The Company’s corporate headquarters and its Mid-Atlantic Regional Office 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.
These offices are leased by the Company under multi-year operating leases. The Company also has an office located in Camp Hill, Pennsylvania, which serves as the Company’s data back-up and recovery site, as well as additional office space for the Mid-Atlantic Regional Office.
of this annual report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes and the reports of the independent registered public accounting firm included in Part II, Item 8 and elsewhere in this report. These historical results are not necessarily indicative of results to be expected from any future period (in thousands, except per share and share amounts).
(3) Total assets as of December 31, 2009 and 2008 include assets reclassified to discontinued operations totaling $115,207 and $116,445, respectively.
(7) Calculated by dividing the policyholder dividend expense by net premiums earned.
The Company reported net income from continuing operations of $10.4 million for the year ended December 31, 2012, compared to $7.4 million for the year ended December 31, 2011. The Company’s consolidated combined ratio was 95.3% in 2012, compared to 94.3% in 2011. The Company’s results of operations for the year ended December 31, 2012, when compared to the same period in 2011, reflect the following:
Net premiums earned increased 20.8%, from $132.2 million in 2011 to $159.6 million in 2012. The increase in net premiums earned reflects new business of $37.7 million, audit premium received from customers of $4.6 million, an increase in the earned but unbilled premium estimate of $1.7 million, and average renewal rate increases of 3.7%. The Company’s renewal retention decreased from 88.6% in 2011 to 83.5% in 2012, primarily reflecting the loss of seven accounts with total annual premiums of approximately $4.3 million in 2012.
Net realized investment gains totaled $3.2 million in 2012, compared to $1.7 million in 2011, primarily reflecting an increase in the estimated fair value of the convertible bond portfolio totaling $789,000 in 2012, compared to a decrease of $1.1 million in 2011.
The Company’s consolidated loss ratio increased from 63.3% in 2011 to 66.0% in 2012. The increase primarily reflects increased loss experience in the segregated portfolio cell reinsurance segment related to the 2012 accident year.
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, 2012, one-half of the premiums would be earned in 2012 and the other half would be earned in 2013. 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.
The Company’s expenses consist primarily of losses and LAE, acquisition and other underwriting expenses, other expenses, policyholder dividends, and income taxes.
The Company evaluates its insurance operations by monitoring certain key measures of growth and profitability. The Company measures growth by monitoring changes in direct premiums written and net premiums written. The Company measures underwriting profitability by examining loss, expense, policyholder dividend expense and combined ratios. On a segmental basis, the Company measures a segment’s operating results by examining net income, diluted earnings per share, and return on average equity.
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.
The preparation of financial statements in accordance with U.S. GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. The Company is required to make estimates and assumptions in certain circumstances that affect amounts reported in the consolidated financial statements and related footnotes. The Company evaluates these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that is believed to be reasonable under the circumstances. There can be no assurance that actual results will conform to the estimates and assumptions and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. The Company believes the following policies are the most sensitive to estimates and judgments.
On a quarterly basis, the Company prepares actuarial analyses to assess the reasonableness of the recorded reserves for unpaid losses and LAE in its workers’ compensation insurance segment. These actuarial analyses incorporate various methodologies, including paid loss development, incurred loss development and a combination of other actuarial
methodologies that incorporate characteristics of paid and incurred methodologies combined with a review of the Company’s exposure base. The recorded amount in each accident year is then compared to the results of these methodologies, with consideration being given to the age of the accident year. As accident years mature, the various methodologies generally produce consistent loss estimates. For more recent accident years, the methodologies produce results that are not as consistent. Accordingly, more emphasis is placed on supplementing the methodologies in more recent accident years with trends in exposure base, medical expense inflation, general inflation, severity, and claim counts, among other things.
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’ compensation insurance book of business. Using standard actuarial methods, the Company estimates reserves based on historical patterns of case development, payment patterns, mix of business, premium rates charged, case reserving adequacy, operational changes, adjustment philosophy and severity and duration trends. However, the number of variables and judgments involved in establishing reserve estimates, combined with some random variation in loss development patterns, results in uncertainty regarding projected ultimate losses.
