Our principal executive offices are 79,533 square feet located in leased premises in Reno, Nevada. In addition to serving as our corporate headquarters, it also serves as a branch office providing services in marketing, loss control, and underwriting related support. As of February 1, 2011, we leased 308,042 square feet of total office space in 13 states. We also own a 15,120 square foot building in Carson City, Nevada, which is used as a storage facility. We believe that our existing office space is adequate for our current needs and we will continue to enter into or exit lease agreements to address future space requirements, as necessary.
The following selected historical consolidated financial data should be read in conjunction with ‘‘
We are a Nevada holding company. Through our insurance subsidiaries, we provide workers’ compensation insurance coverage to select, small businesses in low to medium hazard industries. Workers’ compensation insurance is provided under a statutory system wherein most employers are required to provide coverage for their employees’ medical, disability, vocational rehabilitation, and/or death benefit costs for work-related injuries or illnesses. We provide workers’ compensation insurance in 30 states and the District of Columbia, with a concentration in California. Our revenues are primarily comprised of net premiums earned, net investment income, and net realized gains (losses) on investments.
We target small businesses, as we believe that this market is 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 which are competitive and profitable over the long-term. Our underwriting approach is to consistently underwrite small business accounts at an appropriate and competitive price without sacrificing long-term profitability and stability for short-term top-line revenue growth.
Overall, net income was $62.8 million, $83.0 million, and $101.8 million in 2010, 2009, and 2008. Net income decreased primarily due to year over year reductions in net premiums earned, increasing combined ratios (decreasing underwriting income), and the impact of net investment income and realized gains (losses) on investments.
Net premiums earned declined $82.5 million for the year ended December 31, 2010, compared to prior year. This decrease reflects the impacts of the recession, including high unemployment and fewer hours worked, declines in our policyholders’ payroll, lower net rates, and our application of disciplined pricing objectives and underwriting guidelines in a highly competitive market. The increase in net premiums earned for the year ended December 31, 2009, compared to the same period of 2008, was primarily due to the Acquisition. This increase in 2009 was partially offset by lower premiums, primarily in California and Nevada, as a result of rate reductions, competition, and impacts of economic conditions.
The following table shows the percentage change in our in-force policy count, average policy size, and payroll exposure, upon which our premiums are based, and net rate as of December 31 for each of the periods presented.
Premium revenues in 2011 will continue to reflect rate increases in California, rate changes (increases and reductions) in several of our other states, as well as competitive pressures and the continuing effects of the recession.
We have established a high quality/short duration bias in our investment portfolio with high underlying credit quality of our municipal bond holdings. The performance of our investment portfolio, with its diversified structure and quality bias, has been exceptionally strong.
The following table provides the calculation of our calendar year combined ratios for the years ended December 31:
Losses and LAE Ratio. Expressed as a percentage, this is the ratio of losses and LAE to net premiums earned.
In California, our loss data indicates an upward trend in medical costs that is reflected in our loss reserves. We are also seeing increased medical costs in many of our other states, partially offset by long-term favorable loss cost trends in Nevada. We believe our loss reserve estimates are adequate; however, the ultimate losses will not be known with any certainty for several years. We assume that increasing medical cost trends will continue and will impact our long-term claims costs and loss reserves. Additionally, the impact, if any, of the recession on our claims costs is not yet known. We will continue to evaluate our estimate of loss reserves to reflect the most current data and judgments. Additional information regarding our reserves for losses and LAE is set forth under “-Critical Accounting Policies-Reserves for Losses and LAE.”
Overall, losses and LAE decreased $19.7 million for the year ended December 31, 2010, compared to the same period of 2009, primarily due to lower payroll exposures. Favorable prior accident year loss development decreased $34.8 million to $16.6 million for the year ended December 31, 2010, compared to the same period of 2009. Additionally, a $1.6 million expense related to the commutation of certain reinsurance treaties, and a $0.9 million expense related to the write-off of certain reinsurance recoverables that had previously been accounted for as an allowance for bad debt, are included in losses and LAE for the year ended December 31, 2010.
The table below reflects the losses and LAE reserve adjustments for the periods presented.
Underwriting and Other Operating Expenses Ratio. The underwriting and other operating expenses ratio is the ratio (expressed as a percentage) 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.
In January 2009, we restructured our operations as a result of the Acquisition and incurred one-time pre-tax integration and restructuring charges of approximately $5.7 million, including $2.8 million of severance benefits, for the year ended December 31, 2009. As a result of the restructuring, we achieved pre-tax cost savings of approximately $12.0 million in fiscal 2009.In the first quarter of 2010, we incurred charges of $0.9 million related to staffing reductions to adjust our insurance operations to reflect activity levels at that time.
Beginning in 2011, we anticipate combined annualized cost savings of approximately $23.6 million, comprised of $21.0 million in salaries and benefits and $2.6 million in lease related savings, associated with restructuring activities that occurred in 2010.
Our underwriting and other operating expenses increased 37.1%, for the year ended December 31, 2009, as compared to the same period in 2008, including restructuring items in 2009. The increase was primarily related to the acquired operations of AmCOMP. The increase included a $19.3 million increase in compensation expense, a $5.7 million increase in premium taxes, and $3.0 million increase in bad debt expense.
We accrue the estimated ultimate contingent profit commission through June 30, 2024. Increases or decreases in the estimated contingent profit commission are reflected in commission expense in the period that the estimate is revised. In 2010, an increase in the estimated contingent profit commission of $0.8 million resulted in a decrease in the commission expense for the year. For the year ended December 31, 2009, we decreased commission expenses by $15.0 million as a result of an increase in contingent profit commissions and received cash payment of $10.3 million from the reinsurers. At December 31, 2010, expected amounts to be paid for losses under the LPT Agreement for the period July 1, 1999 through June 30, 2014, were $677.7 million, compared to contractually expected losses and LAE of approximately $775.0 million.
