Safety Insurance Group, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; unaudited. Amounts are in thousands of dollars except per-share data. Safety is a property and casualty insurer focused primarily on Massachusetts, with additional operations in New Hampshire and Maine. Automobile insurance is its principal business.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $215,907 | $212,529 | $633,596 | $625,548 |
| Net earned premiums | $196,968 | $195,524 | $583,126 | $578,059 |
| Net income | $28,908 | $17,954 | $64,849 | $51,078 |
| Diluted EPS | $1.88 | $1.18 | $4.24 | $3.36 |
| Combined ratio | 90.9% | 95.5% | 94.7% | 95.7% |
| Operating cash flow | — | — | $90,397 | $50,085 |
- Q3 revenue rose 1.6% year over year and net income rose 61%; nine-month revenue increased 1.3% and net income increased 27%.
- Direct written premiums grew 1.9% in Q3 and 2.2% year to date. Management attributed the 2018 increase chiefly to commercial automobile and homeowners business. Net written premiums rose 1.5% in Q3 and 0.6% for nine months.
- Q3 losses and loss adjustment expenses fell 5.7% year over year; nine-month losses declined 0.5%. The loss ratio improved to 59.2% for Q3 and 63.0% year to date. Expense ratios were 31.7% in both periods.
- Prior-year reserve releases were $13.0 million in Q3 and $39.3 million for nine months, versus $10.8 million and $31.2 million, respectively, in 2017. Management cited fewer-than-estimated incurred-but-not-reported claims and better-than-estimated severity, particularly in automobile lines.
- Net investment income increased 17.0% in Q3 and 12.5% year to date, supported by higher average invested assets and fixed-maturity income. Investment yield was 3.4% in Q3 and 3.3% for nine months, compared with 3.0% in both 2017 periods. Partnership investment earnings also increased.
- Non-GAAP operating income was $27.1 million in Q3 and $65.7 million year to date, compared with $16.4 million and $48.1 million. The measure excludes specified investment gains, impairments, equity-security unrealized changes, and related taxes.
Financial position, cash flow, and capital
- At September 30, 2018, total assets were $1.879 billion, total liabilities $1.167 billion, and shareholders’ equity $711.9 million. Cash and equivalents were $51.3 million; investments totaled $1.316 billion.
- Operating cash flow for the first nine months was $90.4 million. Investing activities used $44.1 million and shareholder dividends used $36.7 million; cash ended the period at $51.3 million.
- The company had no borrowings under its $30 million revolving credit facility, extended to August 2023, and reported compliance with its covenants. It also had no FHLB-Boston borrowings and stated borrowing capacity of $268.4 million against eligible collateral.
- Loss and LAE reserves were $583.0 million, including $100.6 million recoverable from reinsurers for unpaid losses. Net reserves were $482.4 million; management’s actuarial range was $429.3 million to $504.2 million.
- Cash dividends were $0.80 per share in each 2018 quarter through September, or $2.40 per share year to date. The board declared another $0.80 dividend on October 31, payable December 14, 2018. No shares were repurchased during the first nine months.
Changes, outlook, and risks
- Net income benefited from improved underwriting results, reserve releases, higher investment income, and the reduction in the federal corporate tax rate to 21%. The nine-month effective tax rate was 20.0%, versus 29.6% in 2017.
- Investment-market changes affected reported equity and comprehensive income. Adoption of equity-investment accounting guidance shifted subsequent fair-value changes into net income; nine-month 2018 included a $3.7 million unrealized loss on equity investments. Other comprehensive loss was $21.3 million for nine months, and accumulated other comprehensive loss was $9.2 million at period end.
- Fixed maturities had $23.4 million of gross unrealized losses at September 30, compared with $7.4 million at December 31, 2017. Management attributed most declines to interest rates and temporary market conditions, and said it did not expect to need to sell securities before recovery. The company recorded $228,000 of investment impairment losses for the nine-month period.
- Management expected operating cash flows to meet needs over the next 12 months and anticipated internally generated funds to support longer-term needs, while noting there is no assurance. No earnings or premium-growth guidance was provided. The company said quarterly dividends were expected to continue in 2018, subject to financial position and cash-flow regularity.
- Risk exposures include severe weather and catastrophe losses, competition, insurance regulation and residual-market changes, reserve-estimation uncertainty, investment interest-rate and equity-price risk, and reinsurer credit risk. The company maintained catastrophe reinsurance described as covering a modeled “137-year storm.” Management reported no subsequent material changes to the 2017 Form 10-K risk factors.
- Legal claims arising in the ordinary course and possible Massachusetts insolvency-fund assessments were not expected by management to have a material effect. A 2015 winter-storm reinsurance dispute was settled: $9.2 million was collected in 2018, while the remaining $11.7 million had been expensed in 2017. No material off-balance-sheet arrangements or reportable subsequent events were disclosed.
- The company adopted certain accounting updates in 2018, including the equity-investment fair-value guidance and revenue-recognition guidance; management said the revenue standard had no material impact. It was evaluating expected balance-sheet gross-up from the upcoming lease standard and potential credit-loss effects from CECL.
Important facts for investors to verify
- Whether the unusually large favorable reserve development continues, and how actual claims experience compares with the disclosed reserve range and sensitivity analysis.
- Whether premium growth and underwriting profitability are sustainable without comparable reserve releases; monitor combined ratio and line-of-business trends.
- Investment portfolio credit quality, unrealized losses, equity-market exposure, and the ability to avoid forced sales during catastrophe or liquidity stress.
- Reinsurance recoverability and catastrophe protection, including exposure through Massachusetts residual markets and reinsurer counterparty risk.
- Dividend capacity at the holding company, given regulatory limits on subsidiary dividends, and management’s capital and liquidity needs.