XNAS:SAFT Safety Insurance Group Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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, 2012

 

OR

 

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

 

For the transition period from                  to                 

 

Commission File Number: 000-50070

 

SAFETY INSURANCE GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

13-4181699

(State or other jurisdiction of incorporation or organization)

 

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

 

20 Custom House Street, Boston, Massachusetts 02110

(Address of principal executive offices including zip code)

 

(617) 951-0600

(Registrant’s telephone number, including area code)

 

Not Applicable

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

 

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

 

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

 

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

 

Large accelerated filer  o

 

Accelerated filer  x

 

 

 

Non-accelerated filer  o

 

Smaller reporting company  o

 

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

 

As of August 3, 2012, there were 15,306,948 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, 2012 (Unaudited) and December 31, 2011

3

 

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2012 and 2011 (Unaudited)

4

 

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2012 and 2011 (Unaudited)

5

 

Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2012 and 2011 (Unaudited)

6

 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011 (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, 2012 and 2011

23

 

Liquidity and Capital Resources

27

 

Critical Accounting Policies and Estimates

29

 

Forward-Looking Statements

37

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

37

 

 

 

Item 4.

Controls and Procedures

38

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

38

 

 

 

Item 1A.

Risk Factors

38

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

38

 

 

 

Item 3.

Defaults upon Senior Securities

39

 

 

 

Item 4.

Mine Safety Disclosures

39

 

 

 

Item 5.

Other Information

39

 

 

 

Item 6.

Exhibits

39

 

 

 

SIGNATURE

40

 

 

EXHIBIT INDEX

41

 



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except share data)

 

 

 

June 30,

 

December 31,

 

 

 

2012 

 

2011

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Securities available for sale:

 

 

 

 

 

Fixed maturities, at fair value (amortized cost: $1,057,108 and $1,032,660)

 

$

 1,115,507

 

$

 1,086,813

 

Equity securities, at fair value (cost: $21,037 and $20,431)

 

22,303

 

21,080

 

Total investments

 

1,137,810

 

1,107,893

 

Cash and cash equivalents

 

87,991

 

37,890

 

Accounts receivable, net of allowance for doubtful accounts

 

175,996

 

154,143

 

Receivable for securities sold

 

41

 

-

 

Accrued investment income

 

10,657

 

10,169

 

Taxes recoverable

 

1,814

 

8,406

 

Receivable from reinsurers related to paid loss and loss adjustment expenses

 

8,606

 

3,526

 

Receivable from reinsurers related to unpaid loss and loss adjustment expenses

 

51,820

 

51,774

 

Ceded unearned premiums

 

15,455

 

14,022

 

Deferred policy acquisition costs

 

62,026

 

56,716

 

Equity and deposits in pools

 

14,511

 

14,507

 

Other assets

 

15,516

 

13,448

 

Total assets

 

$

 1,582,243

 

$

 1,472,494

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Loss and loss adjustment expense reserves

 

$

 403,459

 

$

 403,872

 

Unearned premium reserves

 

362,679

 

329,562

 

Accounts payable and accrued liabilities

 

47,831

 

52,032

 

Payable for securities purchased

 

52,620

 

-

 

Payable to reinsurers

 

10,335

 

5,338

 

Deferred income taxes

 

5,194

 

3,014

 

Other liabilities

 

18,786

 

22,363

 

Total liabilities

 

900,904

 

816,181

 

 

 

 

 

 

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Common stock:  $0.01 par value; 30,000,000 shares authorized; 17,032,693 and 16,915,432 shares issued

 

170

 

169

 

Additional paid-in capital

 

160,116

 

157,167

 

Accumulated other comprehensive income, net of taxes

 

38,782

 

35,621

 

Retained earnings

 

537,840

 

518,925

 

Treasury stock, at cost: 1,728,645 shares

 

(55,569

)

(55,569

)

Total shareholders’ equity

 

681,339

 

656,313

 

Total liabilities and shareholders’ equity

 

$

 1,582,243

 

$

 1,472,494

 

 

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,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Net earned premiums

 

$

159,070

 

$

148,720

 

$

314,606

 

$

293,366

 

Net investment income

 

10,500

 

9,470

 

20,409

 

19,635

 

Net realized gains on investments

 

617

 

1,277

 

1,073

 

858

 

Finance and other service income

 

4,521

 

4,470

 

9,026

 

8,875

 

Total revenue

 

174,708

 

163,937

 

345,114

 

322,734

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

102,695

 

114,184

 

200,739

 

235,814

 

Underwriting, operating and related expenses

 

48,010

 

44,071

 

96,548

 

86,700

 

Interest expense

 

22

 

21

 

44

 

43

 

