The following table sets forth our selected historical consolidated financial data as of and for each of the five years ended December 31, 2010, 2009, 2008, 2007, and 2006.
The selected historical consolidated financial data for the years ended December 31, 2010, 2009 and 2008 and as of December 31, 2010 and 2009 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, 2007 and 2006 and as of December 31, 2008, 2007 and 2006 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.
Our Insurance Subsidiaries began writing private passenger automobile and homeowners insurance business in New Hampshire during 2008 and personal umbrella business during 2009. During the years ended December 31, 2010 and 2009, the Company wrote $2,774 and $978 in direct written premiums, respectively, and approximately 3,300 and 1,250 policies, respectively, in New Hampshire.
We have been subject to extensive regulation in the private passenger automobile insurance industry in Massachusetts, which represented 68.7% of our direct written premiums in 2010. Owners of registered automobiles in Massachusetts are required to maintain minimum automobile insurance coverage. Prior to April 1, 2008, the Commissioner of Insurance (the "Commissioner") had fixed and established the maximum rates that could be charged for private passenger automobile insurance. Prior to April 1, 2008, as a servicing carrier of CAR, we were required to issue a policy to all qualified applicants. In addition, based on our market share prior to April 1, 2009, we had been assigned certain licensed producers by CAR that were unable to obtain a voluntary contract with another insurer. We call these agents Exclusive Representative Producers, or ERPs.
In the second decision referenced above, 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, the Commissioner would institute a system that introduces competitive pricing to the Massachusetts private passenger automobile insurance market, which the Commissioner described as "managed competition" ("Managed Competition"). 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 Commissioner has also issued a number of bulletins addressing issues related to the implementation of Managed Competition (the "Rating Bulletins").
•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.
(1)The exercise price of the options grant effective on November 27, 2002, is equal to the IPO price of our stock on that same day. The exercise price of the remaining option grants is equal to the closing price of our common stock on the grant date.
(2)The fair value per share of the restricted stock grant is equal to the closing price of the Company's common stock on the grant date.
(3)The shares cannot be sold, assigned, pledged, or otherwise transferred, encumbered or disposed of until the recipient is no longer a member of our Board of Directors. Reinsurance
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 ("FAIR Plan"). 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 continue to adjust our reinsurance programs as a result of the changes to the models and the number of homes we write. As of January 1, 2011, our catastrophe
We do not believe that inflation has had a material effect on our consolidated results of operations, except insofar as inflation may affect interest rates.
selected point estimate of net loss and LAE reserves based upon the analysis of our actuaries was $351,244 as of December 31, 2010 compared to $374,832 for December 31, 2009. We have recorded reserves closer to the high in the ranges of our projections.
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, 2010 and December 31, 2009.
Our IBNR reserves consist of our estimate of the total loss reserves required less our case reserves. The IBNR reserves for CAR assumed private passenger and commercial automobile business are 25.4% and 34.6%, respectively, of our total reserves for CAR assumed private passenger and commercial automobile business as of December 31, 2010 due to the reporting delays in the information we receive from CAR, as described further in the section on CAR Loss and Loss Adjustment Expense Reserves. Our IBNR reserves for FAIR Plan assumed homeowners are 51.3% of our total reserves for FAIR Plan assumed homeowners at December 31, 2010 due to similar reporting delays in the information we receive from FAIR Plan.
The following tables present information by line of business for our total net reserves and the corresponding retained (i.e. direct less ceded) reserves and assumed reserves as of December 31, 2010 and December 31, 2009.
We receive our final calendar year Participation Ratio report from CAR eight months after the end of that year, and thus we have to estimate for six quarters our share of the CAR deficit. For example, for the year ended December 31, 2009 we had to estimate our 2009 policy year CAR Participation Ratio beginning with the first quarter of 2009 through the second quarter of 2010.
Because of the lag in CAR estimates, and in order to try to validate to the extent possible the information CAR does provide, we must try to estimate the effects of the actions of our competitors in order to establish our Participation Ratio. Before final Participation Ratios are available, we estimate the size of CAR and the resulting deficit based on historical analysis of CAR results and estimations of our competitors' cession strategies. Even after our final Participation Ratio is available from CAR, we must continue to estimate the size of CAR and the resulting deficit based upon data published by CAR and our own continuing analysis. As a result, changes in our reserves for CAR may continue to occur until all claims are finally settled. The Loss Reserving Committee at CAR meets 70 days after the end of each quarter to estimate the CAR deficit for all active policy years and publishes estimations, which we use to estimate our share of the deficit. The estimation that CAR calculates is based on data it collects from 19 servicing carriers which settle, reserve and report claims using a variety of methods. Any delays or errors in the collection of this data could have a significant impact on the accuracy of CAR's estimations.
