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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
 
FORM 10-Q
 
R  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended March 31, 2011
 
OR
 
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 R 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 R 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 R
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 R
 
Class
 
April 29, 2011
Common Stock, $0.01 par value per share
 
38,561,537 shares outstanding
 

TABLE OF CONTENTS
 
 
Page
No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2
 

PART I – FINANCIAL INFORMATION
Item 1.  Consolidated Financial Statements
Employers Holdings, Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands, except share data)
 
 
As of
 
As of
 
 
March 31,
2011
 
December 31,
2010
Assets
 
(unaudited)
Available for sale:
 
 
 
 
Fixed maturity securities at fair value (amortized cost $1,851,496 at March 31, 2011
and $1,901,778 at December 31, 2010)
 
$
1,941,145
 
 
$
2,000,364
 
Equity securities at fair value (amortized cost $49,500 at March 31, 2011
and $49,281 at December 31, 2010)
 
84,678
 
 
80,130
 
Total investments
 
2,025,823
 
 
2,080,494
 
Cash and cash equivalents
 
167,231
 
 
119,825
 
Restricted cash and cash equivalents
 
11,321
 
 
16,949
 
Accrued investment income
 
21,425
 
 
23,022
 
Premiums receivable, less bad debt allowance of $7,004 at March 31, 2011 and $7,603
at December 31, 2010
 
129,782
 
 
109,987
 
Reinsurance recoverable for:
 
 
 
 
 
 
Paid losses
 
12,418
 
 
14,415
 
Unpaid losses
 
946,621
 
 
956,043
 
Funds held by or deposited with reinsureds
 
2,682
 
 
3,701
 
Deferred policy acquisition costs
 
34,712
 
 
32,239
 
Federal income taxes recoverable
 
5,045
 
 
4,048
 
Deferred income taxes, net
 
41,087
 
 
38,078
 
Property and equipment, net
 
11,090
 
 
11,712
 
Intangible assets, net
 
12,878
 
 
13,279
 
Goodwill
 
36,192
 
 
36,192
 
Other assets
 
21,032
 
 
20,136
 
Total assets
 
$
3,479,339
 
 
$
3,480,120
 
 
 
 
 
 
Liabilities and stockholders’ equity
 
 
 
 
 
 
Claims and policy liabilities:
 
 
 
 
 
 
Unpaid losses and loss adjustment expenses
 
$
2,267,739
 
 
$
2,279,729
 
Unearned premiums
 
167,571
 
 
149,485
 
Policyholders’ dividends accrued
 
4,965
 
 
5,218
 
Total claims and policy liabilities
 
2,440,275
 
 
2,434,432
 
Commissions and premium taxes payable
 
20,125
 
 
17,313
 
Accounts payable and accrued expenses
 
18,199
 
 
18,601
 
Deferred reinsurance gain—LPT Agreement
 
365,822
 
 
370,341
 
Notes payable
 
132,000
 
 
132,000
 
Other liabilities
 
17,160
 
 
17,317
 
Total liabilities
 
2,993,581
 
 
2,990,004
 
 
 
 
 
 
Commitments and contingencies
 
 
 
 
 
 
 
 
 
 
 
Stockholders’ equity:
 
 
 
 
 
 
Common stock, $0.01 par value; 150,000,000 shares authorized; 53,822,715 and 53,779,118
shares issued and 38,511,187 and 38,965,126 shares outstanding at March 31, 2011 and
December 31, 2010, respectively
 
538
 
 
538
 
Preferred stock, $0.01 par value; 25,000,000 shares authorized; none issued
 
—
 
 
—
 
Additional paid-in capital
 
315,410
 
 
314,212
 
Retained earnings
 
325,372
 
 
319,341
 
Accumulated other comprehensive income, net
 
81,137
 
 
84,133
 
Treasury stock, at cost (15,311,528 shares at March 31, 2011 and 14,813,992 shares
at December 31, 2010)
 
(236,699
)
 
(228,108
)
Total stockholders’ equity
 
485,758
 
 
490,116
 
Total liabilities and stockholders’ equity
 
$
3,479,339
 
 
$
3,480,120
 
See accompanying unaudited notes to the consolidated financial statements.

3
 

Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Income
(in thousands, except per share data)
 
 
Three Months Ended
 
 
March 31
 
 
2011
 
2010
Revenues
 
(unaudited)
Net premiums earned
 
$
82,427
 
 
$
79,291
 
Net investment income
 
20,493
 
 
21,255
 
Realized gains on investments, net
 
234
 
 
540
 
Other income
 
120
 
 
—
 
Total revenues
 
103,274
 
 
101,086
 
 
 
 
 
 
Expenses
 
 
 
 
 
 
Losses and loss adjustment expenses
 
59,421
 
 
40,288
 
Commission expense
 
10,281
 
 
9,905
 
Dividends to policyholders
 
1,012
 
 
1,479
 
Underwriting and other operating expenses
 
25,678
 
 
32,267
 
Interest expense
 
917
 
 
1,580
 
Total expenses
 
97,309
 
 
85,519
 
 
 
 
 
 
Net income before income taxes
 
5,965
 
 
15,567
 
Income tax benefit
 
(2,380
)
 
(530
)
Net income
 
$
8,345
 
 
$
16,097
 
 
 
 
 
 
Earnings per common share (Note 9):
 
 
 
 
 
 
Basic
 
$
0.22
 
 
$
0.38
 
Diluted
 
$
0.21
 
 
$
0.38
 
Cash dividends declared per common share
 
$
0.06
 
 
$
0.06
 
 
 
 
 
 
Realized gains on investments, net
 
 
 
 
 
 
Net realized gains on investments before credit related impairments on fixed maturity securities
 
$
234
 
 
$
540
 
Other than temporary impairment, credit losses recognized in earnings
 
—
 
 
—
 
Portion of impairment recognized in other comprehensive income
 
—
 
 
—
 
Realized gains on investments, net
 
$
234
 
 
$
540
 
 
See accompanying unaudited notes to the consolidated financial statements.
 

