The following table sets forth our selected historical consolidated financial data as of and for each of the five years ended December 31, 2005. Prior to October 16, 2001, Thomas Black Corporation (“TBC”) was the ultimate parent company of Safety Insurance. In the Acquisition, on October 16, 2001, Safety Insurance Group, Inc. became the parent company of TBC.
The selected historical consolidated financial data for the years ended December 31, 2005, 2004 and 2003 and as of December 31, 2005 and 2004 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 as of and for the year then ended December 31, 2002 and for the successor period October 16, 2001 to December 31, 2001 and for the predecessor period January 1, 2001 to October 15, 2001 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. As a result of the Acquisition, financial data for periods prior to the Acquisition may not be comparable with financial data for periods following the Acquisition.
(1) In this financial presentation, the financial data for 2001 has been split into a predecessor period from January 1, 2001 to October 15, 2001 and a successor period from October 16, 2001 to December 31, 2001.
The following discussion contains forward-looking statements. We intend statements which are not historical in nature to be, and are hereby identified as “forward-looking statements” to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In addition, the Company’s senior management may make forward-looking statements orally to analysts, investors, the media and others. This safe harbor requires that we specify important factors that could cause actual results to differ materially from those contained in forward-looking statements made by or on behalf of us. We cannot promise that our expectations in such forward-looking statements will turn out to be correct. Our actual results could be materially different from and worse than our expectations. See “Forward-Looking Statements” on page 61 for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.
In this discussion, “Safety” refers to Safety Insurance Group, Inc. and “our Company,” “we,” “us” and “our” refer to Safety Insurance Group, Inc. and its consolidated subsidiaries. Our subsidiaries consist of Safety Insurance Company (“Safety Insurance”), Safety Indemnity Insurance Company, Whiteshirts Asset Management Corporation (“WAMC”), f/k/a Thomas Black Insurance Agency, Inc., and Whiteshirts Management Corporation, f/k/a RBS, Inc., which is WAMC’s holding company.
We are a leading provider of private passenger automobile insurance in Massachusetts. In addition to private passenger automobile insurance (which represented 80.3% of our direct written premiums in 2005), we offer a portfolio of other insurance products, including commercial automobile (10.8% of 2005 direct written premiums), homeowners (7.2% of 2005 direct written premiums), dwelling fire, umbrella and business owner policies (totaling 1.7% of 2005 direct written premiums). Operating exclusively in Massachusetts through our insurance company subsidiaries, Safety Insurance and Safety Indemnity Insurance Company (together referred to as the “Insurance Subsidiaries”), we have established strong relationships with 637 independent insurance agents in 743 locations throughout Massachusetts. We have used these relationships and our extensive knowledge of the Massachusetts market to become the second largest private passenger automobile insurance carrier in Massachusetts, capturing an approximate 11.3% share of the Massachusetts private passenger automobile market in 2005, according to the CAR Cession Volume Analysis Report of February 27, 2006, based on automobile exposures. These statistics total, for each vehicle insured, the number of months during the year insurance for that vehicle is in effect, to arrive at an aggregate number of car-months for each insurer; this aggregate number, divided by 12, equals the insurer’s number of car-years, a measure we refer to in this discussion as automobile exposures.