As of December 31, 2012, the Company’s best estimate of its ultimate liability for losses and LAE, net of amounts recoverable from reinsurers, for its workers’ compensation insurance segment was $89.2 million.
Management believes that changes in tail factors are reasonably likely considering the impact that changing economic conditions and medical inflation may have on the loss and LAE estimation process. There are loss and LAE risk factors that affect workers’ compensation claims that can change over time and also cause the Company’s loss reserves to fluctuate. Some examples of these risk factors include, but are not limited to, the following:
The Company has utilized the following tail factors for the years ended December 31, 2012, 2011, and 2010:
The Company’s reserves for unpaid losses and LAE in its segregated portfolio cell reinsurance segment as of December 31, 2012 and 2011 are summarized below (in thousands):
Unrealized investment gains or losses on investments carried at estimated fair value, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of accumulated other comprehensive income (loss) and, accordingly, have no effect on net income. When, in the opinion of management, a decline in the fair value of an investment below its cost or amortized cost is considered to be “other-than- temporary,” such investment is written down to its fair value at the balance sheet date. The amount written down is recorded as a realized loss in the consolidated statements of operations and comprehensive income (loss). Generally, the determination of other-than-temporary impairment includes, in addition to other relevant factors, a presumption that if the market value is below cost by a significant amount for a period of time, a write-down is necessary. Notwithstanding this presumption, the determination of other-than-temporary impairment requires judgment about future prospects for an investment and is therefore a matter of inherent uncertainty. For the years ended December 31, 2012, 2011 and 2010, the Company recorded other-than-temporary impairments, excluding impairments in the segregated portfolio cell reinsurance segment, of $127,000, $0 and $6,000, respectively. Other-than-temporary impairments in the segregated portfolio cell reinsurance segment totaled $0, $78,000 and $80,000 for the years ended December 31, 2012, 2011 and 2010, respectively. The Company generally applies the following standards in determining whether the decline in fair value of an investment is other-than-temporary:
The Company recognized other-than-temporary impairments of $127,000 related to two equity securities for the year ended December 31, 2012. The impairments related to equity securities that had been in an unrealized loss position for more than 12 months. The Company did not recognize any other-than-temporary impairments related to its equity security portfolio for the years ended December 31, 2011 or 2010.
As of December 31, 2012, the Company held equity securities, excluding equity securities in the segregated portfolio cell reinsurance segment, with gross unrealized losses of $135,000, none of which were in an unrealized loss position for more than twelve months. The Company does not intend to sell the equity securities and it is not more likely than not that the Company will be required to sell the equity securities before recovery of their cost bases; therefore, management does not consider the equity securities to be other-than-temporarily impaired as of December 31, 2012. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.
There were no write-offs or impairments related to the Company’s limited partnership investments in 2012 or 2010. During 2011, the Company wrote off its interest in the real estate limited partnership. The write off totaled $49,000 and was a result of the limited partnership being liquidated without any benefit to the Company.
Goodwill is assigned to one or more reporting units at the date of acquisition. The Company has allocated 100% of the goodwill recorded on its consolidated balance sheet as of September 30, 2012 to its workers’ compensation insurance segment.
For the 2012 annual impairment test, the fair value of the workers’ compensation insurance segment was estimated using a discounted cash flow analysis, using management’s internal five-year forecast for the workers’ compensation insurance segment and a terminal value estimated using a long-term growth rate of 5.0% and a discount rate of 13.0%. Cash flows were adjusted, as necessary, to maintain adequate capital requirements.
The estimated fair value of the workers’ compensation insurance segment, based on the discounted cash flow analysis, exceeded its carrying value as of September 30, 2012; therefore, goodwill was considered not impaired, and the second step of the impairment test was not necessary.
In the event the operating results of the Company’s workers’ compensation insurance segment were to be adversely impacted by a significant loss of business or higher than expected losses and LAE, management’s internal forecast may need to be re-evaluated, which could result in an estimated fair value that is less than the carrying value of the workers’ compensation insurance segment and the need to recognize a goodwill impairment.
