The following table sets forth our selected historical consolidated financial data as of and for each of the five years ended December 31, 2009.
The selected historical consolidated financial data for the years ended December 31, 2009, 2008 and 2007 and as of December 31, 2009 and 2008 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, 2006 and 2005 and as of December 31, 2007, 2006 and 2005 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.
We have prepared the selected historical consolidated financial data, other than statutory data, in conformity with U. S. generally accepted accounting principles ("GAAP"). We have derived the statutory data from the annual statements of our Insurance Subsidiaries filed with insurance regulatory authorities, which were prepared in accordance with statutory accounting practices, which vary in certain respects from GAAP.
(2)The loss ratio is the ratio of losses and loss adjustment expenses to net earned premiums. The expense ratio, when calculated on a statutory accounting basis, is the ratio of underwriting expenses to net written premiums, and when calculated on a GAAP basis is the ratio of underwriting expense to net earned premiums. The combined ratio is the sum of the loss ratio and the expense ratio. Please refer to Insurance Ratios under
We have been subject to extensive regulation in the private passenger automobile insurance industry in Massachusetts, which represented 69.2% of our direct written premiums in 2009. 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
The Commissioner has issued a number of bulletins addressing issues related to the implementation of Managed Competition (the "Rating Bulletins"). Rating Bulletins 2008-11 and 2009-13 limits voluntary market rates to a level no higher than the rates in the residual market. Rating Bulletin 2008-17 describes how companies may place risks among company affiliates within an insurer group.
CAR runs a reinsurance pool for commercial automobile policies and beginning January 1, 2006, CAR implemented a Limited Servicing Carrier Program ("LSC") for ceded commercial automobile policies. CAR approved Safety Insurance and five other servicing carriers through a Request for Proposal to process ceded commercial automobile business, which is spread equitably among the six servicing carriers. Each Massachusetts commercial automobile insurer must bear a portion of the losses of the commercial reinsurance pool that is serviced by the six servicing carriers in the LSC program. Subject to the Commissioner's review, CAR sets the premium rates for commercial automobile policies reinsured through CAR and this reinsurance pool can generate an underwriting result that is a profit or deficit based upon CAR's rate level. This underwriting result is allocated among every Massachusetts commercial automobile insurance company, including us, based on a company's commercial automobile voluntary market share.
CAR also runs a reinsurance pool for Taxi, Limousine and Car Service risks (the "Taxi/Limo Program"). On April 25, 2007, Safety submitted through a Request for Proposal a bid to process a portion of the Taxi/Limo Program. CAR approved Safety as one of the two servicing carriers for this program beginning January 1, 2008.
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 FAIR Plan in which premiums, expenses, losses and loss adjustment expenses on homeowners business that cannot be placed in the voluntary market are shared by all insurers writing homeowners insurance in Massachusetts. The FAIR Plan has grown dramatically over the past few years as insurance carriers have reduced their exposure to coastal property. The FAIR Plan's exposure to catastrophe losses increased and as a result, the FAIR Plan decided to buy reinsurance to reduce their exposure to catastrophe losses. On July 1, 2009, the FAIR Plan purchased $1,100,000 of catastrophe reinsurance for property losses in excess of $180,000. At December 31, 2009, we had no material amounts recoverable from any reinsurer, excluding the residual markets described above.
•Bodily Injury Code Indications: This method projects ultimate loss estimates for our private passenger and commercial automobile bodily injury coverage based upon extrapolations of the historic number of accidents and the historic number of bodily injury claims per accident. Projected ultimate bodily injury claims are then segregated into expected claims by type of injury
(e.g. soft tissue injury vs. hard tissue injury) based on past experience. An ultimate severity, or average paid loss amounts, is estimated based upon extrapolating historic trends. Projected ultimate loss estimates using this method are the aggregate of estimated losses by injury type.
Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting our ultimate losses, total reserves and resulting IBNR reserves. It is possible that the final outcome may fall above or below these amounts as 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 reasonably possible estimations for net reserves of approximately $332,854 to $378,692 as of December 31, 2009, as compared to a range of $346,014 to $394,268 for 2008. 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. The Company's selected point estimate of net loss and LAE reserves based upon the analysis of our actuaries was $374,832 as of December 31, 2009, as compared to $391,070 for December 31, 2008.
