The Company’s corporate headquarters are located at 25 Race Avenue in Lancaster, Pennsylvania. The Company leases its home office building under a 15-year, non-cancelable operating lease through February 2017. The base rent is subject to an annual increase based upon the consumer price index at the end of each preceding calendar year. In addition to the base rent, the Company is responsible for its proportionate share of expenses related to the building including, but not limited to, utilities, maintenance, real estate taxes, and insurance. The Company has a 5% interest in the limited partnership that owns the building.
The following table sets forth selected historical financial information for the Company for the years ended and as of the dates indicated. This information is derived from the Company’s consolidated financial statements. You should read the following selected financial information along with the information contained in this annual report, including Part II,
The Company reported net income from continuing operations of $7.4 million for the year ended December 31, 2011, compared to net income of $2.9 million for the year ended December 31, 2010. The improvement in the Company’s financial results primarily reflects a reduction in the combined ratio and an increase in net premiums earned, partially offset by a decline in the Company’s limited partnership interests and a decrease in net realized investment gains.
The decline in the Company’s limited partnership interests reflects a reduction in operating results in each of the partnerships. The decrease in net realized investment gains primarily reflects a decline in the estimated fair value of the Company’s convertible bond portfolio, which reported a loss of $1.1 million in 2011, compared to a gain of $1.2 million for the same period in 2010.
Net premiums earned. Net premiums earned represent the earned portion of the Company’s net premiums written. Premiums are earned over the term of the related policies. At the end of each accounting period, the portion of the premiums that are not yet earned are included in unearned premiums and are realized as revenue in subsequent periods over the remaining term of the policy. The Company’s workers’ compensation policies typically have a term of twelve months. Thus, for example, for a policy that is written on July 1, 2011, one-half of the premiums would be earned in 2011 and the other half would be earned in 2012. Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the insured’s records is conducted after policy expiration to make a final determination of applicable premiums. Included with net premiums earned is an estimate for EBUB premiums. The Company can estimate EBUB premiums because it keeps track, by policy, of how much additional premium is billed in final audit invoices to estimate the probable additional amount that it has earned but not yet billed as of the balance sheet date.
Net investment income and realized gains and losses on investments. The Company invests its surplus and the funds supporting its insurance liabilities (including unearned premiums and unpaid losses and LAE) in cash, cash equivalents, fixed income securities, convertible bonds, equity securities, and limited partnership investments. Investment income includes interest earned on invested assets, including the impacts of premium amortization and discount accretion. Realized gains and losses on invested assets are reported separately from net investment income. The Company recognizes realized gains when invested assets are sold for an amount greater than their cost or amortized cost (in the case of fixed income securities) and recognizes realized losses when investment securities are written down as a result of an other than temporary impairment or sold for an amount less than their cost or amortized cost. Realized gains and losses also include the change in the estimated fair value of convertible bonds.
Other revenue. Other revenue includes fees earned for claim administration and risk management services provided to self-insured property/casualty customers. There are other revenue items that the Company recognizes on a segmental basis that are eliminated in consolidation. Such items consist primarily of fees paid by the segregated portfolio cells to other
Acquisition and other underwriting expenses. In the workers’ compensation insurance segment, expenses incurred to underwrite risks are referred to as acquisition and other underwriting expenses, which consist primarily of commissions, premium taxes, assessments and fees and other underwriting expenses incurred in acquiring, writing and administering the Company’s business. In the segregated portfolio cell reinsurance segment, acquisition and other underwriting expenses consist of ceding commissions incurred under the respective reinsurance agreements. Ceding commissions received in the workers’ compensation insurance segment are netted against acquisition and other underwriting expenses.
Other expenses. Other expenses consist of general administrative expenses such as salaries, stock compensation, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately.
Loss ratio. The loss ratio is the ratio (expressed as a percentage) of losses and LAE incurred to net premiums earned and measures the underwriting profitability of a company’s insurance business. The Company measures the loss ratio on an accident year and calendar year loss basis to measure underwriting profitability. An accident year loss ratio measures losses and LAE for insured events occurring in a particular policy year, regardless of when they are reported, as a percentage of net premiums earned during that year. A calendar year loss ratio measures losses and LAE for insured events occurring during a particular policy year and the change in loss reserves from prior accident years as a percentage of net premiums earned during that year.
