to be reclassified to net income in their entirety are cross referenced to a related footnote for additional information. ASU 2013-02 was effective for interim and annual periods beginning after December 15, 2012. The impact of adoption was not material to the Company’s consolidated financial condition and results of operations.

 

3.  Earnings per Weighted Average Common Share

 

Basic earnings per weighted average common share (“EPS”) is calculated by dividing net income by the weighted average number of basic common shares outstanding during the period including unvested restricted shares which are considered participating securities.  Diluted earnings per share amounts are based on the weighted average number of common shares including non-vested performance stock grants and the net effect of potentially dilutive common stock options.

 

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

 

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)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

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

 

$

21,423

 

$

18,059

 

$

33,548

 

$

32,043

 

 

 

 

 

 

 

 

 

 

 

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

 

15,271,200

 

15,380,053

 

15,307,808

 

15,359,983

 

Common equivalent shares- stock options

 

2,121

 

5,818

 

2,526

 

7,330

 

Common equivalent shares- non-vested performance stock grants

 

79,371

 

35,429

 

68,865

 

21,923

 

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

 

15,352,692

 

15,421,300

 

15,379,199

 

15,389,236

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

1.40

 

$

1.17

 

$

2.19

 

$

2.09

 

Diluted earnings per share

 

$

1.40

 

$

1.17

 

$

2.18

 

$

2.08

 

 

Diluted EPS excludes stock options with exercise prices and exercise tax benefits greater than the average market price of the Company’s common stock during the period because their inclusion would be anti-dilutive.  There were no anti-dilutive stock options for both the three and six months ended June 30, 2014 and 2013.

 

4.  Share-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 share-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.  The Incentive Plan was amended in March of 2013 to remove “share recycling” plan provisions.  Hence, shares of stock covered by an award under the Incentive Plan that are forfeited are no longer available for issuance in connection with 2013 and future grants of awards.  At June 30, 2014, there were 455,072 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.

 

Accounting and Reporting for Stock-Based Awards

 

Accounting Standards Codification (“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.  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).

 

The following table summarizes stock option activity under the Incentive Plan for the six months ended June 30, 2014.

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Shares

 

Weighted

 

Average

 

Aggregate

 

 

 

Under

 

Average

 

Remaining

 

Intrinsic

 

 

 

Option

 

Exercise Price

 

Contractual Term

 

Value

 

Outstanding at beginning of year

 

20,200

 

$

41.64

 

 

 

 

 

Exercised

 

(4,000

)

$

36.76

 

 

 

 

 

Outstanding at end of period

 

16,200

 

$

42.85

 

1.7  years

 

$

138

 

Exercisable at end of period

 

16,200

 

$

42.85

 

1.7  years

 

$

138

 

 

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Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value, which is the difference between the fair value based upon the Company’s closing stock price on June 30, 2014 and the exercise price which would have been received by the option holders had all option holders exercised their options as of that date.  The exercise price on stock options outstanding under the Incentive Plan at June 30, 2014 was $42.85. The range of exercise prices on stock options outstanding under the Incentive Plan at June 30, 2013 was $18.50 to $42.85.  The total intrinsic value of options exercised during the six months ended June 30, 2014 and 2013 was $58 and $565, respectively.

 

As of March 31, 2011, all compensation expense related to non-vested option awards had been recognized.  Cash received from options exercised was $147 and $2,224 for the six months ended June 30, 2014 and 2013, respectively.

 

Restricted Stock

 

Service-based restricted stock awarded 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 compensation expense over the requisite service period. Service-based restricted stock awards generally vest over a three-year period and vest 30% on the first and second anniversaries of the grant date and 40% on the third anniversary of the grant date, except for non-executive employees’ restricted stock awards which vest ratably over a five-year service period and independent directors’ stock awards which vest immediately.  Independent directors’ stock awards 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.