4
 

Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
 
 
Three Months Ended
 
 
March 31
 
 
2011
 
2010
Operating activities
 
(unaudited)
Net income
 
$
8,345
 
 
$
16,097
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
Depreciation and amortization
 
1,841
 
 
1,982
 
Stock-based compensation
 
640
 
 
865
 
Amortization of premium on investments, net
 
2,017
 
 
1,413
 
Allowance for doubtful accounts
 
(599
)
 
365
 
Deferred income tax (benefit) expense
 
(1,397
)
 
4,070
 
Realized gains on investments, net
 
(234
)
 
(540
)
Realized losses on retirement of assets
 
68
 
 
63
 
Change in operating assets and liabilities:
 
 
 
 
 
 
Accrued investment income
 
1,597
 
 
1,528
 
Premiums receivable
 
(19,196
)
 
6,014
 
Reinsurance recoverable on paid and unpaid losses
 
11,419
 
 
10,004
 
Funds held by or deposited with reinsureds
 
1,019
 
 
1,305
 
Federal income taxes recoverable
 
(997
)
 
(6,327
)
Unpaid losses and loss adjustment expenses
 
(11,990
)
 
(31,731
)
Unearned premiums
 
18,086
 
 
312
 
Accounts payable, accrued expenses and other liabilities
 
467
 
 
(1,468
)
Deferred reinsurance gain – LPT Agreement
 
(4,519
)
 
(4,350
)
Other
 
(1,252
)
 
2,515
 
Net cash provided by operating activities
 
5,315
 
 
2,117
 
Investing activities
 
 
 
 
 
 
Purchase of fixed maturities
 
(23,925
)
 
(36,433
)
Purchase of equity securities
 
(1,054
)
 
(455
)
Proceeds from sale of fixed maturities
 
22,099
 
 
21,171
 
Proceeds from sale of equity securities
 
1,096
 
 
568
 
Proceeds from maturities and redemptions of investments
 
49,457
 
 
20,354
 
Capital expenditures and other, net
 
(863
)
 
(764
)
Restricted cash and cash equivalents provided by (used in) investing activities
 
5,628
 
 
(31
)
Net cash provided by investing activities
 
52,438
 
 
4,410
 
Financing activities
 
 
 
 
 
 
Acquisition of treasury stock
 
(8,591
)
 
(4,381
)
Cash transactions related to stock-based compensation
 
554
 
 
(871
)
Dividends paid to stockholders
 
(2,310
)
 
(2,555
)
Net cash used in financing activities
 
(10,347
)
 
(7,807
)
Net increase (decrease) in cash and cash equivalents
 
47,406
 
 
(1,280
)
Cash and cash equivalents at the beginning of the period
 
119,825
 
 
188,833
 
Cash and cash equivalents at the end of the period
 
$
167,231
 
 
$
187,553
 
 
 See accompanying unaudited notes to the consolidated financial statements.

5
 

Employers Holdings, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
 (Unaudited)
1. Basis of Presentation
Employers Holdings, Inc. (EHI) is a Nevada holding company. Through its 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), EHI is engaged in the commercial property and casualty insurance industry, specializing in workers' compensation products and services. 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 2010 Annual Report on Form 10-K for the year ended December 31, 2010.
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.
Use of Estimates
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, investments, and the valuation of goodwill and intangible assets.
Reclassifications
Certain prior period information has been reclassified to conform to the current period presentation.

6
 

2. 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 March 31, 2011
 
(in thousands)
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
134,541
 
 
$
8,687
 
 
$
(202
)
 
$
143,026
 
U.S. Agencies
 
105,852
 
 
6,219
 
 
(135
)
 
111,936
 
States and municipalities
 
911,485
 
 
41,300
 
 
(5,931
)
 
946,854
 
Corporate
 
437,144
 
 
26,378
 
 
(3,650
)
 
459,872
 
Residential mortgage-backed securities
 
227,716
 
 
16,025
 
 
(745
)
 
242,996
 
Commercial mortgage-backed securities
 
21,658
 
 
1,068
 
 
(3
)
 
22,723
 
Asset-backed securities
 
13,100
 
 
648
 
 
(10
)
 
13,738
 
Total fixed maturity securities
 
1,851,496
 
 
100,325
 
 
(10,676
)
 
1,941,145
 
Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
Consumer goods
 
19,218
 
 
8,085
 
 
(106
)
 
27,197
 
Energy and utilities
 
4,977
 
 
6,382
 
 
(2
)
 
11,357
 
Financial
 
6,627
 
 
3,114
 
 
(64
)
 
9,677
 
Technology and communications
 
7,894
 
 
9,624
 
 
(52
)
 
17,466
 
Industrial and other
 
10,784
 
 
8,204
 
 
(7
)
 
18,981
 
Total equity securities
 
49,500
 
 
35,409
 
 
(231
)
 
84,678
 
Total investments
 
$
1,900,996
 
 
$
135,734
 
 
$
(10,907
)
 
$
2,025,823
 
 
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
At December 31, 2010
 
(in thousands)
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
135,265
 
 
$
9,619
 
 
$
(159
)
 
$
144,725
 
U.S. Agencies
 
116,747
 
 
7,142
 
 
(87
)
 
123,802
 
States and municipalities
 
927,668
 
 
43,054
 
 
(4,720
)
 
966,002
 
Corporate
 
453,851
 
 
28,655
 
 
(3,082
)
 
479,424
 
Residential mortgage-backed securities
 
230,518
 
 
16,926
 
 
(688
)
 
246,756
 
Commercial mortgage-backed securities
 
23,877
 
 
1,201
 
 
(1
)
 
25,077
 
Asset-backed securities
 
13,852
 
 
727
 
 
(1
)
 
14,578
 
Total fixed maturity securities
 
1,901,778
 
 
107,324
 
 
(8,738
)
 
2,000,364
 
Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
Consumer goods
 
19,141
 
 
7,550
 
 
(45
)
 
26,646
 
Energy and utilities
 
5,106
 
 
5,160
 
 
(1
)
 
10,265
 
Financial
 
6,603
 
 
2,916
 
 
(19
)
 
9,500
 
Technology and communications
 
7,499
 
 
8,500
 
 
(9
)
 
15,990
 
Industrial and other
 
10,932
 
 
6,841
 
 
(44
)
 
17,729
 
Total equity securities
 
49,281
 
 
30,967
 
 
(118
)
 
80,130
 
Total investments
 
$
1,951,059
 
 
$
138,291
 
 
$
(8,856
)
 
$
2,080,494
 

7
 

The amortized cost and estimated fair value of fixed maturity securities at March 31, 2011, 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
 
$
108,865
 
 
$
111,111
 
Due after one year through five years
 
550,811
 
 
583,353
 
Due after five years through ten years
 
600,927
 
 
631,986
 
Due after ten years
 
328,419
 
 
335,238
 
Mortgage and asset-backed securities
 
262,474
 
 
279,457
 
Total
 
$
1,851,496
 
 
$
1,941,145
 
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, 2011 and December 31, 2010.
 