Our commission expense was $38.5 million, $36.2 million, and $43.6 million for the years ended December 31, 2010, 2009, and 2008, respectively. The increase from 2009 to 2010 was primarily due to a $15.0 million adjustment in the accrual for the LPT contingent profit commission during the year ended December 31, 2009 and re-negotiation of the terms of a separate reinsurance agreement resulting in an additional $1.8 million in commission expense in the fourth quarter of 2010. This increase was partially offset by lower net premiums earned and a $3.0 million reduction in the
Dividends to policyholders were $4.3 million, $6.9 million, and $1.3 million for the years ended December 31, 2010, 2009, and 2008, respectively. The decrease in dividends to policyholders from 2009 to 2010 was primarily due to lower premium levels on dividend policies in Florida and Wisconsin and fewer policies eligible for dividend payments in 2010. The increase in 2009, compared to 2008, was primarily due to the Acquisition.
We incur interest expenses on notes payable. We also had an interest rate swap agreement on our credit facility with Wells Fargo Bank, National Association (Wells Fargo), which expired on September 30, 2010.
Interest expense decreased 23.2% for the year ended December 31, 2010, compared to the same period of 2009, primarily due to a $50.0 million reduction in the principal balance on our credit facility with Wells Fargo in the fourth quarter of 2009 and the expiration of the interest rate swap in the third quarter of 2010. Interest expense increased $5.3 million for the year ended December 31, 2009, compared to the same period of 2008, as we had no debt or related interest expense for the first ten months of 2008.
Additionally, on May 27, 2010, we received approval from the Nevada Commissioner of Insurance to pay $150.0 million in extraordinary dividends from EICN special surplus. This $150.0 million extraordinary dividend was paid by EICN to EGI, and subsequently from EGI to EHI, on June 3, 2010. As a result of the payment of the extraordinary dividend from special surplus, any dividends paid by EICN through June 3, 2011 will require prior approval by the Nevada Commissioner of Insurance.
Based on reported capital, surplus, and dividends paid within the last 12 months, the maximum dividends that may be paid by EICN between June 3 and December 31, 2011, and by EPIC in 2011, without prior approval by the respective state insurance regulator are $51.9 million and $15.5 million, respectively.
As of December 31, 2010, the holding company had cash and fixed maturity securities maturing within the next 24 months of $74.9 million. Ten million dollars of our line of credit is due annually beginning on December 31, 2011 through December 31, 2014. We believe that the liquidity needs of the holding company over the next 24 months will be met with cash, maturing investments, and dividends from our insurance subsidiaries.
Share Repurchases.In November 2009, the EHI Board of Directors (Board of Directors) authorized a share repurchase program for $50 million of the Company’s common stock from January 1, 2010 through December 31, 2010 (the 2010 Program). Through September 30, 2010, we repurchased a total of 3,291,709 shares of common stock under the 2010 Program at an average price of $15.19 per share, including commissions, for a total of $50.0 million.
On November 3, 2010, the Board of Directors authorized a share repurchase program for up to $100 million of the Company’s common stock from November 8, 2010 through June 30, 2012 (the 2011 Program). Through December 31, 2010, we repurchased a total of 867,149 shares of common stock under the 2011 Program at an average price of $16.59 per share, including commissions, for a total of $14.4 million. Repurchases under this program may be commenced or suspended from time to time without prior notice, and the program may be suspended or discontinued at any time.
Our insurance subsidiaries had total cash and fixed maturity securities of $270.5 million maturing within the next 24 months at December 31, 2010. We believe that our subsidiaries’ liquidity needs over the next 24 months will be met with cash from operations, investment income, and maturing investments.
decreased underwriting and other operating expenses paid of $12.0 million, including lower premium taxes paid of $5.9 million;
increased commissions paid of $4.8 million, primarily due to $10.3 million received from the LPT contingent profit commission in 2009;
Net cash provided by operating activities decreased $26.6 million in 2009, compared to 2008. This decrease was primarily due to increased payments for losses and LAE of $103.3 million and increase payments for underwriting and other operating expenses of $39.3 million, partially offset by increased net premiums received of $62.6 million, decreased income taxes paid of $26.3 million, increased investment income of $13.3 million, and cash received on the LPT contingent commission of $10.3 million.
Net cash used in financing activities was $74.7 million in 2010, compared to $135.3 million in 2009. In 2008, $120.9 million of net cash was provided by financing activities. The majority of cash used in financing activities in 2010 was to repurchase $64.4 million of our common stock and to pay dividends to stockholders. In 2009, the majority of cash used in financing activities was to repurchase $74.2 million of our common stock and to pay down $50 million of the line of credit provided by the Amended Credit Facility. In 2008, cash was provided by proceeds from our Amended Credit Facility, which was later used for the acquisition of AmCOMP.
We employ an investment strategy that emphasizes asset quality and considers the durations of fixed maturity securities against anticipated claim payments and expenditures, other liabilities, and capital 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 our growth strategy.
We carry our portfolio of equity securities on our balance sheet at fair value. We 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. At December 31, 2010, equity securities represented 3.9% of our investment portfolio.
The following table shows the percentage of total market share of our fixed maturity securities as of December 31, 2010 by credit rating category, as defined by Standard & Poor’s.
Investments that we currently own could be subject to default by the issuer or could suffer declines in fair value that become other-than-temporary. We regularly assess individual securities as part of our ongoing portfolio management, including the identification of other-than-temporary declines in fair value. Our other-than-temporary assessment includes reviewing the extent and duration of declines in fair value of investments below amortized cost, historical and projected financial performance and near-term prospects of the issuer, the outlook for industry sectors, credit rating, and macro-economic changes. We also make a determination as to whether it is not more likely than not that we will not be required to sell the security before its fair value recovers above cost, or to maturity.
For the year ended December 31, 2010, we recognized an impairment of $46 thousand in the fair value of one of our fixed maturity holdings as a result of an anticipated sale of this security due to a strategic rebalancing in our investment portfolio and not from credit impairment. None of our equity securities were impaired in 2010. We determined that the unrealized losses on equity securities at December 31, 2010 were not considered to be other-than-temporary due to the financial condition and the near term prospects of the issuers. We also determined that the remaining unrealized losses on fixed maturity securities were primarily the result of prevailing interest rates and not the credit quality of the issuers.
