Edgar Filing: Employers Holdings, Inc.

form10q.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 September 30, 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 þ 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		October 30, 2010
Common Stock, $0.01 par value per share		39,830,742 shares outstanding

TABLE OF CONTENTS



		Page No.
PART 1 – FINANCIAL INFORMATION

Item 1	Consolidated Financial Statements
	Consolidated Balance Sheets as of September 30, 2010 (Unaudited) and December 31, 2009	3
	Unaudited Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2010 and 2009	4
	Unaudited Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 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	16
Item 3	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4	Controls and Procedures	33


	PART II – OTHER INFORMATION

Item 1	Legal Proceedings	34
Item 1A	Risk Factors	34
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 3	Defaults Upon Senior Securities	34
Item 4	(Removed and Reserved)	34
Item 5	Other Information	34
Item 6	Exhibits	35

PART I – FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Employers Holdings, Inc. and Subsidiaries

Consolidated Balance Sheets
(in thousands, except share data)
	As of September 30, 2010			As of December 31, 2009
Assets	(unaudited)
Available for sale:
Fixed maturity securities at fair value (amortized cost $1,848,308 at September 30, 2010 and $1,859,074 at December 31, 2009)	$	2,011,661		$	1,960,292
Equity securities at fair value (cost $40,102 at September 30, 2010 and $39,936 at December 31, 2009)		72,514			69,268
Total investments		2,084,175			2,029,560

Cash and cash equivalents		144,000			191,572
Accrued investment income		21,276			23,055
Premiums receivable, less bad debt allowance of $8,181 at September 30, 2010 and $9,879 at December 31, 2009		108,494			119,976
Reinsurance recoverable for:
Paid losses		12,302			13,673
Unpaid losses, less allowance of $1,269 at September 30, 2010 and $1,335 at December 31, 2009		995,548			1,051,170
Funds held by or deposited with reinsureds		79,292			82,339
Deferred policy acquisition costs		32,702			33,695
Federal income taxes recoverable		9,452			4,092
Deferred income taxes, net		14,498			43,502
Property and equipment, net		12,783			13,059
Intangible assets, net		13,729			15,442
Goodwill		36,192			36,192
Other assets		18,771			19,326
Total assets	$	3,583,214		$	3,676,653

Liabilities and stockholders’ equity
Claims and policy liabilities:
Unpaid losses and loss adjustment expenses	$	2,325,831		$	2,425,658
Unearned premiums		153,520			158,577
Policyholders’ dividends accrued		5,615			7,958
Total claims and policy liabilities		2,484,966			2,592,193

Commissions and premium taxes payable		18,891			20,763
Accounts payable and accrued expenses		21,050			19,033
Deferred reinsurance gain—LPT Agreement		375,060			388,574
Notes payable		132,000			132,000
Other liabilities		22,489			25,691
Total liabilities		3,054,456			3,178,254

Commitments and contingencies

Stockholders’ equity:
Common stock, $0.01 par value; 150,000,000 shares authorized; 53,777,585 and 53,563,299 shares issued and 39,830,742 and 42,908,165 shares outstanding at September 30, 2010, and December 31, 2009, respectively		538			536
Preferred stock, $0.01 par value; 25,000,000 shares authorized; none issued		—			—
Additional paid-in capital		313,117			311,282
Retained earnings		301,577			266,491
Accumulated other comprehensive income, net		127,248			83,812
Treasury stock, at cost (13,946,843 shares at September 30, 2010 and 10,655,134 shares at December 31, 2009)		(213,722	)		(163,722	)
Total stockholders’ equity		528,758			498,399
Total liabilities and stockholders’ equity	$	3,583,214		$	3,676,653

Employers Holdings, Inc. and Subsidiaries

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

	Three Months Ended September 30,					Nine Months Ended September 30,
	2010		2009			2010		2009
Revenues	(unaudited)
Net premiums earned	$	80,695	$	98,240		$	238,221	$	314,221
Net investment income		20,689		22,334			62,592		68,704
Realized gains on investments, net		8		3,564			900		1,060
Other income		393		183			600		388
Total revenues		101,785		124,321			302,313		384,373

Expenses
Losses and loss adjustment expenses		52,764		53,395			138,097		166,657
Commission expense (benefit)		9,971		(1,276	)		29,052		25,611
Dividends to policyholders		1,584		1,539			3,386		5,418
Underwriting and other operating expenses		25,722		33,688			83,132		102,624
Interest expense		1,632		1,824			4,832		5,608
Total expenses		91,673		89,170			258,499		305,918

Net income before income taxes		10,112		35,151			43,814		78,455
Income tax expense		58		4,594			1,164		6,698
Net income	$	10,054	$	30,557		$	42,650	$	71,757

Earnings per common share (Note 10):
Basic	$	0.25	$	0.68		$	1.02	$	1.54
Diluted	$	0.25	$	0.67		$	1.01	$	1.53
Cash dividends declared per common share	$	0.06	$	0.06		$	0.18	$	0.18

Net realized gains on investments
Net realized gains on investments before credit related impairments on fixed maturity securities fixed maturity securities	$	8	$	3,564		$	900	$	2,981

Other than temporary impairment, credit losses recognized in earnings		—		—			—		(1,921	)
Portion of impairment recognized in other comprehensive income		—		—			—		—
Realized gains on investments, net	$	8	$	3,564		$	900	$	1,060




See accompanying unaudited notes to the consolidated financial statements.