 

In addition to service-based awards, the Company grants performance-based restricted shares to certain employees.  These performance shares cliff vest after a three-year performance period provided certain performance measures are attained.   A portion of these awards, which contain a market condition, vest according to the level of total shareholder return achieved by the Company compared to its property-casualty insurance peers over a three-year period. The remainder, which contain a performance condition, vest according to the level of Company’s combined ratio results compared to a target based on the historic performance of its property-casualty insurance peers.

 

Actual payouts can range from 0% to 200% of target shares awarded depending upon the level of achievement of the respective market and performance conditions during a three fiscal-year performance period. Compensation expense for share awards with a performance condition is based on the probable number of awards expected to vest using the performance level most likely to be achieved at the end of the performance period.

 

Performance-based awards with market conditions are accounted for and measured differently from an award that has a performance or service condition.  The effect of a market condition is reflected in the award’s fair value on the grant date.  That fair value is recognized as compensation cost over the requisite service period regardless of whether the market-based performance objective has been satisfied.

 

All of the Company’s restricted stock awards are issued as incentive compensation and are equity classified.

 

The following table summarizes restricted stock activity under the Incentive Plan during the six months ended June 30, 2014, assuming a target payout for the 2014 performance-based shares.

 

 

 

Shares

 

Weighted

 

Performance-based

 

Weighted

 

 

 

Under

 

Average

 

Shares Under

 

Average

 

 

 

Restriction

 

Fair Value

 

Restriction

 

Fair Value

 

Outstanding at beginning of year

 

211,234

 

$

43.51

 

37,456

 

$

44.13

 

Granted

 

49,014

 

$

54.05

 

27,928

 

$

58.09

 

Vested and unrestricted

 

(81,149

)

$

43.80

 

 

$

 

Forfeited

 

(367

)

$

47.90

 

 

$

 

Outstanding at end of period

 

178,732

 

$

46.28

 

65,384

 

$

50.10

 

 

As of June 30, 2014, there was $8,647 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 six months ended June 30, 2014 and 2013 was $3,554 and $4,230, respectively.  For the six months ended June 30, 2014 and 2013, the Company recorded compensation expense related to restricted stock of $1,514 and $1,489, net of income tax benefits of $815 and $801, respectively.

 

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)

 

5.  Investments

 

The gross unrealized gains and losses on investments in fixed maturity securities, including redeemable preferred stocks that have characteristics of fixed maturities, and equity securities, including interests in mutual funds, and other invested assets were as follows for the periods indicated.

 

 

 

As of June 30, 2014

 

 

 

 

 

 

 

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

 

$

1,509

 

$

 

$

(1

)

$

 

$

1,508

 

Obligations of states and political subdivisions

 

445,560

 

19,431

 

(571

)

 

464,420

 

Residential mortgage-backed securities (1)

 

188,357

 

7,698

 

(1,693

)

 

194,362

 

Commercial mortgage-backed securities

 

27,837

 

252

 

(31

)

 

28,058

 

Other asset-backed securities

 

12,375

 

83

 

 

 

12,458

 

Corporate and other securities

 

400,012

 

11,138

 

(708

)

 

410,442

 

Subtotal, fixed maturity securities 

 

1,075,650

 

38,602

 

(3,004

)

 

1,111,248

 

Equity securities (2)

 

84,974

 

12,664

 

(98

)

 

97,540

 

Other invested assets (5)

 

7,552

 

 

 

 

7,552

 

Totals

 

$

1,168,176

 

$

51,266

 

$

(3,102

)

$

 

$

1,216,340

 

 

 

 

As of December 31, 2013

 

 

 

 

 

 

 

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

 

$

1,510

 

$

 

$

(7

)

$

 

$

1,503

 

Obligations of states and political subdivisions

 

461,256

 

10,248

 

(4,179

)

 

467,325

 

Residential mortgage-backed securities (1)

 

205,053

 

6,879

 

(3,230

)

 

208,702

 

Commercial mortgage-backed securities

 

31,885

 

342

 

(8

)

 

32,219

 

Other asset-backed securities

 

13,357

 

124

 

(36

)

 

13,445

 

Corporate and other securities

 

374,171

 

9,882

 

(2,290

)

