UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
R ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2015
OR
o 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)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, $0.01 par value per share | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes R No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes o No R
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. R
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 | February 10, 2016 | |
Common Stock, $0.01 par value per share | 32,216,480 shares outstanding | |
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Definitive Proxy Statement relating to the 2016 Annual Meeting of Stockholders are incorporated by reference in Items 10, 11, 12, 13 and 14 of Part III of this report.
Page No. | ||
Forward-Looking Statements | ||
Item 1 | Business | |
Item 1A | Risk Factors | |
Item 1B | Unresolved Staff Comments | |
Item 2 | Properties | |
Item 3 | Legal Proceedings | |
Item 4 | Mine Safety Disclosures | |
Item 5 | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | |
Item 6 | Selected Financial Data | |
Item 7 | Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations | |
Item 7A | Quantitative and Qualitative Disclosures About Market Risk | |
Item 8 | Financial Statements and Supplementary Data | |
Item 9 | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | |
Item 9A | Controls and Procedures | |
Item 9B | Other Information | |
Item 10 | Directors, Executive Officers and Corporate Governance | |
Item 11 | Executive Compensation | |
Item 12 | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | |
Item 13 | Certain Relationships and Related Transactions and Director Independence | |
Item 14 | Principal Accountant Fees and Services | |
Item 15 | Exhibits and Financial Statement Schedules | |
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FORWARD-LOOKING STATEMENTS
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. Undue reliance should not be placed 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 experience, loss reserves, acquisitions, competition, the impact of changes in interest rates, 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 set forth in Item 1A, “Risk Factors” and the other documents that we have filed with the Securities and Exchange Commission.
NOTE REGARDING RELIANCE ON STATEMENTS IN OUR CONTRACTS
The agreements included or incorporated by reference as exhibits to this Annual Report on Form 10-K may contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties were made solely for the benefit of the other parties to the applicable agreement and:
• | were not intended to be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate; |
• | may have been qualified in such agreement by disclosures that were made to the other party in connection with the negotiation of the applicable agreement; |
• | may apply contract standards of “materiality” that are different from “materiality” under the applicable securities laws; and |
• | were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement. |
Notwithstanding the inclusion of the foregoing cautionary statements, we acknowledge that we are responsible for considering whether additional specific disclosures of material information regarding material contractual provisions are required to make the statements in this report not misleading.
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PART I
Item 1. Business
General
Employers Holdings, Inc. (EHI) is a holding company incorporated in Nevada in 2005. Unless otherwise indicated, all references to “we,” “us,” “our,” the “Company” or similar terms refer to EHI together with its subsidiaries. We had 716 full-time employees at December 31, 2015 and our principal executive offices are located at 10375 Professional Circle in Reno, Nevada.
Our insurance subsidiaries have each been assigned an A.M. Best Company (A.M. Best) rating of “A-” (Excellent), with a “negative” financial outlook.
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, amendments to those reports, and Proxy Statements for our Annual Meetings of Stockholders are available free of charge on our website at www.employers.com as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (SEC). Our website also provides access to reports filed by our Directors, executive officers and certain significant stockholders pursuant to Section 16 of the Securities Exchange Act of 1934. In addition, our Corporate Governance Guidelines, Code of Business Conduct and Ethics, Code of Ethics for Senior Financial Officers, and charters for the Audit, Board Governance and Nominating, and Compensation committees of our Board of Directors are available on our website. Copies of these documents may also be obtained free of charge by written request to Investor Relations, 10375 Professional Circle, Reno, Nevada 89521-4802. The SEC also maintains a website at www.sec.gov that contains the information that we file electronically with the SEC.
Strategy
Business Strategy
Our strategy is to pursue profitable growth opportunities across market cycles and maximize total investment returns within the constraints of prudent portfolio management. We pursue profitable growth opportunities by focusing on disciplined underwriting and claims management, utilizing medical provider networks designed to produce superior medical and indemnity outcomes, establishing and maintaining strong, long-term relationships with independent insurance agencies, and developing important alternative distribution channels. We continue to execute a number of strategic initiatives, including: focusing on internal and customer facing business process excellence; emphasizing the settlement of open claims; diversifying our risk exposure across our markets; utilizing a three-company pricing platform; utilizing territorial multipliers in California; non-renewing under-performing business; and targeting profitable classes of business across all of our markets.
Capital Strategy
We believe that we have a strong capital position. We periodically reassess our capital needs to ensure an optimal use of capital consistent with our goal to create shareholder value over the long-term. Our capital strategy is focused on supporting our business operations by maintaining capital levels commensurate with our desired ratings from independent rating agencies, satisfying regulatory constraints and legal requirements, and sustaining a level of financial flexibility to prudently manage our business through insurance and economic cycles while allowing us to take advantage of investment opportunities, including mergers and acquisitions and related financings, as and when they arise.
We expect to return capital not needed for these purposes to our common stockholders in the form of dividends and common stock repurchases. We believe that, generally over time, the combination of dividends to common stockholders and common stock repurchases will not exceed operating income. The timing and actual numbers of shares that may be repurchased in the future will depend on a variety of factors, including our financial position, earnings, share price, corporate and regulatory requirements, and other market and economic conditions. Additional information regarding our capital is set forth under “Part II, Item 7–Liquidity and Capital Resources.”
Description of Business
We are a specialty provider of workers' compensation insurance focused on select small businesses in low to medium hazard industries. We employ a disciplined, conservative underwriting approach designed to individually select specific types of businesses, predominantly those in the lowest four of the seven workers' compensation insurance industry defined hazard groups, that we believe will have fewer and less costly claims relative to other businesses in the same hazard groups. Workers' compensation is provided for 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 operate as a single reportable segment and conduct operations in 33 states and the District of Columbia, with a concentration in California, where over one-half of our business is generated. We had total assets of $3.8 billion at December 31, 2015 and 2014. The following table highlights key results of our operations for the last three years.
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Years Ended December 31, | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
(in millions, except ratios) | ||||||||||||
Net premiums written | $ | 689.3 | $ | 687.6 | $ | 678.5 | ||||||
Total revenues | 752.1 | 773.5 | 723.5 | |||||||||
Net income | 94.4 | 100.7 | 63.8 | |||||||||
Combined ratio(1) | 94.1 | % | 97.0 | % | 103.9 | % | ||||||
Impact of the Loss Portfolio Transfer Agreement (LPT Agreement)(2) | 3.0 | 8.0 | 5.9 | |||||||||
Combined ratio before the impact of the LPT Agreement(2) | 97.1 | % | 105.0 | % | 109.8 | % | ||||||
(1) | The combined ratio, a key measurement of underwriting profitability, is the sum of the loss and loss adjustment expenses (LAE), commission expenses, and underwriting and other operating expenses, measured as a percentage of earned premium. |
(2) | The impact of the LPT Agreement includes: (a) amortization of Deferred reinsurance gain–LPT Agreement (Deferred Gain); (b) adjustments to LPT Agreement ceded reserves; and (c) adjustments to Contingent commission receivable–LPT Agreement. Deferred Gain reflects the unamortized gain from our LPT Agreement. Under GAAP, this gain is deferred and is being amortized using the recovery method. Amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries over the life of the LPT Agreement, except for the contingent profit commission, which is amortized through June 30, 2024. The amortization is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT Agreement and the expected losses and LAE subject to the contingent profit commission under the LPT Agreement. Our reevaluation results in corresponding adjustments, if needed, to reserves, ceded reserves, contingent commission receivable, and the Deferred Gain, with the net effect being an increase or decrease, as the case may be, to net income. Combined ratio before impact of the LPT Agreement is not a measurement of financial performance under GAAP, but rather reflects the difference in accounting treatment between statutory accounting principles and GAAP, and should not be considered in isolation or as an alternative to the combined ratio or any other measure of performance derived in accordance with GAAP. |
Our insurance subsidiaries are domiciled in the following states:
State of Domicile | |
Employers Insurance Company of Nevada (EICN) | Nevada |
Employers Compensation Insurance Company (ECIC) | California |
Employers Preferred Insurance Company (EPIC) | Florida |
Employers Assurance Company (EAC) | Florida |
Products and Services
Workers' compensation provides insurance coverage for the statutorily prescribed benefits that employers are required to provide to their employees who may be injured or suffer illness in the course of employment. The level of benefits varies by state, the nature and severity of the injury or disease, and the wages of the injured worker. Each state has a statutory, regulatory, and adjudicatory system that sets the amount of wage replacement to be paid, determines the level of medical care required to be provided, establishes the degree of permanent impairment, and specifies the options in selecting healthcare providers. These state laws generally require two types of benefits for injured employees: (a) medical benefits, including expenses related to the diagnosis and treatment of an injury, disease, or both, as well as any required rehabilitation, and (b) indemnity payments, which consist of temporary wage replacement, permanent disability payments, and death benefits to surviving family members.
Disciplined Underwriting
Our strategy is to focus on disciplined underwriting and continue to pursue profitable growth opportunities across market cycles. We carefully monitor market trends to assess new business opportunities that we expect will meet our pricing and risk standards. We price our policies based on the specific risks associated with each potential insured rather than solely on the industry class in which a potential insured is classified. Our disciplined underwriting approach is a critical element of our culture and we believe that it has allowed us to offer competitive prices, diversify our risks, and out-perform the industry.
We execute our underwriting processes through automated systems and experienced underwriters with specific knowledge of local markets. We have developed automated underwriting templates for specific classes of business that produce faster quotes when certain underwriting criteria are met. Our underwriting guidelines consider many factors, such as type of business, nature of operations, and risk exposures, and are designed to minimize or prevent underwriting of certain classes of business.
Loss Control
Our loss control professionals provide consultation to policyholders to assist them in preventing losses and containing costs once claims occur. They also assist our underwriting personnel in evaluating potential and current policyholders and are an important part of our underwriting discipline.
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Premium Audit
We conduct premium audits on substantially all of our policyholders annually upon the policy expiration. Premium audits allow us to comply with applicable state and reporting bureau requirements and to verify that policyholders have accurately reported their payroll and employee job classifications. We also selectively perform interim audits on certain classes of business or if unusual claims are filed or concerns are raised regarding projected annual payrolls, which could result in substantial variances at final audit.
Claims and Medical Case Management
The role of our claims department is to actively and efficiently investigate, evaluate, and pay claims, and to aid injured workers in returning to work in accordance with applicable laws and regulations. We have implemented rigorous claims guidelines and control procedures in our claims units and have claims operations throughout the markets we serve. We also provide medical case management services for those claims that we determine will benefit from such involvement.
We utilize an outcome-based medical network that incorporates predictive analytics to identify medical providers who achieve superior clinical outcomes for our injured workers that allows us to optimize our provider network and enhance the quality of care. We have also implemented a proactive pharmacy benefit management program that, along with our outcome based medical network, focuses on reducing claims costs and accelerating injured workers' return to work.
In addition to our medical networks, we work closely with local vendors, including attorneys, medical professionals, pharmacy benefits managers, and investigators, to bring local expertise to our reported claims. We pay special attention to reducing costs and have established discounting arrangements with the aforementioned service providers. We use preferred provider organizations, bill review services, and utilization management to closely monitor medical costs. We actively pursue fraud and subrogation recoveries to mitigate claims costs. Subrogation rights are based upon state and federal laws, as well as the insurance policies we issue. Our fraud and subrogation efforts are handled through dedicated units.
Our claims department also provides claims management services for those claims incurred by the Nevada State Industrial Insurance System (the Fund) and assumed by EICN and subject to a 100% retroactive reinsurance agreement (the LPT Agreement) with dates of injury prior to July 1, 1995. Additional information regarding the LPT Agreement is set forth under “–Reinsurance–LPT Agreement.” We receive a management fee from the third party reinsurers equal to 7% of the loss payments on these claims.
Information Technology
Core Operating Systems
We have an efficient, cost-effective and scalable infrastructure that complements our geographic reach and business model and have developed a highly automated underwriting system. This technology applies our underwriting standards and guidelines and allows for the electronic submission, review, and quoting of insurance applications. This policy administration system reduces transaction costs and provides for more efficient and timely processing of applications for small policies that meet our underwriting standards. We believe this approach saves our independent agents and brokers considerable time in processing customer applications and maintains our competitiveness in our target markets. We will continue to invest in technology and systems across our business to maximize efficiency, facilitate customer self-service, and create increased capacity that will allow us to lower our expense ratios while growing premiums.
Business Continuity/Disaster Recovery
We maintain business continuity and disaster recovery plans for our critical business functions, including the restoration of information technology infrastructure and applications. We have two data centers that act as production facilities and as disaster recovery sites for each other. In addition, we utilize an off-site data storage facility for critical customer and systems data.
Customers and Workers' Compensation Premiums
The workers' compensation insurance industry classifies risks into seven hazard groups, as defined by the National Council on Compensation Insurance (NCCI), based on severity of claims, with businesses in the first or lowest group having the lowest claims costs.
We target select small businesses engaged in low to medium hazard industries. Our historical loss experience has been more favorable for lower industry defined hazard groups than for higher hazard groups. Further, we believe it is generally less costly to service and manage the risks associated with these lower hazard groups. Our underwriters use their local market expertise and disciplined underwriting to select specific types of businesses and risks within the classes of business we underwrite that allow us to generate loss ratios that are better than the industry average.
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The following table sets forth our in-force premiums by hazard group and as a percentage of our total in-force premiums as of December 31:
Hazard Group | 2015 | Percentage of 2015 Total | 2014 | Percentage of 2014 Total | 2013 | Percentage of 2013 Total | |||||||||||||||
(in millions, except percentages) | |||||||||||||||||||||
A | $ | 159.6 | 25.8 | % | $ | 165.6 | 26.4 | % | $ | 146.2 | 23.7 | % | |||||||||
B | 159.2 | 25.7 | 159.3 | 25.4 | 130.0 | 21.1 | |||||||||||||||
C | 203.5 | 32.8 | 207.5 | 33.0 | 239.5 | 38.8 | |||||||||||||||
D | 86.0 | 13.9 | 82.6 | 13.2 | 80.9 | 13.1 | |||||||||||||||
E | 9.7 | 1.6 | 11.0 | 1.7 | 18.6 | 3.0 | |||||||||||||||
F | 1.4 | 0.2 | 1.8 | 0.3 | 2.1 | 0.3 | |||||||||||||||
G | 0.1 | <0.1 | 0.1 | <0.1 | 0.1 | <0.1 | |||||||||||||||
Total | $ | 619.5 | 100.0 | % | $ | 627.9 | 100.0 | % | $ | 617.4 | 100.0 | % | |||||||||
In-force premiums for our top ten types of insureds and as a percentage of our total in-force premiums as of December 31, 2015 were as follows:
Employer Classifications | In-force Premiums | Percentage of Total | |||||
(in millions, except percentages) | |||||||
Restaurants | $ | 157.9 | 25.5 | % | |||
Automobile Service or Repair Shops | 50.5 | 8.2 | |||||
Hotels, Motels, and Clubs | 47.2 | 7.6 | |||||
Dentists, Optometrists, and Physicians | 34.1 | 5.5 | |||||
Gasoline Stations | 23.9 | 3.9 | |||||
Real Estate Management | 21.4 | 3.5 | |||||
Wholesale Stores | 20.6 | 3.3 | |||||
Schools – Colleges and Religious Organizations | 16.3 | 2.6 | |||||
Apparel Manufacturing | 16.2 | 2.6 | |||||
Groceries and Provisions | 15.3 | 2.5 | |||||
Total | $ | 403.4 | 65.2 | % | |||
We currently write business in 33 states and the District of Columbia. Our business is concentrated in California, which makes the results of our operations more dependent on the trends that are unique to that state and that may differ from national trends. State legislation, local competition, economic and employment trends, and workers' compensation medical costs trends can be material to our financial results.
