Employers Holdings, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing is an annual report, not a standalone quarterly report; selected fourth-quarter results are included below. Employers Holdings is a workers’ compensation insurer focused on small businesses in low- to medium-hazard industries, operating in 44 states and Washington, D.C., with more than half of in-force premiums in California.
Financial performance
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net premiums written | $742.8 million | $723.7 million | +2.6% |
| Net premiums earned | $731.1 million | $716.5 million | +2.0% |
| Total revenues | $800.4 million | $801.4 million | −0.1% |
| Net income | $141.3 million | $101.2 million | +39.6% |
| Diluted earnings per share | $4.24 | $3.06 | +38.6% |
| Operating cash flow | $180.2 million | $142.3 million | +26.6% |
- Underwriting: Underwriting income rose to $101.7 million from $68.0 million. The combined ratio improved to 86.1% from 90.5% (below 100% indicates an underwriting profit). The loss and LAE ratio fell to 51.5% from 58.2%, while the underwriting and other operating expense ratio increased to 21.7% from 19.5%; the commission ratio was 12.9% versus 12.8%.
- Investment results: Net investment income increased to $81.2 million from $74.6 million. Net realized and unrealized investment results shifted to a $13.1 million loss from a $7.4 million gain, including $25.6 million of unrealized equity-security losses. Equity fair-value changes began flowing through earnings in 2018 under newly adopted accounting guidance.
- Liquidity and capital: Cash and cash equivalents were $101.4 million; total investments were $2.73 billion; total assets were $3.92 billion; and stockholders’ equity was $1.02 billion. The company reported $20 million of surplus notes, due in 2034, with interest and principal payments subject to Florida regulatory approval. Operating subsidiaries held $2.70 billion in cash and investments; management expected their liquidity needs over the next 24 months to be met from operations, investment income, and maturities.
- Cash returns: The company paid $26.7 million in common dividends in 2018 and repurchased $4.6 million under its $50 million authorization. The Board declared a $0.22-per-share dividend in February 2019.
Material changes and unusual items
- 2018 net income benefited from $66.2 million of favorable prior-year loss development, compared with $18.5 million in 2017. The company attributed favorable development partly to claims-settlement initiatives. This reserve development materially supported reported earnings and is not necessarily indicative of future results.
- Management identified several 2018 items that collectively increased pretax income by $43.3 million: favorable prior-year loss development, LPT Agreement reserve and contingent-commission adjustments, and the new earnings treatment of equity-security fair-value changes. The LPT-related adjustments contributed $2.7 million; the filing’s $43.3 million total also includes the $66.2 million favorable development offset by other listed effects.
- The combined ratio improved despite a 13% increase in underwriting and other operating expenses, which management linked largely to accelerated digital technology development. The company expects these investments to continue raising the expense ratio in 2019 and 2020, with anticipated premiums and efficiency gains expected to offset costs over time.
- The Tax Cuts and Jobs Act reduced the federal corporate tax rate to 21% beginning in 2018. The effective tax rate was 16.6%, versus 29.7% in 2017; 2017 included a $7.0 million deferred-tax remeasurement charge.
- At year-end, the company had a pending acquisition of PartnerRe Insurance Company of New York, expected to be funded with cash on hand. The stated purchase price was estimated at approximately $45.8 million, subject to closing conditions including New York regulatory approval. Cerity, its direct-to-customer subsidiary, began offering coverage in Illinois on January 23, 2019.
- Fourth quarter: Net income was $25.6 million, versus $31.3 million in fourth-quarter 2017. Fourth-quarter 2018 included $25.4 million of favorable prior-year loss development and $27.4 million of net unrealized equity losses.
Outlook, risks, and contingencies
- Management cited favorable loss-cost and claim-frequency trends, successful claims initiatives, and a strong balance sheet, while reporting an 11.8% overall renewal price decrease in 2018 amid competitive conditions. It did not provide numerical earnings or premium guidance.
- Claims inflation and reserve estimation are key uncertainties. Management noted 2018 increases in medical and indemnity costs per claim; it estimated that a 1% increase in medical-cost inflation above the rate embedded in reserves could increase lifetime future medical costs on current claims by approximately $87 million, net of reinsurance.
- California concentration exposes results to state-specific regulation, claims litigation, economic conditions, and natural perils. California represented approximately 54% of in-force premiums; California and Nevada together represented about 76% of loss reserves.
- Reinsurance recoverables for paid and unpaid losses were $511.1 million, including $408.2 million associated with the legacy LPT Agreement. The LPT reinsurers had $311.6 million of collateral in trust. The current excess-of-loss program covered $190 million above a $10 million per-occurrence retention, subject to exclusions, through June 30, 2019. The company remains responsible to policyholders if reinsurers fail to pay.
- Other material risks include intense price competition, dependence on independent agents and ADP (13.1% of in-force premiums), restricted upstream dividends from regulated insurance subsidiaries, investment-market and interest-rate risk, cyber and technology execution risk, and catastrophe or terrorism exposure. The filing states that routine litigation is not expected to have a material effect on operations, liquidity, or financial position.
- Auditors issued unqualified opinions on the consolidated financial statements and internal control over financial reporting; management reported no material weaknesses.
Important facts for investors to verify
- How much of 2018 earnings growth came from favorable reserve development versus current-year underwriting performance, and whether reserve assumptions remain adequate.
- Current accident-year claims trends, especially medical and indemnity severity, and the effect of renewal-rate reductions on future margins.
- Progress, costs, and expected returns from digital investment, including the projected expense-ratio impact through 2020 and Cerity’s rollout.
- Renewal terms and counterparty strength for the excess-of-loss program, and adequacy and collateralization of LPT recoverables.
- Closing status, regulatory approvals, funding, and final purchase price for the PRNY acquisition.
- Investment portfolio performance and volatility under the accounting treatment that records equity-security fair-value changes in earnings.