The following table sets forth our selected historical consolidated financial data as of and for each of the five years ended December 31, 2003. Prior to October 16, 2001, Thomas Black Corporation was the ultimate parent company of Safety Insurance. In the Acquisition, on October 16, 2001, Safety Insurance Group, Inc. became the parent company of Thomas Black Corporation.
The selected historical consolidated financial data for the years ended December 31, 2003 and 2002, the successor period October 16, 2001 to December 31, 2001, and for the predecessor period January 1, 2001 to October 15, 2001, and as of December 31, 2003 and 2002 have been derived from the financial statements of Safety Insurance Group, Inc. included in this annual report which have been audited by PricewaterhouseCoopers LLP, independent accountants. The selected historical consolidated financial data as of December 31, 2001 have been derived from Safety Insurance Group, Inc.'s consolidated financial statements not included in this annual report, which have been audited by PricewaterhouseCoopers LLP. The selected historical consolidated financial data for the years ended December 31, 2000, 1999 and as of December 31, 2000 and 1999 have been derived from Thomas Black Corporation's consolidated financial statements not included in this annual report, which have been audited by PricewaterhouseCoopers LLP. As a result of the Acquisition, financial data for periods
In connection with the Company's plan for the sale of our common stock in the IPO, the Board of Directors of Safety (the "Board") declared a 23.24 for 1 common stock split on November 12, 2002 in the form of a stock dividend that became effective immediately after the Company filed its amended and restated certificate of incorporation prior to the offering. In accordance with the provisions of FAS 128, Earnings Per Share, earnings per share presented in the consolidated financial statements of the Company have been adjusted retroactively for the stock split.
The holders of our preferred stock agreed to amend the terms of the preferred stock to cause it to automatically convert into common stock upon the closing of the IPO at the IPO price. Based upon the $12.00 per share IPO price, 1,866,665 additional common shares were issued in connection with the preferred share exchange (the "Preferred Share Exchange") upon the close of the IPO.
As of December 31, 2003, the Company had 15,259,991 common shares outstanding. The 5,809,992 common shares outstanding prior to the November 27, 2002 IPO increased to 14,359,991 at the IPO due to the addition of the new 6,333,334 common shares sold at IPO, the 350,000 common shares sold as part of the Direct Sale, and an additional 1,866,665 common shares issued in the Preferred Share Exchange. On December 5, 2002, the 14,359,991 shares outstanding increased to 15,259,991 common shares outstanding due to the underwriters purchase of an additional 900,000 common shares pursuant to their over-allotment option exercise.
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, SARs and restricted stock awards. The maximum number of shares of common stock with respect to which awards may be granted under the Incentive Plan is 1,250,000. The grants made since inception under the Incentive Plan are as follows:
(1)The exercise price is equal to the IPO price of our stock.
proposal formally to the Commissioner or others in Massachusetts government. It is uncertain whether and to what extent the issues raised by the Attorney General will be addressed by CAR. We cannot be certain whether any material changes, if adopted by CAR, would affect our profitability.
While state-mandated average maximum private passenger automobile insurance rates increased 2.7% for 2003, our average premium per automobile exposure in the twelve months ended December 31, 2003 increased from the twelve months ended December 31, 2002 by approximately 6.9%. This increase was primarily the result of purchases of new automobiles by our insureds. Further, we believe that the continued benefits of our rate pursuit initiative, which validates insured rating classifications and discount eligibility, contributed to the increase in our average premiums received per automobile exposure. The table below shows average Massachusetts-mandated private passenger automobile premium rate changes and changes in our average premium per automobile exposure from 1992-2003.
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 expenses, which
Our statutory insurance ratios for the years ended December 31, 2003, 2002 and 2001, respectively, are outlined in the following table:
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 for the years ended December 31, 2003, 2002 and 2001, respectively, are outlined in the following table:
•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 90 days, federal deferred tax assets in excess of statutory limitations, furniture, equipment, leasehold improvements and prepaid expenses.
