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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 workers' compensation 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 traditional and specialty insurance agencies, developing important alternative distribution channels, and offering workers' compensation solutions directly to customers. We believe that developing and implementing new technologies and capabilities will fundamentally 24 -------------------------------------------------------------------------------- transform and enhance the digital experience of our workforce, customers, policyholders and agents. These new technologies and capabilities include: (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 further 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; further diversifying our risk exposure across geographic markets and economic sectors, when appropriate; and utilizing a multi-company pricing platform and territory-specific pricing.
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, lingeringU.S. labor market shortages impacting certain employer classifications that we insure, inflationary pressures, volatility and credit concerns in certain financial and banking markets, monetary and fiscal policy measures, overall general economic instability and residual effects of 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 ofMarch 31, 2023 , have experienced adverse economic impacts. Certain classes of business that we insure continue to be adversely and disproportionately affected by these challenges, although to a lesser extent than in previous years. 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 anticipate 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 recognized$9.4 million of audit premium pick-up during the three months endedMarch 31, 2023 , as our payroll exposure increased with theU.S. labor market strengthening and rising wages. Decreases in market interest rates and a strongU.S. equity market during the first quarter of 2023 resulted in a partial rebound in the fair value of our fixed maturity investments and equity securities. Additionally, the dramatic increases in market interest rates experienced throughout 2022, despite the modest decreases experienced during the first quarter of 2023, favorably impacted our net investment income during the first three months of 2023. While we have no international operations, the geo-political uncertainties with the ongoingRussia andUkraine conflict have indirectly impacted the value of our investment portfolio, and we are unable to predict the impact these uncertainties will have on the global economy or on our financial condition and results of operations. 25 --------------------------------------------------------------------------------
Results of Operations
Our results of operations are as follows:
Three Months Ended
March 31,
2023 2022
(in millions)
Gross premiums written $ 194.9 $ 172.4
Net premiums written $ 193.1 $ 170.4
Net premiums earned $ 172.7 $ 150.2
Net investment income 27.6 19.1
Net realized and unrealized gains (losses) on investments 6.4 (17.3)
Other (loss) income (0.2) -
Total revenues 206.5 152.0
Losses and LAE 107.4 94.2
Commission expense 23.4 20.9
Underwriting and general and administrative expenses 44.4 39.3
Interest and financing expenses 2.3 0.1
Total expenses 177.5 154.5
Income tax expense (benefit) 5.4 (0.2)
Net income (loss) $ 23.6 $ (2.3)
Overview
Our net income was
compared to net loss of
key factors that affected our financial performance during the three months
ended
•Net premiums earned increased 15.0%; •Losses and LAE increased 14.0%; •Underwriting and general and administrative expenses increased 13.0%; •Underwriting loss was$2.5 million , compared to an underwriting loss of$4.2 million ; •Net investment income increased 44.5%; and •Net realized and unrealized gains (losses) on investments were$6.4 million compared to$(17.3) million .
Summary of Consolidated Financial Results
Gross Premiums Written
Gross premiums written were
2023
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 on our fixed maturity securities, less bank service charges and custodial and portfolio management fees.
Net investment income increased 44.5%, or
ended
primarily due to higher bond yields and higher invested balances of fixed
maturity securities and short-term investments, as measured by amortized cost.
26 -------------------------------------------------------------------------------- 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 gains (losses) on investments on our Consolidated Statements of Comprehensive Income (Loss). Net realized and unrealized gains (losses) on investments were$6.4 million for three months endedMarch 31, 2023 , compared to$(17.3) million for the corresponding period of 2022. The net realized and unrealized gains (losses) on investments for the three months endedMarch 31, 2023 and 2022 included$8.0 million and$(17.0) million of net realized and unrealized gains (losses) on equity securities and other investments, respectively, and$1.6 million and$0.3 million of net realized losses on fixed maturity securities, respectively. The net investment gains on our equity securities during the three months endedMarch 31, 2023 were largely consistent with the performance ofU.S. equity markets. The net realized investment losses on our fixed maturity securities during the three months endedMarch 31, 2023 were primarily the result of a$1.4 million increase in our allowance for CECL, which resulted primarily from volatility and credit concerns in certain financial and banking markets. The net investment losses on our equity securities during the three months endedMarch 31, 2022 were primarily the result of significant volatility in financial markets resulting from increasing inflationary concerns, rising market interest rates and geo-political events. The net investment losses on our fixed maturity securities for the three months endedMarch 31, 2022 included a$2.0 million increase in our allowance for CECL.
