Newswires
EMPLOYERS HOLDINGS, INC. – 10-Q – Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations
You should read the following discussion and analysis in conjunction with our consolidated financial statements and the related notes thereto included in Item 1 of Part I. Unless otherwise indicated, all references to "we," "us," "our," "the Company," or similar terms refer to EHI, together with its subsidiaries. In this Quarterly Report on Form 10-Q, the Company and its management discuss and make statements based on currently available information regarding their intentions, beliefs, current expectations, and projections of, among other things, the Company's future performance, economic or market conditions, including the evolving nature of the COVID-19 pandemic, current levels of inflation, labor market expectations, catastrophic events or geo-political conditions, legislative or regulatory actions or court decisions taken in response to the COVID-19 pandemic or otherwise, business growth, retention rates, loss costs, claim trends and the impact of key business initiatives, future technologies and planned investments. Certain of these statements may constitute "forward-looking" statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and are often identified by words such as "may," "will," "could," "would," "should," "expect," "plan," "anticipate," "target," "project," "intend," "believe," "estimate," "predict," "potential," "pro forma," "seek," "likely," or "continue," or other comparable terminology and their negatives. The Company and its management caution investors that such forward-looking statements are not guarantees of future performance. Risks and uncertainties are inherent in the Company's future performance. Factors that could cause the Company's actual results to differ materially from those indicated by such forward-looking statements include, among other things, those discussed or identified from time to time in the Company's public filings with theSEC , including the risks detailed in the Company's Annual Reports on Form 10-K and in Part II, Item 1A of this report. Except as required by applicable securities laws, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Overview
We are aNevada holding company. Through our insurance subsidiaries, we provide workers' compensation insurance coverage to select, small businesses primarily 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 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. Our strategy is to pursue profitable growth opportunities across market cycles and maximize total investment returns within the constraints of prudent portfolio management. We pursue profitable growth opportunities by focusing on disciplined underwriting and claims management, utilizing medical provider networks designed to produce superior medical and indemnity outcomes, establishing and maintaining strong, long-term relationships with independent insurance agencies, and developing important alternative distribution channels. We believe that developing and implementing new technologies and capabilities will fundamentally transform and enhance the digital experience of our workforce, customers, policyholders and agents, 27 -------------------------------------------------------------------------------- including: (i) continued investments in new technology, data analytics, and process improvement capabilities focused on improving the agent experience and enhancing agent efficiency; and (ii) the further development of digital insurance solutions, including direct-to-customer workers' compensation coverage and developing collaborations with strategic digital partners. We also continue to execute a number of ongoing business initiatives, including: achieving internal and customer-facing business process excellence; diversifying our risk exposure across geographic markets and economic sectors; utilizing a multi-company pricing platform and territory-specific pricing; and thoughtfully offering new classes of business that are complementary to our small business, low-hazard business model.
The insurance industry is highly competitive, and there is significant
competition in the national workers' compensation industry that is based on
price and quality of services. We compete with other specialty workers'
compensation carriers, state agencies, multi-line insurance companies,
professional employer organizations, self-insurance funds, and state insurance
pools.
The effects of supply chain interruptions, challenges with the labor market, inflationary pressures, geo-political conditions, overall general economic instability and the COVID-19 pandemic have continued to cause disruptions in business activity. All states, includingCalifornia , where we generated 45% of our in-force premiums as ofSeptember 30, 2022 , have experienced adverse economic impacts. Certain classes of business that we insure, especially those related to the restaurant and hospitality industries, continue to be affected by these challenges. Nonetheless, we closed another quarter with a record number of policies in-force. Our year-over-year new and renewal business premiums have increased, in addition to audit premium increases, which are driving our premium growth. As labor market shortages improve and wage inflation continues, we expect that rising payrolls will continue to bring further improvement to our top line. 