The temporary differences between the tax and book bases of assets and liabilities are recorded as deferred income taxes. Management evaluates the recoverability of the net deferred tax asset based on historical trends of generating taxable income or losses, as well as expectations of future taxable income or loss. As of December 31, 2012, the Company recorded a net deferred tax asset of $3.2 million. Management expects that the net deferred tax asset is fully recoverable. If this assumption were to change, any amount of the net deferred tax asset that the Company could not expect to recover would be provided for as an allowance and would be reflected as an increase in income tax expense in the period in which it was established.
Amounts recoverable from Company’s reinsurers are estimated in a manner consistent with the reserves for unpaid losses and LAE associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts. Reinsurance balances recoverable on paid and unpaid loss and LAE are reported separately as assets, instead of being netted with the appropriate liabilities, because reinsurance does not relieve the Company of its legal liability to its policyholders. Reinsurance balances recoverable are subject to credit risk associated with the particular reinsurer. Additionally, the same uncertainties associated with estimating unpaid losses and LAE affect the estimates for the ceded portion of these liabilities. The Company continually monitors the financial condition of its reinsurers and where necessary obtains collateral. As of December 31, 2012, the Company had reinsurance recoverables of $19.7 million.
An increase in the equity interest in the Company’s limited partnership interests, primarily related to the multi-strategy fund of funds and structured financial opportunity fund; and
The components of consolidated net income, by segment, for the years ended December 31, 2012 and 2011 were as follows (in thousands):
(1) Ceded premiums written include premiums ceded to the segregated portfolio cell reinsurance segment of $37,826 and $33,994 for the years ended December 31, 2012 and 2011, respectively.
The workers’ compensation insurance ratios were as follows for the years ended December 31, 2012 and 2011:
The increase in direct premiums written primarily reflects new business of $37.7 million, an increase in audit premium, average renewal rate increases of 3.7%, partially offset by a decrease in the renewal retention rate. Traditional and alternative market direct premiums written totaled $145.1 million and $37.8 million, respectively, for the year ended December 31, 2012. Audit premium, including the EBUB estimate, increased direct premiums written by $6.3 million in 2012, compared to $3.5 million in 2011. The traditional book of business recognized audit premium from customers of $4.3 million in 2012, compared to $2.3 million in 2011. The renewal retention rate decreased from 88.6% in 2011 to 83.5% in 2012, which primarily reflects the loss of seven accounts with total annual premiums of approximately $4.3 million in 2012.
The increase in net realized investment gains from 2011 to 2012 primarily reflect an increase in the estimated fair value of the Company’s convertible bond portfolio of $789,000 in 2012, compared to a decrease of $1.1 million for the same period in 2011.
The other expense ratio was 16.6% in 2012, compared to 16.2% in 2011. The increase in the ratio primarily reflects an increase in audit and legal fees from 2011 to 2012 and customer accounts written off in 2012, partially offset by an increase in net premiums earned.
The effective tax rate was 29.5% and 33.2% for the years ended December 31, 2012 and 2011, respectively. The primary difference between the statutory tax rate of 35.0% and the effective tax rate reflects tax exempt income on municipal bond securities and the tax benefit associated with workers’ compensation insurance business ceded to Eastern Re.
The following table represents the operations of the segregated portfolio cell reinsurance segment for the years ended December 31, 2012 and 2011 (in thousands):
The segregated portfolio cell reinsurance ratios were as follows for the years ended December 31, 2012 and 2011:
The increase in net investment income primarily reflects an increase in invested assets.
The expense ratios are consistent with the contractual ceding commissions for the years ended December 31, 2012 and 2011.
The increase in consolidated revenue from 2010 to 2011 primarily reflects the following:
A decline in the Company’s limited partnership interests, which 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.
The workers’ compensation insurance segment’s combined ratio was 89.7% in 2011, compared to 96.0% in 2010, which primarily reflects a reduction in both the loss and expense ratios. The decrease in the loss ratio primarily reflects the impact of audit premium, including the EBUB estimate. The decrease in the expense ratio primarily reflects the release of state assessment accruals of $1.0 million.
