As of February 1, 2017, we leased 204,736 square feet of office space in 6 states, including our principal executive offices located in Reno, Nevada. We believe that our existing office space is adequate for our current needs. We will continue to enter into or exit lease agreements to address future space requirements, as necessary.
Losses and LAE decreased 3% in 2016 and 5% in 2015, each compared to the previous year;
Income tax expense was $34.0 million, $5.0 million, and $5.9 million in 2016, 2015, and 2014, respectively.
The following noteworthy items were included in our 2016 results of operations: (1) favorable prior year accident year loss development of $18.4 million, including $17.0 million of favorable development on our voluntary business and $1.4 million of favorable development on our assigned risk business, which decreased our losses and LAE by the same amount; (2) favorable development in the estimated reserves ceded under the LPT Agreement, which resulted in a $3.1 million cumulative adjustment to the Deferred Gain and reduced our losses and LAE by the same amount (LPT Reserve Adjustment); and (3) an increase in the contingent commission receivable under the LPT Agreement, which resulted in a $1.8 million cumulative adjustment to the Deferred Gain, and reduced our losses and LAE by the same amount (LPT Contingent Commission Adjustment). Collectively, these items increased our net income before taxes by $23.3 million for the year ended December 31, 2016.
Net premiums written were $694.6 million, $689.3 million, and $687.6 million for the years ended December 31, 2016, 2015, and 2014, respectively, which included $6.8 million, $8.4 million, and $10.1 million of reinsurance premiums ceded, respectively. The decreases in reinsurance premiums ceded from 2014 to 2016 reflect the increases in our retention on a per occurrence basis under our current excess of loss reinsurance program compared to earlier periods.
Net premiums earned were $694.8 million, $690.4 million, and $684.5 million for the years ended December 31, 2016, 2015, and 2014, respectively. Net premiums earned are primarily a function of the amount and timing of net premiums previously written.
Net realized gains (losses) on investments were $11.2 million, $(10.7) million, and $16.3 million for the years ended December 31, 2016, 2015, and 2014, respectively. Net realized gains on investments in 2016 were primarily the result of the sale of equity securities as part of a re-balancing of our equity investments portfolio to meet cash needs at the holding company, and to provide cash to support the internal restructuring of our insurance subsidiaries. Those gains were partially offset by $5.8 million in other-than-temporary impairments of certain equity securities due to our intent to sell securities, and the downturn in the energy sector during that year. Net realized losses on investments in 2015 were primarily the result of other-than-temporary impairments of certain equity securities during the fourth quarter due to the downturn in the energy sector during that year. The net realized gains on investments for the year ended December 31, 2014 was primarily related to a re-balancing of our equity investment portfolio. Additional information regarding our Investments is set forth under “-Liquidity and Capital Resources-Investments” and Note 6 in the Notes to our Consolidated Financial Statements.
Losses and LAE, Commission Expenses, and Underwriting and Other Operating Expenses
We analyze our calendar year loss and LAE ratio to measure our profitability in a particular year and to evaluate the adequacy of our premium rates charged in a particular year to cover expected losses and LAE from all periods, including development (whether
Our current accident year loss estimates were 65.2%, 66.2%, and 73.6% for the years ended December 31, 2016, 2015, and 2014, respectively. The decreasing trend in our current accident year loss estimates reflects the impact of key business initiatives, including: accelerating the settlement of open claims; diversifying our risk exposure across geographic markets; and leveraging data-driven strategies to target, underwrite, and price profitable classes of business across all of our markets. In addition, we have increased rates in the LA Area in California limiting our growth in that territory, while we continue to grow in other territories within and outside of California. The current accident year loss estimate for the year ended December 31, 2016 includes the impact of $6.5 million in large losses recognized in the second quarter of 2016, which increased the current accident year loss estimate for the year.
Income tax expense was $34.0 million, $5.0 million, and $5.9 million for the years ended December 31, 2016, 2015, and 2014, respectively, representing effective tax rates of 24.2%, 5.0%, and 5.5% for the years ended December 31, 2016, 2015, and 2014, respectively. For 2016, tax-advantaged investment income, LPT Reserve Adjustments, Deferred Gain amortization and certain other adjustments reduced our income tax expense computed at a statutory 35% rate by $15.3 million. For 2015, tax-advantaged investment income, pre-Privatization loss and LAE reserve adjustments, LPT Reserve Adjustments, Deferred Gain amortization and certain other adjustments reduced our income tax expense computed at a statutory 35% rate by $29.8 million. For 2014, tax-advantaged investment income, pre-Privatization loss and LAE reserve adjustments, LPT Reserve Adjustments, Deferred Gain amortization and certain other adjustments reduced our income tax expense computed at a statutory 35% rate by $31.4 million.
