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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______to ______                 

Commission File Number: 000-50070

SAFETY INSURANCE GROUP, INC.

(Exact name of registrant as specified in its charter)

Delaware

13-4181699

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

20 Custom House Street, Boston, Massachusetts 02110

(Address of principal executive offices including zip code)

(617) 951-0600

(Registrant’s telephone number, including area code)

Not Applicable

(Former name or former address, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol

Name of each exchange on which registered

Common Stock, par value $0.01 per share

SAFT

The Nasdaq Stock Market, LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes   No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes   No 

Securities registered pursuant to Section 12(b) of the Act:

As of May 6, 2020 there were 15,309,497 shares of common stock with a par value of $0.01 per share outstanding.

SAFETY INSURANCE GROUP, INC.

TABLE OF CONTENTS

Page No.

Part I. Financial Information

Item 1.

Consolidated Financial Statements

Consolidated Balance Sheets

3

Consolidated Statements of Operations

4

Consolidated Statements of Comprehensive (Loss) Income

5

Consolidated Statements of Changes in Shareholders’ Equity

6

Consolidated Statements of Cash Flows

7

Notes to Unaudited Consolidated Financial Statements

8

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

25

Item 3.

Quantitative and Qualitative Information about Market Risk

45

Item 4.

Controls and Procedures

45

Part II. Other Information

Item 1

Legal Proceedings

47

Item 1A.

Risk Factors

47

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

47

Item 3.

Defaults upon Senior Securities

47

Item 4.

Mine Safety Disclosures

48

Item 5.

Other Information

48

Item 6.

Exhibits

48

EXHIBIT INDEX

49

SIGNATURE

50

2

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands, except share data)

    

March 31, 

    

December 31, 

2020

2019

(Unaudited)

Assets

Investments:

Fixed maturities, available for sale, at fair value (amortized cost: $1,159,859 and $1,192,357, allowance for expected credit losses of $2,510 at March 31, 2020)

$

1,165,455

$

1,228,040

Equity securities, at fair value (cost: $153,359 and $151,121)

 

149,888

 

177,637

Other invested assets

 

41,881

 

37,278

Total investments

 

1,357,224

 

1,442,955

Cash and cash equivalents

 

41,567

 

44,407

Accounts receivable, net of allowance for expected credit losses of $334 at March 31, 2020

 

189,671

 

193,369

Receivable for securities sold

 

1,067

 

1,784

Accrued investment income

 

9,152

 

8,404

Taxes recoverable

 

 

1,003

Receivable from reinsurers related to paid loss and loss adjustment expenses

 

14,039

 

11,319

Receivable from reinsurers related to unpaid loss and loss adjustment expenses

 

121,337

 

122,372

Ceded unearned premiums

 

30,191

 

35,182

Deferred policy acquisition costs

 

72,132

 

74,287

Deferred income taxes

 

6,001

 

Equity and deposits in pools

 

30,004

 

29,791

Operating lease right-of-use-assets

34,256

 

33,998

Other assets

 

24,078

 

23,798

Total assets

$

1,930,719

$

2,022,669

Liabilities

Loss and loss adjustment expense reserves

$

608,693

$

610,566

Unearned premium reserves

 

428,291

 

442,219

Accounts payable and accrued liabilities

 

55,911

 

75,016

Payable for securities purchased

 

4,343

 

6,377

Payable to reinsurers

 

2,446

 

12,911

Deferred income taxes

5,717

Taxes payable

543

Debt

30,000

Operating lease liabilities

34,256

33,998

Other liabilities

 

4,127

 

27,459

Total liabilities

 

1,168,610

 

1,214,263

Commitments and contingencies (Note 8)

Shareholders’ equity

Common stock: $0.01 par value; 30,000,000 shares authorized; 17,732,359 and 17,662,779 shares issued

177

177

Additional paid-in capital

 

204,064

 

202,321

Accumulated other comprehensive income, net of taxes

 

6,404

 

28,190

Retained earnings

 

645,691

 

661,553

Treasury stock, at cost: 2,422,862 and 2,279,570 shares

 

(94,227)

 

(83,835)

Total shareholders’ equity

 

762,109

 

808,406

Total liabilities and shareholders’ equity

$

1,930,719

$

2,022,669

The accompanying notes are an integral part of these financial statements.

3

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

(Dollars in thousands, except per share data)

Three Months Ended March 31, 

    

    

2020

    

2019

 

Net earned premiums

$

197,895

$

194,491

Net investment income

 

10,710

 

11,751

Earnings from partnership investments

 

1,339

 

835

Net realized losses on investments

 

(631)

 

(164)

Change in net unrealized gains on equity investments

(29,988)

11,801

Net impairment losses on investments (a)

(220)

Credit loss expense

(2,510)

Finance and other service income

 

4,229

 

4,085

Total revenue

 

181,044

 

222,579

Losses and loss adjustment expenses

 

120,746

 

126,027

Underwriting, operating and related expenses

 

63,082

 

60,434

Interest expense

 

47

 

22

Total expenses

 

183,875

 

186,483

(Loss) income before income taxes

 

(2,831)

 

36,096

Income tax (benefit) expense

 

(841)

 

6,150

Net (loss) income

$

(1,990)

$

29,946

(Loss) earnings per weighted average common share:

Basic

$

(0.13)

$

1.97

Diluted

$

(0.13)

$

1.95

Cash dividends paid per common share

$

0.90

$

0.80

Number of shares used in computing earnings per share:

Basic

 

15,230,784

 

15,140,804

Diluted

 

15,347,083

 

15,305,785

(a) No portion of the other-than-temporary impairments recognized in the period indicated were included in Other Comprehensive Income for the period ended March 31, 2019.