Total expenses

 

150,727

 

158,276

 

297,331

 

322,557

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

23,981

 

5,661

 

47,783

 

177

 

Income tax expense

 

7,025

 

1,576

 

13,618

 

45

 

Net income

 

$

16,956

 

$

4,085

 

$

34,165

 

$

132

 

 

 

 

 

 

 

 

 

 

 

Earnings per weighted average common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

1.11

 

$

0.27

 

$

2.24

 

$

0.01

 

Diluted

 

$

1.11

 

$

0.27

 

$

2.24

 

$

0.01

 

 

 

 

 

 

 

 

 

 

 

Cash dividends paid per common share

 

$

0.50

 

$

0.50

 

$

1.00

 

$

1.00

 

 

 

 

 

 

 

 

 

 

 

Number of shares used in computing earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

15,302,801

 

15,184,605

 

15,260,080

 

15,142,682

 

Diluted

 

15,309,012

 

15,198,804

 

15,267,434

 

15,159,513

 

 

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,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net income

 

$

16,956

 

$

4,085

 

$

34,165

 

$

132

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Unrealized holding gains during the period, net of tax expense of $1,214, $3,723, $2,077, and $2,601

 

2,255

 

6,914

 

3,858

 

4,832

 

Reclassification adjustment for gains included in net income, net of tax expense of ($216), ($447), ($376), and ($300)

 

(401

)

(830

)

(697

)

(558

)

Unrealized gains on securities available for sale

 

1,854

 

6,084

 

3,161

 

4,274

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

18,810

 

$

10,169

 

$

37,326

 

$

4,406

 

 

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, 2010

 

$

168

 

$

151,317

 

$

21,972

 

$

535,545

 

$

(55,526

)

$

653,476

 

Net income, January 1 to June 30, 2011

 

 

 

 

 

 

 

132

 

 

 

132

 

Other comprehensive income, net of deferred federal income taxes

 

 

 

 

 

4,274

 

 

 

 

 

4,274

 

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

 

1

 

2,714

 

 

 

 

 

 

 

2,715

 

Exercise of options, net of federal income taxes

 

 

 

960

 

 

 

 

 

 

 

960

 

Dividends paid

 

 

 

 

 

 

 

(15,135

)

 

 

(15,135

)

Balance at June 30, 2011

 

$

169

 

$

154,991

 

$

26,246

 

$

520,542

 

$

(55,526

)

$

646,422

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Comprehensive

 

 

 

 

 

Total

 

 

 

Common

 

Paid-in

 

Income,

 

Retained

 

Treasury

 

Shareholders’

 

 

 

Stock

 

Capital

 

Net of Taxes

 

Earnings

 

Stock

 

Equity

 

Balance at December 31, 2011

 

$

169

 

$

157,167

 

$

35,621

 

$

518,925

 

$

(55,569

)

$

656,313

 

Net income, January 1 to June 30, 2012

 

 

 

 

 

 

 

34,165

 

 

 

34,165

 

Other comprehensive income, net of deferred federal income taxes

 

 

 

 

 

3,161

 

 

 

 

 

3,161

 

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

 

1

 

2,507

 

 

 

 

 

 

 

2,508

 

Exercise of options, net of federal income taxes

 

 

 

442

 

 

 

 

 

 

 

442

 

Dividends paid

 

 

 

 

 

 

 

(15,250

)

 

 

(15,250

)

Balance at June 30, 2012

 

$

170

 

$

160,116

 

$

38,782

 

$

537,840

 

$

(55,569

)

$

681,339

 

 

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,

 

 

 

2012

 

2011

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

34,165

 

$

132

 

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

 

 

 

 

 

Depreciation and amortization, net

 

7,283

 

6,252

 

Provision for deferred income taxes

 

478

 

1

 

Net realized gains on investments

 

(1,073

)

(858

)

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(21,853

)

(14,708

)

Accrued investment income

 

(488

)

(87

)

Receivable from reinsurers

 

(5,126

)

(3,168

)

Ceded unearned premiums

 

(1,433

)

909

 

Deferred policy acquisition costs

 

(5,310

)

(5,155

)

Other assets

 

4,459

 

(906

)

Loss and loss adjustment expense reserves

 

(413

)

(641

)

Unearned premium reserves

 

33,117

 

31,069

 

Accounts payable and accrued liabilities

 

(4,201

)

(14,952

)

Payable to reinsurers

 

4,997

 

1,725

 

Other liabilities

 

(3,577

)

6,463

 

Net cash provided by operating activities

 

41,025

 

6,076

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Fixed maturities purchased

 

(94,035

)

(123,820

)

Equity securities purchased

 

(6,403

)