Additional information regarding our Investments is set forth under "-Liquidity
and Capital Resources-Investments."
Other (Loss) Income
Other (loss) income consists of net gains and losses on fixed assets,
non-investment interest, 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 current accident year loss estimate continues to consider, and benefit from, overall declines in the on-leveled frequency of compensable indemnity claims. Total claims costs have also been reduced by cost savings associated with our continued focus on accelerating claims settlements. We believe that our current accident year loss estimate is adequate; however, ultimate losses will not be known with any certainty for many years.
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.
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 from the
underwriting expense ratios of our reportable segments.
Interest and Financing Expenses
Interest and financing expenses include fees and interest associated with our$75.0 million three-year revolving credit facility, fees and interest associated with our various credit arrangements with the FHLB, finance lease interest, and other financing fees. Income Tax Expense (Benefit) Income tax expense (benefit) was$5.4 million for the three months endedMarch 31, 2023 , compared to$(0.2) million for the corresponding period of 2022. The effective tax rate for the three months endedMarch 31, 2023 was 18.6% and the effective 27 -------------------------------------------------------------------------------- tax rates for the three months endedMarch 31, 2022 were 8.0%. 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 net income before income taxes for our Employers' segment are
set forth in the following table:
Three Months Ended
March 31,
2023 2022
(dollars in millions)
Gross premiums written $ 194.2 $ 171.2
Net premiums written $ 192.4 $ 169.2
Net premiums earned $ 171.3 $ 149.6
Net investment income 24.8 17.6
Net realized and unrealized gains (losses) on
investments 5.6 (15.6)
Other (loss) income (0.2) -
Total revenues 201.5 151.6
Losses and LAE 108.5 95.9
Commission expense 23.3 20.9
Underwriting expenses 37.4 32.8
Interest and financing expenses 2.2 -
Other expenses - -
Total expenses 171.4 149.6
Net income before income taxes $ 30.1 $ 2.0
Underwriting income $ 2.1 $ -
Combined ratio 98.7 % 100.0 %
Underwriting Results
Gross Premiums Written and Net Premiums Written
Gross premiums written were$194.2 million for the three months endedMarch 31, 2023 , compared to$171.2 million for the corresponding period of 2022. 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 the expansion in the classes of business that Employers offers. We also recognized$9.4 million of audit premium pick-up during the three months endedMarch 31, 2023 , as our payroll exposure increased with theU.S. labor market strengthening and rising wages. In addition, our renewal premiums benefited from continued strong retention rates during the three months endedMarch 31, 2023 .