 

381,763

 

Subtotal, fixed maturity securities 

 

1,087,232

 

27,475

 

(9,750

)

 

1,104,957

 

Equity securities (2)

 

83,134

 

8,821

 

(84

)

 

91,871

 

Other invested assets (5)

 

5,748

 

 

 

 

5,748

 

Totals

 

$

1,176,114

 

$

36,296

 

$

(9,834

)

$

 

$

1,202,576

 

 


(1)  Residential mortgage-backed securities consists primarily of obligations of U.S. Government agencies including collateralized mortgage obligations issued, guaranteed and/or insured by the following issuers: Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA) and the Federal Home Loan Bank (FHLB).

 

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

 

(3)  Our investment portfolio included 150 and 220 securities in an unrealized loss position at June 30, 2014 and December 31, 2013, respectively.

 

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

 

(5) Other invested assets are accounted for under the equity method which approximated fair value.

 

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

 

 

 

As of June 30, 2014

 

 

 

Amortized

 

Estimated

 

 

 

Cost

 

Fair Value

 

Due in one year or less

 

$

42,154

 

$

42,955

 

Due after one year through five years

 

322,593

 

331,183

 

Due after five years through ten years

 

220,573

 

227,762

 

Due after ten years

 

261,760

 

274,469

 

Asset-backed securities

 

228,570

 

234,879

 

Totals

 

$

1,075,650

 

$

1,111,248

 

 

The gross realized gains and losses on sales of investments were as follows for the periods indicated.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Gross realized gains

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

$

310

 

$

95

 

$

484

 

$

474

 

Equity securities

 

406

 

61

 

817

 

87

 

Gross realized losses

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

(333

)

(14

)

(863

)

(16

)

Equity securities

 

(4

)

(2

)

(39

)

(3

)

Net realized gains on investments

 

$

379

 

$

140

 

$

399

 

$

542

 

 

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

 

The following tables as of June 30, 2014 and December 31, 2013 present the gross unrealized losses included in the Company’s investment portfolio and the fair value of those securities aggregated by investment category.  The tables also present the length of time that they have been in a continuous unrealized loss position.

 

 

 

As of June 30, 2014

 

 

 

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

 

$

 

$

 

$

1,509

 

$

1

 

$

1,509

 

$

1

 

Obligations of states and political subdivisions

 

28,139

 

219

 

18,661

 

352

 

46,800

 

571

 

Residential mortgage-backed securities

 

27,088

 

597

 

35,706

 

1,096

 

62,794

 

1,693

 

Commercial mortgage-backed securities

 

2,470

 

1

 

96

 

30

 

2,566

 

31

 

Corporate and other securities

 

43,484

 

306

 

28,222

 

402

 

71,706

 

708

 

Subtotal, fixed maturity securities

 

101,181

 

1,123

 

84,194

 

1,881

 

185,375

 

3,004

 

Equity securities

 

1,298

 

53

 

1,464

 

45

 

2,762

 

98

 

Total temporarily impaired securities

 

$

102,479

 

$

1,176

 

$

85,658

 

$

1,926

 

$

188,137

 

$

3,102

 

 

12



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

 

 

As of December 31, 2013

 

 

 

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

 

$

1,503

 

$

7

 

$

 

$

 

$

1,503

 

$

7

 

Obligations of states and political subdivisions

 

131,114

 

3,898

 

3,362

 

281

 

134,476

 

4,179

 

Residential mortgage-backed securities

 

50,048

 

1,570

 

37,166

 

1,660

 

87,214

 

3,230

 

Commercial mortgage-backed securities

 

6,008

 

8

 

 

 

6,008

 

8

 

Other asset-backed securities

 

3,240

 

31

 

4,608

 

5

 

7,848

 

36

 

Corporate and other securities

 

86,312

 

2,223

 

2,235

 

67

 

88,547

 

2,290

 

Subtotal, fixed maturity securities

 

278,225

 

7,737

 

47,371

 

2,013

 

325,596

 

9,750

 

Equity securities

 