(10,360

)

Proceeds from sales and paydowns of fixed maturities

 

88,107

 

123,453

 

Proceeds from maturities, redemptions, and calls of fixed maturities

 

32,034

 

32,000

 

Proceed from sales of equity securities

 

6,039

 

4,166

 

Fixed assets purchased

 

(1,859

)

(2,051

)

Net cash provided by investing activities

 

23,883

 

23,388

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from stock options exercised

 

441

 

897

 

Excess tax benefit (expense) from stock options exercised

 

2

 

(6

)

Dividends paid to shareholders

 

(15,250

)

(15,135

)

Net cash used for financing activities

 

(14,807

)

(14,244

)

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

50,101

 

15,220

 

Cash and cash equivalents at beginning of year

 

37,890

 

40,291

 

Cash and cash equivalents at end of period

 

$

87,991

 

$

55,511

 

 

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

 

7



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

1.  Basis of Presentation

 

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

 

The consolidated financial statements include Safety Insurance Group, Inc. and its subsidiaries (the “Company”).  The subsidiaries consist of Safety Insurance Company, Safety Indemnity Insurance Company, Safety Property and Casualty Insurance Company, Whiteshirts Asset Management Corporation (“WAMC”), and Whiteshirts Management Corporation, which is WAMC’s holding company.  All intercompany transactions have been eliminated.  Prior period amounts have been reclassified to conform to the current period presentation.

 

The financial information as of June 30, 2012 and for the three and six months ended June 30, 2012 and 2011 is unaudited; however, in the opinion of the Company, the information includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial condition and results of operations for the periods.  These unaudited consolidated financial statements may not be indicative of financial results for the full year and should be read in conjunction with the audited financial statements included in the Company’s annual report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on March 13, 2012.

 

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 in New Hampshire insurance during 2011.

 

2.  Recent Accounting Pronouncements

 

In October 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-26 (Topic 944), Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, which updated guidance to address diversity in practice for the accounting of costs associated with acquiring or renewing insurance contracts.  This guidance modifies the definition of acquisition costs to specify that a cost be directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred.  The guidance also specifies that advertising costs only should be included as deferred acquisition costs if the direct-response advertising accounting criteria are met.  The new guidance was effective for reporting periods beginning after December 15, 2011 and was to be applied prospectively, with retrospective application permitted.  The adoption of the guidance had no impact on the Company’s consolidated financial condition and results of operations.

 

In May 2011, the FASB issued ASU No. 2011-04  (Topic 820), Fair Value Measurements, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (IFRS), which clarifies the application of existing fair value measurement and disclosure requirements and amends certain fair value measurement principles, requirements and disclosures.  To improve consistency in global application across jurisdictions, changes in wording were made to ensure that U.S. GAAP and IFRS fair value measurement and disclosure requirements are described in the same way.  The guidance was to be applied prospectively for reporting periods beginning after December 15, 2011.  The adoption of the guidance had no impact on the Company’s consolidated financial condition and results of operations.

 

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

 

8



Table of Contents

 

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

 

In December 2011, the FASB issued ASU 2011-12 (Topic 220), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU No. 2011-05, which indefinitely defers certain provisions of ASU 2011-05 (Topic 220), Presentation of Comprehensive Income, that revised the manner in which entities present comprehensive income in financial statements.  One of ASU 2011-05 provisions would require entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented.  Accordingly, this requirement is indefinitely deferred and will be further deliberated by the FASB at a future date.  The amendment was effective for fiscal years and interim periods within those years that begin after December 15, 2011.  The adoption of the guidance had no impact on 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 unvested restricted shares and the net effect of potentially dilutive common shares outstanding.

 

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

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

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

 

$

16,956

 

$

4,085

 

$

34,165

 

$

132

 

 

 

 

 

 

 

 

 

 

 

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

 

15,302,801

 

15,184,605

 

15,260,080

 

15,142,682

 

Common equivalent shares- stock options

 

6,211

 

14,199

 

7,354

 

16,831

 

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

 

15,309,012

 

15,198,804

 

15,267,434

 

15,159,513

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

1.11

 

$

0.27

 

$

2.24

 

$

0.01

 

Diluted earnings per share

 

$

1.11

 

$

0.27

 

$

2.24

 

$

0.01

 

 

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 82,100 anti-dilutive stock options for both the three and six months ended June 30, 2012.  There were no anti-dilutive stock options for both the three and six months ended June 30, 2011.

 

4.  Stock-Based Compensation

 

Management Omnibus Incentive Plan

 

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

 

The maximum number of shares of common stock with respect to which awards may be granted is 2,500,000.  Shares of stock covered by an award under the Incentive Plan that are forfeited will again be available for issuance in connection with future grants of awards under the plan.  At June 30, 2012, there were 617,698 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.

