Edgar Filing: Employers Holdings, Inc.

form10_q.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

ACT OF 1934

For the quarterly period ended March 31, 2010

⁭ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

ACT OF 1934

For the transition period from ____ to ____

Commission file number: 001-33245

EMPLOYERS HOLDINGS, INC.

(Exact name of registrant as specified in its charter)


Nevada (State or other jurisdiction of incorporation or organization)		04-3850065 (I.R.S. Employer Identification Number)

10375 Professional Circle, Reno, Nevada 89521 (Address of principal executive offices and zip code)

(888) 682-6671

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Class		April 30, 2010
Common Stock, $0.01 par value per share		42,725,526 shares outstanding

TABLE OF CONTENTS

		Page
		No.

PART I – FINANCIAL INFORMATION

Item 1	Consolidated Financial Statements
Consolidated Balance Sheets as of March 31, 2010 (Unaudited) and December 31, 2009		3
Unaudited Consolidated Statements of Income for the Three Months Ended March 31, 2010 and 2009		4
Unaudited Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2010 and 2009		5
Unaudited Notes to Consolidated Financial Statements		6
Item 2	Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations	15
Item 3	Quantitative and Qualitative Disclosures About Market Risk	29
Item 4	Controls and Procedures	29


	PART II – OTHER INFORMATION

Item 1	Legal Proceedings	30
Item 1A	Risk Factors	30
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 3	Defaults Upon Senior Securities	30
Item 4	(Removed and Reserved)	30
Item 5	Other Information	30
Item 6	Exhibits	31

PART I – FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Employers Holdings, Inc. and Subsidiaries

Consolidated Balance Sheets
(in thousands, except share data)
	As of March 31, 2010		As of December 31, 2009
Assets	(unaudited)
Available for sale:
Fixed maturity securities at fair value (amortized cost $1,852,723 at March 31, 2010 and $1,859,074 at December 31, 2009)	$	1,955,110	$	1,960,292
Equity securities at fair value (cost $40,103 at March 31, 2010 and $39,936 at December 31, 2009)		72,314		69,268
Total investments		2,027,424		2,029,560

Cash and cash equivalents		190,323		191,572
Accrued investment income		21,527		23,055
Premiums receivable, less bad debt allowance of $10,310 at March 31, 2010 and $9,879 at December 31, 2009		113,531		119,976
Reinsurance recoverable for:
Paid losses		12,546		13,673
Unpaid losses, less allowance of $1,269 at March 31, 2010 and $1,335 at December 31, 2009		1,042,359		1,051,170
Funds held by or deposited with reinsureds		81,034		82,339
Deferred policy acquisition costs		33,606		33,695
Federal income taxes recoverable		10,419		4,092
Deferred income taxes, net		36,386		43,502
Property and equipment, net		13,660		13,059
Intangible assets, net		14,784		15,442
Goodwill		36,192		36,192
Other assets		17,758		19,326
Total assets	$	3,651,549	$	3,676,653

Liabilities and stockholders’ equity
Claims and policy liabilities:
Unpaid losses and loss adjustment expenses	$	2,393,927	$	2,425,658
Unearned premiums		158,889		158,577
Policyholders’ dividends accrued		8,387		7,958
Total claims and policy liabilities		2,561,203		2,592,193

Commissions and premium taxes payable		21,110		20,763
Accounts payable and accrued expenses		18,831		19,033
Deferred reinsurance gain—LPT Agreement		384,224		388,574
Notes payable		132,000		132,000
Other liabilities		25,005		25,691
Total liabilities	$	3,142,373	$	3,178,254

Commitments and contingencies

Stockholders’ equity:
Common stock, $0.01 par value; 150,000,000 shares authorized; 53,700,379 and 53,563,299 shares issued and 42,725,526 and 42,908,165 shares outstanding at March 31, 2010, and December 31, 2009, respectively		537			536
Preferred stock, $0.01 par value; 25,000,000 shares authorized; none issued		—			—
Additional paid-in capital		311,278			311,282
Retained earnings		280,030			266,491
Accumulated other comprehensive income, net		85,434			83,812
Treasury stock, at cost (10,974,853 shares at March 31, 2010 and 10,655,134 shares at December 31, 2009)		(168,103	)		(163,722	)
Total stockholders’ equity		509,176			498,399
Total liabilities and stockholders’ equity	$	3,651,549		$	3,676,653

See accompanying unaudited notes to the consolidated financial statements.

Employers Holdings, Inc. and Subsidiaries

Consolidated Statements of Income
(in thousands, except per share data)

	Three Months Ended March 31,
	2010			2009
	(unaudited)
Revenues
Net premiums earned	$	79,291		$	111,600
Net investment income		21,255			23,306
Realized gains (losses) on investments, net		540			(2,112	)
Other income		—			146
Total revenues		101,086			132,940

Expenses
Losses and loss adjustment expenses		40,288			59,162
Commission expense		9,905			13,658
Dividends to policyholders		1,479			2,018
Underwriting and other operating expenses		32,267			36,484
Interest expense		1,580			1,959
Total expenses		85,519			113,281
Net income before income taxes		15,567			19,659
Income tax (benefit)		(530	)		(1,196	)
Net income	$	16,097		$	20,855

Earnings per common share (Note 10):
Basic	$	0.38		$	0.43
Diluted	$	0.38		$	0.43
Cash dividends declared per common share	$	0.06		$	0.06

Net realized gains (losses) on investments
Net realized gains (losses) on investments before credit related impairments on fixed maturity securities	$	540		$	(319	)

Total other-than-temporary impairments on securities		—			(1,793	)
Portion of impairment recognized in other comprehensive income		—			—
Credit related impairments included in net realized gains or losses on investments		—			(1,793	)
Net realized gains (losses) on investments, net	$	540		$	(2,112	)




See accompanying unaudited notes to the consolidated financial statements.