3,933

 

73

 

299

 

11

 

4,232

 

84

 

Total temporarily impaired securities

 

$

282,158

 

$

7,810

 

$

47,670

 

$

2,024

 

$

329,828

 

$

9,834

 

 

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 June 30, 2014 were reviewed for potential other-than-temporary asset impairments.  The Company held no securities at June 30, 2014 with a material (20% or greater) unrealized loss for four or more consecutive quarters.  Specific qualitative analysis was also performed for any additional securities appearing on the Company’s “Watch List,” if any.  Qualitative analysis considered such factors as the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, changes to the rating of the security by a rating agency and the historical volatility of the fair value of the security.

 

The qualitative analysis performed by the Company concluded that the unrealized losses recorded on the investment portfolio at June 30, 2014 resulted from fluctuations in market interest rates and other temporary market conditions as opposed to fundamental changes in the credit quality of the issuers of such securities.  Therefore, decreases in fair values of the Company’s securities are viewed as being temporary.

 

During the six months ended June 30, 2014 and 2013, there was no significant deterioration in the credit quality of any of the Company’s holdings and no OTTI charges were recorded related to the Company’s portfolio of investment securities.  At June 30, 2014 and December 31, 2013, 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:

 

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)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Interest on fixed maturity securities

 

$

9,616

 

$

10,033

 

$

20,020

 

$

20,733

 

Dividends on equity securities

 

743

 

272

 

1,400

 

443

 

Equity in earnings of other invested assets

 

182

 

 

303

 

 

Interest on other assets

 

20

 

23

 

40

 

97

 

Interest on cash and cash equivalents

 

 

2

 

1

 

10

 

Total investment income 

 

10,561

 

10,330

 

21,764

 

21,283

 

Investment expenses

 

652

 

603

 

1,282

 

1,169

 

Net investment income 

 

$

9,909

 

$

9,727

 

$

20,482

 

$

20,114

 

 

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

 

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

 

The Company’s Level 1 securities consist of equity securities whose values are based on quoted prices in active markets for identical assets.  The Company’s Level 2 securities are comprised of available-for-sale fixed maturity securities whose fair value was

 

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)

 

determined using observable market inputs.  The Company’s Level 3 security is a real estate investment trust equity investment whose fair value was determined using the trust’s net asset value obtained from its audited financial statements; however, the Company is required to submit a request 45 days before a quarter end to dispose of the security.  Fair values for securities for which quoted market prices were unavailable were estimated based upon reference to observable inputs such as benchmark interest rates, market comparables, and other relevant inputs.  Investments valued using these inputs include U.S. Treasury securities and obligations of U.S. Government agencies, obligations of international government agencies, obligations of states and political subdivisions, corporate securities, commercial and residential mortgage-backed securities, and other asset-backed securities.  Inputs into the fair value application that are utilized by asset class include but are not limited to:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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).

 

With the exception of the REIT which is categorized as a Level 3 security, the Company’s entire available-for-sale portfolio was priced based upon quoted market prices or other observable inputs as of June 30, 2014.  There were no significant changes to the valuation process during the six months ending June 30, 2014.  As of June 30, 2014 and December 31, 2013, no quotes or prices obtained were adjusted by management.  All broker quotes obtained were non-binding.

 

At June 30, 2014 and December 31, 2013, investments in fixed maturities and equity securities classified as available-for-sale had a fair value which equaled carrying value of $1,208,788  and $1,196,828 , respectively. At June 30, 2014 and December 31, 2013, we held no short-term investments. The carrying values of cash and cash equivalents and investment income accrued approximated fair value.

