(b) Common shares outstanding exclude non-vested restricted shares of 45, 90 and 134 as of December 31, 2005, 2004 and 2003, respectively.
In 2007, Infinity continued to generate strong operating results with a return on equity of 11.4%. Net earnings and diluted earnings per share were $71.9 million and $3.87, respectively, in 2007, compared to $87.3 million and $4.26 in 2006. Operating earnings, which exclude realized gains and losses on investments, declined 12.0% primarily from a decline in underwriting income. Infinity reported a GAAP combined ratio of 93.5% for the twelve months ended December 31, 2007 compared to 90.8% for the same period in 2006. Underwriting results in 2007 and 2006 benefited from $13.5 million and $31.2 million, respectively, of favorable development on prior accident year loss and LAE reserves. Excluding favorable development, Infinity’s GAAP combined ratio for 2007 increased to 94.8% from 94.1% in 2006, primarily as a result of increasing frequency trends in California, Florida and Pennsylvania. See Results of Operations - Underwriting - Profitability for a more detailed discussion of Infinity’s underwriting results.
During 2007, Infinity repurchased 3,587,411 shares or 18.3% of the shares outstanding on January 1, 2007. Book value per share at December 31, 2007 was $37.11, an increase of 9.5% from that at December 31, 2006.
In 2007, Infinity observed competitors aggressively trying to grow market share by increasing agency commission and other incentives, increasing advertising, loosening underwriting standards and modestly reducing rates. This level of competition is expected to continue throughout 2008. Infinity will continue to monitor its competitive position, rate adequacy and growth opportunities on a state-by-state basis while striving to maintain a desirable combination of profitability and growth.
development patterns vary from those seen historically. This estimation of IBNR requires selection of hundreds of such factors. A single point estimate for the subset being evaluated is then selected from the results of various tests, based on a combination of simple averages of the point estimates of the various tests and selections based on professional actuarial judgment. During recent years, paid methods have been less reliable as a result of changes in settlement practices, so Infinity has more heavily relied on incurred methods.
In February 2008, Infinity increased its quarterly dividend to $0.11 per share from $0.09 per share. At this current amount, Infinity’s 2008 annualized dividend payments will be approximately $7.1 million.
In January 2005, the Board of Directors authorized a share repurchase program expiring on December 31, 2007, whereby the
Company could repurchase up to an aggregate amount of $50 million of its outstanding common shares. This program was completed on December 28, 2006. During 2006, Infinity repurchased 1,178,300 shares at an average cost of $41.53. During 2005, Infinity repurchased 29,720 shares at an average cost of $33.59.
Funds to meet expenditures at the holding company come primarily from dividends from the insurance subsidiaries, borrowing on its line of credit, as well as cash and investments held by the holding company. As of December 31, 2007, Infinity had $170.9 million of cash and investments. In 2007, Infinity’s insurance subsidiaries paid Infinity $90.3 million in dividends. In 2008, Infinity’s insurance subsidiaries may pay to Infinity up to $79.0 million in ordinary dividends without prior regulatory approval.
Infinity and its insurance subsidiaries’ contractual obligations as of December 31, 2007, are (in thousands):
Approximately 95% of the fixed maturities that Infinity held at December 31, 2007 were rated “investment grade” (credit rating of AAA to BBB) by nationally recognized rating agencies. The average credit rating of Infinity’s fixed maturity portfolio was AA+ at December 31, 2007. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated or non-investment grade. Management believes that a high quality investment portfolio is more likely to generate a stable and predictable investment return.
Investments in mortgage-backed securities (“MBS”) represented 37% of Infinity’s fixed maturity portfolio at December 31, 2007. MBS are, in periods of rising interest rates, subject to significant extension risk due to the fact that mortgages may be repaid more slowly than expected as borrowers postpone refinancing in anticipation of lower fixed rates in the future. As of December 31, 2007, all of Infinity’s MBS are investment grade according to the NAIC rating guidelines. In addition, 88% of the MBS portfolio is rated “AAA” by a nationally recognized rating agency.