The decrease in the net loss in the corporate/other segment primarily reflects an improvement in the operating results of those segregated portfolio cells in which the Company has an equity interest. The Company reported an increase in its equity interest of $568,000 in 2011, compared to a decrease in its equity interest of $6,000 in 2010.
The following table represents the operations of the workers’ compensation insurance segment for the years ended December 31, 2011 and 2010 (in thousands).
The workers’ compensation insurance ratios were as follows for the years ended December 31, 2011 and 2010:
The decrease in the calendar period loss and LAE ratio from 2010 to 2011 primarily reflects the impact of audit premium. 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 acquisition and other underwriting expense ratio was 6.8% in 2011, compared to 6.3% in 2010.
The other expense ratio was 16.2% in 2011, compared to 18.3% in 2010. The decrease in the other expense ratio primarily reflects the impact of the increase in net premiums earned, including the impact of audit premium from customers.
The segregated portfolio cell reinsurance ratios were as follows for the years ended December 31, 2011 and 2010:
The increase in reinsurance premiums assumed reflects new business of $6.0 million, an increase in audit premium, renewal rate increases of 1.1%, and an increase in the renewal retention rate. Audit premium from customers increased direct premiums written by $280,000 in 2011, compared to a decrease of $974,000 in 2010. The renewal retention rate increased from 87.1% in 2010 to 91.3% in 2011.
The decrease in net investment income primarily reflects a reduction in short-term interest rates from 2010 to 2011.
An increase in the net deferred tax asset, which primarily reflects the increase in unearned premiums, intangible asset amortization and a decrease in the tax basis of limited partnerships; and
Total liabilities were $244.9 million as of December 31, 2012, compared to $217.4 million as of December 31, 2011. The increase in the Company’s liabilities primarily reflects the following items:
An increase in reserves for unpaid losses and LAE and unearned premiums, which primarily reflects the Company’s premium growth in 2012;
An increase in the segregated portfolio cell dividend payable, which reflects the 2012 financial results of the individual segregated portfolio cells, reduced by dividends paid to the cell participants in 2012; and
A decrease in the ceded reinsurance balances payable, which primarily reflects the timing of payments to the Company’s reinsurer.
Total shareholders’ equity was $135.9 million as of December 31, 2012, compared to $128.3 million as of December 31, 2011. The increase in shareholders’ equity reflects the following items:
Common stock repurchases of $2.4 million and shareholder dividends of $2.1 million, which reduced shareholders’ equity; and
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, 2012 had an effective duration of 3.17 years.
For the years ended December 31, 2012, 2011 and 2010, 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, 2012, the Company’s investment portfolio included securities with gross unrealized gains totaling $125,000, excluding gross unrealized gains on investments in the segregated portfolio cell reinsurance segment of $4,000; therefore, based on current gross unrealized gains in the investment portfolio as of December 31, 2012, 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.
Our domestic insurance subsidiaries’ ability to pay dividends to EIHI is limited by the insurance laws and regulations of Pennsylvania and Indiana. The maximum annual dividends that the domestic insurance entities may pay without prior approval from the Pennsylvania Insurance Department and the Indiana Insurance Department is limited to the greater of 10% of statutory surplus or 100% of statutory net income for the most recently filed annual statement, or $10.0 million in 2013. The maximum dividend that may be paid in 2013 by Eastern Alliance, Allied Eastern, Eastern Advantage, or Employers Security, without prior approval from the respective domiciliary insurance departments is $5.7 million, $2.0 million, $1.0 million, and $1.3 million, respectively.
The decrease in cash flows used in financing activities primarily reflects a decrease in common stock repurchases from 2011 to 2012.
Cash Flows From Continuing Operations for the Years Ended December 31, 2011 and 2010.
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, 2012 were as follows (in thousands):
As of December 31, 2012, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
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, 2012, 2011 and 2010.
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.
Amortization of policy acquisition costs for the years ended December 31, 2012, 2011 and 2012 were as follows (in thousands):
Eastern Re is an exempt entity under the Companies Law of the Cayman Islands; however, Eastern Re’s earnings and profits are subject to federal income tax for earnings subsequent to June 16, 2006, the date on which Eastern Re became a United States owned foreign corporation.