On June 15, 2005, CAR approved rules to modify the ERP subscription relief process, making the reassignment of ERP exposures from an oversubscribed servicing carrier more timely and responsive, while enhancing equity in the ERP distribution for all servicing carriers (the “ERP Subscription Rules”). Also, the current practice of two and three-party agreements between ERPs and servicing carriers would be prohibited. On September 30, 2005, the Commissioner approved the ERP Subscription Rules, and instructed CAR to complete a redistribution of all ERPs that will establish for all servicing carriers overall parity in the quantity and quality of their ERP exposures. The redistribution plan for ERPs as adopted by the CAR Governing Committee on November 16 and December 14, 2005, was approved by the Commissioner on January 27, 2006. On January 31, 2006 CAR notified each reassigned ERP and all servicing carriers of the redistribution. According to the January 31, 2006 CAR Private Passenger ERP Redistribution Summary, 18 Safety ERPs with 25,590 exposures were assigned to other servicing carriers beginning with new business effective March 1, 2006 and renewal business May 1, 2006. In addition, CAR assigned 29 ERPs with 24,670 exposures from other servicing carriers to Safety, however 25 of these ERPs with 23,116 exposures were given voluntary contracts by their former servicing carrier or other carriers and are no longer eligible for assignment to Safety as ERPs. We expect that the redistribution of ERPs will eliminate our disproportionate share of high loss ratio ERP business, and would therefore result in a reduction of the expense we incur because of our disproportionate share of high loss ratio ERPs. However, it is possible that other servicing carriers or ERPs could bring challenges, with regards to the redistribution of ERPs, and as a result there can be no assurances that our expenses will be reduced.
On June 1, 2005, the Governor filed legislation that would introduce more competition into the Massachusetts automobile insurance marketplace, reduce rates for good drivers, target fraud and excessive personal injury costs, and allow insurers rate flexibility. At this time we are unable to predict whether the Governor’s legislation will be enacted by the legislature.
While state-mandated average maximum private passenger automobile insurance rates decreased 1.7% for 2005, our average premium per automobile exposure in the year ended December 31, 2005 increased from the year ended December 31, 2004 by approximately 0.1%. This increase was primarily the result of purchases of new automobiles by our insureds. We believe that the continued benefits of our rate pursuit initiative, which validates insured rating classifications and discount eligibility, also contributed to the increase in our average premiums received per automobile exposure. The table below shows average Massachusetts-mandated private passenger automobile premium rate changes and changes in our average premium per automobile exposure from 1996-2005.
· Amounts related to ceded reinsurance are shown gross as prepaid reinsurance premiums and reinsurance recoverables, rather than netted against unearned premium reserves and loss and loss adjustment expense reserves, respectively, as required by SAP.
· Equity securities are reported at quoted market values, which may differ from the National Association of Insurance Commissioners market values as required by SAP.
(1) The exercise price of the options grant effective on November 27, 2002 is equal to the IPO price of our stock on that same day. The exercise price of the remaining option grants is equal to the closing price of our common stock on the grant effective date.
We reinsure with other insurance companies a portion of our potential liability under the policies we have underwritten, thereby protecting us against an unexpectedly large loss or a catastrophic occurrence that could produce large losses, primarily in our homeowners line of business. As of January 1, 2006 our catastrophe reinsurance provides gross per occurrence reinsurance coverage up to $250,000. Our catastrophe reinsurance protects us in the event of a “415-year storm” (that is, a storm of a severity expected to occur once in a 415-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 Montpelier Re, Endurance Re and Amlin Bermuda which are rated “A-” (Excellent). We are a participant in CAR, a state-established body that runs the residual market reinsurance programs for both private passenger and commercial automobile insurance in Massachusetts under which premiums, expenses, losses and loss adjustment expenses on ceded business are shared by all insurers writing automobile insurance in Massachusetts. We also participate in the Massachusetts Property Insurance Underwriting Association (“FAIR Plan”) in which premiums, expenses, losses and loss adjustment expenses on homeowners business that cannot be placed in the voluntary market are shared by all insurers writing homeowners insurance in Massachusetts. At December 31, 2005, we had no material amounts recoverable from any reinsurer, excluding the residual markets described above.
On March 10, 2005, our Board of Directors adopted a resolution that prohibits Safety from purchasing finite reinsurance without approval by the Board. To date, the Company has never purchased a finite reinsurance contract.
Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting future events. It is possible that the final outcome may fall above or below these amounts as a result of a number of factors, including immature data, sparse data, or significant growth in a line of business. Using these methodologies our actuaries established a range of reasonable possible estimations for net reserves of approximately $332,266 to $382,506 as of December 31, 2005, as compared to a range of $329,403 to $384,536 for 2004. In general, the low and high values of the ranges represent reasonable minimum and maximum values of the indications based on the techniques described above.