Employers Holdings, Inc. and Subsidiaries

Consolidated Statements of Cash Flows
(in thousands)
	Three Months Ended
	March 31,
	2010			2009
	(unaudited)
Operating activities
Net income	$	16,097		$	20,855
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,982			3,006
Stock-based compensation		865			821
Amortization of premium on investments, net		1,413			1,218
Allowance for doubtful accounts		365			695
Deferred income tax expense		4,070			4,355
Realized (gains) losses on investments, net		(540	)		2,112
Realized losses on retirement of assets		63			26
Change in operating assets and liabilities:
Accrued investment income		1,528			1,534
Premiums receivable		6,014			(12,694	)
Reinsurance recoverable on paid and unpaid losses		10,004			10,891
Funds held by or deposited with reinsureds		1,305			1,076
Federal income taxes		(6,327	)		1,370
Unpaid losses and loss adjustment expenses		(31,731	)		(11,924	)
Unearned premiums		312			10,832
Accounts payable, accrued expenses and other liabilities		(1,468	)		(6,421	)
Deferred reinsurance gain – LPT Agreement		(4,350	)		(4,348	)
Other		2,515			7,372
Net cash provided by operating activities		2,117			30,776

Investing activities
Purchase of fixed maturities		(36,433	)		(110,512	)
Purchase of equity securities		(455	)		(150	)
Proceeds from sale of fixed maturities		21,171			21,890
Proceeds from sale of equity securities		568			3,276
Proceeds from maturities and redemptions of investments		20,354			59,883
Cash paid for acquisition, net of cash and cash equivalents acquired		—			(100	)
Capital expenditures and other, net		(764	)		(1,261	)
Net cash provided by (used in) investing activities		4,441			(26,974	)

Financing activities
Acquisition of treasury stock		(4,381	)		(13,355	)
Cash transactions related to stock-based compensation		(871	)		—
Dividends paid to stockholders		(2,555	)		(2,909	)
Net cash used in financing activities		(7,807	)		(16,264	)

Net decrease in cash and cash equivalents		(1,249	)		(12,462	)
Cash and cash equivalents at the beginning of the period		191,572			202,893
Cash and cash equivalents at the end of the period	$	190,323		$	190,431
See accompanying unaudited notes to consolidated financial statements.

Employers Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

1. Basis of Presentation

Employers Holdings, Inc. (EHI) is a holding company and through its four wholly-owned insurance subsidiaries, Employers Insurance Company of Nevada (EICN), Employers Compensation Insurance Company (ECIC), Employers Preferred Insurance Company (EPIC), and Employers Assurance Company (EAC), is engaged in the commercial property and casualty insurance industry, specializing in workers’ compensation products and services. EICN, domiciled in Nevada, ECIC, domiciled in California, and EPIC and EAC, both domiciled in Florida, provide insurance to employers against liability for workers’ compensation claims in 30 states. Unless otherwise indicated, all references to the “Company” refer to EHI, together with its subsidiaries.

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) necessary for a fair presentation of the Company’s consolidated financial position and results of operations for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. These financial statements have been prepared consistent with the accounting policies described in the Company’s 2009 Annual Report on Form 10-K for the year ended December 31, 2009.

The Company considers an operating segment to be any component of its business whose operating results are regularly reviewed by the Company’s chief operating decision makers to make decisions about resources to be allocated to the segment and assess its performance based on discrete financial information. Currently, the Company has one operating segment: workers’ compensation insurance and related services.

Estimates and Assumptions

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. As a result, actual results could differ from these estimates. The most significant areas that require management judgment are the estimate of unpaid losses and loss adjustment expenses (LAE), evaluation of reinsurance recoverables, recognition of premium revenue, deferred policy acquisition costs, deferred income taxes, and the valuation of goodwill and investments.

Reclassifications

Certain prior period information has been reclassified to conform to the current period presentation.

2. New Accounting Standards

In January 2010, the Financial Accounting Standards Board issued Update Number 2010-06, Improving Disclosures about Fair Value Measurements to Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures. The update changes fair value disclosures by requiring: (a) separate disclosure of the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and a description of the reasons for the transfers; and (b) separate information about purchases, sales, issuances, and settlements of Level 3 fair value measurements. The update clarifies existing disclosures by requiring: (a) fair value measurement disclosures for each class of assets and liabilities; and (b) disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements that fall in either Level 2 or Level 3. As required, the Company plans to present the disclosures regarding the purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements for fiscal periods beginning after December 15, 2010. The Company adopted the standard that required disclosures for fiscal periods beginning after December 15, 2009 (Note 4). The adoption of these requirements did not have a material impact to the consolidated financial statements.

3. Investments

The amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the Company’s investments were as follows.

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(in thousands)
At March 31, 2010
Fixed maturity securities
U.S. Treasuries	$	134,007	$	6,452	$	(115	)	$	140,344
U.S. Agencies		116,830		6,976		—			123,806
States and municipalities		976,487		48,119		(1,750	)		1,022,856
Corporate		335,075		24,395		(255	)		359,215
Residential mortgaged-backed securities		249,126		17,191		(605	)		265,712
Commercial mortgaged-backed securities		28,749		1,103		—			29,852
Asset-backed securities		12,449		876		—			13,325
Total fixed maturity securities		1,852,723		105,112		(2,725	)		1,955,110

Equity securities
Consumer goods		14,421		9,121		(4	)		23,538
Energy and utilities		4,715		4,884		—			9,599
Financial		6,868		3,619		(5	)		10,482
Technology and communications		7,929		8,130		(26	)		16,033
Industrial and other		6,170		6,492		—			12,662
Total equity securities		40,103		32,246		(35	)		72,314
Total investments	$	1,892,826	$	137,358	$	(2,760	)	$	2,027,424

