SECURITIES AND EXCHANGE COMMISSION ---------- WASHINGTON D.C. 20549 -------------------------------------------------------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998 ---------- Commission File Number 333-42749 AMERICAN SAFETY INSURANCE GROUP, LTD. (Exact name of Registrant as specified in its charter) Bermuda Not Applicable (State or other jurisdiction (I.R.S. Employer of incorporation) Identification No.) 44 Church Street P.O. Box 2064 Hamilton HM HX, Bermuda (Address, zip code of principal executive offices) (441) 296-8560 (Registrant's telephone number, including area code) Indicate by check mark whether Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No The aggregate number of shares outstanding of Registrant's common stock, $.01 par value, on November 13, 1998 was 6,074,770. ---------- AMERICAN SAFETY INSURANCE GROUP, LTD. FORM 10-Q TABLE OF CONTENTS Page PART I - FINANCIAL INFORMATION Item 1. Financial Statements................................................................ 3 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................................. 9 Item 3. Quantitative and Qualitative Disclosures About Market Risks......................... 14 PART II - OTHER INFORMATION Item 1. Legal Proceedings................................................................... 15 Item 2. Changes in Securities and Use of Proceeds........................................... 15 Item 3. Defaults Upon Senior Securities..................................................... 15 Item 4. Submission of Matters to a Vote of Security Holders................................. 15 Item 5. Other Information................................................................... 15 Item 6. Exhibits and Reports on Form 8-K.................................................... 15 PART I- FINANCIAL INFORMATION ITEM 1. Financial Statements American Safety Insurance Group, Ltd. and Subsidiaries Consolidated Balance Sheets December 31, September 30, Assets 1997 1998 ------ ---- ---- (unaudited) Investments: Securities available for sale, at fair value: Fixed maturities............................................................ $26,462,275 $47,468,356 Equity investments.......................................................... 1,054,549 3,995,367 Short-term investments.......................................................... 1,823,830 1,037,049 --------- --------- Total investments........................................................ 29,340,654 52,500,772 Cash ................................................................... 2,768,831 6,234,933 Accrued investment and interest income............................................... 781,798 2,196,895 Notes receivable: Related parties................................................................. 580,000 580,000 Other ................................................................... 4,697,804 13,723,188 Premiums receivable.................................................................. 6,809,436 6,390,636 Commissions receivable............................................................... 18,630 40,598 Ceded unearned premium............................................................... 649,175 1,222,833 Reinsurance recoverable.............................................................. 778,975 1,000,627 Due from affiliate................................................................... 288,951 228,371 Income tax recoverable............................................................... 152,802 205,189 Deferred income taxes................................................................ 209,795 205,533 Goodwill ................................................................... 270,010 256,681 Other assets ................................................................... 321,339 864,701 ------- ------- Total assets............................................................. $47,668,200 $85,650,957 =========== =========== Liabilities and Shareholders' Equity Liabilities: Unpaid losses and loss adjustment expenses...................................... $11,571,539 $12,677,533 Unearned premiums............................................................... 2,331,579 4,438,636 Liability for deductible fees held.............................................. 3,539,032 2,852,353 Reinsurance on paid loss and loss adjustment expenses........................... 256,085 779,373 Reinsurance deposits on retroactive contract........................... ........ 537,500 373,444 Ceded premiums payable.......................................................... 5,990,907 3,385,783 Due to affiliate: Ceded premiums payable...................................................... 217,062 595,649 Reinsurance on paid loss and loss adjustment expenses....................... 41,085 328,072 Accounts payable and accrued expenses........................................... 1,342,515 2,223,008 --------- --------- Total liabilities........................................................ 25,827,304 27,653,851 ========== ========== Shareholders' equity: Preferred stock, $0.01 par value; authorized 5,000,000 shares; no shares issued and outstanding Common stock, $0.01 par value; authorized 15,000,000 shares; issued and outstanding at December 31, 1997, 2,925,230 shares and at September 30, 1998, 6,074,770 shares.......................................................... 