 
March 31, 2011
 
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
 
Estimated
Fair
Value
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Gross
Unrealized
Losses
 
 
(in thousands)
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
10,826
 
 
$
(202
)
 
$
—
 
 
$
—
 
 
$
10,826
 
 
$
(202
)
U.S. Agencies
 
13,163
 
 
(135
)
 
—
 
 
—
 
 
13,163
 
 
(135
)
States and municipalities
 
133,707
 
 
(5,931
)
 
—
 
 
—
 
 
133,707
 
 
(5,931
)
Corporate
 
116,047
 
 
(3,650
)
 
—
 
 
—
 
 
116,047
 
 
(3,650
)
Residential mortgage-backed securities
 
20,548
 
 
(401
)
 
3,364
 
 
(344
)
 
23,912
 
 
(745
)
Commercial mortgage-backed securities
 
2,437
 
 
(3
)
 
—
 
 
—
 
 
2,437
 
 
(3
)
Asset-backed securities
 
3,258
 
 
(10
)
 
—
 
 
—
 
 
3,258
 
 
(10
)
Total fixed maturity securities
 
299,986
 
 
(10,332
)
 
3,364
 
 
(344
)
 
303,350
 
 
(10,676
)
Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer goods
 
3,370
 
 
(97
)
 
124
 
 
(9
)
 
3,494
 
 
(106
)
Energy and utilities
 
161
 
 
(2
)
 
—
 
 
—
 
 
161
 
 
(2
)
Financial
 
1,463
 
 
(50
)
 
84
 
 
(14
)
 
1,547
 
 
(64
)
Technology and communications
 
755
 
 
(52
)
 
—
 
 
—
 
 
755
 
 
(52
)
Industrial and other
 
395
 
 
(7
)
 
—
 
 
—
 
 
395
 
 
(7
)
Total equity securities
 
6,144
 
 
(208
)
 
208
 
 
(23
)
 
6,352
 
 
(231
)
Total investments
 
$
306,130
 
 
$
(10,540
)
 
$
3,572
 
 
$
(367
)
 
$
309,702
 
 
$
(10,907
)
 

8
 

 
 
December 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
 
Gross
Unrealized
Losses
 
 
(in thousands)
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
4,548
 
 
$
(159
)
 
$
—
 
 
$
—
 
 
$
4,548
 
 
$
(159
)
U.S. Agencies
 
14,500
 
 
(87
)
 
—
 
 
—
 
 
14,500
 
 
(87
)
States and municipalities
 
124,245
 
 
(4,720
)
 
—
 
 
—
 
 
124,245
 
 
(4,720
)
Corporate
 
123,216
 
 
(3,082
)
 
—
 
 
—
 
 
123,216
 
 
(3,082
)
Residential mortgage-backed securities
 
15,161
 
 
(304
)
 
3,465
 
 
(384
)
 
18,626
 
 
(688
)
Commercial mortgage-backed securities
 
1365
 
 
(1
)
 
—
 
 
—
 
 
1,365
 
 
(1
)
Asset-backed securities
 
923
 
 
(1
)
 
—
 
 
—
 
 
923
 
 
(1
)
Total fixed maturity securities
 
283,958
 
 
(8,354
)
 
3,465
 
 
(384
)
 
287,423
 
 
(8,738
)
Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer goods
 
4,993
 
 
(45
)
 
—
 
 
—
 
 
4,993
 
 
(45
)
Energy and utilities
 
163
 
 
(1
)
 
—
 
 
—
 
 
163
 
 
(1
)
Financial
 
1,695
 
 
(16
)
 
66
 
 
(3
)
 
1,761
 
 
(19
)
Technology and communications
 
801
 
 
(9
)
 
—
 
 
—
 
 
801
 
 
(9
)
Industrial and other
 
2,999
 
 
(44
)
 
—
 
 
—
 
 
2,999
 
 
(44
)
Total equity securities
 
10,651
 
 
(115
)
 
66
 
 
(3
)
 
10,717
 
 
(118
)
Total investments
 
$
294,609
 
 
$
(8,469
)
 
$
3,531
 
 
$
(387
)
 
$
298,140
 
 
$
(8,856
)
Based on reviews of the fixed maturity securities, the Company determined that unrealized losses as of March 31, 2011 and December 31, 2010 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, the Company’s intent on not selling the securities, and a determination 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, 2011 and December 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.
Realized gains on investments, net 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,
 
 
2011
 
2010
 
 
(in thousands)
Realized gains on investments, net
 
 
 
 
Fixed maturity securities
 
$
(27
)
 
$
260
 
Equity securities
 
261
 
 
280
 
Total
 
$
234
 
 
$
540
 
Change in unrealized gains (losses)
 
 
 
 
 
 
Fixed maturity securities
 
$
(8,937
)
 
$
1,169
 
Equity securities
 
4,329
 
 
2,879
 
Total
 
$
(4,608
)
 
$
4,048
 

9
 

Net investment income was as follows:
 
 
Three Months Ended
 
 
March 31,
 
 
2011
 
2010
 
 
(in thousands)
Fixed maturity securities
 
$
20,544
 
 
$
21,360
 
Equity securities
 
449
 
 
333
 
Cash equivalents and restricted cash
 
105
 
 
176
 
 
 
21,098
 
 
21,869
 
Investment expenses
 
(605
)
 
(614
)
Net investment income
 
$
20,493
 
 
$
21,255
 
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 March 31, 2011 and December 31, 2010, securities having a fair value of $562.0 million and $558.6 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 March 31, 2011 and December 31, 2010 was $52.6 million and $52.9 million, respectively. Additionally, the Company's debt was secured by fixed maturity securities and restricted cash and cash equivalents that had a fair value of $126.2 million and $131.0 million at March 31, 2011 and December 31, 2010, respectively.
3. Fair Value of Financial Instruments
The estimated fair value of the Company’s financial instruments as of March 31, 2011, was as follows:
 
 
Carrying Value
 
Estimated Fair Value
 
 
(in thousands)
Financial assets
 
 
 
 
Investments
 
$
2,025,823
 
 
$
2,025,823
 
Cash and cash equivalents
 
167,231
 
 
167,231
 
Restricted cash and cash equivalents
 
11,321
 
 
11,321
 
Financial liabilities
 
 
 
 
 
Notes payable
 
132,000
 
 
132,000
 
As of December 31, 2010, the estimated fair value of the Company’s financial instruments was equal to the carrying value. 
The Company's estimates of fair value for financial assets and liabilities are based on the inputs used in the valuation and give the highest priority to quoted prices in active markets and require that observable inputs be used in the valuations 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 - Valuations based on unadjusted quoted market prices for identical assets or liabilities in active markets. The Company uses the quoted market prices as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy.
•
Level 2 - Valuations based on observable inputs (other than Level 1 prices), such as quoted market prices for similar assets or liabilities at the measurement date; quoted prices in inactive markets; or other inputs that are observable, either directly or indirectly. When quoted market prices are unavailable, the Company estimates fair value based on objectively verifiable information, if available, and these estimates are included in the amount disclosed in Level 2 of the hierarchy.
•
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.
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

10
 

assets on the bid price as it 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, Short-Term Investments. 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. An Option Adjusted Spread model is also used to develop prepayment and interest rate scenarios. Industry standard models are used to analyze and value securities with embedded options or prepayment sensitivities.
Each asset class is evaluated based on relevant market information, credit information, perceived market movements, and sector news. The market inputs utilized in the pricing evaluation 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.
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 would be required to produce 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 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, 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, 2011
 
