We conduct most of our operations in approximately 99 thousand square feet of leased space at 20 Custom House Street in downtown Boston, Massachusetts. Our lease expires in December 2018.
The following table sets forth our selected historical consolidated financial data as of and for each of the five years ended December 31, 2007.
The selected historical consolidated financial data for the years ended December 31, 2007, 2006 and 2005 and as of December 31, 2007, 2006, and 2005 have been derived from the financial statements of Safety Insurance Group, Inc. included in this annual report which have been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm. The selected historical consolidated financial data for the years ended December 31, 2004 and 2003 and as of December 31, 2004 and 2003 have been derived from Safety Insurance Group, Inc.'s consolidated financial statements not included in this annual report, which have been audited by PricewaterhouseCoopers LLP.
underwriting deficit. This deficit is allocated among every Massachusetts automobile insurance company, including us, based on a complex formula that takes into consideration a company's voluntary market share, the rate at which it cedes business to CAR, and the company's utilization of a credit system CAR has designed to encourage carriers to reduce their use of CAR. In addition, based on our market share, we have been assigned certain licensed producers by CAR that have been unable to obtain a voluntary contract with another insurer. We call these agents Exclusive Representative Producers, or ERPs. As a servicing carrier of CAR, we were required to issue a policy to all qualified applicants.
On July 16, 2007, the Commissioner issued two decisions that significantly change how private passenger automobile insurance will be regulated in Massachusetts. In the first decision, the Commissioner announced that she would not fix and establish the maximum premium rates that can be charged for private passenger automobile insurance policies issued or renewed after April 1, 2008. In a letter accompanying the decision, the Commissioner stated that in place of the "fixed and established" system, she would institute a system that introduces competitive pricing to the Massachusetts private passenger automobile insurance market, which the Commissioner has described as "managed competition" ("Managed Competition") to the private passenger automobile insurance market. On October 5, 2007, the Commissioner issued a Competitive Rating Regulation; 211 CMR 79.00: Private Passenger Motor Vehicle Insurance Rates that describes the technical details of Managed Competition (the "Regulation"). There are three types of filings in the Regulation:
2.Advisory Rate Filing, which is a filing made by a Rating Organization for insurers that write less than 1% of the private passenger market in Massachusetts. A 2.5% rate decrease was filed by the Automobile Insurers Bureau of Massachusetts on behalf of those insurers on October 22, 2007.
3.Residual Market Rate Filing, which is a filing made by CAR or by a rating organization on behalf of CAR for policies written in CAR or through the Massachusetts Automobile Insurance Plan (the "MAIP"). A 9.3% rate increase was filed by the Automobile Insurers Bureau of Massachusetts on October 24, 2007, on behalf of CAR. However, these rates will be charged to risks in cases where these rates do not "exceed the premium charges, which would be used by each risk's Servicing Carrier for that risk if such risk were written on a voluntary basis." Therefore, each risk that is in CAR or the MAIP will get the lower of the CAR filed rate or each carrier's voluntary market rate filing.
The Commissioner has also issued a number of "Regulatory Review Standards Applicable to Private Passenger Motor Vehicle Insurance" (the "Rating Bulletins"). Rating Bulletins 2007-07 and 2007-08 limit rates to not more than 110% of what the 2007 premium rate level would have been for each risk. Rating Bulletin 2007-10 sets standards for filing policy forms and application for insurance. Rating Bulletin 2007-11 offers guidance on required and optional discounts, and Rating Bulletin
2007-12 limits the ability of companies to offer different rate levels within companies of the same insurance group.
As noted above, in 2007 and previous years, the Commissioner set the maximum premium rates that could be charged and minimum commissions that had to be paid to agents for private passenger automobile insurance. Beginning in 2007, the effective date of the Commissioner's rate decision was April 1st as compared to January 1st of 2006 and prior rate decisions. The 2006 rates were 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 an 8.7% decrease for 2006. Coinciding with the 2007 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.
(1)Source: Commissioner rate decisions for 1998 - 2007. The 2007 rate decrease became effective on April 1, 2007. (2)Source: Safety Insurance. Statutory Accounting Principles
On June 25, 2002, the Board adopted the 2002 Management Omnibus Incentive Plan (the "Incentive Plan"). The Incentive Plan provides for a variety of awards, including nonqualified stock options ("NQSOs"), stock appreciation rights and restricted stock ("RS") awards.