The table below sets forth the scheduled maturities of fixed maturity securities at December 31, 2007 based on their fair values (in thousands). Securities that do not have a single maturity date are reported at average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.
The following table provides information about Infinity’s fixed maturity investments at December 31, 2007 which are sensitive to interest rate risk. The table shows expected principal cash flows by expected maturity date for each of the five subsequent years and collectively for all years thereafter. Callable bonds and notes are included based on call date or maturity date depending upon which date produces the most conservative yield. MBS and sinking fund issues are included based on maturity year adjusted for expected payment patterns. Actual cash flows may differ from those expected.
Credit risk is managed by diversifying the portfolio to avoid concentrations in any single industry group or issuer and by limiting investments in securities with lower credit ratings. The largest investment in any one fixed income security, excluding U.S. governments and agencies securities, is $18.0 million or 1.5% of the fixed income investment portfolio. The top five investments make up 5.9% of the fixed income portfolio. The average credit quality rating for Infinity’s fixed maturity portfolio was AA+ at December 31, 2007. Non-performing fixed maturities, securities that have not produced investment income during the previous twelve months, were $0.2 million or 0.02% of the $1.2 billion portfolio as of December 31, 2007.
In early 2008, several municipal bond insurers had their credit ratings downgraded or placed under review by the major nationally recognized credit rating agencies. Fitch, one of the nationally recognized credit rating agencies, downgraded AMBAC to “AA” from “AAA”. These downgrades were as a result of a perceived weakening by the rating agencies of the insurers’ financial strength as a result of losses these insurers incurred from mortgage-backed and asset-backed securities they had insured that were now experiencing increased delinquencies and defaults from weakening of the economy in general and weakening within the housing market in particular. Infinity’s investment portfolio consists of $312.5 million of municipal bonds, of which $233.3 million are insured. Of the insured bonds, 32% are insured with FSA, 32% with MBIA, 18% with FGIC, 17% with AMBAC and 1% with XL Capital. The following table presents the underlying ratings, represented by the lower of either Standard and Poor’s or Fitch’s ratings, of the insured municipal bond portfolio:
Equity price risk is the potential economic loss from adverse changes in equity security prices. Infinity’s exposure to equity price risk is limited as its equity investments comprise only 3.9% of its total investment portfolio. During 2007, Infinity moved from a strategy of investing in large positions in individual stocks to an equity portfolio consisting of a Vanguard publicly traded exchange traded fund designed to track the MSCI U.S. Broad Market Index. At December 31, 2007, Infinity’s equity portfolio was $49.7 million.
(1) 2007, 2006 and 2005 exclude $0.1 million, $5.0 million and $9.8 million, respectively, of premiums written on behalf of other companies. 2006 and 2005 also exclude $0.7 million and $4.3 million, respectively of unearned premium transfers.
Gross written premiums for the year ended December 31, 2007 increased 3.3% compared to the twelve months ended 2006. During the first six months of 2007, gross written premiums grew 14.6% primarily from growth in California as Infinity continued to benefit from new policies issued as a result of the California Department of Motor Vehicles implementation of electronic enforcement of compulsory insurance laws that were effective October 1, 2006. However, during the last six months of 2007 premiums declined 7.8% as the implementation of electronic enforcement in California was completed September 30, 2007 and as a result of slowing new business application counts in states such as Arizona, Connecticut and Florida. During 2007, Infinity implemented 52 rate revisions in various states with an overall rate increase of 3.3%. Infinity’s policies-in-force at December 31, 2007 increased 2.8% compared to December 31, 2006.
Personal auto insurance in Infinity’s twelve Focus States increased 7.7% for the year ended December 31, 2007 compared with 2006, primarily from growth in Arizona, California, Nevada and Texas. The 9.3% gross premium growth in California was primarily attributable to the 21.2% growth during the first six months of 2007 compared with the same period in 2006, during which time Infinity continued to benefit from new policies issued as a result of electronic enforcement of compulsory insurance laws. However, as expected, premium growth slowed during the third quarter of 2007 to 8.3% and declined 11.5% in the fourth quarter of 2007 as the implementation of electronic enforcement was completed on September 30, 2007. In addition, slowing new application counts, due in part to rate decreases taken by competitors, contributed to the decline in California during the fourth quarter of 2007.