The accompanying notes are an integral part of these financial statements.

4

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive (Loss) Income

(Unaudited)

(Dollars in thousands)

Three Months Ended March 31, 

    

2020

    

2019

Net (loss) income

$

(1,990)

$

29,946

Other comprehensive (loss) income, net of tax:

Unrealized holding (losses) gains during the period, net of income tax (benefit) expense of ($5,924) and $5,296.

 

(22,284)

 

19,923

Reclassification adjustment for net realized losses on investments included in net (loss) income, net of income tax benefit of $132 and $35.

 

498

 

130

Other comprehensive (loss) income, net of tax:

 

(21,786)

 

20,053

Comprehensive (loss) income

$

(23,776)

$

49,999

The accompanying notes are an integral part of these financial statements.

5

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

(Dollars in thousands)

    

    

    

    

    

Accumulated

    

    

    

    

    

    

Other

Additional

Comprehensive

Total

Common

Paid-in

(Loss) Income,

Retained

Treasury

Shareholders’

Stock

Capital

Net of Taxes

Earnings

Stock

Equity

Balance at December 31, 2018

$

176

$

196,292

$

(10,706)

$

616,717

$

(83,835)

$

718,644

Cumulative effect of adoption of updated accounting guidance for callable debt securities at January 1, 2019, net of taxes

(2,373)

(2,373)

Net income, January 1 to March 31, 2019

 

29,946

 

29,946

Unrealized gains on securities available for sale, net of deferred federal income taxes

 

20,053

 

20,053

Restricted share awards issued

 

1

 

462

 

463

Recognition of employee share-based compensation, net of deferred federal income taxes

 

1,260

 

1,260

Dividends paid and accrued

 

(12,300)

 

(12,300)

Acquisition of treasury stock

 

 

Balance at March 31, 2019

$

177

$

198,014

$

9,347

$

631,990

$

(83,835)

$

755,693

    

    

    

    

    

Accumulated

    

    

    

    

    

    

Other

Additional

Comprehensive

Total

Common

Paid-in

Income,

Retained

Treasury

Shareholders’

Stock

Capital

Net of Taxes

Earnings

Stock

Equity

Balance at December 31, 2019

$

177

$

202,321

$

28,190

$

661,553

$

(83,835)

$

808,406

Net loss, January 1 to March 31, 2020

 

(1,990)

 

(1,990)

Unrealized losses on securities available for sale, net of deferred federal income taxes

 

(21,786)

 

(21,786)

Restricted share awards issued

 

 

528

 

528

Recognition of employee share-based compensation, net of deferred federal income taxes

 

1,215

 

1,215

Dividends paid and accrued

 

(13,872)

 

(13,872)

Acquisition of treasury stock

 

(10,392)

 

(10,392)

Balance at March 31, 2020

$

177

$

204,064

$

6,404

$

645,691

$

(94,227)

$

762,109

The accompanying notes are an integral part of these financial statements.

6

Safety Insurance Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

Three Months Ended March 31, 

    

2020

    

2019

Cash flows from operating activities:

Net (loss) income

$

(1,990)

$

29,946

Adjustments to reconcile net (loss) income to net cash used for operating activities:

Investment amortization, net

 

1,774

 

777

Fixed Asset depreciation, net

 

1,606

 

1,207

Stock based compensation

1,744

1,723

(Credit) Provision for deferred income taxes

 

(5,927)

 

469

Net realized losses on investments

 

631

 

164

Net impairment losses on investments

220

Credit loss expense

2,510

Earnings from partnership investments

 

(1,339)

 

(835)

Change in net unrealized gains on equity investments

29,988

(11,801)

Changes in assets and liabilities:

Accounts receivable

 

3,698

 

1,408

Accrued investment income

 

(748)

 

(1,030)

Receivable from reinsurers

 

(1,685)

 

(16,992)

Ceded unearned premiums

 

4,991

 

437

Deferred policy acquisition costs

 

2,155

 

1,450

Taxes recoverable

1,003

Other assets

 

877

 

(3,849)

Loss and loss adjustment expense reserves

 

(1,873)

 

(2,957)

Unearned premium reserves

 

(13,928)

 

(4,991)

Taxes payable

543

2,196

Accounts payable and accrued liabilities

 

(18,748)

 

(17,357)

Payable to reinsurers

 

(10,465)

 

6,719

Other liabilities

 

(23,332)

 

5,084

Net cash used for operating activities

 

(28,515)

 

(8,012)

Cash flows from investing activities:

