Employers Holdings, Inc. — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 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 amounts below are in millions unless otherwise stated.
Financial results and key metrics
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net premiums earned | $78.2 | $104.4 | $157.5 | $216.0 |
| Total revenue | $99.4 | $127.1 | $200.5 | $260.1 |
| Net investment income | $20.6 | $23.1 | $41.9 | $46.4 |
| Net income | $16.5 | $20.3 | $32.6 | $41.2 |
| Diluted EPS | $0.39 | $0.44 | $0.76 | $0.87 |
| Combined ratio | 101.9% | 97.4% | 103.9% | 98.6% |
Premiums earned fell 25.0% in Q2 and 27.1% in the first half year over year. Net income declined 18.9% and 20.9%, respectively. Combined ratios above 100% indicate underwriting losses in both 2010 periods. H1 loss and LAE ratio was 54.3% versus 52.4%; underwriting and other operating expense ratio rose to 36.4% from 31.9%.
Prior-period reserve development reduced losses by $5.5 million in Q2 and $16.6 million in H1, versus $15.7 million and $29.2 million in the comparable 2009 periods. H1 net income excluding amortization of the LPT deferred reinsurance gain—a company-defined non-GAAP measure—was $23.9 million, down from $32.5 million. LPT gain amortization contributed $8.7 million to reported H1 income.
- Cash flow: H1 operating cash flow was negative $9.8 million, compared with positive $40.7 million in 2009. Investing activities provided $39.6 million and financing used $28.2 million; cash increased $1.6 million to $193.1 million.
- Balance sheet at June 30: Assets were $3.61 billion, investments $2.01 billion, gross unpaid losses and LAE $2.36 billion, and reported stockholders’ equity $521.3 million. Notes payable were $132.0 million, including a $100 million credit facility and $32 million of surplus notes.
- Liquidity and capital: The parent reported $117.0 million of cash and fixed maturities maturing within 24 months; insurance subsidiaries reported $354.7 million. Management said expected liquidity needs over that period would be met from available cash, maturities, operations, investment income and subsidiary dividends. Insurance-subsidiary dividends are subject to regulatory limits; further EICN dividends through June 3, 2011 require prior approval.
- Shareholder returns: H1 share repurchases totaled $21.9 million; dividends declared were $0.12 per share. The quarterly dividend was $0.06 per share.
Material changes and management commentary
- Management attributed falling premiums to recession-related unemployment, reduced hours and insured payrolls, lower average policy size, competitive pricing, and disciplined underwriting. Year-over-year in-force premiums fell 20.8%; policy count fell 4.2% and average annual policy size was $7,903. Insured payroll declined approximately 16% over the prior 12 months.
- California filed rate increases totaled 25.2% since February 2009, while filed rates were reduced 6.8% in Florida and 6.7% in Nevada. Management reported increased California renewal rates, but continuing pressure in other markets.
- Net investment income declined 9.6% in H1, reflecting lower average invested assets and lower yields. The portfolio was 96.8% fixed maturities, rated AA+ on average, with a 4.80 duration. Management described its investment approach as high-quality and short-duration oriented.
- On July 2, 2010, the company announced a reorganization, combining four regional units into Eastern and Western units and eliminating approximately 160 positions. It expected 2010 restructuring charges of $2.4 million for workforce reductions and $1.3 million and $1.8 million for facility leases in Q3 and Q4. Management projected net savings of $2.7 million for the remainder of 2010 and annualized savings of $18.3 million beginning in 2011.
- A new reinsurance program effective July 1, 2010 provides $195 million of per-occurrence coverage above a $5 million retention, subject to a $2 million annual aggregate deductible and exclusions.
Risks, contingencies and other disclosures
- Loss reserves and reinsurance recoverables depend on estimates, actuarial assumptions and claims development. Management noted that medical-cost inflation is increasing in California and other states, and that ultimate claims may differ materially from recorded reserves. H1 prior-period favorable development was lower than in 2009.
- Other identified exposures include economic and competitive pressure on premiums, interest-rate and equity-market risk, and regulatory or legal changes affecting workers’ compensation claims. The company reported no material change in market risk since year-end 2009.
- Unrealized investment losses totaled $2.2 million at June 30; management attributed fixed-maturity losses primarily to interest rates and did not consider the losses other-than-temporary. The filing reports no off-balance-sheet arrangements and says ordinary-course litigation is not expected to materially affect results, liquidity or financial position.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. No material changes to the risk factors in the 2009 Form 10-K were reported.
Important facts for investors to verify
- Whether premium and policy declines stabilize, particularly in California, Florida and Nevada, and how rate changes affect retention and underwriting profitability.
- Reserve adequacy, medical-cost trends, and the sustainability of favorable prior-year loss development.
- Whether the restructuring delivers the projected savings and whether additional charges arise.
- Liquidity at the holding-company level, regulatory capacity for subsidiary dividends, and debt repayment or refinancing needs.
- Investment income and portfolio sensitivity to interest rates, credit conditions and equity-market movements.
- The contribution of LPT deferred-gain amortization and unusually low effective tax rates to reported earnings.