Employers Holdings, Inc. — Q3 2013 Form 10-Q
Business context and period. Unaudited results cover the three and nine months ended September 30, 2013; balance-sheet comparisons are against December 31, 2012. The company provides workers’ compensation insurance in 31 states and the District of Columbia, with more than half of its business generated in California.
Financial results and key metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Net premiums earned | $164.4m | $131.8m | $472.4m | $360.6m |
| Total revenue | $183.3m | $151.1m | $531.2m | $419.6m |
| Net income | $27.6m | $7.8m | $49.7m | $19.1m |
| Diluted EPS | $0.86 | $0.25 | $1.56 | $0.60 |
| Combined ratio | 96.2% | 109.0% | 101.9% | 112.5% |
Q3 underwriting income was $6.2m, compared with an $11.9m underwriting loss a year earlier; the nine-month underwriting loss narrowed to $9.1m from $45.1m. Net investment income was $17.8m in Q3 and $52.8m year to date; nine-month investment income declined from $54.2m in 2012. Net realized investment gains were $1.1m in Q3 and $5.7m for nine months.
For the nine months, operating cash flow was $124.0m, investing cash use was $165.0m, and financing cash provided was $0.1m. Cash and cash equivalents ended at $99.8m, down from $140.7m at year-end 2012. At September 30, total investments were $2.25bn; total assets were $3.65bn, liabilities $3.09bn, and GAAP stockholders’ equity $556.5m. Notes payable totaled $112.0m: an $80.0m credit-facility balance and $32.0m of surplus notes. Debt was 12.1% of capitalization when equity includes the deferred LPT gain.
Insurance subsidiaries had $371.6m of cash and fixed maturities maturing within 24 months; the holding company had $58.8m of cash and fixed maturities maturing in that period. The filing says expected liquidity needs over the next 24 months can be met from available cash, maturing investments, operations, and subsidiary dividends. Dividends from insurance subsidiaries are subject to regulatory restrictions.
Material changes and drivers
- Gross premiums written rose 14.6% in Q3 and 20.5% year to date; net premiums earned rose 24.8% and 31.0%, respectively. Management attributed growth to increased policy count and average policy size and higher net rates. Year-over-year in-force premiums, policy count, average policy size, payroll exposure, and net rate increased 19.1%, 10.2%, 8.1%, 9.0%, and 9.3%, respectively.
- The Q3 combined ratio improved by 12.8 percentage points year over year, reflecting lower loss and expense ratios. The nine-month ratio also improved but remained above 100%, indicating an underwriting loss.
- Q3 earnings included a $10.1m favorable LPT reserve adjustment, which increased net income by about $0.32 per share. A separate reallocation of $24.3m of reserves among tax years reduced the nine-month effective tax rate by 10.5 percentage points and increased net income by $5.0m. These items materially affect comparison of reported earnings.
- Management’s non-GAAP “net income before impact of the LPT Agreement” was $13.6m for Q3 and $27.0m for nine months, versus $2.7m and $5.2m, respectively, in 2012. This measure excludes LPT amortization and adjustments and is not a GAAP performance measure.
- Investment-related other comprehensive income was a $38.3m loss for the first nine months, mainly due to rising interest rates; accumulated other comprehensive income declined to $91.2m from $129.5m at year-end 2012. The company reported a 4.2-year fixed-maturity portfolio duration and a weighted average fixed-income quality of AA.
Outlook, commentary, and risks
Management expected 2013 premiums across its markets to reflect overall net rate increases, decelerating policy-count growth, and increasing average policy size. It cited disciplined underwriting, persistently low investment yields, high national unemployment, and uncertain near-term economic conditions. The company had increased filed California rates cumulatively by 41.3% since early 2009. It cautioned that savings from California’s SB 863 reforms were uncertain, dependent on implementation, and not included in current rate filings.
Management considered current accident-year loss estimates adequate but noted ultimate claims costs will remain uncertain for years. Prior-period unfavorable loss development was primarily associated with assigned-risk business. Key sensitivities include reserve adequacy, reinsurance recoverables, premium recognition, investment valuation, and deferred taxes. Rising rates can reduce fixed-income fair values and equity; the company also faces investment credit/default risk and concentration in California. It reported no material change in market risks, no off-balance-sheet arrangements, and no material change to previously disclosed risk factors. Management said pending or threatened litigation was not expected to materially affect results, liquidity, or financial position.
The July 2013–June 2014 reinsurance program provides $195m of per-occurrence coverage above a $5m retention, subject to a $2m annual aggregate deductible and exclusions. The company reported compliance with credit-facility covenants. Disclosure controls were assessed as effective.
Important facts for investors to verify
- How much of reported profit growth is attributable to the $10.1m LPT reserve adjustment and $5.0m tax-related reserve reallocation, versus recurring underwriting performance.
- Whether premium growth and improved combined ratios persist, particularly if policy-count growth slows or loss costs change; the nine-month combined ratio remained above 100%.
- Reserve adequacy and the development of assigned-risk and current accident-year claims, as well as the collectability and timing of reinsurance recoverables.
- Interest-rate effects on investment income, portfolio fair value, and equity; assess the significance of the $38.3m year-to-date decline in investment-related other comprehensive income.
- Liquidity and capital availability at the holding company, including subsidiary dividend limits, pledged or deposited securities, and scheduled debt repayments.
- Actual implementation and financial impact of California SB 863 reforms and the renewal terms and protection provided by the reinsurance program.