Employers Holdings, Inc. and Subsidiaries

Consolidated Statements of Cash Flows
(in thousands)
	Nine Months Ended
	September 30,
	2010			2009
Operating activities	(unaudited)
Net income	$	42,650		$	71,757
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		5,477			7,834
Stock-based compensation		2,982			4,097
Amortization of premium on investments, net		4,238			3,668
Allowance for doubtful accounts		(1,764	)		1,901
Deferred income tax expense		5,045			9,092
Realized (gains) on investments, net		(900	)		(1,060	)
Realized losses on retirement of assets		252			64
Change in operating assets and liabilities:
Accrued investment income		1,779			1,327
Premiums receivable		13,180			18,759
Reinsurance recoverable on paid and unpaid losses		57,059			29,093
Funds held by or deposited with reinsureds		3,047			4,099
Federal income taxes		(5,360	)		4,730
Unpaid losses and loss adjustment expenses		(99,827	)		(62,834	)
Unearned premiums		(5,057	)		(22,224	)
Accounts payable, accrued expenses and other liabilities		(1,014	)		(14,503	)
Deferred reinsurance gain – LPT Agreement		(13,514	)		(13,377	)
Other		(2,672	)		3,944
Net cash provided by operating activities		5,601			46,367

Investing activities
Purchase of fixed maturities		(165,273	)		(165,906	)
Purchase of equity securities		(454	)		(11,934	)
Proceeds from sale of fixed maturities		77,859			56,557
Proceeds from sale of equity securities		567			19,475
Proceeds from maturities and redemptions of investments		94,521			131,413
Cash paid for acquisition, net of cash and cash equivalents acquired		—			(100	)
Capital expenditures and other, net		(1,684	)		(4,020	)
Net cash provided by investing activities		5,536			25,485

Financing activities
Proceeds from exercise of stock options		74			—
Acquisition of treasury stock		(50,000	)		(53,593	)
Cash transactions related to stock-based compensation		(1,229	)		(123	)
Dividends paid to stockholders		(7,554	)		(8,408	)
Net cash used in financing activities		(58,709	)		(62,124	)

Net (decrease) increase in cash and cash equivalents		(47,572	)		9,728
Cash and cash equivalents at the beginning of the period		191,572			202,893
Cash and cash equivalents at the end of the period	$	144,000		$	212,621


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 and the District of Columbia. 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 and any new accounting standards (Note 2).

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. 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 on the consolidated financial statements. As required, the Company will 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.

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
At September 30, 2010	(in thousands)
Fixed maturity securities
U.S. Treasuries	$	133,564	$	15,161	$	—		$	148,725
U.S. Agencies		114,318		9,114		—			123,432
States and municipalities		940,372		79,831		(6	)		1,020,197
Corporate		399,176		38,811		(33	)		437,954
Residential mortgage-backed securities		224,930		18,569		(450	)		243,049
Commercial mortgage-backed securities		25,151		1,463		—			26,614
Asset-backed securities		10,797		893		—			11,690
Total fixed maturity securities		1,848,308		163,842		(489	)		2,011,661

Equity securities
Consumer goods		14,421		8,735		(48	)		23,108
Energy and utilities		4,715		4,643		—			9,358
Financial		6,868		3,050		(173	)		9,745
Technology and communications		7,928		9,676		(37	)		17,567
Industrial and other		6,170		6,596		(30	)		12,736
Total equity securities		40,102		32,700		(288	)		72,514
Total investments	$	1,888,410	$	196,542	$	(777	)	$	2,084,175


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
At December 31, 2009	(in thousands)
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 mortgage-backed securities		265,056		15,697		(790	)		279,963
Commercial mortgage-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 at September 30, 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	$	129,406	$	131,660
Due after one year through five years		498,853		538,237
Due after five years through ten years		590,673		655,817
Due after ten years		368,498		404,594
Mortgage and asset-backed securities		260,878		281,353
Total	$	1,848,308	$	2,011,661

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 September 30, 2010 and December 31, 2009.