(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.
a significant event. We continue to adjust our reinsurance programs as a result of the changes to the models. As of January 2008, 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 "208-year storm" (that is, a storm of a severity expected to occur once in a 208-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, New Castle and PARIS RE 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, 2007, the FAIR Plan purchased $979,500 of catastrophe reinsurance for property losses in excess of $180,000. At December 31, 2007, we had no material amounts recoverable from any reinsurer, excluding the residual markets described above.
•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.
Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting our ultimate losses, total reserves and resulting IBNR reserves. It is possible that the final outcome may fall above or below these amounts as
For our private passenger automobile, commercial automobile and homeowners lines of business as of December 31, 2007 and 2006, 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, 2007 and 2006, 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 CAR deficit, which consists of premium ceded to CAR less CAR losses and LAE, is allocated among every automobile insurance company writing business in Massachusetts based on a complex formula (the "Participation Ratio") that takes into consideration a company's voluntary market share, the amount of business it cedes to CAR and credits the company earns under a system CAR has designed to encourage carriers to voluntarily write business in selected under-priced classes and territories.
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, 2007, a 1 percentage-point change in the loss and LAE ratio would result in a change in reserves of $6,092. Each 1 percentage-point change in the loss and loss expense ratio would have a $3,960 effect on net income, or $0.25 per diluted share.
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, 2007. 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 following table presents a comparison of prior year development of our net reserves for losses and LAE for the years ended December 31, 2007, 2006 and 2005. Each accident year represents all claims for an annual accounting period in which loss events occurred, regardless of when the losses are actually reported, booked or paid. Our financial statements reflect the aggregate results of the current and all prior accident years.
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 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 following table presents information by line of business for prior year development of our net reserves for losses and LAE for the year ended December 31, 2007.
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, 2007; 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, 2007.
Our homeowners line of business prior year reserves decreased by $3,265 for the year ended December 31, 2007. Our retained homeowners and FAIR Plan homeowners reserve decreased by $2,941 and $324, respectively.
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 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.
For further information, see "Results of Operations: Net Realized Investment Losses."
Net Investment Income. Net investment income for the year ended December 31, 2007, was $44,255 compared to $40,293 for 2006, an increase of 9.8%. Average cash and investment securities (at cost) increased by $84,369, or 9.2%, to $1,002,349 for the year ended December 31, 2007, from $917,980 for 2006. The net effective yield on the investment portfolio remained at 4.4% during the year ended December 31, 2007, similar to 4.4% during 2006. Our duration decreased to 4.2 years at December 31, 2007, from 4.6 years at December 31, 2006.
(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), Federal National Mortgage Association (FNMA) and Small Business Administration (SBA). The total of these fixed maturity securities was $258,310 at amortized cost and $258,876 at fair value as of December 31, 2007. 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, 2007, 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 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 SVO 1 or 2).
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses incurred for the year ended December 31, 2007, increased by $20,587 or 5.8%, to $374,493 from $353,906 for the comparable 2006 period. Our GAAP loss ratio for the year ended December 31, 2007, increased to 61.5% compared to 56.6% for the comparable 2006 period. Our GAAP loss ratio excluding loss adjustment expenses for the year ended December 31, 2007, increased to 52.7% from 49.2% for the comparable 2006 period. The loss ratio increased primarily as a result of a decrease in personal automobile average earned premiums, less favorable development, and slightly higher claim frequency than the comparable 2006 period. Total prior year favorable development included in the pre-tax results for the year ended December 31, 2007 was $30,791 compared to prior year favorable development of $42,747 for the comparable 2006 period.
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
(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), Federal National Mortgage Association (FNMA) and Small Business Administration (SBA). The total of these fixed maturity securities was $175,394 at amortized cost and $173,539 at fair value as of December 31, 2006. 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, 2006, 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 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).
Other-than-temporary impairments are recorded as realized losses, which serve to reduce net income and earnings per share. Temporary losses are recorded as unrealized losses, which do not impact net income and earnings per share but reduce other comprehensive net income. The risks inherent in the assessment of other-than-temporary impairments include the risk that market factors may differ from our expectations; we may decide to subsequently sell a security for unforeseen business needs; or the credit assessment could change in the near term, resulting in a charge to earnings.