 

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

 

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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)

 

 

 

As of June 30, 2014

 

 

 

Total

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

U.S. Treasury securities

 

$

1,508

 

$

 

$

1,508

 

$

 

Obligations of states and political subdivisions

 

464,420

 

 

464,420

 

 

Residential mortgage-backed securities

 

194,362

 

 

194,362

 

 

Commercial mortgage-backed securities

 

28,058

 

 

28,058

 

 

Other asset-backed securities

 

12,458

 

 

12,458

 

 

Corporate and other securities

 

410,442

 

 

410,442

 

 

Equity securities

 

97,540

 

81,154

 

 

16,386

 

Total investment securities

 

$

1,208,788

 

$

81,154

 

$

1,111,248

 

$

16,386

 

 

 

 

As of December 31, 2013

 

 

 

Total

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

U.S. Treasury securities

 

$

1,503

 

$

 

$

1,503

 

$

 

Obligations of states and political subdivisions

 

467,325

 

 

467,325

 

 

Residential mortgage-backed securities

 

208,702

 

 

208,702

 

 

Commercial mortgage-backed securities

 

32,219

 

 

32,219

 

 

Other asset-backed securities

 

13,445

 

 

13,445

 

 

Corporate and other securities

 

381,763

 

 

381,763

 

 

Equity securities

 

91,871

 

75,951

 

 

15,920

 

Total investment securities

 

$

1,196,828

 

$

75,951

 

$

1,104,957

 

$

15,920

 

 

There were no transfers between Level 1 and Level 2 during the three and six months ended June 30, 2014 and 2013.

 

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

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

Level 3

 

Level 3

 

Level 3

 

Level 3

 

 

 

Fair Value

 

Fair Value

 

Fair Value

 

Fair Value

 

 

 

Securities

 

Securities

 

Securities

 

Securities

 

Balance at beginning of period

 

$

16,194

 

$

5,406

 

$

15,920

 

$

5,346

 

Net gains and losses included in earnings

 

 

 

 

 

Net gains included in other comprehensive income

 

192

 

127

 

466

 

187

 

Purchases and sales

 

 

 

 

 

Transfers into Level 3

 

 

 

 

 

Transfers out of Level 3

 

 

 

 

 

Balance at end of period

 

$

16,386

 

$

5,533

 

$

16,386

 

$

5,533

 

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

 

$

 

$

 

$

 

$

 

 

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 and six months ended June 30, 2014 and 2013.  The Company held one Level 3 security at June 30, 2014.

 

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Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

6.   Loss and Loss Adjustment Expense Reserves

 

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

 

 

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

Reserves for losses and LAE at beginning of year

 

$

455,014

 

$

423,842

 

Less receivable from reinsurers related to unpaid losses and LAE

 

(60,346

)

(52,185

)

Net reserves for losses and LAE at beginning of year

 

394,668

 

371,657

 

Incurred losses and LAE, related to:

 

 

 

 

 

Current year

 

249,332

 

233,530

 

Prior years

 

(19,894

)

(14,409

)

Total incurred losses and LAE

 

229,438

 

219,121

 

Paid losses and LAE related to:

 

 

 

 

 

Current year

 

137,294

 

129,903

 

Prior years

 

87,846

 

85,738

 

Total paid losses and LAE

 

225,140

 

215,641

 

Net reserves for losses and LAE at end of period

 

398,966

 

375,137

 

Plus receivable from reinsurers related to unpaid losses and LAE

 

58,823

 

57,459

 

Reserves for losses and LAE at end of period

 

$

457,789

 

$

432,596

 

 

At the end of each period, the reserves were re-estimated for all prior accident years.  The Company’s prior year reserves decreased by $19,894 and $14,409 for the six months ended June 30, 2014 and 2013, respectively, and resulted from re-estimations of prior years ultimate loss and LAE liabilities.  The decrease in prior years reserves during the 2014 and 2013 periods are primarily composed of reductions in our retained automobile reserves and our retained homeowners reserves.

 

The Company’s private passenger automobile line of business reserves decreased for the six months ended June 30, 2014 and 2013 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.

 

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

 

7.  Commitments and Contingencies

 

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

 

Massachusetts law requires that insurers licensed to do business in Massachusetts participate in the Massachusetts Insurers Insolvency Fund (“Insolvency Fund”).  Members of the Insolvency Fund are assessed a proportionate share of the obligations and 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 are not expected to have a material effect upon the financial position of the Company.