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 an additional$9.0 million during the three months endedSeptember 30, 2022 , as our payroll exposure increased with the labor market strengthening and rising wages. Recent increases in market interest rates have negatively impacted the fair value of our fixed maturity investments through the first nine months of 2022. In addition, economic and market disruptions caused by inflationary pressures and geo-political conditions have negatively impacted the fair value of our equity securities during that period. The negative impacts to our investment portfolio experienced thus far in 2022 have consisted primarily of unrealized investment losses. Conversely, the recent increases in market interest rates have favorably impacted our net investment income throughout the first nine months of 2022. While we have no international operations, the geo-political uncertainties with the ongoingRussia andUkraine conflict have indirectly impacted the value of our investment portfolio. Contributing factors include supply chain disruptions, inflationary pressures and interest rate and general market volatility. 28 --------------------------------------------------------------------------------
Results of Operations
Our results of operations are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(in millions)
Gross premiums written $ 188.6 $ 152.3 $ 540.4 $ 447.7
Net premiums written $ 186.8 $ 149.8 $ 535.3 $ 442.7
Net premiums earned $ 178.7 $ 147.1 $ 494.1 $ 418.0
Net investment income 23.7 18.4 62.8 54.9
Net realized and unrealized gains (losses) on
investments 1.9 2.7 (65.5) 29.6
Other income 0.1 0.1 0.3 0.8
Total revenues 204.4 168.3 491.7 503.3
Losses and LAE 112.3 91.2 299.7 244.5
Commission expense 25.3 19.9 69.9 54.7
Underwriting and general and administrative
expenses 41.9 37.4 120.6 121.0
Interest and financing expenses 1.1 0.1 1.6 0.4
Other expenses - 1.1 - 4.1
Total expenses 180.6 149.7 491.8 424.7
Income tax expense (benefit) 4.7 3.6 (1.4) 14.1
Net income $ 19.1 $ 15.0 $ 1.3 $ 64.5
Overview
Our net income was $19.1 million and $1.3 million for the three and nine months
ended September 30, 2022 , respectively, compared to net income of $15.0 million
and $64.5 million for the corresponding periods of 2021. The key factors that
affected our financial performance during the three and nine months ended
September 30, 2022 , compared to the same periods of 2021 included:
•Net premiums earned increased 21.5% and 18.2%, respectively;
•Losses and LAE increased 23.1% and 22.6%, respectively;
•Underwriting and general and administrative expenses increased 12.0% and
decreased 0.3%, respectively;
•Underwriting (loss) income was $(0.8) million and $3.9 million , compared to
$(1.4) million and $(2.2) million respectively;
•Net investment income increased 28.8% and 14.4%, respectively; and
•Net realized and unrealized gains (losses) on investments were $1.9 million and
$(65.5) million compared to $2.7 million and $29.6 million , respectively.
Summary of Consolidated Financial Results
Gross Premiums Written
Gross premiums written were$188.6 million and$540.4 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$152.3 million and$447.7 million for the corresponding periods of 2021. The year-over-year changes 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 and Losses 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
29 -------------------------------------------------------------------------------- on our fixed maturity securities, less bank service charges and custodial and portfolio management fees. We have established a high quality/short duration bias in our investment portfolio. Net investment income increased 28.8% and 14.4% for the three and nine months endedSeptember 30, 2022 , respectively, compared to the same periods of 2021. The increases were primarily due to higher bond yields and higher invested balances of fixed maturity securities and cash and cash equivalents, as measured by amortized cost. Realized and 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 (losses) gains on investments on our Consolidated Statements of Comprehensive (Loss) Income. Net realized and unrealized gains (losses) on investments were$1.9 million and$(65.5) million for three and nine months endedSeptember 30, 2022 , compared to$2.7 million and$29.6 million for the corresponding periods of 2021. The net realized and unrealized gains on investments for the three months endedSeptember 30, 2022 and 2021 included$(3.1) million and$1.9 million of net realized and unrealized (losses) gains on equity securities and other investments, respectively, and$5.0 million and$0.8 million of net realized gains on fixed maturity securities, respectively. The net realized and unrealized gains (losses) on investments for the nine months endedSeptember 30, 2022 and 2021 included$(62.1) million and$25.9 million of net realized and unrealized (losses) gains on equity securities and other investments, respectively, and$(3.4) million and$3.7 million of net realized (losses) gains on fixed maturity securities, respectively. The unrealized investment gains and losses we experienced on our equity and fixed maturity securities during the three and nine months endedSeptember 30, 2022 were primarily the result of significant volatility in financial markets resulting from increasing inflationary concerns, rising market interest rates and recent world events. The realized investment gains and losses on our fixed maturity securities for the three and nine months endedSeptember 30, 2022 included a$5.2 million net decrease and a$4.5 million net increase in our allowance for CECL, respectively. The unrealized investment gains and losses on our equity securities during the three and nine months endedSeptember 30, 2021 were largely consistent with the performance ofU.S. equity markets. The realized investment gains and losses on our fixed maturity securities for the nine months endedSeptember 30, 2021 included a$0.6 million net decrease in our allowance for CECL.