Our insurance subsidiaries' ability to pay dividends to their parent is based on reported capital, surplus, and dividends paid within the last 12 months. For 2017, EICN and EPIC cannot pay any dividends without prior regulatory approval; ECIC can pay $4.6 million of dividends through June 21, 2017 and $38.1 million thereafter without prior regulatory approval, provided that no dividends are paid prior to June 21, 2017; and EAC can pay $18.0 million of dividends beginning July 6, 2017 without prior regulatory approval.
Each of our insurance subsidiaries became a member of the Federal Home Loan Bank (FHLB) in January 2016. 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. Currently, none of our subsidiaries has advances outstanding under the FHLB facility.
Our insurance subsidiaries are required by law to maintain a certain minimum level of surplus on a statutory basis. Surplus is calculated by subtracting total liabilities from total admitted assets. The amount of capital in our insurance subsidiaries is maintained relative to standardized capital adequacy measures such as risk-based capital (RBC), as established by the National Association of Insurance Commissioners. The RBC standard was designed to provide a measure by which regulators can assess the adequacy of an insurance company's capital and surplus relative to its operations. An insurance company must maintain capital and surplus of at least 200% of RBC. Each of our insurance subsidiaries had total adjusted capital in excess of the minimum RBC requirements that correspond to any level of regulatory action at December 31, 2016.
Net cash provided by operating activities in 2014 included net premiums received of $673.7 million, and investment income received of $82.7 million. These operating cash inflows were partially offset by net claims payments of $386.6 million, underwriting and other operating expenses paid of $122.6 million, and commissions paid of $78.9 million.
Net cash used in investing activities in 2016, 2015, and 2014 was primarily related to the investment of premiums received and the reinvestment of funds from maturities, redemptions, and interest income. These investing cash outflows were partially offset by investment sales whose proceeds were used to fund claims payments, underwriting and other operating expenses, common stock dividend payments, and common stock repurchases.
Net cash used in financing activities in 2016 included purchases of our common stock and payments of dividends to common stockholders. These financing cash outflows were partially offset by net proceeds from stock-based compensation, mainly proceeds from exercises of stock options.
Net cash used in financing activities in 2015 and 2014 included payments of dividends to common stockholders and repayment of notes payable and capital leases. These financing cash outflows were partially offset by net proceeds from stock-based compensation, mainly proceeds and income tax benefits from exercises of stock options.
Dividends. Dividends paid to stockholders were $11.5 million, $7.7 million, and $7.6 million in 2016, 2015, and 2014, respectively. The declaration and payment of future dividends to common stockholders will be at the discretion of our Board of Directors and will depend upon many factors, including our financial position, capital requirements of our operating subsidiaries, legal and regulatory requirements, and any other factors our Board of Directors deems relevant. On February 22, 2017, the Board of Directors declared a $0.15 dividend per share, payable March 22, 2017, to stockholders of record on March 8, 2017.
Share Repurchases. On February 16, 2016, the Board of Directors authorized a share repurchase program for up to $50.0 million of our common stock from February 22, 2016 through February 22, 2018 (the 2016 Program). We expect that shares of common stock may be purchased at prevailing market prices through a variety of methods, including open market or private transactions, in accordance with applicable laws and regulations and as determined by management. The timing and actual number of shares repurchased will depend on a variety of factors, including the share price, corporate and regulatory requirements, and other market and economic conditions. Repurchases under the 2016 Program may be commenced, modified, or suspended from time-to-time without prior notice. As of December 31, 2016, we had a remaining common stock repurchase authorization of $28.9 million under the 2016 Program. See Item 5, Issuer Purchases of Equity Securities.
As of December 31, 2016, the capital resources available to us consisted of: (i) $32.0 million of notes payable consisting of surplus notes maturing in 2034; (ii) $840.6 million of stockholders' equity; and (iii) the $174.9 million Deferred Gain.
Notes Payable. The surplus notes bear interest at a fixed rate of between 405 and 425 basis points in excess of the 90-day LIBOR per annum, payable quarterly. We may redeem the surplus notes at any time at their face value of $32.0 million, plus accrued and unpaid interest. The surplus notes mature in 2034.
Notes payable includes payments of the principal and estimated interest expense on our surplus notes outstanding based on LIBOR plus a margin. The interest rates used ranged from 4.9% to 5.1%.