As of December 31, 2015, our policyholders had average annual in-force premiums of $7,332. We are not dependent on any single policyholder and the loss of any single policyholder would not have a material adverse effect on our business.
Our in-force premiums and number of policies in-force were as follows as of December 31:
2015 | 2014 | 2013 | |||||||||||||||||||
State | In-force Premiums | Policies In-force | In-force Premiums | Policies In-force | In-force Premiums | Policies In-force | |||||||||||||||
(dollars in millions) | |||||||||||||||||||||
California | $ | 352.2 | 44,080 | $ | 370.8 | 47,093 | $ | 367.8 | 48,032 | ||||||||||||
Other | 267.3 | 40,416 | 257.1 | 38,209 | 249.6 | 36,024 | |||||||||||||||
Total | $ | 619.5 | 84,496 | $ | 627.9 | 85,302 | $ | 617.4 | 84,056 | ||||||||||||
From 2013 through 2015, our total in-force premiums and number of policies in-force have remained relatively flat, while in-force premiums and policy count in California decreased 4.2% and 8.2%, respectively, reflecting our efforts to continue to diversify and grow our business in profitable markets. We cannot be certain how these trends will ultimately impact our consolidated financial position and results of operations.
Our premiums are generally a function of the applicable premium rate, the amount of the insured's payroll, and if applicable, a factor reflecting the insured's historical loss experience (experience modification factor). Premium rates vary by state according to the nature of the employees' duties and the business of the employer. The premium is computed by applying the applicable premium rate to each class of the insured's payroll after it has been appropriately classified. Total policy premium is determined
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after applying an experience modification factor and a further adjustment, known as a schedule rating adjustment, and other adjustments, which may be made in certain circumstances, to increase or decrease the policy premium. Schedule rating adjustments are made based on individual risk characteristics of the insured and subject to maximum amounts as established in our premium rate filings.
Our premium rates are based upon actuarial analyses for each state in which we do business, except in “administered pricing” states, primarily Florida and Wisconsin, where premium rates are set by state insurance regulators.
Our net rate (total in-force premiums divided by total insured payroll exposure) increased 0.7%, 11.2%, and 12.9% in California during the years ended December 31, 2015, 2014, and 2013, 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. Pricing in California reflects changes to schedule rating, filed rates, and experience modifiers. We began leveraging territorial multipliers and multiple insurance subsidiaries, each with different rate filings, to provide additional pricing options in California for policies incepting on or after June 1, 2014.
Losses and LAE Reserves and Loss Development
We are directly liable for losses and LAE under the terms of the insurance policies our insurance subsidiaries write. Significant periods of time can elapse between the occurrence of an insured loss, the reporting of the loss to us, and our payment of that loss. Loss reserves are reflected on our consolidated balance sheets under the line item caption “Unpaid losses and loss adjustment expenses.” Estimating reserves is a complex process that involves a considerable degree of judgment by management and is inherently uncertain. Loss reserve estimates represent a significant risk to our business, which we attempt to mitigate by frequently and routinely reviewing loss cost trends.
For a detailed description of our reserves, the judgments, key assumptions and actuarial methodologies that we use to estimate our reserves, and the role of our consulting actuary, see “Item 7 –Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations –Critical Accounting Policies –Reserves for Losses and LAE” and Note 9 in the Notes to our Consolidated Financial Statements.
The following tables show changes in the historical loss reserves, on a gross basis and net of reinsurance, at December 31 for each of the 10 years prior to 2015 for EICN and ECIC, and for each of the years ended December 31, 2008 through December 31, 2014 for EPIC and EAC. This information is presented on a GAAP basis and the paid and reserve data is presented on a calendar year basis.
The top line of each table shows the net and gross reserves for unpaid losses and LAE recorded at each year-end. Such amounts represent an estimate of unpaid losses and LAE occurring in that year as well as future payments on claims occurring in prior years. The upper portion of these tables (net and gross cumulative amounts paid, respectively) presents the cumulative amounts paid during subsequent years on those losses for which reserves were carried as of each specific year. The lower portions (net and gross reserves re-estimated, respectively) show the re-estimated amounts of the previously recorded reserves based on experience as of the end of each succeeding year. The re-estimated amounts change as more information becomes known about the actual losses for which the initial reserve was carried. An adjustment to the carrying value of unpaid losses for a prior year will also be reflected in the adjustments for each subsequent year. The net and gross cumulative redundancy (deficiency) line represents the cumulative change in estimates since the initial reserve was established. It is equal to the difference between the initial reserve and the latest re-estimated reserve amount. A redundancy means that the original estimate was higher than the current estimate. A deficiency means that the current estimate is higher than the original estimate.
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2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012(1) | 2013(1) | 2014 | 2015 | |||||||||||||||||||||||
Net reserves for losses and LAE | (in millions) | ||||||||||||||||||||||||||||||||
Originally estimated | $ | 1,208.5 | $ | 1,209.7 | $ | 1,217.1 | $ | 1,430.1 | $ | 1,373.2 | $ | 1,323.7 | $ | 1,331.5 | $ | 1,426.2 | $ | 1,587.4 | $ | 1,700.2 | $ | 1,719.3 | |||||||||||
Net cumulative amounts paid as of: | |||||||||||||||||||||||||||||||||
One year later | 106.9 | 109.1 | 127.9 | 214.5 | 206.7 | 218.6 | 225.5 | 261.7 | 319.7 | 355.2 | |||||||||||||||||||||||
Two years later | 175.5 | 186.0 | 219.5 | 342.2 | 361.0 | 371.1 | 390.5 | 456.5 | 558.7 | ||||||||||||||||||||||||
Three years later | 229.9 | 249.1 | 295.6 | 449.9 | 472.8 | 485.6 | 515.1 | 610.8 | |||||||||||||||||||||||||
Four years later | 279.4 | 302.9 | 354.9 | 532.1 | 557.8 | 577.0 | 619.4 | ||||||||||||||||||||||||||
Five years later | 321.1 | 345.8 | 405.6 | 598.5 | 628.9 | 656.4 | |||||||||||||||||||||||||||
Six years later | 354.8 | 384.5 | 448.1 | 656.1 | 692.1 | ||||||||||||||||||||||||||||
Seven years later | 384.9 | 417.6 | 484.7 | 708.4 | |||||||||||||||||||||||||||||
Eight years later | 412.2 | 447.6 | 521.3 | ||||||||||||||||||||||||||||||
Nine years later | 437.3 | 475.9 | |||||||||||||||||||||||||||||||
Ten years later | 459.8 | ||||||||||||||||||||||||||||||||
Net reserves re-estimated as of: | |||||||||||||||||||||||||||||||||
One year later | 1,101.4 | 1,149.6 | 1,151.2 | 1,378.8 | 1,359.0 | 1,324.8 | 1,333.3 | 1,433.2 | 1,592.0 | 1,693.1 | |||||||||||||||||||||||
Two years later | 1,049.6 | 1,085.4 | 1,100.7 | 1,352.0 | 1,340.4 | 1,313.1 | 1,334.0 | 1,429.8 | 1,603.8 | ||||||||||||||||||||||||
Three years later | 1,004.6 | 1,035.0 | 1,079.9 | 1,320.0 | 1,324.8 | 1,312.3 | 1,329.6 | 1,428.7 | |||||||||||||||||||||||||
Four years later | 970.7 | 1,010.4 | 1,046.6 | 1,303.0 | 1,305.2 | 1,302.5 | 1,305.2 | ||||||||||||||||||||||||||
Five years later | 949.4 | 973.9 | 1,038.7 | 1,277.7 | 1,291.3 | 1,258.7 | |||||||||||||||||||||||||||
Six years later | 917.8 | 962.8 | 1,004.4 | 1,263.7 | 1,235.2 | ||||||||||||||||||||||||||||
Seven years later | 907.6 | 921.9 | 987.2 | 1,199.6 | |||||||||||||||||||||||||||||
Eight years later | 869.8 | 904.1 | 927.3 | ||||||||||||||||||||||||||||||
Nine years later | 849.8 | 837.1 | |||||||||||||||||||||||||||||||
Ten years later | 786.0 | ||||||||||||||||||||||||||||||||
Net cumulative redundancy (deficiency): | 422.5 | 372.6 | 289.8 | 230.5 | 138.0 | 65.0 | 26.3 | (2.5 | ) | (16.4 | ) | 7.1 | — | ||||||||||||||||||||
Gross reserves - December 31 | 2,350.0 | 2,307.8 | 2,269.7 | 2,506.5 | 2,425.7 | 2,279.7 | 2,272.4 | 2,231.5 | 2,330.5 | 2,369.7 | 2,347.5 | ||||||||||||||||||||||
Reinsurance recoverable, gross | 1,141.5 | 1,098.1 | 1,052.6 | 1,076.4 | 1,052.5 | 956.0 | 940.8 | 805.4 | 743.1 | 669.5 | 628.2 | ||||||||||||||||||||||
Net reserves - December 31 | 1,208.5 | 1,209.7 | 1,217.1 | 1,430.1 | 1,373.2 | 1,323.7 | 1,331.5 | 1,426.2 | 1,587.4 | 1,700.2 | 1,719.3 | ||||||||||||||||||||||
Gross re-estimated reserves | 1,716.5 | 1,726.2 | 1,782.0 | 2,073.3 | 2,067.9 | 2,030.9 | 2,038.5 | 2,128.5 | 2,279.8 | 2,342.5 | 2,347.5 | ||||||||||||||||||||||
Re-estimated reinsurance recoverables | 930.6 | 889.1 | 854.7 | 873.7 | 832.7 | 772.3 | 733.4 | 699.9 | 676.1 | 649.5 | 628.2 | ||||||||||||||||||||||
Net re-estimated reserves | 785.9 | 837.1 | 927.3 | 1,199.6 | 1,235.2 | 1,258.6 | 1,305.1 | 1,428.6 | 1,603.7 | 1,693.0 | 1,719.3 | ||||||||||||||||||||||
Gross reserves for losses and LAE | |||||||||||||||||||||||||||||||||
Originally estimated | 2,350.0 | 2,307.8 | 2,269.7 | 2,506.5 | 2,425.7 | 2,279.7 | 2,272.4 | 2,231.5 | 2,330.5 | 2,369.7 | 2,347.5 | ||||||||||||||||||||||
Gross cumulative amounts paid as of: | |||||||||||||||||||||||||||||||||
One year later | 152.0 | 152.9 | 170.6 | 258.4 | 269.8 | 260.8 | 263.6 | 296.9 | 355.4 | 386.3 | |||||||||||||||||||||||
Two years later | 264.4 | 272.5 | 304.1 | 449.2 | 466.4 | 451.4 | 463.7 | 527.3 | 625.5 | ||||||||||||||||||||||||
Three years later | 361.5 | 377.5 | 422.9 | 599.2 | 616.2 | 601.0 | 624.0 | 712.7 | |||||||||||||||||||||||||
Four years later | 453.0 | 473.8 | 522.3 | 719.4 | 736.3 | 728.1 | 759.4 | ||||||||||||||||||||||||||
Five years later | 537.2 | 557.0 | 609.8 | 821.0 | 843.2 | 838.6 | |||||||||||||||||||||||||||
Six years later | 611.1 | 632.5 | 686.1 | 914.3 | 937.4 | ||||||||||||||||||||||||||||
Seven years later | 677.5 | 699.3 | 754.2 | 997.6 | |||||||||||||||||||||||||||||
Eight years later | 738.7 | 760.9 | 819.8 | ||||||||||||||||||||||||||||||
Nine years later | 795.4 | 817.5 | |||||||||||||||||||||||||||||||
Ten years later | 846.1 | ||||||||||||||||||||||||||||||||
Gross reserves re-estimated as of: | |||||||||||||||||||||||||||||||||
One year later | 2,233.1 | 2,233.2 | 2,200.7 | 2,470.7 | 2,373.5 | 2,299.7 | 2,164.6 | 2,196.1 | 2,282.7 | 2,342.5 | |||||||||||||||||||||||
Two years later | 2,170.3 | 2,162.7 | 2,148.4 | 2,405.8 | 2,370.6 | 2,178.1 | 2,123.4 | 2,139.2 | 2,279.8 | ||||||||||||||||||||||||
Three years later | 2,119.8 | 2,110.6 | 2,110.2 | 2,386.4 | 2,245.5 | 2,136.2 | 2,067.7 | 2,128.5 | |||||||||||||||||||||||||
Four years later | 2,084.9 | 2,074.5 | 2,094.1 | 2,260.0 | 2,185.5 | 2,076.4 | 2,038.5 | ||||||||||||||||||||||||||
Five years later | 2,053.9 | 2,050.2 | 1,983.2 | 2,194.8 | 2,122.7 | 2,030.9 | |||||||||||||||||||||||||||
Six years later | 2,027.7 | 1,936.4 | 1,906.2 | 2,132.8 | 2,067.9 | ||||||||||||||||||||||||||||
Seven years later | 1,918.3 | 1,857.2 | 1,840.9 | 2,073.3 | |||||||||||||||||||||||||||||
Eight years later | 1,846.3 | 1,791.6 | 1,782.0 | ||||||||||||||||||||||||||||||
Nine years later | 1,778.9 | 1,726.2 | |||||||||||||||||||||||||||||||
Ten years later | 1,716.5 | ||||||||||||||||||||||||||||||||
Gross cumulative redundancy: | $ | 633.5 | $ | 581.6 | $ | 487.7 | $ | 433.2 | $ | 357.8 | $ | 248.8 | $ | 233.9 | $ | 103.0 | $ | 50.7 | $ | 27.2 | $ | — | |||||||||||
(1) | The net cumulative deficiency for the 2013 and 2012 accident years included $(3.2) million and $(2.9) million, respectively, related to assigned risk business. |
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Reinsurance
Reinsurance is a transaction between insurance companies in which an original insurer, or ceding company, remits a portion of its premiums to a reinsurer, or assuming company, as payment for the reinsurer assuming a portion of the risk. Excess of loss reinsurance may be written in layers, in which a reinsurer or group of reinsurers accepts a band of coverage in excess of a specified amount, or retention, and up to a specified amount. Any liability exceeding the coverage limits of the reinsurance program is retained by the ceding company. The ceding company also bears the credit risk of a reinsurer's insolvency. Consistent with general industry practices, we purchase excess of loss reinsurance to protect against the impact of large individual, irregularly-occurring losses, and aggregate catastrophic losses from natural perils and terrorism, excluding nuclear, biological, chemical, and radiological events. Such reinsurance reduces the magnitude of such losses on our net income and the capital of our insurance subsidiaries.
