Employers Holdings, Inc.
2018 Annual Report
To our shareholders
Douglas D. Dirks
President and CEO
Michael D. Rumbolz
Chair of the Board
April 12, 2019
To our shareholders,
EMPLOYERS® had an exceptional year in 2018, as evidenced
by a return on equity of 14.4% and an adjusted return on equity
of 12.5%. Our strong performance in 2018 was primarily driven
by excellent underwriting results, which produced a combined
ratio of 86.1% and a combined ratio before the impact of our
loss portfolio transfer agreement (LPT) of 88.1%.
We achieved these outstanding underwriting results through
the successful execution of our key business strategies,
which include:
• We are now licensed to write business throughout
the continental United States, thereby diversifying our
geographic risk exposure.
•
•
•
Implementation of Predictive Analytics Initiatives that allow
us to more effectively target, price and underwrite profitable
classes of business.
Execution of innovative techniques to quickly and efficiently
settle claims, including the use of predictive analytics, the
use of cost saving medical provider networks, as well as
closing higher severity claims more quickly, resulting in
overall claim savings.
Strong new business growth, in particular with our
targeted, most profitable classes of business.
HIGHLIGHTS (1)
($ in millions, except share and per share amounts)
Year Ended December 31,
Net insurance premiums written
Net insurance premiums earned
Underwriting income
Net income
Net income per diluted share
Adjusted net income
Adjusted net income per diluted share
Net income before impact of the LPT
Net income before impact of the LPT per diluted share
2018
$ 742.8
$ 731.1
$ 101.7
$ 141.3
$ 4.24
$ 136.8
$ 4.11
$ 126.7
$ 3.80
2017
$ 723.7
$ 716.5
$ 68.0
$ 101.2
$ 3.06
$ 95.5
$ 2.89
$ 89.6
$ 2.71
Change
3 %
2 %
50 %
40 %
39 %
43 %
42 %
41 %
40 %
Diluted weighted average shares outstanding
33,311,337 sh
33,060,760 sh
250,577 sh
Combined ratio
Combined ratio before the impact of LPT
Return on equity
Adjusted return on equity
86.1 %
88.1 %
14.4 %
12.5 %
90.5 %
92.1 %
11.3 %
9.8 %
(4.4) pts
(4.0) pts
3.1 pts
2.7 pts
(1) A Glossary of Financial Measures and reconciliation tables of GAAP to non-GAAP measures follow
this letter.
Return on Equity
We are focused on producing an attractive return on equity for
Deferred Gain. Our $2.5 billion portfolio of fixed income investments
our shareholders. This measure is influenced by factors related to
provide us with a steady source of income. To minimize interest rate
both our income statement and balance sheet, such as the profit-
ability of our underwriting and investing decisions, claims and risk
management, reserve development, and growth in stockholders’
risk, our fixed income portfolio is weighted toward short-term and
intermediate-term bonds; however, our investment strategy balances
consideration of duration, yield, and credit risk. We also have a $0.2
equity. Our 2018 adjusted return on equity of 12.5% increased by 2.7
billion portfolio of equity securities. We strive to limit our exposure to
percentage points from that of 2017 largely as the result of a 43%
the equity price risk associated with these securities by diversifying
increase in our adjusted net income, partially offset by a significant
our holdings across several industry sectors. We believe that our
(and beneficial) increase in our adjusted stockholders’ equity.
current asset allocation meets our strategy to preserve capital for
Underwriting
Our net written premiums in 2018 increased $19 million from
2017. This growth occurred despite extremely competitive market
conditions, including a declining rate environment in vi rtually all of the
states in which we do business. As a result of our success on both
new and renewal business opportunities, our policies in-force
increased year-over-year, led by a 5% increase outside of the state of
California. This growth was achieved due to both our recent entry into
new states as well as growth in many of our existing states.
We grew our new business revenue $48 million year over year, a 29%
increase from 2017. For every month in 2018 we had increases in
submissions, quotes and bound policies over the comparable month
a year ago. A significant amount of our new business growth came
from targeted classes of business, which historically have been our
most profitable. This growth was equally strong in both our core
business distribution channel as well as our alternative distribution
channels.
Our 2018 current accident year loss ratio of 62.6% was consistent
with that of 2017 despite declining rates. Further, we experienced
significant favorable reserve development on our voluntary business
in 2018, for the fourth year in a row. These positive developments
reflect: (i) the ongoing benefits of our aforementioned underwriting
and claims strategies; and (ii) continued favorable loss trends
characterized by observed declines in frequency and stable levels
of severity.
Our 2018 commission expense ratio of 12.9% was also consistent
with that of 2017. The slight increase in 2018 reflects an increase in
the percentage of business produced by our alternative distribution
channels, which is subject to a higher commission rate.
Our 2018 underwriting and other operating expense ratio of 21.7%
increased 2.2 percentage points over that of 2017. The increase was
largely the result of our aggressive development and implementation
of new digital technologies and capabilities which are discussed later
in this report.
Investing
Our investment portfolio is structured to support our need for:
(i) optimizing our risk-adjusted total return; (ii) providing adequate
liquidity; (iii) facilitating financial strength and stability; and
(iv) ensuring regulatory and legal compliance.
As of December 31, 2018, the fair value of our investment portfolio
was $2.7 billion, or 2.3 times our shareholders’ equity including the
claims and policy liabilities and to provide sufficient capital resources
to support and grow our ongoing operations.
Our net investment income of $81 million increased 9% from 2017,
mainly as a result of an increase in market interest rates, as well as
some modest changes we made to our asset allocation during the
year. The pretax book yield on our invested assets was 3.4% in
2018 versus 3.1% in 2017.
12/31/2018
12/31/2017
50%
40%
30%
20%
10%
0%
Corporates States &
Munis
RMBS
Equities Bank Loans
UST &
Agencies
CMBS &
ABS
As of December 31, 2018, our fixed maturities had a
weighted average credit rating of AA- and a duration of 4.1
Financial Strength
Our stockholders’ equity including the Deferred Gain ended 2018
at $1.2 billion. In light of our financial strength, the Board of Directors
recently increased our quarterly dividend by 10%, to $0.22 per
share. Since 2015, the Board has increased our quarterly dividend
by nearly 300%.
As a result of the successes we achieved in 2018, our book value
per share, book value per share including the Deferred Gain, and
adjusted book value per share increased by 9.7%, 6.9% and 19.7%
during 2018, respectively. The table that follows illustrates
our success in growing book value per share.
PER SHARE AMOUNTS
December 31,
Percent Change (2)
2018
2017
2016
2018
2017
Book value per share
$ 31.08
$ 29.07
$ 26.16
9.7 % 13.4 %
Book value per share including
the Deferred Gain
$ 35.64
$ 34.09
$ 31.61
6.9 %
9.7 %
Adjusted book value per share
$ 36.06
$ 30.80
$ 29.29
19.7 % 7.2 %
(2) Represents the year-over-year change in book value per share after taking into account
dividends declared during such periods.
Looking Forward
During 2018, we initiated a plan of aggressive development and
implementation of new technologies and capabilities that we believe
will fundamentally transform and enhance the digital experience of our
customers. Earlier this year, we further defined these ongoing
initiatives to include: (i) continued investments in new technology,
data analytics and process improvement capabilities focused on
improving the agent experience and enhancing agent efficiency;
and (ii) the launch of Cerity, a subsidiary separate from our other
insurance businesses, which offers digital, direct-to-customer
workers’ compensation insurance solutions.
Regarding our agency initiatives, our implementation plans have
and will allow us to roll out new capabilities centered on the agent’s
experience as they are developed, consequently allowing us to
realize financial and operational benefits sooner.
Regarding Cerity, we officially launched our new direct-to-customer
platform in Illinois in January of this year and have since extended
its reach to Arizona, Nevada, Oregon, Texas, and Utah. Subject
to necessary regulatory approvals, we will continue to build-out
Cerity’s capabilities to meet the insurance needs of small businesses
nationwide as soon as possible.
The development and implementation of these new technologies and
capabilities increased our underwriting and other operating expense
ratio in 2018 and we expect that they will continue to increase our
underwriting and other operating expense ratio in 2019 and 2020,
as compared to that experienced in prior years. However, we expect
that these additional expenses will, over time, be more than offset by
anticipated new premium writings and operational efficiency gains.
We firmly believe that these new technological and intellectual
capabilities will support our future growth initiatives, permit direct
access to workers’ compensation insurance to those customers
seeking an online experience, provide us with greater pricing
precision, flexibility and operational efficiencies, and promote
long-term value creation.
Respectfully submitted,
Douglas D. Dirks
President and CEO
Michael D. Rumbolz
Chair of the Board
EMPLOYERS HOLDINGS, INC.
Summary Consolidated Balance Sheets
$ in millions, except per share amounts
ASSETS
Investments, cash and cash equivalents
Accrued investment income
Premiums receivable, net
Reinsurance recoverable on paid and unpaid losses
Deferred policy acquisition costs
Deferred income taxes, net
Contingent commission receivable—LPT Agreement
Other assets
Total assets
LIABILITIES
Unpaid losses and LAE
Unearned premiums
Commissions and premium taxes payable
Deferred Gain
Notes payable
Other liabilities
Total liabilities
STOCKHOLDERS' EQUITY
Common stock and additional paid-in capital
Retained earnings
Accumulated other comprehensive (loss) income, net
Treasury stock, at cost
Total stockholders’ equity
Total liabilities and stockholders’ equity
Stockholders' equity including the Deferred Gain (1)
Adjusted stockholders' equity (1)
Book value per share (1)
Book value per share including the Deferred Gain (1)
Adjusted book value per share (1)
December 31,
2018
December 31,
2017
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
2,829.7
18.0
333.1
511.1
48.2
26.9
32.0
120.2
3,919.2
2,207.9
336.3
57.3
149.6
20.0
129.9
2,901.0
389.4
1,030.7
(13.7 )
(388.2 )
1,018.2
3,919.2
1,167.8
1,181.5
31.08
35.64
36.06
2,752.0
19.6
326.7
544.2
45.8
28.7
31.4
91.7
3,840.1
2,266.1
318.3
55.3
163.6
20.0
69.1
2,892.4
381.8
842.2
107.4
(383.7 )
947.7
3,840.1
1,111.3
1,003.9
29.07
34.09
30.80
(1) See the accompanying Glossary of Financial Measures for information regarding our use of Non-GAAP Financial Measures.
EMPLOYERS HOLDINGS, INC.
Summary Consolidated Income Statements
$ in millions
Underwriting revenues:
Gross premiums written
Premiums ceded
Net premiums written
Net premiums earned
Underwriting expenses:
Losses and LAE incurred
Commission expense
Underwriting and other operating expenses
Underwriting income
Net investment income
Net realized and unrealized (losses) gains on investments (1)
Gain on redemption of notes payable
Other income
Interest and financing expenses
Other expenses
Income tax expense
Net income
Unrealized AFS investment gains (losses) arising during the period, net of tax
Reclassification adjustment for realized AFS investment losses (gains) in net income, net of tax
Total Comprehensive income
Net income
Amortization of the Deferred Gain – losses
Amortization of the Deferred Gain - contingent commission
LPT reserve adjustment
LPT contingent commission adjustments
Net income before impact of the LPT
Net realized and unrealized losses (gains) on investments
Gain on redemption of notes payable
Write-off of previously capitalized costs
Amortization of intangibles
Income tax (benefit) expense related to items excluded from Net income
Net impact of Federal tax reform
Adjusted net income (1)
Years Ended
December 31,
2018
2017
748.9
(6.1 )
742.8
731.1
(376.7 )
(94.2 )
(158.5 )
101.7
81.2
(13.1 )
—
1.2
(1.5 )
—
(28.2 )
141.3
(48.5 )
1.4
94.2
141.3
(9.9 )
(2.0 )
(2.2 )
(0.5 )
126.7
13.1
—
—
0.2
(2.8 )
(0.4 )
136.8
$
$
$
$
$
729.7
(6.0 )
723.7
716.5
(417.2 )
(91.4 )
(139.9 )
68.0
74.6
7.4
2.1
0.8
(1.4 )
(7.5 )
(42.8 )
101.2
19.9
(4.8 )
116.3
101.2
(9.3 )
(2.0 )
—
(0.3 )
89.6
(7.4 )
(2.1 )
7.5
0.3
0.6
7.0
95.5
$
$
$
$
$
(1) See the accompanying Glossary of Financial Measures for information regarding our use of Non-GAAP Financial Measures.
EMPLOYERS HOLDINGS, INC.
Return on Equity
$ in millions
Net income
Impact of the LPT Agreement
Net realized and unrealized losses (gains) on investments
Gain on redemption of notes payable
Write-off of previously capitalized costs
Amortization of intangibles
Income tax (benefit) expense related to items excluded from Net income
Net impact of Federal tax reform
Adjusted net income (1)
Stockholders' equity - end of period
Stockholders' equity - beginning of period
Average stockholders' equity
Stockholders' equity - end of period
Deferred Gain - end of period
Accumulated other comprehensive loss (income), before taxes - end of period
Income tax related to accumulated other comprehensive loss (income), before taxes -
end of period
Adjusted stockholders' equity - end of period
Adjusted stockholders' equity - beginning of period
Average adjusted stockholders' equity (1)
Return on stockholders' equity
Annualized return on stockholders' equity
Adjusted return on stockholders' equity (1)
Annualized adjusted return on stockholders' equity (1)
Years Ended
December 31,
2018
2017
A $
B $
141.3
(14.6 )
13.1
—
—
0.2
(2.8 )
(0.4 )
136.8
$
1,018.2
947.7
C $
983.0
$
D $
1,018.2
149.6
17.3
(3.6 )
1,181.5
1,003.9
1,092.7
$
$
$
$
$
$
101.2
(11.6 )
(7.4 )
(2.1 )
7.5
0.3
0.6
7.0
95.5
947.7
840.6
894.2
947.7
163.6
(136.0 )
28.6
1,003.9
941.0
972.5
A / C
14.4 %
11.3 %
B / D
12.5 %
9.8 %
(1) See the accompanying Glossary of Financial Measures for information regarding our use of Non-GAAP Financial Measures.
EMPLOYERS HOLDINGS, INC.
Combined Ratios
$ in millions
Net premiums earned
Losses and LAE incurred
Amortization of the Deferred Gain - losses
Amortization of the Deferred Gain - contingent commission
LPT reserve adjustment
LPT contingent commission adjustments
Losses and LAE before impact of the LPT (1)
Prior accident year favorable loss reserve development
Losses and LAE before impact of the LPT - current accident
year
Commission expense
Underwriting and other operating expenses
Combined ratio:
Loss and LAE ratio
Commission expense ratio
Underwriting and other operating expense ratio
Combined ratio
Combined ratio before impact of the LPT: (1)
Loss and LAE ratio before impact of the LPT
Commission expense ratio
Underwriting and other operating expense ratio
Combined ratio before impact of the LPT
Combined ratio before impact of the LPT: current accident
year: (1)
Loss and LAE ratio before impact of the LPT
Commission expense ratio
Underwriting and other operating expense ratio
Combined ratio before impact of the LPT: current accident year
A
B
C
D
E
F
B/A
E/A
F/A
C/A
E/A
F/A
D/A
E/A
F/A
Years Ended
December 31,
2018
2017
$
$
$
$
731.1
376.7
9.9
2.0
2.2
0.5
391.3
(66.2 )
457.5
94.2
158.5
$
$
$
$
51.5 %
12.9
21.7
86.1 %
53.5 %
12.9
21.7
88.1 %
62.6 %
12.9
21.7
97.2 %
716.5
417.2
9.3
2.0
—
0.3
428.8
(18.5 )
447.3
91.4
139.9
58.2 %
12.8
19.5
90.5 %
59.8 %
12.8
19.5
92.1 %
62.4 %
12.8
19.5
94.7 %
(1) See the accompanying Glossary of Financial Measures for information regarding our use of Non-GAAP Financial Measures.
EMPLOYERS HOLDINGS, INC.
Book Value Per Share
$ in millions, except per share amounts
Numerators:
Stockholders' equity
Plus: Deferred Gain
Stockholders' equity including the Deferred Gain (1)
Accumulated other comprehensive loss (income), before taxes
Income tax (benefit) expense related to accumulated other comprehensive loss
(income), before taxes
Adjusted stockholders' equity (1)
Denominator (shares outstanding)
Book value per share (1)
Book value per share including the Deferred Gain (1)
Adjusted book value per share (1)
Cash dividends declared per share
YTD Change in: (2)
Book value per share
Book value per share including the Deferred Gain
Adjusted book value per share
December 31,
2018
December 31,
2017
A $
B
C $
1,018.2
149.6
1,167.8
17.3
(3.6 )
1,181.5
D
32,765,792
A / D $
B / D
C / D
31.08
35.64
36.06
$
$
$
$
0.80
$
9.7 %
6.9
19.7
947.7
163.6
1,111.3
(136.0 )
28.6
1,003.9
32,597,819
29.07
34.09
30.80
0.60
13.4 %
9.7
7.2
(1) See the accompanying Glossary of Financial Measures for information regarding our use of Non-GAAP Financial Measures.
(2) Represents the year-over-year change in book value per share after taking into account dividends declared during such periods.
EMPLOYERS HOLDINGS, INC.
Earnings Per Share
$ in millions, except per share amounts
Numerators:
Net income
Impact of the LPT Agreement
Net income before impact of the LPT (1)
Net realized and unrealized losses (gains) on investments
Gain on redemption of notes payable
Write-off of previously capitalized costs
Amortization of intangibles
Income tax (benefit) expense related to items excluded from Net income
Net impact of Federal tax reform
Adjusted net income (1)
Denominators:
Average common shares outstanding (basic)
Average common shares outstanding (diluted)
Earnings per share:
Basic
Diluted
Earnings per share before impact of the LPT: (1)
Basic
Diluted
Adjusted earnings per share: (1)
Basic
Diluted
Years Ended
December 31,
2018
2017
A
B
$
$
C
$
D
E
A / D
A / E
B / D
B / E
C / D
C / E
$
$
$
141.3
(14.6 )
126.7
13.1
—
—
0.2
(2.8 )
(0.4 )
136.8
32,884,828
33,311,337
4.30
4.24
3.85
3.80
4.16
4.11
$
$
$
$
$
$
101.2
(11.6 )
89.6
(7.4 )
(2.1 )
7.5
0.3
0.6
7.0
95.5
32,501,576
33,060,760
3.11
3.06
2.76
2.71
2.94
2.89
(1) See the accompanying Glossary of Financial Measures for information regarding our use of Non-GAAP Financial Measures.
Glossary of Financial Measures
Within this report we present the following measures, each of which are “non-GAAP financial measures.” A
reconciliation of these measures to the Company's most directly comparable GAAP financial measures is included
herein. Management believes that these non-GAAP measures are important to the Company's investors, analysts and
other interested parties who benefit from having an objective and consistent basis for comparison with other
companies within our industry. Management further believes that these measures are more relevant than comparable
GAAP measures in evaluating our financial performance.
The LPT Agreement is a non-recurring transaction that does not result in ongoing cash benefits to the Company.
Management believes that providing non-GAAP measures that exclude the effects of the LPT Agreement
(amortization of deferred reinsurance gain, adjustments to LPT Agreement ceded reserves and adjustments to
contingent commission receivable) is useful in providing investors, analysts and other interested parties a
meaningful understanding of the Company's ongoing underwriting performance.
Deferred reinsurance gain (Deferred Gain) reflects the unamortized gain from the LPT Agreement. This gain has
been deferred and is being amortized using the recovery method, whereby the amortization is determined by the
proportion of actual reinsurance recoveries to total estimated recoveries, except for the contingent profit
commission, which is being amortized through June 30, 2024. Amortization is reflected in losses and LAE incurred.
Adjusted net income is net income excluding the effects of the LPT Agreement, net realized and unrealized gains
(losses) on investments (net of tax), net impact of Federal tax reform, gain on redemption of notes payable (net of
tax), write-off of previously capitalized costs (net of tax) and amortization of intangible assets (net of tax).
Management believes that providing this non-GAAP measures is helpful to investors, analysts and other interested
parties in identifying trends in the Company's operating performance because such items have limited significance
to its ongoing operations or can be impacted by both discretionary and other economic factors and may not represent
operating trends. The Company previously referred to Adjusted net income as Operating income.
Stockholders' equity including the Deferred Gain is stockholders' equity including the Deferred Gain. Management
believes that providing this non-GAAP measure is useful in providing investors, analysts and other interested parties
a meaningful measure of the Company's total underwriting capital.
Adjusted stockholders' equity is stockholders' equity including the Deferred Gain, less accumulated other
comprehensive income (net of tax). Management believes that providing this non-GAAP measure is useful to
investors, analysts and other interested parties since it serves as the denominator to the Company's operating return
on equity metric.
Return on stockholders' equity and Adjusted return on stockholders' equity. Management believes that these
profitability measures are widely used by our investors, analysts and other interested parties. The Company
previously referred to Adjusted return on stockholders' equity as Operating return on adjusted stockholders' equity.
Book value per share, Book value per share including the Deferred Gain, and Adjusted book value per share.
Management believes that these valuation measures are widely used by our investors, analysts and other interested
parties.
Net income, Combined ratio, and Combined ratio before impact of the LPT. Management believes that these
performance and underwriting measures are widely used by our investors, analysts and other interested parties.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
For the transition period from ____ to ____
Commission file number: 001-33245
EMPLOYERS HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Nevada
(State or other jurisdiction
of incorporation or organization)
04-3850065
(I.R.S. Employer
Identification Number)
10375 Professional Circle, Reno, Nevada 89521
(Address of principal executive offices and zip code)
(888) 682-6671
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock, $0.01 par value per share
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes
No
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes
No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files). Yes
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or
any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company,
or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” “smaller reporting
company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with
any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2018 was
$1,109,698,729.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
Class
Common Stock, $0.01 par value per share
February 14, 2019
32,829,863 shares outstanding
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Definitive Proxy Statement relating to the 2019 Annual Meeting of Stockholders are incorporated by reference in
Items 10, 11, 12, 13 and 14 of Part III of this report.
TABLE OF CONTENTS
Page
No.
FORWARD-LOOKING STATEMENTS
NOTE REGARDING RELIANCE ON STATEMENTS IN OUR CONTRACTS
Item 1
Business
Item 1A Risk Factors
Item 1B Unresolved Staff Comments
Item 2
Item 3
Properties
Legal Proceedings
Item 4 Mine Safety Disclosures
PART 1
PART II
Item 5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
Item 6
Selected Financial Data
Item 7 Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations
Item 7A Quantitative and Qualitative Disclosures About Market Risk
Item 8
Financial Statements and Supplementary Data
Item 9
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Item 9A Controls and Procedures
Item 9B Other Information
Item 10 Directors, Executive Officers and Corporate Governance
Item 11 Executive Compensation
PART III
Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13 Certain Relationships and Related Transactions, and Director Independence
Item 14 Principal Accountant Fees and Services
Item 15 Exhibits and Financial Statement Schedules
SIGNATURES
PART IV
2
3
3
4
14
22
22
22
22
23
25
27
46
48
85
85
85
86
86
86
87
87
88
95
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements if accompanied by
meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those
discussed. You should not place undue reliance on these statements, which speak only as of the date of this report. Forward-looking
statements include those related to our expected financial position, business, financing plans, litigation, future premiums, revenues,
earnings, pricing, investments, business relationships, expected losses, accident year loss estimates, loss experience, loss reserves,
acquisitions, competition, the impact of changes in interest rates, rate increases with respect to our business, the impact of key
business initiatives, future technologies, and planned investments. Statements including words such as “expect,” “intend,” “plan,”
“believe,” “estimate,” “may,” “anticipate,” “will,” or similar statements of a future or forward-looking nature identify forward-
looking statements.
We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information,
future events or otherwise, except as required by law. All forward-looking statements address matters that involve risks and
uncertainties that could cause actual results to differ materially from historical or anticipated results, depending on a number of
factors. These risks and uncertainties include, but are not limited to, those set forth in Item 1A, “Risk Factors” and the other
documents that we have filed with the Securities and Exchange Commission.
NOTE REGARDING RELIANCE ON STATEMENTS IN OUR CONTRACTS
The agreements included or incorporated by reference as exhibits to this Annual Report on Form 10-K may contain representations
and warranties by each of the parties to the applicable agreement. These representations and warranties were made solely for the
benefit of the other parties to the applicable agreement and:
•
were not intended to be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the
parties if those statements prove to be inaccurate;
• may have been qualified in such agreement by disclosures that were made to the other party in connection with the negotiation
of the applicable agreement;
• may apply contract standards of “materiality” that are different from “materiality” under the applicable securities laws; and
•
were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement.
Notwithstanding the inclusion of the foregoing cautionary statements, we acknowledge that we are responsible for considering
whether additional specific disclosures of material information regarding material contractual provisions are required to make the
statements in this report not misleading.
3
Item 1. Business
General
PART I
Employers Holdings, Inc. (EHI) is a holding company, which was incorporated in Nevada in 2005. Unless otherwise indicated,
all references to “we,” “us,” “our,” the “Company” or similar terms refer to EHI together with its subsidiaries. Through our wholly
owned insurance subsidiaries, Employers Insurance Company of Nevada, Employers Compensation Insurance Company,
Employers Preferred Insurance Company, and Employers Assurance Company, we are engaged in the commercial property and
casualty insurance industry, specializing in workers' compensation products and services. We had 704 full-time employees at
December 31, 2018 and our principal executive offices are located at 10375 Professional Circle in Reno, Nevada. Our insurance
subsidiaries have each been assigned an A.M. Best Company (A.M. Best) rating of “A-” (Excellent), with a “positive” outlook,
which is the 4th highest of 13 A.M. Best ratings.
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, amendments to those reports,
and Proxy Statements for our Annual Meetings of Stockholders are available free of charge on our website at www.employers.com
as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission
(SEC). Our website also provides access to reports filed by our Directors, executive officers and certain significant stockholders
pursuant to Section 16 of the Securities Exchange Act of 1934. In addition, our Corporate Governance Guidelines, Code of Business
Conduct and Ethics, Code of Ethics for Senior Financial Officers, and charters for the Audit, Board Governance and Nominating,
Executive, Finance, Compensation, and Risk committees of our Board of Directors are available on our website. Copies of these
documents may also be obtained free of charge by written request to Investor Relations, 10375 Professional Circle, Reno, Nevada
89521-4802. The SEC also maintains a website at www.sec.gov that contains the information that we file electronically with the
SEC.
Property and Casualty Insurance in General
A widely-used measure of relative underwriting performance for an insurance company is the combined ratio. Combined ratio is
calculated by adding: (i) the ratio of losses and loss adjustment expense (LAE) to earned premiums (known as the “loss and LAE
ratio”); (ii) the ratio of commission expenses to earned premiums (known as the “commission expense ratio”); and (iii) the ratio
of underwriting and other operating expenses to earned premiums (known as the “underwriting and operating expenses ratio”),
with each component determined in accordance with U.S. generally accepted accounting principles (GAAP). A combined ratio
under 100% indicates that an insurance company is generating an underwriting profit. A combined ratio over 100% indicates that
an insurance company is generating an underwriting loss.
In insurance and reinsurance operations, “float” arises when premiums are received before losses and other expenses are paid, an
interval that may extend over many years. During that time, the insurer has the opportunity to invest the money, thereby earning
investment income and generating investment gains and losses.
Insurance companies operating at a GAAP combined ratio of greater than 100% can be profitable when investment income and
net investment gains are taken into account. The length of time between receiving premiums and paying out losses and other
expenses, commonly referred to as the “tail,” can significantly affect how profitable float can be. Long-tail losses, such as workers’
compensation, pay out over longer periods of time providing us the opportunity to generate significant investment earnings from
float.
Underwriting income or loss is determined by deducting losses and LAE, commission expenses, and underwriting and other
operating expenses from net premiums earned.
Our Strategy
Business Strategy
Our strategy is to pursue profitable growth opportunities across market cycles and maximize total investment returns within the
constraints of prudent portfolio management. We pursue profitable growth opportunities by focusing on disciplined underwriting
and claims management, utilizing medical provider networks designed to produce superior medical and indemnity outcomes,
establishing and maintaining strong, long-term relationships with independent insurance agencies, development and
implementation of new technologies designed to transform the way small businesses and insurance agents utilize digital capabilities
and developing important alternative distribution channels. We continue to execute a number of ongoing business initiatives,
including: focusing on internal and customer-facing business process excellence; offering quotes and insurance coverage directly
to customers through a desktop and mobile-friendly platform; accelerating the settlement of open claims; diversifying our risk
exposure across geographic markets; utilizing a multi-company pricing platform; utilizing territory-specific pricing; development
4
and implementation of new technologies to transform the way insurance agents utilize digital capabilities; and leveraging data-
driven strategies to target, price, and underwrite profitable classes of business across all of our markets.
Capital Strategy
We believe that we have a strong capital position. We periodically reassess our capital needs to ensure an optimal use of capital
consistent with our goal to create shareholder value over the long-term. Our capital strategy is focused on supporting our business
operations by maintaining capital levels commensurate with our desired ratings from independent rating agencies, satisfying
regulatory constraints and legal requirements, and sustaining a level of financial flexibility to prudently manage our business
through insurance and economic cycles while allowing us to take advantage of investment opportunities, including acquisitions
of insurance and insurance-related entities, as and when they arise.
We also believe in returning capital not needed for these purposes to our stockholders through regular quarterly dividends and,
when feasible, common stock repurchases. During each of the years ended December 31, 2018, 2017, and 2016, we paid dividends
on our common stock of $26.7 million, $19.7 million, and $11.5 million, respectively, and during the three-year period ending
December 31, 2018, we repurchased $25.7 million of our common stock. Any future returns of capital to our stockholders are
dependent on a variety of factors, including our financial position, holding company liquidity, share price, corporate and regulatory
requirements, and other market and economic conditions.
Description of Business
We are a specialty provider of workers' compensation insurance focused on select small businesses in low to medium hazard
industries. We employ a disciplined, conservative underwriting approach designed to individually select specific types of
businesses, predominantly those in the lowest four of the seven workers' compensation insurance industry-defined hazard groups,
that we believe will have fewer and less costly claims relative to other businesses in the same hazard groups. Workers' compensation
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 operate as a single reportable
segment and conduct operations in 44 states and the District of Columbia (D.C.), with a concentration in California, where over
one-half of our business is generated.
In 1999, the Nevada State Industrial Insurance System (the Fund) entered into a retroactive 100% quota share reinsurance agreement
(LPT Agreement) through a loss portfolio transfer transaction with third party reinsurers. The LPT Agreement commenced on
June 30, 1999 and will remain in effect until all claims under the covered policies have closed, the LPT Agreement is commuted
or terminated, upon the mutual agreement of the parties, or the reinsurers' aggregate maximum limit of liability is exhausted,
whichever occurs first. The LPT Agreement does not provide for any additional termination terms. On January 1, 2000, we assumed
all of the assets, liabilities and operations of the Fund, including the Fund's rights and obligations associated with the LPT Agreement.
We account for the LPT Agreement as retroactive reinsurance. Upon entry into the LPT Agreement, an initial deferred reinsurance
gain (Deferred Gain) was recorded as a liability on our Consolidated Balance Sheets. We are entitled to receive a contingent profit
commission under the LPT Agreement. The contingent profit commission is estimated based on both actual paid results to date
and projections of expected paid losses under the LPT Agreement.
We had total assets of $3.9 billion at December 31, 2018 and 2017. The following table highlights key results of our operations
for the last three years.
Net premiums written
Total revenues
Net income
Combined ratio
Impact of the LPT Agreement(1)
Combined ratio before the impact of the LPT Agreement(1)
2018
Years Ended December 31,
2017
(in millions, except ratios)
2016
$
$
742.8
800.4
141.3
$
723.7
801.4
101.2
86.1%
2.0%
88.1%
90.5%
1.6%
92.1%
694.6
779.8
106.7
91.8%
2.3%
94.1%
(1) The impact of the LPT Agreement includes: (a) amortization of the Deferred Gain; (b) adjustments to LPT Agreement ceded reserves; and
(c) adjustments to Contingent commission receivable–LPT Agreement. The Deferred Gain reflects the unamortized gain from our LPT
Agreement. Under GAAP, this gain is deferred and is being amortized using the recovery method. Amortization is determined by the
proportion of actual reinsurance recoveries to total estimated recoveries over the life of the LPT Agreement, except for the contingent profit
commission, which is amortized through June 30, 2024. The amortization is reflected in losses and LAE. We periodically reevaluate the
remaining direct reserves subject to the LPT Agreement and the expected losses and LAE subject to the contingent profit commission under
the LPT Agreement. Our reevaluation results in corresponding adjustments, if needed, to loss reserves, ceded loss reserves, contingent
commission receivable, and the Deferred Gain, with the net effect being an increase or decrease to our net income. Combined ratio before
5
impact of the LPT Agreement is not a measurement of financial performance under GAAP, but rather reflects the difference in accounting
treatment between statutory accounting principles and GAAP, and should not be considered in isolation or as an alternative to the combined
ratio or any other measure of performance derived in accordance with GAAP.
Our insurance subsidiaries are domiciled in the following states:
Employers Insurance Company of Nevada (EICN)
Employers Compensation Insurance Company (ECIC)
Employers Preferred Insurance Company (EPIC)
Employers Assurance Company (EAC)
Products and Services
State of Domicile
Nevada
California
Florida
Florida
Workers' compensation provides insurance coverage for the statutorily prescribed benefits that employers are required to provide
to their employees who may be injured or suffer illness in the course of employment. The level of benefits varies by state, the
nature and severity of the injury or disease, and the wages of the injured worker. Each state has a statutory, regulatory, and
adjudicatory system that sets the amount of wage replacement to be paid, determines the level of medical care required to be
provided, establishes the degree of permanent impairment, and specifies the options in selecting healthcare providers. These state
laws generally require two types of benefits for injured employees: (a) medical benefits, including expenses related to the diagnosis
and treatment of an injury, disease, or both, as well as any required rehabilitation, and (b) indemnity payments, which consist of
temporary wage replacement, permanent disability payments, and death benefits to surviving family members.
Disciplined Underwriting
Our strategy is to focus on disciplined underwriting and continue to pursue profitable growth opportunities across market cycles.
We carefully monitor market trends to assess business opportunities that we expect will meet our pricing and risk standards. We
price our policies based on the specific risks associated with each potential insured rather than solely on the industry class in which
a potential insured is classified. Our disciplined underwriting approach, workers' compensation specialization, expertise in
underwriting small businesses, and data-driven strategies are critical elements of our culture, which we believe allow us to offer
competitive prices, diversify our risks, and out-perform the industry.
We execute our underwriting processes through automated systems and experienced underwriters with specific knowledge of the
local markets in which we operate. We have developed automated underwriting templates for specific classes of business that
produce faster quotes when certain underwriting criteria are met. Our underwriting guidelines consider many factors, such as type
of business, nature of operations, and risk exposures, and are designed to minimize or prevent underwriting of certain classes of
business that we view as being unattractive.
Loss Control
Our loss control professionals provide consultation to policyholders, as a component of our workers' compensation insurance
product, to assist them in preventing or reducing the frequency and severity of losses and containing costs once claims occur. They
also assist our underwriting personnel by conducting risk evaluations of potential and current policyholders and are an important
part of our underwriting discipline.