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, 2010, a 1 percentage-point change in the loss and LAE ratio would result in a change in reserves of $5,519. Each 1 percentage-point change in the loss and loss expense ratio would have had a $3,588 effect on net income, or $0.24 per diluted share.
Our assumptions consider that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for establishing our reserves. Our individual key assumptions could each have a reasonable possible range of plus or minus 5 percentage-points for each estimation, although there is no guarantee that our assumptions will not have more than a 5 percentage point variation. The following sensitivity tables present information for each of our primary lines of business on the effect each 1 percentage-point change in each of our key assumptions on unpaid frequency and severity could have on our retained (i.e., direct minus ceded) loss and LAE reserves and net income for the year ended December 31, 2010. In evaluating the information in the table, it should be noted that a 1 percentage-point change in a single assumption would change estimated reserves by 1 percentage-point. A 1 percentage-point change in both our key assumptions would change estimated reserves within a range of plus or minus 2 percentage-points.
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, 2010. 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. Our prior year reserves decreased by $48,157, $44,065 and $35,938 for the years ended December 31, 2010, 2009 and 2008, 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, 2010, 2009 and 2008. 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 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, 2010.
The following table presents information by line of business for prior year development of retained reserves for losses and LAE for the year ended December 31, 2010; that is, all our reserves except for business ceded or assumed from CAR and other residual markets.
Our private passenger automobile line of business prior year reserves decreased by $31,944 for the year ended December 31, 2010. The decrease was primarily due to improved retained private passenger results of $24,326 for the accident years 2005 through 2009, and improved assumed CAR results for the private passenger automobile pool of $3,026 for accident years 2008 through 2009. The improved retained private passenger results were primarily due to fewer IBNR claims than previously estimated and better than previously estimated severity on our established bodily injury and property damage case reserves. The improved CAR results were due primarily to improved CAR private passenger loss ratios as published and reported by the CAR Loss Reserving Committee.
Our commercial automobile line of business prior year reserves decreased by $7,876 for the year ended December 31, 2010 due primarily to fewer IBNR claims than previously estimated.
Our retained homeowners line of business prior year reserves decreased by $3,457 for the year ended December 31, 2010. Our FAIR Plan homeowners reserve decreased by $1,068 for the year ended December 31, 2010.
In our determination of whether a decline in fair value below amortized cost is an other-than-temporary impairment ("OTTI"), 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
The effect of assumed and ceded premiums on net written and net earned premiums is presented in the following table.
(3)The Company's investment portfolio included 80 securities in an unrealized loss position at December 31, 2010.
(4)Amounts in this column represent all other-than-temporary impairment ("OTTI") recognized in accumulated other comprehensive income. As of December 31, 2010, with the exception of one security which represented less than 0.1% of our total investment in fixed income securities, 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. All of our securities received a rating assigned by Moody's of Ba or higher, except the few securities not rated by Moody's, all of which are rated investment grade by Standard & Poor's. The Company holds no subprime mortgage debt securities. All of the Company's holdings in mortgage-backed securities are either U.S. Government or Agency guaranteed or are rated investment grade by either Moody's or Standard & Poor's.
illustrates the length of time that they have been in a continuous unrealized loss position as of December 31, 2010.
Of the $5,669 gross unrealized losses as of December 31, 2010, $4,747 relates to obligations of U.S. Treasuries, states and political subdivisions. The remaining $922 of gross unrealized losses relates to holdings of investment grade residential mortgage-backed, corporate and other securities.
ASC 820, Fair Value Measurements and Disclosure provides a revised definition of fair value, establishes a framework for measuring fair value and expands financial statement disclosure requirements for fair value information. Under ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exit price). ASC 820 establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources ("observable inputs") and a reporting entity's internal assumptions based upon the best information available when external market data is limited or unavailable ("unobservable inputs"). The fair value hierarchy in ASC 820 prioritizes fair value measurements into three levels based on the nature of the inputs as follows:
Our Level 1 securities consist of equity securities whose values are based on quoted prices in active markets for identical assets. Our Level 2 securities are comprised of our available for sale fixed maturity securities whose fair value was determined using observable market inputs. Fair values for securities for which quoted market prices were unavailable were estimated based upon reference to observable inputs such as benchmark interest rates, market comparables, and other relevant inputs. Investments valued using these inputs include U.S. Treasury securities and obligations of U.S. Government agencies, obligations of international government agencies, obligations of states and political subdivisions, corporate securities, commercial and residential mortgage-backed securities, and other asset-backed securities. Inputs into the fair value application that are utilized by asset class include but are not limited to:
•Corporate fixed maturities: overall credit quality, the establishment of a risk adjusted credit spread over the applicable risk free yield curve for discounted cash flow valuations; assessments
In order to ensure the fair value determination is representative of an exit price (consistent with ASC 820), our procedures for validating quotes or prices obtained from third-parties include, but are not limited to, obtaining a minimum of two price quotes for each fixed maturity security if possible, as discussed above, the periodic testing of sales activity to determine if there are any significant differences between the market price used to value the security as of the balance sheet date and the sales price of the security for sales that occurred around the balance sheet date, and the periodic review of reports provided by our investment manager regarding those securities with ratings changes and securities placed on our "Watch List." In addition, valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by our external investment manager, whose investment professionals are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price (consistent with ASC 820).