(in thousands)
Fixed maturity securities
 
 
 
 
 
 
U.S. Treasuries
 
$
—
 
 
$
143,026
 
 
$
—
 
U.S. Agencies
 
—
 
 
111,936
 
 
—
 
States and municipalities
 
—
 
 
946,854
 
 
—
 
Corporate
 
—
 
 
459,872
 
 
—
 
Residential mortgage-backed securities
 
—
 
 
242,996
 
 
—
 
Commercial mortgage-backed securities
 
—
 
 
22,723
 
 
—
 
Asset-backed securities
 
—
 
 
13,738
 
 
—
 
Total fixed maturity securities
 
$
—
 
 
$
1,941,145
 
 
$
—
 
Equity securities
 
 
 
 
 
 
 
 
 
Consumer goods
 
$
27,197
 
 
$
—
 
 
$
—
 
Energy and utilities
 
11,357
 
 
—
 
 
—
 
Financial
 
9,677
 
 
—
 
 
—
 
Technology and communications
 
17,466
 
 
—
 
 
—
 
Industrial and other
 
18,981
 
 
—
 
 
—
 
Total equity securities
 
$
84,678
 
 
$
—
 
 
$
—
 
 

11
 

 
 
Level 1
 
Level 2
 
Level 3
At December 31, 2010
 
(in thousands)
Fixed maturity securities
 
 
 
 
 
 
U.S. Treasuries
 
$
—
 
 
$
144,725
 
 
$
—
 
U.S. Agencies
 
—
 
 
123,802
 
 
—
 
States and municipalities
 
—
 
 
966,002
 
 
—
 
Corporate
 
—
 
 
479,424
 
 
—
 
Residential mortgage-backed securities
 
—
 
 
246,756
 
 
—
 
Commercial mortgage-backed securities
 
—
 
 
25,077
 
 
—
 
Asset-backed securities
 
—
 
 
14,578
 
 
—
 
Total fixed maturity securities
 
$
—
 
 
$
2,000,364
 
 
$
—
 
Equity securities
 
 
 
 
 
 
 
 
 
Consumer goods
 
$
26,646
 
 
$
—
 
 
$
—
 
Energy and utilities
 
10,265
 
 
—
 
 
—
 
Financial
 
9,500
 
 
—
 
 
—
 
Technology and communications
 
15,990
 
 
—
 
 
—
 
Industrial and other
 
17,729
 
 
—
 
 
—
 
Total equity securities
 
$
80,130
 
 
$
—
 
 
$
—
 
4. Income Taxes
Income tax expense for interim periods is measured using an estimated effective tax rate for the annual period. During the three months ended March 31, 2011 and 2010, the Company recognized net income before taxes of $6.0 million and $15.6 million and an income tax benefit of $2.4 million and $0.5 million, yielding effective tax rates of (39.9)% and (3.4)%, respectively. The following is a reconciliation of the federal statutory income tax rates to the Company’s effective tax rates for the periods presented.
 
 
Three Months Ended March 31,
 
 
2011
 
2010
Expense computed at statutory rate
 
35.0
 %
 
35.0
 %
Dividends received deduction and tax-exempt interest
 
(49.4
)
 
(24.0
)
LPT Agreement
 
(26.8
)
 
(12.8
)
Pre-privatization reserve adjustments
 
—
 
 
(3.3
)
Stock based compensation
 
—
 
 
0.9
 
Other
 
1.3
 
 
0.8
 
 
 
(39.9
)%
 
(3.4
)%

12
 

5. 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,
 
 
2011
 
2010
 
 
(in thousands)
Unpaid losses and LAE, gross of reinsurance, at beginning of period
 
$
2,279,729
 
 
$
2,425,658
 
Less reinsurance recoverables, excluding bad debt allowance, on unpaid losses and LAE
 
956,043
 
 
1,052,505
 
Net unpaid losses and LAE at beginning of period
 
1,323,686
 
 
1,373,153
 
Losses and LAE, net of reinsurance, incurred in:
 
 
 
 
 
 
Current period
 
63,110
 
 
55,759
 
Prior periods
 
830
 
 
(11,121
)
Total net losses and LAE incurred during the period
 
63,940
 
 
44,638
 
Deduct payments for losses and LAE, net of reinsurance, related to:
 
 
 
 
 
 
Current period
 
3,690
 
 
4,406
 
Prior periods
 
62,818
 
 
63,086
 
Total net payments for losses and LAE during the period
 
66,508
 
 
67,492
 
Ending unpaid losses and LAE, net of reinsurance
 
1,321,118
 
 
1,350,299
 
Reinsurance recoverable, excluding bad debt allowance in 2010, on unpaid losses and LAE
 
946,621
 
 
1,043,628
 
Unpaid losses and LAE, gross of reinsurance, at end of period
 
$
2,267,739
 
 
$
2,393,927
 
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 6).
The change in the liability for unpaid losses and LAE attributable to insured events for prior periods was $0.8 million and $(11.1) million for the three months ended March 31, 2011 and 2010, respectively. The increase in the first quarter of 2011 was related to the Company's assigned risk business, while the major sources of favorable development in the first quarter of 2010 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.
6. 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 $4.5 million and $4.4 million of the Deferred Gain for the three months ended March 31, 2011 and 2010, 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 $365.8 million and $370.3 million as of March 31, 2011 and December 31, 2010, respectively, and is included in the accompanying consolidated balance sheets.
7. Accumulated Other Comprehensive Income, net
Accumulated other comprehensive income is comprised of unrealized gains on investments classified as available-for-sale and unrealized losses on an interest rate swap, net of deferred tax expense. The following table summarizes the components of accumulated other comprehensive income, net:
 
 
March 31,
 
 
2011
 
2010
 
 
(in thousands)
Net unrealized gain on investments, before taxes
 
$
124,827
 
 
$
134,598
 
Net unrealized loss on interest rate swap, before taxes
 
—
 
 
(1,560
)
Deferred tax expense on net unrealized gains
 
(43,690
)
 
(47,604
)
Total accumulated other comprehensive income, net
 
$
81,137
 
 
$
85,434
 

13
 

The following table summarizes the changes in the components of total comprehensive income for the periods presented:
 
 
Three Months Ended March 31,
 
 
2011
 
2010
 
 
(in thousands)
Unrealized (losses) gains during the period, before taxes
 
$
(4,374
)
 
$
5,208
 
Less: income tax (benefit) expense
 
(1,530
)
 
3,235
 
Unrealized (losses) gains during the period, net of taxes
 
(2,844
)
 
1,973
 
Less reclassification adjustment:
 
 
 
 
 
 
Realized gains in net income
 
234
 
 
540
 
Income tax expense
 
82
 
 
189
 
Reclassification adjustment for gains realized in net income
 
152
 
 
351
 
Other comprehensive (loss) income
 
(2,996
)
 
