Employers Holdings, Inc. — Q2 2012 Form 10-Q
Business and period. The company provides workers’ compensation insurance, principally to small businesses, through subsidiaries operating in 31 states and the District of Columbia. California accounts for more than half of its business. This unaudited report covers the three and six months ended June 30, 2012; comparisons are with the corresponding 2011 periods.
Financial performance
| Metric | Q2 2012 | First six months 2012 | Comparable 2011 |
|---|---|---|---|
| Net premiums earned | $119.0 million | $228.9 million | $88.1 million Q2; $170.6 million six months |
| Total revenue | $138.3 million | $268.5 million | $109.5 million Q2; $212.8 million six months |
| Net income | $5.0 million | $11.2 million | $8.3 million Q2; $16.6 million six months |
| Diluted EPS | $0.16 | $0.35 | $0.21 Q2; $0.43 six months |
| Underwriting result | Loss of $15.8 million | Loss of $33.3 million | Loss of $14.3 million Q2; $28.2 million six months |
| Combined ratio | 113.3% | 114.6% | 116.2% Q2; 116.5% six months |
Gross premiums written increased 42% in Q2 and 40% for the first half year over year. Losses and loss adjustment expenses rose 38% and 37%, respectively. Net investment income declined 9.9% in Q2 and 10.1% for the first half; net realized investment gains were $0.9 million and $2.7 million, respectively. A $2.3 million Q2 and $6.7 million first-half income tax benefit supported net income; effective tax rates were negative, reflecting tax-exempt income and the LPT Agreement.
Financial position and cash flow
- At June 30, 2012, total assets were $3.54 billion, including $2.01 billion of investments and $208.8 million of cash and cash equivalents. GAAP stockholders’ equity was $454.7 million, down from $474.2 million at year-end 2011.
- Unpaid losses and loss adjustment expenses were $2.28 billion gross of reinsurance; reinsurance recoverable for unpaid losses was $920.0 million. The balance sheet also included $345.2 million of deferred gain under the LPT Agreement.
- Notes payable totaled $122.0 million: $90.0 million outstanding on the credit facility and $32.0 million in surplus notes. Debt represented 13.2% of capitalization when including the deferred LPT gain. The company said it was in compliance with credit covenants.
- For the first half, operating cash flow was $54.4 million, investing cash outflow was $56.4 million, and financing cash outflow was $41.4 million. Cash declined $43.5 million to $208.8 million.
- Cash and fixed maturities maturing within 24 months were $134.9 million at the holding company and $319.2 million at insurance subsidiaries. Management expected liquidity needs over that period to be met from cash, operations, maturing investments, and subsidiary dividends. A capital contribution of up to $70 million to operating subsidiaries was expected in Q3 2012.
Changes, outlook and risks
- Growth and underwriting: Premium growth reflected rising policy count and payroll exposure, as well as rate increases. Year-over-year in-force policy count rose 38.3%, payroll exposure 32.2%, and net rate 3.8%. The combined ratio remained above 100%, indicating an underwriting loss before investment income.
- Claims and pricing: Management reported increased indemnity claim frequency and medical and indemnity costs in California, as well as rising costs in several other states; Nevada trends remained favorable. Prior-period adverse development was entirely related to assigned-risk business. Management considered current-year reserves adequate but noted ultimate claims costs remain uncertain. California advisory rates and industry loss-cost benchmarks had risen; the company’s filed California rates had increased cumulatively 41.3% since February 2009, including a 6% increase effective June 15, 2012.
- Acquisition-cost accounting: A new standard effective January 1, 2012 narrowed the costs eligible for capitalization. It increased underwriting and operating expense by $2.2 million in Q2 and $5.2 million in the first half; the company estimated an approximately $7 million increase for full-year 2012.
- Investment and reinsurance: The portfolio was 93.9% fixed maturities, with duration of 4.1 and weighted-average credit quality of AA. Management attributed fixed-maturity unrealized losses primarily to interest rates, but recognized $0.5 million of impairment on seven equity securities. A new reinsurance program began July 1, 2012, providing $195 million excess of a $5 million per-occurrence retention, subject to a $2 million annual aggregate deductible and exclusions.
- Capital returns and outlook: The company repurchased $37.3 million of stock in the first half; its expanded $200 million repurchase authorization ran through June 30, 2013. Management expected 2012 premiums to reflect rate increases, policy-count and average-policy-size growth, and lessened competitive pressure. It also cited a persistently slow economic recovery and did not expect near-term conditions to change significantly.
- Other matters: Management reported no material change in previously disclosed risk factors, no material market-risk change since year-end, and no off-balance-sheet arrangements. Routine pending or threatened litigation was not expected to materially affect results, liquidity, or financial position.
Important facts for investors to verify
- Whether premium growth can translate into underwriting improvement given combined ratios above 100% and rising claim costs.
- Whether loss reserves and reinsurance recoverables remain adequate, particularly for California and assigned-risk claims.
- The effect of the new acquisition-cost accounting standard on full-year expenses and reported earnings.
- Whether investment income remains pressured by declining yields and how investment valuations and credit quality evolve.
- The funding and capital effects of the planned subsidiary contribution, repurchases, and restrictions on insurance-subsidiary dividends.