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SAFT > SEC Filings for SAFT > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Annual Report


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

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

Executive Summary and Overview

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

We are a leading provider of private passenger automobile insurance in Massachusetts. In addition to private passenger automobile insurance (which represented 65.9% of our direct written premiums in 2012), we offer a portfolio of other insurance products, including commercial automobile (11.0% of 2012 direct written premiums), homeowners (18.9% of 2012 direct written premiums), dwelling fire, umbrella and business owner policies (totaling 4.2% of 2012 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 879 in 1,023 locations throughout Massachusetts and New Hampshire during 2012. 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 11.0% and 12.4% 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 February 26, 2013, 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 business during 2009, and commercial automobile business during 2011. During the years ended December 31, 2012, 2011, and 2010, we wrote $9,057, $5,750, and $2,774 in direct written premiums, respectively, and approximately 11,000, 4,500, and 3,300 policies, respectively, in New Hampshire.

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Recent Trends and Events

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 were 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 was effective September 15, 2012.

The quarter ended December 31, 2012 was impacted by Superstorm Sandy which caused widespread damage in the Northeastern United States on October 29 and 30, 2012. As a result, we incurred $7,977 of catastrophe losses for the quarter ended December 31, 2012.

For the year ended December 31, 2012, we incurred $10,332 of catastrophe losses compared to $63,394 and $9,429 for the comparable 2011 and 2010 periods, respectively.

We define a "catastrophe" as an event that produces pre-tax losses before reinsurance in excess of $1,000 and involves multiple first-party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time following the event. Catastrophes are caused by various natural events including high winds, winter storms, tornadoes, hailstorms, and hurricanes. The nature and level of catastrophes in any period cannot be reliably predicted.

Catastrophe losses incurred by the type of event are shown in the following table.

                                               Years Ended December 31,
            Event                              2012        2011      2010
            Windstorms and hailstorms       $    2,355   $ 12,311   $     -
            Tornado and windstorms                   -     16,697     3,300
            Rainstorms                               -          -     6,129
            Floods                                   -      1,380         -
            Icestorms and snowstorms                 -     23,971         -
            Hurricane and tropical storms        7,977      7,025         -

            Total losses incurred(1)        $   10,332   $ 61,384   $ 9,429

Total losses incurred includes losses plus defense and cost containment expenses and excludes adjusting and other claims settlement expenses.

We did not have any recoveries from our primary catastrophe reinsurance treaties during the three-year period ended December 31, 2012 because there was no individual catastrophe for which our losses exceeded our retention under the treaties.

Massachusetts Automobile Insurance Market

We have been subject to extensive regulation in the private passenger automobile insurance industry in Massachusetts, which represented 65.9% of our direct written premiums in 2012. 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 fixed and established the premium rates and the rating plan to be used by all insurance

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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 has approved Safety Insurance and three other servicing carriers effective July 1, 2011 to continue the program. Subject to the Commissioner's review, CAR sets the premium rates for commercial automobile policies reinsured through CAR and this reinsurance pool can generate an underwriting result that is a profit or deficit based upon CAR's rate level. This underwriting result is allocated among every Massachusetts commercial automobile insurance company, including us, based on a company's commercial automobile voluntary market share.

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

During 2012, we increased our rates approximately 4.7%. 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.

Statutory Accounting Principles

Our results are reported in accordance with GAAP, which differ from amounts reported in accordance with statutory accounting principles ("SAP") as prescribed by insurance regulatory authorities, which in general reflect a liquidating, rather than going concern concept of accounting. Specifically, under GAAP:

Policy acquisition costs such as commissions, premium taxes and other variable costs incurred which are directly related to the successful acquisition of a new or renewal insurance contract are capitalized and amortized on a pro rata basis over the period in which the related premiums are earned, rather than expensed as incurred, as required by SAP.

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

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

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

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

Insurance Ratios

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

Our GAAP insurance ratios are presented in the following table for the periods indicated.

