Employers Holdings, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. The company provides workers’ compensation insurance, primarily to small businesses, across 42 states and the District of Columbia; California generated 54% of in-force premiums. Financial statements are unaudited.
Key financial results
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net premiums earned | $178.0 million | $171.7 million | $354.6 million | $347.1 million |
| Total revenues | $204.1 million | $193.2 million | $392.0 million | $389.5 million |
| Net income | $42.5 million | $24.8 million | $68.1 million | $48.0 million |
| Diluted EPS | $1.28 | $0.75 | $2.05 | $1.46 |
| Underwriting income | $25.6 million | $11.5 million | $44.0 million | $20.5 million |
| Combined ratio | 85.6% | 93.3% | 87.6% | 94.1% |
- Q2 loss and LAE ratio was 49.3% versus 61.8%; first-half ratio was 51.7% versus 61.9%. Commission and operating expense ratios increased: Q2 commission ratio was 13.8% and operating expense ratio 22.5%.
- Net investment income rose to $20.3 million in Q2 and $39.7 million in the first half, from $18.2 million and $36.9 million, respectively. Average pre-tax book yield was 3.29%, up from 3.12% a year earlier.
- Net realized and unrealized investment results were a $5.7 million gain in Q2, versus $1.1 million, but a $2.4 million loss for the first half, versus a $3.3 million gain. First-half results included $9.4 million of unrealized equity-security losses and $2.0 million of fixed-maturity impairments.
- Operating cash flow was $86.2 million for the first half, versus $42.6 million. Investing cash flow was positive $3.2 million, versus negative $52.0 million; financing cash use was $16.4 million. Cash, cash equivalents and restricted cash increased $73.0 million to $147.3 million.
Financial position and liquidity
- At June 30, total assets were $3.87 billion, total liabilities $2.91 billion, and stockholders’ equity $956.5 million. Investments totaled $2.61 billion. Unpaid losses and LAE were $2.23 billion; reinsurance recoverable on unpaid losses was $512.5 million.
- Cash and investments at the holding company totaled $101.1 million; operating subsidiaries held $2.65 billion. Management said subsidiary liquidity needs over the next 24 months were expected to be met by operations, investment income and maturing investments.
- Notes payable were $20.0 million, comprising two surplus notes due in 2034; interest and principal payments are subject to regulatory approval. No advances were outstanding under the FHLB facility. The filing reports $41.0 million of total scheduled notes-payable obligations including estimated interest.
- The board declared a $0.20 per-share dividend payable August 22, 2018. A $50 million repurchase authorization was in place; $0.4 million had been used through June 30.
- Fixed maturities were 92% of the investment portfolio and had a duration of 4.4. The portfolio’s weighted average credit quality was AA-; 0.4% was below investment grade. Securities on deposit with states totaled $954.4 million, with $140 million of letters of credit issued in lieu of California deposits.
Material changes and management commentary
- Gross premiums written were $186.4 million for Q2 and $398.0 million for the first half, compared with $184.5 million and $382.1 million. Growth reflected higher new-business policy counts, partly offset by lower average rates and declines in renewal business. Renewal pricing was down 9.7% year over year.
- Management attributed improved underwriting results chiefly to favorable prior-year loss development: $16.5 million in Q2 and $28.9 million in the first half, primarily on voluntary business and accident years 2015–2017. The company linked favorable trends partly to accelerated claims settlement initiatives. Current accident-year loss ratio was 62.5%, compared with 63.8%.
- Management identified $22.7 million of Q2 and $22.2 million of first-half pretax income effects from specified items, including favorable prior-year development, LPT adjustments and equity-security fair-value changes. The Tax Cuts and Jobs Act also reduced the statutory tax rate to 21%; effective tax rates were 17.2% for Q2 and 15.6% for the first half.
- Underwriting and operating expense ratios rose, with management citing increased compensation, bad-debt expense, professional fees and premium taxes, largely associated with investment in digital capabilities. The commission ratio also rose, partly due to higher incentive commissions and growth in partnership-channel business.
- GAAP equity was $956.5 million, while management’s non-GAAP adjusted stockholders’ equity was $1.12 billion. Adoption of an accounting standard for equity securities moved $74.0 million, net of tax, from accumulated other comprehensive income to retained earnings; first-half market changes also reduced accumulated other comprehensive income.
Outlook, contingencies and risks
- No specific earnings or premium guidance was provided. Management said it believed disciplined underwriting, claims initiatives and the balance sheet positioned the company for the current market cycle, while acknowledging competitive conditions and declining renewal pricing.
- A proposed acquisition of PartnerRe Insurance Company of New York remained subject to closing conditions, including New York regulatory approval. Expected consideration was approximately $40 million of statutory capital and surplus at closing plus $5.8 million, funded with cash on hand. The seller agreed to indemnify pre-closing liabilities; the company would acquire no employees or ongoing operations.
- A new reinsurance program effective July 1, 2018 provides $190 million of coverage above a $10 million per-occurrence retention, subject to exclusions. The company considers its reinsurance program and capitalization adequate.
- Key uncertainties include estimates of unpaid claims and reinsurance recoverables, future severity and frequency of claims, investment valuation and interest-rate or equity-market movements. Management noted a slight first-half increase in medical and indemnity costs per claim and cautioned that ultimate losses may not be known for years.
- The LPT Agreement covers legacy claims and includes a remaining deferred gain of $154.7 million and estimated remaining covered liabilities of $420.3 million. Ordinary-course litigation was not expected by management to materially affect results, liquidity or financial position. No material changes to previously disclosed risk factors or market risks were reported.
Important facts for investors to verify
- How much of earnings and the lower combined ratio reflects repeatable current-year underwriting versus favorable prior-year reserve development and LPT-related adjustments.
- Whether claim severity, medical costs and renewal pricing remain consistent with management’s assumptions, particularly in California.
- The drivers and potential persistence of investment gains and losses, including unrealized equity volatility and fixed-maturity impairments.
- Closing status, final purchase price and regulatory approval for the PartnerRe Insurance Company of New York acquisition.
- Capital and liquidity availability after dividends, subsidiary dividend restrictions, collateral requirements, and any use of the share-repurchase authorization.