Our entire available for sale portfolio was priced based upon quoted market prices or other observable inputs as of December 31, 2010. There were no significant changes to the valuation process during the year ended December 31, 2010. As of December 31, 2010 and December 31, 2009, no quotes or prices obtained were adjusted by management. All broker quotes obtained were non-binding.
Transfers in and out of Level 3 are attributable to changes in the ability to observe significant inputs in determining fair value exit pricing. On January 1, 2010 our Level 3 securities consisted of one asset-backed security whose price was based solely on a single broker quote which was deemed to be obtained through unobservable inputs. This security was sold in October 2010.
Finance and Other Service Income. Finance and other service income includes revenues from premium installment charges, which we recognize when earned, and other miscellaneous income and fees. Finance and other service income for the year ended December 31, 2010, was $18,511 compared to $16,844 for the comparable 2009 period.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses incurred for the year ended December 31, 2010, increased by $14,547, or 4.2%, to $360,848 from $346,301 for the comparable 2009 period. Our GAAP loss ratio for the year ended December 31, 2010, increased to 65.4% compared to 65.1% for the comparable 2009 period. Our GAAP loss ratio excluding loss adjustment expenses for the year ended December 31, 2010 increased to 56.0% from 55.8% for the comparable 2009 period. Total prior year favorable development included in the pre-tax results for the year ended December 31, 2010 was $48,157, compared to prior year favorable development of $44,065 for the comparable 2009 period.
Income Tax Expense. Our effective tax rates were 28.6% and 27.2% for the years ended December 31, 2010 and 2009, respectively. These effective rates were lower than the statutory rate of 35% primarily due to adjustments for tax-exempt investment income.
Net Written Premiums. Net written premiums for the year ended December 31, 2009, decreased by $20,275, or 3.7%, to $532,629 from $552,904 for 2008. This decrease was due to the factors that decreased direct written premiums combined with decreases in premiums assumed from CAR, and partially offset by decreases in premiums ceded to CAR. Written premiums assumed and ceded to CAR decreased as a result of the phase-out of the CAR personal automobile reinsurance pool, which was replaced by an assigned risk plan, the MAIP. Beginning with policy effective dates after March 31, 2009, all personal automobile business was eligible for MAIP and could no longer be ceded to CAR.
$1,060,554 for the comparable 2008 period. The net effective yield on the investment portfolio decreased to 4.1% during the year ended December 31, 2009, compared to 4.3% during 2008 primarily due to lower yields on cash and short-term securities. Our duration increased to 3.3 years at December 31, 2009, from 3.2 years at December 31, 2008.
Net Realized Gains (Losses) on Investments. Net realized losses on investments were $167 for the year ended December 31, 2009 compared to net realized gains of $678 for the year ended December 31, 2008.
The gross unrealized gains and losses on investments in fixed maturity securities and equity securities, including interests in mutual funds, were as follows:
(1)Residential mortgage-backed securities consists primarily of obligations of U.S. Government agencies including collateralized mortgage obligations and mortgage backed securities 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 the Federal Home Loan Bank (FHLB). The total of these fixed maturity securities was $289,447 at amortized cost and $300,172 at fair value as of December 31, 2009.
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, 2009.
The following table shows our insured investments by Moody's rating where it is available with and without the impact of the insurance guarantee as of December 31, 2009.
Of the $5,017 gross unrealized losses as of December 31, 2009, $1,525 relates to fixed maturity obligations of U.S. Treasuries and obligations of states and political subdivisions. The remaining $3,492 of gross unrealized losses relates primarily to holdings of investment grade mortgage-backed and other securities.
The unrealized losses recorded on the investment portfolio at December 31, 2009 resulted from fluctuations in market interest rates and other temporary market conditions as opposed to fundamental changes in the credit quality of the issuers of such securities. Given our current level of liquidity, the fact that we do not intend to sell these securities, and that it's more likely than not that we will not be required to sell these securities prior to recovery of the cost basis of these securities, these decreases in values are viewed as being temporary.
During the year ended December 31, 2009, there was no significant deterioration in the credit quality of any of our holdings. During the year ended December 31, 2008, there was a significant deterioration in the issuer's financial condition of one of our holdings, American International Group, Inc. Accordingly, in the third quarter of 2008 we recorded an OTTI charge of $1,032 for this security. We sold this security during the third quarter of 2009 and recognized an additional loss of $14.