As of December 31, 2016, the total amortized cost of our investment portfolio was $2.4 billion and its fair value was $2.6 billion. These investments provide a source of income, which may fluctuate with changes in interest rates and our current investment
While we oversee all of our investment activities, we employ Conning as our independent investment manager. Conning follows our written investment guidelines based upon strategies approved by our Board of Directors and our asset allocation is reevaluated by management and reviewed by the Finance Committee of the Board of Directors on a quarterly basis. We also utilize Conning's investment advisory services. These services include investment accounting and portfolio modeling using DFA. The DFA tool is utilized in developing a tailored set of portfolio targets and objectives, which in turn, are considered when constructing an optimal portfolio.
As of December 31, 2016, our investment portfolio, which is classified as available-for-sale, consisted of 91.9% fixed maturity securities. We strive to limit the interest rate risk associated with fixed maturity investments by managing the duration of these securities. Our fixed maturity securities (excluding cash and cash equivalents) had a duration of 4.3 years at December 31, 2016. 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 “AA-,” using ratings assigned by S&P. Our fixed maturity securities portfolio had a weighted average quality of “AA-” as of December 31, 2016, with 57.2% of the portfolio rated “AA” or better, based on market value.
The following table shows the estimated fair value, the percentage of the fair value to total invested assets, the average book yield, and the average tax equivalent yield (each based on the fair value of each category of invested assets) as of December 31, 2016.
The following table shows the percentage of total estimated fair value of our fixed maturity securities as of December 31, 2016 by credit rating category, using the lower of ratings assigned by Moody's Investors Service and/or S&P.
We recognized impairments of $5.8 million (consisting of 37 equity securities), $17.2 million (consisting of 27 equity securities), and $0.5 million (consisting of seven equity securities) during the years ended December 31, 2016, 2015, and 2014, respectively. The other-than temporary impairments recognized during these years related to equity securities were the result of the Company's intent to sell and/or the severity and duration of the change in fair values of these securities, primarily due to the downturn in the energy sector that occurred during the fourth quarter of 2015 and the first quarter of 2016. Certain unrealized losses on equity securities were not considered to be other-than-temporary due to the financial condition and near-term prospects of the issuers, and our intent to hold the securities until fair value recovers to above cost.
For additional information regarding our investments, including the cost or amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of our investments, the amortized cost and estimated fair value of fixed maturity securities by contractual maturity, and net realized and unrealized investment gains (losses) on fixed maturity and equity securities, see Note 6 in the Notes to our Consolidated Financial Statements.
The amount by which estimated losses in the aggregate differ from those previously estimated for a specific time period is known as reserve “development.” Reserve development is unfavorable when losses ultimately settle for more than the amount reserved or subsequent estimates indicate a basis for reserve increases on open claims, causing the previously estimated loss reserves to be ''deficient.'' Reserve development is favorable when estimates of ultimate losses indicate a decrease in established reserves, causing the previously estimated loss reserves to be ''redundant.'' Development is reflected in our operating results through an adjustment to incurred losses and LAE during the period in which it is recognized.
IBNR is an actuarial estimate of future payments on claims that have occurred but have not yet been reported to us. In addition to this provision for late reported claims, we also estimate and make a provision for the extent to which the case reserves on known claims may develop and for additional payments on closed claims, known as “reopening.” IBNR reserves apply to the entire body
of claims arising from a specific time period, rather than a specific claim. Most of our IBNR reserves relate to estimated future claim payments on recorded open claims.
We compile and aggregate our claims data by grouping the claims according to the year in which the claim occurred (“accident year”) when analyzing claim payment and emergence patterns and trends over time. Additionally, claims data is aggregated and compiled separately for different types of claims, claimant benefits, or methods of claim closure and for different states, territories within states, or groups of states in which we do business.
Our Internal Actuary and the Consulting Actuary prepare reserve estimates for all accident years using our own historical claims data, industry data and many of the generally accepted actuarial methodologies for estimating loss reserves, such as paid loss development methods, incurred loss development methods, and Bornhuetter-Ferguson methods. These methods vary in their responsiveness to different information, characteristics, and dynamics in the data, and the results assist the actuary in considering these characteristics and dynamics in the historical data. The methods employed for each segment of claims data, and the relative weight accorded to each method, vary depending on the nature of the claims segment and on the age of the claims.
subsidiaries' data and industry-wide data, as well as on broader inflation indices. The results of this method would differ if different inflation rates were selected.