Additional information regarding our Investments is set forth under "-Liquidity
and Capital Resources-Investments."
Other Income
Other income consists of net gains and losses on fixed assets, non-investment interest, installment fee revenue, and other miscellaneous income. Beginning in 2022, installment fee revenue is included within our net investment 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 current accident year loss estimate continues to consider overall declines in the on-leveled frequency of compensable indemnity claims. Total claims costs have also been reduced by cost savings associated with increased claims settlement activity that has continued into the first nine months of 2022. We believe that our current accident year loss estimate is adequate; however, ultimate losses will not be known with any certainty for many years. See "-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 agency incentive payments, other marketing costs, and fees. See "-Summary of Financial Results by Segment -Employers".
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
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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 fees and interest associated with the Credit Agreement and the FHLB Advances, FHLB Letter of Credit Agreement fees, finance lease interest, and other financing fees.
Other Expenses
During the three and nine months endedSeptember 30, 2021 , we recorded charges of$0.1 million and$3.1 million , respectively, of employee severance costs resulting from a 2021 reduction-in-force. This action was taken to better align our expenses with our revenues. Additionally, during the three months endedSeptember 30, 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.
Income Tax Expense (Benefit)
Income tax expense (benefit) was$4.7 million and$(1.4) million for the three and nine months endedSeptember 30, 2022 , compared to$3.6 million and$14.1 million for the corresponding periods of 2021. The effective tax rate for the three months endedSeptember 30, 2022 was 19.7% and the effective tax rates for the three and nine months endedSeptember 30, 2021 were 19.4% and 17.9%, respectively. The effective tax rate for the nine months endedSeptember 30, 2022 was not meaningful. The effective rates during each of the periods presented included income tax benefits and exclusions associated with tax-advantaged investment income, LPT adjustments, and deferred gain amortization.
Summary of Financial Results by Segment
EMPLOYERS
The components of Employers' net income before income taxes are set forth in the
following table:
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(dollars in millions)
Gross premiums written $ 187.1 $ 152.0 $ 536.8 $ 446.7
Net premiums written $ 185.3 $ 149.5 $ 531.7 $ 441.7
Net premiums earned $ 177.9 $ 146.9 $ 492.1 $ 417.6
Net investment income 21.4 17.5 57.7 52.5
Net realized and unrealized gains (losses) on
investments 2.4 3.1 (56.0) 29.7
Other income 0.1 0.1 0.3 0.8
Total revenues 201.8 167.6 494.1 500.6
Losses and LAE 113.8 93.1 304.7 250.3
Commission expense 25.2 19.9 69.8 54.7
Underwriting expenses 35.7 31.1 101.8 99.9
Interest and financing expenses 1.0 - 1.3 -
Other expenses - 1.1 - 4.1
Total expenses 175.7 145.2 477.6 409.0
Net income before income taxes $ 26.1 $ 22.4 $ 16.5 $ 91.6
Underwriting income $ 3.2 $ 2.8 $ 15.8 $ 12.7
Combined ratio 98.3 % 98.1 % 96.8 % 96.9 %
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Underwriting Results
Gross Premiums Written
Gross premiums written were$187.1 million and$536.8 million for the three and nine months endedSeptember 30, 2022 , compared to$152.0 million and$446.7 million for the corresponding periods of 2021. The growth in Employers' premiums written throughout 2022 is the result of higher new and renewal business premiums and final audit premiums. The growth in new business premiums we are currently experiencing is the result of increases in new business submissions, quotes and binds in the majority of the states in which we operate, which is being largely driven by a recent expansion in the classes of business that Employers offers. We also increased our final audit premium accruals by an additional$9.0 million during the three months endedSeptember 30, 2022 , as our payroll exposure increased with the labor market strengthening and rising wages. In addition, our retention rate has remained strong throughout the first nine months of 2022. Net premiums written were$185.3 million and$531.7 million for the three and nine months endedSeptember 30, 2022 , compared to$149.5 million and$441.7 million for the corresponding periods of 2021. Reinsurance premiums ceded were$1.8 million and$5.1 million for the three and nine months endedSeptember 30, 2022 , compared to$2.5 million and$5.0 million for the corresponding periods of 2021. Net Premiums Earned Net premiums earned were$177.9 million and$492.1 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$146.9 million and$417.6 million for the corresponding periods of 2021. In-force premiums represent the estimated annual premium on all policies that are active and in-force on such date. More specifically, in-force premiums include policy endorsements but exclude estimated final audit premiums. We focus on in-force premium because it represents premium that is available for renewal in the future. The following table shows Employers' in-force premiums and number of policies in-force for each of our largest states and all other states combined for the periods presented: September 30, 2022 December 31, 2021 September 30, 2021 December 31, 2020 In-force Policies In-force Policies In-force