                                               Years Ended
                                              December 31,
                                         2012     2011      2010
                       GAAP ratios:
                       Loss ratio         65.7 %    78.0 %   65.4 %
                       Expense ratio      31.2      29.9     31.3

                       Combined ratio     96.9 %   107.9 %   96.7 %

Share-Based Compensation

On June 25, 2002, the Board of Directors of the Company (the "Board") adopted the 2002 Management Omnibus Incentive Plan (the "Incentive Plan"). The Incentive Plan provides for a variety of awards, including nonqualified stock options ("NQSOs"), stock appreciation rights and restricted stock ("RS") awards.

On March 10, 2006, the Board approved amendments to the Incentive Plan, subject to shareholder approval, to (i) increase the number of shares of common stock available for issuance by 1,250,000 shares, (ii) remove obsolete provisions, and (iii) make other non-material changes. A total of 1,250,000 shares of common stock had previously been authorized for issuance under the Incentive Plan. The Incentive Plan, as amended, was approved by the shareholders at the 2006 Annual Meeting of Shareholders which was held on May 19, 2006. Under the Incentive Plan, as amended, the maximum number of shares of common stock with respect to which awards may be granted is 2,500,000. As of December 31, 2012, there were 620,457 shares available for future grant. The Board and the Compensation Committee intend to issue more awards under the Incentive Plan in the future. Grants outstanding under the Incentive Plan as of December 31, 2012, were comprised of 231,883 restricted shares and 87,500 nonqualified stock options.

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Grants made under the Incentive Plan during the years 2008 through 2013 were as follows.

     Type of                     Number of
     Equity                       Awards       Fair Value
     Awarded   Effective Date     Granted      per Share           Vesting Terms
       RS      March 10, 2008        76,816    $     35.80 (1) 3 years, 30%-30%-40%
       RS      March 10, 2008         4,000    $     35.80 (1) No vesting period(2)
       RS      March 20, 2008        45,779    $     34.37 (1) 5 years, 20% annually
       RS      March 9, 2009         95,953    $     28.66 (1) 3 years, 30%-30%-40%
       RS      March 9, 2009          4,000    $     28.66 (1) No vesting period(2)
       RS      March 19, 2009        38,046    $     33.24 (1) 5 years, 20% annually
       RS      March 9, 2010         77,360    $     38.78 (1) 3 years, 30%-30%-40%
       RS      March 9, 2010          4,000    $     38.78 (1) No vesting period(2)
       RS      March 23, 2010        25,590    $     38.09 (1) 5 years, 20% annually
       RS      March 9, 2011         68,637    $     47.35 (1) 3 years, 30%-30%-40%
       RS      March 9, 2011          4,000    $     47.35 (1) No vesting period(2)
       RS      March 23, 2011        22,567    $     44.94 (1) 5 years, 20% annually
       RS      March 8, 2012         77,844    $     41.75 (1) 3 years, 30%-30%-40%
       RS      March 8, 2012          4,000    $     41.75 (1) No vesting period(2)
       RS      March 21, 2012        20,912    $     41.96 (1) 5 years, 20% annually


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

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


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, 2013, we have purchased four layers of excess catastrophe reinsurance providing $515,000 of coverage for property losses in excess of $50,000 up to a maximum of $565,000. Our reinsurers co-participation is 50.0% of $50,000 for the 1st layer, 80.0% of $80,000 for the 2nd layer, 80.0% of $250,000 for the 3rd layer, and 80.0% of $135,000 for the 4th layer. As a result of the changes to the models, and our revised reinsurance program, our catastrophe reinsurance in 2013 protects us in the event of a "127-year storm" (that is, a storm of a severity expected to occur once in a 127-year period). Swiss Re, our primary reinsurer, maintains an A.M. Best rating of "A" (Excellent). Most of our other reinsurers have an A.M. Best rating of "A" (Excellent) however in no case is a reinsurer rated below "A-" (Excellent).

We are a participant in CAR, a state-established body that runs the residual market reinsurance programs for both private passenger and commercial automobile insurance in Massachusetts under which premiums, expenses, losses and loss adjustment expenses on ceded business are shared by all

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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, 2012, the FAIR Plan purchased $1,000,000 of catastrophe reinsurance for property losses in excess of $200,000. At December 31, 2012, we had no material amounts recoverable from any reinsurer, excluding $51,140 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

The following table shows certain of our selected financial results.