In estimating case incurred development and IBNR reserves, the Company performs most of its detailed analysis on a net of reinsurance basis, and then considers expected recoveries in arriving at its recorded amounts for unpaid losses and LAE. To estimate such reserves, the Company relies primarily on the historical claim data and trends from its workers’
The term “developed together” refers to the summation of the claims data for a particular data stratification. For example, “All loss and LAE data developed together” represents all loss and LAE data of the Company, regardless of medical, indemnity or expense components, developed together using the historical data for this particular data stratification. The term “developed independently” refers to a specific data element. For example, “The indemnity portion of lost time claims developed independently” represents the development of the indemnity portion of a claim separately using historical data for this particular type of claim. Developing claims using different data stratifications allows the Company to identify trends for a specific group of claims that would not necessarily be readily identifiable if the data were included with other types of claim information. For example, developing the medical portion of a claim separately may allow the Company to identify a medical inflation trend that may not have been evident if it had been included with indemnity claim information. The combination of the different data stratifications and standard actuarial methods, including the following, produce different actuarial indications for the Company to evaluate:
The Company’s reserves for unpaid losses and LAE in its segregated portfolio cell reinsurance segment as of December 31, 2011 and 2010 are summarized below (in thousands):
For the years ended December 31, 2011, 2010 and 2009, the Company recorded other-than-temporary impairments of $0, $6,000, and $189,000, respectively, related to its fixed income security portfolio.
As of December 31, 2011, the Company held fixed income securities, excluding fixed income securities in the segregated portfolio cell reinsurance segment, with gross unrealized losses of $15,000, none of which were in an unrealized loss position for more than twelve months. Management has evaluated the unrealized losses related to those fixed income securities and determined that they are primarily due to a fluctuation in interest rates and not to credit issues of the issuer or the underlying assets in the case of asset-backed securities. The Company does not intend to sell the fixed income securities and it is not more likely than not that the Company will be required to sell the fixed income securities before recovery of their amortized cost bases, which may be maturity; therefore, management does not consider the fixed income securities to be other-than-temporarily impaired as of December 31, 2011. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.
The Company performs its annual goodwill impairment test as of September 30. The Company adopted Accounting Standards Update No. 2011-08 (“ASU 2011-08”), Testing Goodwill for Impairment, effective September 30, 2011. Under ASU 2011-08, the Company assessed certain qualitative factors to determine if it was more likely than not that the fair value of the workers’ compensation insurance segment was less than its carrying amount. As a result of this assessment, it was determined that it was not more likely than not that fair value of the workers’ compensation insurance segment was less than its carrying amount; therefore, the performance of the two-step impairment test was not required.
In October 2010, the FASB issued ASU 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”). ASU 2010-26 provides specific types of costs that should be capitalized in connection with the acquisition or renewal of insurance contracts. Those costs include incremental direct costs of contract acquisition incurred in connection with independent third parties and certain costs related to activities performed by the insurer for the contract, including underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. Under ASU 2010-26, costs incurred by an entity related to unsuccessful acquisition or renewal efforts must be charged to expense as incurred. ASU 2010-26 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 and is to be applied prospectively. Retrospective application to all prior periods upon the date of adoption is permitted, but not required. Early adoption is permitted but only at the beginning of an entity’s annual reporting period. The Company currently capitalizes and defers commissions and related expenses, premium taxes and certain underwriting personnel salaries. The Company will adopt ASU 2010-26 effective January 1, 2012 and apply it prospectively. Upon adoption, the Company will reduce the amount of acquisition costs capitalized related to certain underwriting personnel salaries to give effect to unsuccessful acquisition or renewal activities. If the Company had adopted ASU 2010-26 effective January 1, 2011, underwriting salaries capitalized and deferred would have been reduced by approximately $1.3 million, which would have decreased the Company’s net income by approximately $870,000.
The increase in consolidated revenue from 2010 to 2011 primarily reflects the growth in net premiums written, including the impact of audit premiums, partially offset by a decline in the Company’s limited partnership interests and a decrease in net realized investment gains.
The decrease in the calendar period loss and LAE ratio from 2010 to 2011 primarily reflects the impact of audit premium and a reduction in the impact of severity-related claims. Audit premium, including the EBUB estimate, reduced the 2011 loss ratio by 2.1 percentage points, compared to increasing the 2010 loss ratio by 1.0 percentage points. The Company did not record any prior year reserve development in 2011 or 2010.