The scheduled maturity dates for fixed maturity securities, including the amortized cost and estimated fair value at December 31, 2010 are shown below. Actual maturities may differ from those scheduled as a result of prepayments by the issuer.
Net realized and unrealized investment gains (losses) on fixed maturity and equity securities were as follows for the years ended December 31:
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, 2010. The interest rates range from 1.55% to 4.54%.
The losses and LAE reserves are presented gross of our reinsurance recoverables on unpaid losses, which were as follows for each of the periods presented above:
The preparation of financial statements in accordance with GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. Our accounting policies are described in the Notes to our Consolidated Financial Statements, but we believe that the following matters are particularly important to an understanding of our financial statements because changes in these estimates or changes in the assumptions used to make them could have a material impact on the results of operations, financial condition, and cash flows.
Accounting for workers’ compensation insurance requires us to estimate the liability for the expected ultimate cost of unpaid losses and LAE (loss reserves) as of a balance sheet date. Loss reserve estimates are inherently uncertain because the ultimate amount we pay for many of the claims we have incurred as of the balance sheet date will not be known for many years. Our estimate of loss reserves is intended to equal the difference between the expected ultimate losses and LAE of all claims that have occurred as of a balance sheet date and amounts already paid. We establish loss reserves based on our own analysis of emerging claims experience and environmental conditions in our markets and review of the results of various actuarial projections. Our aggregate carried reserve for unpaid losses and LAE is the sum of our reserves for each accident year (point estimate) and represents our best estimate of outstanding loss reserves.
development is unfavorable when losses ultimately settle for more than the amount reserved or subsequent estimates indicate a basis for reserve increases on open claims, causing the previously estimated loss reserves to be ‘‘deficient.’’ Reserve development is favorable when estimates of ultimate losses indicate a decrease in established reserves, causing the previously estimated loss reserves to be ‘‘redundant.’’ Development is reflected in our operating results through an adjustment to incurred losses and LAE during the period in which it is recognized.
Most of our IBNR reserves relate to estimated future claim payments on recorded open claims. Workers’ compensation claims are generally reported to the employer and to the insurance company relatively quickly and relatively small amounts are paid on claims that have already been closed. Consequently, late reporting and reopening of claims are a less significant part of IBNR for our insurance subsidiaries.
Actuarial methodologies are used by workers’ compensation insurance companies, including us, to analyze and estimate the aggregate amount of unpaid losses and LAE. As mentioned above, management considers the results of various actuarial projection methods and their underlying assumptions, among other factors, in establishing reserves for unpaid losses and LAE.
We retain an independent actuarial consulting firm (Consulting Actuary) to perform comprehensive studies of our losses and LAE liability on a semi-annual basis. The role of our Consulting Actuary is to conduct sufficient analyses to produce a range of reasonable estimates, as well as a point estimate, of our unpaid losses and LAE liability, and to present those results to our actuarial staff and to management. In 2009, we changed our Consulting Actuary.
We compile and aggregate our claims data by grouping the claims according to the year or quarter in which the claim occurred (“accident year” or “accident quarter”) when analyzing claim payment and emergence patterns and trends over time. Additionally, claims data is aggregated and compiled separately for different types of claims or claimant benefits, or for different states or groups of states in which we do business, or both.
Management’s best estimate of unpaid losses and LAE, net of reinsurance, was $13.8 million, $54.6 million, and $16.5 million above the value calculated based on the historically utilized paid loss methods for EICN and a combination of methodologies for our other insurance subsidiaries at December 31, 2010, 2009, and 2008, respectively.
Estimates of incurred losses and LAE attributable to insured events for prior years have decreased due to continued favorable development in such prior accident years.
In California, where our operations began in 2002, the actuaries’ and management's initial expectations of the ultimate level of 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 our 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 we 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 our California insurance subsidiary has been more favorable than those initial expectations through 2009, due at least in part to the impact of enactment of the major changes in the California workers’ compensation environment, however, our recent loss experience, beginning in 2010, indicates an upward trend in medical costs that is reflected in our loss reserves. We assume that increasing medical cost trends will continue and will impact our long-term claims costs and loss reserves. At each evaluation date, the projected claim activity underlying prior loss reserves is replaced by actual claim activity, and the expectation of future emergence and payment of California claims underlying the actuarial projections is reevaluated based on our insurance subsidiaries’ emerging experience and on updating the benchmarks that are derived from observing and analyzing the insurance industry data for California workers’ compensation.
We have also seen a significant improvement in claims emergence and payment patterns in Nevada in recent years, and have given these improved patterns significant weight in establishing loss reserves for our Nevada business. If future emergence in Nevada more closely resembles long-term historical patterns of the Nevada State Industrial Insurance System (the Fund), our current loss reserves could develop unfavorably over time. Additionally, the impact, if any, of the recession on our claim costs is not yet known. We will continue to evaluate our estimate of loss reserves to reflect the most current data and judgments.
Our insurance subsidiaries have been operating in a period of drastically changing environmental conditions in our major markets, entry into new markets, and operational changes. During periods characterized by such changes, at each evaluation, the actuaries and management must make judgments as to the relative weight to accord to long-term historical and recent company data, external data, evaluations of environmental and operational changes, and other factors in selecting the methods to use in projecting ultimate losses and LAE, the parameters to incorporate in those methods, and the relative weights to accord to the different projection indications. At each evaluation, management has given weight to new data, recent indications, and evaluations of environmental conditions and changes that implicitly reflect management’s expectation as to the degree to which the future will resemble the most recent information and most recent changes, compared with long-term claim payment, claims emergence, and claim cost inflation patterns.
illustrating that changes in estimates of loss reserves can be significant from year to year. We have no basis for anticipating whether actual future payments of losses and LAE may be either greater than or less than the reserve for unpaid losses and LAE on our current balance sheet.