29,252 60,747 Additional paid-in capital...................................................... 2,751,789 33,814,677 Retained earnings............................................................... 18,751,222 22,954,963 Other comprehensive income...................................................... 308,633 1,166,719 Total shareholders' equity............................................... 21,840,896 57,997,106 ---------- ---------- Total liabilities and shareholders' equity...................................... $47,668,200 $85,650,957 =========== =========== See accompanying notes to consolidated financial statements (unaudited). 3 American Safety Insurance Group, Ltd. and Subsidiaries Consolidated Statements of Earnings (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, 1997 1998 1997 1998 Revenues: Direct premiums earned...................................$1,280,313 $1,051,603 $2,419,322 $3,086,805 Assumed premiums earned: Affiliate............................................ 517,367 1,015,857 1,773,776 2,429,850 Nonaffiliates........................................1,915,436 895,562 3,830,017 3,936,552 --------- -------- --------- --------- Total assumed premiums earned...................2,432,803 1,911,419 5,603,793 6,366,402 --------- --------- ---------- --------- Ceded premiums earned: Affiliate............................................ 333,647 677,600 870,369 2,111,717 Nonaffiliates........................................ 397,069 485,547 646,840 1,264,067 ------- ------- ------- --------- Total ceded premiums earned..................... 730,716 1,163,147 1,517,209 3,375,784 ------- --------- --------- --------- Net premiums earned.............................2,982,400 1,799,875 6,505,906 6,077,423 --------- ---------- --------- --------- Net investment income.................................... 465,885 825,279 1,177,217 2,307,049 Interest on notes receivable............................. 178,939 791,060 635,504 1,486,678 Brokerage commission income.............................. 484,970 229,392 1,564,706 890,342 Management fees from affiliate........................... 157,034 183,186 443,950 549,722 Net realized gains(losses)............................... 9,357 60,529 14,243 155,608 Other income............................................. 2,081 3,900 10,748 15,483 ----- ----- ------ ------ Total revenues.......................................4,280,666 3,893,221 10,352,274 11,482,305 --------- --------- ---------- ---------- Expenses: Losses and loss adjustment expenses incurred.............1,524,045 1,150,611 3,533,048 3,621,763 Acquisition expenses.....................................1,155,052 (85,635) 1,768,834 334,584 Other expenses........................................... 854,355 1,299,582 2,445,573 3,352,077 ------- --------- --------- --------- Total expenses.......................................3,533,452 2,364,558 7,747,455 7,308,424 --------- --------- --------- --------- Earnings before income taxes............................. 747,214 1,528,663 2,604,819 4,173,881 Income tax expense (benefit).................................. 91,444 (69,520) 382,528 (29,862) ------ -------- ------- -------- Net earnings......................................... $655,770 $1,598,183 $2,222,291 $4,203,743 ======== ========== ========== ========== Net earnings per share: Basic ................................................ $ 0.23 $ 0.26 $0.77 $0.76 ====== ======= ===== ===== Diluted ................................................ $ 0.22 $ 0.26 $0.75 $0.75 ====== ======= ===== ===== Common shares used in computing earnings per share: Basic ................................................2,872,830 6,074,770 2,872,830 5,522,497 ========= ========= ========= ========== Diluted ................................................2,974,133 6,119,089 2,974,133 5,607,457 ========= ========= ========= ========= See accompanying notes to consolidated financial statements (unaudited). 4 American Safety Insurance Group, Ltd. and Subsidiaries Consolidated Statements of Cash Flow (Unaudited) Nine months ended September 30, 1997 1998 ---- ---- Cash flow from operating activities: Net earnings........................................................ $2,222,291 $ 4.203,743 Adjustments to reconcile net earnings to net cash provided by Realized losses (gains) on sale of investments................... (14,243) (155,608) Amortization of deferred acquisition costs....................... 485,871 343,967 Change in: Accrued investment and interest income........................ 311,074 (1,415,097) Premiums receivable........................................... (2,887,190) 418,800 Commissions receivable........................................ 35,666 (21,968) Reinsurance recoverable and ceded unearned premiums........... (285,915) (795,310) Due from affiliate............................................ 95,207 60,580 Income taxes.................................................. 57,451 (48,125) Unpaid losses and loss adjustment expenses.................... 1,820,173 1,105,994 Unearned premiums............................................. 759,632 2,107,057 Liability for deductible fees held............................ 2,764,485 (850,735) Ceded premiums payable ....................................... 1,641,711 (2,605,124) Due to affiliate.............................................. 