Employers Holdings, Inc. — Q3 2012 Form 10-Q
Business and period: Workers’ compensation insurer serving small businesses in 31 states and the District of Columbia, with more than half of its business in California. This unaudited filing covers the three and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods unless stated otherwise. Amounts below are in millions except per-share data and ratios.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenues | $151.1 | $112.9 | $419.6 | $325.7 |
| Net premiums earned | $131.8 | $92.6 | $360.6 | $263.2 |
| Net investment income | $17.5 | $19.6 | $54.2 | $60.4 |
| Net income | $8.2 | $11.8 | $19.4 | $28.4 |
| Diluted EPS | $0.26 | $0.31 | $0.61 | $0.74 |
| Combined ratio | 108.7% | 112.9% | 112.4% | 115.3% |
| Underwriting result | $(11.5) | $(12.0) | $(44.8) | $(40.2) |
Premium growth reflected increased policy count and rate: gross premiums written rose 41% in Q3 and 40% year to date; net premiums earned rose 42% and 37%, respectively. The Q3 and year-to-date combined ratios improved, but remained above 100%, indicating underwriting losses before investment income. Loss and LAE ratios were 74.6% and 74.2%, versus 72.8% and 72.6%. Net investment income fell 11% and 10%, respectively, as average pretax book yields declined to 3.6% and 3.7% from 4.0% and 4.1%. Realized investment gains increased to $1.8 million for Q3 and $4.6 million year to date.
Cash from operations was $90.9 million for the first nine months, versus $36.0 million a year earlier. Investing used $52.7 million, while financing used $47.3 million, primarily for share repurchases and dividends; cash declined $9.1 million to $243.2 million. The company declared dividends of $0.06 per share for Q3 and $0.18 year to date.
Financial position and liquidity
- At September 30, total assets were $3.59 billion, total liabilities $3.11 billion, and GAAP stockholders’ equity $473.2 million. Equity including the unamortized LPT deferred gain, a company-defined non-GAAP measure, was $814.8 million.
- Investments totaled $2.03 billion at fair value, including $1.91 billion of fixed maturities. The fixed-income portfolio had a 4.1-year duration and an AA weighted-average quality; 0.1% was below investment grade. Unrealized investment gains, net of tax, contributed $139.7 million to accumulated other comprehensive income.
- Notes payable were $122.0 million: $90.0 million on the credit facility and $32.0 million in surplus notes. Debt was 13.0% of capitalization including the LPT deferred gain. The company reported compliance with debt covenants. Holding-company cash and near-term fixed-maturity maturities totaled $90.2 million; the corresponding subsidiary amount was $392.8 million. Some assets are pledged, deposited with states, or held in trust.
- The company repurchased $41.4 million of stock in the first nine months. Since the program began, it had repurchased 9.4 million shares for $148.4 million; $51.6 million remained authorized at quarter-end.
Changes, outlook, and risks
- Net income declined despite higher premiums, in part because losses and LAE grew with the larger book of business and investment income decreased. Nine-month underwriting losses widened to $44.8 million from $40.2 million.
- A change in the guaranty-fund assessment estimate reduced the liability by $2.9 million, with related asset adjustments; the net effect increased nine-month net income by $1.2 million, or $0.04 per share.
- New acquisition-cost accounting increased underwriting and other operating expense by $1.3 million in Q3 and $6.5 million year to date. Management expected approximately $7 million of additional expense for full-year 2012 from this guidance.
- The company expects 2012 premiums to reflect rate increases, growth in policy count and average policy size, and lessened competitive pressure. It reported cumulative California filed rate increases of 41.3% since February 2009. The WCIRB’s October 2012 amended advisory filing proposed no increase above the July 2012 industry-average filed rate, citing uncertainty around California’s newly enacted SB 863 and potential savings. The company said savings depend on implementation and were not included in its current rate filings.
- Management cited rising California indemnity claim frequency and medical and indemnity costs; prior-period reserve development in the first nine months was adverse by $1.3 million and related entirely to assigned-risk business. Management considers current accident-year reserves adequate, while noting ultimate losses may not be known for years. Low investment yields and persistently high unemployment were also cited as ongoing pressures.
- The LPT Agreement continues to provide coverage for specified pre-July 1995 claims. Its remaining deferred gain was $341.6 million; management notes this accounting amortization does not create ongoing cash benefits. The filing reports no material change in market risk, no material change in risk factors, and no off-balance-sheet arrangements. Pending or threatened litigation was not expected by management to materially affect results, liquidity, or financial position.
Important facts for investors to verify
- Whether premium growth and California rate actions keep pace with claim frequency, severity, and reserve development.
- How California SB 863 is implemented and whether it produces the cost savings assumed in future pricing.
- The sustainability of underwriting improvement, given combined ratios above 100% and continued reserve uncertainty.
- Investment yield, portfolio valuations, and the effect of interest-rate or credit changes on investment income and capital.
- How the LPT Agreement, acquisition-cost accounting, and the guaranty-fund estimate affect reported earnings versus ongoing operating performance.
- Holding-company liquidity, subsidiary dividend capacity, collateral restrictions, and capital allocation through repurchases and dividends.