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, 2009 and December 31, 2008.
For our private passenger automobile, commercial automobile and homeowners lines of business as of December 31, 2009 and 2008, due to the relatively long time we have been writing these lines of insurance and our stable long-term trends in frequency and severity, the range of reserves is relatively narrow. For our all other lines of business as of December 31, 2009 and 2008, due to the relatively short time we have been writing these lines of business, the sparse amount of data and the resulting immature history available for our analysis, the range of reserves is relatively wide. We have recorded reserves closer to the high in the ranges of our projections.
The following tables present our total net reserves and the corresponding case reserves and IBNR reserves for each line of business as of December 31, 2009 and December 31, 2008.
Our IBNR reserves for CAR assumed private passenger and commercial automobile business are 26.1% and 44.9% respectively of our total reserves for CAR assumed private passenger and commercial automobile business as of December 31, 2009 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.
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, 2008, we had nine months of reported 2008 CAR financial data, and we had to estimate and record as IBNR reserves what CAR would report to us for the last three months of the year.
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, 2008 we had to estimate our 2008 policy year CAR Participation Ratio beginning with the first quarter of 2008 through the second quarter of 2009.
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' current 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
Although we rely to a significant extent in setting our reserves on the information CAR provides, we are cautious in our use of that information, both because of the delays described above and because the CAR estimates incorporate data CAR receives from all other CAR servicing carriers in Massachusetts. We do not have direct access to that data or firsthand knowledge of how those carriers are currently conducting their operations. As a result, we are cautious in recording CAR reserves for the calendar years for which we have to estimate our Participation Ratio and these reserves are subject to significant judgments and estimates.
To further clarify the effects of changes in our reserve estimates for CAR and other residual markets, the next two tables break out the information in the table above by source of the business (i.e., non-residual market vs. residual market).
Our private passenger automobile line of business prior year reserves decreased by $30,489 for the year ended December 31, 2009. The decrease was primarily due to improved retained private passenger results of $18,275 for the accident years 2004 through 2008, and improved assumed CAR results for the private passenger automobile pool of $8,596 for accident years 2005 through 2008. The improved retained private passenger results were primarily due to fewer incurred but not yet reported claims than previously estimated and better than previously estimated severity on the Company's 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.
We adopted ASC 320, Investments-Debt and Equity Securities (prior authoritative literature-FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments) effective April 1, 2009. ASC 320 requires entities to separate an other-than-temporary impairment of a debt security into two components when there are credit related losses associated with the impaired debt security for which the Company asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis. Prior to April 1, 2009, we had to determine whether we had the intent and ability to hold the investment for a sufficient period of time for the value to recover. When the analysis of the above factors resulted in the Company's conclusion that declines in market values were other-than-temporary, the cost of the securities was written down to market value and the reduction in value was reflected as a realized loss. The adoption of ASC 320 did not have an impact on our consolidated results of operations or financial position.
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.
Net Earned Premiums. Net earned premiums for the year ended December 31, 2009, decreased by $44,587 or 7.7%, to $531,969 from $576,556 for the comparable 2008 period. This decrease was due to the factors that decreased direct and net written premiums.
Net Investment Income. Net investment income for the year ended December 31, 2009, was $43,308, compared to $45,771 for 2008, a decrease of 5.4%. Average cash and investment securities (at cost) increased by $1,363, or less than 0.1%, to $1,061,916 for the year ended December 31, 2009, from
(1)Obligations of U.S. Government agencies include collateralized mortgage obligations issued, guaranteed and/or insured by the following issuers: Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA) and Small Business Administration (SBA). The total of these fixed maturity securities was $294,648 at amortized cost and $306,077 at fair value as of December 31, 2009. 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, 2009, with the exception of two securities which represented 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. 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, 2009.
The unrealized losses recorded on the fixed maturity 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 other-than-temporary impairment charge of $1,032 for this security. We sold this security during the third quarter of 2009 and recognized an additional loss of $14.