Premium Audit
We conduct premium audits on all of our policyholders annually upon the policy expiration or termination. Premium audits allow
us to comply with applicable state and reporting bureau requirements and to verify that policyholders have accurately reported
their payroll and employee job classifications. We also selectively perform audit reviews and/or update renewal payroll on policies
in certain classes of business or if unusual claims are filed or concerns are raised regarding projected annual payrolls, which could
result in substantial variances at final audit. These variances result in adjustments to our written and earned premiums, as well as
our net losses and LAE, in the periods in which they become known.
Claims and Medical Case Management
The role of our claims department is to actively and efficiently investigate, evaluate, and pay claims, and to aid injured workers
in returning to work in accordance with applicable laws and regulations. We have implemented rigorous claims guidelines and
control procedures in our claims units and have claims operations throughout the markets we serve. We also provide medical case
management services for those claims that we determine will benefit from such involvement.
We utilize an outcome-based medical network that incorporates predictive analytics to identify medical providers who achieve
superior clinical outcomes for our injured workers that allows us to optimize our provider network and enhance the quality of
care. We have also implemented a proactive pharmacy benefit management program that, along with our outcome-based medical
6
network, focuses on reducing claims costs and accelerating injured workers' return to work. We have an Injured Employee Hotline
that allows employees who are injured at work to receive professional nurse consultation by phone when reporting the claim. This
service has proven to reduce overall claims costs and is intended to ensure the injured worker receives appropriate and timely
medical care.
In addition to our medical networks, we work closely with local vendors, including attorneys, medical professionals, pharmacy
benefits managers, and investigators, to bring local expertise to our reported claims. We pay special attention to reducing costs
and have established discounting arrangements with the aforementioned service providers. We use preferred provider organizations,
bill review services, and utilization management to closely monitor medical costs. We actively pursue fraud and subrogation
recoveries to mitigate claims costs. Subrogation rights are based upon state and federal laws, as well as the insurance policies we
issue. Our fraud and subrogation efforts are handled through dedicated units.
We implemented a claim triage predictive model nationally that provides us with early identification of those claims likely to
develop into large losses. Leveraging this information, we ensure the right resources and strategies are brought to bear on those
claims early in the process.
Our claims department also provides claims management services for those claims incurred by the Fund, which were assumed by
EICN and are subject to the LPT Agreement with dates of injury prior to July 1, 1995. Additional information regarding the LPT
Agreement is set forth under “–Reinsurance–LPT Agreement.” We receive a management fee from the third party reinsurers equal
to 7% of the loss payments on these claims.
Information Technology
Core Operating Systems
We have an efficient, cost-effective and scalable infrastructure that complements our geographic reach and business model. We
continue to invest in technology to automate business processes and advanced data and analytics capabilities that will enable us
to lower our expense ratios while growing premiums over the long-term and set a foundation for our future needs. Our technology
saves our independent agents, brokers, and policyholders considerable time and maintains our competitiveness in our target markets.
Development and Implementation of New Technologies and Capabilities
We have recently initiated a plan of aggressive development and implementation of new technologies and capabilities that are
designed to help transform the way small businesses and insurance agents utilize digital capabilities to improve their customer
experience. We have chosen to reinvest the expected financial benefits from corporate income tax reform back into our business
over the next several years by greatly accelerating the development and deployment of these new digital capabilities. We believe
that these new technological and intellectual capabilities will support our future growth initiatives, provide direct access to workers'
compensation insurance to those customers seeking an online experience, provide us with greater pricing precision and flexibility,
and promote long-term value creation.
The development and implementation of these new technologies and capabilities increased our underwriting and other operating
expense ratio in 2018 and we expect that they will continue to increase our underwriting and other operating expense ratio in 2019
and 2020, as compared to that experienced in prior years. However, in future periods we expect that these additional expenses
will, over time, be more than offset by anticipated new premium writings and operational efficiency gains.
Business Continuity/Disaster Recovery
We maintain business continuity and disaster recovery plans for our critical business functions, including the restoration of
information technology infrastructure and applications. We utilize two data centers that act as production facilities and as disaster
recovery sites for each other. In addition, we utilize an off-site data storage facility for critical customer and systems data.
Cyber Security
Our operations rely on the secure processing, storage, and transmission of confidential and other information. Our business,
including our ability to adequately price products and services, establish reserves, provide an effective and secure service to our
customers and report our financial results in a timely and accurate manner, depends significantly on the integrity, availability and
timeliness of the data we maintain, as well as the data held by third parties, service providers and systems.
In an effort to ensure the privacy, confidentiality and integrity of this data, we are continually enhancing our cyber and other
information security in order to remain secure against emerging threats, as well as increasing our ability to detect, and recover
from, a cyber-attack or unauthorized access.
7
Customers and Workers' Compensation Premiums
The workers' compensation insurance industry classifies risks into seven hazard groups, as defined by the National Council on
Compensation Insurance (NCCI), based on severity of claims, with businesses in the first or lowest group having the lowest claims
costs.
We target select small businesses engaged in low to medium hazard industries. Our historical loss experience has been more
favorable for lower industry-defined hazard groups than for higher hazard groups. Further, we believe it is generally less costly
to service and manage the risks associated with these lower hazard groups. Our underwriters use their local market expertise and
disciplined underwriting to select specific types of businesses and risks within the classes of business we underwrite that allow
us to generate loss ratios that are better than the industry average.
We focus heavily on in-force premiums, which represent the estimated annual premium on all policies that have not expired or
have not been canceled. The following table shows a reconciliation of our gross premiums earned during the years ended
December 31, 2018, 2017, and 2016 to in-force premiums as of December 31, 2018, 2017, and 2016:
Gross premiums earned
Less: Final audit and retroactive adjustments
Less: Involuntary premium
In-force premium
2018
2017
(in millions)
2016
$
$
737.2
61.1
9.9
666.2
$
$
722.5
85.5
10.2
626.9
$
$
701.6
72.6
10.4
618.6
The following table sets forth our in-force premiums by hazard group and as a percentage of our total in-force premiums as of
December 31:
Hazard
Group
2018
Percentage
of 2018 Total
2017
Percentage
of 2017 Total
2016
Percentage
of 2016 Total
A
B
C
D
E
F
G
Total
$
$
189.5
171.6
188.7
100.5
12.2
3.2
0.5
666.2
(in millions, except percentages)
28.4% $
25.8
28.3
15.1
1.8
0.5
0.1
100.0% $
176.9
159.4
188.0
91.9
9.4
1.0
0.3
626.9
28.2% $
25.4
30.0
14.7
1.5
0.2
<0.1
100.0% $
162.6
161.0
195.7
88.0
9.8
1.3
0.2
618.6
26.3%
26.0
31.7
14.2
1.6
0.2
<0.1
100.0%
In-force premiums for our top ten types of insureds and as a percentage of our total in-force premiums as of December 31, 2018
were as follows:
Employer Classifications
In-force
Premiums
(in millions, except percentages)
Percentage
of Total
Restaurants and Other Eating Places
Traveler Accommodation
Automobile Dealers
Activities Related to Real Estate
Offices of Physicians
Automotive Repair and Maintenance
Other Store Retailers
Grocery Stores
Nondurable Goods Merchant Wholesalers
Services to Buildings and Dwellings
Total
$
$
185.5
51.0
46.5
24.5
22.2
19.6
19.2
18.5
17.9
16.2
421.1
27.8%
7.7
7.0
3.7
3.3
2.9
2.9
2.8
2.7
2.4
63.2%
We currently write business in 44 states and D.C. Our business is concentrated in California, which makes the results of our
operations more dependent on the trends that are unique to that state and that may differ from national trends. State and federal
legislation and regulation, court decisions, local competition, economic and employment trends, and workers' compensation
medical cost trends can materially impact our financial results.
8
As of December 31, 2018 and 2017, our policyholders had average annual in-force premiums of $7,281 and $7,333, respectively.
We are not dependent on any single policyholder and the loss of any single policyholder would not have a material adverse effect
on our business.
The following table shows our in-force premiums and number of policies in-force for each state with at least five percent of our
in-force premiums and all other states combined as of December 31:
State
2018
2017
2016
In-force
Premiums
Policies
In-force
In-force
Premiums
Policies
In-force
In-force
Premiums
Policies
In-force
(dollars in millions)
California
Florida
Other (42 states and D.C.)
Total
$
$
357.1
41.0
268.1
666.2
41,988
5,833
43,677
91,498
$
$
349.4
41.8
235.7
626.9
40,573
5,625
39,296
85,494
$
$
348.3
35.2
235.1
618.6
42,120
5,263
37,439
84,822
From 2016 through 2018, our total in-force premiums and number of policies in-force increased 7.7% and 7.9%, respectively.
During the same period, our in-force premiums in California increased 2.5%, while policy count in California decreased 0.3%,
reflecting our efforts to continue to diversify and grow our business in new and profitable markets. We cannot be certain how these
trends will ultimately impact our consolidated financial position and results of operations.
Our premiums are generally a function of the applicable premium rate, the amount of the insured's payroll, and if applicable, a
factor reflecting the insured's historical loss experience (experience modification factor). Premium rates vary by state according
to the nature of the employees' duties and the business of the employer. The premium is computed by applying the applicable
premium rate to each class of the insured's payroll after it has been appropriately classified. Total policy premium is determined
after applying an experience modification factor and a further adjustment, known as a schedule rating adjustment, and other
adjustments, which may be made in certain circumstances, to increase or decrease the policy premium. Schedule rating adjustments
are made based on individual risk characteristics of the insured and subject to maximum amounts as established in our premium
rate filings.
Our premium rates are based upon actuarial analyses for each state in which we do business, except in “administered pricing”
states, primarily Florida, Wisconsin, and Idaho, where premium rates are set by state insurance regulators.
Pricing on our renewals showed an overall price decrease of 11.8% for the year ended December 31, 2018, versus the rate level
in effect on such business a year earlier. We believe that we can continue to write attractive business due to favorable loss costs
and frequency trends and the success of our accelerated claims initiatives, despite the competitive market conditions we currently
face. Given the strength of our balance sheet, the execution of our underwriting, claims, and investment strategies, we believe that
we are well positioned for the current market cycle.
Losses and LAE Reserves and Loss Development
We are directly liable for losses and LAE under the terms of the insurance policies our insurance subsidiaries write. Significant
periods of time can elapse between the occurrence of an insured loss, the reporting of the loss to us, and our payment of that loss.
Loss reserves are reflected on our Consolidated Balance Sheets under the line item caption “Unpaid losses and loss adjustment
expenses.” Estimating reserves is a complex process that involves a considerable degree of judgment by management and is
inherently uncertain. Loss reserve estimates represent a significant risk to our business, which we attempt to mitigate by frequently
and routinely reviewing loss cost trends.
For a detailed description of our reserves, the judgments, key assumptions and actuarial methodologies that we use to estimate
our reserves, and the role of our consulting actuary, see “Item 7 –Management's Discussion and Analysis of Consolidated Financial
Condition and Results of Operations –Critical Accounting Policies –Reserves for Losses and LAE” and Note 9 in the Notes to
our Consolidated Financial Statements.
Reinsurance
Reinsurance is a transaction between insurance companies in which an original insurer, or ceding company, remits a portion of
its premiums to a reinsurer, or assuming company, as payment for the reinsurer assuming a portion of the risk. Excess of loss
reinsurance may be written in layers, in which a reinsurer or group of reinsurers accepts a band of coverage in excess of a specified
amount, or retention, and up to a specified amount. Any liability exceeding the coverage limits of the reinsurance program is
retained by the ceding company. The ceding company also bears the risk of a reinsurer's unwillingness or inability to pay. Consistent
with general industry practices, we purchase excess of loss reinsurance to protect us against the impact of large individual,
irregularly-occurring losses, and aggregate catastrophic losses from natural perils and terrorism, excluding nuclear, biological,
9
chemical, and radiological events. Such reinsurance reduces the magnitude of such losses on our net income and the capital of
our insurance subsidiaries.
Excess of Loss Reinsurance
Our current reinsurance program applies to all covered losses occurring between 12:01 a.m. July 1, 2018 and 12:01 a.m. July 1,
2019 and consists of one treaty covering excess of loss and catastrophic loss events in four layers of coverage. Our reinsurance
coverage is $190.0 million in excess of our $10.0 million retention on a per occurrence basis, subject to certain exclusions. The
coverage under our annual reinsurance programs that ended July 1, 2018 and 2017 was $190.0 million in excess of our $10.0
million retention on a per occurrence basis. We are solely responsible for any losses we suffer above $200.0 million except those
covered by the Terrorism Risk Insurance Program Reauthorization Act of 2015 (TRIPRA of 2015). See "—Terrorism Risk Insurance
Program." Covered losses which occur prior to expiration or cancellation of the agreement continue to be obligations of the
subscribing reinsurers, subject to the other conditions in the agreement. The subscribing reinsurers may terminate the agreement
only for our breach of the obligations of the agreement. We are responsible for the losses if the subscribing reinsurer cannot or
refuses to pay.
The agreement includes certain exclusions for which our subscribing reinsurers are not liable for losses, including but not limited
to losses arising from the following: reinsurance assumed by us under pooling arrangements; financial guarantee and insolvency;
certain nuclear risks; liability as a member, subscriber, or reinsurer of any pool, syndicate, or association, but not assigned risk
plans; liability arising from participation or membership in any insolvency fund; loss or damage caused by war other than acts of
terrorism or civil commotion; workers' compensation business covering persons employed in Minnesota; and any loss or damage
caused by any act of terrorism involving biological, chemical, nuclear, or radioactive pollution or contamination. Our underwriting
guidelines generally require that insured risks fall within the coverage provided in the reinsurance program. Executive review and
approval would be required if we were to write risks outside the reinsurance program.
The agreement provides that we, or any subscribing reinsurer, may request commutation of any outstanding claim or claims 10
years after the effective date of termination or expiration of the agreements and provides a mechanism for the parties to achieve
valuation for commutation. We may require a special commutation of the percentage share of any loss in the reinsurance program
of any subscribing reinsurer that is in runoff.
We believe that our reinsurance program meets our current needs.
LPT Agreement
In 1999, the Fund entered into a retroactive 100% quota share reinsurance agreement through a loss portfolio transfer transaction
with third party reinsurers. The LPT Agreement commenced on June 30, 1999 and will remain in effect until all claims under the
covered policies have closed, the agreement is commuted, or terminated, upon the mutual agreement of the parties, or the reinsurers'
aggregate maximum limit of liability is exhausted, whichever occurs earlier. The LPT Agreement does not provide for any additional
termination terms. On January 1, 2000, EICN assumed all of the assets, liabilities and operations of the Fund, including the Fund's
rights and obligations associated with the LPT Agreement.
Under the LPT Agreement, the Fund initially ceded $1.5 billion in liabilities for the incurred but unpaid losses and LAE related
to claims incurred prior to July 1, 1995, for consideration of $775.0 million in cash. The LPT Agreement, which ceded to the
reinsurers substantially all of the Fund's outstanding losses as of June 30, 1999 for claims with original dates of injury prior to
July 1, 1995, provides coverage for losses up to $2.0 billion, excluding losses for burial and transportation expenses. The estimated
remaining liabilities subject to the LPT Agreement were approximately $408.2 million and $438.9 million, as of December 31,
2018 and 2017, respectively (See Note 10 in the Notes to our Consolidated Financial Statements). Losses and LAE paid with
respect to the LPT Agreement totaled approximately $773.7 million and $749.3 million through December 31, 2018 and 2017,
respectively.
The reinsurers agreed to assume responsibilities for the claims at the benefit levels which existed in June 1999. The LPT Agreement
required each reinsurer to place assets supporting the payment of claims by them in a trust that requires collateral be held at a
specified level. The level must not be less than the outstanding reserve for losses and a loss expense allowance equal to 7% of
estimated paid losses discounted at a rate of 6%. If the assets held in trust fall below this threshold, we may require the reinsurers
to contribute additional assets to maintain the required minimum level of collateral. The value of these assets as of December 31,
2018 and 2017 was $311.6 million and $380.8 million, respectively.
The reinsurers currently party to the LPT Agreement are Chubb Bermuda Insurance Limited, XL Re Limited, and National
Indemnity Company. The contract provides that during the term of the agreement all reinsurers need to maintain a rating of not
less than “A-” (Excellent) as determined by A.M. Best. Currently, each of the reinsurers party to the LPT Agreement has a rating
that satisfies this requirement.
We account for the LPT Agreement as retroactive reinsurance. Upon entry into the LPT Agreement, an initial deferred reinsurance
gain was recorded as a liability on our Consolidated Balance Sheets as Deferred Gain. We are also entitled to receive a contingent
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profit commission under the LPT Agreement. The contingent profit commission is estimated based on both actual paid results to
date and projections of expected paid losses under the LPT Agreement. As of December 31, 2018, our estimate of the ultimate
expected contingent profit commission was $68.3 million, of which $36.4 million has been settled as of December 31, 2018.
Recoverability of Reinsurance
Reinsurance makes the assuming reinsurer liable to the ceding company to the extent of the reinsurance; however, it does not
discharge the ceding company from its primary liability to its policyholders in the event the reinsurer cannot or refuses to pay its
obligations under such reinsurance. We monitor the financial strength of our reinsurers and do not believe that we are currently
exposed to any material credit risk as substantially all of our reinsurance is recoverable from large, well-capitalized reinsurance
companies. At December 31, 2018, $2.0 million of our reinsurance recoverables were collateralized by cash or letters of credit
and an additional $311.6 million was held in trust accounts for our benefit in support of reinsurance recoverables related to the
LPT Agreement.
The following table provides information regarding our ceded reinsurance recoverables for losses and LAE as of December 31,
2018.
Reinsurer
ACE Property & Casualty Insurance Company
American Healthcare Indemnity Company
Aspen Insurance UK Limited
Chubb Bermuda Insurance Limited
Finial Reinsurance
Hannover Ruck SE
Lloyd's Syndicates
Markel Bermuda Limited
Munich Reinsurance America, Inc.
National Indemnity Company
National Union Fire Insurance Co of Pittsburgh
Partner Reinsurance Co of the US
Safety National Casualty Corporation
St Paul Fire & Marine Insurance Company
Swiss Reinsurance America Corporation
Tokio Marine America Insurance Company (TMAIC) (US)
Tokio Millenium Re AG
XL Bermuda Ltd
XL Reinsurance America Inc.
All Other
Total
A.M. Best
Rating(1)
Total Paid
Losses and
LAE
Total Unpaid
Losses and
LAE
(in millions)
Total
A++
N/R
A
A++
A-
A+
A
A
A+
A++
A
A
A+
A++
A+
A++
A+
A+
A+
Various
$
$
— $
—
—
0.6
—
—
0.1
—
—
3.2
0.1
—
—
—
0.1
0.1
—
2.1
—
0.4
6.7
$
1.7
2.1
4.7
40.8
4.5
8.9
36.8
1.2
3.4
224.5
1.2
1.5
2.0
4.0
8.8
6.4
2.8
142.9
1.3
4.9
504.4
$
$
1.7
2.1
4.7
41.4
4.5
8.9
36.9
1.2
3.4
227.7
1.3
1.5
2.0
4.0
8.9
6.5
2.8
145.0
1.3
5.3
511.1
(1) A.M. Best's highest financial strength ratings for insurance companies are “A++” and “A+” (Superior), “A” and “A-” (Excellent),
and “B++” and “B+” (Good).
We review the aging of our reinsurance recoverables on a quarterly basis and no material amounts due from our reinsurers have
been written-off as uncollectible since our inception in 2000. At December 31, 2018, less than 0.5% of our reinsurance recoverables
on paid losses were greater than 90 days overdue.
Terrorism Risk Insurance Program
The Terrorism Risk Insurance Act of 2002 (2002 Act) was initially enacted in November 2002, modified and extended in 2005,
again in 2007, and most recently in 2015. Now known as the Terrorism Risk Insurance Program Reauthorization Act of 2015
(TRIPRA of 2015), the program is designed to allow the insurance industry and the federal government to share losses from
declared terrorist events according to a specific formula, and is in effect until December 31, 2020.
The workers' compensation laws of the various states generally do not permit the exclusion of coverage for losses arising from
terrorism or nuclear, biological, chemical, or radiological attacks. In addition, we are not able to limit our losses arising from any
one catastrophe or from any one claimant. Our reinsurance policies exclude coverage for losses arising out of nuclear, biological,
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chemical, or radiological attacks. Under TRIPRA of 2015, federal protection may be provided to the insurance industry for certain
acts of foreign and domestic terrorism, including nuclear, biological, chemical, or radiological attacks.
The impacts of any future terrorist acts are unpredictable, and the ultimate impact on our insurance subsidiaries, if any, of losses
from any future terrorist acts will depend upon their nature, extent, location, and timing. We monitor the geographic concentration
of our policyholders to help mitigate the risk of loss from terrorist acts.
Investments
Our investment portfolio is structured to support our need for: (i) optimizing our risk-adjusted total return; (ii) providing adequate
liquidity; (iii) facilitating financial strength and stability; and (iv) ensuring regulatory and legal compliance.
As of December 31, 2018, the total amortized cost of our investment portfolio was $2.7 billion and its fair value was $2.7 billion.
These investments provide a steady source of income, which may fluctuate with changes in interest rates and our current investment
strategies.
While we oversee all of our investment activities, we employ independent investment managers (Investment Managers). Our
Investment Managers follow our written investment guidelines based upon strategies approved by our Board of Directors and our
asset allocation is reevaluated by management and reviewed by the Finance Committee of the Board of Directors on a quarterly
basis. We also utilize our Investment Managers' investment advisory services to assist us in developing a tailored set of portfolio
targets and objectives.
Additional information regarding our investment portfolio, including our approach to managing investment risk, is set forth under
“Item 7 –Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations –Liquidity and
Capital Resources –Investments” and “Item 7A –Quantitative and Qualitative Disclosures about Market Risk.”
Marketing and Distribution
We market our workers' compensation insurance products through independent local, regional, and national agents and brokers,
through alternative distribution channels, including our largest partner ADP, Inc. (ADP) and national, regional, and local trade
groups and associations, and direct-to-customer.
Independent Insurance Agents and Brokers
We establish and maintain strong, long-term relationships with independent insurance agencies that actively market our products
and services. We offer ease of doing business, provide responsive service, and pay competitive commissions. Our sales
representatives and underwriters work closely with independent agencies to market and underwrite our business. This results in
enhanced understanding of the businesses and risks we underwrite and the needs of prospective customers. We do not delegate
underwriting authority to agents or brokers. We are not dependent on any one agency and the loss of any one agency would not
be material to our operations.
We had approximately 4,000 independent agencies that marketed and sold our insurance products at December 31, 2018.
Independent agencies generated 76.7%, 72.8%, and 74.7% of in-force premiums at December 31, 2018, 2017, and 2016,
respectively, and our largest agency generated two percent or less of our in-force premiums at each of December 31, 2018, 2017,
and 2016.
Alternative Distribution Channels
We have developed and continue to add to important distribution channels for our products and services that serve as an alternative
to our strong independent agency distribution channel. These alternative distribution channels utilize partnerships and alliances
with entities such as payroll companies and health care and property and casualty insurers for which we provide workers’
compensation insurance coverage. Our small business, low to medium hazard workers’ compensation insurance products are
jointly offered and marketed with and through our partners and alliances.
Alternative distribution channels generated 23.1%, 21.6%, and 18.2% of our in-force premiums as of December 31, 2018, 2017,
and 2016, respectively.
A significant concentration of our business is being generated by ADP. ADP is the largest payroll services provider in the United
States servicing small and medium-sized businesses. As part of its services, ADP sells our workers' compensation insurance product
along with its payroll and accounting services through its insurance agency and field sales staff primarily to small businesses.
ADP generated 13.1%, 13.9%, and 12.0% of our in-force premiums as of December 31, 2018, 2017, and 2016, respectively. The
majority of this business is written through ADP's small business unit, which has accounts of 1 to 50 employees. We pay ADP
fees that are a percentage of premiums received for services provided through the ADP program.
Our relationship with ADP is non-exclusive; however, we believe we are a key partner of ADP for our selected markets and classes
of business. Our agreement with ADP may be terminated at any time by either party without cause upon a 120 day notice.
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Direct-to-Customer
To address the changing behaviors of small and micro-businesses, we recently launched Cerity Services, Inc. ("Cerity"), a subsidiary
separate from our other insurance businesses, which offers digital, direct-to-customer workers' compensation insurance solutions.
Cerity is based in Austin, Texas and began offering workers' compensation insurance in Illinois on January 23, 2019. Cerity focuses
on a limited number of classes where we believe that customers prefer an online experience.
Competition and Market Conditions
The insurance industry is highly competitive, and there is significant competition in the national workers' compensation industry
that is based on price and quality of services. We compete with other specialty workers' compensation carriers, state agencies,
multi-line insurance companies, professional employer organizations, self-insurance funds, and state insurance pools. Many of
our competitors are significantly larger, more widely known, and/or possess considerably greater financial resources. Our primary
competitors are AmTrust Financial Services, Inc., Berkshire Hathaway Homestate Companies, The Hartford Financial Services
Group, Inc., ICW Group, and Travelers Insurance Group Holdings, Inc.
The workers' compensation sector continued to see average medical and indemnity claims costs increase, while the industry overall
saw a decline in claim frequency in 2017, the most recent year for which industry data is available.
Regulation
State Insurance Regulation
Insurance companies are subject to regulation and supervision by the insurance regulator in the state in which they are domiciled
and, to a lesser extent, other states in which they conduct business. These state agencies have broad regulatory, supervisory, and
administrative powers, including, among other things, the power to grant and revoke licenses to transact business, license agencies,
set the standards of solvency to be met and maintained, determine the nature of, and limitations on, investments and dividends,
approve policy forms and rates in some states, periodically examine financial statements, determine the form and content of
required financial statements, set the rates that we may charge in some states, and periodically examine market conduct.
Detailed annual and quarterly financial statements, prepared in accordance with statutory accounting principles (SAP), and other
reports are required to be filed with the insurance regulator in each of the states in which we are licensed to transact business. The
California Department of Insurance (California DOI), Florida Office of Insurance Regulation (Florida OIR), and Nevada Division
of Insurance (Nevada DOI) periodically examine the statutory financial statements of their respective domiciliary insurance
companies. In 2015, the California DOI and Nevada DOI completed financial examinations for ECIC and EICN, respectively,
and in 2016, the Florida OIR completed its regularly scheduled exams for EPIC and EAC. There were no material findings.
Many states have laws and regulations that limit an insurer's ability to withdraw from a particular market. For example, states may
limit an insurer's ability to cancel or not renew policies. Furthermore, certain states prohibit an insurer from withdrawing one or
more lines of business from the state, except pursuant to a plan that is approved by the state insurance regulator. The state insurance
regulator may disapprove a plan that may lead to market disruption. We are subject to laws and regulations of this type, and these
laws and regulations may restrict our ability to exit unprofitable markets.
Holding Company Regulation. Nearly all states have enacted legislation that regulates insurance holding company systems. Each
insurance company in a holding company system is required to register with the insurance regulator of its state of domicile and
furnish information concerning the operations of companies within the holding company system that may materially affect the
operations, management or financial condition of the insurers within the system. All transactions within a holding company system
affecting an insurer must have fair and reasonable terms, the charges or fees for services performed must be reasonable, the insurer's
total statutory surplus following any transaction must be both reasonable in relation to its outstanding liabilities and adequate for
its needs, and are subject to other standards and requirements established by law and regulation. Notice to state insurance regulators
is required prior to the consummation of certain affiliated and other transactions involving our insurance subsidiaries and such
transactions may be disapproved by the state insurance regulators.
Pursuant to applicable insurance holding company laws, EICN is required to register with the Nevada DOI, ECIC is required to
register with the California DOI, and EPIC and EAC are required to register with the Florida OIR. Additionally, EPIC and EAC
are commercially domiciled in California and are required to register with the California DOI. Under these laws, the respective
state insurance regulators may examine us at any time, require disclosure of material transactions, and require prior notice for, or
approval of, certain transactions.
Change of Control. Our insurance subsidiaries are domiciled in Florida, California and Nevada. The insurance laws of these states
generally require that any person seeking to acquire control of a domestic insurance company obtain the prior approval of the
state's insurance commissioner. In Florida, "control" is generally presumed to exist through the direct or indirect ownership of 5%
or more of the voting securities of a domestic insurance company or of any entity that controls a domestic insurance company. In
California and Nevada, "control" is presumed to exist through the direct or indirect ownership of 10% or more of the voting
13
securities of a domestic insurance company or of any entity that controls a domestic insurance company. In addition, insurance
laws in many states in which we are licensed require pre-notification to the state's insurance commissioner of a change in control
of a non-domestic insurance company licensed in those states.
Statutory Accounting and Solvency Regulations. State insurance regulators closely monitor the financial condition of insurance
companies reflected in financial statements based on SAP and can impose significant financial and operating restrictions on an
insurance company that becomes financially impaired under SAP guidelines. State insurance regulators can generally impose
restrictions or conditions on the activities of a financially impaired insurance company, including: the transfer or disposition of
assets; the withdrawal of funds from bank accounts; payment of dividends or other distributions; the extension of credit or the
advancement of loans; and investments of funds, including business acquisitions or combinations.
Financial, Dividend, and Investment Restrictions. State laws require insurance companies to maintain minimum levels of surplus
and place limits on the amount of premiums a company may write based on the amount of that company's surplus. These limitations
may restrict the rate at which our insurance operations can grow.
State laws also require insurance companies to establish reserves for payments of policyholder liabilities and impose restrictions
on the kinds of assets in which insurance companies may invest. These restrictions may require us to invest in assets more
conservatively than we would if we were not subject to state restrictions and may prevent us from obtaining as high a return on
our assets as we might otherwise be able to realize absent the restrictions.
The ability of EHI to pay dividends on common stock, repurchase common stock, and to pay other expenses will be dependent
to a significant extent upon the ability of our insurance subsidiaries (EICN, ECIC, EPIC, and EAC) to pay dividends to their
immediate holding company, Employers Group, Inc. (EGI) and, in turn, the ability of EGI to pay dividends to EHI. Additional
information regarding financial, dividend, and investment restrictions is set forth in Note 15 in the Notes to our Consolidated
Financial Statements.
Insurance Assessments. All of the states where our insurance subsidiaries are licensed to transact business require property and
casualty insurers doing business within the state to pay various insurance assessments. We accrue 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 defer these costs and recognize them as an expense as the related premiums are earned. Various mechanisms
exist in some of these states for assessed insurance companies to recover certain assessments. Additional information regarding
insurance assessments is set forth in Note 12 in the Notes to our Consolidated Financial Statements.
Pooling Arrangements. As a condition to conducting business in some states, insurance companies are required to participate in
mandatory workers' compensation shared market mechanisms, or pooling arrangements, which provide workers' compensation
insurance coverage to private businesses that are otherwise unable to obtain coverage.
The National Association of Insurance Commissioners (NAIC). The NAIC is a group formed by state insurance regulators to
discuss issues and formulate policy with respect to regulation, reporting, and accounting of and by U.S. insurance companies.
Although the NAIC has no legislative authority and insurance companies are at all times subject to the laws of their respective
domiciliary states and other states in which they conduct business, the NAIC is influential in determining the form in which
insurance laws are enacted. Model Insurance Laws, Regulations, and Guidelines (Model Laws) have been promulgated by the
NAIC as a minimum standard by which state regulatory systems and regulations are measured. Adoption of state laws that provide
for substantially similar regulations to those described in the Model Laws is a requirement for accreditation of state insurance
regulatory agencies by the NAIC.
Under the Model Laws, insurers are required to maintain minimum levels of capital based on their investments and operations.
These risk-based capital (RBC) requirements provide a standard by which regulators can assess the adequacy of an insurance
company's capital and surplus relative to its operations. An insurance company must maintain capital and surplus of at least 200%
of the RBC computed by the NAIC's RBC model, known as the “Authorized Control Level” of RBC. At December 31, 2018, each
of our insurance subsidiaries had total adjusted capital in excess of the minimum RBC requirements.
The key financial ratios of the NAIC's Insurance Regulatory Information System (IRIS) were developed to assist state regulators
in overseeing the financial condition of insurance companies. These ratios are reviewed by financial examiners of the NAIC and
state insurance regulators for the purposes of detecting financial distress and preventing insolvency and to select those companies
that merit highest priority in the allocation of the regulators' resources. IRIS identifies 13 key financial ratios and specifies a “usual
range” for each. Departure from the usual ranges on four or more of the ratios can lead to inquiries from individual state insurance
regulators as to certain aspects of an insurer's business. None of our insurance subsidiaries is currently subject to any action by
any state regulator with respect to IRIS ratios.
Item 1A. Risk Factors
Investing in our common stock involves risks. In evaluating our company, you should carefully consider the risks described below,
together with all the information included or incorporated by reference in this report. The risks facing our company include, but
14
are not limited to, those described below. Additional risks that we are not presently aware of or that we currently believe are
immaterial may also impair our business operations. The occurrence of one or more of these events could significantly and adversely
affect our business, financial condition, results of operations, cash flows, and stock price, and you could lose all or part of your
investment.
Our liability for losses and LAE is based on estimates and may be inadequate to cover our actual losses and expenses.
We must establish and maintain reserves for our estimated losses and LAE. We establish loss reserves on our financial statements
that represent an estimate of amounts needed to pay and administer claims with respect to insured claims that have occurred,
including claims that have occurred but have not yet been reported to us. Loss reserves are estimates of the ultimate cost of
individual claims based on actuarial estimation techniques, are inherently uncertain, and do not represent an exact measure of
liability. Additionally, any changes to our claims management and/or actuarial reserving processes could introduce volatility in
our estimates of losses and LAE. Any changes in these estimates could be material and could have an adverse effect on our results
of operations and financial condition during the period the changes are made.
Several factors contribute to the inherent uncertainty in establishing estimated losses, including the length of time to settle long-
term, severe cases, claim cost inflation (deflation) trends, and uncertainties in the long-term outcome of legislative reforms.
Judgment is required in applying actuarial techniques to determine the relevance of historical payment and claim settlement patterns
under current facts and circumstances. In certain states, we have a relatively short operating history and must rely on a combination
of industry experience and our specific experience regarding claims emergence and payment patterns, medical cost inflation, and
claim cost trends, adjusted for future anticipated changes in claims-related and economic trends, as well as regulatory and legislative
changes, to establish our best estimate of reserves for losses and LAE. As we receive new information and update our assumptions
over time regarding the ultimate liability, our loss reserves may prove to be inadequate to cover our actual losses, and we have in
the past made, and may in the future make, adjustments to our reserves based on a number of factors.
The insurance business is subject to extensive regulation and legislative changes, which impact the manner in which we operate
our business.
Our insurance business is subject to extensive regulation by the applicable state agencies in the jurisdictions in which we operate,
most significantly by the insurance regulators in California, Florida, and Nevada, the states in which our insurance subsidiaries
are domiciled. Changes in laws and regulations could have a significant negative impact on our business. As of December 31,
2018, more than one-half of our in-force premiums were generated in California. Accordingly, we are particularly affected by
regulation in California.