Policies In-force Policies State Premiums In-force Premiums In-force Premiums In-force Premiums In-force (dollars in millions) California$ 272.2 42,562$ 258.4 40,704$ 256.0 40,160$ 262.0 39,610 Florida 46.5 8,847 41.1 7,989 40.0 7,837 37.9 6,898 New York 26.2 7,366 24.5 7,307 25.5 7,117 26.7 6,657 Other (43 states and D.C.) 258.2 59,096 245.9 54,164 244.0 53,814 251.1 50,124 Total in-force$ 603.1 117,871$ 569.9 110,164$ 565.5 108,928$ 577.7 103,289 Estimated audit premium 32.1 - 35.4 - 35.5 - (2.7) - Total in-force, including estimated audit premium$ 635.2 117,871$ 605.3 110,164$ 601.0 108,928$ 575.0 103,289 Our alternative distribution channels generated$183.8 million and$156.7 million , or 30.5% and 27.7%, of our in-force premiums as ofSeptember 30, 2022 and 2021, respectively. These alternative distribution channels utilize partnerships and alliances with entities such as payroll companies, health care and property and casualty insurers, and digital agents for which we provide workers' compensation insurance coverage. These relationships also allow us to access new customers that we may not have access to through our independent agent distribution channel.
Losses and LAE, Commission Expenses, and Underwriting Expenses
The following table presents calendar year combined ratios for our Employers
segment.
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
Loss and LAE ratio 64.0 % 63.4 % 61.9 % 59.9 %
Commission expense ratio 14.2 13.5 14.2 13.1
Underwriting expense ratio 20.1 21.2 20.7 23.9
Combined Ratio 98.3 % 98.1 % 96.8 % 96.9 %
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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.
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(dollars in millions)
Losses and LAE $ 113.8 $ 93.1 $ 304.7 $ 250.3
Prior accident year favorable development,
net 0.3 0.1 10.3 15.6
Current accident year losses and LAE
Current accident year loss and LAE ratio 64.1 % 63.4 % 64.0 % 63.7 % The increase in our total losses and LAE during the three months endedSeptember 30, 2022 , as compared to the same period of 2021, was primarily due to higher earned premium and a higher current accident year estimate. There was no prior loss reserve development recognized on our voluntary business during the three months endedSeptember 30, 2022 and 2021, but$0.3 million and$0.1 million of net favorable development was recognized on our assigned risk business during those periods, respectively. The increase in our total losses and LAE during the nine months endedSeptember 30, 2022 , as compared to the same period of 2021, was primarily due to higher earned premium, a higher current accident year estimate and less net favorable development recognized during the current year. Favorable prior loss reserve development totaled$10.3 million and$15.6 million during the nine months endedSeptember 30, 2022 and 2021, respectively, which included$9.6 million and$15.0 million of net favorable development on our voluntary business, respectively, and$0.7 million and$0.6 million of net favorable development on our assigned risk business, respectively. Favorable prior year loss development on our voluntary business during the nine months endedSeptember 30, 2022 was primarily related to observed favorable paid loss cost trends related primarily to accident years 2017 and prior. Favorable prior year loss development on our voluntary business during the nine months endedSeptember 30, 2021 was the result of observed favorable paid loss cost trends related primarily to accident years 2017 and prior, partially offset by$8.0 million of unfavorable development relating to two catastrophic non-COVID claims that occurred in accident year 2020. Our current accident year loss and LAE ratio was 64.1% and 64.0% for the three and nine months endedSeptember 30, 2022 , respectively, compared to 63.4% and 63.7% for the corresponding periods of 2021. Our current accident year ratio in 2022 was largely consistent with our current accident year ratio in 2021. Our current accident year loss and LAE ratio continues to reflect the impact of our key business initiatives: 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. Commission Expense Ratio. The commission expense ratio was 14.2% for each of the three and nine months endedSeptember 30, 2022 , respectively, compared to 13.5% and 13.1% for the corresponding periods of 2021. Our commission expenses were$25.2 million and$69.8 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$19.9 million and$54.7 million for the corresponding periods of 2021. Our commission expense ratios increased 0.7 and 1.1 percentage points, or 5.2% and 8.4% for the three and nine months endedSeptember 30, 2022 , respectively, compared to the same periods of 2021. The increase for the three months endedSeptember 30, 2022 related primarily to an 33 --------------------------------------------------------------------------------
increase in 2022 agency incentive accruals and an increase in new business
writings. The increase for the nine months ended
primarily related to an increase in 2022 agency incentive accruals and a
reversal of commissions relating to non-compliant and uncollectible premium
recorded in the first quarter of 2021 which lowered the ratio for the nine
months ended
Underwriting Expenses Ratio. The underwriting expense ratio was 20.1% and 20.7% for the three and nine months endedSeptember 30, 2022 , respectively, compared to 21.2% and 23.9% for the corresponding periods of 2021. The improvements in our underwriting expense ratio from period-to-period is largely the result of higher earned premiums coupled with active expense management.