ASC 820, Fair Value Measurements and Disclosure (prior authoritative literature-FAS157, Fair Value Measurements) 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:
Fair values for our fixed maturity securities are based on prices provided by our custodian bank and our investment manager. Both our custodian bank and our investment manager use a variety of independent, nationally recognized pricing services to determine market valuations. If the pricing service cannot provide fair value determinations, we obtain non-binding price quotes from broker-dealers. A minimum of two quoted prices is obtained for the majority of fixed maturity securities in our investment portfolio. Our custodian bank is our 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 our 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 our custodian bank is used in our financial statements for the security. If the variance between the primary and secondary price quotes exceeds an accepted tolerance level, we obtain a quote from an alternative source, if possible, and we document and resolve any differences between the pricing sources. In addition, we may request that our 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, we may decide to value the security in our financial statements using the secondary or alternative source if we believe that pricing is more reflective of the security's value than the primary pricing provided by our custodian bank. We analyze 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.
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 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. On January 1 and December 31, 2009, 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.
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
Approximately 99.8% of our portfolio was priced based upon quoted market prices or other observable inputs as of December 31, 2009. There were no significant changes to the valuation process during the year ending 2009.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses incurred for the year ended December 31, 2009, decreased by $23,522 or 6.4%, to $346,301 from $369,823 for the comparable 2008 period. Our GAAP loss ratio for the year ended December 31, 2009, increased to 65.1% compared to 64.1% for the comparable 2008 period. Our GAAP loss ratio excluding loss adjustment expenses for the year ended December 31, 2009, increased to 55.8% from 55.1% for the comparable 2008 period. The loss ratio increased primarily as a result of the decrease in our personal automobile earned premium per exposure. Total prior year favorable development included in the pre-tax results for the year ended December 31, 2009 was $44,065 compared to prior year favorable development of $35,938 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.
Income Tax Expense. Our effective tax rates were 27.2% and 28.4% for the years ended December 31, 2009 and 2008, respectively. These effective rates were lower than the statutory rate of 35% primarily due to adjustments for tax-exempt investment income.
Net Income. Net income for the year ended December 31, 2009 decreased by $16,106 or 22.9%, to $54,152 from $70,258 for the comparable 2008 period. This decrease was primarily due to the factors discussed above.
Net Written Premiums. Net written premiums for the year ended December 31, 2008, decreased by $47,668 or 7.9% to $552,904 from $600,572 for 2007. This decrease was primarily 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. These decreases in CAR premiums are primarily due to the replacement of the current reinsurance program run by CAR with an assigned risk plan effective April 1, 2008 as discussed above in "Executive Summary and Overview: Massachusetts Automobile Insurance Market."
Net Investment Income. Net investment income for the year ended December 31, 2008, was $45,771 compared to $44,255 for 2007, an increase of 3.4%. Average cash and investment securities (at cost) increased by $58,205, or 5.8%, to $1,060,554 for the year ended December 31, 2008, from $1,002,349 for 2007. The net effective yield on the investment portfolio decreased to 4.3% during the year ended December 31, 2008, compared to 4.4% during 2007. Our duration decreased to 3.2 years at December 31, 2008, from 4.2 years at December 31, 2007.
The gross unrealized gains (losses) of investments in fixed maturity securities and equity securities, including interests in mutual funds, was as follows:
As of December 31, 2008, our portfolio of fixed maturity investments was comprised entirely of investment grade corporate fixed maturity securities, U.S. government and agency securities and asset-
In our determination of other-than-temporary impairments, we consider several factors and circumstances including the issuer's overall financial condition, the issuer's credit and financial strength ratings, a weakening of the general market conditions in the industry or geographic region in which the issuer operates, a prolonged period (typically six months or longer) in which the fair value of an issuer's securities remains below our amortized cost, our ability and intent to hold these investments for a period of time sufficient to allow for recovery of our costs, and any other factors that may raise doubt about the issuer's ability to continue as a going concern.
We continue to hold no subprime mortgage debt securities. All of our holdings in mortgage-backed securities are either U.S. Government or agency guaranteed or are rated Aaa/AAA. The unrealized losses recorded on the fixed maturity investment portfolio at December 31, 2008, 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 and our positive operating cash flows, we intend to and believe we have the ability to hold these securities for a period of time sufficient to allow for recovery in fair value. Therefore, these decreases in values are viewed as being temporary.
As of December 31, 2008, approximately 99.8% of the investment portfolio recorded at fair value was priced based upon quoted market prices or other observable inputs. The following table summarizes our total fair value measurements and the fair value measurements based on Level 3 inputs for investments as of December 31, 2008.
