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EIG > SEC Filings for EIG > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for EMPLOYERS HOLDINGS, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for EMPLOYERS HOLDINGS, INC.


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Consolidated Financial Condition
and Results of Operations
You should read the following discussion and analysis in conjunction with our consolidated financial statements and the related notes thereto included in Item 1 of Part I. Unless otherwise indicated, all references to "we," "us," "our," "the Company," or similar terms refer to Employers Holdings, Inc. (EHI), together with its subsidiaries. The information contained in this quarterly report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this quarterly report and in our other reports filed with the Securities and Exchange Commission (SEC), including our Annual Report on Form 10-K for the year ended December 31, 2011 (Annual Report).
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements if accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed. You should not place undue reliance on these statements, which speak only as of the date of this report. Forward-looking statements include those related to our expected financial position, business, financing plans, litigation, future premiums, revenues, earnings, pricing, investments, business relationships, expected losses, loss reserves, acquisitions, competition, rate increases with respect to our business, response to regulatory changes and changes in laws, and the insurance industry in general. Statements including words such as "expect," "intend," "plan," "believe," "estimate," "may," "anticipate," "will" or similar statements of a future or forward-looking nature identify forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law. All forward-looking statements address matters that involve risks and uncertainties that could cause actual results to differ materially from historical or anticipated results, depending on a number of factors. These risks and uncertainties include, but are not limited to, those described in our Annual Report and other documents that we have filed with the SEC.
Overview
We are a Nevada holding company. Through our insurance subsidiaries, we provide workers' compensation insurance coverage to select, small businesses in low to medium hazard industries. Workers' compensation insurance is provided under a statutory system wherein most employers are required to provide coverage for their employees' medical, disability, vocational rehabilitation, and/or death benefit costs for work-related injuries or illnesses. We provide workers' compensation insurance in 31 states and the District of Columbia, with a concentration in California, where over one-half of our business is generated. Our revenues are primarily comprised of net premiums earned, net investment income, and net realized gains on investments.
We target small businesses, as we believe that this market is traditionally characterized by fewer competitors, more attractive pricing, and stronger persistency when compared to the U.S. workers' compensation insurance industry in general. We believe we are able to price our policies at levels that are competitive and profitable over the long-term. Our underwriting approach is to consistently underwrite small business accounts at appropriate and competitive prices without sacrificing long-term profitability and stability for short-term top-line revenue growth.
Our goal is to maintain our focus on disciplined underwriting and to continue to pursue profitable growth opportunities across market cycles; however, we continue to be affected by persistently low investment yields and continuing high levels of unemployment nationally. We do not believe overall economic conditions will change significantly in the near-term.
We market and sell our workers' compensation insurance products through independent local, regional, and national agents and brokers; through our strategic partnerships and alliances, including our principal partners ADP, Inc. and Anthem Blue Cross of California; and through relationships with national and regional trade groups and associations, including the National Federation of Independent Business.
Results of Operations
Overall, net income was $8.2 million and $19.4 million for the three and nine months ended September 30, 2012, respectively, compared to $11.8 million and $28.4 million for the corresponding periods of 2011. We recognized underwriting losses of $11.5 million and $44.8 million for the three and nine months ended September 30, 2012, respectively, compared to underwriting losses of $12.0 million and $40.2 million for the same periods of 2011. Underwriting income or loss is determined by deducting losses and LAE, commission expense, policyholder dividends, and underwriting and other operating expenses from net premiums earned. Key factors that affected our financial performance during the three and nine months ended September 30, 2012, compared to the same period of 2011, include:
Gross premiums written increased 41% and 40%;

Net premiums earned increased 42% and 37%;

Losses and LAE increased 46% and 40%;

Underwriting and other operating expenses increased 16% and 18%; and


Income tax benefit decreased to $1.2 million and $7.9 million during the three and nine months ended September 30, 2012, respectively, compared to $4.4 million and $8.7 million for the corresponding periods of 2011.