Excess of Loss Reinsurance
Our current reinsurance program applies to all covered losses occurring between 12:01 a.m. July 1, 2015 and 12:01 a.m. July 1, 2016. The reinsurance program consists of one treaty covering excess of loss and catastrophic loss events in five layers of coverage. Our reinsurance coverage is $193.0 million in excess of our $7.0 million retention on a per occurrence basis, subject to certain exclusions. We are solely responsible for any losses we suffer above $200.0 million except those covered by the Terrorism Risk Insurance Program Reauthorization Act of 2015 (TRIPRA of 2015). See "—Terrorism Risk Insurance Program." Covered losses which occur prior to expiration or cancellation of the agreement continue to be obligations of the subscribing reinsurers, subject to the other conditions in the agreement. The subscribing reinsurers may terminate the agreement only for our breach of the obligations of the agreement. We are responsible for the losses if the subscribing reinsurer cannot or refuses to pay.
The agreement includes certain exclusions for which our subscribing reinsurers are not liable for losses, including but not limited to losses arising from the following: reinsurance assumed by us under pooling arrangements; financial guarantee and insolvency; certain nuclear risks; liability as a member, subscriber, or reinsurer of any pool, syndicate, or association, but not assigned risk plans; liability arising from participation or membership in any insolvency fund; loss or damage caused by war other than acts of terrorism or civil commotion; workers' compensation business covering persons employed in Minnesota; and any loss or damage caused by any act of terrorism involving biological, chemical, nuclear, or radioactive pollution or contamination. Our underwriting guidelines generally require that insured risks fall within the coverage provided in the reinsurance program. Executive review and approval would be required if we were to write risks outside the reinsurance program.
The agreement provides that we, or any subscribing reinsurer, may request commutation of any outstanding claim or claims 10 years after the effective date of termination or expiration of the agreements and provides a mechanism for the parties to achieve valuation for commutation. We may require a special commutation of the percentage share of any loss in the reinsurance program of any subscribing reinsurer that is in runoff.
LPT Agreement
In 1999, the Fund entered into a retroactive 100% quota share reinsurance agreement through a loss portfolio transfer transaction with third party reinsurers. The LPT Agreement commenced on June 30, 1999 and will remain in effect until all claims under the covered policies have closed, the agreement is commuted, or terminated, upon the mutual agreement of the parties, or the reinsurers' aggregate maximum limit of liability is exhausted, whichever occurs earlier. The LPT Agreement does not provide for any additional termination terms. On January 1, 2000, EICN assumed all of the assets, liabilities and operations of the Fund, including the Fund's rights and obligations associated with the LPT Agreement.
Under the LPT Agreement, the Fund initially ceded $1.5 billion in liabilities for the incurred but unpaid losses and LAE related to claims incurred prior to July 1, 1995, for consideration of $775.0 million in cash. The LPT Agreement, which ceded to the reinsurers substantially all of the Fund's outstanding losses as of June 30, 1999 for claims with original dates of injury prior to July 1, 1995, provides coverage for losses up to $2.0 billion, excluding losses for burial and transportation expenses. The estimated remaining liabilities subject to the LPT Agreement were approximately $498.0 million and $534.8 million, as of December 31, 2015 and 2014, respectively (See Note 10 in the Notes to our Consolidated Financial Statements). Losses and LAE paid with respect to the LPT Agreement totaled approximately $695.2 million and $668.4 million through December 31, 2015 and 2014, respectively.
The reinsurers agreed to assume responsibilities for the claims at the benefit levels which existed in June 1999. The LPT Agreement required each reinsurer to place assets supporting the payment of claims by them in a trust that requires collateral be held at a specified level. The level must not be less than the outstanding reserve for losses and a loss expense allowance equal to 7% of estimated paid losses discounted at a rate of 6%. If the assets held in trust fall below this threshold, we may require the reinsurers to contribute additional assets to maintain the required minimum level of collateral. The value of these assets as of December 31, 2015 and 2014 was $1.4 billion and $1.5 billion, respectively.
The reinsurers currently party to the LPT Agreement are ACE Bermuda Insurance Limited, XL Re Limited, and National Indemnity Company. The contract provides that during the term of the agreement all reinsurers need to maintain a rating of not less than
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“A-” (Excellent) as determined by A.M. Best. Currently, each of the reinsurers party to the LPT Agreement has a rating that satisfies this requirement.
We account for the LPT Agreement as retroactive reinsurance. Upon entry into the LPT Agreement, an initial deferred reinsurance gain was recorded as a liability on our consolidated balance sheet as Deferred Gain. We are also entitled to receive a contingent profit commission under the LPT Agreement. The contingent profit commission is estimated based on both actual paid results to date and projections of expected paid losses under the LPT Agreement. As of December 31, 2015, our estimate of ultimate expected contingent profit commission was $65.6 million, of which $36.4 million has been settled as of December 31, 2015.
Recoverability of Reinsurance
Reinsurance makes the assuming reinsurer liable to the ceding company to the extent of the reinsurance; however, it does not discharge the ceding company from its primary liability to its policyholders in the event the reinsurer cannot or refuses to pay its obligations under such reinsurance. We monitor the financial strength of our reinsurers and do not believe that we are currently exposed to any material credit risk through our reinsurance arrangements because our reinsurance is recoverable from large, well-capitalized reinsurance companies. At December 31, 2015, $1.4 billion was in trust accounts for reinsurance related to the LPT Agreement and an additional $3.7 million, not related to the LPT Agreement, was collateralized by cash or letters of credit.
The following table provides certain information regarding our ceded reinsurance recoverables for losses and LAE as of December 31, 2015.
Reinsurer | A.M. Best Rating(1) | Total Losses and LAE Paid | Total Unpaid Losses and LAE | Total | ||||||||||
(in millions) | ||||||||||||||
ACE Bermuda Insurance Limited | A++ | $ | 0.7 | $ | 49.8 | $ | 50.5 | |||||||
American Healthcare Indemnity Company | B++ | — | 2.5 | 2.5 | ||||||||||
Aspen Insurance UK Limited | A | — | 6.5 | 6.5 | ||||||||||
Everest Reinsurance Company | A+ | — | 1.8 | 1.8 | ||||||||||
Finial Reinsurance | A- | 0.2 | 5.3 | 5.5 | ||||||||||
Hannover Ruck SE | A+ | 0.1 | 17.3 | 17.4 | ||||||||||
Lloyd's Syndicates | A | 0.1 | 48.7 | 48.8 | ||||||||||
Markel Bermuda Limited | A | — | 2.4 | 2.4 | ||||||||||
Munich Reinsurance America, Inc | A+ | 0.1 | 6.8 | 6.9 | ||||||||||
National Indemnity Company | A++ | 3.7 | 273.9 | 277.6 | ||||||||||
National Union Fire Insurance Co of Pittsburgh | A | — | 1.5 | 1.5 | ||||||||||
Partner Reinsurance Europe SE | A | — | 1.4 | 1.4 | ||||||||||
ReliaStar Life Insurance Company | A | 0.1 | 1.7 | 1.8 | ||||||||||
Safety National Casualty Corporation | A+ | — | 2.4 | 2.4 | ||||||||||
St Paul Fire & Marine Insurance Company | A++ | — | 4.3 | 4.3 | ||||||||||
Swiss Reinsurance America Corporation | A+ | 0.1 | 13.1 | 13.2 | ||||||||||
Tokio Marine America Insurance Company (TMAIC) (US) | A++ | — | 8.1 | 8.1 | ||||||||||
XL Re Limited | A | 2.3 | 174.3 | 176.6 | ||||||||||
All Other | Various | 0.3 | 6.4 | 6.7 | ||||||||||
Total | $ | 7.7 | $ | 628.2 | $ | 635.9 | ||||||||
(1) | A.M. Best's highest financial strength ratings for insurance companies are “A++” and “ A+” (Superior), “A” and “A-” (Excellent), |
and "B++" and "B+" (Good).
We review the aging of our reinsurance recoverables on a quarterly basis. At December 31, 2015, 0.1% of our reinsurance recoverables on paid losses were greater than 90 days overdue.
Terrorism Risk Insurance Program
The Terrorism Risk Insurance Act of 2002 (2002 Act) was initially enacted in November 2002, modified and extended in 2005, again in 2007, and most recently in 2015. Now known as the Terrorism Risk Insurance Program Reauthorization Act of 2015 (TRIPRA of 2015), the program is designed to allow the insurance industry and the federal government to share losses from declared terrorist events according to a specific formula, and is in effect until December 31, 2020.
The workers' compensation laws of the various states generally do not permit the exclusion of coverage for losses arising from terrorism or nuclear, biological, chemical, or radiological attacks. In addition, we are not able to limit our losses arising from any one catastrophe or from any one claimant. Our reinsurance policies exclude coverage for losses arising out of nuclear, biological,
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chemical, or radiological attacks. Under TRIPRA of 2015, federal protection may be provided to the insurance industry for certain acts of foreign and domestic terrorism, including nuclear, biological, chemical, or radiological attacks.
The impacts of any future terrorist acts are unpredictable, and the ultimate impact on our insurance subsidiaries, if any, of losses from any future terrorist acts will depend upon their nature, extent, location, and timing. We monitor the geographic concentration of our policyholders to help mitigate the risk of loss from terrorist acts.
Investments
As of December 31, 2015, the total amortized cost of our investment portfolio was $2.4 billion and the fair value of the portfolio was $2.5 billion. These investments provide a source of income, which may fluctuate with changes in interest rates and our current investment strategies that may also impact the fair value of our portfolio. Our investment strategy balances consideration of duration, yield, and credit risk.
We seek to maximize total investment returns within the constraints of prudent portfolio management. The asset allocation is reevaluated by management and reviewed by the Finance Committee of the Board of Directors on a quarterly basis. We employ Conning Inc. (Conning) as our independent investment manager. Conning follows our written investment guidelines based upon strategies approved by our Board of Directors. We also utilize Conning's investment advisory services. These services include investment accounting and portfolio modeling using Dynamic Financial Analysis (DFA). The DFA tool is utilized in developing a tailored set of portfolio targets and objectives, which in turn, are considered when constructing an optimal portfolio.
Additional information regarding our investment portfolio, including our approach to managing investment risk, is set forth under “Item 7 –Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations –Liquidity and Capital Resources –Investments” and “Item 7A –Quantitative and Qualitative Disclosures about Market Risk.”
Marketing and Distribution
We market our workers' compensation insurance products through independent local, regional, and national agents and brokers and through alternative distribution channels, including our partner ADP, Inc. (ADP) and national, regional, and local trade groups and associations.
Independent Insurance Agents and Brokers
We establish and maintain strong, long-term relationships with independent insurance agencies that actively market our products and services. We offer ease of doing business, provide responsive service, and pay competitive commissions. Our sales representatives and underwriters work closely with independent agencies to market and underwrite our business. This results in enhanced understanding of the businesses and risks we underwrite and the needs of prospective customers. We do not delegate underwriting authority to agents or brokers. We are not dependent on any one agency and the loss of any one agency would not be material.
We had 5,123 independent agencies that marketed and sold our insurance products at December 31, 2015. Independent agencies generated 75.8%, 76.2%, and 76.7% of in-force premiums at December 31, 2015, 2014, and 2013, respectively, and our largest agency generated 1.0% of in-force premiums at each of December 31, 2015, 2014, and 2013.
Alternative Distribution Channels
We have developed and continue to add to important distribution channels for our products and services that serve as an alternative to our strong independent agency distribution channel. These alternative distribution channels utilize partnerships and alliances with entities such as payroll companies and health care and property and casualty insurers for which we provide workers’ compensation insurance coverage. Our small business, low to medium hazard workers’ compensation insurance products are jointly offered and marketed with and through our partners and alliances.
Alternative distribution channels generated 23.9%, 23.6%, and 23.0% of our in-force premiums as of December 31, 2015, 2014, and 2013, respectively.
In 2015, a concentration of our business was generated by ADP. ADP is the largest payroll services provider in the United States servicing small and medium-sized businesses. As part of its services, ADP sells our workers' compensation insurance product along with its payroll and accounting services through its insurance agency and field sales staff primarily to small businesses. ADP generated 11.5%, 11.3%, and 10.7% of our in-force premiums as of December 31, 2015, 2014, and 2013, respectively. The majority of this business is written through ADP's small business unit, which has accounts of 1 to 50 employees. We pay ADP fees that are a percentage of premiums received for services provided through the ADP program.
Our relationship with ADP is non-exclusive; however, we believe we are a key partner of ADP for our selected markets and classes of business. Our agreement with ADP may be terminated at any time by either party without cause upon 120 days notice.
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Competition and Market Conditions
The insurance industry is highly competitive, and there is significant competition in the national workers' compensation industry that is based on price and quality of services. We compete with other specialty workers' compensation carriers, state agencies, multi-line insurance companies, professional employer organizations, self-insurance funds, and state insurance pools. Many of our competitors are significantly larger, are more widely known, and/or possess considerably greater financial resources. Our primary competitors in California are AmTrust Financial Services, Inc., Berkshire Hathaway Homestate Companies, California State Compensation Insurance Fund, The Hartford Financial Services Group, Inc., ICW Group, and Travelers Insurance Group Holdings, Inc.
The workers' compensation sector continued to see average medical and indemnity claims costs increase, while the industry overall saw a decline in claim frequency in 2014, the most recent year for which industry data is available. We continue to have concerns related to the volatility and uncertainty in the financial markets and economic conditions generally.
In California, the Workers' Compensation Insurance Rating Bureau (WCIRB) reported indemnity claim frequency for accident years 2013 and 2014 continued to increase, contrary to the trends observed in other states. The WCIRB attributed the elevated claim frequency in 2013 and 2014 to late reported claims, cumulative trauma injuries, and claims from the Los Angeles Basin.
Regulation
State Insurance Regulation
Insurance companies are subject to regulation and supervision by the insurance regulator in the state in which they are domiciled and, to a lesser extent, other states in which they conduct business. Our insurance subsidiaries are subject to regulation by the states in which our insurance subsidiaries are domiciled or transact business. These state agencies have broad regulatory, supervisory, and administrative powers, including among other things, the power to grant and revoke licenses to transact business, license agencies, set the standards of solvency to be met and maintained, determine the nature of, and limitations on, investments and dividends, approve policy forms and rates in some states, periodically examine financial statements, determine the form and content of required financial statements, set the rates that we may charge in some states, and periodically examine market conduct.
Detailed annual and quarterly financial statements, prepared in accordance with statutory accounting principles (SAP), and other reports are required to be filed with the insurance regulator in each of the states in which we are licensed to transact business. The California Department of Insurance (California DOI), Florida Office of Insurance Regulation (Florida OIR), and Nevada Division of Insurance (Nevada DOI) periodically examine the statutory financial statements of their respective domiciliary insurance companies. In 2015, the California DOI and Nevada DOI completed financial examinations for ECIC and EICN, respectively. There were no material findings. The Florida OIR is in the process of completing its regularly scheduled exams of EPIC and EAC.
Many states have laws and regulations that limit an insurer's ability to withdraw from a particular market. For example, states may limit an insurer's ability to cancel or not renew policies. Furthermore, certain states prohibit an insurer from withdrawing one or more lines of business from the state, except pursuant to a plan that is approved by the state insurance regulator. The state insurance regulator may disapprove a plan that may lead to market disruption. We are subject to laws and regulations of this type, and these laws and regulations may restrict our ability to exit unprofitable markets.