66,805 665,574 Accounts payable and accrued expenses......................... (312,317) 880,493 Other, net.................................................... (368,118) (156,138) --------- --------- Net cash provided by operating activities............ 6,392,583 3,738,103 ---------- --------- Cash flow from investing activities: Purchases of fixed maturities....................................... (12,553,086) (72,086,248) Purchases of equity investments..................................... (1,170,146) (3,527,435) Proceeds from maturity and redemption of fixed maturities........... - 7,441,489 Proceeds from sale of fixed maturities.............................. 4,322,883 44,773,017 Proceeds from sale of equity investments............................ 712,955 330,941 Decrease (increase) in short-term investments....................... (1,124,265) 786,781 Increase in notes receivable-other.................................. (119,423) (9,025,384) (Increase) decrease in notes receivable-related parties............. 1,292,506 - Purchase of fixed assets, net....................................... (147,755) (68.137) --------- -------- Net cash used in investing activities................ (8,786,331) (31,374,976) ----------- ------------ Cash flow financing activities: Proceeds from sale of common stock.................................. 297,279 31,102,975 - Proceeds from surplus note.......................................... 1,250,000 - --------- ----------------- Net cash provided by financing activities............ 1,547,279 31,102,975 ---------- ---------- Net increase (decrease) in cash...................... (846,469) 3,466,102 Cash at beginning of period............................................ 3,271,957 2,768,831 ----------------- --------- Cash at end of period.................................................. $2,425,488 $ 6,234,933 =========== =========== See accompanying notes to consolidated financial statements (unaudited). 5 American Saftey Insurance Group, Ltd. and Subsidiaries Consolidated Statements of Comprehensive Earnings (Unaudited) Three months ended Nine months ended September 30, September 30, 1997 1998 1997 1998 Net earnings.................................................. $ 655,769 $1,598,182 $2,222,291 $4,203,742 Other comprehensive earnings before income taxes: Unrealized gains (losses) on securities available for sale.... 263,238 857,248 195,414 748,235 Reclassification adjustment for realized gains included in net earnings 9,357 60,529 14,243 155,608 ------ ------ ------- ------- Total other comprehensive earnings before taxes............... 272,595 917,777 209,657 903,843 Income tax expense related to items of comprehensive income.. 41,714 70,192 37,686 45,757 ------ ------ -------- ------ Other comprehensive earnings net of income taxes.............. 230,881 847,585 171,971 858,086 ------- ------- ------- ------- Total comprehensive earnings.................................. $ 886,650 $2,445,767 $2,394,262 $5,061,828 ========= =========== ========== ========== See accompanying notes to consolidated financial statements (unaudited). 6 American Safety Insurance Group, Ltd. and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Note 1 - Basis of Presentation The accompanying unaudited interim consolidated financial statements of American Safety Insurance Group, Ltd. ("American Safety") and its subsidiaries (collectively, the "Company") are prepared in accordance with generally accepted accounting principles in the United States and, in the opinion of management, reflect all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the interim period presented. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates, based on the best information available, in recording transactions resulting from business operations. The balance sheet amounts that involve a greater extent of accounting estimates and actuarial determinations subject to future changes are the Company's liabilities for unpaid losses and loss adjustment expenses. As additional information becomes available (or actual amounts are determinable), the recorded estimates may be revised and reflected in operating results. While management believes that the liability for unpaid losses and loss adjustment expenses is adequate to cover the ultimate liability, such estimates may be more or less than the amounts actually paid when claims are settled. The results of operations for the nine months ended September 30, 1998 may not be indicative of the results that may be expected for the full year ending December 31, 1998. These unaudited interim consolidated financial statements and notes should be read in conjunction with the financial statements and notes included in the audited consolidated financial statements of American Safety and its subsidiaries for the year ended December 31, 1997. The unaudited interim consolidated financial statements include the accounts of American Safety and each of its subsidiaries. All significant intercompany balances have been eliminated. Note 2 - Accounting Pronouncements In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (Statement 130). Statement 130 establishes standards for reporting and displaying comprehensive income and its components in a full set of general purpose financial statements. The Company adopted Statement 130 effective January 1, 1998. The primary component of the differences between net income