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SAFT > SEC Filings for SAFT > Form 10-Q on 10-May-2013All Recent SEC Filings

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Form 10-Q for SAFETY INSURANCE GROUP INC


10-May-2013

Quarterly Report


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 65.9 % of our direct written premiums in 2012) and commercial automobile insurance (11.0% of 2012 direct written premiums), we offer a portfolio of other insurance products, including homeowners (18.9% of 2012 direct written premiums) and 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 statistics compiled by the Commonwealth Automobile Reinsurers ("CAR").

The Insurance Subsidiaries began writing private passenger automobile and homeowners insurance in New Hampshire during 2008, personal umbrella insurance in New Hampshire during 2009, and commercial automobile insurance in New Hampshire during 2011. During the three months ended March 31, 2013 and 2012, we wrote $2,709 and $1,663, respectively, in direct written premiums in New Hampshire.

Recent Trends and Events

For the quarter ended March 31, 2013, loss and loss adjustment expenses incurred increased by $14,101, or 14.4%, to $112,145 from $98,044 for the comparable 2012 period. The increase was primarily due to a more typical level of catastrophe and non-catastrophe claims activity throughout out our personal and commercial property lines as a result of severe and snowy winter weather in the Northeast during the quarter ended March 31, 2013, compared to unusually low claims activity attributable to the mild weather with minimal snowfall during the comparable 2012 period.


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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 (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 2012, we increased our Massachusetts private passenger rates approximately 4.7%. Our Massachusetts rates include a 13.0% commission rate for agents. Our direct automobile written premiums increased by 6.1% in 2012 with increased exposures and average written premium per exposure in our commercial automobile line of business.

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.


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Our GAAP insurance ratios are outlined in the following table.

Three Months Ended March 31,

                     2013               2012
GAAP ratios:
Loss ratio                67.4 %             63.0 %
Expense ratio             30.1               31.2
Combined ratio            97.5 %             94.2 %

Share-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 share-based compensation awards, including nonqualified stock options, incentive stock options, stock appreciation rights and restricted stock ("RS") awards.

The maximum number of shares of common stock with respect to which awards may be granted is 2,500,000. The Incentive Plan was amended in March of 2013 to remove "share recycling" plan provisions. Hence, shares of stock covered by an award under the Incentive Plan that are forfeited are no longer available for issuance in connection with 2013 and future grants of awards. At March 31, 2013, there were 529,555 shares available for future grant. The Board of Directors and the Compensation Committee intend to issue more awards under the Incentive Plan in the future.

A summary of share-based awards granted under the Incentive Plan during the three months ended March 31, 2013 is as follows:

Type of                    Number of      Fair
Equity                      Awards      Value per
Awarded   Effective Date    Granted       Share          Vesting Terms
  RS      March 11, 2013      28,988   $     46.96    3 years, 30%-30%-40%
  RS      March 11, 2013       4,000   $     46.96   No vesting period (1)
  RS      March 11, 2013      35,429   $     43.90   3 years, cliff vesting
  RS      March 27, 2013      22,485   $     48.65   5 years, 20% annually



(1) 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, 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 commercial automobile insurance in Massachusetts under which premiums, expenses, losses and loss adjustment expenses on ceded business are


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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, 2012, the FAIR Plan purchased $1,000,000 of catastrophe reinsurance for property losses in excess of $200,000. At March 31, 2013, we had no material amounts recoverable from any reinsurer, excluding $51,332 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 Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012



The following table shows certain of our selected financial results.



                                                  Three Months Ended March 31,
                                                    2013               2012
Direct written premiums                        $       185,554    $       176,253
Net written premiums                           $       178,688    $       169,298
Net earned premiums                            $       166,439    $       155,536
Net investment income                                   10,387              9,909
Net realized gains on investments                          402                456
Finance and other service income                         4,568              4,505
Total revenue                                          181,796            170,406
Loss and loss adjustment expenses                      112,145             98,044
Underwriting, operating and related expenses            50,098             48,538
Interest expenses                                           22                 22
Total expenses                                         162,265            146,604
Income before income taxes                              19,531             23,802
Income tax expense                                       5,547              6,593
Net income                                     $        13,984    $        17,209
Earnings per weighted average common share:
Basic                                          $          0.91    $          1.13
Diluted                                        $          0.91    $          1.13
Cash dividends paid per common share           $          0.60    $          0.50

Direct Written Premiums. Direct written premiums for the three months ended March 31, 2013 increased by $9,301, or 5.3%, to $185,554 from $176,253 for the comparable 2012 period. The 2013 increase occurred primarily in our personal automobile, commercial automobile, and homeowners business lines, which experienced increases of 4.8%, 2.6% and 4.5%, respectively, in average written premium per exposure. Written exposures decreased by 1.2% in our personal automobile line and increased by 11.0% and 5% in our commercial automobile and our homeowners business lines, respectively.

Net Written Premiums. Net written premiums for the three months ended March 31, 2013 increased by $9,390, or 5.5%, to $178,688 from $169,298 for the comparable 2012 period. The 2013 increase was primarily due to the factors that increased direct written premiums.


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Net Earned Premiums. Net earned premiums for the three months ended March 31, 2013 increased by $10,903, or 7.0% to $166,439 from $155,536 for the comparable 2012 period. The 2013 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.