Our underwriting expenses were
and nine months ended
million
During the three months endedSeptember 30, 2022 , our payroll-related expenses increased$1.6 million , premium tax and assessment expenses increased$1.5 million and bad debt expense increased$1.2 million , each compared to the same period of 2021. During the nine months endedSeptember 30, 2022 , our premium tax and assessment expenses increased$4.5 million and bad debt expense increased$1.7 million , partially offset by a decrease in professional services expenses of$1.6 million , a decrease in information technology related expenses of$1.3 million and a decrease in payroll-related expenses of$0.9 million , each compared to the same period of 2021.
Underwriting Income
Underwriting income for our Employers segment was$3.2 million and$15.8 million for each of the three and nine months endedSeptember 30, 2022 , respectively, compared to$2.8 million and$12.7 million for the corresponding periods of 2021. 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 and Losses on Investments, Other Income, Interest and Financing Expenses and Other Expenses see "-Results of Operations -Summary of Consolidated Financial Results".
CERITY
The components of Cerity's net loss before income taxes are set forth in the
following table:
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(in millions)
Gross premiums written $ 1.5 $ 0.3 $ 3.6 $ 1.0
Net premiums written $ 1.5 $ 0.3 $ 3.6 $ 1.0
Net premiums earned $ 0.8 $ 0.2 $ 2.0 $ 0.4
Net investment income 1.2 0.7 2.7 2.1
Net realized and unrealized (losses) gains on
investments (0.3) (0.1) (1.6) 0.2
Total revenues 1.7 0.8 3.1 2.7
Losses and LAE 0.6 0.2 1.3 0.3
Underwriting expenses 3.4 3.3 9.9 9.6
Total expenses 4.1 3.5 11.3 9.9
Net loss before income taxes $ (2.4) $ (2.7) $ (8.2) $ (7.2)
Underwriting loss $ (3.3) $ (3.3) $ (9.3) $ (9.5)
Combined ratio n/m n/m n/m n/m
n/m - not meaningful
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Underwriting Results
Gross Premiums Written and Net Premiums Written
Gross premiums written and net premiums written were$1.5 million and$3.6 million for the three and nine months endedSeptember 30, 2022 compared to$0.3 million and$1.0 million for the corresponding periods of 2021. The growth in Cerity's premiums written throughout 2022 is largely the result of: (i) a recent expansion in the classes of business that Cerity offers; and (ii) Cerity's growing number of collaborations with strategic digital partners.
Net Premiums Earned
Net premiums earned were$0.8 million and$2.0 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$0.2 million and$0.4 million for the three and nine months endedSeptember 30, 2021 , respectively.
Underwriting Expenses
Underwriting expenses for our Cerity segment were$3.4 million and$9.9 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$3.3 million and$9.6 million for the corresponding periods of 2021. During the three months endedSeptember 30, 2022 , our information technology related expenses increased$0.1 million and advertising expenses increased$0.1 million , compared to the corresponding period of 2021. During the nine months endedSeptember 30, 2022 , our information technology expenses increased$0.4 million , and advertising expenses increased$0.3 million , partially offset by a decrease in professional fees expenses of$0.5 million , compared to the corresponding period of 2021. Underwriting losses for our Cerity segment were$3.3 million and$9.3 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$3.3 million and$9.5 million for the corresponding periods of 2021. Underwriting income or loss is determined by deducting losses and LAE, commission expense, and underwriting expenses from net premiums earned.
