We conduct most of our operations in approximately 89 thousand square feet of leased space at 20 Custom House Street in downtown Boston, Massachusetts. Our lease expires in December 2008.
The following table sets forth our selected historical consolidated financial data as of and for each of the five years ended December 31, 2006.
We have prepared the selected historical consolidated financial data, other than statutory data, in conformity with U. S. generally accepted accounting principles (“GAAP”). We have derived the statutory data from the annual statements of our Insurance Subsidiaries filed with insurance regulatory authorities, which were prepared in accordance with statutory accounting practices, which vary in certain respects from GAAP.
The selected financial data presented below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the accompanying notes included in this Form 10-K in order to more fully understand the historical consolidated financial data.
We are subject to the extensive regulation of the private passenger automobile insurance industry in Massachusetts, which represented 76.0% of our direct written premiums in 2006. 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,
On December 31, 2004, the Commissioner approved new rules for CAR, which became effective on January 1, 2005 (the “Approved Rules”). The Approved Rules provided for the adoption of an assigned risk plan by CAR. Shortly thereafter, litigation was commenced in Suffolk Superior Court by Commerce Insurance Company against the Commissioner seeking an order permanently enjoining implementation and/or enforcement of the Approved Rules. Certain ERPs, Arbella Mutual Insurance Company and the Center for Insurance Research intervened as plaintiffs and CAR intervened as a defendant in this lawsuit. On June 20, 2005, the Massachusetts Superior Court ruled that the Commissioner lacked the statutory authority to implement the Approved Rules and ordered them vacated. As a result, the Approved Rules did not go into effect. The Commissioner appealed the decision of the Massachusetts Superior Court. On August 23, 2006, the Massachusetts Supreme Judicial Court overturned the decision of the Massachusetts Superior Court and unanimously ruled that the Commissioner did not need legislative approval to put in place the provisions in the Approved Rules which establish an assigned risk plan. On October 18, 2006, the Commissioner reviewed the Approved Rules and proposed changes (the “Revised Rules”) that would, in part, establish an assigned risk plan called the Massachusetts Automobile Insurance Plan (the “MAIP”). As proposed, the Revised Rules would: 1) eliminate provisions in the current CAR Rules that are no longer necessary in light of the litigation described above; 2) integrate the Revised Rules into the current CAR Rules; 3) set a timetable for the implementation of the MAIP; and 4) revise the MAIP to conform with the Supreme Judicial Court’s remand regarding the so-called “clean in three” provisions contained in the Approved Rules. A hearing was held November 10, 2006, on the Revised Rules and on December 13, 2006, the Commissioner approved changes to the MAIP rules (the “MAIP Rules”) that called for three year phase in of an assigned risk plan beginning April 1, 2007.
While the litigation described above was pending and before the MAIP Rules were approved, in order to address certain perceived inequities in the distribution of ERP exposures, CAR approved on June 15, 2005, rules to modify the ERP subscription relief process, making the reassignment of ERP exposures from an oversubscribed servicing carrier more timely and responsive, while enhancing equity in the ERP distribution for all servicing carriers (the “ERP Subscription Rules”). Also, the practice of two and three-party agreements between ERPs and servicing carriers was prohibited. On September 30, 2005, the Commissioner approved the ERP Subscription Rules, and instructed CAR to complete a redistribution of all ERPs to establish for all servicing carriers overall parity in the quantity and quality of their ERP exposures. The redistribution plan for ERPs, as adopted by the CAR Governing Committee on November 16 and December 14, 2005, was approved by the Commissioner on January 27, 2006. On January 31, 2006, CAR notified each reassigned ERP and all servicing carriers of the redistribution.
CAR also runs a reinsurance pool for commercial automobile policies and 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 among the six servicing carriers. Each Massachusetts commercial automobile insurer must bear a portion of the losses of the commercial reinsurance pool that is serviced by the six servicing carriers in the LSC program. Subject to Commissioner review, CAR sets the premium rates for commercial automobile policies reinsured through CAR and this reinsurance pool can generate an underwriting result that is a profit or deficit based upon CAR’s rate level. This underwriting result is allocated among every Massachusetts commercial automobile insurance company, including us, based on a company’s commercial automobile voluntary market share.