Personal auto gross written premium growth in Arizona of 26.6% during the twelve months ended December 31, 2007 as compared with the same period in 2006 was primarily attributable to continued penetration in the Phoenix Urban Zone. However, gross written premiums in the fourth quarter of 2007 in Arizona were down compared to the fourth quarter of 2006. Infinity believes this decline in gross written premiums in the fourth quarter to be in part due to stricter immigration laws being enforced in Arizona.
Gross written premiums in Texas grew in each of the four quarters of 2007 as compared to 2006. Gross written premiums for the twelve months ended December 31, 2007 grew 30.1% compared to the same period in 2006. The growth can be attributed primarily to further penetration in the targeted Urban Zones of Dallas, Houston and San Antonio. Infinity’s gross written premiums in Nevada continued to grow throughout 2007 following the introduction of the Low Cost and Value-Added products in Las Vegas in March 2006.
with 15 of the 20 urban zones posting gross written premium growth. Gross written premiums in the Non-Urban Zones declined 3.9% during 2007 as compared with 2006. This decline is primarily a result of a decline in Florida and Georgia’s Non-Urban Zones as a result of rate increases and redirecting market efforts to the targeted Urban Zones in those states. Although actively trying to retain profitable business, Infinity does expect gross written premiums in the Non-Urban Zones to decline further in 2008.
Personal auto premiums in Infinity’s Maintenance states declined 33.2% during the twelve months ended December 31, 2007 compared with the same period in 2006 primarily as a result of declines in Alabama, Mississippi and South Carolina. To improve profitability, Infinity increased rates in South Carolina by 5.2% during the fourth quarter of 2006 and raised rates in 2007 by 7.6% and 4.2% in Alabama and Mississippi, respectively, which has slowed new business production.
Gross written premium for the Commercial Vehicle program declined 13.0% during the twelve months ended December 31, 2007 compared with 2006. Premium growth in California and Georgia was more than offset by a decline in premium in Florida and New York. To improve profitability, Infinity increased rates in Florida by 9.3% during the fourth quarter of 2006 and another 1.7% during July 2007. Gross written premiums in New York should continue to decline as it is not a Focus State for Infinity.
Ceded reinsurance and the effects of unearned premium transfers grew by 4.4% during the twelve months ended December 31, 2007 compared with the same period in 2006. The increase is a result of a one-time unearned premium transfer of $0.7 million in 2006. Excluding this unearned premium transfer, ceded reinsurance premiums declined 9.6%. Infinity maintains an excess loss reinsurance treaty for higher limits personal auto liability coverages. Premiums ceded under this treaty declined during 2007 as Infinity sold the renewal rights on the Connecticut book of business assumed from Great American Insurance, which consisted predominately of higher policy limits for standard and preferred business.
In Infinity’s twelve Focus States, personal auto gross written premiums for the year ended December 31, 2006 grew 6.0% compared with 2005, primarily from growth in Arizona, California, Connecticut and Texas. Gross written premiums in California grew 5.3% during 2006 compared to that in 2005. Gross written premium growth of 14.4% during the last six months of 2006 as compared with that in the last six months of 2005 offset a 2.5% decline in premiums during the first six months of 2006 as compared with that in the same period in 2005. During the month of March, several competitors in California implemented new class plan filings that made Infinity’s rates less competitive and as a result, new business applications declined. Although Infinity reacted by filing a class plan to refine the Company’s rate structure, the plan was not approved by the California Department of Insurance until April with an effective date of June 1, 2006. This delayed approval suppressed gross written premium growth resulting in the 2.5% decline in gross written premiums during the first six months. However, during the fourth quarter of 2006, new application counts in California increased 57.1% compared to new application counts during the fourth quarter of 2005, which is primarily attributable to the California Department of Motor Vehicle’s implementation of electronic enforcement of compulsory insurance laws on October 1, 2006. As a result, Infinity’s gross written premiums in California grew 30.3% during the fourth quarter of 2006 compared to that of the same period of 2005. The implementation of electronic enforcement may have favorably impacted Infinity’s retention ratio in California as the policy retention rate at December 31, 2006 increased nearly three points from the retention rate at September 30, 2006. Policies-in-force at December 31, 2006 increased 9.8% compared with the policies-in-force at December 31, 2005.