Fixed maturities purchased

 

(32,329)

 

(31,389)

Equity securities purchased

 

(12,095)

 

(5,169)

Other invested assets purchased

 

(3,389)

 

(1,750)

Proceeds from sales and paydowns of fixed maturities

 

33,433

 

33,587

Proceeds from maturities, redemptions, and calls of fixed maturities

 

28,909

 

7,260

Proceed from sales of equity securities

 

8,638

 

4,874

Proceeds from other invested assets redeemed

106

Fixed assets purchased

 

(2,977)

 

(1,127)

Net cash provided by investing activities

 

20,296

 

6,286

Cash flows from financing activities:

Debt

 

30,000

 

Dividends paid to shareholders

 

(14,229)

 

(12,964)

Acquisition of treasury stock

(10,392)

Net cash provided by (used for) financing activities

 

5,379

 

(12,964)

Net decrease in cash and cash equivalents

 

(2,840)

 

(14,690)

Cash and cash equivalents at beginning of year

 

44,407

 

37,582

Cash and cash equivalents at end of period

$

41,567

$

22,892

The accompanying notes are an integral part of these financial statements.

7

Table of Contents

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

1. Basis of Presentation

The consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates.

The consolidated financial statements include Safety Insurance Group, Inc. and its subsidiaries (the “Company”). The subsidiaries consist of Safety Insurance Company, Safety Indemnity Insurance Company, Safety Property and Casualty Insurance Company, Safety Asset Management Corporation (“SAMC”), and Safety Management Corporation, which is SAMC’s holding company. All intercompany transactions have been eliminated.

The financial information for the three months ended March 31, 2020 and 2019 is unaudited; however, in the opinion of the Company, the information includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial condition, results of operations, and cash flows for the periods. The financial information as of December 31, 2019 is derived from the audited financial statements included in the Company's 2019 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on February 28, 2020.

These unaudited interim consolidated financial statements may not be indicative of financial results for the full year and should be read in conjunction with the audited financial statements included in the Company’s 2019 Annual Report on Form 10-K filed with the SEC on February 28, 2020.

The Company is a leading provider of property and casualty insurance focused primarily on the Massachusetts market. The Company’s principal product line is automobile insurance. The Company operates through its insurance company subsidiaries, Safety Insurance Company, Safety Indemnity Insurance Company, and Safety Property and Casualty Insurance Company (together referred to as the “Insurance Subsidiaries”).

The Insurance Subsidiaries began writing private passenger automobile and homeowners insurance in New Hampshire during 2008, personal umbrella insurance in New Hampshire during 2009, and commercial automobile insurance in New Hampshire during 2011. The Insurance Subsidiaries began writing all of these lines of business in Maine during 2016.

Management has assessed and concluded that there were no conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date the financial statements were issued.

2. Recent Accounting Pronouncements

On March 20, 2019, the SEC adopted amendments to Regulation S-K and related rules and forms to modernize and simplify certain disclosure requirements for public companies. The amendments are intended to reduce the costs and burdens of the disclosure process while continuing to require disclosure of all material information. The amended rules generally were effective on May 2, 2019 and reduce disclosures but some provisions added new requirements. The adoption of the new rules did not have a material impact on the Company’s financial position, results of operations, cash flows, or disclosures.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, which changes the fair value

8

Table of Contents

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

measurement disclosure requirements under ASC 820. The Company’s adoption of ASU 2018-13 on January 1, 2020 did not have an impact on the fair value disclosures included in Note 5 – Investments.

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities, which requires certain premiums on callable debt securities to be amortized to the earliest call date. The amortization period for callable debt securities purchased at a discount will not be impacted. The Company adopted ASU 2017-08 effective January 1, 2019 which resulted in the recognition of $2,373 of additional amortization, net of tax, as a cumulative effect adjustment which decreased retained earnings by that amount.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Statements, which amends the guidance for the impairment of financial instruments and is expected to result in more timely recognition of impairment losses. The update introduces an impairment model referred to as the current expected credit loss (“CECL”) model. The impairment model is based on expected losses rather than incurred losses. Under the new guidance, an entity recognizes as an allowance its estimate of expected credit losses. The ASU is also intended to reduce the complexity of the current guidance by decreasing the number of credit impairment models that entities use to account for debt instruments. For public business entities that are SEC filers, the amendments in ASU No. 2016-13 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company adopted the updated guidance on January 1, 2020 using the modified rertrospective approach. The updated guidance did not have a material impact on the opening balance of retained earnings. The Company has elected not to measure expected credit losses for accrued interest receivables related to its finance receivables and fixed maturity securities. At March 31, 2020, the Company recognized an allowance for expected credit losses related to its available-for-sale (“AFS”) debt securities of $2,510. As permitted, the Company has not restated comparative information for 2019 and, therefore, the comparative information for 2019 is reported under the prior model and is not comparable to the information presented for 2020.