1,622
 
Net income
 
8,345
 
 
16,097
 
Total comprehensive income
 
$
5,349
 
 
$
17,719
 
8. Stock-Based Compensation
On March 16, 2011, 355,063 stock options and 126,975 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 $19.81. The stock options have a service vesting period of four years and vest 25% on March 16, 2012, and 25% on each of the subsequent three anniversaries of such date. The stock options and RSUs 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 and are subject to partial accelerated vesting in the case of retirement. 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 $2.5 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 share units (PSUs) awarded in 2007, resulting in the vesting of 196,071 shares of common stock.
A total of 43,597 and 7,783 stock options were exercised during the three months ended March 31, 2011 and the year ended December 31, 2010, respectively.
9. 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 occur if outstanding options were to be exercised.
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 March 31,
 
 
2011
 
2010
 
 
(in thousands, except share data)
Net income available to stockholders—basic and diluted
 
$
8,345
 
 
$
16,097
 
Weighted average number of shares outstanding—basic
 
38,674,176
 
 
42,722,452
 
Effect of dilutive securities:
 
 
 
 
Stock options
 
92,847
 
 
—
 
Restricted stock units
 
110,101
 
 
107,062
 
Dilutive potential shares
 
202,948
 
 
107,062
 
Weighted average number of shares outstanding—diluted
 
38,877,124
 
 
42,829,514
 
Diluted earnings per share exclude outstanding options and other common stock equivalents in periods where the inclusion of such potential common stock instruments would be anti-dilutive. For the three months ended March 31, 2011 and 2010, 1.1 million and 1.2 million stock options, respectively, were excluded from diluted earnings per share, as the options exercise price was greater than the average market price of the common stock during the period. During the same periods, 0.5 million and 0.7 million outstanding RSUs and stock options, respectively, were excluded from diluted earnings per share under the treasury method, as the potential proceeds on settlement or exercise was greater than the value of shares acquired.

14
 

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 2010 Annual Report on Form 10-K for the year ended December 31, 2010 (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. Our revenues are primarily comprised of net premiums earned, net investment income, and net realized gains (losses) on investments.
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 of California.
Results of Operations
Overall, net income was $8.3 million and $16.1 million for the three months ended March 31, 2011 and 2010, respectively. We recognized an underwriting loss of $14.0 million during the first quarter of 2011, compared to a $4.6 million underwriting loss during the first quarter of 2010. Underwriting income or loss is determined by deducting losses and LAE, commission expense, dividends to policyholders, and underwriting and other operating expenses from net premiums earned. Key factors that effected our financial performance during the first quarter of 2011, compared to the first quarter of 2010 include:
•
25.3%, or $20.8 million, increase in gross premiums written (4.0% increase in net premiums earned);
•
47.5%, or $19.1 million, increase in losses and LAE (due to the change in prior accident year loss development and an increase in our current accident year loss estimate to 76.6%);
•
20.4%, or $6.6 million, decrease in underwriting and other operating expenses; and
•
$1.9 million increase in income tax benefit.
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 $851.6 million and $860.5 million at March 31, 2011 and December 31, 2010, 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 $485.8 million

15
 

and $490.1 million at March 31, 2011 and December 31, 2010, respectively. As a result of accretive share repurchases in the quarter, shares outstanding declined to 38,511,187 from 38,965,126. Additionally, we have returned $2.3 million to shareholders in 2011 through a $0.06 per share quarterly dividend.
Our goal is to maintain focus on disciplined underwriting and to continue to pursue profitable growth opportunities across market cycles; however, 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 believe that we will be positioned to grow our business when the economy and employment trends improve.
The comparative components of net income are set forth in the following table for the three months ended:
 
 
March 31,
 
 
2011
 
2010
 
 
(in thousands)
Gross premiums written
 
$
103,227
 
 
$
82,378
 
Net premiums written
 
101,126
 
 
79,774
 
 
 
 
 
 
Net premiums earned
 
$
82,427
 
 
$
79,291
 
Net investment income
 
20,493
 
 
21,255
 
Realized gains on investments
 
234
 
 
540
 
Other income
 
120
 
 
—
 
Total revenues
 
103,274
 
 
101,086
 
 
 
 
 
 
Losses and LAE
 
59,421
 
 
40,288
 
Commission expense
 
10,281
 
 
9,905
 
Dividends to policyholders
 
1,012
 
 
1,479
 
Underwriting and other operating expenses
 
25,678
 
 
32,267
 
Interest expense
 
917
 
 
1,580
 
Income tax benefit
 
(2,380
)
 
(530
)
Total expenses
 
94,929
 
 
84,989
 
Net income
 
$
8,345
 
 
$
16,097
 
Less impact of the deferred reinsurance gain— LPT Agreement
 
$
4,519
 
 
$
4,350
 
Net income before impact of the deferred reinsurance gain— LPT Agreement(1)
 
$
3,826
 
 
$
11,747
 
 
(1)
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.
Net Premiums Earned
Net premiums earned increased 4.0% for the three months ended March 31, 2011, compared to the same period of 2010. This increase reflects our continued focus on executing our growth strategy and our application of disciplined pricing objectives and underwriting guidelines in a highly competitive market.

16
 

The following table shows the percentage change in our in-force premium, policy count, average policy size, and payroll exposure, upon which our premiums are based, and net rate.
 
As of March 31, 2011
 
Year-to-Date Percentage Increase (Decrease)
 
Year-Over-Year Percentage Increase (Decrease)
In-force premium
1.8
 %
 
(7.9
)%
In-force policy count
7.8
 
 
11.7
 
Average in-force policy size
(5.6
)
 
(17.6
)
In-force payroll exposure
2.6
 
 
(2.8
)
Net rate(1)
(0.8
)
 
(5.3
)
 
(1)
Net rate, defined as total premium in-force divided by total insured payroll exposure, 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, 2011
 
