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EIG > SEC Filings for EIG > Form 10-Q on 7-Nov-2013All Recent SEC Filings

Show all filings for EMPLOYERS HOLDINGS, INC.

Form 10-Q for EMPLOYERS HOLDINGS, INC.


7-Nov-2013

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, 2012 (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 experience, loss reserves, acquisitions, competition, the impact of changes in interest rates, rate increases with respect to our business, 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 believe overall economic conditions will remain uncertain 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, regional, and local trade groups and associations. Results of Operations
Overall, net income was $27.6 million and $49.7 million for the three and nine months ended September 30, 2013, respectively, compared to $7.8 million and $19.1 million for the corresponding periods of 2012. We recognized underwriting income (losses) of $6.2 million and $(9.1) million for the three and nine months ended September 30, 2013, respectively, compared to underwriting losses of $11.9 million and $45.1 million for the same periods of 2012. Underwriting income or loss is determined by deducting losses and LAE, commission expense, 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, 2013, compared to the same periods of 2012, include:
Gross premiums written increased 14.6% and 20.5%;

Net premiums earned increased 24.8% and 31.0%;

Losses and LAE increased 9.2% and 23.2%;


Underwriting and other operating expenses increased 7.8% and 3.0%; and

Income tax benefit increased $2.1million and decreased $5.6 million.

Our results of operations were also impacted by: (1) favorable development in the estimated reserves ceded under the LPT Agreement. This adjustment to the estimated reserves ceded resulted in a $10.1 million cumulative adjustment to the Deferred Gain, which reduced our losses and LAE by the same amount during the third quarter of 2013 (LPT Reserve Adjustment); and (2) a reallocation of reserves from non-taxable periods prior to January 1, 2000, which reduced our effective tax rate by 10.5 percentage points for the nine months ended September 30, 2013.
A primary measure of our performance is our ability to increase stockholders' equity, including the impact of the Deferred reinsurance gain-LPT Agreement (Deferred Gain), over the long-term; however, during periods of rising interest rates, the fair value of the fixed income component of our investment portfolio may be negatively impacted, thereby reducing stockholders' equity. For the nine months ended September 30, 2013, the unrealized gain in our portfolio, net of deferred tax expense, declined by $38.3 million, principally as a result of the upward movement in interest rates year to date. The following table shows our stockholders' equity including the Deferred Gain, stockholders' equity on a GAAP basis, and number of common shares outstanding.

                                                        September 30, 2013       December 31, 2012
                                                            (in thousands, except share data)
Stockholders' equity including the Deferred Gain(1)   $            817,131     $           820,424
GAAP stockholders' equity                             $            556,529     $           539,381
Common shares outstanding                                       31,206,549              30,771,479

(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,
                                                  2013          2012          2013          2012
                                                                  (in thousands)
Gross premiums written                         $ 168,569     $ 147,032     $ 533,600     $ 442,920
Net premiums written                             165,885       144,353       524,907       435,081

Net premiums earned                            $ 164,429     $ 131,766     $ 472,357     $ 360,621
Net investment income                             17,799        17,506        52,849        54,188
Realized gains on investments, net                 1,075         1,838         5,735         4,561
Other income                                          29            30           276           225
Total revenues                                   183,332       151,140       531,217       419,595

Losses and LAE                                   105,767        96,823       326,677       265,150
Commission expense                                19,946        16,681        58,466        47,118
Underwriting and other operating expenses         32,493        30,147        96,282        93,452
Interest expense                                     815           896         2,420         2,656
Income tax benefit                                (3,274 )      (1,173 )      (2,291 )      (7,903 )
Total expenses                                   155,747       143,374       481,554       400,473
Net income                                     $  27,585     $   7,766     $  49,663     $  19,122
Less amortization of the Deferred Gain
related to losses                              $   3,195     $   3,646     $   9,775     $  11,630
Less amortization of the Deferred Gain
related to contingent commission                     396           293         1,184           818
Less impact of the LPT Reserve Adjustment(1)      10,112             -        10,112             -
Less impact of LPT Contingent Commission
Adjustments(2)                                       318         1,139         1,617         1,503
Net income before impact of the LPT
Agreement(3)                                   $  13,564     $   2,688     $  26,975     $   5,171