The following table summarizes the changes in our Level 3 fair value measurements for the year ended December 31, 2008.
On January 1 and December 31, 2008, 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, 2008.
fees. Finance and other service income for the year ended December 31, 2008, was $17,995 compared to $16,623 for the 2007 period.
Underwriting, Operating and Related Expenses. Underwriting, operating and related expense for the year ended December 31, 2008 increased by $2,330 or 1.4%, to $172,987 from $170,657 for the comparable 2007 period. Our GAAP expense ratios for the year ended December 31, 2008, increased to 30.0% compared to 28.0% for the comparable 2007 period. The expense ratio increased primarily as a result of decreases in net earned premiums as discussed above.
Income Tax Expense. Our effective tax rates were 28.4% and 30.0% for the years ended December 31, 2008 and 2007, respectively. These effective rates were lower than the statutory rate of 35% primarily due to adjustments for tax-exempt investment income.
Net Income. Net income for the year ended December 31, 2008 decreased by $17,155 or 19.6%, to $70,258 from $87,413 for the comparable 2007 period. This decrease was primarily due to the factors discussed above.
As a holding company, Safety's assets consist primarily of the stock of our direct and indirect subsidiaries. Our principal source of funds to meet our obligations and pay dividends to shareholders, therefore, is dividends and other permitted payments from our subsidiaries, principally Safety Insurance. Safety is the borrower under our credit facility.
securities in excess of purchases of fixed maturities. Net cash used by investing activities was $28,880 and $74,814 during the years ended December 31, 2008 and 2007, which resulted primarily from purchases of fixed maturities in excess of sales, paydowns, calls, and maturities of fixed maturities. The reduction in cash provided by investing activities in 2009 and 2008 compared to 2007 was a result of a redeployment of cash received from sales, paydowns, and maturities of fixed income securities to cash and cash equivalents.
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 2009 and 2008 were as follows:
On February 16, 2010, our Board approved a quarterly cash dividend on our common stock of $0.40 per share which will be paid on March 15, 2010 to shareholders of record on March 1, 2010. We plan to continue to declare and pay quarterly cash dividends in 2010, depending on our financial position and the regularity of our cash flows.
We have obligations to make future payments under contracts and credit-related financial instruments and commitments. At December 31, 2009, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:
As of December 31, 2009, the Company had loss and LAE reserves of $439,706, unpaid reinsurance recoverables of $64,874 and net loss and LAE reserves of $374,832. 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
The consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America ("GAAP"). The consolidated financial statements include Safety Insurance Group, Inc. and its subsidiaries (the "Company"). The subsidiaries consist of Safety Insurance Company, Safety Indemnity Insurance Company, Safety Property and Casualty Insurance Company, Whiteshirts Asset Management Corporation ("WAMC"), and Whiteshirts Management Corporation, which is WAMC's holding company. All intercompany transactions have been eliminated.
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. 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.
Diluted EPS excludes stock options with exercise prices and exercise tax benefits greater than the average market price of the Company's common stock during the period because their inclusion would be anti-dilutive. There were 167,925, 168,925 and 174,925, anti-dilutive stock options for the year ended December 31, 2009, 2008 and 2007.
Prior to January 1, 2006, the Company accounted for share-based compensation to employees and non-employee directors in accordance with the recognition and measurement principles of ASC 718, Share Based Compensation, (prior authoritative literature Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," as allowed by FAS 123, "Accounting for Stock-Based
Compensation" and as amended by FAS 148, "Accounting for Stock-Based Compensation-Transition and Disclosure.") Accordingly, no compensation cost related to stock options was reflected in net income, as all options granted under this plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The Company historically reported pro forma results under the disclosure-only provisions of ASC 718, (prior authoritative literature FAS 123.)
Effective January 1, 2006, the Company adopted ASC 718, Share Based Compensation (prior authoritative literature FAS 123R (revised 2004), "Share-Based Payment,") which requires the Company to measure and recognize the cost of employee services received in exchange for an award of equity instruments. Under the provisions of ASC 718, (prior authoritative literature FAS 123R), share-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite service period (generally the vesting period of the equity grant).