More generally, insurance regulators have broad regulatory powers designed to protect policyholders and claimants, and not
stockholders or other investors. Regulations vary from state to state, but typically address or include:
standards of solvency, including RBC measurements;
restrictions on the nature, quality, and concentration of investments;
restrictions on the types of terms that we can include in the insurance policies we offer;
requirements for the handling and reporting of claims and procedures for adjusting claims;
restrictions on the way rates are developed and premiums are determined;
the manner in which agents may be appointed;
establishment of liabilities for unearned premiums, unpaid losses and LAE;
limitations on our ability to transact business with affiliates;
•
•
•
• mandates that may affect wage replacement and medical care benefits paid under the workers' compensation system;
•
•
•
•
•
• mergers, acquisitions, and divestitures involving our insurance subsidiaries;
•
•
•
•
licensing requirements and approvals that affect our ability to do business;
compliance with all applicable privacy laws;
compliance with cyber-security laws and regulations;
potential assessments for the settlement of covered claims under insurance policies issued by impaired, insolvent, or
failed insurance companies or other assessments imposed by regulatory agencies; and
the amount of dividends that our insurance subsidiaries may pay to EGI and, in turn, the ability of EGI to pay dividends
to EHI.
•
Workers' compensation insurance is statutorily provided for in all of the states in which we do business. State laws and regulations
specify the form and content of policy coverage and the rights and benefits that are available to injured workers, their representatives,
and medical providers. Additionally, any retrospective change in regulatorily required benefits could materially increase the benefits
costs that we would be responsible for to the extent of the legislative increase. In “administered pricing” states, insurance rates
are set by the state insurance regulators and are adjusted periodically. Rate competition is generally not permitted in these states.
Of the states in which we currently operate, Florida, Wisconsin, and Idaho are administered pricing states. Additionally, we are
exposed to the risk that other states in which we operate will adopt administered pricing laws.
15
Legislation and regulation impact our ability to investigate fraud and other abuses of the workers' compensation system in the
states in which we do business. Our relationships with medical providers are also impacted by legislation and regulation, including
penalties for failure to make timely payments.
Federal legislation typically does not directly impact our workers' compensation business, but our business can be indirectly
affected by changes in healthcare, occupational safety and health, and tax and financial regulations. Since healthcare costs are the
largest component of our loss costs, we may be impacted by changes in healthcare legislation, such as the effects of the Affordable
Care Act, or any modification thereof, which could affect healthcare costs and delivery in the future. There is also the possibility
of federal regulation of insurance.
This extensive regulation of our business may affect the cost or demand for our products and may limit our ability to obtain rate
increases or to take other actions that we might desire to maintain our profitability. In addition, we may be unable to maintain all
required approvals or comply fully with applicable laws and regulations, or the relevant governmental authority's interpretation
of such laws and regulations. If that were to occur, we might lose our ability to conduct business in certain jurisdictions. Further,
changes in the level of regulation of the insurance industry or changes in laws or regulations or interpretations by regulatory
authorities could impact our operations, require us to bear additional costs of compliance, and impact our profitability.
If we fail to price our insurance policies appropriately, our business competitiveness, financial condition, and results of
operations could be materially adversely affected.
Premiums are based on the particular class of business and our estimates of expected losses and LAE and other expenses related
to the policies we underwrite. We analyze many factors when pricing a policy, including the policyholder's prior loss history and
industry classification. Inaccurate information regarding a policyholder's past claims experience or inaccurate estimates of expected
losses and LAE could put us at risk for mispricing our policies, which could have a material adverse effect on our business, financial
condition, and results of operations. For example, when initiating coverage on a policyholder, we must rely on the information
provided by the policyholder, agent, or the policyholder's previous insurer(s) to properly estimate future claims expense. In order
to set premium rates accurately, we must utilize an appropriate pricing model that correctly assesses risks based on their individual
characteristics and takes into account actual and projected industry characteristics.
We rely on statistical data models and analytics that leverages internal and external data.
We use models to help make decisions related to, among other things, underwriting, pricing, claims management, reserving, capital
allocation, and investments. These models incorporate various assumptions and forecasts that are subject to inherent limitations
of any statistical analysis as the historical internal and industry data and assumptions used in the models may not accurately reflect
the future. As a result, actual results may differ materially from expectations and our results of operations and financial condition
could be materially adversely affected.
As our industry becomes increasingly reliant on data analytics to improve pricing and be more targeted in marketing, our competitors
may have better information or be more efficient in leveraging analytics than we are, which could put us at a competitive
disadvantage.
Our concentration in California ties our performance to the business, economic, demographic, natural perils, competitive, and
regulatory conditions in that state.
Our business is concentrated in California, where we generated 54% of our in-force premiums as of December 31, 2018.
Accordingly, the loss environment and unfavorable business, economic, demographic, natural perils, competitive, and regulatory
conditions in California could negatively impact our business.
Many California businesses are dependent on tourism revenues, which are, in turn, dependent on a robust economy. A downturn
in the national economy or the economy of California, or any other event that causes deterioration in tourism, could adversely
impact small businesses, such as restaurants, that we have targeted as customers. The departure from California or insolvency of
a significant number of small businesses could also have a material adverse effect on our financial condition and results of
operations. California is also exposed to climate and environmental changes, natural perils such as earthquakes, and susceptible
to the possibility of pandemics or terrorist acts. Additionally, the workers' compensation industry has seen an increase in claims
litigation in California, which could expose us to further liabilities beyond what are currently expected and included on our
financials. Because of the concentration of our business in California, we may be exposed to losses and business, economic, and
regulatory risks or risk from natural perils that are greater than the risks associated with companies with greater geographic
diversification.
We rely on independent insurance agents and brokers.
We market and sell the majority of our insurance products through independent, non-exclusive insurance agents and brokers. These
agents and brokers are not obligated to promote our products and can and do sell our competitors' products. In addition, these
agents and brokers may find it easier to promote the broader range of programs of some of our competitors than to promote our
single-line workers' compensation insurance products. Additionally, any changes in the distribution of our insurance products,
16
including Cerity's direct-to-customer workers' compensation insurance offerings or other potential market disruptions, could
negatively impact the relationship between us and our independent agents and brokers. The loss of a number of our independent
agents and brokers or the failure or inability of these agents and brokers to successfully market our insurance programs could have
a material adverse effect on our business, financial condition, and results of operations.
We rely on our relationship with our principal distribution partner.
We have an agreement with our principal distribution partner, ADP, to market and service our insurance products through its sales
forces and insurance agencies. ADP generated 13.1% of our total in-force premiums as of December 31, 2018. Our agreement
with ADP is not exclusive, and ADP may terminate the agreement without cause upon a 120-day notice. The termination of this
agreement, our failure to maintain a good relationship with ADP, or its failure to successfully market our products may materially
reduce our revenues and could have a material adverse effect on our results of operations. In addition, we are subject to the risk
that ADP may face financial difficulties, reputational issues, or problems with respect to its own products and services, any of
which may lead to decreased sales of our products and services. Moreover, if ADP consolidates or aligns itself with another
company or changes its products that are currently offered with our workers' compensation insurance products, we may lose
business or suffer decreased revenues.
We are also subject to credit risk with respect to ADP, as it collects premiums on our behalf for the workers' compensation products
that are marketed together with its own products. Any failure to remit such premiums to us or to remit such amounts on a timely
basis could have an adverse effect on our results of operations.
A downgrade in our financial strength rating could reduce the amount of business that we are able to write or result in the
termination of certain of our agreements with our strategic partners.
Rating agencies rate insurance companies based on financial strength as an indication of an ability to pay claims. Our insurance
subsidiaries are currently assigned a group letter rating of “A-” (Excellent), with a “positive” outlook, by A.M. Best, which is the
rating agency that we believe has the most influence on our business. This rating is assigned to companies that, in the opinion of
A.M. Best, have demonstrated an excellent overall performance when compared to industry standards. A.M. Best considers
“A-” (Excellent) rated companies to have an excellent ability to meet their ongoing obligations to policyholders. This rating does
not refer to our ability to meet non-insurance obligations.
The financial strength ratings of A.M. Best and other rating agencies are subject to periodic review using, among other things,
proprietary capital adequacy models, and are subject to revision or withdrawal at any time. Insurers' financial strength ratings are
directed toward the concerns of policyholders and insurance agents and are not intended for the protection of investors or as a
recommendation to buy, hold, or sell securities. Our competitive position relative to other companies is determined in part by our
financial strength rating. A reduction in our A.M. Best rating could adversely affect the amount of business we could write, as
well as our relationships with independent agents and brokers and our principal distribution partners, reinsurers, and other business
partners.
A.M. Best may increase the frequency and scope of its reviews, and request additional information from the companies that it
rates, including additional information regarding the valuation of investment securities held. We cannot predict what actions rating
agencies may take, or what actions we may take in response to the actions of rating agencies.
If we are unable to obtain reinsurance or collect on ceded reinsurance, our ability to write new policies and to renew existing
policies could be adversely affected and our financial condition and results of operations could be materially adversely affected.
At December 31, 2018, we had $511.1 million of reinsurance recoverables for paid and unpaid losses and LAE, of which $6.7
million was due to us on paid claims.
We purchase reinsurance to protect us against the costs of severe claims and catastrophic events, including natural perils and acts
of terrorism, excluding nuclear, biological, chemical, and radiological events. On July 1, 2018, we entered into a new reinsurance
program that is effective through June 30, 2019. The reinsurance program consists of one treaty covering excess of loss and
catastrophic loss events in four layers of coverage. Our reinsurance coverage is $190.0 million in excess of our $10.0 million
retention on a per occurrence basis, subject to certain exclusions.
The availability, amount, and cost of reinsurance depend on market conditions and our loss experience and may vary significantly.
We cannot be certain that our reinsurance agreements will be renewed or replaced prior to their expiration with terms satisfactory
to us. If we are unable to renew or replace our reinsurance agreements with terms satisfactory to us, our net liability on individual
risks would increase and we would have greater exposure to large and catastrophic losses, which could have a material adverse
effect on our financial condition and results of operations.
In addition, we are subject to credit risk with respect to our reinsurers, and they may refuse to pay or delay payment of losses we
cede to them. We remain liable to our policyholders even if we are unable to make recoveries that we believe we are entitled to
under our reinsurance contracts. Losses may not be recovered from our reinsurers until claims are paid and, in the case of long-
term workers' compensation cases, the creditworthiness of our reinsurers may change before we can recover amounts that we are
17
entitled to. The inability of any of our reinsurers to meet their financial obligations could have a material adverse effect on our
financial condition and results of operations.
We obtained reinsurance covering the losses incurred prior to July 1, 1995, and we could be liable for all of those losses if the
coverage provided by the LPT Agreement proves inadequate or we fail to collect from the reinsurers that are party to such
transaction.
On January 1, 2000, EICN assumed all of the assets, liabilities, and operations of the Fund, including losses incurred by the Fund
prior to such date. EICN also assumed the Fund's rights and obligations associated with the LPT Agreement that the Fund entered
into with third party reinsurers with respect to its losses incurred prior to July 1, 1995. See “Item 1 -Business -Reinsurance -LPT
Agreement.” The reinsurers under the LPT Agreement agreed to assume responsibility for the claims at the benefit levels which
existed in June 1999. Accordingly, if the Nevada legislature were to increase the benefits payable for the pre-July 1, 1995 claims,
we would be responsible for the increased benefit costs to the extent of the legislative increase.
We could be liable for some or all of those ceded losses if the coverage provided by the LPT Agreement proves inadequate or we
fail to collect from the reinsurers party to such transaction. As of December 31, 2018, the estimated remaining liabilities subject
to the LPT Agreement were $408.2 million. If we are unable to collect on these reinsurance recoverables, our financial condition
and results of operations could be materially adversely affected.
The LPT Agreement requires each reinsurer to place assets supporting the payment of claims by them in individual trusts that
require that collateral be held at a specified level. The collateralization level must not be less than the outstanding reserve for
losses and a loss expense allowance equal to 7% of estimated paid losses discounted at a rate of 6%. If the assets held in trust fall
below this threshold, we can require the reinsurers to contribute additional assets to maintain the required minimum level. The
value of these assets at December 31, 2018 was $311.6 million. If the value of the collateral in the trusts drops below the required
minimum level and the reinsurers are unable to contribute additional assets, we could be responsible for substituting a new reinsurer
or paying those claims without the benefit of reinsurance. One of the reinsurers has collateralized its obligations under the LPT
Agreement by placing shares of stock of a publicly held corporation in a trust. The other reinsurers have placed U.S. treasury and
fixed maturity securities in trusts to collateralize their obligations to us. The value of this collateral is subject to market fluctuations.
The LPT Agreement provides us with the ability to commute any contract with the reinsurers to the LPT Agreement if the credit
rating of any such reinsurer were to fall below “A-” (Excellent) as determined by A.M. Best.
Intense competition and the fact that we write only a single line of insurance could adversely affect our ability to sell policies
at rates we deem adequate.
The market for workers' compensation insurance products is highly competitive. Competition in our business is based on many
factors, including premiums charged, services provided, ease of doing business, financial ratings assigned by independent rating
agencies, speed of claims payments, reputation, policyholder dividends, perceived financial strength, and general experience. In
some cases, our competitors offer lower priced products than we do. If our competitors offer more competitive premiums,
policyholder dividends, or payment plans, services or commissions to independent agents, brokers, and other distributors, we
could lose market share, have to reduce our premium rates, or increase commission rates, which could adversely affect our
profitability. We compete with regional and national insurance companies, professional employer organizations, third-party
administrators, self-insured employers, and state insurance funds. Our main competitors vary from state to state, but are usually
those companies that offer a full range of services in underwriting, loss control, and claims. We compete on the basis of the services
that we offer to our policyholders and on ease of doing business rather than solely on price.
Many of our competitors are significantly larger and possess greater financial, marketing, and management resources than we do.
Some of our competitors benefit financially by not being subject to federal income tax. Intense competitive pressure on prices can
result from the actions of even a single large competitor. Competitors with more surplus than us have the potential to expand in
our markets more quickly than we can and invest more heavily in new technologies. Greater financial resources also permit an
insurer to gain market share through more competitive pricing, even if that pricing results in reduced underwriting margins or an
underwriting loss.
Many of our competitors are multi-line carriers that can price the workers' compensation insurance they offer at a loss in order to
obtain other lines of business at a profit. This creates a competitive disadvantage for us, as we only offer a single line of insurance.
For example, a business may find it more efficient or less expensive to purchase multiple lines of commercial insurance coverage
from a single carrier.
The property and casualty insurance industry is cyclical in nature and is characterized by periods of so-called “soft” market
conditions, in which premium rates are stable or falling, insurance is readily available, and insurers' profits decline, and by periods
of so-called “hard” market conditions, in which rates rise, insurance may be more difficult to find, and insurers' profits increase.
According to the Insurance Information Institute, since 1970, the property and casualty insurance industry experienced hard market
conditions from 1975 to 1978, 1984 to 1987, and 2001 to 2004. Although the financial performance of an individual insurance
company is dependent on its own specific business characteristics, the profitability of most workers' compensation insurance
18
companies generally tends to follow this cyclical market pattern. We believe the workers' compensation industry currently has
excess underwriting capacity resulting in lower rate levels and smaller profit margins. We continue to experience price competition
in our target markets.
Because of cyclicality in the workers' compensation market, due in large part to competition, capacity, and general economic
factors, we cannot predict the timing or duration of changes in the market cycle. This cyclical pattern has in the past and could in
the future adversely affect our financial condition and results of operations. If we are unable to compete effectively, our business,
financial condition, and results of operations could be materially adversely affected.
We may be unable to realize our investment objectives and economic conditions in the financial markets could lead to investment
losses.
Investment income is an important component of our revenue and net income. Our investment portfolio is managed by independent
asset managers that operate under investment guidelines approved by our Board of Directors. Although these guidelines stress
diversification and capital preservation, our investments are subject to a variety of risks that are beyond our control, including
risks related to general economic conditions, interest rate fluctuations, and market volatility. Interest rates are highly sensitive to
many factors, including governmental monetary policies and domestic and international economic and political conditions. These
and other factors affect the capital markets and, consequently, the value of our investment portfolio.
We are exposed to significant financial risks related to the capital markets, including the risk of potential economic loss principally
arising from adverse changes in the fair value of financial instruments. The major components of market risk affecting us are
interest rate risk, credit risk, and equity price risk. For more information regarding market risk, see "Item 7A–Quantitative and
Qualitative Disclosures About Market Risk."
The outlook for our investment income is dependent on the future direction of interest rates, maturity schedules, and cash flow
from operations that is available for investment. The fair values of fixed maturity securities that are available-for-sale (AFS)
fluctuate with changes in interest rates and cause fluctuations in our stockholders' equity. Any significant decline in our investment
income or the value of our investments as a result of changes in interest rates, deterioration in the credit of companies or
municipalities in which we have invested, decreased dividend payments, general market conditions, or events that have an adverse
impact on any particular industry or geographic region in which we hold significant investments could have an adverse effect on
our net income and, as a result, on our stockholders' equity and policyholder surplus.
The valuation of our investments, including the determination of the amount of impairments, includes estimates and assumptions
and could result in changes to investment valuations that may adversely affect our financial condition and results of operations.
Beginning on January 1, 2018, we are required to measure equity securities at fair value with changes in fair value recognized in
net income, which causes increased volatility in our results of operations. Equity securities represented 7.3% of our total investment
portfolio as of December 31, 2018. The use of internally developed valuation techniques may have a material effect on the estimated
fair value amounts of our investments and our financial condition.
Additionally, we regularly review the valuation of our entire portfolio of fixed maturity investments, including the identification
of other-than-temporary declines in fair value. The determination of the amount of impairments taken on our investments is based
on our periodic evaluation and assessment of our investments and known and inherent risks associated with the various asset
classes. There can be no assurance that we have accurately determined the level of other-than-temporary impairments reflected
on our financial statements and additional impairments may need to be taken in the future. Historical trends may not be indicative
of future impairments.
We may require additional capital in the future, which may not be available to us or may be available only on unfavorable
terms.
Our future capital requirements will depend on many factors, including state regulatory requirements, our ability to write new
business successfully, and to establish premium rates and reserves at levels sufficient to cover losses. If we have to raise additional
capital, equity or debt financing may not be available on terms that are favorable to us. In the case of equity financings, there could
be dilution to our stockholders and the securities may have rights, preferences, and privileges senior to our common stock. In the
case of debt financings, we may be subject to covenants that restrict our ability to freely operate our business. If we cannot obtain
adequate capital on favorable terms or at all, we may be unable to implement our future growth or operating plans and our business,
financial condition, and results of operations could be materially adversely affected.
The capital and credit markets continue to experience volatility and disruption that could negatively affect market liquidity. These
conditions could produce downward pressure on stock prices and limit the availability of credit for certain issuers without regard
to those issuers' underlying financial strength. In addition, we could be forced to delay raising capital or be unable to raise capital
on favorable terms, or at all, which could decrease our profitability, significantly reduce our financial flexibility, and cause rating
agencies to reevaluate our financial strength ratings.
19
We are a holding company with no direct operations. We depend on the ability of our subsidiaries to transfer funds to us to
meet our obligations, and our insurance subsidiaries' ability to pay dividends to us is restricted by law.
EHI is a holding company that transacts substantially all of its business through operating subsidiaries. Its primary assets are the
shares of stock of our insurance subsidiaries. The ability of EHI to meet its operating and financing cash needs depends on the
surplus and earnings of our subsidiaries, and upon the ability of our insurance subsidiaries to pay dividends to EGI and, in turn,
the ability of EGI to pay dividends to EHI.
Payments of dividends by our insurance subsidiaries are restricted by state insurance laws, including laws establishing minimum
solvency and liquidity thresholds, and could be subject to contractual restrictions in the future, including those imposed by
indebtedness we may incur in the future. As a result, we may not be able to receive dividends from these subsidiaries and we may
not receive dividends in the amounts necessary to meet our obligations or to pay dividends on our common stock.
A failure to effectively maintain, enhance and modernize our information technology systems, and effectively develop and
deploy new technologies, could adversely affect our business.
Our success depends on our ability to maintain effective information technology systems, to enhance those systems to better
support our business in an efficient and cost-effective manner and to develop new technologies and capabilities in pursuit of our
long-term strategy. We have recently launched an initiative that is focused on developing new technologies and capabilities and
enhancing our information technology infrastructure. Some technology development initiatives are long-term in nature, may
negatively impact our expense ratios as we invest in the projects, may cost more than anticipated to complete, or may not be
completed. Additionally, our technology initiatives may be more costly or time-consuming than anticipated, may not deliver the
expected benefits upon completion, and/or may need to be replaced or become obsolete more quickly than expected, which could
result in accelerated recognition of expenses. If we fail to maintain or enhance our existing information technology systems or if
we were to experience failure in developing and implementing new technologies, our relationships, ability to do business with
our clients and/or our competitive position may be adversely affected. We could also experience other adverse consequences,
including additional costs or write-offs of capitalized costs, unfavorable underwriting and reserving decisions, internal control
deficiencies, and information security breaches resulting in loss or inappropriate disclosure of data.
We rely on our information technology and telecommunication systems, including those of third parties that we outsource
certain business functions to, and the failure of these systems or cyber-attacks on these systems could materially and adversely
affect our business.
Our business is highly dependent upon the successful and uninterrupted functioning of our information technology and
telecommunications systems. We rely on these systems to process and generate new and renewal business, provide customer
service, administer and make payments on claims, facilitate collections, and automatically underwrite and administer the policies
we write. The failure of any of our systems could interrupt our operations or materially impact our ability to evaluate and write
new business. We outsource certain business functions to third parties and our information technology and telecommunications
systems interface with and depend on third-party systems, which may expose us to increased risk related to data and information
security. Additionally, we could experience service disruptions if demand for such services exceeds capacity or such third-party
systems fail or experience interruptions. Any administrative or technical controls and other preventative actions we take or require
such service providers to take to reduce the risk of cyber-attacks or system failures may be insufficient to prevent such attacks or
other security breaches. Cyber-attacks resulting in a breach of security could jeopardize the privacy, confidentiality, and integrity
of our data or our customers' data, which could harm our reputation and expose us to potential liability.
Certain events outside of our control, including cyber-attacks, natural catastrophes, or other failures or outages to information
technology and telecommunications systems that we rely on, could render our systems inoperable such that we would be unable
to service our agents, insureds, and injured workers, generate and service direct-to-customer business, or meet certain regulatory
requirements. If such an event were to occur, there is no guarantee that our existing business continuity plans would be sufficient
to restore our systems or secure our data within a reasonable timeframe and, our business, financial condition, and results of
operations could be materially adversely affected.
Our industry is increasingly becoming subject to rapid changes in technology that may alter historical methods of doing
business.
The insurance industry continues to be impacted by innovation, technological changes, and changing customer preferences,
including the emergence of “InsurTech” companies and the deployment of new technologies based on artificial intelligence and
machine learning that are becoming increasing competitive with and may disrupt more traditional business models. If we do not
effectively anticipate and adapt to these changes it could limit our ability to compete, decrease the value of our insurance products
to insureds and agents, and materially adversely affect our business and results of operations.
Our business could also be affected by technological changes in the industries that represent our target markets, including tasks/
roles that are currently performed by people being replaced by automation, artificial intelligence, or other advances outside of our
20
control, which could impact our insureds payrolls, upon which our premiums are based, and materially adversely affect our business
and results of operations.
Acts of terrorism and natural or man-made catastrophes could materially adversely impact our financial condition and results
of operations.
Under our workers' compensation policies and applicable laws in the states in which we operate, we are required to provide workers'
compensation benefits for losses arising from acts of terrorism. The impact of any terrorist act is unpredictable, and the ultimate
impact on us would depend upon the nature, extent, location, and timing of such an act. We would be particularly adversely affected
by a terrorist act affecting any metropolitan area where our policyholders have a large concentration of workers.
Notwithstanding the protection provided by the reinsurance we have purchased and any protection provided by the 2002 Act, or
its extension, TRIPRA of 2015, the risk of severe losses to us from acts of terrorism has not been eliminated because our excess
of loss reinsurance treaty program contains various sub-limits and exclusions limiting our reinsurers' obligation to cover losses
caused by acts of terrorism. Our excess of loss reinsurance treaties do not protect against nuclear, biological, chemical, or
radiological events. If such an event were to impact one or more of the businesses we insure, we would be entirely responsible
for any workers' compensation claims arising out of such event, subject to the terms of the 2002 Act and TRIPRA of 2015 and
could suffer substantial losses as a result.
Our operations also expose us to claims arising out of natural or man-made catastrophes because we may be required to pay
benefits to workers who are injured in the workplace as a result of a catastrophe. Catastrophes can be caused by various unpredictable
events, either natural or man-made. Any catastrophe occurring in the communities in which we operate or that have significant
impacts on one or more of our targeted classes of business could expose us to potentially substantial losses and, accordingly, could
have a material adverse effect on our financial condition and results of operations.
Administrative proceedings or legal actions involving our insurance subsidiaries could have a material adverse effect on our
business, financial condition and results of operations.
Our insurance subsidiaries are involved in various administrative proceedings and legal actions in the normal course of their
business. Our subsidiaries have responded to such actions and intend to defend these claims. These claims concern issues including
eligibility for workers' compensation insurance coverage or benefits, the extent of injuries, wage determinations, disability ratings,
and bad faith and extra-contractual liability. Adverse decisions in multiple administrative proceedings or legal actions could require
us to pay significant amounts in the aggregate or to change the manner in which we administer claims, which could have a material
adverse effect on our financial condition and results of operations.
Our business is largely dependent on the efforts of our management because of its industry and technical expertise, knowledge
of our markets, and relationships with the independent agents and brokers and partners that sell our products.
Our success depends in substantial part upon our ability to attract and retain qualified executive officers, experienced underwriting
and claims personnel, and other skilled employees who are knowledgeable about our business. The current success of our business
is dependent in significant part on the efforts of our executive officers. Many of our regional and local officers are also important
to our operations because of their industry expertise, knowledge of our markets, and relationships with the independent agents
and brokers who sell our products. We have entered into employment agreements with certain of our key executives. Currently,
we maintain key man life insurance for our Chief Executive Officer. If we were to lose the services of members of our management
team or key regional or local executives, we may be unable to find replacements satisfactory to us and our business. As a result,
our operations may be disrupted and our financial performance and results of operations may be adversely affected.
Assessments and other surcharges for guaranty funds, second injury funds, and other mandatory pooling arrangements may
reduce our profitability.
All states require insurance companies licensed to do business in their state to bear a portion of the unfunded obligations of insolvent
insurance companies. These obligations are funded by assessments that can be expected to continue in the future in the states in
which we operate. Many states also have laws that establish second injury funds to provide compensation to injured employees
for aggravation of a prior condition or injury, which are funded by either assessments based on paid losses or premium. In addition,
as a condition to the ability to conduct business in some states, insurance companies are required to participate in mandatory
workers' compensation shared market mechanisms or pooling arrangements, which provide workers' compensation insurance
coverage from private insurers. The effect of these assessments and mandatory shared market mechanisms or changes in them
could reduce our profitability in any given period or limit our ability to grow our business.
State insurance laws, certain provisions of our charter documents, and Nevada corporation law could prevent or delay a change
in control that could be beneficial to us and our stockholders.
Our insurance subsidiaries are domiciled in Florida, California, and Nevada. The insurance laws of these states generally require
that any person seeking to acquire control of a domestic insurance company obtain the prior approval of the state's insurance
commissioner. In Florida, "control" is generally presumed to exist through the direct or indirect ownership of 5% or more of the
21
voting securities of a domestic insurance company or of any entity that controls a domestic insurance company. In California and
Nevada, "control" is presumed to exist through the direct or indirect ownership of 10% or more of the voting securities of a domestic
insurance company or of any entity that controls a domestic insurance company. In addition, insurance laws in many states in
which we are licensed require pre-notification to the state's insurance commissioner of a change in control of a non-domestic
insurance company licensed in those states. Because we have insurance subsidiaries domiciled in Florida, California, and Nevada,
any transaction that would constitute a change in control of us would generally require the party acquiring control to obtain the
prior approval of the insurance commissioners of these states and may require pre-notification of the change of control in these
or other states in which we are licensed to transact business. The time required to obtain these approvals may result in a material
delay of, or deter, any such transaction. These laws may discourage potential acquisition proposals or tender offers, and may delay,
deter, or prevent a change of control, even if the acquisition proposal or tender offer is favorable to our stockholders.
Provisions of our amended and restated articles of incorporation and amended and restated by-laws could discourage, delay, or
prevent a merger, acquisition, or other change in control of us, even if our stockholders might consider such a change in control
to be favorable. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect Directors
and take other corporate actions. In particular, our amended and restated articles of incorporation and amended and restated by-
laws currently include provisions:
•
•
•
•
•
dividing our Board of Directors into classes until the 2021 stockholder meeting;
eliminating the ability of our stockholders to call special meetings of stockholders;
permitting our Board of Directors to issue preferred stock in one or more series;
imposing advance notice requirements for nominations for election to our Board of Directors and/or for proposing
matters that can be acted upon by stockholders at the stockholder meetings; and
prohibiting stockholder action by written consent, thereby limiting stockholder action to that taken at an annual or special
meeting of our stockholders.
These provisions may make it difficult for stockholders to replace Directors and could have the effect of discouraging a future
takeover attempt that is not approved by our Board of Directors, but which stockholders might consider favorable. Additionally,
these provisions could limit the price that investors are willing to pay in the future for shares of our common stock.
Corporate taxes.
We are subject to U.S. federal and various state taxes and our provision for income taxes, our recorded tax liabilities and net
deferred tax assets, including any valuation allowances, are recorded based on estimates. These estimates require us to make
significant judgments regarding a number of factors including, among others, the applicability of various federal and state laws,
the interpretations given to those tax laws by taxing authorities, courts and by us, the timing of future income and deductions, and
our expected levels and sources of future taxable income. Any changes in tax laws and/or interpretations of tax laws could
significantly change our estimates of the amount of future tax liabilities and/or benefits or deductions expected to be available to
us in future periods. Any changes to our prior estimates would be reflected in the current period and could have a materially adverse
effect on our financial condition and results of operations.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
As of February 1, 2019, we leased 225,274 square feet of office space in 7 states, including our principal executive offices located
in Reno, Nevada. We believe that our existing office space is adequate for our current needs. We will continue to enter into or exit
lease agreements to address future space requirements, as necessary.
Item 3. Legal Proceedings
From time to time, we are involved in pending and threatened litigation in the normal course of business in which claims for
monetary damages are asserted and/or insurance or reinsurance coverage is disputed.
Expected or actual reductions in our reinsurance recoveries due to reinsurance coverage disputes (as opposed to a reinsurer’s
inability to pay) are not recorded as an uncollectible reinsurance recoverable. Rather, they are factored into the determination of,
and are reflected in, our net loss and LAE reserves.
In the opinion of management, the ultimate liability, if any, arising from such pending or threatened litigation is not expected to
have a material effect on our result of operations, liquidity, or financial position.
Item 4. Mine Safety Disclosures
Not applicable.
22
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information, Holders, and Stockholder Dividends
Our common stock is listed on the New York Stock Exchange (NYSE) under the symbol “EIG.” There were 897 registered holders
of record as of February 14, 2019.
We currently expect that quarterly cash dividends will continue to be declared and paid to our stockholders in the future; however,
any determination to declare and pay additional or future dividends will be at the discretion of our Board of Directors and will be
dependent upon:
•
•
•
•
•
•
the surplus and earnings of our insurance subsidiaries and their ability to pay dividends and/or other statutorily permissible
payments to their parent;
our results of operations and cash flows;
our financial position and capital requirements;
general business conditions;
any legal, tax, regulatory, and/or contractual restrictions on the payment of dividends; and
any other factors our Board of Directors deems relevant.
Issuer Purchases of Equity Securities
The following table provides information with respect to the Company's repurchases of its common stock during the quarter ended
December 31, 2018:
Period
October 1 – October 31, 2018
November 1 – November 30, 2018
December 1 – December 31, 2018
Total
Total Number
of Shares
Purchased
Average
Price Paid
Per Share(1)
Total Number
of Shares
Purchased as
Part of
Publicly
Announced
Program
Approximate
Dollar Value
of Shares that
May Yet be
Purchased
Under the
Program(2)
(in millions)
— $
—
102,531
102,531
$
—
—
41.06
41.06
— $
—
102,531
102,531
49.6
49.6
45.4
(1)
(2)
Includes fees and commissions paid on stock repurchases.
On February 21, 2018, the Board of Directors authorized a share repurchase program for repurchases of up to $50.0 million of the
Company's common stock (the 2018 Program). The 2018 Program provides that shares may be purchased at prevailing market prices
from February 26, 2018 through February 26, 2020 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 that may
be 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 2018 Program may be commenced, modified, or suspended from time to time without
prior notice, and the program may be suspended or discontinued at any time.
Performance Graph
The following information compares the cumulative total return on $100 invested in the common stock of EHI, ticker symbol
EIG, for the period commencing at the close of market on December 31, 2013 and ending on December 31, 2018 with the cumulative
total return on $100 invested in each of the Standard and Poor's (S&P) 500 Index (S&P 500) and the Standard and Poor's 500
Property-Casualty Insurance Index (S&P P&C Insurance Index). The calculation of cumulative total return assumes the
reinvestment of dividends. The following graph and related information shall not be deemed to be “soliciting material” or to be
“filed” with the SEC, nor shall such information be incorporated by reference into any filing pursuant to the Securities Act of 1933
or the Securities Exchange Act of 1934, except to the extent that we specifically incorporate it by reference into such filing.
23
Employers Holdings, Inc.
Cumulative Total Return Performance
Employers Holdings, Inc.
S&P 500
S&P 500 P&C Insurance Index
12/31/2013
100.00
$
100.00
100.00
12/31/2014
75.13
$
113.69
115.74
12/31/2015
88.08
$
115.26
126.77
12/31/2016
129.35
$
129.05
146.68
12/31/2017
147.12
$
157.22
179.52
12/31/2018
141.73
$
150.33
171.10
Period Ending
24
Item 6. Selected Financial Data
The following selected historical consolidated financial data should be read in conjunction with ''Item 7–Management's Discussion
and Analysis of Consolidated Financial Condition and Results of Operations'' and the consolidated financial statements and related
notes included elsewhere in this Annual Report on Form 10-K.
