On June 20, 2007, we applied for admission in the State of New Hampshire for a Certificate of Authority to transact insurance business. On October 16, 2007, the State of New Hampshire Insurance Department issued a Certificate of Authority for property and casualty insurance to each of our Insurance Subsidiaries. We began writing private passenger automobile and homeowners business in New Hampshire on October 15, 2008.
The Commissioner's decision to implement an assigned risk plan brought to a close a lengthy period of regulatory and judicial consideration of the Massachusetts private passenger residual market.
The Commissioner has issued a number of bulletins addressing issues related to the implementation of Managed Competition (the "Rating Bulletins"). Rating Bulletins 2007-07, 2007-08, and 2008-09 limit rates to not more than 110% of what the previous year's premium rate level would
The Commissioner has also issued a number of Rating Bulletins for policies effective April 1, 2009 through March 31, 2010. Rating Bulletin 2008-09 limits residual market (MAIP) rates to 110% of what the 2008 premium rate level would have been for each risk. Rating Bulletin 2008-11 limits voluntary market rates to a level no higher than the rates in the residual market. Rating Bulletin 2008-17 describes how companies may place risks among company affiliates within an insurer group.
For the year ended December 31, 2008, our average private passenger automobile premium per exposure decreased by 7.9% from the year ended December 31, 2007. The table below shows average Massachusetts private passenger automobile premium rate changes and changes in our average premium per automobile exposure.
(1)Source: Commissioner rate decisions for 1998-2007 and Safety Insurance for 2008. The 11.7% average rate decrease in 2007 was in effect for the period April 1, 2007 through March 31, 2008. Under Managed Competition, the 6.7% average rate decrease in 2008 is effective for the period April 1, 2008 through March 31, 2009. (2)Source: Safety Insurance. Statutory Accounting Principles
•Amounts related to ceded reinsurance are shown gross of ceded unearned premiums and reinsurance recoverables, rather than netted against unearned premium reserves and loss and loss adjustment expense reserves, respectively, as required by SAP.
(1)The exercise price of the options grant effective on November 27, 2002, is equal to the IPO price of our stock on that same day. The exercise price of the remaining option grants is equal to the closing price of our common stock on the grant date. (2)The fair value per share of the restricted stock grant is equal to the closing price of the Company's common stock on the grant date. (3)The shares cannot be sold, assigned, pledged, or otherwise transferred, encumbered or disposed of until the recipient is no longer a member of our Board of Directors. Reinsurance
The following tables present the point estimation of the recorded reserves and the range of estimations by line of business for net loss and LAE reserves as of December 31, 2008 and December 31, 2007.
The following tables present our total net reserves and the corresponding case reserves and IBNR reserves for each line of business as of December 31, 2008 and December 31, 2007.
For our private passenger automobile, commercial automobile and homeowners lines of business as of December 31, 2008 and 2007, due to the relatively long time we have been writing these lines of insurance, and our stable long-term trends in frequency and severity, the range of reserves is relatively narrow. For our all other lines of business as of December 31, 2008 and 2007, due to the relatively short time we have been writing these lines of business, the sparse amount of data and the resulting immature history available for our analysis, the range of reserves is relatively wide. We have recorded reserves closer to the high in the ranges of our projections.
The following tables present information by line of business for our total net reserves and the corresponding retained (i.e. direct less ceded) reserves and assumed reserves as of December 31, 2008 and December 31, 2007.
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, 2007 we had to estimate our 2007 policy year CAR Participation Ratio beginning with the first quarter of 2007 through the second quarter of 2008.
using a variety of methods. Any delays or errors in the collection of this data could have a significant impact on the accuracy of CAR's estimations.
The portion of reserves based upon CAR estimates should decline over time as a result of the institution of the MAIP and phase-out of the CAR reinsurance pool, as described elsewhere in this report.
Establishment of appropriate reserves is an inherently uncertain process. There can be no certainty that currently established reserves based on our key assumptions regarding frequency and severity in our lines of business, or our assumptions regarding our share of the CAR loss will prove adequate in light of subsequent actual experience. To the extent that reserves are inadequate and are strengthened, the amount of such increase is treated as a charge to earnings in the period that the deficiency is recognized. To the extent that reserves are redundant and are released, the amount of the release is a credit to earnings in the period the redundancy is recognized. For the year ended December 31, 2008, a 1 percentage-point change in the loss and LAE ratio would result in a change in reserves of $5,766. Each 1 percentage-point change in the loss and loss expense ratio would have had a $3,748 effect on net income, or $0.23 per diluted share.
