Employers Holdings, Inc. — Q2 2013 Form 10-Q
Business and period: Employers Holdings provides workers’ compensation insurance, principally to small businesses, in 31 states and the District of Columbia. More than half of its business is generated in California. This filing covers the quarter and six months ended June 30, 2013; balance-sheet comparisons are with December 31, 2012. Amounts below are in millions unless noted.
Financial performance and condition
- Revenue and earnings: Q2 total revenue was $181.6, up from $138.3 a year earlier; six-month revenue was $347.9, versus $268.5. Net premiums earned rose 34.5% in Q2 and 34.6% for the first half, to $160.0 and $307.9, respectively. Q2 net income was $14.6 ($0.46 diluted EPS), versus $5.0 ($0.16); six-month net income was $22.1 ($0.70 diluted EPS), versus $11.4 ($0.35).
- Underwriting and margins: The company reported underwriting losses of $5.1 in Q2 and $15.3 for the first half, improved from losses of $15.8 and $33.2 in the respective 2012 periods. Combined ratios improved to 103.2% in Q2 and 105.0% year to date, from 113.3% and 114.5%. Ratios above 100% indicate underwriting losses before investment income. Q2 and first-half loss and LAE ratios were 70.4% and 71.7%; expense ratios improved, supported by premium growth outpacing operating expense growth.
- Investment results: Net investment income declined 3.6% in Q2 to $17.6 and 4.4% for the first half to $35.1, primarily as average pre-tax book yields fell. Net realized investment gains increased to $3.9 in Q2 and $4.7 for the first half. The portfolio’s fair value was $2,210.4, including $2,070.0 of fixed maturities; the reported fixed-income portfolio duration was 4.2 years.
- Cash flow: First-half operating cash flow was $85.2, up from $54.0. Investing used $127.0, largely for securities purchases; financing used $1.8, including $3.7 of dividends paid. Cash and cash equivalents fell $43.6 to $97.1.
- Balance sheet, liquidity, and debt: At June 30, total assets were $3,617.5, total liabilities $3,095.5, and GAAP stockholders’ equity $521.9. Notes payable were $112.0: $80.0 under the credit facility and $32.0 in surplus notes. Debt was 12.3% of capitalization when measured against equity including the LPT deferred gain. Management reported $76.1 of holding-company cash and near-term fixed-maturity maturities, and $356.6 at insurance subsidiaries; it expects liquidity needs over the next 24 months to be met from available cash, maturities, operations, and subsidiary dividends. Subsidiary dividends are subject to insurance regulation. The company reported compliance with credit-facility covenants.
- Capital and distributions: GAAP equity declined from $539.4 at year-end, while equity including the LPT deferred gain declined from $820.4 to $796.1. The quarterly dividend was $0.06 per share. The share-repurchase program expired June 30, 2013; cumulative repurchases under it were 9.4 million shares for $148.8.
Material changes and management commentary
- Growth in gross premiums written was 24.2% in Q2 and 23.4% for the first half. Management attributed premium growth to higher policy counts, larger average policies, and higher net rates. Year-over-year in-force premiums rose 23.9%, policy count 15.2%, average policy size 7.5%, and net rate 10.1%.
- Current accident-year loss estimates improved to 73.0% of net premiums earned for Q2 and 74.0% for the first half, versus 77.0% in both 2012 periods. Prior-period adverse development was $0.5 in Q2 and $1.7 for the first half, primarily tied to assigned-risk business. Management said current-year estimates were adequate but cautioned ultimate losses will take years to determine.
- Unrealized investment gains, net of deferred tax, fell $41.8 for the first half; accumulated other comprehensive income declined to $87.8 from $129.5. Management linked the quarterly decline in portfolio value principally to rising interest rates. It said fixed-maturity unrealized losses were primarily rate-related, not credit-related, and did not consider them other-than-temporary impairments; it recorded a $0.1 impairment on one equity security.
- Management expects 2013 premiums to reflect overall net rate increases, decelerating policy-count growth, and increasing average policy size. It cited persistently low investment yields and high national unemployment and did not expect a significant near-term change in overall economic conditions.
Outlook, risks, and contingencies
- The company’s investment income and equity remain exposed to interest-rate movements; fixed maturities represented 93.6% of the investment portfolio. It also identifies credit and equity-price risk. Management reported no material change in market risk since December 31, 2012.
- Loss reserves and reinsurance recoverables depend on significant estimates and assumptions. The $2,291.3 gross unpaid-loss and LAE liability is partly offset by $801.1 of reinsurance recoverables. Actual claims and payment patterns may differ materially from estimates.
- The legacy LPT Agreement covers specified pre-July 1995 claims. The remaining deferred gain was $274.2; estimated remaining covered liabilities were $655.6. The filing reports no current-period adjustment to estimated ceded reserves.
- A new reinsurance program began July 1, 2013, covering $195.0 in excess of a $5.0 per-occurrence retention, subject to a $2.0 annual aggregate deductible and exclusions. Management considers coverage adequate, but recovery depends on contract terms and reinsurer performance.
- California workers’ compensation reform SB 863 may reduce system costs, but timing and savings are uncertain and were not included in current rate filings. California remains a key concentration.
- Management said routine pending or threatened litigation was not expected to materially affect results, liquidity, or financial position. It reported no material changes to the risk factors in the latest annual report, no off-balance-sheet arrangements, and effective disclosure controls.
Important facts for investors to verify
- Whether premium growth and improving combined ratios persist, and whether underwriting reaches profitability below a 100% combined ratio.
- Reserve adequacy, especially assigned-risk prior-period development, and the assumptions underlying unpaid losses and reinsurance recoverables.
- The effect of interest-rate changes on investment income, unrealized gains, GAAP equity, and liquidity; confirm whether unrealized losses remain non-credit-related.
- Actual timing and financial impact of SB 863, California rate actions, and the company’s premium-growth outlook.
- Availability of regulated subsidiary dividends, credit-facility repayment requirements, and performance of the new reinsurance program and legacy LPT Agreement.