Safety Insurance Group, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited. Dollar amounts are in thousands except per-share data. Safety is a property-and-casualty insurer focused primarily on Massachusetts, with operations in New Hampshire and Maine; private passenger and commercial automobile insurance are key lines.
Financial performance and position
- Revenue: $222.6 million, up 6.1% from $209.7 million. Net earned premiums rose 1.3% to $194.5 million; direct written premiums declined 0.2% to $203.4 million, while net written premiums were essentially unchanged at $189.9 million.
- Profit: Net income was $29.9 million versus $9.1 million; diluted EPS was $1.95 versus $0.60. Non-GAAP operating income, which excludes investment gains and losses and related taxes, increased to $20.9 million from $10.8 million; operating diluted EPS was $1.36 versus $0.71.
- Investment contribution: Net investment income increased 11.6% to $11.8 million, with a 3.5% annualized portfolio yield versus 3.3%. Earnings from partnership investments fell to $0.8 million from $4.9 million. A $11.8 million gain from changes in unrealized equity investment values (versus a $3.5 million loss in 2018) materially lifted reported results.
- Underwriting and margins: Loss and LAE expense fell 8.4% to $126.0 million. The GAAP loss ratio improved to 64.8% from 71.7%, the expense ratio to 31.1% from 31.7%, and the combined ratio to 95.9% from 103.4%. Lower losses reflected less winter-weather activity than in Q1 2018 and favorable prior-year reserve development of $12.0 million, compared with $14.2 million.
- Cash flow: Operating cash flow was negative $8.0 million, versus negative $2.0 million. Investing activities provided $6.3 million; financing used $13.0 million, primarily for dividends. Cash declined to $22.9 million from $37.6 million.
- Balance sheet and liquidity: At March 31, total assets were $1.918 billion, total investments $1.360 billion, and shareholders’ equity $755.1 million. Loss and LAE reserves were $581.8 million, including $109.2 million recoverable from reinsurers for unpaid losses. The company reported no outstanding borrowings under its $30 million revolving facility, which matures in 2023, and stated it could borrow $282.3 million from FHLB-Boston against eligible collateral.
- Shareholder returns: The quarterly dividend was $0.80 per share, unchanged from Q1 2018. The board declared another $0.80 dividend for payment in June 2019. No shares were repurchased in the quarter.
Material changes versus Q1 2018
- Reported net income increased substantially, reflecting improved underwriting and a swing in unrealized equity investment results; non-GAAP operating income also rose, principally because of lower loss and LAE expense.
- Net investment income improved, but partnership investment earnings and realized investment results were lower than the prior-year quarter.
- Operating cash use increased, attributed by management to the timing of expense payments. Cash and cash equivalents fell by $14.7 million during the quarter.
- Effective January 1, 2019, the company adopted lease accounting guidance and recorded right-of-use assets and lease liabilities of approximately $36.0 million. It also recorded a $3.0 million cumulative-effect reduction to retained earnings from adoption of callable-debt premium amortization guidance.
Outlook, commentary, and risks
- Management said it expects positive operating cash flows in the future and believes cash flows and liquidity are sufficient for operating needs over the next 12 months. It expects to continue quarterly dividends in 2019, subject to financial position and cash-flow regularity. No earnings or revenue guidance was provided.
- For 2019, approved rate changes included a 3.1% increase in Massachusetts commercial auto rates effective June 1 and a 1.8% increase in New Hampshire commercial auto rates effective March 1. Management maintained catastrophe reinsurance intended to cover losses from a storm of approximately 139-year severity.
- Net loss and LAE reserves were $472.6 million, against an actuarial range of $430.9 million to $492.7 million. A one-percentage-point change in the loss and LAE ratio would change reserves by approximately $1.9 million and net income by $1.5 million, or $0.10 per diluted share. Reserve estimates are sensitive to claim frequency, severity, development patterns, and residual-market data.
- The investment portfolio had $12.4 million of gross unrealized losses. The company recognized a $0.2 million credit impairment loss on one fixed-maturity security; management viewed other portfolio declines as temporary and said it did not expect to be forced to sell securities before recovery.
- Risks include severe weather and catastrophe losses, competition, insurance regulation and residual-market assessments, reserve estimation uncertainty, interest-rate and equity-market changes, and possible liquidity needs. Massachusetts dividend rules constrain distributions from insurance subsidiaries; $86.7 million was available for dividends in 2019 without prior regulatory approval based on 2018 statutory results. The company reported compliance with credit covenants and no substantial doubt about its ability to continue as a going concern.
- Routine legal claims and potential Massachusetts Insurers Insolvency Fund assessments were not expected by management to have a material adverse effect. No subsequent events requiring recognition or disclosure were reported, and no material changes to previously disclosed risk factors were identified.
Important facts for investors to verify
- How much of reported earnings growth reflects recurring underwriting and investment income versus the $11.8 million unrealized equity gain and other investment items.
- Whether favorable reserve development continues and how actual claims compare with management’s reserve assumptions and disclosed actuarial range.
- Whether operating cash flow turns positive as management expects, given negative Q1 operating cash flow and the timing of claims and expense payments.
- The adequacy and collectability of reinsurance, including exposure to catastrophe events and residual markets such as CAR and the FAIR Plan.
- Future dividend capacity under insurance-subsidiary regulatory limits and the company’s capital, liquidity, and investment-portfolio conditions.