Level 1-Valuations based on quoted prices in active markets for identical assets and liabilities;
On January 1 and December 31, 2009, one fixed maturity security was manually priced solely using broker quotes. This was deemed to render the fair value measurements as based upon unobservable inputs and accordingly, it was classified within Level 3. Transfers in and out of Level 3 would be attributable to changes in the ability to observe significant inputs in determining fair value exit pricing. As noted in the table above, no transfers were made in or out of Level 3 inputs during the year ended December 31, 2009.
Finance and Other Service Income. Finance and other service income includes revenues from premium installment charges, which we recognize when earned, and other miscellaneous income and fees. Finance and other service income for the year ended December 31, 2009, was $16,844 compared to $17,995 for the comparable 2008 period.
Underwriting, Operating and Related Expenses. Underwriting, operating and related expense for the year ended December 31, 2009 decreased by $1,863, or 1.1%, to $171,124 from $172,987 for the comparable 2008 period. Our GAAP expense ratios for the year ended December 31, 2009 increased to 32.2% compared to 30.0% for the comparable 2008 period. The expense ratio increased primarily as a result of decreases in net earned premiums as discussed above. In addition, an amount of $7,547 related to our January 2010 agreement with the Massachusetts Attorney General's office was recorded as an increase to our underwriting expenses for the year ended December 31, 2009. For further information, please see Part I-Item 3, Legal Proceedings.
Net cash used for financing activities was $30,865, $66,550, and $29,795 during the years ended December 31, 2010, 2009, and 2008, respectively. Net cash used for financing activities is primarily comprised of dividend payments to shareholders and the acquisition of treasury stock. Net cash used for financing activities during 2010 decreased by $35,685 compared to 2009 primarily due to the decrease in treasury stock acquisitions. Net cash used for financing activities during 2009 increased by $36,755 compared to 2008 primarily due to the increase in treasury stock acquisitions.
Our obligations under the credit facility are secured by pledges of our assets and the capital stock of our operating subsidiaries. The credit facility is guaranteed by our non-insurance company subsidiaries. The credit facility contains covenants including requirements to maintain minimum risk-based capital ratios and statutory surplus of Safety Insurance as well as limitations or restrictions on indebtedness, liens, and other matters. Among other covenants, the credit facility restricts our payment of dividends (i) if a default under the credit facility is continuing or would result therefrom or (ii) in an amount in excess of 50% of our prior year's net income, as determined in accordance with GAAP. Although we paid $27,098 in dividends to shareholders in 2010 which exceeded 50% of our prior year net income by $22, prior consent to pay the excess amount was obtained from RBS Citizens. As of December 31, 2010, we were in compliance with all other covenants. In addition, the credit facility includes customary events of default, including a cross-default provision permitting the lenders to accelerate the facility if the Company (i) defaults in any payment obligation under debt having a principal amount in excess of $10,000 or (ii) fails to perform any other covenant permitting acceleration of all such debt.
Our insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of the Commissioner. The Massachusetts statute limits the dividends an insurer may pay in any twelve-month period, without the prior permission of the Commissioner, to the greater of (i) 10% of the insurer's surplus as of the preceding December 31 or (ii) the insurer's net income for the twelve-month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices.
Since the initial public offering of its common stock in November 2002, the Company has paid regular quarterly dividends to shareholders of its common stock. Quarterly dividends paid during 2010 and 2009 were as follows:
a cost of $55,526. As of December 31, 2009, we had purchased 1,564,548 of our common shares on the open market under the program at a cost of $49,712.
We have no material obligations under a guarantee contract meeting the characteristics identified in ASC 460, Guarantees. We have no material retained or contingent interests in assets transferred to an unconsolidated entity. We have no material obligations, including contingent obligations, under contracts that would be accounted for as derivative instruments. We have no obligations, including contingent obligations, arising out of a variable interest in an unconsolidated entity held by, and material to, us, where such entity provides financing, liquidity, market risk or credit risk support to, or engages in leasing, hedging or research and development services with us. We have no direct investments in real estate and no holdings of mortgages secured by commercial real estate. Accordingly, we have no material off-balance sheet arrangements.
As of December 31, 2010, the Company had loss and LAE reserves of $404,391, unpaid reinsurance recoverables of $53,147 and net loss and LAE reserves of $351,244. Our loss and LAE reserves are estimates as described in more detail under "Critical Accounting Policies and Estimates." The specific amounts and timing of obligations related to case reserves, IBNR reserves and related LAE reserves are not set contractually, and the amounts and timing of these obligations are unknown. Nonetheless, based upon our cumulative claims paid over the last ten years, the Company estimates that its loss and LAE reserves will be paid in the period shown above. While management believes that historical performance of loss payment patterns is a reasonable source for projecting future claims payments, there is inherent 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
Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as "believe," "expect," "anticipate," "intend," "plan," "estimate," "aim," "projects," or words of similar meaning and expressions that indicate future events and trends, or future or conditional verbs such as "will," "would," "should," "could," or "may." All statements that address expectations or projections about the future, including statements about the Company's strategy for growth, product development, market position, expenditures and financial results, are forward-looking statements.