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(in thousands)
At December 31, 2009
Fixed maturity securities
U.S. Treasuries	$	140,269	$	6,366	$	(171	)	$	146,464
U.S. Agencies		117,844		7,125		—			124,969
States and municipalities		979,364		50,600		(1,687	)		1,028,277
Corporate		314,692		23,335		(417	)		337,610
Residential mortgaged-backed securities		265,056		15,697		(790	)		279,963
Commercial mortgaged-backed securities		29,407		391		(24	)		29,774
Asset-backed securities		12,442		793		—			13,235
Total fixed maturity securities		1,859,074		104,307		(3,089	)		1,960,292

Equity securities
Consumer goods		14,421		8,069		(6	)		22,484
Energy and utilities		4,715		5,067		—			9,782
Financial		6,613		2,861		(74	)		9,400
Technology and communications		7,930		7,686		(15	)		15,601
Industrial and other		6,257		5,758		(14	)		12,001
Total equity securities		39,936		29,441		(109	)		69,268
Total investments	$	1,899,010	$	133,748	$	(3,198	)	$	2,029,560

The amortized cost and estimated fair value of fixed maturity securities and short-term investments at March 31, 2010, by contractual maturity are shown below. Expected maturities differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized Cost		Estimated Fair Value
	(in thousands)
Due in one year or less	$	148,337	$	151,418
Due after one year through five years		478,983		509,849
Due after five years through ten years		540,583		575,274
Due after ten years		394,496		409,680
Mortgage and asset-backed securities		290,324		308,889
Total	$	1,852,723	$	1,955,110

The following is a summary of investments that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or greater as of March 31, 2010 and December 31, 2009.

	March 31, 2010
	Less Than 12 Months					12 Months or Greater					Total
	Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Estimated Unrealized Losses
	(in thousands)
Fixed maturity securities
U.S. Treasuries	$	9,087	$	(115	)	$	—	$	—		$	9,087	$	(115	)
States and municipalities		47,431		(1,068	)		11,281		(682	)		58,712		(1,750	)
Corporate		40,752		(204	)		3,582		(51	)		44,334		(255	)
Residential mortgaged-backed securities		—		—			3,936		(605	)		3,936		(605	)
Total fixed maturity securities		97,270		(1,387	)	$	18,799		(1,338	)		116,069		(2,725	)

Equity securities
Consumer goods		225		(4	)		—		—			225		(4	)
Financial		140		(5	)		—		—			140		(5	)
Technology and communications		246		(26	)		—		—			246		(26	)
Total equity securities		611		(35	)		—		—			611		(35	)
Total investments	$	97,881	$	(1,422	)	$	18,799	$	(1,338	)	$	116,680	$	(2,760	)

	December 31, 2009
	Less Than 12 Months					12 Months or Greater					Total
	Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Estimated Unrealized Losses
	(in thousands)
Fixed maturity securities
U.S. Treasuries	$	10,922	$	(171	)	$	—	$	—		$	10,922	$	(171	)
States and municipalities		45,939		(889	)		15,715		(798	)		61,654		(1,687	)
Corporate		21,238		(312	)		5,506		(105	)		26,744		(417	)
Residential mortgaged-backed securities		28		—			4,164		(790	)		4,192		(790	)
Commercial mortgage-backed securities		1,998		(24	)		—		—			1,998		(24	)
Total fixed maturity securities		80,125		(1,396	)		25,385		(1,693	)		105,510		(3,089	)

Equity securities
Consumer goods		79		(6	)		—		—			79		(6	)
Financial		1,271		(74	)		—		—			1,271		(74	)
Technology and communications		270		(15	)		—		—			270		(15	)
Industrial and other		214		(14	)		—		—			214		(14	)
Total equity securities		1,834		(109	)		—		—			1,834		(109	)
Total investments	$	81,959	$	(1,505	)	$	25,385	$	(1,693	)	$	107,344	$	(3,198	)

Based on reviews of the fixed maturity securities, the Company determined that unrealized losses as of March 31, 2010 and 2009 were primarily the result of changes in prevailing interest rates and not the credit quality of the issuers. The fixed maturity securities whose fair values were less than amortized cost were not determined to be other-than-temporarily impaired given the severity and duration of the impairment, the credit quality of the issuers and the Company’s intent on not selling the securities and a determination was made that it is not more likely than not that the Company will be required to sell the securities until fair value recovers above cost, or to maturity.

Based on reviews of the equity securities as of March 31, 2010, the Company determined that the unrealized losses as of that date were not considered to be other-than-temporary due to the financial condition and near term prospects of the issuers. Based on reviews of the equity securities as of March 31, 2009, the Company recognized total impairments of $1.8 million in the fair values of 25 equity securities as of that date because of the severity and duration of the change in fair values of those securities.

Net realized gains (losses) and the change in unrealized gains (losses) on fixed maturity and equity securities are determined on a specific-identification basis and were as follows.

	Three Months Ended March 31,
	2010		2009
	(in thousands)
Net realized gains (losses)
Fixed maturity securities	$	260	$	(159	)
Equity securities		280		(1,779	)
Short-term investments		—		(174	)
Total	$	540	$	(2,112	)

Change in unrealized gains (losses)
Fixed maturity securities	$	1,169	$	21,763
Equity securities		2,879		(3,919	)
Short-term investments		—		161
Total	$	4,048	$	18,005

Net investment income was as follows.

	Three Months Ended March 31,
	2010			2009
	(in thousands)
Fixed maturity securities	$	21,360		$	22,447
Equity securities		333			373
Short-term investments and cash equivalents		176			1,093
		21,869			23,913
Investment expenses		(614	)		(607	)
Net investment income	$	21,255		$	23,306

The Company is required by various state laws and regulations to keep securities or letters of credit on deposit in depository accounts with the states in which we do business. As of March 31, 2010 and December 31, 2009, securities having a fair value of $556.6 million and $554.2 million, respectively, were on deposit. These laws and regulations govern not only the amount, but also the type of security that is eligible for deposit. In all states the deposits are limited to fixed maturity securities. Additionally, certain reinsurance contracts require Company funds to be held in trust for the benefit of the ceding reinsurer to secure the outstanding liabilities assumed by the Company. The fair value of securities held in trust for reinsurance at both March 31, 2010 and December 31, 2009 was $6.1 million.