Additionally, the Financial Accounting Standards Board issued guidance that, beginning in 2012, changed the definition of policy acquisition costs which may be capitalized. Our underwriting and other operating expenses increased $1.3 million and $6.5 million during the three and nine months ended September 30, 2012 as a result of this change (see Note 3 in the Notes to Consolidated Financial Statements for additional information). We expect that the total impact of this guidance for 2012 will be approximately $7 million in increased underwriting and other operating expenses.
We measure our performance by our ability to increase stockholders' equity, including the impact of the deferred reinsurance gain-LPT Agreement (Deferred Gain), over the long-term. The following table shows our stockholders' equity including the Deferred Gain, stockholders' equity on a GAAP basis, and number of common shares outstanding at:

                                                        September 30, 2012       December 31, 2011
                                                            (in thousands, expect share data)
Stockholders' equity including the Deferred Gain(1)   $            814,780     $           827,380
GAAP stockholders' equity                             $            473,216     $           474,186
Common shares outstanding                                       30,724,086              32,996,809

(1) Stockholders' equity, including the Deferred Gain, is a non-GAAP measure that is defined as total stockholders' equity plus the Deferred Gain, which we believe is an important supplemental measure of our capital position.

The comparative components of net income are set forth in the following table:

                                            Three Months Ended             Nine Months Ended
                                               September 30,                 September 30,
                                            2012           2011           2012           2011
                                                             (in thousands)
Gross premiums written                  $  147,032     $  104,514     $  442,920     $  315,571
Net premiums written                    $  144,353     $  102,557        435,081        309,249

Net premiums earned                     $  131,766     $   92,601     $  360,621     $  263,156
Net investment income                       17,506         19,584         54,188         60,383
Realized gains on investments, net           1,838            647          4,561          1,983
Other income                                    30             82            225            205
Total revenues                             151,140        112,914        419,595        325,727

Losses and LAE                              98,255         67,438        267,471        191,009
Commission expense                          14,865         10,968         44,541         32,368
Policyholder dividends                         867            840          2,517          2,766
Underwriting and other operating
expenses                                    29,280         25,334         90,935         77,212
Interest expense                               896            906          2,656          2,731
Income tax benefit                          (1,173 )       (4,355 )       (7,903 )       (8,738 )
Total expenses                             142,990        101,131        400,217        297,348
Net income                              $    8,150     $   11,783     $   19,378     $   28,379
Less impact of the Deferred Gain        $    3,646     $    4,203     $   11,630     $   12,984
Net income before impact of the
Deferred Gain(1)                        $    4,504     $    7,580     $    7,748     $   15,395

(1) We define net income before impact of the Deferred Gain as net income less:
(a) amortization of Deferred Gain and (b) adjustments to LPT Agreement ceded reserves. Deferred Gain reflects the unamortized gain from our LPT Agreement. Under GAAP, this gain is deferred and is being amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries, and the amortization is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT Agreement. Our reevaluation results in corresponding adjustments, if needed, to reserves, ceded reserves, reinsurance recoverables, and the Deferred Gain, with the net effect being an increase or decrease, as the case may be, to net income. Net income before impact of the Deferred Gain is not a measurement of financial performance under GAAP, but rather reflects the difference in accounting treatment between statutory and GAAP, and should not be considered in isolation or as an alternative to net income before income taxes, net income, or any other measure of performance derived in accordance with GAAP.


We present net income before impact of the Deferred Gain because we believe that it is an important supplemental measure of operating performance to be used by analysts, investors and other interested parties in evaluating us. The LPT Agreement was a non-recurring transaction and the Deferred Gain does not result in ongoing cash benefits. Consequently, we believe this presentation is useful in providing a meaningful understanding of our operating performance. In addition, we believe this non-GAAP measure, as we have defined it, is helpful to our management in identifying trends in our performance because the excluded item has limited significance on our current and ongoing operations. Net Premiums Earned
Net premiums earned increased 42.3% and 37.0% for the three and nine months ended September 30, 2012, compared to the corresponding periods in 2011. These increases are primarily due to increasing policy count as we continue to execute our strategy.
The following table shows the percentage change in our in-force premium, policy count, average policy size, payroll exposure upon which our premiums are based, and net rate.

