Safety Insurance Group, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019; comparisons are to the corresponding 2018 periods. The filing is unaudited. Dollar amounts below are in millions unless stated otherwise. Safety is a property-and-casualty insurer focused primarily on Massachusetts, with operations also in New Hampshire and Maine; private passenger auto is its largest product line.
Financial performance
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net earned premiums | $198.4 | $197.0 | $589.3 | $583.1 |
| Total revenue | $215.3 | $215.9 | $653.9 | $633.6 |
| Net investment income | $11.9 | $11.1 | $34.3 | $31.8 |
| Losses and loss adjustment expenses | $135.0 | $116.7 | $383.4 | $367.6 |
| Net income | $15.6 | $28.9 | $71.5 | $64.8 |
| Diluted EPS | $1.01 | $1.88 | $4.64 | $4.24 |
| Non-GAAP operating income | $15.1 | $27.1 | $58.6 | $65.7 |
| Combined ratio | 98.7% | 90.9% | 96.0% | 94.7% |
- Q3 loss ratio rose to 68.0% from 59.2%, while the expense ratio improved to 30.7% from 31.7%. For nine months, the loss ratio was 65.1% versus 63.0%, and the expense ratio was 30.9% versus 31.7%.
- Q3 net income and diluted EPS fell materially, principally reflecting higher incurred losses, including a settled umbrella-policy litigation claim. For nine months, GAAP net income increased, while non-GAAP operating income declined. The filing’s non-GAAP measure excludes investment gains and losses, equity unrealized gains or losses, impairment losses and related taxes.
- Direct written premiums increased 2.6% in Q3 and 0.9% for nine months. Management attributed growth primarily to commercial auto and homeowners. Nine-month investment income rose 7.6%, reflecting higher average invested assets and yields.
- Operating cash flow was $69.7 million for nine months, down from $90.4 million. Investing activities used $20.8 million; financing activities used $38.9 million, primarily for shareholder dividends. Cash and equivalents were $47.5 million at September 30.
Balance sheet, debt and liquidity
- At September 30, total assets were $2.034 billion, total liabilities $1.242 billion, and shareholders’ equity $792.1 million. Investments totaled $1.409 billion, including $1.208 billion of available-for-sale fixed maturities.
- Loss and LAE reserves were $601.5 million gross, including $117.9 million of related reinsurance recoverables; unearned premium reserves were $466.0 million. Net loss and LAE reserves were $483.6 million.
- No amounts were drawn on the $30 million revolving credit facility, which matures in August 2023; the agreement permits expansion to $50 million. The company reported covenant compliance. It also had no FHLB borrowing outstanding and stated it could borrow up to $296.8 million against eligible collateral.
- Operating lease assets and liabilities were each $35.8 million. The filing reports no material off-balance-sheet arrangements and management said it had no substantial doubt about the company’s ability to continue as a going concern.
Material changes, unusual items and outlook
- Umbrella claim settlement: A liability claim seeking extra-contractual damages was settled and court-approved during Q3. The company accrued $15.5 million of direct loss, partly offset by $8.55 million of reinsurance, for a $6.95 million pre-tax impact and $5.49 million after-tax impact, or $0.36 per diluted share. The expected reinsurance recovery had since been collected.
- Prior-year reserve releases were $25.5 million for the first nine months, versus $39.3 million a year earlier. Management cited improved experience, including fewer reported-but-not-yet-estimated auto claims and better-than-expected severity on established auto case reserves; the umbrella matter partly offset releases in other lines.
- Net unrealized gains on equity investments added $15.2 million to nine-month 2019 income, compared with a $3.7 million loss in 2018. This contributed to the difference between GAAP net income and non-GAAP operating income. Comprehensive income was $110.4 million versus $43.5 million.
- The company recorded $397,000 of investment impairment losses for nine months, all described as credit losses on fixed-maturity securities. Management viewed other unrealized investment losses as temporary and said it was more likely than not that securities would not need to be sold before recovery.
- No formal earnings or premium guidance was provided. Management expected positive operating cash flows to continue and said current cash flows were sufficient for operating needs over the next 12 months, while cautioning that longer-term liquidity depends on market, regulatory and economic conditions. It planned to continue quarterly dividends subject to financial position and cash flows. The board declared a $0.90-per-share Q4 dividend after quarter-end.
- Rate changes approved or filed in 2019 included Massachusetts private passenger auto +1.9%, commercial auto +3.1%, and homeowners +2.2%; New Hampshire commercial auto +1.8% and homeowners +3.8% (effective December 1, 2019). Safety maintained catastrophe reinsurance intended to cover a “139-year storm,” subject to stated retentions, limits and participation.
Risks and contingencies
- Loss-reserve estimates are inherently uncertain and sensitive to claim frequency, severity, litigation, inflation, and delayed residual-market data. The actuarial range for net reserves was $448.1 million to $507.1 million, against a selected estimate of $483.6 million. Management estimated that a one-percentage-point change in the loss and LAE ratio would change reserves by $5.9 million and net income by $4.7 million, or $0.30 per diluted share.
- Other cited risks include competition, Massachusetts insurance regulation and residual markets, severe weather and catastrophe losses, reinsurance counterparty exposure, and interest-rate, equity-price and investment-liquidity risks. A 100-basis-point rise in rates was estimated to reduce fixed-maturity fair value by about $41.0 million; a 100-basis-point decline was estimated to increase it by about $36.7 million.
- Ordinary-course claims and potential Massachusetts Insurers Insolvency Fund assessments were not expected by management to have a material adverse effect, though estimates and future assessments could change. The filing reported no subsequent events requiring disclosure and no material change to previously disclosed risk factors.
Important facts for investors to verify
- Whether the Q3 deterioration in loss ratio and earnings is primarily attributable to the one-time umbrella settlement or signals broader claims-cost pressure; track subsequent combined ratios and reserve development.
- The adequacy of the $483.6 million net reserve estimate, including assumptions for auto severity, IBNR claims and residual-market reporting delays.
- The sustainability and quality of earnings: nine-month GAAP income benefited from equity fair-value movements, while non-GAAP operating income declined year over year.
- Reinsurance recoverability and catastrophe protection terms, including coverage limits, retentions, participation and exposure through Massachusetts residual markets.
- Dividend capacity, given the $0.90 quarterly dividend, insurer dividend restrictions and the company’s reliance on subsidiary distributions; confirm future cash generation and statutory capital.