4. Fair Value of Financial Instruments

The estimated fair values of the Company’s financial instruments are as follows.

	Carrying Value		Estimated Fair Value
Financial assets	(in thousands)
Investments	$	2,027,424	$	2,027,424
Cash and cash equivalents		190,323		190,323
Financial liabilities
Notes payable		132,000		132,000
Derivative		1,560		1,560

The Company’s estimate of fair value for financial assets and liabilities is based on the inputs used in the valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuation when available. The disclosure of fair value estimates is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company’s significant market assumptions. The three levels of the hierarchy are as follows:

·	Level 1 - Unadjusted quoted market prices for identical assets or liabilities in active markets that the Company has the ability to access.

Level 2 - Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.

Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement and involve management judgement. The fair values of certain privately held or thinly traded securities are determined using internal analytical methods based on the best information available.

Valuation of Investments. For investments that have quoted market prices in active markets, the Company uses the unadjusted quoted market prices as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. When quoted market prices are unavailable, the Company estimates fair value based on objectively verifiable information, if available. The fair value estimates determined by using objectively verifiable information are included in the amount disclosed in Level 2 of the hierarchy. If quoted market prices and an estimate determined by using objectively verifiable information are unavailable, the Company produces an estimate of fair value based on internally developed valuation techniques, which, depending on the level of observable market inputs, will render the fair value estimate as Level 2 or Level 3. The Company bases all of its estimates of fair value for assets on bid price as that represents what a third party market participant would be willing to pay in an arm’s length transaction. The valuation methods used by the Company, by type of investment, are described below.

·	Equity Securities. The Company utilizes market quotations for equity securities that have quoted prices in active markets.

Fixed Maturity Securities and Short-Term Investments. Estimates of fair value measurements for these securities are estimated using relevant inputs including available market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. Additionally, an Option Adjusted Spread model is used to develop prepayment and interest rate scenarios. Industry standard models are used to analyze and value securities with embedded options or prepayment sensitivities.

·	Derivatives. The fair value of the Company’s interest rate swap, reported as a component of other liabilities in the accompanying consolidated balance sheets, is derived by using an industry standard swap valuation model, with market-based inputs for swaps having similar characteristics.

Each asset class is valued based on relevant market information, credit information, perceived market movements, and sector news. The market inputs utilized in the valuation include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The extent of the use of each market input depends on the asset class and the market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities, additional inputs may be necessary.

These methods of valuation will only produce an estimate of fair value if there is objectively verifiable information to produce a valuation. If objectively verifiable information is not available, the Company produces an estimate of fair value using some of the same methodologies, making assumptions for market based inputs that are unavailable.

Most estimates of fair value for fixed maturities and investments are based on estimates using objectively verifiable information and are included in the amount disclosed in Level 2 of the hierarchy. The fair value estimates for determining Level 3 fair value include the Company’s assumptions about risk assessments and market participant assumptions based on the best information available, including quotes from market makers and other broker/dealers recognized as market participants, using standard or trade derived inputs, new issue data, monthly payment information, cash flow generation, prepayment speeds, spread adjustments, and/or rating updates.

The following table presents the items on the accompanying consolidated balance sheets that are stated at fair value and the fair value measurements.

	Level 1		Level 2			Level 3
At March 31, 2010	(in thousands)
Fixed maturity securities
U.S. Treasuries	$	—	$	140,344		$	—
U.S. Agencies		—		123,806			—
States and municipalities		—		1,022,856			—
Corporate		—		359,215			—
Residential mortgage-backed securities		—		265,712			—
Commercial mortgage-backed securities		—		29,852			—
Asset-backed securities		—		13,325			—
Total fixed maturity securities		—		1,955,110			—

Equity securities
Consumer goods		23,538		—			—
Energy and utilities		9,599		—			—
Financial		10,482		—			—
Technology and communications		16,033		—			—
Industrial and other		12,662		—			—
Total equity securities	$	72,314	$	—		$	—

Derivatives
Other liabilities	$	—	$	(1,560	)	$	—

	Level 1		Level 2			Level 3
At December 31, 2009	(in thousands)
Fixed maturity securities
U.S. Treasuries	$	—	$	146,464		$	—
U.S. Agencies		—		124,969			—
States and municipalities		—		1,028,277			—
Corporate		—		337,610			—
Residential mortgage-backed securities		—		279,963			—
Commercial mortgage-backed securities		—		29,774			—
Asset-backed securities		—		13,235			—
Total fixed maturity securities		—		1,960,292			—

Equity securities
Consumer goods		22,484		—			—
Energy and utilities		9,782		—			—
Financial		9,400		—			—
Technology and communications		15,601		—			—
Industrial and other		12,001		—			—
Total equity securities	$	69,268	$	—		$	—

Derivatives
Other liabilities	$	—	$	(2,180	)	$	—

5. Income Taxes

Income tax benefit for interim periods is measured using an estimated effective tax rate for the annual period. During the three months ended March 31, 2010 and 2009, the Company recognized net income before taxes of $15.6 million and $19.7 million and an income tax benefit of $0.5 million and $1.2 million, yielding effective tax rates of (3.4)% and (6.1)%, respectively. The following is a reconciliation of the statutory income tax rate to the Company’s effective tax rate for the three months ended:

