Employers Holdings, Inc. quarterly report, Q1 FY2011

Employers Holdings, Inc. — Q1 2011 Form 10-Q

Business and period: Unaudited results for the three months ended March 31, 2011, compared with Q1 2010. The company provides workers’ compensation insurance, primarily to small businesses, in 30 states and the District of Columbia, with significant exposure to California.

Financial results and position

Metric	Q1 2011	Q1 2010
Net premiums earned	$82.4 million	$79.3 million
Total revenues	$103.3 million	$101.1 million
Net investment income	$20.5 million	$21.3 million
Losses and loss adjustment expenses	$59.4 million	$40.3 million
Net income	$8.3 million	$16.1 million
Diluted earnings per share	$0.21	$0.38
Operating cash flow	$5.3 million	$2.1 million

Gross premiums written increased 25.3% to $103.2 million; net premiums earned rose 4.0%. Net premiums written were $101.1 million.
The combined ratio was 116.9%, versus 105.9%; a ratio above 100% indicates an underwriting loss. The underwriting loss widened to $14.0 million from $4.6 million. The loss and LAE ratio rose to 72.1% from 50.8%.
Underwriting and other operating expenses fell 20.4% to $25.7 million. Interest expense declined to $0.9 million from $1.6 million. An income tax benefit of $2.4 million, versus $0.5 million, partly offset lower pretax income.
Net cash increased $47.4 million, reflecting $52.4 million of investing cash inflow and $10.3 million of financing outflow, as well as operating cash flow. Cash and cash equivalents were $167.2 million at quarter-end.
At March 31, 2011, total assets were $3.48 billion, investments were $2.03 billion, and stockholders’ equity was $485.8 million. Notes payable totaled $132.0 million. Equity plus the deferred LPT reinsurance gain, a company-defined non-GAAP measure, was $851.6 million.
Quarterly dividend declared was $0.06 per share. The company repurchased 497,536 shares during the quarter for approximately $8.6 million; shares outstanding declined to 38.5 million from 39.0 million at year-end.

Material changes and management commentary

Losses and LAE increased 47.5%. Prior-period development was unfavorable by $0.8 million in Q1 2011, compared with favorable development of $11.1 million in Q1 2010. The current accident-year loss estimate increased to 76.6% from 70.3% of earned premiums.
Management attributed higher loss estimates principally to increasing California loss costs, including claims frequency and medical and indemnity costs. It also cited adverse development in assigned-risk business. Management considers its current-year estimate adequate, but noted ultimate losses may not be known for several years.
Operating expenses benefited from lower compensation costs following workforce reductions and from improved collections. Compensation expense decreased $5.4 million year over year; the company reported headcount down by more than 225 from March 2010.
Management described the economic recovery and employment trends as uncertain and did not expect significant near-term improvement. It expects 2011 premium revenue to reflect rate changes, policy-count growth, lower average policy size, competition, and continuing recession effects.
In California, the company had increased filed rates cumulatively by 28.3% since February 2009 and anticipated filing another rate increase in Q3 2011. The WCIRB reported a 39.8% cumulative increase in its claims-cost benchmark since January 2009; the state commissioner had not adjusted the benchmark since that date.

Liquidity, capital, risks, and contingencies

The company reported $132.0 million of debt: $100.0 million outstanding under its credit facility and $32.0 million of surplus notes. The credit facility is secured by securities and restricted cash with a fair value of $126.2 million and requires at least $5.0 million of holding-company cash; the company reported compliance with covenants.
The holding company had $104.3 million of cash and cash equivalents plus fixed maturities maturing within 24 months. Insurance-subsidiary dividends are restricted by state insurance laws; dividends from EICN through June 3, 2011 required prior regulatory approval following a 2010 extraordinary dividend.
Investments were predominantly fixed maturities; their duration was 4.93 years and average credit quality was AA. Unrealized investment losses were attributed primarily to interest-rate changes, and the company reported no other-than-temporary impairment in the quarter. Interest-rate, credit, and equity-market risk remain relevant.
Gross unpaid losses and LAE were $2.27 billion, with $946.6 million of reinsurance recoverables. Reserve estimates depend on actuarial assumptions and actual claim outcomes may differ materially. The LPT Agreement covers specified pre-July 1995 claims and had a $365.8 million remaining deferred gain.
Management said pending or threatened ordinary-course litigation was not expected to materially affect results, liquidity, or financial position. No material change to previously disclosed risk factors was reported; no off-balance-sheet arrangements were reported.
No quantitative earnings or premium guidance was provided. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported.

Important facts for investors to verify

Whether the elevated current accident-year loss estimate and unfavorable assigned-risk development continue, and how reserve estimates compare with subsequent claims experience.
Whether California rate actions keep pace with loss-cost trends and whether the anticipated Q3 2011 filing is approved and implemented.
The collectability and timing of reinsurance recoverables, including LPT Agreement recoveries, and the effect of the agreement’s deferred gain on reported earnings.
Holding-company liquidity, regulatory restrictions on insurance-subsidiary dividends, and the terms and collateral requirements of the credit facility.
Investment portfolio sensitivity to interest rates and credit conditions, and the sustainability of underwriting results excluding investment income and tax benefits.