Forward-looking statements are not guarantees of future performance. By their nature, forward-looking statements are subject to risks and uncertainties. There are a number of factors, many of which are beyond our control, that could cause actual future conditions, events, results or trends to differ significantly and/or materially from historical results or those projected in the forward-looking statements. These factors include but are not limited to the competitive nature of our industry and the possible adverse effects of such competition. Although a number of national insurers that are much larger than we are do not currently compete in a material way in the Massachusetts private passenger automobile market, if one or more of these companies decided to aggressively enter the market it could have a material adverse effect on us. Other significant factors include conditions for business operations and restrictive regulations in Massachusetts, the possibility of losses due to claims resulting from severe weather, the possibility that the Commissioner may approve future Rule changes that change the operation of the residual market, the possibility that the AG's proposed regulations will be enacted and existing insurance-related laws and regulations will become further restrictive in the future, our possible need for and availability of additional financing, and our dependence on strategic relationships, among others, and other risks and factors identified from time to time in our reports filed with the SEC. Refer to Part I, Item 1A - Risk Factors.
The Company is a leading provider of personal lines property and casualty insurance focused primarily on the Massachusetts market. The Company's principal product line is private passenger automobile insurance, which accounted for 68.7% of its direct written premiums in 2010. The Company operates through its insurance company subsidiaries, Safety Insurance Company, Safety Indemnity Insurance Company and Safety Property and Casualty Company (together referred to as the "Insurance Subsidiaries").
The Company began writing private passenger automobile and homeowners insurance business in New Hampshire during 2008 and began writing New Hampshire personal umbrella business during 2009. During the years ended December 31, 2010 and 2009, the Company wrote $2,774 and $978, respectively, in direct written premiums in New 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. Short-term investments, which consist of U.S. Treasury bills, are reported at amortized cost which approximates fair value. Other invested assets, which include collateral loans, are state at cost, which approximates fair value. Unrealized gains or losses on fixed maturity and equity securities reported at fair value are excluded from earnings and reported in a separate component of shareholders' equity, known as "Accumulated other comprehensive 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.
Amounts that vary with and are primarily related to acquiring new and renewal business, principally commissions and premium taxes, are deferred and amortized ratably over the effective period of the policies. All other acquisition expenses are expensed as incurred. Deferred policy acquisition costs are reviewed to determine if they are recoverable from future income, and if not, are charged to expense. Future investment income attributable to related premiums is not taken into account in measuring the recoverability of the carrying value of this asset. Amortization of acquisition costs in the amount of $101,980, $96,503 and $100,899 was charged to underwriting expenses for the years ended December 31, 2010, 2009 and 2008, respectively.
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.
Premiums received in advance of the policy effective date are recorded as a liability and not recognized as income until earned. Such amounts are included in accounts payable and accrued liabilities and totaled $13,793 and $15,302 at December 31, 2010 and 2009, respectively.
Basic earnings per weighted average common share ("EPS") is calculated by dividing net income by the weighted average number of basic common shares outstanding during the period including unvested restricted shares which are considered participating securities. Diluted earnings per share amounts are based on the weighted average number of common shares including unvested restricted shares and the net effect of potentially dilutive common shares outstanding. At December 31, 2010, 2009 and 2008, the Company's potentially dilutive instruments were common shares under options of 151,003, 215,337 and 238,666, respectively.
As permitted by ASC 718, the Company elected the modified prospective transition method. Under the modified prospective transition method, (i) compensation expense for share-based awards granted prior to January 1, 2006 is recognized over the remaining service period using the compensation cost calculated for pro forma disclosure purposes as adjusted to incorporate forfeiture assumptions, and (ii) compensation expense for all share-based awards granted subsequent to December 31, 2005 is based on the grant date fair value estimated in accordance with the provisions of ASC 718. Results for periods prior to January 1, 2006 have not been restated.
ASC 855, Subsequent Events, establishes principles and requirements for subsequent events. ASC 855 is effective for interim and annual financial periods ending after June 15, 2009, and was applied prospectively. In February 2010, the FASB issued updated guidance which amended the subsequent events disclosure requirements to eliminate the requirement for SEC filers to disclose the date through which it has evaluated subsequent events, clarify the period through which conduit bond obligors must evaluate subsequent events and refine the scope of the disclosure requirements for reissued financial statements. The updated guidance was effective upon issuance. The adoption of the guidance had no impact on the Company's consolidated financial condition or results of operations.