Range of Net Reserves for Losses and LAE as of December 31, 2004
For our private passenger and commercial auto lines of business as of December 31, 2005, due to the relatively long time we have been writing these lines of insurance, and our stable long-term trends in frequency and severity, the range of reserves are relatively narrow compared to the mid-point estimation
The following tables present information by line of business for our net reserves for losses and LAE as of December 31, 2005 and December 31, 2004.
We receive a Settlement of Balances report from CAR that reports our share of CAR premium, losses and LAE, on a lagged basis, seventy-five days after the end of every quarter. CAR-published financial data is always at least one quarter behind the financial data we report. For example, when we reported our financial results for the year ended December 31, 2005, we had nine months of reported 2005 CAR financial data, and we had to estimate what CAR would report to us for the last three months of the year.
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, 2005 a 1 percentage-point change in the loss and LAE ratio would result in a change in reserves of $6,228. Each 1 percentage-point change in the loss and loss expense ratio would have a $4,048 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. Our assumptions could
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, 2005. Each accident year represents all claims for an annual calendar 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.
Our private passenger automobile line of business prior year reserves decreased by $31,754 for the year ended December 31, 2005. The decrease was primarily due to improved assumed CAR results for the private passenger automobile pool for the 2004 accident year of $15,263 and for the 2003 accident year of $4,216. The improved CAR results were due primarily to improved CAR private passenger loss ratios for 2004 and 2003 as published and reported by the CAR Loss Reserving Committee at the November 30, 2005 meeting, as compared to the published results at the December 1, 2004 meeting. In addition, we reduced our retained private passenger automobile reserves for the 2004 and 2002 accident years by $9,768 and $1,883, respectively, primarily due to better than previously estimated severity on our established bodily injury case reserves during 2005.
Our Homeowners line of business prior year reserves decreased by $2,949 for the year ended December 31, 2005. The decrease was due to improved FAIR Plan results for the 2004, 2003 and 2002 accident years of $656, $687 and $323 respectively, and better than previously estimated severity on property reserves on our established case reserves for 2003 and 2002 of $751 and $983, respectively, partially offset by increased severity on our established case reserves for 2004 of $1,077. The improved FAIR Plan results were due primarily to the increase in business written by the FAIR Plan in Massachusetts coastal territories such as Cape Cod without the occurrence of a catastrophe.
In estimating all our loss reserves, including CAR, we follow the guidance prescribed by Statement of Financial Accounting Standards (“FAS”) No. 60, “Accounting and Reporting by Insurance Enterprises” and FAS No. 113, “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.”
For further information, see “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations: Losses and Loss Adjustment Expenses.”
Direct Written Premiums. Direct written premiums for the year ended December 31, 2005 increased by $20,818, or 3.3% to $649,113 from $628,295 for 2004. The 2005 increase occurred primarily in our personal automobile line, which experienced a 0.1% increase in average written premium and a 2.4% increase in written exposures. In addition, our commercial automobile line’s average written premium decreased by 0.3%, with a 7.6% increase in written exposures. Our homeowners line average written premium increased by 7.3%, with a 2.9% decrease in written exposures.
Net Written Premiums. Net written premiums for the year ended December 31, 2005 increased by $13,913 or 2.2% to $632,836 from $618,923 for 2004. This was primarily due to the factors that increased direct written premiums combined with a decrease in premiums ceded to CAR.
Net Earned Premiums. Net earned premiums for the year ended December 31, 2005 increased by $30,539, or 5.2%, to $622,831 from $592,292 for 2004. This was primarily due to the factors that increased direct written premiums combined with a decrease in premiums ceded to CAR.
As of December 31, 2005, our portfolio of fixed maturity investments was comprised entirely of investment grade corporate fixed maturity securities, U.S. government and agency securities and asset-backed securities (i.e., all our securities received a rating assigned by Moody’s Investors Service, Inc. 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).