and comprehensive income for the Company is unrealized gains on securities. Total comprehensive income for the three months ended September 30, 1997 was $886,650 as compared to $2,445,767 for the three months ended September 30, 1998. Total comprehensive income for the nine months ended September 30, 1997, was $2,394,262 as compared to $5,061,828 for the nine months ended September 30, 1998. Note 3 - Nature of Operations The following is a description of certain risks facing casualty insurers: Legal/Regulatory Risk is the risk that changes in the legal or regulatory environment in which an insurer operates will create additional expenses not anticipated by the insurer in pricing its products and beyond those recorded in the financial statements. Regulatory initiatives designed to reduce insurer profits or otherwise affecting the industry in which the Company operates, new legal theories or insurance company insolvencies through guaranty fund assessments, may create costs for the Company beyond those recorded in the financial statements. The Company attempts to mitigate this risk by writing insurance business in several states, thereby spreading this risk over a large geographic area, and by obtaining reinsurance. 7 Credit Risk is the risk that issuers of securities owned by the Company or secured notes receivable will default or that other parties, including reinsurers that have obligations to the insurer, will not pay or perform. The Company attempts to mitigate this risk by adhering to a conservative investment strategy, by obtaining sufficient collateral for secured note obligations and by maintaining sound reinsurance, credit and collection policies. Interest Rate Risk is the risk that interest rates will change and cause a decrease in the value of an insurer's investments. The Company attempts to mitigate this risk by attempting to match the maturities of its assets with the expected payouts of its liabilities. Note 4 - Investments The amortized cost and estimated fair values of investments at December 31, 1997 and September 30, 1998 are as follows: Amount Gross Gross at which Amortized Unrealized Unrealized Estimated Shown in the Cost Gains Losses Fair Value Balance Sheet December 31, 1997: Securities available for sale: Fixed maturities: U.S. Treasury securities and obligations of U.S. Government corporations and agencies....... 11,725,010 128,883 2,376 11,851,517 11,851,517 Obligations of states and political subdivisions.... 4,782,325 220,175 -- 5,002,500 5,002,500 Corporate securities................................ 6,545,888 51,986 13,508 6,584,366 6,584,366 Mortgage-backed securities ......................... 3,016,040 30,693 22,841 3,023,892 3,023,892 --------- ------ ------ --------- --------- Total Fixed maturities.......................... 26,069,263 431,737 38,725 26,462,275 26,462,275 Equity investments - common stocks.................... 1,045,493 12,688 3,632 1,054,549 1,054,549 --------- ------ ----- --------- --------- Total............................................. $27,114,756 444,425 42,357 27,516,824 27,516,824 =========== ======= ====== ========== ========== September 30, 1998: Securities available for sale: Fixed maturities: U.S. Treasury securities and obligations of U.S. Government corporations and agencies...... $18,443,594 817,499 11,276 19,249,817 19,249,817 Obligations of States and political subdivisions.... 6,521,633 316,529 9,321 6,828,841 6,828,841 Corporate securities................................ 18,451,509 430,534 19,031 18,863,012 18,863,012 Mortgage-backed securities.......................... 2,464,617 63,062 993 2,526,686 2,526,686 ----------- ------ --- ---------- ---------- Total Fixed maturities.......................... 45,881,353 1,627,624 40,621 47,468,356 47,468,356 Equity investments - common stocks.................... 4,253,529 4,855 263,018 3,995,366 3,995,366 --------- ----- ------- --------- --------- Total.......................................... $50,134,882 1,632,479 303,639 51,463,722 51,463,722 =========== ========= ======= ========== ========== Note 5 - Notes Receivable Notes receivable represent indebtedness under various secured lending arrangements with related and unrelated parties. On May 29, 1998, the Company made a loan to an unaffiliated borrower, which amounts to 8.2% of the Company's total assets. The note is secured by real estate and the personal guaranties of the principals of the borrower. Note 6 - Shareholder Matters On January 29, 1998, the Company effectuated a 1,310-for-one share split and increased its authorized capital to 15,000,000 common shares and 5,000,000 preferred shares in contemplation of the Company's initial public offering which became effective February 12, 1998. All share and per share amounts have been retroactively adjusted to effect this split. 