•Equity securities are reported at quoted market values, which may differ from the National Association of Insurance Commissioners ("NAIC") market values as required by SAP.
Significant periods of time can elapse between the occurrence of an insured loss, the reporting to us of that loss and our final payment of that loss. To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities. Our reserves represent estimates of amounts needed to pay reported and unreported losses and the expenses of investigating and paying those losses, or loss adjustment expenses. Every quarter, we review our previously established reserves and adjust them, if necessary. Refer to "Results of Operations: Losses and Loss Adjustment Expenses" for a more detailed discussion.
When a claim is reported, claims personnel establish a "case reserve" for the estimated amount of the ultimate payment. The amount of the reserve is primarily based upon an evaluation of the type of claim involved, the circumstances surrounding each claim and the policy provisions relating to the loss. The estimate reflects the informed judgment of such personnel based on general insurance reserving practices and on the experience and knowledge of the claims person. During the loss adjustment period, these estimates are revised as deemed necessary by our claims department based on subsequent developments and periodic reviews of the cases.
We also maintain reserves for estimated losses incurred but not yet reported. Incurred but not yet reported reserves are determined in accordance with commonly accepted actuarial reserving techniques on the basis of our historical information and experience. We review and make adjustments to incurred but not yet reported reserves quarterly.
We use a systematic methodology to evaluate declines in market values below cost or amortized cost of our investments. This methodology ensures that we evaluate available evidence concerning any declines in a disciplined manner. Refer to "Results of Operations: Net Realized Investment Losses" for a more detailed discussion.
The table below shows certain of our selected financial results for the years ended December 31, 2003, 2002 and 2001. For comparative purposes, the predecessor and successor periods have been combined under the caption "For the Year Ended December 31, 2001."
Direct Written Premiums. Direct written premiums for the year ended December 31, 2003 increased by $54,989, or 10.6%, to $571,545 from $516,556 for the comparable 2002 period. The 2003 increase occurred primarily in our private passenger automobile line which experienced a 6.9% increase in average written premium and a 2.8% increase in written exposures. In addition, we increased our commercial automobile line average rates by 7.1% effective December 16, 2002 and had a 6.9% increase in written exposures, while we increased our homeowners line average rates by 9.3% effective February 19, 2003, which was partly offset by a 2.4% decrease in written exposures.
(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 $121,833 at fair value and $120,928 at amortized cost as of December 31, 2003. As such, the asset-backed securities presented exclude such issuers already presented under U.S. Treasury securities and obligations of U.S. Government Agencies. As of December 31, 2003, our portfolio of fixed maturity investments was comprised entirely of investment grade corporate fixed maturities securities, U.S. government and agency securities and asset-backed securities (i.e., all our securities received a rating assigned by Moody's Investors Services, Inc. of Baa or higher, except the few securities not rated by Moody's which received S&P ratings of Aaa/Aa or higher, as well as a rating assigned by the Securities Valuation Office of the National Association of Insurance Commissioners of 1 or 2).
The composition of our fixed income security portfolio by Moody's rating(1) was as follows:
Other-than-temporary impairments are recorded as a realized loss, which serves to reduce net income and earnings per share. Temporary losses are recorded as unrealized losses, which do not impact net income and earnings per share but reduce other comprehensive net income. The risks inherent in the assessment of other-than-temporary impairments include the risk that market factors may differ from our expectations; we may decide to subsequently sell a security for unforeseen business needs; or the credit assessment could change in the near term, resulting in a charge to earnings.