December 31, 2010
 
March 31, 2010
 
December 31, 2009
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
 
$
177,482
 
 
30,996
 
 
$
172,621
 
 
29,244
 
 
$
176,028
 
 
27,721
 
 
$
180,474
 
 
27,812
 
Illinois
 
19,927
 
 
1,213
 
 
18,617
 
 
932
 
 
18,948
 
 
799
 
 
19,389
 
 
801
 
Nevada
 
16,197
 
 
3,577
 
 
16,940
 
 
3,596
 
 
21,355
 
 
3,875
 
 
24,050
 
 
4,119
 
Florida
 
15,096
 
 
2,133
 
 
15,071
 
 
1,963
 
 
22,983
 
 
2,182
 
 
27,964
 
 
2,630
 
Wisconsin
 
13,637
 
 
776
 
 
14,573
 
 
764
 
 
18,402
 
 
842
 
 
24,125
 
 
922
 
Other
 
84,519
 
 
9,333
 
 
83,315
 
 
8,061
 
 
97,280
 
 
7,582
 
 
109,023
 
 
7,870
 
Total
 
$
326,858
 
 
48,028
 
 
$
321,137
 
 
44,560
 
 
$
354,996
 
 
43,001
 
 
$
385,025
 
 
44,154
 
Our strategic partnerships and alliances generated $71.9 million and $72.3 million, or 22.0% and 20.4%, of our in-force premiums as of March 31, 2011 and 2010, respectively. 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 we continue to see a steady level of new business submittals and where our policy count has increased 6.0% during the first quarter of 2011.
In April 2011, the Workers' Compensation Insurance Rating Bureau (WCIRB) stated that it would make an informational filing highlighting the cost drivers that indicate a cumulative 39.8% increase in the claims cost benchmark since January 1, 2009 based on an analysis of December 31, 2010 loss experience. This includes deterioration of more than ten percentage points in the claims cost benchmark since the WCIRB's previous recommendation for a 27.7% increase based on an analysis of June 30, 2010 loss experience. The WCIRB indicated that this further deterioration was due to: (a) continued adverse loss development on the 2009 accident year; (b) high emerging costs on the 2010 accident year, primarily due to increased claims frequency; (c) less optimistic forecasts for statewide wage growth in California; and (d) increased LAE that is likely as a result of certain Workers' Compensation Appeals Board decisions. The California Commissioner has not adjusted the claims cost benchmark since January 1, 2009.
We set our own premium rates in California based upon actuarial analyses of current and anticipated loss trends with a goal of maintaining underwriting profitability. Due to increasing loss costs, primarily medical cost inflation, we have increased our filed premium rates by a cumulative 28.3% since February 1, 2009. We anticipate filing an additional rate increase for new and renewal policies in California in the third quarter of 2011.

17
 

The following table sets forth the percentage increases to our filed California rates 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
 
March 15, 2011
 
2.5
 
We expect that premium revenues in 2011 will continue to reflect rate changes (increases and reductions) in the states in which we operate, increasing policy count as we continue to execute our growth strategy, lower average policy size, as well as competitive pressures and the residual effects of the recession.
Net Investment Income and Realized Gains on Investments.
We invest our holding company assets, statutory surplus, and the funds supporting our insurance liabilities, including unearned premiums and unpaid losses and 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.
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.
Net investment income decreased 3.6% for the three months ended March 31, 2011, compared to the same period of 2010. The decrease was primarily related to a 0.2 percentage point decrease in the average pre-tax book yield on invested assets for the three months ended March 31, 2011, to 4.1%, compared to 4.3% for the same period of 2010. The tax-equivalent yield on invested assets decreased to 5.3% at March 31, 2011, compared to 5.5% at March 31, 2010.
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.
Realized gains on investments were $0.2 million and $0.5 million for the first quarter of 2011 and 2010, respectively.
Additional information regarding our Investments is set forth under “—Liquidity and Capital Resources—Investments.”
Combined Ratio
The combined ratio, expressed as a percentage, is a key measurement of underwriting profitability. The combined ratio is the sum of the losses and LAE ratio, the commission expense ratio, dividends to policyholders' ratio, and underwriting and other operating expenses ratio. When the combined ratio is below 100%, we have recorded underwriting income, and conversely, when the combined ratio is greater than 100%, we cannot be profitable without investment income. Because we only have one operating segment, holding company expenses are included in our calculation of the combined ratio.
The following table provides the calculation of our calendar year combined ratios for the three months ended:
 
March 31,
 
2011
 
2010
Losses and LAE ratio
72.1
%
 
50.8
%
Underwriting and other operating expenses ratio
31.1
 
 
40.7
 
Commission expense ratio
12.5
 
 
12.5
 
Dividends to policyholders' ratio
1.2
 
 
1.9
 
Combined ratio
116.9
%
 
105.9
%
Losses and LAE Ratio. Expressed as a percentage, this is the ratio of losses and LAE to net premiums earned.
Losses and LAE represents our largest expense item and includes claim payments made, amortization of the LPT Deferred Gain, 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.

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In California, we are experiencing an increase in indemnity claims frequency (the number of claims expressed as a percentage of payroll) and our loss experience indicates an upward trend in medical and indemnity costs that are reflected in our current accident year loss estimate. We are also seeing increased medical and indemnity costs in many of our other states, partially offset by long-term favorable loss cost trends in Nevada. We believe our current accident year loss estimate is adequate; however, ultimate losses will not be known with any certainty for several years. We assume that increasing medical and indemnity cost trends will continue to impact our long-term claims costs and current accident year loss estimate.
Overall, losses and LAE increased 47.5% for the three months ended March 31, 2011, compared to the same period of 2010, primarily due to the impact of prior accident year loss development and an increase in the current accident year loss estimate. Prior accident year loss development for the three months ended March 31, 2011 was $(0.8) million, related to our assigned risk business, compared to $11.1 million of favorable development for the same period of 2010. Our current accident year loss estimates were 76.6% and 70.3% for the three months ended March 31, 2011 and 2010, respectively. The increase in the current accident year loss estimate is primarily due to continued increasing loss costs in California.
The table below reflects the losses and LAE reserve adjustments for the three months ended:
 
 
March 31,
 
 
2011
 
2010
 
 
(in millions)
Prior accident year (unfavorable) favorable loss development, net
 
$
(0.8
)
 
$
11.1
 
LPT amortization of the deferred reinsurance gain
 
$
4.5
 
 
4.4
 
Excluding the impact from the LPT Agreement, losses and LAE would have been $63.9 million and $44.6 million, or 77.6% and 56.3%, of net premiums earned for the three months ended March 31, 2011 and 2010, respectively.
Underwriting and Other Operating Expenses Ratio. The underwriting and other operating expenses ratio is the ratio (expressed as a percentage) of underwriting and other operating expenses to net premiums earned and measures an insurance company's operational efficiency in producing, underwriting, and administering its insurance business.
Underwriting and other operating expenses are those costs that we incur to underwrite and maintain the insurance policies we issue, excluding commission. These expenses include premium taxes and certain other general expenses that vary with, and are primarily related to, producing new or renewal business. Other underwriting expenses include 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. Policy acquisition costs are variable based on premiums earned; however, other operating costs are more fixed in nature and become a smaller percentage of net premiums earned as premiums increase.
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.
Underwriting and other operating expenses decreased 20.4% for the three months ended March 31, 2011, compared to the same period of 2010. The decrease reflects efforts to manage our expenses. During the three months ended March 31, 2011, compensation expenses declined $5.4 million, compared to the same period of 2010, as our headcount decreased by over 225 (including the reductions associated with our July 2010 reorganization) since March 31, 2010. Additionally, we incurred one-time restructuring 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 at that time.
Our bad debt expense decreased $1.2 million for the three months ended March 31, 2011, compared to the same period of 2010, as we experienced improved collections of certain accounts receivable balances.
Commission Expense Ratio. The commission expense ratio is the ratio (expressed as a percentage) of commission expense to net premiums earned and measures the cost of compensating agents and brokers for the business we have underwritten.
Commission expense includes direct commissions to our agents and brokers for the premiums that they produce for us, as well as 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).
Commission expense increased 3.8% for the three months ended March 31, 2011, compared to the same period of 2010, primarily due to higher net premiums earned.