Holding Company Regulation. Nearly all states have enacted legislation that regulates insurance holding company systems. Each insurance company in a holding company system is required to register with the insurance regulator of its state of domicile and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. All transactions within a holding company system affecting an insurer must have fair and reasonable terms, the charges or fees for services performed must be reasonable, the insurer's total statutory surplus following any transaction must be both reasonable in relation to its outstanding liabilities and adequate for its needs, and are subject to other standards and requirements established by law and regulation. Notice to state insurance regulators is required prior to the consummation of certain affiliated and other transactions involving our insurance subsidiaries and such transactions may be disapproved by the state insurance regulators.
Pursuant to applicable insurance holding company laws, EICN is required to register with the Nevada DOI, ECIC is required to register with the California DOI, and EPIC and EAC are required to register with the Florida OIR. Under these laws, the respective state insurance departments may examine us at any time, require disclosure of material transactions and require prior notice for, or approval of, certain transactions.
Change of Control. Our insurance subsidiaries are domiciled in Florida, California and Nevada. The insurance laws of these states generally require that any person seeking to acquire control of a domestic insurance company obtain the prior approval of the state's insurance commissioner. In Florida, "control" is generally presumed to exist through the direct or indirect ownership of 5% or more of the voting securities of a domestic insurance company or of any entity that controls a domestic insurance company. In California and Nevada, "control" is presumed to exist through the direct or indirect ownership of 10% or more of the voting
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securities of a domestic insurance company or of any entity that controls a domestic insurance company. In addition, insurance laws in many states in which we are licensed require pre-notification to the state's insurance commissioner of a change in control of a non-domestic insurance company licensed in those states.
Statutory Accounting and Solvency Regulations. State insurance regulators closely monitor the financial condition of insurance companies reflected in financial statements based on SAP and can impose significant financial and operating restrictions on an insurance company that becomes financially impaired under SAP guidelines. State insurance regulators can generally impose restrictions or conditions on the activities of a financially impaired insurance company, including: the transfer or disposition of assets; the withdrawal of funds from bank accounts; payment of dividends or other distributions; the extension of credit or the advancement of loans; and investments of funds, including business acquisitions or combinations.
Financial, Dividend, and Investment Restrictions. State laws require insurance companies to maintain minimum levels of surplus and place limits on the amount of premiums a company may write based on the amount of that company's surplus. These limitations may restrict the rate at which our insurance operations can grow.
State laws also require insurance companies to establish reserves for payments of policyholder liabilities and impose restrictions on the kinds of assets in which insurance companies may invest. These restrictions may require us to invest in assets more conservatively than we would if we were not subject to state law restrictions and may prevent us from obtaining as high a return on our assets as we might otherwise be able to realize absent the restrictions.
The ability of EHI to pay dividends on our common stock and to pay other expenses will be dependent to a significant extent upon the ability of EICN and EPIC to pay dividends to their immediate holding company, Employers Group, Inc. (EGI) and, in turn, the ability of EGI to pay dividends to EHI. Additional information regarding financial, dividend, and investment restrictions is set forth in Note 15 in the Notes to our Consolidated Financial Statements.
Insurance Assessments. All of the states where our insurance subsidiaries are licensed to transact business require property and casualty insurers doing business within the state to pay various insurance assessments. We accrue a liability for estimated insurance assessments as direct premiums are written, losses are recorded, or as other events occur in accordance with various states' laws and regulations, and defer these costs and recognize them as an expense as the related premiums are earned. Various mechanisms exist in some of these states for assessed insurance companies to recover certain assessments. Additional information regarding insurance assessments is set forth in Note 12 in the Notes to our Consolidated Financial Statements.
Pooling Arrangements. As a condition to conduct business in some states, insurance companies are required to participate in mandatory workers' compensation shared market mechanisms, or pooling arrangements, which provide workers' compensation insurance coverage to private businesses that are otherwise unable to obtain coverage due, for example, to their prior loss experiences.
The National Association of Insurance Commissioners (NAIC). The NAIC is a group formed by state insurance regulators to discuss issues and formulate policy with respect to regulation, reporting, and accounting of and by U.S. insurance companies. Although the NAIC has no legislative authority and insurance companies are at all times subject to the laws of their respective domiciliary states and, to a lesser extent, other states in which they conduct business, the NAIC is influential in determining the form in which insurance laws are enacted. Model Insurance Laws, Regulations, and Guidelines (Model Laws) have been promulgated by the NAIC as a minimum standard by which state regulatory systems and regulations are measured. Adoption of state laws that provide for substantially similar regulations to those described in the Model Laws is a requirement for accreditation of state insurance regulatory agencies by the NAIC.
Under the Model Laws, insurers are required to maintain minimum levels of capital based on their investments and operations. These risk-based capital (RBC) requirements provide a standard by which regulators can assess the adequacy of an insurance company's capital and surplus relative to its operations. An insurance company must maintain capital and surplus of at least 200% of the RBC computed by the NAIC's RBC model, known as the “Authorized Control Level” of RBC. At December 31, 2015, each of our insurance subsidiaries had total adjusted capital in excess of the minimum RBC requirements.
The key financial ratios of the NAIC's Insurance Regulatory Information System (IRIS) were developed to assist state regulators in overseeing the financial condition of insurance companies. These ratios are reviewed by financial examiners of the NAIC and state insurance regulators for the purposes of detecting financial distress and preventing insolvency and to select those companies that merit highest priority in the allocation of the regulators' resources. IRIS identifies 13 key financial ratios and specifies a “usual range” for each. Departure from the usual ranges on four or more of the ratios can lead to inquiries from individual state insurance regulators as to certain aspects of an insurer's business. None of our insurance subsidiaries are currently subject to any action by any state regulator with respect to IRIS ratios.
Item 1A. Risk Factors
Investing in our common stock involves risks. In evaluating our company, you should carefully consider the risks described below, together with all the information included or incorporated by reference in this report. The risks facing our company include, but
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are not limited to, those described below. Additional risks that we are not presently aware of or that we currently believe are immaterial may also impair our business operations. The occurrence of one or more of these events could significantly and adversely affect our business, financial condition, results of operations, cash flows, and stock price, and you could lose all or part of your investment.
Our liability for losses and LAE is based on estimates and may be inadequate to cover our actual losses and expenses.
We must establish and maintain reserves for our estimated losses and LAE. We establish loss reserves in our financial statements that represent an estimate of amounts needed to pay and administer claims with respect to insured claims that have occurred, including claims that have occurred but have not yet been reported to us. Loss reserves are estimates of the ultimate cost of individual claims based on actuarial estimation techniques, are inherently uncertain, and do not represent an exact measure of liability.
Several factors contribute to the inherent uncertainty in establishing estimated losses, including the length of time to settle long-term, severe cases, claim cost inflation (deflation) trends, and uncertainties in the long-term outcome of legislative reforms. Judgment is required in applying actuarial techniques to determine the relevance of historical payment and claim settlement patterns under current facts and circumstances. In certain states, we have a relatively short operating history and must rely on a combination of industry experience and our specific experience regarding claims emergence and payment patterns, medical cost inflation, and claim cost trends, adjusted for future anticipated changes in claims-related and economic trends, as well as regulatory and legislative changes, to establish our best estimate of reserves for losses and LAE. As we receive new information and update our assumptions over time regarding the ultimate liability, our loss reserves may prove to be inadequate to cover our actual losses, and we have in the past made, and may in the future make, adjustments to our reserves based on a number of factors. Any changes in these estimates could be material and could have an adverse effect on our results of operations and financial condition during the period the changes are made.
The insurance business is subject to extensive regulation and legislative changes, which impact the manner in which we operate our business.
Our insurance business is subject to extensive regulation by the applicable state agencies in the jurisdictions in which we operate, most significantly by the insurance regulators in California, Florida, and Nevada, the states in which our insurance subsidiaries are domiciled. As of December 31, 2015, over one-half of our in-force premiums were generated in California. Accordingly, we are particularly affected by regulation in California. The passage of any form of rate regulation in California could impair our ability to operate profitably in California, and any such impairment could have a material adverse effect on our financial condition and results of operations.
More generally, insurance regulators have broad regulatory powers designed to protect policyholders and claimants, and not stockholders or other investors. Regulations vary from state to state, but typically address or include:
• | standards of solvency, including RBC measurements; |
• | restrictions on the nature, quality, and concentration of investments; |
• | restrictions on the types of terms that we can include in the insurance policies we offer; |
• | mandates that may affect wage replacement and medical care benefits paid under the workers' compensation system; |
• | requirements for the handling and reporting of claims and procedures for adjusting claims; |
• | restrictions on the way rates are developed and premiums are determined; |
• | the manner in which agents may be appointed; |
• | establishment of liabilities for unearned premiums, unpaid losses and LAE; |
• | limitations on our ability to transact business with affiliates; |
• | mergers, acquisitions, and divestitures involving our insurance subsidiaries; |
• | licensing requirements and approvals that affect our ability to do business; |
• | compliance with all applicable privacy laws; |
• | potential assessments for the settlement of covered claims under insurance policies issued by impaired, insolvent, or failed insurance companies or other assessments imposed by regulatory agencies; and |
• | the amount of dividends that our insurance subsidiaries may pay to EGI and, in turn, the ability of EGI to pay dividends to EHI. |
Workers' compensation insurance is statutorily provided for in all of the states in which we do business. State laws and regulations specify the form and content of policy coverage and the rights and benefits that are available to injured workers, their representatives, and medical providers. In “administered pricing” states, insurance rates are set by the state insurance regulators and are adjusted periodically. Rate competition is generally not permitted in these states. Of the states in which we currently operate, Florida, Wisconsin, and Idaho are administered pricing states. Additionally, we are exposed to the risk that other states in which we operate will adopt administered pricing laws.
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Legislation and regulation impact our ability to investigate fraud and other abuses of the workers' compensation system in the states in which we do business. Our relationships with medical providers are also impacted by legislation and regulation, including penalties for failure to make timely payments.
Federal legislation typically does not directly impact our workers' compensation business, but our business can be indirectly affected by changes in healthcare, occupational safety and health, and tax and financial regulations. Since healthcare costs are the largest component of our loss costs, we may be impacted by changes in healthcare legislation, such as the ongoing implementation of the Affordable Care Act, which could affect healthcare costs and delivery in the future. There is also the possibility of federal regulation of insurance.
This extensive regulation of our business may affect the cost or demand for our products and may limit our ability to obtain rate increases or to take other actions that we might desire to maintain our profitability. In addition, we may be unable to maintain all required approvals or comply fully with applicable laws and regulations, or the relevant governmental authority's interpretation of such laws and regulations. If that were to occur, we might lose our ability to conduct business in certain jurisdictions. Further, changes in the level of regulation of the insurance industry or changes in laws or regulations or interpretations by regulatory authorities could impact our operations, require us to bear additional costs of compliance, and impact our profitability.
If we fail to price our insurance policies appropriately, our business competitiveness, financial condition, and results of operations could be materially adversely affected.
Premiums are based on the particular class of business and our estimates of expected losses and LAE and other expenses related to the policies we underwrite. We analyze many factors when pricing a policy, including the policyholder's prior loss history and industry classification. Inaccurate information regarding a policyholder's past claims experience could put us at risk for mispricing our policies, which could have a material adverse effect on our business, financial condition, and results of operations. For example, when initiating coverage on a policyholder, we must rely on the information provided by the policyholder or the policyholder's previous insurer(s) to properly estimate future claims expense. In order to set premium rates accurately, we must utilize an appropriate pricing model which correctly assesses risks based on their individual characteristics and takes into account actual and projected industry characteristics.
Our concentration in California ties our performance to the business, economic, demographic, natural perils, competitive, and regulatory conditions in that state.
Our business is concentrated in California, where we generated 57% of our in-force premiums as of December 31, 2015. Accordingly, the loss environment and unfavorable business, economic, demographic, natural perils, competitive, and regulatory conditions in California could negatively impact our business.
Many California businesses are dependent on tourism revenues, which are, in turn, dependent on a robust economy. A downturn in the national economy or the economy of California, or any other event that causes deterioration in tourism, could adversely impact small businesses, such as restaurants, that we have targeted as customers. The departure from California or insolvency of a significant number of small businesses could also have a material adverse effect on our financial condition and results of operations. California is also exposed to climate and environmental changes, natural perils such as earthquakes, and susceptible to the possibility of pandemics or terrorist acts. Accordingly, we could suffer losses as a result of catastrophic events in this state. Additionally, the workers' compensation industry has seen an increase in claims litigation in California. Because of the concentration of our business in California, we may be exposed to losses and business, economic, and regulatory risks or risk from natural perils that are greater than the risks associated with companies with greater geographic diversification.
We rely on independent insurance agents and brokers.
We market and sell our insurance products primarily through independent, non-exclusive insurance agents and brokers. These agents and brokers are not obligated to promote our products and can and do sell our competitors' products. In addition, these agents and brokers may find it easier to promote the broader range of programs of some of our competitors than to promote our single-line workers' compensation insurance products. The loss of a number of our independent agents and brokers or the failure or inability of these agents to successfully market our insurance programs could have a material adverse effect on our business, financial condition, and results of operations.
We rely on our relationship with our principal distribution partner.
We have an agreement with our principal distribution partner, ADP, to market and service our insurance products through its sales forces and insurance agencies. ADP generated 11.5% of our total in-force premiums as of December 31, 2015. Our agreement with ADP is not exclusive, and ADP may terminate the agreement without cause upon 120 days notice. The termination of this agreement, our failure to maintain a good relationship with ADP, or its failure to successfully market our products may materially reduce our revenues and could have a material adverse effect on our results of operations. In addition, we are subject to the risk that ADP may face financial difficulties, reputational issues, or problems with respect to its own products and services, which may lead to decreased sales of our products and services. Moreover, if ADP consolidates or aligns itself with another company or
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changes its products that are currently offered with our workers' compensation insurance products, we may lose business or suffer decreased revenues.
We are also subject to credit risk with respect to ADP, as it collects premiums on our behalf for the workers' compensation products that are marketed together with its own products. Any failure to remit such premiums to us or to remit such amounts on a timely basis could have an adverse effect on our results of operations.
A downgrade in our financial strength rating could reduce the amount of business that we are able to write or result in the termination of certain of our agreements with our strategic partners.
Rating agencies rate insurance companies based on financial strength as an indication of an ability to pay claims. Our insurance subsidiaries are currently assigned a group letter rating of “A-” (Excellent) by A.M. Best, which is the rating agency that we believe has the most influence on our business. This rating is assigned to companies that, in the opinion of A.M. Best, have demonstrated an excellent overall performance when compared to industry standards. A.M. Best considers “A-” (Excellent) rated companies to have an excellent ability to meet their ongoing obligations to policyholders. This rating does not refer to our ability to meet non-insurance obligations.
The financial strength ratings of A.M. Best and other rating agencies are subject to periodic review using, among other things, proprietary capital adequacy models, and are subject to revision or withdrawal at any time. Insurance financial strength ratings are directed toward the concerns of policyholders and insurance agents and are not intended for the protection of investors or as a recommendation to buy, hold, or sell securities. Our competitive position relative to other companies is determined in part by our financial strength rating. A reduction in our A.M. Best rating could adversely affect the amount of business we could write, as well as our relationships with independent agents and brokers and our principal distribution partners, reinsurers, and other business partners.