The aggregate carried reserve calculated by management represents our best estimate of our outstanding unpaid losses and LAE. In establishing management's best estimate of unpaid losses and LAE at December 31 for the last three years, management and our Internal Actuary reviewed and considered the following: (a) our Internal Actuary's and the Consulting Actuary's assumptions, point estimates, and ranges; (b) the inherent uncertainty of workers' compensation loss reserves; and (c) the potential for legislative and/or judicial reversal of California workers' compensation reforms. Management did not quantify a specific loss reserve increment for each uncertainty, but rather established an overall provision that represented management's best estimate of loss reserves in light of the historical data, actuarial assumptions, point estimate and range, and current facts and circumstances.
As of December 31, 2016, California and Nevada represented approximately 77% of our loss reserves on our Consolidated Balance Sheet.
If the actual gross loss reserves under the LPT Agreement were at the high or the low end of the actuarial range, the impact on our financial results, excluding the impact of the contingent profit commission, would have been as follows:
Reinsurance recoverables represent: (a) amounts currently due from reinsurers on paid losses and LAE; (b) amounts recoverable from reinsurers on estimates of reported losses; and (c) amounts recoverable from reinsurers on actuarial estimates of IBNR for losses and LAE. These recoverables are based on our current estimates of the underlying loss reserves, and are reported on our Consolidated Balance Sheets separately as assets, as reinsurance does not relieve us of our legal liability to policyholders. We bear credit risk with respect to the reinsurers, which can be significant considering that some of the loss reserves remain outstanding for an extended period of time. Reinsurers may refuse or fail to pay losses that we cede to them, or they might delay payment. We are required to pay losses even if a reinsurer refuses or fails to meet its obligations under the applicable reinsurance agreement. We continually monitor the financial condition and financial strength ratings of our reinsurers. No material amounts due from reinsurers have been written-off as uncollectible since our inception in 2000, and we believe that amounts currently reflected in our consolidated financial statements will similarly not require any material prospective adjustment.
Under the LPT Agreement, the Fund initially ceded $1.5 billion in liabilities for the incurred but unpaid losses and LAE related to claims incurred prior to July 1, 1995 for consideration of $775.0 million in cash. The estimated remaining liabilities subject to the LPT Agreement were $465.5 million as of December 31, 2016. Losses and LAE paid with respect to the LPT Agreement totaled $722.7 million at December 31, 2016. We account for the LPT Agreement as retroactive reinsurance. Entry into the LPT Agreement resulted in a deferred reinsurance gain that was recorded on our Consolidated Balance Sheets as a liability. The Deferred Gain is being amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries through the life of the LPT Agreement, and the amortization is reflected in losses and LAE. Changes in estimates of the reserves ceded under the LPT Agreement may significantly impact the Deferred Gain on our Consolidated Balance Sheets and losses and LAE in our Consolidated Statements of Comprehensive Income.
We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, we determine deferred tax assets and liabilities on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the timing differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
We record uncertain tax positions in accordance with ASC 740 on the basis of a two-step process. Recognition (Step 1) occurs when we conclude that a tax position, based solely on its technical merits, is more likely than not to be sustained upon examination. Measurement (Step 2) is addressed only if Step 1 has been satisfied. Under Step 2, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, that is more likely than not to be realized upon ultimate settlement.
We use third party pricing services to assist us with our investment accounting function. The fair values of our available-for-sale fixed maturity and equity securities are based on quoted market prices, when available. These fair values are obtained primarily from third party pricing services, which generally use Level 1 or Level 2 inputs in accordance with GAAP guidance. The Company obtains a quoted price for each security from third party pricing services, which are derived through recently reported trades for identical or similar securities. For securities not actively traded, the third party pricing services may use quoted market prices of similar instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, broker quotes, benchmark yields, credit spreads, default rates, and prepayment speeds. The Company also performs quarterly analysis on the prices received from third parties to determine whether the prices are reasonable estimates of fair value, including confirming the fair values of these securities through observable market prices using an alternative pricing source. If differences are noted in this review, the Company may obtain additional information from other pricing services to validate the quoted price. (See Note 5 in the Notes to our Consolidated Financial Statements.)
Consolidated Statements of Comprehensive Income - This standard requires that the tax effects of stock-based compensation be recognized in the income tax expense. Net tax benefits related to stock-based compensation of $1.4 million were recognized as a reduction to Income tax expense and an increase to Net income in the Consolidated Statements of Comprehensive Income for the year ended December 31, 2016. These changes increased basic and diluted earnings per share by $0.04 for the year ended December 31, 2016. This standard also requires that assumed proceeds under the treasury stock method be modified to exclude the excess tax benefits that would have been recognized in Additional paid-in capital. These changes were applied on a prospective basis.
