Employers Holdings, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; unaudited. Employers Holdings provides workers’ compensation insurance, primarily to small businesses, through its insurance subsidiaries in 31 states and the District of Columbia, with significant concentration in California.
Financial results and position
| Metric | Q1 2012 | Q1 2011 / prior date |
|---|---|---|
| Net premiums earned | $109.9 million | $82.4 million |
| Total revenue | $130.1 million | $103.3 million |
| Net investment income | $18.4 million | $20.5 million |
| Net realized investment gains | $1.8 million | $0.2 million |
| Net income | $6.2 million; $0.19 diluted EPS | $8.3 million; $0.21 diluted EPS |
| Operating cash flow | $24.4 million | $5.3 million |
| Cash and cash equivalents | $201.6 million | $252.3 million at Dec. 31, 2011 |
| Total investments | $2.006 billion | $1.951 billion at Dec. 31, 2011 |
| Total assets | $3.506 billion | $3.482 billion at Dec. 31, 2011 |
| GAAP stockholders’ equity | $465.7 million | $474.2 million at Dec. 31, 2011 |
| Notes payable | $122.0 million | $122.0 million at Dec. 31, 2011 |
- The combined ratio was 116.0%, versus 116.9%; the company recorded an underwriting loss of $17.5 million, compared with $14.0 million. A ratio above 100% indicates underwriting losses before investment income.
- Net premiums earned rose 33%, and gross premiums written increased 38%. In-force premiums grew 32.6% year over year; policy count rose 38.7%.
- Losses and loss adjustment expenses rose 36% to $80.9 million. The loss and LAE ratio increased to 73.6% from 72.1%. The filing reports $0.5 million of favorable prior-year loss development, entirely from assigned-risk business.
- Net investment income declined 10.3%, reflecting purchase timing and a lower average pre-tax book yield, 4.1% versus 4.3%. Net income fell despite revenue growth, as underwriting expenses increased and investment income declined; a larger income tax benefit partly offset these effects.
- Net cash decreased $50.7 million, primarily reflecting investment purchases and $18.7 million of share repurchases. Dividends paid were $1.9 million.
Changes, outlook, and management commentary
- Management attributed premium growth chiefly to increasing policy count and execution of its growth strategy. Strategic partnerships generated 23.6% of in-force premiums, up from 22.0% a year earlier.
- Management expects 2012 premiums to reflect rate increases, continued policy-count growth, increasing average policy size, and reduced competitive pressure. It cautioned that economic recovery remained slow and near-term conditions were not expected to change significantly.
- California loss costs are a key concern. Management cited rising medical and indemnity costs and increased indemnity claim frequency in California, with improving loss-cost trends in Nevada partly offsetting increases in other states. The company reported cumulative California filed rate increases of 41.3% since February 2009, including a 6% increase scheduled for policies effective June 15, 2012. Separately, the WCIRB recommended an advisory pure-premium increase of 4.1% effective July 1, 2012.
- A new accounting standard for policy acquisition costs reduced Q1 capitalized costs by $3.6 million versus the prior method, while reducing amortization expense by $0.6 million. Its net effect increased Q1 underwriting and other operating expenses by $3.0 million. The company expects approximately $7 million of increased operating expenses for 2012 from adoption.
- The company amortized $4.2 million of deferred gain under its legacy loss portfolio transfer (LPT) reinsurance agreement in Q1. The remaining deferred gain was $349.0 million; estimated remaining liabilities covered by the agreement were $798.0 million. Management also presented non-GAAP net income before the Deferred Gain impact of $2.1 million, down from $3.8 million.
- At March 31, the holding company reported $146.3 million of cash and cash equivalents and fixed maturities maturing within 24 months. Insurance subsidiaries had $272.8 million of cash and fixed maturities maturing within 24 months. Management said anticipated liquidity needs over that horizon would be met from cash, maturities, operating cash flow, investment income, and subsidiary dividends, subject to regulatory limits.
- Debt comprised $90 million outstanding under a secured credit facility and $32 million of surplus notes. The company reported compliance with applicable credit covenants. Its reinsurance program provided $195 million of per-occurrence coverage above a $5 million retention, subject to a $2 million annual aggregate deductible and exclusions.
- Investment portfolio fair value was $2.006 billion, with 93.8% in fixed maturities. The fixed-maturity portfolio had a 4.3 duration and weighted-average quality of AA; 0.2% was below investment grade. Management reported no material change in market risk from year-end.
- Management identified estimates of unpaid losses and LAE, reinsurance recoverables, premium recognition, deferred taxes, investments, and goodwill and intangible assets as important judgment areas. It said pending and threatened litigation was not expected to materially affect results, liquidity, or financial position; no material changes to previously disclosed risk factors were reported. Disclosure controls were deemed effective.
Important facts for investors to verify
- Whether premium growth can be sustained while improving the combined ratio and underwriting profitability.
- Actual claims frequency, medical and indemnity cost trends, and reserve development—particularly in California and assigned-risk business.
- The adequacy and collectability of reinsurance recoverables, including the LPT agreement and the current excess-of-loss program.
- Whether investment income and portfolio yields can stabilize, and the effects of interest-rate, credit, and equity-market movements.
- The realized effect of the acquisition-cost accounting change on full-year expenses and earnings.
- Cash availability at the holding company, regulatory limits on subsidiary dividends, debt repayment terms, and continued share repurchases.
- The relationship between GAAP results and management’s non-GAAP measures, including the Deferred Gain adjustment.