Ratings are assigned by Moody’s, or the equivalent, as discussed above. Such ratings are generally assigned upon the issuance of the securities and are subject to revision on the basis of ongoing evaluations. Ratings in the table are as of the date indicated.
Interest Expenses. Interest expense for the year ended December 31, 2005 was $948 compared to $672 for the comparable 2004 period due to increased LIBOR rates on our credit facility advances in 2005.
Net Income. Net income for the year ended December 31, 2005 increased by $50,192, or 111.6%, to $95,182 from $44,990 for the comparable 2004 period. This increase was primarily due to the increase in premiums and decrease in the loss ratio, as discussed above.
Direct Written Premiums. Direct written premiums for the year ended December 31, 2004 increased by $56,750, or 9.9%, to $628,295 from $571,545 for 2003. The 2004 increase occurred primarily in our personal automobile line, which experienced a 6.1% increase in average written premium and a 3.5% increase in written exposures. In addition, our commercial automobile line’s average written premium increased by 6.0%, while we had a 5.6% increase in written exposures. Our homeowners line average written premium increased by 8.3%, which was partly offset by a 1.7% decrease in written exposures.
(1) Obligations of U.S. Government agencies include collateralized mortgage obligations issued, guaranteed and/or insured by the following issuers: Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association (FNMA). The total of these fixed maturity securities was $120,636 at fair value and $120,729 at amortized cost as of December 31, 2004. 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, 2004, our portfolio of fixed maturity investments was comprised entirely of investment grade corporate fixed maturity securities, U.S. government and agency securities and asset-backed securities (i.e., all our securities received a rating assigned by Moody’s Investors Service, Inc. of Baa or higher, except the few securities not rated by Moody’s which received S&P ratings of AA/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).
The unrealized losses recorded on the fixed maturity investment portfolio at December 31, 2004 resulted from fluctuations in market interest rates as opposed to fundamental changes in the credit quality of the issuers of such securities. Therefore, these decreases in values are viewed as being temporary as we have the intent and ability to retain such investments for a period of time sufficient to allow for recovery in market value.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses incurred for the year ended December 31, 2004 increased $4,092, or 1.0%, to $425,061 from $420,969 for the comparable 2003 period. Our GAAP loss ratio for the year ended December 31, 2004 decreased to 71.8% compared to 77.9% for the comparable 2003 period. Our GAAP loss ratio excluding loss adjustment expenses for the year ended December 31, 2004 decreased to 64.6% from 70.2% for the comparable 2003 period. The 2004 decrease in our GAAP loss ratios is primarily due to an increase in average written premium, a decrease in claim frequency in our personal automobile, commercial automobile and homeowners lines of business and favorable loss development primarily due to an improvement in prior year CAR results.
Income Tax Expense. Our effective tax rates were 31.5% and 28.0% for the year ended December 31, 2004 and 2003, respectively. These effective rates were lower than the statutory rate of 35% primarily due to adjustments for tax-exempt investment income. The increase in the effective tax rate during 2004 was due to a reduced level of annual estimated tax-exempt interest relative to annual estimated income before taxes in the current period. Additionally, our effective tax rate for the year ended December 31, 2004 was adversely impacted by an adjustment of $544 related to an increase in a previously established valuation allowance against state deferred tax assets from 80% to a full 100% of the asset.
Net cash provided by operating activities was $116,417, $126,176, and $85,185 during the years ended December 31, 2005, 2004 and 2003, respectively. Our operations typically generate substantial positive cash flows from operations as most premiums are received in advance of the time when claim and benefit payments are required. These positive operating cash flows are expected to continue to meet our liquidity requirements.
