Employers Holdings, Inc. annual report, FY2014

Employers Holdings, Inc. — FY2014 Form 10-K

Business context and reporting period. This is the annual report for the fiscal year ended December 31, 2014 (with unaudited fourth-quarter results also disclosed). Employers Holdings provides workers’ compensation insurance to small businesses in low- to medium-hazard industries across 31 states and the District of Columbia. California generated about 59% of in-force premiums. The company operates as one reportable segment.

Financial performance and condition

Metric	2014	2013
Total revenue	$773.5 million	$723.6 million
Net premiums earned	$684.5 million	$642.3 million
Net premiums written	$687.6 million	$678.5 million
Net income	$100.7 million	$63.8 million
Diluted earnings per share	$3.14	$2.00
Combined ratio	97.0%	103.9%
Operating cash flow	$169.4 million	$163.7 million

Revenue rose 6.9%; net income rose 57.8%. Net premiums written grew about 1.4%, reflecting slower premium growth during the company’s California pricing actions.
Underwriting income was $20.6 million, versus an underwriting loss of $24.8 million in 2013. The reported combined ratio improved below 100%, indicating underwriting profit.
Excluding the LPT Agreement’s effects, the combined ratio was 105.0% versus 109.8%, and non-GAAP net income before LPT effects was $45.7 million versus $25.9 million. These are company-defined non-GAAP measures.
Net investment income was $72.4 million, little changed from $70.8 million; net realized investment gains increased to $16.3 million from $9.5 million. Average pre-tax book yield declined to 3.2% from 3.4%.
Cash and cash equivalents were $103.6 million at year-end. Total investments were $2.45 billion at fair value; total assets were $3.77 billion. Gross unpaid losses and LAE were $2.37 billion, or $1.70 billion net of reinsurance.
Total stockholders’ equity was $686.8 million, up from $568.7 million. The company also reported $893.9 million of equity including the $207.0 million deferred LPT gain, a non-GAAP measure.
Debt totaled $92.0 million: $60.0 million under a credit facility due December 31, 2015, and $32.0 million in surplus notes due in 2034. The company repaid $10.0 million of its credit facility during 2014 and reported compliance with covenants.
Operating cash flow was $169.4 million; investing activities used $85.5 million and financing activities used $14.8 million. Cash increased $69.1 million during the year. The annual dividend declared was $0.24 per share.

Material changes and unusual items

Reported earnings included $31.1 million from favorable LPT reserve adjustments and $10.8 million from an increased estimated LPT contingent commission. A $13.1 million reserve reallocation from non-taxable pre-2000 periods reduced the effective tax rate by 3.4 percentage points and added $3.6 million to net income. The company said these items collectively increased 2014 net income by $45.5 million.
The 2013 comparison also included $23.8 million of net income benefit from LPT adjustments and tax-related reserve reallocation, while 2013 had $6.9 million of unfavorable prior-year loss development.
Losses and LAE were $453.4 million, down from $463.6 million. The calendar-year loss ratio improved to 66.2% from 72.2%, while underwriting and other operating expense and commission ratios also declined.
In-force premiums grew 1.7% and policies in force grew 1.5%. California in-force policy count fell 2.0%, as the company sought to moderate California growth and diversify. California net rates increased 11.2% in 2014.
Fourth-quarter 2014 net income was $29.1 million, including $11.7 million of favorable LPT reserve and contingent commission adjustments.

Outlook, management commentary, and risks

No specific earnings, premium, or combined-ratio guidance is provided. Management’s stated strategy is disciplined underwriting, profitable growth, claims management, and diversification. Initiatives included centralized sales and underwriting management, business-process improvements, and a new California pricing platform.
Management cited increasing medical and indemnity costs per claim, including more California cumulative-trauma claims. California claim litigation had increased in 2013; its rate of increase moderated in 2014. Management considered current accident-year reserves adequate but noted ultimate losses may take years to emerge.
Loss-reserve estimates are a key uncertainty. A 1-percentage-point increase in medical-cost inflation above the rate implicit in reserves was estimated to increase lifetime costs on current claims by about $96 million net of reinsurance. The carried net reserve was within the actuarial range, but management cautioned actual outcomes could fall outside that range.
California concentration exposes results to state-specific regulation, competition, economic conditions, claim trends, and natural catastrophes. The filing also identifies pricing adequacy, competition, investment and interest-rate risk, reinsurance collectability, and dependence on agents and ADP as material risks. ADP generated 11.3% of in-force premiums and either party may terminate the agreement on 120 days’ notice.
The current excess-of-loss program provided $195 million of coverage above a $5 million per-occurrence retention, subject to a $2 million annual aggregate deductible and exclusions. The company remains liable to policyholders if reinsurers do not pay. LPT-related remaining liabilities were estimated at $534.8 million, supported by $1.5 billion in trust assets.
The holding company reported $63.3 million of cash and fixed maturities maturing within 24 months, against the $60 million credit-facility payment due in 2015. Management expected liquidity needs to be met by cash, investments, and subsidiary dividends, which are legally restricted. Insurer subsidiaries had $568.8 million of cash and fixed maturities maturing within 24 months.
Insurance subsidiaries were rated A- (Excellent) by A.M. Best with a negative outlook. Each subsidiary exceeded applicable risk-based capital requirements. The independent auditor gave unqualified opinions on the financial statements and internal control; management reported no material weakness.
Management said pending or threatened litigation in the ordinary course was not expected to materially affect results, liquidity, or financial position. The filing reports no off-balance-sheet arrangements.

Important facts for investors to verify

How much of future earnings and underwriting performance depends on LPT reserve and contingent-commission estimates, and how those estimates develop.
Whether California rate actions can offset medical-cost inflation, cumulative-trauma claims, and litigation trends without materially reducing policy count or retention.
Reserve adequacy, including sensitivity to medical inflation and the assumptions behind the actuarial range.
Reinsurance collectability, collateral quality and concentration, and renewal terms for the excess-of-loss program.
Availability of holding-company liquidity for the 2015 credit-facility maturity, considering statutory dividend limits and the subsidiaries’ capital needs.
Investment portfolio exposure to interest rates and equity prices; the filing estimates that a 100-basis-point rate rise would reduce fixed-maturity fair value by $88.9 million before tax.
Whether the A.M. Best negative outlook, California concentration, or ADP relationship changes affect business volume, pricing, or distribution.