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, 2018

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, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” “smaller reporting company,” and "emerging growth 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
 
 
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 18, 2018
Common Stock, $0.01 par value per share
 
32,799,666 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 millions, except share data)
 
 
As of
 
As of
 
 
September 30,
2018
 
December 31,
2017
Assets
 
(unaudited)
 
 
Investments:
 
 
 
 
Fixed maturity securities at fair value (amortized cost $2,423.0 at September 30, 2018 and $2,421.0 at December 31, 2017)
 
$
2,394.6

 
$
2,463.4

Equity securities at fair value (cost $94.2 at September 30, 2018 and $116.7 at December 31, 2017)
 
189.6

 
210.3

Equity securities at cost
 
6.4

 
—

Short-term investments at fair value (amortized cost $4.0 at December 31, 2017)
 
—

 
4.0

Total investments
 
2,590.6


2,677.7

Cash and cash equivalents
 
203.0

 
73.3

Restricted cash and cash equivalents
 
2.0

 
1.0

Accrued investment income
 
19.0

 
19.6

Premiums receivable (less bad debt allowance of $7.9 at September 30, 2018 and $10.0 at December 31, 2017)
 
352.7

 
326.7

Reinsurance recoverable for:
 
 
 
 
Paid losses
 
7.9

 
7.2

Unpaid losses
 
511.8

 
537.0

Deferred policy acquisition costs
 
50.8

 
45.8

Deferred income taxes, net
 
20.6

 
28.7

Property and equipment, net
 
16.5

 
13.9

Intangible assets, net
 
7.7

 
7.9

Goodwill
 
36.2

 
36.2

Contingent commission receivable—LPT Agreement
 
32.0

 
31.4

Cloud computing arrangements
 
21.8

 
—

Other assets
 
25.9

 
33.7

Total assets
 
$
3,898.5

 
$
3,840.1

Liabilities and stockholders’ equity
 
 

 
 

Unpaid losses and loss adjustment expenses
 
$
2,233.7

 
$
2,266.1

Unearned premiums
 
356.0

 
318.3

Commissions and premium taxes payable
 
59.8

 
55.3

Accounts payable and accrued expenses
 
24.6

 
23.7

Deferred reinsurance gain—LPT Agreement
 
152.1

 
163.6

Notes payable
 
20.0

 
20.0

Non-cancellable obligations
 
18.2

 
2.7

Other liabilities
 
42.9

 
42.7

Total liabilities
 
$
2,907.3

 
$
2,892.4

Commitments and contingencies
 


 


Stockholders’ equity:
 
 

 
 

Common stock, $0.01 par value; 150,000,000 shares authorized; 56,904,018 and 56,695,174 shares issued and 32,796,666 and 32,597,819 shares outstanding at September 30, 2018 and December 31, 2017, respectively
 
$
0.6

 
$
0.6

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

 
—

Additional paid-in capital
 
385.2

 
381.2

Retained earnings
 
1,011.9

 
842.2

Accumulated other comprehensive (loss) income, net of tax
 
(22.5
)
 
107.4

Treasury stock, at cost (24,107,352 shares at September 30, 2018 and 24,097,355 shares at December 31, 2017)
 
(384.0
)
 
(383.7
)
Total stockholders’ equity
 
991.2

 
947.7

Total liabilities and stockholders’ equity
 
$
3,898.5

 
$
3,840.1

See accompanying unaudited notes to the consolidated financial statements.

3


Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
(in millions, except per share data)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2018
 
2017
 
2018

2017
Revenues
 
(unaudited)
 
(unaudited)
Net premiums earned
 
$
192.9

 
$
187.9

 
$
547.5

 
$
535.0

Net investment income
 
20.2

 
18.5

 
59.9

 
55.4

Net realized and unrealized gains on investments
 
15.6

 
4.1

 
13.2

 
7.4

Gain on redemption of notes payable
 
—

 
—

 
—

 
2.1

Other income
 
0.2

 
0.4

 
0.4

 
0.5

Total revenues
 
228.9

 
210.9

 
621.0

 
600.4

Expenses
 
 

 
 

 
 
 
 
Losses and loss adjustment expenses
 
106.6

 
116.9

 
289.7

 
332.0

Commission expense
 
24.8

 
23.7

 
73.1

 
66.7

Underwriting and other operating expenses
 
38.8

 
33.6

 
118.1

 
102.1

Interest and financing expenses
 
0.4

 
0.3

 
1.1

 
1.1

Other expenses
 
—


7.5


—


7.5

Total expenses
 
170.6

 
182.0

 
482.0

 
509.4

Net income before income taxes
 
58.3

 
28.9

 
139.0

 
91.0

Income tax expense
 
10.7

 
7.0

 
23.3

 
21.1

Net income
 
$
47.6

 
$
21.9

 
$
115.7

 
$
69.9

 
 
 
 
 
 
 
 
 
Comprehensive income
 
 
 
 
 
 
 
 
Unrealized AFS investment (losses) gains arising during the period (net of taxes of $(2.4) and $1.6 for the three months ended September 30, 2018 and 2017, respectively, and $(15.0) and $11.3 for the nine months ended September 30, 2018 and 2017, respectively)
 
$
(9.2
)
 
$
3.0

 
$
(56.3
)
 
$
20.9

Reclassification adjustment for realized AFS investment losses (gains) in net income (net of taxes of $(1.4) for the three months ended September 30, 2017, and $0.1 and $(2.6) for the nine months ended September 30, 2018 and 2017, respectively)
 
—

 
(2.7
)
 
0.4


(4.8
)
Other comprehensive (loss) income, net of tax
 
(9.2
)
 
