12. Subsequent Events

 

On November 3, 2010, the Board of Directors authorized a share repurchase program for up to $100 million of the Company's common stock. The Company expects that shares may be purchased at prevailing market prices from November 8, 2010 through June 30, 2012 through a variety of methods, including open market or private transactions, in accordance with applicable laws and regulations and as determined by the Company’s management. The timing and actual number of shares repurchased will depend on a variety of factors, including the share price, corporate and regulatory requirements, and other market and economic conditions. Repurchases under the stock repurchase program may be commenced, modified or suspended from time to time without prior notice, and the program may be suspended or discontinued at any time.

In November 2010, the Company re-negotiated the terms of a reinsurance agreement, which will result in an expense of approximately $1.8 million in the fourth quarter of 2010.

 

 

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Item 2.  Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations

 

You should read the following discussion and analysis in conjunction with our consolidated financial statements and the related notes thereto included in Item 1 of Part I.  Unless otherwise indicated, all references to “we,” “us,” “our,” “the Company” or similar terms refer to Employers Holdings, Inc. (EHI), together with its subsidiaries. The information contained in this quarterly report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this quarterly report and in our other reports filed with the Securities and Exchange Commission (SEC), including our 2009 Annual Report on Form 10-K for the year ended December 31, 2009 (Annual Report).

 

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements if accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed. You should not place undue reliance on these statements, which speak only as of the date of this report. Forward-looking statements include those related to our expected financial position, business, financing plans, litigation, future premiums, revenues, earnings, pricing, investments, business relationships, expected losses, loss reserves, acquisitions, competition, and rate increases with respect to our business and the insurance industry in general. Statements including words such as “expect,” “intend,” “plan,” “believe,” R 20;estimate,” “may,” “anticipate,” “will” or similar statements of a future or forward-looking nature identify forward-looking statements.

 

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. All forward-looking statements address matters that involve risks and uncertainties that could cause actual results to differ materially from historical or anticipated results, depending on a number of factors. These risks and uncertainties include, but are not limited to, those described in our Annual Report and other documents that we have filed with the SEC.

 

Overview

 

We are a Nevada holding company. Through our insurance subsidiaries, we provide workers’ compensation insurance coverage to select, small businesses in low to medium hazard industries. Workers’ compensation insurance is provided under a statutory system wherein most employers are required to provide coverage for their employees’ medical, disability, vocational rehabilitation, and/or death benefit costs for work-related injuries or illnesses. We provide workers’ compensation insurance in 30 states and the District of Columbia, with a concentration in California.

 

We target small businesses, as we believe that this market is characterized by fewer competitors, more attractive pricing, and stronger persistency when compared to the U.S. workers’ compensation insurance industry in general. We believe we are able to price our policies at levels which are competitive and profitable over the long-term. Our underwriting approach is to consistently underwrite small business accounts at an appropriate and competitive price without sacrificing long-term profitability and stability for short-term top-line revenue growth.

 

We market and sell our workers' compensation insurance products through independent local, regional and national agents and brokers, and through our strategic partnerships and alliances, including our principal partners ADP, Inc. and Anthem Blue Cross.

 

We measure our performance by our ability to increase stockholders’ equity, including the impact of the deferred reinsurance gain–LPT Agreement (Deferred Gain), over the long-term. Our stockholders’ equity, including the Deferred Gain, was $903.8 million and $887.0 million at September 30, 2010 and December 31, 2009, respectively. Stockholders’ equity, including the Deferred Gain, is a non-GAAP measure that is defined as total stockholders’ equity plus the deferred reinsurance gain—LPT Agreement, which we believe is an important supplemental measure of our capital position. Stockholders’ equity on a GAAP basis was $528.8 million and $498.4 million at September 30, 2010 and December 31, 2009, respectively.

 

Revenues

 

We continue to be affected by the impacts of the most recent economic recession. The pace of recovery remains uncertain and, although it appears to us that the declines in total employment and payroll may have leveled-off, we do not believe the situation will significantly improve in the near-term.

 

We derive our revenues primarily from two sources: Net Premiums Earned and Net Investment Income.

 

Net Premiums Earned.  Net premiums earned decreased 24.2%, or $76.0 million, for the nine months ended September 30, 2010, compared to the same period of 2009. High unemployment and declining hours worked are reflected in our policyholders’ payroll, and have led to declining premiums in most of the states in which we operate. As of September 30, 2010, year-over-year in-force premiums declined 19.4%. Our average annual policy size decreased 17.0% to $7,545

as of September 30, 2010. Similarly, during the nine and twelve months ended September 30, 2010, our in-force policy count decreased approximately 1% and 3%, respectively. The total payroll of our insureds, upon which we base our premium, declined approximately 11% and 15% for the nine and twelve months ended September 30, 2010, respectively.