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations General American Safety is a specialty insurance holding company which, through its subsidiaries, develops, underwrites, manages and markets primary casualty insurance and reinsurance programs in the alternative insurance market for (i) environmental specialty risks; (ii) employee leasing and staffing industry risks; and (iii) other specialty risks. The Company has demonstrated expertise in developing specialty insurance coverages and custom designed risk management programs not generally available in the standard insurance market. The Company's specialty insurance programs include coverages for general liability, pollution liability, professional liability, workers' compensation and surety, as well as custom designed risk management programs (including captive and rent-a-captive programs), for contractors, consultants and other businesses and property owners who are involved with environmental remediation or exposures, employee leasing and staffing, and other specialty risks. Through its U.S. brokerage and management services subsidiaries, the Company also provides specialized insurance program development, underwriting, risk placement, reinsurance, program management, brokerage, loss control, claims administration and marketing services. The Company insures and places risks through its U.S. insurance subsidiary, American Safety Casualty Insurance Company, as well as its non-subsidiary risk retention group affiliate, American Safety Risk Retention Group, Inc., and substantial unaffiliated insurance and reinsurance companies. The Company also reinsures and places, through its Bermuda reinsurance subsidiary, American Safety Reinsurance, Ltd., and substantial unaffiliated reinsurers, a portion of the risk underwritten directly by its U.S. insurance subsidiary, American Safety Casualty Insurance Company, its risk retention group affiliate and other insurers. Substantially all of the reinsurance business that the Company currently assumes is for primary insurance programs that the Company has developed and underwritten. In January 1998, the Company formed American Safety Reinsurance, Ltd., a Bermuda reinsurance subsidiary, and transferred a substantial portion of its reinsurance business on a going forward basis to the subsidiary. The Company is able to select its roles as program developer, primary underwriter, reinsurer, program manager and broker based on its assessment of each risk profile. After determining its roles, the Company utilizes its insurance and reinsurance subsidiaries, its insurance brokerage and management services subsidiaries, and its risk retention group affiliate to generate risk premium revenues, program management fees, insurance and reinsurance commissions and investment income. A.M. Best Company ("A.M. Best"), an independent nationally recognized insurance rating service and publisher, has assigned a rating of "A (Excellent)" on a group basis to American Safety, as well as its U.S. insurance subsidiary and its non-subsidiary risk retention group affiliate. On June 15, 1998, A.M. Best increased American Safety's financial size rating from a VI to a VII as a result of the Company's initial public offering on February 12, 1998. A.M. Best's ratings are an independent opinion of an insurer's ability to meet its obligations to policyholders, which opinion is of concern primarily to policyholders, insurance agents and brokers, and should not be considered an investment recommendation. The Company's financial position and results of operations are subject to change based on various factors, including competitive conditions in the insurance industry, unpredictable developments in loss trends, changes in loss reserves, market acceptance of new coverages and enhancements, and changes in levels of general business activity and economic conditions. During this decade, the Company has operated in a soft market cycle which is characterized by excess insurance capacity and declining insurance premium rates. The Company's reported combined ratio for its insurance operations may not provide an indication of the Company's overall profitability from insurance and 9 reinsurance programs due to the exclusion of fee and commission income and expenses generated in related management and agency subsidiaries. Certain of the Company's insurance policies and reinsurance assumed, including general and pollution liability policies covering environmental remediation risks, as well as workers' compensation policies, may be subject to claims brought years after an incident has occurred or the policy period had ended. The Company maintains reserves to cover its estimated liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred. The Company has reviewed its internal business systems and believes that the systems, primarily its computer system, will process date information accurately and without interruption when required to process dates in the year 1999 and beyond. The Company has not been required to expend significant resources to address the year 2000 issue and does not anticipate any significant expenditures. Statements made in this Report that are not based on historical information are deemed to be "forward-looking statements" under applicable federal securities laws. Such forward-looking statements are based largely on current expectations and assumptions of management and are subject to a number of risks and uncertainties which could cause actual results to differ materially from those contemplated, including, without limitation, competitive conditions in the insurance industry, unpredictable developments in loss trends, changes in loss reserves, market acceptance of new coverages and enhancements, and changes in levels of general business activity and economic conditions. Results of Operations The following table sets forth the Company's consolidated revenues (dollars in thousands): Percent Increase (Decrease) Three Nine Three months ended Nine Months ended months months September 30, September 30, ended ended 1997 1998 1997 1998 1997 1998 Net earned premium Reinsurance: Workers' compensation.............................. $1,857 $742 $3,794 $3,633 (60.0)% (4.2)% General Liability from affiliate................... 