In 2008, we reversed $10.6 million of a remaining liability for unrecognized tax benefits, including $2.3 million in interest, as certain statutory periods had expired. The reversal of the liability caused a decrease in our tax expense and effective tax rate in 2008.
Our investments in fixed maturity and equity securities are classified as available-for-sale and are reported at fair value with unrealized gains and losses excluded from earnings and reported in a separate component of equity, net of deferred taxes, as a component of net accumulated other comprehensive income (loss). Realized gains and losses on sales of investments are recognized in operations on the specific identification basis.
Impairment of Investment Securities. Impairment of an investment security results in a reduction of the carrying value of the security and the realization of a loss when the fair value of the security declines below our cost or amortized cost, as applicable, and the impairment is deemed to be other-than-temporary. We regularly review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. We consider various factors in determining if a decline in the fair value of an individual security is other-than-temporary.
any reduction or elimination of dividends, or nonpayment of scheduled interest payments; and
As of December 31, 2010, there was recently issued accounting guidance that we either implemented during the year or will implement in future periods. None of this guidance that has been implemented had, or is expected to have, a material effect on our consolidated financial condition or results of operation; however, we have not yet determined the effect certain pronouncements that will be implemented in future periods will have on our financial statements. See Note 2 in the Notes to our Consolidated Financial Statements.
Consolidated Statements of Stockholders’ Equity for each of the three years ended December 31, 2010
Management of Employers Holdings, Inc. and Subsidiaries (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal control over financial reporting. As defined by the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or under the supervision of, the Company’s principal executive officer and principal financial officer, and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles (GAAP).
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO Framework).
In our opinion, Employers Holdings, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the COSO criteria.
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, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2011 expressed an unqualified opinion thereon.
Employers Holdings, Inc. (EHI) is a Nevada holding company. Through its wholly owned insurance subsidiaries, Employers Insurance Company of Nevada (EICN), Employers Compensation Insurance Company (ECIC), Employers Preferred Insurance Company (EPIC), and Employers Assurance Company (EAC), EHI is engaged in the commercial property and casualty insurance industry, specializing in workers’ compensation products and services. Unless otherwise indicated, all references to the “Company” refer to EHI, together with its subsidiaries.
On October 31, 2008, the Company acquired 100% of the outstanding common stock of AmCOMP Incorporated (AmCOMP), including two insurance subsidiaries, AmCOMP Preferred Insurance Company and AmCOMP Assurance Corporation (the Acquisition) (see Note 4). On December 16, 2008, the Florida Insurance Commissioner approved the name changes of AmCOMP Preferred Insurance Company and AmCOMP Assurance Corporation to EPIC and EAC, respectively.
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). All intercompany transactions and balances have been eliminated in consolidation. The accompanying consolidated statement of income for the year ended December 31, 2008, does not include the results of AmCOMP for the period prior to the Acquisition Date.
The Company considers an operating segment to be any component of its business whose operating results are regularly reviewed by the Company’s chief operating decision makers to make decisions about resources to be allocated to the segment and assess its performance based on discrete financial information. Currently, the Company has one operating segment, workers’ compensation insurance and related services.
The preparation of 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 financial statements and the reported amounts of revenue 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 policy acquisition costs, deferred income taxes, policyholders’ dividends, the valuation of assets acquired and liabilities assumed in its business combination and the valuation of investments.
Certain prior year information has been reclassified to conform to the current period presentation.
The Company had $16.9 million and $2.7 million of restricted cash at December 31, 2010 and 2009, respectively, primarily related to funds held in trust for Clarendon National Insurance Company (Clarendon).
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 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 in the consolidated statements of income and to other comprehensive income, respectively. 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).
Earned premiums include an estimate for earned but unbilled premiums. The Company estimates the amount of earned but unbilled premiums by analyzing the historical final premiums billed compared to the original estimated amounts billed. At December 31, 2010, premiums receivable on the consolidated balance sheet are net of $4.0 million to be returned to policyholders for final audits. At December 31, 2009, premiums receivable included $0.2 million of additional premiums expected to be received from policyholders for final audits.
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 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 had write-offs, net of recoveries of amounts previously written off, of $0.8 million, $1.2 million, and $1.0 million for the years ended December 31, 2010, 2009, and 2008, respectively.
Policy acquisition costs, consisting of commissions, premium taxes, and certain other underwriting costs that vary with, and are primarily related to, the production of new or renewal business are deferred and amortized as the related premiums are earned.
Deferred policy acquisition costs were $32.2 million and $33.7 million at December 31, 2010 and 2009, respectively. Amortization for the years ended December 31, 2010, 2009, and 2008, was $72.1 million, $87.6 million, and $66.4 million, respectively.
Commission expense includes direct commissions to agents and brokers for the premiums that they produce for the Company, as well as incentive payments, other marketing costs, and fees. Additionally, the Company is entitled to receive a contingent profit commission under the LPT Agreement. The contingent profit is an amount based on the favorable difference between actual paid losses and LAE and expected paid losses and LAE under the LPT Agreement. Loss expenses are deemed to be 7% of total losses paid and are paid to the Company as compensation for management of the LPT claims. The calculation of actual amounts paid versus expected amounts is determined every five years beginning June 30, 2004 for the first twenty-five years of the agreement. The reinsurers pay the Company 30% of any favorable difference between the actual and expected amounts paid at each calculation point. Conversely, the Company could be required to return any previously paid contingent profit commission, plus interest, in the event of unfavorable differences. The Company accrues the estimated ultimate contingent profit commission through June 30, 2024. Increases or decreases in the estimated contingent profit commission are reflected in commission expense in the period that the estimate is revised.
At December 31, 2010, the Company reduced its estimate of certain administrative fees due under its joint marketing agreements (Change in Estimate), which reduced its accrual for commission expense by $3.0 million. This Change in Estimate was the result of new information that materially impacted conditions that existed as of December 31, 2010 and is reflected in the financial statements for the period ended December 31, 2010. This Change in Estimate increased net income by $3.0 million, or $0.07 per basic and diluted share, for the three and twelve months ended December 31, 2010.
