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SAFT > SEC Filings for SAFT > Form 10-Q on 9-Aug-2013All Recent SEC Filings

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Form 10-Q for SAFETY INSURANCE GROUP INC


9-Aug-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 the Commonwealth Automobile Reinsurers ("CAR").

The Insurance Subsidiaries began writing private passenger automobile and homeowners insurance in New Hampshire during 2008, personal umbrella insurance in New Hampshire during 2009, and commercial automobile insurance in New Hampshire during 2011. During the six months ended June 30, 2013 and 2012, we wrote $6,272 and $3,963, respectively, in direct written premiums in New Hampshire.

Recent Trends and Events

For the quarter ended June 30, 2013, loss and loss adjustment expenses incurred increased by $4,281, or 4.2%, to $106,976 from $102,695 for the comparable 2012 period. The increase was primarily due to a more typical level of claims activity for the quarter ended June 30, 2013 compared to an unusually low level of claim activity for the comparable 2012 period.

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


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"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%. On July 15, 2013, we began a new rating plan using 768 rating tiers which we expect will result in no change to our rate level. 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.

Our GAAP insurance ratios are outlined in the following table.

                  Three Months Ended June 30,      Six Months Ended June 30,
                     2013             2012           2013             2012
GAAP ratios:
Loss ratio               63.1 %           64.6 %         65.2 %           63.8 %
Expense ratio            30.4             30.2           30.2             30.7
Combined ratio           93.5 %           94.8 %         95.4 %           94.5 %

Share-Based Compensation

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


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

Type of                    Number of      Fair
Equity                      Awards      Value per
Awarded   Effective Date    Granted     Share (1)        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 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, 2013, the FAIR Plan purchased $1,000,000 of catastrophe reinsurance for property losses in excess of $200,000. At June 30, 2013, we had no material amounts recoverable from any reinsurer, excluding $56,435 recoverable from CAR.

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

Effects of Inflation

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


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                             Results of Operations



Three and Six Months Ended June 30, 2013 Months Compared to Three and Six Months
                              Ended June 30, 2012



The following table shows certain of our selected financial results.



                                      Three Months Ended June 30,           Six Months Ended June 30,
                                        2013               2012               2013              2012
Direct written premiums            $       198,875    $       185,830    $      384,429    $      362,083
Net written premiums               $       189,849    $       176,993    $      368,537    $      346,291
Net earned premiums                $       169,550    $       159,070    $      335,989    $      314,606
Net investment income                        9,727             10,500            20,114            20,409
Net realized gains on
investments                                    140                617               542             1,073
Finance and other service
income                                       4,584              4,521             9,152             9,026
Total revenue                              184,001            174,708           365,797           345,114
Loss and loss adjustment
expenses                                   106,976            102,695           219,121           200,739
Underwriting, operating and
related expenses                            51,467             48,010           101,565            96,548
Interest expense                                21                 22                43                44
Total expenses                             158,464            150,727           320,729           297,331
Income before income taxes                  25,537             23,981            45,068            47,783
Income tax expense                           7,478              7,025            13,025            13,618
Net income                         $        18,059    $        16,956    $       32,043    $       34,165
Earnings per weighted average
common share:
Basic                              $          1.17    $          1.11    $         2.09    $         2.24
Diluted                            $          1.17    $          1.11    $         2.08    $         2.24
Cash dividends paid per common
share                              $          0.60    $          0.50    $         1.20    $         1.00

Direct Written Premiums. Direct written premiums for the quarter ended June 30, 2013 increased by $13,045, or 7.0%, to $198,875 from $185,830 for the comparable 2012 period. Direct written premiums for the six months ended June 30, 2013 increased by $22,346, or 6.2%, to $384,429 from $362,083 for the comparable 2012 period. The 2013 increases occurred primarily in our personal automobile and homeowners business lines, which experienced increases of 3.9%, and 5.7%, respectively, in average written premium per exposure. Written exposures decreased slightly in our personal automobile line by 0.4% and increased by 5.4% in our homeowners business line. 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 quarter ended June 30, 2013 increased by $12,856, or 7.3%, to $189,849 from $176,993 for the comparable 2012 period. Net written premiums for the six months ended June 30, 2013 increased by $22,246, or 6.4%, to $368,537 from $346,291 for the comparable 2012 period. The 2013 increase was primarily due to the factors that increased direct personal automobile and homeowners written premiums.

