Employers Holdings, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Employers Holdings provides workers’ compensation insurance, principally to small businesses, through subsidiaries operating in 30 states and the District of Columbia, with significant exposure to California. All amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net premiums earned | $92.6 | $80.7 | $263.2 | $238.2 |
| Total revenue | $112.9 | $101.8 | $325.7 | $302.3 |
| Net investment income | $19.6 | $20.7 | $60.4 | $62.6 |
| Losses and loss adjustment expenses | $67.4 | $52.8 | $191.0 | $138.1 |
| Income before taxes | $7.4 | $10.1 | $19.6 | $43.8 |
| Income tax benefit (expense) | $4.4 benefit | $0.1 expense | $8.7 benefit | $1.2 expense |
| Net income | $11.8 | $10.1 | $28.4 | $42.7 |
| Diluted earnings per share | $0.31 | $0.25 | $0.74 | $1.01 |
| Combined ratio | 112.9% | 111.6% | 115.3% | 106.5% |
Underwriting losses were $12.0 million for Q3 and $40.2 million year to date, compared with $9.3 million and $15.4 million, respectively, in 2010. A combined ratio above 100% indicates underwriting losses before investment income. Net income before the impact of the deferred gain from the LPT Agreement, a company-defined non-GAAP measure, was $7.6 million for Q3 and $15.4 million year to date, versus $5.3 million and $29.1 million in 2010.
Financial position, cash flow and capital
- At September 30, 2011, total assets were $3.514 billion, total liabilities $3.008 billion and GAAP stockholders’ equity $506.1 million. Equity including the $357.4 million deferred LPT gain was $863.5 million, a non-GAAP measure.
- Cash and cash equivalents were $206.8 million; investments totaled $2.035 billion, including $1.960 billion in fixed maturities and $74.4 million in equities. Net unpaid losses and LAE were $1.322 billion; gross reserves were $2.249 billion, with $927.7 million in reinsurance recoverables.
- Notes payable were $132.0 million: $100.0 million outstanding under the credit facility and $32.0 million in surplus notes. The company reported compliance with credit covenants. Debt represented 13.3% of capitalization including the deferred LPT gain.
- For the nine months, operating cash flow was $36.0 million, investing cash flow $97.8 million and financing cash outflow $46.8 million; cash increased $87.0 million. Financing outflows principally reflected $40.7 million of treasury stock purchases and $6.9 million of shareholder dividends.
- Holding-company liquidity included $137.8 million of cash and cash equivalents and fixed maturities maturing within 24 months. Insurance subsidiaries had $301.5 million of cash and fixed maturities maturing within 24 months. Management said it expected these resources, operating cash flows and permitted subsidiary dividends to meet liquidity needs over that period.
Material changes and management commentary
- Gross premiums written rose 26% in Q3 and 30% year to date; net premiums earned increased 14.8% and 10.5%, respectively. In-force policy count rose 30.1% year over year, while average policy size fell 13.7% and net rate declined 3.4%.
- Losses and LAE increased 27.8% in Q3 and 38.3% year to date, reflecting higher earned premiums, higher current-accident-year loss estimates and favorable prior-year development in 2010. Current-accident-year loss estimates were 77.2% for Q3 and 77.3% year to date, up from 71.3% and 70.6% in 2010. Prior-period development was unfavorable by $0.6 million year to date in 2011, compared with $15.0 million favorable in 2010.
- Net income rose in Q3 but declined for the nine-month period. The 2011 periods benefited from income tax benefits, including effects of tax-exempt interest and the LPT Agreement; the nine-month effective tax rate was negative 44.5%. Net investment income declined as portfolio yields eased, while realized investment gains increased to $2.0 million year to date from $0.9 million.
- Management said the economic recovery remained slow and did not expect significant near-term improvement. It cited rising California indemnity claim frequency and medical and indemnity costs in California and other states, partially offset by favorable long-term loss-cost trends in Nevada. Management considered current reserves adequate but noted ultimate losses may differ, potentially materially.
- California accounted for more than half of business. The company had increased filed California rates cumulatively 33.3% since February 2009, including a 3.9% increase effective September 15, 2011. The company cited industry indications of deteriorating projected California claims costs.
- Management reported no material change in market risk since year-end 2010. The investment portfolio had a duration of 4.65; 72.3% of fixed maturities were rated AA or better, and 0.2% were below investment grade. Investment fair values included net unrealized gains; management attributed fixed-maturity unrealized losses primarily to interest rates and reported no other-than-temporary impairments.
Outlook, contingencies and unusual items
- No specific earnings or revenue guidance was provided. Management expected 2011 premiums to reflect policy-count growth alongside rate changes, lower average policy size, competition and lingering recession effects.
- The LPT Agreement covers up to $2.0 billion of specified pre-July 1995 claims in exchange for $775.0 million of consideration. The remaining deferred gain was $357.4 million and is amortized as reinsurance recoveries occur; management describes the transaction as non-recurring and not an ongoing cash benefit.
- A new reinsurance program effective July 1, 2011 provides $195 million excess of a $5.0 million per-occurrence retention, subject to a $2.0 million annual aggregate deductible and exclusions.
- Prospective adoption of ASU 2010-26 was estimated to increase 2012 underwriting and other operating expenses by $7 million to $8 million and reduce assets by the same amount; retrospective impact remained under evaluation. The company expected no material impact from other newly issued accounting standards discussed in the filing.
- On November 2, 2011, after quarter-end, the board expanded the share-repurchase authorization from $100 million to $200 million and extended it through June 30, 2013. Management may modify, suspend or discontinue the program.
- Ordinary-course litigation was not expected by management to materially affect results, liquidity or financial position. The filing reported no material changes to previously disclosed risk factors, no off-balance-sheet arrangements, and effective disclosure controls.
Important facts for investors to verify
- Whether worsening current-year loss trends, particularly in California, persist and whether premium pricing keeps pace with claims costs.
- Reserve adequacy and the significance of assigned-risk business in unfavorable prior-period development; reserves depend on estimates with long settlement periods.
- How much reported earnings depend on tax benefits and amortization of the LPT deferred gain, versus ongoing underwriting performance.
- Investment portfolio exposure to interest-rate movements, credit deterioration and unrealized losses, alongside the liquidity effects of regulatory deposits and pledged securities.
- Repurchase pace and funding relative to debt maturities, holding-company liquidity and restrictions on dividends from regulated insurance subsidiaries.