In the ordinary course of business and in accordance 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.
The 100% quota share retroactive reinsurance agreement was entered into in 1999 by the Nevada State Industrial Insurance System (the Fund) and assumed by EICN, which the Company refers to as the Loss Portfolio Transfer (LPT) Agreement (see Note 10). The Company accounts for this transaction as retroactive reinsurance, whereby the initial deferred gain was recorded as a liability in the accompanying consolidated balance sheets as deferred reinsurance gain - LPT Agreement. This gain is amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries, and is recorded in losses and LAE incurred in the accompanying consolidated statements of income. Any adjustment to the estimated reserves ceded under the LPT Agreement is recognized in earnings in the period of change with a corresponding change to reinsurance recoverables for unpaid losses and deferred reinsurance gain. A cumulative amortization adjustment is also then recognized in earnings so that the deferred reinsurance gain reflects the balance that would have existed had the revised reserves been available at the inception of the LPT Agreement.
Leased property and equipment meeting capital lease criteria are capitalized at the lower of the present value of the related lease payments or the fair value of the leased asset at the inception of the lease. Amortization is calculated using the straight-line method based on the term of the lease and is included in the depreciation expense of property and equipment. See Note 13 for additional disclosures related to capital leases.
The Company accounts for its restructuring plans by recording a loss when it is probable that a liability has been incurred. The amount of the loss is estimated and recorded at fair value using the Company’s incremental interest rate.
respectively. Policyholder dividends are ultimately paid at the sole discretion of the Board of Directors and must be approved by the Board prior to payment. Board-approved dividends accrued for 2010, 2009, and 2008 policies reflect the full potential amount allowed under the respective policies.
Cash equivalents include investments in commercial paper of companies with high credit ratings, 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, 2010 and 2009, 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. To reduce credit risk, the Company performs ongoing evaluations of its policyholders’ financial condition, but does not generally require collateral. 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, 2010, $11.6 million was collateralized by cash or letter of credit and an additional $962.1 million was in trust accounts for reinsurance related to the LPT Agreement.
The Company enters into securities lending agreements with financial institutions to improve investment income. Selected securities are loaned and are secured by collateral equal to at least 102% of the fair value of the securities. Collateral is in the form of cash or securities issued or guaranteed by the U.S. government, and the securities lending agent has provided counterparty indemnification in the event of borrower insolvency. The maximum amounts loaned under our securities lending program during the years ended 2010 and 2009 were $36.2 million and $36.7 million, respectively. As of December 31, 2010 and 2009, there were no outstanding securities lending transactions.
Estimated fair value amounts, defined as the quoted market price of a financial instrument, have been determined using available market information and other appropriate valuation methodologies. Judgment is required in developing the estimates of fair value where quoted market prices are not available. Accordingly, these estimates are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimating methodologies may have an effect on the estimated fair value amounts.
The following methods and assumptions were used by the Company in estimating the fair value disclosures for financial investments in the accompanying consolidated financial statements and in these notes for the years ended 2010 and 2009:
Investments. The estimated fair values for available-for-sale securities generally represent quoted market prices for securities traded in the public marketplace or estimated values for securities not traded in the public marketplace. Additional data with respect to fair values of the Company’s investment securities is disclosed in Note 6. The fair values reported in the accompanying consolidated balance sheets equal the carrying amounts for these investments.
Notes payable. The Company’s notes payable are composed of floating rate long-term debt. Accordingly, the carrying amount reported in the accompanying consolidated balance sheets is estimated to approximate fair value.
The estimated fair values of the Company’s financial instruments at December 31, 2010, are as follows:
The Company tests for impairment of goodwill and non-amortizable intangible assets in the fourth quarter of each year. At the end of each quarter, management considers the results of the previous analysis as well as any recent developments that may constitute triggering events requiring the impairment analysis of goodwill and other intangible assets to be updated. The Company has assessed the continuing negative effects of the economic slowdown on the Company’s gross premiums written and changes in the Company’s stock price and determined that there were no impairments as of December 31, 2010 and 2009.
The following table presents the gross carrying value, accumulated amortization and net carrying value for the Company’s intangible assets, by major class, as of December 31:
During the years ended December 31, 2010, 2009, and 2008, the Company recognized $2.2 million, $2.8 million, and $0.6 million in amortization expenses, respectively. These amortization expenses are included in the accompanying consolidated statements of income in underwriting and other operating expenses. Amortization expense for the next five years related to amortizable intangible assets is expected to be as follows:
In January 2010, the Financial Accounting Standards Board (FASB) issued guidance on Improving Disclosures about Fair Value Measurements that requires additional disclosures regarding fair value measurements. The update changes fair value disclosures by requiring: (a) separate disclosure of the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and a description of the reasons for the transfers; and (b) separate disclosure of information about purchases, sales, issuances, and settlements of Level 3 fair value measurements. This guidance was effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures regarding Level 3 fair value measurements, which were effective for fiscal years beginning after December 15, 2010. The Company has included the required disclosures in the Notes to Consolidated Financial Statements.
In October 2010, the FASB issued Update Number 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. This update changes the definition of acquisition costs which may be capitalized to specify costs which relate directly to the successful acquisition of new or renewal insurance contracts; adds to the definition the concept of incremental costs; further restricts costs to be capitalized by identifying only those costs which may be capitalized; and requires additional granularity in the disclosures related to type of acquisition costs capitalized during the period. This guidance becomes effective for interim and annual reporting periods beginning after December 15, 2011. The Company has not yet determined if it will adopt the standard on a prospective or retrospective basis and is evaluating the impact the adoption will have on its financial statements.
