| SAFETY INSURANCE GROUP INC ITEM 1A RISK FACTORS An investment in our common stock involves a number of risks |
| Any of the risks described below could result in a significant or material adverse effect on our results of operations or financial condition, and a corresponding decline in the market price of our common stock |
| Because we are primarily a private passenger automobile insurance carrier, our business may be adversely affected by conditions in this industry |
| Approximately 80dtta3prca of our direct written premiums for the year ended December 31, 2005 were generated from private passenger automobile insurance policies |
| As a result of our focus on that line of business, negative developments in the economic, competitive or regulatory conditions affecting the private passenger automobile insurance industry could have a material adverse effect on our results of operations and financial condition |
| In addition, these developments would have a disproportionate effect on us, compared to insurers which conduct operations in multiple business lines |
| Because we write insurance only in Massachusetts, our business may be adversely affected by conditions in Massachusetts |
| All of our direct written premiums are generated in Massachusetts |
| Our revenues and profitability are therefore subject to prevailing regulatory, economic, demographic, competitive and other conditions in Massachusetts |
| Changes in any of these conditions could make it more costly or difficult for us to conduct our business |
| Adverse regulatory developments in Massachusetts, which could include, among others, reductions in the maximum rates permitted to be charged, inadequate rate increases or more fundamental changes in the design or implementation of the Massachusetts automobile insurance regulatory framework, could have a material adverse effect on our results of operations and financial condition |
| In addition, these developments would have a disproportionate effect on us, compared to insurers which conduct operations in multiple states |
| We have exposure to claims related to severe weather conditions, which may result in an increase in claims frequency and severity |
| We are subject to claims arising out of severe weather conditions, such as rainstorms, snowstorms and ice storms, that may have a significant effect on our results of operations and financial condition |
| The incidence and severity of weather conditions are inherently unpredictable |
| There is generally an increase in claims frequency and severity under the private passenger automobile insurance we write when severe weather occurs because a higher incidence of vehicular accidents and other insured losses tend to occur as a result of severe weather conditions |
| In addition, we have exposure to an increase in claims frequency and 25 ______________________________________________________________________ severity under the homeowners and other property insurance we write because property damage may result from severe weather conditions |
| Because some of our insureds live near the Massachusetts coastline, we also have a potential exposure to losses from hurricanes and major coastal storms such as Nor’easters |
| Although we purchase catastrophe reinsurance to limit our exposure to these types of natural catastrophes, in the event of a major catastrophe resulting in property losses to us in excess of dlra250dtta0 million, our losses would exceed the limits of this reinsurance |
| If we are not able to attract and retain independent agents, it could adversely affect our business |
| We market our insurance solely through independent agents |
| We must compete with other insurance carriers for the business of independent agents |
| Some of our competitors offer a larger variety of products, lower prices for insurance coverage or higher commissions |
| While we believe that the commissions and services we provide to our agents are competitive with other insurers, changes in commissions, services or products offered by our competitors could make it harder for us to attract and retain independent agents to sell our insurance products |
| Established competitors with greater resources may make it difficult for us to market our products effectively and offer our products at a profit |
| The property and casualty insurance business is highly competitive and many of our competitors have substantially greater financial and other resources than us |
| We compete with both large national writers and smaller regional companies |
| Further, our competitors include other companies which, like us, serve the independent agency market, as well as companies which sell insurance directly to customers |
| Direct writers may have certain competitive advantages over agency writers, including increased name recognition, loyalty of the customer base to the insurer rather than to an independent agency and, potentially, lower cost structures |
| A material reduction in the amount of business independent agents sell would directly and negatively affect our profitability and our ability to compete with insurers that do not rely solely on the independent agency market to sell their products |
| In the past, competition in the Massachusetts personal auto insurance market has included offering significant discounts from the maximum permitted rates, and there can be no assurance that these conditions will not recur |
| Further, our Company and others compete on the basis of the commissions and other cash and non-cash incentives provided to agents |
| Although a number of national insurers that are much larger than we are do not currently compete in a material way in the Massachusetts personal auto market, if one or more of these companies decided to aggressively enter the market it could reduce our share of the Massachusetts market and thereby have a material adverse effect on us |
| These companies include some that would be able to sustain significant losses in order to acquire market share, as well as others which use distribution methods that compete with the independent agent channel |
| As a holding company, Safety Insurance Group, Inc |
| is dependent on the results of operations of the Safety Insurance Company |
| Safety Insurance Group, Inc |
| is a company and a legal entity separate and distinct from Safety Insurance Company, our principal operating subsidiary |
| As a holding company without significant operations of its own, the principal sources of Safety Insurance Group, Inc |
| ’s funds are dividends and other distributions from Safety Insurance Company |
| Our rights to participate in any distribution of assets of Safety Insurance Company are subject to prior claims of policyholders, creditors and preferred stockholders, if any, of Safety Insurance Company (except to the extent that our rights, if any, as a creditor are recognized) |
| Consequently, our ability to pay debts, expenses and cash dividends to our stockholders may be limited |
| The ability of Safety Insurance Company to pay dividends is subject to limits under Massachusetts insurance law |
| to pay dividends, and our 26 ______________________________________________________________________ subsidiaries’ ability to incur indebtedness or to use the proceeds of equity offerings, will be subject to limits under our revolving credit facility |
| We are subject to comprehensive regulation by Massachusetts and our ability to earn profits may be restricted by these regulations |
| General Regulation |
| We are subject to regulation by government agencies in Massachusetts, and we must obtain prior approval for certain corporate actions |
| We must comply with regulations involving: · transactions between an insurance company and any of its affiliates; · the payment of dividends; · the acquisition of an insurance company or of any company controlling an insurance company; · approval or filing of premium rates and policy forms; · solvency standards; · minimum amounts of capital and surplus which must be maintained; · limitations on types and amounts of investments; · restrictions on the size of risks which may be insured by a single company; · limitation of the right to cancel or non-renew policies in some lines; · regulation of the right to withdraw from markets or terminate involvement with agencies; · requirements to participate in residual markets; · licensing of insurers and agents; · deposits of securities for the benefit of policyholders; and · reporting with respect to financial condition |
| In addition, insurance department examiners from Massachusetts perform periodic financial and market conduct examinations of insurance companies |
| Such regulation is generally intended for the protection of policyholders rather than security holders |
| Massachusetts requires that all licensed property and casualty insurers bear a portion of the losses suffered by some insureds as a result of impaired or insolvent insurance companies by participating in the Massachusetts Insurers Insolvency Fund (“Insolvency Fund”) |
| Members of the Insolvency Fund are assessed a proportionate share of the obligations and expenses of the Insolvency Fund in connection with an insolvent insurer |
| In 2005, the Company received a refund of prior years’ assessments from the Insolvency Fund of dlra50 |
| In 2004 and 2003, the Company received notice of assessments from the Insolvency Fund amounting to dlra2cmam538 and dlra3cmam423 |
| These assessments were made by the Insolvency Fund to cover the cost of paying eligible claims of policyholders of these insolvent insurers, and by CAR, to recover the shares of net CAR losses that would have been assessed to the insolvent companies but for their insolvencies |
| In addition, Massachusetts has established an underwriting association in order to ensure that property insurance is available for owners of high risk property who are not able to obtain insurance from private insurers |
| The losses of this underwriting association are shared by all insurers that write property and casualty insurance in Massachusetts |
| We are assessed from time to time to pay these losses |
| The effect of these assessments could reduce our profitability in any given period and limit our ability to grow our business |
| Because we are unable to predict with certainty changes in the political, economic or regulatory environments in Massachusetts in the future, there can be no assurance that existing insurance-related laws 27 ______________________________________________________________________ and regulations will not become more restrictive in the future or that new restrictive laws will not be enacted and, therefore, it is not possible to predict the potential effects of these laws and regulations on us |
| Massachusetts Personal Auto Regulation |
| We are subject to the extensive regulation of the private passenger automobile insurance industry in Massachusetts |
| Generally, we are required by law to issue a policy to any applicant who seeks it |
| We are assigned certain agents that have been unable to obtain a voluntary contract with another insurer, on the basis of our market share |
| In addition, we are required to participate in a state mandated reinsurance program run by CAR, to which we cede certain undesirable risks and from which we are allocated a portion of the program’s overall losses |
| This program operates at an underwriting deficit and results in expense for us |
| Our ability to earn profits may be restricted by these requirements |
| Our marketing and underwriting strategies are limited by maximum premium rates and minimum agency commission levels for personal automobile insurance, which are mandated by the Commissioner |
| The Commissioner mandated an average rate decrease in private passenger automobile premiums of 1dtta7prca for 2005 |
| The Commissioner mandated average rate increases of 2dtta5prca and 2dtta7prca for 2004 and 2003, respectively, and no rate change for 2002 |
| The Commissioner announced on December 15, 2005, a 8dtta7prca statewide average rate decrease for 2006 |
| In addition, the Commissioner annually establishes the minimum commission rate that insurers must pay their auto insurance agents |
| The Commissioner approved a commission rate, as a percentage of premiums of 10dtta9prca, 10dtta5prca, 11dtta0prca, and 11dtta7prca in 2005, 2004, 2003, and 2002, respectively |
| The Commissioner approved a commission rate of 11dtta8prca for 2006 |
| Premium rates are set following a proceeding in which the Commissioner considers historic information relating to claims costs as well as outside factors affecting insurance costs |
| If the information considered does not accurately predict the future benefit and expense costs of insurers, or if the Commissioner otherwise sets inadequate premium rates, our future profitability could be decreased |
| Future increases in commission rates would also decrease our profitability |
| We may enter new markets and there can be no assurance that our diversification strategy will be effective |
| Although we intend to concentrate on our core businesses in Massachusetts, we also may seek to take advantage of prudent opportunities to expand our core businesses into other states where we believe the independent agent distribution channel is strong |
| As a result of a number of factors, including the difficulties of finding appropriate expansion opportunities and the challenges of operating in an unfamiliar market, we may not be successful in this diversification |
| Additionally, in order to carry out any such strategy we would need to obtain the appropriate licenses from the insurance regulatory authority of any such state |
| Today, we do not possess any licenses outside of Massachusetts and we could encounter unexpected regulatory obstacles that prevent us from obtaining these licenses in a timely fashion, or at all |
| Our failure to maintain a commercially acceptable financial strength rating would significantly and negatively affect our ability to implement our business strategy successfully |
| AM Best has currently assigned Safety Insurance an ‘‘A (Excellent)’’ rating |
| An ‘‘A’’ rating is AMBest’s third highest rating, out of 13 possible rating classifications for solvent companies |
| An ‘‘A’’ rating is assigned to insurers that in AM Best’s opinion have a strong ability to meet their ongoing obligations to policyholders |
| Moreover, an ‘‘A’’ rating is assigned to companies that have, on balance, excellent balance sheet strength, operating performance and business profile when compared to the standards established by AM Best |
| AM Best bases its ratings on factors that concern policyholders and not upon factors concerning investor protection |
| Such ratings are subject to change and are not recommendations to buy, sell or hold securities |
| An important factor in an insurer’s ability to compete effectively is its AM Best rating |
| Our AM Best rating is lower than those of some of our competitors |
| Any future decrease in our rating could affect our competitive position |
| 28 ______________________________________________________________________ Our losses and loss adjustment expenses may exceed our reserves, which could significantly affect our business |
| The reserves for losses and loss adjustment expenses that we have established are estimates of amounts needed to pay reported and unreported claims and related expenses based on facts and circumstances known to us as of the time we established the reserves |
| Reserves are based on historical claims information, industry statistics and other factors |
| The establishment of appropriate reserves is an inherently uncertain process |
| If our reserves are inadequate and are strengthened, we would have to treat the amount of such increase as a charge to our earnings in the period that the deficiency is recognized |
| As a result of these factors, there can be no assurance that our ultimate liability will not materially exceed our reserves and have a negative effect on our results of operations and financial condition |
| Due to the inherent uncertainty of estimating reserves, it has been necessary, and may over time continue to be necessary, to revise estimated future liabilities as reflected in our reserves for claims and policy expenses |
| The historic development of reserves for losses and loss adjustment expenses may not necessarily reflect future trends in the development of these amounts |
| Accordingly, it is not appropriate to extrapolate redundancies or deficiencies based on historical information |
| If we lose key personnel, our ability to implement our business strategy could be delayed or hindered |
| Our future success depends significantly upon the efforts of certain key management personnel, including David F Brussard, our Chief Executive Officer and President |
| We have entered into employment agreements with Messrs |
| The loss of key personnel could prevent us from fully implementing our business strategy and could significantly and negatively affect our financial condition and results of operations |
| As we continue to grow, we will need to recruit and retain additional qualified management personnel, and our ability to do so will depend upon a number of factors, such as our results of operations and prospects and the level of competition then prevailing in the market for qualified personnel |
| Market fluctuations and changes in interest rates can have significant and negative effects on our investment portfolio |
| Our results of operations depend in part on the performance of our invested assets |
| As of December 31, 2005, 99dtta7prca of our investment portfolio was invested in fixed maturity securities and 0dtta3prca in common equity securities |
| Certain risks are inherent in connection with debt securities including loss upon default and price volatility in reaction to changes in interest rates and general market factors |
| We may not be able to successfully alleviate risk through reinsurance arrangements which could cause us to reduce our premiums written in certain lines or could result in losses |
| In order to reduce risk and to increase our underwriting capacity, we purchase reinsurance |
| The availability and the cost of reinsurance protection is subject to market conditions, which are outside of our control |
| As a result, we may not be able to successfully alleviate risk through these arrangements |
| For example, if reinsurance capacity for homeowners risks were reduced as a result of terrorist attacks or other causes, we would seek to reduce the amount of homeowners business we write |
| In addition, we are subject to credit risk with respect to our reinsurance because the ceding of risk to reinsurers does not relieve us of our liability to our policyholders |
| A significant reinsurer’s insolvency or inability to make payments under the terms of a reinsurance treaty could have a material adverse effect on our results of operations and financial condition |
| 29 ______________________________________________________________________ There are anti-takeover provisions contained in our organizational documents and in laws of the State of Delaware and the Commonwealth of Massachusetts that could impede an attempt to replace or remove our management or prevent the sale of our company, which could diminish the value of our common stock |
| Our certificate of incorporation, bylaws and the laws of Delaware contain provisions that may delay, deter or prevent a takeover attempt that stockholders might consider in their best interests |
| For example, our organizational documents provide for a classified board of directors with staggered terms, prevent stockholders from taking action by written consent, prevent stockholders from calling a special meeting of stockholders, provide for supermajority voting requirements to amend our certificate of incorporation and certain provisions of our bylaws and provide for the filling of vacancies on our board of directors by the vote of a majority of the directors then in office |
| These provisions will render the removal of the incumbent board of directors or management more difficult |
| In addition, these provisions may prevent stockholders from receiving the benefit of any premium over the market price of our common stock offered by a bidder in a potential takeover |
| Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging takeover attempts in the future |
| The Massachusetts insurance law prohibits any person from acquiring control of us, and thus indirect control of Safety Insurance, without the prior approval of the Commissioner |
| That law presumes that control exists where any person, directly or indirectly, owns, controls, holds the power to vote or holds proxies representing 10prca or more of our outstanding voting stock |
| Even persons who do not acquire beneficial ownership of more than 10prca of the outstanding shares of our common stock may be deemed to have acquired such control if the Commissioner determines that such control exists in fact |
| Therefore, any person seeking to acquire a controlling interest in us would face regulatory obstacles which could delay, deter or prevent an acquisition that stockholders might consider in their best interests |
| Section 203 of the General Corporation Law of Delaware, the jurisdiction in which Safety Group is organized, may affect the ability of an “interested stockholder” to engage in certain business combinations including mergers, consolidations or acquisitions of additional shares, for a period of three years following the time that the stockholder becomes an interested stockholder |
| An interested stockholder is defined to include persons owning directly or indirectly 15prca or more of the outstanding voting stock of the corporation |
| Future sales of shares of our common stock by our existing stockholders in the public market, or the possibility or perception of such future sales, could adversely affect the market price of our stock |
| Investors currently known to be the beneficial owners of greater than 5dtta0prca of our outstanding common stock, hold approximately 30prca of the common stock of Safety Insurance Group, Inc |
| on a fully diluted basis |
| No prediction can be made as to the effect, if any, that future sales of shares by our existing stockholders, or the availability of shares for future sale, will have on the prevailing market price of our common stock from time to time |
| Sales of substantial amounts of our common stock in the public market by our existing stockholders, or the possibility or perception that such sales could occur, could cause the prevailing market prices for our common stock to decrease |
| If such sales reduce the market price of our common stock, our ability to raise additional capital in the equity markets may be adversely affected |