Employers Holdings, Inc. — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010; balance-sheet figures are as of September 30, 2010. Amounts below are in U.S. dollars; financial statement amounts are generally shown in millions. The company provides workers’ compensation insurance, primarily to small businesses, in 30 states and the District of Columbia, with significant exposure to California.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net premiums earned | $80.7m | $98.2m | $238.2m | $314.2m |
| Total revenue | $101.8m | $124.3m | $302.3m | $384.4m |
| Net income | $10.1m | $30.6m | $42.7m | $71.8m |
| Diluted EPS | $0.25 | $0.67 | $1.01 | $1.53 |
| Combined ratio | 111.6% | 88.9% | 106.5% | 95.6% |
| Net investment income | $20.7m | $22.3m | $62.6m | $68.7m |
- Revenue declined 18.1% in Q3 and 21.3% for the nine-month period; net income fell 67.1% and 40.6%, respectively. The 2010 combined ratios above 100% indicate underwriting losses for both periods.
- For nine months, the loss and LAE ratio rose to 58.0% from 53.0%; the commission expense ratio rose to 12.2% from 8.2%, and the underwriting and other operating expense ratio rose to 34.9% from 32.7%. Favorable prior-year loss development was $16.6m, down from $39.6m in 2009. Q3 had no favorable prior-year development, versus $10.4m in the prior-year quarter.
- Net income included amortization of the LPT Agreement deferred gain of $13.5m for nine months and $4.8m in Q3. Excluding this amortization, the company’s non-GAAP net income measure was $29.1m for nine months and $5.3m for Q3.
- Net cash from operating activities was $5.6m for nine months, compared with $46.4m a year earlier. Investing activities provided $5.5m; financing activities used $58.7m, principally for share repurchases and dividends. Cash and equivalents declined to $144.0m from $191.6m at year-end 2009.
- At September 30, total assets were $3.58bn, total liabilities $3.05bn, and GAAP stockholders’ equity $528.8m. Equity including the $375.1m deferred LPT gain was $903.8m, a company-defined non-GAAP capital measure.
- Investments totaled $2.08bn at fair value. Fixed maturities had a 4.91-year duration and an average credit quality of AA; 75.8% were rated AA or better. The portfolio’s weighted-average tax-equivalent yield was 5.4%; reported average pretax book yield was 4.3% for the first nine months.
- Debt was $132.0m: $100.0m outstanding under the credit facility and $32.0m in surplus notes. The company reported compliance with credit covenants. Holding-company cash and fixed maturities maturing within 24 months totaled $126.3m; the insurance subsidiaries reported $391.1m in cash and such maturities.
Material changes, outlook and risks
- Premium pressure reflected recession-related unemployment and lower insured payrolls, lower net rates, competitive conditions, and disciplined underwriting. Year-over-year in-force premiums fell 19.4%; average annual policy size fell 17.0% to $7,545. Insured payroll declined approximately 11% over nine months, while policy count was down about 1% over that period.
- Management said near-term economic improvement remained uncertain. California’s insurance regulator had not acted on the WCIRB’s amended recommendation for a 27.7% increase in the state claims-cost benchmark effective January 1, 2011. The company had increased its filed California rates cumulatively by 25.2% since February 2009 and expected to file further California rates for policies effective on or after March 15, 2011. Florida approved a 7.8% rate increase effective January 1, 2011; filed rate decreases had applied in Florida and Nevada during 2010.
- A July 2010 reorganization combined four regional operating units into two, eliminated approximately 160 positions, and included closure of four offices. The company recorded $4.2m of Q3 restructuring charges and expected a further approximately $1.4m of lease-related charges in Q4 2010. Management anticipated annualized savings of approximately $19.0m beginning in 2011.
- In November 2010, the board authorized a new share repurchase program of up to $100m through June 30, 2012. The prior $50m program had been completed by September 30, 2010. Also after quarter-end, a renegotiated reinsurance agreement was expected to result in approximately $1.8m of Q4 expense.
- Key uncertainties include the estimation of long-tail workers’ compensation reserves, medical-cost inflation, changing claim emergence and payment patterns, and the collectability of reinsurance recoverables. Management stated that reserves were its best estimate but that ultimate claims could differ, potentially materially. The company reported approximately $996.8m of reinsurance recoverables on unpaid losses.
- The LPT Agreement covers specified pre-July 1995 claims, with $375.1m of deferred gain remaining at quarter-end. The company reported no material change in market risk since year-end 2009. Routine pending or threatened litigation was not expected by management to materially affect results, liquidity or financial position; no material risk-factor changes were reported.
Important facts for investors to verify
- Whether premium declines, payroll trends and California rate actions stabilize or continue to pressure earned premiums and underwriting results.
- Reserve adequacy, including the pace and sources of favorable prior-year development, medical-cost trends and the assumptions behind unpaid-loss estimates.
- Reinsurance recoverable quality and timing, and future development of the LPT Agreement and its deferred gain.
- Execution and timing of the reorganization’s expected $19.0m annualized savings, including the additional lease costs and Q4 reinsurance expense.
- Liquidity and refinancing needs, including credit-facility maturities, insurance-subsidiary dividend restrictions and the planned share repurchase program.
- Investment portfolio sensitivity to interest rates, credit conditions and falling reinvestment yields.