We are subject to the extensive regulation of the private passenger automobile insurance industry in Massachusetts, which represented 80.3% of our direct written premiums in 2005. Owners of registered automobiles in Massachusetts are required to maintain minimum automobile insurance coverages. We are required to participate in a state-mandated reinsurance program run by CAR to which we cede certain unprofitable risks and from which we are allocated a portion of the overall losses. As a servicing carrier of CAR, we are required to issue a policy to all qualified applicants. This program operates at an underwriting deficit. This deficit is allocated among every Massachusetts automobile insurance company, including us, based on a complex formula that takes into consideration a company’s voluntary market share, the rate at which it cedes business to CAR, and the company’s utilization of a credit system CAR has designed to encourage carriers to reduce their use of CAR. In addition, based on our market share, we
are assigned certain licensed producers by CAR that have been unable to obtain a voluntary contract with another insurer. We call these agents Exclusive Representative Producers, or ERPs.
Beginning January 1, 2006 CAR has implemented a Limited Servicing Carrier Program (“LSC”) for ceded commercial automobile policies. CAR approved Safety and five other servicing carriers through a Request for Proposal to process approximately $200,000 of ceded commercial automobile business based on CAR data as of December 31, 2005, which will be spread equitably amongst the six servicing carriers.
Each year, the Commissioner sets maximum premium rates that may be charged and minimum commissions that must be paid to agents for private passenger automobile insurance. The Commissioner announced on December 15, 2005, a 8.7% statewide average private passenger automobile insurance rate decrease for 2006, compared to a 1.7% decrease for 2005. Coinciding with the 2006 rate decision, the Commissioner also approved an 11.8% commission rate agents receive for selling private passenger automobile insurance, as a percentage of premiums, compared to a commission rate of 10.9% in 2005.
Under GAAP, the loss ratio is computed in the same manner as under SAP, but the expense ratio is determined by matching underwriting expenses to the period over which net premiums were earned, rather than to the period that net premiums were written. Our GAAP insurance ratios are outlined in the following table:
On June 25, 2002, 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 December 31, 2005, there were 225,958 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, 2005 were comprised of 98,417 restricted shares and 496,086 nonqualified stock options. Grants made under the Incentive Plan are as follows:
Management determines the Company’s loss and LAE reserves estimate based upon the work of the Company’s actuaries and management’s own assessment of reasonable reserves. A reasonable estimate is derived primarily by considering a range of indications calculated by the Company’s actuaries using generally accepted actuarial techniques. Our key assumptions are the ultimate frequency and severity of claims, based upon the most recent ten years of claims reported to the Company and the data CAR reports to us to calculate our share of the residual market, as of the date of the applicable balance sheet. For each accident year and each coverage within a line of business our actuaries calculate reserve ranges using actuarial techniques such as:
· Paid Loss Indications: This method projects ultimate loss estimates based upon extrapolations of historic paid loss trends. This method tends to be used on short tail lines such as automobile physical damage.
· Incurred Loss Indications: This method projects ultimate loss estimates based upon extrapolations of historic incurred loss trends. This method tends to be used on long tail lines of business such as automobile liability and homeowner’s liability.
The following tables present the recorded reserves and the range of estimations by line of business for net loss and LAE reserves as of December 31, 2005 and December 31, 2004.
The Company’s net loss and LAE reserves, based on management’s best estimate, were set at $370,166 as of December 31, 2005, as compared to $366,730 for 2004.
and we recorded reserves slightly higher than the mid-point of the range. For our private passenger line as of December 31, 2004 we recorded reserves at the mid-point of the range, and for our commercial automobile line of business we recorded reserves higher than the range due to our rapid growth in this line over the years prior to 2004.
For our homeowners and all other lines of business as of December 31, 2005, due to the relatively short time we have been writing these lines of business, and the resulting immature data available for our analysis, the range of reserves are relatively wide compared to the mid-point estimation and we recorded reserves closer to the high of the range of projections. For our homeowners and all other lines of business as of December 31, 2004, we recorded reserves higher than the range for homeowners and we recorded reserves very close to the high of the range of projections for all other lines of business.
