Safety Insurance Group

Auto insurers can be great businesses to own, as evidenced by the fortune Buffett made buying and holding GEICO. Here's a look at the unique story of Safety Insurance Group (SAFT).
Safety has about 11% share of the Massachusetts automobile insurance market. It has been profitable every year since inception in 1979, with high returns on equity and strong combined ratios in recent years. The company pays a healthy dividend, now yielding 3%. Senior management also owned 7% of the stock at year end '06.

Despite a history of market leadership and profitability, SAFT shares are trading at 5.1 times trailing earnings, 1.05 times book value, and about 41% below their 52 week high. These numbers make the stock suspiciously cheap.

I need to do some more research before I can state with confidence why the valuation is so low, but my guess is that the unusually onerous regulatory environment in Massachusetts is to blame. Safety can neither choose the risks it takes nor how to price those risks.

Some of the regulations Massachusetts has in place include a "take all comers" policy which prohibits insures from denying coverage based on an applicant's driving record or other underwriting criteria.

You might think that insurers would be allowed offset the "take all comers" risk through shrewd product pricing, but that's not the case. The State Commissioner of Insurance sets the premiums which insurance companies are obligated to use. Effective April of this year, rates will be decreased 11.7%. This follows a decrease of 8.7% in 2006 and a decrease of 1.7% in 2005. That's right--decrease.

Not surprisingly, lowered premiums have put profits under pressure. Net income for 4th quarter 2006 and 1st quarter 2007 were below the comparable prior year quarters. That said, Safety still managed to increase book value by over 25% in 2006 and maintain profitability and market leadership.

It seems the company does a decent job of navigating some tough waters--waters few others choose to swim. Safety's 10K reports, "Many large national private passenger automobile insurance writers, such as State Farm, Allstate, Progressive, Berkshire Hathaway [GEICO], and Farmers, write very little or no private passenger automobile insurance business in Massachusetts." I suppose one can debate whether this is a pro (entrenched leadership, less competition) or con (indication of market's unattractiveness) for Safety's stock.

My goal here is to highlight an interesting story and not to make a stock recommendation. I'm undecided myself. Whether or not five times earnings and a hair over book value make it worthwhile to own a Massachusetts auto insurer is a tough call. If you have any comments that can help flesh out the SAFT story, please post.