Safety Insurance Group, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Financial figures are in thousands of dollars, except per-share data and ratios. The filing is unaudited.
Business context
Safety is a property and casualty insurer focused primarily on Massachusetts, with automobile insurance as its principal business. It also writes homeowners and other lines in Massachusetts and New Hampshire, and began writing business in Maine in 2016.
Financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net earned premiums | $190,712 | $186,582 | $563,759 | $551,593 |
| Total revenue | $210,085 | $201,270 | $612,864 | $596,911 |
| Losses and LAE | $124,961 | $128,931 | $366,084 | $484,281 |
| Underwriting, operating and related expenses | $58,406 | $53,624 | $171,876 | $157,919 |
| Net income (loss) | $18,597 | $11,981 | $52,632 | $(24,143) |
| Diluted EPS | $1.23 | $0.80 | $3.48 | $(1.62) |
| Combined ratio | 96.1% | 97.8% | 95.4% | 116.4% |
Direct written premiums rose 4.3% in Q3 and 3.0% for the nine-month period year over year. Net earned premiums increased 2.2% in both periods. Nine-month net income improved from a loss to a profit, principally because 2015 included severe winter-storm losses. Q3 loss expense also declined, partly because of hail losses in Q3 2015. The 2016 results include favorable prior-year reserve development of $11,734 for Q3 and $33,601 for nine months.
Net investment income fell 9.9% in Q3 and 8.4% year to date; management attributed the decline to a lower average invested-asset balance following claim payments for 2015 winter events and increased fixed-maturity amortization. The nine-month annualized portfolio yield was 3.1%, versus 3.4% a year earlier. Net realized investment gains were $4,891 for Q3 and $4,928 for nine months, compared with losses of $310 and $72, respectively, in 2015. No Q3 2016 investment impairment was recorded; nine-month impairment losses were $429.
Financial position, cash flow and capital
- At September 30, 2016, total assets were $1.796 billion, investments were $1.275 billion, cash and cash equivalents were $52.3 million, and shareholders’ equity was $687.3 million. Total assets were $1.704 billion and equity was $644.5 million at year-end 2015.
- Operating cash flow was $75.8 million for the nine months, compared with cash used of $10.8 million in 2015. Investing activities used $39.6 million; financing activities used $31.5 million, primarily for dividends. Period-end cash was $52.3 million, up from $47.5 million at year-end 2015.
- Loss and LAE reserves were $552.2 million, including $80.6 million of reinsurance recoverables on unpaid losses. Unearned premium reserves were $439.7 million.
- No amounts were outstanding on the $30 million revolving credit facility or FHLB-Boston borrowing capacity; the company reported covenant compliance. It stated it could borrow up to $185.4 million from FHLB-Boston against eligible collateral.
- Cash dividends were $0.70 per share each quarter, or $2.10 per share for the nine months. On November 1, 2016, the board declared another $0.70-per-share dividend, payable December 15.
Changes, outlook and risks
- The loss ratio improved to 65.5% for Q3 and 64.9% year to date, while the expense ratio increased to 30.6% and 30.5%, respectively. Management attributed higher expenses and expense ratios to increased contingent commissions and bonus compensation.
- Management reported approved rate increases for selected Massachusetts and New Hampshire lines, with effective dates in 2016; the filing also describes the company’s 2016 entry into Maine. It did not provide earnings or revenue guidance.
- Management expects operating cash flows to meet near-term requirements and anticipates sufficient internally generated funds beyond the next 12 months, while noting that market, regulatory and economic changes could affect that outlook.
- Catastrophe exposure remains a central risk. The 2016 excess catastrophe reinsurance program provides $615 million of coverage above a $50 million retention, subject to stated layers and reinsurer participation. The company reported $67.9 million of expected recovery related to the 2015 snow event and $32.3 million recoverable on paid and unpaid losses at quarter-end.
- A $22.8 million reinsurance recovery related to 2015 winter-storm losses is in arbitration. No collectability provision was recorded; management believes the amount is valid and recoverable. The company also participates in Massachusetts residual-market programs, whose assessments and reserve estimates involve uncertainty.
- Net reserves for losses and LAE were estimated at $471.6 million, within an actuarial range of $420.7 million to $485.9 million. A one-percentage-point change in the loss and LAE ratio would change nine-month reserves by approximately $5.6 million and net income by approximately $3.7 million, or $0.24 per diluted share.
- Other stated risks include competition, severe weather, insurance regulation, interest-rate and equity-market movements, investment liquidity, and the uncertainty inherent in estimating claims reserves. Management said there were no material changes to previously disclosed risk factors. Disclosure controls were judged effective, with no material changes in internal control over financial reporting reported.
Most important facts for investors to verify
- How much of the year-over-year earnings improvement reflects lower catastrophe losses versus favorable prior-year reserve development, and whether that development persists.
- The status and collectability of the $22.8 million disputed reinsurance recovery and the timing of other 2015 winter-storm recoveries.
- Whether premium growth and approved rate increases can offset higher operating expenses and declining investment income.
- Actual claims development relative to the disclosed reserve range, particularly given the sensitivity of earnings to reserve assumptions.
- Catastrophe exposure, reinsurance recoverability, and statutory limits on dividends from insurance subsidiaries to the holding company.