Business context and reporting period
Employers Holdings, Inc. filed this Form 10-K for the fiscal year ended December 31, 2011. The company provides workers’ compensation insurance to small businesses, primarily in low- to medium-hazard industries, across 31 states and the District of Columbia. California represented 56% of in-force premiums at year-end. The company reports one operating segment.
Key financial metrics
| Metric | 2011 | 2010 |
|---|---|---|
| Total revenue | $464.2 million | $415.6 million |
| Net premiums earned | $363.4 million | $321.8 million |
| Net premiums written | $410.0 million | $313.1 million |
| Net income | $48.3 million | $62.8 million |
| Diluted EPS | $1.29 | $1.51 |
| GAAP combined ratio | 114.0% | 106.8% |
| Operating cash flow | $43.2 million | $57.0 million |
| Cash and cash equivalents | $252.3 million | $119.8 million |
| Total investments, at fair value | $1.951 billion | $2.080 billion |
| Notes payable | $122.0 million | $132.0 million |
| Total assets | $3.482 billion | $3.480 billion |
Net investment income was $80.1 million, down from $83.0 million. Net realized investment gains rose to $20.2 million from $10.1 million. GAAP stockholders’ equity was $474.2 million, versus $490.1 million. The company declared $0.24 per share in dividends for both years.
Material changes versus the prior comparable period
- Premium growth rebounded: net premiums written rose 31% and net premiums earned rose 13%. In-force premiums increased 22.7%, driven mainly by policy-count growth; the number of in-force policies rose 36.2%.
- Underwriting results weakened. The GAAP combined ratio increased to 114.0% from 106.8%, and the company reported an underwriting loss of $50.9 million, compared with a $21.8 million loss in 2010. The statutory combined ratio also rose, to 112.1% from 109.8%.
- Losses and loss adjustment expenses increased 36% to $264.7 million. The current accident-year loss estimate increased to 77.2% from 70.6%. Prior-year reserve development was unfavorable by $1.1 million in 2011, compared with favorable development of $14.1 million in 2010.
- Underwriting and other operating expenses declined 5% to $100.7 million. Commission expense increased to $45.5 million, primarily with higher earned premiums.
- Net income fell 23%, despite higher premiums and realized investment gains. Management’s non-GAAP net income before the impact of the LPT deferred gain was $31.2 million, down from $44.6 million; the reported 2011 net income included $17.1 million of LPT deferred-gain impact.
- Cash increased substantially, supported by investment sales and maturities; investing activities provided $199.2 million. Financing activities used $109.9 million, including $92.0 million of share repurchases and $8.9 million of dividends.
Outlook, management commentary, risks and unusual items
- Management expected 2012 premiums to reflect overall rate increases, continued policy-count growth, higher average policy size and lessened competitive pressures. It did not provide specific earnings or revenue guidance and said the economic recovery remained slow.
- The company increased California filed rates cumulatively 33.3% since February 2009, citing rising loss costs, especially medical costs. It also reported increasing indemnity-claim frequency in California and rising medical and indemnity costs in several markets.
- Management estimated that a 1 percentage-point increase in medical-cost inflation above the level implicit in reserves could increase lifetime future medical costs on existing claims by approximately $81 million, net of reinsurance.
- Loss reserves are a significant estimation risk: gross unpaid losses and LAE were $2.272 billion, with $940.8 million of unpaid-loss reinsurance recoverables and $1.332 billion net reserves. California and Nevada represented approximately 78% of reserves.
- The legacy LPT Agreement covers pre-July 1995 Nevada claims. Estimated remaining liabilities under the agreement were approximately $807.5 million, supported by $896.1 million of trust assets. The company remains liable to policyholders if reinsurers fail to pay; a portion of collateral consists of publicly traded stock and is exposed to market-price changes.
- The 2011 excess-of-loss reinsurance program provided $195 million of coverage above a $5 million per-occurrence retention, subject to a $2 million annual aggregate deductible and exclusions. Nuclear, biological, chemical and radiological terrorism risks are excluded from the treaty.
- California concentration, intense price competition, interest-rate and credit risks in the investment portfolio, regulatory limits on insurer dividends, and dependence on distribution partners ADP and Anthem are material risks. The company’s insurers held A.M. Best ratings of A- with a stable outlook.
- In 2012, adoption of new insurance acquisition-cost accounting guidance was expected to increase underwriting and operating expenses by approximately $7 million and reduce total assets by a similar amount.
- Fourth-quarter 2011 included $18.2 million of realized investment gains, largely from strategic portfolio rebalancing. The quarter also reflected a $0.8 million pretax reduction in operating expenses for an over-accrual of sales incentives and a $1.0 million increase in income-tax expense, primarily from writing off a prior-year deferred tax asset.
- The company reported no material litigation exposure in management’s view, no off-balance-sheet arrangements, and effective internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether pricing and underwriting actions can offset continuing medical-cost inflation and the deterioration in accident-year loss estimates.
- Reserve adequacy, particularly for California claims and the potential effect of medical inflation, legislative or judicial changes, and later claim development.
- Collectibility and collateral adequacy of reinsurance recoverables, especially under the LPT Agreement and its stock-backed collateral.
- Whether premium growth can continue without weakening underwriting discipline, given the company’s California concentration and competitive market.
- Capacity to fund dividends, repurchases and debt obligations while insurance-subsidiary dividends are subject to regulatory limits; verify covenant compliance and available holding-company liquidity.
- The extent to which 2011 earnings depended on realized investment gains and LPT accounting effects, and the effect of the approximately $7 million 2012 accounting-standard expense.