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. Beginning in 2007, the effective date of the Commissioner’s rate decision will be April 1st of each year as compared to January 1st of 2006 and prior rate decisions. The 2006 rates will be in effect from January 1, 2006 until March 31, 2007. The Commissioner announced on December 15, 2006, an 11.7% statewide average private passenger automobile insurance rate decrease for 2007, compared to a 8.7% decrease for 2006. Coinciding with the 2006 rate decision, the Commissioner also approved a 13.0% commission rate agents receive for selling private passenger automobile insurance, as a percentage of premiums, compared to a commission rate of 11.8% in 2006.
Our results are reported in accordance with GAAP, which differ from amounts reported in accordance with statutory accounting principles (“SAP”) as prescribed by insurance regulatory authorities. Specifically, under GAAP:
· Certain assets are included in the consolidated balance sheets whereas, under SAP, such assets are designated as “non admitted assets,” and charged directly against statutory surplus. These assets consist primarily of premium receivables that are outstanding over ninety days, federal deferred tax assets in excess of statutory limitations, furniture, equipment, leasehold improvements and prepaid expenses.
· 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.
· Fixed maturities securities, which are classified as available-for-sale, are reported at current market values, rather than at amortized cost, or the lower of amortized cost or market, depending on the specific type of security, as required by SAP.
On March 10, 2006, the Board of Directors (“Board”) of the Company approved amendments to the Incentive Plan, subject to shareholder approval, to (i) increase the number of shares of common stock available for issuance by 1,250,000 shares, (ii) remove obsolete provisions, and (iii) make other non-material changes. A total of 1,250,000 shares of common stock had previously been authorized for issuance under the Incentive Plan. The Incentive Plan, as amended, was approved by the shareholders at the 2006 Annual Meeting of Shareholders which was held on May 19, 2006. Under the Incentive Plan, as amended, the maximum number of shares of common stock with respect to which awards may be granted is 2,500,000. As of December 31, 2006, there were 1,289,991 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, 2006, were comprised of 126,790 restricted shares and 373,996 nonqualified stock options. Grants made under the Incentive Plan are as follows.
(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 effective date.
(2) The fair value of the restricted stock grant is equal to the closing price of our common stock on the grant effective date.
We reinsure with other insurance companies a portion of our potential liability under the policies we have underwritten, thereby protecting us against an unexpectedly large loss or a catastrophic occurrence that could produce large losses, primarily in our homeowners line of business. We use various software products to measure our exposure to catastrophe losses and the probable maximum loss to us for catastrophe losses such as hurricanes. The models include estimates for our share of the catastrophe losses generated in the residual market for property insurance by the Massachusetts Property Insurance Underwriting Association. In the aftermath of Hurricane Katrina in 2005, the reinsurance market has seen from the various software modelers, increases in the estimate of damage from hurricanes in the southern and northeast portions of the United States due to revised estimations of increased hurricane activity and increases in the estimation of demand surge in the periods following a significant event. We have adjusted our reinsurance programs as a result of the changes to the models. As of January 2007, our catastrophe reinsurance provides gross per occurrence reinsurance coverage up to $280,000. As a result of the changes to the models, and our revised reinsurance program, our catastrophe reinsurance protects us in the event of a “300-year storm”
(that is, a storm of a severity expected to occur once in a 300-year period). Swiss Re, our primary reinsurer, maintains an A.M. Best rating of “A+” (Superior). All of our other reinsurers have an A.M. Best rating of “A” (Excellent) or better except for Folksamerica, Montpelier Re, Endurance Re and Amlin Bermuda which are rated “A-” (Excellent). We are a participant in CAR, a state-established body that runs the residual market reinsurance programs for both private passenger and commercial automobile insurance in Massachusetts under which premiums, expenses, losses and loss adjustment expenses on ceded business are shared by all insurers writing automobile insurance in Massachusetts. We also participate in the Massachusetts Property Insurance Underwriting Association (“FAIR Plan”) in which premiums, expenses, losses and loss adjustment expenses on homeowners business that cannot be placed in the voluntary market are shared by all insurers writing homeowners insurance in Massachusetts. The FAIR Plan has grown dramatically over the past few years as insurance carriers have reduced their exposure to coastal property. The FAIR Plan’s exposure to catastrophe losses has increased and as a result the FAIR Plan has decided to buy reinsurance to reduce their exposure to catastrophe losses. On July 1, 2006, the FAIR Plan purchased $455,000 of catastrophe reinsurance for property losses in excess of $180,000. At December 31, 2006, we had no material amounts recoverable from any reinsurer, excluding the residual markets described above.
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.
When reviewing reserves, we analyze historical data and estimate the impact of various loss development factors, such as our historical loss experience and that of the industry, trends in claims frequency and severity, our mix of business, our claims processing procedures, legislative enactments,
· Bodily Injury Code Indications: This method projects ultimate loss estimates for our private passenger and commercial automobile bodily injury coverage based upon extrapolations of the historic number of accidents and the historic number of bodily injury claims per accident. Projected ultimate bodily injury claims are then segregated into expected claims by type of injury (e.g. soft tissue injury vs. hard tissue injury) based on past experience. An ultimate severity, or average paid loss amounts, is estimated based upon extrapolating historic trends. Projected ultimate loss estimates using this method are the aggregate of estimated losses by injury type.
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, 2006 and December 31, 2005.
For our private passenger automobile, commercial automobile and homeowners lines of business as of December 31, 2006 and 2005, 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. We recorded reserves slightly higher than the mid-point of the range.
For our all other lines of business as of December 31, 2006 and 2005, 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 are relatively wide. We recorded reserves closer to the high of the range of projections.
We receive a Settlement of Balances report from CAR that reports our share of CAR premium, losses and LAE, on a lagged basis, seventy-five days after the end of every quarter. CAR-published financial data is always at least one quarter behind the financial data we report. For example, when we reported our financial results for the year ended December 31, 2006, we had nine months of reported 2006 CAR financial data, and we had to estimate and record as IBNR reserves what CAR would report to us for the last three months of the year.
Our estimated share of CAR loss and LAE reserves is based on assumptions about our Participation Ratio, the size of CAR, and the resulting deficit (similar assumptions apply with respect to the FAIR Plan). Our assumptions consider that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for establishing our CAR reserves. Each of our assumptions could have a reasonably possible range of plus or minus 5 percentage-points for each estimation. The following sensitivity table presents information of the effect each 1 percentage-point change in our assumptions on our share of reserves for CAR and other residual markets could have on our assumed loss and LAE reserves and net income for the year ended December 31, 2006. In evaluating the information in the table, it should be noted that a 1 percentage-point change in our assumptions would change estimated reserves by 1 percentage-point.
The changes we have recorded in our reserves in the past illustrate the uncertainty of estimating reserves. The Company’s prior year reserves decreased by $42,747, $39,620 and $6,778 for the years ended December 31, 2006, 2005 and 2004, respectively.
The following table presents a comparison of prior year development of our net reserves for losses and LAE for the years ended December 31, 2006, 2005 and 2004. Each accident year represents all claims for an annual accounting period in which loss events occurred, regardless of when the losses were actually reported, booked, or paid. Our financial statements reflect the aggregate results of the current and all prior accident years.
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 decrease in prior year reserves during the 2005 period resulted from re-estimations of prior year ultimate loss and LAE liabilities and is composed primarily of a reduction of $22,162 in CAR assumed reserves and a reduction of $14,600 in the Company’s retained automobile reserves. The decrease in prior year reserves during the 2004 period is composed primarily of a reduction of $6,854 in CAR assumed reserves, a reduction of $2,523 in our homeowners line of business, and an increase of $2,928 in the Company’s retained automobile reserves.
Prior Year Net Direct minus Ceded Loss and LAE Reserve Development Summary
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, 2006.
Our commercial automobile line of business prior year reserves decreased by $6,770 for the year ended December 31, 2006. The decrease was primarily due to more favorable commercial automobile bodily injury severity than previously estimated for the 2005, 2004 and 2003 accident years and fewer IBNR claims than previously estimated.
Our Homeowners line of business prior year reserves decreased by $4,116 for the year ended December 31, 2006, primarily as a result of improved severity on our established case reserves for 2005 and 2004 related to our retained homeowners business.
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.
Direct Written Premiums. Direct written premiums for the year ended December 31, 2006, decreased by $19,602, or 3.0% to $629,511 from $649,113 for 2005. The 2006 decrease occurred primarily in our personal automobile line, which experienced a 6.8% decrease in average written premium and a 1.0% decrease in written exposures. Offsetting these results, our commercial automobile line’s average written premium increased by 13.2% with a 12.3% increase in written exposures. Our homeowners line average written premium increased by 5.7% with a 0.3% decrease in written exposures.
Net Written Premiums. Net written premiums for the year ended December 31, 2006, decreased by $11,928 or 1.9% to $620,908 from $632,836 for 2005. This was primarily due to the factors that decreased direct written premiums offset with a decrease in premiums ceded to CAR.
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, 2006.
Direct Written Premiums. Direct written premiums for the year ended December 31, 2005, increased by $20,818, or 3.3% to $649,113 from $628,295 for 2004. The 2005 increase occurred primarily in our personal automobile line, which experienced a 0.1% increase in average written premium and a 2.4% increase in written exposures. In addition, our commercial automobile line’s average written premium decreased by 0.3%, with a 7.6% increase in written exposures. Our homeowners line average written premium increased by 7.3%, with a 2.9% decrease in written exposures.
Net Written Premiums. Net written premiums for the year ended December 31, 2005, increased by $13,913 or 2.2% to $632,836 from $618,923 for 2004. This was primarily due to the factors that increased direct written premiums combined with a decrease in premiums ceded to CAR.
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 amortized 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.
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 (i.e., all our securities received a rating assigned by Moody’s Investors Service, Inc. (“Moody’s”) of Baa or higher, except the few securities not rated by Moody’s which received Standard & Poor’s ratings of A- or higher, as well as a rating assigned by the Securities Valuation Office of the National Association of Insurance Commissioners of 1 or 2).
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.
Net Income. Net income for the year ended December 31, 2005, increased by $50,192, or 111.6%, to $95,182 from $44,990 for the comparable 2004 period. This increase was primarily due to the increase in premiums and decrease in the loss ratio, as discussed above.
As a holding company, Safety’s assets consist primarily of the stock of our direct and indirect subsidiaries. Our principal source of funds to meet our obligations and pay dividends to shareholders, therefore, is dividends and other permitted payments from our subsidiaries, principally Safety Insurance. Safety is the borrower under our credit facilities.
Net cash provided by operating activities was $101,227, $116,417, and $126,176 during the years ended December 31, 2006, 2005 and 2004, respectively. 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.
Net cash used for investing activities was $230,397 and $82,770 during the years ended December 31, 2006 and 2005, which resulted primarily from purchases of fixed maturities in excess of sales and maturities of fixed maturities. Net cash provided by investing activities was $7,820 during the year ended December 31, 2004, which resulted primarily from sales and maturities of fixed maturities in excess of purchases of fixed maturities.
Net cash used for financing activities was $7,574, $26,293, and $4,607 during the years ended December 31, 2006, 2005, and 2004, respectively. Net cash used for financing activities is primarily comprised of dividend payments to shareholders during 2006 and 2004 and of the pay down of the revolving credit facility and dividend payments to shareholders in 2005.
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 2007, depending on our financial position and the regularity of our cash flows.
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.
· Descriptions of plans or objectives of management for future operations, products or services;
· Forecasts of future economic performance, liquidity, need for funding and income; and
· Descriptions of assumptions underlying or relating to any of the foregoing.
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, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 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.
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 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.
Liabilities for losses and loss adjustment expenses (“LAE”) include case basis estimates for open claims reported prior to year-end and estimates of unreported claims and claim adjustment expenses. The estimates are continually reviewed and modified to reflect current conditions, and any resulting adjustments are reflected in current operating results. Adjustments for anticipated salvage and subrogation are recorded on incurred and reported and incurred but not reported losses.
Effective January 1, 2006, the Company adopted FAS 123R (revised 2004), “Share-Based Payment,” which requires the Company to measure and recognize the cost of employee services received in exchange for an award of equity instruments. Under the provisions of FAS 123R, share-based compensation cost is
measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite service period (generally the vesting period of the equity grant).
The gross realized gains (losses) on sales of fixed maturities and equity securities were as follows for the periods indicated:
As of December 31, the Company’s fixed income securities portfolio was comprised entirely of investment grade securities as defined by Moody’s Investor Services, Inc., Standard and Poor’s, or the Securities Valuation Office of the National Association of Insurance Commissioners. The unrealized losses recorded on the fixed maturity investment portfolio at December 31, 2006, 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.
Long-term incentive compensation is provided under the Company’s 2002 Management Omnibus Incentive Plan (“the Incentive Plan”) which provides for a variety of stock-based compensation awards, including nonqualified stock options (“NQSOs”), incentive stock options, stock appreciation rights and restricted stock (“RS”) awards.
At December 31, 2006, the aggregate intrinsic value of outstanding shares under option was $8,668 with a weighted average remaining contractual term of 7.7 years. At December 31, 2006, the aggregate intrinsic value of outstanding shares under option and exercisable was $864 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 $50.71 on December 31, 2006, 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, 2006, $12.00 to $35.23 at December 31, 2005 and $12.00 to $21.40 at December 31, 2004. The weighted average grant-date fair value of options granted during the twelve months ended December 31, 2006, 2005 and 2004 was estimated at $16.05, $12.62 and $5.13, respectively. The total intrinsic value of options exercised during the twelve months ended December 31, 2006, 2005 and 2004 was $8,963, $6,563 and $3,193, respectively.
A summary of the status of non-vested options as of December 31, 2006, is presented below:
As of December 31, 2006, there was $2,265 of unrecognized compensation expense related to non-vested option awards that is expected to be recognized over a weighted average period of 3.4 years.
As a result of adopting FAS 123R on January 1, 2006, the Company’s net income for the twelve months ended December 31, 2006 was lowered by $554, net of income tax benefit of $299. The impact on basic and diluted EPS for the twelve months ended December 31, 2006 was a reduction of $0.04 and $0.03 per share.
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, 2006, 2005 and 2004 is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions:
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. In 2006, the Company received notice of assessments from the Insolvency Fund amounting to $464 which it expensed for the year ended December 31, 2006. In 2005 the Company received a refund of prior years’ assessments from the Insolvency Fund of $50, which was credited for the year ended December 31, 2005. In 2004, the Company received notice of assessments from the Insolvency Fund amounting to $2,538 which it expensed for the year ended December 31, 2004.
It is anticipated that there will be additional assessments from time to time relating to various insolvencies. 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 upon the financial position of the Company.
The Company has a $30,000 revolving credit facility with Citizens Bank of Massachusetts which expires on June 17, 2008. Loans under the credit facility bear interest at the Company’s 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 the Company under the credit facility are secured by pledges of the Company’s assets and the capital stock of its operating subsidiaries. The credit facility is guaranteed by the non-insurance company subsidiaries of the Company. The credit facility contains 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. As of December 31, 2006, the Company was in compliance with all such covenants.
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, 2006, and at December 31, 2005. 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, 2006 and December 31, 2005.
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, 2006 are $39.
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.
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
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 $3,178 and $4,742 was established against state deferred tax assets at December 31, 2006 and 2005, 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.
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 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 2006, the statutory surplus of Safety Insurance was $457,505 and its net income for 2006 was $110,075. As a result, a maximum of $110,075 is available in 2007 for such dividends without prior approval of the Commissioner.