Property and equipment, including expenditures for significant improvements and purchased software, is carried at cost less accumulated depreciation and amortization. Leasehold improvements are capitalized and amortized over the remaining term of the lease. Maintenance, repairs and minor improvements are expensed as incurred. When property and equipment is retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in operations. Depreciation is computed under the straight-line method. The estimated useful lives of property and equipment range from 3-7 years.
Property and equipment, which is included in other assets on the consolidated balance sheets, consisted of the following as of December 31, 2012 and 2011 (in thousands):
For the 2012 impairment test, the fair value of the workers’ compensation insurance segment was estimated using a discounted cash flow analysis, using management’s internal five-year forecast for the workers’ compensation insurance segment and a terminal value estimated using a long-term growth rate of 5.0% and a discount rate of 13.0%. Cash flows were adjusted, as necessary, to maintain adequate capital requirements.
The Company evaluates the remaining useful life of its intangible assets with a finite life on a quarterly basis to determine whether events or circumstances warrant a revision to the remaining period of amortization. The Company evaluates its intangible assets with an indefinite life for impairment on at least an annual basis. There were no adjustments to the remaining amortization period or impairment charges related to the Company’s intangible assets during 2012, 2011, or 2010.
The Company adopted the Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan (the “Stock Incentive Plan”) on December 18, 2006. Under the terms of the Stock Incentive Plan, stock awards may be made in the form of incentive stock options, non-qualified stock options or restricted stock. The Company records compensation expense based on the fair value of the stock award on the grant date using the straight-line attribution method.
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, 2012 and 2011 were as follows (in thousands):
In August 2012, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2012-03, “Technical Amendments and Corrections to SEC Sections: Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (“SAB”) No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB ASU 2010-22” (“ASU 2012-03). This update amends various SEC paragraphs pursuant to the issuance of SAB No. 114. The adoption of ASU 2012-03 is not expected to have a material impact on the Company’s financial condition or results of operations.
In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 requires entities to present net income and comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. The option to present items of other comprehensive income in the statement of changes in equity was eliminated. ASU 2011-05 was effective for public entities as of the beginning of a fiscal year that began after December 15, 2011 (including interim periods) and is effective for nonpublic entities for fiscal years ending after December 15, 2012 and interim and annual periods thereafter. Early adoption was permitted and retrospective application is required. The Company adopted ASU 2011-05 effective January 1, 2012. The Company presents comprehensive income in the consolidated statement of operations and comprehensive income; therefore, the adoption of ASU 2011-05 did not change the Company’s presentation of comprehensive income.
On June 21, 2010, EIHI completed the sale of its wholly-owned group benefits insurance subsidiary, Eastern Life, to Security Life Insurance Company of America (“Security”). The agreement effected a statutory merger of Eastern Life into Security, with Security continuing as the surviving corporation. Total transaction consideration to EIHI was $34,102, which represented Eastern Life’s GAAP shareholder’s equity as of May 31, 2010 plus $250. The consideration consisted of cash and a $1,750 promissory note from Security’s parent. The note bears interest at 4.0%, payable quarterly, and is due in full on July 1, 2013. The issuance of the $1,750 promissory note related to the sale of Eastern Life is considered a non-cash investing activity and has been excluded from the consolidated statement of cash flows for the year ended December 31, 2010.
The sale of Eastern Life resulted in the recognition of a gain totaling $564, which is included in discontinued operations in 2010. 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 the year ended December 31, 2010.
For the year ended December 31, 2010, the group benefits insurance segment reported net premiums earned of $18,262 and total revenue of $20,563. Income before income taxes in the group benefits insurance segment totaled $952 for the year ended December 31, 2010.
The sale of Atlantic RE resulted in the recognition of a loss totaling $14,029, which is included in discontinued operations in 2010. The loss includes the recognition of an estimated contingent profit commission of $3,018, which is based on the adequacy of the run-off specialty reinsurance segment’s reserves for losses and LAE as of September 30, 2010, compared to a predetermined targeted reserve for losses and LAE. The recognition of the contingent profit commission is considered a non-cash investing activity and has been excluded from the consolidated statement of cash flows for the year ended December 31, 2010. Transaction expenses related to the sale of Atlantic RE totaled $510 for the year ended December 31, 2010, and have been included in discontinued operations.