In January 2010, the FASB issued ASC Update No. 2010-06 (Topic 820), Improving Disclosures about Fair Value Measurements, which amends and clarifies existing guidance related to fair value measurements and disclosures. This guidance requires new disclosures for (1) transfers in and out of Level 1 and Level 2 and reasons for such transfers; and (2) the separate presentation of purchases, sales, issuances and settlement in the Level 3 reconciliation. It also clarifies guidance around disaggregation and disclosures of inputs and valuation techniques for Level 2 and Level 3 fair value measurements. The Company adopted this guidance effective for quarter ended March 31, 2010, except for the new disclosures in the Level 3 reconciliation. The Level 3 disclosures are effective for periods ending after December 15, 2010 and were implemented for year end December 31, 2010. The adoption of the guidance did not have an impact on the Company's consolidated financial condition or results of operations.
In October 2010, the FASB issued updated guidance to address diversity in practice for the accounting of costs associated with acquiring or renewing insurance contracts. This guidance modifies the definition of acquisition costs to specify that a cost be directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred. The guidance also specifies that advertising costs only should be included as deferred acquisition costs if the direct-response advertising accounting criteria are met. The new guidance is effective for reporting periods beginning after December 15, 2011 and should be applied prospectively, with retrospective application permitted. The Company is in process of evaluating the impact of adoption on its consolidated financial conditions and results of operations.
(2)Equity securities includes interests in mutual funds of $11,210 and $9,736 at cost and $11,699 and $9,876 at fair value as of December 31, 2010 and 2009, respectively, held to fund the Company's executive deferred compensation plan.
The gross realized gains (losses) on investments were as follows for the periods indicated:
The following tables as of December 31, 2010 and December 31, 2009 illustrate the gross unrealized losses included in the Company's investment portfolio and the fair value of those securities aggregated by investment category. The tables also illustrate the length of time that they have been in a continuous unrealized loss position.
As of December 31, 2010, the Company held insured investment securities of approximately $244,893 which represented approximately 22.7% of the Company's total investment portfolio. Approximately $63,398 of these securities are pre-refunded, meaning that funds have been set aside in escrow to satisfy the future interest and principal obligations of the bond.
The following table shows the Company's insured investments by Moody's rating where it is available both with and without the impact of the insurance guarantee as of December 31, 2010.
The unrealized losses in the Company's fixed income portfolio as of December 31, 2010 were reviewed for potential other- than-temporary asset impairments. The Company held no debt and equity securities at December 31, 2010 with a material (20% or greater) unrealized loss for four or more
consecutive quarters. Specific qualitative analysis was also performed for any additional securities appearing on the Company's "Watch List," if any. Qualitative analysis considered such factors as the financial condition and the near term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, changes to the rating of the security by a rating agency and the historical volatility of the fair value of the security.
During the year ended December 31, 2010 and 2009, there was no significant deterioration in the credit quality of any of the Company's holdings and no OTTI charges were recorded related to the Company's portfolio of investment securities.
ASC 320, Investments-Debt and Equity Securities requires that the Company record, as of the beginning of the interim period of adoption, a cumulative effect adjustment to reclassify the noncredit component of a previously recognized OTTI from retained earnings to other comprehensive income (loss). At April 1, 2009 and December 31, 2010, there were no amounts included in accumulated other comprehensive income related to securities which were considered by the Company to be other-than-temporarily impaired.
Fair values for the Company's fixed maturity securities are based on prices provided by its custodian bank and its investment manager. Both the custodian bank and the investment manager use a variety of independent, nationally recognized pricing services to determine market valuations. If the pricing service cannot provide fair value determinations, the Company obtains non-binding price quotes from broker-dealers. A minimum of two quoted prices is obtained for the majority of our available for sale fixed maturity securities in the Company's investment portfolio. The Company's custodian bank is its primary provider of quoted prices from third-party pricing services and broker-dealers. To provide reasonable assurance of the validity of each price or quote, a secondary third-party pricing service or broker-dealer quote is obtained from the Company's investment manager. An examination of the pricing data is then performed for each security. If the variance between the primary and secondary price quotes for a security is within an accepted tolerance level, the quoted price obtained from the Company's custodian bank is used in the Company's financial statements for the security. If the variance between the primary and secondary price quotes exceeds an accepted tolerance level, the Company obtains a quote from an alternative source, if possible, and documents and resolves any differences between the pricing sources. In addition, the Company may request that its investment manager and their traders provide input as to which vendor is providing prices that their traders believe are reflective of fair value for the security. Following this process, the Company may decide to value the security in its financial statements using the secondary or alternative source if it believes that pricing is more reflective of the security's value than the primary pricing provided by its custodian bank. The Company analyzes market valuations received to verify reasonableness, to understand the key assumptions used and their sources, and to determine an appropriate ASC 820 fair value hierarchy level based upon trading activity and the observability of market inputs. Based on this evaluation and investment class analysis, each price is classified into Level 1, 2 or 3.
being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price (consistent with ASC 820).