The CAR deficit, which consists of premium ceded to CAR less CAR losses and LAE, is allocated among every automobile insurance company writing business in Massachusetts based on a complex formula (the “Participation Ratio”) that takes into consideration a company’s voluntary market share, the
amount of business it cedes to CAR and credits the company earns under a system CAR has designed to encourage carriers to voluntarily write business in selected under-priced classes and territories.
We receive our final calendar year Participation Ratio report from CAR eight months after the end of that year, and thus we have to estimate for six quarters our share of the CAR deficit. For example, for the year ended December 31, 2004 we had to estimate our 2004 policy year CAR Participation Ratio beginning with the first quarter of 2004 through the second quarter of 2005.
Our assumptions consider that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for establishing our reserves. Our key assumptions could have a reasonable possible range of plus or minus 5 percentage-points for each estimation. However, as 2005 demonstrates, there is no guarantee that our assumptions will not have more than a 5 percentage-point variation. The following sensitivity tables present information for each of our primary lines of business on the effect each 1 percentage-point change in each of our key assumptions on unpaid frequency and severity
The changes we have recorded in our reserves in the past illustrate the uncertainty of estimating reserves. Primarily due to an improvement in CAR results, the Company’s prior year reserves decreased by $39,620 and $6,778 for the years ended December 31, 2005 and 2004, respectively. The company’s prior year reserves increased by $181 for the year ended December 31, 2003.
The following table presents information by line of business for prior year development of direct minus ceded reserves for losses and LAE for the year ended December 31, 2005; that is, all our reserves except for business ceded or assumed from CAR and other residual markets.
The following table presents information by line of business for prior year development of reserves assumed from CAR and other residual markets for losses and LAE for the year ended December 31, 2005.
Our commercial automobile line of business prior year reserves decreased by $5,007 for the year ended December 31, 2005. The decrease was primarily due to more favorable commercial automobile bodily injury severity than previously estimated on our established case reserves during 2005.
Net Investment Income. Investment income for the year ended December 31, 2005 was $31,573 compared to $27,259 for 2004. Average cash and investment securities (at cost) increased by $102,624, or 14.0%, to $837,200 for the year ended December 31, 2005 from $734,576 for 2004 due to a $72,871 increase in average cash and a $29,753 increase in average securities. Net effective yield on the investment portfolio remained relatively unchanged at 3.8% during the year ended December 31, 2005 compared to 3.7% during 2004. Our duration decreased to 3.2 years at December 31, 2005 from 3.4 years at December 31, 2004.
(1) Obligations of U.S. Government agencies include collateralized mortgage obligations issued, guaranteed and/or insured by the following issuers: Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association (FNMA). The total of these fixed maturity securities was $115,284 at fair value and $117,766 at amortized cost as of December 31, 2005. As such, the asset-backed securities presented exclude such issuers already presented under U.S. Treasury securities and obligations of U.S. Government Agencies.
The unrealized losses recorded on the fixed maturity investment portfolio at December 31, 2005 resulted from fluctuations in market interest rates as opposed to fundamental changes in the credit quality of the issuers of such securities. Therefore, these decreases in values are viewed as being temporary as we
have the intent and ability to retain such investments for a period of time sufficient to allow for recovery in market value.
Of the $8,521 gross unrealized losses as of December 31, 2005, $5,712 relates to fixed maturity obligations of U.S. government agencies and obligations of states and political subdivisions. The remaining $2,809 of gross unrealized losses relates primarily to holdings of investment grade asset-backed, corporate and other fixed maturity securities.