Net Earned Premiums. Net earned premiums for the quarter ended June 30, 2013 increased by $10,480, or 6.6%, to $169,550 from $159,070 for the comparable 2012 period. Net earned premiums for the six months ended June 30, 2013 increased by $21,383, or 6.8% to $335,989 from $314,606 for the comparable 2012 period. The 2013 increase was primarily due to the factors that increased direct personal automobile and homeowners written premiums.


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

                                  Three Months Ended June 30,           Six Months Ended June 30,
                                    2013               2012               2013              2012
Written Premiums
Direct                         $       198,875    $       185,830    $      384,429    $      362,083
Assumed                                  5,227              4,006            11,263             8,729
Ceded                                  (14,253 )          (12,843 )         (27,155 )         (24,521 )
Net written premiums           $       189,849    $       176,993    $      368,537    $      346,291

Earned Premiums
Direct                         $       178,146    $       166,868    $      351,835    $      329,274
Assumed                                  4,441              4,154             9,765             8,421
Ceded                                  (13,037 )          (11,952 )         (25,611 )         (23,089 )
Net earned premiums            $       169,550    $       159,070    $      335,989    $      314,606

Net Investment Income. Net investment income for the quarter ended June 30, 2013 decreased by $773 or 7.4%, to $9,727 from $10,500 for the comparable 2012 period. Net investment income for the six months ended June 30, 2013 decreased by $295, or 1.4%, to $20,114 from $20,409 for the comparable 2012 period. Net effective annualized yield on the investment portfolio decreased to 3.4% and 3.5%, respectively, for the quarter and six months ended June 30, 2013, from 3.8% and 3.7% for the comparable 2012 periods. Our duration was 3.8 years at June 30, 2013 compared to 3.6 years at December 31, 2012.

Net Realized Gains on Investments. Net realized gains on investments were $140 for the quarter ended June 30, 2013 compared to net realized gains of $617 for the comparable 2012 period. Net realized gains on investments were $542 for the six months ended June 30, 2013 compared to net realized gains of $1,073 for the comparable 2012 period.

The gross unrealized gains and losses on investments in fixed maturity securities, including redeemable preferred stocks that have characteristics of fixed maturities, and equity securities were as follows:

                                                                   As of June 30, 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    $         16    $                 (13 )   $              -    $     2,515
Obligations of states and
political subdivisions               456,616          15,416                   (2,583 )                  -        469,449
Residential mortgage-backed
securities (1)                       206,958           8,011                   (2,825 )                  -        212,144
Commercial mortgage-backed
securities                            33,586             575                      (37 )                  -         34,124
Other asset-backed securities         14,361             636                      (25 )                  -         14,972
Corporate and other
securities                           377,177          10,165                   (2,518 )                  -        384,824
Subtotal, fixed maturity
securities                         1,091,210          34,819                   (8,001 )                  -      1,118,028
Equity securities                     42,798           3,901                     (188 )                  -         46,511
Totals                           $ 1,134,008    $     38,720    $              (8,189 )   $              -    $ 1,164,539



(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 292 securities in an unrealized loss position at June 30, 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 June 30, 2013
                                                       Estimated
                                                      Fair Value        Percent
U.S. Treasury securities and obligations of U.S.
Government agencies                                  $     217,850            19.5 %
Aaa/Aa                                                     485,747            43.4
A                                                          192,572            17.2
Baa                                                         82,684             7.4
Ba                                                          45,083             4.0
B                                                           62,509             5.6
Caa                                                          7,007             0.6
Not rated                                                   24,576             2.3
Total                                                $   1,118,028           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 June 30, 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 June 30, 2013.

                                                             As of June 30, 2013
                               Less than 12 Months             12 Months or More                   Total
                            Estimated       Unrealized     Estimated       Unrealized     Estimated     Unrealized
                            Fair Value        Losses       Fair Value        Losses      Fair Value       Losses
U.S. Treasury securities   $      1,499    $         13   $          -    $          -   $     1,499   $         13
Obligations of states
and political
subdivisions                     69,631           2,551          1,003              32        70,634          2,583
Residential
mortgage-backed
securities                       68,818           2,629          8,994             196        77,812          2,825
Commercial
mortgage-backed
securities                       10,241              37              -               -        10,241             37
Other asset-backed
securities                        6,589              25              -               -         6,589             25
Corporate and other
securities                      106,565           2,410          5,413             108       111,978          2,518
Subtotal, fixed maturity
securities                      263,343           7,665         15,410             336       278,753          8,001
Equity securities                 6,239             188              -               -         6,239            188
Total temporarily
impaired securities        $    269,582    $      7,853   $     15,410    $        336   $   284,992   $      8,189
. . .
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