The following tables summarize the changes in the Company's Level 3 fair value measurements for the periods indicated.
On March 10, 2006, the Board 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. The maximum number of shares of common stock with
A summary of stock based awards granted under the Incentive Plan is as follows:
(3)The shares cannot be sold, assigned, pledged, or otherwise transferred, encumbered or disposed of until the recipient is no longer a member of the Board of Directors.
The fair value of stock options used to compute both net income and earnings per share disclosures for the years ended December 31, 2010, 2009 and 2008 is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions:
At December 31, 2010, the aggregate intrinsic value of outstanding shares under option was $1,573 with a weighted average remaining contractual term of 4.7 years. At December 31, 2009, the aggregate intrinsic value of outstanding shares under option and exercisable was $971 with a weighted average remaining contractual term of 5.5 years. At December 31, 2008, the aggregate intrinsic value of outstanding shares under option and exercisable was $1,629 with a weighted average remaining contractual term of 6.3 years. Aggregate intrinsic value represents the total pretax intrinsic value, based upon the Company's closing year end stock price of $47.72, $36.23 and $38.06 for December 31, 2010, 2009 and 2008, respectively, which would have been received by the option holders had all option holders exercised their options as of those dates. The range of exercise prices on stock options outstanding under the Incentive Plan was $13.30 to $42.85 at December 31, 2010, and $12.00 to $42.85 at December 31, 2009 and 2008. The total intrinsic value of options exercised during the years ended December 31, 2010, 2009 and 2008 was $1,080, $442 and $2,227, respectively.
A summary of the status of non-vested options as of December 31, 2010 is presented below:
As of December 31, 2010, there was $65 of unrecognized compensation expense related to non-vested option awards that is expected to be recognized over a weighted average period of 0.2 years.
Cash received from options exercised was $1,990, $367 and $1,416 for the years ended December 31, 2010, 2009, and 2008, respectively.
As a result of adopting ASC 718, Compensation-Stock Compensation on January 1, 2006, the Company's net income for the twelve months ended December 31, 2010 was lowered by $240, net of income tax benefit of $129. The Company's net income for the twelve months ended December 31, 2009 was lowered by $336, net of income tax benefit of $181. The impact on basic and diluted EPS for the twelve months ended December 31, 2010 and 2009 was a reduction of $0.02 and $0.02 per share, respectively.
The following table summarizes restricted stock activity under the Incentive Plan for the years ending December 31.
As of December 31, 2010, there was $6,511 of unrecognized compensation expense related to non-vested restricted stock awards that is expected to be recognized over a weighted average period of 1.8 years. The total fair value of the shares that were vested and unrestricted during the years ended December 31, 2010, 2009 and 2008 was $3,782, $3,412 and $2,733, respectively. For the years ended December 31, 2010, 2009 and 2008, the Company recorded compensation expense related to restricted stock of $2,617, $2,493 and $2,230, net of income tax benefits of $1,409, $1,342 and $1,201, respectively.
The Company has various non-cancelable long-term operating leases. The approximate minimum annual rental payments due under these lease agreements as of December 31, 2010 are as follows:
On January 14, 2010, the Company announced it had reached an agreement with the AG to change the way in which the Company calculated motorcycle premiums for certain types of coverage dating back to January 1, 2002. Under the terms of the settlement, the Company agreed to pay refunds to certain motorcycle policyholders. The Company has deposited $7,408 into a trust fund to be used to pay the amount of those refunds and has paid $330 to the Commonwealth of Massachusetts, which includes reimbursement of costs and expenses related to the implementation of the settlement by the AG. Of the total settlement to date, $7,547 was recorded as an increase to the Company's Underwriting, operating and other expenses for the year ended December 31, 2009 and $191 of additional refunds subsequently identified by the AG and deposited to the trust fund by the Company in July 2010 was recorded as Underwriting, operating and other expenses for the year ended December 31, 2010.
The Company's obligations under the credit facility are secured by pledges of its assets and the capital stock of its operating subsidiaries. The credit facility is guaranteed by the Company's non-insurance company subsidiaries. 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, and other matters. Among other covenants, the credit facility restricts the Company's payment of dividends (i) if a default under the credit facility is continuing or would result therefrom or (ii) in an amount in excess of 50% of the Company's prior year's net income, as determined in accordance with GAAP. Although the Company paid $27,098 in dividends to shareholders in 2010 which exceeded 50% of its prior year net income by $22, prior consent to pay the excess amount was obtained from RBS Citizens. As of December 31, 2010, the Company was in compliance with all other covenants. In addition, the credit facility includes customary events of default, including a cross-default provision permitting the lenders to accelerate the facility if the Company (i) defaults in any payment obligation under debt having a principal amount in excess of $10,000 or (ii) fails to perform any other covenant permitting acceleration of all such debt.