Income Statement Data
Revenues:
Net premiums earned
Net investment income
Net realized and unrealized (losses) gains on investments
Gain on redemption of notes payable
Other income
Total revenues
Total expenses
Net income before income taxes
Income tax expense
Net income
Earnings per common share:
Basic
Diluted
Selected Operating Data
Gross premiums written(1)
Net premiums written(2)
Net income before impact of the LPT Agreement(3)(4)(5)
Earnings per common share before impact of the LPT Agreement(5)
Basic
Diluted
Cash dividends declared per common share
Balance Sheet Data
Cash and cash equivalents
Total investments
Reinsurance recoverable on paid and unpaid losses
Total assets
Unpaid losses and loss adjustment expense
Unearned premiums
Deferred Gain(3)(4)
Notes payable
Total liabilities
Total stockholders' equity
Other Financial Data
Total stockholders' equity including Deferred Gain(3)(4)(6)
2018
Years Ended December 31,
2016
(in millions, except per share amounts and ratios)
2015
2017
$
$
$
$
$
$
$
$
$
$
$
$
$
$
731.1
81.2
(13.1)
—
1.2
800.4
630.9
169.5
28.2
141.3
4.30
4.24
748.9
742.8
126.7
3.85
3.80
0.80
$
$
$
$
$
$
$
716.5
74.6
7.4
2.1
0.8
801.4
657.4
144.0
42.8
101.2
3.11
3.06
729.7
723.7
89.6
2.76
2.71
0.60
$
$
$
$
$
$
$
694.8
73.2
11.2
—
0.6
779.8
639.1
140.7
34.0
106.7
3.29
3.24
701.4
694.6
90.1
2.78
2.73
0.36
$
$
$
$
$
$
690.4
72.2
(10.7)
—
0.2
752.1
652.7
99.4
5.0
94.4
2.94
2.90
697.7
689.3
74.0
2.31
2.27
0.24
2014
684.5
72.4
16.3
—
0.3
773.5
666.9
106.6
5.9
100.7
3.19
3.14
697.7
687.6
45.7
1.45
1.43
0.24
2018
2017
$
As of December 31,
2016
(in millions)
67.2
$
2,552.6
588.7
3,773.4
2,301.0
310.3
174.9
32.0
2,932.8
840.6
73.3
2,677.7
544.2
3,840.1
2,266.1
318.3
163.6
20.0
2,892.4
947.7
2015
2014
$
56.6
2,487.2
635.9
3,755.8
2,347.5
308.9
189.5
32.0
2,995.0
760.8
103.6
2,448.4
680.2
3,769.7
2,369.7
310.8
207.0
92.0
3,082.9
686.8
$
$
101.4
2,727.7
511.1
3,919.2
2,207.9
336.3
149.6
20.0
2,901.0
1,018.2
$
1,167.8
$
1,111.3
$
1,015.5
$
950.3
$
893.8
(1) Gross premiums written is the sum of direct premiums written and assumed premiums written before the effect of ceded reinsurance. Direct
premiums written are the premiums on all policies our insurance subsidiaries have issued during the year. Assumed premiums written are
premiums that our insurance subsidiaries have received from any authorized state-mandated pools.
(2) Net premiums written is the sum of direct premiums written and assumed premiums written less ceded premiums written. Ceded premiums
written is the portion of direct premiums written that we cede to our reinsurers under our reinsurance contracts. (See Note 10 in the Notes
to our Consolidated Financial Statements.)
(3) In connection with our January 1, 2000 assumption of the assets, liabilities and operations of the Fund, EICN assumed the Fund's rights
and obligations associated with the LPT Agreement, a retroactive 100% quota share reinsurance agreement with third party reinsurers,
which substantially reduced our exposure to losses for pre-July 1, 1995 Nevada insured risks. Pursuant to the LPT Agreement, the Fund
initially ceded $1.5 billion in liabilities for incurred but unpaid losses and LAE, which represented substantially all of the Fund's outstanding
losses as of June 30, 1999 for claims with original dates of injury prior to July 1, 1995.
25
(4) Deferred reinsurance gain–LPT Agreement reflects the unamortized gain from our LPT Agreement. Under GAAP, this gain is deferred and
is being amortized using the recovery method. Amortization is determined by the proportion of actual reinsurance recoveries to total
estimated recoveries over the life of the LPT Agreement, except for the contingent profit commission, which is amortized through June
30, 2024. The amortization is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT
Agreement and the expected losses and LAE subject to the contingent profit commission under the LPT Agreement. Our reevaluations
result in corresponding adjustments, if needed, to reserves, ceded reserves, contingent commission receivable, and the Deferred Gain, with
the net effect being an increase or decrease, as the case may be, to net income.
(5) We define net income before impact of the LPT Agreement as net income before the impact of: (a) amortization of the Deferred Gain; (b)
adjustments to the LPT Agreement ceded reserves; and (c) adjustments to Contingent commission receivable–LPT Agreement. These are
not measurements of financial performance under GAAP, but rather reflect the difference in accounting treatment between SAP and GAAP,
and should not be considered in isolation or as an alternative to any other measure of performance derived in accordance with GAAP.
We present net income before impact of the LPT Agreement because we believe that it is an important supplemental measure of our ongoing
operating performance. This measure is used by analysts, investors, and other interested parties in evaluating us.
The LPT Agreement was a non-recurring transaction which does not affect our ongoing operations and consequently we believe these
presentations are useful in providing a meaningful understanding of our operating performance. In addition, we believe these non-GAAP
measures, as we have defined them, are helpful to our management in identifying trends in our performance because the items excluded
have limited significance to our current and ongoing operations.
The table below shows the reconciliation of net income to net income before impact of the LPT Agreement for the periods presented:
Net income
Less amortization of the Deferred Gain related to losses
Less amortization of the Deferred Gain related to contingent
commission
Less impact of LPT Reserve Adjustments(a)
Less impact of LPT Contingent Commission Adjustments(b)
Net income before impact of the LPT Agreement
2018
$
$
141.3
9.9
2.0
2.2
0.5
126.7
$
$
2017
Years Ended December 31,
2016
(in millions)
106.7
$
9.7
101.2
9.3
$
2015
2.0
—
0.3
89.6
$
2.0
3.1
1.8
90.1
$
2014
94.4
9.5
1.9
6.4
2.6
74.0
$
$
100.7
11.2
1.9
31.1
10.8
45.7
(a) Any adjustment to the estimated reserves ceded under the LPT Agreement results in a cumulative adjustment to the Deferred
Gain, which is also included in losses and LAE incurred in the Consolidated Statements of Comprehensive Income, such that
the Deferred Gain reflects the balance that would have existed had the revised reserves been recognized at the inception of the
LPT Agreement (LPT Reserve Adjustment). (See Note 2 in the Notes to our Consolidated Financial Statements.)
(b) 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 on our Consolidated Statements 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 (LPT Contingent Commission Adjustment). (See Note 2 in the Notes to our
Consolidated Financial Statements.)
(6) We define Total stockholders' equity including the Deferred Gain as total stockholders' equity plus the Deferred Gain. Total stockholders'
equity including the Deferred Gain is not a measurement of financial position under GAAP and should not be considered in isolation or as
an alternative to Total stockholders' equity or any other measure of financial health derived in accordance with GAAP.
We present Total stockholders' equity including the Deferred Gain because we believe that it is an important supplemental measure of
financial position to be used by analysts, investors, and other interested parties in evaluating us. Furthermore, the LPT Agreement is a non-
recurring transaction and the treatment of the Deferred Gain does not result in ongoing cash benefits or charges to our current operations.
Consequently, we believe this presentation is useful in providing a meaningful understanding of our financial position.
The table below shows the reconciliation of Total stockholders' equity to Total stockholders' equity including the Deferred Gain for the
periods presented:
2018
2017
As of December 31,
2016
(in millions)
840.6
$
174.9
$ 1,015.5
$
$
$
947.7
163.6
$ 1,111.3
2015
2014
760.8
189.5
950.3
$
$
686.8
207.0
893.8
Total stockholders' equity
Deferred Gain
Total stockholders' equity including the Deferred Gain
$ 1,018.2
149.6
$ 1,167.8
26
Item 7. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the
consolidated financial statements, the accompanying notes thereto, and the financial statement schedules included in Item 8 and
Item 15 of this report. In addition to historical information, the following discussion contains forward-looking statements that are
subject to risks and uncertainties and other factors described in Item 1A of this report. Our actual results in future periods may
differ from those referred to herein due to a number of factors, including the risks described in the sections entitled “Risk Factors”
and “Forward-Looking Statements” elsewhere in this report.
Overview
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 44 states and the
District of Columbia, with a concentration in California, where over one-half of our business is generated. Our revenues are
primarily comprised of net premiums earned, net investment income, and net realized gains on investments.
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 given our expertise in underwriting
this market segment. 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.
Our underwriting results have improved over the past several years. This improvement reflects the increased pricing flexibility
afforded to us through the use of multiple writing companies within states and territorial pricing in California. In addition, our
ongoing underwriting initiatives, which are described below, have allowed us to expand our operations while also focusing on
under-performing classes of business, as needed.
Pricing on our renewals showed an overall price decrease of 11.8% for the year ended December 31, 2018, versus the rate level
in effect on such business a year earlier. We believe that we can continue to write attractive business due to favorable loss costs
and frequency trends and the success of our accelerated claims initiatives, despite the competitive market conditions we currently
face. Given the strength of our balance sheet, the execution of our underwriting, claims, and investment strategies, we believe that
we are well positioned for the current market cycle.
On August 11, 2017, we entered into a stock purchase agreement (Purchase Agreement), as amended on October 25, 2018, with
Partner Reinsurance Company of the U.S. (PRUS) with respect to the acquisition (Acquisition) of all of the outstanding shares of
capital stock of PartnerRe Insurance Company of New York (PRNY). The purchase price is equal to the sum of: (i) the amount
of statutory capital and surplus of PRNY at closing (which is currently estimated to be approximately $40.0 million); and (ii) $5.8
million. We expect to fund the Acquisition with cash on hand.
Pursuant to the Purchase Agreement, all liabilities and obligations of PRNY existing as of the closing date, whether known or
unknown, will be indemnified by PRUS. In addition, PartnerRe Ltd., the parent company of PRUS, has provided us with a Guaranty
that unconditionally, absolutely and irrevocably guarantees the full and prompt payment and performance by PRUS of all of its
obligations, liabilities and indemnities under the Purchase Agreement and the transactions contemplated thereby.
We will not be acquiring any employees or ongoing business operations pursuant to the Acquisition. The Acquisition is subject to
certain closing conditions, including, among other things, approval from the Department of Financial Services of the State of New
York.
27
Results of Operations
A primary measure of our performance is our ability to increase Adjusted stockholders' equity over the long-term. We believe that
this measure is important to our investors, analysts, and other interested parties who benefit from having an objective and consistent
basis for comparison with other companies within our industry. The following table shows a reconciliation of our Stockholders'
equity on a GAAP basis to our Adjusted stockholders' equity.
GAAP stockholders' equity
Deferred reinsurance gain–LPT Agreement
Less: Accumulated other comprehensive (loss) income, net(1)
Adjusted stockholders' equity(2)
December 31,
2018
2017
(in millions)
$
$
1,018.2
149.6
(13.7)
1,181.5
$
$
947.7
163.6
107.4
1,003.9
(1) The adoption of ASU no. 2016-01 resulted in a $74.0 million reclassification adjustment from Accumulated other comprehensive income,
net to Retained earnings as of January 1, 2018.
(2) Adjusted stockholders' equity is a non-GAAP measure consisting of total GAAP stockholders' equity plus the Deferred Gain, less
Accumulated other comprehensive (loss) income, net.
Our net income was $141.3 million, $101.2 million, and $106.7 million in 2018, 2017, and 2016, respectively, and our underwriting
income was $101.7 million, $68.0 million, and $57.3 million for the same periods, respectively. The key factors that affected our
financial performance during the previous two years included:
• Losses and LAE decreased 10% in 2018 and only slightly in 2017, each compared to the previous year;
• Underwriting and other operating expenses increased 13% in 2018 and 3% in 2017, each compared to the previous year;
• Net realized and unrealized (losses) gains on investments of $(13.1) million, $7.4 million, and $11.2 million in 2018,
2017, and 2016, respectively; and
•
Income tax expense was $28.2 million ($28.6 million excluding the impact of the enactment of Tax Cuts and Jobs Act
on December 22, 2017 (Enactment)), $42.8 million ($35.8 million excluding the impact of the Enactment, and $34.0
million in 2018, 2017, and 2016, respectively.
We continue to execute a number of ongoing business initiatives, including: focusing on internal and customer-facing business
process excellence; offering quotes and insurance coverage directly to customers through a desktop and mobile-friendly platform;
accelerating the settlement of open claims; diversifying our risk exposure across geographic markets; utilizing a multi-company
pricing platform; utilizing territory-specific pricing; development and implementation of new technologies to transform the way
insurance agents utilize digital capabilities; and leveraging data-driven strategies to target, price, and underwrite profitable classes
of business across all of our markets.
The following items were included in our 2018 results of operations: (1) favorable prior year accident year loss development of
$66.2 million, including $65.5 million of favorable development on our voluntary business and $0.7 million of favorable
development on our assigned risk business, which decreased our losses and LAE by the same amount; (2) favorable development
in the estimated reserves ceded under the LPT Agreement that resulted in a $2.2 million LPT Reserve Adjustment; (3) an increase
in the contingent commission receivable under the LPT Agreement, which resulted in a $0.5 million cumulative adjustment to the
Deferred Gain, and reduced our losses and LAE by the same amount (LPT Contingent Commission Adjustment); and (4) the
inclusion of $25.6 million in net unrealized losses on equity securities during the period (unrealized gains and losses on equity
securities were not included in net income during the comparable 2017 and 2016 periods). Collectively, these items increased our
net income before taxes by $43.3 million. Additionally, our income tax expense was favorably impacted by the Tax Cuts and Jobs
Act which reduced the statutory tax rate from 35% to 21% beginning in 2018.
The following items were included in our 2017 results of operations: (1) favorable prior year accident year loss development of
$18.5 million, including $17.4 million of favorable development on our voluntary business and $1.1 million of favorable
development on our assigned risk business, which decreased our losses and LAE by the same amount; (2) a write-off of $7.5
million of previously capitalized costs relating to the development of information technology capabilities that had not yet been
placed in service (See –Other expenses); (3) a $7.0 million increase in our income tax expense resulting from a reduction of our
net deferred tax asset resulting from Enactment, which reduced the statutory rate from 35% to 21% beginning in 2018 (See –
Income tax expense); and (4) an increase in the contingent commission receivable under the LPT Agreement, which resulted in a
$0.3 million cumulative adjustment to the Deferred Gain, and reduced our losses and LAE by the same amount (LPT Contingent
Commission Adjustment). Collectively, these items increased our net income before taxes by $11.3 million and increased our
income tax expense by $7.0 million for the year ended December 31, 2017.
28
The following items were included in our 2016 results of operations: (1) favorable prior year accident year loss development of
$18.4 million, including $17.0 million of favorable development on our voluntary business and $1.4 million of favorable
development on our assigned risk business, which decreased our losses and LAE by the same amount; (2) favorable development
in the estimated reserves ceded under the LPT Agreement, which resulted in a $3.1 million cumulative adjustment to the Deferred
Gain and reduced our losses and LAE by the same amount (LPT Reserve Adjustment); and (3) an increase in the contingent
commission receivable under the LPT Agreement, which resulted in a $1.8 million cumulative adjustment to the Deferred Gain,
and reduced our losses and LAE by the same amount (LPT Contingent Commission Adjustment). Collectively, these items increased
our net income before taxes by $23.3 million for the year ended December 31, 2016.
The components of net income are set forth in the following table:
Gross premiums written
Net premiums written
Net premiums earned
Net investment income
Net realized and unrealized (losses) gains on investments
Gain on redemption of notes payable
Other income
Total revenues
Losses and LAE
Commission expense
Underwriting and other operating expenses
Interest and financing expenses
Other expense
Total expenses
Income tax expense
Net income
Less amortization of the Deferred Gain related to losses
Less amortization of the Deferred Gain related to contingent commission
Less impact of LPT Reserve Adjustments(1)
Less impact of LPT Contingent Commission Adjustments(2)
Net income before impact of the LPT Agreement(3)
$
$
$
$
$
2018
Years Ended December 31,
2017
(in millions)
729.7
$
723.7
$
748.9
742.8
$
$
731.1
81.2
(13.1)
—
1.2
800.4
376.7
94.2
158.5
1.5
—
630.9
28.2
141.3
9.9
2.0
2.2
0.5
126.7
$
$
$
716.5
74.6
7.4
2.1
0.8
801.4
417.2
91.4
139.9
1.4
7.5
657.4
42.8
101.2
9.3
2.0
—
0.3
89.6
$
$
$
2016
701.4
694.6
694.8
73.2
11.2
—
0.6
779.8
417.9
83.5
136.1
1.6
—
639.1
34.0
106.7
9.7
2.0
3.1
1.8
90.1
(1) LPT Reserve Adjustments result in a cumulative adjustment to the Deferred Gain, which is recognized in losses and LAE incurred on our
Consolidated Statements of Comprehensive Income, such that the Deferred Gain reflects the balance that would have existed had the
revised reserves been recognized at the inception of the LPT Agreement. (See Note 2 in the Notes to our Consolidated Financial Statements.)
(2) LPT Contingent Commission Adjustments result in a cumulative adjustment to the Deferred Gain, which is recognized in losses and LAE
incurred on our Consolidated Statements 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. (See Note 2 in the Notes to
our Consolidated Financial Statements.)
(3) We define net income before impact of the LPT Agreement as net income before the impact of: (a) amortization of the Deferred Gain; (b)
adjustments to the LPT Agreement ceded reserves; and (c) adjustments to the Contingent commission receivable –LPT Agreement. The
Deferred Gain reflects the unamortized gain from the LPT Agreement. Under GAAP, this gain is deferred and is being amortized using
the recovery method in which amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries
over the life of the LPT Agreement, except for the contingent profit commission, which is amortized through June 30, 2024. The amortization
is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT Agreement and the expected
losses and LAE subject to the contingent profit commission under the LPT Agreement. Our reevaluation results in corresponding
adjustments, if needed, to reserves, ceded reserves, contingent commission receivable, and the Deferred Gain, with the net effect being an
increase or decrease to our net income. Net income before impact of the LPT Agreement is not a measurement of financial performance
under GAAP, but rather reflects the difference in accounting treatment between statutory and GAAP, and should not be considered in
isolation or as an alternative to net income before income taxes or net income, or any other measure of performance derived in accordance
with GAAP.
We present net income before impact of the LPT Agreement because we believe that it is an important supplemental measure of our ongoing
operating performance to be used by analysts, investors and other interested parties in evaluating us. The LPT Agreement was a non-
29
recurring transaction, under which the Deferred Gain does not affect our ongoing operations, and, consequently, we believe this presentation
is useful in providing a meaningful understanding of our operating performance. In addition, we believe this non-GAAP measure, as we
have defined it, is helpful to our management in identifying trends in our performance because the excluded item has limited significance
in our current and ongoing operations.
Gross Premiums Written
Gross premiums written were $748.9 million, $729.7 million, and $701.4 million for the years ended December 31, 2018, 2017,
and 2016, respectively. The increase in 2018 was primarily due to increases in new business premiums written, partially offset by
declines in renewal business premiums. The increase in new business premiums was primarily driven by higher policy counts and
payroll exposure, partially offset by decreases in average rates. The increase in 2017 was primarily due to increases in new business
premiums written and final audit premiums, partially offset by declines in renewal business premium, year-over-year. Final audit
premiums increased $10.8 million in 2017, compared to 2016, positively impacted by California Assembly Bill 2883 (AB 2883),
which limited certain officers' payroll from being excluded from the calculation of premiums effective January 1, 2017. In October
2017, California passed Senate Bill 189 (SB 189), which expanded the scope of employees that qualify for these exclusions. SB
189 went into effect on July 1, 2018 and reversed some of the benefits of AB 2883 in 2018.
Net Premiums Written
Net premiums written were $742.8 million, $723.7 million, and $694.6 million for the years ended December 31, 2018, 2017, and
2016, respectively, which included $6.1 million, $6.0 million, and $6.8 million of reinsurance premiums ceded, respectively. The
decrease in reinsurance premiums ceded from 2016 to 2017 reflects the increase in our retention on a per occurrence basis under
our excess of loss reinsurance program compared to earlier periods.
Net Premiums Earned
Net premiums earned were $731.1 million, $716.5 million, and $694.8 million for the years ended December 31, 2018, 2017, and
2016, respectively. Net premiums earned are primarily a function of the amount and timing of net premiums previously written.
The following table shows the percentage change in our in-force premiums, policy count, average policy size, and payroll exposure
upon which our premiums are based as of December 31, 2018 and 2017, respectively, overall, for California, where 54% of our
premiums were generated, and for all other states, excluding California:
In-force premiums
In-force policy count
Average in-force policy size
In-force payroll exposure
Percentage Change
2018 Over 2017
Percentage Change
2017 Over 2016
Overall
6.3%
7.0
(0.7)
22.0
California
2.2%
3.5
(1.2)
24.4
All Other
States
Overall
11.4%
10.2
1.1
20.5
1.3%
0.8
0.5
3.1
California
0.3%
(3.7)
4.1
5.7
All Other
States
2.7%
5.2
(2.4)
1.5
Net Investment Income and Net Realized and Unrealized (Losses) Gains on Investments
We invest in fixed maturity securities, equity securities, short-term investments, and cash equivalents. Net investment income
includes interest and dividends earned on our invested assets and amortization of premiums and discounts on our fixed maturity
securities, less bank service charges and custodial and portfolio management fees. We have established a high quality/short duration
bias in our investment portfolio.
Net investment income was $81.2 million, $74.6 million, and $73.2 million for the years ended December 31, 2018, 2017, and
2016, respectively. The increase in 2018 was primarily due to an increase in the pre-tax yield on invested assets. The average pre-
tax book yield on our invested assets was 3.4%, 3.1%, and 3.1% at December 31, 2018, 2017, and 2016, respectively. The average
tax-equivalent yield on our invested assets (which adjusts the book yield of our investments in tax-advantaged securities to an
equivalent pre-tax book yield) was 3.5%, 3.5%, and 3.6% as of the same dates, respectively.
Realized and certain unrealized gains and losses on our investments are reported separately from our net investment income.
Realized gains and losses on investments include the gain or loss on a security at the time of sale compared to its original or
adjusted cost (equity securities) or amortized cost (fixed maturity securities). Realized losses are also recognized when securities
are written down as a result of an other-than-temporary impairment. Beginning in 2018, equity securities at fair value are no longer
classified as AFS and changes in fair value are included in Net realized and unrealized (losses) gains on investments on our
Consolidated Statements of Comprehensive Income.
Net realized and unrealized (losses) gains on investments were $(13.1) million, $7.4 million, and $11.2 million for the years ended
December 31, 2018, 2017, and 2016, respectively. Net realized and unrealized losses on investments in 2018 included $25.6 million
of unrealized losses on equity securities, partially offset by $12.5 million of net realized gains on investments. The unrealized
30
losses on equity securities for the year ended December 31, 2018 were primarily the result of volatility in equity markets. Realized
gains were primarily related to the sale of fixed maturity and equity securities, resulting from a rebalancing of our investment
portfolio, partially offset by $3.3 million in other-than-temporary impairments of certain fixed maturity securities due to our intent
to sell the securities. Net realized gains on investments in 2017 were primarily related to sales of municipal securities, whose
proceeds were reinvested in taxable fixed maturity securities, and sales of equity securities as part of a routine rebalancing of our
equity portfolio. Those gains were partially offset by $1.4 million in other-than temporary impairments of certain fixed maturity
and equity securities due to our intent to sell those securities and/or the severity and duration of the change in fair value of those
securities. Net realized gains on investments in 2016 were primarily the result of the sale of equity securities as part of a routine
rebalancing of our equity portfolio to meet cash needs at the holding company, and to provide cash to support the internal
restructuring of our insurance subsidiaries. Those gains were partially offset by $5.8 million in other-than-temporary impairments
of certain equity securities due to our intent to sell those securities, and the downturn in the energy sector during that year. Additional
information regarding our Investments is set forth under “–Liquidity and Capital Resources–Investments” and Note 6 in the Notes
to our Consolidated Financial Statements.
Other Income
Other income consists of net gains on fixed assets, non-investment interest, installment fee revenue, and other miscellaneous
income. Other income was $1.2 million, $0.8 million, and $0.6 million for the years ended December 31, 2018, 2017, and 2016,
respectively.
Losses and LAE, Commission Expenses, and Underwriting and Other Operating Expenses
The following table presents our calendar year combined ratios.
Loss and LAE ratio
Underwriting and other operating expenses ratio
Commission expense ratio
Combined ratio
Years Ended December 31,
2017
2016
2018
51.5%
21.7
12.9
86.1%
58.2%
19.5
12.8
90.5%
60.1%
19.7
12.0
91.8%
We include all of the operating expenses of our holding company in the calculation of our combined ratio, which added
approximately two percentage points to that ratio in each of the years ended December 31, 2018, 2017, and 2016.
Loss and LAE Ratio.
We analyze our loss and LAE ratios on both a calendar year and accident year basis.
The calendar year loss and LAE ratio is calculated by dividing the losses and LAE incurred during the calendar year, regardless
of when the underlying insured event occurred, by the net premiums earned during that calendar year. The calendar year loss and
LAE ratio includes changes made during the calendar year in reserves for losses and LAE established for insured events occurring
in the current and prior years. The calendar year loss and LAE ratio for a particular year will not change in future periods.
The accident year loss and LAE ratio is calculated by dividing losses and LAE, regardless of when such losses and LAE are
incurred, for insured events that occurred during a particular year by the net premiums earned for that year. 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. The accident year loss and LAE ratio is based on
our statutory financial statements and is not derived from our GAAP financial information.
We analyze our calendar year loss and LAE ratio to measure our profitability in a particular year and to evaluate the adequacy of
our premium rates charged in a particular year to cover expected losses and LAE from all periods, including development (whether
favorable or unfavorable) of reserves established in prior periods. In contrast, we analyze our accident year loss and LAE ratios
to evaluate our underwriting performance and the adequacy of the premium rates we charged in a particular year in relation to
ultimate losses and LAE from insured events occurring during that year. The loss and LAE ratios provided in this report are
calendar year basis, except where they are expressly identified as accident year loss and LAE ratios.
Losses and LAE represents our largest expense item and includes claim payments made, amortization of the Deferred Gain, LPT
Reserve Adjustments, LPT Contingent Commission Adjustments, estimates for future claim payments and changes in those
estimates for current and prior periods, and costs associated with investigating, defending, and adjusting claims. The quality of
our financial reporting depends in large part on accurately predicting our losses and LAE, which are inherently uncertain as they
are estimates of the ultimate cost of individual claims based on actuarial estimation techniques.
Our indemnity claims frequency (the number of claims expressed as a percentage of payroll) continued to decrease year-over-
year in 2018 and 2017; however, in 2018, we saw an upward movement in medical and indemnity costs per claim that is reflected
31
in our current accident year loss estimate. Total claims costs have also been reduced by cost savings associated with increased
claims settlement activity that continued through 2018. 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.”
Overall, losses and LAE were $376.7 million, $417.2 million, and $417.9 million for the years ended December 31, 2018, 2017,
and 2016, respectively. The decrease in our losses and LAE from 2017 to 2018 was primarily attributable to favorable prior accident
year loss development of $66.2 million, which included $65.5 million of favorable development on our voluntary risk business
and $0.7 million of favorable development related to our assigned risk business. The decrease in our losses and LAE from 2016
to 2017 was primarily due to a lower current accident year loss estimate year-over-year. Net favorable prior accident year loss
development in 2017 and 2016 was $18.5 million and $18.4 million, respectively, which included $17.4 million and $17.0 million
of favorable development on our voluntary risk business, respectively, and $1.1 million and $1.4 million of favorable development
related to our assigned risk business, respectively. Favorable prior accident year loss development in each period was the result
of our determination that adjustments were necessary to reflect observed favorable paid loss trends in each of these years. Paid
loss trends have been impacted by our internal initiatives to reduce loss costs, including the accelerated claims settlement activity
that began in 2014 and have continued through 2018. Additionally, there were favorable LPT Reserve Adjustments of $2.2 million
and $3.1 million that decreased losses and LAE by those amounts for the years ended December 31, 2018 and 2016, respectively.
There were no LPT Reserve Adjustments in 2017.
Our current accident year loss ratio estimates were 62.6%, 62.4%, and 65.2% for the years ended December 31, 2018, 2017, and
2016, respectively. The slight increase in our current accident year loss estimate in 2018, compared to 2017, reflects the impact
of rate decreases in many of the states in which we operate, largely offset by the continued impact of key business initiatives,
including: an emphasis on the accelerated settlement of open claims; diversifying our risk exposure across geographic markets;
and leveraging data-driven strategies to target, underwrite, and price profitable classes of business across all of our markets. The
current accident year loss estimate for the year ended December 31, 2016 included the impact of $6.5 million in large losses
recognized during that year, which increased the current accident year loss estimate for the year ended December 31, 2016.
Excluding the impact from the LPT Agreement, losses and LAE would have been $391.3 million, $428.8 million, and $434.5
million, or 53.5%, 59.8%, and 62.5% of net premiums earned, for the years ended December 31, 2018, 2017, and 2016, respectively.
The table below reflects prior accident year loss and LAE reserve adjustments and the impact of the LPT on net income before
taxes.
Prior accident year favorable development, net
Amortization of the Deferred Gain related to losses
Amortization of the Deferred Gain related to contingent commission
Impact of LPT Reserve Adjustments
Impact of LPT Contingent Commission Adjustments
Total impact of the LPT
Total losses and LAE reserve adjustments
Underwriting and Other Operating Expenses Ratio.
$
$
$
2018
2016
$
$
Years Ended December 31,
2017
(in millions)
18.5
$
9.3
$
2.0
—
0.3
11.6
30.1
66.2
9.9
2.0
2.2
0.5
14.6
80.8
$
$
18.4
9.7
2.0
3.1
1.8
16.6
35.0
Underwriting and other operating expenses are those costs that we incur to underwrite and maintain the insurance policies we
issue, excluding commission. These expenses include premium taxes and certain other general expenses that vary with, and are
primarily related to, producing new or renewal business. These policy acquisition costs are variable based on premiums earned.
Policyholder dividends, changes in estimates of future write-offs of premiums receivable, general administrative expenses such
as salaries and benefits, rent, office supplies, depreciation, and all other operating expenses not otherwise classified separately are
also included in Underwriting and other operating expenses. These expenses are more fixed in nature and become a smaller
percentage of net premiums earned as premiums increase.
Our underwriting and other operating expenses ratio was 21.7%, 19.5%, and 19.7%, and our underwriting and other operating
expenses were $158.5 million, $139.9 million, and $136.1 million for the years ended December 31, 2018, 2017, and 2016,
respectively. During the year ended December 31, 2018, our compensation-related expenses increased $8.5 million, our professional
fees increased $5.6 million, our bad debt expense increased $1.4 million, and our premium tax and assessments increased $1.4
million, each as compared to 2017. These increases were largely the result of our aggressive development and implementation of
32
new digital technologies and capabilities. During the year ended December 31, 2017, our compensation-related expenses increased
$2.6 million and professional fees increased $1.9 million, partially offset by a $0.7 million decrease in our premium taxes and
assessments, each as compared to 2016.
Commission Expense Ratio.
Commission expenses include direct commissions to our agents and brokers, including our partnerships and alliances, for the
premiums that they produce for us, as well as incentive payments, other marketing costs, and fees.
Our commission expense ratio was 12.9%, 12.8%, and 12.0%, and our commission expenses were $94.2 million, $91.4 million,
and $83.5 million for the years ended December 31, 2018, 2017, and 2016, respectively. The increases in the commission expense
ratios for 2018 and 2017, compared to 2016, were primarily the result of increased levels of agency incentive commissions and
an increase in the percentage of business produced by our partnerships and alliances for those years, which are subject to a higher
commission rate.
Other Expenses
We actively invest in technology and systems across our business with a view toward maximizing efficiency, facilitating customer
self-service, and creating increased capacity that will allow us to lower our expense ratios while growing premiums.
In 2017, we wrote-off $7.5 million of previously capitalized costs relating to the development of information technology capabilities
that had not yet been placed in service. This charge was the result of our continual evaluation of ongoing technology initiatives.
Income Tax Expense
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 part of the State of Nevada and therefore was not
subject to federal income tax. Accordingly, our pre-Privatization loss and LAE reserve adjustments, LPT Reserve Adjustments
and Deferred Gain amortization impact our net income but do not change our taxable income.
Income tax expense was $28.2 million ($28.6 million excluding the impact of Enactment), $42.8 million ($35.8 million excluding
the impact of Enactment), and $34.0 million for the years ended December 31, 2018, 2017, and 2016, respectively, representing
effective tax rates of 16.6% (16.8% excluding the impact of Enactment), 29.7% (24.9% excluding the impact of Enactment), and
24.2% for the years ended December 31, 2018, 2017, and 2016, respectively.
Enactment significantly revised U.S. corporate income tax law by, among other things, reducing the corporate statutory income
tax rate from 35% to 21%, beginning January 1, 2018. This reduction in the corporate statutory income tax rate required us to re-
evaluate certain of our deferred tax assets and liabilities, as of the date of Enactment, to reflect the revised income tax rates
applicable to future periods.
Tax-advantaged investment income, LPT Contingent Commission Adjustments, Deferred Gain amortization and certain other
adjustments reduced our income tax expense computed at a statutory rate of 21% for 2018 and 35% for 2017 and 2016 by $7.4
million, $14.6 million, and $15.3 million for the years ended December 31, 2018, 2017, and 2016, respectively. For the year ended
December 31, 2017, the reductions were partially offset by a $7.0 million increase in our income tax expense due to the re-
evaluation of our deferred tax assets and liabilities as of the date of Enactment. For the year ended December 31, 2017, we were
required to base certain of our income tax estimates and assumptions on incomplete information and/or preliminary interpretations
of the effects of Enactment. As a result, we made an adjustment of $(0.4) million to our income tax expense due to a further
evaluation of our deferred tax assets and liabilities during the year ended December 31, 2018.
For additional information regarding our income tax expense see Note 8 in the Notes to our Consolidated Financial Statements.
Liquidity and Capital Resources
Holding Company Liquidity
We are a holding company and our ability to fund our operations is contingent upon existing capital and the ability of our 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' ability to pay dividends to their parent is based on reported capital, surplus, and dividends paid within
the prior 12 months. For 2019, the maximum dividend that may be paid by EPIC without prior regulatory approval is $19.0 million.
EICN can pay $2.1 million of dividends through January 25, 2019, and $19.8 million thereafter, without prior regulatory approval;
ECIC can pay $8.8 million of dividends through September 5, 2019, and $57.2 million thereafter, without prior regulatory approval;
and EAC can pay $0.9 million of dividends through May 18, 2019, and $19.8 million thereafter, without prior regulatory approval.
33
Total cash and investments at the holding company were $129.6 million at December 31, 2018, consisting of $41.3 million of
cash and cash equivalents, $25.0 million of short-term investments, $24.6 million of fixed maturity securities, and $38.7 million
of equity securities. We do not currently have a revolving credit facility because we currently believe that the holding company's
cash needs for the foreseeable future will be met with its cash and investments on hand, as well as dividends available from our
insurance subsidiaries.
Operating Subsidiaries' Liquidity
The primary sources of cash for our operating subsidiaries, which include our insurance and other operating subsidiaries, are
premium collections, investment income, sales and maturities of investments and reinsurance recoveries. The primary uses of cash
for our operating subsidiaries are payments of losses and LAE, commission expenses, underwriting and other operating expenses,
ceded reinsurance, investment purchases and dividends paid to their parent.
Total cash and investments held by our operating subsidiaries was $2,700.1 million at December 31, 2018, consisting of $60.7
million of cash, cash equivalents, and restricted cash, $2,471.8 million of fixed maturity securities, and $167.6 million of equity
securities. Sources of immediate and unencumbered liquidity at our operating subsidiaries as of December 31, 2018 consisted of
$59.5 million of cash and cash equivalents, $161.2 million of publicly-traded equity securities whose proceeds are available within
three business days, and $1,405.4 million of highly liquid fixed maturity securities whose proceeds are available within three
business days. We believe that our subsidiaries' liquidity needs over the next 24 months will be met with cash from operations,
investment income, and maturing investments.
Each of our insurance subsidiaries is a member of the Federal Home Loan Bank of San Francisco (FHLB). Membership allows
our subsidiaries access to collateralized advances, which may be used to support and enhance liquidity management. The amount
of advances that may be taken is dependent on statutory admitted assets on a per company basis. Currently, none of our subsidiaries
has advances outstanding under the FHLB facility.