In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard was effective for fiscal years beginning after December 15, 2018. In 2018, the FASB issued two additional updates, ASU 2018-10, Codification Improvements to Topic 842, Leases and ASU 2018-11, Leases (Topic 842): Targeted Improvements, both of which have the same effective date and transition requirements as ASU 2016-02. ASU 2018-10 makes sixteen technical corrections to alleviate unintended consequences from applying the new standard and does not make any substantive changes to the core provisions or principals of the new standard. ASU 2019-11 creates an additional transition method which allows companies to elect to not adjust their comparative period financial information and disclosures for the effects of the new lease standard and also creates a practical expedient for lessors to not separate lease and non-lease components. The Company adopted ASU 2016-02, ASU 2018-10 and ASU 2018-11 effective January 1, 2019 (“the application date”) using the required modified retrospective transition approach. In accordance with the guidance, the Company has elected not to adjust comparative periods. As such, Accounting Standards Codification (“ASC”) 842 will be applied to each lease that had commenced as of the application date with a cumulative effect adjustment as of that date. As of January 1, 2019, a right of use asset and lease liability of $35,984 were recorded in the Consolidated Balance Sheets. There was no impact on retained earnings or other components of equity in the Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019.

9

Table of Contents

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

3. Earnings per Weighted Average Common Share

Basic earnings per weighted average common share (“EPS”) are calculated by dividing net income by the weighted average number of basic common shares outstanding during the period. Diluted earnings per share amounts are based on the weighted average number of common shares including non-vested performance stock grants.

The following table sets forth the computation of basic and diluted EPS for the periods indicated.

Three Months Ended March 31, 

 

2020

2019

(Loss) Earnings attributable to common shareholders - basic and diluted:

Net (loss) income from continuing operations

$

(1,990)

$

29,946

Allocation of loss (income) for participating shares

10

(167)

Net (loss) income from continuing operations attributed to common shareholders

$

(1,980)

$

29,779

(Loss) Earnings per share denominator - basic and diluted

Total weighted average common shares outstanding, including participating shares

15,304,758

15,225,774

Less: weighted average participating shares

(73,974)

(84,970)

Basic (loss) earnings per share denominator

15,230,784

15,140,804

Common equivalent shares- non-vested performance stock grants

 

116,299

 

164,981

Diluted (loss) earnings per share denominator

 

15,347,083

 

15,305,785

Basic (loss) earnings per share

$

(0.13)

$

1.97

Diluted (loss) earnings per share

$

(0.13)

$

1.95

Undistributed (loss) earnings attributable to common shareholders - basic and diluted:

Net (loss) income from continuing operations attributable to common shareholders -Basic

$

(0.13)

$

1.97

Dividends declared

(0.90)

(0.80)

Undistributed (loss) earnings

$

(1.03)

$

1.17

Net (loss) income from continuing operations attributable to common shareholders -Diluted

$

(0.13)

$

1.95

Dividends declared

(0.90)

(0.80)

Undistributed (loss) earnings

$

(1.03)

$

1.15

Diluted EPS excludes non vested performance stock grants with exercise prices and exercise tax benefits greater than the average market price of the Company’s common stock during the period because their inclusion would be anti-dilutive. There were no anti-dilutive shares related to non vested performance stock grants for the three months ended March 31, 2020 and 2019.

4.  Share-Based Compensation

2018 Long Term Incentive Plan

On April 2, 2018, the Company’s Board of Directors adopted the Safety Insurance Group, Inc. 2018 Long-Term Incentive Plan (“the 2018 Plan”), which was subsequently approved by our shareholders at the 2018 Annual Meeting of Shareholders. The 2018 Plan enables the grant of stock awards, performance shares, cash-based performance units, other stock-based awards, stock options, stock appreciation rights, and stock unit awards, each of which may be granted separately or in tandem with other awards. Eligibility to participate includes officers, directors, employees and other individuals who provide bona fide services to the Company. The 2018 Plan supersedes the Company’s 2002 Management Omnibus Incentive Plan (“the 2002 Incentive Plan”).

The 2018 Plan establishes an initial pool of 350,000 shares of common stock available for issuance to our employees and other eligible participants. The maximum number of shares of common stock between both the 2018 Plan

10

Table of Contents

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

and 2002 Incentive Plan with respect to which awards may be granted is 2,850,000. No further grants will be allowed under the 2002 Incentive Plan. At March 31, 2020, there were 234,170 shares available for future grant.

Accounting and Reporting for Stock-Based Awards

Accounting Standards Codification (“ASC”) 718, Compensation —Stock Compensation requires the Company to measure and recognize the cost of employee services received in exchange for an award of equity instruments. Under the provisions of ASC 718, share-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite service period (generally the vesting period of the equity grant).

Restricted Stock

Service-based restricted stock awarded in the form of unvested shares is recorded at the market value of the Company’s common stock on the grant date and amortized ratably as compensation expense over the requisite service period. Service-based restricted stock awards generally vest over a three-year period and vest 30% on the first and second anniversaries of the grant date and 40% on the third anniversary of the grant date, except for non-executive employees’ restricted stock awards granted prior to 2018 which vest ratably over a five-year service period and independent directors’ stock awards which vest immediately. Our independent directors are subject to stock ownership guidelines, which require them to have a value four times their annual cash retainer.