The increasing profitability in Arizona allowed Infinity to take a modest rate decrease in April 2006, which increased the competitiveness of Infinity’s products in Phoenix, resulting in the 48.2% growth during the twelve months ended December 31, 2006 compared with the same period in 2005. The growth in the Connecticut book of business of 73.8% during 2006 as compared to 2005 is a result of growth of Infinity’s Low Cost product, which was introduced in the Connecticut market during February 2006. The increase in personal auto gross written premiums in Texas of 18.9% for the year ended December 31, 2006 compared with the same period in 2005 is primarily attributable to further penetration in Houston, where Infinity aggressively appointed new agents and expanded its marketing programs.
Gross written premiums in the Maintenance States decreased 10.6% during 2006 as compared to 2005, primarily as a result of a decline in South Carolina. During the last half of 2005, Infinity increased rates in South Carolina 5.7% which slowed new business production during 2006.
Gross written premiums for the Commercial Vehicle business decreased 4.7% during 2006 as compared with 2005 as a result of declining gross written premiums in the Non-Focus state of New York. Excluding New York, gross written premiums and policies-in-force increased 4.0% and 4.9%, respectively, over gross written premiums and policies-in-force in 2005, primarily as a result of gross written premium growth of 22.4% and 8.4% in Texas and Florida, respectively. In both Texas and Florida, increased marketing efforts have contributed to the growth. In addition, in Texas, a new rating structure was introduced in April 2006, which made the program more competitive.
A key operating performance measure of insurance companies is underwriting profitability, as opposed to overall profitability or net earnings. Underwriting profitability is measured by the combined ratio. When the combined ratio is under 100%, underwriting results are generally considered profitable; when the ratio is over 100%, underwriting results are generally considered unprofitable. The combined ratio does not reflect investment income, other income, other expenses or federal income taxes.
Overall, the statutory combined ratio for the year ended December 31, 2007 increased 3.1 points compared to 2006. For the twelve months ended December 31, 2007, Infinity had $13.5 million of favorable development on prior accident period loss and LAE reserves compared with $31.2 million of favorable development for the year ended December 31, 2006. Excluding the favorable development from both years, the combined ratio increased 1.1 points. Catastrophe related losses were $0.7 million and $0.8 million during 2007 and 2006, respectively.
The combined ratio in the twelve Focus States increased 6.1 points in 2007 compared to that in 2006. The loss and LAE ratio increased 7.1 points primarily as a result of increasing frequency trends in California, Florida and Pennsylvania as well as increasing severity trends in Florida. In addition, the settlement of an extra-contractual claim in Florida contributed 0.9 points to the increase in the loss and LAE ratio. (See Note 17 of the Consolidated Financial Statements for additional information on the settlement of the extra-contractual claim). The growth in gross written premiums over which to spread fixed costs has contributed to the 1.0 point decline in the underwriting expense ratio, in addition to a greater amount of fee income, which reduces underwriting expenses.
The 2007 combined ratio for the Commercial Vehicle business declined 39.0 points compared to 2006 with a loss and LAE ratio decline of 44.1 points offset by a 5.1 point increase in the underwriting expense ratio. During 2006, in the state of Florida, Infinity incurred losses on a few extra-contractual claims and incurred two large losses. In 2007, Infinity had favorable development on extra-contractual claims in Florida. Combined, these items resulted in a 9.0 point reduction in the loss and LAE ratio. In addition, the loss and LAE ratio declined as a result of favorable development on prior accident year loss and LAE reserves experienced during 2007 compared to unfavorable development during 2006. The increase in the underwriting expense ratio is primarily due to a decline in premium written over which to spread fixed costs.