The Company had no amounts outstanding on its credit facility at December 31, 2010 and 2009. 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, 2010 and 2009.
The effect of assumed and ceded premiums on net written and earned premiums and losses and LAE is as follows:
At the end of each period, the reserves were re-estimated for all prior accident years. The Company's prior year reserves decreased by $48,157, $44,065, and $35,938 for the years ended December 31, 2010, 2009, and 2008, respectively. The decrease in prior year reserves during 2010 resulted from re-estimations of prior year ultimate loss and LAE liabilities and is primarily composed of reductions of $34,248 in our retained automobile reserves, $7,269 in our retained homeowners and retained all other reserves, and $5,572 in CAR assumed reserves. The decrease in prior year reserves during 2009 resulted from re-estimations of prior year ultimate loss and LAE liabilities and is primarily composed of reductions of $24,979 in the Company's retained automobile reserves, $11,551 in reserves assumed from CAR, and $6,103 in the Company's retained homeowners and all other reserves. The decrease in prior year reserves during 2008 resulted from re-estimations of prior years ultimate loss and LAE liabilities and is primarily composed of reductions of $21,752 in the Company's retained automobile reserves and $8,905 in reserves assumed from CAR.
As of December 31, 2010, 2009, and 2008, the Company had no unrecognized tax benefits, and none which if recognized would affect the effective tax rate. The Company does not currently anticipate significant changes in the amount of unrecognized income tax benefits during the next twelve months.
The Company records interest and penalties associated with audits as a component of Income before income taxes. Penalties are recorded in Underwriting, operating and other expenses, and interest expense is recorded in Interest expenses in the Consolidated Statement of Operations. The Company had no interest and penalties accrued as of December 31, 2010 and 2009.
As of December 31, 2010, the Company was no longer subject to examination of its U.S. federal tax returns for years prior to 2007. The Company is not currently under examination by the IRS. During the year 2009, the Massachusetts Department of Revenue concluded its review of the 2005 and 2006 tax periods. The resulting audit adjustments were immaterial to the Company's financial position.
On August 3, 2007, the Board approved a share repurchase program of up to $30,000 of the Company's outstanding common shares. On March 19, 2009, the Board increased this existing share repurchase program by authorizing repurchase of up to $60,000 of the Company's outstanding common shares. On August 4, 2010, the Board again increased the existing share repurchase program by authorizing repurchase of up to $90,000 of the Company's outstanding common shares. Under the program, the Company may repurchase shares of its common stock for cash in public or private transactions, in the open market or otherwise, at management's discretion. The timing of such repurchases and actual number of shares repurchased will depend on a variety of factors including price, market conditions and applicable regulatory and corporate requirements. The program does not require the Company to repurchase any specific number of shares and may be modified, suspended or terminated at any time without prior notice. During the year ended December 31, 2010, the Company purchased 162,907 shares of its common shares on the open market under the program at a cost of $5,814. During the year ended December 31, 2009, the Company purchased 1,332,535 of its common shares on the open market under the program at a cost of $42,196. As of December 31, 2010 the Company had purchased 1,727,455 shares on the open market at a cost of $55,526. As of December 31, 2009, the Company had purchased 1,564,548 of its common shares on the open market under the program at a cost of $49,712.
The Insurance Subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of the Commonwealth of Massachusetts Commissioner of Insurance (the "Commissioner"). Massachusetts statute limits the dividends an insurer may pay in any twelve month period, without the prior permission of the Commissioner, to the greater of (i) 10% of the insurer's surplus as of the preceding December 31 or (ii) the insurer's net income for the twelve-month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices. Our insurance company subsidiaries may not declare an "extraordinary dividend" (defined as any dividend or distribution that, together with other distributions made within the preceding twelve 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 2010, the statutory surplus of Safety Insurance was $582,432 and its net income for 2010 was $51,560. As a result, a maximum of $58,243 is available in 2011 for such dividends without prior approval of the Commissioner. During the year ended December 31, 2010, Safety Insurance recorded dividends to Safety of $28,198.
At December 31, 2010 and 2009 investments in fixed maturities and equity securities classified as available for sale had a fair value which equaled carrying value of $1,077,861 and $1,028,205, respectively. At December 31, 2010 and 2009 other invested assets had a carrying value at cost of $2,817 and $409, which approximates fair value. At December 31, 2010 and 2009, we held no short-term investments. The carrying values of cash and cash equivalents and investment income accrued approximates fair value.
At December 31, 2010 and 2009 the Company had no amounts outstanding on its secured credit facility.