As of December 31, 2012 and 2011, intangible assets consisted of the following (in thousands):
The following table provides a summary of the equity awards that were not included in the Company’s earnings per share calculation for the years ended December 31, 2012, 2011 and 2010 because to do so would have been anti-dilutive:
As of December 31, 2012, the Company has repurchased 4,017,105 shares of its common stock and can repurchase up to an additional 920,030 shares, as authorized by the Company’s Board of Directors. The share repurchases will be held as treasury stock and are available for issuance in connection with the Company’s Stock Incentive Plan.
For the years ended December 31, 2012, 2011 and 2010, the Company’s share repurchases were as follows:
Vested and non-vested stock options and restricted stock awards as of December 31, 2012 and 2011 were as follows:
As of December 31, 2012, there were 57,268 shares of common stock available for issuance of future share-based awards.
The following table presents additional information regarding options outstanding as of December 31, 2012:
The following table summarizes restricted stock activity for the year ended December 31, 2012.
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, 2012.
The statutory capital and surplus and statutory net income (loss) of Eastern Alliance, Allied Eastern, Eastern Advantage and Employers Security as of December 31, 2012 and 2011 and for the years ended December 31, 2012, 2011, and 2010 was as follows (in thousands):
Pennsylvania and Indiana impose the NAIC risk-based capital requirements that require insurance companies to calculate and report information under a risk-based formula. These risk-based capital requirements attempt to measure statutory capital and surplus needs based on the risks in an insurance company’s mix of products and investment portfolio. Under the formula, a company first determines its “authorized control level” risk-based capital. This authorized control level takes into account (i) the risk with respect to the insurer’s assets; (ii) the risk of adverse insurance experience with respect to the insurer’s liabilities and obligations; (iii) the interest rate risk with respect to the insurer’s business; and (iv) all other business and other relevant risks as are set forth in the risk-based capital instructions. Insurers failing to meet adequate capital levels may be subject to insurance department scrutiny and ultimately rehabilitation or liquidation. The capital levels of Eastern Alliance, Allied Eastern, Eastern Advantage and Employers Security exceeded risk-based capital requirements as of December 31, 2012 and 2011. The minimum statutory capital and surplus required to be maintained by Eastern Alliance, Allied Eastern, Eastern Advantage and Employers Security is not significant in relation to each respective company’s statutory capital and surplus as of December 31, 2012 and 2011.
Under Cayman Islands regulations, Eastern Re is required to maintain minimum capital of $120. Eastern Re is in compliance with the minimum capital requirements as of December 31 2012.
As of December 31, 2012, there were no restrictions on the payment of dividends to stockholders by EIHI. EIHI’s ability to declare and pay dividends will depend in part on dividends received from its insurance subsidiaries.
Eastern Re must receive approval from the Cayman Islands Monetary Authority before it can pay a dividend to EIHI. As of December 31, 2012, there were no restrictions on the payment of dividends to EIHI by its non-insurance subsidiaries, Global Alliance, Employers Alliance or Eastern Services.
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, 2012 and 2011:
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, 2012 and 2011, excluding the segregated portfolio cell segment (in thousands):
The Company’s equity securities consist of exchange traded funds and equity securities of natural gas companies for which there is an active market and quoted market prices; therefore, the Company has classified its equity securities as Level 1 securities.
The estimated fair value of the Company’s equity securities, excluding equity securities in the segregated portfolio cell reinsurance segment, as of December 31, 2012 and 2011, by investment strategy and/or industry, are as follows (in thousands):
Corporate securities include an investment in a fixed income mutual fund, held by the segregated portfolio cell reinsurance segment, with a cost and estimated fair value of $26,600 and $26,656, respectively, as of December 31, 2012. The fixed income mutual fund’s investment objective is to provide a total return that is consistent with the preservation of capital through investing in high grade U.S. Dollar fixed income securities with a maximum maturity not exceeding five years.