Net cash used for investing activities was $82,770 during the year ended December 31, 2005, which resulted primarily from purchases of fixed maturities in excess of sales and maturities of fixed maturities. Net cash provided by investing activities was $7,820 during the year ended December 31, 2004, which resulted primarily from sales and maturities of fixed maturities in excess of purchases of fixed maturities. Net cash used for investing activities was $89,205 during the year ended December 31, 2003, which resulted primarily from purchases of fixed maturities in excess of sales and maturities of fixed maturities.
Net cash used for financing activities was $26,293 during the year ended December 31, 2005 and resulted primarily from the pay down of the revolving credit facility and from dividends paid to shareholders. Net cash used for financing activities was $4,607 and $4,473 during the years ended December 31, 2004 and 2003, respectively, and resulted primarily from dividends paid to shareholders.
Our insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of the Commissioner. The Massachusetts statute limits the dividends an insurer may pay in any twelve-month period, without the prior permission of the Commissioner, to the greater of (i) 10% of the insurer’s surplus as of the preceding December 31 or (ii) the insurer’s net income for the twelve-month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices. Our insurance company subsidiaries may not declare an “extraordinary dividend” (defined as any dividend or distribution that, together with other distributions made within the preceding twelve 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 2005, the statutory surplus of Safety Insurance was $350,833, and its net income for 2005 was $92,432. As a result, a maximum of $92,432 is available in 2006 for such dividends without prior approval of the Division. During the year ended December 31, 2005, Safety Insurance recorded dividends to Safety of $24,900.
Management believes that the current level of cash flow from operations provides us with sufficient liquidity to meet our operating needs over the next 12 months. We expect to be able to continue to meet our operating needs after the next 12 months from internally generated funds. Since our ability to meet our obligations in the long term (beyond such twelve-month period) is dependent upon such factors as market
We have no material obligations under a guarantee contract meeting the characteristics identified in paragraph 3 of Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements, Including Indirect Guarantees of Indebtedness of Others”. 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 obligation, 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.
We have obligations to make future payments under contracts and credit-related financial instruments and commitments. At December 31, 2005, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:
· Projections of revenues, income, earnings per share, capital expenditures, dividends, capital structure or other financial items;
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, 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 1, Item 1A - Risk Factors.
We have completed integrated audits of Safety Insurance Group, Inc.’s 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005, and an audit of its 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for
The Company is a leading provider of personal lines property and casualty insurance focused exclusively on the Massachusetts market. Its principal product line is private passenger automobile insurance, which accounted for 80.3% of its direct written premiums in 2005. The Company operates through its insurance company subsidiaries, Safety Insurance Company and Safety Indemnity Insurance Company (together referred to as the “Insurance Subsidiaries”).
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 charged to expenses 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 taken into account in measuring the recoverability of the carrying value of this asset. All other acquisition expenses are charged to expense as incurred. Amortization of acquisition costs in the amount of $93,515, $88,425 and $82,203 were charged to underwriting expenses for the years ended December 31, 2005, 2004 and 2003, respectively.
Purchases of equipment and leasehold improvements are carried at cost less accumulated depreciation. Maintenance and repairs are charged to expense as incurred; improvements are capitalized.
In accordance with the provisions of the Financial Accounting Standards Board’s Emerging Issues Task Force (“EITF”) No. 85-1, “Classifying Notes Received for Capital Stock,” all outstanding principal and accrued interest related to these notes are recorded as contra-equity in the consolidated financial statements.
See Note 10 for terms of promissory notes received from management.
Deferred income taxes are generally recognized when assets and liabilities have different values for financial statement and tax reporting purposes, and for other temporary taxable and deductible differences
Diluted EPS excludes stock options with exercise prices greater than the average market price of the Company’s common stock during the period because their inclusion would be anti-dilutive. There were no anti-dilutive stock options for the years ended December 31, 2005, 2004 and 2003.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FAS 123 to these stock options.
The fair value of stock options used to compute pro forma net income and earnings per share disclosures for the years ended December 31, 2005, 2004 and 2003 is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions:
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.