Consolidated Statements of Cash Flows - This standard requires that the excess tax benefits from stock-based compensation be reported as cash flows from operating activities rather than the previous requirement to present the excess tax benefits from stock-based compensation as an inflow from financing activities and an outflow from operating activities. This update resulted in a change in presentation that was applied on a prospective basis and prior periods have not been adjusted.
Consolidated Statements of Comprehensive Income for each of the three years ended December 31, 2016
Consolidated Statements of Cash Flows for each of the three years ended December 31, 2016
Management conducted an assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2016 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (COSO Framework).
We have audited Employers Holdings, Inc. and Subsidiaries' internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Employers Holdings, Inc. and Subsidiaries' management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.
In our opinion, Employers Holdings, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Consolidated Balance Sheets of Employers Holdings, Inc. and Subsidiaries as of December 31, 2016 and 2015, and the related Consolidated Statements of Comprehensive Income, Stockholders’ Equity and Cash Flows for each of the three years in the period ended December 31, 2016 and our report dated February 24, 2017 expressed an unqualified opinion thereon.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Employers Holdings, Inc. and Subsidiaries at December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Employers Holdings, Inc. and Subsidiaries' internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 24, 2017 expressed an unqualified opinion thereon.
The Company operates as a single operating segment, workers’ compensation insurance, through its wholly owned subsidiaries. The Company considers an operating segment to be any component of its business whose operating results are regularly reviewed by the Company's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance based on discrete financial information.
The Company reduced its estimated loss and LAE reserves ceded under the LPT Agreement (LPT Reserve Adjustments) in each of the years 2016, 2015, and 2014 as a result of the determination that adjustments were necessary to reflect observed favorable paid loss trends in each of these years. The following table shows the financial statement impact related to the LPT Reserve Adjustments.
The Company increased its estimate of Contingent commission receivable - LPT Agreement (LPT Contingent Commission Adjustments) in each of 2016, 2015, and 2014 as a result of the determination that adjustments were necessary to reflect observed favorable paid loss trends in each of those years. The following table shows the impact to the Consolidated Statements of Comprehensive Income related to these changes in estimates.
The Company reallocated loss and LAE reserves from non-taxable periods prior to January 1, 2000 to taxable years, which reduced its effective tax rates, in each of 2015 and 2014. These changes in estimates were the result of the determination that a reallocation of reserves among accident years was appropriate to address a continuation of observed loss trends in each of those years. The following table shows the financial statement impact of these changes in estimates.
Investment income consists primarily of interest and dividends generated by investment securities. Interest is recorded as earned on an accrual basis and dividends are recorded as earned at the ex-dividend date. Interest income on mortgage-backed and asset-
Premiums written are recognized as revenues, net of any applicable underlying reinsurance coverage, and are earned over the term of the related policy. At the end of the policy term, payroll-based premium audits are performed on substantially all policyholder accounts to determine the actual amount of net premiums earned for that policy year. Earned but unbilled premiums include estimated future audit premiums based on the Company's historical experience. These estimates are subject to changes in policyholders' payrolls, economic conditions, and seasonality, and are continually reviewed and adjusted as experience develops or new information becomes known. Any such adjustments are included in current operations; however, they are partially offset by the resulting changes in losses and LAE, commission expenses, and premium taxes. The Company's premiums receivable on its Consolidated Balance Sheets included $58.4 million and $53.5 million of additional premiums expected to be received from policyholders for final audits at December 31, 2016 and 2015, respectively.
The Company establishes a bad debt allowance on its premiums receivable through a charge included in underwriting and other operating expenses in its Consolidated Statements of Comprehensive Income. This bad debt allowance is determined based on estimates and assumptions to project future experience. After all collection efforts have been exhausted, the Company reduces the bad debt allowance for write-offs of premiums receivable that have been deemed uncollectible. The Company's bad debt allowance was $9.8 million and $12.2 million at December 31, 2016 and 2015, respectively. The Company had write offs, net of recoveries of amounts previously written off, of $6.0 million, $2.4 million, and $3.4 million for the years ended December 31, 2016, 2015, and 2014, respectively.
Ceded reinsurance premiums are accounted for on a basis consistent with those used in accounting for the underlying premiums, and are reported as reductions to arrive at net premiums written and earned.
Pursuant to the LPT Agreement, loss expenses are deemed to be 7% of total losses paid and are payable to the Company as compensation for management of the claims under the LPT Agreement. The Deferred Gain is amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries through the life of the LPT Agreement, and is recorded in losses and LAE incurred in the Company's Consolidated Statements of Comprehensive Income. Any adjustment to the estimated loss and LAE reserves ceded under the LPT Agreement results in a cumulative adjustment to the Deferred Gain, which is also recognized in losses and LAE incurred in the Company's Consolidated Statements of Comprehensive Income, such that the Deferred Gain reflects the balance that would have existed had the revised reserves been recognized at the inception of the LPT Agreement.
