Document


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549


FORM 10-Q

R  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 2016

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____  to ____

Commission file number: 001-33245

EMPLOYERS HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Nevada
(State or other jurisdiction
of incorporation or organization)
 
04-3850065
(I.R.S. Employer
Identification Number)
 
 
 
10375 Professional Circle, Reno, Nevada  89521
(Address of principal executive offices and zip code)
(888) 682-6671
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer R
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No R
 
Class
 
October 20, 2016
Common Stock, $0.01 par value per share
 
32,087,739 shares outstanding



TABLE OF CONTENTS
 
 
Page
No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


PART I – FINANCIAL INFORMATION
Item 1.  Consolidated Financial Statements
Employers Holdings, Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands, except share data)
 
 
As of
 
As of
 
 
September 30,
2016
 
December 31,
2015
Assets
 
(unaudited)
 
 
Available for sale:
 
 
 
 
Fixed maturity securities at fair value (amortized cost $2,273,100 at September 30, 2016 and $2,221,100 at December 31, 2015)
 
$
2,383,900

 
$
2,288,500

Equity securities at fair value (cost $114,400 at September 30, 2016 and $137,500 at December 31, 2015)
 
184,500

 
198,700

Short-term investments at fair value (amortized cost $14,000 at September 30, 2016)
 
14,000

 
—

Total investments
 
2,582,400


2,487,200

Cash and cash equivalents
 
84,100

 
56,600

Restricted cash and cash equivalents
 
2,700

 
2,500

Accrued investment income
 
20,300

 
20,600

Premiums receivable (less bad debt allowance of $10,700 at September 30, 2016 and $12,200 at December 31, 2015)
 
317,100

 
301,100

Reinsurance recoverable for:
 
 
 
 
Paid losses
 
8,300

 
7,700

Unpaid losses
 
591,500

 
628,200

Deferred policy acquisition costs
 
46,800

 
44,300

Deferred income taxes, net
 
41,100

 
67,900

Property and equipment, net
 
22,600

 
24,900

Intangible assets, net
 
8,300

 
8,500

Goodwill
 
36,200

 
36,200

Contingent commission receivable—LPT Agreement
 
31,100

 
29,200

Other assets
 
31,800

 
40,900

Total assets
 
$
3,824,300

 
$
3,755,800

 
 
 
 
 
Liabilities and stockholders’ equity
 
 

 
 

Claims and policy liabilities:
 
 

 
 

Unpaid losses and loss adjustment expenses
 
$
2,330,000

 
$
2,347,500

Unearned premiums
 
325,600

 
308,900

Total claims and policy liabilities
 
2,655,600

 
2,656,400

Commissions and premium taxes payable
 
50,500

 
52,500

Accounts payable and accrued expenses
 
17,500

 
24,100

Deferred reinsurance gain—LPT Agreement
 
177,800

 
189,500

Notes payable
 
32,000

 
32,000

Other liabilities
 
40,800

 
40,500

Total liabilities
 
$
2,974,200

 
$
2,995,000

Commitments and contingencies
 


 


Stockholders’ equity:
 
 

 
 

Common stock, $0.01 par value; 150,000,000 shares authorized; 56,124,974 and 55,589,454 shares issued and 32,109,976 and 32,216,480 shares outstanding at September 30, 2016 and December 31, 2015, respectively
 
$
600

 
$
600

Preferred stock, $0.01 par value; 25,000,000 shares authorized; none issued
 
—

 
—

Additional paid-in capital
 
368,600

 
357,200

Retained earnings
 
744,500

 
682,000

Accumulated other comprehensive income, net
 
117,600

 
83,600

Treasury stock, at cost (24,014,998 shares at September 30, 2016 and 23,372,974 shares at December 31, 2015)
 
(381,200
)
 
(362,600
)
Total stockholders’ equity
 
850,100

 
760,800

Total liabilities and stockholders’ equity
 
$
3,824,300

 
$
3,755,800

See accompanying unaudited notes to the consolidated financial statements.

3


Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
(in thousands, except per share data)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016

2015
Revenues
 
(unaudited)
 
(unaudited)
Net premiums earned
 
$
173,300

 
$
179,000

 
$
522,800

 
$
508,600

Net investment income
 
17,900

 
18,500

 
54,100

 
53,800

Net realized gains on investments
 
1,600

 
2,000

 
9,100

 
5,100

Other income
 
—

 
—

 
600

 
100

Total revenues
 
192,800

 
199,500

 
586,600

 
567,600

Expenses
 
 

 
 

 
 
 
 
Losses and loss adjustment expenses
 
109,000

 
115,800

 
328,000

 
323,500

Commission expense
 
21,300

 
21,000

 
63,500

 
62,600

Underwriting and other operating expenses
 
31,700

 
31,600

 
101,600

 
97,600

Interest expense
 
400

 
700

 
1,200

 
2,100

Total expenses
 
162,400

 
169,100

 
494,300

 
485,800

Net income before income taxes
 
30,400

 
30,400

 
92,300

 
81,800

Income tax expense
 
7,800

 
5,900

 
21,100

 
14,100

Net income
 
$
22,600

 
$
24,500

 
$
71,200

 
$
67,700

Comprehensive income
 
 
 
 
 
 
 
 
Unrealized (losses) gains during the period (net of tax (benefit) expense of $(2,300) and $(5,900) for the three months ended September 30, 2016 and 2015, respectively, and $21,500 and $(14,200) for the nine months ended September 30, 2016 and 2015, respectively)
 
$
(4,200
)
 
$
(11,100
)
 
$
39,900

 
$
(26,500
)
Reclassification adjustment for realized gains in net income (net of taxes of $600 and $700 for the three months ended September 30, 2016 and 2015, respectively, and $3,200 and $1,800 for the nine months ended September 30, 2016 and 2015, respectively)
 
(1,000
)
 
(1,300
)
 
(5,900
)

(3,300
)
Other comprehensive (loss) income, net of tax
 
(5,200
)
 
(12,400
)
 
34,000

 
(29,800
)
Total comprehensive income
 
$
17,400

 
$
12,100

 
$
105,200

 
$
37,900

 
 
 
 
 
 
 
 
 
Net realized gains on investments
 
 
 
 
 
 
 
 
Net realized gains on investments before credit related impairments
 
$
1,600

 
$
2,100

 
$
14,400

 
$
5,300

Other than temporary impairment recognized in earnings
 
—

 
(100
)
 
(5,300
)
 
(200
)
Net realized gains on investments
 
$
1,600

 
$
2,000

 
$
9,100

 
$
5,100

 
 
 
 
 
 
 
 
 
Earnings per common share (Note 11):
 
 
 
 
 
 
 
 
Basic
 
$
0.70

 
$
0.76

 
$
2.19

 
$
2.12

Diluted
 
$
0.69

 
$
0.75

 
$
2.16

 
$
2.08

Cash dividends declared per common share
 
$
0.09

 
$
0.06

 
$
0.27

 
$
0.18

See accompanying unaudited notes to the consolidated financial statements.

