SAFETY INSURANCE GROUP INC quarterly report, Q1 FY2018

Full document

Safety Insurance Group, Inc. — 2018 Q1 Form 10-Q

Reporting period: Three months ended March 31, 2018; unaudited. Dollar amounts are in thousands except per-share data. Safety is a property and casualty insurer focused primarily on Massachusetts, with automobile insurance its principal business.

Financial performance

  • Revenue: $209.7 million, up 2.4% from $204.8 million. Net earned premiums rose 1.2% to $192.0 million; direct written premiums increased 2.0% to $203.7 million, while net written premiums declined 0.4% to $190.0 million.
  • Net income: $9.1 million, down 24.1% from $12.0 million. Diluted EPS was $0.60 versus $0.79. Non-GAAP operating income was $10.8 million, approximately flat with $10.8 million; operating income per diluted share was $0.71 versus $0.72.
  • Investment results: Net investment income rose 15.8% to $10.5 million; annualized portfolio yield was 3.3%, compared with 2.9%. Partnership investment earnings increased to $4.9 million from $0.1 million. Net realized investment gains were $1.3 million, while the change in unrealized equity gains was a $3.5 million loss.
  • Underwriting and margins: Loss and loss adjustment expenses rose 7.2% to $137.6 million, primarily due to winter weather. The GAAP loss ratio increased to 71.7% from 67.7%; expense ratio was 31.7% versus 31.5%; combined ratio deteriorated to 103.4% from 99.2%, indicating an underwriting loss before investment and other income.
  • Cash flow: Operating cash flow was negative $2.0 million versus positive $0.9 million. Investing cash flow was negative $2.5 million versus positive $22.0 million; financing cash outflow, principally shareholder dividends, was $12.3 million. Cash declined to $24.8 million from $41.7 million.
  • Balance sheet and liquidity: At March 31, total assets were $1.797 billion, liabilities $1.112 billion, and shareholders’ equity $685.6 million. Investments totaled $1.297 billion. Equity declined from $701.0 million at year-end, notably reflecting investment-related accumulated other comprehensive losses.
  • Debt: No borrowings were outstanding under the $30 million revolving credit facility or from FHLB-Boston. The credit facility matures August 14, 2018; the company reported covenant compliance. It also reported $273.2 million of potential FHLB borrowing capacity, subject to eligible collateral.

Changes, outlook, and notable items

  • Premium growth was led primarily by commercial automobile and homeowners. Massachusetts direct written premiums were $197.6 million; New Hampshire, $6.0 million; and Maine, $0.1 million.
  • Favorable prior-year reserve development was $14.2 million, compared with $10.4 million in Q1 2017. Management attributed improvements mainly to lower-than-estimated incurred-but-not-reported claims and better-than-estimated severity in certain established auto reserves. The selected net loss and LAE reserve estimate was $492.7 million, within an actuarial range of $438.3 million to $511.8 million.
  • The 2017 Tax Cuts and Jobs Act lowered the statutory federal corporate tax rate. The effective tax rate was 18.5% versus 27.8%; management noted tax-exempt investment income also reduced the effective rate. The company said it continued evaluating certain tax-reform accounting effects.
  • Adoption of the new equity investment accounting guidance moved equity-security fair-value changes into net income. A $16.9 million after-tax cumulative adjustment increased retained earnings and reduced accumulated other comprehensive income at adoption; a separate $4.7 million tax-effect reclassification also shifted amounts between those accounts. The company reported no material effect from adopting the new revenue standard.
  • Comprehensive loss was $16.8 million, compared with comprehensive income of $16.3 million, primarily reflecting $25.9 million of after-tax other comprehensive losses, including fixed-maturity valuation changes.
  • No formal earnings guidance was provided. Management said it expected positive operating cash flows to continue and believed liquidity was sufficient for operating needs over the next 12 months, while noting longer-term funding depends on market, regulatory, and economic conditions. The board declared a $0.80-per-share dividend payable June 15, 2018 and said quarterly dividends were planned for 2018 subject to financial position and cash-flow regularity.
  • Catastrophe coverage for 2018 was described as protecting against a “137-year storm,” with four excess catastrophe reinsurance layers providing $615 million of coverage above $50 million, subject to stated participation terms. Reinsurance recoverables remain exposed to counterparty and collection risk.
  • A dispute over 2015 winter-storm reinsurance was settled by arbitration: the reinsurer paid $9.2 million, collected in 2018; the remaining $11.7 million had been expensed in 2017. Management said pending ordinary-course claims and expected Massachusetts insolvency-fund assessments were not expected to materially affect financial position.
  • Key risks include severe weather, reserve-estimation uncertainty, competition, Massachusetts insurance regulation and residual-market assessments, interest-rate and equity-market changes, and possible need for additional financing. Management reported effective disclosure controls and no material changes in internal control over financial reporting.

Investor verification priorities

  1. Review the drivers and durability of the 103.4% combined ratio, including winter-weather losses, rate changes, and the level of favorable reserve development.
  2. Assess reserve adequacy against the disclosed $438.3–$511.8 million actuarial range and test sensitivity to claim frequency and severity.
  3. Check investment portfolio exposure to interest rates, credit quality, and equity volatility, including the effect of accounting changes on reported earnings and equity.
  4. Confirm liquidity and refinancing plans around the August 2018 credit-facility maturity, and evaluate reliance on regulated subsidiary dividends.
  5. Verify catastrophe reinsurance terms, counterparty recoverables, and the sustainability of the $0.80 quarterly dividend relative to cash generation and earnings.