Employers Holdings, Inc. — Q2 2014 Form 10-Q
Business and period: Workers’ compensation insurer focused on small businesses, operating in 31 states and the District of Columbia, with substantial California concentration. Results cover the three and six months ended June 30, 2014; comparative periods are 2013.
Financial results
- Q2 revenue and earnings: Total revenue was $200.3 million, up 10.3% from $181.6 million. Net income was $45.6 million versus $14.6 million; diluted EPS was $1.42 versus $0.46.
- First-half revenue and earnings: Total revenue was $388.8 million, up 11.8% from $347.9 million. Net income was $56.4 million versus $22.1 million; diluted EPS was $1.76 versus $0.70.
- Premiums and investment income: Net premiums earned rose 7.9% in Q2 to $172.7 million and 10.4% for the first half to $339.8 million. First-half net investment income was $36.3 million, up 3.6%; realized investment gains were $12.4 million versus $4.7 million.
- Underwriting: Underwriting income was $20.7 million in Q2 and $12.2 million for the first half, compared with losses of $5.1 million and $15.3 million, respectively, in 2013. Combined ratios were 88.0% for Q2 and 96.4% for the first half, versus 103.2% and 105.0%. Results benefited materially from LPT Agreement estimate changes described below.
- Cash flow: First-half operating cash flow was $78.1 million versus $85.2 million. Investing used $74.4 million and financing used $1.2 million; cash and cash equivalents increased $2.5 million to $37.0 million.
- Balance sheet and capital: At June 30, total assets were $3.76 billion, investments were $2.45 billion, and GAAP stockholders’ equity was $645.3 million, up from $568.7 million at year-end 2013. Equity including the $223.1 million LPT deferred gain, a company-defined non-GAAP measure, was $868.3 million. Notes payable were $102.0 million.
- Liquidity: The holding company reported $68.8 million of cash and fixed maturities maturing within 24 months; insurance subsidiaries reported $496.6 million on the same basis. Management said anticipated holding-company and subsidiary liquidity needs over the next 24 months would be met from available resources and subsidiary dividends, subject to insurance-law restrictions. The company was in compliance with credit-facility covenants.
Material changes, outlook, and risks
- Unusual earnings items: Favorable paid-loss trends led to a $20.1 million LPT reserve adjustment and a $7.3 million LPT contingent-commission adjustment, both reducing losses and LAE. A $12.0 million reserve reallocation reduced the first-half effective tax rate by 3.7 percentage points and tax expense by $2.2 million. Together, these items increased Q2 net income by $29.6 million. Management’s non-GAAP net income before the impact of the LPT Agreement was $14.6 million in Q2 and $21.0 million for the first half.
- Premium outlook: Management expected 2014 premiums to reflect overall net rate increases, increasing average policy size, and moderate policy-count growth. In-force premiums increased 7.4% year over year overall and 9.3% in California. California accounted for 60% of in-force premiums at quarter-end.
- Claims and pricing risks: Management reported increased medical and indemnity costs per claim, including more cumulative-trauma claims, and said current accident-year loss estimates increased as anticipated cost trends exceeded rate increases. It considered estimates adequate but noted ultimate losses may remain uncertain for years. Prior-year unfavorable loss development was primarily associated with assigned-risk business.
- Investments and reinsurance: Investment yields remained low; the average pre-tax book yield was 3.3%, down from 3.4% in Q2 2013 and 3.5% in first-half 2013. Fixed maturities had a 4.2-year duration. The July 1, 2014–June 30, 2015 reinsurance program provides $195 million excess of a $5 million per-occurrence retention, subject to a $2 million annual aggregate deductible and exclusions.
- Other disclosures: Management reported no material change in market risk or risk factors, no material impact expected from pending or threatened ordinary-course litigation, and effective disclosure controls. No formal earnings guidance was provided.
Important facts for investors to verify
- How much of reported earnings and the improved combined ratio reflects the $29.6 million of LPT and tax estimate changes, and how results trend excluding those items.
- Whether medical, indemnity, and cumulative-trauma claim costs continue to outpace pricing, and how subsequent reserve development compares with estimates.
- Whether premium and policy growth, particularly in California, is maintained without compromising underwriting profitability.
- Whether investment income and portfolio values withstand persistent low yields, interest-rate changes, and equity-market volatility.
- Whether subsidiary dividend capacity, the debt repayment schedule, and reinsurance recoveries support liquidity and capital needs.