402 904 1,447 2,020 124.9 39.6% --- --- ----- ----- -------- ----- Total reinsurance.................................. 2,259 1,646 5,241 5,653 (27.1)% 7.9% Primary insurance: Surety............................................. 723 153 1,265 424 (78.8)% (66.5)% ------------------------------------------------------ Total primary insurance............................ 723 153 1,265 424 (78.8)% (66.5)% Total net earned premium............................... 2,982 1,799 6,506 6,077 (39.7)% (6.6)% Net investment income.................................. 466 825 1,177 2,307 77.0% 96.0% Interest on notes receivable........................... 179 791 636 1,487 341.9% 133.8% Commission and fee income: Brokerage commission income........................ 485 229 1,565 890 (52.8)% (43.1)% Management fees from affiliates.................... 157 183 444 550 16.6% 23.9% ------------------------------------------------------- Total commission and fee income........................ 642 412 2,009 1,440 (35.8)% (28.3)% Net realized gains (losses)............................ 9 61 14 156 577.8% 1014.3% Other income........................................... 2 4 11 15 100.0% 36.4% ----------------------------------------------------------- Total revenues................................ $4,280 $3,892 $10,353 $11,482 (9.1)% 10.9% ========================================================== 10 The following table sets forth the components of the Company's GAAP combined ratio for the periods indicated: Three months ended Nine months ended September 30 September 30 ------------ ------------ 1997 1998 1997 1998 ---- ---- ---- ---- Insurance operations: Loss and loss adjustment expense ratio.................... 51.1% 63.9% 54.3% 59.6% Expense ratio............................................. 41.1 4.1 33.7 9.2 ---- --- ---- --- Combined ratio........................................ 92.2% 68.0% 88.0% 68.8% ===== ===== ===== ===== Quarter Ended September 30, 1998 Compared to Quarter Ended September 30, 1997 Net Premiums Earned. Net premiums decreased 39.7% to $1.8 million for the quarter ended September 30, 1998 from $3.0 million in the quarter ended September 30, 1997. The primary factor accounting for this result is the decrease of bail bond premium production from a discontinued program during 1997. Although net premiums earned decreased $1.2 million as stated above, net income was not significantly impacted since bail bond premiums have a low margin. General liability reinsurance premiums increased 124.9% from $402,000 in the quarter ended September 30, 1997 to $904,000 in the quarter ended September 30, 1998. In the Company's primary insurance business, net premiums earned from the Company's U.S. insurance subsidiary's surety program decreased from $723,000 in the quarter ended September 30, 1997 to $153,000 in the quarter ended September 30, 1998 primarily as a result of the discontinued bail bond program. Net Investment Income. Net investment income increased 77.0% from $466,000 in the quarter ended September 30, 1997 to $825,000 in the quarter ended September 30, 1998 as a result of the investment of additional cash flows from insurance operations and from investment of the Company's initial public offering proceeds. The average annual pre-tax yield on investments was 7.4% in the quarter ended September 30, 1997 and 6.2% in the quarter ended September 30, 1998. The average annual after-tax yield on investments was 6.8% in the quarter ended September 30, 1997 and 5.7% in the quarter ended September 30, 1998. Interest from Notes Receivable. Interest from notes receivable increased 341.9% from $179,000 in the quarter ended September 30, 1997 to $791,000 in the quarter ended September 30, 1998 as a result of increases in outstanding notes receivable. Brokage Commission Income. Income from insurance brokerage operations decreased 52.8% from $485,000 in the quarter ended September 30, 1997 to $229,000 in the quarter ended September 30, 1998 as a result of additional premiums being directly written by the Company's U.S. insurance subsidiary in which acquisition expenses and brokerage income are eliminated due to consolidation. Management Fees. Management fees increased 16.6% from $157,000 in the quarter ended September 30, 1997 to $183,000 in the quarter ended September 30, 1998 as a result of increased service levels provided by the Company to its risk retention group affiliate. 11 Net Realized Gains (Losses). Net realized gains from the sale of investments increased from a gain of $9,000 in the quarter ended September 30, 1997 to a gain of $61,000 in the quarter ended September 30, 1998. Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses decreased 24.5% from $1.5 million in the quarter ended September 30, 1997 to $1.2 million in the quarter ended September 30, 1998 due to the 39.7% decrease in net premiums earned and a corresponding decrease in reserves resulting from the decrease in the workers' compensation line of business. Acquisition Expenses. Policy acquisition expenses decreased 107.4% from $1.2 million in the quarter ended September 30, 1997 to $(86,000) in the quarter ended September 30, 1998 as a result of increased premiums directly written by the Company's U.S. insurance subsidiary where acquisition expenses and brokerage income are eliminated due to consolidation, and the decrease in bail bond premiums discussed above. This decrease is also attributable to the decrease in bail bond premium discussed above. Other Expenses. Other expenses increased 52.1% from $854,000 in the quarter ended September 30, 1997 to $1.3 million in the quarter ended September 30, 1998 due to salary and benefit increases and increased staffing for new and existing programs. Income Taxes. Federal and state income taxes decreased from an expense of $91,000 in the quarter ended September 30, 1997 to a benefit of $70,000 in the quarter ended September 30, 1998 due to additional premiums being ceded to the Company's Bermuda reinsurance subsidiary and investment income earned in Bermuda. Nine months ended September 30, 1998 Compared to Nine months ended September 30, 1997 Net Premiums Earned. Net premiums earned decreased 6.6% to $6.1 million in the nine months ended September 30, 1998 from $6.5 million in the nine months ended September 30, 1997. The primary factor accounting for this result is the decrease of bail bond premium production from a discontinued program during 1997. Although net premiums earned decreased $400,000 as stated above, net income was not significantly impacted since bail bond premiums have a low margin. General liability reinsurance premiums increased 39.6% from $1.4 million in the nine months ended September 30, 1997 to $2.0 million in the nine months ended September 30, 1998. In the Company's primary insurance business, net premiums earned from the Company's U.S. insurance subsidiary's surety program decreased from $1.3 million in the nine months ended September 30, 1997 to $424,000 in the nine months ended September 30, 1998 primarily as a result of the discontinued bail bond program. Net Investment Income. Net investment income increased 96.0% from $1.2 million in the nine months ended September 30, 1997 to $2.3 million in the nine months ended September 30, 1998 as a result of the investment of additional cash flows from insurance operations and from investment of the proceeds of the Company's initial public offering. The average annual pre-tax yield on investments was 6.9% in the nine months ended September 30, 1997 and 7.5% in the nine months ended September 30, 1998. The average annual after-tax yield on investments was 6.2% in the nine months ended September 30, 1997 and 6.9% in the nine months ended September 30, 1998. Interest from Notes Receivable. Interest from notes receivable increased 133.8% from $636,000 in the nine months ended September 30, 1997 to $1.5 million in the nine months ended September 30, 1998 as a result of increases in outstanding notes receivable. Brokerage Commission Income. Income from insurance brokerage operations decreased 43.1% from $1.6 million in the nine months ended September 30, 1997 to $890,000 in the nine months ended September 30, 1998. 12 as a result of additional premiums being directly written by the Company's U.S. insurance subsidiary in which acquisition expenses and brokerage income are eliminated due to consolidation. Management Fees. Management fees increased 23.9% from $444,000 in the nine months ended September 30, 1997 to $550,000 in the nine months ended September 30, 1998 as a result of increased services provided by the Company to its risk retention group affiliate. Net Realized Gains. Net realized gains from the sale of investments increased from $14,000 in the nine months ended September 30, 1997 to $156,000 in the nine months ended September 30, 1998. Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses increased 2.5% from $3.5 million in the nine months ended September 30, 1997 to $3.6 million in the nine months ended September 30, 1998 which results from changes in the net premiums earned and a corresponding increase in reserves resulting from an increase in the general liability line of business. Acquisition Expenses. Policy acquisition expenses decreased 81.1% from $1.8 million in the nine months ended September 30, 1997 to $335,000 in the nine months ended September 30, 1998 as a result of increased premiums being directly written by the Company's U.S. insurance subsidiary in which acquisition expenses and brokerage income are eliminated due to consolidation, and the decrease in bail bond premium discussed above. Other Expenses. Other expenses increased 37.1% from $2.4 million in the nine months ended September 30, 1997 to $3.4 million in the nine months ended September 30,1998 due to salary and benefit increases and increased staffing required to handle new and existing programs. Income taxes. Federal and state income taxes decreased from an expense of $383,000 in the nine months ended September 30, 1997 to a benefit of $30,000 in the nine months ended September 30, 1998 due to additional premiums being ceded to the Company's Bermuda reinsurance subsidiary and investment income earned in Bermuda. Liquidity and Capital Resources The Company historically has met its cash requirements and financed its growth principally through cash flows generated from operations. The