The changes we have recorded in our reserves in the past illustrate the uncertainty of estimating reserves. Our prior year reserves decreased by $35,938, $30,791 and $42,747 for the years ended December 31, 2008, 2007 and 2006, respectively.
The decreases in prior years reserves during the 2008 period resulted from re-estimations of prior year ultimate loss and LAE liabilities. The 2008 decrease is primarily composed of reductions of $21,752 in our retained automobile reserves and $8,905 in CAR assumed reserves. The decreases in prior years reserves during the 2007 period resulted from re-estimations of prior year ultimate loss and LAE liabilities. The 2007 decrease is primarily composed of reductions of $15,503 in our retained automobile reserves and $11,335 in CAR assumed reserves. The decrease in prior year reserves during the 2006 period resulted from re-estimations of prior year ultimate loss and LAE liabilities and is
composed primarily of a reduction of $23,945 in the Company's retained automobile reserves and a reduction of $14,006 in CAR assumed reserves.
The following table presents information by line of business for prior year development of retained (i.e., direct minus ceded) reserves for losses and LAE for the year ended December 31, 2008; 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, 2008.
Our private passenger automobile line of business prior year reserves decreased by $26,960 for the year ended December 31, 2008. The decrease was primarily due to improved retained private passenger results of $17,313 for the accident years 2002 through 2007, and improved assumed CAR results for the private passenger automobile pool of $7,847 for accident years 2004 through 2007. The improved CAR results were due primarily to improved CAR private passenger loss ratios as published and reported by the CAR Loss Reserving Committee meetings. The improved retained private passenger results were primarily due to fewer IBNR claims than previously estimated and better than previously estimated severity on our established bodily injury and property damage case reserves.
In our determination of whether a decline in fair value below amortized cost is an other-than-temporary impairment, we consider and evaluate several factors and circumstances including the issuer's overall financial condition, the issuer's credit and financial strength ratings, a weakening of the general market conditions in the industry or geographic region in which the issuer operates, a prolonged period (typically six months or longer) in which the fair value of an issuer's securities remains below our amortized cost, our ability and intent to hold these investments for a period of time
Net Written Premiums. Net written premiums for the year ended December 31, 2008, decreased by $47,668 or 7.9% to $552,904 from $600,572 for 2007. This decrease was primarily due to the factors that decreased direct written premiums combined with decreases in premiums assumed from CAR, and partially offset by decreases in premiums ceded to CAR. These decreases in CAR premiums are primarily due to the replacement of the current reinsurance program run by CAR with an assigned risk
Net Earned Premiums. Net earned premiums for the year ended December 31, 2008, decreased by $32,652, or 5.4%, to $576,556 from $609,208 for 2007. This decrease was due to the factors that decreased direct and net written premiums.
Ratings are assigned by Moody's, or the equivalent, as discussed above. Such 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.
Of the $28,410 gross unrealized losses as of December 31, 2008, $6,376 relates to fixed maturity obligations of U.S. Government agencies and obligations of states and political subdivisions. The remaining $22,034 of gross unrealized losses relates primarily to holdings of investment grade asset-backed, corporate, other fixed maturity and equity securities.
During the year ended December 31, 2008, there was a significant deterioration in the issuer's financial condition of one of our holdings, American International Group, Inc. Accordingly, we recorded an other-than-temporary impairment charge of $1,032 for this security. During the year ended December 31, 2007, there was no significant deterioration in the credit quality of any of our other holdings.
We use observable inputs for the vast majority of our investment portfolio. Fair value measurements for securities for which quoted prices are unavailable are estimated based upon reference to observable inputs, such as benchmark interest rates, market comparables, broker quotes and other relevant inputs. In circumstances where quoted prices or observable inputs are adjusted to reflect management's best estimate of fair value, such fair value measurements are considered a lower level measurement in the FAS 157 fair value hierarchy.
As of December 31, 2008, approximately 99.8% of the investment portfolio recorded at fair value was priced based upon quoted market prices or other observable inputs. The following table
Underwriting, Operating and Related Expenses. Underwriting, operating and related expense for the year ended December 31, 2008 increased by $2,330 or 1.4%, to $172,987 from $170,657 for the
Interest Expenses. Interest expense for the year ended December 31, 2008 was $81 compared to $83 for the comparable 2007 period. The credit facility commitment fee included in interest expense was $75 for both 2008 and 2007.
