Employers Holdings, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; balance-sheet comparisons are to December 31, 2015. Results are unaudited. The company provides workers’ compensation insurance, primarily to small businesses, across 34 states and the District of Columbia; California generated 56% of in-force premiums.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net premiums earned | $173.3 million | $179.0 million | $522.8 million | $508.6 million |
| Total revenue | $192.8 million | $199.5 million | $586.6 million | $567.6 million |
| Net income | $22.6 million | $24.5 million | $71.2 million | $67.7 million |
| Diluted EPS | $0.69 | $0.75 | $2.16 | $2.08 |
| Underwriting income before tax | $11.3 million | $10.6 million | $29.7 million | $24.9 million |
| Combined ratio | 93.5% | 94.1% | 94.3% | 95.1% |
Q3 revenue declined 3.4% and net income declined 7.8% year over year; for the first nine months, revenue rose 3.3% and net income rose 5.2%. The nine-month effective tax rate increased to 22.9% from 17.2%; Q3 rate was 25.7% versus 19.4%. The company declared dividends of $0.09 per share for Q3 and $0.27 per share year to date.
Cash, capital, and investments
- Operating cash flow was $97.0 million for the first nine months, versus $94.0 million. Investing activities used $49.1 million, versus $139.1 million; financing activities used $20.4 million, versus $2.3 million. Cash and cash equivalents increased $27.5 million to $84.1 million.
- Total assets were $3.824 billion; total liabilities were $2.974 billion and stockholders’ equity was $850.1 million. Adjusted stockholders’ equity, a company-defined non-GAAP measure, was $910.3 million, up from $866.7 million at year-end 2015.
- Notes payable were $32.0 million. The company reported $32.0 million of surplus notes maturing in 2034; stated debt was 3.0% of total capitalization including the deferred LPT gain. Estimated contractual payments on notes payable, including interest, totaled $60.6 million.
- Investments totaled $2.582 billion at fair value, including $2.384 billion of fixed maturities and $184.5 million of equity securities. Fixed maturities had a duration of 4.2 years and weighted average credit quality of AA-; 0.8% were below investment grade.
- Holding-company cash and investments totaled $65.1 million. The insurer subsidiaries had $452.1 million in cash, short-term investments, and fixed maturities maturing within 24 months. Management believed liquidity needs over the next 24 months could be met from available resources and subsidiary dividends, subject to regulatory restrictions.
Material changes and operating drivers
- Gross premiums written fell 2.4% in Q3 but rose 2.4% year to date. Q3 premium declines reflected $5.0 million less in final audit premiums. Year-to-date growth from higher final audit premiums was partly offset by lower renewal premiums and net rates.
- Year-over-year in-force premiums declined 2.5% in California but increased 2.3% in other states. In-force premiums and policy count in the Los Angeles area fell 13.2% and 13.9%, respectively; California outside that area grew 10.3% and 4.1%.
- The combined ratio improved year over year for both periods, primarily because of lower current-accident-year loss estimates. Current-accident-year loss estimates were 64.1% for Q3 and 65.6% year to date, compared with 66.3% and 66.8%. Management cited claims settlement efforts, diversification, non-renewal of underperforming business, and targeting profitable classes.
- The LPT agreement generated favorable reserve and contingent-commission estimate adjustments of $3.1 million and $1.8 million, respectively, increasing nine-month net income by $4.9 million in total. These adjustments occurred in Q2. The remaining deferred gain was $177.8 million; estimated remaining liabilities subject to the LPT were $472.3 million.
- Accumulated other comprehensive income rose to $117.6 million from $83.6 million, reflecting unrealized investment gains. The company recognized $5.3 million of other-than-temporary impairments on equity securities in the first nine months, primarily related to intent to sell and the energy-sector downturn.
Outlook, risks, and contingencies
- The filing provides no specific earnings, premium, or combined-ratio guidance. Management described its strategy as disciplined underwriting, profitable growth, claims management, and prudent portfolio investment.
- Management noted slight upward movement in medical and indemnity costs per claim despite lower indemnity claim frequency. It considers current accident-year reserves adequate, but emphasized that workers’ compensation claims are long-tail and ultimate losses may differ materially from estimates.
- Investment portfolio risks include interest-rate, credit, and equity-price exposure. Management reported no material change in market risk since December 31, 2015, and stated that unrealized fixed-maturity losses were primarily interest-rate related.
- The company’s reinsurance program, effective July 1, 2016 through June 30, 2017, provides $190 million excess of a $10 million per-occurrence retention, subject to exclusions. FHLB membership provides access to collateralized advances; none were outstanding.
- Insurance-subsidiary dividends are subject to state restrictions. Securities with fair value of about $1.0 billion were on deposit with states. Management did not expect pending or threatened litigation to materially affect results, liquidity, or financial position; it reported no material changes to previously disclosed risk factors and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether lower renewal rates and California/Los Angeles-area premium declines persist, and whether growth outside California offsets them.
- Reserve adequacy and future loss-cost trends, including the effects of medical and indemnity severity and prior-period development.
- The sustainability of underwriting results excluding LPT amortization and estimate adjustments; the filing’s non-GAAP “net income before impact of the LPT Agreement” was $19.6 million for Q3 and $57.6 million year to date.
- Investment portfolio sensitivity to interest rates, credit deterioration, and equity-price changes, including further impairments or realized gains and losses.
- Availability of subsidiary dividends and liquidity under insurance regulation, and the pace and price of share repurchases. The company repurchased 642,024 shares for $18.6 million through September 30 under a $50 million authorization.