 

8.  Debt

 

The Company has a Revolving Credit Agreement (the “Credit Agreement”) with RBS Citizens, NA (“RBS Citizens”).  The Credit Agreement provides a $30,000 revolving credit facility with an accordion feature allowing for future expansion of the

 

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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)

 

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 Credit Agreement has a maturity date of August 14, 2018.

 

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. As of June 30, 2014, the Company was in compliance with all covenants.  In addition, the credit facility includes customary events of default, including a cross-default provision permitting the lenders to accelerate the facility if the Company (i) defaults in any payment obligation under debt having a principal amount in excess of $10,000 or (ii) fails to perform any other covenant permitting acceleration of all such debt.

 

The Company had no amounts outstanding on its credit facility at June 30, 2014 and December 31, 2013.  The credit facility commitment fee included in interest expense was computed at a rate of 0.25% per annum on the $30,000 commitment at June 30, 2014 and 2013.

 

9.   Income Taxes

 

Federal income tax expense for the six months ended June 30, 2014 and 2013 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 any liability for uncertain tax positions under ASC 740, Income Taxes.

 

During the six months ended June 30, 2014, 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.

 

The Company’s U.S. federal tax return for the year ended December 31, 2011 was examined by the IRS.  The examination was completed during the quarter ending June 30, 2014 with no findings.  In the Company’s opinion, adequate tax liabilities have been established for all open years. However, the amount of these tax liabilities could be revised in the near term if estimates of the Company’s ultimate liability are revised. Tax years prior to 2010 are closed.

 

10.  Share Repurchase Program

 

On August 3, 2007, the Board of Directors approved a share repurchase program of up to $30,000 of the Company’s outstanding common shares.  As of June 30, 2014, the Board of Directors had authorized increases to the existing share repurchase program of up to $150,000 of its outstanding common shares.  Under the program, the Company may repurchase shares of its common stock for cash in public or private transactions, in the open market or otherwise.  The timing of such repurchases and actual number of shares repurchased will depend on a variety of factors including price, market conditions and applicable regulatory and corporate requirements.  The program does not require the Company to repurchase any specific number of shares and it may be modified, suspended or terminated at any time without prior notice.

 

During the six months ending June 30, 2014, the Company purchased 460,023 shares under the program at a cost of $23,467.  During the six months ending June 30, 2013, the Company purchased 90,902 shares on the open market under the program at a cost of $4,799.  As of June 30, 2014, the Company had purchased 2,279,570 shares at a cost of $83,835.  As of December 31, 2013, the Company had purchased 1,819,547 shares on the open market at a cost of $60,368.

 

11.  Related Party Transactions

 

Mr. A. Richard Caputo, Jr., a member of the Company’s Board of Directors and the Chairman of its Investment Committee, is a principal of The Jordan Company, LP (“Jordan”).  In 2012, the Company participated as a lender in two loans made by syndicates of lenders to a portfolio company in which funds managed by Jordan are controlling or a significant investor.  The first loan, made to Vantage Specialties, Inc., currently bears interest at a rate of 5.00% per annum and matures on February 10, 2018.  The Company’s original participation in the loan was $2,500.  The second loan, made to ARCAS Automotive (formerly known as Sequa Auto),

 

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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)

 

currently bears interest at the rate of 6.25% per annum and has a maturity date of November 15, 2018. The Company’s original participation in the loan was $1,200. Both loans amortized in equal quarterly installments of 0.25% of the principal amount per quarter. The Company made the loans on the same terms as the other lenders participating in the syndicate.  The loans were subject to the approval of the Company’s full Investment Committee.