                                           As of September 30, 2012
                              Year-to-Date Increase       Year-Over-Year Increase
In-force premiums                        29.7 %                           38.6 %
In-force policy count                    25.7                             34.7
Average in-force policy size              3.2                              2.9
In-force payroll exposure                21.9                             29.1
Net rate(1)                               6.4                              7.4

(1) Net rate, defined as total premium in-force divided by total insured payroll exposure, is a function of a variety of factors, including rate changes, underwriting risk profiles and pricing, and changes in business mix related to economic and competitive pressures.

Our in-force premiums and number of policies in-force by select states were as follows:

                 September 30, 2012            December 31, 2011            September 30, 2011            December 31, 2010
                Premiums       Policies      Premiums       Policies       Premiums       Policies      Premiums       Policies
  State         In-force       In-force      In-force       In-force       In-force       In-force      In-force       In-force
                                                           (dollars in thousands)
California   $    299,272       44,766     $   221,910       36,867     $    206,272       35,139     $   172,621       29,244
Illinois           29,291        3,235          24,744        2,433           23,041        2,045          18,617          932
Georgia            21,971        2,915          16,393        2,050           14,530        1,716          10,772          757
Florida            17,332        2,805          15,226        2,399           14,993        2,309          15,071        1,963
Nevada             15,281        3,890          14,639        3,718           14,675        3,630          16,940        3,596
Other             127,683       18,653         101,009       13,226           95,080       11,762          87,116        8,069
Total        $    510,830       76,264     $   393,921       60,693     $    368,591       56,601     $   321,137       44,561

Our strategic partnerships and alliances generated $114.5 million and $87.9 million, or 22.4% and 23.8%, of our in-force premiums as of September 30, 2012 and 2011, respectively. We believe that the bundling of products and services through these relationships contributes to higher retention rates than business generated by our independent agents. These relationships also allow us to access new customers that we may not have access to through our independent agent distribution channel. We continue to expand our existing relationships and actively seek new partnerships and alliances.
In April 2011, the Workers' Compensation Insurance Rating Bureau (WCIRB) of California provided an informational filing highlighting the cost drivers that indicated a cumulative 39.8% increase in the claims cost benchmark since January 1, 2009 based on an analysis of December 31, 2010 loss experience. This included deterioration of more than 12 percentage points in the claims cost benchmark since the WCIRB's previous recommendation for a 27.7% increase based on an analysis of June 30, 2010 loss experience. The WCIRB indicated that this further deterioration was due to: (a) continued adverse loss development on the 2009 accident year; (b) high emerging costs on the 2010 accident year, primarily due to increased claims frequency; (c) less optimistic forecasts for statewide wage growth in California; and (d) increased LAE that is likely as a result of certain Workers' Compensation Appeals Board decisions.
In August 2011, the WCIRB modified its benchmark for pure premium rates. The WCIRB's pure premium rate filings are now based on the industry average filed pure premium rate, rather than the pure premium rate approved by the California Commissioner of Insurance. The WCIRB submitted its benchmark for the proposed advisory pure premium rate to be effective January 1, 2012. The WCIRB noted that while 2012 projected claims costs continue to be below pre-reform highs and the proposed pure premium