In addition to service-based awards, the Company grants performance-based restricted shares to certain employees.  These performance shares cliff vest after a three-year performance period provided certain performance measures are attained.  A portion of these awards, which contain a market condition, vest according to the level of total shareholder return achieved by the Company compared to its property-casualty insurance peers over a three-year period. The remainder, which contain a performance condition, vest according to the level of Company’s combined ratio results compared to a target based on its property-casualty insurance peers.

Actual payouts can range from 0% to 200% of target shares awarded depending upon the level of achievement of the respective market and performance conditions during a three calendar-year performance period.  Compensation expense for share awards with a performance condition is based on the probable number of awards expected to vest using the performance level most likely to be achieved at the end of the performance period.

Performance-based awards with market conditions are accounted for and measured differently from awards that have a performance or service condition.  The effect of a market condition is reflected in the award’s fair value on the grant date.  That fair value is recognized as compensation cost over the requisite service period regardless of whether the market-based performance objective has been satisfied.

All of the Company’s restricted stock awards are issued as incentive compensation and are equity classified.

11

Table of Contents

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

The following table summarizes restricted stock activity under the Incentive Plan during the three months ended March 31, 2020 assuming a target payout for the 2020 performance-based shares.

    

Shares 

    

Weighted

Performance-based

    

Weighted

Under

Average

Shares Under

Average

Restriction

Fair Value

Restriction

Fair Value

Outstanding at beginning of year

 

78,202

$

79.09

84,105

$

79.34

Granted

 

34,799

90.10

36,649

(1)

84.68

Vested and unrestricted

 

(43,480)

78.07

(42,123)

73.55

Forfeited

(1,868)

84.61

Outstanding at end of period

 

69,521

$

85.24

76,763

$

84.94

(1) Includes a true-up of previously awarded performance-based restricted share awards. The updated shares were calculated based on the attainment of pre-established performance objectives and granted under the 2002 Incentive Plan.

As of March 31, 2020, there was $9,428 of unrecognized compensation expense related to non-vested restricted stock awards that is expected to be recognized over a weighted average period of 1.8 years.  The total fair value of the shares that were vested and unrestricted during the three months ended March 31, 2020 and 2019 was $6,493 and $7,771, respectively.  For the three months ended March 31, 2020 and 2019, the Company recorded compensation expense related to restricted stock of $1,378 and $1,361, net of income tax benefits of $366 and $362, respectively.

5.  Investments

The gross unrealized gains and losses on investments in fixed maturity securities, including redeemable preferred stocks that have characteristics of fixed maturities, and equity securities, including interests in mutual funds, and other invested assets were as follows for the periods indicated.

As of March 31, 2020

    

Cost or

    

Allowance for

    

Gross Unrealized

    

Estimated

Amortized

Expected Credit

Fair

Cost

Losses

Gains

Losses  (3)

Value

U.S. Treasury securities

$

1,823

$

$

60

$

$

1,883

Obligations of states and political subdivisions

 

224,800

 

 

8,924

 

(34)

 

233,690

Residential mortgage-backed securities (1)

 

288,122

 

 

12,998

 

(103)

 

301,017

Commercial mortgage-backed securities

 

105,678

 

 

3,553

 

(165)

 

109,066

Other asset-backed securities

 

26,659

 

 

63

 

(1,415)

 

25,307

Corporate and other securities

 

512,777

 

(2,510)

 

9,127

 

(24,902)

 

494,492

Subtotal, fixed maturity securities 

 

1,159,859

 

(2,510)

 

34,725

 

(26,619)

 

1,165,455

Equity securities (2)

 

153,359

 

 

13,874

 

(17,345)

 

149,888

Other invested assets (4)

 

41,881

 

 

 

 

41,881

Totals

$

1,355,099

$

(2,510)

$

48,599

$

(43,964)

$

1,357,224

12

Table of Contents

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

As of December 31, 2019

 

 

    

Cost or

    

Gross Unrealized

    

Estimated

 

Amortized

Fair

 

Cost

Gains

Losses

Value

 

U.S. Treasury securities

$

1,504

$

8

$

$

1,512

Obligations of states and political subdivisions

 

241,597

 

9,799

 

 

251,396

Residential mortgage-backed securities (1)

 

301,503

 

6,608

 

(909)

 

307,202

Commercial mortgage-backed securities

 

106,902

 

3,233

 

(397)

 

109,738

Other asset-backed securities

 

36,068

 

218

 

(64)

 

36,222

Corporate and other securities

 

504,783

 

18,455

 

(1,268)

 

521,970

Subtotal, fixed maturity securities 

 

1,192,357

 

38,321

 

(2,638)

 

1,228,040

Equity securities (2)

 

151,121

 

27,879

 

(1,363)

 

177,637

Other invested assets (4)

 

37,278

 

 

 

37,278

Totals

$

1,380,756

$

66,200

$

(4,001)

$

1,442,955

(1) Residential mortgage-backed securities consists primarily of obligations of U.S. Government agencies including collateralized mortgage obligations issued, guaranteed and/or insured by the following issuers: Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA) and the Federal Home Loan Bank (FHLB).
(2) Equity securities include common stock, preferred stock, mutual funds and interests in mutual funds held to fund the Company’s executive deferred compensation plan.
(3) The Company’s investment portfolio included 733 and 229 securities in an unrealized loss position at March 31, 2020 and December 31, 2019, respectively.
(4) Other invested assets are accounted for under the equity method which approximated fair value.