The decrease in the calendar period loss and LAE ratio from 2010 to 2011 reflects a decrease in the accident period loss ratio, an increase in favorable reserve development, and an improvement in audit premium. The accident period loss ratio was 65.9% in 2011, compared to 79.9% in 2010. The 2010 accident period loss ratio primarily reflects management’s estimate of the impact of the economic environment on the Company’s workers’ compensation book of business as of December 31, 2010 and the impact of severity-related claims in 2010. The Company recorded favorable reserve development of $2.9 million in 2011, compared to favorable reserve development of $1.4 million in 2010. The favorable reserve development primarily reflects the impact of claim settlements for amounts at, or less than, previously established case and IBNR reserves. Audit premium reduced the 2011 loss ratio by 0.6 percentage points, compared to increasing the 2010 loss ratio by 2.8 percentage points.
The decrease in revenue primarily reflects a decrease in the Company’s equity interest in SprinklerPro, a reduction in the operating results of a limited partnership interest, and the loss of a third party administration customer in the first quarter of 2011.
Net realized investment gains for the year ended December 31, 2011 primarily reflect gains from the sale of securities in EIHI’s investment portfolio to fund the repurchase of the Company’s common stock.
The effective tax rate was 47.9% in 2011, compared to 32.1% in 2010. The increase in the income tax benefit from 2010 to 2011 primarily reflects the reversal of the net deferred liability related to the Company’s outside basis difference in its foreign operations during 2011.
(1) Ceded premiums written include premiums ceded to the segregated portfolio cell reinsurance segment of $28,798 and $28,661 for the years ended December 31, 2010 and 2009, respectively.
The decrease in net investment income primarily reflects a decline in the average yield on the fixed income portfolio and a decline in short-term interest rates from 2009 to 2010. The average yield on the fixed income portfolio was 3.52% as of December 31, 2010, compared to 3.61% as of December 31, 2009.
The increase in the calendar period loss and LAE ratio reflects an increase in the accident period loss ratio and no development on prior accident period reserves. The accident period loss ratio was 70.4% and 65.6% for the years ended December 31, 2010 and 2009, respectively. The increase in the accident period loss ratio primarily reflects an increase in severity-related claims, specifically in the fourth quarter 2010, as well as the continuing impact of the current economic environment on the Company’s book of business. Favorable loss reserve development totaled $3.7 million for the year ended December 31, 2009. Severity-related claims for the year ended December 31, 2010 and 2009 were as follows:
Other expenses as a percent of net premiums earned was 18.3% for the year ended December 31, 2010, compared to 18.8% for the same period in 2009. The decrease primarily reflects the growth in premium revenue in the Company’s Southeast region.
The following table represents the operations of the segregated portfolio cell reinsurance segment for the years ended December 31, 2010 and 2009 (in thousands):
The segregated portfolio dividend expense represents the amount of net income or loss in a specific period that may be payable to the segregated portfolio dividend participants.
The decrease in revenue primarily reflects a decrease in the Company’s equity interest in the segregated portfolio cell with an unaffiliated carrier that writes insurance coverage for sprinkler contractors, a reduction in the operating results of a limited partnership interest, and net realized investment losses in 2010.
Total liabilities were $217.4 million as of December 31, 2011, compared to $188.6 million as of December 31, 2010. The increase in liabilities primarily reflects the Company’s premium growth in 2011. The increase in loss reserves, unearned premiums and ceded reinsurance balances payable are primarily attributable to the increase in written premium in 2011. The increase in accounts payable and accrued expenses primarily reflects an increase in the Company’s benefit plan liabilities and commissions payable. The increase in the benefit plan liabilities reflects the impact of current interest rate environment on the discount rate used to estimate the benefit obligation. The increase in commissions payable primarily reflects the increase in premiums written.
Liquidity is a measure of an entity’s ability to secure sufficient cash to meet its contractual obligations and operating needs. The Company’s principal sources of funds are premiums, investment income and proceeds from sales and maturities of investments. The Company’s primary use of funds is to pay claims and operating expenses and to purchase investments. The Company’s investment portfolio is structured so that investments mature periodically over time in reasonable relation to current expectations of future claim payments. The Company’s fixed income investment portfolio as of December 31, 2011 had an effective duration of 2.76 years.
For the years ended December 31, 2011, 2010 and 2009, the Company’s cash inflows from premiums and investment activity were sufficient to support the Company’s cash outflows related to claims and operating expenses. Management expects future cash flows from operations in its workers’ compensation insurance and segregated portfolio cell reinsurance segments to be sufficient to cover claims and operating expenses. However, in the event cash flows from operations are not sufficient, the Company may have to liquidate investments to cover such costs. As of December 31, 2011, the Company’s investment portfolio included securities with gross unrealized gains totaling $5.9 million, excluding gross unrealized gains on investments in the segregated portfolio cell reinsurance segment of $493,000; therefore, based on current gross unrealized gains in the investment portfolio as of December 31, 2011, management does not believe it would have to sell securities at a loss in the event cash flows from operations proved insufficient to cover the Company’s operating needs.