Company's primary sources of cash flow are proceeds from the sale or maturity of invested assets, premiums earned, investment income, commission income and management fees. The Company's short-term cash requirements are primarily for claims payments, reinsurance premiums, commissions, salaries, employee benefits and other operating expenses, and the purchase of investment securities, which have historically been satisfied from operating cash flows. Due to the uncertainty regarding settlement of unpaid claims, the long-term liquidity requirements of the Company may vary, and the Company has attempted to structure its investment portfolio to take into account the historical payout patterns. Management believes that the Company's current cash flows are sufficient for its short-term needs and the Company's invested assets are sufficient for its long-term needs. The Company also purchases reinsurance to mitigate the effect of large claims. On a consolidated basis, net cash provided from operations was $6.4 million for the nine months ended September 30, 1997 as compared to $3.7 million for the nine months ended September 30, 1998 due to a discontinued rent-a-captive program. The positive cash flows for both periods were primarily attributable to net premiums written, net earnings, and increases in reserves for unpaid losses. Because workers' compensation and general liability claims may be paid over an extended period of time, the Company has established loss reserves for such lines of business. The assets supporting the Company's reserves continue to earn investment income until claims payments are made. 13 Total assets increased from $47.7 million at December 31, 1997 to $85.7 million at September 30, 1998, primarily due to the proceeds of the Company's initial public offering in February 1998. Cash, invested assets and notes receivable increased from $34.9 million at September 30, 1997 to $73.0 million at September 30, 1998. American Safety is an insurance holding company whose principal assets are its investment portfolio and its investment in the capital stock of its subsidiaries. As an insurance holding company, American Safety's ability to pay dividends to its shareholders will depend, to a significant degree on the ability of the Company's subsidiaries to pay dividends to American Safety. The jurisdictions in which the Company and its insurance and reinsurance subsidiaries are domiciled place limitations on the amount of dividends or other distributions payable by insurance companies in order to protect the solvency of insurers. Managements believes it has significant liquidity in the near term to accomplish its business objectives. As of September 30, 1998 the Company had no investments in derivative financial instruments. Income Taxes American Safety is incorporated under the laws of Bermuda and, under current Bermuda law, is not obligated to pay any taxes in Bermuda based upon income or capital gains. American Safety has received an undertaking from the Minister of Finance in Bermuda pursuant to the provisions of The Exempted Undertakings Tax Protection Act 1966, which exempts American Safety and its shareholders, other than shareholders ordinarily resident in Bermuda, from any Bermuda taxes computed on profits, income or any capital asset, gain or appreciation, or any tax in the nature of estate, duty or inheritance until March 28, 2016. The Company, exclusive of its United States subsidiaries, does not expect to be subject to direct United States income taxation. The Company's U.S. subsidiaries are subject to taxation in the United States. Inflation Property and casualty insurance premiums are established before the amounts of losses and loss adjustment expenses are known and therefore before the extent by which inflation may affect such expenses is known. Consequently, the Company attempts, in establishing its premiums, to anticipate the potential impact of inflation. However, for competitive and regulatory reasons, the Company may be limited in raising its premiums consistent with anticipated inflation, in which event the Company, rather than its insureds, would absorb inflation costs. Inflation also affects the rate of investment return on the Company's investment portfolio with a corresponding effect on the Company's investment income. Item 3. Quantitative and Qualitative Disclosures About Market Risks. Not Applicable. 14 PART II - OTHER INFORMATION Item 1. Legal Proceedings. Not applicable. Item 2. Changes in Securities and Use of Proceeds. Not applicable. Item 3. Defaults Upon Senior Securities. Not applicable. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. Item 5. Other Information. Not applicable. Item 6. Exhibits and Reports on Form 8-K. (a) The following exhibits are filed as part of this Report: Exhibit No. Description 11 Computation of Earnings Per Share 27 Financial Data Schedule (b) Reports on Form 8-K. No reports on Form 8-K were filed by the Company during the period covered by this Report. 15 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 14th day of August 1998. American Safety Insurance Group, Ltd. By: /s/ Lloyd A. Fox ------------------------------------------- Lloyd A. Fox President and Chief Executive Officer By: /s/ Steven B. Mathis ------------------------------------------- Steven B. Mathis Chief Financial Officer (Principal Financial Officer)