The amortized cost and the estimated fair value of fixed maturity securities, by maturity, are shown below for the period indicated. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

As of March 31, 2020

    

Amortized

    

Estimated

Cost

Fair Value

Due in one year or less

$

51,519

$

51,881

Due after one year through five years

 

295,621

 

287,963

Due after five years through ten years

 

311,755

 

305,990

Due after ten years through twenty years

 

79,555

 

83,326

Due after twenty years

 

950

 

906

Asset-backed securities

 

420,459

 

435,389

Totals

$

1,159,859

$

1,165,455

The gross realized losses and gains on sales of investments were as follows for the periods indicated.

Three Months Ended March 31, 

    

    

2020

    

2019

 

Gross realized gains

Fixed maturity securities

$

889

$

115

Equity securities

 

1,576

 

953

Gross realized losses

Fixed maturity securities

 

(301)

 

(667)

Equity securities

 

(2,795)

 

(565)

Net realized losses on investments

$

(631)

$

(164)

In the normal course of business, the Company enters into transactions involving various types of financial instruments, including investments in fixed maturities and equity securities. Investment transactions have credit

13

Table of Contents

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

exposure to the extent that a counter party may default on an obligation to the Company. Credit risk is a consequence of carrying, trading and investing in securities. To manage credit risk, the Company focuses on higher quality fixed income securities, reviews the credit strength of all companies in which it invests, limits its exposure in any one investment and monitors the portfolio quality, taking into account credit ratings assigned by recognized statistical rating organizations.

The following tables as of March 31, 2020 and December 31, 2019 present the gross unrealized losses included in the Company’s investment portfolio and the fair value of those securities aggregated by investment category. The tables also present the length of time that they have been in a continuous unrealized loss position.

As of March 31, 2020

Less than 12 Months

12 Months or More

Total

    

Estimated

    

Unrealized

    

Estimated

    

Unrealized

    

Estimated

    

Unrealized

Fair Value

Losses

Fair Value

Losses

Fair Value

Losses

U.S. Treasury securities

$

$

$

$

$

$

Obligations of states and political subdivisions

 

656

 

34

 

 

 

656

 

34

Residential mortgage-backed securities

 

20,492

 

99

 

195

 

4

 

20,687

 

103

Commercial mortgage-backed securities

 

22,272

 

165

 

 

 

22,272

 

165

Other asset-backed securities

 

14,840

534

8,202

881

23,042

1,415

Corporate and other securities

 

233,543

 

23,185

 

8,758

 

1,717

 

242,301

 

24,902

Subtotal, fixed maturity securities

 

291,803

 

24,017

 

17,155

 

2,602

 

308,958

 

26,619

Equity securities

 

67,644

 

13,991

 

9,909

 

3,354

 

77,553

 

17,345

Total temporarily impaired securities

$

359,447

$

38,008

$

27,064

$

5,956

$

386,511

$

43,964

As of December 31, 2019

Less than 12 Months

12 Months or More

Total

    

Estimated

    

Unrealized

    

Estimated

    

Unrealized

    

Estimated

    

Unrealized

Fair Value

Losses

Fair Value

Losses

Fair Value

Losses

U.S. Treasury securities

$

$

$

$

$

$

Obligations of states and political subdivisions

 

 

 

 

 

 

Residential mortgage-backed securities

 

61,933

 

409

 

31,655

 

500

 

93,588

 

909

Commercial mortgage-backed securities

 

36,398

 

397

 

866

 

 

37,264

 

397

Other asset-backed securities

 

21,281

64

462

 

21,743

 

64

Corporate and other securities

 

26,386

 

481

 

13,718

 

787

 

40,104

 

1,268

Subtotal, fixed maturity securities

 

145,998

 

1,351

 

46,701

 

1,287

 

192,699

 

2,638

Equity securities

 

8,849

 

391

 

14,143

 

972

 

22,992

 

1,363

Total temporarily impaired securities

$

154,847

$

1,742

$

60,844

$

2,259

$

215,691

$

4,001

Impairments

Beginning January 1, 2020, ASC 326, Credit Losses: Measurement of Credit Losses on Financial Instruments changed the process by which AFS debt securities are evaluated for impairment, requiring as the standard requires a new impairment model based on expected credit losses rather than incurred credit losses. Under the new guidance, an entity recognizes its estimate of expected credit losses through an allowance account.

For fixed maturities that the Company does not intend to sell or for which it is more likely than not that the Company would not be required to sell before an anticipated recovery in value, the Company separates the credit loss component of the impairment from the amount related to all other factors and reports the credit loss component as credit loss expense. The impairment related to all other factors (non-credit factors) is reported in other comprehensive income. The allowance is adjusted for any additional credit losses and subsequent recoveries. Upon recognizing a credit loss, the cost basis is not adjusted.