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
In June 2009, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Codification ("ASC") 105, Generally Accepted Accounting Principles (prior authoritative literature-Statement of Financial Accounting Standard ("FAS") No.168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles). ASC 105 is now the single source of authoritative nongovernmental GAAP. ASC 105 reorganizes the thousands of
ASC 820, Fair Value Measurements and Disclosures (prior authoritative literature-FAS No.157, Fair Value Measurements) defines fair value, sets out a framework for measuring fair value and requires additional disclosures about fair value measurements. This standard applies to fair value measurements already required or permitted by existing standards and was effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company adopted ASC 820 on January 1, 2008. The adoption of ASC 820 did not have an impact on the Company's consolidated results of operations or financial position. See Note 3, "Investments," for further information regarding the Company's investments and fair value measurements.
ASC 260, Other Presentation Matters-Participating Securities and the Two Class Method (prior authoritative literature-Emerging Issues Task Force 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities) addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting. ASC 260 requires that such instruments that hold unforfeitable rights to dividends or dividend equivalents, regardless of whether paid or unpaid, should be considered participating securities and accordingly, should be included in the calculation of earnings per share ("EPS") under the two-class method instead of the treasury stock method. Under the Company's employee incentive compensation plan, restricted stock grantees have unforfeitable rights to dividends before the vesting period and are therefore, participating securities and treated as a separate class of securities in calculating earning per share. The Company adopted ASC 260 effective January 1, 2009, and has since used the two-class method to calculate earnings per share. In accordance with the adoption provisions of ASC 260, all prior period earnings per share data has been adjusted retroactively to conform to the provisions of ASC 260. For the years ended December 31, 2008 and 2007 basic EPS was reduced by $0.06 cents per share and diluted EPS was reduced by $0.05 cents per share from previously disclosed amounts.
ASC 820, Fair Value Measurements and Disclosures (prior authoritative literature FSP FAS 157-4, Determining Fair Value When Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that are Not Orderly) expands certain disclosure requirements and is effective for periods ending after June 15, 2009. The Company adopted ASC 820 effective for its interim period ending June 30, 2009, and its adoption did not have an impact on the Company's consolidated financial condition or results of operations.
ASC 855, Subsequent Events (prior authoritative literature FAS No. 165, 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 shall be applied prospectively.
The Company comprises one business segment: property and casualty insurance operations. Management organizes the business around private passenger automobile insurance in Massachusetts sold exclusively through independent agents and offers other personal and commercial insurance as complementary products. In accordance with ASC 820, Segment Reporting (prior authoritative standard FAS 131, "Disclosures About Segments of an Enterprise and Related Information,") the financial information of the segment is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
The gross unrealized gains and losses on investments in fixed maturity securities and equity securities, including interests in mutual funds, were as follows for the periods indicated:
(2)Equity securities consist solely of interests in mutual funds held to fund the Company's executive deferred compensation plan.
(4)Amounts in this column represent OTTI recognized in accumulated other comprehensive income.
The amortized cost and the estimated fair value of fixed maturity securities, by maturity, are shown below for the periods indicated. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The gross realized (losses) gains on sales of fixed maturity, short-term, and equity securities were as follows for the periods indicated:
The following tables as of December 31, 2009 and December 31, 2008 illustrate the gross unrealized losses included in the Company's investment portfolio and the fair value of those securities
The following table shows the Company's insured investment securities that are backed by financial guarantors including pre-refunded securities as of December 31, 2009. The Company does not have any direct investment holdings in a financial guarantee insurance company.
ASC 320, Investments-Debt and Equity Securities (prior authoritative literature-FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments) requires entities to
separate an other-than-temporary impairment ("OTTI") of a debt security into two components when there are credit related losses associated with the impaired debt security for which the Company asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis. Prior to April 1, 2009, the Company had to determine whether it had the intent and ability to hold the investment for a sufficient period of time for the value to recover. When the analysis of the above factors resulted in the Company's conclusion that declines in market values were other-than-temporary, the cost of the securities was written down to market value and the reduction in value was reflected as a realized loss.
As of December 31, 2009, with the exception of two securities which represented 0.1% of the Company's total investment in fixed income securities, the Company's fixed income securities portfolio was comprised entirely of investment grade corporate fixed maturity securities, U.S. Government and Agency securities, states and political subdivision securities, and asset-backed securities (i.e., all securities received a rating assigned by Moody's Investors Service, Inc. of Baa or higher, except the few securities not rated by Moody'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.