FHLB membership also allows our insurance subsidiaries access to Letter of Credit Agreements and on March 9, 2018, ECIC,
EPIC, and EAC entered into Letter of Credit Agreements with the FHLB. The Letter of Credit Agreements are between the FHLB
and each of EAC, in the amount of $40.0 million, ECIC, in the amount of $50.0 million, and EPIC, in the amount of $50.0 million.
The Letter of Credit Agreements became effective March 9, 2018 and expire March 31, 2019. The Letter of Credit Agreements
may only be used to satisfy, in whole or in part, insurance deposit requirements with the State of California and are fully secured
with eligible collateral at all times (See Note 11).
We purchase reinsurance to protect us against the costs of severe claims and catastrophic events. On July 1, 2018, we entered into
a new reinsurance program that is effective through June 30, 2019. The reinsurance program consists of one treaty covering excess
of loss and catastrophic loss events in four layers of coverage. Our reinsurance coverage is $190.0 million in excess of our $10.0
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.
Our insurance subsidiaries are required by law to maintain a certain minimum level of surplus on a statutory basis. Surplus is
calculated by subtracting total liabilities from total admitted assets. The amount of capital in our insurance subsidiaries is maintained
relative to standardized capital adequacy measures such as risk-based capital (RBC), as established by the National Association
of Insurance Commissioners. The RBC standard was designed to provide a measure by which regulators can assess the adequacy
of an insurance company's capital and surplus relative to its operations. An insurance company must maintain capital and surplus
of at least 200% of RBC. Each of our insurance subsidiaries had total adjusted capital in excess of the minimum RBC requirements
that correspond to any level of regulatory action at December 31, 2018.
Various state laws and regulations require us to hold investment securities or letters of credit on deposit with certain states in which
we do business. Securities having a fair value of $867.7 million and $1,009.7 million were on deposit at each of December 31,
2018 and 2017, respectively. These laws and regulations govern both the amount and types of investment securities that are eligible
for deposit. Additionally, standby letters of credit from the FHLB have been issued in lieu of $140.0 million of securities on deposit
at December 31, 2018.
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. The fair value of fixed maturity securities held in trust for the benefit of our ceding reinsurers
was $23.2 million and $24.5 million at December 31, 2018 and 2017, respectively.
Sources of Liquidity
We monitor the cash flows of each of our subsidiaries individually, as well as collectively as a consolidated group. We use trend
and variance analyses to project future cash needs, making adjustments to our forecasts as appropriate.
34
The table below shows our net cash flows. For additional information regarding our cash flows, see Item 8, Consolidated
Statements of Cash Flows.
Cash, cash equivalents, and restricted cash provided by (used in):
2018
Operating activities
Investing activities
Financing activities
Increase in cash, cash equivalents, and restricted cash
Operating Activities
$
$
Years Ended December 31,
2017
(in millions)
142.3
$
(112.8)
(26.0)
3.5
180.2
(119.6)
(32.9)
27.7
$
$
$
2016
122.8
(87.5)
(23.6)
11.7
Net cash provided by operating activities in 2018 included net premiums received of $745.9 million and investment income
received of $91.1 million. These operating cash inflows were partially offset by net claims payments of $416.4 million, underwriting
and other operating expenses paid of $142.1 million, and commissions paid of $92.6 million.
Net cash provided by operating activities in 2017 included net premiums received of $702.4 million and investment income
received of $90.0 million. These operating cash inflows were partially offset by net claims payments of $419.2 million, underwriting
and other operating expenses paid of $123.6 million, and commissions paid of $84.6 million.
Net cash provided by operating activities in 2016 included net premiums received of $694.9 million and investment income
received of $87.8 million. These operating cash inflows were partially offset by net claims payments of $433.7 million, underwriting
and other operating expenses paid of $125.8 million, and commissions paid of $84.2 million.
Investing Activities
Net cash used in investing activities in 2018, 2017, and 2016 was primarily related to the investment of premiums received and
the reinvestment of funds from maturities, redemptions, and interest income. These investing cash outflows were partially offset
by investment sales whose proceeds were used to fund claims payments, underwriting and other operating expenses, stockholder
dividend payments, and for common stock repurchases during 2018 and 2016.
Financing Activities
Net cash used in financing activities in 2018 included common stock repurchases and stockholder dividend payments.
Net cash used in financing activities in 2017 included stockholder dividend payments and the purchase of a note payable.
Net cash used in financing activities in 2016 was primarily related to common stock repurchases and payments of stockholder
dividends, partially offset by net proceeds from stock-based compensation, mainly proceeds from exercises of stock options.
Dividends. Dividends paid to stockholders were $26.7 million, $19.7 million, and $11.5 million in 2018, 2017, and 2016,
respectively. The declaration and payment of future dividends to common stockholders will be at the discretion of our Board of
Directors and will depend upon many factors, including our financial position, capital requirements of our operating subsidiaries,
legal and regulatory requirements, and any other factors our Board of Directors deems relevant. On February 20, 2019, the Board
of Directors declared a $0.22 dividend per share, payable March 20, 2019, to stockholders of record on March 6, 2019.
Share Repurchases. On February 21, 2018, the Board of Directors authorized a share repurchase program for repurchases of up
to $50.0 million of the Company's common stock (the 2018 Program). The 2018 Program provides that shares may be purchased
at prevailing market prices from February 26, 2018 through February 26, 2020 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 that may be 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 2018 Program may be commenced,
modified, or suspended from time to time without prior notice, and the program may be suspended or discontinued at any time.
Through December 31, 2018, we repurchased a total of 112,528 shares of common stock under the 2018 Program at an average
price of $40.95 per share, including commissions, for a total cost of $4.6 million. As of December 31, 2018, we had a remaining
common stock repurchase authorization of $45.4 million under the 2018 Program. See Item 5, Issuer Purchases of Equity Securities.
Capital Resources
As of December 31, 2018, the capital resources available to us consisted of: (i) $20.0 million in surplus notes maturing in 2034;
(ii) $1,018.2 million of stockholders' equity; and (iii) the $149.6 million Deferred Gain.
35
The following outlines each component of our total capital resources:
Notes Payable. The surplus notes bear interest at a rate of between 405 and 425 basis points in excess of the 90-day LIBOR per
annum, payable quarterly. We may redeem the surplus notes at any time at their face value of $20.0 million, plus accrued and
unpaid interest. The surplus notes mature in 2034.
Both the payment of interest and repayment of the surplus notes are subject to the prior approval of the Florida Department of
Financial Services.
In 2017, EHI purchased one of EPIC's outstanding notes payable in the amount of $12.0 million for $9.9 million, resulting in a
$2.1 million gain. As a result of EHI's purchase of the note, it was no longer considered outstanding on a consolidated basis as of
December 31, 2017. The note was formally redeemed and retired by EPIC in May 2018.
Stockholders' Equity. The following table summarizes our beginning and ending stockholders' equity balance and the changes
thereto for each of the years ended December 31, 2018, 2017, and 2016:
Beginning Balance
Stock-based obligations
Stock options exercised
Shares withheld to satisfy minimum tax withholdings for certain stock-
based obligations
Grant date fair value adjustment
Acquisition of common stock
Dividends declared
Net income for the year
Change in net unrealized (losses) gains on investments, net of taxes
Ending Balance
$
$
December 31,
2018
2017
2016
(in millions)
840.6
$
6.9
6.0
(2.2)
(0.2)
—
(19.7)
101.2
15.1
947.7
$
$
$
947.7
9.4
1.1
(2.9)
—
(4.6)
(26.7)
141.3
(47.1)
1,018.2
760.8
5.8
9.6
(0.6)
—
(21.1)
(11.5)
106.7
(9.1)
840.6
Deferred Gain. The Deferred Gain, which totaled $149.6 million and $163.6 million as of December 31, 2018 and 2017,
respectively, reflects the unamortized gain from the LPT Agreement. See Note 2 in the Notes to our Consolidated Financial
Statements.
Contractual Obligations and Commitments. The following table identifies our long-term debt and contractual obligations as of
December 31, 2018.
Operating leases
Non-cancellable contracts
Notes payable(1)
Capital leases
Unpaid losses and LAE reserves(2)(3)
Unfunded investments
Total contractual obligations
Payment Due By Period
Total
Less Than
1-Year
$
$
22.5
18.8
41.4
0.9
2,207.9
50.0
2,341.5
$
$
5.3
5.9
1.4
0.3
370.4
50.0
433.3
1-3 Years
(in millions)
7.3
$
6.7
2.7
0.5
480.2
—
497.4
$
$
$
4-5 Years
More Than
5 Years
3.7
6.2
2.7
0.1
288.7
—
301.4
$
$
6.2
—
34.6
—
1,068.6
—
1,109.4
(1) Notes payable includes payments of the principal and estimated interest expense on our surplus notes outstanding based on LIBOR plus a
margin. The interest rates used ranged from 6.8% to 6.9%.
(2) 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.
36
(3) The unpaid losses and LAE reserves are presented gross of reinsurance recoverables for unpaid losses, which were as follows for each of
the periods presented above:
Recoveries Due By Period
Total
Less Than
1 Year
1-3 Years
(in millions)
4-5 Years
More Than
5 Years
Reinsurance recoverables on unpaid losses and LAE
$
(504.4) $
(27.4) $
(52.0) $
(49.2) $
(375.8)
Investments
Our investment portfolio is structured to support our need for: (i) optimizing our risk-adjusted total return; (ii) providing adequate
liquidity; (iii) facilitating financial strength and stability; and (iv) ensuring regulatory and legal compliance.
As of December 31, 2018, the total amortized cost of our investments recorded at fair value was $2,670.6 million and its fair value
was $2,721.3 million. These investments provide a steady source of income, which may fluctuate with changes in interest rates
and our current investment strategies.
We also have a $6.4 million investment in FHLB stock which we record at cost. We receive periodic dividends from the FHLB
for this investment, when declared, which can vary from period to period.
Our Investment Managers follow our written investment guidelines based upon strategies approved by our Board of Directors and
our asset allocation is reevaluated by management and reviewed by the Finance Committee of the Board of Directors on a quarterly
basis. We also utilize our Investment Managers' investment advisory services to assist us in developing a tailored set of portfolio
targets and objectives.
As of December 31, 2018, our investment portfolio consisted of 92% fixed maturity securities. We strive to limit the interest rate
risk associated with fixed maturity investments by managing the duration of these securities. Our fixed maturity securities (excluding
cash and cash equivalents) had a duration of 4.1 at December 31, 2018. To minimize interest rate risk, our portfolio is weighted
toward short-term and intermediate-term bonds; however, our investment strategy balances consideration of duration, yield, and
credit risk. Our investment guidelines require that the minimum weighted average quality of our fixed maturity securities portfolio
be “A+,” using ratings assigned by S&P. Our fixed maturity securities portfolio had a weighted average quality of “AA-” as of
December 31, 2018, with 50.5% of the portfolio rated “AA” or better, based on market value. Other securities within fixed maturity
securities consist of bank loans, which are classified as AFS and are reported at fair value.
We also have a portfolio of equity securities, which we record at fair value. We strive to limit the exposure to equity price risk
associated with equity securities by diversifying our holdings across several industry sectors. Equity securities represented 7% of
our investment portfolio at December 31, 2018.
We believe that our current asset allocation meets our strategy to preserve capital for claims and policy liabilities and to provide
sufficient capital resources to support and grow our ongoing insurance operations.
The following table shows the estimated fair value, the percentage of the fair value to total invested assets, the average book yield,
and the average tax equivalent yield (each based on the book value of each category of invested assets) as of December 31, 2018.
Category
U.S. Treasuries
U.S. Agencies
States and municipalities
Corporate securities
Residential mortgaged-backed securities
Commercial mortgaged-backed securities
Asset-backed securities
Other securities
Equity securities
Short-term investments
Total investments at fair value
Weighted average yield
(1) Computed using a statutory income tax rate of 21%.
Estimated Fair
Value
Percentage of
Total
Book Yield
(in millions, except percentages)
Tax Equivalent
Yield(1)
3.9%
0.4
19.4
40.1
16.6
3.5
2.4
5.5
7.3
0.9
100.0%
2.2%
4.3
3.3
3.3
3.2
2.9
3.3
5.3
4.8
2.4
3.4%
2.2%
4.3
3.9
3.3
3.2
2.9
3.3
5.3
5.2
2.4
3.5%
$
$
106.4
11.4
528.0
1,090.4
451.5
94.3
64.5
149.9
199.9
25.0
2,721.3
37
The following table shows the percentage of total estimated fair value of our fixed maturity securities as of December 31, 2018
by credit rating category, using the lower of the ratings assigned by Moody's Investors Service or S&P.
Rating
“AAA”
“AA”
“A”
“BBB”
Below Investment Grade
Total
Percentage of Total
Estimated Fair Value
8.3%
42.2
31.3
12.4
5.8
100.0%
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 impairment 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 be required to sell the security before its fair value recovers
to above cost, or maturity.
We believe that we have appropriately identified the declines in the fair values of our unrealized losses for the years ended
December 31, 2018, 2017, and 2016. We recognized impairments on fixed maturity securities of $3.3 million (consisting of sixty-
six securities) and $0.5 million (consisting of nine securities) during the years ended December 31, 2018 and 2017, respectively.
The other-than-temporary impairments recognized during these years were the result of our intent to sell these securities and/or
the severity of the change in fair values of these securities. We 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 remaining fixed maturity
securities whose fair value was less than amortized cost were not determined to be other-than-temporarily impaired given the lack
of severity and duration of the impairment, the credit quality of the issuers, our intent to not sell the securities, and a determination
that it is not more likely than not that we will be required to sell the securities until fair value recovers to above cost, or principal
value upon maturity.
The adoption of ASU 2016-01 removed the impairment assessment for equity securities at fair value beginning in 2018, and
changes in fair value are included in Net realized and unrealized (losses) gains on investments on our Consolidated Statements of
Comprehensive Income. Prior to the adoption of this standard, we recognized impairments on equity securities of $0.9 million
(consisting of seven equity securities) and $5.8 million (consisting of thirty-seven equity securities) during the years ended
December 31, 2017 and 2016, respectively. The other-than temporary impairments recognized during these years were the result
of our intent to sell and/or the severity and duration of the change in fair values of these securities. The impairments on equity
securities in 2016 were primarily due to the downturn in the energy sector that occurred during the first quarter. Certain unrealized
losses on equity securities in 2017 and 2016 were not considered to be other-than-temporary due to the financial condition and
near-term prospects of the issuers, and our intent to hold the securities until fair value recovers to above cost.
For additional information regarding our investments, including the cost or amortized cost, gross unrealized gains, gross unrealized
losses, and estimated fair value of our investments, the amortized cost and estimated fair value of fixed maturity securities by
contractual maturity, and net realized and unrealized (losses) gains on investments, see Note 6 in the Notes to our Consolidated
Financial Statements.
Off-Balance Sheet Arrangements
We currently have operating leases that constitute off-balance sheet arrangements. Our operating lease obligations are provided
under "–Liquidity and Capital Resources–Capital Resources–Contractual Obligations and Commitments."
Critical Accounting Policies
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 understand our financial statements because
changes in these estimates or changes in the assumptions used to make them could have a material impact on our results of
operations, financial condition, and cash flows.
Reserves for Losses and LAE
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
38
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 loss reserves is the sum of our reserves for each accident year and represents our best estimate of outstanding loss reserves.
The amount by which estimated losses in the aggregate differ from those previously estimated for a specific time period is known
as reserve “development.” Reserve development is unfavorable when losses ultimately settle for more than the amount reserved
or subsequent estimates indicate a basis for reserve increases, 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.
Although claims for which reserves are established may not be paid for several years or more, we do not discount loss reserves
in our financial statements for the time value of money, in accordance with GAAP.
The three main components of our loss reserves are case reserves, incurred but not reported (IBNR) loss reserves, and LAE reserves.
When claims are reported to us, we establish individual estimates of the ultimate cost of each claim (case reserves). These case
reserves are continually monitored and revised in response to new information and for amounts paid.
IBNR is an actuarial estimate of future payments on claims that have occurred but have not yet been reported to us. In addition
to this provision for late reported claims, we also estimate and make a provision for the extent to which the case reserves on known
claims may develop and for additional payments on closed claims, known as “reopening.” IBNR reserves apply to the entire body
of claims arising from a specific time period, rather than a specific claim. Most of our IBNR reserves relate to estimated future
claim payments on recorded open claims.
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, and adjusting and other.
A portion of our obligations for losses and LAE are ceded to unaffiliated reinsurers. The amount of reinsurance that will be
recoverable on our losses and LAE includes both the reinsurance recoverable from our excess of loss reinsurance contracts, as
well as reinsurance recoverable under the terms of the LPT Agreement.
Our loss reserves (gross and net of reinsurance), including the main components of such reserves, were as follows:
As of December 31,
2017
2018
Case reserves
IBNR
LAE reserves
Gross unpaid losses and LAE reserves
Less reinsurance recoverables on unpaid losses and LAE
Net unpaid losses and LAE reserves
$
$
$
(in millions)
940.6
955.7
311.6
2,207.9
504.4
1,703.5
$
986.2
964.4
315.5
2,266.1
537.0
1,729.1
We use actuarial methods to analyze and estimate the aggregate amount of loss reserves. Management considers the results of
various actuarial projection methods and their underlying assumptions, among other factors, in establishing loss reserves.
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 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 loss reserves, and to present those results to our Internal Actuary and to management
as supplemental data in selecting management's best estimate of ultimate losses.
39
We compile and aggregate our claims data by grouping the claims according to the year in which the claim occurred (“accident
year”) when analyzing claim payment and emergence patterns and trends over time. Additionally, claims data is aggregated and
compiled separately for different types of claims, claimant benefits and for different states, territories within states, or groups of
states in which we do business.
Our Internal Actuary and the Consulting Actuary prepare reserve estimates for all accident years using our own historical claims
data, industry data and many of the generally accepted actuarial methodologies for estimating loss reserves, such as paid loss
development methods, incurred loss development methods, and Bornhuetter-Ferguson methods. These methods vary in their
responsiveness to different information, characteristics, and dynamics in the data, and the results assist the actuary in considering
these characteristics and dynamics in the historical data. The methods employed for each segment of claims data, and the relative
weight accorded to each method, vary depending on the nature of the claims segment and on the age of the claims.
Each actuarial methodology requires the selection and application of various parameters and assumptions. The key parameters
and assumptions include: the pattern with which our aggregate claims data will be paid or will emerge over time; the magnitude
and changes in claim settlement activity, claims cost inflation rates; the effects of legislative benefit changes and/or judicial changes;
and trends in the frequency of claims, both overall and by severity of claim. We believe the pattern with which our aggregate
claims data will be paid or emerge over time, claim settlement activity, claims cost inflation rates, and claim frequencies are the
most important parameters and assumptions.
Management, along with our Internal Actuary and the Consulting Actuary, separately analyze LAE and estimate unpaid LAE.
These analyses rely primarily on examining the relationship between the aggregate amounts that have been spent on LAE
historically, compared with the volume of claims activity for the corresponding historical calendar periods. The portion of unpaid
LAE that will be recoverable from reinsurers is estimated based on the contractual reinsurance terms.
The ranges of estimates of loss reserves produced by our Internal Actuary and the Consulting Actuary are intended to represent
the range in which it is most likely that the ultimate losses will fall. These ranges are narrower than the range of indications
produced by the individual methods applied because it is not likely that the high or low result will emerge for every claim segment
and accident year. Each actuary's point estimate of loss reserves is based on a judgmental selection for each claim segment from
within the range of results indicated by the different actuarial methods.
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 in the second and fourth quarters 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 and case reserve activity by our Internal Actuary.
The aggregate carried reserve calculated by management represents our best estimate of our outstanding unpaid losses and LAE.
In establishing management's best estimate of unpaid losses and LAE at December 31 for the last three years, management and
our Internal Actuary reviewed and considered the following: (a) our Internal Actuary's and the Consulting Actuary's assumptions,
point estimates, and ranges; (b) the inherent uncertainty of workers' compensation loss reserves; and (c) the potential for legislative
and/or judicial reversal of California workers' compensation reforms. Management did not quantify a specific loss reserve increment
for each uncertainty, but rather established an overall provision that represented management's best estimate of loss reserves in
light of the historical data, actuarial assumptions, point estimate and range, and current facts and circumstances.
The table below provides the actuarial range of loss reserves that management considered when selecting its best estimate and our
carried reserves.
Low end of actuarial range
Carried reserves
High end of actuarial range
As of December 31,
2017
2018
(in millions)
$
$
1,484.8
1,703.5
1,897.3
1,533.1
1,729.1
1,916.5
As of December 31, 2018, California and Nevada loss reserves represented approximately 76% of our total loss reserves on our
Consolidated Balance Sheet.
In California, our recent loss experience from 2012 through 2018, indicates a slight downward trend in medical severity and a
slight upward trend in indemnity severity. The reduction in medical severity can be attributed to a number of factors including
California Senate Bill 863 (SB 863), which was enacted in 2012 and largely became effective in 2013/2014. Among the more
significant changes, SB 863 introduced independent medical review (IMR) into the dispute resolution process and also introduced
filing fees for medical liens. On the indemnity side, various provisions of SB 863 resulted in an overall increase in certain benefits.
Our indemnity claims frequency (the number of claims expressed as a percentage of payroll) has decreased year-over-year for the
40
past three years. Aside from the impact of recent regulatory changes, we believe our increased emphasis on claims settlements,
as well as our various underwriting initiatives, have contributed to more favorable trends in our California results.
In Nevada, we have compiled a lengthy history of workers' compensation claims payment patterns based on the business of the
Fund and EICN, but the emergence and payment of claims in recent years has been more favorable than in the long-term history
in Nevada with the Fund. The expected patterns of claim payments and emergence used in the projection of our ultimate claim
payments are based on both long and short-term historical data. In recent evaluations, claim patterns have continued to emerge in
a manner consistent with short-term historical data. Consequently, our selection of claim projection patterns has relied more heavily
on patterns observed in recent years.
Our insurance subsidiaries have been operating in a period characterized by 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 more 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.
We have actively driven a significant increase in claims settlement activity beginning in 2014 and continuing through 2018, which
has primarily affected accident years 2009 and forward, that is the result of an internal initiative that emphasizes the settlement
of open claims. This settlement activity has been recognized in the actuarial analysis using a methodology developed to adjust the
data and loss development patterns to account for the settlements arising from this initiative.
Approximately 59% of our claims payments during the three years ended December 31, 2018 related to medical care for injured
workers. The utilization and cost of medical services in the future is a significant source of uncertainty in the establishment of
loss reserves for workers' compensation. Our loss reserves are established based on reviewing the results of actuarial methods,
most of which do not contain explicit medical claim cost inflation rates; however, because medical care may be provided to an
injured worker over many years, and in some cases decades, the pace of medical claim cost inflation has a significant impact on
our ultimate claim payments. For example, if the rate of medical claim cost inflation increases by 1% above the inflation rate that
is implicitly included in the loss reserves at December 31, 2018, we estimate that future medical costs over the lifetime of current
claims would increase by approximately $87.0 million on a net-of-reinsurance basis.
The range of estimates of loss reserves produced by our actuarial reviews of medical cost inflation data provides some indication
of the potential variability of future losses and LAE payments; however, the full range of potential variation is difficult to estimate
because our insurance subsidiaries do not have a lengthy operating history in many of the states in which we now operate. Our
reserve estimates reflect expected increases in the costs of contested claims, but do not assume any losses resulting from significant
new legal liability theories. Our reserve estimates also assume that there will not be significant future changes in the regulatory
and legislative environment. In the event of significant new legal liability theories or new regulation or legislation, we will attempt
to quantify its impact on our business.
If the actual loss reserves were at the high or the low end of the actuarial range, the impact on our financial results would have
been as follows:
Increase (decrease) in reserves
At low end of range
At high end of range
Increase (decrease) in stockholders' equity and net income
At low end of range
At high end of range
December 31,
2018
2017
(in millions)
(218.7) $
193.8
$
172.8
(153.1)
(196.0)
187.4
127.4
(121.8)
$
$
Actual losses are affected by a more complex combination of forces and dynamics than any one model or actuarial methodology
can represent, and each methodology is an approximation of these complex forces and dynamics. None of the methods are designed
or intended to produce an indication that is systematically higher or lower than the other methods. At any given evaluation date,
some of the actuarial projection methods produce indications outside the actuary's selected range. Accordingly, we believe that
the range of potential outcomes is considerably wider than the actuarially estimated range of the most likely outcomes. We have
no basis for anticipating whether actual future payments of losses and LAE may be either greater than or less than the loss reserves
currently on our Consolidated Balance Sheets.
41
Additionally, any adjustment to the estimated ceded reserves under the LPT Agreement results in a cumulative adjustment to the
Deferred Gain, which is also included in losses and LAE incurred in the Consolidated Statements 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. The table below provides the actuarial range of estimated liabilities for gross loss reserves under the LPT
Agreement and our carried reserves.
Low end of actuarial range
LPT carried reserves
High end of actuarial range
Reinsurance Recoverables
As of December 31,
2018
(in millions)
$
374.9
408.2
470.4
Reinsurance recoverables represent: (a) amounts currently due from reinsurers on paid losses and LAE; (b) amounts recoverable
from reinsurers on estimates of reported losses; and (c) amounts recoverable from reinsurers on actuarial estimates of IBNR for
losses and LAE. These recoverables are based on our current estimates of the underlying loss reserves, and are reported on our
Consolidated Balance Sheets separately as assets, as reinsurance does not relieve us of our legal liability to policyholders. We bear
credit risk with respect to the reinsurers, which can be significant considering that some of the loss reserves remain outstanding
for an extended period of time. Reinsurers may refuse or fail to pay losses that we cede to them, or they might delay payment. We
are required to pay losses even if a reinsurer refuses or fails to meet its obligations under the applicable reinsurance agreement.
We continually monitor the financial condition and financial strength ratings of our reinsurers. No material amounts due from
reinsurers have been written-off as uncollectible since our inception in 2000, and we believe that amounts currently reflected on
our consolidated financial statements will similarly not require any material prospective adjustment.
Under the LPT Agreement, the Fund initially ceded $1.5 billion in liabilities for the incurred but unpaid losses and LAE related
to claims incurred prior to July 1, 1995 for consideration of $775.0 million in cash. The estimated remaining liabilities subject to
the LPT Agreement were $408.2 million as of December 31, 2018. Losses and LAE paid with respect to the LPT Agreement
totaled $773.7 million at December 31, 2018. We account for the LPT Agreement as retroactive reinsurance. Entry into the LPT
Agreement resulted in a deferred reinsurance gain that was recorded on our Consolidated Balance Sheets as a liability. The Deferred
Gain is being amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance
recoveries to total estimated recoveries through the life of the LPT Agreement, and the amortization is reflected in losses and LAE.
Changes in estimates of the reserves ceded under the LPT Agreement may significantly impact the Deferred Gain on our
Consolidated Balance Sheets and losses and LAE on our Consolidated Statements of Comprehensive Income.
Additionally, we are entitled to receive a contingent profit commission under the LPT Agreement. The contingent profit commission
is an amount based on the favorable difference between actual paid losses and LAE and expected paid losses and LAE as established
in the LPT Agreement. 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. We are paid 30% of the favorable difference between the actual
and expected losses and LAE paid at each calculation point. Each quarter, management records its best estimate of the estimated
ultimate contingent profit commission through June 30, 2024, which is impacted by estimates for ceded losses and LAE. The
related Deferred Gain is amortized using the recovery method, whereby the amortization is determined by the proportion of actual
reinsurance recoveries to total estimated recoveries over the life of the contingent profit commission, or through June 30, 2024,
and is recorded in losses and LAE incurred in the accompanying Consolidated Statements of Comprehensive Income. Changes
in estimates of the reserves ceded under the LPT Agreement may significantly impact the Contingent commission receivable–
LPT Agreement and the Deferred Gain on our Consolidated Balance Sheets and losses and LAE on our Consolidated Statements
of Comprehensive Income.
Recognition of Premium Revenue
Premium revenue is recognized as earned over the period of the contract in proportion to the amount of insurance protection
provided. At the end of the policy term, payroll-based premium audits are performed on substantially all policyholder accounts
to determine net premiums earned for the policy year. Earned but unbilled premiums include estimated future audit premiums
based on our historical experience. These estimates are subject to changes in policyholders' payrolls, economic conditions, and
seasonality, and are continually reviewed and adjusted as experience develops or new information becomes known. Any such
adjustments are included in current operations; however, they are partially offset by the resulting changes in losses and LAE,
commission expenses, and premium taxes. Although considerable variability is inherent in such estimates, we believe that the net
effect of any estimates currently reflected on our consolidated financial statements will similarly not require any material prospective
adjustment.
42
Income Taxes
We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that have been included in the financial statements. Under this method, we
determine deferred tax assets and liabilities on the basis of the differences between the financial statement and tax bases of assets
and liabilities by using enacted tax rates in effect for the year in which the timing differences are expected to reverse. The effect
of the recent change in tax rates on our deferred tax assets and liabilities was recognized in income as of the date of Enactment.
We record uncertain tax positions in accordance with ASC 740, Income Taxes, on the basis of a two-step process. Recognition
(Step 1) occurs when we conclude that a tax position, based solely on its technical merits, is more likely than not to be sustained
upon examination. Measurement (Step 2) is addressed only if Step 1 has been satisfied. Under Step 2, the tax benefit is measured
as the largest amount of benefit, determined on a cumulative probability basis, that is more likely than not to be realized upon
ultimate settlement.
We recognize deferred tax assets when it is determined that such assets are more likely than not to be realized in future periods.
In making such a determination, we consider all available positive and negative evidence, including future reversals of existing
taxable temporary differences, projected future taxable income, projected future tax rates, tax-planning strategies, and results of
recent operations. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net
recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which would reduce our provision
for income taxes.
In the year ended December 31, 2017, we were required to base certain of our income tax estimates and assumptions on incomplete
information and/or preliminary interpretations of the effects of Enactment. As a result, we made an adjustment to our income tax
expense due to a further evaluation of our deferred tax assets and liabilities during the year ended December 31, 2018. The total
adjustments made for the years ended December 31, 2018 and 2017 were $(0.4) million and $7.0 million, respectively.
Valuation of Investments
Our investments in fixed maturity securities, equity securities at fair value (prior to 2018), and short-term investments are classified
as AFS and are reported at fair value with unrealized gains and losses excluded from earnings and reported as a separate component
of stockholders' equity, net of deferred taxes, in accumulated other comprehensive income.
Beginning in 2018, with the adoption of ASU 2016-01, our investments in equity securities at fair value are no longer classified
as AFS and changes in fair value are included in Net realized and unrealized (losses) gains on investments on our Consolidated
Statements of Comprehensive Income.
Realized gains and losses resulting from sales of investments are recognized in operations on a specific-identification basis.
We use third party pricing services to assist us with our investment accounting function. The fair values of our AFS fixed maturity
and equity securities are based on quoted market prices, when available. These fair values are obtained primarily from third party
pricing services, which generally use Level 1 or Level 2 inputs in accordance with GAAP guidance. The Company obtains a quoted
price for each security from third party pricing services, which is derived through recently reported trades for identical or similar
securities. For securities not actively traded, the third party pricing services may use quoted market prices of similar instruments
or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs
that are often used in the valuation methodologies include, but are not limited to, broker quotes, benchmark yields, credit spreads,
default rates, and prepayment speeds. The Company also performs quarterly analysis on the prices received from third parties to
determine whether the prices are reasonable estimates of fair value, including confirming the fair values of these securities through
observable market prices using an alternative pricing source. If differences are noted in this review, the Company may obtain
additional information from other pricing services to validate the quoted price (See Note 5 in the Notes to our Consolidated
Financial Statements).
Impairment of Investment Securities. The adoption of ASU 2016-01 removed the impairment assessment for equity securities at
fair value beginning in 2018, and changes in fair value are included in Net realized and unrealized (losses) gains on investments
in the Consolidated Statements of Comprehensive Income. Prior to adoption of this standard, 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. 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 in 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.
43
Goodwill and Other Intangible Assets
We prepare an impairment analysis for goodwill and other intangible assets, whereby we identify whether events have occurred
that may impact the carrying value of these assets and make assumptions regarding future events, such as cash flows and profitability.
Differences between the assumptions used to prepare these valuations and actual results could materially impact the carrying
amount of these assets and our operating results.
New Accounting Standards
Recently Issued Accounting Standards
In August 2018, the Financial Accounting Standards Board (FASB) issued ASU Number 2018-13, Fair Value Measurement (Topic
820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This update removes the
disclosure requirements for the amounts of and the reasons for transfers between Level 1 and Level 2 and disclosure of the policy
for timing of transfers between levels. This update also removes disclosure requirements for the valuation processes for Level 3
fair value measurements. Additionally, this update adds disclosure requirements for the changes in unrealized gains and losses for
recurring Level 3 fair value measurements and quantitative information for certain unobservable inputs in Level 3 fair value
measurements. This update becomes effective for fiscal years beginning after December 15, 2019, including interim periods within
those fiscal years. The Company has determined that the impact of this new standard will not be material to the Company's financial
statements.
In July 2018, the FASB issued ASU Number 2018-09, Codification Improvements. This update provides clarification, corrects
errors in and makes minor improvements to the Codification within various ASC topics. Many of the amendments in this update
have transition guidance with effective dates for annual periods beginning after December 15, 2018 and some amendments in this
update do not require transition guidance and are effective upon issuance of this update. We will adopt amendments as they become
applicable and have determined that the impact of these improvements will not be material to our consolidated financial condition
and results of operations.
In July 2018, the FASB issued ASU Number 2018-11, Leases (Topic 842): Targeted Improvements. This update provides entities
with an additional and optional transition method to adopt ASU Number 2016-02 with a cumulative-effect adjustment in the period
of adoption. This update also provides guidance for a practical expedient that permits lessors to not separate non-lease components
from the associated lease components. Additionally, in July 2018, the FASB issued ASU Number 2018-10, Codification
Improvements to Topic 842, Leases. This update provides additional guidance on the new lease model with improvements in
numerous aspects of the guidance in ASC 842 including, but not limited to, implicit rates, reassessment of lease classification,
terms and purchase options, investment tax credits, and various other transition guidance. In December 2018, the FASB issued
ASU 2018-20, Leases (Topic 842): Narrow-Scope Improvements for Lessors. This update provides amendments to various lease
topics including sales taxes collected from lessees, certain lessor costs paid to third parties, and variable payments for contracts
with lease and non-lease components. These updates will be adopted concurrently with ASU Number 2016-02. We have determined
that the impact of these new standards will not be material to our financial statements.
In January 2017, the FASB issued ASU Number 2017-04, Intangibles-Goodwill and Other (Topic 350). This update simplifies the
measurement of goodwill by eliminating the performance of Step 2 in the goodwill impairment testing. This update allows the
testing to be performed by comparing the fair value of a reporting unit with its carrying amount and recognizing an impairment
charge when the carrying amount exceeds fair value. Additionally, this update eliminates the requirements of any reporting unit
with a zero or negative carrying value to perform Step 2, but requires disclosure of the amount of goodwill allocated to a reporting
unit with zero or negative carrying amount of net assets. This update becomes effective for fiscal years beginning after December
15, 2019. We do not expect that this update will have a material impact to our consolidated financial condition and results of
operations.
