Employers Holdings, Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Employers Holdings writes workers’ compensation insurance, primarily for small businesses; it operated in 31 states and the District of Columbia, with California representing approximately 60% of in-force premiums. Financial amounts below are in millions unless stated otherwise.
Financial results
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net premiums earned | $172.1 | $164.4 | $511.9 | $472.4 |
| Total revenues | $192.1 | $183.3 | $580.8 | $531.2 |
| Net income | $15.2 | $27.6 | $71.6 | $49.7 |
| Diluted EPS | $0.47 | $0.86 | $2.23 | $1.56 |
| Underwriting income (loss) | $(2.8) | $6.2 | $9.4 | $(9.1) |
| Combined ratio | 101.6% | 96.2% | 98.2% | 101.9% |
| Operating cash flow | Not presented by quarter | $136.4 | $124.0 |
Q3 revenue rose about 4.8%, but net income fell about 44.9%, as losses and loss-adjustment expenses increased 15.7% and income tax expense shifted to $1.3 million from a $3.3 million benefit. For the first nine months, revenue increased about 9.3% and net income increased about 44.0%; reported earnings included favorable LPT agreement adjustments and a tax benefit from a reserve reallocation.
Net investment income was $18.2 million in Q3 and $54.5 million for nine months, up 2.1% and 3.1%, respectively. Nine-month realized investment gains were $14.2 million versus $5.7 million in 2013, primarily reflecting sales of equity securities. The filing gives no conventional net profit margin; underwriting profitability is reflected in the combined ratio.
Balance sheet, liquidity and capital
- At September 30, 2014, total assets were $3.78 billion, investments at fair value were $2.46 billion, and stockholders’ equity was $652.6 million, compared with $568.7 million at December 31, 2013.
- Cash and cash equivalents were $59.0 million; restricted cash was $20.8 million. Nine-month cash increased $24.5 million, with $136.4 million provided by operations, $108.9 million used in investing, and $3.0 million used in financing.
- Unpaid losses and LAE were $2.37 billion gross of reinsurance; reinsurance recoverable on unpaid losses was $690.5 million. Unearned premiums were $335.8 million.
- Notes payable were $102.0 million on the balance sheet: $70.0 million under the credit facility and $32.0 million of surplus notes. The company reported compliance with credit covenants. Facility principal payments of $10 million were due December 2014 and $60 million in 2015.
- Management reported holding-company cash and near-term-maturing fixed maturities of $59.6 million, and subsidiary cash and such maturities of $533.4 million. It expected liquidity needs over the next 24 months to be met from available resources and subsidiary dividends, which are subject to insurance regulation.
- GAAP equity plus the unamortized LPT deferred gain was $871.2 million, a non-GAAP measure. Dividends declared were $0.06 per share for Q3 and $0.18 per share for nine months.
Material changes and management commentary
- Net premiums earned grew 4.6% in Q3 and 8.4% for nine months, supported by policy count, average policy size and net rate. Gross premiums written declined 1.3% in Q3 but rose 2.3% year to date. California net rate increased 8.4% year to date; in-force payroll exposure declined.
- The nine-month 2014 results included $22.3 million from an LPT reserve estimate adjustment and $7.9 million from an LPT contingent commission adjustment, both associated with favorable paid-loss trends, plus $2.7 million from a tax-related reserve reallocation. Together these increased net income by $32.9 million. The comparable 2013 items increased net income by $15.1 million. These estimates are material to reported earnings; management also presented non-GAAP net income before LPT impacts of $31.5 million for 9M 2014 versus $27.0 million for 9M 2013.
- Q3 combined ratio rose to 101.6%, indicating an underwriting loss, while the nine-month ratio improved to 98.2%. Management cited higher current accident-year loss estimates, including increased medical and indemnity costs and more cumulative-trauma claims in California. Prior-year unfavorable development was $4.0 million for nine months, primarily in assigned-risk business; management reported no material unfavorable development in voluntary business.
- Management described the economic outlook as uncertain, noted persistently low investment yields, and said increasing claim-cost trends may be offset by rate increases. It did not provide quantified earnings or premium guidance. Management did not anticipate savings from California SB 863 reforms and said those potential savings were not reflected in current rate filings.
- The investment portfolio was $2.46 billion at fair value, with a 4.1-year fixed-income duration and weighted-average quality of AA. Management attributed most fixed-income unrealized losses to interest rates rather than issuer credit; it recorded $0.1 million of equity-security impairment for the nine-month period.
Risks, contingencies and other disclosures
Key estimation risks include loss reserves and LAE, reinsurance recoverables, premium recognition, deferred taxes, and investment valuations. The company buys reinsurance, including $195 million of per-occurrence coverage excess of a $5 million retention under a program effective July 1, 2014 through June 30, 2015, subject to an annual aggregate deductible and exclusions. Securities on deposit with states were $782.7 million; $31.1 million of securities were held in trust for ceding reinsurers. Management reported no material change in market risk or risk factors from year-end 2013, no off-balance-sheet arrangements, and no litigation expected to materially affect results, liquidity or financial position. Disclosure controls were judged effective.
Important facts for investors to verify
- How much of 2014 earnings growth is attributable to the LPT reserve and commission adjustments and tax reallocation, and how do results compare excluding those items?
- Whether California claim severity, cumulative-trauma claims and current accident-year loss estimates continue to rise, and whether pricing increases keep pace with loss costs.
- The development and adequacy of gross loss reserves and the collectability and timing of reinsurance recoverables.
- The availability of holding-company liquidity, subsidiary dividends, and the scheduled credit-facility repayments, including applicable restrictions and covenants.
- The effect of persistently low yields, interest-rate movements and potential investment impairments on investment income and equity.