A.M. Best is in the process of making revisions to its capital adequacy model, which is expected to be completed in late 2016, which could increase the capital and other requirements employed in their models for maintenance of certain rating levels. Additionally, A.M. Best may increase the frequency and scope of their reviews, and request additional information from the companies that they rate, including additional information regarding the valuation of investment securities held. We cannot predict what actions rating agencies may take, or what actions we may take in response to the actions of rating agencies.
If we are unable to obtain reinsurance or collect on ceded reinsurance, our ability to write new policies and to renew existing policies could be adversely affected and our financial condition and results of operations could be materially adversely affected.
At December 31, 2015, we had $635.9 million of reinsurance recoverables for paid and unpaid losses and LAE, of which $7.7 million was due to us on paid claims.
We purchase reinsurance to protect us against the costs of severe claims and catastrophic events, including natural perils and acts of terrorism, excluding nuclear, biological, chemical, and radiological events. On July 1, 2015, we entered into a new reinsurance program that is effective through June 30, 2016. The reinsurance program consists of one treaty covering excess of loss and catastrophic loss events in five layers of coverage. Our reinsurance coverage is $193.0 million in excess of our $7.0 million retention on a per occurrence basis, subject to certain exclusions.
The availability, amount, and cost of reinsurance depend on market conditions and our loss experience and may vary significantly. We cannot be certain that our reinsurance agreements will be renewed or replaced prior to their expiration upon terms satisfactory to us. If we are unable to renew or replace our reinsurance agreements upon terms satisfactory to us, our net liability on individual risks would increase and we would have greater exposure to large and catastrophic losses, which could have a material adverse affect on our financial condition and results of operations.
In addition, we are subject to credit risk with respect to our reinsurers, and they may refuse to pay or delay payment of losses we cede to them. We remain liable to our policyholders even if we are unable to make recoveries that we believe we are entitled to under our reinsurance contracts. Losses may not be recovered from our reinsurers until claims are paid and, in the case of long-term workers' compensation cases, the creditworthiness of our reinsurers may change before we can recover amounts that we are entitled to. The inability of any of our reinsurers to meet their financial obligations could have a material adverse affect on our financial condition and results of operations.
We obtained reinsurance covering the losses incurred prior to July 1, 1995, and we could be liable for all of those losses if the coverage provided by the LPT Agreement proves inadequate or we fail to collect from the reinsurers that are party to such transaction.
On January 1, 2000, EICN assumed all of the assets, liabilities, and operations of the Fund, including losses incurred by the Fund prior to such date. EICN also assumed the Fund's rights and obligations associated with the LPT Agreement that the Fund entered into with third party reinsurers with respect to its losses incurred prior to July 1, 1995, see “Item 1 –Business –Reinsurance –LPT Agreement.” We could be liable for all of those losses if the coverage provided by the LPT Agreement proves inadequate or we fail to collect from the reinsurers party to such transaction. As of December 31, 2015, the estimated remaining liabilities subject
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to the LPT Agreement were $498.0 million. If we are unable to collect on these reinsurance recoverables, our financial condition and results of operations could be materially adversely affected.
The reinsurers under the LPT Agreement agreed to assume responsibilities for the claims at the benefit levels which existed in June 1999. Accordingly, if the Nevada legislature were to increase the benefits payable for the pre-July 1, 1995 claims, we would be responsible for the increased benefit costs to the extent of the legislative increase. If the credit rating of any of the third party reinsurers that are party to the LPT Agreement were to fall below ''A-'' (Excellent) as determined by A.M. Best or one of the reinsurers becomes insolvent, we would be responsible for replacing any such reinsurer or would be liable for the claims that otherwise would have been transferred to such reinsurer. For example, in 2002, the rating of one of the original reinsurers under the LPT Agreement, Gerling Global International Reinsurance Company Ltd. (Gerling), dropped below the mandatory ''A-'' (Excellent) rating to ''B+'' (Good). Accordingly, we entered into an agreement to replace Gerling with National Indemnity Company at a cost to us of $33.0 million. We can give no assurance that circumstances requiring us to replace one or more of the current reinsurers under the LPT Agreement will not occur in the future, that we will be successful in replacing such reinsurer or reinsurers in such circumstances, or that the cost of such replacement or replacements will not have a material adverse effect on our results of operations or financial condition.
The LPT Agreement also required the reinsurers to each place assets supporting the payment of claims by them in individual trusts that require that collateral be held at a specified level. The collateralization level must not be less than the outstanding reserve for losses and a loss expense allowance equal to 7% of estimated paid losses discounted at a rate of 6%. If the assets held in trust fall below this threshold, we can require the reinsurers to contribute additional assets to maintain the required minimum level. The value of these assets at December 31, 2015 was $1.4 billion. If the value of the collateral in the trusts drops below the required minimum level and the reinsurers are unable to contribute additional assets, we could be responsible for substituting a new reinsurer or paying those claims without the benefit of reinsurance. One of the reinsurers has collateralized its obligations under the LPT Agreement by placing shares of stock of a publicly held corporation, with a value of $1.3 billion at December 31, 2015, in a trust to secure the reinsurer's obligation of $273.9 million. The value of this collateral is subject to fluctuations in the market price of such stock. The other reinsurers have placed treasury and fixed maturity securities in trusts to collateralize their obligations.
Intense competition and the fact that we write only a single line of insurance could adversely affect our ability to sell policies at rates we deem adequate.
The market for workers' compensation insurance products is highly competitive. Competition in our business is based on many factors, including premiums charged, services provided, financial ratings assigned by independent rating agencies, speed of claims payments, reputation, policyholder dividends, perceived financial strength, and general experience. In some cases, our competitors offer lower priced products than we do. If our competitors offer more competitive premiums, policyholder dividends, or payment plans, services or commissions to independent agents, brokers, and other distributors, we could lose market share, have to reduce our premium rates, or increase commission rates, which could adversely affect our profitability. We compete with regional and national insurance companies, professional employer organizations, third-party administrators, self-insured employers, and state insurance funds. Our main competitors vary from state to state, but are usually those companies that offer a full range of services in underwriting, loss control, and claims. We compete on the basis of the services that we offer to our policyholders and on ease of doing business rather than solely on price.
Many of our competitors are significantly larger and possess greater financial, marketing, and management resources than we do. Some of our competitors benefit financially by not being subject to federal income tax. Intense competitive pressure on prices can result from the actions of even a single large competitor. Competitors with more surplus than us have the potential to expand in our markets more quickly than we can. Greater financial resources also permit an insurer to gain market share through more competitive pricing, even if that pricing results in reduced underwriting margins or an underwriting loss.
Many of our competitors are multi-line carriers that can price the workers' compensation insurance they offer at a loss in order to obtain other lines of business at a profit. This creates a competitive disadvantage for us, as we only offer a single line of insurance. For example, a business may find it more efficient or less expensive to purchase multiple lines of commercial insurance coverage from a single carrier.
The property and casualty insurance industry is cyclical in nature and is characterized by periods of so-called “soft” market conditions, in which premium rates are stable or falling, insurance is readily available, and insurers' profits decline, and by periods of so-called “hard” market conditions, in which rates rise, insurance may be more difficult to find, and insurers' profits increase. According to the Insurance Information Institute, since 1970, the property and casualty insurance industry experienced hard market conditions from 1975 to 1978, 1984 to 1987, and 2001 to 2004. Although the financial performance of an individual insurance company is dependent on its own specific business characteristics, the profitability of most workers' compensation insurance companies generally tends to follow this cyclical market pattern. We believe the workers' compensation industry currently has excess underwriting capacity resulting in lower rate levels and smaller profit margins. We continue to experience price competition in our target markets.
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Because of cyclicality in the workers' compensation market, due in large part to competition, capacity, and general economic factors, we cannot predict the timing or duration of changes in the market cycle. This cyclical pattern has in the past and could in the future adversely affect our financial condition and results of operations. If we are unable to compete effectively, our business, financial condition, and results of operations could be materially adversely affected.
We may be unable to realize our investment objectives and economic conditions in the financial markets could lead to investment losses.
Investment income is an important component of our revenue and net income. Our investment portfolio is managed by an independent asset manager that operates under investment guidelines approved by our Board of Directors. Although these guidelines stress diversification and capital preservation, our investments are subject to a variety of risks that are beyond our control, including risks related to general economic conditions, interest rate fluctuations, and market volatility. Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. These and other factors affect the capital markets and, consequently, the value of our investment portfolio.
We are exposed to significant financial risks related to the capital markets, including the risk of potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk affecting us are interest rate risk, credit risk, and equity price risk. For more information regarding market risk, see "Item 7A–Quantitative and Qualitative Disclosures About Market Risk."
The outlook for our investment income is dependent on the future direction of interest rates, maturity schedules, and cash flow from operations that is available for investment. The fair values of fixed maturity securities that are “available-for-sale” fluctuate with changes in interest rates and cause fluctuations in our stockholders' equity. Any significant decline in our investment income or the value of our investments as a result of changes in interest rates, deterioration in the credit of companies or municipalities in which we have invested, decreased dividend payments, general market conditions, or events that have an adverse impact on any particular industry or geographic region in which we hold significant investments could have an adverse effect on our net income and, as a result, on our stockholders' equity and policyholder surplus.
The valuation of our investments, including the determination of the amount of impairments, include estimates and assumptions and could result in changes to investment valuations that may adversely affect our financial condition and results of operations. The use of internally developed valuation techniques may have a material effect on the estimated fair value amounts of our investments and our financial condition.
Additionally, we regularly review our entire investment portfolio, including the identification of other-than-temporary declines in fair value. The determination of the amount of impairments taken on our investments is based on our periodic evaluation and assessment of our investments and known and inherent risks associated with the various asset classes. There can be no assurance that we have accurately determined the level of other-than-temporary impairments reflected in our financial statements and additional impairments may need to be taken in the future. Historical trends may not be indicative of future impairments.
We may require additional capital in the future, which may not be available to us or may be available only on unfavorable terms.
Our future capital requirements will depend on many factors, including state regulatory requirements, our ability to write new business successfully, and to establish premium rates and reserves at levels sufficient to cover losses. If we have to raise additional capital, equity or debt financing may not be available on terms that are favorable to us. In the case of equity financings, there could be dilution to our stockholders and the securities may have rights, preferences, and privileges senior to our common stock. In the case of debt financings, we may be subject to covenants that restrict our ability to freely operate our business. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to implement our future growth or operating plans and our business, financial condition, and results of operations could be materially adversely affected.
The capital and credit markets continue to experience volatility and disruption that have negatively affected market liquidity conditions. In some cases, the markets have produced downward pressure on stock prices and limited the availability of credit for certain issuers without regard to those issuers' underlying financial strength. As a result, we may be forced to delay raising capital or be unable to raise capital on favorable terms, or at all, which could decrease our profitability, significantly reduce our financial flexibility, and cause rating agencies to reevaluate our financial strength ratings.
We are a holding company with no direct operations. We depend on the ability of our subsidiaries to transfer funds to us to meet our obligations, and our insurance subsidiaries' ability to pay dividends to us is restricted by law.
EHI is a holding company that transacts substantially all of its business through operating subsidiaries. Its primary assets are the shares of stock of our insurance subsidiaries. The ability of EHI to meet its operating and financing cash needs depends on the surplus and earnings of our subsidiaries, and upon the ability of our insurance subsidiaries to pay dividends to EGI and, in turn, the ability of EGI to pay dividends to EHI.
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Payments of dividends by our insurance subsidiaries are restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds, and could be subject to contractual restrictions in the future, including those imposed by indebtedness we may incur in the future. As a result, we may not be able to receive dividends from these subsidiaries and we may not receive dividends in the amounts necessary to meet our obligations or to pay dividends on our common stock.
We rely on our information technology and telecommunication systems, and the failure of these systems or cyber attacks on our systems could materially and adversely affect our business.
Our business is highly dependent upon the successful and uninterrupted functioning of our information technology and telecommunications systems. We rely on these systems to process new and renewal business, provide customer service, administer and make payments on claims, facilitate collections, and to automatically underwrite and administer the policies we write. The failure of any of our systems could interrupt our operations or materially impact our ability to evaluate and write new business. Our information technology and telecommunications systems interface with and depend on third-party systems, and we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions.
Certain events outside of our control, including cyber attacks on our systems, could render our systems inoperable such that we would be unable to service our agents, insureds, and injured workers, or meet certain regulatory requirements. If such an event were to occur and our systems were unable to be restored or secured within a reasonable timeframe, our business, financial condition, and results of operations could be adversely affected. Additionally, cyber attacks resulting in a breach of security could jeopardize the privacy, confidentiality, and integrity of our data or our customers' data, which could harm our reputation and expose us to possible liability.
Acts of terrorism and catastrophes could materially adversely impact our financial condition and results of operations.
Under our workers' compensation policies and applicable laws in the states in which we operate, we are required to provide workers' compensation benefits for losses arising from acts of terrorism. The impact of any terrorist act is unpredictable, and the ultimate impact on us would depend upon the nature, extent, location, and timing of such an act. We would be particularly adversely affected by a terrorist act affecting any metropolitan area where our policyholders have a large concentration of workers.
Notwithstanding the protection provided by the reinsurance we have purchased and any protection provided by the 2002 Act, or its extension, TRIPRA of 2015, the risk of severe losses to us from acts of terrorism has not been eliminated because our excess of loss reinsurance treaty program contains various sub-limits and exclusions limiting our reinsurers' obligation to cover losses caused by acts of terrorism. Our excess of loss reinsurance treaties do not protect against nuclear, biological, chemical, or radiological events. If such an event were to impact one or more of the businesses we insure, we would be entirely responsible for any workers' compensation claims arising out of such event, subject to the terms of the 2002 Act and TRIPRA of 2015 and could suffer substantial losses as a result.
Our operations also expose us to claims arising out of catastrophes because we may be required to pay benefits to workers who are injured in the workplace as a result of a catastrophe. Catastrophes can be caused by various unpredictable events, either natural or man-made. Any catastrophe occurring in the communities in which we operate or that have significant impacts on one or more of our targeted classes of business could expose us to potentially substantial losses and, accordingly, could have a material adverse effect on our financial condition and results of operations.
Administrative proceedings or legal actions involving our insurance subsidiaries could have a material adverse effect on our business, financial condition and results of operations.
Our insurance subsidiaries are involved in various administrative proceedings and legal actions in the normal course of their insurance operations. Our subsidiaries have responded to the actions and intend to defend against these claims. These claims concern issues including eligibility for workers' compensation insurance coverage or benefits, the extent of injuries, wage determinations, disability ratings, and bad faith and extra-contractual liability. Adverse decisions in multiple administrative proceedings or legal actions could require us to pay significant amounts in the aggregate or to change the manner in which we administer claims, which could have a material adverse effect on our financial condition and results of operations.
Our business is largely dependent on the efforts of our management because of its industry expertise, knowledge of our markets, and relationships with the independent agents and brokers that sell our products.