rate was slightly less than the industry average filed rate, these rates reflected significant deterioration in projected losses and LAE and less optimistic economic forecasts, compared to the prior year.
In April 2012, the WCIRB submitted its pure premium rate filing recommending an increase in advisory pure premium rates to be effective July 1, 2012. That filing proposed a 4.1% increase over the industry average filed pure premium rate as of January 1, 2012. The filing was based on an analysis of December 31, 2011 experience and reflects increased loss development on the 2010 and 2011 accident years, increased LAE, and lower forecasts of wage growth in California for 2012 and 2013.
In August 2012, the WCIRB submitted its pure premium rate filing recommending an increase in advisory pure premium rates to be effective January 1, 2013. That filing proposed a 12.6% increase over the industry average filed pure premium rate as of July 1, 2012. The WCIRB indicated that the proposed rate increase was due to deterioration in loss experience attributable to continued adverse loss development, elevated indemnity claim frequency, an increase in the projection of future loss inflation, an increase in allocated loss adjustment expense, and lower wage growth forecasts.
In September 2012, the California legislature passed Senate Bill No. 863 (SB 863), which was subsequently signed into law. SB 863 includes a number of reforms to California's workers' compensation system, including increases to permanent disability benefits offset by reforms designed to reduce costs in the system. According to the WCIRB, the cost savings are expected to be achieved through a number of measures, including: the creation of a new dispute resolution process outside of the Workers' Compensation Appeals Board for medical treatments and billing issues; new controls on liens; and calls for new fee schedules for physicians, interpreters, ambulatory surgery centers, and home health care.
In October 2012, the WCIRB amended its January 1, 2013 rate filing, noting that loss development continued to deteriorate in the second quarter of 2012, and to account for the provisions of SB 863 that could be evaluated at the time. This new data indicated a pure premium rate that was 9.3% higher than the industry average filed pure premium rate as of July 1, 2012; however, due to the uncertainty surrounding SB 863 and the potential for additional cost savings beyond what was then quantifiable, the WCIRB's amended rate filing proposed no increase above the industry average filed pure premium rate as of July 1, 2012. Any cost savings associated with SB 863 will be dependent on the implementation of the provisions of the bill and are not included in our current rate filings. We will evaluate SB 863's mandated regulations as they are adopted and will adjust our rate filings as indicated.
We set our own premium rates in California based upon actuarial analyses of current and anticipated loss trends with a goal of maintaining underwriting profitability. Due to increasing loss costs, primarily medical cost inflation, we have increased our filed premium rates in California by a cumulative 41.3% since February 1, 2009.
The following table sets forth the percentage increases to our filed California rates effective for new and renewal policies incepting on or after the dates shown.

                      Premium Rate Change
  Effective Date      Filed in California
February 1, 2009                 10.0 %
August 15, 2009                  10.5
March 15, 2010                    3.0
March 15, 2011                    2.5
September 15, 2011                3.9
June 15, 2012                     6.0

We expect that total premiums in 2012 across our markets will continue to reflect:
overall rate increases;

increasing policy count as we continue to execute our strategy;

increasing average policy size; and

lessened competitive pressures.

Net Investment Income and Realized Gains on Investments, Net We invest our holding company assets, statutory surplus, and the funds supporting our insurance liabilities, including unearned premiums and unpaid losses and LAE. We invest in fixed maturity securities, equity securities, and cash equivalents. Net investment income includes interest and dividends earned on our invested assets and amortization of premiums and discounts on our fixed maturity securities, less bank service charges and custodial and portfolio management fees. We have established a high quality/short duration bias in our investment portfolio.
Net investment income decreased 10.6% and 10.3% for the three and nine months ended September 30, 2012, respectively, compared to the corresponding periods of 2011. The decrease was primarily related to decreases in the average pre-tax book yield


on invested assets to 3.6% and 3.7% for the three and nine months ended September 30, 2012, compared to 4.0% and 4.1% for the same periods of 2011. The tax-equivalent yield on invested assets decreased to 4.7% at September 30, 2012, compared to 5.2% at September 30, 2011.
Realized gains and losses on our investments are reported separately from our net investment income. Realized gains and losses on investments include the gain or loss on a security at the time of sale compared to its original or adjusted cost (equity securities) or amortized cost (fixed maturity securities). Realized losses are also recognized when securities are written down as a result of an other-than-temporary impairment.
Net realized gains on investments were $1.8 million and $4.6 million for the three and nine months ended September 30, 2012, respectively, compared to $0.6 million and $2.0 million for the corresponding periods of 2011.
Additional information regarding our Investments is set forth under "-Liquidity and Capital Resources-Investments."
Combined Ratio
The combined ratio, expressed as a percentage, is a key measurement of underwriting profitability. The combined ratio is the sum of the loss and LAE ratio, the commission expense ratio, policyholder dividends ratio, and underwriting and other operating expenses ratio. When the combined ratio is below 100%, we have recorded underwriting income, and conversely, when the combined ratio is greater than 100%, we cannot be profitable without investment income. Because we only have one operating segment, holding company expenses are included in our calculation of the combined ratio.
The following table provides the calculation of our calendar year combined ratios.