Finance and Other Service Income. Finance and other service income includes revenues from premium installment charges, which we recognize when earned, and other miscellaneous income and fees. Finance and other service income for the year ended December 31, 2005 were $16,748 compared to $15,615 for the 2004 period. This resulted from increases in premium installment billing fees primarily due to growth in the number of policies combined with an increase in miscellaneous income from CAR.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses incurred for the year ended December 31, 2005 decreased by $39,468, or 9.3%, to $385,593 from $425,061 for the comparable 2004 period. Our GAAP loss ratio for the year ended December 31, 2005 decreased to 61.9% compared to 71.8% for the comparable 2004 period. Our GAAP loss ratio excluding loss adjustment expenses for the year ended December 31, 2005 decreased to 54.9% from 64.6% for the comparable 2004 period. The loss ratio improved as a result of favorable loss development of $22,162 in CAR assumed prior years reserves, favorable loss development of $14,600 in the Company’s prior years automobile reserves, a decrease in personal and commercial bodily injury claim frequency in our automobile lines of business, favorable loss development of $1,872 in FAIR Plan assumed prior years reserves, and favorable loss development of $986 in homeowners prior years reserves in 2005 compared to favorable loss development of $6,854 in CAR assumed prior years reserves,$2,523 in homeowner prior years reserves, $329 in FAIR Plan assumed prior years reserves, and an increase of $2,928 in the Company’s automobile prior years reserves in 2004.
Net Investment Income. Investment income for the year ended December 31, 2004 was $27,259 compared to $26,086 for 2003. Average cash and investment securities (at amortized cost) increased by $95,645, or 15.0%, to $734,576 for the year ended December 31, 2004 from $638,931 for 2003 due to a $53,491 increase in average cash and a $42,154 increase in average securities. Net effective yield on the investment portfolio decreased to 3.7% during the year ended December 31, 2004 from 4.1% during 2003 due to management’s investment strategy to shorten the portfolio duration, shift to higher rated securities, and increase tax-exempt holdings. Our duration decreased to 3.4 years at December 31, 2004 from 4.2 years at December 31, 2003.
The following table illustrates the gross unrealized losses included in the Company’s 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 December 31, 2004.
During the year ended December 31, 2004, there was no significant deterioration in the credit quality of any of the Company’s holdings and no other-than-temporary impairment charges were recorded related to the Company’s portfolio of investment securities. However, during the year ended December 31, 2003, there was a significant deterioration in the credit quality of one of the Company’s holdings, Continental Airlines. Accordingly, during the first quarter of 2003, the Company recorded an other-than-temporary impairment of $837 for this security. During May 2003, this security was sold at a realized gain of $426.
Underwriting, Operating and Related Expenses. Underwriting, operating and related expense for the year ended December 31, 2004 increased by $14,439, or 11.1%, to $145,075 from $130,636 for the comparable 2003 period. Our GAAP expense ratios for the year ended December 31, 2004 increased to 24.5% compared to 24.2% for the comparable 2003 periods.
Net Income. Net income for the year ended December 31, 2004 increased by $16,508, or 58.0%, to $44,990 from $28,482 for the comparable 2003 period. These increases in net income during 2004 are a result of decreases in the loss ratios, which are due to an increase in average written premium and a decrease in claim frequency in our personal automobile, commercial automobile and homeowners lines of business.
Concurrent with the closing of our November 27, 2002 initial public offering (“IPO”) and repayment of the old credit facility, Safety obtained a new $30,000 revolving credit facility. Safety borrowed the entire $30,000 under this credit facility at the closing of the IPO and paid down the balance to $19,956 on December 5, 2002 with the approximately $10,000 net proceeds from the exercise of the underwriter’s over-allotment option for 900,000 shares of our common stock. Loans under the credit facility bear interest at our option at either (i) the LIBOR rate plus 1.5% per annum or (ii) the higher of Citizens Bank of Massachusetts’ prime rate or 0.5% above the federal funds rate plus 1.5% per annum. Interest only is payable prior to maturity. The obligations of Safety under the credit facility are secured by pledges of the assets of Safety and the capital stock of Safety’s operating subsidiaries. The credit facility is guaranteed by the non-insurance company subsidiaries of Safety. The credit facility contains covenants including requirements to maintain minimum risk based capital ratios and statutory surplus of Safety Insurance as well as limitations or restrictions on indebtedness, liens, dividends, and other matters. As of December 31, 2005, we were in compliance with all such covenants.
Bank of America was the lender under this credit facility. Under an agreement effective on June 17, 2005, Bank of America assigned the $30,000 credit facility to Citizens Bank of Massachusetts. The credit facility was due and payable at maturity on November 27, 2005, which was three years from the closing of the IPO. Under a June 17, 2005 amendment to the credit facility, the maturity date was extended to June 17, 2008. Other terms of the revolving credit facility remain unchanged.