Our success depends in substantial part upon our ability to attract and retain qualified executive officers, experienced underwriting and claims personnel, and other skilled employees who are knowledgeable about our business. The current success of our business is dependent in significant part on the efforts of Douglas D. Dirks, our President and Chief Executive Officer, and Terry Eleftheriou, our Executive Vice President and Chief Financial Officer. Many of our regional and local officers are also important to our operations because of their industry expertise, knowledge of our markets, and relationships with the independent agents and brokers who sell our products. We have entered into employment agreements with certain of our key executives. Currently, we maintain key man life insurance for our Chief Executive Officer. If we were to lose the services of members of our management team or
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key regional or local officers, we may be unable to find replacements satisfactory to us and our business. As a result, our operations may be disrupted and our financial performance and results of operations may be adversely affected.
Assessments and other surcharges for guaranty funds, second injury funds, and other mandatory pooling arrangements may reduce our profitability.
All states require insurance companies licensed to do business in their state to bear a portion of the unfunded obligations of insolvent insurance companies. These obligations are funded by assessments that can be expected to continue in the future in the states in which we operate. Many states also have laws that establish second injury funds to provide compensation to injured employees for aggravation of a prior condition or injury, which are funded by either assessments based on paid losses or premium surcharge mechanisms. In addition, as a condition to the ability to conduct business in some states, insurance companies are required to participate in mandatory workers' compensation shared market mechanisms or pooling arrangements, which provide workers' compensation insurance coverage from private insurers. The effect of these assessments and mandatory shared market mechanisms or changes in them could reduce our profitability in any given period or limit our ability to grow our business.
State insurance laws, certain provisions of our charter documents, and Nevada corporation law could prevent or delay a change of control that could be beneficial to us and our stockholders.
Our insurance subsidiaries are domiciled in Florida, California, and Nevada. The insurance laws of these states generally require that any person seeking to acquire control of a domestic insurance company obtain the prior approval of the state's insurance commissioner. In Florida, "control" is generally presumed to exist through the direct or indirect ownership of 5% or more of the voting securities of a domestic insurance company or of any entity that controls a domestic insurance company. In California and Nevada, "control" is presumed to exist through the direct or indirect ownership of 10% or more of the voting securities of a domestic insurance company or of any entity that controls a domestic insurance company. In addition, insurance laws in many states in which we are licensed require pre-notification to the state's insurance commissioner of a change in control of a non-domestic insurance company licensed in those states. Because we have insurance subsidiaries domiciled in Florida, California, and Nevada, any transaction that would constitute a change in control of us would generally require the party acquiring control to obtain the prior approval of the insurance commissioners of these states and may require pre-notification of the change of control in these or other states in which we are licensed to transact business. The time required to obtain these approvals may result in a material delay of, or deter, any such transaction. These laws may discourage potential acquisition proposals or tender offers, and may delay, deter, or prevent a change of control, even if the acquisition proposal or tender offer is favorable to our stockholders.
Provisions of our amended and restated articles of incorporation and amended and restated by-laws could discourage, delay, or prevent a merger, acquisition, or other change in control of us, even if our stockholders might consider such a change in control to be favorable. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect Directors and take other corporate actions. In particular, our amended and restated articles of incorporation and amended and restated by-laws include provisions:
• | dividing our Board of Directors into three classes; |
• | eliminating the ability of our stockholders to call special meetings of stockholders; |
• | permitting our Board of Directors to issue preferred stock in one or more series; |
• | imposing advance notice requirements for nominations for election to our Board of Directors or for proposing matters that can be acted upon by stockholders at the stockholder meetings; |
• | prohibiting stockholder action by written consent, thereby limiting stockholder action to that taken at an annual or special meeting of our stockholders; and |
• | providing our Board of Directors with exclusive authority to adopt or amend our by-laws. |
These provisions may make it difficult for stockholders to replace Directors and could have the effect of discouraging a future takeover attempt that is not approved by our Board of Directors, but which stockholders might consider favorable. Additionally, these provisions could limit the price that investors are willing to pay in the future for shares of our common stock.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our principal executive offices are 79,533 square feet located in leased premises in Reno, Nevada. As of February 1, 2016, we leased 212,750 square feet of office space in 8 states. We believe that our existing office space is adequate for our current needs. We will continue to enter into or exit lease agreements to address future space requirements, as necessary.
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Item 3. Legal Proceedings
From time to time, we are involved in pending and threatened litigation in the normal course of business in which claims for monetary damages are asserted. In the opinion of management, the ultimate liability, if any, arising from such pending or threatened litigation is not expected to have a material effect on our result of operations, liquidity, or financial position.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information, Holders, and Stockholder Dividends
Our common stock is listed on the New York Stock Exchange (NYSE) under the symbol “EIG.” There were 1,080 holders of record as of February 10, 2016. High and low sales prices and cash dividends declared for the last two fiscal years were as follows:
2015 | 2014 | |||||||||||||||||||||||
Stock Price | Cash Dividends Declared | Stock Price | Cash Dividends Declared | |||||||||||||||||||||
Quarter Ended | High | Low | High | Low | ||||||||||||||||||||
March 31 | $ | 27.22 | $ | 20.62 | $ | 0.06 | $ | 31.60 | $ | 18.91 | $ | 0.06 | ||||||||||||
June 30 | 27.65 | 22.28 | 0.06 | 23.14 | 19.17 | 0.06 | ||||||||||||||||||
September 30 | 26.40 | 21.46 | 0.06 | 22.26 | 18.89 | 0.06 | ||||||||||||||||||
December 31 | 28.35 | 20.86 | 0.06 | 23.70 | 18.81 | 0.06 | ||||||||||||||||||
We currently expect that cash dividends will continue to be paid in the future; however, any determination to pay additional or future dividends will be at the discretion of our Board of Directors and will be dependent upon:
• | the surplus and earnings of our subsidiaries and their ability to pay dividends and/or other statutorily permissible payments to us; |
• | our results of operations and cash flows; |
• | our financial position and capital requirements; |
• | general business conditions; |
• | any legal, tax, regulatory, and/or contractual restrictions on the payment of dividends; and |
• | any other factors our Board of Directors deems relevant. |
Issuer Purchases of Equity Securities
On February 16, 2016, the Board of Directors authorized a share repurchase program for up to $50.0 million of our common stock from February 22, 2016 through February 22, 2018 (the 2016 Program). We expect that shares of common stock may be purchased at prevailing market prices through a variety of methods, including open market or private transactions, in accordance with applicable laws and regulations and as determined by 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 2016 Program may be commenced, modified, or suspended from time-to-time without prior notice.
There were no unregistered sales or purchases of equity securities during the three months ended December 31, 2015.
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Performance Graph
The following information compares the cumulative total return on $100 invested in the common stock of EHI, ticker symbol EIG, for the period commencing on December 31, 2010 and ending on December 31, 2015 with the cumulative total return on $100 invested in each of the Standard and Poor's 500 Index (S&P 500) and the Standard and Poor's 500 Property-Casualty Insurance Index (S&P P&C Insurance Index). The calculation of cumulative total return assumes the reinvestment of dividends. The following graph and related information shall not be deemed to be “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any filing pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that we specifically incorporate it by reference into such filing.
Employers Holdings, Inc.
Cumulative Total Return Performance
Period Ending | |||||||||||||||||||||||
12/31/2010 | 12/31/2011 | 12/31/2012 | 12/31/2013 | 12/31/2014 | 12/31/2015 | ||||||||||||||||||
Employers Holdings, Inc. | $ | 100.00 | $ | 105.05 | $ | 121.17 | $ | 188.07 | $ | 141.30 | $ | 165.65 | |||||||||||
S&P 500 | 100.00 | 102.11 | 118.45 | 156.82 | 178.29 | 180.75 | |||||||||||||||||
S&P P&C Insurance Index | 100.00 | 99.75 | 119.81 | 165.69 | 191.78 | 210.05 | |||||||||||||||||
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Item 6. Selected Financial Data
The following selected historical consolidated financial data should be read in conjunction with ''Item 7–Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations'' and the consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K.
Years Ended December 31, | |||||||||||||||||||
2015 | 2014 | 2013 | 2012 | 2011 | |||||||||||||||
Income Statement Data | (in millions, except per share amounts and ratios) | ||||||||||||||||||
Revenues: | |||||||||||||||||||
Net premiums earned | $ | 690.4 | $ | 684.5 | $ | 642.3 | $ | 501.5 | $ | 363.4 | |||||||||
Net investment income | 72.2 | 72.4 | 70.8 | 72.4 | 80.1 | ||||||||||||||
Net realized (losses) gains on investments | (10.7 | ) | 16.3 | 9.5 | 5.0 | 20.2 | |||||||||||||
Other income | 0.2 | 0.3 | 0.9 | 0.3 | 0.5 | ||||||||||||||
Total revenues | 752.1 | 773.5 | 723.5 | 579.2 | 464.2 | ||||||||||||||
Net income before income taxes | 99.4 | 106.6 | 53.1 | 97.6 | 46.5 | ||||||||||||||
Income tax expense (benefit) | 5.0 | 5.9 | (10.7 | ) | (9.3 | ) | (2.1 | ) | |||||||||||
Net income | $ | 94.4 | $ | 100.7 | $ | 63.8 | $ | 106.9 | $ | 48.6 | |||||||||
Earnings per common share | |||||||||||||||||||
Basic | $ | 2.94 | $ | 3.19 | $ | 2.05 | $ | 3.40 | $ | 1.30 | |||||||||
Diluted | 2.90 | 3.14 | 2.00 | 3.37 | 1.30 | ||||||||||||||
Selected Operating Data | |||||||||||||||||||
Gross premiums written(1) | $ | 697.7 | $ | 697.7 | $ | 689.9 | $ | 580.3 | $ | 418.5 | |||||||||
Net premiums written(2) | $ | 689.3 | $ | 687.6 | $ | 678.5 | $ | 569.7 | $ | 410.0 | |||||||||
Combined ratio(3) | 94.1 | % | 97.0 | % | 103.9 | % | 95.3 | % | 114.0 | % | |||||||||
Net income before impact of the LPT Agreement(4)(5)(6) | $ | 74.0 | $ | 45.7 | $ | 25.9 | $ | 7.0 | $ | 29.3 | |||||||||
Earnings per common share before impact of the LPT Agreement(6) | |||||||||||||||||||
Basic | $ | 2.31 | $ | 1.45 | $ | 0.83 | $ | 0.22 | 0.79 | ||||||||||
Diluted | 2.27 | 1.43 | 0.81 | 0.22 | 0.78 | ||||||||||||||
Cash dividends declared per common share | 0.24 | 0.24 | 0.24 | 0.24 | 0.24 | ||||||||||||||
As of December 31, | |||||||||||||||||||
2015 | 2014 | 2013 | 2012 | 2011 | |||||||||||||||
Balance Sheet Data | (in millions) | ||||||||||||||||||
Cash and cash equivalents | $ | 56.6 | $ | 103.6 | $ | 34.5 | $ | 140.7 | $ | 252.3 | |||||||||
Total investments | 2,487.2 | 2,448.4 | 2,344.8 | 2,149.5 | 1,950.7 | ||||||||||||||
Reinsurance recoverable on paid and unpaid losses | 635.9 | 680.2 | 751.1 | 814.9 | 951.5 | ||||||||||||||
Total assets | 3,755.8 | 3,769.7 | 3,643.5 | 3,511.3 | 3,482.3 | ||||||||||||||
Unpaid losses and loss adjustment expense | 2,347.5 | 2,369.7 | 2,330.5 | 2,231.5 | 2,272.4 | ||||||||||||||
Deferred reinsurance gain–LPT Agreement(4)(5) | 189.5 | 207.0 | 249.1 | 281.0 | 366.0 | ||||||||||||||
Notes payable | 32.0 | 92.0 | 102.0 | 112.0 | 122.0 | ||||||||||||||
Total liabilities | 2,995.0 | 3,082.9 | 3,074.8 | 2,971.9 | 3,020.4 | ||||||||||||||
Total stockholders' equity | 760.8 | 686.8 | 568.7 | 539.4 | 461.9 | ||||||||||||||
Other Financial Data | |||||||||||||||||||
Total stockholders' equity including deferred reinsurance gain–LPT Agreement(4)(5)(7) | $ | 950.3 | $ | 893.8 | $ | 817.8 | $ | 820.4 | $ | 827.9 | |||||||||
(1) | Gross premiums written is the sum of direct premiums written and assumed premiums written before the effect of ceded reinsurance. Direct premiums written are the premiums on all policies our insurance subsidiaries have issued during the year. Assumed premiums written are premiums that our insurance subsidiaries have received from any authorized state-mandated pools. |
(2) | Net premiums written is the sum of direct premiums written and assumed premiums written less ceded premiums written. Ceded premiums written is the portion of direct premiums written that we cede to our reinsurers under our reinsurance contracts. (See Note 10 in the Notes to our Consolidated Financial Statements.) |
(3) | Combined ratio is the sum of the losses and LAE, commission expense, and underwriting and other operating expenses, divided by net premiums earned. Because we only have one operating segment, holding company expenses are included in the combined ratio. |
(4) | In connection with our January 1, 2000 assumption of the assets, liabilities and operations of the Fund, our Nevada insurance subsidiary assumed the Fund's rights and obligations associated with the LPT Agreement, a retroactive 100% quota share reinsurance agreement with third party reinsurers, which substantially reduced our exposure to losses for pre-July 1, 1995 Nevada insured risks. Pursuant to the LPT |
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Agreement, the Fund initially ceded $1.5 billion in liabilities for incurred but unpaid losses and LAE, which represented substantially all of the Fund's outstanding losses as of June 30, 1999 for claims with original dates of injury prior to July 1, 1995.
(5) | 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. Amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries over the life of the LPT Agreement, except for the contingent profit commission, which is amortized through June 30, 2024. The amortization is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT Agreement and the expected losses and LAE subject to the contingent profit commission under the LPT Agreement. Our reevaluations result in corresponding adjustments, if needed, to reserves, ceded reserves, contingent commission receivable, and the Deferred Gain, with the net effect being an increase or decrease, as the case may be, to net income. |
(6) | We define net income before impact of the LPT Agreement as net income before the impact of: (a) amortization of Deferred Gain; (b) adjustments to the LPT Agreement ceded reserves; and (c) adjustments to Contingent commission receivable–LPT Agreement. These are not measurements of financial performance under GAAP, but rather reflect the difference in accounting treatment between SAP and GAAP, and should not be considered in isolation or as an alternative to any other measure of performance derived in accordance with GAAP. |
We present net income before impact of the 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 affect our ongoing operations and consequently we believe these presentations are useful in providing a meaningful understanding of our operating performance. In addition, we believe these non-GAAP measures, as we have defined them, are helpful to our management in identifying trends in our performance because the items excluded have limited significance in our current and ongoing operations.
The table below shows the reconciliation of net income to net income before impact of the LPT Agreement for the periods presented:
Years Ended December 31, | |||||||||||||||||||
2015 | 2014 | 2013 | 2012 | 2011 | |||||||||||||||
(in millions) | |||||||||||||||||||
Net income | $ | 94.4 | $ | 100.7 | $ | 63.8 | $ | 106.9 | $ | 48.6 | |||||||||
Less amortization of the Deferred Gain related to losses | 9.5 | 11.2 | 12.9 | 15.4 | 17.1 | ||||||||||||||
Less amortization of the Deferred Gain related to contingent commission | 1.9 | 1.9 | 1.7 | 1.6 | 1.1 | ||||||||||||||
Less impact of LPT Reserve Adjustments(a) | 6.4 | 31.1 | 19.0 | 73.3 | — | ||||||||||||||
Less impact of LPT Contingent Commission Adjustments(b) | 2.6 | 10.8 | 4.3 | 9.6 | 1.1 | ||||||||||||||
Net income before impact of the LPT Agreement | $ | 74.0 | $ | 45.7 | $ | 25.9 | $ | 7.0 | $ | 29.3 | |||||||||
(a) | Any adjustment to the estimated reserves ceded under the LPT Agreement results in a cumulative adjustment to the Deferred Gain, which is also included in losses and LAE incurred in the consolidated statement of comprehensive income, such that the Deferred Gain reflects the balance that would have existed had the revised reserves been recognized at the inception of the LPT Agreement (LPT Reserve Adjustment). (See Note 2 in the Notes to our Consolidated Financial Statements.) |
(b) | Any adjustment to the contingent profit commission under the LPT Agreement results in a cumulative adjustment to the Deferred Gain, which is also recognized in losses and LAE incurred in the consolidated statement of comprehensive income, such that the Deferred Gain reflects the balance that would have existed had the revised contingent profit commission been recognized at the inception of the LPT Agreement. (LPT Contingent Commission Adjustment). (See Note 2 in the Notes to our Consolidated Financial Statements.) |
(7) | We define Total stockholders' equity including the Deferred Gain as total equity plus the Deferred Gain. Total stockholders' equity including the Deferred Gain is not a measurement of financial position under GAAP and should not be considered in isolation or as an alternative to total equity or any other measure of financial health derived in accordance with GAAP. |
We present Total stockholders' equity including the Deferred Gain because we believe that it is an important supplemental measure of financial position to be used by analysts, investors, and other interested parties in evaluating us. The LPT Agreement was a non-recurring transaction and the treatment of the Deferred Gain does not result in ongoing cash benefits or charges to our current operations and consequently we believe this presentation is useful in providing a meaningful understanding of our financial position.
The table below shows the reconciliation of Total stockholders' equity to Total stockholders' equity including the Deferred Gain for the periods presented:
As of December 31, | |||||||||||||||||||
2015 | 2014 | 2013 | 2012 | 2011 | |||||||||||||||
(in millions) | |||||||||||||||||||
Total stockholders' equity | $ | 760.8 | $ | 686.8 | $ | 568.7 | $ | 539.4 | $ | 461.9 | |||||||||
Deferred Gain | 189.5 | 207.0 | 249.1 | 281.0 | 366.0 | ||||||||||||||
Total stockholders' equity including the Deferred Gain | $ | 950.3 | $ | 893.8 | $ | 817.8 | $ | 820.4 | $ | 827.9 | |||||||||
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Item 7. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and the accompanying notes thereto included in Item 8 and Item 15 of this report. In addition to historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties and other factors described in Item 1A of this report. Our actual results in future periods may differ from those referred to herein due to a number of factors, including the risks described in the sections entitled “Risk Factors” and “Forward-Looking Statements” elsewhere in this report.
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 33 states and the District of Columbia, with a concentration in California, where over one-half of our business is generated. Our revenues are primarily comprised of net premiums earned, net investment income, and net realized gains on investments.
We target small businesses, as we believe that this market is traditionally 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 that are competitive and profitable over the long-term. Our underwriting approach is to consistently underwrite small business accounts at appropriate and competitive prices without sacrificing long-term profitability and stability for short-term top-line revenue growth.
Results of Operations
A primary measure of our performance is our ability to increase Adjusted stockholders' equity over the long-term. The following table shows a reconciliation of our stockholders' equity on a GAAP basis to our Adjusted stockholders' equity and the number of common shares outstanding.
December 31, | |||||||
2015 | 2014 | ||||||
(in millions, except share data) | |||||||
GAAP stockholders' equity | $ | 760.8 | $ | 686.8 | |||
Deferred reinsurance gain–LPT Agreement | 189.5 | 207.0 | |||||
Less: Accumulated other comprehensive income, net | 83.6 | 106.9 | |||||
Adjusted stockholders' equity(1) | $ | 866.7 | $ | 786.9 | |||
Common shares outstanding | 32,216,480 | 31,493,828 | |||||
(1) | Adjusted stockholders' equity is a non-GAAP measure that is defined as total stockholders' equity plus the Deferred reinsurance gain–LPT Agreement (Deferred Gain), less Accumulated other comprehensive income, net. We believe that Adjusted stockholders' equity is an important supplemental measure of our capital position. |
Overall, net income was $94.4 million, $100.7 million, and $63.8 million in 2015, 2014, and 2013, respectively and we recognized underwriting income (losses) of $40.4 million, $20.6 million, and $(24.9) million for the same periods, respectively. Underwriting income or loss is determined by deducting losses and LAE, commission expense, and underwriting and other operating expenses from net premiums earned. Key factors that affected our financial performance during 2015 and 2014, each compared to the previous year, respectively, include:
• | Net premiums earned increased 1% and 7%; |
• | Losses and LAE decreased 5% and 2%; |
• | Underwriting and other operating expenses increased 5% and 3%; |
• | Net realized (losses) gains on investments of $(10.7) million, $16.3 million, and $9.5 million in 2015, 2014, and 2013, respectively; and |
• | Income tax expense was $5.0 million and $5.9 million in 2015 and 2014, respectively, while we had an income tax benefit of $10.7 million in 2013. |
In 2015, we continued to execute a number of strategic initiatives, including: focusing on internal and customer facing business process excellence; emphasizing the settlement of open claims; diversifying our risk exposure across our markets; utilizing a three-company pricing platform; utilizing territorial multipliers in California; non-renewing under-performing business; and targeting profitable classes of business across all of our markets.
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The following items were included in our 2015 results of operations: (1) favorable prior year accident year loss development of $7.2 million, including a $9.0 million favorable development on our voluntary business, partially offset by a $1.8 million unfavorable development on our assigned risk business, which decreased our losses and LAE by the same amount; (2) favorable development in the estimated reserves ceded under the LPT Agreement that resulted in a $6.4 million cumulative adjustment to the Deferred Gain and reduced our losses and LAE by the same amount (LPT Reserve Adjustment); (3) an increase in the contingent commission receivable under the LPT Agreement that resulted in a $2.6 million cumulative adjustment, which reduced our losses and LAE by the same amount (LPT Contingent Commission Adjustment); and (4) a reallocation of $56.3 million of reserves from non-taxable periods prior to January 1, 2000, which reduced our tax expenses by $15.3 million and reduced our effective tax rate by 15.4 percentage points. Collectively, these items increased net income by $31.5 million for the year ended December 31, 2015.
The following items were included in our 2014 results of operations: (1) favorable development in the estimated reserves ceded under the LPT Agreement that resulted in a $31.1 million LPT Reserve Adjustment; (2) an increase in the contingent commission receivable under the LPT Agreement that resulted in a $10.8 LPT Contingent Commission Adjustment; and (3) a reallocation of $13.1 million of reserves from non-taxable periods prior to January 1, 2000, which reduced our effective tax rate by 3.4 percentage points, or $3.6 million. Collectively, these items increased net income by $45.5 million for the year ended December 31, 2014.
The following items were included in our 2013 results of operations: (1) unfavorable prior accident year loss development of $6.9 million, including $5.0 million related to California loss reserves for the 2009 through 2011 accident years and $1.9 million related to our assigned risk business, which increased our losses and LAE by the same amount; (2) favorable development in the estimated reserves ceded under the LPT Agreement, which resulted in a $19.0 million LPT Reserve Adjustment; (3) an increase in the contingent commission receivable under the LPT Agreement that resulted in a $4.3 million LPT Contingent Commission Adjustment; and (4) a reallocation of reserves from non-taxable periods prior to January 1, 2000, which reduced our effective tax rate by 13.9 percentage points, or $7.4 million. Collectively, these items increased net income by $23.8 million for the year ended December 31, 2013.
The comparative components of net income are set forth in the following table:
Years Ended December 31, | |||||||||||
2015 | 2014 | 2013 | |||||||||
(in millions) | |||||||||||
Gross premiums written | $ | 697.7 | $ | 697.7 | $ | 689.9 | |||||
Net premiums written | $ | 689.3 | $ | 687.6 | $ | 678.5 | |||||
Net premiums earned | $ | 690.4 | $ | 684.5 | $ | 642.3 | |||||
Net investment income | 72.2 | 72.4 | 70.8 | ||||||||
Net realized (losses) gains on investments | (10.7 | ) | 16.3 | 9.5 | |||||||
Other income | 0.2 | 0.3 | 0.9 | ||||||||
Total revenues | 752.1 | 773.5 | 723.5 | ||||||||
Losses and LAE | 429.4 | 453.4 | 463.6 | ||||||||
Commission expense | 85.4 | 81.4 | 78.3 | ||||||||
Underwriting and other operating expenses | 135.2 | 129.1 | 125.3 | ||||||||
Interest expense | 2.7 | 3.0 | 3.2 | ||||||||
Income tax expense (benefit) | 5.0 | 5.9 | (10.7 | ) | |||||||
Total expenses | 657.7 | 672.8 | 659.7 | ||||||||
Net income | $ | 94.4 | $ | 100.7 | $ | 63.8 | |||||
Less amortization of the Deferred Gain related to losses | 9.5 | 11.2 | 12.9 | ||||||||
Less amortization of the Deferred Gain related to contingent commission | 1.9 | 1.9 | 1.7 | ||||||||
Less impact of LPT Reserve Adjustments(1) | 6.4 | 31.1 | 19.0 | ||||||||
Less impact of LPT Contingent Commission Adjustments(2) | 2.6 | 10.8 | 4.3 | ||||||||
Net income before impact of the LPT Agreement(3) | $ | 74.0 | $ | 45.7 | $ | 25.9 | |||||
(1) | Any adjustment to the estimated reserves ceded under the LPT Agreement results in a cumulative adjustment to the Deferred Gain, which is included in losses and LAE incurred in the Consolidated Statements of Comprehensive Income, such that the Deferred Gain reflects the balance that would have existed had the revised reserves been recognized at the inception of the LPT Agreement. (See Note 2 in the Notes to our Consolidated Financial Statements.) |
(2) | Any adjustment to the contingent profit commission under the LPT Agreement results in a cumulative adjustment to the Deferred Gain, which is also recognized in losses and LAE incurred in the Consolidated Statements of Comprehensive Income, such that the Deferred |
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Gain reflects the balance that would have existed had the revised contingent profit commission been recognized at the inception of the LPT Agreement. (See Note 2 in the Notes to our Consolidated Financial Statements.)
(3) | We define net income before impact of the LPT Agreement as net income before the impact of: (a) amortization of Deferred Gain; (b) adjustments to LPT Agreement ceded reserves; and (c) adjustments to Contingent commission receivable –LPT Agreement. Deferred Gain reflects the unamortized gain from our LPT Agreement. Under GAAP, this gain is deferred and is being amortized using the recovery method. Amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries over the life of the LPT Agreement, except for the contingent profit commission, which is amortized through June 30, 2024. The amortization is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT Agreement and the expected losses and LAE subject to the contingent profit commission under the LPT Agreement. Our reevaluation results in corresponding adjustments, if needed, to reserves, ceded reserves, contingent commission receivable, and the Deferred Gain, with the net effect being an increase or decrease to net income. Net income before impact of the 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 or net income, or any other measure of performance derived in accordance with GAAP. |
We present net income before impact of the 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, under which the Deferred Gain does not effect our ongoing operations, 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.
Gross Premiums Written
Gross premiums written were $697.7 million, $697.7 million, and $689.9 million for the years ended December 31, 2015, 2014, and 2013, respectively. During this period, overall premiums have remained relatively flat; however, certain strategic initiatives, including diversifying our risk exposure across our markets and non-renewing under-performing business, have resulted in premium declines in California, while premiums in other states grew.
Net Premiums Earned
Net premiums earned were $690.4 million, $684.5 million, and $642.3 million for the years ended December 31, 2015, 2014, and 2013, respectively. The increase in 2015 was primarily related to increased final premium audit billings during the second half of 2015, while the increase in 2014 was primarily due to increasing policy count and higher net rate. Additionally, we saw an increase in premiums from renewals in the fourth quarter of 2015.
The following table shows the percentage change in our in-force premiums, policy count, average policy size, payroll exposure upon which our premiums are based, and net rate as of December 31, 2015 and 2014, respectively, overall and for California, where 57% of our premiums are generated:
Percentage Change 2015 Over 2014 | Percentage Change 2014 Over 2013 | ||||||||||||||||
Overall | California | All Other States | Overall | California | All Other States | ||||||||||||
In-force premiums | (1.3 | )% | (5.0 | )% | 4.0 | % | 1.7 | % | 0.8 | % | 3.0 | % | |||||
In-force policy count | (0.9 | ) | (6.4 | ) | 5.8 | 1.5 | (2.0 | ) | 6.1 | ||||||||
Average in-force policy size | (0.4 | ) | 1.5 | (1.7 | ) | 0.2 | 2.8 | (2.9 | ) | ||||||||
In-force payroll exposure | 1.4 | (5.7 | ) | 6.0 | (2.1 | ) | (9.3 | ) | 3.2 | ||||||||
Net rate(1) | (2.7 | ) | 0.7 | (1.9 | ) | 3.9 | 11.2 | (0.2 | ) | ||||||||
(1) | Net rate, defined as total in-force premiums 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. |
Net Investment Income and Net 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, 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.
Net investment income was $72.2 million, $72.4 million, and $70.8 million for the years ended December 31, 2015, 2014, and 2013, respectively. The average pre-tax book yield on invested assets was 3.2%, 3.2%, and 3.4% at December 31, 2015, 2014, and 2013, respectively, while the tax-equivalent yield on invested assets was 3.8%, 3.8%, and 4.0% as of the same dates, respectively.
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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 also recognized when securities are written down as a result of an other-than-temporary impairment.
Net realized (losses) gains on investments were $(10.7) million, $16.3 million, and $9.5 million for the years ended December 31, 2015, 2014, and 2013, respectively. Net realized losses on investments in 2015 were primarily the result of other-than-temporary impairments of certain equity securities during the fourth quarter due to the continued downturn in the energy sector. The higher net realized gains on investments for the year ended December 31, 2014 was primarily related to a re-balancing of our investment portfolio. Additional information regarding our Investments is set forth under “–Liquidity and Capital Resources–Investments” and Note 6 in the Notes to our Consolidated Financial Statements.
Combined Ratio
The combined ratio, a key measurement of underwriting profitability, is the sum of the loss and LAE ratio, the commission expense 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 have recorded an underwriting loss, and 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, which increased the combined ratio by 2.0, 2.0, and 1.9 percentage points for the years ended December 31, 2015, 2014, and 2013, respectively.
The following table provides the calculation of our calendar year combined ratios.
Years Ended December 31, | ||||||||
2015 | 2014 | 2013 | ||||||
Loss and LAE ratio | 62.2 | % | 66.2 | % | 72.2 | % | ||
Underwriting and other operating expenses ratio | 19.5 | 18.9 | 19.5 | |||||
Commission expense ratio | 12.4 | 11.9 | 12.2 | |||||
Combined ratio | 94.1 | % | 97.0 | % | 103.9 | % | ||
Loss and LAE Ratio. This is the ratio of losses and LAE to net premiums earned.
We analyze our loss and LAE ratios on both a calendar year and accident year basis. A calendar year loss and LAE ratio is calculated by dividing the losses and LAE incurred during the calendar year, regardless of when the underlying insured event occurred, by the net premiums earned during that calendar year. The calendar year loss and LAE ratio includes changes made during the calendar year in reserves for losses and LAE established for insured events occurring in the current and prior years. A calendar year loss and LAE ratio is calculated using premiums and losses and LAE that are net of amounts ceded to reinsurers. The calendar year loss and LAE ratio for a particular year will not change in future periods.
The accident year loss and LAE ratio is calculated by dividing the losses and LAE, regardless of when such loss and LAE are incurred, for insured events that occurred during a particular year by the net premiums earned for that year. The accident year losses and LAE ratio is calculated using premiums and losses and LAE that are net of amounts ceded to reinsurers. The accident year loss and LAE ratio for a particular year can decrease or increase when recalculated in subsequent periods as the reserves established for insured events occurring during that year develop favorably or unfavorably, and is an operating ratio based on our statutory financial statements and is not derived from our GAAP financial information.
We analyze our calendar year loss and LAE ratio to measure our profitability in a particular year and to evaluate the adequacy of our premium rates charged in a particular year to cover expected losses and LAE from all periods, including development (whether favorable or unfavorable) of reserves established in prior periods. In contrast, we analyze our accident year loss and LAE ratios to evaluate our underwriting performance and the adequacy of the premium rates we charged in a particular year in relation to ultimate losses and LAE from insured events occurring during that year. The loss and LAE ratios provided in this report are calendar year basis, except where they are expressly identified as accident year loss and LAE ratios.
Losses and LAE represents our largest expense item and includes claim payments made, amortization of the Deferred Gain, LPT Reserve Adjustments, LPT Contingent Commission Adjustments, 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.
Our indemnity claims frequency (the number of claims expressed as a percentage of payroll) continued to decrease year-over-year in 2015 and 2014; however, our loss experience indicates a slight upward movement in medical and indemnity costs per claim that are reflected in our current accident year loss estimates. In California, we experienced increased costs per claim associated with an increase in the number of cumulative trauma claims filed during 2015 and 2014, compared to 2013. Total claims costs
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have also been reduced by cost savings associated with increased claims settlement activity beginning in 2014 and continuing through 2015. We believe our current accident year loss estimate is adequate; however, ultimate losses will not be known with any certainty for many 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, which may be offset by rate increases. Additional information regarding our reserves for losses and LAE is set forth under “–Critical Accounting Policies–Reserves for Losses and LAE.”
Overall, losses and LAE were $429.4 million, $453.4 million, and $463.6 million for the years ended December 31, 2015, 2014, and 2013, respectively. The decreases from 2013 through 2015 were primarily due to a decrease in the current accident year loss estimate, partially offset by higher net premiums earned over that period. Additionally, there were favorable LPT Reserve Adjustments of $6.4 million, $31.1 million, and $19.0 million that decreased losses and LAE by those amounts for the years ended December 31, 2015, 2014, and 2013, respectively. In 2015, we had $7.2 million of favorable prior accident year loss development, which included $9.0 million of favorable prior accident year loss development on our voluntary risk business, which was partially offset by $1.8 million of unfavorable loss development related to our assigned risk business. Prior accident year loss development in 2014 was primarily related to our assigned risk business. Unfavorable prior accident year development in 2013 included $5.0 million related to California loss reserves for the 2009 through 2011 accident years and $1.9 million related to our assigned risk business. Our current accident year loss estimates were 66.2%, 73.6%, and 77.0% for the years ended December 31, 2015, 2014, and 2013, respectively. The decreasing trend in our current accident year loss estimates reflects the impact of key business initiatives, including: emphasizing the settlement of open claims; diversifying our risk exposure across our markets; non-renewing under-performing business; and targeting profitable classes of business across all of our markets.
Excluding the impact from the LPT Agreement, losses and LAE would have been $449.8 million, $508.4 million, and $501.5 million, or 65.2%, 74.3%, and 78.1% of net premiums earned, for the years ended December 31, 2015, 2014, and 2013, respectively.
The table below reflects losses and LAE reserve adjustments and the impact of the LPT on net income before taxes.
Years Ended December 31, | |||||||||||
2015 | 2014 | 2013 | |||||||||
(in millions) | |||||||||||
Prior accident year favorable (unfavorable) development, net | $ | 7.2 | $ | (4.6 | ) | $ | (7.0 | ) | |||
Amortization of the Deferred Gain related to losses | $ | 9.5 | $ | 11.2 | $ | 12.9 | |||||
Amortization of the Deferred Gain related to contingent commission | 1.9 | 1.9 | 1.7 | ||||||||
Impact of LPT Reserve Adjustments | 6.4 | 31.1 | 19.0 | ||||||||
Impact of LPT Contingent Commission Adjustments | 2.6 | 10.8 | 4.3 | ||||||||
Total impact of the LPT | 20.4 | 55.0 | 37.9 | ||||||||
Total losses and LAE reserve adjustments | $ | 27.6 | $ | 50.4 | $ | 30.9 | |||||
Underwriting and Other Operating Expenses Ratio. The underwriting and other operating expenses ratio is the ratio 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 policyholder dividends, 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. Other operating costs are more fixed in nature and become a smaller percentage of net premiums earned as premiums increase.
Our underwriting and other operating expenses ratio was 19.5%, 18.9%, and 19.5%, and our underwriting and other operating expenses were $135.2 million, $129.1 million, and $125.3 million for the years ended December 31, 2015, 2014, and 2013, respectively. During the year ended December 31, 2015, our bad debt allowance increased $2.8 million, our compensation-related expenses increased $1.5 million, professional fees increased $1.2 million, and IT expense increased $0.9 million, partially offset by a $0.8 million decrease in our premium taxes and assessments, compared to 2014. During the year ended December 31, 2014, premium taxes and assessments increased $1.6 million as net premiums earned increased, professional fees increased $1.0 million, and policyholder dividends increased $0.8 million, compared to 2013.
Commission Expense Ratio. The commission expense ratio is the ratio 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.
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Our commission expense ratio was 12.4%, 11.9%, and 12.2%, and our commission expense was $85.4 million, $81.4 million, and $78.3 million for the years ended December 31, 2015, 2014, and 2013, respectively. The increase in the commission expense ratio in 2015 was primarily due to higher agency incentives, compared to 2014. The decrease in our commission expense ratio in 2014, compared to 2013, was primarily due to lower base commissions paid and lower agency incentives.
Interest Expense
We incur interest expenses on notes payable. Interest expense was $2.7 million, $3.0 million, and $3.2 million for the years ended December 31, 2015, 2014, and 2013, respectively. The decrease in interest expense from 2013 through 2015 was primarily due to the reduction in principal balance on our credit facility with Wells Fargo by $10.0 million in the fourth quarters of each of 2013 and 2014. The remaining $60.0 million principal balance on our credit facility was repaid in the fourth quarter of 2015. Interest paid on the credit facility during the years ended December 31, 2015, 2014, and 2013 totaled $1.3 million, $1.4 million, and $1.6 million, respectively.
Income Tax Expense (Benefit)
Income tax expense (benefit) was $5.0 million, $5.9 million, and $(10.7) million for the years ended December 31, 2015, 2014, and 2013, respectively. The effective tax rate was 5.0%, 5.5%, and (20.2)% for the years ended December 31, 2015, 2014, and 2013, respectively. The decrease in income tax expense in 2015, compared to 2014, was primarily due to the reallocation of $56.3 million in reserves from non-taxable periods prior to January 1, 2000, which reduced our effective tax rate by 15.4 percentage points for the year. The increase in income tax expense in 2014, compared to 2013, was primarily due to increased underwriting income. Underwriting income was $40.4 million, $20.6 million, and $(24.9) million in 2015, 2014, and 2013, respectively.
For additional information regarding our income tax expense (benefit) see Note 8 in the Notes to our Consolidated Financial Statements.
Liquidity and Capital Resources
Holding Company Liquidity
We are a holding company and our ability to fund our operations is contingent upon existing capital and the ability of our insurance subsidiaries' to pay dividends up to the holding company. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws and regulations, including laws establishing minimum solvency and liquidity thresholds. We require cash to pay stockholder dividends, repurchase common stock, make interest and principal payments on any outstanding debt obligations, provide additional surplus to our insurance subsidiaries, and fund our operating expenses.
Based on reported capital, surplus, and dividends paid within the last 12 months, the maximum dividends that may be paid by EICN and EPIC in 2016, without prior approval by the respective state insurance regulator, are $49.7 million and $28.1 million, respectively.
The holding company had $27.1 million of cash and cash equivalents and fixed maturity securities maturing within the next 24 months at December 31, 2015. Total cash and investments at the holding company was $95.2 million at December 31, 2015. We believe that the liquidity needs of the holding company over the next 24 months will be met with cash, investments, and dividends from our insurance subsidiaries.
Operating Subsidiaries' Liquidity
The primary sources of cash for our insurance operating subsidiaries are funds generated from underwriting operations, investment income, maturities and sales of investments, and capital contributions from the parent holding company. 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 $344.4 million of cash and cash equivalents and fixed maturity securities maturing within the next 24 months at December 31, 2015. We believe that our subsidiaries' liquidity needs over the next 24 months will be met with cash from operations, investment income, and maturing investments.
Each of our insurance subsidiaries, EICN, ECIC, EPIC, and EAC, became a member of the Federal Home Loan Bank of San Francisco (FHLB) in January 2016. Membership allows our subsidiaries access to collateralized advances, which may be used to support and enhance liquidity management. The amount of advances that may be taken is dependent on statutory admitted assets on a per company basis. Currently, none of our subsidiaries has advances outstanding under the FHLB facility.
We purchase reinsurance to protect us against the costs of severe claims and catastrophic events. On July 1, 2015, we entered into a new reinsurance program that is effective through June 30, 2016. The reinsurance program consists of one treaty covering excess of loss and catastrophic loss events in five layers of coverage. Our reinsurance coverage is $193.0 million in excess of our $7.0 million retention on a per occurrence basis, subject to certain exclusions. We believe that our reinsurance program meets our needs and that we are sufficiently capitalized.
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Our insurance subsidiaries are required by law to maintain a certain minimum level of surplus on a statutory basis. Surplus is calculated by subtracting total liabilities from total admitted assets. The amount of capital in our insurance subsidiaries is maintained relative to standardized capital adequacy measures such as risk-based capital (RBC), as established by the National Association of Insurance Commissioners. The RBC standard was designed to provide a measure by which regulators can assess the adequacy of an insurance company's capital and surplus relative to its operations. An insurance company must maintain capital and surplus of at least 200% of RBC. Each of our insurance subsidiaries had total adjusted capital in excess of the minimum RBC requirements that correspond to any level of regulatory action at December 31, 2015.
Various state regulations require us to keep securities or letters of credit on deposit with certain states in which we do business. Securities having a fair market value of $881.2 million and $783.9 million were on deposit at December 31, 2015 and 2014, respectively. These laws and regulations govern both the amount and types of fixed maturity securities that are 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. We held fixed maturity securities and restricted cash and cash equivalents that had a fair value of $32.7 million and $33.3 million in trust for the benefit of ceding reinsurers at December 31, 2015 and 2014, respectively.
Sources of Liquidity
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 additional information regarding our cash flows, see Item 8, Consolidated Statement of Cash Flows.
Years Ended December 31, | |||||||||||
2015 | 2014 | 2013 | |||||||||
Cash and cash equivalents provided by (used in): | (in millions) | ||||||||||
Operating activities | $ | 116.4 | $ | 171.9 | $ | 166.5 | |||||
Investing activities | (101.2 | ) | (86.7 | ) | (260.1 | ) | |||||
Financing activities | (62.2 | ) | (16.1 | ) | (12.6 | ) | |||||
Increase (decrease) in cash and cash equivalents | $ | (47.0 | ) | $ | 69.1 | $ | (106.2 | ) | |||
Operating Activities
Net cash provided by operating activities in 2015 included net premiums received of $678.9 million, and investment income received of $84.9 million. These were partially offset by claims payments of $427.7 million (net of $33.9 million recovered from reinsurers), underwriting and other operating expenses paid of $121.3 million (including premium taxes paid of $21.2 million), and commissions paid of $82.9 million.
Net cash provided by operating activities in 2014 included net premiums received of $673.7 million, and investment income received of $82.7 million. These were partially offset by claims payments of $386.6 million (net of $33.2 million recovered from reinsurers), underwriting and other operating expenses paid of $122.6 million (including premium taxes paid of $27.1 million), and commissions paid of $78.9 million.
Net cash provided by operating activities in 2013 included net premiums received of $624.0 million, and investment income received of $78.8 million. These were partially offset by claims payments of $332.8 million (net of $33.1 million recovered from reinsurers), underwriting and other operating expenses paid of $131.2 million (including premium taxes paid of $22.7 million), and commissions paid of $75.1 million.
Investing Activities
Net cash used in investing activities in 2015, 2014, and 2013 was primarily related to the investment of premiums received and the reinvestment of funds from maturities, redemptions, and interest income.
Financing Activities
Net cash used in financing activities in 2015, 2014, and 2013 was primarily to pay stockholder dividends and to pay down the line of credit provided by our credit facility.
Dividends. Dividends paid to stockholders were $7.7 million, $7.6 million, and $7.5 million in 2015, 2014, and 2013, respectively. The declaration and payment of future dividends to holders of our common stock will be at the discretion of our Board of Directors and will depend upon many factors, including our financial position, earnings, capital requirements of our operating subsidiaries, legal and regulatory requirements, and any other factors our Board of Directors deems relevant. On February 16, 2016, the Board of Directors declared a $0.09 dividend per share, payable March 15, 2016, to stockholders of record on March 1, 2016.
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Share Repurchases. On February 16, 2016, the Board of Directors authorized a share repurchase program for up to $50.0 million of our common stock from February 22, 2016 through February 22, 2018 (the 2016 Program). We expect that shares of common stock may be purchased at prevailing market prices through a variety of methods, including open market or private transactions, in accordance with applicable laws and regulations and as determined by 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 2016 Program may be commenced, modified, or suspended from time-to-time without prior notice.
Capital Resources
Our capital structure is comprised of outstanding debt and stockholders' equity. As of December 31, 2015, our capital structure consisted of $32.0 million in surplus notes maturing in 2034, and $950.3 million of stockholders' equity, including the Deferred Gain. Outstanding debt was 3.3% of total capitalization, including the Deferred Gain, as of December 31, 2015.
Ordinary Share Capital. The following table shows our beginning and ending stockholders' equity balance.
December 31, | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
(in millions) | ||||||||||||
Beginning Balance | $ | 686.8 | $ | 568.7 | $ | 539.4 | ||||||
Stock-based compensation | 4.6 | 6.0 | 5.6 | |||||||||
Stock options exercised | 7.6 | 2.2 | 7.4 | |||||||||
Vesting of restricted stock units, net of shares withheld to satisfy minimum tax withholding | (2.7 | ) | (0.6 | ) | (0.9 | |||||||