In June 2016, the FASB issued ASU Number 2016-13, Financial Instruments - Credit Losses (Topic 326). This update replaces
the incurred loss impairment methodology for recognizing credit losses on financial instruments with a methodology that reflects
an entity's current estimate of all expected credit losses. This update requires financial assets measured at amortized cost to be
presented net of an allowance for credit losses. Additionally, this update requires credit losses on available-for-sale fixed maturity
securities to be presented as an allowance rather than as a write-down, allowing an entity to also record reversals of credit losses
in current period net income. This update becomes effective for fiscal years beginning after December 15, 2019, including interim
periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim
periods within those fiscal years. Additionally, in December 2018, the FASB issued ASU 2018-19, Codification Improvements to
Topic 326, Financial Instruments - Credit Losses. This update provides clarification on the effective and transition dates and the
exclusion of operating lease receivables from Topic 326. We are currently evaluating the impact that the adoption of these updates
will have on our consolidated financial condition and results of operations.
In February 2016, the FASB issued ASU Number 2016-02, Leases (Topic 842). This update provides guidance on a new lease
model that includes the recognition of assets and liabilities arising from lease transactions on the balance sheet. Additionally, the
44
update provides clarity on the definition of a lease and the distinction between finance and operating leases. Furthermore, the
update requires certain qualitative and quantitative disclosures pertaining to the amounts recorded in the financial statements. This
update becomes effective for annual reporting periods, including interim periods within those annual periods, beginning after
December 15, 2018 and early adoption is permitted. We have determined that the impact of this new standard will be equal to the
present value of our lease obligations under various non-cancellable operating lease contracts, which amounted to approximately
$18.4 million at December 31, 2018, and will be recognized as lease assets and liabilities on our Consolidated Balance Sheets
upon adoption.
Recently Adopted Accounting Standards
In August 2018, the FASB issued ASU Number 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic
350-40) Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.
This update clarifies certain aspects of ASU 2015-05 and aligns the requirements for capitalizing implementation costs incurred
in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop
or obtain internal-use software and hosting arrangements that include an internal-use software license. This update becomes
effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years and early adoption
is permitted. We elected to adopt this standard as of July 1, 2018 using the retrospective method of adoption. Prior to adoption,
our accounting policy for capitalization of implementation costs followed the existing guidance for internal use software and
therefore this update had no impact on the amounts previously capitalized. In accordance with ASU Number 2018-15, $4.8 million
of capitalized costs included on our June 30, 2018 Consolidated Balance Sheets were reclassified from Property and equipment
to Cloud computing arrangements on the date of adoption. Amortization under the new guidance will commence once the module
or component is ready for its intended use, regardless of whether the hosting arrangement has been placed into service and will
be recognized over the remaining life of the service contract.
In March 2018, the FASB issued ASU Number 2018-05, Income Taxes (Topic 740). This update provides guidance regarding the
application of ASC Topic 740 for the income tax effects of the Tax Cuts and Jobs Act. This update allowed companies to report
provisional amounts of the effects of the Tax Cuts and Jobs Act in their financial statements in the first reporting period they are
able to determine a reasonable estimate and any adjustments to provisional amounts should be included in income from continuing
operations as an adjustment to tax expense or benefit in the reporting period the amounts are determined. We adopted this update
in the fourth quarter of 2017 and included an estimate of the income tax effects on our financial statements for the year ended
December 31, 2017. In accounting for certain tax effects of Enactment in accordance with SAB 118, we made a final adjustment
in 2018 of $(0.4) million.
In February 2018, the FASB issued ASU Number 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220).
The amendments in this update allow a reclassification from accumulated other comprehensive income to retained earnings for
stranded tax effects resulting from Enactment. This update becomes effective for fiscal years beginning after December 15, 2018,
and interim periods within those fiscal years. Early adoption is permitted for reporting periods for which financial statements have
not yet been issued and should be applied in the period of adoption or retrospectively to each period (or periods) in which the
effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. We elected to early
adopt this update and, accordingly, reclassified $17.8 million of net tax effects resulting from Enactment from Accumulated other
comprehensive (loss) income, net of tax, to Retained earnings at December 31, 2017.
In March 2017, the FASB issued ASU Number 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20).
This update shortens the amortization period on callable debt securities held at a premium to the earliest call date, which now
closely aligns the amortization period of premiums and discounts to expectations incorporated in the market pricing on callable
debt securities. This update becomes effective for fiscal years beginning after December 15, 2018 and interim periods within those
fiscal years, and early adoption is permitted. Our current accounting practices align with this standard and the adoption had no
impact on our consolidated financial condition or results of operations.
In January 2016, the FASB issued ASU Number 2016-01, Financial Instruments - Overall (Subtopic 825-10). This update replaced
the guidance to classify equity securities with readily determinable fair values into different categories (trading or available-for-
sale) and requires those equity securities to be measured at fair value with changes in fair value recognized through net income.
Additionally, this update eliminates the disclosure of 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 price
notion. Furthermore, this update clarifies that an evaluation of deferred tax assets related to available-for-sale securities is needed,
in combination with an evaluation of other deferred tax assets, to determine if a valuation allowance is required.
This update did not apply to our investment in Federal Home Loan Bank (FHLB) stock. Rather, it specified that FHLB stock shall
be carried at cost and evaluated periodically for impairment; furthermore, it specified that, beginning January 1, 2018, FHLB stock
shall not be shown with securities accounted for under ASC 321, which provides detailed guidance on, among other things,
accounting and reporting of investments in equity securities that have readily determinable fair values. As a result, our investment
in FHLB stock is presented within Equity securities at cost on our Consolidated Balance Sheet at March 31, 2018. In all periods
45
prior to January 1, 2018, our investment in FHLB stock is presented within Equity securities at fair value on our Consolidated
Balance Sheets.
This update became effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal
years. We adopted this update effective January 1, 2018. Adoption of this accounting standard resulted in a $74.0 million
reclassification adjustment, net of tax, from accumulated other comprehensive income to retained earnings.
In November 2016, the FASB issued ASU Number 2016-18, Statement of Cash Flows (Topic 230). This update provides guidance
for the classification and presentation of restricted cash and restricted cash equivalents in the statement of cash flows. This update
requires amounts generally described as restricted cash and restricted cash equivalents to be included with cash and cash equivalents
when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. It requires the
disclosure of information about the nature of restrictions on its cash, cash equivalents, and amounts generally described as restricted
cash or restricted cash equivalents. This update also requires the entity to disclose, on the face of the statement of cash flows or
in the notes to the financial statements, any restricted cash or restricted cash equivalents disaggregated by the line item in which
they appear within the statement of financial position. The adoption of this standard had no financial impact on our consolidated
financial condition, results of operations, or statement of cash flows.
In May 2014, the FASB issued ASU Number 2014-09, Revenue from Contracts with Customers (Topic 606). This update clarifies
the principles for recognizing revenue and develops revenue standards to improve revenue recognition guidance. This update
requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or
services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. In
applying this guidance companies are required to: (1) identify the contract(s) with a customer; (2) identify the performance
obligations in the contract(s); (3) determine the transaction price; (4) allocate the transaction price to the performance obligations
in the contract(s); and (5) recognize revenue when, or as, the entity satisfies a performance obligation. In August 2015, the FASB
issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the
effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, and interim reporting periods
within that annual reporting period. Insurance contracts are not within the scope of this updated guidance. We have analyzed
revenue streams within the current business operation and determined the adoption of this standard did not have an impact on our
consolidated financial condition and results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of potential economic loss principally arising from adverse changes in the fair value of financial instruments.
The major components of market risk affecting us are credit risk, interest rate risk, and equity price risk.
Credit Risk
Our investment portfolio is exposed to credit risk, which we attempt to manage through issuer and industry diversification. Our
investment guidelines include limitations on the minimum rating of fixed maturity securities and concentrations of a single issuer.
We also bear credit risk with respect to the reinsurers, which can be significant considering that some loss reserves remain
outstanding for an extended period of time. We are required to pay losses even if a reinsurer refuses or fails to meet its obligations
to us under the applicable reinsurance agreement(s). We continually monitor the financial condition and financial strength ratings
of our reinsurers. Additionally, we bear credit risk with respect to premiums receivable, which is generally diversified due to the
large number of entities comprising our policyholder base and their dispersion across many different industries and geographies.
Interest Rate Risk
Investments
The fair value of our fixed maturity portfolio is exposed to interest rate risk, which is the risk of a decline in fair value resulting
from changes in prevailing interest rates, which we strive to limit by managing duration. Our fixed maturity investments (excluding
cash and cash equivalents) had a duration of 4.1 at December 31, 2018. To minimize interest rate risk, our portfolio is weighted
toward short-term and intermediate-term bonds; however, our investment strategy balances consideration of duration, yield and
credit risk. We continually monitor the changes in interest rates and the impact on our liquidity and ability to meet our obligations.
Sensitivity Analysis
The fair values or cash flows of market sensitive instruments are subject to potential losses in future earnings resulting from
changes in interest rates and other market conditions. Our sensitivity analysis applies a hypothetical parallel shift in market rates
and reflects what we believe are reasonably possible near-term changes in those rates (covering a period of time going forward
up to one year from the date of the consolidated financial statements). Actual results may differ from the hypothetical change in
market rates assumed in this disclosure. This sensitivity analysis does not reflect the results of any action that we may take to
mitigate such hypothetical losses in fair value.
46
We use fair values to measure our potential loss in this model, which includes fixed maturity securities and short-term investments.
For invested assets, we use modified duration modeling to calculate changes in fair values. Durations on invested assets are adjusted
for call, put, and interest rate reset features. Invested asset portfolio durations are calculated on a market value weighted basis,
excluding accrued investment income, using holdings as of December 31, 2018. The estimated changes in fair values on our fixed
maturity securities and short-term investments, which had an aggregate value of $2,521.4 million as of December 31, 2018, based
on specific changes in interest rates are as follows:
Hypothetical Changes in Interest Rates
300 basis point rise
200 basis point rise
100 basis point rise
50 basis point decline
100 basis point decline
Estimated Pre-tax Increase
(Decrease) in Fair Value
(in millions, except percentages)
$
(288.2)
(194.3)
(97.4)
48.0
95.2
(11.4)%
(7.7)
(3.9)
1.9
3.8
The most significant assessment of the effects of hypothetical changes in interest rates on investment income would be based on
GAAP guidance related to “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases,” which requires amortization adjustments for mortgage-backed securities. The rates at which the
mortgages underlying mortgage-backed securities are prepaid, and therefore the average life of mortgage-backed securities, can
vary depending on changes in interest rates (for example, mortgages are prepaid faster and the average life of mortgage-backed
securities falls when interest rates decline). Adjustments for changes in amortization are based on revised average life assumptions
and would have an impact on investment income if a significant portion of our commercial and residential mortgage-backed
securities were purchased at significant discounts or premiums to par value. As of December 31, 2018, the par value of our
commercial and residential mortgage-backed securities holdings was $541.8 million, and the amortized cost was 102.6% of par
value. Since a majority of our mortgage-backed securities were purchased at a premium or discount that is significant as a percentage
of par, an adjustment could have a significant effect on investment income. The commercial and residential mortgage-backed
securities portion of the portfolio totaled 20.1% of total investments as of December 31, 2018. Agency-backed residential mortgage
pass-throughs totaled $449.4 million, or 99.5%, of the residential mortgage-backed securities portion of the portfolio as of
December 31, 2018.
Equity Price Risk
Equity price risk is the risk that we may incur losses in the fair value of the equity securities we hold in our investment portfolio.
Adverse changes in the market prices of the equity securities we hold in our investment portfolio would result in decreases in the
fair value of our total assets on our Consolidated Balance Sheets and in net realized and unrealized gains and losses on our
Consolidated Statements of Comprehensive Income. 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.
The table below shows the sensitivity of our equity securities to price changes as of December 31, 2018:
Cost
$
131.9
Fair Value
199.9
$
10% Fair
Value
Decrease
Pre-tax
Impact on
Total
Equity
Securities
10% Fair
Value
Increase
$
179.9
$
(20.0) $
219.9
Pre-tax
Impact on
Total
Equity
Securities
20.0
$
(in millions)
Equity securities
Effects of Inflation
Inflation could impact our financial statements and results of operations. Our estimates for losses and LAE include assumptions
about the timing of closure and future payment of claims and claims handling expenses, such as medical treatments and litigation
costs. To the extent inflation causes these costs to increase above established reserves, we will be required to increase those reserves
for losses and LAE, reducing our earnings in the period in which the deficiency is identified. We consider inflation in the reserving
process by reviewing cost trends and our historical reserving results. We also consider an estimate of increased costs in determining
the adequacy of our rates, particularly as it relates to medical and hospital rates where historical inflation rates have exceeded
general inflation rates.
Fluctuations in rates of inflation also influence interest rates, which in turn impact the market value of our investment portfolio
and yields on new investments. Operating expenses, including payrolls, are also impacted to a certain degree by inflation.
47
Item 8. Financial Statements and Supplementary Data
Management's Report on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2018 and 2017
Consolidated Statements of Comprehensive Income for each of the years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Stockholders' Equity for each of the years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Cash Flows for each of the years ended December 31, 2018, 2017 and 2016
Notes to Consolidated Financial Statements
The following Financial Statement Schedules are filed in Item 15 of Part IV of this report:
Financial Statement Schedules:
Schedule II. Condensed Financial Information of Registrant
Page
49
50
51
52
53
54
55
57
89
Pursuant to Rule 7-05 of Regulation S-X, Financial Statement Schedules I, III, IV, V, and VI have been omitted as the
information to be set forth therein is included in the Notes to Consolidated Financial Statements.
48
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Employers Holdings, Inc. and its Subsidiaries (collectively, 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).
The Company's internal control over financial reporting includes policies and procedures that: (a) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company's assets; (b) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with
GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of its management
and Board of Directors; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use or disposition of the Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements. Projections
of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management conducted an assessment of the effectiveness of the Company's internal control over financial reporting as of
December 31, 2018 based on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (2013 framework).
Based on this assessment, management did not identify any material weaknesses in the internal control over financial reporting
and management has concluded that the Company's internal control over financial reporting was effective as of December 31,
2018.
The Company's independent registered public accounting firm, Ernst & Young LLP, has independently assessed the effectiveness
of the Company's internal control over financial reporting. A copy of their report is included in Item 8 of this report.
February 28, 2019
49
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of
Employers Holdings, Inc. and Subsidiaries
Opinion on Internal Control over Financial Reporting
We have audited Employers Holdings, Inc. and Subsidiaries' internal control over financial reporting as of December 31, 2018,
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). In our opinion, Employers Holdings, Inc. and Subsidiaries' (the
Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based
on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
(PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017, the related consolidated statements
of comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2018,
and the related notes and financial statement schedule listed in the Index at Item 15 and our report dated February 28, 2019
expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s 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 are a public accounting firm registered with the PCAOB and are required to be independent with
respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities
and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material
respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness
exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing
such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for
our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets
of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Ernst & Young LLP
San Francisco, California
February 28, 2019
50
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of
Employers Holdings, Inc. and Subsidiaries
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Employers Holdings, Inc. and Subsidiaries (the Company) as
of December 31, 2018 and 2017, the related consolidated statements of comprehensive income, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2018, and the related notes and financial statement schedule
listed in the Index at Item 15 (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated
financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017,
and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity
with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
(PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, 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 28, 2019 expressed an unqualified opinion thereon.
Adoption of ASU No. 2016-01
As discussed in Note 4 to the consolidated financial statements, the Company changed its method of accounting for investments
in equity securities in 2018 due to the adoption of ASU No. 2016-01, Financial Instruments-Overall (Subtopic 825-10).
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on
the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are
required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable
rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error
or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether
due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis,
evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting
principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial
statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2002
San Francisco, California
February 28, 2019
51
Employers Holdings, Inc. and Subsidiaries
Consolidated Balance Sheets
Assets
Investments:
Fixed maturity securities at fair value (amortized cost $2,513.7 at December 31, 2018 and
$2,421.0 at December 31, 2017)
Equity securities at fair value (cost $131.9 at December 31, 2018 and $116.7 at December
31, 2017)
Equity securities at cost
Short-term investments at fair value (amortized cost $25.0 at December 31, 2018 and $4.0
at December 31, 2017)
Total investments
Cash and cash equivalents
Restricted cash and cash equivalents
Accrued investment income
Premiums receivable (less bad debt allowance of $6.7 at December 31, 2018 and $10.0 at
December 31, 2017)
Reinsurance recoverable for:
Paid losses
Unpaid losses
Deferred policy acquisition costs
Deferred income taxes, net
Property and equipment, net
Intangible assets, net
Goodwill
Contingent commission receivable–LPT Agreement
Cloud computing arrangements
Other assets
Total assets
Liabilities and stockholders’ equity
Unpaid losses and loss adjustment expenses
Unearned premiums
Commissions and premium taxes payable
Accounts payable and accrued expenses
Deferred reinsurance gain—LPT Agreement
Notes payable
Non-cancellable obligations
Other liabilities
Total liabilities
Commitments and contingencies (Note 12)
Stockholders’ equity:
Common stock, $0.01 par value; 150,000,000 shares authorized; 56,975,675 and
56,695,174 shares issued and 32,765,792 and 32,597,819 shares outstanding at
December 31, 2018 and 2017, respectively
Preferred stock, $0.01 par value; 25,000,000 shares authorized; none issued
Additional paid-in capital
Retained earnings
Accumulated other comprehensive (loss) income, net of tax
Treasury stock, at cost (24,209,883 shares at December 31, 2018 and 24,097,355 shares at
December 31, 2017)
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying notes.
52
As of December 31,
2017
2018
(in millions, except share data)
$
2,496.4
$
2,463.4
199.9
6.4
25.0
2,727.7
101.4
0.6
18.0
210.3
—
4.0
2,677.7
73.3
1.0
19.6
333.1
326.7
6.7
504.4
48.2
26.9
18.2
7.7
36.2
32.0
26.0
32.1
3,919.2
2,207.9
336.3
57.3
37.1
149.6
20.0
18.8
74.0
2,901.0
0.6
—
388.8
1,030.7
(13.7)
(388.2)
1,018.2
3,919.2
$
$
$
$
$
7.2
537.0
45.8
28.7
13.9
7.9
36.2
31.4
—
33.7
3,840.1
2,266.1
318.3
55.3
23.7
163.6
20.0
2.7
42.7
2,892.4
0.6
—
381.2
842.2
107.4
(383.7)
947.7
3,840.1
$
$
$
$
$
Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
Revenues
Net premiums earned
Net investment income
Net realized and unrealized (losses) gains on investments
Gain on redemption of notes payable
Other income
Total revenues
Expenses
Losses and loss adjustment expenses
Commission expense
Underwriting and other operating expenses
Interest and financing expenses
Other expenses
Total expenses
Net income before income taxes
Income tax expense
Net income
Comprehensive income
Unrealized AFS investment (losses) gains during the period (net of tax benefit
(expense) of $12.9, $(8.9), and $1.0 for the years ended December 31, 2018,
2017, and 2016, respectively)
Reclassification adjustment for realized AFS investment losses (gains) in net
income (net of tax benefit (expense) of $0.4, $(2.6), and $(3.9) for the years
ended December 31, 2018, 2017, and 2016, respectively)
Other comprehensive (loss) income, net of tax
Total comprehensive income
Net realized and unrealized (losses) gains on investments
Net realized and unrealized (losses) gains on investments before impairments
Other than temporary impairments recognized in earnings
Net realized and unrealized (losses) gains on investments
Earnings per common share (Note 18):
Basic
Diluted
Cash dividends declared per common share and eligible RSUs and PSUs
See accompanying notes.
Years Ended December 31,
2018
2016
2017
(in millions, except per share data)
$
$
$
731.1
81.2
(13.1)
—
1.2
800.4
376.7
94.2
158.5
1.5
—
630.9
169.5
28.2
141.3
$
716.5
74.6
7.4
2.1
0.8
801.4
417.2
91.4
139.9
1.4
7.5
657.4
144.0
42.8
101.2
$
$
694.8
73.2
11.2
—
0.6
779.8
417.9
83.5
136.1
1.6
—
639.1
140.7
34.0
106.7
$
(48.5) $
19.9
$
(1.8)
1.4
(47.1)
94.2
$
(4.8)
15.1
116.3
(9.8) $
(3.3)
(13.1) $
4.30
4.24
0.80
$
$
$
8.8
(1.4)
7.4
3.11
3.06
0.60
$
$
$
$
$
$
$
$
$
$
$
$
(7.3)
(9.1)
97.6
17.0
(5.8)
11.2
3.29
3.24
0.36
53
Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Common Stock
Shares
Amount
Additional
Paid-In
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss),
Net of Tax
Treasury
Stock, at
Cost
Total
Stockholders'
Equity
(in millions, except share data)
Balance, January 1, 2016
55,589,454
$
0.6
$
357.2
$
682.0
$
83.6
$
(362.6) $
760.8
Stock-based obligations (Note 14)
Stock options exercised
Vesting of restricted and performance stock
units, net of shares withheld to satisfy
minimum tax withholding (Note 14)
Acquisition of common stock (Note 13)
Dividends declared
Net income for the year
Change in net unrealized losses on
investments, net of taxes of $4.9
—
586,132
50,691
—
—
$
$
$
$
Balance, December 31, 2016
56,226,277
Balance, January 1, 2017
Stock-based obligations (Note 14)
Stock options exercised
Vesting of restricted and performance stock
units, net of shares withheld to satisfy
minimum tax withholding (Note 14)
Grant date fair value adjustment
Dividends declared
Net income for the year
Net impact of tax Enactment on net unrealized
gains on investments
Change in net unrealized gains on investments,
net of taxes of $(6.3)
56,226,277
—
307,076
161,821
—
—
—
Balance, December 31, 2017
56,695,174
Balance, January 1, 2018
Stock-based obligations (Note 14)
Stock options exercised
Vesting of restricted and performance stock
units, net of shares withheld to satisfy
minimum tax withholding (Note 14)
Acquisition of common stock (Note 13)
Dividends declared
Net income for the year
Reclassification adjustment for adoption of
ASU No. 2016-01
Change in net unrealized losses on
investments, net of taxes of $12.5
56,695,174
—
57,091
223,410
—
—
—
Balance, December 31, 2018
56,975,675
$
—
—
—
—
—
—
—
0.6
0.6
—
—
—
—
—
—
—
—
0.6
0.6
—
—
—
—
—
—
—
—
0.6
$
$
$
$
$
$
$
$
5.8
9.6
(0.6)
—
—
—
—
372.0
372.0
6.9
6.0
(2.2)
(1.5)
—
—
—
—
381.2
381.2
9.4
1.1
(2.9)
—
—
—
—
—
$
$
$
$
—
—
—
—
(11.5)
106.7
—
777.2
777.2
—
—
—
1.3
(19.7)
101.2
(17.8)
—
842.2
842.2
—
—
—
—
(26.7)
141.3
74.0
—
—
—
—
—
—
—
(9.1)
74.5
74.5
$
$
—
—
—
—
—
—
17.8
15.1
107.4
107.4
$
$
—
—
—
—
—
—
(74.0)
(47.1)
—
—
—
(21.1)
—
—
—
(383.7) $
5.8
9.6
(0.6)
(21.1)
(11.5)
106.7
(9.1)
840.6
(383.7) $
840.6
—
—
—
—
—
—
—
—
(383.7) $
6.9
6.0
(2.2)
(0.2)
(19.7)
101.2
—
15.1
947.7
(383.7) $
947.7
—
—
—
(4.6)
—
—
—
—
9.4
1.1
(2.9)
(4.6)
(26.7)
141.3
—
(47.1)
$
388.8
$
1,030.7
$
(13.7) $
(388.2) $
1,018.2
See accompanying notes.
54
Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Operating activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
$
2018
Years Ended December 31,
2017
(in millions)
101.2
$
141.3
$
2016
106.7
Depreciation and amortization
Stock-based compensation
Amortization of premium on investments, net
Allowance for doubtful accounts
Deferred income tax expense
Net realized and unrealized losses (gains) on investments
Gain on redemption of notes payable
Write-off of previously capitalized costs
Change in operating assets and liabilities:
Premiums receivable
Reinsurance recoverable on paid and unpaid losses
Cloud computing arrangements
Current federal income taxes
Unpaid losses and loss adjustment expenses
Unearned premiums
Accounts payable, accrued expenses and other liabilities
Deferred reinsurance gain–LPT Agreement
Non-cancellable obligations
Other
Net cash provided by operating activities
Investing activities
Purchases of fixed maturity securities
Purchases of equity securities
Purchases of short-term investments
Proceeds from sale of fixed maturity securities
Proceeds from sale of equity securities
Proceeds from maturities and redemptions of fixed maturity securities
Proceeds from maturities of short-term investments
Net change in unsettled investment purchases and sales
Capital expenditures and other
Net cash used in investing activities
Financing activities
Acquisition of common stock
Cash transactions related to stock-based compensation
Dividends paid to stockholders
Redemption of notes payable
Payments on capital leases
Net cash used in financing activities
Net increase in cash, cash equivalents, and restricted cash
Cash, cash equivalents, and restricted cash at the beginning of the period
Cash, cash equivalents, and restricted cash at the end of the period
Non-cash transactions
Financed property and equipment purchases
Non-cash exchange of fixed maturity investments for short-term investments
55
6.3
9.4
8.4
(3.3)
14.4
13.1
—
—
(3.1)
33.1
(26.0)
8.6
(58.2)
18.0
19.1
(14.0)
16.1
(3.0)
180.2
(636.7)
(79.3)
(59.7)
204.8
70.7
329.4
39.0
22.4
(10.2)
(119.6)
(4.2)
(1.8)
(26.7)
—
(0.2)
(32.9)
27.7
74.3
102.0
$
8.2
6.8
14.3
0.2
24.2
(7.4)
(2.1)
7.5
(22.2)
44.5
—
(2.7)
(34.9)
8.0
(7.0)
(11.3)
2.7
12.3
142.3
(592.3)
(36.8)
(8.2)
249.8
41.2
215.7
20.2
5.8
(8.2)
(112.8)
—
3.8
(19.7)
(9.9)
(0.2)
(26.0)
3.5
70.8
74.3
$
8.5
5.8
14.6
(2.4)
13.4
(11.2)
—
—
(1.2)
47.2
—
7.7
(46.5)
1.4
(4.2)
(14.6)
—
(2.4)
122.8
(466.8)
(49.1)
(10.0)
132.4
80.4
230.6
—
—
(5.0)
(87.5)
(21.1)
9.0
(11.5)
—
—
(23.6)
11.7
59.1
70.8
$
0.3
— $
$
0.4
— $
0.7
6.0
$
$
$
The following table presents our cash, cash equivalents and restricted cash by category within the Consolidated Balance Sheets:
As of
December 31,
2018
As of
December 31,
2017
$
(in millions)
101.4
0.6
102.0
$
73.3
1.0
74.3
Cash and cash equivalents
Restricted cash and cash equivalents supporting reinsurance obligations
Total cash, cash equivalents and restricted cash
$
$
See accompanying notes.
56
Employers Holdings, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018
1. Basis of Presentation and Summary of Operations
Nature of Operations and Organization
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.
In 1999, the Nevada State Industrial Insurance System (the Fund) entered into a retroactive 100% quota share reinsurance agreement
(the LPT Agreement) through a loss portfolio transfer transaction with third party reinsurers. The LPT Agreement commenced on
June 30, 1999 and will remain in effect until all claims under the covered policies have closed, the LPT Agreement is commuted
or terminated, upon the mutual agreement of the parties, or the reinsurers' aggregate maximum limit of liability is exhausted,
whichever occurs first. The LPT Agreement does not provide for any additional termination terms. On January 1, 2000, EICN
assumed all of the assets, liabilities and operations of the Fund, including the Fund's rights and obligations associated with the
LPT Agreement. See Notes 3 and 10.
The Company accounts for the LPT Agreement as retroactive reinsurance. Upon entry into the LPT Agreement, an initial deferred
reinsurance gain (the Deferred Gain) was recorded as a liability on the Company’s Consolidated Balance Sheets. The Company
is entitled to receive a contingent profit commission under the LPT Agreement. The contingent profit commission is estimated
based on both actual paid results to date and projections of expected paid losses under the LPT Agreement and is recorded as an
asset on the Company's Consolidated Balance Sheets.
Basis of Presentation
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 Company operates as a single operating segment, workers’ compensation insurance, through its wholly owned subsidiaries.
The Company considers an operating segment to be any component of its business whose operating results are regularly reviewed
by the Company's chief operating decision maker to make decisions about resources to be allocated to the segment and assess its
performance based on discrete financial information.
Use of Estimates
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, recoverability of deferred income taxes, and valuation of investments.
Reclassifications
Certain prior period information has been reclassified to conform to the current period presentation.
Pending Acquisition
On August 11, 2017, the Company entered into a stock purchase agreement (Purchase Agreement), as amended on October 25,
2018, with Partner Reinsurance Company of the U.S. (PRUS) with respect to the acquisition (Acquisition) of all of the outstanding
shares of capital stock of PartnerRe Insurance Company of New York (PRNY). The purchase price is equal to the sum of: (i) the
amount of statutory capital and surplus of PRNY at closing (which is currently estimated to be approximately $40.0 million); and
(ii) $5.8 million. The Company expects to fund the Acquisition with cash on hand.
Pursuant to the Purchase Agreement, all liabilities and obligations of PRNY existing as of the closing date, whether known or
unknown, will be indemnified by PRUS. In addition, PartnerRe Ltd., the parent company of PRUS, has provided the Company
with a Guaranty that unconditionally, absolutely and irrevocably guarantees the full and prompt payment and performance by
PRUS of all of its obligations, liabilities and indemnities under the Purchase Agreement and the transactions contemplated thereby.
The Company will not be acquiring any employees or ongoing business operations pursuant to the Acquisition. The Acquisition
57
is subject to certain closing conditions, including, among other things, approval from the Department of Financial Services of the
State of New York.
2. Changes in Estimates
The Company reduced its estimated loss and LAE reserves ceded under the LPT Agreement (LPT Reserve Adjustments) in each
of the years 2018 and 2016 as a result of the determination that adjustments were necessary to reflect observed favorable paid loss
trends in each of these years. There were no LPT Reserve Adjustments in 2017. The following table shows the financial statement
impact related to the LPT Reserve Adjustments.
LPT Reserve Adjustments
Cumulative adjustment to the Deferred Gain(1)
Net income impact from this change in estimate
Earnings per common share impact from this change in estimate:
Basic
Diluted
2018
2016
(in millions, except per share data)
$
(6.3) $
(2.2)
2.2
0.07
0.07
(5.0)
(3.1)
3.1
0.10
0.09
(1) The cumulative adjustments to the Deferred Gain were also recognized in losses and LAE incurred in the Company's Consolidated Statements
of Comprehensive Income, so that the Deferred Gain reflects the balance that would have existed had the revised loss and LAE reserves
been recognized at the inception of the LPT Agreement.
The Company increased its estimate of Contingent commission receivable – LPT Agreement (LPT Contingent Commission
Adjustments) in each of 2018, 2017, and 2016 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.
LPT Contingent Commission Adjustments
Net income impact from this change in estimate
Earnings per common share impact from this change in estimate:
Basic
Diluted
3. Summary of Significant Accounting Policies
Cash and Cash Equivalents
2018
2016
2017
(in millions, except per share data)
$
$
0.5
0.5
$
0.3
0.3
0.02
0.02
0.01
0.01
1.9
1.8
0.06
0.05
The Company considers all liquid investments with maturities of less than three months, as measured from the date of purchase,
to be cash equivalents.
Restricted Cash and Cash Equivalents
Restricted cash and cash equivalents represent cash and cash equivalents held in trust in order to secure certain of the Company's
obligations and, accordingly, are restricted as to withdrawal or usage. As of December 31, 2018 and 2017 the Company held $23.2
million and $24.5 million, respectively, in cash and investments in trust for reinsurance obligations, of which $0.6 million and
$1.0 million, respectively, represented restricted cash and cash equivalents.
Short-Term Investments
The Company considers all liquid investments with maturities of between three and twelve months, as measured from the date of
purchase, to be short-term investments.
Investment Securities
The Company's investments in fixed maturity securities, equity securities at fair value (prior to 2018), and short-term investments
are classified as available-for-sale (AFS) and are reported at fair value with unrealized gains and losses excluded from earnings
and reported as a separate component of stockholders' equity, net of deferred taxes, in Accumulated other comprehensive (loss)
income on the Company’s Consolidated Balance Sheets.
Beginning in 2018, with the adoption of ASU Number 2016-01, Financial Instruments - Overall (Subtopic 825-10), the Company's
investments in equity securities at fair value are no longer classified as AFS and changes in fair value are included in Net realized
58
and unrealized (losses) gains on investments on the Company's Consolidated Statements of Comprehensive Income. Effective
January 1, 2018, the Company's investment in FHLB stock is presented within Equity securities at cost on the Company's
Consolidated Balance Sheets. As of December 31, 2017, the Company's investment in FHLB stock was presented within Equity
securities at fair value on the Company's Consolidated Balance Sheet.
The adoption of ASU 2016-01 also removed the impairment assessment for equity securities at fair value beginning in 2018 and
changes in fair value are included in Net realized and unrealized (losses) gains on investments on the Company's Consolidated
Statements of Comprehensive Income. Prior to adoption of this standard, when, in the opinion of management, a decline in the
fair value of an equity security below its cost was considered to be “other-than-temporary,” the equity security's cost was 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 fixed maturity 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 based on the portion of the loss that is deemed to be a “credit loss”, which is considered a realized loss, and the
portion that is deemed to be an “other than credit loss”, which is considered to be an unrealized loss. If management has the intent
to sell the fixed maturity security or more likely than not will be required to sell the fixed maturity security before its anticipated
recovery, the investment is written down to its fair value and the entire impairment is recorded as a realized loss in the Company's
Consolidated Statements of Comprehensive Income. If management does not have the intent to sell or will not be required to sell
the fixed maturity security but does not expect to recover the amortized cost basis of the fixed maturity security, the amount of
the other-than-temporary impairment is bifurcated (see Note 6).
Investment income consists primarily of interest and dividends generated by investment securities. Interest is recorded as earned
on an accrual basis and dividends are recorded as earned at the ex-dividend date. Interest income on mortgage-backed and asset-
backed securities is determined using the effective-yield method based on estimated principal repayments. Mortgage-backed
securities are adjusted for the effects of changes in prepayment assumptions on the related accretion of discount or amortization
of premium of such securities using the retrospective method.
Realized gains and losses on investments are determined on a specific-identification basis.
Recognition of Revenue and Expense
Revenue Recognition
Premiums written are recognized as revenues, net of any applicable underlying reinsurance coverage, and are earned over the term
of the related policy. At the end of the policy term, payroll-based premium audits are performed on substantially all policyholder
accounts to determine the actual amount of net premiums earned for that policy year. Earned but unbilled premiums include
estimated future audit premiums based on the Company's historical experience. These estimates are subject to changes in
policyholders' payrolls, economic conditions, and seasonality, and are continually reviewed and adjusted as experience develops
or new information becomes known. Any such adjustments are included in current operations; however, they are partially offset
by the resulting changes in losses and LAE, commission expenses, and premium taxes. The Company's premiums receivable on
its Consolidated Balance Sheets included $63.7 million and $64.2 million of additional premiums expected to be received from
policyholders for final audits at December 31, 2018 and 2017, respectively.