The Company paid down the balance of $19,956 on December 8, 2005 and had no amounts outstanding on its credit facility at December 31, 2005. At December 31, 2004, the Company had utilized advances of $19,956. The interest rate on the $30,000 commitment was .25% at December 31, 2005 and 2004. The interest rate on the amounts advanced was 4.26% at December 31, 2004. The average interest rate during 2005 and 2004 was 4.59% and 3.27%, respectively.
On February 16, 2006, our Board approved a quarterly cash dividend on our common stock of $0.18 per share, or $2,844, payable on March 15, 2006 to shareholders of record on March 1, 2006. On November 3, 2005, our Board approved a quarterly cash dividend on our common stock of $0.18 per share, or $2,835, which was paid on December 15, 2005. On August 18, 2005, our Board approved a quarterly cash dividend on our common stock of $0.18 per share, or $2,832, which was paid on September 15, 2005. On May 19, 2005, our Board approved a quarterly cash dividend on our common stock of $0.12 per share, or $1,881, which was paid on June 15, 2005. On February 17, 2005, our Board approved a quarterly cash dividend on our common stock of $0.12 per share, or $1,861, which was paid on March 15, 2005. We plan to continue to declare and pay quarterly cash dividends in 2006, depending on our financial position and the regularity of our cash flows.
changes, insurance regulatory changes and economic conditions, no assurance can be given that the available net cash flow will be sufficient to meet our operating needs. We expect that we would need to borrow or issue capital stock if we needed additional funds, for example, to pay for an acquisition or a significant expansion of our operations. There can be no assurance that sufficient funds for any of the foregoing purposes would be available to us at such time.
As of December 31, 2005, the Company had loss and LAE reserves of $450,716, reinsurance recoverables of $80,550 and net loss and LAE reserves of $370,166. Our loss and LAE reserves are estimates as described in more detail under “Critical Accounting Policies and Estimates”. The specific amounts and timing of obligations related to case reserves, IBNR reserves and related LAE reserves are not set contractually, and the amounts and timing of these obligations are unknown. Based upon our cumulative claims paid over the last ten years, the Company estimates that its loss and LAE reserves will be paid in the period shown above. While management believes that historical performance of loss payment patterns is a reasonable source for projecting future claims payments, there is inherent uncertainty in this estimated projected settlement of loss and LAE reserves, and as a result these estimates will differ, perhaps significantly, from actual future payments. Our operations typically generate substantial positive cash flows from operations as most premiums are received in advance of the time when claim and benefit payments are required. These positive operating cash flows are expected to continue to meet our liquidity requirements, including any unexpected variations in the timing of claim settlements.
Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “aim,” “projects,” or words of similar meaning and expressions that indicate future events and trends, or future or conditional verbs such as “will,” “would,” “should,” “could,” or “may”. All statements that address expectations or projections about the future, including statements about the Company’s strategy for growth, product development, market position, expenditures and financial results, are forward-looking statements.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Safety Insurance Group, Inc. at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under 15(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2005 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
Investments in fixed maturities available for sale, which include taxable and non-taxable bonds and redeemable preferred stocks, are reported at fair value. Investments in equity securities available for sale, which include interests in mutual funds, are reported at fair value. Fair values are derived from external market quotations. Unrealized gains or losses on fixed maturity and equity securities, reported at fair value, are excluded from earnings and reported in a separate component of shareholders’ equity, known as “Accumulated other comprehensive income (loss), net of federal income taxes”, until realized. Realized gains or losses on the sale or maturity of investments are determined on the basis of the specific cost identification method. Fixed maturities and equity securities that experience declines in value that are other-than-temporary are written down to fair value with a corresponding charge to net realized losses on investments.
Amounts included in accounts receivable represent premiums as well as finance charges, which are billed on a monthly installment basis. A majority of the Company’s premiums are billed on a monthly installment basis. Accounts receivable are stated net of allowances for doubtful accounts. At December 31, 2005 and 2004, these allowances were $220 and $183, respectively. Uncollected premium balances over ninety days past due are written off.