	September 30, 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
Fixed maturity securities	(in thousands)
States and municipalities	$	4,038	$	(6	)	$	—	$	—		$	4,038	$	(6	)
Corporate		14,812		(33	)		—		—			14,812		(33	)
Residential mortgage-backed securities		9,398		(41	)		3,634		(409	)		13,032		(450	)
Total fixed maturity securities		28,248		(80	)		3,634		(409	)		31,882		(489	)

Equity securities
Consumer goods		420		(48	)		—		—			420		(48	)
Financial		1,850		(156	)		87		(17	)		1,937		(173	)
Technology and communications		327		(37	)		—		—			327		(37	)
Industrial and other		321		(30	)		—		—			321		(30	)
Total equity securities		2,918		(271	)		87		(17	)		3,005		(288	)
Total investments	$	31,166	$	(351	)	$	3,721	$	(426	)	$	34,887	$	(777	)

	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
Fixed maturity securities	(in thousands)
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 mortgage-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 September 30, 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 September 30, 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 September 30, 2009, the Company recognized total impairments of $1.9 million in the fair values of 26 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 September 30,					Nine Months Ended September 30,
	2010		2009			2010		2009
	(in thousands)
Net realized gains (losses)
Fixed maturity securities	$	8	$	—		$	620	$	(422	)
Equity securities		—		3,564			280		1,656
Short-term investments		—		—			—		(174	)
Total	$	8	$	3,564		$	900	$	1,060

Change in unrealized gains (losses)
Fixed maturity securities	$	31,015	$	64,184		$	62,135	$	91,100
Equity securities		7,936		5,796			3,080		9,982
Short-term investments		—		(111	)		—		(70	)
Total	$	38,951	$	69,869		$	65,215	$	101,012

Net investment income was as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(in thousands)
Fixed maturity securities	$	20,781		$	22,157		$	63,139		$	67,505
Equity securities		344			336			1,025			1,063
Short-term investments and cash equivalents		165			433			231			2,038
		21,290			22,926			64,395			70,606
Investment expenses		(601	)		(592	)		(1,803	)		(1,902	)
Net investment income	$	20,689		$	22,334		$	62,592		$	68,704

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 it does business. As of September 30, 2010 and December 31, 2009, securities having a fair value of $577.9 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 September 30, 2010 and December 31, 2009 was $5.8 million and $6.1 million, respectively.

4. Fair Value of Financial Instruments

The estimated fair value of the Company’s financial instruments as of September 30, 2010, is as follows:

	Carrying Value		Estimated Fair Value
	(in thousands)
Financial assets
Investments	$	2,084,175	$	2,084,175
Cash and cash equivalents		144,000		144,000
Financial liabilities
Notes payable		132,000		132,000

As of December 31, 2009, the estimated fair value of the Company’s financial instruments was equal to the carrying value.

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 judgment. The fair value of certain privately held or thinly traded securities is 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 the 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, which expired on September 30, 2010 and is 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 September 30, 2010	(in thousands)
Fixed maturity securities
U.S. Treasuries	$	—	$	148,725	$	—
U.S. Agencies		—		123,432		—
States and municipalities		—		1,020,197		—
Corporate		—		437,954		—
Residential mortgage-backed securities		—		243,049		—
Commercial mortgage-backed securities		—		26,614		—
Asset-backed securities		—		11,690		—
Total fixed maturity securities	$	—	$	2,011,661	$	—

Equity securities
Consumer goods	$	23,108	$	—	$	—
Energy and utilities		9,358		—		—
Financial		9,745		—		—
Technology and communications		17,567		—		—
Industrial and other		12,736		—		—
Total equity securities	$	72,514	$	—	$	—

	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 expense for interim periods is measured using an estimated effective tax rate for the annual period. During the nine months ended September 30, 2010 and 2009, the Company recognized net income before taxes of $43.8 million and $78.5 million and an income tax expense of $1.2 million and $6.7 million, yielding effective tax rates of 2.7% and 8.5%, respectively. The following is a reconciliation of the federal statutory income tax rates to the Company’s effective tax rates.

	Nine Months Ended September 30,
	2010			2009
Expense computed at statutory rate		35.0	%		35.0	%
Dividends received deduction and tax-exempt interest		(20.2	)		(14.1	)
LPT Agreement		(11.2	)		(7.2	)
Pre-privatization reserve adjustments		(2.4	)		(0.6	)
LPT contingent profit commission		(0.5	)		(5.6	)
Stock based compensation		0.5			0.1
Other		1.5			0.9
		2.7	%		8.5	%

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 nine months ended:

	September 30,
	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		166,618			219,627
Prior periods		(15,007	)		(39,593	)
Total net losses and LAE incurred during the period		151,611			180,034
Deduct payments for losses and LAE, net of reinsurance, related to:
Current period		33,797			48,166
Prior periods		161,953			165,491
Total net payments for losses and LAE during the period		195,750			213,657
Ending unpaid losses and LAE, net of reinsurance		1,329,014			1,396,505
Reinsurance recoverable, excluding bad debt allowance, on unpaid losses and LAE		996,817			1,047,139
Unpaid losses and LAE, gross of reinsurance, at end of period	$	2,325,831		$	2,443,644

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 $15.0 million and $39.6 million for the nine months ended September 30, 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. The commutation of certain reinsurance treaties during the third quarter of 2010 resulted in a $1.6 million increase in losses and LAE incurred in prior periods for the nine months ended September 30, 2010, which was included in the $15.0 million prior period development.