(1) Any adjustment to the estimated reserves ceded under the LPT Agreement results in a cumulative adjustment to the Deferred Gain, which is also included in losses and LAE incurred in the consolidated statement of comprehensive income, such that the Deferred Gain reflects the balance that would have existed had the revised reserves been recognized at the inception of the LPT Agreement (LPT Reserve Adjustment).


(2) Any adjustment to the contingent profit commission under the LPT Agreement results in a cumulative adjustment to the Deferred Gain, which is also recognized in losses and LAE incurred in the consolidated statement of comprehensive income, such that the Deferred Gain reflects the balance that would have existed had the revised contingent profit commission been recognized at the inception of the LPT Agreement (LPT Contingent Commission Adjustments).

(3) We define net income before impact of the LPT Agreement as net income before the impact of: (a) amortization of Deferred Gain; (b) adjustments to LPT Agreement ceded reserves; and (c) adjustments to contingent commission receivable-LPT Agreement. Deferred Gain reflects the unamortized gain from our LPT Agreement. Under GAAP, this gain is deferred and is being amortized using the recovery method. Amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries over the life of the LPT Agreement, except for the contingent profit commission, which is amortized through June 30, 2024. The amortization is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT Agreement and the expected losses and LAE subject to the contingent profit commission under the LPT Agreement. Our reevaluation results in corresponding adjustments, if needed, to reserves, ceded reserves, contingent commission receivable, 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 LPT Agreement is not a measurement of financial performance under GAAP, but rather reflects a 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 or net income, or any other measure of performance derived in accordance with GAAP.

We present net income before impact of the LPT Agreement 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 under which the Deferred Gain does not effect our ongoing operations, and, 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 24.8% and 31.0% for the three and nine months ended September 30, 2013, compared to the corresponding periods in 2012. These increases were primarily due to increasing policy count, increasing average policy size, and higher net rate.
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, 2013
                              Year-to-Date Increase       Year-Over-Year Increase
In-force premiums                        13.2 %                           19.1 %
In-force policy count                     5.3                             10.2
Average in-force policy size              7.5                              8.1
In-force payroll exposure                 5.5                              9.0
Net rate(1)                               7.3                              9.3

(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, 2013            December 31, 2012            September 30, 2012            December 31, 2011
                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   $    360,545       48,086     $   317,890       46,829     $    299,272       44,766     $   221,910       36,867
Illinois           31,270        3,252          30,555        3,302           29,291        3,235          24,744        2,433
Georgia            25,327        3,713          22,985        3,150           21,971        2,915          16,393        2,050
Florida            19,337        3,209          17,676        2,918           17,332        2,805          15,226        2,399
Nevada             15,942        3,739          15,522        3,876           15,281        3,890          14,639        3,718
Other             155,997       22,046         132,714       19,739          127,683       18,653         101,009       13,226
Total        $    608,418       84,045     $   537,342       79,814     $    510,830       76,264     $   393,921       60,693

Our strategic partnerships and alliances generated $139.3 million and $114.5 million, or 22.9% and 22.4%, of our in-force premiums as of September 30, 2013 and 2012, 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 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 Workers' Compensation Insurance Rating Bureau, 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.
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 can offer no assurance that SB 863 will result in any cost savings for us or any indication as to when, if ever, any cost savings might occur.
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 the beginning of 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 2013 across our markets will reflect:
overall net rate increases;

decelerating policy count growth; and

increasing average policy size.