Based upon the qualitative analysis performed, the Company's decision to hold these securities, the Company's current level of liquidity and its positive operating cash flows, management believes it is more likely than not that it will not be required to sell any of its securities before the anticipated recovery in the fair value to its amortized cost basis.
ASC 320, Investments-Debt and Equity Securities (prior authoritative literature-FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments) 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 December 31, 2009 and December 31, 2008, 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 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.
In order to ensure the fair value determination is representative of an exit price (consistent with ASC 820), the Company's 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 its investment manager regarding those securities with ratings changes and securities placed on the Company's "Watch List." In addition, valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by the Company's external
Approximately 99.8% of the Company's portfolio was priced based upon quoted market prices or other observable inputs as of December 31, 2009. There were no significant changes to the valuation process during the year ending 2009.
The following tables summarize our total fair value measurements and the fair value measurements based on Level 3 inputs for investments for the periods indicated.
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 tables above, no transfers were made in or out of Level 3 inputs during the years ended December 31, 2009 and 2008.
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 respect to which awards may be granted is 2,500,000. Shares of stock covered by an award under the Incentive Plan that are forfeited will again be available for issuance in connection with future grants of awards under the plan. At December 31, 2009, there were 920,434 shares available for future grant. The Board of Directors and the Compensation Committee intend to issue more awards under the Incentive Plan in the future.
A summary of the status of non-vested options as of December 31, 2009 is presented below:
Cash received from options exercised was $367, $1,416 and $426 for the years ended December 31, 2009, 2008, and 2007, 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, 2009 are as follows:
In addition, on November 21, 2008, the Massachusetts Office of the Attorney General (the "AG") delivered a civil investigative demand (the "CID") to Safety Insurance Company. The CID directed the Company to produce certain information related to its policies and practices in connection with underwriting insurance policies on motorcycles and adjusting total loss claims under such policies. Other insurance companies are also being investigated by the AG related to their policies and practices related to motorcycle insurance.
The focus of the AG's investigation was on the insured values determined by us for purposes of charging premiums for physical damage insurance coverage. In 2008, coverage for motorcycles represented 1.9% of the Company's total private passenger automobile insurance. The Company has been cooperating with the AG and responding to the CID and various related additional requests for information by the AG since that time.
In connection with the matters addressed by the CID, the AG delivered a letter to Safety Insurance Company dated February 2, 2009, in which the AG stated that it "has reason to believe that Safety Insurance Company has violated the Massachusetts Consumer Protection Act, G.L. c. 93A, §2, by engaging in unfair and deceptive acts and practices regarding motorcycle insurance. Specifically, the AG stated it "has reason to believe that the Company overcharged its customers for motorcycle insurance and engaged in related unfair claims settlement practices." By issuing this letter the AG met a statutory prerequisite to filing a civil complaint under the Massachusetts Consumer Protection Act against the Company.
At the end of each period, the reserves were re-estimated for all prior accident years. The Company's prior year reserves decreased by $44,065, $35,938, and $30,791 for the years ended December 31, 2009, 2008, and 2007, respectively. 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. The decrease in prior year reserves during 2007 resulted from re-estimations of prior years ultimate loss and LAE liabilities and is primarily composed of reductions of $15,503 in the Company's retained automobile reserves, $11,335 in CAR assumed reserves and $2,941 in the Company's retained homeowner's reserves.
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 $2,079 and $1,619 was established against state deferred tax assets at December 31, 2009 and 2008, 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 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, 2009 and 2008.
As of December 31, 2009, the Company was no longer subject to examination of its U.S. federal tax returns for years prior to 2006. 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 of Directors approved a share repurchase program of up to $30,000 of the Company's outstanding common shares. On March 24, 2009, the Board of Directors increased this existing share repurchase program by authorizing repurchase of up to $60,000 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.
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 2009, the statutory surplus of Safety Insurance was $556,575 and its net income for 2009 was $46,956. As a result, a maximum of $55,657 is available in 2010 for such dividends without prior approval of the Commissioner. During the year ended December 31, 2009, Safety Insurance recorded dividends to Safety of $64,412.
At December 31, 2009 and 2008 the Company had no amounts outstanding on its secured credit facility.