The amortized cost and estimated fair value of fixed income securities and convertible bonds, excluding fixed income securities held by the segregated portfolio cell reinsurance segment, as of December 31, 2012, 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, 2012 and 2011 are as follows (in thousands):
Management has evaluated the unrealized losses related to its equity securities and determined that they are primarily related to the current market conditions and not due to underlying issues related to the issuer or the industry in which the issuer operates. The equity securities have been in an unrealized loss position for less than twelve months and none of the securities had an estimated fair value less than 80% of its cost basis. The Company does not intend to sell the equity securities and it is not more likely than not that the Company will be required to sell the equity securities before recovery of their cost bases; therefore, management does not consider the equity securities to be other-than-temporarily impaired as of December 31, 2012.
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, 2012, 2011, and 2010 (in thousands):
Other-than-temporary impairments related to the Company’s fixed income and equity securities for the years ended December 31, 2012, 2011 and 2010 were as follows:
For the years ended December 31, 2012, 2011 and 2010, 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 $789, $(1,054) and $1,166, respectively.
Net investment income for the years ended December 31, 2012, 2011, and 2010 was as follows (in thousands):
Incurred losses by segment were as follows for the year ended December 31, 2012 (in thousands):
Incurred losses by segment were as follows for the year ended December 31, 2011 (in thousands):
For the years ended December 31, 2012, 2011 and 2010, the estimates of ultimate losses and LAE for prior accident periods produced from our actuarial methods were reasonably consistent with the estimates we prepared as of December 31, 2011 and , therefore, we have not changed our best estimate of these amounts. Accordingly, the Company did not recognize any development on prior accident period workers’ compensation insurance reserves for the years ended December 31, 2012, 2011 or 2010.
For the year ended December 31, 2012, the Company recognized net favorable development on prior accident year segregated portfolio cell reinsurance reserves of $2.1 million, representing 9.6% of the Company’s estimated segregated portfolio cell reinsurance reserves as of December 31, 2011 and 6.6% of the Company’s segregated portfolio cell reinsurance net premiums earned for the year ended December 31, 2012. The favorable development arose primarily from accident year 2010, 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 unfavorable development recorded in 2012 related to accident year 2011 primarily reflects the emergence of unexpected loss trends and a large loss in one of the segregated portfolio cells.
The following table provides a summary of the Company’s losses and loss adjustment expenses incurred on a direct, assumed, ceded and net basis for the years ended December 31, 2012, 2011, and 2010 (in thousands):
The income tax benefit of $810, $824 and $130 recorded for the years ended December 31, 2012, 2011 and 2010 is attributable to the fact that the Company has recently generated earnings in its foreign operations that have been offset by deficits in the Company’s cumulative foreign historic earnings and profits. The cumulative deficit of $10,572 as of December 31, 2012 can only be offset by future earnings in the Company’s foreign operations.
The significant components of the net deferred tax asset as of December 31, 2012 and 2011 are as follows (in thousands):
As of December 31, 2012, the Company has not recognized any future tax benefit related to its foreign operations at Eastern Re. The unrecognized tax benefit, which represents the excess of the tax basis over the amount for financial reporting (i.e., outside basis difference) of Eastern Re, was $10,572 and $11,367 as of December 31, 2012 and 2011, respectively. The outside basis difference primarily 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, 2012.
The total unrecognized federal tax benefit of $203 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, 2008.
The following table provides information related to the Company’s ESOP as of December 31, 2012 and 2011 (in thousands, except share and per share data):
Stock compensation expense related to the ESOP totaled $1,194, $977 and $774 for the years ended December 31, 2012, 2011 and 2010, respectively.
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, 2012, 2011, and 2010 totaled $312, $289, and $297, respectively.
The pension plan’s fixed income securities consist of pooled separate accounts that are valued at the net participation value of participation units held by the pension plan. The value of the participation units is determined by the trustee based on the estimated fair values of the underlying assets of the pooled separate account; therefore, the estimated fair value of the pooled separate accounts is considered a Level 2 fair value measurement.