The major components of cash flow from continuing operations are as follows for the years ended December 31, 2011, 2010, and 2009 (in thousands):
The increase in cash flows used in financing activities primarily reflects an increase in common stock repurchases in 2011, partially offset by a decrease in shareholder dividends and debt payments. The decrease in shareholder dividends primarily reflects the reduction in outstanding common stock due to the common stock repurchases. During 2010, the Company paid its only outstanding loan in full.
Cash Flows From Continuing Operations for the Years Ended December 31, 2010 and 2009.
The following table summarizes information about contractual obligations and commercial commitments before the impact of purchase accounting adjustments. The minimum payments under these agreements as of December 31, 2011 were as follows (in thousands):
In our opinion, the consolidated financial statements listed in the index appearing under Item 15 a) (1) present fairly, in all material respects, the financial position of Eastern Insurance Holdings, Inc. and its subsidiaries (collectively, the “Company”) at December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15 a) (2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in “Management’s Report on Internal Control Over Financial Reporting” appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Eastern Insurance Holdings, Inc. (“EIHI”) is an insurance holding company offering workers’ compensation insurance and reinsurance products through its direct and indirect wholly-owned subsidiaries, Global Alliance Holdings, Ltd. (“Global Alliance”), Eastern Alliance Insurance Company (“Eastern Alliance”), Allied Eastern Indemnity Company (“Allied Eastern”), Eastern Advantage Assurance Company (“Eastern Advantage”), Employers Security Insurance Company (“Employers Security”), Employers Alliance, Inc. (“Employers Alliance”), Eastern Re Ltd., S.P.C. (“Eastern Re”), and Eastern Services Corporation (“Eastern Services”), collectively referred to as the “Company.”
The Company currently operates in three segments: workers’ compensation insurance, segregated portfolio cell reinsurance, and corporate/other. Prior to the sale of Atlantic RE and Eastern Life, the Company’s operations included a run-off specialty reinsurance segment and a group benefits insurance segment. The components of the run-off specialty reinsurance segment that were not transferred to Atlantic RE have been included in the corporate/other segment for the years ended December 31, 2011, 2010 and 2009.
The Company’s investments in fixed income securities are classified as available-for-sale and are carried at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss), net of tax. The estimated fair value of the Company’s fixed income securities are based on prices obtained from an independent pricing service. Prices obtained from the independent pricing service are determined based on quoted market prices or, in the absence of quoted market prices, dealer quotes or matrix pricing, all of which are based on observable market-based inputs when available. Management has controls in place to validate the reasonableness of fair values provided by the independent pricing service, including testing the fair value of a sample of securities on a quarterly basis by comparing fair values from different pricing sources. Adverse credit market conditions have caused some markets to become relatively illiquid, thus reducing the availability of certain data used by the independent pricing services and dealers.
The Company discounts its reserves for unpaid losses and LAE for workers’ compensation claims on a non-tabular basis, using a discount rate of 3.0%, based upon regulatory guidelines. The reserves for unpaid losses and LAE have been reduced for the effects of discounting by approximately $5,723 and $4,633 as of December 31, 2011 and 2010, respectively.
Policy acquisition costs consist of commissions, premium taxes and underwriting salaries that vary with and are primarily related to the production of premium. Policy acquisition costs are deferred and amortized over the period in which the related premiums are earned. Deferred acquisition costs are limited to the estimated amounts recoverable after providing for losses and loss adjustment expenses that are expected to be incurred based upon historical and current experience. Anticipated investment income is considered in determining recoverability.
The Company includes income tax-related interest and penalties as a component of income tax expense. The Company did not incur any income tax-related interest or penalties during 2011, 2010 or 2009.