                          Three Months Ended March 31,
                            2013               2012
Written Premiums
Direct                 $       185,554    $       176,253
Assumed                          6,036              4,723
Ceded                          (12,902 )          (11,678 )
Net written premiums   $       178,688    $       169,298

Earned Premiums
Direct                 $       173,689    $       162,406
Assumed                          5,324              4,267
Ceded                          (12,574 )          (11,137 )
Net earned premiums    $       166,439    $       155,536

Net Investment Income. Net investment income for the three months ended March 31, 2013 increased by $478, or 4.8%, to $10,387 from $9,909 for the comparable 2012 period. Net effective annualized yield on the investment portfolio remained consistent at 3.6% for the three months ended March 31, 2013 and 2012. Our duration was 3.7 years at March 31, 2013 compared to 3.6 years at December 31, 2012.

Net Realized Gains on Investments. Net realized gains on investments were $402 for the three months ended March 31, 2013 compared to $456 for the comparable 2012 period.

The gross unrealized gains and losses on investments in fixed maturity securities, including redeemable preferred stock with the characteristics of fixed maturities, and equity securities, including interests in mutual funds, were as follows:

                                                                    As of March 31, 2013
                                                                        Gross Unrealized Losses (2)
                                      Cost or        Gross             Non-OTTI                 OTTI          Estimated
                                     Amortized     Unrealized         Unrealized             Unrealized         Fair
                                       Cost          Gains              Losses               Losses (3)         Value
U.S. Treasury securities            $     2,512   $         47   $                   -     $             -   $     2,559
Obligations of states and
political subdivisions                  454,385         29,773                     (62 )                 -       484,096
Residential mortgage-backed
securities (1)                          209,320         10,546                  (1,398 )                 -       218,468
Commercial mortgage-backed
securities                               36,719            795                      (4 )                 -        37,510
Other asset-backed securities            17,831            841                      (5 )                 -        18,667
Corporate and other securities          365,136         16,389                    (419 )                 -       381,106
Subtotal, fixed maturity
securities                            1,085,903         58,391                  (1,888 )                 -     1,142,406
Equity securities                        42,096          3,021                     (48 )                 -        45,069
Totals                              $ 1,127,999   $     61,412   $              (1,936 )   $             -   $ 1,187,475



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

(2) Our investment portfolio included 86 securities in an unrealized loss position at March 31, 2013.

(3) Amounts in this column represent other-than-temporary impairments recognized in accumulated other comprehensive income.


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The composition of our fixed income security portfolio by Moody's rating was as follows:

                                                             As of March 31, 2013
                                                             Estimated
                                                            Fair Value     Percent
U.S. Treasury securities and obligations of U.S.
Government agencies                                        $     224,686       19.7 %
Aaa/Aa                                                           511,107       44.7
A                                                                182,606       16.0
Baa                                                               80,564        7.1
Ba                                                                50,344        4.4
B                                                                 59,642        5.2
Caa                                                                5,931        0.5
Not rated                                                         27,536        2.4
Total                                                      $   1,142,406      100.0 %

Ratings are generally assigned upon the issuance of the securities and are subject to revision on the basis of ongoing evaluations. Ratings in the table are as of the date indicated.

As of March 31, 2013, our portfolio of fixed maturity investments was comprised principally of investment grade corporate fixed maturity securities, U.S. government and agency securities, and asset-backed securities. The portion of our non-investment grade portfolio of fixed maturity investments is primarily comprised of variable rate secured and senior bank loans and high yield bonds. We have no exposure to European sovereign debt.

The following table illustrates the gross unrealized losses included in our investment portfolio and the fair value of those securities, aggregated by investment category. The table also illustrates the length of time that they have been in a continuous unrealized loss position as of March 31, 2013.

                                                                      As of March 31, 2013
                                        Less than 12 Months             12 Months or More                   Total
                                     Estimated       Unrealized     Estimated       Unrealized     Estimated     Unrealized
                                     Fair Value        Losses       Fair Value        Losses      Fair Value       Losses
Obligations of states and
political subdivisions              $      5,650    $         40   $      1,015    $         23   $     6,665   $         63
Residential mortgage-backed
securities                                55,223           1,378          8,686              20        63,909          1,398
Commercial mortgage-backed
securities                                 3,206               4              -               -         3,206              4
Other asset-backed securities              4,608               5              -               -         4,608              5
Corporate and other securities            22,263             165          1,744             253        24,007            418
Subtotal, fixed maturity
securities                                90,950           1,592         11,445             296       102,395          1,888
Equity securities                          2,025              33            348              15         2,373             48
Total temporarily impaired
securities                          $     92,975    $      1,625   $     11,793    $        311   $   104,768   $      1,936

As of March 31, 2013, we held insured investment securities of approximately $111,477, which represented approximately 9.3% of our total investments. Approximately $51,922 of these securities are pre-refunded, meaning that funds have been set aside in escrow to satisfy the future interest and principal obligations of the bond.


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The following table shows our insured investment securities that are backed by financial guarantors including pre-refunded securities as of March 31, 2013. We do not have any direct investment holdings in a financial guarantee insurance company.

                                                      As of March 31, 2013
                                                                           Exposure Net
                                                        Pre-refunded      of Pre-refunded
Financial Guarantor                       Total          Securities         Securities
Municipal bonds
Ambac Assurance Corporation            $     18,343    $        9,107    $           9,236
Financial Guaranty Insurance Company            274               274                    -
Assured Guaranty Municipal
Corporation                                  43,384            21,271               22,113
National Public Finance Guaranty
Corporation                                  49,476            21,270               28,206
Total municipal bonds                       111,477            51,922               59,555
Total                                  $    111,477    $       51,922    $          59,555

The Moody's rating of the Company's insured investments held at March 31, 2013 are essentially the same with or without the investment guarantees.

We reviewed the unrealized losses in our fixed income and equity portfolio as of . . .

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