Safety Insurance Group: Lower Losses Drive Earnings Growth

The second quarter is usually one of Safety Insurance Group's (SAFT 3.94%) best, as warming weather means lower insurance losses for this Massachusetts-based property and casualty insurance company. But this year, this seasonally strong period was especially good, helping Safety earn $26.8 million, a 27% improvement over the year-ago period.

Here's what shareholders of this sleepy insurance company should know now:

Safety Insurance Group's second quarter: By the Numbers

Data source: Safety Insurance Group. PPT = percentage points.

On virtually every metric, the second quarter was a good one for Safety Insurance, as its combined ratio, net income, and diluted earnings per share all moved in the right direction. 

Image source: Getty Images.

What happened this quarter

Insurance companies are fickle things, certainly a little more difficult to analyze than your average services company. Here are the moving pieces and important things you should know about Safety's second quarter:

• Earnings comparisons require an asterisk. Thanks to an accounting change this year, unrealized gains on an insurer's investment portfolio now flow through net income. In the past, only realized gains were counted in net income. Backing out gains and losses on its investment portfolio, Safety earned $1.81 per diluted share in the second quarter, compared to $1.37 per diluted share in the year-ago period, a 32% improvement year over year, largely driven by lower insurance losses and lower taxes on profits.
• Lower taxes helped the bottom line. A lower corporate tax rate is a boon to purely American companies, Safety included. Note that its effective tax rate declined to about 19.1% this quarter, compared to 30.1% in the year-ago period. 
• Insurance losses dropped meaningfully. Safety Insurance Group reported a combined ratio of just 90%, an improvement over its combined ratio of 92.3% in the year-ago period. Lower insurance losses did the heavy lifting here, as insurance losses and related expenses consumed just 58.3% of premiums earned this quarter, versus 60.7% of premiums earned in the year-ago period. For perspective, I should point out that this is the lowest its loss and combined ratios have been, looking back at any quarter in the last five years.
• Conservatism paid dividends. Safety Insurance said its pre-tax underwriting results included $12.1 million of prior-year favorable development, which occurs when an insurer reduces the loss estimates it made in earlier accounting periods. Safety routinely shows prior-year favorable development, evidence of its conservative underwriting culture. (A poorly managed insurer would report prior-year adverse development, which occurs when insurers are too optimistic about how much they'll lose to insurance losses.)

Looking ahead

The second quarter is always a good one for Safety Insurance, as warmer weather means fewer opportunities for car and homeowners insurance claims. In the last five years, it has recorded an underwriting loss only once in the second quarter -- in 2015, when large winter losses spilled into its second-quarter results. 

Safety Insurance Group's underwriting record is undeniably excellent, the result of a conservative approach to underwriting and a sticky customer base. But that positive attribute comes at a cost: Safety Insurance is a slow-growing insurance company. In the most recent quarter, net premiums grew by less than 1%, despite larger rate increases in many of its core insurance lines year over year.

Shareholders would prefer higher premium growth, but in the near term, investors can now look forward to the third quarter, which has historically been a good one due to the same weather-related seasonality that buoyed earnings this quarter.