The statute of limitations has expired for the Company’s federal taxable years through December 31, 2007.
claims in a timely manner, to meet the costs of the Pennsylvania Insurance Department to administer the fund and to maintain a minimum balance in the fund of $500 million. If the Security Fund determines that the balance in the Security Fund is less than $500 million based on the actuarial study, then an assessment up to one percent of direct written premium is made to all companies licensed to write workers’ compensation in Pennsylvania. Eastern Alliance, Allied Eastern and Eastern Advantage recognize a liability and the related expense for the assessments when premiums covered under the Security Fund are written; when an assessment from the Security Fund has been imposed or it is probable that an assessment will be imposed; and the amount of the assessment is reasonably estimable. The Company did not record a liability related to the Security Fund as of December 31, 2011 or 2010 because the Company received notification that an assessment would not be imposed.
The factors management considered in determining that it was not more likely than not that the fair value of the workers’ compensation insurance segment was less than its carrying amount included year over year premium growth, an increase in the renewal retention rate, and a reduction in the segment’s combined ratio. In addition, the Company continues to increase its agency base and has experienced growth in each of its regional offices. Management also considered the increase in the Company’s stock price, which closed at $13.15 on September 30, 2011, compared to $10.39 on September 30, 2010, an increase of 26.6%.
Comprehensive income includes all changes in shareholders’ equity during the reporting period, net of tax. The components of accumulated other comprehensive income, net of tax, as of December 31, 2011 and 2010 were as follows (in thousands):
In September 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-08, Testing Goodwill for Impairment. ASU 2011-08 provides an entity the option to first assess qualitative factors in determining whether the existence of certain events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, the performance of the two-step impairment test is unnecessary. If, however, an entity determines that is it more likely than not that the fair value is less than the carrying amount, the first step of the impairment test (calculation of the reporting unit’s fair value) is required. ASU 2011-08 provides examples of events and circumstances that an entity should consider in evaluating whether the fair value of a reporting unit is less than its carrying amount, but other relevant events or circumstances should be considered as necessary. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The Company adopted the provisions of ASU 2011-08 effective September 30, 2011.
The sale of Eastern Life resulted in the recognition of a gain totaling $564, which is included in discontinued operations. Transaction expenses related to the sale of Eastern Life totaled $873 ($567, net of tax) for the year ended December 31, 2010, and have been included in discontinued operations. Certain corporate expenses previously reported in the group benefits insurance segment were reclassified to continuing operations. The reclassification of these corporate expenses totaled $500 for each of the years ended December 31, 2010 and 2009.
The estimated contingent profit commission is included in other assets and any decrease in the estimated amount would be recorded as a loss from discontinued operations. As of December 31, 2011, management believes that the estimated contingent profit commission is realizable; however, due to the inherent uncertainty in the run-off specialty reinsurance segment’s reserves for losses and LAE, the estimated realizable amount could decrease in the future.
For the years ended December 31, 2010 and 2009, the run-off specialty reinsurance segment reported net premiums earned of $1 and $1,133, respectively, and total revenue of $4,180 and $957, respectively. Total revenue for the year ended December 31, 2010 excludes the loss on the sale of Atlantic RE of $14,029. The loss before income taxes in the run-off specialty reinsurance segment totaled $(12,924) and $(663) for the years ended December 31, 2010 and 2009, respectively.
As of December 31, 2011 and 2010, intangible assets consisted of the following (in thousands):
Basic earnings per share are computed by dividing net income (loss) by the weighted average number of shares outstanding for the respective period. Diluted earnings per share are computed by dividing net income (loss) by the weighted average number of shares outstanding for the period, including dilutive potential common shares outstanding for the period. For the years ended December 31, 2011, 2010 and 2009, there were 887,574, 957,799 and 784,361 equity awards, respectively, that were not included in the Company’s earnings per share from continuing operations calculation because to do so would have been anti-dilutive.
As of January 1, 2009, contingent warrants to purchase 306,099 common shares of EIHI stock at an exercise price of $1.63 were outstanding. These warrants were awarded in 1999 as compensation to a Director of the Company who acted as the insurance broker for premium production in the Company’s run-off specialty reinsurance segment. The number of warrants ultimately earned was contingent upon achievement of predetermined direct premiums written thresholds. As of January 1, 2009, 244,879 warrants were earned. The remaining 61,220 warrants will not be earned because the specialty reinsurance segment was placed into run-off on July 1, 2008 and, therefore, there is no additional premium production. On March 10, 2009, the Director notified the Company that he was exercising the 244,879 earned warrants. Furthermore, as provided in the terms of the warrant, the Director instructed the Company to retain 64,588 shares in payment of the exercise price. Accordingly, on March 31, 2009, 180,291 shares of EIHI common stock were issued to the Director in full satisfaction of the 244,879 warrants earned. This was a non-cash transaction that had no impact on cash flows from operating or financing activities.
