Safety Insurance Group (NASDAQ:SAFT) reported that winter weather activity and an accounting change were drags on its first-quarter results, though a lower tax rate was a net positive to the Massachusetts-based insurance company. 

Here's what shareholders should know now.

Safety Insurance Group's Q1: By the numbers

Metric

Q1 2018

Q1 2017

Year-Over-Year Change

Combined ratio

103.4%

99.2%

4.2 ppt

Net income

$9.1 million

$12 million

(24%)

Diluted EPS

$0.60

$0.79

(24%)

Book value per share

$44.85

$44.54

(1%)

Data source: Safety Insurance Group.

What happened this quarter

Here are some things shareholders should know about Safety's first quarter.

  • Earnings need some adjustments: In prior periods, Safety's unrealized gains or losses on its investment portfolio didn't flow through to its net income line. Now they do, thanks to an accounting change that affects financial companies of all types, from insurers to banks. Backing out gains and losses on its investment portfolio, Safety earned $0.71 per share, down slightly from $0.72 per share it earned on the same non-GAAP basis in the year-ago period.
  • Lower taxes helped: Safety's effective tax rate declined to 18.5% from 27.8% in the year-ago period, due to the Tax Cuts and Jobs Act. The company's tax rate is lower than the new statutory corporate tax rate (21%) because some of its investment income is derived from tax-exempt securities.
  • Losses increased: Safety reported a loss ratio of 71.7% this quarter, up from 67.7% in the year-ago period. The company said in its quarterly filing that "winter weather-related activity" was to blame for a higher loss ratio. The combined ratio, which measures losses and operating costs as a percentage of earned premiums, jumped to 103.4%, up from 99.2% in the first quarter of 2017. (A lower combined ratio is better.)
  • Benefiting from conservatism: Safety said its first-quarter results included $14.2 million of prior-year favorable development, which occurs when an insurer reduces its loss assumptions for contracts underwritten in earlier periods. A long record of reporting prior-year favorable development suggest that Safety Insurance Group makes very conservative estimates about losses, which is exactly what you want to see in an insurance company. It's better to have surprises to the upside than to the downside, to be sure.

What you should know about Safety Insurance

Safety Insurance Group doesn't host conference calls, and only infrequently updates qualitative information about its business in quarterly and annual filings. As the company moves through a new year, it's a good time to review how Safety Insurance makes its money and where it competes for business.

Car cutout attached to a roll of $100 bills.

Image source: Getty Images.

Safety Insurance Group is primarily an auto insurance company, as it generates more than 70% of its direct written premium volume from personal and commercial auto insurance policies. Homeowners policies make up the vast majority of the balance, though it also has small exposures to dwelling fire, umbrella, and business owner policies, which are included as "other" insurance in the chart below.

Bar chart showing Safety's premiums by insurance line.

Data from Safety Insurance Group's 10-Q. Figures are from 2017. Chart by author.

Though the company competes in New Hampshire and Maine (markets it entered in 2008 and 2016, respectively), it derives a very small percentage of its premiums from these two states. It's most dominant in Massachusetts, where it generates more than 97% of its premiums from independent agents.

Insurance Line

Rank in Massachusetts

Market Share in 2017

Commercial auto

No. 2

15.6%

Personal auto

No. 4

9.3%

Homeowners

No. 3

7.3%

Data source: Quarterly report.

The "legacy" business in Massachusetts remains its bread-and-butter business. Founded in 1979, its Massachusetts business has a multidecade head start on its operations in New Hampshire and Maine. The company generates virtually all of its business from relationships with 892 independent agents located in the three states in which it operates.

Looking ahead

Safety Insurance Group has proven conservative in managing its risks and adequately pricing its policies, though it shows in tepid premium growth. Direct written premiums increased by only 2% in the first quarter compared to the year-ago period. Since 2013, direct written premiums have grown at a compounded rate of less than 2% per year.

Like any property and casualty insurer, Safety Insurance should benefit from rising interest rates over time. The company noted that its investment portfolio now yields about 3.3%, up from 2.9% last year. Given its investments have duration of less than four years, it is most exposed to interest rates on the short end of the curve.

In other words, Safety shareholders should root for more rate increases by the Federal Reserve, as rate increases will quickly pay dividends in the form of higher interest income on its $622 million bond portfolio. 

Jordan Wathen has no position in any of the stocks mentioned. The Motley Fool recommends Safety Insurance Group. The Motley Fool has a disclosure policy.