                                                       Years Ended December 31,
                                                     2012        2011        2010
    Direct written premiums                        $ 696,220   $ 649,262   $ 604,957

    Net written premiums                           $ 663,942   $ 620,316   $ 576,807

    Net earned premiums                            $ 642,469   $ 598,368   $ 551,950
    Net investment income                             40,870      39,060      41,395
    Net realized gains (losses) on investments         1,975       4,360         863
    Finance and other service income                  18,553      18,370      18,511

    Total revenue                                    703,867     660,158     612,719

    Loss and loss adjustment expenses                422,217     466,640     360,848
    Underwriting, operating and related expenses     200,138     179,157     172,823
    Interest expense                                      88          88          88

    Total expenses                                   622,443     645,885     533,759

    Income before income taxes                        81,424      14,273      78,960
    Income tax expense                                23,354         571      22,618

    Net income                                     $  58,070   $  13,702   $  56,342

    Earnings per weighted average common share:
    Basic                                          $    3.80   $    0.90   $    3.74

    Diluted                                        $    3.80   $    0.90   $    3.74

    Cash dividends paid per common share           $    2.20   $    2.00   $    1.80

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Direct Written Premiums. Direct written premiums for the year ended December 31, 2012 increased by $46,958, or 7.2%, to $696,220 from $649,262 for the comparable 2011 period. The 2012 increases occurred primarily in our personal automobile and homeowners lines, which experienced increases of 4.9% and 4.1%, respectively, in average written premium per exposure. Written exposures remained constant in our personal automobile line and increased by 7.2% and 12.5% in our homeowners line and commercial automobile line, respectively. The increase in homeowners exposures is primarily the result of our pricing strategy of offering account discounts to policyholders who insure both an automobile and home with us.

Net Written Premiums. Net written premiums for the year ended December 31, 2012 increased by $43,626, or 7.0%, to $663,942 from $620,316 for 2011. The 2012 increase was primarily due to the factors that increased direct written premiums.

Net Earned Premiums. Net earned premiums for the year ended December 31, 2012 increased by $44,101, or 7.4%, to $642,469 from $598,368 for the comparable 2011 period. The 2012 increase was primarily due to the factors that increased direct written premiums.

The effect of reinsurance on net written and net earned premiums is presented in the following table.

                                                Years Ended
                                               December 31,
                                             2012        2011
                    Written Premiums
                    Direct                 $ 696,220   $ 649,262
                    Assumed                   17,943      16,521
                    Ceded                    (50,221 )   (45,467 )

                    Net written premiums   $ 663,942   $ 620,316

                    Earned Premiums
                    Direct                 $ 673,596   $ 626,483
                    Assumed                   16,910      15,790
                    Ceded                    (48,037 )   (43,905 )

                    Net earned premiums    $ 642,469   $ 598,368

Net Investment Income. Net investment income for the year ended December 31, 2012 increased by $1,810, or 4.6%, to $40,870 from $39,060 for the comparable 2011 period. Net effective annual yield on the investment portfolio increased to 3.7% for the year ended December 31, 2012 from 3.6% for the comparable 2011 period. Our duration was 3.6 years at December 31, 2012, down from 3.7 years at December 31, 2011.

Net Realized Gains on Investments. Net realized gains on investments were $1,975 for the year ended December 31, 2012 compared to $4,360 for the comparable 2011 period.

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The gross unrealized gains and losses on investments in fixed maturity securities, equity securities, including interests in mutual funds, and other invested assets were as follows:

                                              As of December 31, 2012
                                                         Gross Unrealized
                        Cost or        Gross         Non-OTTI          OTTI
                       Amortized     Unrealized     Unrealized      Unrealized     Estimated
                         Cost          Gains          Losses         Losses(4)    Fair Value
U.S. Treasury
securities            $     7,112   $         43   $           -    $         -   $     7,155
Obligations of
states and
subdivisions              455,249         35,951             (17 )            -       491,183
securities(1)             215,438         11,465          (1,006 )            -       225,897
securities                 39,388          1,086               -              -        40,474
Other asset-backed
securities                 21,288            898               -              -        22,186
Corporate and other
securities                361,939         16,988            (269 )            -       378,658

Subtotal, fixed
maturity securities     1,100,414         66,431          (1,292 )            -     1,165,553
. . .
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