 

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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)

 

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 six months ended June 30, 2011 is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Expected dividend yield

 

NA

 

NA

 

NA

 

1.68

%

Expected volatility

 

NA

 

NA

 

NA

 

0.36

 

Risk-free interest rate

 

NA

 

NA

 

NA

 

4.76

%

Expected holding period (in years)

 

NA

 

NA

 

NA

 

6.5

 

 

Expected dividend yield is the Company’s dividend yield on the measurement date and is based on the assumption that the current yield will continue in the future.  Expected volatility is based on historical volatility of the Company’s common stock as well as the volatility of a peer group of property and casualty insurers measured for a period equal to the expected holding period of the option.  The risk-free interest rate is based upon the yield on the measurement date of a zero-coupon U.S. Treasury bond with a maturity period equal to the expected holding period of the option.  The expected holding period is based upon the simplified method provided in SEC Staff Accounting Bulletin No. 107, Share-Based Payment, which utilizes the mid-points between the vesting dates and the expiration date of the option award to calculate the overall expected term.  There were no stock options granted during the three and six months ended June 30, 2012 and 2011.

 

The following table summarizes stock option activity under the Incentive Plan for the six months ended June 30, 2012.

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Shares

 

Weighted

 

Average

 

Aggregate

 

 

 

Under

 

Average

 

Remaining

 

Intrinsic

 

 

 

Option

 

Exercise Price

 

Contractual Term

 

Value

 

Outstanding at beginning of year

 

125,700

 

$

37.63

 

 

 

 

 

Exercised

 

(15,800

)

$

27.89

 

 

 

 

 

Forfeitures

 

(300

)

$

42.85

 

 

 

 

 

Outstanding at end of period

 

109,600

 

$

39.02

 

3.3 years

 

$

359

 

Exercisable at end of period

 

109,600

 

$

39.02

 

3.3 years

 

$

359

 

 

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, 2012 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 range of exercise prices on stock options outstanding under the Incentive Plan was $13.30 to $42.85 at June 30, 2012 and 2011.  The total intrinsic value of options exercised during the six months ended June 30, 2012 and 2011 was $202 and $162, respectively.

 

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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)

 

As of March 31, 2011, all compensation expense related to non-vested option awards had been recognized.  Cash received from options exercised was $441 and $897 for the six months ended June 30, 2012 and 2011, respectively.

 

Restricted Stock

 

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 as expense over the vesting period of each grant.  Restricted stock awards generally vest over a three-year period and unrestrict 30% on the second and third anniversaries of the grant date and 40% on the fourth anniversary of the grant date, except for non-executive employees’ restricted stock awards which vest ratable 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.

 

The following table summarizes restricted stock activity under the Incentive Plan during the six months ended June 30, 2012.

 

 

 

Shares

 

Weighted

 

 

 

Under

 

Average

 

 

 

Restriction

 

Fair Value

 

Outstanding at beginning of year

 

282,117

 

$

39.24

 

Granted

 

102,756

 

$

41.79

 

Vested and unrestricted

 

(117,245

)

$

36.49

 

Forfeited

 

(1,295

)

$

36.68

 

Outstanding at end of period

 

266,333

 

$

41.45

 

 

As of June 30, 2012, there was $8,490 of unrecognized compensation expense related to non-vested restricted stock awards that is expected to be recognized over a weighted average period of 1.8 years.  The total fair value of the shares that were vested and unrestricted during the six months ended June 30, 2012 and 2011 was $4,278 and $3,953, respectively.  For the six months ended June 30, 2012 and 2011, the Company recorded compensation expense related to restricted stock of $1,485 and $1,461, net of income tax benefits of $799 and $787, 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 June 30, 2012

 

 

 

 

 

 

 

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

 

$

7,521

 

$

284

 

$

 

$

 

$

7,805

 

Obligations of states and political subdivisions

 

450,661

 

29,597

 

(183

)

 

480,075

 

Residential mortgage-backed securities (1)

 

205,604

 

14,483

 

(197

)

 

219,890

 

Commercial mortgage-backed securities

 

45,896

 

1,256

 

(4

)

 

47,148

 

Other asset-backed securities

 

14,373

 

899

 

 

 

15,272

 

Corporate and other securities

 

333,053

 

12,961

 

(697

)

 

345,317

 

Subtotal, fixed maturity securities

 

1,057,108

 

59,480

 

(1,081

)

 

1,115,507

 

Equity securities (2)

 

21,037

 

1,346

 

(80

)

 

22,303

 

Totals

 

$

1,078,145

 