 

 

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Our net rate, defined as total premium in-force divided by total insured payroll, declined approximately 4% and 6% for the nine and twelve months ended September 30, 2010, respectively. Net rate is a function of a variety of factors, including rate changes, underwriting risk profiles and pricing, and changes in business mix related to economic and competitive pressures.

 

Our total in-force premiums and number of policies in-force for our five largest states and all other states combined are shown in the table below.

 

		September 30, 2010								December 31, 2009								September 30, 2009								December 31, 2008
State		Premium In-force				Policies In-force				Premium In-force				Policies In-force				Premium In-force				Policies In-force				Premium In-force				Policies In-force
		(dollars in thousands)
California		$	172,693				28,586			$	180,474				27,812			$	186,465				28,144			$	203,694				27,942
Illinois			19,150				850				19,389				801				19,126				787				17,885				689
Nevada			18,624				3,662				24,050				4,119				25,829				4,300				38,971				5,221
Wisconsin			16,172				783				24,125				922				26,607				927				29,040				892
Florida			15,724				1,932				27,964				2,630				32,960				2,749				46,248				3,115
Other			85,938				7,698				109,023				7,870				116,536				7,941				129,770				7,740
Total		$	328,301				43,511			$	385,025				44,154			$	407,523				44,848			$	465,608				45,599

Our strategic partnerships and alliances generated $71.0 million, or 21.6%, of our in-force premiums as of September 30, 2010, compared to $76.1 million, or 18.6%, as of September 30, 2009. This percentage increase was primarily due to the higher retention rates for this business than for business produced by our independent agents. We believe that the bundling of services through these relationships has contributed to the higher retention rates. These relationships also allow us to access new customers that we may not have access to through our independent agent distribution channel. We continue to expand existing relationships and actively seek new partnerships and alliances.

 

Approximately one-half of our business is generated in California, where, through August 2010, we saw increased net rate on renewal business for 17 consecutive months. In September 2010, our net rate on renewal business declined by 2.8% in California. We continue to see a steady level of new business submittals and our policy count in California has increased 2.8% in the nine months ended September 30, 2010.

 

In April 2009, the Workers’ Compensation Insurance Rating Bureau (WCIRB), which makes rating recommendations in California, submitted a revised recommendation to increase the claims cost benchmark 23.7% effective July 1, 2009. This recommendation was based upon the WCIRB’s evaluation of March 31, 2009 loss experience and included a 16.9% rate increase due to increased medical costs and a 5.8% increase directly attributable to additional costs arising from certain Workers’ Compensation Appeals Board decisions. On July 8, 2009, the California Commissioner of Insurance (California Commissioner) rejected the recommendation of the WCIRB and left the claims cost benchmark unchanged.

 

In August 2009, the WCIRB recommended a 22.8% increase in the claims cost benchmark effective January 1, 2010. This recommendation was based upon the WCIRB’s evaluation of March 31, 2009 loss experience and included a 16.0% rate increase due to increased medical costs and a 5.8% increase directly attributable to expected additional costs arising from Workers’ Compensation Appeals Board decisions. On November 9, 2009, the California Commissioner again rejected the WCIRB recommendation and left the claims cost benchmark unchanged. On April 16, 2010, the WCIRB submitted an analysis of premium and loss experience as of December 31, 2009, indicating a 21.1% increase in the claims cost benchmark, without making a recommendation. The California Commissioner took no action as a result of that analysis. On August 18, 2010, the WCIRB recommended a 29.6% increase in the claims cost benchmark effective January 1, 2011, based on the WCIRB’s evaluation of March 31, 2010 loss experience. The WCIRB subsequently amended its August filing in September 2010 to recommend a 27.7% increase in the claims cost benchmark in lieu of the 29.6% increase based on an analysis of June 30, 2010 loss experience. The California Commissioner has not issued a decision on the recommendation of the WCIRB as of the date of this filing.

 

We set our own premium rates in California based upon actuarial analysis of current and anticipated loss trends with a goal of maintaining underwriting profitability. We reduced our filed premium rates in California from 2003 through 2008 as a result of favorable loss costs trends originating from the 2003 and 2004 legislative reforms. However, due to recent increases in loss costs, primarily medical cost inflation, we have increased our filed premium rates by a cumulative 25.2% since February 1, 2009. We expect to file new rates in California for new and renewal policies to be effective on or after March 15, 2011.

 

 

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The following table sets forth the percentage increases to our filed California rates that became effective for new and renewal policies incepting on or after the dates shown.