Of the $1,993 gross unrealized losses as of December 31, 2003, $1,593 relates to fixed maturity obligations of states and political subdivisions and U.S. government agencies. The remaining $400 of
Massachusetts law requires that we participate in the Massachusetts Insurers Insolvency Fund, which pays claims up to $300 of a policyholder of an insolvent insurer if the claim existed prior to the declaration of insolvency or arose within sixty days after the declaration of insolvency. We account for allocations from the Massachusetts Insurers Insolvency Fund as underwriting expenses. Underwriting expenses in 2003 and 2002 included $3,423 and $2,103 of charges representing our allocation from the Massachusetts Insurers Insolvency Fund. Although the timing and amounts of any future assessments are not known, based upon existing knowledge, management's opinion is that such future assessments will not have a material effect on the consolidated financial position of the Company.
unamortized deferred debt issuance costs related to the Acquisition debt which were expensed upon the repayment of this debt, concurrent with the IPO.
Interest Expense. Interest expense for the year ended December 31, 2003 decreased by $6,608 to $646 from $7,254 for the comparable 2002 period. Interest expense for the 2002 period was related to old debt facilities that were extinguished concurrent with Safety's IPO on November 27, 2002. Primarily as a result of the IPO, Safety significantly reduced debt outstanding to $19,956 at December 31, 2003 from $96,500 prior to the November 27, 2002 IPO.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Direct Written Premiums. Direct written premiums for the year ended December 31, 2002 increased by $44,690, or 9.5%, to $516,556 from $471,866 for the comparable 2001 period. This increase was primarily due to an approximate 5.2% increase in the average written premium per automobile exposure on our private passenger automobile business, a 2.2% increase in our private passenger automobile written exposures, and a 7.6% increase in our commercial automobile written exposures. We also increased our average rates on commercial automobile insurance by 7.2% effective January 1, 2002, and in addition we increased our average rates on homeowners insurance by 9.8% effective February 19, 2002.
Net Written Premiums. Net written premiums for the year ended December 31, 2002 increased by $52,148, or 11.2%, to $517,614 from $465,466 for the comparable 2001 period. This increase was primarily due to the increase in direct written premiums, and an increase in assumed premiums from CAR.
Of the $926 gross unrealized losses as of December 31, 2002, $99 relates to fixed maturity obligations of states and political subdivisions, and U.S. government agencies. The remaining $827 of gross unrealized losses relates to holdings of investment grade asset-backed, corporate and other fixed maturities securities.
Gross unrealized losses for the year ended December 31, 2002 decreased from $8,083 at December 31, 2001 to $926 at December 31, 2002. During the year ended December 31, 2002, there was a significant deterioration in the credit quality of two of our holdings in the telecommunications
sector. The Company recognized an after-tax realized loss of $2,020 for one of these securities sold in June and recorded an other-than-temporary impairment charge of $1,043 for the other telecommunications security. During September 2002, this other security was sold at a realized loss of $79. For the year ended December 31, 2001, we did not record any other-than-temporary impairment charges relating to our portfolio of investment securities.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses incurred for the year ended December 31, 2002 increased $23,236, or 6.6%, to $375,178 from $351,942 for the comparable 2001 period. Our GAAP loss ratio for the year ended December 31, 2002 decreased to 76.7% compared to 78.7% for the comparable 2001 period. Our GAAP loss ratio, excluding loss adjustment expenses for the year ended December 31, 2002 increased to 68.3% compared to 67.9% for the year ended December 31, 2001. We experienced higher assumed residual market losses during the year ended December 31, 2002 than for the year ended December 31, 2001, which is the result of our increased share of 2002 CAR results, a higher CAR loss ratio and strengthening of prior year CAR reserves. Finally, in 2002 we released $2,262 of loss reserves related to prior years, compared to $7,303 in 2001.
Underwriting, Operating and Related Expenses. Underwriting, operating and related expenses for the year ended December 31, 2002 increased by $11,060, or 9.4%, to $128,866 from $117,806 for the comparable 2001 period. Our GAAP expense ratios (a percentage of net premiums earned) were 26.3% for the years ended December 31, 2002 and 2001.
