Employers Holdings, Inc. — Q1 2013 Form 10-Q
Business and period: The company provides workers’ compensation insurance, primarily to small businesses, across 31 states and the District of Columbia. California accounts for over half of its business. This unaudited report covers the three months ended March 31, 2013; comparisons are with Q1 2012 unless stated otherwise. Dollar amounts below are in millions unless noted.
Financial results and position
| Metric | Q1 2013 | Q1 2012 / comparison |
|---|---|---|
| Gross premiums written | $175.0 | $142.8; up 22.5% |
| Net premiums earned | $148.0 | $109.9; up 34.6% |
| Total revenue | $166.3 | $130.1 |
| Net investment income | $17.4 | $18.4; down 5.3% |
| Net realized investment gains | $0.8 | $1.8 |
| Losses and loss adjustment expenses | $108.3 | $80.5; up 34.5% |
| Net income | $7.5 | $6.3 |
| Diluted earnings per share | $0.24 | $0.19 |
| Operating cash flow | $41.6 | $24.4 |
| Cash and cash equivalents at quarter-end | $130.9 | $140.7 at Dec. 31, 2012 |
Underwriting losses narrowed to $10.2 million from $17.4 million. The combined ratio improved to 106.9% from 115.9%, but remained above 100%, indicating an underwriting loss before investment income. The loss and LAE ratio was 73.2%, the commission ratio 12.4%, and the underwriting and other operating expense ratio 21.3%.
At March 31, total investments were $2.198 billion at fair value, including $2.060 billion of fixed maturities; total assets were $3.574 billion and stockholders’ equity was $548.1 million. Notes payable were $112.0 million: $80.0 million outstanding on the credit facility and $32.0 million in surplus notes. Management also reported $825.5 million of equity including the unamortized LPT deferred gain, a non-GAAP measure. The company declared dividends of $0.06 per share.
Material changes and management commentary
- Premium growth reflected higher policy count and net rates. Year-over-year in-force policy count increased 22.2%, in-force premiums 29.3%, and net rate 10.2%.
- Underwriting and other operating expenses declined 4.4% year over year, and the expense ratio improved by 8.7 percentage points. Management attributed the improvement partly to premiums growing faster than expenses and to a prior-year accounting change that had increased Q1 2012 expenses.
- Current accident-year loss estimates were 75.1% of earned premiums versus 76.9% a year earlier. Net prior-year loss development was adverse by $1.1 million, primarily related to assigned-risk business. Management said claim frequency was relatively unchanged and reported downward trends in medical and indemnity costs per claim; ultimate losses remain uncertain.
- The estimated annualized investment yield declined: average pre-tax book yield was 3.5% versus 3.8% in Q1 2012. The portfolio was 93.7% fixed maturities, with duration of 4.1 and weighted-average credit quality of AA.
Outlook, liquidity, and risks
Management expected 2013 premiums across its markets to reflect overall rate increases, decelerating policy-count growth, and increasing average policy size. It did not provide quantified earnings guidance. Management cited persistently low investment yields and high national unemployment and did not expect near-term economic conditions to change significantly.
Management said holding-company liquidity needs for the next 24 months were expected to be met by cash, maturing investments, and subsidiary dividends; insurance-subsidiary liquidity needs were expected to be met by operating cash flow, investment income, and maturing investments. The holding company had $87.8 million of cash and fixed maturities maturing within 24 months; subsidiaries had $357.8 million on the same basis. Subsidiary dividends are subject to state insurance restrictions. The company reported compliance with credit-facility covenants.
Risks include uncertainty in loss reserves and reinsurance recoverables, California concentration, interest-rate and equity-market exposure, and reliance on investment income while underwriting remains unprofitable. The company’s California rate filings did not yet include potential savings from SB 863 reforms; management said savings depend on implementation and were not assured. Its reinsurance program provided $195 million of coverage above a $5 million per-occurrence retention, subject to terms, exclusions, and an annual aggregate deductible.
The LPT Agreement covers specified pre-July 1995 claims. Its remaining deferred gain was $277.5 million at quarter-end, and $4.0 million was amortized during Q1. This accounting affects reported losses and earnings; the company also presents “net income before impact of the LPT Agreement” as a non-GAAP supplemental measure. Gross unrealized investment losses were $1.7 million; management attributed fixed-maturity losses primarily to interest rates and did not consider the losses other-than-temporary. No material change in market risk or risk factors was reported. Management said ordinary-course litigation was not expected to materially affect results, liquidity, or financial position. Disclosure controls were deemed effective.
Important facts for investors to verify
- Whether premium growth can be sustained as policy-count growth decelerates, and whether pricing adequately offsets future claim-cost trends.
- Loss-reserve adequacy and subsequent development, particularly for assigned-risk business and long-tail claims.
- Underlying underwriting performance after considering the LPT Agreement, including the assumptions behind the company’s non-GAAP presentation.
- Investment yield and portfolio valuation sensitivity to interest rates, credit conditions, and equity markets.
- Actual timing and effect of California SB 863 reforms, and the availability of subsidiary dividends to support the holding company.
- Reinsurance recoverability and coverage terms, along with debt maturities and continued covenant compliance.