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 increased 1.7% and decreased 2.5% for the three and nine months ended September 30, 2013, compared to the same periods of 2012. The increase for the third quarter of 2013 was primarily related to an increase in invested assets, partially offset by a decrease in the average pre-tax book yield on invested assets to 3.4%, compared to 3.6% for the third quarter of 2012. The decrease for the nine months ended September 30, 2013 was primarily related to a decrease in the average pre-tax book yield on invested assets to 3.5%, compared to 3.7% for the same period of 2012. The tax-equivalent yield on invested assets decreased to 4.2% at September 30, 2013, compared to 4.7% at September 30, 2012.
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 $1.1 million and $5.7 million for the three and nine months ended September 30, 2013, respectively, compared to $1.8 million and $4.6 million for the corresponding periods of 2012.
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, 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,
                                            2013           2012         2013           2012
Loss and LAE ratio                           64.3 %         73.5 %       69.2 %         73.5 %
Underwriting and other operating
expenses ratio                               19.8           22.9         20.3           25.9
Commission expense ratio                     12.1           12.6         12.4           13.1
Combined ratio                               96.2 %        109.0 %      101.9 %        112.5 %

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. Our indemnity claims frequency (the number of claims expressed as a percentage of payroll) was relatively unchanged for the three and nine months ended September 30, 2013, compared to the same periods of 2012, and our loss experience indicates a downward trend in medical and indemnity costs per claim that are reflected in our current accident year loss estimate. We believe our current accident year loss estimate is adequate; however, ultimate losses will not be known with any certainty for many years.
Overall, losses and LAE increased 9.2% and 23.2% for the three and nine months ended September 30, 2013, compared to the same periods of 2012. This increase was primarily due to higher net earned premiums in 2013. Prior accident year loss development in both periods was primarily related to our assigned risk business. Our current accident year loss estimates were 72.8% and 73.6% for the three and nine months ended September 30, 2013, compared to 77.2% and 77.0% for the three and nine months ended September 30, 2012. The decreases in our current accident year loss estimates are primarily the result of net rate increases more than offsetting increases in loss costs.
Excluding the impact from the LPT Agreement, losses and LAE would have been $119.8 million and $101.9 million, or 72.9% and 77.3% of net premiums earned, for the three months ended September 30, 2013 and 2012, respectively. For the nine months ended September 30, 2013 and 2012, losses and LAE would have been $349.4 million and $279.1 million, or 74.0% and 77.4% 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,
                                                   2013           2012         2013         2012
                                                     (in thousands)             (in thousands)
Prior accident year (unfavorable) loss
development, net                               $    (146 )     $   (227 )   $ (1,797 )   $ (1,281 )
Amortization of the Deferred Gain related to
losses                                             3,195          3,646        9,775       11,630
Amortization of the Deferred Gain related to
contingent commission                                396            293        1,184          818
Impact of the LPT Reserve Adjustment              10,112              -       10,112            -
Impact of LPT Contingent Commission
Adjustments                                          318          1,139        1,617        1,503

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 policyholder dividends, 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 3.1 and 5.6 percentage points, while our underwriting and other operating expenses increased 7.8% and 3.0% for the three and nine months ended September 30, 2013, respectively, compared to the same periods of 2012. The lower underwriting and other operating expenses ratios are primarily due to net premiums earned increasing at a faster rate than our expenses during these periods. During the three months ended September 30, 2013, our premium taxes and assessments expenses increased $2.6 million, and compensation related expenses increased $1.0 million, compared to the same period of 2012. During the nine months ended September 30, 2013, our premium taxes and assessments expenses increased $5.0 million, compensation related expenses increased $3.7 million and information technology expenses increased $1.6 million, compared to the same period of 2012. Additionally, the implementation of new accounting guidance for deferred policy acquisition costs (DAC) increased our underwriting and other operating expenses by $1.3 million and $6.5 million for the three and nine months ended September 30, 2012. Excluding the impact of the new DAC guidance in 2012, . . .

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