Underwriting, operating and related expenses for the year ended December 31, 2002 included $4,476 in compensation expenses related to put and call options on shares held by management, while the comparable 2001 period included $6,801 related to $3,354 of expense incurred under the employee stock ownership plan and the supplemental executive stock ownership plan, both of which were terminated at the Acquisition, $2,000 in compensation paid to our former majority owner, $1,238 in compensation expense related to put and call options on shares held by management and $209 in fees paid to TJC Management.
Transaction Expenses. Transaction expenses for the year ended December 31, 2002 decreased to $0 from $9,479 for the comparable 2001 period. The transaction expenses for the year ended December 31, 2001 represent costs incurred by the seller and paid by us in connection with the Acquisition. Such seller costs primarily included transaction expenses in the predecessor period related primarily to transaction bonuses to employees, fees paid to Thomas Black Corporation's investment banker and legal fees. These costs were non-recurring in nature and did not result from ongoing insurance operations.
Other Expenses. Other expenses for the year ended December 31, 2002 increased to $6,250 from $0 for the comparable 2001 period. Other expenses are comprised of $4,000 of TJC management
Income Taxes. Our effective tax rate on net income before preferred stock dividends was 10.9% and 33.0% for the year ended December 31, 2002 and 2001, respectively. For the year ended December 31, 2002, the effective rate was lower than the statutory rate of 35% primarily due to adjustments for tax-exempt investment income. For the year ended December 31, 2001, the effective tax rate was lower than the statutory rate of 35% primarily due to adjustments for tax-exempt investment income, offset by non-deductible employee stock ownership plan and certain Acquisition related transaction expenses. See note 13 to our consolidated financial statements.
Net cash used for financing activities was $4,473 during the year ended December 31, 2003, which resulted from dividends paid to shareholders less paydown of management notes. Financing activities were a source of $776 liquidity for us during the year ended December 31, 2002 when we obtained cash to pay down our long-term debt principally from borrowings under our new 2002 credit facility, and also from issuing our common stock in our IPO that closed November 27, 2002.
When we completed the Preferred Share Exchange at the closing of the IPO, all of our outstanding preferred stock was converted into shares of our common stock, valued at the IPO price. Based on the IPO price of $12.00 per share, we issued an aggregate of 1,866,665 shares of common stock in the Preferred Share Exchange. We used proceeds from the IPO, the Direct Sale and our new 2002 credit facility to pay accrued dividends of $1,500 on the preferred shares on that date.
On both February 24, 2004 and November 21, 2003, our Board approved a quarterly cash dividend on our common stock of $0.10 per share, or $1,526 based on 15,259,991 common shares outstanding, paid on March 15, 2004 and December 15, 2003 to shareholders of record on March 1, 2004 and December 1, 2003, respectively. On August 21, 2003, our Board approved an increase in our quarterly cash dividend from $0.07 per share to $0.10 per share, or $1,526 based on 15,259,991 common shares outstanding, paid on September 15, 2003 to shareholders of record on September 1, 2003. On both May 22 and February 20, 2003, our Board approved a quarterly cash dividend on our common stock of $0.07 per share, or $1,068 based on 15,259,991 common shares outstanding, paid on June 16 and March 17, 2003 to shareholders of record on June 2 and March 3, 2003, respectively. We plan to continue to declare and pay quarterly cash dividends in 2004, depending on our financial position and the regularity of our cash flows.
Management believes that the current level of cash flow from operations provides us with sufficient liquidity to meet our operating needs over the next 12 months. We expect to be able to continue to meet our operating needs after the next 12 months from internally generated funds. Since our ability to meet our obligations in the long term (beyond such 12-month period) is dependent upon such factors as market 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.
We have no material obligations under a guarantee contract meeting the characteristics identified in paragraph 3 of Financial Accounting Standards Board ("FASB") Interpretation No. ("FIN") 45, "Guarantor's Accounting and Disclosure Requirements, Including Indirect Guarantees of Indebtedness of Others". We have no material retained or contingent interests in assets transferred to an unconsolidated entity. We have no material obligations, including contingent obligations, under contracts that would be accounted for as derivative instruments. We have no obligation, including contingent obligations, arising out of a variable interest in an unconsolidated entity held by, and material to, us, where such entity provides financing, liquidity, market risk or credit risk support to, or engages in leasing, hedging or research and development services with us. We have no direct investments in real estate and no holdings of mortgages secured by commercial real estate. Accordingly, we have no material off-balance sheet arrangements.
Forward-looking statements might include one or more of the following, among others:
In our opinion, the accompanying consolidated statements of operations, changes in shareholders' equity, comprehensive income and cash flows present fairly, in all material respects, the results of operations and cash flows of Safety Insurance Group, Inc. and its subsidiaries (formerly Thomas Black Corporation) for the period from January 1, 2001 through October 15, 2001 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit 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.
The Company is a leading provider of personal lines property and casualty insurance focused exclusively on the Massachusetts market. Its principal product line is private passenger automobile insurance, which accounted for 81.0% of its direct written premiums in 2003. The Company operates through its insurance company subsidiaries, Safety Insurance Company and Safety Indemnity Insurance Company (together referred to as the "Insurance Subsidiaries").
The Company was incorporated on June 25, 2001, in the State of Delaware. On October 16, 2001, the Company acquired (the "Acquisition") all of the issued and outstanding common stock of TBC and its property and casualty subsidiaries for $121,076. In connection with the Acquisition, an allocation of purchase price of $121,076 was made to the estimated fair values of the assets acquired and the liabilities assumed as of the acquisition date of October 16, 2001 as follows:
In connection with the Company's sale of its common stock in the IPO, the Company changed its name to Safety Insurance Group, Inc. In conjunction with the IPO, the Board of Directors of the Company (the "Board") declared a 23.24 for 1 common stock split on November 12, 2002 in the form of a stock dividend that became effective immediately after the time the Company filed its amended and restated certificate of incorporation, prior to the IPO. In accordance with the provisions of FAS 128, "Earnings Per Share", all earnings per share for the successor period presented in the consolidated financial statements of the Company for the successor period have been adjusted retroactively for the stock split. The stock appreciation rights ("SARs") and restricted shares referred to in Note 6 have been similarly adjusted for the stock split.
As of December 31, 2002, the Company had 15,259,991 common shares outstanding. The 5,809,992 common shares outstanding prior to our November 27, 2002 IPO increased to 14,359,991 at the IPO due to the addition of the new 6,333,334 common shares sold at IPO, the 350,000 common shares sold as part of the Direct Sale, and an additional 1,866,665 common shares issued in the Preferred Share Exchange. As of December 31, 2002, the 14,359,991 shares outstanding increased to 15,259,991
common shares outstanding due to the underwriters purchase of an additional 900,000 common shares pursuant to their over-allotment option exercise on December 5, 2002.
Cash equivalents consist of money market accounts, which are stated at fair value.
Amounts which vary with and are primarily related to acquiring new and renewal business, principally commissions and premium taxes, are deferred and amortized ratably over the effective period of the policies. All other acquisition expenses are charged to expenses as incurred. Deferred policy acquisition costs are reviewed to determine if they are recoverable from future income, and if not, are charged to expense. Future investment income attributable to related premiums is taken into account in measuring the recoverability of the carrying value of this asset. All other acquisition expenses are charged to expense as incurred. Amortization of acquisition costs in the amount of $82,203, $69,644, $13,424, and $46,513 were charged to underwriting expenses for the years ended December 31, 2003 and 2002, for the period October 16, 2001 through December 31, 2001, and for the period January 1, 2001 through October 15, 2001, respectively.
Equity and deposits in pools represents the net receivable cash amounts due from the residual market mechanisms, Commonwealth Automobile Reinsurers ("CAR"), for automobile and Massachusetts Property Insurance Underwriting Association, for homeowner insurance in Massachusetts. See Note 10 for a discussion of the Company's accounting for amounts assumed from residual markets.