0.3

 
(55.9
)
 
16.1

Total comprehensive income
 
$
38.4

 
$
22.2

 
$
59.8

 
$
86.0

 
 
 
 
 
 
 
 
 
Net realized and unrealized gains on investments
 
 
 
 
 
 
 
 
Net realized and unrealized gains on investments before impairments
 
$
15.6

 
$
4.1

 
$
15.2

 
$
7.6

Other than temporary impairment recognized in earnings
 
—

 
—

 
(2.0
)
 
(0.2
)
Net realized and unrealized gains on investments
 
$
15.6

 
$
4.1

 
$
13.2

 
$
7.4

 
 
 
 
 
 
 
 
 
Earnings per common share (Note 12):
 
 
 
 
 
 
 
 
Basic
 
$
1.45

 
$
0.67

 
$
3.52

 
$
2.15

Diluted
 
$
1.43

 
$
0.66

 
$
3.48

 
$
2.12

Cash dividends declared per common share and eligible RSUs and PSUs
 
$
0.20

 
$
0.15

 
$
0.60

 
$
0.45

See accompanying unaudited notes to the consolidated financial statements.

4


Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
For the Three Months Ended September 30, 2018 and 2017
(Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Additional Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income, Net
 
Treasury Stock at Cost
 
Total Stockholders' Equity
 
Shares Issued
 
Amount
 
 
 
 
 
 
(in millions, except share data)
Balance, July 1, 2018
56,866,727

 
$
0.6

 
$
382.4

 
$
970.8

 
$
(13.3
)
 
$
(384.0
)
 
$
956.5

Stock-based obligations
—

 
—

 
2.0

 
—

 
—

 
—

 
2.0

Stock options exercised
37,291

 
—

 
0.8

 
—

 
—

 
—

 
0.8

Dividends declared
—

 
—

 
—

 
(6.6
)
 
—

 
—

 
(6.6
)
Net income for the period
—

 
—

 
—

 
47.6

 
—

 
—

 
47.6

Change in net unrealized losses on investments, net of taxes of $2.4
—

 
—

 
—

 
—

 
(9.2
)
 
—

 
(9.2
)
Balance, September 30, 2018
56,904,018

 
$
0.6

 
$
385.2

 
$
1,011.9

 
$
(22.5
)
 
$
(384.0
)
 
$
991.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, July 1, 2017
56,510,352

 
$
0.6

 
$
376.6

 
$
815.4

 
$
90.3

 
$
(383.7
)
 
$
899.2

Stock-based obligations
—

 
—

 
0.8

 
—

 
—

 
—

 
0.8

Stock options exercised
1,998

 
—

 
—

 
—

 
—

 
—

 
—

Vesting of RSUs and PSUs, net of shares withheld to satisfy tax withholdings
8,934

 
—

 
(0.2
)
 
—

 
—

 
—

 
(0.2
)
Dividends declared
—

 
—

 
—

 
(4.9
)
 
—

 
—

 
(4.9
)
Net income for the period
—

 
—

 
—

 
21.9

 
—

 
—

 
21.9

Change in net unrealized gains on investments, net of taxes of $0.2
—

 
—

 
—

 
—

 
0.3

 
—

 
0.3

Balance, September 30, 2017
56,521,284

 
$
0.6

 
$
377.2

 
$
832.4

 
$
90.6

 
$
(383.7
)
 
$
917.1


See accompanying unaudited notes to the consolidated financial statements.


5


Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
For the Nine Months Ended September 30, 2018 and 2017
(Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Additional Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income, Net
 
Treasury Stock at Cost
 
Total Stockholders' Equity
 
Shares Issued
 
Amount
 
 
 
 
 
 
(in millions, except share data)
Balance, January 1, 2018
56,695,174

 
$
0.6

 
$
381.2

 
$
842.2

 
$
107.4

 
$
(383.7
)
 
$
947.7

Stock-based obligations
—

 
—

 
5.9

 
—

 
—

 
—

 
5.9

Stock options exercised
51,091

 
—

 
1.0

 
—

 
—

 
—

 
1.0

Vesting of RSUs and PSUs, net of shares withheld to satisfy tax withholdings
157,753

 
—

 
(2.9
)
 
—

 
—

 
—

 
(2.9
)
Acquisition of common stock
—

 
—

 
—

 
—

 
—

 
(0.3
)
 
(0.3
)
Dividends declared
—

 
—

 
—

 
(19.9
)
 
—

 
—

 
(19.9
)
Net income for the period
—

 
—

 
—

 
115.7

 
—

 
—

 
115.7

Reclassification adjustment for adoption of ASU No. 2016-01
—

 
—

 
—

 
74.0

 
(74.0
)
 
—

 
—

Change in net unrealized losses on investments, net of taxes of $14.9
—

 
—

 
—

 
—

 
(55.9
)
 
—

 
(55.9
)
Balance, September 30, 2018
56,904,018

 
$
0.6

 
$
385.2

 
$
1,011.9

 
$
(22.5
)
 
$
(384.0
)
 
$
991.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, January 1, 2017
56,226,277

 
$
0.6

 
$
372.0

 
$
777.2

 
$
74.5

 
$
(383.7
)
 
$
840.6

Stock-based obligations
—

 
—

 
4.0

 
—

 
—

 
—

 
4.0

Stock options exercised
169,024

 
—

 
3.3

 
—

 
—

 
—

 
3.3

Vesting of RSUs and PSUs, net of shares withheld to satisfy tax withholdings
125,983

 
—

 
(2.1
)
 
—

 
—

 
—

 
(2.1
)
Dividends declared
—

 
—

 
—

 
(14.7
)
 
—

 
—

 
(14.7
)
Net income for the period
 
 
—

 
—

 
69.9

 
—

 
—

 
69.9

Change in net unrealized gains on investments, net of taxes of $8.7
 
 
—

 
—

 
—

 
16.1

 
—

 
16.1

Balance, September 30, 2017
56,521,284

 
$
0.6

 
$
377.2

 
$
832.4

 
$
90.6

 
$
(383.7
)
 
$
917.1


See accompanying unaudited notes to the consolidated financial statements.


6


Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(in millions)
 
 
Nine Months Ended
 
 
September 30,
 
 
2018
 
2017
Operating activities
 
(unaudited)
Net income
 
$
115.7

 
$
69.9

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
5.1

 
6.2

Stock-based compensation
 
5.9

 
3.9

Amortization of premium on investments, net
 
6.4

 
11.2

Allowance for doubtful accounts
 
(2.1
)
 
0.1

Deferred income tax expense
 
23.0

 
7.9

Net realized and unrealized (gains) on investments
 
(13.2
)
 
(7.4
)
Gain on redemption of notes payable
 
—

 
(2.1
)
Write-off of previously capitalized costs
 
—

 
7.5

Change in operating assets and liabilities:
 
 

 
 

Premiums receivable
 
(23.9
)
 
(26.9
)
Reinsurance recoverable on paid and unpaid losses
 
24.5

 
27.8

Cloud computing arrangements
 
(21.8
)
 
—

Current federal income taxes
 
(2.9
)
 
(5.2
)
Unpaid losses and loss adjustment expenses
 
(32.4
)
 
(2.1
)
Unearned premiums
 
37.7

 
20.8

Accounts payable, accrued expenses and other liabilities
 
3.8

 
(9.8
)
Deferred reinsurance gain—LPT Agreement
 
(11.5
)
 
(8.5
)
Non-cancellable obligations
 
15.5

 
—

Other
 
3.3

 
10.5

Net cash provided by operating activities
 
133.1

 
103.8

Investing activities
 
 

 
 

Purchases of fixed maturity securities
 
(472.9
)
 
(403.7
)
Purchases of equity securities
 
(31.2
)
 
(13.8
)
Purchases of short-term investments
 
(34.9
)
 
(8.2
)
Proceeds from sale of fixed maturity securities
 
169.8

 
181.8

Proceeds from sale of equity securities
 
58.1

 
14.6

Proceeds from maturities and redemptions of fixed maturity securities
 
294.7

 
159.3

Proceeds from maturities of short-term investments
 
38.9

 
18.7

Net change in unsettled investment purchases and sales
 
5.0

 
(21.4
)
Capital expenditures and other
 
(7.6
)
 
(7.8
)
Net cash provided by (used in) investing activities
 
19.9

 
(80.5
)
Financing activities
 
 

 
 

Acquisition of common stock
 
(0.3
)
 
—

Cash transactions related to stock-based compensation
 
(1.9
)
 
1.2

Dividends paid to stockholders
 
(19.9
)
 
(14.7
)
Redemption of notes payable
 
—

 
(9.9
)
Payments on capital leases
 
(0.2
)
 
(0.2
)
Net cash used in financing activities
 
(22.3
)
 
(23.6
)
Net increase (decrease) in cash, cash equivalents and restricted cash
 
130.7

 
(0.3
)
Cash, cash equivalents and restricted cash at the beginning of the period
 
74.3

 
70.8

Cash, cash equivalents and restricted cash at the end of the period
 
$
205.0

 
$
70.5


7


The following table presents our cash, cash equivalents and restricted cash by category within the Consolidated Balance Sheets:
 
 
As of
 
As of
 
 
September 30,
2018
 
December 31,
2017
 
 
(in millions)
Cash and cash equivalents
 
$
203.0

 
$
73.3

Restricted cash and cash equivalents supporting reinsurance obligations
 
2.0

 
1.0

Total cash, cash equivalents and restricted cash
 
$
205.0

 
$
74.3

 
See accompanying unaudited notes to the consolidated financial statements.

8


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.
In 1999, the Nevada State Industrial Insurance System (the Fund) entered into a retroactive 100% quota share reinsurance agreement (the LPT 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 LPT Agreement is commuted or terminated, upon the mutual agreement of the parties, or the reinsurers' aggregate maximum limit of liability is exhausted, whichever occurs first. 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 (See Note 8).
The Company accounts for the LPT Agreement as retroactive reinsurance. Upon entry into the LPT Agreement, an initial deferred reinsurance gain (the Deferred Gain) was recorded as a liability on the Company’s Consolidated Balance Sheets. The Company is 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 and is recorded as an asset on the Company's Consolidated Balance Sheets.
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 Form 10-K for the year ended December 31, 2017 (Annual Report).
The Company operates as a single operating segment, workers' compensation insurance, through its wholly owned subsidiaries. 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.
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, recoverability of deferred income taxes, and valuation of investments.
Reclassifications
Certain prior period information has been reclassified to conform to the current period presentation.
The Company reclassified $14.0 million of service contract fees associated with hosting arrangements from Other assets to Cloud computing arrangements on the Company's Consolidated Balance Sheets as of September 30, 2018. Additionally, $4.8 million of implementation costs for these hosting arrangements were reclassified from Property and equipment to Cloud computing arrangements on the Company's Consolidated Balance Sheets as a result of the early adoption of ASU Number 2018-15 (See Note 3).
Pending Acquisition
On August 11, 2017, the Company entered into a stock purchase agreement (Purchase Agreement), as amended, with Partner Reinsurance Company of the U.S. (PRUS) with respect to the acquisition (Acquisition) of all of the outstanding shares of capital stock of PartnerRe Insurance Company of New York (PRNY). The purchase price is equal to the sum of: (i) the amount of statutory

9


capital and surplus of PRNY at closing (which is currently estimated to be approximately $40.0 million); and (ii) $5.8 million. The Company expects to fund the Acquisition with cash on hand.
Pursuant to the Purchase Agreement, all liabilities and obligations of PRNY existing as of the closing date, whether known or unknown, will be indemnified by PRUS. In addition, PartnerRe Ltd., the parent company of PRUS, has provided the Company with a Guaranty that unconditionally, absolutely and irrevocably guarantees the full and prompt payment and performance by PRUS of all of its obligations, liabilities, and indemnities under the Purchase Agreement and the transactions contemplated thereby.
The Company will not be acquiring any employees or ongoing business operations pursuant to the Acquisition. The Acquisition is subject to certain closing conditions, including, among other things, approval from the Department of Financial Services of the State of New York.
2. Change in Estimates
The Company reduced its estimated loss and LAE 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 2018. The following table shows the financial statement impact related to the LPT Reserve Adjustment.
 
 
Nine Months Ended
 
 
September 30, 2018
 
 
(in millions, except per share data)
LPT Reserve Adjustment
 
$
(6.3
)
Cumulative adjustment to the Deferred Gain(1)
 
(2.2
)
Net income impact from this change in estimate
 
2.2

Earnings per common share impact from this change in estimate:
 
 
Basic and Diluted
 
0.07

(1)
The cumulative adjustment to the Deferred reinsurance gain–LPT Agreement (Deferred Gain) was also recognized in losses and LAE incurred in the Company's Consolidated Statement of Comprehensive Income, so that the Deferred Gain reflects the balance that would have existed had the revised loss and LAE reserves been recognized at the inception of the LPT Agreement.
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 2018. The following table shows the financial statement impact related to the LPT Contingent Commission Adjustment.
 
 
Nine Months Ended
 
 
September 30, 2018
 
 
(in millions, except per share data)
LPT Contingent Commission Adjustment
 
$
0.5

Net income impact from this change in estimate
 
0.5

Earnings per common share impact from this change in estimate:
 
 
Basic and Diluted
 
0.02

3. New Accounting Standards
Recently Issued Accounting Standards
In August 2018, the FASB issued ASU Number 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This update removes the disclosure requirements for the amounts of and the reasons for transfers between Level 1 and Level 2 and disclosure of the policy for timing of transfers between levels. This update also removes disclosure requirements for the valuation processes for Level 3 fair value measurements. Additionally, this update adds disclosure requirements for the changes in unrealized gains and losses for recurring Level 3 fair value measurements and quantitative information for certain unobservable inputs in Level 3 fair value measurements. This update becomes effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company does not expect that this update will have a material impact on its consolidated financial condition and results of operations.
In July 2018, the FASB issued ASU Number 2018-09, Codification Improvements. This update provides clarification, corrects errors in and makes minor improvements to the Codification within various ASC topics. Many of the amendments in this update have transition guidance with effective dates for annual periods beginning after December 15, 2018 and some amendments in this update do not require transition guidance and are effective upon issuance of this update. The Company will adopt amendments as

10


they become applicable and has determined that the impact of these improvements will not be material to its consolidated financial condition and results of operations.
In February 2016, the FASB issued ASU Number 2016-02, Leases (Topic 842). This update provides guidance on a new lease 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 determined that the impact of this new standard will be equal to the present value of the Company's lease obligations under various non-cancellable operating lease contracts, which amounted to approximately $21.1 million at September 30, 2018, and will be recognized as lease assets and liabilities on the Company's Consolidated Balance Sheets upon adoption.
In July 2018, the FASB issued ASU Number 2018-11, Leases (Topic 842): Targeted Improvements. This update provides entities with an additional and optional transition method to adopt ASU Number 2016-02 with a cumulative-effect adjustment in the period of adoption. This update also provides guidance for a practical expedient that permits lessors to not separate non-lease components from the associated lease components. Additionally, in July 2018, the FASB issued ASU Number 2018-10, Codification Improvements to Topic 842, Leases. This update provides additional guidance on the new lease model with improvements in numerous aspects of the guidance in ASC 842 including, but not limited to, implicit rates, reassessment of lease classification, terms and purchase options, investment tax credits, and various other transition guidance. These updates will be adopted concurrently with ASU Number 2016-02. The Company has determined that the impact of these new standards will not be material to the Company's financial statements.
Recently Adopted Accounting Standards
In August 2018, the FASB issued ASU Number 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This update clarifies certain aspects of ASU 2015-05 and aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software and hosting arrangements that include an internal-use software license. This update becomes effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years and early adoption is permitted. The Company early adopted this standard as of July 1, 2018 using the retrospective method of adoption. Prior to adoption, the Company's accounting policy for capitalization of implementation costs followed the existing guidance for internal use software and therefore this update had no impact on the amounts previously capitalized. In accordance with ASU Number 2018-15, $4.8 million of capitalized costs included in the Company's June 30, 2018 Consolidated Balance Sheets were reclassified from Property and equipment to Cloud computing arrangements on the date of adoption. Amortization under the new guidance will commence once the module or component is ready for its intended use, regardless of whether the hosting arrangement has been placed into service and will be recognized over the remaining life of the service contract.
In March 2018, the FASB issued ASU Number 2018-05, Income Taxes (Topic 740). This update provides guidance regarding the application of ASC Topic 740 for the income tax effects of the Tax Cuts and Jobs Act. This update allowed companies to report provisional amounts of the effects of the Tax Cuts and Jobs Act in their financial statements in the first reporting period they are able to determine a reasonable estimate and any adjustments to provisional amounts should be included in income from continuing operations as an adjustment to tax expense or benefit in the reporting period the amounts are determined. The Company adopted this update in the fourth quarter of 2017 and included an estimate of the income tax effects in its financial statements for the year ended December 31, 2017. The Company does not expect the amounts of any future income tax adjustments related to the effects of the Tax Cuts and Jobs Act to be material.
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 those equity securities to be measured at fair value with changes in fair value recognized through net income. Additionally, this update eliminates the disclosure of 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 did not apply to the Company’s investment in Federal Home Loan Bank (FHLB) stock. Rather, it specified that FHLB stock shall be carried at cost and evaluated periodically for impairment; furthermore, it specified that, beginning January 1, 2018, FHLB stock shall not be shown with securities accounted for under ASC 321, which provides detailed guidance on, among other things, accounting and reporting of investments in equity securities that have readily determinable fair values. As a result, the Company’s investment in FHLB stock is presented within Equity securities at cost on the Company's Consolidated Balance Sheet

11


at March 31, 2018. In all periods prior to January 1, 2018, the Company's investment in FHLB stock is presented within Equity securities at fair value on the Company's Consolidated Balance Sheets.
This update became effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted this update effective January 1, 2018. Adoption of this accounting standard resulted in a $74.0 million reclassification adjustment, net of tax, from accumulated other comprehensive income to retained earnings.
4. Fair Value of Financial Instruments
The carrying value and the estimated fair value of the Company’s financial instruments at fair value were as follows:
 
 
September 30, 2018
 
December 31, 2017
 
 
Carrying Value
 
Estimated Fair Value
 
Carrying Value
 
Estimated Fair Value
 
 
(in millions)
Financial assets
 
 
 
 
 
 
 
 
Total investments at fair value
 
$
2,584.2

 
$
2,584.2

 
$
2,677.7

 
$
2,677.7

Cash and cash equivalents
 
203.0

 
203.0

 
73.3

 
73.3

Restricted cash and cash equivalents
 
2.0

 
2.0

 
1.0

 
1.0

Financial liabilities
 
 

 
 

 
 
 
 
Notes payable
 
$
20.0

 
$
23.4

 
$
20.0

 
$
23.6

Assets and liabilities recorded at fair value on the Company's 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.
•
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.
The Company uses third party pricing services to assist it with its investment accounting function. The ultimate pricing source varies depending on the investment security and pricing service used, but investment securities valued on the basis of observable inputs (Levels 1 and 2) are generally assigned values on the basis of actual transactions. Securities valued on the basis of pricing models with significant unobservable inputs or non-binding broker quotes are classified as Level 3. The Company performs quarterly analyses on the prices it receives from third parties to determine whether the prices are reasonable estimates of fair value, including confirming the fair values of these securities through observable market prices using an alternative pricing source, as it is ultimately management’s responsibility to ensure that the fair values reflected in the Company’s consolidated financial statements are appropriate. If differences are noted in these analyses, the Company may obtain additional information from other pricing services to validate the quoted price.
The Company bases all of its estimates of fair value for assets on the bid prices, when available, as they represent what a third-party market participant would be willing to pay in an arm's length transaction.
For securities not actively traded, third party pricing services may use quoted market prices of similar instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, broker quotes, benchmark yields, credit spreads, default rates, and prepayment speed assumptions. There were no material adjustments made to the prices obtained from third party pricing services as of September 30, 2018 and December 31, 2017.
These methods of valuation only produce an estimate of fair value if there is objectively verifiable information to produce a valuation. When objectively verifiable information is not available, the Company produces an estimate of fair value using some of the same methodologies, making assumptions for market-based inputs that are unavailable.
The Company's estimates of fair value for its notes payable are based on a combination of the variable 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 at each of the periods presented.
Each of the Company's insurance operating subsidiaries is a member of the FHLB of San Francisco. Members are required to purchase stock in the FHLB in addition to maintaining collateral deposits that back any funds advanced. The Company's investment in FHLB stock is recorded at cost, which approximates fair value, as purchases and sales of these securities are at par value with

12


the issuer. FHLB stock is considered a restricted security and is periodically evaluated by the Company for impairment based on the ultimate recovery of par value. 
The following table presents the Company's investments at fair value and the corresponding fair value measurements.
 
 
September 30, 2018
 
December 31, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
 
 
(in millions)
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
—

 
$
111.3

 
$
—

 
$
—

 
$
137.0

 
$
—

U.S. Agencies
 
—

 
11.4

 
—

 
—

 
11.8

 
—

States and municipalities
 
—

 
527.4

 
—

 
—

 
642.5

 
—

Corporate securities
 
—

 
1,110.9

 
—

 
—

 
1,118.0

 
—

Residential mortgage-backed securities
 
—

 
423.9

 
—

 
—

 
389.3

 
—

Commercial mortgage-backed securities
 
—

 
95.1

 
—

 
—

 
106.0

 
—

Asset-backed securities
 
—

 
66.5

 
—

 
—

 
58.8

 
—

Other securities
 
—

 
48.1

 
—

 
—

 
—

 
—

Total fixed maturity securities
 
$
—

 
$
2,394.6

 
$
—

 
$
—

 
$
2,463.4

 
$
—

Equity securities at fair value:
 
 
 
 
 
 
 
 
 
 
 
 
Industrial and miscellaneous
 
$
162.0

 
$
—

 
$
—

 
$
181.7

 
$
—

 
$
—

Non-redeemable preferred stock (FHLB)
 
—

 
—

 
—

 
—

 
—

 
4.7

Other
 
27.6

 
—

 
—

 
23.9

 
—

 
—

Total equity securities at fair value
 
189.6

 
—

 
—

 
205.6

 
—

 
4.7

Short-term investments
 
—

 
—

 
—

 
—

 
4.0

 
—

Total investments at fair value
 
$
189.6

 
$
2,394.6

 
$
—

 
$
205.6

 
$
2,467.4

 
$
4.7

Certain cash equivalents, principally money market securities, are measured at fair value using the net asset value (NAV) per share. The following table presents cash equivalents at NAV and total cash and cash equivalents carried at fair value on the Company's Consolidated Balance Sheets.
 
September 30, 2018
 
December 31, 2017
 
(in millions)
Cash and cash equivalents at fair value
$
56.0

 
$
34.3

Cash equivalents measured at NAV, which approximates fair value
147.0

 
39.0

Total cash and cash equivalents
$
203.0

 
$
73.3

The following table provides a reconciliation of the beginning and ending balances of investments that are recorded at fair value and are measured using Level 3 inputs for the nine months ended September 30, 2018 and 2017.
 
 
Level 3 Securities
 
 
2018
 
2017
 
 
(in millions)
Beginning balance, January 1
 
$
4.7

 
$
11.9

Transfers out of Level 3 (1)
 
(4.7
)
 
(7.0
)
Purchases and sales, net
 
—

 
(0.2
)
Ending balance, September 30
 
$
—

 
$
4.7

(1)
The transfer during the nine months ended September 30, 2018 was the result of adoption of ASU 2016-01, which specified that FHLB stock shall be carried at cost and is no longer measured at fair value. Transfers during the nine months ended September 30, 2017 were from Level 3 to Level 2 as observable market data became available for these securities.
5. Investments
The Company's investments in fixed maturity securities, equity securities at fair value (prior to 2018), and short-term investments are classified as available-for-sale (AFS) that are reported at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity, net of deferred taxes, in Accumulated other comprehensive (loss) income (AOCI) on the Company’s Consolidated Balance Sheets. Beginning in 2018, with the adoption of ASU 2016-01, the

13


Company's investments in equity securities at fair value are no longer classified as AFS and changes in fair value are included in Net realized and unrealized gains on investments on the Company's Consolidated Statements of Comprehensive Income. Effective January 1, 2018, the Company's investment in FHLB stock is presented within Equity securities at cost on the Company's Consolidated Balance Sheets. Other securities within fixed maturity securities consist of bank loans, which are classified as AFS and are reported at fair value.
The cost or amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the Company’s AFS investments were as follows:
 
 
Cost or Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
 
(in millions)
At September 30, 2018
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
112.7

 
$
0.8

 
$
(2.2
)
 
$
111.3

U.S. Agencies
 
11.3

 
0.2

 
(0.1
)
 
11.4

States and municipalities
 
518.4

 
11.5

 
(2.5
)
 
527.4

Corporate securities
 
1,129.1

 
5.9

 
(24.1
)
 
1,110.9

Residential mortgage-backed securities
 
437.7

 
1.6

 
(15.4
)
 
423.9

Commercial mortgage-backed securities
 
98.6

 
—

 
(3.5
)
 
95.1

Asset-backed securities
 
67.1

 
0.1

 
(0.7
)
 
66.5

Other securities
 
48.1

 
—

 
—

 
48.1

Total fixed maturity securities
 
2,423.0

 
20.1

 
(48.5
)
 
2,394.6

Total AFS investments
 
$
2,423.0

 
$
20.1

 
$
(48.5
)
 
$
2,394.6

At December 31, 2017
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
135.8

 
$
2.0

 
$
(0.8
)
 
$
137.0

U.S. Agencies
 
11.3

 
0.5

 
—

 
11.8

States and municipalities
 
617.0

 
25.5

 
—

 
642.5

Corporate securities
 
1,103.4

 
18.0

 
(3.4
)
 
1,118.0

Residential mortgage-backed securities
 
388.3

 
3.6

 
(2.6
)
 
389.3

Commercial mortgage-backed securities
 
106.5

 
0.4

 
(0.9
)
 
106.0

Asset-backed securities
 
58.7

 
0.3

 
(0.2
)
 
58.8

Total fixed maturity securities
 
2,421.0

 
50.3

 
(7.9
)
 
2,463.4

Equity securities at fair value
 
 
 
 
 
 
 
 
Industrial and miscellaneous
 
100.8

 
81.5

 
(0.6
)
 
181.7

Non-redeemable preferred stock (FHLB)
 
4.7

 
—

 
—

 
4.7

Other
 
11.2

 
12.7

 
—

 
23.9

Total equity securities at fair value
 
116.7

 
94.2

 
(0.6
)
 
210.3

Short-term investments
 
4.0

 
—

 
—

 
4.0

Total AFS investments
 
$
2,541.7

 
$
144.5

 
$
(8.5
)
 
$
2,677.7

The cost and estimated fair value of the Company’s equity securities recorded at fair value at September 30, 2018 were as follows:
 
 
Cost
 
Estimated Fair Value
 
 
(in millions)
At September 30, 2018
 
 
 
 
Equity securities at fair value
 
 
 
 
Industrial and miscellaneous
 
$
78.3

 
$
162.0

Other
 
15.9

 
27.6

Total equity securities at fair value
 
$
94.2

 
$
189.6


14


The amortized cost and estimated fair value of the Company's fixed maturity securities at September 30, 2018, 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
 
$
154.3

 
$
154.6

Due after one year through five years
 
804.4

 
803.1

Due after five years through ten years
 
730.4

 
718.5

Due after ten years
 
130.5

 
132.9

Mortgage and asset-backed securities
 
603.4

 
585.5

Total
 
$
2,423.0

 
$
2,394.6

The following is a summary of AFS 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, 2018 and December 31, 2017.
 
 
September 30, 2018
 
December 31, 2017
 
 
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
 
$
52.3

 
$
(1.4
)
 
20

 
$
86.0

 
$
(0.5
)
 
28

U.S. Agencies
 
3.7

 
(0.1
)
 
2

 
—

 
—

 
—

States and municipalities
 
148.9

 
(2.5
)
 
41

 
—

 
—

 
—

Corporate securities
 
828.6

 
(19.5
)
 
267

 
307.6

 
(2.3
)
 
113

Residential mortgage-backed securities
 
293.4

 
(9.4
)
 
97

 
165.0

 
(0.8
)
 
45

Commercial mortgage-backed securities
 
66.8

 
(2.1
)
 
29

 
41.8

 
(0.2
)
 
19

Asset-backed securities
 
52.8

 
(0.7
)
 
35

 
29.3

 
(0.2
)
 
25

Total less than 12 months
 
$
1,446.5

 
$
(35.7
)
 
491

 
$
629.7

 
$
(4.0
)
 
230

 
 
 
 
 
 
 
 
 
 
 
 
 
12 months or greater:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
42.8

 
$
(0.8
)
 
16

 
$
23.4

 
$
(0.3
)
 
10

Corporate securities
 
82.3

 
(4.6
)
 
32

 
53.2

 
(1.1
)
 
17

Residential mortgage-backed securities
 
101.8

 
(6.0
)
 
42

 
77.1

 
(1.8
)
 
32

Commercial mortgage-backed securities
 
26.7

 
(1.4
)
 
12

 
25.1

 
(0.7
)
 
8

Total 12 months or greater
 
$
253.6

 
$
(12.8
)
 
102

 
$
178.8

 
$
(3.9
)
 
67

At December 31, 2017, the Company also had $0.6 million of gross unrealized losses on 24 equity securities that were in a continuous loss position for less than 12 months.
The Company recognized impairments on fixed maturity securities of $2.0 million (consisting of 57 securities) during the nine months ended September 30, 2018 as a result of the Company's intent to sell these securities. There were no other-than-temporary impairments on fixed maturity securities recognized during the nine months ended September 30, 2017. The Company determined that the remaining unrealized losses on fixed maturity securities for the nine months ended September 30, 2018 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 lack of 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 at an amount less than their amortized cost.
The adoption of ASU 2016-01 removed the impairment assessment for equity securities at fair value, and, beginning in 2018, changes in fair value are included in Net realized and unrealized gains on investments on the Company's Consolidated Statements of Comprehensive Income. Prior to the adoption of this standard, the Company recognized an impairment on equity securities of $0.2 million (consisting of one security) during the nine months ended September 30, 2017. The other-than-temporary impairment recognized during this period was the result of the severity and duration of the change in fair value of this security. Certain unrealized

15


losses on equity securities during the nine months ended September 30, 2017 were not considered to be other-than-temporary due to the financial condition and near-term prospects of the issuers, and the Company's intent to hold the securities until fair value recovers to above cost.
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 on fixed maturity securities are also recognized when securities are written down as a result of an other-than-temporary impairment.
Net realized gains on investments and the change in unrealized gains on the Company's investments recorded at fair value are determined on a specific-identification basis and were as follows:
 
 
Gross Realized Gains
 
Gross Realized Losses
 
Change in Net Unrealized Gains (Losses)
 
Changes in Fair Value Reflected in Earnings
 
Changes in Fair Value Reflected in AOCI, before tax
 
 
 
 
(in millions)
Three Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
$
—

 
$
—

 
$
(11.6
)
 
$
—

 
$
(11.6
)
Equity securities
 
4.9

 
(0.5
)
 
11.2

 
15.6

 
—

Total investments
 
$
4.9

 
$
(0.5
)
 
$
(0.4
)
 
$
15.6

 
$
(11.6
)
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
$
2.1

 
$
(2.6
)
 
$
(70.8
)
 
$
(0.5
)
 
$
(70.8
)
Equity securities
 
13.0

 
(1.1
)
 
1.8

 
13.7

 
—

Total investments
 
$
15.1

 
$
(3.7
)
 
$
(69.0
)
 
$
13.2

 
$
(70.8
)
Three Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
$
3.5

 
$
(0.7
)
 
$
(1.9
)
 
$
2.8

 
$
(1.9
)
Equity securities
 
1.3

 
—

 
2.4

 
1.3

 
2.4

Total investments
 
$
4.8

 
$
(0.7
)
 
$
0.5

 
$
4.1

 
$
0.5

 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
$
4.0

 
$
(0.8
)
 
$
17.0

 
$
3.2

 
$
17.0

Equity securities
 
4.4

 
(0.2
)
 
7.8

 
4.2

 
7.8

Total investments
 
$
8.4

 
$
(1.0
)
 
$
24.8

 
$
7.4

 
$
24.8

Net investment income was as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
(in millions)
Fixed maturity securities
 
$
18.8

 
$
17.4

 
$
56.5

 
$
52.4

Equity securities
 
1.5

 
1.7

 
4.8

 
5.2

Cash equivalents and restricted cash
 
0.9

 
0.2

 
1.4

 
0.4

Gross investment income
 
21.2

 
19.3

 
62.7

 
58.0

Investment expenses
 
(1.0
)
 
(0.8
)
 
(2.8
)
 
(2.6
)
Net investment income
 
$
20.2

 
$
18.5

 
$
59.9

 
$
55.4

The Company is required by various state laws and regulations to hold securities or letters of credit in depository accounts with certain states in which it does business. These laws and regulations govern not only the amount but also the types of securities that are eligible for deposit. As of September 30, 2018 and December 31, 2017, securities having a fair value of $864.3 million and $1,009.7 million, respectively, were on deposit. Additionally, standby letters of credit from the FHLB were in place in lieu of $140.0 million of securities on deposit as of September 30, 2018 (See Note 9).
Certain reinsurance contracts require the Company's 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 at September 30, 2018 and December 31, 2017 was $23.0 million and $24.5 million, respectively.

16


6. Income Taxes
Income tax expense for interim periods is measured using an estimated effective tax rate for the annual period. The Company's effective tax rates were 18.4% and 16.8% for the three and nine months ended September 30, 2018, respectively, compared to 24.2% and 23.2% for the same periods of 2017. Tax-advantaged investment income, Deferred Gain amortization, LPT Reserve Adjustments, LPT Contingent Commission Adjustments, and certain other adjustments reduced the Company's effective income tax rate below the U.S. statutory rates of 21% and 35% for periods in 2018 and 2017, respectively.
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.
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
(in millions)
Unpaid losses and LAE at beginning of period
 
$
2,227.9

 
$
2,284.9

 
$
2,266.1

 
$
2,301.0

Less reinsurance recoverable, excluding bad debt allowance, on unpaid losses and LAE
 
512.5

 
559.8

 
537.0

 
580.0

Net unpaid losses and LAE at beginning of period
 
1,715.4

 
1,725.1

 
1,729.1

 
1,721.0

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

 
 

Current period
 
121.1

 
119.7

 
342.5

 
341.0

Prior periods
 
(11.9
)
 
(0.2
)
 
(40.8
)
 
(0.5
)
Total net losses and LAE incurred during the period
 
109.2

 
119.5

 
301.7

 
340.5

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

 
 

Current period
 
31.2

 
23.5

 
56.9

 
45.2

Prior periods
 
71.5

 
75.3

 
252.0

 
270.5

Total net paid losses and LAE during the period
 
102.7

 
98.8

 
308.9

 
315.7

Ending unpaid losses and LAE, net of reinsurance
 
1,721.9

 
1,745.8

 
1,721.9

 
1,745.8

Reinsurance recoverable, excluding bad debt allowance, on unpaid losses and LAE
 
511.8

 
553.1

 
511.8

 
553.1

Unpaid losses and LAE at end of period
 
$
2,233.7

 
$
2,298.9

 
$
2,233.7

 
$
2,298.9

Total net losses and LAE included in the above table exclude amortization of the deferred reinsurance gain—LPT Agreement, LPT Reserve Adjustments, and LPT Contingent Commission Adjustments, which totaled $2.6 million and $2.5 million for the three months ended September 30, 2018 and 2017, respectively, and $12.0 million and $8.5 million for the nine months ended September 30, 2018 and 2017, respectively (See Note 8).
The change in incurred losses and LAE attributable to prior periods included $12.0 million and $40.5 million of favorable development on the Company's voluntary risk business for the three and nine months ended September 30, 2018, respectively, and $0.1 million of unfavorable development and $0.3 million of favorable development on the Company's assigned risk business for the three and nine months ended September 30, 2018, respectively. The favorable prior accident year loss development on voluntary business during the three and nine months ended September 30, 2018 was the result of the Company's determination that adjustments were necessary to reflect observed favorable paid loss trends. Paid loss trends have been impacted by cost savings associated with accelerated claims settlement activity that began in 2014 and continued in 2018.
8. LPT Agreement
The Company is party to the LPT Agreement under which $1.5 billion in liabilities for losses and LAE related to claims incurred by the Fund prior to July 1, 1995 were reinsured for consideration of $775.0 million. The LPT Agreement provides coverage up to $2.0 billion. 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 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

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to the Deferred Gain are recorded in losses and LAE incurred in the accompanying consolidated statements of comprehensive income.
The Company amortized $2.6 million and $2.5 million of the Deferred Gain for the three months ended September 30, 2018 and 2017, respectively, and $9.3 million and $8.5 million for the nine months ended September 30, 2018 and 2017, respectively. Additionally, the Deferred Gain was further reduced by $2.2 million for the nine months ended September 30, 2018 due to a favorable LPT Reserve Adjustment and by $0.5 million of amortization for the nine months ended September 30, 2018 due to a favorable LPT Contingent Commission Adjustment (see Note 2). The remaining Deferred Gain was $152.1 million and $163.6 million as of September 30, 2018 and December 31, 2017, respectively. The estimated remaining liabilities subject to the LPT Agreement were $414.0 million and $438.9 million as of September 30, 2018 and December 31, 2017, respectively. Losses and LAE paid with respect to the LPT Agreement totaled $767.8 million and $749.3 million from inception through September 30, 2018 and December 31, 2017, respectively.
9. Notes Payable and Other Financing Arrangements
Notes payable is comprised of the following:
 
September 30, 2018
 
December 31, 2017
 
(in millions)
Dekania Surplus Note, due April 29, 2034
$
10.0

 
$
10.0

Alesco Surplus Note, due December 15, 2034