Advance premiums are recorded as a liability and not recognized as income until earned. Such amounts are included in accounts payable and accrued liabilities and totaled $20,437 and $21,207 at December 31, 2005 and 2004, respectively.
The Company, as primary insurer, will be required to pay losses in their entirety in the event that the reinsurers are unable to discharge their obligations under the reinsurance agreements.
as defined by Statement of Financial Accounting Standards (“FAS”) No. 109, “Accounting for Income Taxes”. A valuation allowance is established where management has assessed that it is more likely than not that the Company will not be able to utilize the full deferred tax asset.
Basic earnings per weighted average common share (“EPS”) are calculated by dividing net income by the weighted average number of basic common shares outstanding during the period. Diluted EPS are calculated by dividing net income by the weighted average number of basic common shares outstanding and the net effect of potentially dilutive common shares. At December 31, 2005, 2004 and 2003, the Company’s potentially dilutive instruments were common shares under options of 496,086, 711,410 and 771,000, respectively, and common shares under restriction of 94,417, 70,271and 0, respectively.
On June 25, 2002, 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, Stock Appreciation Rights, and restricted stock awards. The Company has granted certain stock option awards under this Incentive Plan and follows the accounting for these options under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, as allowed by FAS 123, “Accounting for Stock-Based Compensation” and as amended by FAS 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard No. (“FAS”) 123R (revised 2004), “Share-Based Payment” was issued. This statement requires companies to measure and recognize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value. FAS 123R replaces FAS 123, “Accounting for Stock-Based Compensation”, and supersedes Accounting Principles Board No. (“APB”) 25, “Accounting for Stock Issued to Employees”. In April 2005, the SEC postponed the effective date of FAS 123R until the fiscal year beginning after June 15, 2005. The Company is currently evaluating the effects of FAS 123R.
In May 2005, the FASB issued FAS No. 154, “Accounting Changes and Error Corrections”. FAS No. 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to a newly adopted accounting principle. The statement will be effective for the Company for all accounting changes and any error corrections occurring after January 1, 2006.
The Company comprises one business segment: property and casualty insurance operations. Management organizes the business around private passenger automobile insurance in Massachusetts sold exclusively through independent agents and offers other personal and commercial insurance as complementary products. In accordance with FAS 131, “Disclosures About Segments of an Enterprise and Related Information”, the financial information of the segment is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
(1) Obligations of U.S. Government agencies includes collateralized mortgage obligations issued, guaranteed and/or insured by the following issuers: Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association (FNMA). The total of these fixed maturity securities was $115,284 and $120,636 at fair value and $117,766 and $120,729 at amortized cost as of December 31, 2005 and 2004, respectively. As such, the asset-backed securities presented exclude such issuers already presented under U.S. Treasury securities and obligations of U.S. Government Agencies.
The amortized cost and the estimated fair value of fixed maturity securities, by maturity, at December 31, 2005 are shown below. 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.
Gross gains of $478, $1,535 and $11,141 and gross losses of $185, $263 and $253 were realized on sales of fixed maturities for years ended December 31, 2005, 2004 and 2003, respectively. Gross gains of $12, $2 and $0 were realized on the sales of equity securities for the years ended December 31, 2005, 2004 and 2003, respectively. Proceeds from fixed maturities maturing were $11,125, $7,520, and $0 for the years ended December 31, 2005, 2004 and 2003, respectively.
The Company’s investment portfolio included 185 securities in an unrealized loss position at December 31, 2005. The Company’s methodology of assessing other-than-temporary impairment is based upon analysis of each security as of the balance sheet date and considers various factors including the length of time and the extent to which fair value has been less than the cost, the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, and the Company’s intent to hold the investment for a period of time sufficient to allow for recovery of its costs.
As of December 31, 2005, our portfolio of fixed maturity investments was comprised entirely of investment grade corporate fixed maturity securities, U.S. government and agency securities and asset-backed securities. The unrealized losses recorded on the fixed maturity investment portfolio at December 31, 2005 resulted from fluctuations in market interest rates as opposed to fundamental changes in the credit quality of the issuers of such securities. Therefore, these decreases in values are viewed as being temporary as the Company has the intent and ability to retain such investments for a period of time sufficient to allow for recovery in market value.