 

12.  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 property and casualty insurance focused primarily on the Massachusetts market.  Our principal product line is automobile insurance.  In addition to private passenger automobile insurance (which represented 63.9% of our direct written premiums in 2013) and commercial automobile insurance (11.8% of 2013 direct written premiums), we offer a portfolio of other insurance products, including homeowners (19.8% of 2013 direct written premiums) and dwelling fire, umbrella and business owner policies (totaling 4.5% of 2013 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 893 in 1,047 locations throughout Massachusetts and New Hampshire during 2013.  We have used these relationships and our extensive knowledge of the Massachusetts market to become the third largest private passenger automobile and the third largest commercial automobile insurance carrier in Massachusetts, capturing an approximate 10.8% and 13.1% share, respectively, of the Massachusetts private passenger and commercial automobile markets in 2013 according to statistic compiled by the Commonwealth Automobile Reinsurers (“CAR”).

 

The Insurance Subsidiaries began writing private passenger automobile and homeowners insurance in New Hampshire during 2008, personal umbrella insurance in New Hampshire during 2009, and commercial automobile insurance in New Hampshire during 2011.  During the six months ended June 30, 2014 and 2013, we wrote $8,712 and $6,272, 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 63.9% of our direct written premiums in 2013.  Private passenger automobile insurance has been heavily regulated in Massachusetts.  In many respects, the private passenger automobile insurance market in Massachusetts prior to 2008 was unique, in comparison to other states.  This was due to a number of factors, including unusual regulatory conditions, the market dominance of domestic companies, the relative absence of large national companies, and the heavy reliance on independent insurance agents as the market’s principal distribution channel.  Perhaps most significantly, prior to 2008, the Massachusetts Commissioner of Insurance (the “Commissioner”) fixed and established the premium rates and the rating plan to be used by all insurance companies doing business in the private passenger automobile insurance market and the Massachusetts private passenger automobile insurance residual market mechanism featured a reinsurance program run by CAR in which companies were assigned producers.

 

In 2008, the Commissioner issued a series of decisions to introduce what she termed “managed competition” to Massachusetts automobile insurance premium rates and in doing so replaced the fixed and established regime with a prior approval

 

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Table of Contents

 

rate review process, governed by regulations that set certain terms and conditions that insurers must comply with in establishing their rates.  The Commissioner also replaced the former reinsurance program with an assigned risk plan.

 

These decisions removed many of the factors that had historically distinguished the Massachusetts private passenger automobile insurance market from the market in other states.  However, certain of the historically unique factors have not been eliminated, including compulsory insurance, affinity group marketing, and the prominence of independent agents.

 

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 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”).  CAR approved Safety Insurance as one of the two servicing carriers for this program beginning January 1, 2011 until December 31, 2016.

 

We have filed and been approved for a private passenger rate change effective June 1, 2014  that increases the variation of rates within our tiering system and has resulted in no change to the overall rate level. Our rates include a 13.0% commission rate for agents.

 

Insurance Ratios

 

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

 

Our GAAP insurance ratios are outlined in the following table.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

GAAP ratios:

 

 

 

 

 

 

 

 

 

Loss ratio

 

60.9

%

63.1

%

64.8

%

65.2

%

Expense ratio

 

30.5

 

30.4

 

30.4

 

30.2

 

Combined ratio

 

91.4

%

93.5

%

95.2

%

95.4

%

 

Share-Based Compensation

 

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

 

The maximum number of shares of common stock with respect to which awards may be granted is 2,500,000.  The Incentive Plan was amended in March of 2013 to remove “share recycling” plan provisions.  Hence, shares of stock covered by an award under the Incentive Plan that are forfeited are no longer available for issuance in connection with 2013 and future grants of awards.  At June 30, 2014, there were 455,072 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 share based awards granted under the Incentive Plan during the six months ended June 30, 2014 is as follows:

 

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Table of Contents

 

Type of

 

 

 

Number of

 

Fair

 

 

 

Equity

 

 

 

Awards

 

Value per

 

 

 

Awarded

 

Effective Date

 

Granted

 

Share

 

Vesting Terms

 

RS

 

March 11, 2014

 

24,426

 

$

54.35

(1)

3 years, 30%-30%-40%

 

RS

 

March 11, 2014

 

4,000

 

$

54.35

(1)

No vesting period (3)

 

RS

 

March 11, 2014

 

27,928

 

$

58.09

(2)

3 years, cliff vesting (4)