4


Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
 
 
Nine Months Ended
 
 
September 30,
 
 
2016
 
2015
Operating activities
 
(unaudited)
Net income
 
$
71,200

 
$
67,700

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
6,400

 
5,900

Stock-based compensation
 
4,300

 
3,200

Amortization of premium on investments, net
 
11,400

 
9,500

Allowance for doubtful accounts
 
(1,500
)
 
3,700

Deferred income tax expense
 
8,500

 
4,500

Realized gains on investments, net
 
(9,100
)
 
(5,100
)
Excess tax benefits from stock-based compensation
 
—

 
(800
)
Other
 
(200
)
 
(100
)
Change in operating assets and liabilities:
 
 

 
 

Premiums receivable
 
(14,500
)
 
(14,300
)
Reinsurance recoverable for paid and unpaid losses
 
36,100

 
38,000

Federal income taxes
 
3,000

 
2,200

Unpaid losses and loss adjustment expenses
 
(17,500
)
 
(11,800
)
Unearned premiums
 
16,700

 
16,300

Accounts payable, accrued expenses and other liabilities
 
(6,200
)
 
2,400

Deferred reinsurance gain—LPT Agreement
 
(11,700
)
 
(14,600
)
Contingent commission receivable—LPT Agreement
 
(1,900
)
 
(2,800
)
Other
 
2,000

 
(9,900
)
Net cash provided by operating activities
 
97,000

 
94,000

Investing activities
 
 

 
 

Purchase of fixed maturity securities
 
(325,200
)
 
(365,600
)
Purchase of equity securities
 
(38,800
)
 
(77,700
)
Purchase of short-term investments
 
(8,000
)
 
(18,500
)
Proceeds from sale of fixed maturity securities
 
111,700

 
87,000

Proceeds from sale of equity securities
 
70,200

 
21,400

Proceeds from maturities and redemptions of investments
 
145,100

 
214,000

Capital expenditures
 
(3,900
)
 
(7,400
)
Change in restricted cash and cash equivalents
 
(200
)
 
7,700

Net cash used in investing activities
 
(49,100
)
 
(139,100
)
Financing activities
 
 

 
 

Acquisition of treasury stock
 
(18,600
)
 
—

Cash transactions related to stock-based compensation
 
7,100

 
3,100

Dividends paid to stockholders
 
(8,800
)
 
(5,800
)
Payments on notes payable and capital leases
 
(100
)

(400
)
Excess tax benefits from stock-based compensation
 
—

 
800

Net cash used in financing activities
 
(20,400
)
 
(2,300
)
Net increase (decrease) in cash and cash equivalents
 
27,500

 
(47,400
)
Cash and cash equivalents at the beginning of the period
 
56,600

 
103,600

Cash and cash equivalents at the end of the period
 
$
84,100

 
$
56,200

 See accompanying unaudited notes to the consolidated financial statements.

5


Employers Holdings, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
 (Unaudited)
1. Basis of Presentation and Summary of Operations
Employers Holdings, Inc. (EHI) is a Nevada holding company. Through its wholly owned insurance subsidiaries, Employers Insurance Company of Nevada (EICN), Employers Compensation Insurance Company (ECIC), Employers Preferred Insurance Company (EPIC), and Employers Assurance Company (EAC), EHI is engaged in the commercial property and casualty insurance industry, specializing in workers' compensation products and services. Unless otherwise indicated, all references to the “Company” refer to EHI, together with its subsidiaries.
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) necessary for a fair presentation of the Company’s consolidated financial position and results of operations for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. These financial statements have been prepared consistent with the accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
The Company considers an operating segment to be any component of its business whose operating results are regularly reviewed by the Company’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance based on discrete financial information. Currently, the Company has one operating segment, workers’ compensation insurance and related services.
Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. As a result, actual results could differ from these estimates. The most significant areas that require management judgment are the estimate of unpaid losses and loss adjustment expenses (LAE), evaluation of reinsurance recoverables, recognition of premium revenue, deferred income taxes, and investments.
Reclassifications
Certain prior period information has been reclassified to conform to the current period presentation.
2. Change in Estimates
The Company reduced its estimated reserves ceded under the Loss Portfolio Transfer Agreement (LPT Reserve Adjustment) as a result of the determination that an adjustment was necessary to reflect observed favorable paid loss trends during the second quarter of 2016. The following table shows the financial statement impact related to the reduction in estimated reserves ceded under the Loss Portfolio Transfer Agreement (LPT Agreement).
 
 
Nine Months Ended
 
 
September 30, 2016
 
 
(in millions, except per share data)
Change in estimated reserves ceded under the LPT Agreement
 
$
(5.0
)
Cumulative adjustment to the Deferred Gain(1)
 
(3.1
)
Net income impact of change in estimate
 
3.1

EPS impact of change in estimate
 
 
Basic
 
0.10

Diluted
 
0.09

(1)
The cumulative adjustment to the Deferred reinsurance gain–LPT Agreement (Deferred Gain) was also recognized in losses and LAE incurred in the Consolidated Statement of Comprehensive Income, so that the Deferred Gain reflects the balance that would have existed had the revised reserves been recognized at the inception of the LPT Agreement.

6


The Company increased its estimate of contingent commission receivable – LPT Agreement (LPT Contingent Commission Adjustment) as a result of the determination that an adjustment was necessary to reflect observed favorable paid loss trends during the second quarter of 2016. The following table shows the financial statement impact related to these changes in estimates.
 