$

60,826

 

$

(1,161

)

$

 

$

1,137,810

 

 

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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)

 

 

 

As of December 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

 

$

7,525

 

$

366

 

$

 

$

 

$

7,891

 

Obligations of states and political subdivisions

 

443,338

 

25,630

 

(150

)

 

468,818

 

Residential mortgage-backed securities (1)

 

277,885

 

17,147

 

(106

)

 

294,926

 

Commercial mortgage-backed securities

 

51,986

 

1,439

 

(278

)

 

53,147

 

Other asset-backed securities

 

12,848

 

932

 

 

 

13,780

 

Corporate and other securities

 

239,078

 

10,128

 

(955

)

 

248,251

 

Subtotal, fixed maturity securities

 

1,032,660

 

55,642

 

(1,489

)

 

1,086,813

 

Equity securities (2)

 

20,431

 

1,111

 

(462

)

 

21,080

 

Totals

 

$

1,053,091

 

$

56,753

 

$

(1,951

)

$

 

$

1,107,893

 

 


(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 include interests in mutual funds held to fund the Company’s executive deferred compensation plan.

(3)  Our investment portfolio included 172 and 55 securities in an unrealized loss position at June 30, 2012 and December 31, 2011, respectively.

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

 

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

 

 

 

As of June 30, 2012

 

 

 

Amortized

 

Estimated

 

 

 

Cost

 

Fair Value

 

Due in one year or less

 

$

28,480

 

$

28,827

 

Due after one year through five years

 

247,945

 

259,031

 

Due after five years through ten years

 

247,155

 

260,525

 

Due after ten years

 

267,655

 

284,814

 

Asset-backed securities

 

265,873

 

282,310

 

Totals

 

$

1,057,108

 

$

1,115,507

 

 

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,

 

 

 

2012

 

2011

 

2012

 

2011

 

Gross realized gains

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

$

669

 

$

1,254

 

$

1,058

 

$

1,577

 

Equity securities

 

196

 

31

 

266

 

102

 

Gross realized losses

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

(226

)

(8

)

(226

)

(821

)

Equity securities

 

(22

)

 

(25

)

 

Net realized gains on investments

 

$

617

 

$

1,277

 

$

1,073

 

$

858

 

 

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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)

 

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, 2012 and December 31, 2011 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, 2012

 

 

 

Less than 12 Months

 

12 Months or More

 

Total

 

 

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

Estimated

 

Unrealized

 

 

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

Obligations of states and political subdivisions

 

$

7,239

 

$

183

 

$

 

$

 

$

7,239

 

$

183

 

Residential mortgage-backed securities

 

22,426

 

192

 

55

 

5

 

22,481

 

197

 

Commercial mortgage-backed securities

 

1,672

 

4

 

 

 

1,672

 

4

 

Corporate and other securities

 

74,492

 

697

 

 

 

74,492

 

697

 

Subtotal, fixed maturity securities

 

105,829

 

1,076

 

55

 

5

 

105,884

 

1,081

 

Equity securities

 

1,296

 

75

 

238

 

5

 

1,534

 

80

 

Total temporarily impaired securities

 

$

107,125

 

$

1,151

 

$

293

 

$

10

 

$

107,418

 

$

1,161

 

 

 

 

As of December 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

 

Obligations of states and political subdivisions

 

$

8,804

 

$

135

 

$

4,590

 

$

15

 

$

13,394

 

$

150

 

Residential mortgage-backed securities

 

4,333

 

99

 

79

 

7

 

4,412

 

106

 

Commercial mortgage-backed securities

 

4,563

 

278

 

 

 

4,563

 

278

 

Corporate and other securities

 

22,745

 

943

 

1,986

 

12

 

24,731

 

955

 

Subtotal, fixed maturity securities

 

40,445

 

1,455

 

6,655

 

34

 

47,100

 

1,489

 

Equity securities

 

7,185

 

462

 

 

 

7,185

 

462

 

Total temporarily impaired securities

 

$

47,630

 

$

1,917

 

$

6,655

 

$

34

 

$

54,285

 

$

1,951

 

 

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.

 

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 unrealized losses in the Company’s fixed income and equity portfolio as of June 30, 2012 were reviewed for potential other-than-temporary asset impairments.  The Company held no securities at June 30, 2012 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, 2012 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, 2012 and 2011, 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, 2012 and December 31, 2011, there were no amounts included in accumulated other comprehensive income related to securities which were considered by the Company to be other-than-temporarily impaired.