The Company recognizes deferred tax assets when it determines that such assets are more likely than not to be realized in future periods. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If the Company determines that it would be able to realize its deferred tax assets in the future in excess of their net recorded amount, the Company would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.
Financial instruments that potentially subject the Company to concentrations of credit risk are primarily cash and cash equivalents (including restricted cash equivalents), short-term investments, investment securities, premiums receivable, and reinsurance recoverable balances.
has assessed the effects of current economic conditions on the Company's financial condition and results of operations and changes in the Company's stock price and determined that there were no impairments of these assets as of December 31, 2016 and 2015.
Intangible assets related to state licenses are not subject to amortization. Intangibles related to insurance relationships are amortized in proportion to the expected period of benefit over the next two years.
During the years ended December 31, 2016, 2015, and 2014, the Company recognized $0.3 million, $0.5 million, and $0.7 million in amortization expenses associated with its intangible assets, respectively. These amortization expenses are included in the Company's Consolidated Statements of Comprehensive Income in underwriting and other operating expenses. Future amortization expenses associated with the Company's intangible assets are expected to be as follows:
The Company provides stock-based compensation to its directors and certain of its employees, which is recognized in its Consolidated Statements of Comprehensive Income based on estimated fair values over the relevant service period (see Note 14).
In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) Number 2016-09, Compensation - Stock Compensation (Topic 718). This update simplifies several aspects of the accounting for stock-based payment award transactions, including income taxes and classification of awards on the balance sheet and the statement of cash flows. The Company elected to early adopt this standard in the quarter ended September 30, 2016 with an effective date of January 1, 2016. Adoption of this standard had the following impacts on the Company's consolidated financial statements:
This standard also allows the Company to make a policy election as to whether it will include an estimate of stock-based compensation awards expected to be forfeited or whether it will account for forfeitures as they occur. The Company has elected to continue to estimate forfeitures in the computation of its stock-based compensation, consistent with previous guidance, and this election had no impact on the Company's consolidated financial statements.
For securities not actively traded, third party pricing services may use quoted market prices of similar instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, broker quotes, benchmark yields, credit spreads, default rates, and prepayment speeds. There were no adjustments to prices obtained from third party pricing services as of December 31, 2016 and 2015 that were material to the consolidated financial statements.
The Company's estimates of fair value for its financial liabilities are based on a combination of the variable interest rates for notes with similar durations to discount the projection of future payments on notes payable. The fair value measurements for notes payable have been determined to be Level 2.
Certain cash equivalents, principally money market securities, are measured at fair value using the net asset value (NAV) per share. The following table presents cash equivalents at NAV and total cash and cash equivalents carried at fair value on the Company's Consolidated Balance Sheets.
The following table provides a reconciliation of the beginning and ending balances that are measured using Level 3 inputs for the year ended December 31, 2016.
The Company is required by various state laws and regulations to hold securities or letters of credit in depository accounts with certain states in which it does business. As of December 31, 2016 and 2015, securities having a fair value of $1,009.7 million and $881.2 million, respectively, were on deposit. These laws and regulations govern not only the amount but also the type of securities that are eligible for deposit.
Depreciation and amortization expenses related to property and equipment for the years ended December 31, 2016, 2015, and 2014 were $8.2 million, $7.8 million, and $6.3 million, respectively. Internally developed software costs of $1.3 million and $1.2 million were capitalized during each of the years ended December 31, 2016 and 2015, respectively.
As of December 31, 2016 and 2015, the Company had no unrecognized tax benefits.
Tax years 2013 through 2016 remained open and are subject to full examination by the federal taxing authority. The significant components of deferred income taxes, net, were as follows as of December 31:
Total net losses and LAE included in the above table excludes the impact of the amortization of the Deferred Gain and LPT Reserve Adjustments (Note 10).
favorable paid loss trends in each of these years. Paid loss trends have been impacted by cost savings associated with accelerated claims settlement activity that began in 2014 and continued through 2016.
In Nevada, the Company has compiled a lengthy history of workers' compensation claims payment patterns based on the business of the Fund and EICN, but the emergence and payment of claims in recent years has been more favorable than in the long-term history in Nevada with the Fund. The expected patterns of claim payments and emergence used in the projection of the Company's ultimate claim payments are based on both the long and short-term historical paid data. In recent evaluations, claim patterns have continued to emerge in a manner consistent with short-term historical data. Consequently, for California and Nevada, the Company has relied more heavily on claim projection patterns observed in recent years.