Overall, the statutory combined ratio for the year ended December 31, 2006 decreased 1.3 points compared to 2005. For the twelve months ended December 31, 2006, Infinity had $31.2 million of favorable development on prior accident period loss and LAE reserves compared with $17.0 million of favorable development for the year ended December 31, 2005. The favorable development in both years is primarily attributable to California. Excluding the favorable development from both years, the combined ratio increased 0.2 points, attributable to a higher underwriting expense ratio resulting from increased marketing and advertising expenses. Catastrophe related losses were $0.8 million and $2.3 million during 2006 and 2005, respectively.
The 2006 combined ratio in the Focus States increased 3.0 points compared to that in 2005. The loss and LAE ratio increased 1.5 points primarily from strengthening LAE reserves. The underwriting ratio increase of 1.5 points is primarily a result of an increase in advertising and in part from a larger portion of the shared service costs being attributed to these states.
Improvements in both the loss and LAE and underwriting ratios contributed to the 10.7 point improvement in the Maintenance States. During 2006, South Carolina had favorable development on prior accident period loss reserves. Included in the 2006 underwriting expense ratio is a one time benefit of $1.9 million related to a refund from the South Carolina Reinsurance Facility. Excluding this amount, the underwriting ratio for the Maintenance States would be 26.6%, a 0.2 point increase over the 26.4% in 2005.
Investment income is composed primarily of gross investment revenue, investment management fees and expenses and interest expense incurred on the Quota Share Agreements, as shown in the following table (in thousands):
Changes in investment income reflect fluctuations in market rates and changes in average invested assets. Investment income declined $1.0 million for the twelve months ended December 31, 2007 as compared with the same period in 2006. Gross investment income for the twelve months ended December 31, 2006 included a one-time benefit of $0.7 million related to the catch up of amortization of bond discount on securities sold that had previously been impaired. In addition, Infinity’s gross investment income declined as average invested assets decreased 1.5% in 2007 compared to 2006. Investment expenses declined as a result of the lower average invested asset balance and as a result of lower investment management fees.
Investment income increased $2.9 million for the twelve months ended December 31, 2006 from 2005. Gross investment income for the twelve months ended December 31, 2006 included a one-time benefit of $0.7 million related to the catch up of amortization of bond discount on securities sold that had previously been impaired. Infinity’s average invested assets increased 0.9%. With rising interest rates in 2006, Infinity used proceeds from sales and maturities of securities to acquire higher yielding securities. As a result, Infinity’s weighted-average gross investment yield increased to 5.0% in 2006 from 4.8% in 2005.
As a result of rising interest rates in 2006, Infinity had fewer fixed maturity investments with gains that could be sold to utilize the capital loss carryforward and net realized gains on sales declined compared with 2005. Impairments on equities increased in 2006 as the Company moved towards investing in a more diversified portfolio of equities rather than remaining in large positions in individual stocks. Since Infinity no longer intended to hold these large positions for any length of time, any equity having an unrealized loss at year-end 2006 was impaired for that amount.
Other income for the twelve months ended December 31, 2007 was relatively flat compared to 2006. A $0.7 million decline in finance charges on assumed business that is in runoff was offset by a $1.1 million fee received on renewal premium from the 2005 sale of the Assumed Agency Business’ Connecticut personal auto book. The other items included in other income of $1.3 million in 2007 are non-recurring items.
The adoption of SFAS 123(R) on January 1, 2006 was the primary reason for the 6.8% increase in corporate general and administrative expenses in 2006 as compared to 2005. In 2005, prior to the adoption of SFAS 123(R), Infinity did not expense stock based compensation costs. (See Note 6 of the Consolidated Financial Statements for additional information on stock based compensation costs).
Infinity has recorded a valuation allowance equal to 100% of the available capital loss carryforward. As capital gains are generated, Infinity takes credit for the deferred tax asset and reduces the valuation allowance. In addition, Infinity includes the tax on losses recorded on other-than-temporarily impaired securities in the valuation allowance.
Consolidated Statements of Earnings: Years ended December 31, 2007, 2006 and 2005
Consolidated Statements of Cash Flows: Years ended December 31, 2007, 2006 and 2005