	March 31,
	2010			2009

Expense computed at statutory rate		35.0	%		35.0	%
Dividends received deduction and tax-exempt interest		(24.0	)		(27.1	)
LPT Agreement		(12.8	)		(13.3	)
Pre-privatization reserve adjustments		(3.3	)		(1.2	)
Stock based compensation		0.9			—
Other		0.8			0.5
Effective tax rate		(3.4	)%		(6.1	)%

6. Liability for Unpaid Losses and Loss Adjustment Expenses

The following table represents a reconciliation of changes in the liability for unpaid losses and LAE for the three months ended:

	March 31,
	2010			2009
	(in thousands)
Unpaid losses and LAE, gross of reinsurance, at beginning of period	$	2,425,658		$	2,506,478
Less reinsurance recoverables, excluding bad debt allowance, on unpaid losses and LAE		1,052,505			1,076,350
Net unpaid losses and LAE at beginning of period		1,373,153			1,430,128
Losses and LAE, net of reinsurance, incurred in:
Current period		55,759			77,010
Prior periods		(11,121	)		(13,500	)
Total net losses and LAE incurred during the period		44,638			63,510
Deduct payments for losses and LAE, net of reinsurance, related to:
Current period		4,406			6,800
Prior periods		63,086			58,962
Total net payments for losses and LAE during the period		67,492			65,762
Ending unpaid losses and LAE, net of reinsurance		1,350,299			1,427,876
Reinsurance recoverable, excluding bad debt allowance, on unpaid losses and LAE		1,043,628			1,066,678
Unpaid losses and LAE, gross of reinsurance, at end of period	$	2,393,927		$	2,494,554

Total net losses and LAE included in the above table excludes the impact of the amortization of the deferred reinsurance gain–LPT Agreement (Deferred Gain) (Note 7).

The reduction in the liability for unpaid losses and LAE attributable to insured events for prior periods was $11.1 million and $13.5 million for the three months ended March 31, 2010 and 2009, respectively. The major sources of favorable development in both periods were actual paid losses being less than expected and the impact of new information on selected claim payments and emergence patterns used in the projection of future loss payments.

7. LPT Agreement

The Company is party to a 100% quota share retroactive reinsurance agreement (LPT Agreement) under which $1.5 billion in liabilities for losses and LAE related to claims incurred by EICN prior to July 1, 1995 were reinsured for consideration of $775.0 million. The LPT Agreement provides coverage up to $2.0 billion. The initial Deferred Gain resulting from the LPT Agreement was recorded as a liability in the accompanying consolidated balance sheets and is being amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries. The Company amortized $4.4 million and $4.3 million of the Deferred Gain for the three months ended March 31, 2010 and 2009, respectively. Any adjustments to the Deferred Gain are recorded in losses and LAE incurred in the accompanying consolidated statements of income. No adjustments occurred in the current period. The remaining Deferred Gain was $384.2 million and $388.6 million as of March 31, 2010 and December 31, 2009 respectively, and is included in the accompanying consolidated balance sheets.

8. Accumulated Other Comprehensive Income

Accumulated other comprehensive income is comprised of unrealized gain on investments classified as available-for-sale and unrealized losses on interest rate swap, net of deferred tax expense. The following table summarizes the components of accumulated other comprehensive income.

	March 31,
	2010			2009
	(in thousands)
Net unrealized gain on investments, before taxes	$	134,598		$	72,753
Net unrealized loss on interest rate swap, before taxes		(1,560	)		(3,353	)
Deferred tax expense on net unrealized gains		(47,604	)		(24,619	)
Total accumulated other comprehensive income, net	$	85,434		$	44,781

The following table summarizes the changes in the components of total comprehensive income for the three months ended.

	March 31,
	2010		2009
	(in thousands)
Unrealized gains during the period, before taxes	$	5,208	$	16,408
Less: income tax expense		3,235		5,804
Unrealized gains during the period, net of taxes		1,973		10,604
Less reclassification adjustment:
Realized gains (losses) in net income		540		(2,112	)
Income tax expense (benefit)		189		(739	)
Reclassification adjustment for gains (losses) realized in net income		351		(1,373	)
Other comprehensive income gains		1,622		11,977
Net income		16,097		20,855
Total comprehensive income	$	17,719	$	32,832

9. Stock-Based Compensation

On March 30, 2010, 406,020 options and 163,660 restricted stock units (RSUs) were awarded to certain officers of the Company. The fair value of the RSUs on the grant date and the per share exercise price of the options was $15.31. The options have a service vesting period of four years and vest 25% on March 30, 2011, and 25% on each of the subsequent three anniversaries of such date. The options are subject to accelerated vesting in circumstances of death or disability of the holder or in connection with a change of control of the Company. The options expire seven years from the date of grant. The aggregate fair value of the options and RSUs on the date of grant was $2.4 million and $2.5 million, respectively.

During the first quarter of 2010, the EHI Board of Directors certified the performance period results of the performance shares awarded in 2007. Of the 196,071 awards that vested, 58,991 shares of common stock were withheld to satisfy minimum employee tax withholding.

10. Earnings Per Share

Basic earnings per share includes no dilution and is computed by dividing income applicable to stockholders by the weighted average number of shares outstanding for the period. Diluted earnings per share reflects the potential dilutive impact of all convertible securities on earnings per share. Diluted earnings per share includes shares assumed issued under the “treasury stock method,” which reflects the potential dilution that would have occurred had shares been repurchased from the proceeds of potentially dilutive shares.

The following table presents the net income and the weighted average common shares outstanding used in the earnings per common share calculations for the three months ended.

	March 31,
	2010		2009
	(in thousands, except share data)
Net income available to stockholders—basic and diluted	$	16,097	$	20,855
Weighted average number of shares outstanding—basic		42,722,452		48,576,655
Effect of dilutive securities:
Performance share awards		—		23,022
Unvested restricted stock units		107,062		13,176
Dilutive potential shares		107,062		36,198
Weighted average number of shares outstanding—diluted		42,829,514		48,612,853

The Company’s outstanding options have been excluded in computing the diluted earnings per share for the three months ended March 31, 2010 and March 31, 2009 because their inclusion would be anti-dilutive.