Loss reserves shown in the Company's Consolidated Balance Sheets are net of $28.1 million and $26.8 million for anticipated subrogation recoveries as of December 31, 2016 and 2015, respectively.
EPIC has a $10.0 million surplus note to Dekania CDO II, Ltd. issued as part of a pooled transaction. The note matures in 2034 and became callable by the Company in 2009. The terms of the note provide for quarterly interest payments at a rate 425 basis points in excess of the 90-day LIBOR. Both the payment of interest and repayment of the principal under this note and the surplus notes described in the succeeding two paragraphs are subject to the prior approval of the Florida Department of Financial Services. Interest paid during each of the years ended December 31, 2016, 2015, and 2014 was $0.5 million. Interest accrued as of December 31, 2016 and 2015 was $0.1 million.
EPIC has a $12.0 million surplus note to ICONS, Inc. issued as part of a pooled transaction. The note matures in 2034 and became callable by the Company in 2009. The terms of the note provide for quarterly interest payments at a rate 425 basis points in excess of the 90-day LIBOR. Interest paid during each of the years ended December 31, 2016, 2015, and 2014 was $0.6 million, $0.6 million and $0.5 million, respectively. Interest accrued as of December 31, 2016 and 2015 was $0.1 million.
Principal payment obligations on notes payable outstanding at December 31, 2016, were as follows:
The Company leases office facilities and certain equipment under operating and capital leases. Most leases have renewal options, typically with increased rental rates during the option period. Certain of these leases contain options to purchase the property at amounts that approximate fair market value; other leases contain options to purchase at a bargain purchase price. At December 31, 2016, the remaining lease terms expire over the next six years.
On February 16, 2016, the Board of Directors authorized a share repurchase program for up to $50.0 million of the Company's common stock from February 22, 2016 through February 22, 2018 (the 2016 Program). The Company expects that its common stock may be purchased at prevailing market prices through a variety of methods, including open market or private transactions, in accordance with applicable laws and regulations and as determined by management. The timing and actual number of shares repurchased will depend on a variety of factors, including the share price, corporate and regulatory requirements, and other market and economic conditions. Repurchases under the 2016 Program may be commenced, modified, or suspended from time-to-time without prior notice, and the 2016 Program may be suspended or discontinued at any time. Through December 31, 2016, the Company has repurchased a total of 724,381 shares of common stock at an average price of $29.08 per share, including commissions, for a total of $21.1 million.
Since the Company's initial public offering in January 2007 through December 31, 2016, the Company has repurchased a total of 24,097,355 shares of common stock at an average cost per share of $15.92, which is reported as treasury stock, at cost, on its Consolidated Balance Sheets.
As of December 31, 2016, the only incentive awards outstanding under the Plan were nonqualified stock options, RSUs, and PSUs.
The fair value of the stock options granted is estimated using a Black-Scholes option pricing model that uses the assumptions noted in the following table. During the years ended December 31, 2016, 2015, and 2014, the expected stock price volatility used to value the stock options granted in 2016, 2015, and 2014 was based on the volatility of the Company's historical stock price since February 2007. The expected term of the stock options granted in 2016, 2015, and 2014 was calculated using the 'plain-vanilla' calculation provided in the guidance of the Securities and Exchange Commission's Staff Accounting Bulletin No. 107. The dividend yield was calculated using amounts authorized by the Board of Directors. The risk-free interest rate is the yield on the grant date of the stock options of U.S. Treasury zero coupon securities with a maturity comparable to the expected term of the stock options.
Changes in outstanding stock options for the year ended December 31, 2016 were as follows:
The Company has awarded RSUs to non-employee members of the Board of Directors and certain employees of the Company. The RSUs awarded to non-employee members of the Board of Directors generally vest on the first anniversary of the award date. RSU grants allow each non-employee Director to decide whether to defer settlement of the RSUs until six months after termination of Board service or settle the RSUs at vesting. Dividend equivalents are granted to Directors who elected to defer settlement of the RSUs after the grants vested. RSUs awarded to employees of the Company have a service vesting period of approximately four years from the date awarded and vest 25% on or after each of the subsequent four anniversaries of such date. These RSUs are subject to accelerated vesting in certain limited circumstances, such as: retirement, death or disability of the holder, or in connection with a change of control of the Company.