19
 

Dividends to Policyholders Ratio. The dividends to policyholders ratio is the ratio (expressed as a percentage) of dividends to policyholders expense to net premiums earned and measures the cost of returning premium to policyholders in the form of dividends.
In administered pricing states such as Florida and Wisconsin, insurance rates are set by state insurance regulators. Rate competition generally is not permitted and policyholder dividend programs are an important competitive factor in these states. We offer dividend programs to eligible policyholders, under which a portion of the policyholders' premium may be returned in the form of a dividend.
Florida statutes also require the return of the portion of policyholders' premiums that are deemed to be excessive profits under Florida law. We account for these payments as dividends to policyholders.
Dividends to policyholders were $1.0 million and $1.5 million for the three months ended March 31, 2011 and 2010, respectively. The decrease in dividends to policyholders from 2010 to 2011 was primarily due to lower premium levels on dividend policies in Florida and Wisconsin and fewer policies eligible for dividend payments in 2011.
Interest Expense
We incur interest expenses on notes payable. We also had an interest rate swap agreement on our credit facility with Wells Fargo Bank, National Association (Wells Fargo), which expired on September 30, 2010.
Interest expense was $0.9 million and $1.6 million for the three months ended March 31, 2011 and 2010, respectively. The decrease in interest expense was primarily due to the expiration of the interest rate swap in the third quarter of 2010.
Income Tax Benefit
Income tax benefit was $2.4 million and $0.5 million for the three months ended March 31, 2011 and 2010, respectively. The effective tax rates for the three months ended March 31, 2011 and 2010 were (39.9)% and (3.4)%, respectively. The increased tax benefit is primarily due to an increase in tax exempt income as a percentage of pretax net income to approximately 139% for the three months ended March 31, 2011, from approximately 53% for the same period of 2010. Additionally, there was a $3.9 million increase in non-taxable favorable reserve development related to periods prior to January 1, 2000 during the first quarter of 2010.
Liquidity and Capital Resources
Parent Company
Operating Cash and Cash Equivalents. We are a holding company and our ability to fund our operations is contingent upon our insurance subsidiaries and their ability to pay dividends up to the holding company. 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.
On May 27, 2010, we received approval from the Nevada Commissioner of Insurance to pay $150.0 million in extraordinary dividends from EICN special surplus. This $150.0 million extraordinary dividend was paid by EICN to Employers Group, Inc. (EGI) and subsequently from EGI to EHI on June 3, 2010. As a result of the payment of the extraordinary dividend from special surplus, any dividends paid by EICN through June 3, 2011 will require prior approval by the Nevada Commissioner of Insurance.
As of March 31, 2011, the holding company had $104.3 million of cash and cash equivalents and fixed maturity securities maturing within the next 24 months. Ten million dollars of our line of credit is due on December 31, 2011 and 2012. 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.
Share Repurchases. In November 2010, the EHI Board of Directors (Board of Directors) authorized a share repurchase program for up to $100 million of the Company's common stock from November 8, 2010 through June 30, 2012 (the 2011 Program). From inception of the 2011 Program through March 31, 2011, we repurchased a total of 1,364,685 shares of common stock at an average price of $16.84 per share, including commissions, for a total of $23.0 million. Repurchases under this program may be commenced or suspended from time-to-time without prior notice, and the program may be suspended or discontinued at any time.
Outstanding Debt. In December 2010, we entered into the Third Amended and Restated Credit Agreement with Wells Fargo (Amended Credit Facility) under which we were provided with: (a) $100.0 million line of credit through December 31, 2011; (b) $90.0 million line of credit from January 1, 2012 through December 31, 2012; (c) $80.0 million line of credit from January 1, 2013 through December 31, 2013; (d) $70.0 million line of credit from January 1, 2014 through December 31, 2014; and (e) $60.0 million line of credit from January 1, 2015 through December 31, 2015. Amounts outstanding bear interest at a rate equal to, at our option: (a) a fluctuating rate of 1.75% above prime rate or (b) a fixed rate that is 1.75% above the LIBOR rate then in effect. The Amended Credit Facility is secured by fixed maturity securities and restricted cash and cash equivalents that had a fair value of $126.2 million and $134.1 million at March 31, 2011 and 2010, respectively. The Amended Credit Facility contains customary non-financial covenants and requires us to maintain $5.0 million of cash and cash equivalents at all times at the holding company. We are currently in compliance with all applicable covenants.

20
 

Our capital structure is comprised of outstanding debt and stockholders’ equity. As of March 31, 2011, 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 $851.6 million of stockholders’ equity, including the deferred reinsurance gain—LPT Agreement. Outstanding debt was 13.4% of total capitalization, including the deferred reinsurance gain—LPT Agreement, as of March 31, 2011.
Operating Subsidiaries
Operating Cash and Cash Equivalents. The primary sources of cash for our insurance operating 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.
Our insurance subsidiaries had total cash and cash equivalents and fixed maturity securities of $299.8 million maturing within the next 24 months at March 31, 2011. 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, 2010, we entered into a new reinsurance program that is effective through June 30, 2011. We believe that our reinsurance program meets our needs and that we are sufficiently capitalized.
Various state regulations require us to keep securities or letters of credit on deposit with the states in which we do business. Securities having a fair market value of $562.0 million and $558.6 million were on deposit at March 31, 2011 and December 31, 2010, respectively. These laws and regulations govern both the amount and type of fixed maturity security that is eligible for deposit. Additionally, certain reinsurance contracts require Company funds to be held in trust for the benefit of the ceding reinsurer to secure the outstanding liabilities we assumed. The fair value of securities held in trust for reinsurance at March 31, 2011 and December 31, 2010 was $52.6 million and $52.9 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,
 
 
2011
 
2010
 
 
(in thousands)
Cash and cash equivalents (used in) provided by:
 
 
 
 
Operating activities
 
$
5,315
 
 
$
2,117
 
Investing activites
 
52,438
 
 
4,410
 
Financing activities
 
(10,347
)
 