Direct Written Premiums. Direct written premiums for the year ended December 31, 2007, decreased by $9,663, or 1.5% to $619,848 from $629,511 for 2006. The 2007 decrease occurred primarily in our personal automobile line, as a result of a state mandated private passenger rate decrease of 11.7% effective April 1, 2007. Our personal automobile line experienced a 5.5% decrease in average written premium and a 2.6% increase in written exposures. Our commercial automobile line's average written premium decreased by 4.0% with a 1.9% decrease in written exposures. Partially offsetting these decreases was an increase in our average written premium in our homeowners line by 6.6% with a 8.8% increase in written exposures.
In our determination of other-than-temporary impairments, we consider several factors and circumstances including the issuer's overall financial condition, the issuer's credit and financial strength ratings, a weakening of the general market conditions in the industry or geographic region in which the issuer operates, a prolonged period (typically six months or longer) in which the fair value of an issuer's securities remains below our amortized cost, our ability and intent to hold these investments for
a period of time sufficient to allow for recovery of our costs, and any other factors that may raise doubt about the issuer's ability to continue as a going concern.
Safety Insurance's sources of funds primarily include premiums received, investment income and proceeds from sales and redemptions of investments. Safety Insurance's principal uses of cash are the payment of claims, operating expenses and taxes, the purchase of investments and payment of dividends to Safety.
Net cash provided by operating activities was $72,815, $116,828, and $101,227 during the years ended December 31, 2008, 2007 and 2006, respectively. The 2008 decline in net cash provided by operating activities was primarily due to the decrease of $46,339 in direct written premiums, as discussed above. 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.
We had no amounts outstanding on our credit facility at December 31, 2008 and December 31, 2007. The credit facility commitment fee included in interest expenses was computed at a rate of 0.25% on the $30,000 commitment at December 31, 2008 and 2007.
Our 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 Commissioner. The 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. Our 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
On February 17, 2009, our Board approved a quarterly cash dividend on our common stock of $0.40 per share which will be paid on March 13, 2009 to shareholders of record on March 2, 2009. We plan to continue to declare and pay quarterly cash dividends in 2009, 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 twelve-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 obligations to make future payments under contracts and credit-related financial instruments and commitments. At December 31, 2008, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:
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 for fixed maturity securities are based on estimates obtained from independent pricing services. Fair values for equity securities are derived from external market quotations. Short term investments, which consist of U.S. Treasury bills, are reported at amortized cost which approximates fair value. 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 (loss) income, net of 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.
The Company and its subsidiaries file a consolidated United States ("U.S.") federal income tax return. The method of allocation among members of the consolidated group is subject to a written agreement approved by the Board of Directors (the "Board"). The consolidated tax liability is allocated on the basis of the members' proportionate contribution to consolidated taxable income.
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.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115," which is effective for fiscal years beginning after November 15, 2007. This statement permits an entity to choose to measure many financial instruments and certain other items at
fair value at specified election dates. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The Company has chosen not to elect the fair value option permitted by this statement.
In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, "The Hierarchy of Generally Accepted Accounting Principles," which identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States ( the GAAP hierarchy). This Statement is effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board (PCAOB) amendments to AU Section 411, "The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles." The Company does not expect this statement will have a material impact on its consolidated results of operations or financial position.
The following tables illustrate the gross unrealized losses included in the Company's investment portfolio and the fair value of those securities aggregated by investment category. The tables also illustrate the length of time that they have been in a continuous unrealized loss position.
Depreciation and amortization expense for the years ended December 31, 2008, 2007 and 2006 was $2,443, $1,153 and $850, respectively.
(1)The exercise price of the options grant effective on November 27, 2002, is equal to the IPO price of our stock on that same day. The exercise price of the remaining option grants is equal to the closing price of our common stock on the grant date. (2)The fair value per share of the restricted stock grant is equal to the closing price of the Company's common stock on the grant date. (3)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. Stock Options
The fair value of stock options used to compute both pro forma and actual net income and earnings per share disclosures for the years ended December 31, 2008, 2007 and 2006 is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions:
At December 31, 2008, the aggregate intrinsic value of outstanding shares under option was $1,629 with a weighted average remaining contractual term of 6.3 years. At December 31, 2007, the aggregate intrinsic value of outstanding shares under option and exercisable was $3,552 with a weighted average remaining contractual term of 6.7 years. Aggregate intrinsic value represents the total pretax intrinsic value, based upon the Company's closing stock price of $38.06 on December 31, 2008, which would have been received by the option holders had all option holders exercised their options as of that date. The range of exercise prices on stock options outstanding under the Incentive Plan was $12.00 to $42.85 at December 31, 2008, 2007, and 2006. There were no options granted during the twelve months ended December 31, 2008 and 2007. The weighted average grant-date fair value of options granted during the twelve months ended December 31, 2006 was estimated at $16.05. The total intrinsic value of options exercised during the twelve months ended December 31, 2008, 2007 and 2006 was $2,227, $618 and $8,963, respectively.