Methods of depreciation and useful lives by asset category are as follows:
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 $21,551 and $18,820 at December 31, 2203 and 2002, respectively.
In accordance with the provisions of EITF 85-1, "Classifying Notes Received for Capital Stock," all outstanding principal and accrued interest related to these notes are recorded as contra-equity in the consolidated financial statements.
See Note 12 for terms of promissory notes received from management.
Deferred income taxes are generally recognized when assets and liabilities have different values for financial statement and tax reporting purposes, and for other temporary taxable and deductible differences 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.
The fair value of stock options used to compute pro forma net income and earnings per share disclosures for the years ended December 31, 2003 and 2002 is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions:
In June 2001, the FASB issued FAS 141, "Business Combinations". FAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. With respect to deferred credits (i.e. negative goodwill), FAS 141 calls for the recognition of all existing deferred credits arising from business combinations for which the Acquisition date was after June 30, 2001 to be recognized through the income statement as an extraordinary gain. Effective with the Acquisition, the Company adopted FAS 141 and accounted for the Acquisition under the purchase method. The Company recognized the resultant deferred credit of $117,523 through earnings as an extraordinary gain in the successor period of 2001.
In May, 2003, the FASB issued FAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities, equity or both in its statement of financial position. At December 31, there are no financial instruments held by the Company for which FAS 150 would apply.
In July 2003, FIN 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51" was issued. FIN 46 provides guidance regarding the application of Accounting Research Bulletin No. 51, Consolidated Financial Instruments. The adoption of FIN 46 did not have an impact on the Company's financial statements at December 31, 2003.
In January 2003, the FASB issued an exposure draft of EITF 03-1, "The Meaning of Other-Than-Temporary Impairment ("OTTI") and Its Application to Certain Investments". The exposure draft offers different views on how OTTI should be defined and provides new disclosure requirements for OTTI on debt and equity investments. In July 2003, the Task Force discussed the model for various types of securities investments and suggested further refinements to the model. The adoption of EITF 03-01 did not have a material impact on the Company's financial statements at December 31, 2003. The Company has included the new disclosure requirements for the year ended December 31, 2003 in Note 4.
The gross unrealized appreciation (depreciation) of investments in fixed maturities securities was as follows:
Gross gains of $11,141 and $4,022 and gross losses of $253 and $3,256 were realized on sales of fixed maturities for years ended December 31, 2003 and 2002, respectively. Gross gains of $1,009 and $2,832 and gross losses of $5,293 and $3,598 were realized on sales of fixed maturities for the for the period October 16, 2001 through December 31, 2001 and for the period January 1, 2001 through October 15, 2001, respectively. Proceeds from fixed maturities maturing were $0, $71,750, $0, and $21,625 for the years ended December 31, 2003 and 2002, for the period October 16, 2001 through December 31, 2001, and for the period January 1, 2001 through October 15, 2001.
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, 2003.
The Company's investment portfolio included 43 securities in an unrealized loss position at December 31, 2003. 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
The Company entered into SARs agreements with executive management on October 16, 2001. Under the terms of the agreements, the Company granted 103,488 SARs on October 16, 2001 for past and future services. The agreements designated the number of "covered shares" for each executive and other employees and established the exercise price of $6.88 per share. Prior to the IPO, the SARs were to vest 20% at the end of each year commencing on December 31, 2002. As of the close of the IPO, the SARs became fully vested and were automatically exercised. Soon thereafter, the participants each received a cash payment equal to the excess of the $12.00 IPO price per common share over the exercise price of $6.88 per share.
For the successor period ended December 31, 2001, no compensation expense was recorded related to the SARs. Upon the close of the IPO, compensation expense related to the SARs of $529 was recognized as a charge to earnings.