(7,807
)
Net increase (decrease) in cash and cash equivalents
 
$
47,406
 
 
$
(1,280
)
Net cash provided by operating activities increased $3.2 million for the three months ended March 31, 2011, compared to the same period of 2010.
Significant items increasing net cash from operations included:
•
decreased underwriting and other operating expenses paid of $2.9 million;
•
decreased commissions paid of $2.1 million;
•
decreased income taxes paid of $1.6 million; and
•
decreased losses and LAE paid of $1.0 million; and
•
decreased interest paid of $0.7 million.
Significant items decreasing net cash from operations included:
•
decreased net premiums received of $3.9 million; and
•
increased investment income received of $ 1.0 million.
Net cash provided by investing activities was $52.4 million for the three months ended March 31, 2011, compared to $4.4 million for the same period of the prior year. The difference was primarily due to lower levels of reinvestment of funds from maturities and redemptions of investments for the first quarter of 2011, compared to the first quarter of 2010.
Net cash used in financing activities was $10.3 million for the three months ended March 31, 2011, compared to $7.8 million for the same period in 2010. The majority of cash used in financing activities was to repurchase our common stock and to pay dividends

21
 

to stockholders. The year-over-year increase in cash used in financing activities was primarily due to increased repurchases of common stock.
Investments
The amortized cost of our investment portfolio was $1.90 billion and the fair value was $2.03 billion as of March 31, 2011.
We employ an investment strategy that emphasizes asset quality and considers the durations of fixed maturity securities against anticipated claim payments and expenditures, other liabilities and capital needs. Our investment portfolio is structured so that investments mature periodically in reasonable relation to current expectations of future claim payments. Currently, we make claim payments from positive cash flow from operations and use excess cash to invest in operations, invest in marketable securities, return capital to our stockholders, and fund our growth strategy.
As of March 31, 2011, our investment portfolio, which is classified as available-for-sale, consisted of 95.8% fixed maturity securities whose fair values may fluctuate due to interest rate changes. We strive to limit interest rate risk by managing the duration of our fixed maturity securities. Our fixed maturity securities (excluding cash and cash equivalents) had a duration of 4.93 at March 31, 2011. To minimize interest rate risk, our portfolio is weighted toward short-term and intermediate-term bonds; however, our investment strategy balances consideration of duration, yield, and credit risk. Our investment guidelines require that the minimum weighted average quality of our fixed maturity securities portfolio shall be “AA”. As of March 31, 2011, our fixed maturity securities portfolio had an average quality of “AA” using ratings assigned by Standard & Poor’s with 73.1% of the market value rated “AA” or better.
We carry our portfolio of equity securities on our balance sheet at fair value. We minimize our exposure to equity price risk by investing primarily in the equity securities of mid-to-large capitalization issuers and by diversifying our equity holdings across several industry sectors. At March 31, 2011, equity securities represented 4.2% of our investment portfolio.
Given the economic uncertainty and continued market volatility, we believe that our asset allocation best meets our strategy to preserve capital for policyholders, to provide sufficient income to support insurance operations, and to effectively grow book value over a long-term investment horizon.
We seek to maximize total investment returns within the constraints of prudent portfolio management. The asset allocation is reevaluated by the Finance Committee of the Board of Directors on a quarterly basis. We employ Conning Asset Management (Conning) to act as our independent investment manager. Conning follows our written investment guidelines based upon strategies approved by the Board of Directors. In addition to the construction and management of the portfolio, we utilize the investment advisory services of Conning. These services include investment accounting and company modeling using Dynamic Financial Analysis (DFA). The DFA tool is utilized to develop portfolio targets and objectives, which in turn are used in constructing an optimal portfolio.
The following table shows the fair value, the percentage of the fair value to total invested assets and the tax equivalent yield based on the fair value of each category of invested assets as of March 31, 2011.
Category
 
Fair
Value
 
Percentage
of Total
 
Yield
 
 
(in thousands, except percentages)
U.S. Treasuries
 
$
143,026
 
 
7.1
%
 
3.6
%
U.S. Agencies
 
111,936
 
 
5.5
 
 
4.0
 
States and municipalities
 
946,854
 
 
46.7
 
 
5.9
 
Corporate securities
 
459,872
 
 
22.7
 
 
4.8
 
Residential mortgage-backed securities
 
242,996
 
 
12.0
 
 
5.4
 
Commercial mortgage-backed securities
 
22,723
 
 
1.1
 
 
5.3
 
Asset-backed securities
 
13,738
 
 
0.7
 
 
3.8
 
Equity securities
 
84,678
 
 
4.2
 
 
4.5
 
Total
 
$
2,025,823
 
 
100.0
%
 
 
 
Weighted average yield
 
 
 
 
 
 
 
5.3
 

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The following table shows the percentage of total fair value of our fixed maturity securities as of March 31, 2011 by credit rating category, as defined by Standard & Poor's.
Rating
 
Percentage of Total
Fair Value
“AAA”
 
37.4
%
“AA”
 
35.7
 
“A”
 
20.0
 
“BBB”
 
6.6
 
Below investment grade
 
0.3
 
Total
 
100.0
%
Investments that we currently own could be subject to default by the issuer or could suffer declines in fair value that become other-than-temporary. We regularly assess individual securities as part of our ongoing portfolio management, including the identification of other-than-temporary declines in fair value. Our other-than-temporary assessment includes reviewing the extent and duration of declines in fair value of investments below amortized cost, historical and projected financial performance and near-term prospects of the issuer, the outlook for industry sectors, credit rating, and macro-economic changes. We also make a determination as to whether it is not more likely than not that we will be required to sell the security before its fair value recovers above cost, or to maturity.
Based on our review of fixed maturity and equity securities we believe that we have appropriately identified the declines in the fair values of our unrealized losses at March 31, 2011 and 2010. We also determined that the unrealized losses on equity securities at March 31, 2011 and 2010 were not considered to be other-than-temporary due to the financial condition and the near term prospects of the issuers. We determined that the unrealized losses on fixed maturity securities were primarily the result of prevailing interest rates and not the credit quality of the issuers.
The cost or amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of our investments were as follows:
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
At March 31, 2011
 
(in thousands)
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
134,541
 
 
$
8,687
 
 
$
(202
)
 
$
143,026
 
U.S. Agencies
 
105,852
 
 
6,219
 
 
(135
)
 
111,936
 
States and municipalities
 
911,485
 
 
41,300
 
 
(5,931
)
 
946,854
 
Corporate
 
437,144
 
 
26,378
 
 
(3,650
)
 
459,872
 
Residential mortgaged-backed securities
 
227,716
 
 
16,025
 
 
(745
)
 
242,996
 
Commercial mortgaged-backed securities
 
21,658
 
 
1,068
 
 
(3
)
 
22,723
 
Asset-backed securities
 
13,100
 
 
648
 
 
(10
)
 
13,738
 
Total fixed maturity securities
 
1,851,496
 
 
100,325
 
 
(10,676
)
 
1,941,145
 
Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
Consumer goods
 
19,218
 
 
8,085
 
 
(106
)
 
27,197
 
Energy and utilities
 
4,977
 
 
6,382