The unaudited pro forma financial information for the year ended December 31, 2008 combines the results for EHI for the year ended December 31, 2008, which includes the results of AmCOMP subsequent to the acquisition date, and the historical results of AmCOMP for the period January 1, 2008 through October 31, 2008, including a charge of $8.0
million for realized Florida excessive profits for accident years 2003-2006. The historical financial information has been adjusted to give effect to pro forma items that are directly attributable to the Acquisition and are expected to have a continuing impact on the consolidated results. These items include adjustments for amortization of intangible assets acquired, increases in interest expense and decreases in underwriting and other expenses for integration and restructuring savings. The following table summarizes the pro forma financial information:
The Company’s estimates of fair value for financial assets and liabilities are based on the inputs used in the valuation and give the highest priority to quoted prices in active markets and require that observable inputs be used in the valuations when available. The disclosure of fair value estimates is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company’s significant market assumptions.
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 valuation methods used by the Company, by type of investment, are described below.
Equity Securities. The Company utilizes market quotations for equity securities that have quoted prices in active markets.
Each asset class is evaluated based on relevant market information, credit information, perceived market movements, and sector news. The market inputs utilized in the pricing evaluation include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The extent of the use of each market input depends on the asset class and the market conditions.
The Company had no Level 3 investment activity during the year ended December 31, 2010.
The amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the Company’s investments were as follows:
Based on reviews of the fixed maturity securities, the Company determined that unrealized losses as of December 31, 2010 and 2009 were primarily the result of changes in prevailing interest rates and not the credit quality of the issuers.
As of December 31, 2010, the Company expected to sell one fixed maturity security that was in an unrealized loss position before reaching maturity and recognized an impairment of less than $0.1 million as a realized loss on investments. All other fixed maturity securities whose fair values were 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, and a determination was made that it is not more likely than not that the Company will be required to sell the securities until fair value recovers above cost, or to maturity.
Net realized gains (losses) and the change in unrealized gains (losses) on fixed maturity and equity securities are determined on a specific-identification basis and were as follows:
The Company is required by various state laws and regulations to keep securities or letters of credit on deposit with the states in which it does business. As of December 31, 2010 and 2009, securities having a fair value of $558.6 million and $554.2 million, respectively, were on deposit. These laws and regulations govern not only the amount, but also the type of security that is 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 assumed by the Company. The fair value of securities held in trust for reinsurance at December 31, 2010 and 2009, was $52.9 million and $6.1 million, respectively.
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 increases GAAP net income, but does not increase taxable income. For the years ended December 31, 2010, 2009, and 2008 there were downward adjustments of pre-Privatization unpaid loss reserves of $3.9 million, $1.6 million, and $6.8 million, respectively.
As of December 31, 2010 and 2009, the Company had no unrecognized tax benefits. The following is a reconciliation of the beginning and ending amounts for unrecognized tax benefits and related interest for the year ended:
During the third quarter of the year ended December 31, 2008, the Company reversed $10.6 million of liabilities for previously unrecognized tax benefits (including $2.3 million of related accrued interest) as a result of certain statutory periods expiring. The total amount of the reversals reduced the effective tax rate during 2008.
Tax years 2007 through 2009 are subject to examination by the federal taxing authority.
The significant components of deferred income taxes, net, were as follows as of December 31:
At December 31, 2010, the Company had no net operating loss carry forward.
The major sources of this favorable development in all the years presented above include actual paid losses that have been less than expected and the impact of new information on selected patterns of claims emergence and payment used in the projection of future loss payments.
Loss reserves shown in the consolidated balance sheets are net of $18.2 million and $19.2 million for anticipated subrogation recoveries as of December 31, 2010 and 2009, respectively.
Ceded losses and LAE incurred includes the amortization of the deferred reinsurance gain - LPT Agreement.
Recoverables from reinsurers on unpaid losses and LAE amounted to $1.0 billion and $1.1 billion at December 31, 2010 and 2009, respectively. At December 31, 2010 and 2009, approximately $0.8 billion and $0.9 billion, respectively, of those recoverables were related to the LPT Agreement that was entered into in 1999 by the Fund and assumed by EICN. Under the LPT Agreement, substantially all of the Fund’s losses and LAE on claims incurred prior to July 1, 1995, have been ceded to three unaffiliated reinsurers on a 100% quota share basis. Investments have been placed in trust by the three reinsurers as security for payment of the reinsured claims. Under the LPT Agreement, $1.5 billion in liabilities for the incurred but unpaid losses and LAE related to claims incurred prior to July 1, 1995, were reinsured for consideration of $775 million. The LPT Agreement provides coverage up to $2.0 billion. Through December 31, 2010, the Company has paid losses and LAE claims totaling $530.8 million related to the LPT Agreement.
On December 28, 2010, the Company entered into the Third Amended and Restated Credit Agreement (Amended Credit Facility) with Wells Fargo Bank, National Association (Wells Fargo), under which the Company is 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 the Company’s 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. The Amended Credit Facility is secured by fixed maturity securities and cash and cash equivalents that had a fair value of $131.0 million at December 31, 2010. The Amended Credit Facility contains customary non-financial covenants and requires EHI to maintain $5.0 million of cash and cash equivalents at all times. The Company is currently in compliance with all applicable covenants.
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, 2010, the remaining lease terms expire over the next eight years.
The future lease payments for the next five years and thereafter on these non-cancelable operating and capital leases at December 31, 2010, were as follows:
The Company writes workers’ compensation insurance in California in which unpaid workers’ compensation liabilities from insolvent insurers are the responsibility of the California Insurance Guarantee Association (CIGA). The Company passes through the CIGA assessment to its policyholders via a surcharge based upon the estimated annual premium at the policy’s inception and has received, and expects to continue to receive, these guarantee fund assessments which are paid to CIGA based on premiums written by the Company. As of December 31, 2010 and 2009, the Company recorded an asset of $6.2 million and $7.1 million, respectively, in other assets, for assessments paid to the CIGA that includes prepaid policy surcharges still to be collected in the future from policyholders.
On November 4, 2009, the Board of Directors authorized a share repurchase program for up to $50.0 million of the Company’s common stock from January 1, 2010 through December 31, 2010 (the 2010 Program). Through September 30, 2010, the Company repurchased 3,291,709 shares of common stock under the 2010 Program at an average price of $15.19 per share, including commissions, for a total of $50.0 million.