 

Effective Date		Premium Rate Change Filed in California
February 1, 2009			10.0	%
August 15, 2009			10.5
March 15, 2010			3.0

 

We have also seen rate reductions and downward pressure on premiums in several of our other states, particularly in Florida and Nevada, which had 6.8% and 6.7% filed rate decreases, respectively. The 6.8% filed rate decrease in Florida was for new and renewal policies incepting on or after January 1, 2010. The 6.7% filed rate decrease in Nevada was for new and renewal policies incepting on or after March 1, 2010. Furthermore, the recession disproportionately impacted premiums and the number of our policies in-force in these states. Classes of small businesses that have been particularly affected by the recession include contractors and restaurants. Declining payrolls due to reduced employment and work hours, closures of small businesses and our continued focus on profitable underwriting have contributed to the lower premium revenues.

 

On October 15, 2010, the Florida Insurance Commissioner approved a 7.8% increase in workers’ compensation rates to be effective January 1, 2011 for new and renewal business.

 

Premium revenues in 2010 will continue to reflect rate increases in California, rate reductions in several of our other states, including Florida and Nevada, as well as competitive pressures and the continuing impacts of the recession.

 

Net Investment Income and Realized Gains (Losses) on Investments. We invest our holding company assets, statutory surplus and the funds supporting our insurance liabilities, including unearned premiums and unpaid losses and loss adjustment expenses (LAE). We invest in fixed maturity securities, equity securities, short-term investments, and cash equivalents. Net investment income includes interest and dividends earned on our invested assets and amortization of premiums and discounts on our fixed maturity securities, less bank service charges and custodial and portfolio management fees. Realized gains and losses on our investments are reported separately from our net investment income. Realized gains and losses on investments include the gain or loss on a security at the time of s ale compared to its original or adjusted cost (equity securities) or amortized cost (fixed maturity securities). Realized losses are recognized when securities are written down as a result of an other-than-temporary impairment.

 

We have established a high quality/short duration bias in our investment portfolio with high underlying credit quality of our municipal bond holdings. The performance of our investment portfolio, with its diversified structure and quality bias, has been strong and our realized and unrealized losses have been minimal, considering the volatility and uncertainty in the financial markets.

 

Expenses

 

We continue to manage our expenses and expect a continued decline in our commission and underwriting and other operating expenses during 2010. While the pace of economic recovery remains uncertain, we believe that we are well-positioned to grow our business as the economy recovers.

 

Our expenses consist primarily of the following:

 

Losses and LAE. Losses and LAE represent our largest expense item and include claim payments made, estimates for future claim payments and changes in those estimates for current and prior periods and costs associated with investigating, defending and adjusting claims. The quality of our financial reporting depends in large part on accurately predicting our losses and LAE, which are inherently uncertain as they are estimates of the ultimate cost of individual claims based on actuarial estimation techniques. In some of our states, we have a short operating history and must rely on a combination of industry experience and our specific experience to establish our best estimate of reserves for losses and LAE. The interpretation of historical data can be impacted by external forc es, principally regulatory changes, economic fluctuations and legal trends.

 

We have established reserves for losses based on our current best estimate of loss costs, taking into consideration medical cost and incurred loss trends. As we continue to gain experience in our newer markets, we rely more on our own loss experience and less on industry experience.

 

 

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In California, our loss experience indicates an upward trend in medical costs that is reflected in our loss reserves. We are also seeing increased medical costs in many of our other states, partially offset by favorable loss cost trends in Nevada. We believe our loss reserve estimates are adequate. However, the ultimate losses will not be known with any certainty for several years. We assume that increasing medical cost trends will continue and will impact our long-term claims costs and loss reserves. Additionally, the impact, if any, of the recession on our claim costs is not yet known. We will continue to evaluate our estimate of loss reserves to reflect the most current data and judgments.

 

Commission Expense. Commission expense includes direct commissions to our agents and brokers for the premiums that they produce for us. Also included in commission expense are incentive payments, other marketing costs and fees. Commission expense is net of contingent profit commission income related to the Loss Portfolio Transfer Agreement (LPT Agreement). Commissions paid to our agents and brokers are deferred and amortized to commission expense in our consolidated statements of income as the premiums generating these commissions are earned. We pay commissions that we believe are competitive with other workers’ compensation insurers.

 

In November 2010, we re-negotiated the terms of a reinsurance agreement, which will result in an expense of approximately $1.8 million in the fourth quarter of 2010 and will be reflected in commission expense.