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 $4.8 million and $4.7 million of the Deferred Gain for the three months ended September 30, 2010 and 2009, respectively, and amortized $13.5 million and $13.4 million of the Deferred Gain for the nine months ended September 30, 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 $375.1 million and $388.6 million as of September 30, 2010 and December 31, 2009, respectively, and is included in the accompanying consolidated balance sheets.

8. Accumulated Other Comprehensive Income, net

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.

	September 30,
	2010			2009
	(in thousands)
Net unrealized gain on investments, before taxes	$	195,765		$	155,760
Net unrealized loss on interest rate swap, before taxes		—			(2,400	)
Deferred tax expense on net unrealized gains		(68,517	)		(53,586	)
Total accumulated other comprehensive income, net	$	127,248		$	99,774

The following table summarizes the changes in the components of total comprehensive income for the periods presented.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
	(in thousands)
Unrealized gains during the period, before taxes	$	39,769	$	73,757	$	68,295	$	103,540
Less: income tax expense		12,877		25,503		24,274		35,881
Unrealized gains during the period, net of taxes		26,892		48,254		44,021		67,659
Less reclassification adjustment:
Realized gains in net income		8		3,564		900		1,060
Income tax expense		3		1,247		315		371
Reclassification adjustment for gains realized in net income		5		2,317		585		689
Other comprehensive income gains		26,887		45,937		43,436		66,970
Net income		10,054		30,557		42,650		71,757
Total comprehensive income	$	36,941	$	76,494	$	86,086	$	138,727

9. Stock-Based Compensation

On March 30, 2010, 406,020 stock 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 stock options was $15.31. The stock 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 stock 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 stock options expire seven years from the date of grant. The aggregate fair value of the stock options and RSUs on the date of grant was $2.4 million and $2.5 million, respectively.

On May 27, 2010, 30,728 RSUs were awarded to the directors of the Company. The fair value of the RSUs on the grant date was $15.62 per share and the total fair value on the date of grant was $0.5 million.

During the first quarter of 2010, the EHI Board of Directors certified the performance period results of the performance share units (PSUs) awarded in 2007, resulting in the vesting of 196,071 shares of common stock. During the second quarter of 2010, RSUs which were awarded in prior periods to directors and executives vested into 40,536 and 78,091 shares of common stock, respectively. Of the 314,698 share awards that vested for both PSUs and RSUs, 81,327 shares of common stock were withheld to satisfy minimum tax withholding obligations.

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 periods presented.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
	(in thousands, except share data)
Net income available to stockholders—basic and diluted	$	10,054	$	30,557	$	42,650	$	71,757
Weighted average number of shares outstanding—basic		40,765,528		45,113,973		41,991,051		46,706,063
Effect of dilutive securities:
Performance share units		—		128,976		—		96,111
Stock options		11,828		—		—		—
Restricted stock units		142,372		49,334		107,593		9,577
Dilutive potential shares		154,200		178,310		107,593		105,688
Weighted average number of shares outstanding—diluted		40,919,728		45,292,283		42,098,644		46,811,751

11. Reorganization Plan

On July 2, 2010, the Company announced the reorganization of its operations to eliminate duplicative services and better align resources with business activity and growth opportunities. The Company combined its 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, the Company eliminated approximately 160 positions and announced the closure of four offices. The changes to the Company’s workforce were substantially completed in the third quarter of 2010.

During the three and nine months ended September 30, 2010, the Company recorded total restructuring charges of $4.2 million, including $2.9 million related to workforce reductions and $1.3 million related to leases for facilities that were vacated during the quarter. These charges are included in underwriting and other operating expense in the consolidated statements of income. As of September 30, 2010, the Company had accrued $0.3 million for personnel-related termination costs and $1.3 million related to leases for facilities that were vacated, which are included in accounts payable and accrued expenses on the accompanying consolidated balance sheet. The Company expects to record additional restructuring charges of approximately $1.4 million related to leases for facilities that will be vacated in the fourth quarter of 2010.

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.

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 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.

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.

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 sale 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 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.

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 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 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.

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	)	</