Non-Underwriting Income
For a further discussion of non-underwriting related income, including Net
Investment Income and Net Realized and Unrealized Gains and Losses on
Investments, see "-Results of Operations -Summary of Consolidated Financial
Results Consolidated."
CORPORATE AND OTHER
The components of Corporate and Other's net income (loss) before income taxes
are set forth in the following table:
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(in millions)
Net investment income 1.1 0.2 2.4 0.3
Net realized and unrealized losses on
investments (0.2) (0.3) (7.9) (0.3)
Total revenues (losses) 0.9 (0.1) (5.5) -
Losses and LAE - LPT (2.1) (2.1) (6.3) (6.1)
General and administrative expenses 2.8 3.0 8.9 11.5
Interest and financing expenses 0.1 0.1 0.3 0.4
Total expenses 0.8 1.0 2.9 5.8
Net income (loss) before income taxes
$ (8.4) $ (5.8) 35 --------------------------------------------------------------------------------
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 (Loss) Income.
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(in
millions)
Amortization of the Deferred Gain related to losses$ 1.7 $ 1.7 $ 5.1 $ 5.0 Amortization of the Deferred Gain related to contingent commission 0.4 0.4 1.2 1.1 Total impact of the LPT$ 2.1 $ 2.1 $ 6.3 $ 6.1
General and Administrative Expenses
General and administrative expenses primarily consist of compensation-related expenses, professional fees, and other corporate expenses at the holding company. General and administrative expenses were$2.8 million and$8.9 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$3.0 million and$11.5 million for the corresponding periods of 2021. During the three and nine months endedSeptember 30, 2022 , our compensation-related expenses decreased$0.3 million and$2.8 million , respectively, compared to the same periods of 2021. The decreases are related primarily to the acceleration of share-based awards in connection with the retirement of our prior Chief Executive Officer, which served to increase our compensation-related expenses during the nine months endedSeptember 30, 2021 .
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 and Losses on Investments, and Interest and Financing Expenses see "-Results of Operations -Summary of Consolidated Financial Results".
Liquidity and Capital Resources
The current disruptions to 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 forego repurchases of our common stock; (ii) seek a capital infusion; or (iii) seek any material non-investment asset sales.
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 and distributions to their
parent is based on reported capital, surplus, and dividends paid within the
prior twelve months.
During the first quarter of 2022, ECIC made a$120.0 million return of capital payment to its parent company, who in turn distributed that amount to the holding company. As a result of that distribution, ECIC cannot pay dividends for the remainder of 2022, without prior regulatory approval. During the first quarter of 2022, EICN made a$9.7 million dividend payment to its parent company, who in turn distributed that amount to the holding company. As a result of that payment, EICN cannot pay any dividends for the remainder of 2022 without prior regulatory approval. During the third quarter of 2022, EPIC made a$24.0 million dividend payment, EAC made a$23.2 million dividend payment, and CIC made a$2.7 million dividend payment to their respective parent companies, who in turn distributed that amount to the holding company. As a result of these payments, EPIC, EAC and CIC cannot pay any dividends for the remainder of 2022 without prior regulatory approval.
Total cash and investments at the holding company were
securities.
36 -------------------------------------------------------------------------------- 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 had no outstanding advances under the Credit Agreement atSeptember 30, 2022 . 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 and fees incurred pursuant to the Credit Agreement during the three and nine months endedSeptember 30, 2022 was$0.1 million and$0.2 million , respectively. 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. AtSeptember 30, 2022 , we were in compliance with all debt covenants.
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$2,495.3 million atSeptember 30, 2022 , consisting of$53.5 million of cash and cash equivalents,$2,226.7 million of fixed maturity securities,$156.7 million of equity securities, and$58.4 million of other invested assets. Sources of immediate and unencumbered liquidity at our operating subsidiaries as ofSeptember 30, 2022 consisted of$53.3 million of cash and cash equivalents,$150.4 million of publicly traded equity securities whose proceeds are available within three business days and$767.0 million of highly liquid fixed maturity securities 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.
EICN, ECIC, EPIC, and EAC are members of the 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.
