Employers Holdings, Inc. — FY 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012; filed March 1, 2013. The company is a specialty workers’ compensation insurer serving small businesses in 31 states and the District of Columbia, with 59% of in-force premiums in California.
Financial performance
| Metric | 2012 | 2011, restated | Change |
|---|---|---|---|
| Net premiums earned | $501.5 million | $363.4 million | +38% |
| Total revenue | $579.2 million | $464.2 million | +25% |
| Net income | $106.9 million | $48.6 million | +120% |
| Diluted EPS | $3.37 | $1.30 | Higher |
| Combined ratio (GAAP) | 95.3% | 113.9% | Improved |
| Net cash from operations | $131.8 million | $43.2 million | Higher |
- Underwriting income was $23.3 million, versus an underwriting loss of $50.6 million in 2011. The 2012 result includes substantial favorable LPT Agreement estimate changes.
- Net investment income declined to $72.4 million from $80.1 million; realized investment gains fell to $5.0 million from $20.2 million. The average pre-tax book yield was 3.7%, down from 4.1%.
- Cash and cash equivalents were $140.7 million; total investments were $2.15 billion. Total assets were $3.51 billion and GAAP stockholders’ equity was $539.4 million. Equity including the deferred LPT gain, a non-GAAP measure, was $820.4 million.
- Debt was $112.0 million, comprising $80.0 million under a revolving credit facility and $32.0 million of surplus notes. The company reported compliance with covenants. Cash declined by $111.6 million during the year, as operating cash was more than offset by investment purchases and financing outflows.
- Gross unpaid losses and loss adjustment expenses were $2.23 billion, with $805.4 million of reinsurance recoverables on unpaid losses; net reserves were $1.43 billion. The annual common dividend was $0.24 per share.
Material changes and unusual items
- 2012 earnings were heavily affected by LPT Agreement estimates. Fourth-quarter favorable adjustments reduced losses and LAE by $73.3 million for revised ceded reserves and $8.6 million for the contingent commission estimate. The company said these changes increased full-year net income by $73.3 million and $8.2 million, respectively. Net income before the impact of the LPT Agreement, a non-GAAP measure, was $7.0 million in 2012, compared with $29.3 million in 2011.
- The filing restates prior-period financial statements to correct accounting for the LPT contingent profit commission. The revisions increased restated net income by $0.3 million in 2011 and $0.7 million in 2010; the company said they were not material to those prior periods individually, but their cumulative effect would have been material if recorded in 2012.
- Underwriting and other operating expenses included a $7.1 million increase from adoption of new deferred policy acquisition cost guidance. Premium growth reflected higher policy counts and rates: in-force premiums increased 36.4% and in-force policy count increased 31.5% year over year.
- Prior accident-year reserve development was unfavorable by $1.8 million in 2012, versus $1.1 million unfavorable in 2011. California and Nevada represented approximately 79% of year-end net reserves.
Outlook, commentary, and risks
- Management expected 2013 premiums to reflect overall rate increases, decelerating policy-count growth, and increasing average policy size. It did not expect overall economic conditions to change significantly in the near term and cited persistently low investment yields and high unemployment.
- Management described disciplined underwriting and profitable growth across market cycles as priorities. The California workers’ compensation reforms enacted in 2012 could eventually reduce system costs, but savings depend on implementation and were not included in current rate filings.
- Key risks include reserve estimation and medical-cost inflation, California concentration and regulatory changes, competition and pricing pressure, investment-market and interest-rate risk, and reinsurer credit or collateral risk. Management estimated that a 1% increase in medical cost inflation above the rate reflected in reserves could add approximately $84 million to lifetime net medical costs on current claims.
- The LPT Agreement covered estimated remaining liabilities of approximately $672 million at year-end. Reinsurer collateral in trust was about $1.0 billion; the filing notes that one reinsurer’s collateral included publicly traded stock valued at $804 million, securing an obligation of $370 million, creating market-value exposure.
- The insurance subsidiaries had an A.M. Best rating of A- (Excellent) with a negative outlook. The company reported that each subsidiary exceeded applicable risk-based capital requirements. Management and the independent auditor concluded internal control over financial reporting was effective at year-end; the auditor issued an unqualified opinion on the financial statements.
Important facts for investors to verify
- Reconcile reported 2012 earnings and the 95.3% combined ratio with the large, non-recurring LPT reserve and contingent-commission adjustments; assess underlying results excluding LPT effects.
- Review the restatement disclosures and confirm the revised LPT accounting, contingent commission receivable, and deferred reinsurance gain balances.
- Assess reserve adequacy, particularly medical-cost inflation, California and Nevada exposure, and the range of actuarial estimates.
- Evaluate the collectability and collateral quality of reinsurance recoverables, including the LPT trust collateral exposed to equity-price changes.
- Monitor premium growth and pricing against loss trends, California reform implementation, investment yields, and the company’s ability to fund holding-company obligations from regulated subsidiary dividends.