 
Nine Months Ended
 
 
September 30, 2016
 
 
(in millions, except per share data)
Change in estimate of contingent commission receivable – LPT Agreement
 
$
1.9

Cumulative adjustment to the Deferred Gain(1)
 
(1.8
)
Net income impact of change in estimate
 
1.8

EPS impact of change in estimate
 
 
Basic
 
0.06

Diluted
 
0.05

(1)
The cumulative adjustment to the Deferred Gain was also recognized in losses and LAE incurred in the Consolidated Statement of Comprehensive Income, so that the Deferred Gain reflects the balance that would have existed had the revised reserves been recognized at the inception of the LPT Agreement.
3. New Accounting Standards
Recently Adopted Accounting Standards
In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) Number 2016-09, Compensation - Stock Compensation (Topic 718). This update simplifies several aspects of the accounting for share-based payment award transactions, including income taxes and classification of awards on the balance sheet and on the statement of cash flows. This update becomes effective for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2016 and early adoption is permitted. The Company elected to early adopt this standard in the quarter ended September 30, 2016 with an effective date of January 1, 2016. Adoption of this standard had the following impacts on the Company's consolidated financial statements:
•
Consolidated Statements of Comprehensive Income – This standard requires that the tax effects of stock-based compensation be recognized in the income tax expense. Net tax benefits related to stock-based compensation of $0.1 million and $1.4 million were recognized as reductions to Income tax expense and increases to Net income in the Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2016, respectively. These changes had no impact on the Company's basic and diluted earnings per share for the three months ended September 30, 2016, but increased basic and diluted earnings per share by $0.04 for the nine months ended September 30, 2016. This standard also requires that assumed proceeds under the treasury stock method be modified to exclude the excess tax benefits that would have been recognized in Additional paid-in capital. These changes were applied on a prospective basis.
•
Consolidated Statements of Cash Flows – This standard requires that the excess tax benefits from stock-based compensation be reported as cash flows from operating activities rather than the previous requirement to present the excess tax benefits from stock-based compensation as an inflow from financing activities and an outflow from operating activities. This update resulted in a change in presentation that was applied on a prospective basis and prior periods have not been adjusted.
This standard allows the Company to make a policy election as to whether it will include an estimate of stock-based compensation awards expected to be forfeited or whether it will account for forfeitures as they occur. The Company has elected to continue to estimate forfeitures in the computation of its stock-based compensation, consistent with previous guidance, and had no impact on the Company's consolidated financial statements.
Finally, this standard allows the Company to withhold an amount in excess of the supplemental rate from an employee’s stock-based compensation for federal tax withholding purposes without triggering liability accounting. It also clarifies that all cash payments made to tax authorities on an employee’s behalf should be presented as cash flows from financing activities in the Consolidated Statements of Cash Flows. This update related to tax withholding and presentation of cash flows had no impact on the Company's consolidated financial statements.
Recently Issued Accounting Standards – Not Yet Adopted
In January 2016, the FASB issued ASU Number 2016-01, Financial Instruments - Overall (Subtopic 825-10). This update replaces the guidance to classify equity securities with readily determinable fair values into different categories (trading or available-for-sale) and requires equity securities to be measured at fair value with changes in fair value recognized through net income.

7


Additionally, this update eliminates the method and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost. It requires financial instruments to be measured at fair value using the exit price notion. Furthermore, this update clarifies that an evaluation of deferred tax assets related to available-for-sale securities is needed, in combination with an evaluation of other deferred tax assets, to determine if a valuation allowance is required. This update becomes effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. This update will result in a reclassification adjustment, net of tax, to retained earnings from accumulated other comprehensive income, which will be determined based on the fair value of securities at the effective date of adoption.
In February 2016, the FASB issued ASU Number 2016-02, Leases (Topic 842). This update provides guidance on a new lessee model that includes the recognition of assets and liabilities arising from lease transactions on the balance sheet. Additionally, the update provides clarity on the definition of a lease and the distinction between finance and operating leases. Furthermore, the update requires certain qualitative and quantitative disclosures pertaining to the amounts recorded in the financial statements. This update becomes effective for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2018 and early adoption is permitted. The Company has not yet estimated the full impact that the adoption will have on its consolidated financial condition and results of operations.
In June 2016, the FASB issued ASU Number 2016-13, Financial Instruments - Credit Losses (Topic 326). This update replaces the incurred loss impairment methodology for recognizing credit losses on financial instruments with a methodology that reflects an entity's current estimate of all expected credit losses. This update requires financial assets measured at amortized cost to be presented net of an allowance for credit losses. Additionally, this update requires credit losses on available-for-sale debt securities to be presented as an allowance rather than as a write-down, allowing an entity to also record reversals of credit losses in current period net income. This update becomes effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted as of fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company has not yet estimated the full impact that the adoption will have on its consolidated financial condition and results of operations.
In August 2016, the FASB issued ASU Number 2016-15, Statement of Cash Flows (Topic 230). This update provides guidance and clarification on eight specific cash flow issues due to diversity in practice of how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The cash flow issues affected are debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments or other debt instruments with coupon rates that are insignificant in relation to the effective interest rate of the borrowing, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, beneficial interest in securitization transactions, and separately identifiable cash flows and application of the predominance principle. This update becomes effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The Company has not yet estimated the full impact that the adoption will have on its consolidated financial condition and results of operations.
4. Fair Value of Financial Instruments
The carrying value and the estimated fair value of the Company’s financial instruments were as follows:
 
 
September 30, 2016
 
December 31, 2015
 
 
Carrying Value
 
Estimated Fair Value
 
Carrying Value
 
Estimated Fair Value
 
 
(in millions)
Financial assets
 
 
 
 
 
 
 
 
Investments
 
$
2,582.4

 
$
2,582.4

 
$
2,487.2

 
$
2,487.2

Cash and cash equivalents
 
84.1

 
84.1

 
56.6

 
56.6

Restricted cash and cash equivalents
 
2.7

 
2.7

 
2.5

 
2.5

Financial liabilities
 
 

 
 

 
 
 
 
Notes payable
 
$
32.0

 
$
35.0

 
$
32.0

 
$
36.6

Assets and liabilities recorded at fair value on the consolidated balance sheets are categorized based upon the levels of judgment associated with the inputs used to measure their fair value. Level inputs are defined as follows:
•
Level 1 - Inputs are unadjusted quoted market prices for identical assets or liabilities in active markets at the measurement date.
•
Level 2 - Inputs other than Level 1 prices that are observable for similar assets or liabilities through corroboration with market data at the measurement date.

8


•
Level 3 - Inputs that are unobservable that reflect management's best estimate of what willing market participants would use in pricing the assets or liabilities at the measurement date.
Fair values of available-for-sale fixed maturity and equity securities are based on quoted market prices, where available. If quoted market prices and an estimate determined by using objectively verifiable information are unavailable, the Company produces an estimate of fair value based on internally developed valuation techniques, which, depending on the level of observable market inputs, will render the fair value estimate as Level 2 or Level 3. The Company bases all of its estimates of fair value for assets on the bid price, as it represents what a third-party market participant would be willing to pay in an arm's length transaction.
These methods of valuation will only produce an estimate of fair value if there is objectively verifiable information to produce a valuation. If objectively verifiable information is not available, the Company would be required to produce an estimate of fair value using some of the same methodologies, making assumptions for market-based inputs that are unavailable.
The Company's estimates of fair value for financial liabilities are based on the interest rates for notes with similar durations to discount the projection of future payments on notes payable. The fair value measurements for notes payable have been determined to be Level 2.
The following table presents the items on the accompanying Consolidated Balance Sheets that are stated at fair value and the corresponding fair value measurements.
 
 
September 30, 2016
 
December 31, 2015
 
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
 
 
(in millions)
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
—

 
$
127.9

 
$
—

 
$
—

 
$
120.2

 
$
—

U.S. Agencies
 
—

 
13.0

 
—

 
—

 
24.4

 
—

States and municipalities
 
—

 
897.2

 
—

 
—

 
854.5

 
—

Corporate securities
 
—

 
996.5

 
—

 
—

 
925.3

 
—

Residential mortgage-backed securities
 
—

 
235.0

 
—

 
—

 
237.9

 
—

Commercial mortgage-backed securities
 
—

 
86.5

 
—

 
—

 
80.3

 
—

Asset-backed securities
 
—

 
27.8

 
—

 
—

 
45.9

 
—

Total fixed maturity securities
 
$
—

 
$
2,383.9

 
$
—

 
$
—

 
$
2,288.5

 
$
—

Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
Corporate equity securities
 
$
179.6

 
$
—

 
$
—

 
$
198.7

 
$
—

 
$
—

Federal Home Loan Bank stock
 
—

 
—

 
4.9

 
—

 
—

 
—

Total equity securities
 
$
179.6

 
$
—

 
$
4.9

 
$
198.7

 
$
—

 
$
—

Short-term investments
 
$
—

 
$
14.0

 
$
—

 
$
—

 
$
—

 
$
—

The following table provides a reconciliation of the beginning and ending balances that are measured using Level 3 inputs for the nine months ended September 30, 2016.
 
 
Equity Securities
 
 
(in millions)
Beginning balance, January 1, 2016
 
$
—

Purchases
 
4.9

Ending balance, September 30, 2016
 
$
4.9

Each of the Company's insurance operating subsidiaries is a member of the Federal Home Loan Bank (FHLB) of San Francisco. Members are required to purchase stock in the FHLB in addition to maintaining collateral deposits that back any funds advanced. Investment in FHLB stock is recorded at cost, as purchases and sales of these securities are at par value with the issuer. The stock is considered a restricted security and is periodically evaluated for impairment based on the ultimate recovery of par value. Due to the nature of FHLB stock, its carrying value approximates fair value.

9


5. Investments
The cost or amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the Company’s investments were as follows:
 
 
Cost or Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
 
(in millions)
At September 30, 2016
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
122.9

 
$
5.0

 
$
—

 
$
127.9

U.S. Agencies
 
11.9

 
1.1

 
—

 
13.0

States and municipalities
 
842.9

 
54.6

 
(0.3
)
 
897.2

Corporate securities
 
957.9

 
39.4

 
(0.8
)
 
996.5

Residential mortgage-backed securities
 
225.3

 
9.7

 
—

 
235.0

Commercial mortgage-backed securities
 
84.5

 
2.0

 
—

 
86.5

Asset-backed securities
 
27.7

 
0.1

 
—

 
27.8

Total fixed maturity securities
 
2,273.1

 
111.9

 
(1.1
)
 
2,383.9

Equity securities
 
 
 
 
 
 
 
 
Corporate equity securities
 
109.5

 
71.4

 
(1.3
)
 
179.6

Federal Home Loan Bank stock
 
4.9

 
—

 
—

 
4.9

Total equity securities
 
114.4

 
71.4

 
(1.3
)
 
184.5

Short-term investments
 
14.0

 
—

 
—

 
14.0

Total investments
 
$
2,401.5

 
$
183.3

 
$
(2.4
)
 
$
2,582.4

At December 31, 2015
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
116.4

 
$
3.9

 
$
(0.1
)
 
$
120.2

U.S. Agencies
 
23.0

 
1.4

 
—

 
24.4

States and municipalities
 
809.4

 
45.1

 
—

 
854.5

Corporate securities
 
913.4

 
19.9

 
(8.0
)
 
925.3

Residential mortgage-backed securities
 
231.8

 
7.1

 
(1.0
)
 
237.9

Commercial mortgage-backed securities
 
81.1

 
0.2

 
(1.0
)
 
80.3

Asset-backed securities
 
46.0

 
—

 
(0.1
)
 
45.9

Total fixed maturity securities
 
2,221.1

 
77.6

 
(10.2
)
 
2,288.5

Equity securities
 
 
 
 
 
 
 
 
Corporate equity securities
 
137.5

 
65.8

 
(4.6
)
 
198.7

Total equity securities
 
137.5

 
65.8

 
(4.6
)
 
198.7

Total investments
 
$
2,358.6

 
$
143.4

 
$
(14.8
)
 
$
2,487.2

The amortized cost and estimated fair value of fixed maturity securities at September 30, 2016, by contractual maturity, are shown below. Expected maturities differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
Amortized Cost
 
Estimated Fair Value
 
 
(in millions)
Due in one year or less
 
$
149.6

 
$
151.2

Due after one year through five years
 
920.1

 
958.6

Due after five years through ten years
 
600.6

 
641.2

Due after ten years
 
265.3

 
283.6

Mortgage and asset-backed securities
 
337.5

 
349.3

Total
 
$
2,273.1

 
$
2,383.9


10


The following is a summary of investments that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or greater as of September 30, 2016 and December 31, 2015.
 
 
September 30, 2016
 
December 31, 2015
 
 
Estimated Fair Value
 
Gross Unrealized Losses
 
Number of Issues
 
Estimated Fair Value
 
Gross Unrealized Losses
 
Number of Issues
 
 
(in millions, except number of issues data)
Less than 12 months:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
—

 
$
—

 
—

 
$
27.4

 
$
(0.1
)
 
20

States and municipalities
 
44.3

 
(0.3
)
 
12

 
—

 
—

 
—

Corporate securities
 
—

 
—

 
—

 
328.4

 
(4.7
)
 
122

Residential mortgage-backed securities
 
—

 
—

 
—

 
50.5

 
(0.8
)
 
24

Commercial mortgage-backed securities
 
—

 
—

 
—

 
51.5

 
(1.0
)
 
22

Asset-backed securities
 
—

 
—

 
—

 
34.1

 
—

 
27

Total fixed maturity securities
 
44.3

 
(0.3
)
 
12

 
491.9

 
(6.6
)
 
215

Equity securities
 
13.5

 
(1.1
)
 
30

 
35.8

 
(4.6
)
 
45

Total less than 12 months
 
$
57.8

 
$
(1.4
)
 
42

 
$
527.7

 
$
(11.2
)
 
260

 
 
 
 
 
 
 
 
 
 
 
 
 
12 months or greater:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
Corporate securities
 
$
24.4

 
$
(0.8
)
 
10

 
$
34.6

 
$
(3.3
)
 
15

Residential mortgage-backed securities
 
—

 
—

 
—

 
7.1

 
(0.2
)
 
25

Asset-backed securities
 
—

 
—

 
—

 
11.1

 
(0.1
)
 
4

Total fixed maturity securities
 
24.4

 
(0.8
)
 
10

 
52.8

 
(3.6
)
 
44

Equity securities
 
2.2

 
(0.2
)
 
7

 
—

 
—

 
—

Total 12 months or greater
 
$
26.6

 
$
(1.0
)
 
17

 
$
52.8

 
$
(3.6
)
 
44

 
 
 
 
 
 
 
 
 
 
 
 
 
Total available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
—

 
$
—

 
—

 
$
27.4

 
$
(0.1
)
 
20

States and municipalities
 
44.3

 
(0.3
)
 
12

 
—

 
—

 
—

Corporate securities
 
24.4

 
(0.8
)
 
10

 
363.0

 
(8.0
)
 
137

Residential mortgage-backed securities
 
—

 
—

 
—

 
57.6

 
(1.0
)
 
49

Commercial mortgage-backed securities
 
—

 
—

 
—

 
51.5

 
(1.0
)
 
22

Asset-backed securities
 
—

 
—

 
—


45.2

 
(0.1
)
 
31

Total fixed maturity securities
 
68.7

 
(1.1
)
 
22

 
544.7

 
(10.2
)
 
259

Equity securities
 
15.7

 
(1.3
)
 
37

 
35.8

 
(4.6
)
 
45

Total available-for-sale
 
$
84.4

 
$
(2.4
)
 
59

 
$
580.5

 
$
(14.8
)
 
304

Based on reviews of the fixed maturity securities, the Company determined that unrealized losses for the nine months ended September 30, 2016 were primarily the result of changes in prevailing interest rates and not the credit quality of the issuers. The fixed maturity securities whose total fair value was less than amortized cost were not determined to be other-than-temporarily impaired given the severity and duration of the impairment, the credit quality of the issuers, the Company’s intent to not sell the securities, and a determination that it is not more likely than not that the Company will be required to sell the securities until fair value recovers to above amortized cost, or principal value upon maturity.
Based on reviews of the equity securities, the Company recognized a total impairment of $5.3 million in the fair value of 32 equity securities for the nine months ended September 30, 2016, as a result of the Company's intent to sell and/or the severity and duration of the change in fair value of the securities. The remaining unrealized losses on equity securities were not considered to be other-than-temporary due to the financial condition and near-term prospects of the issuers. The other-than-temporary impairment of

11


equity securities was primarily due to the Company's intent to sell certain securities and the downturn in the energy sector that continued through the first quarter of 2016.
Net realized gains on investments and the change in unrealized gains (losses) on fixed maturity and equity securities are determined on a specific-identification basis and were as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016

2015
 
2016

2015
 
 
(in millions)
Net realized gains on investments
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
Gross gains
 
$
—

 
$
0.2

 
$
1.3

 
$
0.5

Gross losses
 
—

 
(0.2
)
 
(0.5
)
 
(0.4
)
Net realized gains on fixed maturity securities
 
$
—

 
$
—

 
$
0.8

 
$
0.1

Equity securities
 
 
 
 
 
 
 
 
Gross gains
 
$
1.6

 
$
2.2

 
$
14.3

 
$
5.6

Gross losses
 
—

 
(0.2
)
 
(6.0
)
 
(0.6
)
Net realized gains on equity securities
 
$
1.6

 
$
2.0

 
$
8.3

 
$
5.0

Total
 
$
1.6

 
$
2.0

 
$
9.1

 
$
5.1

 
 
 
 
 
 
 
 
 
Change in unrealized gains (losses)
 
 

 
 

 
 
 
 
Fixed maturity securities
 
$
(10.2
)
 
$
8.0

 
$
43.4

 
$
(11.0
)
Equity securities
 
2.1

 
(27.0
)
 
8.9

 
(34.8
)
Total
 
$
(8.1
)
 
$
(19.0
)
 
$
52.3

 
$
(45.8
)
Net investment income was as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(in millions)
Fixed maturity securities
 
$
16.9

 
$
17.3

 
$
50.8

 
$
51.6

Equity securities
 
1.7

 
1.7

 
5.4

 
4.0

Cash equivalents and restricted cash
 
0.1

 
0.1

 
0.2

 
0.1

Gross investment income
 
18.7

 
19.1

 
56.4

 
55.7

Investment expenses
 
(0.8
)
 
(0.6
)
 
(2.3
)
 
(1.9
)
Net investment income
 
$
17.9

 
$
18.5

 
$
54.1

 
$
53.8

The Company is required by various state laws and regulations to keep securities or letters of credit in depository accounts with certain states in which it does business. Securities having a fair value of $1.0 billion and $881.2 million were on deposit as of September 30, 2016 and December 31, 2015, respectively. These laws and regulations govern not only the amount, but also the types of securities that are eligible for deposit.
Certain reinsurance contracts require Company funds to be held in trust for the benefit of the ceding reinsurer to secure the outstanding liabilities assumed by the Company. The fair value of fixed maturity securities and restricted cash and cash equivalents held in trust for the benefit of ceding reinsurers was $27.7 million and $32.7 million at September 30, 2016 and December 31, 2015, respectively.

12


6. Income Taxes
Income tax expense for interim periods is measured using an estimated effective tax rate for the annual period. The following is a reconciliation of the federal statutory income tax rate to the Company’s effective tax rates for the periods presented.
 
 
Nine Months Ended
 
 
September 30,
 
 
2016
 
2015
Statutory tax rate
 
35.0
 %
 
35.0
 %
Dividends received deduction and tax-exempt interest
 
(7.1
)
 
(7.6
)
LPT deferred gain amortization
 
(3.3
)
 
(4.3
)
LPT reserve adjustment
 
(1.5
)
 
(2.0
)
Pre-privatization reserve adjustment, excluding LPT
 
—

 
(4.6
)
Stock based compensation
 
(1.1
)
 
—

Other
 
0.9

 
0.7

Effective tax rate
 
22.9
 %
 
17.2
 %
7. Liability for Unpaid Losses and Loss Adjustment Expenses 
The following table represents a reconciliation of changes in the liability for unpaid losses and LAE.
 
 
Nine Months Ended
 
 
September 30,
 
 
2016
 
2015
 
 
(in millions)
Unpaid losses and LAE, gross of reinsurance, at beginning of period
 
$
2,347.5

 
$
2,369.7

Less reinsurance recoverable, excluding bad debt allowance, on unpaid losses and LAE
 
628.2

 
669.5

Net unpaid losses and LAE at beginning of period
 
1,719.3

 
1,700.2

Losses and LAE, net of reinsurance, incurred during the period related to:
 
 

 
 

Current period
 
343.1

 
339.7

Prior periods
 
(1.5
)
 
1.3

Total net losses and LAE incurred during the period
 
341.6

 
341.0

Paid losses and LAE, net of reinsurance, related to:
 
 

 
 

Current period
 
42.8

 
43.9

Prior periods
 
279.6

 
274.2

Total net paid losses and LAE during the period
 
322.4

 
318.1

Ending unpaid losses and LAE, net of reinsurance
 
1,738.5

 
1,723.1

Reinsurance recoverable, excluding bad debt allowance, on unpaid losses and LAE
 
591.5

 
634.8

Unpaid losses and LAE, gross of reinsurance, at end of period
 
$
2,330.0

 
$
2,357.9

Total net losses and LAE included in the above table excludes the impact of the aggregate of amortization of the deferred reinsurance gain—LPT Agreement, LPT Reserve Adjustments, and LPT Contingent Commission Adjustments, which totaled $13.6 million and $17.5 million for the nine months ended September 30, 2016 and 2015, respectively (Note 8).
The changes in the estimates of incurred losses and LAE attributable to insured events for prior periods were related to the Company's assigned risk business.
8. LPT Agreement
The Company is party to a 100% quota share retroactive reinsurance agreement (LPT Agreement) under which $1.5 billion in liabilities for losses and LAE related to claims incurred by EICN prior to July 1, 1995 were reinsured for consideration of $775.0 million. The LPT Agreement provides coverage up to $2.0 billion. The initial Deferred Gain resulting from the LPT Agreement was recorded as a liability in the accompanying consolidated balance sheets as Deferred reinsurance gain–LPT Agreement. The Company is also entitled to receive a contingent profit commission under the LPT Agreement. The contingent profit commission is an amount based on the favorable difference between actual paid losses and LAE and expected paid losses and LAE as established in the LPT Agreement. The Company records its estimate of contingent profit commission in the accompanying consolidated balance sheets as Contingent commission receivable–LPT Agreement and a corresponding liability is recorded in the accompanying consolidated balance sheets in Deferred reinsurance gain–LPT Agreement. The Deferred Gain 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 date through

13


which the Company is entitled to receive a contingent profit commission under the LPT Agreement. The amortization is recorded in losses and LAE incurred in the accompanying consolidated statements of comprehensive income. Any adjustments to the Deferred Gain are recorded in losses and LAE incurred in the accompanying consolidated statements of comprehensive income.
The Company amortized $8.7 million and $8.5 million of the Deferred Gain for the nine months ended September 30, 2016 and 2015, respectively. Additionally, the Deferred Gain was reduced by $3.1 million and $6.4 million for the nine months ended September 30, 2016 and 2015, respectively, due to favorable LPT Reserve Adjustments and by $1.8 million and $2.6 million for the nine months ended September 30, 2016 and 2015, respectively, due to favorable LPT Contingent Commission Adjustments. The remaining Deferred Gain was $177.8 million and $189.5 million as of September 30, 2016 and December 31, 2015, respectively. The estimated remaining liabilities subject to the LPT Agreement were $472.3 million and $498.0 million as of September 30, 2016 and December 31, 2015, respectively. Losses and LAE paid with respect to the LPT Agreement totaled $715.9 million and $695.2 million from inception through September 30, 2016 and December 31, 2015, respectively.
9. Accumulated Other Comprehensive Income, net
Accumulated other comprehensive income, net, is comprised of unrealized gains on investments classified as available-for-sale, net of deferred tax expense. The following table summarizes the components of accumulated other comprehensive income, net:
 
 
September 30, 2016
 
December 31, 2015
 
 
(in millions)
Net unrealized gain on investments, before taxes
 
$
180.9

 
$
128.6

Deferred tax expense on net unrealized gains
 
(63.3
)
 
(45.0
)
Total accumulated other comprehensive income, net
 
$
117.6

 
$
83.6

10. Stock-Based Compensation
The Company awarded stock options, restricted stock units (RSUs) and performance share units (PSUs) to certain officers of the Company as follows:
 
Number Awarded
 
Weighted Average Fair Value on Date of Grant
 
Weighted Average Exercise Price
 
Aggregate Fair Value on Date of Grant
 
 
 
 
 
 
 
(in millions)
March 2016
 
 
 
 
 
 
 
Stock options(1)
67,431

 
$
8.38

 
$
27.72

 
$
0.6

RSUs(1)
80,816

 
27.72

 
—

 
2.2

PSUs(2)
97,236

 
27.72

 
—

 
2.7

 
 
 
 
 
 
 
 
May 2016
 
 
 
 
 
 
 
RSUs(1)
17,892

 
30.18

 
—

 
0.5

(1)
The stock options and RSUs awarded in March 2016 were awarded to certain officers of the Company and vest 25% on March 15, 2017, and each of the subsequent three anniversaries of that date. The stock options and RSUs are subject to accelerated vesting in certain circumstances, including but not limited to: death, disability, retirement, or in connection with change of control of the Company. The stock options expire seven years from the date of grant.
The RSUs awarded in May 2016 were awarded to non-employee Directors of the Company and have a service vesting period of one year from the date of grant.
(2)
The PSUs awarded in March 2016 were awarded to certain officers of the Company and have a performance period of two years followed by an additional one year vesting period. The PSU awards are subject to certain performance goals with payouts that range from 0% to 200% of the target awards. The value shown in the table represents the aggregate number of PSUs awarded at the target level.
A total of 484,829 and 463,466 stock options were exercised during the nine months ended September 30, 2016 and the year ended December 31, 2015, respectively.

14


11. Earnings Per Share
Basic earnings per share excludes dilution and is computed by dividing income applicable to stockholders by the weighted average number of shares outstanding for the period. Diluted earnings per share reflects the potential dilutive impact of all convertible securities on earnings per share. Diluted earnings per share includes shares assumed issued under the “treasury stock method,” which reflects the potential dilution that would occur if outstanding RSUs and PSUs had vested and options were to be exercised. The following table presents the net income and the weighted average number of shares outstanding used in the earnings per common share calculations.
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016

2015
 
2016

2015
 
 
(in millions, except share data)
Net income available to stockholders—basic and diluted
 
$
22.6

 
$
24.5

 
$
71.2

 
$
67.7

Weighted average number of shares outstanding—basic
 
32,449,617

 
32,184,143

 
32,497,478

 
32,000,142

Effect of dilutive securities:
 
 
 
 
 
 
 
 
PSUs
 
238,633

 
72,612

 
196,898

 
161,335

Stock options
 
192,827

 
245,708

 
251,068

 
289,348

RSUs
 
67,885

 
21,877

 
70,429

 
47,268

Dilutive potential shares
 
499,345


340,197

 
518,395

 
497,951

Weighted average number of shares outstanding—diluted
 
32,948,962

 
32,524,340

 
33,015,873

 
32,498,093

Diluted earnings per share excludes outstanding options and other common stock equivalents in periods where the inclusion of such options and common stock equivalents would be anti-dilutive. The following table presents options, PSUs, and RSUs that were excluded from diluted earnings per share.
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
Options excluded as the exercise price was greater than the average market price
 
—

 
80,800

 
—

 
26,933

Options, PSUs and RSUs excluded under the treasury method as the potential proceeds on settlement or exercise price were greater than the value of shares acquired
 
67,431

 
336,006

 
98,021

 
316,273


15


Item 2.  Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations
You should read the following discussion and analysis in conjunction with our consolidated financial statements and the related notes thereto included in Item 1 of Part I. Unless otherwise indicated, all references to “we,” “us,” “our,” “the Company,” or similar terms refer to Employers Holdings, Inc. (EHI), together with its subsidiaries. The information contained in this quarterly report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this quarterly report and in our other reports filed with the Securities and Exchange Commission (SEC), including our Annual Report on Form 10-K for the year ended December 31, 2015 (Annual Report).
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements if accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed. You should not place undue reliance on these statements, which speak only as of the date of this report. Forward-looking statements include those related to our expected financial position, business, financing plans, litigation, future premiums, revenues, earnings, pricing, investments, business relationships, strategic initiatives, 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 described in our Annual Report and other documents that we have filed with the SEC.
Overview
We are a Nevada holding company. Through our insurance subsidiaries, we provide workers’ compensation insurance coverage to select, small businesses in low to medium hazard industries. Workers’ compensation insurance is provided under a statutory system wherein most employers are required to provide coverage for their employees’ medical, disability, vocational rehabilitation, and/or death benefit costs for work-related injuries or illnesses. We provide workers’ compensation insurance in 34 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.
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 geographic markets; utilizing a three-company pricing platform; utilizing territorial multipliers in California; and targeting profitable classes of business across all of our markets.

16


Results of Operations
A primary measure of our performance is our ability to increase our 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.
 
 
September 30, 2016
 
December 31, 2015
 
 
(in millions, except share data)
GAAP stockholders' equity
 
$
850.1

 
$
760.8

Deferred reinsurance gain–LPT Agreement
 
177.8

 
189.5

Less: Accumulated other comprehensive income, net
 
117.6

 
83.6

Adjusted stockholders' equity(1)
 
$
910.3

 
$
866.7

Common shares outstanding
 
32,109,976

 
32,216,480

(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 $22.6 million and $71.2 million for the three and nine months ended September 30, 2016, respectively, compared to $24.5 million and $67.7 million for the corresponding periods of 2015. We recognized underwriting income before tax of $11.3 million and $29.7 million for the three and nine months ended September 30, 2016, respectively, compared to $10.6 million and $24.9 million for the corresponding periods of 2015. Underwriting income or loss is determined by deducting losses and LAE, commission expense, and underwriting and other operating expenses from net premiums earned.
Our results of operations during the nine months ended September 30, 2016 were impacted by: (1) favorable development in the estimated reserves ceded under the LPT Agreement that resulted in a $3.1 million cumulative adjustment to the Deferred Gain and reduced our losses and LAE by the same amount during the second quarter of 2016 (LPT Reserve Adjustment) and (2) an increase in the contingent commission receivable under the LPT Agreement that resulted in a $1.8 million cumulative adjustment, which reduced our losses and LAE by the same amount (LPT Contingent Commission Adjustment) during the second quarter of 2016. Collectively, these items increased net income by $4.9 million during the second quarter of 2016.
Our results of operations during the nine months ended September 30, 2015 were impacted by: (1) favorable development in the estimated reserves ceded under the LPT Agreement that resulted in a $6.4 million LPT Reserve Adjustment during the nine months ended September 30, 2015; (2) an increase in the contingent commission receivable under the LPT Agreement that resulted in a $2.6 million LPT Contingent Commission Adjustment during the nine months ended September 30, 2015; and (3) a reallocation of $19.4 million of reserves from non-taxable periods prior to January 1, 2000 during the second quarter of 2015, which reduced our tax expenses by $3.8 million and reduced our effective tax rate by 4.6 percentage points for the nine months ended September 30, 2015. Collectively, these items increased net income by $12.8 million for the nine months ended September 30, 2015.

17


The comparative components of net income are set forth in the following table:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016

2015
 
 
(in millions)
Gross premiums written
 
$
164.4

 
$
168.5

 
$
545.7

 
$
533.1

Net premiums written
 
$
163.0

 
$
166.5

 
$
540.4

 
$
526.7

 
 
 
 
 
 
 
 
 
Net premiums earned
 
$
173.3

 
$
179.0

 
$
522.8

 
$
508.6

Net investment income
 
17.9

 
18.5

 
54.1

 
53.8

Net realized gains on investments
 
1.6

 
2.0

 
9.1

 
5.1

Other income
 
—

 
—

 
0.6

 
0.1

Total revenues
 
192.8


199.5

 
586.6

 
567.6

 
 
 
 
 
 
 
 
 
Losses and LAE
 
109.0

 
115.8

 
328.0

 
323.5

Commission expense
 
21.3

 
21.0

 
63.5

 
62.6

Underwriting and other operating expenses
 
31.7

 
31.6

 
101.6

 
97.6

Interest expense
 
0.4

 
0.7

 
1.2

 
2.1

Income tax expense
 
7.8

 
5.9

 
21.1

 
14.1

Total expenses
 
170.2

 
175.0

 
515.4

 
499.9

Net income
 
$
22.6

 
$
24.5

 
$
71.2

 
$
67.7

Less amortization of the Deferred Gain related to losses
 
$
2.5

 
$
2.3

 
$
7.2

 
$
7.1

Less amortization of the Deferred Gain related to contingent commission
 
0.5

 
0.4

 
1.5

 
1.4

Less impact of LPT Reserve Adjustments(1)
 
—

 
—

 
3.1

 
6.4

Less impact of LPT Contingent Commission Adjustments(1)
 
—

 
—

 
1.8

 
2.6

Net income before impact of the LPT Agreement(2)
 
$
19.6

 
$
21.8

 
$
57.6

 
$
50.2

(1)
Any adjustment to the contingent profit commission under the LPT Agreement results in a cumulative adjustment to the Deferred Gain, which is recognized 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 contingent profit commission been recognized at the inception of the LPT Agreement (LPT Contingent Commission Adjustments).
(2)
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 a 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 LPT Agreement has limited significance on our current and ongoing operations.
Gross Premiums Written
Gross premiums written is the sum of both direct premiums written and assumed premiums written before the effect of ceded reinsurance. Gross premiums written decreased 2.4% for the three months ended September 30, 2016 and increased 2.4% for the nine months ended September 30, 2016, compared to the same periods of 2015. The year-over-year decrease in gross premiums written for the quarter was primarily due to a $5.0 million decrease in our final audit premiums in the third quarter of 2016, compared to the third quarter of 2015. The year-over-year increase in gross premiums written for the nine months ended September 30, 2016 was primarily due to final audit premiums that were $18.9 million higher, partially offset by declines in

18


premium due to lower levels of renewal premiums, year-over-year. The declines in renewal premiums year-over-year were due to declines in the LA Area of California, partially offset by increases in states outside California, as well as territories outside of southern California. While overall renewal premiums were down slightly year-over-year, primarily driven by lower net rates, our policy unit retention rate increased for the three and nine months ended September 30, 2016, compared to the same periods of 2015. Premiums from new business written increased for the three and nine months ended September 30, 2016, compared to the same periods of 2015.
Net Premiums Earned
Net premiums earned are those portions of the premiums that apply to the expired portions of the policies in force. Net premiums earned are recognized as revenue. Net premiums earned decreased 3.2% for the three months ended September 30, 2016 and increased 2.8% for the nine months ended September 30, 2016, compared to the same periods of 2015. The year-over-year decrease in net premiums earned was primarily the result of $5.0 million decrease in our final audit premiums for the three months ended September 30, 2016, while the year-over-year increase for the nine months ended September 30, 2016 was primarily due to final audit premiums that were $18.9 million higher, partially offset by declines in premium due to lower levels of renewal premiums. The declines in renewal premiums year-over-year were due to declines in the LA Area of California, partially offset by increases in states outside California, as well as territories outside of southern California. Fifty-six percent of our in-force premiums were generated in California and no other state represented a significant concentration of business as of September 30, 2016.
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 overall and for California:
 
As of September 30, 2016
 
Year-to-Date (Decrease) Increase
 
Year-Over-Year (Decrease) Increase
 
Overall
 
California
 
All Other States
 
Overall
 
California
 
All Other States
In-force premiums
(0.3
)%
 
(1.3
)%
 
1.1
 %
 
(0.5
)%
 
(2.5
)%
 
2.3
 %
In-force policy count
0.6

 
(3.5
)
 
5.0

 
—

 
(5.5
)
 
6.2

Average in-force policy size
(0.9
)
 
2.3

 
(3.8
)
 
(0.5
)
 
3.1

 
(3.7
)
In-force payroll exposure
1.2

 
1.2

 
1.2

 
1.7

 
0.8

 
2.2

Net rate(1)
(1.4
)
 
(2.4
)
 
(0.2
)
 
(2.1
)
 
(3.3
)
 
—

(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.
Our in-force premiums and policy count in the LA Area of California declined 13.2% and 13.9%, respectively, year-over-year as of September 30, 2016, while our in-force premiums and policy count in California outside of the LA Area increased 10.3% and 4.1%, respectively, during the same period. The declines in total in-force premiums were driven by lower net rate.
Our net rate (total in-force premiums divided by total insured payroll exposure) in California decreased 3.3% year-over-year as of September 30, 2016. Net rate is a function of a variety of factors, including rate changes, underwriting risk profiles and pricing, and changes in business mix related to economic and competitive pressures.
Our in-force premiums and number of policies in-force for California and all other states combined were as follows:
 
 
September 30, 2016
 
December 31, 2015
 
September 30, 2015
 
December 31, 2014
State
 
In-force
Premiums
 
Policies
In-force
 
In-force
Premiums
 
Policies
In-force
 
In-force
Premiums
 
Policies
In-force
 
In-force
Premiums
 
Policies
In-force
 
 
(dollars in millions)
California
 
$
347.8

 
42,550

 
$
352.2

 
44,080

 
$
356.8

 
45,021

 
$
370.8

 
47,093

Other