Net premiums written were
2023
Reinsurance premiums ceded were
Net Premiums Earned
Net premiums earned were
2023
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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 including
estimated final audit premium, and number of policies in-force for each of our
largest states and all other states combined for the periods presented:
March 31, 2023 December 31, 2022 March 31, 2022 December 31, 2021
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 $ 281.4 42,402 $ 279.7 42,876 $ 259.8 41,349 $ 258.4 40,704
Florida 49.8 9,245 49.4 9,417 40.9 8,159 41.1 7,989
New York 28.0 7,194 27.3 7,497 24.7 7,215 24.5 7,307
Other (43 states and
D.C.) 265.6 60,416 261.1 58,710 251.0 56,199 245.9 54,164
Total in-force $ 624.8 119,257 $ 617.5 118,500 $ 576.4 112,922 $ 569.9 110,164
Estimated audit premium 43.0 - 42.5 - 45.4 - 42.3 -
Total in-force,
including
estimated audit premium $ 667.8 119,257 $ 660.0 118,500 $ 621.8 112,922 $ 612.2 110,164
We have developed and continue to add other important and emerging distribution
channels for our products and services that serve as an alternative to our
strong traditional insurance agency channel. Specialty agents and distribution
partners generated $197.2 million and $163.9 million , or 31.6% and 28.4%, of our
in-force premiums as of March 31, 2023 and 2022, respectively. Our strong
presence and relationships with these digital and payroll specialty entities
allow us to approach new customers that we would not otherwise have access to
through our traditional insurance agency distribution channel. We believe that
the bundling of products and services through these relationships contributes to
higher retention rates than business generated by our traditional agents, and we
continue to actively seek new partnerships and alliances in these areas.
Losses and LAE, Commission Expenses, and Underwriting Expenses
The following table presents calendar year combined ratios for our Employers
segment.
Three Months Ended
March 31,
2023 2022
Loss and LAE ratio 63.3 % 64.1 %
Commission expense ratio 13.6 14.0
Underwriting expense ratio 21.8 21.9
Combined Ratio 98.7 % 100.0 %
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 reflects 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.
Our calendar year loss and LAE ratio is analyzed to measure profitability in a
particular year and to evaluate the adequacy of 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, our accident year loss and LAE ratios are analyzed to
evaluate underwriting performance and the adequacy of the premium rates 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.
29
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The table below reflects prior accident year loss and LAE reserve adjustments
and the impact to loss ratio.
Three Months Ended
March 31,
2023 2022
(dollars in millions)
Losses and LAE $ 108.5 $ 95.9
Prior accident year favorable development, net 0.2 -
Current accident year losses and LAE
Current accident year loss and LAE ratio
63.5 % 64.1 %
The increase in Employers' losses and LAE during the three months ended
higher earned premium.
Employers' current accident year loss and LAE ratio was 63.5% for the three months endedMarch 31, 2023 , compared to 64.1% for the corresponding period of 2022. Employers' current accident year loss and LAE ratios continue to reflect the impact of key business initiatives: an emphasis on accelerated settlements of open claims; further diversifying its risk exposure across geographic markets, when appropriate; and leveraging data-driven strategies to target, underwrite, and price profitable classes of business across all of its markets. Commission Expense Ratio. Employers' commission expense ratio was 13.6% for the three months endedMarch 31, 2023 , compared to 14.0% for the corresponding period of 2022, and its commission expenses were$23.3 million for the three months endedMarch 31, 2023 , compared to$20.9 million for the corresponding period of 2022. Underwriting Expenses Ratio. Employers' underwriting expense ratio was 21.8% for the three months endedMarch 31, 2023 , compared to 21.9% for the corresponding period of 2022. Employers' underwriting expenses were$37.4 million for the three months endedMarch 31, 2023 , compared to$32.8 million for the corresponding period of 2022. The increase in underwriting expenses was primarily the result of: (i) a$3.0 million increase in Employer's compensation-related expenses; and (ii) an increase in policyholder dividends and bad debt expense, each resulting from its increase in earned premium.
Underwriting Income
Employers' underwriting income was
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".
30
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CERITY
The components of net loss before income taxes for our Cerity segment are set
forth in the following table:
Three Months Ended
March 31,
2023 2022
(in millions)
Gross premiums written $ 0.7 $ 1.2
Net premiums written $ 0.7 $ 1.2
Net premiums earned $ 1.4 $ 0.6
Net investment income 1.7 0.7
Net realized and unrealized gains (losses) on
investments 0.2 (0.4)
Total revenues 3.3 0.9
Losses and LAE 0.9 0.4
Commission expense 0.1 -
Underwriting expenses 4.5 3.2
Total expenses 5.5 3.6
Net loss before income taxes $ (2.2) $ (2.7)
Underwriting loss $ (4.1) $ (3.0)
Combined ratio n/m n/m
n/m - not meaningful
Underwriting Results
Gross Premiums Written and Net Premiums Written
Cerity's gross and net premiums written were$0.7 million for the three months endedMarch 31, 2023 , compared to$1.2 million for the corresponding period of 2022. Cerity's gross and net written premiums for the three months endedMarch 31, 2023 were negatively impacted by cancellation adjustments, which had no impact on its net premiums earned.
Net Premiums Earned
Net premiums earned were
compared to
Losses and LAE, and Underwriting Expenses
Cerity's current accident year loss and LAE ratios for the three months ended
segment.
Cerity's underwriting expenses were$4.5 million for the three months endedMarch 31, 2023 , compared to$3.2 million for the corresponding period of 2022. During the three months endedMarch 31, 2023 , Cerity's professional fees increased$0.5 million , its advertising expenses increased$0.3 million and its compensation-related expenses increased$0.3 million , each compared to the corresponding period of 2022.
Cerity's underwriting losses were
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."
31 --------------------------------------------------------------------------------
CORPORATE AND OTHER
The components of net income (loss) before income taxes for Corporate and Other
are set forth in the following table:
Three Months Ended
March 31,
2023 2022
(in millions)
Net investment income $ 1.1 $ 0.8
Net realized and unrealized gains (losses) on
investments 0.6 (1.3)
Total revenues (losses) 1.7 (0.5)
Losses and LAE - LPT (2.0) (2.1)
General and administrative expenses 2.5 3.3
Interest and financing expenses 0.1 0.1
Total expenses 0.6 1.3
Net income (loss) before income taxes $ 1.1 $ (1.8)
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 (Loss).
Three Months Ended
March 31,
2023 2022
(in millions)
Amortization of the Deferred Gain related to losses $ 1.6 $ 1.7
Amortization of the Deferred Gain related to contingent
commission 0.4 0.4
Total impact of the LPT $ 2.0 $ 2.1
General and Administrative Expenses
Corporate and Other's general and administrative expenses, which consist primarily of compensation-related expenses, professional fees, and other holding company expenses, were$2.5 million for the three months endedMarch 31, 2023 , compared to$3.3 million for the corresponding periods of 2022.
During the three months ended
compensation-related expenses decreased
period of 2022.
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 recent disruptions to theU.S. economy, our current operations and our investment portfolio have, at times, been significant. Nonetheless we believe that our capital position remains strong and that the liquidity available to our holding company and its operating subsidiaries remains adequate. As a result, we do not currently foresee a need to: (i) suspend dividends at either the holding company or our insurance subsidiaries; (ii) forego repurchases of our common stock; (iii) seek additional capital; 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. 32 --------------------------------------------------------------------------------
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 2023, ECIC made a$21.0 million dividend 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 2023, without prior regulatory approval. During the first quarter of 2023, EICN made a$9.8 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 2023 without prior regulatory approval. Total cash and investments at the holding company were$98.3 million atMarch 31, 2023 , consisting of$36.1 million of cash and cash equivalents,$21.6 million of short-term investments,$7.0 million of fixed maturity securities, and$33.6 million of equity securities. OnDecember 15, 2020 , EHI entered into 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. OnFebruary 16, 2023 , the Credit Agreement was amended to: (i) formally replace the Eurodollar interest rate option with an Adjusted Term SOFR option; (ii) amend the definition of consolidated "net worth," as referred to within the Amended Credit Agreement; and (iii) amend the minimum consolidated net worth covenant for fiscal quarters ending afterSeptember 30, 2022 . The interest rates applicable to loans under the Amended Credit Agreement are based on, at EHI's option, a base rate plus a specified margin, ranging from 0.25% to 1.25%, or the Adjusted Term SOFR rate, plus a specified margin, ranging from 1.25% to 2.25%. In addition, EHI will pay a fee on each lender's unused commitment, ranging from 0.20% to 0.50%. Total interest paid and fees incurred pursuant to the Amended Credit Agreement or Credit Agreement, as applicable, during each of the three months endedMarch 31, 2023 and 2022 was$0.1 million . The Amended Credit Agreement contains covenants that require EHI and its consolidated subsidiaries to maintain: (i) a minimum consolidated net worth of no less than$900.0 million ; and (ii) a debt to total capitalization ratio of no more than 35%, in each case as determined in accordance with the Amended Credit Agreement. ThroughMarch 31, 2023 , EHI has remained in compliance with all of the covenants associated with this facility since inception.
EHI had no borrowings outstanding under the facility at any time during the
three months ended
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$2,578.9 million atMarch 31, 2023 , consisting of$50.8 million of cash and cash equivalents,$37.0 million of short-term investments,$2,241.3 million of fixed maturity securities,$177.2 million of equity securities, and$72.6 million of other invested assets. Sources of immediate and unencumbered liquidity at our operating subsidiaries as ofMarch 31, 2023 consisted of$50.6 million of cash and cash equivalents,$37.0 million of short-term investments,$170.5 million of publicly traded equity securities whose proceeds are available within three business days and$636.7 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. All of our insurance subsidiaries 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. During 2022, our insurance subsidiaries, with the exception of CIC, had received aggregate advances of$182.5 million under the FHLB under their Standard Credit Program, all of which remained outstanding atMarch 31, 2023 . The proceeds from these advances were used to purchase an equivalent amount of high-quality collateralized loan obligation securities. As ofMarch 31, 2023 , the Company's weighted average annual interest rate on these advances was 4.87%. Interest paid during the three months endedMarch 31, 2023 and 2022 totaled$2.2 million and less than$0.1 million , respectively. These advances can be repaid at any time without penalty and are collateralized by eligible investment securities. 33 -------------------------------------------------------------------------------- FHLB membership also allows our insurance subsidiaries access to standby Letter of Credit Agreements. The Letter of Credit Agreements in effect will expire onMarch 31, 2024 and 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 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$795.4 million and$745.9 million were on deposit atMarch 31, 2023 andDecember 31, 2022 , 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 bothMarch 31, 2023 andDecember 31, 2022 . Certain reinsurance contracts require company funds to be held in trust for the benefit of the ceding reinsurer to secure the outstanding liabilities we have assumed. The fair value of fixed maturity securities held in trust for the benefit of our ceding reinsurers was$2.7 million and$2.7 million atMarch 31, 2023 andDecember 31, 2022 , respectively.
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 three months ended:
March 31,
2023 2022
(in millions)
Cash, cash equivalents, and restricted cash provided by (used in):
Operating activities $ 4.3 $ 16.8
Investing activities 12.8 (6.1)
Financing activities
(19.6) 44.7
(Decrease) increase 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 three months endedMarch 31, 2023 included net premiums received of$171.7 million and investment income received of$26.8 million . These operating cash inflows were partially offset by net claims payments of$111.5 million , underwriting and general and administrative expenses paid of$53.9 million , commissions paid of$26.5 million , and interest paid of$2.3 million . Net cash provided by operating activities for the three months endedMarch 31, 2022 included net premiums received of$157.3 million and investment income received of$16.7 million . These operating cash inflows were more than offset by net claims payments of$90.4 million , underwriting and general and administrative expenses paid of$45.8 million , and commissions paid of$20.9 million . Investing Activities Net cash provided by investing activities for the three months endedMarch 31, 2023 was primarily related to 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. These investing cash inflows were partially offset by the investment of premiums received and reinvestment of funds from investment sales, maturities, redemptions, and interest income. Net cash used in investing activities for the three months endedMarch 31, 2022 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 partially offset by investment sales, maturities and redemptions whose proceeds were used to fund claim payments, underwriting and general administrative expenses, stockholder dividend payments, and common stock repurchases. 34 --------------------------------------------------------------------------------
Financing Activities
Net cash used in financing activities for the three months ended
was primarily related to common stock repurchases and stockholder dividend
payments.
Net cash provided by financing activities for the three months endedMarch 31, 2022 was primarily related to FHLB advances received partially offset by common stock repurchases and stockholder dividend payments. During the three months endedMarch 31, 2022 , we also borrowed and subsequently repaid$10.0 million under the Credit Agreement. Dividends We paid$7.6 million and$7.4 million in dividends to our stockholders for the three months endedMarch 31, 2023 and 2022, respectively. 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. OnApril 26, 2023 , the Board of Directors declared a quarterly dividend per share of$0.28 , which is payableMay 24, 2023 to stockholders of record onMay 10, 2023 . Share Repurchases We repurchased 267,883 shares of our common stock for$11.3 million during the three months endedMarch 31, 2023 . 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
million
Contractual Obligations and Commitments
Other than operating expenses, our current and long-term cash requirements
include the following contractual obligations and commitments as of
2023
Leases We have entered into lease arrangements for certain equipment and facilities. As ofMarch 31, 2023 , we had lease payment obligations of$13.7 million , with$3.3 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 ofMarch 31, 2023 , we had other purchase obligations of$23.5 million , with$4.5 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 ofMarch 31, 2023 , we had unfunded investment commitments of$44.0 million . FHLB Advances We received advances of$182.5 million from the FHLB under the Standard Credit Program during 2022. These advances, which remained outstanding as ofMarch 31, 2023 , 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 ofMarch 31, 2023 , we had unpaid losses and LAE reserves of$1,953.7 million , of which$307.9 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 of
recoverables on unpaid losses and LAE of
is currently expected to be received within 12 months.
35 --------------------------------------------------------------------------------
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. As ofMarch 31, 2023 , our investment portfolio consisted of 87% 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 3.8 atMarch 31, 2023 . 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 byStandard & 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 ofMarch 31, 2023 . 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$204.1 million atMarch 31, 2023 , which represented 8% of our investment portfolio at that time. We also have a$6.7 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 3% of our investment portfolio as ofMarch 31, 2023 and include private equity limited partnerships. Our investments in private equity limited partnerships totaled$72.6 million atMarch 31, 2023 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 ofMarch 31, 2023 , we had unfunded commitments to these private equity limited partnerships totaling$44.0 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 ofMarch 31, 2023 . Estimated Fair Percentage Category Value of Total Book Yield (in millions, except percentages) U.S. Treasuries $ 89.7 3.6 % 2.5 % U.S. Agencies 2.1 0.1 2.9 States and municipalities 330.9 13.2 3.2 Corporate securities 907.5 36.2 3.4 Residential mortgage-backed securities 360.6 14.4 3.1 Commercial mortgage-backed securities 55.6 2.2 3.2 Asset-backed securities 101.0 4.0 4.8 Collateralized loan obligations 232.0 9.2 6.4 Foreign government securities 10.5 0.4 2.8 Other securities 158.4 6.3 8.5 Equity securities 204.1 8.1 3.2 Short-term investments 58.6 2.3 4.8 Total investments at fair value$ 2,511.0 100.0 % Weighted average yield 4.1 % 36
-------------------------------------------------------------------------------- The following table shows the percentage of total estimated fair value of our fixed maturity securities as ofMarch 31, 2023 by credit rating category, using the lower of the ratings assigned byMoody's Investors Service or S&P. Percentage of Total Rating Estimated Fair Value "AAA" 13.6 % "AA" 35.5 "A" 26.9 "BBB" 12.9 Below Investment Grade 11.1 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. 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 ofMarch 31, 2023 , we have a$5.9 million allowance for CECL on AFS debt securities. During the three months endedMarch 31, 2023 , we recognized a net$1.4 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 atMarch 31, 2023 , 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.
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