A summary of the status of non-vested options as of December 31, 2008, is presented below:
Cash received from options exercised was $1,416, $426 and $3,497 for the years ended December 31, 2008, 2007, and 2006, respectively.
The Company has various non-cancelable long-term operating leases. The approximate minimum annual rental payments due under these lease agreements as of December 31, 2008 are as follows:
We are engaged in ongoing discussions with the AG with respect to the matters raised in the February 2, 2009 letter. In view of the uncertainties involved in this matter and its early stage, we are unable to predict the outcome of this matter and have not established any reserve in connection with it.
During 2003, the Company entered into a three year lease agreement to finance acquisitions of new equipment. There are no amounts due under the capital lease obligation at December 31, 2008 and December 31, 2007. Minimum payments due as of December 31, 2006 were $39 under this obligation.
The Company is subject to concentration of credit risk with respect to reinsurance ceded to CAR. At December 31, 2008 and 2007, respectively, reinsurance receivables on paid and unpaid loss and LAE with a carrying value of $70,717 and $80,702 and ceded unearned premiums of $18,378 and $25,738 were associated with CAR. The Company assumes a proportionate share of the obligations from CAR. The Company makes an estimate of its share of assumed activity from the most recent quarter reported by CAR and records adjustments to the reported activity to reflect its anticipated final assumed obligations. The Company's participation in CAR resulted in assumed net losses of $4,251, $4,962 and $4,753 for the years ended December 31, 2008, 2007 and 2006, respectively.
The effect of reinsurance on net written and earned premiums and losses and LAE is as follows:
At the end of each period, the reserves were re-estimated for all prior accident years. The Company's prior year reserves decreased by $35,938, $30,791, and $42,747 for the years ended December 31, 2008, 2007, and 2006, respectively. The decrease in prior year reserves during 2008 resulted from re-estimations of prior years ultimate loss and LAE liabilities and is primarily composed of reductions of $21,752 in our retained automobile reserves and $8,905 in reserves assumed from CAR ("CAR"). The decrease in prior year reserves during 2007 resulted from re-estimations of prior years ultimate loss and LAE liabilities and is primarily composed of reductions of $15,503 in our retained automobile reserves, $11,335 in CAR assumed reserves and $2,941 in our retained homeowner's reserves. The decrease in prior year reserves during 2006 resulted from re-estimations of prior years ultimate loss and LAE liabilities and is primarily composed of reductions of $23,945 in our retained automobile reserves, $14,006 in CAR assumed reserves, $3,430 in our retained homeowners reserves and $686 in FAIR Plan assumed reserves.
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 $1,619 and $1,728 was established against state deferred tax assets at December 31, 2008 and 2007, respectively. 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.
During the twelve months ended December 31, 2008, the Company purchased 183,889 of its common shares on the open market under the program at a cost of $5,931. During the twelve months ended December 31, 2007, the Company purchased 48,124 of its common shares on the open market under the program at a cost of $1,585.
The Company's insurance company 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 company subsidiaries was $75,144, $89,683 and $116,073 for the years ended December 31, 2008, 2007 and 2006, respectively. Statutory capital and surplus of the Company's insurance subsidiaries was $560,462 and $514,957 at December 31, 2008 and 2007, respectively.
The 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 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 2008, the statutory surplus of Safety Insurance was $560,462 and its net income for 2008 was $68,509. As a result, a maximum of $68,509 is available in 2009 for such dividends without prior approval of the Commissioner.
Short term investments totaling $82,928 at December 31, 2008 are reported at amortized cost which approximates fair value.
At December 31, 2008 and 2007 the Company had no amounts outstanding on its secured credit facility.
An unaudited summary of the Company's 2008 and 2007 quarterly performance, and audited annual performance, is as follows: