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EMPLOYERS HOLDINGS, INC. – 10-K – Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements, the accompanying notes thereto, and the financial statement schedules included in Item 8 and Item 15 of this report. In addition to historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties and other factors described in Item 1A of this report. Our actual results in future periods may differ from those referred to herein due to a number of factors, including the risks described in the sections entitled "Risk Factors" and "Forward-Looking Statements" elsewhere in this report.
Overview
We are aNevada 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 throughoutthe United States , with a concentration inCalifornia , where 45% of our in-force premiums are generated. Our revenues are primarily comprised of net premiums earned, net investment income, and net realized and unrealized 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 theU.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 given our expertise in underwriting and claims handling in this market segment. 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. The insurance industry is highly competitive, and there is significant competition in the national workers' compensation industry that is based on price, commissions and quality of services. We compete with other specialty workers' compensation carriers, state funds, multi-line insurance companies, professional employer organizations, self-insurance funds, and state insurance pools. COVID-19 Impacts The COVID-19 pandemic has caused a reduction in business activity, widespread unemployment, supply chain interruptions, and overall economic instability. All states, includingCalifornia , where we generated 45% of our in-force premiums as ofDecember 31, 2021 , have, in recent times, imposed various restrictions on business operations and social gatherings. Certain classes of business that we insure, especially those related to the restaurant and hospitality industries, continue to be affected by these restrictions related to the COVID-19 pandemic. Further, employee shortages and inflationary pressures may exacerbate and prolong the negative impact of the COVID-19 pandemic on these businesses. The impact of these disruptions and the extent of their potential impacts on our future results of operations will be dictated by the length of time that such disruptions continue, which will depend on the currently unknown duration and severity of the impacts caused by the COVID-19 pandemic and its variants. While new business premium production did not meet our expectations during the first half of 2021, our renewal business remained strong throughout 2021. However, we remain encouraged by the consistent rebound we have experienced since then. We ended the year with a record number of policies in-force, which demonstrates that our policyholders have endured the pandemic and small businesses are actively shopping for workers' compensation coverage. As vaccination efforts continue and labor market shortages improve, we remain confident that rising payrolls will bring further improvement to our top line. In support of this anticipated recovery, we have continued to pursue and advance the significant investments that we have made in delivering a superior customer experience for our independent and digital agents. We continually review and adjust to changes in our policyholders' payrolls, economic conditions, and seasonality, as experience develops or new information becomes known. Any such adjustments are included in our current operations and are made periodically through mid-term endorsements and/or premium audits. We increased our final audit premium accruals by$12.3 million , for the year endedDecember 31, 2021 , as our payroll exposure improved with the labor market strengthening. We have largely remained in work-from-home mode since we closed our buildings to employees and the general public inMarch 2020 , and we remain fully functional while working in this manner. Despite widespread reopening of businesses and ongoing vaccination efforts, the continued impact of the COVID-19 pandemic, including any increases in infection rates, new variants and renewed governmental action to slow the spread of COVID-19, cannot be estimated at this time. Additional information regarding risks and uncertainties related to the COVID-19 pandemic to our business, financial condition, and results of operations are set forth in Part I, Item 1A of this report. 29 --------------------------------------------------------------------------------
Results of Operations
Our results of operations for the three year period endingDecember 31, 2021 are as follows: Years Ended December 31, 2021 2020 2019 (in millions) Gross premiums written$ 589.7 $ 580.1 $ 696.9 Net premiums written$ 583.1 $ 574.9 $ 691.5 Net premiums earned$ 574.4 $ 615.3 $ 695.8 Net investment income 72.7 76.3 88.1 Net realized and unrealized gains on investments 54.6 19.0 51.1 Other income 1.4 0.8 0.9 Total revenues 703.1 711.4 835.9 Losses and LAE 315.2 302.4 365.9 Commission expense 76.1 78.8 88.1
Underwriting and general and administrative expenses 160.2 181.3 187.5
Interest and financing expenses 0.5 0.4 0.6 Other expenses 4.1 0.8 - Total expenses 556.1 563.7 642.1 Net income before income taxes 147.0 147.7 193.8 Income tax expense 27.7 27.9 36.7 Net income$ 119.3 $ 119.8 $ 157.1 Overview
Our net income was
2020, and 2019, respectively. The key factors that affected our financial
performance during those years included:
•Net premiums earned decreased 6.6% in 2021 and 11.6% in 2020, each compared to
the previous year;
•Losses and LAE increased 4.2% in 2021 and decreased 17.4% in 2020, each
compared to the previous year;
•Underwriting and general and administrative expenses decreased 11.6% in 2021
and 3.3% in 2020, each compared to the previous year;
•Net investment income decreased 4.7% in 2021 and 13.4% in 2020, each compared
to the previous year; and
•Net realized and unrealized gains on investments were
million
Summary of Consolidated Financial Results
Gross Premiums Written
Gross premiums written were$589.7 million ,$580.1 million , and$696.9 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively. The period over period changes in gross premiums earned during 2021, 2020 and 2019 were primarily related to our Employers segment. See -Summary of Financial Results by Segment -Employers. Net Premiums Written
Net premiums written are gross premiums written less reinsurance premiums ceded.
Net Premiums Earned
Net premiums earned are primarily a function of the amount and timing of net
premiums previously written.
Net Investment Income and Net Realized and Unrealized Gains on Investments
We invest in fixed maturity securities, equity securities, other invested
assets, short-term investments, and cash equivalents. Net investment income
includes interest and dividends earned on our invested assets and amortization
of premiums and discounts on our fixed maturity securities, less bank service
charges and custodial and portfolio management fees. We have established a high
quality/short duration bias in our investment portfolio.
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Net investment income was $72.7 million , $76.3 million , and $88.1 million for
the years ended December 31, 2021 , 2020, and 2019, respectively. The decrease in
2021 was primarily due to lower interest rates impacting bond yields. The
decrease in 2020 was primarily due to lower bond yields and a sharp increase in
the amortization of bond premiums associated with our residential
mortgage-backed securities, which was caused by an acceleration of near-term
mortgage loan prepayment speed assumptions during the year. The average pre-tax
ending book yield on our invested assets was 3.0%, 3.0%, and 3.3% at
December 31, 2021 , 2020, and 2019, respectively.
Realized and certain unrealized gains and losses on our investments are reported
separately from our net investment income. Realized gains and losses on
investments include the gain or loss on a security at the time of sale compared
to its original or adjusted cost (equity securities) or amortized cost (fixed
maturity securities). Realized losses are also recognized for changes in our
CECL allowance or when securities are written down as a result of an
other-than-temporary impairment. Changes in fair value of equity securities and
other invested assets are also included in Net realized and unrealized gains on
investments on our Consolidated Statements of Comprehensive Income.
Net realized and unrealized gains on investments were
million
2019, respectively.
Net realized and unrealized gains on investments in 2021 included$45.6 million of net realized and unrealized gains on equity securities,$4.1 million of net realized gains on fixed maturity securities and short-term investments, and$4.9 million of unrealized gains on other invested assets. The net investment gains on our equity securities were largely consistent with the performance ofU.S. equity markets. The net investment gains on our fixed maturity securities were largely the result of decreases in market interest rates. The net investment gains on our fixed maturity securities also increased by$0.5 million , related to the change in allowance for CECL. Net realized and unrealized gains on investments in 2020 included$15.8 million of net realized and unrealized gains on equity securities,$4.5 million of net realized gains on fixed maturity securities and short-term investments, and$1.3 million of unrealized losses on other invested assets. The net investments gains on our equity securities were largely consistent with the performance ofU.S. equity markets. The net investment gains on our fixed maturity securities were primarily the result of decreases in market interest rates. The net investment gains on our fixed maturity securities were reduced by a$0.7 million allowance for CECL. Net realized and unrealized losses on investments in 2019 included$46.5 million of net realized and unrealized gains on equity securities,$3.9 million of net realized gains on fixed maturity securities and$0.7 million of unrealized gains on other invested assets. The net investment gains on our equity securities were largely consistent with the performance ofU.S. equity markets. The net investment gains on our fixed maturity securities were primarily related to sales associated with a reallocation of our investment portfolio. Additional information regarding our Investments is set forth under "-Liquidity and Capital Resources-Investments" and Note 5 in the Notes to our Consolidated Financial Statements. Other Income
Other income consists of net gains and losses on fixed assets, non-investment
interest, installment fee revenue, and other miscellaneous income.
Losses and LAE
Losses and LAE represents our largest expense item and includes claim payments made, amortization of the Deferred Gain, LPT Reserve Adjustments, LPT Contingent Commission Adjustments, estimates for future claim payments and changes in those estimates for current and prior periods, and costs associated with investigating, defending, and adjusting claims. The quality of our financial reporting depends in large part on accurately predicting our losses and LAE, which are inherently uncertain as they are estimates of the ultimate cost of individual claims based on actuarial estimation techniques. Our indemnity claims frequency (the number of claims expressed as a percentage of payroll) decreased in 2021 and 2020, as compared to previous years. However, we recognized the impacts of the COVID-19 pandemic, including the potential for further expansions or permanent extensions of presumed compensability of COVID-19 in certain jurisdictions. These trends and considerations are reflected in our current accident year loss estimate. Total claims costs have also been reduced by cost savings associated with increased claims settlement activity that continued through 2021. We believe our current accident year loss estimate is adequate; however, ultimate losses will not be known with any certainty for many years. We assume that increasing medical and indemnity cost trends will continue to impact our long-term claims costs, which may be offset by rate increases. Additional information regarding our reserves for losses and LAE is set forth under "-Critical Accounting Policies -Reserves for Losses and LAE." See also, "-Summary of Financial Results by Segment -Employers."
Commission Expenses
Commission expenses include direct commissions to our agents and brokers,
including our partnerships and alliances, for the premiums that they produce for
us, as well as incentive payments, other marketing costs, and fees. See
"-Summary of Financial Results by Segment -Employers."
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Underwriting and General and Administrative Expenses
Underwriting expenses represent those costs that we incur to underwrite and maintain the insurance policies we issue, excluding commissions. Direct underwriting expenses, such as premium taxes, policyholder dividends, and those expenses that vary directly with the production of new or renewal business, are recognized as the associated premiums are earned. Indirect underwriting expenses, such as the operating expenses of each of the Company's subsidiaries, do not vary directly with the production of new or renewal business and are recognized as incurred.
General and administrative expenses of the holding company are excluded in
determining the underwriting expense ratios of our reportable segments.
Interest and Financing Expenses
Interest and financing expenses include credit facility fees and interest,
letter of credit fees, finance lease interest, and other financing fees.
Other Expenses
During the year endedDecember 31, 2021 , we recorded$3.1 million of employee severance costs resulting from a 2021 reduction-in-force. This action was taken to better align our expenses with current revenues. Additionally, during the year endedDecember 31, 2021 , we wrote off$1.0 million of previously capitalized costs relating to information technologies identified as no longer being utilized. This charge was the result of our continual evaluation of ongoing technology initiatives. In 2020, as a result of the effectiveness of our work-from-home transition, we reduced our real estate footprint and closed and vacated various office locations and, accordingly, we recorded charges of$0.8 million related to the abandonment of certain operating leases.
Income Tax Expense
OnJanuary 1, 2000 , EICN assumed the assets, liabilities, and operations of the Fund pursuant to legislation passed in the 1999Nevada Legislature (the Privatization). Prior to the Privatization, the Fund was part of theState of Nevada and therefore was not subject to federal income tax. Accordingly, our pre-Privatization loss and LAE reserve adjustments, LPT Reserve Adjustments and Deferred Gain amortization impact our net income but do not change our taxable income. Income tax expense was$27.7 million ,$27.9 million , and$36.7 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively, representing effective tax rates of 18.8%, 18.9%, and 18.9% for the years endedDecember 31, 2021 , 2020, and 2019, respectively. Tax-advantaged investment income, LPT Reserve Adjustments, LPT Contingent Commission Adjustments, Deferred Gain amortization and certain other adjustments reduced our income tax expense computed at a statutory rate of 21% by$3.3 million ,$3.1 million , and$4.0 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively.
For additional information regarding our income tax expense see Note 8 in the
Notes to our Consolidated Financial Statements.
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Summary of Financial Results by Segment
EMPLOYERS
The components of Employers' net income before income taxes are set forth in the
following table:
Years Ended December 31,
2021 2020 2019
($ in millions)
Gross premiums written $ 588.2 $ 579.8 $ 696.8
Net premiums written $ 581.6 $ 574.6 $ 691.4
Net premiums earned $ 573.7 $ 615.1 $ 695.8
Net investment income 69.3 72.1 84.1
Net realized and unrealized gains on investments 54.5 20.9 47.7
Other income 1.4 0.8 0.9
Total revenues 698.9 708.9 828.5
Losses and LAE 326.2 314.2 378.6
Commission expense 76.1 78.8 88.1
Underwriting expenses 131.2 151.1 153.2
Interest and financing expenses - 0.1 0.6
Other expenses 4.1 0.7 -
Total expenses 537.6 544.9 620.5
Net income before income taxes $ 161.3 $ 164.0 $ 208.0
Underwriting income $ 40.2 $ 71.0 $ 75.9
Combined ratio 93.1 % 88.5 % 89.1 %
Underwriting Results
Gross Premiums Written
Gross premiums written were $588.2 million , $579.8 million , and $696.8 million
for the years ended December 31, 2021 , 2020, and 2019, respectively. The
increase in 2021 primarily resulted from our appetite expansion effort,
continued strong new business writings, particularly in California , and further
audit premium recognition. Despite the increases we experienced in 2021,
decreases in average rates and policy sizes in many of the states in which we do
business further impacted our gross premiums written. We increased our final
audit accruals by $12.3 million during the year, as payroll exposure improved
with the labor market strengthening. We have experienced increases in new
business submissions, quotes and binds in the majority of the states in which we
operate, including California where increases have occurred since the second
quarter of 2021. Whereas our in-force policies have increased throughout 2021,
our in-force premiums have only begun to increase since May of 2021. In
addition, our retention rate has remained strong throughout 2021.
The decrease in 2020 was primarily driven by the impacts of the COVID-19
pandemic, including higher levels of unemployment and declines in payrolls for
many of our insureds, upon which our premiums are based, particularly in our
restaurant and hospitality classes. In 2020, we reduced our final audit accruals
from approximately $35.0 million to zero to reflect our estimate of the exposure
adjustments on our in-force policies that we expect have resulted and would
result from the impact of economic contraction.
Net Premiums Written
Net premiums written were$581.6 million ,$574.6 million , and$691.4 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively, which included$6.6 million ,$5.2 million , and$5.4 million of reinsurance premiums ceded, respectively.
Net Premiums Earned
Net premiums earned were
the years ended
33 -------------------------------------------------------------------------------- The following table shows the percentage change in Employers' in-force premiums, policy count, average policy size, and payroll exposure upon which our premiums are based as ofDecember 31, 2021 and 2020, respectively, overall, forCalifornia , where 45% of our premiums were generated, and for all other states, excludingCalifornia : Percentage Change Percentage Change 2021 Over 2020 2020 Over 2019 All Other All Other Overall California States Overall California States In-force premiums (1.3) % (1.4) % (1.3) % (13.1) % (20.6) % (5.7) % In-force policy count 6.7 2.8 9.1 4.8 (8.1) 14.7 Average in-force policy size (7.5) (4.0) (9.5) (17.0) (13.6) (17.8) In-force payroll exposure 7.4 10.6 5.8 (0.1) (10.6) 5.8
Losses and LAE, Commission Expenses, and Underwriting Expenses
The following table presents calendar year combined ratios for our Employers
segment.
Years Ended December 31,
2021 2020 2019
Loss and LAE ratio 56.9 % 51.1 % 54.4 %
Commission expense ratio 13.3 12.8 12.7
Underwriting expense ratio 22.9 24.6 22.0
Combined ratio 93.1 % 88.5 % 89.1 %
Loss and LAE Ratio. We analyze our loss and LAE ratios on both a calendar year
and accident year basis.
The calendar year loss and LAE ratio is calculated by dividing the losses and LAE recorded during the calendar year, regardless of when the underlying insured event occurred, by the net premiums earned during that calendar year. The calendar year loss and LAE ratio includes changes made during the calendar year in reserves for losses and LAE established for insured events occurring in the current and prior years. The calendar year loss and LAE ratio for a particular year will not change in future periods. The accident year loss and LAE ratio is calculated by dividing cumulative losses and LAE for reported events that occurred during a particular year by the net premiums earned for that year. The accident year loss and LAE ratio for a particular year can decrease or increase when recalculated in subsequent periods as the reserves established for insured events occurring during that year develop favorably or unfavorably. The accident year loss and LAE ratio is based on our statutory financial statements and is not derived from our GAAP financial information. We analyze our calendar year loss and LAE ratio to measure our profitability in a particular year and to evaluate the adequacy of our premium rates charged in a particular year to cover expected losses and LAE from all periods, including development (whether favorable or unfavorable) of reserves established in prior periods. In contrast, we analyze our accident year loss and LAE ratios to evaluate our underwriting performance and the adequacy of the premium rates we charged in a particular year in relation to ultimate losses and LAE from insured events occurring during that year. The loss and LAE ratios provided in this report are on a calendar year basis, except where they are expressly identified as accident year loss and LAE ratios.
The table below reflects prior accident year loss and LAE reserve adjustments
and the impact to loss ratio.
Years Ended December 31,
2021 2020 2019
($ in millions)
Losses and LAE $ 326.2 $ 314.2 $ 378.6
Prior accident year favorable development, net 39.8 81.6
77.5
Current accident year losses and LAE$ 366.0 $ 395.8
Current accident year loss and LAE ratio 63.8 % 64.3 %
65.6 %
As part of our continued technology and process improvements initiative, we implemented a new comprehensive claims system during 2021, which we believe has enhanced and streamlined our claims handling processes and has positioned us for further improvement.
The increase in our total losses and LAE from 2020 to 2021 was primarily due to
less favorable prior loss reserve development recognized in 2021, partially
offset by lower earned premium in 2021. Net favorable year loss development
recognized in 2021 totaled
2020. The decrease in our total losses and LAE from 2019 to 2020 was
34 -------------------------------------------------------------------------------- primarily due to higher earned premium in 2019, as well as a greater amount of net favorable prior year loss reserve development recognized during 2020. Net favorable prior year accident loss reserve development recognized in 2020 totaled$81.6 million versus$77.5 million recognized in 2019. The net favorable development recognized in 2021 was primarily the result of observed favorable paid loss cost trends predominantly related to accident years 2017 and prior, due primarily to decreasing medical costs and defense and cost containment, partially offset by: (i)$10.0 million of unfavorable development related to accident year 2019, which is reflective of more weight being placed on now sufficiently seasoned loss trends and patterns originating in part from business written in our newer territories; and (ii)$8.0 million of unfavorable loss development associated with two catastrophic non-COVID claims in accident year 2020. The net favorable development recognized in 2020 was primarily the result of observed favorable paid loss cost trends predominantly related to accident years 2018 and prior, due primarily to decreasing medical costs, partially offset by$13.3 million of adverse development on accident year 2019 due, in part, to an inability to fully execute our claims initiatives to reduce loss costs as a result of the COVID-19 pandemic. The net favorable development recognized in 2019 was primarily the result of observed favorable paid loss cost trends predominantly related to accident years 2018 and prior, due primarily to decreasing medical costs and accelerated claims settlements. The decreases in our current accident year loss and LAE ratios from 2019 to 2021 was primarily due to continued declines in indemnity claim frequency. In addition, our current accident year loss and LAE ratios continue to reflect the impact of key business initiatives, including: an emphasis on the accelerated settlement of open claims; diversifying our risk exposure across geographic markets; and leveraging data-driven strategies to target, underwrite, and price profitable classes of business across all of our markets. We continue to believe that the economic conditions resulting from the COVID-19 pandemic, including the potential for a short-term increase in inflation, introduced an increased risk of latent claims reporting and/or medical inflation, particularly for the more recent prior accident years. As a result, since the first quarter of 2020, we have limited the recognition of observed favorable development for accident years subsequent to 2010. Commission Expense Ratio. The commission expense ratio was 13.3%, 12.8%, and 12.7%, and our commission expenses were$76.1 million ,$78.8 million , and$88.1 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively. The increase in the commission expense ratio for 2021 was primarily the result of increased commissions on new business writings, which are subject to a higher commission rate. The increase in the commission expense ratio for 2020 was primarily the result of a higher concentration of alternative distribution channels, which is subject to a higher commission rate, and increased commission expense on new business writings. Underwriting Expense Ratio. The underwriting expense ratio was 22.9%, 24.6%, and 22.0%, and our underwriting expenses were$131.2 million ,$151.1 million , and$153.2 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively. During the year endedDecember 31, 2021 , compensation-related expenses decreased$11.2 million , bad debt expenses decreased$5.2 million , and premium taxes and assessments decreased$4.9 million , each compared to 2020. The 2021 decreases in underwriting expenses resulted from planned expense reductions and employee reductions and departures, which reduced our fixed expenses such as compensation and professional fees, as well as reductions in variable expenses, such as premium taxes and assessments and bad debt expenses, both resulting from the decrease in premiums earned. Additionally, bad debt decreased as a result of significant reductions in audit premium exposure and premium taxes and assessments were further reduced as a result of finalizing prior assessments that were subject to open years. During the year endedDecember 31, 2020 , professional fees decreased$3.6 million and travel expenses decreased$2.0 million , partially offset by an increase in depreciation and amortization of$3.2 million , each compared to 2019.
Underwriting Income
Underwriting income for our Employers segment was$40.2 million ,$71.0 million , and$75.9 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively. Underwriting income or loss is determined by deducting losses and LAE, commission expense, and underwriting expenses from net premiums earned.
Non-Underwriting Income and Expenses
For a further discussion of non-underwriting related income and expenses,
including Net Investment Income and Net Realized and Unrealized Gains on
Investments, Other Income, Interest and Financing Expenses, and Other Expenses,
see "-Results of Operations -Summary of Consolidated Financial Results."
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CERITY
The components of Cerity's net loss before income taxes are set forth in the
following table:
Years Ended December 31,
2021 2020 2019
(in millions)
Gross premiums written $ 1.5 $ 0.3 $ 0.1
Net premiums written $ 1.5 $ 0.3 $ 0.1
Net premiums earned $ 0.7 $ 0.2 $ -
Net investment income 2.8 3.1 0.3
Net realized and unrealized gains on investments 0.3 - 0.1
Other income - - -
Total revenues 3.8 3.3 0.4
Losses and LAE 0.5 0.1 -
Underwriting expenses 12.9 16.6 16.0
Other expenses - 0.1 -
Total expenses 13.4 16.8 16.0
Net loss before income taxes $ (9.6) $ (13.5) $ (15.6)
Underwriting loss $ (12.7) $ (16.5) $ (16.0)
Combined ratio n/m n/m n/m
n/m - not meaningful
Underwriting Results
Gross Premiums Written and Net Premiums Written
Gross premiums written and net premiums written were
and
respectively.
Net premiums earned were
for the years ended
Underwriting Expenses
Underwriting expenses for our Cerity segment were$12.9 million ,$16.6 million , and$16.0 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively. During the year endedDecember 31, 2021 , our compensation-related expense decreased$3.3 million as compared to 2020. During the year endedDecember 31, 2020 , professional fees increased$2.4 million , partially offset by a decrease in depreciation and amortization of$0.8 million and a decrease in compensation-related expenses of$0.7 million , each as compared to 2019.
The 2021 decreases in compensation expenses resulted primarily from employee
reductions and departures.
Underwriting Loss Underwriting losses for our Cerity segment were$12.7 million ,$16.5 million , and$16.0 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively. Underwriting income or loss is determined by deducting losses and LAE, commission expense, and underwriting expenses from net premiums earned.
Non-Underwriting Income and Expenses
For a further discussion of non-underwriting related income and expenses,
including Net Investment Income and Net Realized and Unrealized Gains on
Investments, Other Income, and Other Expenses, see "-Results of Operations
-Summary of Consolidated Financial Results Consolidated."
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CORPORATE AND OTHER
The components of Corporate and Other's net income (loss) before income taxes
are set forth in the following table:
Years Ended December 31,
2021 2020 2019
(in millions)
Net investment income $ 0.6 $ 1.1 $ 3.7
Net realized and unrealized (losses) gains on
investments (0.2) (1.9) 3.3
Total revenues 0.4 (0.8) 7.0
Losses and LAE - LPT (11.5) (11.9) (12.7)
General and administrative expenses 16.1 13.6 18.3
Interest and financing expenses 0.5 0.3 -
Total expenses 5.1 2.0 5.6
Net income (loss) before income taxes $ (4.7) $ (2.8) $ 1.4
Losses and LAE - LPT
The table below reflects the impact of the LPT on Losses and LAE, which are
recorded as a reduction to Losses and LAE incurred on our Consolidated
Statements of Comprehensive Income.
Years Ended December 31,
2021 2020 2019
(in millions)
Amortization of the Deferred Gain related to losses $ 6.7
Amortization of the Deferred Gain related to contingent
commission
1.7 1.8 1.8 Impact of LPT Reserve Adjustments(1) 2.6 1.2 1.8 Impact of LPT Contingent Commission Adjustments(2) 0.5 0.2 0.2 Total impact of the LPT$ 11.5
(1)LPT Reserve Adjustments result in a cumulative adjustment to the Deferred Gain, which is recognized in losses and LAE incurred on our Consolidated Statements of Comprehensive Income, such that the Deferred Gain reflects the balance that would have existed had the revised reserves been recognized at the inception of the LPT Agreement. (See Note 2 in the Notes to our Consolidated Financial Statements.) (2)LPT Contingent Commission Adjustments result in a cumulative adjustment to the Deferred Gain, which is recognized in losses and LAE incurred on our 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. (See Note 2 in the Notes to our Consolidated Financial Statements.)
General and Administrative Expenses
General and administrative expenses primarily consist of compensation related expenses, professional fees, and other corporate expenses at the holding company level. General and administrative expenses were$16.1 million ,$13.6 million , and$18.3 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively. During the year endedDecember 31, 2021 , our compensation-related expenses increased$2.3 million , as compared to 2020. The increase in compensation expenses during the year endDecember 31, 2021 related primarily to theApril 1, 2021 retirement ofDouglas D. Dirks , our former President and Chief Executive Officer, and reflected: (i) an acceleration of certain ofMr. Dirks' outstanding share-based awards pursuant to the retirement provisions of such awards; and (ii) additional vesting of certain ofMr. Dirks' outstanding share-based awards. During the year endedDecember 31, 2020 , our compensation-related expenses decreased$3.2 million , due primarily to lower incentive compensation accruals, and our professional fees decreased$0.9 million , each as compared to 2019.
Non-Underwriting Income and Expenses
For a further discussion of non-underwriting related income and expenses,
including Net Investment Income, Net Realized and Unrealized Gains and Losses on
Investments, and Interest and Financing Expenses, see "-Results of Operations
-Summary of Consolidated Financial Results."
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Liquidity and Capital Resources
COVID-19 Considerations
The pandemic's disruptions on theU.S. economy, our current operations and our investment portfolio have, at times, been significant. Nonetheless we believe that the liquidity available to our holding company and its operating subsidiaries remains adequate and we do not currently foresee a need to: (i) suspend ordinary dividends, or forgo repurchases of our common stock; (ii) seek a capital infusion; or (iii) seek any material non-investment asset sales. Furthermore, the holding company has no outstanding debt obligations and its operating subsidiaries have no interest-bearing debt obligations.
Holding Company Liquidity
We are a holding company and our ability to fund our operations is contingent upon existing capital and the ability of our subsidiaries to pay dividends up to the holding company. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws and regulations, including laws establishing minimum solvency and liquidity thresholds. We require cash to pay stockholder dividends, repurchase common stock, provide additional surplus to our insurance subsidiaries, and fund our operating expenses. Our insurance subsidiaries' ability to pay dividends to their parent is based on reported capital, surplus, and dividends paid within the prior 12 months. For 2022, EICN cannot pay any dividends throughMarch 22, 2022 and can pay$9.7 million thereafter, without prior regulatory approval; EPIC cannot pay any dividends throughJune 18, 2022 , and can pay$24.0 million thereafter, without prior regulatory approval; EAC cannot pay any dividends throughJune 30, 2022 , and can pay$23.2 million thereafter, without prior regulatory approval; and CIC cannot pay dividends throughAugust 30, 2022 , without prior regulatory approval, and$2.7 million thereafter. OnJanuary 14, 2022 , ECIC received regulatory approval from the California DOI to pay an extraordinary distribution, in the amount of$120.0 million , to its parent company, EGI. This distribution was approved by ECIC's Board of Directors onNovember 12, 2021 and it was paid to EGI onFebruary 15, 2022 . As a result of this distribution, ECIC cannot pay dividends throughFebruary 15, 2023 , without prior regulatory approval.
Total cash and investments at the holding company were
securities.
OnDecember 15, 2020 , EHI entered into a Credit Agreement (the Credit Agreement) with a syndicate of financial institutions. The Credit Agreement provides EHI with a$75.0 million three-year revolving credit facility. Borrowings under the Credit Agreement may be used for working capital and general corporate purposes. Pursuant to the Credit Agreement, EHI has the option to request an increase of the credit available under the facility, up to a maximum facility amount of$125.0 million , subject to the consent of lenders and the satisfaction of certain conditions. EHI borrowed and subsequently repaid$27.0 million under the Credit Agreement during the year endedDecember 31, 2021 . EHI had no outstanding advances under the Credit Agreement atDecember 31, 2021 . The interest rates applicable to loans under the Credit Agreement are generally based on a base rate plus a specified margin, ranging from 0.25% to 1.25%, or the Eurodollar rate (which will convert to an alternative reference rate once LIBOR is discontinued) plus a specified margin, ranging from 1.25% to 2.25%. Total interest paid during the year endedDecember 31, 2021 was$0.3 million . The Credit Agreement contains covenants that require us to maintain: (i) a minimum consolidated net worth of no less than 70% of our stockholders' equity as ofSeptember 30, 2020 , plus 50% of our aggregate net income thereafter; and (ii) a debt to total capitalization ratio of no more than 35%, in each case as determined in accordance with the Credit Agreement.
Operating Subsidiaries' Liquidity
The primary sources of cash for our operating subsidiaries, which include our insurance and other operating subsidiaries, are premium collections, investment income, sales and maturities of investments, proceeds from FHLB advances, and reinsurance recoveries. The primary uses of cash for our operating subsidiaries are payments of losses and LAE, commission expenses, underwriting and general and administrative expenses, ceded reinsurance, repayments of FHLB advances, investment purchases and dividends paid to their parent. Total cash and investments held by our operating subsidiaries was$2,771.4 million atDecember 31, 2021 , consisting of$70.5 million of cash, cash equivalents, and restricted cash,$2,332.6 million of fixed maturity securities,$319.4 million of equity securities,$10.5 million of short-term investments, and$38.4 million of other invested assets. Sources of immediate and unencumbered liquidity at our operating subsidiaries as ofDecember 31, 2021 consisted of$71.2 million of cash and cash equivalents,$296.0 million of publicly-traded equity securities whose proceeds are available within three business days,$880.7 million of highly liquid fixed maturity securities whose proceeds are available within three business days, and$10.5 million of short-term investments whose proceeds are available within three business days. We believe that our subsidiaries' liquidity needs over the next 24 months will be met with cash from operations, investment income, and maturing investments. 38 -------------------------------------------------------------------------------- EICN, ECIC, EPIC, and EAC are members of theFederal Home Loan Bank of San Francisco (FHLB). Membership allows our subsidiaries access to collateralized advances, which may be used to support and enhance liquidity management. The amount of advances that may be taken is dependent on statutory admitted assets on a per company basis. During the second quarter of 2020, the FHLB announced its Zero Interest Recovery Advance Program (the FHLB Advance Program). The FHLB Advance Program is a zero percent interest, six-month or one-year credit product that members can use to provide immediate relief to property owners, businesses, and other customers struggling with the financial impacts of the COVID-19 pandemic. Each member was allocated up to$10.0 million in advances under the FHLB Advance Program. OnMay 11, 2020 , our insurance subsidiaries received a total of$35.0 million of advances under the FHLB Advance Program. The advances were secured by collateral previously pledged to the FHLB by our insurance subsidiaries in support of our existing collateralized advance facility, which has been reduced by the amount of these outstanding advances. Our insurance subsidiaries repaid$15.0 million onNovember 4, 2020 ,$5.0 million onMarch 31, 2021 , and$15.0 million onMay 4, 2021 . As ofDecember 31, 2021 , we have no outstanding advances. FHLB membership also allows our insurance subsidiaries access to Letter of Credit Agreements and onMarch 9, 2018 , ECIC, EPIC, and EAC entered into Letter of Credit Agreements with the FHLB. OnJanuary 26, 2021 , we chose to amend our existing Letter of Credit Agreements among the FHLB and EPIC to decrease its respective credit amount. OnAugust 13, 2021 , we chose to amend our existing Letter of Credit Agreements among the FHLB, ECIC and EAC to decrease their respective credit amounts. The amended Letter of Credit Agreements are between the FHLB and each of EAC, in the amount of$25.0 million , ECIC, in the amount of$35.0 million , and EPIC, in the amount of$10.0 million . The amended Letter of Credit Agreements will expireMarch 31, 2022 . The Letter of Credit Agreements may only be used to satisfy, in whole or in part, insurance deposit requirements with theState of California and are fully secured with eligible collateral at all times (See Note 11 in the Notes to our Consolidated Financial Statements). We purchase reinsurance to protect us against the costs of severe claims and catastrophic events, including pandemics. OnJuly 1, 2021 , we entered into a new reinsurance program that is effective throughJune 30, 2022 . The reinsurance program consists of one treaty covering excess of loss and catastrophic loss events in four layers of coverage. Our reinsurance coverage is$190.0 million in excess of our$10.0 million retention on a per occurrence basis, subject to certain exclusions. We believe that our reinsurance program meets our needs and that we are sufficiently capitalized. We further believe that we will not trigger a recovery under our current excess of loss reinsurance program in connection with the COVID-19 pandemic. Our insurance subsidiaries are required by law to maintain a certain minimum level of surplus on a statutory basis. Surplus is calculated by subtracting total liabilities from total admitted assets. The amount of capital in our insurance subsidiaries is maintained relative to standardized capital adequacy measures such as risk-based capital (RBC), as established by theNational Association of Insurance Commissioners . The RBC standard was designed to provide a measure by which regulators can assess the adequacy of an insurance company's capital and surplus relative to its operations. An insurance company must maintain capital and surplus of at least 200% of RBC. Each of our insurance subsidiaries had total adjusted capital in excess of the minimum RBC requirements that correspond to any level of regulatory action atDecember 31, 2021 . Various state laws and regulations require us to hold investment securities or letters of credit on deposit with certain states in which we do business. Securities having a fair value of$861.4 million and$768.7 million were on deposit at each ofDecember 31, 2021 and 2020, respectively. These laws and regulations govern both the amount and types of investment securities that are eligible for deposit. Additionally, standby letters of credit from the FHLB have been issued in lieu of$70.0 million and$275.0 million of securities on deposit atDecember 31, 2021 and 2020, respectively.
Certain reinsurance contracts require company funds to be held in trust for the
benefit of the ceding reinsurer to secure the outstanding liabilities we
assumed. The fair value of fixed maturity securities held in trust for the
benefit of our ceding reinsurers was
Sources of Liquidity
We monitor the cash flows of each of our subsidiaries individually, as well as
collectively as a consolidated group. We use trend and variance analyses to
project future cash needs, making adjustments to our forecasts as appropriate.
39 --------------------------------------------------------------------------------
The table below shows our net cash flows. For additional information regarding
our cash flows, see Item 8, Consolidated Statements of Cash Flows.
Years
Ended
2021 2020 2019
Cash, cash equivalents, and restricted cash provided
by (used in):
(in millions) Operating activities$ 10.8 $ 33.0 $ 122.5 Investing activities (1.7) 84.3 49.2 Financing activities (94.4) (111.9) (118.5) (Decrease) increase in cash, cash equivalents, and restricted cash$ (85.3) $ 5.4 $ 53.2 Operating Activities Net cash provided by operating activities in 2021 included net premiums received of$568.0 million and investment income received of$82.0 million . These operating cash inflows were partially offset by net claims payments of$394.6 million , underwriting and general and administrative expenses paid of$141.0 million , commissions paid of$74.8 million , and federal income taxes paid of$28.2 million . Net cash provided by operating activities in 2020 included net premiums received of$624.6 million and investment income received of$87.2 million . These operating cash inflows were partially offset by net claims payments of$402.6 million , underwriting and general and administrative expenses paid of$171.3 million , commissions paid of$85.7 million , and federal income taxes paid of$18.5 million . Net cash provided by operating activities in 2019 included net premiums received of$746.2 million , investment income received of$98.5 million , and cash received of$19.1 million for theLPT Contingent Commission . These operating cash inflows were partially offset by net claims payments of$403.3 million , underwriting and general and administrative expenses paid of$184.8 million , commissions paid of$95.1 million , and federal income taxes paid of$37.8 million .
Investing Activities
Net cash used in investing activities in 2021 was primarily related to the investment of premiums received and reinvestment of funds from investment sales, maturities, redemptions, and interest income. These investing cash outflows were largely offset by sales, maturities, and redemptions of investments whose proceeds were used to fund claims payments, underwriting and general and administrative expenses, stockholder dividend payments, and common stock repurchases. Net cash provided by investing activities in 2020 was primarily related to sales, maturities, and redemptions of investments whose proceeds were used to fund claims payments, underwriting and general and administrative expenses, stockholder dividend payments, and common stock repurchases, partially offset by the investment of premiums received and reinvestment of funds from investment sales, maturities, redemptions, and interest income.
Net cash provided by investing activities in 2019 was primarily related to
sales, maturities, and redemptions of investments whose proceeds were used to
fund the acquisition of CIC, claims payments, underwriting and general and
administrative expenses, stockholder dividend payments, debt repayment, and
common stock repurchases, partially offset by the investment of premiums
received and reinvestment of funds from investment sales, maturities,
redemptions, and interest income.
Financing Activities
Net cash used in financing activities in 2021 included common stock repurchases and stockholder dividend payments and repayments of FHLB advances. During the year endedDecember 31, 2021 , we borrowed and subsequently repaid$27.0 million under the Credit Agreement. Net cash used in financing activities in 2020 included common stock repurchases and stockholder dividend payments, partially offset by net cash received from the FHLB Advance Program.
Net cash used in financing activities in 2019 included common stock repurchases,
the redemption of notes payable, and stockholder dividend payments.
Dividends. We paid$29.0 million ,$30.5 million , and$28.3 million in dividends to our stockholders in 2021, 2020, and 2019, respectively. The declaration and payment of future dividends to common stockholders will be at the discretion of our Board of Directors and will depend upon many factors, including our financial position, capital requirements of our operating subsidiaries, legal and regulatory requirements, and any other factors our Board of Directors deems relevant. OnFebruary 15, 2022 , the Board of Directors declared a$0.25 dividend per share, payableMarch 15, 2022 , to stockholders of record onMarch 1, 2022 . 40 -------------------------------------------------------------------------------- Repurchases of Common Stock. We repurchased$42.2 million ,$99.8 million and$67.1 million of our common stock in 2021, 2020, and 2019, respectively. OnJuly 21, 2021 , our Board of Directors authorized a new share repurchase authorization for repurchases of up to$50.0 million of our common stock fromJuly 27, 2021 throughDecember 31, 2022 (the 2021 Program). The 2021 Program replaces the 2018 Program, which expired onJune 30, 2021 . Future repurchases of our common stock will be at the discretion of our Board of Directors and will depend upon many factors, including our financial position, capital requirements of our operating subsidiaries, general business and social economic conditions, legal, tax, regulatory, and/or contractual restrictions, and any other factors our Board of Directors deems relevant. As ofDecember 31, 2021 , we had a remaining common stock repurchase authorization of$27.9 million . See Item 5, Issuer Purchases ofEquity Securities . Capital Resources
As of
Stockholders' Equity. The following table summarizes our beginning and ending stockholders' equity balance and the changes thereto for each of the years endedDecember 31, 2021 , 2020, and 2019: December 31, 2021 2020 2019 (in millions) Beginning Balance$ 1,212.8 $ 1,165.8 $ 1,018.2 Stock-based obligations 9.1 9.7 10.1 Stock options exercised 1.1 0.9 0.7
Shares withheld to satisfy minimum tax withholdings
for certain stock-based obligations
(3.8) (2.7) (3.2) Acquisition of common stock (42.2) (99.8) (67.1) Dividends declared (28.7) (30.8) (28.9) Net income for the year 119.3 119.8 157.1 Change in net unrealized gains (losses) on investments, net of taxes (54.5) 49.8 79.0 Ending Balance$ 1,213.1 $ 1,212.8 $ 1,165.8
Deferred Gain. The Deferred Gain, which totaled
million
gain from the LPT Agreement. See Note 2 in the Notes to our Consolidated
Financial Statements.
Contractual Obligations and Commitments
Other than operating expenses, current and long-term cash requirements include
the following contractual obligations and commitments as of
Leases
We have entered into lease arrangements for certain equipment and facilities. As ofDecember 31, 2021 , we had lease payment obligations of$17.1 million , with$3.4 million payable within 12 months.
Other Purchase Obligations
We have other purchase obligations that primarily consist of non-cancellable obligations to acquire capital assets, commitments for information technology and related services, software acquisition and license commitments and other legally binding agreements to purchase services that are to be used in our operations. As ofDecember 31, 2021 , we had other purchase obligations of$21.7 million , with$5.5 million payable within 12 months.
Unfunded Investment Commitments
We have investments in private equity limited partnerships that require capital distributions to fund the investments and can be called at any time deemed necessary. As ofDecember 31, 2021 , we had unfunded investment commitments of$46.4 million .
Unpaid Losses and LAE reserves
We have unpaid losses and LAE reserves payment patterns that are computed based on historical information. Our calculation of loss and LAE reserve payments by period is subject to the same uncertainties associated with determining the level of reserves and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. Actual payments of losses and LAE by period will vary, perhaps materially, to the extent that current estimates of losses and LAE reserves vary from actual ultimate claims amounts due to variations between expected and actual payout patterns. As ofDecember 31, 2021 , we had unpaid losses and LAE reserve payments of$1,981.2 million , 41 --------------------------------------------------------------------------------
with
process, see ''-Critical Accounting Policies-Reserves for Losses and LAE.''
The unpaid losses and LAE reserves payments are gross of reinsurance
recoverables for unpaid losses. As of
recoverables on unpaid losses and LAE of
Investments
Our investment portfolio is structured to support our need for: (i) optimizing our risk-adjusted total return; (ii) providing adequate liquidity; (iii) facilitating financial strength and stability; and (iv) ensuring regulatory and legal compliance. These investments provide a steady source of income, which may fluctuate with changes in interest rates and our current investment strategies. Our Investment Managers follow our written investment guidelines, which are approved by theFinance Committee of the Board of Directors. Our asset allocation is reevaluated by management and reviewed by theFinance Committee of the Board of Directors on a quarterly basis. We also utilize our Investment Managers' investment advisory services to assist us in developing a tailored set of portfolio targets and objectives. As ofDecember 31, 2021 , our investment portfolio consisted of 86% fixed maturity securities. We strive to limit the interest rate risk associated with fixed maturity investments by managing the duration of these securities. Our fixed maturity securities (excluding cash and cash equivalents) had a duration of 3.4 atDecember 31, 2021 . To minimize interest rate risk, our portfolio is weighted toward short-term and intermediate-term bonds; however, our investment strategy balances consideration of duration, yield, and credit risk. Our investment guidelines require that the minimum weighted average quality of our fixed maturity securities portfolio be "A+," using ratings assigned by S&P or an equivalent rating assigned by another nationally recognized statistical rating agency. Our fixed maturity securities portfolio had a weighted average quality of "A+" as ofDecember 31, 2021 . Other securities within fixed maturity securities consist of bank loans, which are classified as AFS and are reported at fair value. Our investment portfolio also contains equity securities. We strive to limit the exposure to equity price risk associated with publicly traded equity securities by diversifying our holdings across several industry sectors. These equity securities had a fair value of$338.8 million atDecember 31, 2021 , which represented 12% of our investment portfolio at that time. We also have a$5.6 million investment in FHLB stock which we record at cost. We receive periodic dividends from the FHLB for this investment, when declared, which can vary from period to period. Our Other invested assets made up 1% of our investment portfolio atDecember 31, 2021 and include private equity limited partnerships. Our investments in private equity limited partnerships totaled$38.4 million atDecember 31, 2021 and are generally not redeemable by the investees and cannot be sold without prior approval of the general partner. These investments have a fund term of 10 to 12 years, subject to two or three one-year extensions at the general partner's discretion. We expect to receive distributions of proceeds from dividends and interest from fund investments, as well as from the disposition of a fund investment or portion thereof, from time-to-time during the full course of the fund term. As ofDecember 31, 2021 , we had unfunded commitments to these private equity limited partnerships totaling$46.4 million .
We believe that our current asset allocation meets our strategy to preserve
capital for claims and policy liabilities and to provide sufficient capital
resources to support and grow our ongoing insurance operations.
42 -------------------------------------------------------------------------------- The following table shows the estimated fair value, the percentage of the fair value to total invested assets, and the average ending book yield (each based on the book value of each category of invested assets) as ofDecember 31, 2021 . Estimated Fair Category Value Percentage of Total Book Yield (in millions, except percentages) U.S. Treasuries$ 65.7 2.4 % 1.8 % U.S. Agencies 2.4 0.1 2.9 States and municipalities 436.1 16.2 2.7 Corporate securities 1,080.3 40.1 3.3 Residential mortgaged-backed securities 321.8 12.0 2.3 Commercial mortgaged-backed securities 92.3 3.4 3.2 Asset-backed securities 68.5 2.5 3.7 Collateralized loan obligations 85.4 3.2 1.9 Foreign government securities 12.5 0.5 2.9 Other securities 177.7 6.6 3.6 Equity securities 338.8 12.6 2.2 Short-term investments 10.5 0.4 0.8 Total investments at fair value$ 2,692.0 100.0 % Weighted average ending yield 3.0 % The following table shows the percentage of total estimated fair value of our fixed maturity securities as ofDecember 31, 2021 by credit rating category, using the lower of the ratings assigned by Moody's Investors Service or S&P. Percentage of Total Rating Estimated Fair Value "AAA" 6.9 % "AA" 35.3 "A" 31.3 "BBB" 15.2 Below Investment Grade 11.3 Total 100.0 % Investments that we currently own could be subject to default by the issuer. We regularly assess individual securities as part of our ongoing portfolio management, including the identification of credit related losses. Our assessment includes reviewing the extent of declines in fair value of investments below amortized cost, historical and projected financial performance and near-term prospects of the issuer, the outlook for industry sectors, credit rating, and macro-economic changes, including those caused by the COVID-19 pandemic. We also make a determination as to whether it is more likely than not that we will be required to sell the security before its fair value recovers to above cost, or maturity. In addition to recognizing realized gains and losses upon the disposition of an investment security, we also recognize: (i) in 2021 and 2020, realized gains or losses on AFS debt securities for changes in CECL; or (ii) prior to 2020, realized losses when securities are written down as a result of other-than-temporary impairment. We recognized$0.2 million and$0.7 million of CECL on AFS debt securities during the years endedDecember 31, 2021 and 2020. The decrease of$0.5 million in 2021 was due to price recoveries and reductions in allowance from disposals. We recognized no other-than-temporary impairments on fixed maturity securities during the year endedDecember 31, 2019 . The remaining fixed maturity securities whose total fair value was less than amortized cost atDecember 31, 2021 , 2020 and 2019, were those in which we had no intent, need or requirement to sell at an amount less than their amortized cost. For additional information regarding our investments, including the cost or amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of our investments, the amortized cost and estimated fair value of fixed maturity securities by contractual maturity, and net realized and unrealized gains on investments, see Note 5 in the Notes to our Consolidated Financial Statements.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Critical Accounting Estimates
The preparation of financial statements in accordance with GAAP requires both
the use of estimates and judgment, relative to the application of appropriate
accounting policies, which include the recognition of premium revenue,
recoverability of deferred
43
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income taxes, and valuation of investments. Our accounting policies are
described in Note 2 to our Consolidated Financial Statements, however, we
believe that the following matters are particularly important to understand our
financial statements because changes in these estimates or changes in the
assumptions used to make them could have a material impact on our results of
operations, financial condition, and cash flows.
Reserves for Losses and LAE
Accounting for workers' compensation insurance requires us to estimate the liability for the expected ultimate cost of unpaid losses and LAE (loss reserves) as of a balance sheet date. Loss reserve estimates are inherently uncertain because the ultimate amount we pay for many of the claims we have incurred as of the balance sheet date will not be known for many years. Our estimate of loss reserves is intended to equal the difference between the expected ultimate losses and LAE of all claims that have occurred as of a balance sheet date and amounts already paid. We establish loss reserves based on our own analysis of emerging claims experience and environmental conditions in our markets and review of the results of various actuarial projections. Our aggregate carried loss reserves is the sum of our reserves for each accident year and represents our best estimate of outstanding loss reserves. The amount by which estimated losses in the aggregate differ from those previously estimated for a specific time period is known as reserve "development." Reserve development is unfavorable when losses ultimately settle for more than the amount estimated or subsequent estimates indicate a basis for reserve increases, causing the previously estimated loss reserves to be ''deficient.'' Reserve development is favorable when estimates of ultimate losses indicate a decrease in established reserves, causing the previously estimated loss reserves to be ''redundant.'' Development is reflected in our operating results through an adjustment to incurred losses and LAE during the period in which it is recognized. Although claims for which reserves are established may not be paid for several years or more, we do not discount loss reserves in our financial statements for the time value of money, in accordance with GAAP.
The three main components of our loss reserves are case reserves, incurred but
not reported (IBNR) loss reserves, and LAE reserves.
When claims are reported to us, we establish individual estimates of the
ultimate cost of each claim (case reserves). These case reserves are continually
monitored and revised in response to new information and for amounts paid.
In addition to case reserves, we establish a provision for IBNR. IBNR is an actuarial estimate comprised of the following: (a) future payments on claims that are incurred but have not yet been reported to us; (b) a reserve for the additional development on claims that have been reported to us; and (c) a provision for additional payments on closed claims that might reopen. IBNR reserves apply to the entire body of claims arising from a specific time period, rather than a specific claim. Most of our IBNR reserves relate to estimated future claim payments on recorded open claims. LAE reserves are our estimate of future expense payments to manage, investigate, administer, and settle claims that have occurred, and include legal expenses. LAE reserves are established in the aggregate, rather than on a claim-by-claim basis. LAE reserves are categorized between defense and cost containment, and adjusting and other. We cede a portion of our obligations for losses and LAE to unaffiliated reinsurers. The amount of reinsurance that will be recoverable on our losses and LAE includes both the reinsurance recoverable from our excess of loss reinsurance contracts, as well as reinsurance recoverable under the terms of the LPT Agreement.
Our loss reserves (gross and net of reinsurance), including the main components
of such reserves, were as follows:
As of December 31,
2021 2020
(in millions)
Case reserves $ 900.2 $ 928.3
IBNR 818.7 861.7
LAE reserves 262.3 279.4
Gross unpaid losses and LAE reserves 1,981.2
2,069.4
Less reinsurance recoverable on unpaid losses and LAE, excluding
CECL allowance
476.9 497.0 Net unpaid losses and LAE reserves$ 1,504.3
We use actuarial methods to analyze and estimate the aggregate amount of loss
reserves. Management considers the results of various actuarial methods and
their underlying assumptions, among other factors, in establishing loss
reserves.
Judgment is required in the actuarial estimation of loss reserves, including the
selection of various actuarial methodologies to project the ultimate cost of
claims. Specifically, judgment is required in the following areas: the selection
of parameters utilized in the various methodologies; the use of industry data
and other benchmarks; and the weighting of differing reserve indications
44
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resulting from alternative methods and assumptions. The adequacy of our ultimate
loss reserves is inherently uncertain and represents a significant risk to our
business. We attempt to mitigate this risk through our claims management
processes and by monitoring and reacting to statistics relating to the cost and
duration of claims.
We compile and aggregate our claims data by grouping the claims according to the
accident year in which the claim occurred when analyzing claim payment and
emergence patterns and trends over time. Additionally, we aggregate and analyze
claims data by claim type, benefits type, and by state, territory within state,
or groups of states in which we do business.
Our Internal Actuary prepared reserve estimates for all accident years using our
own historical claims data, industry data and many of the generally accepted
actuarial methodologies for estimating loss reserves, such as paid loss
development methods, incurred loss development methods, and Bornhuetter-Ferguson
methods. These methods vary in their responsiveness to different information,
characteristics, and dynamics in the data, and the results assist the actuary in
considering these characteristics and dynamics in the historical data. The
methods employed for each segment of claims data, and the relative weight
accorded to each method, vary depending on the nature of the claims segment and
on the age of the claims.
Each actuarial methodology requires the selection and application of various
parameters and assumptions. The key parameters and assumptions include: the
future payment and emergence patterns of our aggregate claims data; the
magnitude and changes in claim settlement activity; the effects of legislative
benefit changes and/or judicial decisions; and trends in the frequency and
severity of claims.
Management, along with our Internal Actuary, separately analyzed LAE and
estimated unpaid LAE. These analyses rely primarily on examining the
relationship between historical aggregate paid LAE and the volume of claims
activity for the corresponding periods. The portion of unpaid LAE that will be
recoverable from reinsurers is estimated based on the contractual reinsurance
terms.
The ranges of estimates of loss reserves produced by our Internal Actuary are
intended to represent the range in which it is most likely that the ultimate
losses will fall. These ranges are narrower than the range of indications
produced by the individual methods applied because it is not likely that the
high or low result will emerge for every claim segment and accident year. Each
actuary's point estimate of loss reserves for each claim segment is based on a
judgmental selection from within the range of results indicated by the different
actuarial methods.
Management formally establishes loss reserves for financial statement purposes
on a quarterly basis. In doing so, we make reference to the most current
analyses of our Internal Actuary, including a review of the assumptions and the
results of the various actuarial methods used. Our Internal Actuary conducted
comprehensive studies in the second and fourth quarters. On the alternate
quarters, our Internal Actuary updates the results of the preceding quarter's
studies for actual claim payment and case reserve activity.
The aggregate carried reserve calculated by management represents our best
estimate of our outstanding unpaid losses and LAE. In establishing management's
best estimate of unpaid losses and LAE at December 31 for the last three years,
management and our Internal Actuary reviewed and considered the following: (a)
our Internal Actuary's assumptions, point estimates, and ranges; and (b) the
inherent uncertainty of workers' compensation loss reserves. Management did not
quantify a specific loss reserve increment for each uncertainty, but rather
established an overall provision that represented management's best estimate of
loss reserves in light of the historical data, actuarial assumptions, point
estimate and range, and current facts and circumstances.
The table below provides the actuarial range of loss reserves, net of
reinsurance, that management considered when selecting its best estimate and our
carried reserves.
As of December 31,
2021 2020
(in millions)
Low end of actuarial range $ 1,351.3 $ 1,392.3
Carried reserves 1,504.3 1,572.4
High end of actuarial range 1,687.1 1,734.1
As of
approximately 70% of our total loss reserves on our Consolidated Balance Sheet.
InCalifornia , our recent loss experience from 2012 through 2019, indicates a slight downward trend in medical severity and a slight upward trend in indemnity severity. The reduction in medical severity can be attributed to a number of factors includingCalifornia Senate Bill 863 (SB 863), which was enacted in 2012 and largely became effective in 2013/2014. Among the more significant changes, SB 863 introduced independent medical review (IMR) into the dispute resolution process and filing fees for medical liens. On the indemnity side, various provisions of SB 863 resulted in an overall increase in certain benefits. Our 45 -------------------------------------------------------------------------------- indemnity claims frequency (the number of claims expressed as a percentage of payroll) has decreased year-over-year for the past four years. Aside from the impact of recent regulatory changes, we believe our increased emphasis on claims settlements, as well as our various underwriting initiatives, have contributed to more favorable trends in ourCalifornia results. InNevada , we have compiled a lengthy history of workers' compensation claims payment patterns based on the business of the Fund and EICN, but the emergence and payment of claims in recent years has been more favorable than in the long-term history inNevada with the Fund. The expected patterns of claim payments and emergence used in the projection of our ultimate claim payments are based on both long and short-term historical data. In recent evaluations, claim patterns have continued to emerge in a manner consistent with short-term historical data. Consequently, our selection of claim projection patterns has relied more heavily on patterns observed in recent years. Our insurance subsidiaries have been operating in a period characterized by changing environmental conditions in our major markets, entry into new markets, and operational changes. During periods characterized by such changes, at each evaluation, the actuaries and management must make judgments as to the relative weight to accord to long-term historical company data, more recent company data, and external data. We also consider the impact of environmental and operational changes and other factors when selecting the methods used to project ultimate losses and LAE, the parameters to incorporate in those methods, and the relative weights applied to those methods. An internal initiative that began in 2014 emphasizes the settlement of open claims. This initiative has actively driven a significant increase in claims settlement activity and has primarily affected accident years 2009 and forward. This settlement activity has been recognized in the actuarial analysis using a methodology that adjusts the data and loss development patterns to account for an increase in settlements arising from this initiative. Approximately 56% of our claims payments during the three years endedDecember 31, 2021 related to medical care for injured workers. The utilization and cost of medical services in the future is a significant source of uncertainty in the establishment of loss reserves for workers' compensation. Our loss reserves are established based on reviewing the results of actuarial methods, most of which do not contain explicit medical claim cost inflation rates; however, because medical care may be provided to an injured worker over many years, and in some cases decades, the pace of medical claim cost inflation can have a significant impact on our ultimate claim payments. For example, if the rate of medical claim cost inflation increases by 1% above the inflation rate that is implicitly included in the loss reserves atDecember 31, 2021 , we estimate that future medical costs over the lifetime of current claims would increase by approximately$67.5 million on a net-of-reinsurance basis. Our reserve estimates reflect expected increases in the costs of contested claims, but do not assume any losses resulting from significant new legal liability theories. Our reserve estimates also assume that there will not be significant future changes in the regulatory and legislative environment. In the event of significant new legal liability theories or new regulation or legislation, we will attempt to quantify its impact on our business.
If the actual loss reserves were at the high or the low end of the actuarial
range, the impact on our financial results would have been as follows:
2021
2020
Increase (decrease) in reserves (1) (in millions) At low end of range$ (153.0) $ (180.1) At high end of range 182.8 161.7 Increase (decrease) in stockholders' equity and net income At low end of range$ 120.9 $ 142.3 At high end of range (144.4) (127.7)
(1) The range of actuarial indications captures the range of reasonable
estimates and is asymmetrical (e.g. not based on a normal distribution).
Actual losses are affected by a more complex combination of forces and dynamics
than any one model or actuarial methodology can represent, and each methodology
is an approximation of these complex forces and dynamics. None of the methods
are designed or intended to produce an indication that is systematically higher
or lower than the other methods. At any given evaluation date, some of the
actuarial projection methods produce indications outside the actuary's selected
range. Accordingly, we believe that the range of potential outcomes is
considerably wider than the actuarially estimated range of the most likely
outcomes. We have no basis for anticipating whether actual future payments of
losses and LAE may be either greater than or less than the loss reserves
currently on our Consolidated Balance Sheets.
Additionally, any adjustment to the estimated ceded reserves under the LPT
Agreement results in a cumulative adjustment to the Deferred Gain, which is also
included in losses and LAE incurred in the Consolidated Statements of
Comprehensive Income, so that the Deferred Gain reflects the balance that would
have existed had the revised reserves been recognized at the
46
--------------------------------------------------------------------------------
inception of the LPT Agreement. The table below provides the actuarial range of
estimated liabilities for gross loss reserves under the LPT Agreement and our
carried reserves.
As of December 31,
2021
(in millions)
Low end of actuarial range $ 286.3
LPT carried reserves 328.7
High end of actuarial range 366.5
Reinsurance Recoverables
Reinsurance recoverables represent: (a) amounts currently due from reinsurers on paid losses and LAE; (b) amounts recoverable from reinsurers on estimates of reported losses; and (c) amounts recoverable from reinsurers on actuarial estimates of IBNR for losses and LAE. These recoverables are based on our current estimates of the underlying loss reserves, and are reported on our Consolidated Balance Sheets separately as assets, as reinsurance does not relieve us of our legal liability to policyholders. We bear credit risk with respect to the reinsurers, which could be significant in the future, considering that some of the loss reserves remain outstanding for an extended period of time. Reinsurers may refuse or fail to pay losses that we cede to them, or they might delay payment. We are required to pay losses even if a reinsurer refuses or fails to meet its obligations under the applicable reinsurance agreement. We continually monitor the financial condition and financial strength ratings of our reinsurers. No material amounts due from reinsurers have been written-off as uncollectible since our inception in 2000, and in assessing future default, we evaluate the allowance for CECL under the ratings based method using the A.M. Best Average Cumulative Net Impairment Rates. Reinsurer ratings are also assessed through this process. Under the LPT Agreement, the Fund initially ceded$1.5 billion in liabilities for the incurred but unpaid losses and LAE related to claims incurred prior toJuly 1, 1995 for consideration of$775.0 million in cash. The estimated remaining liabilities subject to the LPT Agreement were$328.7 million as ofDecember 31, 2021 . Losses and LAE paid with respect to the LPT Agreement totaled$838.8 million atDecember 31, 2021 . We account for the LPT Agreement as retroactive reinsurance. Entry into the LPT Agreement resulted in a deferred reinsurance gain that was recorded on our Consolidated Balance Sheets as a liability. The Deferred Gain is being amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries through the life of the LPT Agreement, and the amortization is reflected in losses and LAE. Changes in estimates of the reserves ceded under the LPT Agreement may significantly impact the Deferred Gain on our Consolidated Balance Sheets and losses and LAE on our Consolidated Statements of Comprehensive Income. Additionally, we are 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 calculation of actual amounts paid versus expected amounts is determined every five years beginningJune 30, 2004 for the first twenty-five years of the agreement. We are paid 30% of the favorable difference between the actual and expected losses and LAE paid at each calculation point. Each quarter, management records its best estimate of the estimated ultimate contingent profit commission throughJune 30, 2024 , which is impacted by estimates for ceded losses and LAE. The Deferred Gain related to the contingent profit commission is amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries over the life of the contingent profit commission, or throughJune 30, 2024 , and is recorded in losses and LAE incurred in the accompanying Consolidated Statements of Comprehensive Income. Changes in estimates of the reserves ceded under the LPT Agreement may significantly impact the Contingent commission receivable-LPT Agreement and the Deferred Gain on our Consolidated Balance Sheets and losses and LAE on our Consolidated Statements of Comprehensive Income. New Accounting Standards
See Note 3 in the Notes to our Consolidated Financial Statements for a summary
of all recently issued and recently adopted accounting standards.
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