Employers Holdings, Inc. — FY 2013 Form 10-K
Business and reporting period. The filing covers the fiscal year ended December 31, 2013, with quarterly results also reported. Employers Holdings is a specialty workers’ compensation insurer focused on small businesses in low- to medium-hazard industries. It operated in 31 states and the District of Columbia; California generated about 60% of in-force premiums. The company reported one operating segment.
Financial results and condition
| Metric | 2013 | 2012 | Change / context |
|---|---|---|---|
| Net premiums written | $678.5 million | $569.7 million | Up 19% |
| Net premiums earned | $642.3 million | $501.5 million | Up 28% |
| Total revenue | $723.6 million | $579.2 million | Up 25% |
| Net income | $63.8 million | $106.9 million | Down 40%; 2012 included larger favorable LPT adjustments |
| Diluted EPS | $2.00 | $3.37 | Down 41% |
| GAAP combined ratio | 103.9% | 95.3% | Above 100% indicates an underwriting loss |
| Underwriting income (loss) | $(24.8) million | $23.3 million | Moved to an underwriting loss |
| Operating cash flow | $163.7 million | $131.2 million | Cash provided by operations |
Losses and loss adjustment expenses rose 61% to $463.6 million. The loss and LAE ratio increased to 72.2% from 57.4%; expense and commission ratios were 19.5% and 12.2%, respectively. Statutory combined ratios were 101.2% in 2013 and 85.8% in 2012, but both benefited from favorable adjustments to ceded LPT reserves.
Net income before the impact of the LPT Agreement, a company-defined non-GAAP measure, was $25.9 million in 2013 versus $7.0 million in 2012 and $29.3 million in 2011. The filing says this measure excludes LPT gain amortization and reserve and contingent-commission adjustments; it should not be treated as a GAAP result.
Net investment income was $70.8 million, down from $72.4 million; realized investment gains were $9.5 million versus $5.0 million. Average pre-tax book yield declined to 3.4% from 3.7%. Total comprehensive income was $24.7 million, down from $119.7 million, including a $39.1 million after-tax decline in other comprehensive income as interest rates rose.
At year-end, total assets were $3.64 billion, investments at fair value were $2.34 billion, cash and cash equivalents were $34.5 million, GAAP equity was $568.7 million, and notes payable were $102.0 million. Cash decreased $106.2 million during the year, mainly as investment activity used cash. Operating subsidiaries had $336.7 million in cash and fixed maturities maturing within 24 months; the holding company reported $56.5 million in cash and such maturities. The company stated it expected liquidity needs over the next 24 months to be met from these resources, operations, and permitted subsidiary dividends.
Material changes, outlook, and unusual items
- Premium growth reflected higher policy counts, average policy size, and rates. Overall in-force premiums rose 14.9% in 2013; net rate increased 8.8% overall and 12.9% in California.
- Management expected 2014 premiums to reflect overall net rate increases and increasing average policy size. It planned to use territorial multipliers and multiple subsidiaries to offer additional California pricing options. The filing gives no quantified earnings or combined-ratio guidance.
- 2013 GAAP net income included favorable LPT adjustments of $19.0 million for ceded reserves and $4.3 million for the contingent commission, plus a $7.4 million income-tax benefit from reallocating reserves among tax periods. These items materially affected reported results. Comparable favorable LPT adjustments in 2012 were larger.
- Prior-year loss development was unfavorable by $6.9 million in 2013, including $5.0 million for California accident years 2009–2011 and $1.9 million for assigned-risk business. Management cited higher indemnity claim frequency, medical and indemnity cost trends, and increased claims litigation in Southern California. The current accident-year loss estimate was 77.0%; ultimate outcomes will take years to emerge.
- Gross unpaid losses and LAE were $2.33 billion, with $742.7 million of reinsurance recoverables on unpaid claims. California and Nevada accounted for about 79% of reserves. Management estimated that a 1 percentage-point increase in medical cost inflation above the rate embedded in reserves could add about $95 million to future net claim costs.
- The LPT Agreement covers qualifying pre-July 1995 Nevada claims. Remaining liabilities under the agreement were estimated at $612.1 million; reinsurer trust assets were $1.3 billion. The company remains liable to policyholders if reinsurers do not pay, and one reinsurer’s collateral included publicly traded stock subject to market-price fluctuations.
- Current excess-of-loss reinsurance provided $195 million above a $5 million per-occurrence retention, subject to a $2 million annual aggregate deductible and exclusions. Terrorism coverage excludes nuclear, biological, chemical, and radiological events. TRIPRA was scheduled to expire December 31, 2014.
- Key risks include California concentration and regulation, reserve estimation uncertainty, medical-cost inflation, rate competition, interest-rate and investment-value changes, and reliance on independent agents and strategic partners ADP and Anthem. The insurers had an A.M. Best rating of A- with a negative outlook.
- Fourth-quarter 2013 net income was $14.2 million versus $87.8 million in fourth-quarter 2012, when large favorable LPT adjustments were recorded. Fourth-quarter 2013 included $8.9 million of favorable LPT reserve adjustment and $2.7 million of favorable contingent-commission adjustment, partly offset by a higher current-year loss estimate and unfavorable prior-year development.
The company declared $0.24 per share in dividends for 2013 and said it expected dividends to continue, subject to board discretion, subsidiary earnings and statutory limits. It contributed $40 million to operating subsidiaries in September 2013. The company reported compliance with debt covenants and regulatory risk-based capital requirements. Ernst & Young issued unqualified opinions on the financial statements and internal control; management reported effective internal control over financial reporting.
Important facts for investors to verify
- How much of reported earnings and statutory underwriting performance reflects recurring insurance results versus LPT accounting adjustments and tax effects.
- Whether California claim frequency, litigation, and medical and indemnity cost trends remain elevated, and whether rates keep pace with loss costs.
- The adequacy of gross and net loss reserves, including sensitivity to medical inflation and the development of California and Nevada claims.
- The collectability and collateral quality of the $751.1 million in total paid and unpaid reinsurance recoverables, particularly the LPT exposure and stock-backed trust collateral.
- Investment portfolio sensitivity to interest rates and credit conditions, and the effect of restricted assets, debt maturities, and statutory limits on parent-company liquidity and dividends.
- Whether the expected 2014 premium growth can be achieved without weakening underwriting standards or profitability.