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,” “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, with a concentration in California.

We target small businesses, as we believe 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. 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.

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 29.0%, or $32.3 million, for the three months ended March 31, 2010, as 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. The total payroll of our insureds, upon which we base our premium, declined approximately 7% and 17% for the three and twelve months ended March 31, 2010, respectively. As of March 31, 2010, year-over-year in-force premiums declined 21.3%. Our average annual policy size decreased 16.5% to $8,256 as of March 31, 2010. Similarly, during the three and twelve months ended March 31, 2010, our in-force policy count decreased 2.6% and 5.7%, respectively. Our net rate, defined as total premium in-force divided by total insured payroll, declined approximately 1% and 5% for the three and twelve months ended March 31, 2010. 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.

	March 31, 2010				December 31, 2009				March 31, 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	$	176,028		27,721	$	180,474		27,812	$	197,397		28,037	$	203,694		27,942
Florida		22,983		2,182		27,964		2,630		41,201		3,038		46,248		3,115
Nevada		21,355		3,875		24,050		4,119		32,921		4,860		38,971		5,221
Illinois		18,948		799		19,389		801		18,678		745		17,885		689
Wisconsin		18,402		842		24,125		922		31,411		946		29,040		892
Other		97,280		7,582		109,023		7,870		129,509		7,977		129,770		7,740
Total	$	354,996		43,001	$	385,025		44,154	$	451,117		45,603	$	465,608		45,599

Our strategic partnerships and alliances generated $72.3 million, or 20.4%, of our in-force premiums as of March 31, 2010, as compared to $77.7 million, or 17.2%, as of March 31, 2009. 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 strategic relationships also allow us to access new customers that we may not have access to through our independent agent distribution channel. We continue to actively seek new partnership and alliance opportunities.

Approximately one-half of our business is generated in California, where we have seen increased net rate on renewal business for 12 consecutive months. We are seeing a steady level of new business submittals and our policy count remains stable.

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.

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 increasing loss costs, primarily medical cost inflation, we increased our premium rates by a cumulative 25.2% since February 1, 2009.

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. The filed rate decrease in Florida was for new and renewal policies incepting on or after January 1, 2010. The 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 policies in-force in these states. Classes of small businesses that have been particularly affected 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.

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

Net Investment Income and Realized Gains (Losses) on Investments. Net investment income decreased 8.8%, or $2.1 million, for the three months ended March 31, 2010, as compared to the same period of 2009.

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 sale compared to its original 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 exceptionally strong and our realized and unrealized losses have been minimal, considering the unprecedented volatility and uncertainty in the financial markets.

Expenses

While we continue to manage our expenses and expect a continued decline in our commission and underwriting and other operating expenses during 2010, we expect upward pressure on the underwriting and other operation expenses ratio to continue until employment and payroll trends improve. While the pace of economic recovery remains uncertain, we believe that we remain 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 forces, 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.

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 commission income related to the 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.

We are entitled to receive a contingent profit commission under the LPT Agreement. The contingent profit is an amount based on the favorable difference between actual paid losses and loss expenses and expected paid losses and loss expenses under the LPT Agreement. (Loss expenses are deemed to be 7% of total losses paid and are paid to us as compensation for management of the LPT claims.) The reinsurers pay us 30% of any favorable difference in actual amounts paid compared to contractually expected amounts to be paid under the agreement. The calculation of the contingent profit commission is determined every five years beginning June 30, 2004 for the first twenty-five years of the agreement. Conversely, we could be required to return any previously paid contingent profit commission, with interest, in the event of unfavorable differences.

We estimate ultimate contingent profit commission through June 30, 2024 and record it as commission expense. Increases or decreases in the estimated contingent profit commission are reflected in commission expense in the period that the estimate is revised.

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, expected premium paid, 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 policyholders 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 such 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 assessments of 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, underwriting and other operating expenses is more fixed in nature and become a larger percentage of net premiums earned as premiums decline.

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. Additionally, we have an interest rate swap agreement on the Amended Credit Facility.

Results of Operations

Three Months Ended March 31, 2010 and 2009

The following table summarizes our consolidated financial results for the three months ended March 31, 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	$	82,378		$	126,846		$	(44,468	)		(35.1	)%
Net premiums written		79,774			123,429			(43,655	)		(35.4	)

Net premiums earned	$	79,291		$	111,600		$	(32,309	)		(29.0	)
Net investment income		21,255			23,306			(2,051	)		(8.8	)
Realized gains (losses) on investments		540			(2,112	)		2,652			n/a
Other income		—			146			(146	)		n/a
Total revenues		101,086			132,940			(31,854	)		(24.0	)

Losses and LAE		40,288			59,162			(18,874	)		(31.9	)
Commission expense		9,905			13,658			(3,753	)		(27.5	)
Dividends to policyholders		1,479			2,018			(539	)		(26.7	)
Underwriting and other operating expenses		32,267			36,484			(4,217	)		(11.6	)
Interest expense		1,580			1,959			(379	)		(19.3	)
Income tax (benefit)		(530	)		(1,196	)		666			n/a
Total expenses		84,989			112,085			(27,096	)		(24.2	)

Net income	$	16,097		$	20,855		$	(4,758	)		(22.8	)%

Selected Operating Data
Losses and LAE ratio		50.8	%		53.1	%		(2.3	)
Commission expense ratio		12.5			12.2			0.3
Dividends to policyholders’ ratio		1.9			1.8			0.1
Underwriting and other operating expenses ratio		40.7			32.7			8.0
Combined ratio(1)		105.9			99.8			6.1
Net income before impact of the deferred
reinsurance gain—LPT Agreement(2)	$	11,747		$	16,507		$	(4,760	)		(28.8	)%

(1)

The combined ratio is calculated by dividing the sum of losses and LAE, commission expense, dividends to policyholders and underwriting and other operating expenses by net premiums earned. Because we only have one operating segment, holding company expenses are included in our calculation of the combined ratio.