As of December 31, 2011, there were 481,706 and 209,462 vested stock options and restricted stock awards, respectively. As of December 31, 2010, there were 361,959 and 160,231 vested stock options and restricted stocks awards, respectively. The total unrecognized stock compensation expense related to non-vested stock options was $791 and $1,593, respectively, and the total unrecognized stock compensation expense related to non-vested restricted stock awards was $29 and $689, respectively, as of December 31, 2011 and 2010. The unrecognized stock compensation expense related to the non-vested stock options and restricted stock awards is expected to be recognized over a weighted average period of approximately 27.0 months and 48.5 months, respectively.
As of December 31, 2011, there were 389,702 shares of common stock available for issuance of future share-based awards. On February 24, 2012, the Company’s Board of Directors approved the issuance of an additional 218,500 non-qualified stock option awards and an additional 128,700 restricted stock awards. The grant date fair value of the awards was $14.45.
The following table presents additional information regarding options outstanding as of December 31, 2011:
Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state, and may change in the future. The Company’s domestic insurance subsidiaries did not have any permitted practices as of or for the year ended December 31, 2011.
The statutory surplus and statutory net income (loss) of Eastern Alliance, Allied Eastern, Eastern Advantage and Employers Security as of December 31, 2011 and 2010 and for the years ended December 31, 2011, 2010, and 2009 was as follows (in thousands):
The Company’s assets and liabilities that are measured at fair value on a recurring basis are segregated between those assets and liabilities that are valued based on quoted prices (unadjusted) in active markets for identical assets or liabilities, which the reporting entity can access at the measurement date (Level 1), direct or indirect observable inputs other than Level 1 quoted prices (Level 2), or unobservable inputs to the extent that observable inputs are not available (Level 3).
The following is a description of the Company’s categorization of the inputs used in the recurring fair value measurements of its financial assets included in its consolidated balance sheet as of December 31, 2011 and 2010:
The following table provides a summary of the fair value measurements of the Company’s fixed income securities, convertible bonds, and equity securities, as of December 31, 2011 and 2010, excluding the segregated portfolio cell segment (in thousands):
There were no transfers between Level 1 and Level 2 securities for the year ended December 31, 2011.
The estimated fair values of the Company’s investments in fixed income securities, convertible bonds, and equity securities are based on prices provided by an independent, nationally recognized pricing service. The prices provided by the independent pricing service are based on quoted market prices, when available, non-binding broker quotes, or matrix pricing. The independent pricing service provides a single price or quote per security and the Company does not adjust security prices. Management has controls in place to validate the reasonableness of fair values provided by the independent pricing service, including testing the fair value of a sample of securities on a quarterly basis by comparing fair values from different pricing sources. Fixed income securities include U.S. Treasuries, agencies backed by the U.S. Government, municipal bonds, mortgage-backed securities, collateralized mortgage obligations, asset-backed securities, and corporate bonds.
exchange market and, therefore, was considered a Level 2 security. Approximately 94.1% of the fund’s underlying investments were considered Level 1 securities as of December 31, 2010, the most recent date for which the Company had audited financial statements of the fund. The Company sold its interest in the international equity fund in the second quarter of 2011.
As of December 31, 2011 and 2010, the estimated fair values of the Company’s other long-term investments, by investment strategy, were as follows (in thousands):
During 2011, the Company wrote off its interest in the real estate limited partnership. The write off totaled $49 and was a result of the limited partnership being liquidated without any benefit to the Company.
Natural resources-The investment objective of the fund is to achieve long-term capital appreciation primarily through investments in hard asset securities and hard asset commodities.
As of December 31, 2011, the only restrictions on the Company’s ability to redeem its interest in its limited partnership investments relate to the timing of redemption (i.e., monthly, quarterly). There are no restrictions related to the amount the Company can redeem, in the event it chooses to redeem all or a portion of its interest in its limited partnership investments. The Company has no unfunded commitments related to these investments as of December 31, 2011.
The change in interest in the Company’s limited partnership investments is included in the change in equity interest in limited partnerships in the consolidated statements of operations and comprehensive income (loss).
The amortized cost and estimated fair value of fixed income securities and convertible bonds, excluding the fixed income mutual fund held by the segregated portfolio cell reinsurance segment which does not have a stated maturity date, as of December 31, 2011, by contractual maturity, are shown below (in thousands). Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.