Dividends to Policyholders.  Florida and Wisconsin are administered pricing states where insurance rates are set by state insurance regulators. Rate competition generally is not permitted in these states and, consequently, policyholder dividend programs are an important competitive factor. In Florida and Wisconsin, and to a much more limited extent in several of our other states, we offer dividend programs to eligible policyholders under which a portion of the premium paid by a policyholder may be returned in the form of a dividend. Eligibility for these programs varies based upon the nature of the policyholder’s operations, estimated annual premium, loss experience, and existing controls intended to minimize workers’ compensation claims and costs. An estimate of policyholders’ dividends is accrued as the related premiums are earned. Dividends to po licyholders do not become a fixed liability until declared by the respective boards of directors of our insurance subsidiaries.

 

Additionally, Florida statutes require the return of policyholders’ premium pursuant to a formula based on levels of underwriting profitability. If such a return is required, we account for the payments as dividends to policyholders.

 

Underwriting and Other Operating Expenses. Underwriting and other operating expenses includes the costs to acquire and maintain an insurance policy (excluding commissions) consisting of premium taxes and certain other general expenses that vary with, and are primarily related to, producing new or renewal business. These acquisition costs are deferred and amortized to underwriting and other operating expenses in the consolidated statements of income as the related premiums are earned. Other underwriting expenses consist of changes in estimates of future write-offs of premiums receivable, general administrative expenses such as salaries and benefits, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately, fees and assessments of boards, bureaus and statistical agencies for policy service and administration items such as rating manuals, rating plans, and experience data. Our underwriting and other operating expenses are a reflection of our operating efficiency in producing, underwriting and administering our business. Policy acquisition costs are variable based on premiums earned. However other operating expenses are more fixed in nature and become a larger percentage of net premiums earned as premiums decline.

 

In July 2010, we announced the reorganization of our operations to eliminate duplicative services and better align resources with business activity and growth opportunities. We combined our four regional operating units into two units, Eastern and Western, with the Strategic Partnerships and Alliances unit remaining structurally unchanged. In connection with these efforts and with general cost control efforts, we eliminated approximately 160 positions. These changes to our workforce were substantially completed in the third quarter of 2010.

 

We recorded total restructuring charges of $4.2 million in the third quarter of 2010, including $2.9 million related to workforce reductions and $1.3 million related to leases for facilities that were vacated during the quarter. We expect to record additional restructuring charges of approximately $1.4 million related to leases for facilities that we will vacate in the fourth quarter of 2010. Beginning in 2011, we anticipate annualized savings of approximately $19.0 million, comprised of $17.7 million in salaries and benefits and $1.3 million in lease related savings.

 

Interest Expense.  We incur interest expenses on surplus notes and the Second Amended and Restated Secured Credit Facility (Amended Credit Facility). Interest expense is paid quarterly in arrears on the surplus notes. The expense for each interest payment on the surplus notes is based on the three month LIBOR rate plus 405 to 425 basis points. Interest expense on the Amended Credit Facility is paid quarterly in arrears and is based on the 30-day LIBOR rate plus 125 basis points.

 

 

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Results of Operations

 

Three Months Ended September 30, 2010 and 2009

 

The following table summarizes our consolidated financial results for the three months ended September 30, 2010 and 2009:

 

		2010				2009				Increase (Decrease) 2010 Over 2009				Percentage Increase (Decrease) 2010 Over 2009
		(in thousands, except percentages)
Selected Financial Data
Gross premiums written		$	83,265			$	84,842			$	(1,577	)			(1.9	)%
Net premiums written			81,312				82,790				(1,478	)			(1.8	)
Net premiums earned		$	80,695			$	98,240			$	(17,545	)			(17.9	)
Net investment income			20,689				22,334				(1,645	)			(7.4	)
Realized gains on investments			8				3,564				(3,556	)			(99.8	)
Other income			393				183				210				114.8
Total revenues			101,785				124,321				(22,536	)			(18.1	)
Losses and LAE			52,764				53,395				(631	)			(1.2	)
Commission expense			9,971				(1,276	)			11,247				n/a
Dividends to policyholders			1,584				1,539				45				2.9
Underwriting and other operating expenses			25,722				33,688				(7,966	)			(23.6	)
Interest expense			1,632				1,824				(192	)			(10.5	)
Income tax expense			58				4,594				(4,536	)			(98.7	)
Total expenses			91,731				93,764				(2,033	)			(2.2	)
Net income		$	10,054			$	30,557			$	(20,503	)			(67.1	)%
Selected Operating Data
Losses and LAE ratio			65.3	%			54.3	%			11.0
Commission expense ratio			12.4				(1.3	)			13.7
Dividends to policyholders’ ratio			2.0				1.6				0.4
Underwriting and other operating expenses ratio			31.9				34.3				(2.4	)
Combined ratio(1)			111.6	%			88.9	%			22.7
Net income before impact of the deferred reinsurance gain— LPT Agreement(2)		$	5,262			$	25,889			$	(20,627	)			(79.7	)%

 

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