The 14,813,992 shares of common stock repurchased by the Company since its initial public offering in February 2007 under all programs are reported as treasury stock, at cost, in the accompanying consolidated balance sheets. As of December 31, 2010, the average cost of common stock repurchased through the Company’s stock repurchase programs since inception was $15.40 per share.
Net stock-based compensation expense recognized in the accompanying consolidated statements of income was as follows:
During the year ended December 31, 2007, the Company made “founders’ grants” to employees, excluding senior officers, in the form of 186,000 nonqualified stock options and also awarded 420,916 nonqualified stock options to its officers. The founders’ grants awards vest pro rata on each of the first three anniversaries of the effective date of EHI’s IPO. The options awarded to the officers of the Company vested 25% on February 8, 2008, 2009, and 2010 and the remaining 25% vested pro rata on February 8, 2011. All options granted in 2007 have an exercise price equal to the fair market value of the Company’s common stock on the date of grant.
The fair value of the stock options granted is estimated using a Black-Scholes option pricing model that uses the assumptions noted in the following table. During the years ended December 31, 2010 and 2009, the expected stock price volatility used to value the options granted in 2010 and 2009 was based on the volatility of the Company’s historical stock price since February 2007. During the year ended December 31, 2008, the expected stock price volatility used to value the options granted was based on a weighted average of the Company’s historical stock price volatility since February 2007 and the historical volatility of peer companies’ stock for a period of time equal to the expected term of the options. The expected term of the options granted in 2010, 2009, and 2008 was calculated using the ‘plain-vanilla’ calculation provided in the guidance of the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107. The dividend yield was calculated using amounts authorized by the Board of Directors. The risk-free interest rate is the yield on the grant date of the options of U.S. Treasury zero coupon securities with a maturity comparable to the expected term of the options.
Changes in outstanding stock options for the year ended December 31, 2010 were as follows:
The fair value of options that vested in 2010 was $1.8 million and as of December 31, 2010, outstanding and exercisable options had intrinsic values of $3.5 million and $0.7 million, respectively. At December 31, 2010, the Company had yet to recognize $4.0 million in deferred compensation related to nonqualified stock options grants and expects to recognize these costs on a straight-line basis over the next 39 months.
On August 8, 2007, officers of the Company were awarded, in aggregate, 140,311 performance share awards (PSAs) for a performance period that ended December 31, 2009. These PSAs were subject to certain performance targets with ultimate payouts of 150% of the target award. The fair market value of the PSAs on the date of grant was $2.6 million. In March 2010, 196,071 PSAs were vested.
On May 28, 2009, the Company awarded the non-employee members of the Board of Directors, in the aggregate, 40,536 RSUs. These RSUs vest on May 28, 2010, except for accelerated vesting in the case of death or disability of the Director or in connection with a change of control. Vested RSUs will be settled in common stock within 30 days after the vesting date or can be deferred until six months following the awardees’ termination of service from the Board of Directors, at the awardees’ election. In the event of a deferral election, dividend equivalents are paid with respect to vested RSUs and are credited as additional vested RSUs.
On May 27, 2010, the Company awarded the non-employee members of the Board of Directors, in the aggregate, 30,728 RSUs. These RSUs vest on May 27, 2011, except for accelerated vesting in the case of death or disability of the Director or in connection with a change of control. Vested RSUs will be settled in common stock within 30 days after the vesting date or can be deferred until six months following the awardees’ termination of service from the Board of Directors, at the awardees’ election. In the event of a deferral election, dividend equivalents are paid with respect to vested RSUs and are credited as additional vested RSUs.
Changes in outstanding RSUs for the year ended December 31, 2010 were as follows:
The combined capital stock, surplus and net income of the Company’s insurance subsidiaries (EICN, ECIC, EPIC, and EAC), prepared in accordance with the statutory accounting practices of the National Association of Insurance Commissioners (NAIC) as well as statutory accounting principles permitted by the states of California, Florida, and Nevada (SAP), were as follows:
Treatment of the LPT Agreement and the surplus notes (see Notes 10 and 11) are the primary differences in the SAP-basis capital stock and total surplus of the insurance subsidiaries of $454.3 million and $661.3 million, and the GAAP-basis equity of the Company of $490.1 million and $498.4 million as of December 31, 2010 and 2009, respectively. Under SAP accounting, the retroactive reinsurance gain resulting from the LPT Agreement is recorded as a special component of surplus (special surplus funds) in the initial year of the contract, and not reported as unassigned surplus until the
The ability of EHI to pay dividends on the Company’s common stock and to pay other expenses will be dependent to a significant extent upon the ability of the Nevada domiciled insurance company, EICN, and the Florida domiciled insurance company, EPIC, to pay dividends to their immediate holding company, Employers Group, Inc. (EGI) and, in turn, the ability of EGI to pay dividends to EHI. ECIC and EAC have the ability to declare and pay dividends to EICN and EPIC, respectively, subject to certain restrictions. The amount of dividends each of the Company’s subsidiaries may pay to their immediate parent is limited by the laws of their respective state of domicile.
As of December 31, 2010, EICN had positive unassigned surplus of $243.1 million. During 2010, EICN paid dividends of $100.3 million to EGI, and subsequently from EGI to EHI. Additionally, as a result of approval by the Nevada Commissioner in 2010 and 2008, extraordinary dividends totaling $150.0 million and $355.0 million were paid to EGI, and in turn to EHI, prior to December 31, 2010 and 2008, respectively, from EICN’s special surplus. As a result of the payment of the extraordinary dividend from special surplus in 2010, any dividends paid by EICN through June 3, 2011 will require prior approval by the Nevada Commissioner. The maximum dividends that may be paid by EICN between June 3 and December 31, 2011 without prior approval is $51.9 million.
ECIC is subject to regulation by the California Department of Insurance (California DOI). The ability of ECIC to pay dividends was further limited by restrictions imposed by the California DOI in its approval of the Company’s October 1, 2008 reinsurance pooling agreement. Under that approval: (a) ECIC must initiate discussions of its business plan with the California DOI if its premium to policyholder surplus ratio exceeds 1.5 to 1; (b) ECIC will not exceed a ratio of premium to policyholder surplus of 2 to 1 without approval of the California DOI; (c) if at any time ECIC’s policyholder surplus decreases to 80% or less than the September 30, 2008 balance, ECIC shall cease issuing new policies in California but may continue to renew existing policies until it has (i) received a capital infusion to bring its surplus position to the same level as that as of September 30, 2008 and (ii) submitted a new business plan to the California DOI; (d) ECIC will maintain a risk based capital (RBC) level of at least 350%; (e) should ECIC fail to comply with any commitments listed herein, ECIC will consent to any request by the California DOI to cease issuing new policies in California, but may continue to renew existing policies until such time that as ECIC is able to achieve full compliance with each commitment; and (f) the obligations listed shall only terminate with the written consent of the California DOI.
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, 2010, 2009, and 2008, EPIC and EAC were in compliance with these statutes.
Additionally, EICN, ECIC, EPIC, and EAC are required to comply with NAIC RBC requirements. RBC is a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC RBC standards are used by regulators to determine appropriate regulatory actions relating to insurers that show signs of weak or deteriorating conditions. As of December 31, 2010, 2009, and 2008, EICN, ECIC, EPIC, and EAC’s total adjusted capital was above all regulatory action levels.
ECIC, EPIC, and EAC are subject to Florida statute and applicable regulations related to Florida excessive profits for workers’ compensation insurance companies. Florida excessive profits are calculated based upon a complex statutory formula which is applied over a rolling three year period. Companies are required to file annual excessive profits forms, and they are required to return so-called “Florida excessive profits” to policyholders in the form of a cash refund or credit toward the future purchase of insurance. As of December 31, 2010 and 2009, the Company had no amounts accrued for estimated additional Florida excessive profits based on its statutory underwriting results for the years ended 2007-2009.
Accumulated other comprehensive income, net, is comprised of unrealized appreciation on investments classified as available-for-sale and unrealized depreciation on derivatives, net of deferred tax expense. The following table summarizes the components of accumulated other comprehensive income, net:
The Company maintains two 401(k) defined contribution plans covering all eligible Company employees. One plan covers eligible employees of the Company that existed prior to the acquisition of AmCOMP (see Note 4) (the Employers 401(k) Plan). Beginning with the plan year 2007, the Company adopted a safe harbor matching contribution to the Employers 401(k) Plan. The safe harbor matching consists of a dollar-for-dollar matching contribution on salary deferrals up to 3% of compensation and then fifty-cents on the dollar matching contribution on salary deferrals from 3% to 5% of compensation. The Company’s contribution to the Employers 401(k) Plan was $1.4 million, $1.6 million, and $1.5 million for the years ended December 31, 2010, 2009, and 2008, respectively.
The second plan covers all eligible employees of the Company acquired in the AmCOMP acquisition (the AmCOMP 401(k) Plan). For employees covered under the AmCOMP 401(k) Plan, the Company’s discretionary match consists of a dollar-for-dollar matching contribution on salary deferrals up to 2% of compensation and then fifty-cents on the dollar matching contribution on salary deferrals for the next 4% of compensation. Expenses relating to the AmCOMP 401(k) Plan were $0.5 million and $0.7 million for the years ended December 31, 2010 and 2009, respectively, and $0.1 million for the two month period ended December 31, 2008.
The following table presents the net income and the weighted average shares outstanding used in the earnings per common share calculations for the years ended December 31:
Diluted earnings per share exclude outstanding options and other common stock equivalents in periods where the inclusion of such potential common stock instruments would be anti-dilutive in the periods presented. For the years ended December 31, 2010, 2009, and 2008, 0.9 million, 1.0 million, and 1.0 million, respectively, of stock options were excluded from diluted earnings per share, as the options’ exercise price was greater than the average market price of the common stock during the period. During the same periods, 0.4 million, 0.7 million, and 0.2 million, respectively, of outstanding RSU’s and stock options were excluded from diluted earnings per share under the treasury method, as the potential proceeds on settlement or exercise was greater than the value of shares acquired.
On July 2, 2010, the Company announced the reorganization of its operations to eliminate duplicative services and better align resources with business activity and growth opportunities. The Company combined its four regional operating units into two units, Eastern and Western, with the Strategic Partnerships and Alliances unit remaining structurally unchanged. In connection with these efforts and with general cost control efforts, the Company eliminated approximately 160 positions and announced the closure of four offices. The changes to the Company’s workforce were substantially completed in the third quarter of 2010.
The restructuring plan included a staff reduction of 14% of the Company’s total workforce and consolidation of corporate activities into the Company’s Reno, Nevada headquarters. During the year ended December 31, 2009, the Company incurred integration and restructuring charges of $5.7 million, including $2.8 million in personnel-related termination costs. These charges are included in underwriting and other operating expenses in the consolidated statements of income. Cash payments relating to the 2009 restructuring were $0.6 million and $5.1 million during the years ending December 31, 2010 and 2009, respectively. As of December 31, 2010 and 2009, the Company had $0.0 million and $0.6 million accrued, respectively, for the remaining 2009 restructuring costs that are included in accounts payable and accrued expenses in the accompanying consolidated balance sheets.
During the third quarter of 2009, the Company sold equity securities, the majority of which were previously impaired and realized a gain of $3.6 million.
Favorable prior accident year reserve development was recognized in each of the first two quarters of 2010 in the amounts of $11.1 million and $5.5 million, respectively, and unfavorable loss development of $0.9 million, was recognized in the fourth quarter of 2010. The unfavorable development in the fourth quarter was related to the write-off of certain reinsurance recoverables that had previously been accounted for as an allowance for bad debt.
During the third and fourth quarters of 2009, the estimate on the LPT ultimate contingent profit commission was increased by $14.1 million and $0.9 million, respectively, yielding a net negative commission expense for the third quarter 2009.