The Company establishes a bad debt allowance on its premiums receivable through a charge included in underwriting and other
operating expenses in its Consolidated Statements of Comprehensive Income. This bad debt allowance is determined based on
estimates and assumptions to project future experience. After all collection efforts have been exhausted, the Company reduces the
bad debt allowance for write-offs of premiums receivable that have been deemed uncollectible. The Company's bad debt allowance
was $6.7 million and $10.0 million at December 31, 2018 and 2017, respectively. The Company had write offs, net of recoveries
of amounts previously written off, of $8.2 million, $3.2 million, and $6.0 million for the years ended December 31, 2018, 2017,
and 2016, respectively.
Deferred Policy Acquisition Costs
Policy acquisition costs, those costs that relate directly to the successful acquisition of new or renewal insurance contracts, including
underwriting, policy issuance and processing, medical and inspection, and sales force contract selling are deferred and amortized
as the related premiums are earned. Amortization of deferred policy acquisition costs for the years ended December 31, 2018,
2017, and 2016, was $112.0 million, $108.2 million, and $104.5 million, respectively.
If the sum of a policy’s expected losses and LAE and deferred policy acquisition costs exceeds the related unearned premiums
and projected investment income, a premium deficiency is determined to exist. In this event, deferred policy acquisition costs are
immediately expensed to the extent necessary to eliminate the premium deficiency. If the premium deficiency exceeds deferred
acquisition costs, a liability is accrued for the excess deficiency. There were no premium deficiency adjustments recognized during
the years ended December 31, 2018, 2017, and 2016.
59
Unpaid Loss and LAE Reserves
Unpaid loss and LAE reserves represent management's best estimate of the ultimate net cost of all reported and unreported losses
incurred for the applicable periods, less payments made. The estimated reserves for losses and LAE include the accumulation of
estimates for all claims reported prior to the balance sheet date, estimates of claims incurred but not reported, and estimates of
expenses for investigating and adjusting all incurred and unadjusted claims (based on projections of relevant historical data).
Amounts reported are subject to the impact of future changes in economic, regulatory and social conditions. Management believes
that, subject to the inherent variability in any such estimate, the reserves are within a reasonable and acceptable range of adequacy.
Estimates for claims prior to the balance sheet date are continually monitored and reviewed, and as settlements are made or reserves
adjusted, the differences are reported in current operations. Salvage and subrogation recoveries are estimated based on a review
of the level of historical salvage and subrogation recoveries.
Reinsurance
In the ordinary course of business, the Company purchases excess of loss reinsurance in order to protect it against the impact of
large and/or catastrophic losses. Additionally, the Company is a party to the LPT Agreement (see Note 10). These reinsurance
arrangements reduce the Company's exposure to such losses since its reinsurers are liable to the Company to the extent of the
reinsurance protection provided. However, the Company remains liable for all losses it incurs to the extent that any reinsurer is
unable or unwilling to make timely payments under its reinsurance agreements.
Balances due from reinsurers on unpaid losses, including an estimate of such recoverables related to reserves for incurred but not
reported losses, are reported as reinsurance recoverables on the Company’s Consolidated Balance Sheets. Reinsurance recoverables
on paid losses represents amounts currently due from reinsurers. Reinsurance recoverables on unpaid losses represents amounts
that will be collectible from reinsurers once the losses are paid. Reinsurance recoverables on unpaid losses and LAE amounted to
$504.4 million and $537.0 million at December 31, 2018 and 2017, respectively.
Ceded reinsurance premiums are accounted for on a basis consistent with those used in accounting for the underlying premiums,
and are reported as reductions to arrive at net premiums written and earned.
Ceded losses and LAE are also accounted for on a basis consistent with those used in accounting for the original policies issued
and the terms of the relevant reinsurance agreement, and are recorded as reductions to losses and LAE incurred.
Pursuant to the LPT Agreement, LAE is deemed to be 7% of total losses paid and is payable to the Company as compensation for
management of the claims under the LPT Agreement. The Deferred Gain is amortized using the recovery method, whereby the
amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries through the life of the
LPT Agreement, and is recorded in losses and LAE incurred in the Company's Consolidated Statements of Comprehensive Income.
Any adjustment to the estimated loss and LAE reserves ceded under the LPT Agreement results in a cumulative adjustment to the
Deferred Gain, which is also recognized in losses and LAE incurred in the Company's Consolidated Statements of Comprehensive
Income, such that the Deferred Gain reflects the balance that would have existed had the revised reserves been recognized at the
inception of the LPT Agreement.
Additionally, the Company is entitled to receive a contingent profit commission under the LPT Agreement. The contingent profit
commission 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 25 years of the agreement. 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 an estimate of contingent profit commission in its Consolidated Balance Sheets as Contingent commission receivable–
LPT Agreement and a corresponding liability is recorded as Deferred reinsurance gain–LPT Agreement. The Contingent
commission receivable–LPT Agreement is reduced as amounts are received from participating reinsurers. The 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 Company's 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 Company's Consolidated Statements 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.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation (see Note 7). Expenditures for maintenance and repairs
are charged against operations as incurred.
Electronic data processing equipment, software, furniture and equipment, and automobiles are depreciated using the straight-line
method over three to seven years. Leasehold improvements are carried at cost less accumulated amortization. The Company
60
amortizes leasehold improvements using the straight-line method over the lesser of the useful life of the asset or the remaining
original lease term, excluding options or renewal periods. Leasehold improvements are generally amortized over three to eight
years.
Cloud Computing Arrangements
The Company capitalizes software license fees and implementation costs associated with hosting arrangements that are service
contracts. These amounts are included in Cloud computing arrangements on the Company's Consolidated Balance Sheets.
Amortization of the software license fees is calculated using the straight-line method over the term of the service contract or based
on the expected utilization of the asset. Amortization of the implementation costs are calculated using the straight-line method
based on the term of the service contract and commence once the module or component is ready for its intended use, regardless
of whether the hosted software has been placed into service, and will be recognized over the remaining life of the service contract.
Obligations Held Under Capital Leases
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 12 for additional
disclosures related to capital leases.
Income Taxes
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets
and liabilities for the expected future tax consequences of events that have been included in the Company's financial statements.
Under this method, the Company determines deferred tax assets and liabilities on the basis of the differences between the financial
statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected
to reverse. As of December 22, 2017, the date that the Tax Cuts and Jobs Act was enacted (Enactment), the effect of the change
in tax rates on the Company's deferred tax assets and liabilities was recognized in income and created stranded tax effects within
accumulated other comprehensive income that did not reflect the newly enacted tax rate. The Company reclassified the net tax
effects from Accumulated other comprehensive income, net of tax, to Retained earnings as of the date of Enactment.
The Company records uncertain tax positions in accordance with ASC 740, Income Taxes, on the basis of a two-step process.
Recognition (Step 1) occurs when the Company concludes that a tax position, based solely on its technical merits, is more likely
than not to be sustained upon examination. Measurement (Step 2) is addressed only if Step 1 has been satisfied. Under Step 2, the
tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, that is more likely than not
to be realized upon ultimate settlement.
The Company recognizes deferred tax assets when it determines that such assets are more likely than not to be realized in future
periods. In making such a determination, the Company considers all available positive and negative evidence, including future
reversals of existing taxable temporary differences, tax-planning strategies, projected future taxable income, projected future tax
rates, and results of recent operations. If the Company determines that it is not more likely than not that it could realize its deferred
tax assets in future periods, it would establish a deferred tax asset valuation allowance that would increase the Company's provision
for income taxes. If the Company determines that it would be able to realize its deferred tax assets in the future in excess of its
net recorded amount, the Company would make an adjustment to the deferred tax asset valuation allowance, which would reduce
the provision for income taxes.
Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk are primarily cash and cash equivalents
(including restricted cash equivalents), short-term investments, investment securities, premiums receivable, and reinsurance
recoverable balances.
The Company’s cash equivalents and short-term investments include investments in money market securities and securities backed
by the U.S. government. The Company's investment securities are diversified throughout many industries and geographic regions
and include investments in U.S. government and U.S. government-sponsored enterprises. The Company believes that it has no
significant concentrations of credit risk from a single issue or issuer within its cash equivalents, short-term investments and
investment securities other than concentrations in U.S. government and U.S. government-sponsored enterprises.
The Company's premiums receivable are generally diversified due to the large number of entities composing the Company's
policyholder base and their dispersion across many different industries.
The Company monitors the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer
insolvencies. The Company also obtains collateral from its reinsurers in order to mitigate the risks related to insolvencies. At
December 31, 2018, $2.0 million of the Company's reinsurance recoverables were collateralized by cash or letters of credit and
an additional $311.6 million was in trust accounts for reinsurance recoverables specifically related to the LPT Agreement.
61
Fair Value of Financial Instruments
The fair values of the Company's financial instruments have been determined using available market information and other
appropriate valuation methodologies. Judgment is required in developing fair value estimates 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 of its financial instruments:
Cash and cash equivalents, short-term investments, premiums receivable, accounts payable and accrued expenses, and other
liabilities. The carrying amounts for each of these financial instruments as reported in the Company's Consolidated Balance Sheets
approximate their fair values.
Investment securities. The Company’s investment securities are predominantly valued on the basis of actual market transactions
or observable inputs. A small portion of the Company’s investment securities are valued on the basis of pricing models with
significant unobservable inputs or nonbinding broker quotes. See Note 5.
Goodwill and Other Intangible Assets
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 effects of current economic conditions on the Company's financial condition and results of operations and changes
in the Company's stock price and determined that there were no impairments of these assets as of December 31, 2018 and 2017.
Intangible assets related to state licenses are not subject to amortization. Intangibles related to insurance relationships were
amortized in proportion to the expected period of benefit and were fully amortized as of December 31, 2018.
The gross carrying value, accumulated amortization, and net carrying value for the Company's intangible assets, by major class,
as of December 31, were as follows:
Gross
Carrying
Value
2018
Accumulated
Amortization
Net
Carrying
Value
Gross
Carrying
Value
(in millions)
2017
Accumulated
Amortization
Net
Carrying
Value
State licenses
Insurance relationships
Total
$
$
7.7
9.4
17.1
$
$
$
— $
(9.4)
(9.4) $
7.7
—
7.7
$
$
7.7
9.4
17.1
$
$
$
— $
(9.2)
(9.2) $
7.7
0.2
7.9
During the years ended December 31, 2018, 2017, and 2016, the Company recognized $0.2 million, $0.3 million, and $0.3 million
in amortization expense associated with its intangible assets, respectively. These amortization expenses are included in the
Company's Consolidated Statements of Comprehensive Income in underwriting and other operating expenses.
Stock-Based Compensation
The Company provides stock-based compensation to its directors and certain of its employees, which is recognized in its
Consolidated Statements of Comprehensive Income based on estimated fair values over the relevant service period (see Note 14).
4. New Accounting Standards
Recently Issued Accounting Standards
In August 2018, the Financial Accounting Standards Board (FASB) issued ASU Number 2018-13, Fair Value Measurement (Topic
820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This update removes the
disclosure requirements for the amounts of and the reasons for transfers between Level 1 and Level 2 and disclosure of the policy
for timing of transfers between levels. This update also removes disclosure requirements for the valuation processes for Level 3
fair value measurements. Additionally, this update adds disclosure requirements for the changes in unrealized gains and losses for
recurring Level 3 fair value measurements and quantitative information for certain unobservable inputs in Level 3 fair value
measurements. This update becomes effective for fiscal years beginning after December 15, 2019, including interim periods within
those fiscal years. The Company has determined that the impact of this new standard will not be material to the Company's financial
statements.
In July 2018, the FASB issued ASU Number 2018-09, Codification Improvements. This update provides clarification, corrects
errors in and makes minor improvements to the Codification within various ASC topics. Many of the amendments in this update
62
have transition guidance with effective dates for annual periods beginning after December 15, 2018 and some amendments in this
update do not require transition guidance and are effective upon issuance of this update. The Company will adopt amendments as
they become applicable and has determined that the impact of these improvements will not be material to its consolidated financial
condition and results of operations.
In July 2018, the FASB issued ASU Number 2018-11, Leases (Topic 842): Targeted Improvements. This update provides entities
with an additional and optional transition method to adopt ASU Number 2016-02 with a cumulative-effect adjustment in the period
of adoption. This update also provides guidance for a practical expedient that permits lessors to not separate non-lease components
from the associated lease components. Additionally, in July 2018, the FASB issued ASU Number 2018-10, Codification
Improvements to Topic 842, Leases. This update provides additional guidance on the new lease model with improvements in
numerous aspects of the guidance in ASC 842 including, but not limited to, implicit rates, reassessment of lease classification,
terms and purchase options, investment tax credits, and various other transition guidance. In December 2018, the FASB issued
ASU 2018-20, Leases (Topic 842): Narrow-Scope Improvements for Lessors. This update provides amendments to various lease
topics including sales taxes collected from lessees, certain lessor costs paid to third parties, and variable payments for contracts
with lease and non-lease components. These updates will be adopted concurrently with ASU Number 2016-02. The Company has
determined that the impact of these new standards will not be material to the Company's financial statements.
In January 2017, the FASB issued ASU Number 2017-04, Intangibles-Goodwill and Other (Topic 350). This update simplifies the
measurement of goodwill by eliminating the performance of Step 2 in the goodwill impairment testing. This update allows the
testing to be performed by comparing the fair value of a reporting unit with its carrying amount and recognizing an impairment
charge when the carrying amount exceeds fair value. Additionally, this update eliminates the requirements of any reporting unit
with a zero or negative carrying value to perform Step 2, but requires disclosure of the amount of goodwill allocated to a reporting
unit with zero or negative carrying amount of net assets. This update becomes effective for fiscal years beginning after December
15, 2019. The Company does not expect that this update will have a material impact to its consolidated financial condition and
results of operations.
In June 2016, the FASB issued ASU Number 2016-13, Financial Instruments - Credit Losses (Topic 326). This update replaces
the incurred loss impairment methodology for recognizing credit losses on financial instruments with a methodology that reflects
an entity's current estimate of all expected credit losses. This update requires financial assets measured at amortized cost to be
presented net of an allowance for credit losses. Additionally, this update requires credit losses on available-for-sale fixed maturity
securities to be presented as an allowance rather than as a write-down, allowing an entity to also record reversals of credit losses
in current period net income. This update becomes effective for fiscal years beginning after December 15, 2019, including interim
periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim
periods within those fiscal years. Additionally, in December 2018, the FASB issued ASU 2018-19, Codification Improvements to
Topic 326, Financial Instruments - Credit Losses. This update provides clarification on the effective and transition dates and the
exclusion of operating lease receivables from Topic 326. The Company is currently evaluating the impact that the adoption of
these updates will have on its consolidated financial condition and results of operations.
In February 2016, the FASB issued ASU Number 2016-02, Leases (Topic 842). This update provides guidance on a new lease
model that includes the recognition of assets and liabilities arising from lease transactions on the balance sheet. Additionally, the
update provides clarity on the definition of a lease and the distinction between finance and operating leases. Furthermore, the
update requires certain qualitative and quantitative disclosures pertaining to the amounts recorded in the financial statements. This
update becomes effective for annual reporting periods, including interim periods within those annual periods, beginning after
December 15, 2018 and early adoption is permitted. The Company has determined that the impact of this new standard will be
equal to the present value of the Company's lease obligations under various non-cancellable operating lease contracts, which
amounted to approximately $18.4 million at December 31, 2018, and will be recognized as right-of-use assets and $20.2 million
at December 31, 2018, will be recognized as lease liabilities on the Company's Consolidated Balance Sheets upon adoption.
Recently Adopted Accounting Standards
In August 2018, the FASB issued ASU Number 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic
350-40) Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.
This update clarifies certain aspects of ASU 2015-05 and aligns the requirements for capitalizing implementation costs incurred
in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop
or obtain internal-use software and hosting arrangements that include an internal-use software license. This update becomes
effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years and early adoption
is permitted. The Company elected to adopt this standard as of July 1, 2018 using the retrospective method of adoption. Prior to
adoption, the Company's accounting policy for capitalization of implementation costs followed the existing guidance for internal
use software and therefore this update had no impact on the amounts previously capitalized. In accordance with ASU Number
2018-15, $4.8 million of capitalized costs included on the Company's June 30, 2018 Consolidated Balance Sheets were reclassified
from Property and equipment to Cloud computing arrangements on the date of adoption. Amortization under the new guidance
63
will commence once the module or component is ready for its intended use, regardless of whether the hosting arrangement has
been placed into service and will be recognized over the remaining life of the service contract.
In March 2018, the FASB issued ASU Number 2018-05, Income Taxes (Topic 740). This update provides guidance regarding the
application of ASC Topic 740 for the income tax effects of the Tax Cuts and Jobs Act. This update allowed companies to report
provisional amounts of the effects of the Tax Cuts and Jobs Act in their financial statements in the first reporting period they are
able to determine a reasonable estimate and any adjustments to provisional amounts should be included in income from continuing
operations as an adjustment to tax expense or benefit in the reporting period the amounts are determined. The Company adopted
this update in the fourth quarter of 2017 and included an estimate of the income tax effects on its financial statements for the year
ended December 31, 2017. In accounting for certain tax effects of Enactment in accordance with SAB 118, the Company made a
final adjustment in 2018 of $(0.4) million.
In February 2018, the FASB issued ASU Number 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220).
The amendments in this update allow a reclassification from accumulated other comprehensive income to retained earnings for
stranded tax effects resulting from Enactment. This update becomes effective for fiscal years beginning after December 15, 2018,
and interim periods within those fiscal years. Early adoption is permitted for reporting periods for which financial statements have
not yet been issued and should be applied in the period of adoption or retrospectively to each period (or periods) in which the
effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. The Company elected
to early adopt this update and, accordingly, reclassified $17.8 million of net tax effects resulting from Enactment from Accumulated
other comprehensive (loss) income, net of tax, to Retained earnings at December 31, 2017.
In March 2017, the FASB issued ASU Number 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20).
This update shortens the amortization period on callable debt securities held at a premium to the earliest call date, which now
closely aligns the amortization period of premiums and discounts to expectations incorporated in the market pricing on callable
debt securities. This update becomes effective for fiscal years beginning after December 15, 2018 and interim periods within those
fiscal years, and early adoption is permitted. The Company's current accounting practices align with this standard and the adoption
had no impact on its consolidated financial condition or results of operations.
In January 2016, the FASB issued ASU Number 2016-01, Financial Instruments - Overall (Subtopic 825-10). This update replaced
the guidance to classify equity securities with readily determinable fair values into different categories (trading or available-for-
sale) and requires those equity securities to be measured at fair value with changes in fair value recognized through net income.
Additionally, this update eliminates the disclosure of 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 price
notion. Furthermore, this update clarifies that an evaluation of deferred tax assets related to available-for-sale securities is needed,
in combination with an evaluation of other deferred tax assets, to determine if a valuation allowance is required.
This update did not apply to the Company’s investment in Federal Home Loan Bank (FHLB) stock. Rather, it specified that FHLB
stock shall be carried at cost and evaluated periodically for impairment; furthermore, it specified that, beginning January 1, 2018,
FHLB stock shall not be shown with securities accounted for under ASC 321, which provides detailed guidance on, among other
things, accounting and reporting of investments in equity securities that have readily determinable fair values. As a result, the
Company’s investment in FHLB stock is presented within Equity securities at cost on the Company's Consolidated Balance Sheet
at March 31, 2018. In all periods prior to January 1, 2018, the Company's investment in FHLB stock is presented within Equity
securities at fair value on the Company's Consolidated Balance Sheets.
This update became effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal
years. The Company adopted this update effective January 1, 2018. Adoption of this accounting standard resulted in a $74.0 million
reclassification adjustment, net of tax, from accumulated other comprehensive income to retained earnings.
In November 2016, the FASB issued ASU Number 2016-18, Statement of Cash Flows (Topic 230). This update provides guidance
for the classification and presentation of restricted cash and restricted cash equivalents in the statement of cash flows. This update
requires amounts generally described as restricted cash and restricted cash equivalents to be included with cash and cash equivalents
when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. It requires the
disclosure of information about the nature of restrictions on its cash, cash equivalents, and amounts generally described as restricted
cash or restricted cash equivalents. This update also requires the entity to disclose, on the face of the statement of cash flows or
in the notes to the financial statements, any restricted cash or restricted cash equivalents disaggregated by the line item in which
they appear within the statement of financial position. The adoption of this standard had no financial impact on the Company's
consolidated financial condition, results of operations, or statement of cash flows.
In May 2014, the FASB issued ASU Number 2014-09, Revenue from Contracts with Customers (Topic 606). This update clarifies
the principles for recognizing revenue and develops revenue standards to improve revenue recognition guidance. This update
requires an entity to recognize revenue as performance obligations are met in order to reflect the transfer of promised goods or
services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. In
applying this guidance companies are required to: (1) identify the contract(s) with a customer; (2) identify the performance
64
obligations in the contract(s); (3) determine the transaction price; (4) allocate the transaction price to the performance obligations
in the contract(s); and (5) recognize revenue when, or as, the entity satisfies a performance obligation. In August 2015, the FASB
issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the
effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, and interim reporting periods
within that annual reporting period. Insurance contracts are not within the scope of this updated guidance. The Company has
analyzed revenue streams within the current business operation and determined the adoption of this standard did not have an
impact on its consolidated financial condition and results of operations.
5. Fair Value of Financial Instruments
The carrying value and the estimated fair value of the Company's financial instruments at fair value were as follows as of
December 31:
Financial assets
Investments at fair value (Note 6)
Cash and cash equivalents
Restricted cash and cash equivalents
Financial liabilities
Notes payable (Note 11)
2018
2017
Carrying
Value
Estimated
Fair Value
Carrying
Value
Estimated
Fair Value
(in millions)
$
2,721.3
101.4
0.6
$
2,721.3
101.4
0.6
$
2,677.7
73.3
1.0
2,677.7
73.3
1.0
20.0
$
23.5
$
20.0
$
23.6
$
$
Assets and liabilities recorded at fair value on the Company's Consolidated Balance Sheets are categorized based upon the levels
of judgment associated with the inputs used to measure their fair value. Level inputs are defined as follows:
• Level 1 - Inputs are unadjusted quoted market prices for identical assets or liabilities in active markets at the measurement
date.
• Level 2 - Inputs other than Level 1 prices that are observable for similar assets or liabilities through corroboration with
market data at the measurement date.
• 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.
The Company uses third party pricing services to assist with its investment accounting function. The ultimate pricing source varies
depending on the investment security and pricing service used, but investment securities valued on the basis of observable inputs
(Levels 1 and 2) are generally assigned values on the basis of actual transactions. Securities valued on the basis of pricing models
with significant unobservable inputs or nonbinding broker quotes are classified as Level 3. The Company performs quarterly
analyses on the prices it receives 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, as it is ultimately
management’s responsibility to ensure that the fair values reflected in the Company’s consolidated financial statements are
appropriate. If differences are noted in these analyses, the Company may obtain additional information from other pricing services
to validate the quoted price.
The Company bases all of its estimates of fair value for assets on the bid price, when available, as it represents what a third-party
market participant would be willing to pay in an arm's length transaction.
For securities not actively traded, third party pricing services may use quoted market prices of similar instruments or discounted
cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often
used in the valuation methodologies include, but are not limited to, broker quotes, benchmark yields, credit spreads, default rates,
and prepayment speeds. There were no material adjustments to prices obtained from third party pricing services as of December 31,
2018 and 2017.
These methods of valuation will only produce an estimate of fair value if there is objectively verifiable information to produce a
valuation. If objectively verifiable information is not available, the Company would be required to produce an estimate of fair
value using some of the same methodologies, making assumptions for market-based inputs that are unavailable.
The Company's estimates of fair value for its financial liabilities are based on a combination of the variable interest rates for notes
with similar durations to discount the projection of future payments on notes payable. The fair value measurements for notes
payable have been determined to be Level 2 at each of the periods presented.
Each of the Company's insurance operating subsidiaries is a member of the Federal Home Loan Bank of San Francisco (FHLB).
Members are required to purchase stock in the FHLB in addition to maintaining collateral deposits that back any funds advanced.
65
The Company's investment in FHLB stock is recorded at cost, which approximates fair value, as purchases and sales of these
securities are at par value with the issuer. FHLB stock is considered a restricted security and is periodically evaluated by the
Company for impairment based on the ultimate recovery of par value.
The following table presents the Company's investments at fair value and the corresponding fair value measurements.
December 31, 2018
Level 2
Level 1
Level 3
Level 1
December 31, 2017
Level 2
Level 3
Fixed maturity securities
U.S. Treasuries
U.S. Agencies
States and municipalities
Corporate securities
Residential mortgage-backed securities
Commercial mortgage-backed securities
Asset-backed securities
Other securities
Total fixed maturity securities
Equity securities at fair value
Industrial and miscellaneous
Non-redeemable preferred (FHLB stock)
Other
Total equity securities at fair value
Short-term investments
Total investments at fair value
$
$
$
$
$
$
— $
—
—
—
—
106.4
11.4
528.0
1,090.4
451.5
94.3
—
64.5
—
—
149.9
— $ 2,496.4
$
$
$
174.8
—
25.1
199.9
199.9
$
— $
— $
—
—
— $
$
$
25.0
$ 2,521.4
(in millions)
— $
—
—
—
—
—
—
—
— $
— $
—
—
— $
— $
— $
— $
—
—
—
—
137.0
11.8
642.5
1,118.0
389.3
106.0
—
58.8
—
—
—
— $ 2,463.4
$
$
181.7
—
23.9
205.6
205.6
$
— $
$
— $
—
—
— $
$
4.0
$
$ 2,467.4
—
—
—
—
—
—
—
—
—
—
4.7
—
4.7
—
4.7
Certain cash equivalents, principally money market securities, are measured at fair value using the net asset value (NAV) per share.
The following table presents cash equivalents at NAV and total cash and cash equivalents carried at fair value on the Company's
Consolidated Balance Sheets.
December 31, 2018 December 31, 2017
Cash and cash equivalents at fair value
Cash equivalents measured at NAV, which approximates fair value
Total cash and cash equivalents
$
$
43.9
57.5
101.4
$
$
34.3
39.0
73.3
The following table provides a reconciliation of the beginning and ending balances that are measured using Level 3 inputs for the
years ended December 31, 2018 and 2017.
Beginning balance, January 1
Transfers out of Level 3(1)
Purchases and sales, net
Ending balance, December 31
Level 3 Securities
2018
2017
(in millions)
$
4.7
(4.7)
—
— $
11.9
(7.0)
(0.2)
4.7
$
$
(1) The transfer during the year ended December 31, 2018 was the result of adoption of ASU 2016-01, which specified that FHLB stock shall
be carried at cost and is no longer measured at fair value. Transfers during the year ended December 31, 2017 were from Level 3 to Level
2 because observable market data became available for the securities.
66
6. Investments
The cost or amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the Company’s AFS
investments were as follows:
At December 31, 2018
Fixed maturity securities
U.S. Treasuries
U.S. Agencies
States and municipalities
Corporate securities
Residential mortgage-backed securities
Commercial mortgage-backed securities
Asset-backed securities
Other securities(1)
Total fixed maturity securities
Short-term investments
Total AFS investments
At December 31, 2017
Fixed maturity securities
U.S. Treasuries
U.S. Agencies
States and municipalities
Corporate securities
Residential mortgage-backed securities
Commercial mortgage-backed securities
Asset-backed securities
Total fixed maturity securities
Equity securities at fair value
Industrial and miscellaneous
Non-redeemable preferred (FHLB stock)
Other
Total equity securities at fair value
Short-term investments
Total AFS investments
Cost or
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
(in millions)
$
$
$
$
106.7
11.3
513.4
1,106.2
459.1
96.7
64.7
155.6
2,513.7
25.0
2,538.7
135.8
11.3
617.0
1,103.4
388.3
106.5
58.7
2,421.0
100.8
4.7
11.2
116.7
4.0
2,541.7
$
$
$
$
0.9
0.1
15.3
5.8
2.2
0.1
0.2
—
24.6
—
24.6
2.0
0.5
25.5
18.0
3.6
0.4
0.3
50.3
81.5
—
12.7
94.2
—
144.5
$
$
$
$
(1.2) $
—
(0.7)
(21.6)
(9.8)
(2.5)
(0.4)
(5.7)
(41.9)
—
(41.9) $
(0.8) $
—
—
(3.4)
(2.6)
(0.9)
(0.2)
(7.9)
(0.6)
—
—
(0.6)
—
(8.5) $
106.4
11.4
528.0
1,090.4
451.5
94.3
64.5
149.9
2,496.4
25.0
2,521.4
137.0
11.8
642.5
1,118.0
389.3
106.0
58.8
2,463.4
181.7
4.7
23.9
210.3
4.0
2,677.7
(1) Other securities within fixed maturity securities consist of bank loans, which are classified as AFS and reported at fair value.
The cost and estimated fair value of the Company's equity securities recorded at fair value at December 31, 2018 were as follows:
At December 31, 2018
Equity securities at fair value
Industrial and miscellaneous
Other
Total equity securities at fair value
Cost
Estimated
Fair Value
(in millions)
$
$
114.6
17.3
131.9
$
$
174.8
25.1
199.9
The amortized cost and estimated fair value of the Company's fixed maturity securities at December 31, 2018, 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.
67
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Mortgage and asset-backed securities
Total
$
$
Amortized
Cost
Estimated
Fair Value
$
(in millions)
141.8
856.9
794.3
100.2
620.5
2,513.7
$
142.1
856.3
784.3
103.4
610.3
2,496.4
The following is a summary of AFS investments that have been in a continuous unrealized loss position for less than 12 months
and those that have been in a continuous unrealized loss position for 12 months or greater as of December 31, 2018 and 2017.
Less than 12 months:
Fixed maturity securities
U.S. Treasuries
States and municipalities
Corporate securities
Residential mortgage-backed securities
Commercial mortgage-backed securities
Asset-backed securities
Other securities
Total less than 12 months
12 months or greater:
Fixed maturity securities
U.S. Treasuries
Corporate securities
Residential mortgage-backed securities
Commercial mortgage-backed securities
Asset-backed securities
Total 12 months or greater
December 31, 2018
Gross
Unrealized
Losses
Estimated
Fair
Value
Estimated
Number
Fair
of Issues
Value
(dollars in millions)
December 31, 2017
Gross
Unrealized
Losses
Number
of Issues
$
12.2
70.1
624.4
156.9
30.9
25.1
137.1
$ 1,056.7
$
$
72.7
193.7
199.8
55.0
16.5
537.7
$
$
$
$
(0.1)
(0.7)
(13.4)
(2.5)
(0.5)
(0.2)
(5.7)
(23.1)
(1.1)
(8.2)
(7.3)
(2.0)
(0.2)
(18.8)
7
21
205
59
13
18
215
538
25
69
72
22
17
205
$
$
$
$
86.0
—
307.6
165.0
41.8
29.3
—
629.7
23.4
53.2
77.1
25.1
—
178.8
$
$
$
$
(0.5)
—
(2.3)
(0.8)
(0.2)
(0.2)
—
(4.0)
(0.3)
(1.1)
(1.8)
(0.7)
—
(3.9)
28
—
113
45
19
25
—
230
10
17
32
8
—
67
At December 31, 2017, the Company also had $0.6 million of gross unrealized losses on twenty-four equity securities that were
in a continuous loss position for less than 12 months.
The Company recognized impairments on fixed maturity securities of $3.3 million (consisting of sixty-six securities) and $0.5
million (consisting of nine securities) during the years ended December 31, 2018 and 2017, respectively, as a result of the Company's
intent to sell these securities and/or the severity of the change in fair values of these securities. There were no other-than-temporary
impairments recognized on fixed maturity securities during the year ended December 31, 2016. The Company determined that
the remaining unrealized losses on fixed maturity securities at December 31, 2018, 2017, and 2016 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 lack of severity and duration of the
impairment, the credit quality of the issuers, the Company’s intent to not sell the securities, and a determination that it is not more
likely than not that the Company will be required to sell the securities at an amount less than their amortized cost.
The adoption of ASU 2016-01 removed the impairment assessment for equity securities at fair value, and, beginning in 2018,
changes in fair value are included in net realized and unrealized gains and losses on investments on the Company's Consolidated
Statements of Comprehensive Income. Prior to adoption of this standard, the Company recognized impairments on equity securities
of $0.9 million (consisting of seven securities) and $5.8 million (consisting of thirty-seven securities) during the years ended
December 31, 2017 and 2016, respectively. The other-than-temporary impairments recognized during these years were the result
of the Company's intent to sell the securities and/or the severity and duration of the change in fair values of these securities. The
impairments on equity securities in 2016 were primarily due to the downturn in the energy sector that occurred during the first
quarter of 2016. Certain unrealized losses on equity securities during the years ended December 31, 2017 and 2016 were not
68
considered to be other-than-temporary due to the financial condition and near-term prospects of the issuers, and the Company's
intent to hold the securities until fair value recovers to above cost.
Realized gains and losses on investments include the gain or loss on a security at the time of sale compared to its original or
adjusted cost (equity securities) or amortized cost (fixed maturity securities). Realized losses on fixed maturity securities are also
recognized when securities are written down as a result of an other-than-temporary impairment.
Net realized gains on investments and the change in unrealized gains (losses) on the Company's investments recorded at fair value
are determined on a specific-identification basis and were as follows:
Year Ended December 31, 2018
Fixed maturity securities
Equity securities
Total investments
Year Ended December 31, 2017
Fixed maturity securities
Equity securities
Total investments
Year Ended December 31, 2016
Fixed maturity securities
Equity securities
Total investments
Net investment income was as follows:
Fixed maturity securities
Equity securities
Short-term investments
Cash equivalents and restricted cash
Gross investment income
Investment expenses
Net investment income
Gross
Realized
Gains
Gross
Realized
Losses
Change in
Net
Unrealized
Gains
(Losses)
Changes in
Fair Value
Reflected in
Earnings
Changes in
Fair Value
Reflected in
AOCI, before
tax
(in millions)
$
$
$
$
$
$
2.2
15.9
18.1
4.7
9.3
14.0
1.9
16.6
18.5
$
$
$
$
$
$
(4.0) $
(1.6)
(5.6) $
(2.2) $
(4.4)
(6.6) $
(0.7) $
(6.6)
(7.3) $
(59.7) $
(25.6)
(85.3) $
(1.8) $
(11.3)
(13.1) $
3.9
17.5
21.4
$
$
(28.9) $
14.9
(14.0) $
2.5
4.9
7.4
1.2
10.0
11.2
$
$
$
$
(59.7)
—
(59.7)
3.9
17.5
21.4
(28.9)
14.9
(14.0)
2018
2016
$
Years Ended December 31,
2017
(in millions)
70.4
$
6.9
0.1
0.6
78.0
(3.4)
74.6
76.0
6.5
0.3
2.0
84.8
(3.6)
81.2
$
$
68.5
7.4
—
0.4
76.3
(3.1)
73.2
$
$
The Company is required by various state laws and regulations to hold securities or letters of credit in depository accounts with
certain states in which it does business. These laws and regulations govern not only the amount but also the types of securities
that are eligible for deposit. As of December 31, 2018 and 2017, securities having a fair value of $867.7 million and $1,009.7
million, respectively, were on deposit. Additionally, standby letters of credit from the FHLB were in place in lieu of $140.0 million
of securities on deposit as of December 31, 2018 (see Note 11).