For fixed maturities where the Company records a credit loss, a determination is made as to the cause of the impairment and whether the Company expects a recovery in the value. For fixed maturities where the Company expects a recovery in value, the constant effective yield method is utilized, and the investment is amortized to par.

14

Table of Contents

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

For fixed maturity investments the Company intends to sell or for which it is more likely than not that the Company will be required to sell before an anticipated recovery in value, the full amount of the impairment is included in credit loss expense. The new cost basis of the investment is the previous amortized cost basis less the impairment recognized in credit loss expense. The new cost basis is not adjusted for any subsequent recoveries in fair value.

The Company uses a systematic methodology to evaluate declines in fair values below cost or amortized cost of our investments. Some of the factors considered in assessing impairment of fixed maturities due to credit losses include the extent to which the fair value is less than amortized cost, the financial condition of and the near and long-term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal payments, changes to the rating of the security by a rating agency, the historical volatility of the fair value of the security and whether it is more like than not that the Company will be required to sell the investment prior to an anticipated recovery in value.

The Company’s analysis of its fixed maturity portfolio at March 31, 2020 concluded that $2,510 of unrealized losses were due to credit factors and were recorded as credit loss expense for the three months ended March 31, 2020. The Company concluded that outside of the securities that were recognized as credit impaired, the unrealized losses recorded on the fixed maturity portfolio at March 31, 2020 resulted from fluctuations in market interest rates and other temporary market conditions as opposed to fundamental changes in the credit quality of the issuers of such securities. Based upon the analysis performed, the Company’s decision to hold these securities, the Company’s current level of liquidity and our history of positive operating cash flows, management believes it is more likely than not that it will not be required to sell any of its securities before the anticipated recovery in the fair value to its amortized cost basis.

During the three months ended March 31, 2019, the company recognized $220 in other-than-temporary impairments under the previous accounting guidance in ASC 320, Investments – Debt and Equity Securities.

The Company holds no subprime mortgage debt securities.  All of the Company’s holdings in mortgage-backed securities are either U.S. Government or Agency guaranteed or are rated investment grade by either Moody’s or Standard & Poor’s.

The following table represents a reconciliation of the beginning and ending balances of the allowance for expected credit losses on fixed maturities classified as available for sale.  

Three Months Ended March 31, 2020

Corporate and other

securities

Balance January 1, 2020

$

Credit losses on securities with no previously recorded credit losses

 

2,510

Net increases (decreases) in allowance on previously impaired securities

 

Reduction due to sales

 

Writeoffs charged against allowance

 

Recoveries of amounts previously written off

 

Balance March 31, 2020

$

2,510

15

Table of Contents

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

Net Investment Income

The components of net investment income were as follows:

Three Months Ended March 31, 

 

    

2020

    

2019

    

Interest on fixed maturity securities

$

9,759

$

11,127

Dividends on equity securities

 

1,206

 

1,082

Equity in earnings of other invested assets

 

516

 

282

Interest on other assets

 

7

 

9

Total investment income 

 

11,488

 

12,500

Investment expenses

 

778

 

749

Net investment income 

$

10,710

$

11,751

Fair Value of Financial Instruments

ASC 820, Fair Value Measurements and Disclosure provides a revised definition of fair value, establishes a framework for measuring fair value and expands financial statement disclosure requirements for fair value information.  Under ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exit price).  ASC 820 establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”).  The fair value hierarchy in ASC 820 prioritizes fair value measurements into three levels based on the nature of the inputs as follows:

Level 1 — Valuations based on quoted prices in active markets for identical assets and liabilities;

Level 2 — Valuations based on observable inputs that do not meet the criteria for Level 1, including quoted prices in inactive markets and quoted prices in active markets for similar, but not identical instruments; and

Level 3 — Valuations based on unobservable inputs.

Fair values for the Company’s fixed maturity securities are based on prices provided by its custodian bank and its investment managers.  Both the Company’s custodian bank and investment managers use a variety of independent, nationally recognized pricing services to determine market valuations.  If the pricing service cannot provide fair value determinations, the Company obtains non-binding price quotes from broker-dealers.  A minimum of two quoted prices is obtained for the majority of the Company’s available-for-sale fixed maturity securities in its investment portfolio.  The Company uses a third-party pricing service as its primary provider of quoted prices from third-party pricing services and broker-dealers.  To provide reasonable assurance of the validity of each price or quote, a secondary third-party pricing service or broker-dealer quote is obtained from the Company’s custodian or investment managers.  An examination of the pricing data is then performed for each security.  If the variance between the primary and secondary price quotes for a security is within an accepted tolerance level, the quoted price obtained from the Company’s primary source is used for the security.  If the variance between the primary and secondary price quotes exceeds an accepted tolerance level, the Company obtains a quote from an alternative source, if possible, and documents and resolves any differences between the pricing sources.  In addition, the Company may request that its investment managers and its traders provide input as to which vendor is providing prices that its traders believe are reflective of fair value for the security.  Following this process, the Company may decide to value the security in its financial statements using the secondary or alternative source if it believes that pricing is more reflective of the security’s value than the primary pricing provided by its custodian bank.  The Company analyzes market valuations received to verify reasonableness, to understand the key assumptions used and their sources, and to determine an appropriate ASC 820 fair value hierarchy level based upon trading activity and the observability of market inputs.  Based on this evaluation and investment class analysis, each price is classified into Level 1, 2 or 3.