(2)

We define net income before impact of the deferred reinsurance gain—LPT Agreement as net income less: (a) amortization of deferred reinsurance gain—LPT Agreement and (b) adjustments to LPT Agreement ceded reserves. Deferred reinsurance gain—LPT Agreement reflects the unamortized gain from our LPT Agreement. Under GAAP, this gain is deferred and is being amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries, and the amortization is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT Agreement. Our reevaluation results in corresponding adjustments, if needed, to reserves, ceded reserves, reinsurance recoverable, and the deferred reinsurance gain, with the net effect being an increase or decrease, as the case may be, to net income. Net income before impact of the deferred reinsurance gain—LPT Agreement is not a measurement of financial performance under GAAP, but rather reflects the difference in accounting treatment between statutory and GAAP, and should not be considered in isolation or as an alternative to net income before income taxes and net income or any other measure of performance derived in accordance with GAAP.

We present net income before impact of the deferred reinsurance gain—LPT Agreement because we believe that it is an important supplemental measure of operating performance to be used by analysts, investors and other interested parties in evaluating us. The LPT Agreement was a non-recurring transaction which does not result in ongoing cash benefits, and, consequently, we believe this presentation is useful in providing a meaningful understanding of our operating performance. In addition, we believe this non-GAAP measure, as we have defined it, is helpful to our management in identifying trends in our performance because the excluded item has

limited significance in our current and ongoing operations. The table below shows the reconciliation of net income to net income before impact of the deferred reinsurance gain—LPT Agreement for the three months ended:

	March 31,
	2010		2009
	(in thousands)
Net income	$	16,097	$	20,855
Less impact of the deferred reinsurance gain—LPT Agreement		4,350		4,348
Net income before impact of the deferred reinsurance gain—LPT Agreement	$	11,747	$	16,507

Our goal is to maintain focus on disciplined underwriting and to continue to pursue profitable growth opportunities across market cycles. The combined ratio is a key operating metric that reflects underwriting profitability. Our combined ratio increased 6.1 percentage points for the three months ended March 31, 2010, to 105.9%, compared to 99.8% for the same period of 2009. This increase was primarily the result of the following.

Net premiums earned decreased 29.0% for the three months ended March 31, 2010, compared to the same period of 2009. This decrease reflects the impacts of the recession, high rates of unemployment, declines in our insureds’ payrolls, lower net rates, and our application of disciplined pricing objectives and underwriting guidelines in a highly competitive market. These factors resulted in 5.7% fewer policies in-force, as compared to a year ago, and a lower average policy size.

Losses and LAE decreased $18.9 million for the three months ended March 31, 2010, compared to the same period of 2009, primarily due to lower net premiums earned. Additionally, during the three months ended March 31, 2010, favorable prior accident year loss development decreased $2.4 million to $11.1 million, compared to the same period of 2009. Our current accident year loss estimates were 70.3% and 69.0% for the three months ended March 31, 2010 and 2009, respectively.

The table below reflects the losses and LAE reserve adjustments for the three months ended March 31, 2010 and 2009.

	March 31,
	2010		2009
	(in millions)
Prior accident year favorable development, net	$	11.1	$	13.5

LPT amortization of the deferred reinsurance gain	$	4.4	$	4.3
LPT reserve favorable change	$	—	$	—

Excluding the impact from the LPT Agreement, losses and LAE would have been $44.6 million and $63.5 million, or 56.3% and 56.9%, of net premiums earned for the three months ended March 31, 2010 and 2009, respectively.

Underwriting and other operating expenses decreased 11.6% for the three months ended March 31, 2010, as compared to the same period in 2009, including restructuring items for both years. We incurred charges of $0.9 million in the first quarter of 2010 related to staffing reductions to adjust our insurance operations to reflect current and expected activity levels. This compared to integration and restructuring charges of $3.8 million for the same period of 2009 related to our acquisition of AmCOMP Incorporated.

Excluding these charges, underwriting and other operating expenses decreased $1.3 million, or 4.1%, for the three months ended March 31, 2010, compared to the same period of 2009. The decrease reflects efforts to manage our expenses during a period of declining premiums. We realized cost savings of $0.9 million in information technology, $0.7 million in compensation, and $0.4 million in general operating expenses. Partially offsetting the decrease was a guarantee fund assessment of $1.0 million in the first quarter of 2010.

·	Commission expense decreased $3.8 million, or 27.5%, for the three months ended March 31, 2010, compared to the three months ended March 31, 2009, primarily as a result of lower net premiums earned.

·	Dividends to policyholders decreased $0.5 million for the three months ended March 31, 2010, compared to the same period of 2009, due to lower premium levels on dividend policies in Florida and Wisconsin.

In addition to the items noted above that resulted in a combined ratio of 105.9, representing an underwriting loss for the first quarter of 2010, our net income for the quarter was impacted by the following.

Net investment income decreased 8.8% for the three months ended March 31, 2010, as compared to the same period of 2009. The decrease was primarily related to a 2.2% decrease in average invested assets for the three months ended March 31, 2010, compared to the same period of 2009. The decrease in our average invested assets was primarily due to repayment of debt and the return of capital to shareholders through share repurchases and shareholder dividends. The average pre-tax book yield on invested assets decreased to 4.3% at March 31, 2010, as compared to 4.6% for the same period of 2009. The tax-equivalent yield on invested assets decreased to 5.5% at March 31, 2010, as compared to 5.6% at March 31, 2009.