 

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

 

Net Investment Income

 

The components of net investment income were as follows:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Interest on fixed maturity securities

 

$

10,598

 

$

9,734

 

$

20,749

 

$

20,174

 

Dividends on equity securities

 

39

 

42

 

140

 

85

 

Interest on other assets

 

274

 

9

 

281

 

12

 

Interest on cash and cash equivalents

 

12

 

12

 

14

 

23

 

Total investment income

 

10,923

 

9,797

 

21,184

 

20,294

 

Investment expenses

 

423

 

327

 

775

 

659

 

Net investment income

 

$

10,500

 

$

9,470

 

$

20,409

 

$

19,635

 

 

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.

 

The Company is responsible for the determination of the value of the investments carried at fair value and the supporting methodologies and assumptions.  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,

 

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)

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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)

 

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).

 

The Company’s entire available-for-sale portfolio was priced based upon quoted market prices or other observable inputs as of June 30, 2012.  There were no significant changes to the valuation process during the six months ending June 30, 2012.  As of June 30, 2012 and December 31, 2011, no quotes or prices obtained were adjusted by management.  All broker quotes obtained were non-binding.

 

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

 

 

 

As of June 30, 2012

 

 

 

Total

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

U.S. Treasury securities

 

$

7,805

 

$

 

$

7,805

 

$

 

Obligations of states and political subdivisions

 

480,075

 

 

480,075

 

 

Residential mortgage-backed securities

 

219,890

 

 

219,890

 

 

Commercial mortgage-backed securities

 

47,148

 

 

47,148

 

 

Other asset-backed securities

 

15,272

 

 

15,272

 

 

Corporate and other securities

 

345,317

 

 

345,317

 

 

Equity securities

 

22,303

 

17,093

 

5,210

 

 

Total investment securities

 

$

1,137,810

 

$

17,093

 

$

1,120,717

 

$

 

 

 

 

As of December 31, 2011

 

 

 

Total

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

U.S. Treasury securities

 

$

7,891

 

$

 

$

7,891

 

$

 

Obligations of states and political subdivisions

 

468,818

 

 

468,818

 

 

Residential mortgage-backed securities

 

294,926

 

 

294,926

 

 

Commercial mortgage-backed securities

 

53,147

 

 

53,147

 

 

Other asset-backed securities

 

13,780

 

 

13,780

 

 

Corporate and other securities

 

248,251

 

 

248,251

 

 

Equity securities

 

21,080

 

15,954

 

5,126

 

 

Total investment securities

 

$

1,107,893

 

$

15,954

 

$

1,091,939

 

$

 

 

There were no transfers between Level 1 and Level 2 during the three and six months ended June 30, 2012 and 2011.

 

Transfers in and out of Level 3 are attributable to changes in the ability to observe significant inputs in determining fair value exit pricing.  The Company held no Level 3 securities at June 30, 2012 and 2011 and no transfers were made in or out of Level 3 during the three and six months ended June 30, 2012 and 2011.

 

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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,

 

 

 

2012

 

2011

 

Reserves for losses and LAE at beginning of year

 

$

403,872

 

$

404,391

 

Less receivable from reinsurers related to unpaid losses and LAE

 

(51,774

)

(53,147

)

Net reserves for losses and LAE at beginning of year

 

352,098

 

351,244

 

Incurred losses and LAE, related to:

 

 

 

 

 

Current year

 

208,348

 

254,661

 

Prior years

 

(7,609

)

(18,847

)

Total incurred losses and LAE

 

200,739

 

235,814

 

Paid losses and LAE related to:

 

 

 

 

 

Current year

 

110,571

 

143,512

 

Prior years

 

90,627

 

92,271

 

Total paid losses and LAE

 

201,198

 

235,783

 

Net reserves for losses and LAE at end of period

 

351,639

 

351,275

 

Plus receivable from reinsurers related to unpaid losses and LAE

 

51,820

 

52,475

 

Reserves for losses and LAE at end of period

 

$

403,459

 

$

403,750

 

 

At the end of each period, the reserves were re-estimated for all prior accident years.  The Company’s prior year reserves decreased by $7,609 and $18,847 for the six months ended June 30, 2012 and 2011, respectively, and resulted from re-estimations of prior years ultimate loss and LAE liabilities.  The decrease in prior years reserves during the 2012 period is primarily composed of a reduction in the Company’s retained automobile reserves, partially offset by an increase in the accident year 2011 reserves of homeowners and all other business lines.  The decrease in prior year reserves during the 2011 period is primarily composed of reductions in the Company’s retained automobile and homeowners reserves.

 

The Company’s private passenger automobile line of business prior year reserves decreased for the six months ended June 30, 2012 and 2011 primarily due to improved retained private passenger results.  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.

 

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.

 

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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)

 

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 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, 2013.