                                            Three Months Ended           Nine Months Ended
                                               September 30,               September 30,
                                            2012           2011         2012           2011
Loss and LAE ratio                           74.6 %         72.8 %       74.2 %         72.6 %
Underwriting and other operating
expenses ratio                               22.2           27.4         25.2           29.3
Commission expense ratio                     11.3           11.8         12.3           12.3
Policyholder dividends ratio                  0.6            0.9          0.7            1.1
Combined ratio                              108.7 %        112.9 %      112.4 %        115.3 %

Loss and LAE Ratio. Expressed as a percentage, this is the ratio of losses and LAE to net premiums earned.
Losses and LAE represents our largest expense item and includes claim payments made, amortization of the Deferred Gain, estimates for future claim payments and changes in those estimates for current and prior periods, and costs associated with investigating, defending, and adjusting claims. The quality of our financial reporting depends in large part on accurately predicting our losses and LAE, which are inherently uncertain as they are estimates of the ultimate cost of individual claims based on actuarial estimation techniques. In California, we are experiencing an increase in indemnity claims frequency (the number of claims expressed as a percentage of payroll) year-over-year. Our loss experience also indicates an upward trend in medical and indemnity costs that are reflected in our current accident year loss estimate. These increases are partially offset by continuing favorable loss cost trends in Nevada and several of our other states. We believe our current accident year loss estimate is adequate; however, ultimate losses will not be known with any certainty for many years. We assume that increasing medical and indemnity cost trends will continue to impact our long-term claims costs and current accident year loss estimate, which may be offset by rate increases.
Overall, losses and LAE increased 45.7% and 40.0% for the three and nine months ended September 30, 2012, respectively, compared to the corresponding periods of 2011. These increases were primarily due to increases in net earned premiums. Prior accident year loss development in both periods was entirely related to our assigned risk business. Our current accident year loss estimate was 77.2% and 77.0% for the three and nine months ended September 30, 2012, compared to 77.2% and 77.3% for the same periods of 2011.
Excluding the impact from the LPT Agreement, losses and LAE would have been $101.9 million and $71.6 million, or 77.3% and 77.4% of net premiums earned, for the three months ended September 30, 2012 and 2011, respectively. For the nine months ended September 30, 2012 and 2011, losses and LAE would have been $279.1 million and $204.0 million, or 77.4% and 77.5% of net premiums earned, respectively.


The table below reflects the losses and LAE reserve adjustments.

                                              Three Months Ended               Nine Months Ended
                                                September 30,                    September 30,
                                             2012             2011            2012            2011
                                                (in millions)                    (in millions)
Prior accident year loss development,
net                                     $      (0.2 )     $     (0.2 )   $      (1.3 )    $     (0.6 )
LPT amortization of the deferred
reinsurance gain                        $       3.6       $      4.2     $      11.6      $     13.0

Underwriting and Other Operating Expenses Ratio. The underwriting and other operating expenses ratio is the ratio (expressed as a percentage) of underwriting and other operating expenses to net premiums earned and measures an insurance company's operational efficiency in producing, underwriting, and administering its insurance business.
Underwriting and other operating expenses are those costs that we incur to underwrite and maintain the insurance policies we issue, excluding commission. These expenses include premium taxes and certain other general expenses that vary with, and are primarily related to, producing new or renewal business. Other underwriting expenses include changes in estimates of future write-offs of premiums receivable, general administrative expenses such as salaries and benefits, rent, office supplies, depreciation, and all other operating expenses not otherwise classified separately. Policy acquisition costs are variable based on premiums earned; however, other operating costs are more fixed in nature and become a smaller percentage of net premiums earned as premiums increase. Our underwriting and other operating expenses ratio decreased 5.2 percentage points and 4.1 percentage points for the three and nine months ended . . .

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