The gross unrealized appreciation (depreciation) of investments in fixed maturity securities, including redeemable preferred stocks that have characteristics of fixed maturities, and equity securities, including interests in mutual funds, was as follows:
The Company sponsors the Safety Insurance Company 401(k) qualified defined contribution retirement plan (the “Retirement Plan”). The Retirement Plan is available to all eligible employees of the Company. An employee must be 21 years of age to be eligible to participate in the Retirement Plan, and is allowed to contribute on a pre-tax basis up to the maximum allowed under federal law. The Retirement Plan is administered by the Company and is subject to the provisions of the Employee Retirement Income Security Act of 1974 (“ERISA”). At the close of each Retirement Plan year, the Company makes a matching contribution equal to 75% of the amount each participant contributed during the plan year from their total pay, up to a maximum amount of 8% of the participant’s base salary, to those participants who have contributed to the Retirement Plan and were employed on the last day of the Retirement Plan year. Compensation expense related to the Retirement Plan was $1,066, $1,074, and $969 for the years ended December 31, 2005, 2004 and 2003, respectively.
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. On December 31, 2005, there were 225,958 shares available for future grant. The Board and the Compensation Committee intend to issue more awards under the Incentive Plan in the future. Grants made under the Incentive Plan are as follows:
(1) The exercise price of the options grant effective on November 27, 2002 is equal to the IPO price of the Company’s stock on that same day. The exercise price of the remaining option grants is equal to the closing price of the Company’s common stock on the grant effective date.
(2) The fair value of the restricted stock grant is equal to the closing price of the Company’s common stock on the grant effective date.
(3) The shares cannot be sold, assigned, pledged, or otherwise transferred, encumbered or disposed of until the recipient is no longer a member of the Board.
The following table summarizes restricted stock activity under the Incentive Plan:
Various claims, generally incidental to the conduct of normal business, are pending or alleged against the Company from time to time. In the opinion of management, based in part on the advice of legal counsel, the ultimate resolution of such claims will not have a material adverse effect on the Company’s consolidated financial statements. However, liabilities related to those proceedings could be established in the near term if estimates of the ultimate resolutions of those proceedings are revised.
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 2005, the Company received a refund of prior years’ assessments from the Insolvency Fund of $50 which it credited for the year ended December 31, 2005. In 2004 and 2003, the Company received notice of assessments from the Insolvency Fund amounting to $2,538 and $3,423 which it expensed for the years ended December 31, 2004 and 2003, respectively.
Concurrent with the closing of the Company’s November 27, 2002 initial public offering (“IPO”) and repayment of the old credit facility, Safety obtained a new $30,000 revolving credit facility. Safety borrowed the entire $30,000 under this credit facility at the closing of the IPO and paid down the balance to $19,956 on December 5, 2002 with the approximately $10,000 net proceeds from the exercise of the underwriter’s over-allotment option for 900,000 shares of our common stock. Loans under the credit facility bear interest at the Company’s option at either (i) the LIBOR rate plus 1.50% per annum or (ii) the higher of the bank’s prime rate or 0.50% above the federal funds rate plus 1.50% per annum. Interest only is payable prior to maturity. The obligations of the Company under the credit facility are secured by pledges of the assets of the Company and the capital stock of the Company’s operating subsidiaries. The credit facility is guaranteed by the non-insurance company subsidiaries of the Company. The credit facility contains covenants including requirements to maintain minimum risk based capital ratios and statutory surplus of Safety Insurance as well as limitations or restrictions on indebtedness, liens, dividends, and other matters. As of December 31, 2005, the Company was in compliance with all such covenants.
Bank of America was the lender under this credit facility. Under an agreement effective on June 17, 2005, Bank of America assigned the revolving credit facility to Citizens Bank of Massachusetts. No material change in the terms or conditions of the revolving credit facility or the pledge of the stock of the Company as security for the revolving credit facility has been made.
The Company incurred interest expense of $948, $672 and $646 for the years ended December 31, 2005, 2004 and 2003,respectively, related to all current outstanding obligations during these periods.