 

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.  Although the Company paid dividends to shareholders during the six months ended June 30, 2012 in excess of 50% of its prior year net income, prior consent to pay the excess amount was obtained from RBS Citizens.  As of June 30, 2012, the Company was in compliance with all other 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, 2012 and December 31, 2011.  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, 2012 and 2011.

 

9. Income Taxes

 

Federal income tax expense for the six months ended June 30, 2012 and 2011 has been computed using estimated effective tax rates.  These rates are revised, if necessary, at the end of each successive interim period to reflect the current estimates of the annual effective tax rates.

 

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

 

During the six months ended June 30, 2012, there were no material changes to the amount of the Company’s unrecognized tax benefits or to any assumptions regarding the amount of its ASC 740 liability.

 

As of June 30, 2012 and December 31, 2011, the Company was no longer subject to examination of its U.S. federal tax returns for years prior to 2008.  The Company is not currently under examination by the IRS.

 

10.  Share Repurchase Program

 

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

 

No share purchases were made by the Company under the program during the six months ending June 30, 2012 and 2011.  As of June 30, 2012 and December 31, 2011, the Company had purchased 1,728,645 shares on the open market at a cost of $55,569.

 

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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)

 

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 February 2012, the Company participated as a lender in a loan made by syndicates of lenders to a portfolio company in which funds managed by Jordan are controlling or a significant investor.  The loan, made to Vantage Specialties, Inc., currently bears interest at a rate of 7.0% per annum and matures on February 10, 2018.  The loan amortizes in equal quarterly installments of 0.25% of the principal amount per quarter.  The Company’s participation in the loan was $2,500.  The Company made the loan on the same terms as the other lenders participating in the syndicate.  The loan was 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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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 67.2% of our direct written premiums in 2011) and commercial automobile insurance (10.5% of 2011 direct written premiums), we offer a portfolio of other insurance products, including homeowners (18.1% of 2011 direct written premiums) and dwelling fire, umbrella and business owner policies (totaling 4.2% of 2011 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 852 in 987 locations throughout Massachusetts and New Hampshire during 2011.  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 11.5% and 13.2% share, respectively, of the Massachusetts private passenger and commercial automobile markets in 2012 according to the Commonwealth Automobile Reinsurers (“CAR”) Cession Volume Analysis Report of August 1, 2012, based on automobile exposures.    These statistics total, for each vehicle insured, the number of months during the year insurance for that vehicle is in effect, to arrive at an aggregate number of car-months for each insurer; this aggregate number divided by 12 equals the insurer’s number of car-years, a measure we refer to in this report as automobile exposures.

 

The Insurance Subsidiaries began writing private passenger automobile and homeowners insurance in New Hampshire during 2008, personal umbrella insurance in New Hampshire during 2009, and commercial automobile insurance in New Hampshire during 2011.  During the six months ended June 30, 2012 and 2011, we wrote $3,963 and $2,462 respectively, in direct written premiums in New Hampshire.

 

Recent Trends and Events

 

·                  For the quarter ended June 30, 2012, loss and loss adjustment expenses incurred decreased by $11,489, or 10.1%, to $102,695 from $114,184 for the comparable 2011 period.  The decrease was primarily due to the absence of catastrophe losses during the quarter ended June 30, 2012, compared to $22,050 in pre-tax catastrophic weather event losses recorded during the comparable 2011 quarter.

 

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·                  We filed and were approved for a Massachusetts private passenger automobile rate increase of 3.6% which was effective May 15, 2012.

 

·                  We filed and were approved for a Massachusetts homeowners rate increase of 6.9% and a Massachusetts personal umbrella rate increase of 2.1%, both of which will be effective September 15, 2012.

 

·                  We filed and were approved for a New Hampshire automobile rate increase of 6.1%, which was effective July 15, 2012 and a New Hampshire homeowners rate increase of 5.1% which will be effective September 15, 2012.

 

Massachusetts Automobile Insurance Market

 

We have been subject to extensive regulation in the private passenger automobile insurance industry in Massachusetts, which represented 67.2% of our direct written premiums in 2011.  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 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”).  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 again approved Safety Insurance beginning January 1, 2011 as one of the two servicing carriers.

 

During 2011, we increased our rates approximately 3.7%, and on March 1, 2012, we began using 17 rating tiers which resulted in a rate increase of 0.7%.  Our rates include a 13.0% commission rate for agents.  Our direct automobile written premiums increased by 5.5% in 2011 with increased exposures and average written premium per exposure in our private passenger and commercial automobile lines of business.

 

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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,

 

 

 

2012

 

2011

 

2012

 

2011

 

GAAP ratios:

 

 

 

 

 

 

 

 

 

Loss ratio

 

64.6

%

76.8

%

63.8

%

80.4

%

Expense ratio

 

30.2

 

29.6

 

30.7

 

29.6

 

Combined ratio

 

94.8

%

106.4

%

94.5

%

110.0

%

 

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 June 30, 2012, there were 617,698 shares available for future grant. The Board of Directors and the Compensation Committee intend to issue more awards under the Incentive Plan in the future.

 

A summary of stock based awards granted under the Incentive Plan during the six months ended June 30, 2012 is as follows:

 

Type of

 

 

 

Number of

 

Fair

 

 

 

Equity

 

 

 

Awards

 

Value per

 

 

 

Awarded

 

Effective Date

 

Granted

 

Share (1)

 

Vesting Terms

 

RS

 

March 8, 2012

 

77,844

 

$

41.75

 

3 years, 30%-30%-40%

 

RS

 

March 8, 2012

 

4,000

 

$

41.75

 

No vesting period (2)

 

RS

 

March 21, 2012

 

20,912

 

$

41.96

 

5 years, 20% annually

 

 


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

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

 

Reinsurance

 

We reinsure with other insurance companies a portion of our potential liability under the policies we have underwritten, thereby protecting us against an unexpectedly large loss or a catastrophic occurrence that could produce large losses, primarily in our homeowners line of business.  We use various software products to measure our exposure to catastrophe losses and the probable maximum loss to us for catastrophe losses such as hurricanes.  The models include estimates for our share of the catastrophe losses generated in the residual market for property insurance by the Massachusetts Property Insurance Underwriting Association (“FAIR Plan”).  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 manage and model our exposure and adjust our reinsurance programs as a result of the changes to the models.  As of January 1, 2012, we have purchased four layers of excess catastrophe reinsurance providing $485,000 of coverage for property losses in excess of $50,000 up to a maximum of $535,000.  Our reinsurers’ co-participation is 50.0% of $30,000 for the 1st layer, 80.0% of $90,000 for the 2nd layer, 80.0% of $200,000 for the 3rd

 

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layer, and 80.0% of $165,000 for the 4th layer.  As a result of the changes to the models and our revised reinsurance program, our catastrophe reinsurance in 2012 protects us in the event of a “140-year storm” (that is, a storm of a severity expected to occur once in a 140-year period).  Swiss Re, our primary reinsurer, maintains an A.M. Best rating of “A” (Excellent).  Most of our other reinsurers have an A.M. Best rating of “A” (Excellent) however in no case is a reinsurer rated below “A-” (Excellent).  Our losses from the individual catastrophe events of 2011 were less than our reinsurance retention.

 

We are a participant in CAR, a state-established body that runs the residual market reinsurance programs for commercial automobile insurance in Massachusetts under which premiums, expenses, losses and loss adjustment expenses on ceded business are shared by all insurers writing automobile insurance in Massachusetts.  We also participate in the FAIR Plan in which premiums, expenses, losses and loss adjustment expenses on homeowners business that cannot be placed in the voluntary market are shared by all insurers writing homeowners insurance in Massachusetts. The FAIR Plan has grown dramatically over the past few years as insurance carriers have reduced their exposure to coastal property.  The FAIR Plan’s exposure to catastrophe losses increased and as a result, the FAIR Plan decided to buy reinsurance to reduce their exposure to catastrophe losses.  On July 1, 2011, the FAIR Plan purchased $1,000,000 of catastrophe reinsurance for property losses in excess of $200,000.  At June 30, 2012, we had no material amounts recoverable from any reinsurer, excluding $42,768 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.

 

Results of Operations

 

Three and Six Months Ended June 30, 2012 Months Compared to Three and Six Months Ended June 30, 2011

 

The following table shows certain of our selected financial results.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Direct written premiums

 

$

185,830

 

$

173,130

 

$

362,083

 

$

337,214

 

Net written premiums

 

$

176,993

 

$

167,825

 

$

346,291

 

$

325,344

 

Net earned premiums

 

$

159,070

 

$

148,720

 

$

314,606

 

$

293,366

 

Net investment income

 

10,500

 

9,470

 

20,409

 

19,635

 

Net realized gains on investments

 

617

 

1,277

 

1,073

 

858

 

Finance and other service income

 

4,521

 

4,470

 

9,026

 

8,875

 

Total revenue

 

174,708

 

163,937

 

345,114

 

322,734

 

Loss and loss adjustment expenses

 

102,695

 

114,184

 

200,739

 

235,814

 

Underwriting, operating and related expenses

 

48,010

 

44,071

 

96,548

 

86,700

 

Interest expenses

 

22

 

21

 

44

 

43

 

Total expenses

 

150,727

 

158,276

 

297,331