Description

Safety Insurance (SAFT) is a high-quality auto insurance company that has specialized in writing business in the state of Massachusetts, where it has compiled a 31-year record of unbroken profitability and excellent historical book value per share growth.  Over time, SAFT has grown to become the second largest auto insurer in the state, with approximately 11% market share.  

Over the last decade, the company has managed to increase its book value per share from $16.07 at year end 2002 to just over $45 as of Q3 2012, despite paying out over $12 per share in dividends along the way.  The stock was recently trading at around $47.40, which is a tiny premium to book value.  SAFT has shown a strong commitment to returning capital to shareholders in the form of dividends, and has also repurchased shares opportunistically at times. The current indicated dividend is $2.40 annually, such that the dividend yield is approximately 5.1%.

The stock is cheap for a couple of reasons.  SAFT is a small cap stock and the daily trade volume is only about 30,000 shares, so institutional investors can’t buy it.  Also, 2011 was one of the worst years for insurance losses globally, with catastrophe losses costing a staggering $150 billion. While SAFT’s little niche of writing car insurance in Massachusetts normally protects the company from the major industry risks, such as Florida wind, Japan and California quake, and European snow, the company did get hit in 2011. SAFT’s combined ratio of 107.9% in 2011 was the highest in the last decade as SAFT recorded $62.7 million in catastrophe losses in 2011 versus $9.4 million in 2010 and $3 million in 2009. However, the company did maintain its string of being profitable in every year since its inception. The silver lining in the insurance businesses is that when there are losses there are usually rate increases, and SAFT has increased its rates across it various policy types in both 2011 and 2012.

Safety enjoyed an excellent 2012 during the first nine months, despite the continuing difficulties on the investment side posed by the Fed’s ZIRP (zero interest rate policy) stance.  Direct written premiums increased by 7.1% in Q3 to $179 million, and for the nine months increased by 7.3%.  Net written premiums increased by 8.5% to $171.7 million for Q3 and by 7.1% to $518 million for the nine months.  Net earned premiums increased 7.4% to $162.5 million in Q3 and by 7.3% to $477.1 million for the nine months.  Net investment income was $10.1 million in Q3 and $30.5 million in the nine months, which is basically flat with last year despite higher investment balances.  This is due to a lower annualized yield on the portfolio (3.6%) and a slightly lower duration (3.6 years).  As expected, losses and loss adjustment expenses declined dramatically year-over-year versus 2011, which was a record loss year for SAFT.  For the first nine months of 2012 the loss ratio was reported at 64.4%, the expense ratio was 30.7%, and the combined ratio was 95.1%.  This compares to last year’s 78.1% loss ratio, 29.7% expense ratio, and 107.8% combined ratio through the first nine months of 2011. For the nine month period, SAFT reported net income of $48.5 million, or $3.17 per share. This is a huge improvement over last year’s reported EPS of 58 cents in Q3 and 59 cents for the first nine months.  My guess is that SAFT will earn somewhere around $4 per share in 2012 depending on the effects of Hurricane Sandy.

Of course, in early Q4 Sandy hit the East Coast and was the second worst loss event in U.S. history, but it appears that Massachusetts did not suffer the same level of insured losses that New York and New Jersey did.  For what it’s worth, SAFT’s disclosure related to Sandy in the Q3 SEC filing stated that “we are currently assessing the impact of Hurricane Sandy on our business but do not believe at this time that it will have a material impact on our consolidated financial position.”   Most insurance companies with significant exposure to Sandy have issued press releases with preliminary loss estimates, so I would be surprised to see a significant hit here.

Reported BVPS increased to $45.46 per share as of September 30, 2012 from $43.22 at December 31, 2011, which of course does not include the hefty dividend.  I expect that year-end BVPS might be something like $46.50.  It seems to me that such a consistently profitable, well managed auto insurance company should trade at something closer to 1.2X book value, and I expect the company will trade for that if it produces its normal strong underwriting profits in 2013.  In a base case scenario, assuming BVPS was in the range of $50 by year-end 2013, the stock would trade at $55 at 1.1X book and $60 at 1.2X book.  In the meantime, investors would pick up $2.40 per share in annual dividends, implying a 21% total return even at the low end of that scenario. In this environment where bargains are relatively scarce and investors are reaching for yield, SAFT looks like a pretty decent place to be.

Catalyst

• Continued book value per share growth, improved 2013 profitability, and potential dividend increase in 2013