Employers Holdings, Inc. — Q2 2011 Form 10-Q
Business and period: Workers’ compensation insurer focused on small businesses in low- to medium-hazard industries, operating in 30 states and the District of Columbia, with significant California exposure. This filing covers the quarter and six months ended June 30, 2011; financial amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $109.5 | $99.4 | $212.8 | $200.5 |
| Net premiums earned | $88.1 | $78.2 | $170.6 | $157.5 |
| Net income | $8.3 | $16.5 | $16.6 | $32.6 |
| EPS, diluted | $0.21 | $0.39 | $0.43 | $0.76 |
| Combined ratio | 116.2% | 101.9% | 116.5% | 103.9% |
- Gross premiums written rose 41% in Q2 and 33% year to date; net premiums earned grew 12.6% and 8.3%, respectively.
- Underwriting losses were $14.3 million in Q2 and $28.2 million for the first half, versus $1.5 million and $6.1 million in the comparable 2010 periods. The first-half loss and LAE ratio increased to 72.5% from 54.3%; the expense ratio was 30.4% versus 36.4%.
- Net investment income declined to $20.3 million in Q2 and $40.8 million for the first half, from $20.6 million and $41.9 million. Net realized investment gains were $1.1 million and $1.3 million, respectively.
- Income taxes were benefits of $2.0 million in Q2 and $4.4 million year to date, compared with expenses of $1.6 million and $1.1 million in 2010. Management attributed the benefits primarily to tax-exempt interest and the LPT Agreement.
- Six-month operating cash flow was $12.7 million, compared with cash used of $9.8 million in 2010. Investing provided $94.3 million, largely reflecting investment-sale proceeds; financing used $24.9 million, mainly for share repurchases and dividends. Cash and cash equivalents were $201.9 million at June 30.
Financial position and capital
- Total assets were $3.50 billion and stockholders’ equity was $498.7 million at June 30, 2011, compared with $3.48 billion and $490.1 million at year-end 2010.
- Investments totaled $2.02 billion at fair value, including $1.93 billion in fixed maturities. The portfolio’s average quality was AA; 73.1% of fixed maturities were rated AA or better. Unrealized investment gains after tax contributed to accumulated other comprehensive income of $99.3 million.
- Gross unpaid losses and LAE were $2.26 billion, with $936.6 million of reinsurance recoverables and $1.32 billion net reserves. Notes payable were $132.0 million: $100.0 million outstanding under the credit facility and $32.0 million in surplus notes. The company reported compliance with credit-facility covenants.
- Management’s supplemental stockholders’ equity measure including the deferred LPT gain was $860.3 million. The company repurchased $21.1 million of shares and paid $4.6 million in dividends during the first half; shares outstanding declined to 37.9 million.
Changes, outlook and risks
- Profitability weakened materially year over year as losses and LAE rose 42% in Q2 and 45% in the first half. Management cited higher earned premiums, the absence of substantial favorable prior-year development seen in 2010, and higher current-accident-year loss estimates. Prior-period development was unfavorable by $0.5 million in the first half of 2011, versus favorable development of $16.6 million in 2010.
- Current-accident-year loss estimates increased to 78.0% for Q2 and 77.3% for the first half, from 70.2% and 70.3%. Management cited rising California medical and indemnity costs, increased indemnity claim frequency, and higher claims costs in other states, partly offset by favorable long-term trends in Nevada. Ultimate reserve adequacy remains uncertain.
- Management said the economic recovery and employment trends remained uncertain and did not expect significant near-term improvement. It expected 2011 premium revenue to reflect rate changes, policy-count growth, lower average policy size, competition, and lingering recession effects. No earnings or revenue guidance was provided.
- California’s WCIRB reported a 39.8% cumulative increase in its claims-cost benchmark since January 2009; management had increased filed California rates cumulatively by 33.3% since February 2009 and listed a further 3.9% increase effective September 15, 2011.
- A new reinsurance program effective July 1, 2011 provides $195 million of coverage excess of a $5 million per-occurrence retention, subject to a $2 million annual aggregate deductible and exclusions. Investment-market risks include interest-rate, credit, and equity-price exposure; the fixed-maturity portfolio duration was 4.85 years. Management reported no material change in market risk since year-end.
- The LPT Agreement covers legacy claims incurred before July 1, 1995. Its remaining deferred gain was $361.6 million and is amortized into loss expense; management noted it does not provide ongoing cash benefits. Management reported no material change in risk factors, no off-balance-sheet arrangements, and no expected material effect from ordinary-course litigation.
Important facts for investors to verify
- Whether the higher current-year loss estimates and deterioration in California claims trends persist, and how they affect reserves and combined ratios.
- Actual prior-year reserve development in subsequent periods, including assigned-risk business, and the adequacy and collectability of reinsurance recoverables.
- Whether premium growth and rate increases keep pace with claims inflation, competitive pressures, and policy-size changes.
- The sustainability of earnings excluding the tax benefit and the amortization of the nonrecurring LPT deferred gain; the filing’s reported results include both items.
- Liquidity available at the holding company, limits on subsidiary dividends, debt obligations, and capital returned through repurchases and dividends.