During the years ended December 31, 2005 and 2004, there was no significant deterioration in the credit quality of any of the Company’s holdings and no other-than-temporary impairment charges were recorded related to the Company’s portfolio of investment securities. However, during the year ended December 31, 2003, there was a significant deterioration in the credit quality of one of the Company’s holdings, Continental Airlines. Accordingly, the Company recorded an other-than-temporary impairment of $837 for this security. During May 2003, this security was sold at a realized gain of $426.
At December 31, 2005 and 2004, the Company held equipment and leasehold improvements with a carrying value of $1,041 and $973, which is net of accumulated depreciation of $1,881 and $1,182, respectively. Depreciation and amortization expense for the years ended December 31, 2005, 2004 and 2003 was $699, $767 and $331, respectively.
The following table summarizes stock option activity under the Incentive Plan:
The Company has various noncancelable long-term operating leases. The approximate minimum annual rental payments due under these lease agreements as of December 31, 2005 are as follows:
Certain lease agreements contain renewal options and, in addition to the minimum annual rentals, generally provide for payment of a share of the real estate taxes and operating expenses in excess of a base amount. Rental expense was $3,042, $2,826, $2,718 for the years ended December 31, 2005, 2004 and 2003, respectively. All leases expire prior to 2011. The Company expects that in the normal course of business, leases that expire will be renewed.
During 2003, the Company entered in to a three-year term lease agreement to finance the acquisition of new equipment. Minimum payments due under this capital lease obligation as of December 31, 2005 are as follows:
CAR is, with few exceptions, required by law to issue a policy to any applicant who seeks it. As a servicing carrier of CAR, this requirement applies to the Company. The Company has entered into service contracts with other insurance carriers under which the Company services the residual market business assigned to the carriers by CAR (the “buyout program”). Business generated through the buyout program is 100% ceded to the applicable carrier and serviced for a fee. Servicing carrier fees amounted to $588, $628 and $548 for the years ended December 31, 2005, 2004 and 2003, respectively.
The following table sets forth a reconciliation of beginning and ending reserves for losses and LAE, as shown, in the Company’s consolidated financial statements for the years indicated:
At the end of each period, the reserves were re-estimated for all prior accident years. Primarily due to an improvement in CAR results, prior year reserves decreased by $39,620 and $6,778 for the years ended December 31, 2005 and 2004, respectively. These decreases in prior year reserves resulted from
During the year ended December 31, 2005, an examination of the Company’s federal income tax returns for the tax periods ended December 31, 2003, 2002, and 2001 by the Internal Revenue Service (“IRS”) was completed. The Company recorded a $1,616 tax benefit representing a reduction in federal income tax reserves for tax years 2001 through 2003, resulting from a settlement reached with the IRS in August 2005. Of this total tax benefit, $455 was recorded as an increase to additional paid-in capital and $1,161 was recorded as a reduction to income tax expense for the year ended December 31, 2005.
The Company’s insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of the Commonwealth of Massachusetts Commissioner of Insurance (the “Commissioner”). Massachusetts statute limits the dividends an insurer may pay in any twelve month period, without the prior permission of the Commissioner, to the greater of (i) 10% of the insurer’s surplus as of the preceding December 31 or (ii) the insurer’s net income for the twelve-month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices. The Company’s insurance company subsidiaries may not declare an “extraordinary dividend” (defined as any dividend or distribution that, together with other distributions made within the preceding twelve months, exceeds the limits established by Massachusetts statute) until thirty days after the Commissioner has received notice of the intended dividend and has not objected. As historically administered by the Commissioner, this provision requires the Commissioner’s prior approval of an extraordinary dividend. Under Massachusetts law an insurer may pay cash dividends only from its unassigned funds, also known as earned surplus, and the insurer’s remaining surplus must be both reasonable in relation to its outstanding liabilities and adequate to its financial needs. At year-end 2005, the statutory surplus of Safety Insurance was $350,833, and its net income for 2005 was $92,432. As a result, a maximum of $92,432 is available in 2006 for such dividends without prior approval of the Commissioner.