On October 16, 2001, the Company entered into a management subscription agreement with certain employees. The management subscription agreement contained certain Company call and employee put options that allowed the employee to put the stock owned by the employee at the time of exercise at a price based upon a formula calculation to the Company under certain circumstances outside of the Company's control and within the employee's control (e.g., employee retirement or resignation). The management subscription agreement was being accounted for as a variable plan in accordance with EITF 00-23, "Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44", whereby employee compensation expenses were being recorded over the period of service of the employee in accordance with FIN 28. Compensation expense related to the management subscription agreement totaled $0, $4,476 and $1,121 for the years ended December 31, 2003 and 2002 and the successor period ended December 31, 2001, respectively.
Prior to the Acquisition, TBC also had a supplemental executive stock ownership plan (the "XSOP"). The XSOP provided certain employees not eligible to fully participate in the ESOP under the applicable provisions of the Internal Revenue Code and ERISA with benefits they would have been entitled to under the provisions of the ESOP. Total compensation expense related to the XSOP during the predecessor period ended October 15, 2001 was $1,119. The net credit to compensation expense for the predecessor period ended October 15, 2001 is comprised of a credit to compensation expense of $2,478 resulting from the revaluation of the December 31, 2000 XSOP obligation at the 2001 fair value of TBC's shares and an expense of $1,359 relating to the compensation earned by employees in the 2001 predecessor period. There was no compensation expense for the successor period ended December 31, 2001 and the years ended December 31, 2003 and 2002 related to the XSOP. There was no XSOP obligation at December 31, 2002. The XSOP Plan was terminated in conjunction with the Acquisition.
In 1995, upon the inception of the ESOP, management discontinued all employer and employee contributions to its then existing qualified defined contribution profit-sharing/retirement plan (the "Retirement Plan"). As a result, the rights of each participant to his /her account on the date of the discontinuance of contributions, to the extent of the fair market value under the general investment fund, became fully vested and nonforfeitable.
(1)The exercise price is equal to the IPO price of our common stock.
The following table summarizes activity and outstanding options under the plan:
Massachusetts law requires that insurers licensed to do business in Massachusetts participate in the Massachusetts Insurers Insolvency Fund ("Insolvency Fund"). Members of the Insolvency Fund are assessed a proportionate share of the obligations and expenses of the Insolvency Fund in connection with an insolvent insurer. It is anticipated that there will be additional assessments from time to time relating to various insolvencies. In 2003, 2002 and 2001, the Company received notice of assessments from the Insolvency Fund amounting to $3,423, $2,103 and $1,398, which it expensed for the years ended December 31, 2003, 2002 and 2001, respectively.
At December 31, 2003 and 2002, the Company had utilized advances of $19,956. The interest rate was 2.81% at December 31, 2003 and an average of 3.22% for the year ended December 31, 2003. The interest rate was 3.20% at December 31, 2002 and an average of 3.34% for the year ended December 31, 2002.
The new credit facility contains specific financial and operating covenants, including requirements to maintain minimum risk-based capital ratios and statutory surplus of Safety Insurance Company as well as limitations or restrictions on indebtedness, liens, dividends, and other matters. The Company is in compliance with these debt covenants at December 31, 2003.
As part of the funding for the Acquisition, the Company entered into a $20,000 revolving credit facility and a $55,000 senior secured term loan with a bank in October 2001. The obligations of the Company on these loans were collateralized by (i) a 100% pledge of the stock of Safety Insurance Company, RBS, Inc. and TBIA, and (ii) a perfected first priority security interest, subject to permitted liens, in all of the assets, whenever acquired, of TBC, RBS, Inc. and TBIA. Both loans bore interest at LIBOR plus 3.75%. The Company utilized the net proceeds from the IPO and the new secured revolving credit facility to repay $66,550 of indebtedness (including accrued interest), thereby paying off this prior credit facility.
The Company also issued $30,000 of senior subordinated notes to obtain funds for the Acquisition. Interest was payable semi-annually on each April 30 and October 31. The senior subordinated notes were to mature December 31, 2011 and could be redeemed at the option of the Company prior to maturity with no redemption premium or penalty. The senior subordinated notes bore an interest rate of 13%. The Company utilized the net proceeds from the IPO and the new secured revolving credit facility to repay $30,293 of indebtedness (including accrued interest), thereby paying off these notes.