During the years ended December 31, 2006 and 2005, there was no significant deterioration in the credit quality of any of the Company's holdings and no other-than-temporary impairment charges were recorded related to the Company's portfolio of investment securities
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses incurred for the year ended December 31, 2006, decreased by $31,687 or 8.2%, to $353,906 from $385,593 for the comparable 2005 period. Our GAAP loss ratio for the year ended December 31, 2006, decreased to 56.6% compared to 61.9% for the comparable 2005 period. Our GAAP loss ratio excluding loss adjustment expenses for the year ended December 31, 2006, decreased to 49.2% from 54.9% for the comparable 2005 period. The loss ratio improved as a result of a decrease in personal and commercial automobile bodily injury and physical damage claim frequency due in part to very favorable weather in 2006 and an increase in favorable development in our personal and commercial automobile and homeowners lines prior years results. Total prior year favorable development included in the pre-tax results for the year ended December 31, 2006 was $42,747 compared to prior year favorable development of $39,620 for the comparable 2005 period.
Net Income. Net income for the year ended December 31, 2006 increased by $16,759, or 17.6%, to $111,941 from $95,182 for the comparable 2005 period. This increase was primarily due to the decrease in the loss ratio and improved investment results as discussed above.
Net cash provided by operating activities was $116,828, $101,227, and $116,417 during the years ended December 31, 2007, 2006 and 2005, 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 financing activities was $21,986, $7,574, and $26,293 during the years ended December 31, 2007, 2006, and 2005, respectively. Net cash used for financing activities is primarily comprised of dividend payments to shareholders during 2007 and 2006, and of the pay down of the revolving credit facility and dividend payments to shareholders in 2005.
We paid down the balance of $19,956 on December 8, 2005, and had no amounts outstanding on our credit facility at December 31, 2007, 2006 and 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, 2007 and 2006.
On February 15, 2008, our Board approved a quarterly cash dividend on our common stock of $0.40 per share which will be paid on March 14, 2008 to shareholders of record on March 3, 2008. We plan to continue to declare and pay quarterly cash dividends in 2008, depending on our financial position and the regularity of our cash flows.
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. and its subsidiaries at December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 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 accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
On June 20, 2007, the Company 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 the Company's insurance company subsidiaries. To date, the Company has not commenced writing business in Hew Hampshire.
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. 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.
Equity and deposits in pools represents the net receivable cash amounts due from the residual market mechanisms, Commonwealth Automobile Reinsurers ("CAR"), for automobile and Massachusetts Property Insurance Underwriting Association ("FAIR Plan"), for homeowner insurance in Massachusetts. See Note 8 for a discussion of the Company's accounting for amounts assumed from residual markets.
Basic earnings per weighted average common share ("EPS") are calculated by dividing net income by the weighted average number of basic common shares outstanding during the period. Diluted EPS are calculated by dividing net income by the weighted average number of basic common shares outstanding and the net effect of potentially dilutive common shares. At December 31, 2007, 2006 and 2005, the Company's potentially dilutive instruments were common shares under options of 334,588, 373,996 and 496,086, respectively, and common shares under restriction of 174,751, 118,790 and 94,417, respectively.
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 Company's insurance subsidiaries, domiciled in the Commonwealth of Massachusetts, prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by the Commonwealth of Massachusetts Division of Insurance ("the Division"). Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws, regulations, and general administrative rules applicable to all insurance enterprises domiciled in a particular state. Permitted statutory accounting practices include practices not prescribed by the Division, but allowed by the Division. See Note 12 for further information.
In February 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 155, "Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140" ("FAS 155"). This statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. This statement also adds clarity regarding interest-only strips and principal-only strips that are not subject to the requirements of Statement No. 133, and requires companies to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments containing an embedded derivative that requires bifurcation. FAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company adopted FAS 155 on January 1, 2007. The adoption of FAS 155 did not have a material impact on the Company's consolidated results of operations or financial position.
For information regarding the Company's adoption of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement 109" ("FIN 48"), see Note 10.
In September 2006, the FASB issued Statement of Financial Accounting Standards No.157, "Fair Value Measurements" ("FAS 157"). FAS 157 defines fair value, sets out a framework for measuring fair value and requires additional disclosures about fair value measurements. This standard applies to fair value measurements already required or permitted by existing standards and is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the potential impact of this statement.