The Company is subject to concentration of credit risk with respect to reinsurance ceded to CAR. At December 31, 2005 and 2004, respectively, reinsurance receivables on paid and unpaid loss and LAE with a carrying value of $84,099 and $90,126 and prepaid reinsurance premiums of $32,186 and $38,229 were associated with CAR. The Company’s participation in CAR resulted in assumed net losses of $5,771, $39,038 and $48,367 for the years ended December 31, 2005, 2004 and 2003, respectively.
re-estimations of prior accident years ultimate loss and LAE liabilities which resulted in reductions of $22,162 in CAR assumed reserves, $14,600 in the Company’s automobile reserves, $1,872 in FAIR Plan assumed reserves, and $986 in homeowners reserves in 2005. At December 31,2004, the re-estimations of prior accident years ultimate loss and LAE liabilities resulted in reductions of $6,854 in CAR assumed reserves, $2,523 in homeowners reserves, $329 in FAIR Plan assumed reserves, and an increase of $2,928 in the Company’s automobile reserves in 2004. Prior year reserves increased by $181 for the year ended December 31, 2003. Conditions and trends that have affected development of the loss and LAE reserves in the past may not necessarily occur in the future.
In connection with the Acquisition, each member of the executive management team issued a recourse promissory note to, and entered into a pledge agreement with the Company. Pursuant to the notes, the Company loaned management an aggregate of $695 in order to purchase common stock in connection with the Acquisition and the Restricted Stock Plan. Pursuant to pledge agreements, the management team pledged the common stock back to the Company as security for the loans made under the promissory notes. The notes bore interest at a rate of 5% annually and were due and payable on the earlier of December 31, 2011 or 90 days after any management team member ceases to be an employee of the Company. Each member could prepay his note at any time without penalty. At December 31, 2003, the loans were carried in the financial statements at $34, which represents the outstanding principal and accrued interest on the notes. During 2004 the Company received $34 representing prepayments of all outstanding loan principal and accrued interest through the dates of final payments. Such loans had been recorded as contra-equity in accordance with the accounting policy described in Note 2.
The deferred income tax asset (liability) represents the tax effects of temporary differences attributable to the Company’s consolidated federal tax return group. Its components were as follows:
The Company believes, based upon consideration of objective and verifiable evidence, including its recent earnings history and its future expectations, that the Company’s taxable income in future years will be sufficient to realize all federal deferred tax assets. A valuation allowance of $4,742 and $4,210 was established against state deferred tax assets at December 31, 2005 and 2004, respectively. This valuation allowance is based upon management’s assessment that it is more likely than not that the Company will not be able to utilize these state deferred tax assets.
The Company’s Insurance Subsidiaries, domiciled in the Commonwealth of Massachusetts, prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by the Division. Statutory net income of the Company’s insurance subsidiaries was $97,337, $44,575 and $28,480 for the years ended December 31, 2005, 2004 and 2003, respectively. Statutory capital and surplus of the Company’s insurance subsidiaries was $350,833 and $278,161 at December 31, 2005 and 2004, respectively.
The Company uses various financial instruments in the normal course of its business. Certain insurance contracts are excluded by Statement of Financial Accounting Standards No. 107, “Disclosures about Fair Value of Financial Instruments,” and, therefore, are not included in the amounts discussed.
At December 31, 2005 and 2004, investments in fixed maturities and equity securities had a fair value, which equaled carrying value, of $714,543 and $664,596, respectively. There were no investments in fixed maturities and equity securities for which a quoted market price or dealer price was not available at December 31, 2005 or, 2004, respectively.
At December 31, 2005 the Company had no amounts outstanding on its secured credit facility. At December 2004, the carrying value of the secured revolving credit facility was $19,956 which approximated its fair value as described in Note 7.
An unaudited summary of the Company’s 2005 and 2004 quarterly performance, and audited annual performance, is as follows: