Employers Holdings, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; unaudited. The company provides workers’ compensation insurance to small businesses in 43 states and the District of Columbia, with 54% of in-force premiums in California.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net premiums earned | $192.9 million | $187.9 million | $547.5 million | $535.0 million |
| Total revenues | $228.9 million | $210.9 million | $621.0 million | $600.4 million |
| Net income | $47.6 million | $21.9 million | $115.7 million | $69.9 million |
| Diluted earnings per share | $1.43 | $0.66 | $3.48 | $2.12 |
| Underwriting income | $22.7 million | $13.7 million | $66.6 million | $34.2 million |
| Combined ratio | 88.2% | 92.7% | 87.8% | 93.6% |
| Operating cash flow | Not reported separately for the quarter | $133.1 million | $103.8 million |
Q3 net premiums written were $187.3 million, versus $177.6 million; nine-month net premiums written were $582.5 million, versus $556.8 million. Net investment income was $20.2 million in Q3 and $59.9 million year to date, up 9.2% and 8.1%, respectively. The average pre-tax book yield on invested assets was 3.30%, compared with 3.12% a year earlier.
Financial condition and liquidity
- At September 30, 2018, total assets were $3.90 billion, total liabilities $2.91 billion, and GAAP stockholders’ equity $991.2 million. Adjusted stockholders’ equity, a company-defined non-GAAP measure, was $1.17 billion, versus $1.00 billion at year-end 2017.
- Cash and cash equivalents were $203.0 million, plus $2.0 million restricted cash. Nine-month cash flow was $133.1 million from operations, $19.9 million from investing activities, and negative $22.3 million from financing activities.
- Unpaid losses and loss adjustment expenses were $2.23 billion gross, with $511.8 million of reinsurance recoverables. Fixed maturity securities had a fair value of $2.39 billion; total investments were $2.59 billion.
- Notes payable totaled $20.0 million, consisting of two surplus notes due in 2034. No advances were outstanding under the Federal Home Loan Bank facility. The company reported $140.2 million of cash and investments at the holding company.
- Dividends paid were $19.9 million in the first nine months. The board declared a further $0.20-per-share dividend payable November 21, 2018. A $50 million share repurchase authorization runs through February 2020; $0.4 million had been repurchased through September 30.
Material changes and unusual items
- Net income increased substantially year over year, but benefited from favorable prior-year loss development of $11.9 million in Q3 and $40.8 million year to date. Management attributed the development primarily to favorable loss-cost trends and accelerated claims settlement efforts.
- Q3 results also included $11.2 million of unrealized gains on equity securities. Nine-month results included $1.8 million of such gains, $11.4 million of net realized investment gains, and $2.0 million of fixed-maturity impairments. Beginning in 2018, equity-security fair-value changes flow through earnings under adopted accounting guidance.
- Management estimated that the favorable reserve development, LPT adjustments, and equity-security unrealized gains together increased pre-tax income by $23.1 million in Q3 and $45.3 million for the nine months. The lower 2018 statutory tax rate under the Tax Cuts and Jobs Act also reduced the effective tax rate: 18.4% for Q3 and 16.8% year to date, versus 24.2% and 23.2% in 2017.
- Renewal pricing decreased 14.1% year over year in both the quarter and year-to-date periods. Gross premiums written nevertheless increased, primarily because of new business growth, higher policy counts, and payroll exposure, partly offset by lower average rates.
- Underwriting and other operating expenses rose, including higher compensation and professional fees; management linked much of the increase to development and implementation of digital technologies. The company early adopted cloud-computing implementation-cost guidance and reported $21.8 million in cloud computing arrangements on the balance sheet.
- Accumulated other comprehensive income moved from $107.4 million at year-end 2017 to a loss of $22.5 million, reflecting investment-market changes and the accounting reclassification associated with adoption of the equity-investment standard.
Outlook, risks, and contingencies
No quantified earnings or premium guidance is provided. Management said it expects subsidiary liquidity needs over the next 24 months to be met through operations, investment income, and maturing investments, and believes the company is sufficiently capitalized. It cited disciplined underwriting, claims management, and investment strategy as supporting its position in a competitive market, while acknowledging continued pricing pressure.
- Loss reserves and ultimate claim costs are estimates and may differ materially from actual outcomes; management noted a slight upward movement in medical and indemnity costs per claim, despite declining claim frequency.
- California concentration, competition and renewal-rate reductions, investment-market and interest-rate exposure, and dependence on subsidiary dividends are key considerations. Insurance-subsidiary dividends are subject to regulatory restrictions.
- The investment portfolio had a 4.4-year fixed-income duration; 2.2% of fixed-maturity fair value was below investment grade. Management said most unrealized fixed-income losses reflected interest rates rather than credit deterioration.
- A reinsurance program effective July 1, 2018 provides $190 million of coverage above a $10 million per-occurrence retention, subject to exclusions. The legacy LPT agreement remains in effect, with $414.0 million of estimated remaining covered liabilities and a $152.1 million deferred gain.
- A proposed acquisition of PartnerRe Insurance Company of New York remained subject to closing conditions, including New York regulatory approval. The estimated purchase price was approximately $45.8 million, funded with cash; the filing does not report that the acquisition had closed.
- Management said ordinary-course litigation was not expected to have a material effect. It reported no material changes to previously disclosed risk factors, effective disclosure controls, and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether favorable reserve development persists and how current accident-year claims costs develop.
- How much of reported earnings growth is recurring underwriting performance versus reserve releases, investment gains, and tax-rate effects.
- Renewal pricing, new-business growth, retention, and California concentration as the competitive environment evolves.
- Investment portfolio valuation, credit quality, interest-rate sensitivity, and the effect of market movements on earnings and equity.
- Regulatory approval and final economics of the pending acquisition, plus the availability of subsidiary dividends and holding-company liquidity.