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EIG > SEC Filings for EIG > Form 10-Q on 1-May-2014All Recent SEC Filings

Show all filings for EMPLOYERS HOLDINGS, INC.

Form 10-Q for EMPLOYERS HOLDINGS, INC.


1-May-2014

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, 2013 (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 $10.8 million and $7.5 million for the three months ended March 31, 2014 and 2013, respectively. We recognized underwriting losses of $8.5 million and $10.2 million for the three months ended March 31, 2014 and 2013, respectively. 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 months ended March 31, 2014, compared to the same period of 2013, include:
Gross premiums written increased 6.3%;

Net premiums earned increased 13.0%;

Losses and LAE increased 12.9%;


Underwriting and other operating expenses increased 5.6%; and

Income taxes increased $1.5 million.

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. The following table shows our stockholders' equity including the Deferred Gain, stockholders' equity on a GAAP basis, and number of common shares outstanding.

                                                         March 31, 2014        December 31, 2013
                                                           (in thousands, except share data)
Stockholders' equity including the Deferred Gain(1)   $          833,058     $           817,775
GAAP stockholders' equity                             $          587,861     $           568,703
Common shares outstanding                                     31,375,759              31,299,930

(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
                                                                 March 31,
                                                          2014               2013
                                                             (in thousands)
Gross premiums written                              $      186,018     $      174,963
Net premiums written                                       183,250            172,026

Net premiums earned                                 $      167,154     $      147,975
Net investment income                                       18,013             17,405
Net realized gains on investments                            3,259                794
Other income                                                    55                103
Total revenues                                             188,481            166,277

Losses and LAE                                             122,256            108,272
Commission expense                                          20,075             18,393
Underwriting and other operating expenses                   33,301             31,540
Interest expense                                               778                808
Income tax expense (benefit)                                 1,318               (226 )
Total expenses                                             177,728            158,787
Net income                                          $       10,753     $        7,490
Less amortization of the Deferred Gain related to
losses                                              $        2,886     $        3,305
Less amortization of the Deferred Gain related to
contingent commission                                          400                382
Less impact of LPT Reserve Adjustments(1)                      679                  -
Less impact of LPT Contingent Commission
Adjustments(2)                                                 334                275
Net income before impact of the LPT Agreement(3)    $        6,454     $        3,528

(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 statements 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 statements 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 13.0% for the three months ended March 31, 2014, compared to the corresponding period in 2013. This increase was 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 premiums, policy count, average policy size, payroll exposure upon which our premiums are based, and net rate overall and for California, where 60% of our premiums are generated:

                                                             As of March 31, 2014
                                            Year-to-Date Increase           Year-Over-Year Increase
                                          Overall         California        Overall         California
In-force premiums                            2.1 %             2.7 %          12.5 %            14.0 %
In-force policy count                        1.5               1.5             4.8               3.0
Average in-force policy size                 0.6               1.2             7.3              10.7
In-force payroll exposure                    1.3               1.3             5.6               3.8
Net rate(1)                                  0.8               1.4             6.5               9.8

(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:

                      March 31, 2014            December 31, 2013             March 31, 2013            December 31, 2012
                  In-force      Policies      In-force       Policies     In-force      Policies      In-force       Policies
    State         Premiums      In-force      Premiums       In-force     Premiums      In-force      Premiums       In-force
                                                            (dollars in thousands)
California       $ 377,807       48,732     $   367,813       48,032     $ 331,361       47,300     $   317,890       46,829
Illinois            30,380        3,152          30,795        3,184        30,915        3,246          30,555        3,302
Georgia             25,439        3,865          25,565        3,762        24,110        3,354          22,985        3,150
Florida             21,597        3,549          19,897        3,270        18,199        3,034          17,676        2,918
North Carolina      15,227        2,131          15,615        2,112        13,809        1,846          12,421        1,629
Other              159,717       23,872         157,739       23,696       141,861       22,604         135,815       21,986
Total            $ 630,167       85,301     $   617,424       84,056     $ 560,255       81,384     $   537,342       79,814

Our strategic partnerships and alliances generated $146.2 million and $126.7 million, or 23.2% and 22.6%, of our in-force premiums as of March 31, 2014 and 2013, 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. At this point, we do not anticipate any cost savings associated with SB 863.


Our net rate (total in-force premiums divided by total insured payroll exposure) increased 1.4% in California during the three months ended March 31, 2014. Pricing in California reflects schedule rating, changes to filed rates, and experience modifiers. We will begin leveraging territorial multipliers and multiple insurance subsidiaries, each with different rate filings, to provide additional pricing options in California for policies incepting on or after June 1, 2014.
We expect that total premiums in 2014 across our markets will reflect:
overall net rate increases;

increasing average policy size; and

stable policy count growth, compared to 2013.

Net Investment Income and Net Realized Gains on Investments 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 3.5% for the three months ended March 31, 2014, compared to the same period of 2013. This increase 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 3.3%, compared to 3.5% for the first quarter of 2013. The tax-equivalent yield on invested assets decreased to 4.0% at March 31, 2014, compared to 4.3% at March 31, 2013.
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 $3.3 million and $0.8 million for the three months ended March 31, 2014 and 2013, respectively.
Additional information regarding our Investments is set forth under "-Liquidity and Capital Resources-Investments."
Combined Ratio
The combined ratio, a key measurement of underwriting profitability, 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 have recorded an underwriting loss and 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
                                                         March 31,
                                                     2014         2013
Loss and LAE ratio                                   73.1 %        73.2 %
Underwriting and other operating expenses ratio      20.0          21.3
Commission expense ratio                             12.0          12.4
Combined ratio                                      105.1 %       106.9 %

Loss and LAE Ratio. 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) has decreased year-over-year; however, our loss experience indicates an upward trend in medical and indemnity costs per claim that are reflected in our current accident year loss estimate. Specifically, we experienced increased costs associated with claims litigation driven by a nearly 15 percentage point increase in the number of claims that are in litigation in our Southern California operations for the three months ended March 31, 2014, compared to the same period of 2013; however, the increase in the number of claims that are in litigation in our Southern California operations was less than one percentage point as of March 31, 2014, compared to December 31, 2013. 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.
Our loss and LAE ratio decreased 0.1 percentage points, while our losses and LAE increased 12.9% for the three months ended March 31, 2014, compared to the same period of 2013. Our current accident year loss estimates were 74.7% and 75.1% for the three months ended March 31, 2014 and 2013, respectively. The decrease in our current accident year loss estimate was primarily the result of net rate increases more than offsetting anticipated increases in loss costs. Prior accident year loss development in both periods was primarily related to our assigned risk business.
Excluding the impact from the LPT Agreement, losses and LAE would have been $126.6 million and $112.2 million, or 75.7% and 75.8% of net premiums earned, for the three months ended March 31, 2014 and 2013, respectively. The table below reflects the losses and LAE reserve adjustments.

                                                            Three Months Ended
                                                                March 31,
                                                        2014                  2013
                                                              (in thousands)
Prior accident year (unfavorable) loss
development, net                                 $          (1,751 )   $         (1,130 )
Amortization of the Deferred Gain related to
losses                                                       2,886                3,305
Amortization of the Deferred Gain related to
contingent commission                                          400                  382
Impact of LPT Reserve Adjustments                              679                    -
Impact of LPT Contingent Commission
Adjustments                                                    334                  275

Underwriting and Other Operating Expenses Ratio. The underwriting and other operating expenses ratio is the ratio 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 1.3 percentage points, while our underwriting and other operating expenses increased 5.6% for the three months ended March 31, 2014, compared to the same period of 2013. The lower underwriting and other operating expenses ratios are primarily due to net premiums earned increasing at a faster rate than our expenses. During the three months ended March 31, 2014, our premium taxes and assessments expenses increased $1.0 million, and IT related expenses increased $0.9 million, compared to the same period of 2013.
Commission Expense Ratio. The commission expense ratio is the ratio of commission expense to net premiums earned and measures the cost of compensating agents and brokers for the business we have underwritten.
Commission expense includes direct commissions to our agents and brokers for the premiums that they produce for us, as well as incentive payments, other marketing costs, and fees.
Our commission expense ratio decreased 0.4 percentage points, while our commission expense increased 9.1% for the three months ended March 31, 2014, compared to the same period of 2013. This increase was primarily due to higher net premiums earned.
Income Tax Expense (Benefit)
Income tax expense (benefit) was $1.3 million and $(0.2) million for the three months ended March 31, 2014 and 2013, respectively. The effective tax rates were 10.9% and (3.1)% for three months ended March 31, 2014 and 2013, respectively. The increased tax expense for the three months ended March 31, 2014, compared to the same period of 2013, was primarily due to a decrease in tax exempt income as a percentage of pre-tax net income and increased in projected annual net income before taxes.
Liquidity and Capital Resources
Parent Company
Operating Cash and Cash Equivalents. We are a holding company and our ability to fund our operations is contingent upon existing capital and the ability of our insurance subsidiaries' to pay dividends up to the holding company. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws and regulations, including laws establishing minimum solvency


and liquidity thresholds. We require cash to pay stockholder dividends, repurchase common stock, make interest and principal payments on our outstanding debt obligations, provide additional surplus to our insurance subsidiaries, and fund our operating expenses.
The holding company had $51.9 million of cash and cash equivalents and fixed maturity securities maturing within the next 24 months at March 31, 2014. Principal payments of $10 million and $60 million on our line of credit are payable on December 31, 2014 and 2015, respectively. We believe that the liquidity needs of the holding company over the next 24 months will be met with cash, investments, and dividends from our insurance subsidiaries. Outstanding Debt. In December 2010, we entered into the Third Amended and Restated Credit Agreement with Wells Fargo (Amended Credit Facility) under which we were provided with: (a) $100.0 million line of credit through December 31, 2011; (b) $90.0 million line of credit from January 1, 2012 through December 31, 2012; (c) $80.0 million line of credit from January 1, 2013 through December 31, 2013; (d) $70.0 million line of credit from January 1, 2014 through December 31, 2014; and (e) $60.0 million line of credit from January 1, 2015 through December 31, 2015. Amounts outstanding bear interest at a rate equal to, at our option: . . .

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