Employers Holdings, Inc. — 2016 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2016, not a standalone fourth quarter. Employers Holdings provides workers’ compensation insurance to small businesses in low- to medium-hazard industries, operating in 36 states and the District of Columbia. California generated 56% of in-force premiums. The company operates as one reportable segment.
Financial performance and position
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Total revenues | $779.8 million | $752.1 million | Up 3.7% |
| Net premiums earned | $694.8 million | $690.4 million | Up 0.6% |
| Net premiums written | $694.6 million | $689.3 million | Up 0.8% |
| Net investment income | $73.2 million | $72.2 million | Up 1.4% |
| Net realized investment gains (losses) | $11.2 million | $(10.7) million | Improved |
| Net income | $106.7 million | $94.4 million | Up 13.0% |
| Diluted EPS | $3.24 | $2.90 | Up 11.7% |
| Combined ratio | 91.8% | 94.1% | Improved 2.3 points |
| Operating cash flow | $122.8 million | $116.4 million | Up $6.4 million |
The combined ratio below 100% indicates an underwriting profit. Underwriting income rose to $57.3 million from $40.4 million. The loss and LAE ratio improved to 60.1% from 62.2%; expense and commission ratios were 19.7% and 12.0%, respectively.
At year-end, total assets were $3.77 billion, investments were $2.55 billion, cash and cash equivalents were $67.2 million, and stockholders’ equity was $840.6 million. Unpaid losses and LAE were $2.30 billion gross and $1.72 billion net of reinsurance. Notes payable totaled $32.0 million, comprising surplus notes due in 2034; principal and interest payments require Florida regulatory approval. The company reported no revolving credit facility and no off-balance-sheet arrangements.
Insurance subsidiaries held $828.9 million of statutory surplus and exceeded applicable risk-based capital requirements. Holding-company cash and investments totaled $57.3 million. The company reported $122.8 million of operating cash flow, while investing and financing activities used $88.6 million and $23.6 million, respectively.
Changes versus prior year and unusual items
- Net income increased despite only modest premium growth, supported by improved underwriting results and a swing from realized investment losses to gains.
- Prior-year accident-year claims developed favorably by $18.4 million in 2016, versus $7.2 million in 2015. The company attributed this partly to accelerated claims settlements.
- LPT Agreement reserve and contingent-commission adjustments added $4.9 million to pretax income in 2016; related deferred-gain amortization reduced losses and LAE by a further $11.7 million. Management’s non-GAAP net income excluding all LPT impacts was $90.1 million, versus $74.0 million in 2015.
- Income tax expense increased to $34.0 million from $5.0 million; the effective tax rate rose to 24.2% from 5.0%. The 2015 rate benefited from reserve reallocations from pre-2000 nontaxable periods; no such reallocation was made in 2016. Early adoption of a stock-compensation accounting update reduced 2016 tax expense by $1.4 million, or $0.04 per diluted share.
- Shareholders’ equity increased to $840.6 million from $760.8 million. The company repurchased $21.1 million of shares and paid $11.5 million in dividends in 2016; declared dividends were $0.36 per share for the year.
Outlook, commentary and key risks
The filing provides no specific earnings, revenue, or premium guidance. Management described its priorities as disciplined underwriting, claims settlement, geographic diversification, territory-specific pricing, and data-driven selection of business. Technology investments are expected to increase depreciation expense beginning in 2018, which management expects to be largely offset by future efficiency gains. The Board declared a $0.15-per-share dividend payable in March 2017.
- Claims reserves: Estimates are inherently uncertain and sensitive to medical and indemnity cost inflation, claim development, and legislative or judicial changes. Management estimated that a 1% increase in medical-cost inflation above the rate embedded in reserves would increase future medical costs on current claims by approximately $88 million net of reinsurance.
- Geographic and distribution concentration: California represented 56% of in-force premiums. ADP generated 12.4%; its agreement can be terminated by either party on 120 days’ notice. Restaurants accounted for 25.8% of in-force premiums.
- Reinsurance: The current program provides $190 million of per-occurrence coverage above a $10 million retention, subject to exclusions, through June 30, 2017. The company remains liable to policyholders if reinsurers do not pay. LPT-related estimated remaining liabilities were $465.5 million, supported by $355.7 million of trust assets at year-end.
- Market and investment risks: Management cited competitive pricing pressure and rising average medical and indemnity costs. A hypothetical 100-basis-point increase in interest rates would reduce the fair value of fixed-maturity and short-term investments by an estimated $101.9 million pretax.
- Other risks and contingencies: Risks include regulatory and rate restrictions, catastrophe and terrorism exposure, cyber and systems disruptions, and dependence on subsidiary dividends subject to regulatory limits. Management did not expect pending or threatened litigation to have a material effect; scheduled 2015–2016 insurance regulatory examinations had no material findings.
The company and its auditor reported effective internal control over financial reporting, and the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- How much of 2016 earnings growth is repeatable after separating favorable prior-year reserve development, LPT effects, investment gains, and the unusual tax comparison with 2015.
- Whether recent favorable claims experience persists, particularly given rising claim costs and the sensitivity of reserves to medical inflation.
- The adequacy and collateralization of LPT recoverables, including the decline in trust assets from $1.45 billion in 2015 to $355.7 million in 2016, and the status of the $465.5 million estimated remaining LPT liabilities.
- Whether geographic diversification can continue while California remains the largest market, and whether ADP distribution and restaurant-class exposures remain within management’s risk appetite.
- The renewal terms and cost of reinsurance after June 30, 2017, and the effect of statutory restrictions on the parent company’s ability to fund dividends and repurchases.