The gross unrealized losses and estimated fair value of fixed income securities, excluding those securities in the segregated portfolio cell reinsurance segment, classified as available-for-sale by category and length of time an individual security has been in a continuous unrealized position as of December 31, 2011 and 2010 are as follows (in thousands):
The gross realized gains and gross realized losses recognized by the Company as a result of the sale of investments were as follows for the years ended December 31, 2011, 2010, and 2009 (in thousands):
For the years ended December 31, 2011, 2010 and 2009, the Company recorded other-than-temporary impairments, excluding the segregated portfolio cell reinsurance segment, related to its fixed income and equity securities totaling $0, $6 and $1,852, respectively. Other-than-temporary impairments in the segregated portfolio cell reinsurance segment totaled $78, $80, and $749 for the years ended December 31, 2011, 2010 and 2009, respectively.
For the years ended December 31, 2011, 2010 and 2009, the change in the estimated fair value of convertible bonds included in net realized investment gains (losses) in the consolidated statement of operations and comprehensive income totaled $(1,054), $1,166 and $877, respectively.
The change in the Company’s net unrealized gains and losses for the years ended December 31, 2011, 2010, and 2009 was as follows (in thousands):
The following table provides a summary of the activity in the Company’s reserves for unpaid losses and LAE for the years ended December 31, 2011, 2010, and 2009 (in thousands):
For the years ended December 31, 2011, 2010 and 2009, the Company increased (decreased) its workers’ compensation insurance and segregated portfolio cell reinsurance reserves for unpaid losses and LAE, including the accretion of prior period discount, by the following amounts (in thousands):
For the years ended December 31, 2011, 2010 and 2009, the Company increased (decreased) its workers’ compensation insurance reserves for unpaid losses and LAE by the following amounts by accident year (in thousands):
segments. This is because the workers’ compensation and segregated portfolio cell reinsurance segments derive their books of business from the same general business demographics and geography. Prior period reserve development in the segregated portfolio cell reinsurance segment results in an increase or decrease in the segment’s losses and LAE incurred and a corresponding decrease or increase in the segregated portfolio cell dividend expense.
For the year ended December 31, 2011, the Company recognized net favorable development on prior accident year segregated portfolio cell reinsurance reserves of $2.9 million, representing 12.6% of the Company’s estimated segregated portfolio cell reinsurance reserves as of December 31, 2010 and 10.1% of the Company’s segregated portfolio cell reinsurance net premiums earned for the year ended December 31, 2011. The favorable development arose primarily from accident years 2010 and 2009, but was generally prevalent in most prior accident years, and resulted from actual loss development being somewhat lower than the Company had expected based on its historical loss development experience, reflecting continued improvements in loss mitigation and underwriting.
The following table provides a summary of the Company’s premiums on a direct, assumed, ceded, and net basis for the years ended December 31, 2011, 2010, and 2009 (in thousands):
The components of the consolidated income tax provision from continuing operations for the years ended December 31, 2011, 2010, and 2009 are as follows (in thousands):
The reconciliation of taxes computed at the statutory tax rate of 35.0% for the years ended December 31, 2011, 2010, and 2009 to the consolidated income tax expense from continuing operations is as follows (in thousands):
The income tax benefit of $824 recorded in 2011 is attributable to the fact that the Company has not recorded federal income taxes associated with its foreign operations due to significant deficits in the Company’s foreign earnings and profits.
The significant components of the net deferred tax asset as of December 31, 2011 and 2010 are as follows (in thousands):
arises from losses at Eastern Re recognized for financial statement purposes, which have not yet been recognized for tax purposes. Management presently believes that the Company will not be able to recognize these tax benefits in the foreseeable future and, therefore, has not recognized the future tax benefits as of December 31, 2011.
There were no unrecognized tax benefits recorded by the Company in 2010 or 2009.
The total unrecognized federal tax benefit of $26 would impact the Company’s consolidated effective tax rate if recognized. The liability for unrecognized tax benefits is included in federal income tax recoverable on the consolidated balance sheets. The Company’s practice is to recognize interest and penalties related to income tax matters in income tax expense. The statute of limitations has expired for the Company’s federal taxable years through December 31, 2007.
EIHI and its subsidiaries join in the filing of a consolidated federal tax return in the United States. Each subsidiary pays its share of the federal tax liability as if the subsidiary filed on a separate return basis with a current period credit for net losses to the extent used in consolidation.
The Company sponsors an ESOP. Eligible employees generally include those employees who have reached the age of 21 and have completed one year of service. ESOP shares are allocated to participants based on the ratio of their individual compensation during the plan year to the total compensation of eligible employees during the plan year.