For the three months ended March 31, 2010, realized gains on investments were $0.5 million, compared to realized losses, which were $2.1 million, for the same period of 2009. The realized losses for the first quarter of 2009 were the result of other-than-temporary impairments on equity securities in our investment portfolio.

·	Interest expense decreased $0.4 million for the three months ended March 31, 2010, compared to the same period of 2009, primarily due to a $50.0 million reduction in the principal balance on the Amended Credit Facility in the fourth quarter of 2009.

Income tax benefit decreased $0.7 million for the three months ended March 31, 2010, compared to the same period of 2009. The effective tax rates for the three months ended March 31, 2010 and 2009 were (3.4)% and (6.1)%, respectively. The increase in the effective tax rate was primarily the result of an increase in the non-deductible portion of the vested equity shares issued during the first quarter of 2010 and a decrease in the projected annualized tax-exempt interest for 2010 as compared to 2009. This was partially offset by an increase in non-taxable favorable reserve development related to periods prior to January 1, 2000. Also contributing to the tax benefit rate in both periods were the amortization of the deferred reinsurance gain—LPT Agreement and reserve releases for periods prior to the privatization of the Nevada State Industrial Insurance System, the predecessor to EICN, which were non-taxable.

Overall, net income decreased 22.8% for the three months ended March 31, 2010, compared to the same period of 2009. Net income includes amortization of the deferred reinsurance gain—LPT Agreement of $4.4 million and $4.3 million for the three months ended March 31, 2010 and 2009, respectively. Excluding the impact of the deferred reinsurance gain—LPT Agreement, net income would have been $11.7 million and $16.5 million for the three months ended March 31, 2010 and March 31, 2009, respectively.

Liquidity and Capital Resources

Parent Company. We are a holding company and our ability to fund our operations is contingent upon our insurance subsidiaries’ and their ability to pay dividends. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds. We require cash to pay stockholder dividends, repurchase common stock, make interest and principal payments on our outstanding debt obligations, fund our operating expenses, and support our growth strategy.

As of March 31, 2010, the holding company had cash and fixed maturity securities maturing within the next 24 months of $150.9 million. Fifty million dollars of our line of credit is due on or before December 31, 2010 and March 26, 2011, respectively. We believe that the liquidity needs of the holding company over the next 24 months will be met with cash, maturing investments, and dividends from our insurance subsidiaries.

During the first quarter of 2010, EICN and EPIC paid EHI dividends of $97.3 million and $14.9 million, respectively.

In November 2009, the EHI Board of Directors (Board of Directors) authorized a share repurchase program for up to $50 million of the Company’s common stock from January 1, 2010 through December 31, 2010 (the 2010 Program). Repurchases under the 2010 Program may be commenced or suspended from time to time without prior notice, and the program may be suspended or discontinued at any time. Through March 31, 2010, we have repurchased 319,719 shares of common stock under the 2010 Program, at the average price of $13.70 per share, including commissions, for a total of $4.4 million.

We entered into the Amended Credit Facility, under which we borrowed $150.0 million, in September 2008. We are currently in compliance with all applicable covenants. The outstanding principal balance at March 31, 2010 was $100.0 million. The Amended Credit Facility is secured by fixed maturity securities and cash and cash equivalents that had a fair value of $134.1 million and $212.6 million at March 31, 2010 and 2009, respectively.

As of March 31, 2010 and 2009, total outstanding debt was $132.0 million and $182.0 million, respectively. Interest and fees on debt obligations totaled $1.6 million for the first three months of 2010, down $0.4 million from the same period of 2009.

Our capital structure is comprised of outstanding debt and stockholders’ equity. As of March 31, 2010, our capital structure consisted of $100.0 million principal balance on our Amended Credit Facility, $32.0 million in surplus notes maturing in 2034, and $893.4 million of stockholders’ equity, including the deferred reinsurance gain—LPT Agreement. Outstanding debt was 12.9% of total capitalization, including the deferred reinsurance gain—LPT Agreement, as of March 31, 2010.

Operating Subsidiaries. The primary sources of cash for our insurance subsidiaries are funds generated from underwriting operations, investment income, and maturing investments. The primary uses of cash are payments of claims and operating expenses, purchases of investments, and payments of dividends to the parent holding company, which are subject to state insurance laws and regulations.

As of March 31, 2010, our insurance subsidiaries had total cash and fixed maturity securities maturing within the next 24 months of $406.9 million. We believe that our subsidiaries’ liquidity needs over the next 24 months will be met with cash from operations, investment income, and maturing investments.

We purchase reinsurance to protect us against the costs of severe claims and catastrophic events. On July 1, 2009, we entered into a new reinsurance program that is effective through June 30, 2010. We believe that our reinsurance program meets our needs and that we are sufficiently capitalized.

We are required by various state laws and regulations to keep securities or letters of credit in depository accounts with the states in which we do business. As of March 31, 2010 and 2009, securities having a fair value of $556.6 million and $592.3 million, respectively, were on deposit. These laws and regulations govern not only the amount, but also the type of security that is eligible for deposit and in all cases are restricted or limited to fixed maturity securities. Additionally, certain reinsurance contracts require Company funds to be held in trust for the benefit of the ceding reinsurer to secure the outstanding liabilities assumed by us. The fair value of securities held in trust for reinsurance at March 31, 2010 and 2009, was $6.1 million and $7.0 million, respectively.

Cash Flows

We monitor cash flows at both the consolidated and subsidiary levels. We use trend and variance analyses to project future cash needs making adjustments to our forecasts, as appropriate.

The table below shows our net cash flows for the three months ended:

	March 31,
	2010			2009
	(in thousands)
Cash and cash equivalents provided by (used in):
Operating activities	$	2,117		$	30,776
Investing activities		4,441			(26,974	)
Financing activities		(7,807	)		(16,264	)
Net decrease in cash and cash equivalents	$	(1,249	)	$	(12,462	)