Changes in outstanding RSUs for the year ended December 31, 2016 were as follows:
At December 31, 2016, the Company had yet to recognize $3.5 million in deferred compensation related to outstanding RSUs and expects to recognize these costs on a straight-line basis over the next 39 months. The grant date fair value of RSUs vested and the intrinsic value of vested RSUs for the years ended December 31, were as follows:
The PSUs awarded in March 2015 and 2016 were awarded to certain employees of the Company and have a performance period of two years followed by an additional one year vesting period. The PSU awards are subject to certain performance goals with payouts that range from 0% to 200% of the target awards. The values shown in the table represent the aggregate number of PSUs awarded at the target level.
Net income for the Company's insurance subsidiaries prepared in accordance with SAP for the years ended December 31, 2016, 2015 and 2014 was $101.4 million, $87.8 million and $58.6 million, respectively.
The ability of EHI to pay dividends on the Company's common stock and to pay other expenses will be dependent to a significant extent upon the ability of the Nevada domiciled insurance company, EICN, the California domiciled insurance company, ECIC, and the Florida domiciled insurance companies, EPIC and EAC, to pay dividends to their immediate holding company, Employers Group, Inc. (EGI) and, in turn, the ability of EGI to pay dividends to EHI. The amount of dividends each of the Company's subsidiaries may pay to their immediate parent is limited by the laws of its respective state of domicile.
Under Florida law, without regulatory approval, EPIC and EAC may pay dividends if they do not exceed the greater of: the lesser of 10% of surplus or net income, not including realized capital gains, plus a 2-year carry forward; 10% of surplus, with dividends payable limited to unassigned funds minus 25% of unrealized capital gains; or, the lesser of 10% of surplus or net investment income plus a 3-year carry forward with dividends payable limited to unassigned funds minus 25% of unrealized capital gains. During 2016, EPIC paid an extraordinary dividend in the form of the common stock of EAC, valued at $179.8 million, to EGI as part of the internal restructuring of the Company's insurance subsidiaries. As a result of the payment of its extraordinary dividend,
ECIC is subject to regulation by the California Department of Insurance (California DOI). The ability of ECIC to pay dividends was further limited by restrictions imposed by the California DOI in its approval of the Company's October 1, 2008 reinsurance pooling agreement. Under that approval: (a) ECIC must initiate discussions of its business plan with the California DOI if its net written premium to policyholder surplus ratio exceeds 1.5 to 1; (b) ECIC will not exceed a ratio of net written premium to policyholder surplus of 2 to 1 without approval of the California DOI; (c) if at any time ECIC's policyholder surplus decreases to 80% or less than the September 30, 2008 balance, ECIC shall cease issuing new policies in California, but may continue to renew existing policies until it has (i) received a capital infusion to bring its surplus position to the same level as that as of September 30, 2008 and (ii) submitted a new business plan to the California DOI; (d) ECIC will maintain a risk based capital (RBC) level of at least 350% of the authorized control level; (e) should ECIC fail to comply with any commitments listed herein, ECIC will consent to any request by the California DOI to cease issuing new policies in California, but may continue to renew existing policies until such time that as ECIC is able to achieve full compliance with each commitment; and (f) the obligations listed shall only terminate with the written consent of the California DOI. During the years ended December 31, 2016, 2015, and 2014, ECIC was in compliance with these requirements.
EPIC and EAC are subject to regulation by the Florida Department of Financial Services (FDFS). Florida statute Section 624.408 requires EPIC and EAC to maintain minimum capital and surplus of the greater of $4.0 million or 10% of total liabilities. Florida statute Section 624.4095 requires EPIC and EAC to maintain a ratio of written premiums, defined as 1.25 times written premiums, to surplus of no greater than 10-to-1 for gross written premiums and 4-to-1 for net written premiums. During the years ended December 31, 2016, 2015, and 2014, EPIC and EAC were in compliance with these statutes.
Additionally, EICN, ECIC, EPIC, and EAC are required to comply with NAIC RBC requirements. RBC is a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC RBC standards are used by regulators to determine appropriate regulatory actions relating to insurers that show signs of weak or deteriorating conditions. As of December 31, 2016, 2015, and 2014, EICN, ECIC, EPIC, and EAC each had total adjusted capital above all regulatory action levels.
The Company maintains a 401(k) defined contribution plan covering all eligible Company employees (the Employers 401(k) Plan). Under the Employers 401(k) Plan, the Company's safe harbor matching consists of 100% matching contribution on salary deferrals up to 3% of compensation and then 50% matching contribution on salary deferrals from 3% to 5% of compensation. The Company's matching contribution to the Employers 401(k) Plan was $1.9 million, $1.8 million, and $1.7 million for the years ended December 31, 2016, 2015, and 2014, respectively.
Quarterly results for the years ended December 31, 2016 and 2015 were as follows: