We target small businesses, as we believe that this market is traditionally characterized by fewer competitors, more attractive pricing, and stronger persistency when compared to the U.S. workers’ compensation insurance industry in general. We believe we are able to price our policies at levels that are competitive and profitable over the long-term. Our underwriting approach is to consistently underwrite small business accounts at appropriate and competitive prices without sacrificing long-term profitability and stability for short-term top-line revenue growth.
A primary measure of our performance is our ability to increase Adjusted stockholders' equity over the long-term. The following table shows a reconciliation of our stockholders' equity on a GAAP basis to our Adjusted stockholders' equity and the number of common shares outstanding.
Adjusted stockholders' equity is a non-GAAP measure that is defined as total stockholders' equity plus the Deferred reinsurance gain-LPT Agreement (Deferred Gain), less Accumulated other comprehensive income, net. We believe that Adjusted stockholders' equity is an important supplemental measure of our capital position.
Overall, net income was $94.4 million, $100.7 million, and $63.8 million in 2015, 2014, and 2013, respectively and we recognized underwriting income (losses) of $40.4 million, $20.6 million, and $(24.9) million for the same periods, respectively. Underwriting income or loss is determined by deducting losses and LAE, commission expense, and underwriting and other operating expenses from net premiums earned. Key factors that affected our financial performance during 2015 and 2014, each compared to the previous year, respectively, include:
The following items were included in our 2015 results of operations: (1) favorable prior year accident year loss development of $7.2 million, including a $9.0 million favorable development on our voluntary business, partially offset by a $1.8 million unfavorable 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 that resulted in a $6.4 million cumulative adjustment to the Deferred Gain and reduced our losses and LAE by the same amount (LPT Reserve Adjustment); (3) an increase in the contingent commission receivable under the LPT Agreement that resulted in a $2.6 million cumulative adjustment, which reduced our losses and LAE by the same amount (LPT Contingent Commission Adjustment); and (4) a reallocation of $56.3 million of reserves from non-taxable periods prior to January 1, 2000, which reduced our tax expenses by $15.3 million and reduced our effective tax rate by 15.4 percentage points. Collectively, these items increased net income by $31.5 million for the year ended December 31, 2015.
The comparative components of net income are set forth in the following table:
Any adjustment to the contingent profit commission under the LPT Agreement results in a cumulative adjustment to the Deferred Gain, which is also recognized in losses and LAE incurred in the Consolidated Statements of Comprehensive Income, such that the Deferred
Gross premiums written were $697.7 million, $697.7 million, and $689.9 million for the years ended December 31, 2015, 2014, and 2013, respectively. During this period, overall premiums have remained relatively flat; however, certain strategic initiatives, including diversifying our risk exposure across our markets and non-renewing under-performing business, have resulted in premium declines in California, while premiums in other states grew.
Net premiums earned were $690.4 million, $684.5 million, and $642.3 million for the years ended December 31, 2015, 2014, and 2013, respectively. The increase in 2015 was primarily related to increased final premium audit billings during the second half of 2015, while the increase in 2014 was primarily due to increasing policy count and higher net rate. Additionally, we saw an increase in premiums from renewals in the fourth quarter of 2015.
The accident year loss and LAE ratio is calculated by dividing the losses and LAE, regardless of when such loss and LAE are incurred, for insured events that occurred during a particular year by the net premiums earned for that year. The accident year losses and LAE ratio is calculated using premiums and losses and LAE that are net of amounts ceded to reinsurers. The accident year loss and LAE ratio for a particular year can decrease or increase when recalculated in subsequent periods as the reserves established for insured events occurring during that year develop favorably or unfavorably, and is an operating ratio based on our statutory financial statements and is not derived from our GAAP financial information.
Our indemnity claims frequency (the number of claims expressed as a percentage of payroll) continued to decrease year-over-year in 2015 and 2014; however, our loss experience indicates a slight upward movement in medical and indemnity costs per claim that are reflected in our current accident year loss estimates. In California, we experienced increased costs per claim associated with an increase in the number of cumulative trauma claims filed during 2015 and 2014, compared to 2013. Total claims costs
have also been reduced by cost savings associated with increased claims settlement activity beginning in 2014 and continuing through 2015. We believe our current accident year loss estimate is adequate; however, ultimate losses will not be known with any certainty for many years. We assume that increasing medical and indemnity cost trends will continue to impact our long-term claims costs and current accident year loss estimate, which may be offset by rate increases. Additional information regarding our reserves for losses and LAE is set forth under “-Critical Accounting Policies-Reserves for Losses and LAE.”
Excluding the impact from the LPT Agreement, losses and LAE would have been $449.8 million, $508.4 million, and $501.5 million, or 65.2%, 74.3%, and 78.1% of net premiums earned, for the years ended December 31, 2015, 2014, and 2013, respectively.
Underwriting and Other Operating Expenses Ratio. The underwriting and other operating expenses ratio is the ratio of underwriting and other operating expenses to net premiums earned and measures an insurance company's operational efficiency in producing, underwriting, and administering its insurance business.
Our underwriting and other operating expenses ratio was 19.5%, 18.9%, and 19.5%, and our underwriting and other operating expenses were $135.2 million, $129.1 million, and $125.3 million for the years ended December 31, 2015, 2014, and 2013, respectively. During the year ended December 31, 2015, our bad debt allowance increased $2.8 million, our compensation-related expenses increased $1.5 million, professional fees increased $1.2 million, and IT expense increased $0.9 million, partially offset by a $0.8 million decrease in our premium taxes and assessments, compared to 2014. During the year ended December 31, 2014, premium taxes and assessments increased $1.6 million as net premiums earned increased, professional fees increased $1.0 million, and policyholder dividends increased $0.8 million, compared to 2013.
Our commission expense ratio was 12.4%, 11.9%, and 12.2%, and our commission expense was $85.4 million, $81.4 million, and $78.3 million for the years ended December 31, 2015, 2014, and 2013, respectively. The increase in the commission expense ratio in 2015 was primarily due to higher agency incentives, compared to 2014. The decrease in our commission expense ratio in 2014, compared to 2013, was primarily due to lower base commissions paid and lower agency incentives.
We are a holding company and our ability to fund our operations is contingent upon existing capital and the ability of our insurance subsidiaries' to pay dividends up to the holding company. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws and regulations, including laws establishing minimum solvency and liquidity thresholds. We require cash to pay stockholder dividends, repurchase common stock, make interest and principal payments on any outstanding debt obligations, provide additional surplus to our insurance subsidiaries, and fund our operating expenses.
Our insurance subsidiaries had $344.4 million of cash and cash equivalents and fixed maturity securities maturing within the next 24 months at December 31, 2015. We believe that our subsidiaries' liquidity needs over the next 24 months will be met with cash from operations, investment income, and maturing investments.
We purchase reinsurance to protect us against the costs of severe claims and catastrophic events. On July 1, 2015, we entered into a new reinsurance program that is effective through June 30, 2016. The reinsurance program consists of one treaty covering excess of loss and catastrophic loss events in five layers of coverage. Our reinsurance coverage is $193.0 million in excess of our $7.0 million retention on a per occurrence basis, subject to certain exclusions. We believe that our reinsurance program meets our needs and that we are sufficiently capitalized.
Various state regulations require us to keep securities or letters of credit on deposit with certain states in which we do business. Securities having a fair market value of $881.2 million and $783.9 million were on deposit at December 31, 2015 and 2014, respectively. These laws and regulations govern both the amount and types of fixed maturity securities that are eligible for deposit. Additionally, certain reinsurance contracts require company funds to be held in trust for the benefit of the ceding reinsurer to secure the outstanding liabilities we assumed. We held fixed maturity securities and restricted cash and cash equivalents that had a fair value of $32.7 million and $33.3 million in trust for the benefit of ceding reinsurers at December 31, 2015 and 2014, respectively.
Net cash used in financing activities in 2015, 2014, and 2013 was primarily to pay stockholder dividends and to pay down the line of credit provided by our credit facility.
Dividends. Dividends paid to stockholders were $7.7 million, $7.6 million, and $7.5 million in 2015, 2014, and 2013, respectively. The declaration and payment of future dividends to holders of our common stock will be at the discretion of our Board of Directors and will depend upon many factors, including our financial position, earnings, capital requirements of our operating subsidiaries, legal and regulatory requirements, and any other factors our Board of Directors deems relevant. On February 16, 2016, the Board of Directors declared a $0.09 dividend per share, payable March 15, 2016, to stockholders of record on March 1, 2016.
Outstanding Debt. In December 2010, we entered into a credit facility under which we were provided with: (a) $100.0 million line of credit through December 31, 2011; (b) $90.0 million line of credit from January 1, 2012 through December 31, 2012; (c) $80.0 million line of credit from January 1, 2013 through December 31, 2013; (d) $70 million line of credit from January 1, 2014 through December 31, 2014; and (e) $60 million line of credit from January 1, 2015 through December 31, 2015. Amounts outstanding bear interest at a rate equal to, at our option: (a) a fluctuating rate of 1.75% above prime rate or (b) a fixed rate that is 1.75% above the LIBOR rate then in effect. In accordance with the terms of the contract, we repaid the remaining outstanding principal balance of $60.0 million of the line of credit provided by the credit facility during the fourth quarter of 2015.
Notes payable obligations reflect payments for the principal and estimated interest expense based on LIBOR rates plus a margin. The estimated interest expense was based on the contractual obligations of the debt outstanding as of December 31, 2015. The interest rates range from 4.4% to 4.7%.
Estimated losses and LAE reserve payment patterns have been computed based on historical information. Our calculation of loss and LAE reserve payments by period is subject to the same uncertainties associated with determining the level of reserves and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our reserving process, see ''-Critical Accounting Policies-Reserves for Losses and LAE.'' Actual payments of losses and LAE by period will vary, perhaps materially, from the above table to the extent that current estimates of losses and LAE reserves vary from actual ultimate claims amounts due to variations between expected and actual payout patterns.
The cost or amortized cost of our investment portfolio was $2.4 billion and the fair value was $2.5 billion as of December 31, 2015.
We employ an investment strategy that emphasizes asset quality and considers the durations, maturities, and anticipated cash flows of securities against anticipated claim payments, other expenditures and liabilities, and capital and liquidity needs. Our investment portfolio is structured so that investments mature periodically in reasonable relation to current expectations of future claim payments. Currently, we make claim payments from positive cash flow from operations and use excess cash to invest in operations, invest in marketable securities, return capital to our stockholders, and fund growth.
We seek to maximize total investment returns within the constraints of prudent portfolio management. The asset allocation is reevaluated by management and reviewed by the Finance Committee of the Board of Directors on a quarterly basis. We employ Conning Inc. (Conning) to act as our independent investment manager. Conning follows our written investment guidelines based upon strategies approved by the Board of Directors. In addition to the construction and management of the portfolio, we utilize the investment advisory services of Conning.
We carry our portfolio of equity securities on our balance sheet at fair value. We seek to minimize our exposure to equity price risk by investing primarily in the equity securities of mid-to-large capitalization issuers and by diversifying our equity holdings across several industry sectors. Equity securities represented 8.0% of our investment portfolio at December 31, 2015.
Given current economic uncertainty and continuing market volatility, we believe that our current asset allocation best meets our strategy to preserve capital for policyholders, to provide sufficient income to support our insurance operations, and to effectively grow book value over a long-term investment horizon.
The following table shows the percentage of total estimated fair value of our fixed maturity securities as of December 31, 2015 by credit rating category, using the lower of ratings assigned by Moody's Investor Service and/or S&P.
Based on reviews of the equity securities, the Company recognized impairments of $17.2 million, $0.5 million, and $0.1 million in the fair values of twenty-seven, seven, and one equity securities for the years ended December 31, 2015, 2014, and 2013, respectively, primarily as a result of the severity and duration of the change in fair values of those securities. The remaining 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. The other-than-temporary impairments of equity securities in 2015 were primarily due to the continued downturn in the energy sector during the fourth quarter.
LAE reserves are our estimate of the future expenses of investigating, administering, and settling claims that will be paid to manage claims that have occurred, including legal expenses. LAE reserves are established in the aggregate, rather than on a claim-by-claim basis. LAE reserves are categorized between Defense and Cost Containment (DCC) and Adjusting and Other (AO).
Judgment is required in the actuarial estimation of loss reserves, including the selection of various actuarial methodologies to project the ultimate cost of claims. Specifically, judgment is required in the following areas: the selection of projection parameters based on historical company data, the use of industry data and other benchmarks; the identification and quantification of potential changes in parameters from historical levels to current and future levels due to changes in future claims development expectations; and the weighting of differing reserve indications resulting from alternative methods and assumptions. The adequacy of our ultimate loss reserves is inherently uncertain and represents a significant risk to our business. We attempt to mitigate this risk through our claims management processes and by monitoring and reacting to statistics relating to the cost and duration of claims.
We retain an independent actuarial consulting firm (Consulting Actuary) to perform comprehensive studies of our loss and LAE reserves on a semi-annual basis. The role of the Consulting Actuary is to conduct sufficient analyses to produce a range of reasonable estimates, as well as a point estimate, of our liability for unpaid losses and LAE, and to present those results to our Internal Actuary and to management as supplemental data used in selecting management's best estimate of ultimate losses.
Our Internal Actuary has been named as the Appointed Actuary for financial statement periods ending on or after December 31, 2015 and all reserve figures shown as of December 31, 2015 are based on our internal actuarial analysis. In prior years, the Consulting Actuary was the Appointed Actuary and reserve figures for those years are based on those analyses.
the past 15 years. The rate of medical cost inflation in the general U.S. economy, as measured by the consumer price index-medical care, has averaged approximately 3.7% over the past 15 years.
Management formally establishes loss reserves for financial statement purposes on a quarterly basis. In doing so, we make reference to the most current analyses of our Internal Actuary and of the Consulting Actuary, including a review of the assumptions and the results of the various actuarial methods used. Comprehensive studies are conducted as of June 30 and December 31 by both our Internal Actuary and the Consulting Actuary. On the alternate quarters, the results of the preceding quarter's studies are updated for actual claim payment activity by our Internal Actuary.
The table below provides the actuarial range of estimated liabilities for net unpaid losses and LAE that management considered when selecting its best estimate and our carried reserves.
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. Although considerable variability is inherent in such estimates, we believe that amounts currently reflected in our consolidated financial statements will similarly not require any material prospective adjustment.
In May 2015, the Financial Accounting Standards Board issued ASU Number 2015-09, Financial Services - Insurance (Topic 944). This update expands the breadth of disclosures that an insurance entity must provide about its short-duration insurance contracts. This expanded disclosure includes the presentation of incurred and paid claims development tables by accident year for a period of up to 10 years. This update becomes effective for annual reporting periods beginning after December 15, 2015 and interim periods beginning after December 15, 2016 and early adoption is permitted. As this update focuses only on disclosures, it will not impact our consolidated financial condition and results of operations.
In January 2016, the FASB issued ASU Number 2016-01, Financial Instruments - Overall (Subtopic 825-10). This update replaces the guidance to classify equity transactions with readily determinable fair values into different categories (trading or available-for-sale) and requires equity securities to be measured at fair value with changes in fair value recognized through net income. Additionally, this update eliminates the method and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost. It requires financial instruments to be measured at fair value using the exit notion price. Furthermore, this update clarifies that an evaluation of deferred tax assets related to available-for-sale securities is needed, in combination with and evaluation of other deferred tax assets, to determine if a valuation allowance is required. This update becomes effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We have not yet estimated the full effect that adoption will have on our consolidated financial condition and results of operations.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING
We have audited Employers Holdings, Inc. and Subsidiaries' internal control over financial reporting as of December 31, 2015, 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.
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, 2015 and 2014, 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, 2015 and our report dated February 19, 2016 expressed an unqualified opinion thereon.
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, 2015, 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 19, 2016 expressed an unqualified opinion thereon.
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. As a result, actual results could differ from these estimates. The most significant areas that require management judgment are the estimate of unpaid losses and loss adjustment expenses (LAE), evaluation of reinsurance recoverables, recognition of premium revenue, deferred income taxes, and investments.
The Company increased its estimate of Contingent commission receivable - LPT Agreement (LPT Contingent Commission Adjustments) in each of 2015, 2014, and 2013 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 cumulative adjustments to the Deferred Gain were also recognized in losses and LAE incurred in the consolidated statement of comprehensive income, so that the Deferred Gain reflects the balance that would have existed had the revised reserves been recognized at the inception of the LPT Agreement.
When, in the opinion of management, a decline in the fair value of an equity security below its cost is considered to be “other-than-temporary,” the equity security's cost is written down to its fair value at the time the other-than-temporary decline is identified. The determination of an other-than-temporary decline for debt securities 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 bifurcation of the write-down may be necessary. If management has the intent to sell the debt security or more likely than not will be required to sell the debt security before its
anticipated recovery, the investment is written down to its fair value and the entire impairment is recorded as a realized loss due to credit in the accompanying consolidated statements of comprehensive income. If management does not have the intent to sell or will not be required to sell the debt security but does not expect to recover the amortized cost basis of the debt security, the amount of the other-than-temporary impairment is bifurcated between credit loss and other loss and recorded as a component of realized gains and losses and to other comprehensive income, respectively, in the consolidated statements of comprehensive income. The amount of any write-down is determined by the difference between the cost or amortized cost of the debt security and its fair value at the time the other-than-temporary decline is identified (see Note 6).
The Company establishes a bad debt allowance on its premiums receivable through a charge included in underwriting and other operating expenses in the accompanying 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 $12.2 million and $7.9 million at December 31, 2015 and 2014, respectively. The Company had write-offs, net of recoveries of amounts previously written off, of $2.4 million, $3.4 million, and $2.5 million for the years ended December 31, 2015, 2014, and 2013, respectively.
In the ordinary course of business and consistent with general insurance industry practices, the Company purchases excess of loss reinsurance to protect the Company against the impact of large and/or catastrophic losses in its workers' compensation business. Additionally, the Company is a party to a 100% quota share retroactive reinsurance agreement (see Note 10). This reinsurance reduces the financial impact of such losses on current operations and the equity of the Company. Reinsurance makes the assuming reinsurer liable to the ceding company to the extent of the reinsurance coverage provided. It does not, however, discharge the Company from its liability to its policyholders in the event the reinsurer is unable or unwilling to meet its obligations under its reinsurance agreement with the Company.
Ceded losses and LAE are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the relevant reinsurance agreement.
Additionally, the Company is entitled to receive a contingent profit commission under the LPT Agreement. The contingent profit is equal to 30% of the favorable difference between actual paid losses and LAE and expected paid losses and LAE as established in the LPT Agreement based on losses paid through June 30, 2024. The contingent profit commission is paid every five years beginning June 30, 2004 for the first twenty-five years of the agreement. The Company is paid 30% of the favorable difference between the actual and expected losses and LAE paid at each calculation point. The Company could be required to return any previously received contingent profit commission, plus interest, in the event of unfavorable differences through June 30, 2024. The Company records its estimate of contingent profit commission in the accompanying consolidated balance sheets as Contingent commission receivable-LPT Agreement and a corresponding liability is recorded on the accompanying consolidated balance sheets in Deferred reinsurance gain-LPT Agreement. The Contingent commission receivable-LPT Agreement is reduced as amounts are received from participating reinsurers. In 2014, the Company received $11.7 million in cash related to the contingent profit commission. The related Deferred reinsurance gain-LPT Agreement is amortized using the recovery method. The amortization of the contingent profit commission is determined by the proportion of actual reinsurance recoveries to total estimated recoveries over the life of the contingent profit commission (through June 30, 2024), and is recorded in losses and LAE incurred in the accompanying consolidated statements of comprehensive income. Any adjustment to the contingent profit commission under the LPT Agreement results in a cumulative adjustment to the Deferred Gain, which is also recognized in losses and LAE incurred in the consolidated statement of comprehensive income, such that the Deferred Gain reflects the balance that would have existed had the revised contingent profit commission been recognized at the inception of the LPT Agreement.
The Company's accounting for income taxes considers the current and deferred tax consequences of all transactions that have been recognized in its consolidated financial statements using the provisions of enacted tax laws. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The effect on deferred tax assets and
Cash equivalents include investments in money market securities and securities backed by the U.S. government. Investments are diversified throughout many industries and geographic regions. The Company limits the amount of credit exposure with any one financial institution and believes that no significant concentration of credit risk exists with respect to cash and cash equivalents and investments.