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 are as follows:
The preferred stock at December 31, 2001 was carried in the financial statements at its liquidation preference of $22,400 plus accrued dividends of $280. A total of $1,499 of dividends was accrued through the closing of the IPO and paid to the holders of the preferred stock concurrent with the Preferred Share Exchange.
At the end of each period, the reserves were re-estimated for all prior accident years and were increased by $181 for the year ended December 31, 2003 and decreased by $2,262, $703, and $6,600 for the year ended December 31, 2002, the period October 15, 2001 through December 31, 2001, and the the period January 1, 2001 through October 15, 2001, respectively. Conditions and trends that have affected development of the loss and LAE reserves in the past may not necessarily occur in the future.
The agreement, which was amended concurrent with the IPO, provides for:
In connection with the Acquisition, each member of the executive management team issued a recourse promissory note to, and entered into a pledge agreement with the Company. Pursuant to the notes, the Company loaned management an aggregate of $695 in order to purchase common stock in connection with the Acquisition and the Restricted Stock Plan. Pursuant to pledge agreements, the management team pledged the common stock back to the Company as security for the loans made under the promissory notes. The notes bear interest at a rate of 5% annually and are due and payable on the earlier of December 31, 2011 or 90 days after any management team member ceases to be an employee of the Company. Each member may prepay his note at any time without penalty. During the year ended December 31, 2003, the Company received $715 in payments of outstanding loan principal and accrued interest. At December 31, 2003 and 2002, the loans are carried in the financial statements at $34 and $737 which represents the outstanding principal and accrued interest on the notes. Such loans have been recorded as contra-equity in accordance with the accounting policy described in Note 3.
Gross deferred income tax assets prior to valuation allowances totaled $35,475 and $32,917 at December 31, 2003 and 2002, respectively. Gross deferred income tax liabilities totaled $23,232 and $23,596 at December 31, 2003 and 2002, respectively.
The Company believes, based upon consideration of objective and verifiable evidence, including its recent earnings history and its future expectations, that the Company's taxable income in future years will be sufficient to realize all federal deferred tax assets. A valuation allowance of $3,551 and $3,076 was established in 2003 and 2002 against state net operating loss carryforwards. This valuation allowance is based upon management's assessment that it is more likely than not that the Company will not be able to utilize these state deferred tax assets. There were available alternative minimum tax credit carry forwards of $0 and $166 at December 31, 2003 and 2002, respectively.
The Company's Insurance Subsidiaries, domiciled in the Commonwealth of Massachusetts, prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by the Division. Statutory net income of the Company's insurance subsidiaries was $28,480, $21,496, and $10,300 for the years ended December 31, 2003, 2002 and 2001, respectively. Statutory capital and surplus of the Company's insurance subsidiaries was $258,551 and $234,204 at December 31, 2003 and 2002, respectively. In 1998, the National Association of Insurance Commissioners ("NAIC") adopted the Codification of Statutory Accounting Principles guidance, which replaces the current accounting practices and procedures manual as the NAIC's primary guidance on statutory accounting as of January 1, 2001. The codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas, e.g., deferred income taxes are recorded. The Division has adopted the codification guidance, effective January 1, 2001. The effect of adoption was an increase to the statutory capital and surplus of the Company's insurance subsidiaries of approximately $16,162.
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 2003, the statutory surplus of Safety Insurance was $258,551, and its net income for 2003 was $27,007. A maximum of $27,007 will be available by the end of 2004 for such dividends without prior approval of the Commissioner.
At December 31, 2003 and 2002, investments in fixed maturities had a fair value, which equaled carrying value, of $673,636 and $603,886, respectively. There were no investments in fixed maturities for which a quoted market price or dealer price was not available at December 31, 2003 and 2002, respectively.