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Table of Contents

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

Fair values of instruments are based on (i) quoted prices in active markets for identical assets (Level 1), (ii) quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations in which all significant inputs are observable in active markets (Level 2) or (iii) valuations derived from valuation techniques in which one or more significant inputs are unobservable in the marketplace (Level 3).

The Company’s Level 1 securities consist of equity securities whose values are based on quoted prices in active markets for identical assets.  The Company’s Level 2 securities are comprised of available-for-sale fixed maturity securities whose fair value was determined using observable market inputs.  The Company’s Level 3 security consists of an investment in the Federal Home Loan Bank of Boston related to Safety Insurance Company’s membership stock, which is not redeemable in a short-term time frame.  Fair values for securities for which quoted market prices were unavailable were estimated based upon reference to observable inputs such as benchmark interest rates, market comparables, and other relevant inputs.  Investments valued using these inputs include U.S. Treasury securities, obligations of states and political subdivisions, corporate and other securities, commercial and residential mortgage-backed securities, and other asset-backed securities.  Inputs into the fair value application that are utilized by asset class include but are not limited to:

Obligations of states and political subdivisions:  overall credit quality, including assessments of market sectors and the level and variability of sources of payment such as general obligation, revenue or lease; credit support such as insurance, state or local economic and political base, prefunded and escrowed to maturity covenants.

Corporate and other securities: overall credit quality, the establishment of a risk adjusted credit spread over the applicable risk-free yield curve for discounted cash flow valuations; assessments of the level of industry economic sensitivity, company financial policies, indenture restrictive covenants, and/or security and collateral.

Residential mortgage-backed securities, U.S. agency pass-throughs, collateralized mortgage obligations (“CMOs”), non U.S. agency CMOs:  estimates of prepayment speeds based upon historical prepayment rate trends, underlying collateral interest rates, original weighted average maturity, vintage year, borrower credit quality characteristics, interest rate and yield curve forecasts, U.S. government support programs, tax policies, and delinquency/default trends.

Commercial mortgage-backed securities:  overall credit quality, including assessments of the level and variability of credit support and collateral type such as office, retail, or lodging, predictability of cash flows for the deal structure, prevailing economic market conditions.

Other asset-backed securities:  overall credit quality, estimates of prepayment speeds based upon historical trends and characteristics of underlying loans, including assessments of the level and variability of collateral, revenue generating agreements, area licenses agreements, product sourcing agreements and equipment and property leases.

Federal Home Loan Bank of Boston (“FHLB-Boston”): value is equal to the cost of the member stock purchased.

In order to ensure the fair value determination is representative of an exit price (consistent with ASC 820), the Company’s procedures for validating quotes or prices obtained from third parties include, but are not limited to, obtaining a minimum of two price quotes for each fixed maturity security if possible, as discussed above, the periodic testing of sales activity to determine if there are any significant differences between the market price used to value the security as of the balance sheet date and the sales price of the security for sales that occurred around the balance sheet date, and the periodic review of reports provided by its external investment manager regarding those securities with

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Table of Contents

Safety Insurance Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands except per share and share data)

ratings changes and securities placed on its “Watch List.” In addition, valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by the Company’s external investment manager, whose investment professionals are familiar with the securities being priced and the markets in which they trade, to ensure the fair value determination is representative of an exit price (consistent with ASC 820).

All unadjusted estimates of fair value for our fixed maturities priced by the pricing services as described above are included in the amounts disclosed in Level 2. With the exception of the FHLB-Boston security, which is categorized as a Level 3 security, the Company’s entire portfolio was priced based upon quoted market prices or other observable inputs as of March 31, 2020. There were no significant changes to the valuation process during the three months ended March 31, 2020. As of March 31, 2020 and December 31, 2019, no quotes or prices obtained were adjusted by management. All broker quotes obtained were non-binding.

At March 31, 2020 and December 31, 2019, investments in fixed maturities classified as available-for-sale had a fair value which equaled carrying value $1,165,455 and $1,228,040, respectively. We have no short-term investments. The carrying values of cash and cash equivalents and investment income accrued approximated fair value.

The following tables summarize the Company’s total fair value measurements for investments for the periods indicated.

As of March 31, 2020

    

Total

    

Level 1 Inputs

    

Level 2 Inputs

    

Level 3 Inputs

U.S. Treasury securities

$

1,883

$

$

1,883

$

Obligations of states and political subdivisions

 

233,690

 

 

233,690

 

Residential mortgage-backed securities

 

301,017

 

 

301,017

 

Commercial mortgage-backed securities

 

109,066

 

 

109,066

 

Other asset-backed securities

 

25,307

 

 

25,307

 

Corporate and other securities

 

494,492

 

 

494,492

 

Equity securities

 

117,082

 

115,396