At December 31, 2015 and 2014, the outstanding premiums receivable balance was generally diversified due to the large number of entities composing the Company's policyholder base and their dispersion across many different industries. The Company also has recoverables from its reinsurers. Reinsurance contracts do not relieve the Company of its obligations to claimants or policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The Company obtains collateral to mitigate the risks related to reinsurance insolvencies. At December 31, 2015, $3.7 million was collateralized by cash or letters of credit and an additional $1.4 billion was in trust accounts for reinsurance related to the LPT Agreement.
The following methods and assumptions were used by the Company in estimating the fair value for financial instruments in the accompanying consolidated financial statements and in these notes for the years ended 2015 and 2014:
In April 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) Number 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40). The update provides guidance to purchasers to assist in determining whether a cloud computing arrangement includes a software license and how to account for such an arrangement. This update becomes effective for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2015 and early adoption is permitted. The Company does not expect the adoption to have a material impact on its consolidated financial condition and results of operations.
Level 3 - Inputs that are unobservable that reflect management's best estimate of what willing market participants would use in pricing the assets or liabilities at the measurement date.
Fair values of available-for-sale fixed maturity and equity securities are based on quoted market prices, where available. These fair values are obtained primarily from third party pricing services, which generally use Level 1 or Level 2 inputs. 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 a 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. There were no adjustments to prices obtained from third party pricing services as of December 31, 2015 and 2014 that were material to the consolidated financial statements.
If quoted market prices and an estimate determined by using objectively verifiable information are unavailable, the Company produces an estimate of fair value based on internally developed valuation techniques, which, depending on the level of observable market inputs, will render the fair value estimate as Level 2 or Level 3. The Company bases all of its estimates of fair value for assets on the bid price, as it represents what a third-party market participant would be willing to pay in an arm's length transaction.
The following table presents the items in the accompanying consolidated balance sheets that are stated at fair value and the corresponding fair value measurements.
The Company had no Level 3 investments during the years ended December 31, 2015 and 2014.
The amortized cost and estimated fair value of fixed maturity securities at December 31, 2015, by contractual maturity, are shown below. Expected maturities differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Based on reviews of the fixed maturity securities, the Company determined that unrealized losses for the years ended December 31, 2015, 2014, and 2013 were primarily the result of changes in prevailing interest rates and not the credit quality of the issuers. The fixed maturity securities whose fair value was less than amortized cost were not determined to be other-than-temporarily impaired given the severity and duration of the impairment, the credit quality of the issuers, the Company’s intent on not selling the securities,
Based on reviews of the equity securities, the Company recognized total impairments of $17.2 million, $0.5 million and $0.1 million in the fair values of 27, seven, and one equity securities primarily as a result of the severity and duration of the change in fair values of those securities as of December 31, 2015, 2014, and 2013, respectively. The remaining 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. The other-than-temporary impairments of equity securities in 2015 were primarily due to the continued downturn in the energy sector during the fourth quarter.
On January 1, 2000, EICN assumed the assets, liabilities, and operations of the Fund pursuant to legislation passed in the 1999 Nevada Legislature (the Privatization). Prior to the Privatization, the Fund was a part of the State of Nevada and therefore was not subject to federal income tax; accordingly, it did not take an income tax deduction with respect to the establishment of its unpaid loss and LAE reserves. Due to favorable loss experience after the Privatization, it was determined that certain of the pre-Privatization unpaid loss and LAE reserves assumed by EICN as part of the Privatization were no longer necessary and the unpaid loss and LAE reserves were reduced accordingly. Such downward adjustments of pre-Privatization unpaid loss reserves increased GAAP net income by $15.3 million, $3.6 million, and $7.4 million for the years ended December 31, 2015, 2014, and 2013, respectively, but did not increase taxable income. There were downward adjustments of pre-Privatization unpaid loss reserves, excluding the LPT, of $56.3 million, $13.1 million, and $27.2 million for the years ended December 31, 2015, 2014, and 2013, respectively.
As of December 31, 2015 and 2014, the Company had no unrecognized tax benefits.
Tax years 2012 through 2015 are subject to full examination by the federal taxing authority.
At December 31, 2015, the Company had a $25.0 million net operating loss carry-forward. This is due to expire beginning 2032 through 2033. At December 31, 2015, the Company had a minimum tax credit of $28.0 million that may be carried forward indefinitely.
In 2015, the Company had $7.2 million of favorable prior accident year loss development, which included $9.0 million of favorable prior accident year loss development on its voluntary risk business, which was partially offset by $1.8 million of unfavorable loss development related to its assigned risk business. In 2014, the increase in the estimate of incurred losses and LAE attributable to insured events in prior years was primarily related to the Company's assigned risk business. In 2013, the increase in the estimate of incurred losses and LAE attributable to insured events in prior years included $5.0 million related to actual paid losses that were more than expected and the impact of new information on selected patterns of claims emergence and payments used in the projection of future loss payments and $1.9 million related to the Company's assigned risk business.
In California, where the Company's operations began on July 1, 2002, the actuaries' and management's initial expectations of ultimate losses and patterns of loss emergence and payment were based on benchmarks derived from analyses of historical insurance industry data in California. No historical data from the Company's California insurance subsidiary existed prior to July 1, 2002; however, some historical data was available for the prior years for some of the market segments the Company entered in California, but was limited as to the number of loss reserve evaluation points available. The industry-based benchmarks were judgmentally adjusted for the anticipated impact of significant environmental changes, specifically the enactment of major changes to the statutory workers' compensation benefit structure and the manner in which claims are administered and adjudicated in California. The actual emergence and payment of claims by the Company's California insurance subsidiary have been more favorable than those initial expectations through 2008, due in part to the enactment of the major changes in the California workers' compensation environment. The Company's recent loss experience, from 2010 through 2015, indicates an upward trend in medical costs that is reflected in our loss reserves; however, the Company's indemnity claims frequency (the number of claims expressed as a percentage of payroll) decreased year-over-year in 2015 and 2014. The Company's estimates assume that increasing medical cost trends will continue and will impact the Company's long-term claims costs and loss reserves.
Loss reserves shown in the consolidated balance sheets are net of $26.8 million and $25.1 million for anticipated subrogation recoveries as of December 31, 2015 and 2014, respectively.
On December 28, 2010, the Company entered into a credit facility, under which the Company was provided with: (a) $100.0 million line of credit through December 31, 2011; (b) $90.0 million line of credit from January 1, 2012 through December 31, 2012; (c) $80.0 million line of credit from January 1, 2013 through December 31, 2013; (d) $70.0 million line of credit from January 1, 2014 through December 31, 2014; and (e) $60.0 million line of credit from January 1, 2015 through December 31, 2015. Amounts outstanding bear interest at a rate equal to, at our option: (a) a fluctuating rate of 1.75% above prime rate or (b) a fixed rate that is 1.75% above the LIBOR rate then in effect. Interest paid during the years ended December 31, 2015, 2014, and 2013 totaled $1.3 million, $1.4 million, and $1.6 million, respectively. In accordance with the terms of the contract, the remaining principal balance of $60.0 million was repaid on the credit facility during the fourth quarter of 2015.
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 the second quarter of 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, 2015, 2014, and 2013 was $0.5 million. Interest accrued as of December 31, 2015 and 2014 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 the second quarter of 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, 2015, 2014, and 2013 was $0.6 million, $0.5 million and $0.6 million, respectively. Interest accrued as of December 31, 2015 and 2014 was $0.1 million.
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, 2015, the remaining lease terms expire over the next six years.
Included in the future minimum capital lease payments are future interest charges of $0.1 million. Facilities rent expense was $4.9 million, $4.8 million, and $5.0 million for the years ended December 31, 2015, 2014, and 2013, respectively.
All of the states where the Company's insurance subsidiaries are licensed to transact business require property and casualty insurers doing business within the respective state to pay various insurance assessments. The Company accrues a liability for estimated insurance assessments as direct premiums are written, losses are recorded, or as other events occur in accordance with various states' laws and regulations, and defers these costs and recognizes them as an expense as the related premiums are earned. The Company had an accrued liability for guaranty fund assessments, second injury funds assessments, and other insurance assessments totaling $22.0 million and $18.8 million as of December 31, 2015 and 2014, respectively. These liabilities are generally expected to be paid over one to eighty year periods based on individual state's regulations. The Company also recorded an asset of $21.4 million and $13.0 million, as of December 31, 2015 and 2014, respectively, for prepaid policy charges still to be collected in the future from policyholders, assessments that may be recovered through a reduction in future premium taxes in certain states, and for expected refunds of certain prepaid assessments based on a change in the Company's premium over time. These assets are expected to be realized over one to ten year periods in accordance with their type and individual state's regulations.
Since the Company's initial public offering in January 2007 through December 31, 2015, the Company repurchased a total of 23,372,974 shares of common stock at an average cost per share of $15.51, which is reported as treasury stock, at cost, on the accompanying consolidated balance sheets. There were no stock repurchase programs authorized by the Board of Directors as of December 31, 2015.
As of December 31, 2015, nonqualified stock options, RSUs, and PSUs have been granted, but no incentive stock options, stock appreciation rights, or shares of restricted stock have been granted under the Plan.
Changes in outstanding stock options for the year ended December 31, 2015 were as follows:
At December 31, 2015, the Company had yet to recognize $1.4 million in deferred compensation related to nonqualified stock option grants and expects to recognize these costs on a straight-line basis over the next 39 months. The fair value of options vested and the intrinsic value of outstanding and exercisable options as of December 31, were as follows:
At December 31, 2015, the Company had yet to recognize $3.2 million in deferred compensation related to RSU grants 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 Company awarded PSUs to certain officers of the Company as follows:
The PSUs granted in 2013 and 2014 have a performance period of three years and are subject to certain performance goals, based on the Company's statutory combined ratio, with payouts that range from 0% to 200% of the target awards. The ultimate payout of the PSUs awarded in 2013 was 0% of the target award.
Net income for the Company's insurance subsidiaries prepared in accordance with SAP for the years ended December 31, 2015, 2014 and 2013 was $87.8 million, $58.6 million and $19.3 million, respectively.
these restrictions may only be declared and distributed as an extraordinary dividend upon the prior approval of the Nevada Commissioner of Insurance (Nevada Commissioner). EICN may not pay such an extraordinary dividend or make an extraordinary distribution until the Nevada Commissioner either approves or does not disapprove the payment within 30 days after receiving notice of its declaration. An extraordinary dividend or distribution is defined by statute to include any dividend or distribution of cash or property whose fair market value, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of: (a) 10% of EICN's statutory surplus as regards to policyholders at the next preceding December 31; or (b) EICN's statutory net income, not including realized capital gains, for the 12-month period ending at the next preceding December 31. As of December 31, 2015, EICN had positive unassigned surplus of $423.1 million. During 2015, EICN did not pay any dividends. The maximum dividends that may be paid in 2016 by EICN without prior approval is $49.7 million.
Under Florida law, without regulatory approval, EPIC 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 2015, EPIC did not pay any dividends. The maximum dividends that may be paid in 2016 by EPIC without prior approval is $28.1 million.
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 times 1.25 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, 2015, 2014, and 2013, EPIC and EAC were in compliance with these statutes.
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
Basic earnings per share includes no dilution and is computed by dividing income applicable to stockholders by the weighted average number of shares outstanding for the period. Diluted earnings per share reflect the potential dilutive impact of all convertible securities on earnings per share. Diluted earnings per share includes shares assumed issued under the “treasury stock method,” which reflects the potential dilution that would occur if outstanding RSUs and PSUs vested, and options were to be exercised.
Diluted earnings per share excludes outstanding options and other common stock equivalents in periods where the inclusion of such options and common stock equivalents would be anti-dilutive. The following table presents options, PSUs and RSUs that were excluded from diluted earnings per share.
The fourth quarter of 2015 was impacted by two changes in estimates: (1) favorable prior accident year loss development of $8.5 million, which included $9.0 million of favorable prior accident year loss development on the Company's voluntary risk business, partially offset by $0.5 million of unfavorable loss development related to assigned risk business, that increased net income by $8.5 million or $0.26 per basic and diluted share; and (2) a $36.9 million reallocation of reserves from non-taxable periods prior to January 1, 2000 to taxable years, which reduced our effective tax rate by 65.3 percentage points, resulting in an increase to net income of $11.5 million, or $0.36 and $0.35 per basic and diluted share, respectively.
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 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.