As ofSeptember 30, 2022 , our insurance subsidiaries had received advances of$182.5 million from the FHLB under the Standard Credit Program. The proceeds from these advances were used to purchase an equivalent amount of high-quality collateralized loan obligation securities. The annual interest rate on these advances is adjusted daily per SOFR. As ofSeptember 30, 2022 , the Company's weighted average annual interest rate on these advances was 1.78%. Interest paid during the three and nine months endedSeptember 30, 2022 totaled$1.0 million and$1.2 million , respectively. These advances can be repaid at any time without penalty and are collateralized by eligible investment securities. During the second quarter of 2020, the FHLB announced its Recovery Advance Program. The Recovery 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 Recovery Advance Program. OnMay 11, 2020 , our insurance subsidiaries received a total of$35.0 million of advances from the FHLB under the Recovery 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 of such advances onNovember 4, 2020 ,$5.0 million onMarch 31, 2021 , and$15.0 million onMay 4, 2021 . As ofSeptember 30, 2022 , we have no outstanding advances under the Recovery Advance Program. FHLB membership also allows our insurance subsidiaries access to standby Letter of Credit Agreements. OnJanuary 26, 2021 , EPIC chose to amend its existing Letter of Credit Agreement to decrease its credit amount to$10.0 million . OnAugust 13, 2021 , EAC and ECIC chose to amend their existing Letter of Credit Agreements to decrease their respective credit amounts to$25.0 million and$35.0 million . The amended Letter of Credit Agreements will expire onMarch 31, 2023 . 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 10). We purchase reinsurance to protect us against the costs of severe claims and catastrophic events, including pandemics. OnJuly 1, 2022 , we entered into a new reinsurance program that is effective throughJune 30, 2023 . The reinsurance program consists 37 -------------------------------------------------------------------------------- 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. 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$690.1 million and$861.4 million were on deposit atSeptember 30, 2022 andDecember 31, 2021 , 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 securities on deposit at bothSeptember 30, 2022 andDecember 31, 2021 .
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.
The table below shows our net cash flows for the nine months ended:
September 30,
2022 2021
(in millions)
Cash, cash equivalents, and restricted cash provided by (used in):
Operating activities $ 67.5 $ (9.3)
Investing activities (97.7) 22.5
Financing activities
103.2 (78.0)
Increase (decrease) in cash, cash equivalents, and restricted cash
For additional information regarding our cash flows, see Item 1, Consolidated
Statements of Cash Flows.
Operating Activities Net cash provided by operating activities for the nine months endedSeptember 30, 2022 included net premiums received of$478.1 million and investment income received of$60.2 million . These operating cash inflows were partially offset by net claims payments of$286.6 million , underwriting and general and administrative expenses paid of$111.1 million , commissions paid of$59.9 million , and federal income taxes paid of$11.6 million . Net cash used in operating activities for the nine months endedSeptember 30, 2021 included net premiums received of$418.5 million and investment income received of$60.0 million . These operating cash inflows were more than offset by net claims payments of$298.7 million , underwriting and general and administrative expenses paid of$112.1 million , commissions paid of$52.7 million , and federal income taxes paid of$23.9 million .
Investing Activities
Net cash used in investing activities for the nine months endedSeptember 30, 2022 were primarily related to FHLB advances received, and reinvestment of funds from investment sales, maturities, redemptions, and interest income. These investing cash outflows were partially offset by investment sales, maturities and redemptions 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 for the nine months endedSeptember 30, 2021 were 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 reinvestment of funds from investment sales, maturities, redemptions, and interest income.
Financing Activities
Net cash provided by financing activities for the nine months endedSeptember 30, 2022 was primarily related to FHLB advances received partially offset by common stock repurchases and stockholder dividend payments. During the nine months endedSeptember 30, 2022 , we also borrowed and subsequently repaid$10.0 million under the Credit Agreement. Net cash used in financing activities for the nine months endedSeptember 30, 2021 was primarily related to common stock repurchases, stockholder dividend payments, and repayments of FHLB advances. During the nine months endedSeptember 30, 2021 , we also borrowed and subsequently repaid$27.0 million under the Credit Agreement. 38 --------------------------------------------------------------------------------
Dividends
We paid$49.3 million and$21.5 million in dividends to our stockholders for the nine months endedSeptember 30, 2022 and 2021, respectively. The dividends paid during 2022 included a special dividend of$1.00 per share, which totaled$27.5 million , paid to eligible shareholders onJune 15, 2022 . The declaration and payment of future dividends to common stockholders, including any special dividends that may be declared in the future, 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. OnOctober 26, 2022 , the Board of Directors declared a quarterly dividend per share of$0.26 , which is payableNovember 23, 2022 to stockholders of record onNovember 9, 2022 .
Share Repurchases
We repurchased 186,799 shares of our common stock for$7.4 million during the three months endedSeptember 30, 2022 . 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. Capital Resources
As of
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 ofSeptember 30, 2022 , we had lease payment obligations of$15.5 million , with$3.5 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 ofSeptember 30, 2022 , we had other purchase obligations of$27.8 million , with$9.4 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 ofSeptember 30, 2022 , we had unfunded investment commitments of$57.3 million . FHLB Advances We received advances of$182.5 million from the FHLB under the Standard Credit Program. These advances can be repaid at any time without prepayment penalties or additional fees.
Unpaid Losses and LAE Expenses
We have developed unpaid losses and LAE expense payment patterns that are computed based on historical information. Our calculation of loss and LAE expense 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 expense vary from actual ultimate claims amounts due to variations between expected and actual payment patterns. As ofSeptember 30, 2022 , we had unpaid losses and LAE reserves of$1,979.9 million , of which$320.3 million is currently expected to be paid within 12 months. The unpaid losses and LAE expense payment patterns are gross of reinsurance recoverables for unpaid losses. As ofSeptember 30, 2022 , we had reinsurance recoverables on unpaid losses and LAE of$456.4 million , of which$31.2 million is currently expected to be received within 12 months.
Investments
Our investment portfolio is structured to support our need for: (i) optimizing
our risk-adjusted total returns; (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.
39
--------------------------------------------------------------------------------
As of September 30, 2022 , our investment portfolio consisted of 90% 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 4.0 at September 30, 2022 . 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 Standard &
Poor's (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 of September 30, 2022 . 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 $182.2 million at September 30, 2022 , which
represented 8% of our investment portfolio at that time. We also have a $6.3
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 2% of our investment portfolio as of
September 30, 2022 and include private equity limited partnerships. Our
investments in private equity limited partnerships totaled $58.4 million at
September 30, 2022 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 3 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 of September 30, 2022 , we had unfunded
commitments to these private equity limited partnerships totaling $57.3 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.
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 ofSeptember 30, 2022 . Estimated Fair Percentage Category Value of Total Book Yield (in millions, except percentages) U.S. Treasuries $ 90.7 3.8 % 2.3 % U.S. Agencies 2.1 0.1 2.9 States and municipalities 355.1 14.7 3.1 Corporate securities 901.7 37.3 3.4 Residential mortgage-backed securities 353.5 14.6 3.0 Commercial mortgage-backed securities 57.5 2.4 3.2 Asset-backed securities 59.5 2.5 4.0 Collateralized loan obligations 259.6 10.7 4.1 Foreign government securities 9.6 0.4 2.8 Other securities 145.8 6.0 6.0 Equity securities 182.2 7.5 3.2 Total investments at fair value$ 2,417.3 100.0 % Weighted average yield 3.6 % The following table shows the percentage of total estimated fair value of our fixed maturity securities as ofSeptember 30, 2022 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" 13.6 % "AA" 36.4 "A" 26.7 "BBB" 12.4 Below Investment Grade 10.9 Total 100.0 % Investments that we currently own could be subject to credit risk and subsequent default by the issuer. We regularly assess individual securities as part of our ongoing portfolio management, including the identification of credit related losses. Our 40 -------------------------------------------------------------------------------- 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. We also make a determination as to whether it is not more likely than not that we will be required to sell the security before its fair value recovers to above cost, or maturity. In addition to recognizing realized gains and losses upon the disposition of an investment security, we also recognize realized gains or losses on AFS debt securities for changes in CECL. As ofSeptember 30, 2022 , we have a$4.7 million allowance for CECL on AFS debt securities. During the nine months endedSeptember 30, 2022 , we recognized a net$4.5 million increase to our allowance for CECL on AFS debt securities. The remaining fixed maturity securities whose total fair value was less than amortized cost atSeptember 30, 2022 , were those in which we had no intent, need, or requirement to sell at an amount less than their amortized cost.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Critical Accounting Estimates
The unaudited interim consolidated financial statements included in this quarterly report include amounts based on the use of estimates and judgments of management for those transactions that are not yet complete. We believe that the estimates and judgments that were most critical to the preparation of the consolidated financial statements involved the reserves for losses and LAE and reinsurance recoverables. These estimates and judgments require the use of assumptions about matters that are highly uncertain and therefore are subject to change as facts and circumstances develop. Our accounting policies are discussed under "Critical Accounting Estimates" in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report.
TENET HEALTHCARE CORP – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
AMERISAFE INC – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations.
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