As a result of the pension plan’s frozen status, the primary investment objective of the pension plan is to achieve a rate of return commensurate with the safety of principal. The pension plan’s targeted asset allocation is 100% fixed income securities and/or cash equivalents.
Net premiums earned in the workers’ compensation insurance segment for the years ended December 31, 2012, 2011 and 2012 were as follows (in thousands):
The corporate/other segment primarily includes the expenses of EIHI, the third party administration activities of the Company, and the results of operations of Eastern Re, as well as certain eliminations necessary to reconcile the segment information to the consolidated statements of operations and comprehensive income (loss). The Company cancelled the remaining reinsurance contracts at Eastern Re in 1999 on a run-off basis and continues to have exposure for outstanding claims as of December 31, 2012. The corporate/other segment also included the Company’s 10% interest in a segregated portfolio cell with an unaffiliated primary carrier that wrote insurance coverage for sprinkler contractors, known as “SprinklerPro”. The Company non-renewed the contract for its 10% interest in SprinklerPro on a run-off basis effective April 1, 2009. The Company commuted the SprinklerPro contract during the second quarter of 2012 and recognized a realized loss of $641,000 related to the commutation.
The following table represents the segment results for the year ended December 31, 2011 (in thousands):
The segregated portfolio cell reinsurance segment’s assets and liabilities as of December 31, 2012 and 2011, which are included in the Company’s consolidated balance sheets, were as follows:
On September 6, 2011, the Company served a written demand (the “Arbitration Demand”) initiating arbitration proceedings against various AIG Companies under 24 reinsurance treaties pursuant to which the Company reinsured AIG Companies for certain pollution liability risks related to underground storage tanks for the policy years 1990 through 1999 (the “Treaties”). The Treaties were cancelled by Eastern Re in 1999. In the Arbitration Demand, the Company seeks an award from the arbitration panel compelling AIG Companies to permit the Company to examine the bases for certain paid losses and loss reserves ceded by AIG Companies to Eastern Re under the Treaties. The Company believes that the Treaties permit such an audit.
During the first quarter of 2012, the Company received quarterly claims data from AIG Companies that reflected unfavorable claim development under the reinsurance treaties. The Company is unable to substantiate the reliability of the claims data reported by AIG Companies and, as a result, has not adjusted its consolidated financial statements for the amounts reported by AIG Companies. The Company continues to believe it has adequately reserved the claims at issue.
Eastern Alliance Insurance Co. v. Managepoint, LLC, d/b/a Management 2000 Group, Inc., a/k/a Management, Inc.
Eastern Alliance brought this action against Managepoint, Inc., Managepoint, LLC, and Management 2000 Group, Inc. (collectively, the “Defendants”) to recover amounts due and owing under five workers’ compensation deductible insurance policies issued to the Defendants. As of December 31, 2012, the aggregate amount due and unpaid for claims under the policies was approximately $259, all of which has been reserved for. In addition, there are outstanding claim reserves totaling approximately $274 under the policies as of December 31, 2012. Eastern Alliance seeks recovery of all amounts presently due, together with amounts which will have accrued and become due and owing as of the time of trial.
On November 21, 2012, the Defendants filed a complaint, denying Eastern Alliance’s assertion that they operate as the same entity, and thus, are liable for the debts of the other, and renouncing any liability for any amounts set forth in the complaint. The Defendants also raised a number of affirmative defenses, including that Eastern Alliance breached its duty of good faith and fair dealing by, among other things, failing to obtain required approvals to settling workers’ compensation claims and improperly invoicing, collecting, and retaining various overpayments by the Defendants.
This matter is presently in discovery, and it is too early and there is not enough information to predict an outcome. It is reasonably possible that the final outcome of this matter could go against the Company, which could result in a material, adverse effect on the Company’s results of operations and financial condition.
In addition to the corporate headquarters, the Company maintains leased office space in Camp Hill, Pennsylvania, Wexford, Pennsylvania, Charlotte, North Carolina, Franklin, Tennessee, Richmond, Virginia, Indianapolis, Indiana, and Madison, Mississippi. These offices are leased by the Company under multi-year operating leases. The leases contain escalating lease payments over the term of the lease and the Company calculates rent expense on a straight-line basis.