As of December 31, 2011 and 2010, the estimated fair value of unearned ESOP shares were $4,396 and $4,259, respectively.
For the years ended December 31, 2011, 2010, and 2009 the Company made a cash contribution of $979, $958, and $937 to the ESOP, respectively. The ESOP used these contributions, along with dividends received on the unallocated shares
of the Company’s stock held by the ESOP, to make the semi-annual principal and interest payments to the Company related to the outstanding balance of the promissory note. Dividends used by the ESOP to fund the semi-annual principal and interest payments totaled $121, $142, and $163 in 2011, 2010, and 2009, respectively. The transactions between the Company and the ESOP are considered non-cash transactions for purposes of the consolidated statements of cash flows.
The Company sponsors a contributory defined contribution plan covering eligible employees. Employees are eligible to participate in the defined contribution plan upon the attainment of 21 years of age. The Company provides a matching contribution up to 75% of the first 4% of an employee’s contributions. Employees are immediately vested in the employer matching contributions regardless of years of service. The Company’s contributions to the defined contribution plan for the years ended December 31, 2011, 2010, and 2009 totaled $289, $297, and $309, respectively.
As of December 31, 2011 and 2010, the projected benefit obligation, fair value of plan assets and funded status of the pension plan and the postretirement plan were as follows (in thousands):
*The weighted average discount rate used to measure net periodic benefit cost was 5.50% for the period from January 1, 2011 to June 30, 2011 and 5.62% for the period from July 1, 2011 to December 31, 2011. The change in the discount rate on July 1, 2011 was due to the purchase of the annuity and the related settlement that occurred in July 2011.
The Company currently operates in three business segments. Prior to the sale of Atlantic RE and Eastern Life, the Company’s operations included a run-off specialty reinsurance segment and a group benefits insurance segment. The components of the run-off specialty reinsurance segment that were not transferred to Atlantic RE have been included in the corporate/other segment for the years ended December 31, 2011, 2010 and 2009.
The Company offers alternative market workers’ compensation solutions to individual companies, groups and associations (referred to as “segregated portfolio cell dividend participants”) through the creation of segregated portfolio cells. The segregated portfolio cells are segregated pools of assets that function as insurance companies within an insurance
company. The pool of assets and associated liabilities of each segregated portfolio cell are solely for the benefit of the segregated portfolio cell dividend participants, and the pool of assets of one segregated portfolio cell are statutorily protected from the creditors of the others. This permits the Company to provide customers with a turn-key alternative markets solution that includes program design, fronting, claims administration, risk management, segregated portfolio cell rental, asset management and segregated portfolio management services. The Company outsources the asset management and segregated portfolio cell management services to a third party. The segregated portfolio cell structure provides dividend participants the opportunity to share in both underwriting profit and investment income derived from their respective segregated portfolio cell’s financial results. The segregated portfolio cell reinsurance segment generated fee revenue to the Company’s workers’ compensation insurance and corporate/other segments totaling approximately $5,515, $4,469 and $4,054 for the years ended December 31, 2011, 2010 and 2009, respectively.
The Company is a preferred shareholder in certain of the segregated portfolio cells. For those segregated portfolio cells in which the Company participates, the Company shares in the operating and investment results of those cells and recognizes its share of the segregated portfolio dividend in the consolidated statements of operations and comprehensive income (loss). The Company’s share of the segregated portfolio dividend totaled $568, $(6) and $985 for the years ended December 31, 2011, 2010 and 2009, respectively, and is included in the corporate/other segment.
At this stage of the proceedings, both the Company and AIG Companies have appointed arbitrators. The parties are currently in the process of attempting to select an umpire.
While the Company believes it has adequately reserved the claims at issue in the arbitration, and that it is entitled to the relief it requested in the arbitration, it is reasonably possible that the final outcome of the arbitration could go against the Company.
The Company maintains regional offices in North Carolina, Indiana, Tennessee and Wexford, Pennsylvania and leases office space in each of these locations under multi-year operating leases.
The Company has an agreement with Alliance Impairment Management, Inc. (“AIM”), which provides case management services to certain of the Company’s insurance subsidiaries. For the years ended December 31, 2011, 2010, and 2009, the Company paid fees to AIM totaling approximately $3,700, $3,200 and $2,600, respectively. Bruce Eckert, the Company’s Vice Chairman (Chief Executive Officer as of December 31, 2010), is an investor in AIM.