Employers Holdings, Inc. — FY2014 Form 10-K
Business context and reporting period. This is the annual report for the fiscal year ended December 31, 2014 (with unaudited fourth-quarter results also disclosed). Employers Holdings provides workers’ compensation insurance to small businesses in low- to medium-hazard industries across 31 states and the District of Columbia. California generated about 59% of in-force premiums. The company operates as one reportable segment.
Financial performance and condition
| Metric | 2014 | 2013 |
|---|---|---|
| Total revenue | $773.5 million | $723.6 million |
| Net premiums earned | $684.5 million | $642.3 million |
| Net premiums written | $687.6 million | $678.5 million |
| Net income | $100.7 million | $63.8 million |
| Diluted earnings per share | $3.14 | $2.00 |
| Combined ratio | 97.0% | 103.9% |
| Operating cash flow | $169.4 million | $163.7 million |
- Revenue rose 6.9%; net income rose 57.8%. Net premiums written grew about 1.4%, reflecting slower premium growth during the company’s California pricing actions.
- Underwriting income was $20.6 million, versus an underwriting loss of $24.8 million in 2013. The reported combined ratio improved below 100%, indicating underwriting profit.
- Excluding the LPT Agreement’s effects, the combined ratio was 105.0% versus 109.8%, and non-GAAP net income before LPT effects was $45.7 million versus $25.9 million. These are company-defined non-GAAP measures.
- Net investment income was $72.4 million, little changed from $70.8 million; net realized investment gains increased to $16.3 million from $9.5 million. Average pre-tax book yield declined to 3.2% from 3.4%.
- Cash and cash equivalents were $103.6 million at year-end. Total investments were $2.45 billion at fair value; total assets were $3.77 billion. Gross unpaid losses and LAE were $2.37 billion, or $1.70 billion net of reinsurance.
- Total stockholders’ equity was $686.8 million, up from $568.7 million. The company also reported $893.9 million of equity including the $207.0 million deferred LPT gain, a non-GAAP measure.
- Debt totaled $92.0 million: $60.0 million under a credit facility due December 31, 2015, and $32.0 million in surplus notes due in 2034. The company repaid $10.0 million of its credit facility during 2014 and reported compliance with covenants.
- Operating cash flow was $169.4 million; investing activities used $85.5 million and financing activities used $14.8 million. Cash increased $69.1 million during the year. The annual dividend declared was $0.24 per share.
Material changes and unusual items
- Reported earnings included $31.1 million from favorable LPT reserve adjustments and $10.8 million from an increased estimated LPT contingent commission. A $13.1 million reserve reallocation from non-taxable pre-2000 periods reduced the effective tax rate by 3.4 percentage points and added $3.6 million to net income. The company said these items collectively increased 2014 net income by $45.5 million.
- The 2013 comparison also included $23.8 million of net income benefit from LPT adjustments and tax-related reserve reallocation, while 2013 had $6.9 million of unfavorable prior-year loss development.
- Losses and LAE were $453.4 million, down from $463.6 million. The calendar-year loss ratio improved to 66.2% from 72.2%, while underwriting and other operating expense and commission ratios also declined.
- In-force premiums grew 1.7% and policies in force grew 1.5%. California in-force policy count fell 2.0%, as the company sought to moderate California growth and diversify. California net rates increased 11.2% in 2014.
- Fourth-quarter 2014 net income was $29.1 million, including $11.7 million of favorable LPT reserve and contingent commission adjustments.
Outlook, management commentary, and risks
- No specific earnings, premium, or combined-ratio guidance is provided. Management’s stated strategy is disciplined underwriting, profitable growth, claims management, and diversification. Initiatives included centralized sales and underwriting management, business-process improvements, and a new California pricing platform.
- Management cited increasing medical and indemnity costs per claim, including more California cumulative-trauma claims. California claim litigation had increased in 2013; its rate of increase moderated in 2014. Management considered current accident-year reserves adequate but noted ultimate losses may take years to emerge.
- Loss-reserve estimates are a key uncertainty. A 1-percentage-point increase in medical-cost inflation above the rate implicit in reserves was estimated to increase lifetime costs on current claims by about $96 million net of reinsurance. The carried net reserve was within the actuarial range, but management cautioned actual outcomes could fall outside that range.
- California concentration exposes results to state-specific regulation, competition, economic conditions, claim trends, and natural catastrophes. The filing also identifies pricing adequacy, competition, investment and interest-rate risk, reinsurance collectability, and dependence on agents and ADP as material risks. ADP generated 11.3% of in-force premiums and either party may terminate the agreement on 120 days’ notice.
- The current excess-of-loss program provided $195 million of coverage above a $5 million per-occurrence retention, subject to a $2 million annual aggregate deductible and exclusions. The company remains liable to policyholders if reinsurers do not pay. LPT-related remaining liabilities were estimated at $534.8 million, supported by $1.5 billion in trust assets.
- The holding company reported $63.3 million of cash and fixed maturities maturing within 24 months, against the $60 million credit-facility payment due in 2015. Management expected liquidity needs to be met by cash, investments, and subsidiary dividends, which are legally restricted. Insurer subsidiaries had $568.8 million of cash and fixed maturities maturing within 24 months.
- Insurance subsidiaries were rated A- (Excellent) by A.M. Best with a negative outlook. Each subsidiary exceeded applicable risk-based capital requirements. The independent auditor gave unqualified opinions on the financial statements and internal control; management reported no material weakness.
- Management said pending or threatened litigation in the ordinary course was not expected to materially affect results, liquidity, or financial position. The filing reports no off-balance-sheet arrangements.
Important facts for investors to verify
- How much of future earnings and underwriting performance depends on LPT reserve and contingent-commission estimates, and how those estimates develop.
- Whether California rate actions can offset medical-cost inflation, cumulative-trauma claims, and litigation trends without materially reducing policy count or retention.
- Reserve adequacy, including sensitivity to medical inflation and the assumptions behind the actuarial range.
- Reinsurance collectability, collateral quality and concentration, and renewal terms for the excess-of-loss program.
- Availability of holding-company liquidity for the 2015 credit-facility maturity, considering statutory dividend limits and the subsidiaries’ capital needs.
- Investment portfolio exposure to interest rates and equity prices; the filing estimates that a 100-basis-point rate rise would reduce fixed-maturity fair value by $88.9 million before tax.
- Whether the A.M. Best negative outlook, California concentration, or ADP relationship changes affect business volume, pricing, or distribution.