The Company's investment portfolio included 143 securities in an unrealized loss position at December 31, 2007. The Company's methodology of assessing other-than-temporary impairment is based upon analysis of each security as of the balance sheet date and considers various factors including the length of time and the extent to which fair value has been less than the cost, the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, and the Company's intent to hold the investment for a period of time sufficient to allow for recovery of its costs.
During the years ended December 31, 2007, 2006 and 2005, there was no significant deterioration in the credit quality of any of the Company's holdings and no other-than-temporary impairment charges were recorded related to the Company's portfolio of investment securities.
Depreciation and amortization expense for the years ended December 31, 2007, 2006 and 2005 was $1,153, $850 and $699 respectively.
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, 2007, 2006 and 2005 is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions:
Expected dividend yield is the Company's dividend yield on the measurement date and is based on the assumption that the current yield will continue in the future. Expected volatility is based on historical volatility of the Company's common stock as well as the volatility of a peer group of property and casualty insurers measured for a period equal to the expected holding period of the option. The risk-free interest rate is based upon the yield on the measurement date of a zero-coupon U.S. Treasury bond with a maturity period equal to the expected holding period of the option. The expected holding period is based upon the simplified method provided in SEC Staff Accounting Bulletin No. 107, "Share-Based Payment," which utilizes the mid-points between the vesting dates and the expiration date of the option award to calculate the overall expected term.
A summary of the status of non-vested options as of December 31, 2007, is presented below:
The following table summarizes restricted stock activity under the Incentive Plan.
Certain lease agreements contain renewal options and, in addition to the minimum annual rentals, generally provide for payment of a share of the real estate taxes and operating expenses in excess of a base amount. Rental expense was $3,482, $3,147 and $3,042 for the years ended December 31, 2007, 2006 and 2005, respectively. All leases expire prior to 2019. The Company expects that in the normal course of business, leases that expire will be renewed.
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 2007, the Company received a net refund of prior years' assessments from the Insolvency Fund of $112, which was credited for the year ended December 31, 2007. 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.
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.
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, 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, 2007 and 2006, respectively, reinsurance receivables on paid and unpaid loss and LAE with a carrying value of $80,702 and $77,246 and ceded unearned premiums of $25,738 and $29,937 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 $4,962, $4,753 and $5,771 for the years ended December 31, 2007, 2006 and 2005, respectively.
During the year ended December 31, 2005, an examination of the Company's federal income tax returns for the tax periods ended December 31, 2003, 2002, and 2001 by the Internal Revenue Service ("IRS") was completed. The Company recorded a $1,616 tax benefit representing a reduction in federal income tax reserves for tax years 2001 through 2003, resulting from a settlement reached with the IRS in August 2005. Of this total tax benefit, $455 was recorded as an increase to additional paid-in capital and $1,161 was recorded as a reduction to income tax expense for the year ended December 31, 2005. The Company is not currently under examination by the IRS.
As of January 1, 2007 and December 31, 2007, the Company had no unrecognized tax benefits, and none which if recognized would affect the effective tax rate. The Company does not currently
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.
For fixed maturities not traded in active markets, estimates of fair value are obtained by referring to traded securities with similar attributes and using a matrix pricing methodology. This methodology considers such factors as the issuer's industry, the security's rating, its coupon rate, its position in the capital structure of the issuer, and other relevant factors. The types of fixed maturities not traded in active markets include municipal bonds, most corporate bonds, and most asset-backed, mortgage backed and other collateralized securities. For these investments, management also receives fair value information from independent pricing services.
The carrying values of cash and cash equivalents and investment income accrued approximate fair value.
At December 31, 2007 and 2006 the Company had no amounts outstanding on its secured credit facility.
Although net income for the fourth quarters of 2007 and 2006 was lower than the preceding quarters of each respective fiscal year, this is not due to any unusual transactions or events. The net income in the fourth quarters of 2007 and 2006 include the effects of Massachusetts private passenger automobile rate decreases of 11.7% and 8.7% effective April 1, 2007 and January 1, 2006, respectively. These amounts also include the impact of higher claims frequencies during the fourth quarters primarily due to weather.