Certain reinsurance contracts require the Company's 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 fixed maturity securities and restricted cash and cash equivalents
held in trust for the benefit of ceding reinsurers at December 31, 2018 and 2017 was $23.2 million and $24.5 million, respectively.
69
7. Property and Equipment
Property and equipment consists of the following:
Furniture and equipment
Leasehold improvements
Computers and software
Automobiles
Property and equipment, gross
Accumulated depreciation
Property and equipment, net
As of December 31,
2018
2017
(in millions)
3.3
3.2
61.9
1.1
69.5
(51.3)
18.2
$
$
1.7
2.9
54.2
1.1
59.9
(46.0)
13.9
$
$
Depreciation expenses related to property and equipment for the years ended December 31, 2018, 2017, and 2016 were $6.1
million, $7.9 million, and $8.2 million, respectively. Internally developed software costs of $2.9 million and $2.1 million were
capitalized during each of the years ended December 31, 2018 and 2017, respectively.
Additionally, in 2017, the Company wrote-off $7.5 million of previously capitalized costs relating to the development of information
technology capabilities that had not yet been placed in service, which is recognized in Other expenses in the Company's Consolidated
Statements of Comprehensive Income. The Company incurred this charge as part of a continual evaluation of its ongoing technology
initiatives.
Cloud Computing Arrangements
The Company capitalized $26.0 million of service contract fees and implementation costs associated with hosting arrangements
on the Company's Consolidated Balance Sheets as of December 31, 2018. The Company had no capitalized assets associated with
hosting arrangements as of December 31, 2017. Total amortization for hosting arrangements for the year ended December 31,
2018 was $0.8 million.
8. Income Taxes
The Company files a consolidated federal income tax return. The insurance subsidiaries pay premium taxes on premiums in lieu
of some states' income or franchise taxes.
The Tax Cuts and Jobs Act significantly revised U.S. corporate income tax law by, among other things, reducing the corporate
statutory income tax rate from 35% to 21%, beginning January 1, 2018. This reduction in the corporate statutory income tax rate
required the Company to re-evaluate certain of its deferred tax assets and liabilities, as of the date of Enactment, to reflect the
revised income tax rates applicable to future periods.
The Company's provision for income taxes consisted of the following:
Years Ended December 31,
2017
(in millions)
17.9
$
0.7
18.6
13.2
0.6
13.8
$
(0.4)
14.8
14.4
28.2
$
7.0
17.2
24.2
42.8
$
2016
20.3
0.3
20.6
—
13.4
13.4
34.0
Current tax expense:
Federal
State
Total current tax expense
Deferred federal tax expense:
Impact of tax Enactment
Other
Total deferred federal tax expense
Income tax expense
2018
$
$
70
The differences between the statutory federal tax rate of 21% for 2018 and 35% for 2017 and 2016 and the Company's effective
tax rate on net income before income taxes as reflected in the Consolidated Statements of Comprehensive Income were as follows:
Expense computed at statutory rate
Tax-advantaged investment income
LPT deferred gain amortization
Stock based compensation
LPT Reserve Adjustment
Impact of tax Enactment
Other
Income tax expense
2018
$
$
$
Years Ended December 31,
2017
(in millions)
50.4
$
(7.6)
(4.0)
(3.4)
—
7.0
0.4
42.8
35.6
(2.9)
(2.6)
(1.4)
(0.5)
(0.4)
0.4
28.2
$
$
2016
49.3
(8.5)
(4.7)
(1.6)
(1.1)
—
0.6
34.0
The LPT Reserve Adjustments for the years ended December 31, 2018 and 2016 increased GAAP net income by $2.2 million and
$3.1 million, respectively, but did not affect taxable income. There were no LPT Reserve Adjustments in 2017. The LPT Contingent
Commission Adjustments increased net income by $0.5 million, $0.3 million, and $1.8 million during 2018, 2017, and 2016,
respectively, but did not increase taxable income.
As of December 31, 2018 and 2017, 2016 the Company had no material unrecognized tax benefits.
The Company made cash payments of $4.2 million, $21.3 million and $13.7 million for income taxes during the years ended
December 31, 2018, 2017, and 2016, respectively.
Tax years 2015 through 2018 remained open and are subject to full examination by the federal taxing authority. The significant
components of deferred income taxes, net, were as follows as of December 31:
2018
Deferred Tax
2017
Deferred Tax
Assets
Liabilities
Assets
Liabilities
Unrealized capital gains, net
Deferred policy acquisition costs
Intangible assets
Loss reserve discounting for tax reporting
Unearned premiums
Allowance for bad debt
Stock-based compensation
Accrued liabilities
Minimum tax credit
Other
Total
Deferred income taxes, net
$
$
$
— $
—
—
31.1
13.3
1.4
2.9
4.9
—
2.6
56.2
26.9
$
$
(in millions)
10.6
10.3
1.6
—
—
—
—
—
—
6.8
29.3
$
$
— $
—
—
29.0
12.8
2.1
2.5
4.2
20.0
2.8
73.4
28.7
$
28.5
9.7
1.7
—
—
—
—
—
—
4.8
44.7
Enactment had no impact on the amount of the Company's minimum tax credit as of December 31, 2018. Despite a repeal of the
corporate alternative minimum tax, the Company's minimum tax credit was fully recognized in the year ended December 31, 2018.
Deferred tax assets are required to be reduced by a valuation allowance if it is more likely than not that all or some portion of the
deferred tax asset will not be realized. Realization of the deferred income tax asset is dependent on the Company generating
sufficient taxable income in future years as the deferred income tax charges become deductible for tax reporting purposes. Although
realization is not assured, management believes that it is more likely than not that the net deferred income tax asset will be realized.
The Company is required to discount its loss and LAE reserves for federal income tax purposes. The Company’s income tax
deduction associated with its loss and LAE reserves is discounted using interest rates prescribed by the U.S. Treasury, as well as
established loss payment patterns. Enactment changed the prescribed interest rates to rates based on corporate bond yield curves
and extends the time periods associated with loss payment patterns, which resulted in an acceleration of future income tax payments.
These changes became effective for tax years beginning after 2017 and are subject to a transition rule that spreads the additional
tax payment from the amount determined by applying these changes over the eight years beginning in 2018. This item is a taxable
71
temporary difference and had no direct impact on the Company’s total income tax expense for 2017 or future years. The Company
has followed the guidance of Revenue Procedure 2019-06 to complete its accounting for loss reserve discounting.
9. Liability for Unpaid Losses and Loss Adjustment Expenses
Accounting for workers' compensation insurance requires the Company 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 the Company will pay for many of the claims it has incurred as of the balance sheet date will not be known for
many years. The 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. The Company establishes loss reserves based on
its own analysis of emerging claims experience and environmental conditions in its markets and review of the results of various
actuarial projections. The Company's aggregate carried reserve for unpaid losses and LAE is the sum of its reserves for each
accident year and represents its best estimate of outstanding loss reserves.
The amount by which estimated losses in the aggregate differ from those previously estimated for a specific time period is known
as reserve “development.” Reserve development is unfavorable when losses ultimately settle for more than the amount reserved
or subsequent estimates indicate a basis for reserve increases on open claims, causing the previously estimated loss reserves to be
''deficient.'' Reserve development is favorable when estimates of ultimate losses indicate a decrease in established reserves, causing
the previously estimated loss reserves to be ''redundant.'' Development is reflected in the Company's operating results through an
adjustment to incurred losses and LAE during the period in which it is recognized.
Although claims for which reserves are established may not be paid for several years or more, the Company does not discount
loss reserves in its financial statements for the time value of money, in accordance with GAAP.
The three main components of reserves for unpaid losses and LAE are case reserves, incurred but not reported (IBNR) loss reserves,
and LAE reserves.
When claims are reported, the Company establishes individual estimates of the ultimate cost of each claim (case reserves). These
case reserves are continually monitored and revised in response to new information and for amounts paid.
IBNR is an actuarial estimate of future payments on claims that have occurred but have not yet been reported. In addition to this
provision for late reported claims, the Company also estimates and makes a provision for the extent to which the case reserves on
known claims may develop and for additional payments on closed claims, known as “reopening.” IBNR reserves apply to the
entire body of claims arising from a specific time period, rather than a specific claim. Most of the Company's IBNR reserves relate
to estimated future claim payments on recorded open claims.
LAE reserves are the Company's 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, and adjusting and other.
A portion of the Company's obligations for losses and LAE are ceded to unaffiliated reinsurers. The amount of reinsurance that
will be recoverable on its losses and LAE reserves includes both the reinsurance recoverable from excess of loss reinsurance
contracts, as well as reinsurance recoverable under the terms of the LPT Agreement.
The Company uses actuarial methods to analyze and estimate the aggregate amount of unpaid losses and LAE. Management
considers the results of various actuarial projection methods and their underlying assumptions, among other factors, in establishing
reserves for unpaid losses and LAE.
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 Company's Internal Actuary prepares reserve estimates for all accident years using our own historical claims data, industry
data and many of the generally accepted actuarial methodologies for estimating loss reserves, such as paid loss development
methods, incurred loss development methods, and Bornhuetter-Ferguson methods. These methods vary in their responsiveness to
different information, characteristics, and dynamics in the data, and the results assist the actuary in considering these characteristics
and dynamics in the historical data. The methods employed for each segment of claims data, and the relative weight accorded to
each method, vary depending on the nature of the claims segment and on the age of the claims.
Each actuarial methodology requires the selection and application of various parameters and assumptions. The key parameters
and assumptions include: the pattern with which our aggregate claims will be paid or emerge over time; the magnitude and changes
in claim settlement activity, claims cost inflation rates; the effects of legislative benefit changes and/or judicial changes; and trends
in the frequency of claims, both overall and by severity of claim. The Company believes the pattern with which our aggregate
72
data will be paid or emerge over time, claim settlement activity, claims cost inflation rates, and claim frequencies are the most
important parameters and assumptions.
The following table represents a reconciliation of changes in the liability for unpaid losses and LAE.
Unpaid losses and LAE at beginning of period
Less reinsurance recoverable on unpaid losses and LAE
Net unpaid losses and LAE at beginning of period
Losses and LAE, net of reinsurance, incurred during the period related to:
$
2018
Years Ended December 31,
2017
(in millions)
2,301.0
$
580.0
1,721.0
2,266.1
537.0
1,729.1
$
Current year
Prior years(1)
Total net losses and LAE incurred during the period(1)
Paid losses and LAE, net of reinsurance, related to:
Current year
Prior years(2)
Total net paid losses and LAE during the period(2)
Ending unpaid losses and LAE, net of reinsurance
Reinsurance recoverable on unpaid losses and LAE
Unpaid losses and LAE at end of period
457.5
(66.2)
391.3
93.0
323.9
416.9
1,703.5
504.4
2,207.9
$
447.3
(18.5)
428.8
76.9
343.8
420.7
1,729.1
537.0
2,266.1
$
$
2016
2,347.5
628.2
1,719.3
452.9
(18.4)
434.5
78.7
354.1
432.8
1,721.0
580.0
2,301.0
(1) Losses and LAE, net of reinsurance, incurred during the period related to prior years and Total net losses and LAE incurred during the
period included in the above table excludes the impact of the amortization of the Deferred Gain and LPT Reserve Adjustments (Note 10).
Including these amounts, Losses and LAE, net of reinsurance, incurred during the period related to prior years was $(80.8) million, $(30.1)
million, and $(35.0) million and Total net losses and LAE incurred during the period was $376.7 million, $417.2 million, and $417.9 million
for the years ended December 31, 2018, 2017, and 2016, respectively.
(2) Paid losses and LAE, net of reinsurance, related to prior years and Total net paid losses and LAE during the period included in the above
table excludes the impact of the amortization of the Deferred Gain and LPT Reserve Adjustments (Note 10). Including these amounts, Paid
losses and LAE, net of reinsurance, related to prior years was $309.3 million, $332.2 million, and $337.5 million and Total net paid losses
and LAE during the period was $402.4 million, $409.1 million, and $416.2 million for the years ended December 31, 2018, 2017, and 2016,
respectively.
In 2018, the Company had $66.2 million of favorable prior accident year loss development, which included $65.5 million of
favorable development on its voluntary risk business and $0.7 million of favorable development related to its assigned risk business.
In 2017, the Company had $18.5 million of favorable prior accident year loss development, which included $17.4 million of
favorable development on its voluntary risk business and $1.1 million of favorable development related to its assigned risk business.
In 2016, the Company had $18.4 million of favorable prior accident year loss development, which included $17.0 million of
favorable development on its voluntary risk business and $1.4 million of favorable development related to its assigned risk business.
The favorable prior accident year loss development on voluntary business in these years was the result of the Company's
determination that adjustments were necessary to reflect observed favorable paid loss trends. Paid loss trends have been impacted
by cost savings associated with accelerated claims settlement activity that began in 2014 and continued through 2018.
In California, where the Company's operations began in 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 2016, indicates an upward trend in medical and indemnity
costs that are reflected in its loss reserves. Loss experience in 2017 indicated a slight downward movement in medical and indemnity
costs per claim. The Company's indemnity claims frequency (the number of claims expressed as a percentage of payroll) continued
to decrease year-over-year for the past three years; however, in 2018, the Company saw an upward movement in medical and
indemnity costs per claim that is reflected in the Company's current accident year loss estimate. The Company's reserve estimates
assume that increasing medical cost trends will continue and will impact the Company's long-term claims costs and loss reserves.
73
The Company continues to develop its own loss experience in California and will rely more on its experience and less on historical
industry data in projecting its reserve requirements as such data becomes available. As the actual experience of the Company
emerges, it will continue to evaluate prior estimates, which may result in additional adjustments in reserves.
In Nevada, the Company has compiled a lengthy history of workers' compensation claims payment patterns based on the business
of the Fund and EICN, but the emergence and payment of claims in recent years has been more favorable than in the long-term
history in Nevada with the Fund. The expected patterns of claim payments and emergence used in the projection of the Company's
ultimate claim payments are based on both the long and short-term historical paid data. In recent evaluations, claim patterns have
continued to emerge in a manner consistent with short-term historical data. Consequently, the Company has relied more heavily
on claim projection patterns observed in recent years in Nevada.
Loss reserves shown in the Company's Consolidated Balance Sheets are net of $34.4 million and $35.0 million for anticipated
subrogation recoveries as of December 31, 2018 and 2017, respectively.
The Company compiles and aggregates its claims data by grouping the claims according to the year in which the claim occurred
(“accident year”) when analyzing claim payment and emergence patterns and trends over time. For the purposes of defining claims
frequency, the number of reported claims includes any claim that has case reserves and/or loss and LAE payments associated with
them.
The Company analyzed the usefulness of disaggregation of its results and determined the characteristics associated with the policies
and the related unpaid loss reserves, incurred losses, and payment patterns are similar in nature. As such, the following tables
show the Company's historical incurred and cumulative paid losses and LAE development, net of reinsurance, as well as IBNR
loss reserves and the number of reported claims on an aggregated basis as of December 31, 2018 for each of the previous 10
accident years.
Incurred Losses and LAE, Net of Reinsurance
Years Ended December 31,
As of December 31, 2018
Accident
Year
2009(1) 2010(1) 2011(1) 2012(1) 2013(1) 2014(1) 2015(1) 2016(1) 2017(1)
2018
IBNR
Cumulative
number of
reported claims
(in millions, except claims counts)
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Total
204.9
224.4
253.7
228.1
267.3
348.8
246.1
272.0
359.9
452.6
$ 255.4 $ 266.9 $ 279.0 $ 280.1 $ 283.6 $ 283.7 $ 291.2 $ 290.5 $ 290.5 $ 287.9
255.2
287.8
379.8
464.6
430.5
419.6
395.4
391.3
422.5
$ 3,734.7
258.8
288.8
382.8
468.9
434.6
423.9
414.6
412.4
259.9
292.6
388.2
472.6
432.9
425.8
419.0
262.0
296.3
386.4
478.6
445.8
422.2
250.2
277.4
360.9
460.6
463.4
$
11.0
16.7
24.0
41.1
61.2
72.2
78.7
94.4
145.1
220.0
22,681
18,540
19,578
25,989
28,869
28,524
27,135
25,621
24,746
23,617
74
Accident Year
2009(1)
2010(1)
2011(1)
2012(1)
2013(1)
2014(1)
2015(1)
2016(1)
2017(1)
2018
(in millions)
Cumulative Paid Losses and LAE, Net of Reinsurance
Years Ended December 31,
59.0 $ 130.6 $ 174.1 $ 202.0 $ 219.3 $ 232.1 $ 242.3 $ 249.5 $ 255.1 $
$
47.1
105.6
47.4
143.8
115.1
58.6
171.7
162.6
148.3
68.5
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Total
All outstanding liabilities for unpaid losses and LAE prior to 2009, net of reinsurance
Total outstanding liabilities for unpaid losses and LAE, net of reinsurance
190.7
193.8
214.2
184.4
65.3
206.2
217.5
261.4
263.8
172.7
65.5
215.4
230.1
289.9
317.4
248.9
174.5
65.6
221.3
238.2
305.0
346.1
297.2
246.9
166.8
63.5
258.7
226.5
243.8
316.9
365.9
323.4
290.5
227.7
160.2
77.9
$ 2,491.6
371.5
$ 1,614.6
(1) Data presented for these calendar years is required supplementary information, which is unaudited.
The following table represents a reconciliation of claims development to the aggregate carrying amount of the liability for unpaid
losses and LAE:
Liabilities for unpaid losses and LAE, net of reinsurance
Reinsurance recoverable on unpaid losses
Unallocated LAE (adjusting and other)
Total liability for unpaid losses and LAE
December 31, 2018
(in millions)
$
$
1,614.6
504.4
88.9
2,207.9
The following table presents the average annual percentage payout of incurred claims by age, net of reinsurance, as of December 31,
2018 and is presented as required supplementary information, which is unaudited:
Average Annual Percentage Payout of Claims by Age, Net of Reinsurance
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
Year 10
16.8%
24.6%
16.4%
11.0%
6.9%
4.6%
3.3%
2.3%
2.0%
1.3%
10. Reinsurance
The Company purchases reinsurance from third parties in the normal course of its business in order to manage its exposures. The
Company's reinsurance coverage is provided on both a quota share and excess of loss basis.
The effects of reinsurance on the Company's written and earned premiums and on its losses and LAE incurred were as follows:
Direct premiums
Assumed premiums
Gross premiums
Ceded premiums
Net premiums
Ceded losses and LAE incurred
2018
Years Ended December 31,
2017
2016
Written
Earned
Written
Earned
Written
Earned
$
739.0
$
727.2
$
(in millions)
719.5
$
9.9
748.9
(6.1)
$
$
742.8
$
9.5
10.0
737.2
(6.1)
731.1
$
$
10.2
729.7
(6.0)
723.7
(0.5)
$
712.5
$
691.0
$
10.0
722.5
(6.0)
716.5
$
$
10.4
701.4
(6.8)
694.6
0.1
$
691.0
10.6
701.6
(6.8)
694.8
75
Ceded losses and LAE incurred includes the amortization of the Deferred Gain, LPT Reserve Adjustments, and LPT Contingent
Commission Adjustments.
Excess of Loss Reinsurance
The Company has consistently maintained excess of loss reinsurance coverage to protect it against the impact of large and/or
catastrophic losses in its workers' compensation business. The Company currently maintains reinsurance for losses from a single
occurrence or catastrophic event in excess of $10.0 million and up to $200.0 million, subject to certain exclusions. This current
reinsurance program is effective July 1, 2018 through June 30, 2019. The coverage under the Company's annual reinsurance
programs that ended July 1, 2018 and 2017 was $190.0 million, in excess of its $10.0 million retention on a per occurrence basis.
The reinsurance coverage includes coverage for acts of terrorism, excluding nuclear, biological, chemical, and radiological events.
Any liability outside the coverage limits of the reinsurance program is retained by the Company.
LPT Agreement
Recoverables from reinsurers on unpaid losses and LAE amounted to $504.4 million and $537.0 million at December 31, 2018
and 2017, respectively. At each of December 31, 2018 and 2017, $408.2 million and $438.9 million, respectively, of those
recoverables was 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 totaling $311.6 million and $380.8 million at December 31, 2018
and 2017, respectively, have been placed in trust by the three reinsurers as security for payment of the reinsured claims. Under
the LPT Agreement, initially $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 $775.0 million. The LPT Agreement provides coverage up to $2.0 billion.
Through December 31, 2018, the Company has paid losses and LAE claims totaling $773.7 million related to the LPT Agreement.
The Company amortized $11.9 million, $11.3 million, and $11.7 million of the Deferred Gain for the years ended December 31,
2018, 2017, and 2016, respectively. Additionally, the Deferred Gain was reduced by $2.2 million and $3.1 million for the years
ended December 31, 2018 and 2016, respectively, due to favorable LPT Reserve Adjustments and by $0.5 million, $0.3 million,
and $1.8 million for the years ended December 31, 2018, 2017, and 2016, respectively, due to favorable LPT Contingent
Commission Adjustments (Note 2).
11. Notes Payable and Other Financing Arrangements
Notes payable is comprised of the following:
December 31,
2018
2017
Dekania Surplus Note, due April 29, 2034
Alesco Surplus Note, due December 15, 2034
Total
$
$
$
(in millions)
10.0
10.0
20.0
$
10.0
10.0
20.0
EPIC has a $10.0 million surplus note to Dekania CDO II, Ltd. issued as part of a pooled transaction. The note matures in 2034
and became callable by the Company in 2009. The terms of the note provide for quarterly interest payments at a rate 425 basis
points in excess of the 90-day LIBOR. Both the payment of interest and repayment of the principal under this note and the surplus
notes described in the succeeding two paragraphs are subject to the prior approval of the Florida Department of Financial Services.
Interest paid during each of the years ended December 31, 2018, 2017, and 2016 was $0.7 million, $0.6 million, and $0.5 million.
Interest accrued as of December 31, 2018 and 2017 was $0.1 million.
EPIC has a $10.0 million surplus note to Alesco Preferred Funding V, LTD issued as part of a pooled transaction. The note matures
in 2034 and became callable by the Company in 2009. The terms of the note provide for quarterly interest payments at a rate 405
basis points in excess of the 90-day LIBOR. Interest paid during each of the years ended December 31, 2018, 2017, and 2016 was
$0.6 million, $0.5 million, and $0.5 million, respectively. Interest accrued as of December 31, 2018 and 2017 was less than $0.1
million.
EPIC had a $12.0 million surplus note to ICONS, Inc. issued as part of a pooled transaction. This note was purchased by EHI in
2017 for $9.9 million, resulting in a $2.1 million gain. As a result of EHI's purchase of the note, it was no longer considered
outstanding on a consolidated basis at December 31, 2017. The note was formally redeemed and retired by EPIC in May 2018.
Interest paid to third parties during each of the years ended December 31, 2017 and 2016 was $0.3 million and $0.6 million,
respectively.
76
Principal payment obligations on notes payable outstanding at December 31, 2018, were as follows:
Year
2019 - 2023
Thereafter
Total
Principal Due
(in millions)
$
$
—
20.0
20.0
Other financing arrangements is comprised of the following:
Each of the Company's insurance subsidiaries is a member of the FHLB. Membership allows the insurance subsidiaries access to
collateralized advances, which may be used to support and enhance liquidity management. The amount of advances that may be
taken is dependent on statutory admitted assets on a per company basis. Currently, none of the Company's insurance subsidiaries
has advances outstanding under the FHLB facility.
FHLB membership also allows the Company's insurance subsidiaries access to standby letters of credit. On March 9, 2018, ECIC,
EPIC, and EAC entered into standby Letter of Credit Reimbursement Agreements (Letter of Credit Agreements) with the FHLB.
The Letter of Credit Agreements are between the FHLB and each of EAC, in the amount of $40.0 million, ECIC, in the amount
of $50.0 million, and EPIC, in the amount of $50.0 million. The Letter of Credit Agreements became effective March 9, 2018 and
expire March 31, 2019; however, the Letter of Credit Agreements will remain evergreen with automatic one-year extensions unless
the FHLB notifies the beneficiary at least 60 days prior to the then applicable expiration date of its election not to renew. The
Letter of Credit Agreements may only be used to satisfy, in whole or in part, insurance deposit requirements with the State of
California and are fully secured with eligible collateral at all times. The Letter of Credit Agreements are subject to annual
maintenance charges and a fee of 15 basis points on issued amounts. As of December 31, 2018 letters of credit totaling $140.0
million were issued in lieu of securities on deposit with the State of California under these Letter of Credit Agreements.
As of December 31, 2018, investment securities having a fair value of $244.1 million were pledged to the FHLB by the Company's
insurance subsidiaries in support of the collateralized advance facility and the Letter of Credit Agreements.
12. Commitments and Contingencies
Leases
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,
2018, the remaining lease terms expire over the next nine years.
The future lease payments for the next five years on these non-cancellable operating and capital leases at December 31, 2018,
were as follows:
Year
2019
2020
2021
2022
2023
Thereafter
Total
Operating Leases
Capital Leases
$
$
(in millions)
5.3
4.4
2.9
1.9
1.8
6.2
22.5
$
$
0.3
0.3
0.2
0.1
—
—
0.9
Included in the future minimum capital lease payments are future interest charges of $0.2 million. Facilities rent expense was $5.0
million, $4.8 million, and $4.9 million for the years ended December 31, 2018, 2017, and 2016, respectively.
Property held under capital leases is included in property and equipment as follows:
Asset Class
Automobiles
Accumulated amortization
Total
2018
2017
(in millions)
1.1
(0.4)
0.7
$
1.1
(0.3)
0.8
$
77
Contingencies Surrounding Insurance Assessments
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 $18.6 million and $12.4 million as of December 31, 2018 and 2017, 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 $14.9
million and $14.1 million, as of December 31, 2018 and 2017, respectively, for prepaid policy charges still to be collected in the
future from policyholders, or assessments that may be recovered through a reduction in future premium taxes in certain states.
These assets are expected to be realized over one to ten year periods in accordance with their type and each individual state's
regulations.
Capital Commitment
As of December 31, 2018, the Company had an unfunded commitment to invest $50.0 million into a private investment fund.
13. Stockholders' Equity
Stock Repurchase Programs
On February 21, 2018, the Board of Directors authorized a share repurchase program for up to $50.0 million of the Company's
common stock from February 26, 2018 through February 26, 2020 (the 2018 Program). The Company expects that its common
stock may be purchased at prevailing market prices through a variety of methods, including open market or private transactions,
in accordance with applicable laws and regulations and as determined by management. The timing and actual number of shares
repurchased will depend on a variety of factors, including the share price, corporate and regulatory requirements, and other market
and economic conditions. Repurchases under the 2018 Program may be commenced, modified, or suspended from time-to-time
without prior notice, and the 2018 Program may be suspended or discontinued at any time. Through December 31, 2018, the
Company has repurchased a total of 112,528 shares of common stock at an average price of $40.95 per share, including commissions,
for a total of $4.6 million under the 2018 Program.
Since the Company's initial public offering in January 2007 through December 31, 2018, the Company has repurchased a total of
24,209,883 shares of common stock at an average cost per share of $16.04 through various stock repurchase programs, which is
reported as treasury stock, at cost, on its Consolidated Balance Sheets.
14. Stock-Based Compensation
The Employers Holdings, Inc. Amended and Restated Equity and Incentive Plan (the Plan) is administered by the Compensation
Committee of the Board of Directors, which is authorized to grant, at its discretion, awards to officers, employees, non-employee
directors, consultants, and independent contractors. The maximum number of common shares reserved for grants of awards under
the Plan was 5,500,000 shares, prior to reductions for grants made. The Plan provides for the grant of stock options (both incentive
stock options and nonqualified stock options), stock appreciation rights, shares of restricted stock, restricted stock units (RSUs),
performance stock units (PSUs), and other stock-based awards.
Commencing in 2017, employees who were awarded RSUs and PSUs are entitled to receive dividend equivalents for eligible
awards, payable in cash, when the underlying award vests and becomes payable. If the underlying award does not vest or is
forfeited, dividend equivalents with respect to the underlying award will also fail to become payable and will be forfeited. These
awards are not considered participating securities for the purposes of determining earnings per share.
As of December 31, 2018, the only incentive awards outstanding under the Plan were nonqualified stock options, RSUs, and PSUs.
78
Compensation costs are recognized based on expected performance, if applicable, net of any estimated forfeitures on a straight-
line basis over the requisite employee service periods. Forfeiture rates are based on historical experience and are adjusted in
subsequent periods for differences in actual forfeitures from those estimated. Net stock-based compensation expense recognized
in the Company's Consolidated Statements of Comprehensive Income was as follows:
Stock-based compensation expense related to:
Stock options
RSUs
PSUs
Total
Less: related tax benefit
Net stock-based compensation expense
Stock Options
2018
$
$
Years Ended December 31,
2017
(in millions)
0.5
$
2.0
4.3
6.8
2.4
4.4
0.3
2.5
6.5
9.3
2.0
7.3
$
$
$
2016
0.7
1.9
3.2
5.8
2.0
3.8
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 year ended December 31, 2016, the expected stock price volatility used to value the stock
options granted in 2016 was based on the volatility of the Company's historical stock price since February 2007. No stock options
were granted in 2018 or 2017. The expected term of the stock options granted in 2016 was calculated using the 'plain-vanilla'
calculation provided in the guidance of the SEC's SAB No. 107. The dividend yield was calculated using amounts authorized by
the Board of Directors. The risk-free interest rate is the yield on the grant date of the stock options of U.S. Treasury zero coupon
securities with a maturity comparable to the expected term of the stock options.
The Company anticipates issuing new shares of common stock upon the exercise of its outstanding stock options.
The fair value of the stock options granted during the year ended December 31, 2016 was calculated using the following weighted
average assumptions:
Expected volatility
Expected life (in years)
Dividend yield
Risk-free interest rate
Weighted average grant date fair values of stock options granted
Changes in outstanding stock options for the year ended December 31, 2018 were as follows:
Stock options outstanding at December 31, 2015
Granted
Exercised
Expired
Forfeited
Stock options outstanding at December 31, 2016
Exercised
Forfeited
Stock options outstanding at December 31, 2017
Exercised
Forfeited
Stock options outstanding at December 31, 2018
Exercisable at December 31, 2018
Number of Stock
Options
Weighted-
Average Price
$
1,121,545
67,431
(586,132)
(6,075)
(32,673)
564,096
(307,076)
(9,673)
247,347
(57,091)
—
190,256
149,327
18.31
27.72
16.39
22.48
24.35
21.04
19.44
24.45
22.90
20.17
—
23.71
22.95
79
2016
38.0%
4.8
1.3%
1.4%
$8.46
Weighted Average
Remaining
Contractual Life
2.8 years
6.2 years
3.3 years
3.4 years
2.7 years
2.4 years
At December 31, 2018, the Company had yet to recognize $0.2 million of unamortized expense related to stock option grants and
expects to recognize these costs on a straight-line basis over the next 15 months. The fair value of stock options vested and the
intrinsic value of outstanding and exercisable stock options as of December 31, were as follows:
Fair value of stock options vested
Intrinsic value of outstanding stock options
Intrinsic value of exercisable stock options
2018
$
2017
(in millions)
0.6
$
5.3
3.6
$
0.4
3.4
2.8
2016
0.8
10.6
7.6
The intrinsic value of stock options exercised was $1.4 million, $7.6 million, and $7.6 million for the years ended December 31,
2018, 2017, and 2016.
RSUs
The Company has awarded RSUs to non-employee members of the Board of Directors and certain employees of the Company.
The RSUs awarded to non-employee members of the Board of Directors generally vest on the first anniversary of the award date.
RSU grants allow each non-employee Director to decide whether to defer settlement of the RSUs until six months after termination
of Board service or settle the RSUs at vesting. Dividend equivalents are granted to Directors who elected to defer settlement of
the RSUs after the grants vested. RSUs awarded to employees of the Company have a service vesting period of approximately
four years from the date awarded and vest 25% on or after each of the subsequent four anniversaries of such date. These RSUs
are subject to accelerated vesting in certain limited circumstances, such as: retirement, death or disability of the holder, or in
connection with a change of control of the Company.
Changes in outstanding RSUs for the year ended December 31, 2018 were as follows:
RSUs outstanding at December 31, 2015
Granted
Forfeited
Vested
RSUs outstanding at December 31, 2016
Granted
Forfeited
Vested
RSUs outstanding at December 31, 2017
Granted
Forfeited
Vested
RSUs outstanding at December 31, 2018
Vested but unsettled RSUs at December 31, 2018
Number of RSUs
319,033
100,218
(21,872)
(72,995)
324,384
87,276
(13,711)
(102,785)
295,164
87,857
(3,370)
(129,351)
250,300
67,620
Weighted Average
Grant Date Fair Value
20.71
$
28.20
24.87
21.56
22.55
37.94
29.28
22.89
26.67
40.26
33.51
24.53
32.45
23.35
At December 31, 2018, the Company had yet to recognize $4.7 million of unamortized expense related to outstanding RSUs and
expects to recognize these costs on a straight-line basis over the next 39 months. The grant date fair value of RSUs vested and the
intrinsic value of vested RSUs for the years ended December 31, were as follows:
Grant date fair value of RSUs vested
Intrinsic value of RSUs vested
2018
2017
(in millions)
2.4
$
4.3
$
3.2
5.5
$
2016
1.6
2.1
The intrinsic value of outstanding RSUs was $10.5 million, $13.1 million, and $12.8 million at December 31, 2018, 2017, and
2016.
80
PSUs
The Company has awarded PSUs to certain employees of the Company as follows:
Date of Grant
Target Number
Awarded
Fair Value on
Date of Grant
Aggregate Fair Value
on Date of Grant
March 2016(1)
March 2017(1)
March 2018(1)
$
97,236
97,440
96,940
$
27.72
37.60
40.30
(in millions)
2.7
3.7
3.9
(1) The PSUs awarded in March 2016, 2017, and 2018 were awarded to certain employees of the Company and have a performance period of
two years followed by an additional one year vesting period. The PSU awards are subject to certain performance goals with payouts that
range from 0% to 200% of the target awards. The values shown in the table represent the aggregate number of PSUs awarded at the target
level.
At December 31, 2018, the Company had yet to recognize $5.5 million of unamortized expense related to PSU grants and expects
to recognize these costs on a straight-line basis over the next 24 months. This is based on the expectation of the Company achieving
a 200% of target rate for the 2016 PSUs, a 200% of target rate for the 2017 PSUs, and a 125% of target rate for the 2018 PSUs.
15. Statutory Matters
Statutory Financial Data
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 (SAP) of the National Association of Insurance Commissioners
(NAIC) as well as SAP permitted by the states of California, Florida, and Nevada, were as follows:
December 31,
2018
2017
Capital stock and unassigned surplus
Paid in capital
Surplus notes
Total statutory surplus
$
$
$
(in millions)
558.5
349.4
20.0
927.9
$
510.6
349.8
32.0
892.4
Net income for the Company's insurance subsidiaries prepared in accordance with SAP for the years ended December 31, 2018,
2017 and 2016 was $159.3 million, $116.8 million, and $101.4 million, respectively.
Treatment of the LPT Agreement, deferred policy acquisition costs, fair value of financial instruments, and the surplus notes (see
Notes 5, 10, and 11) are the primary differences in the SAP-basis capital stock and total surplus of the insurance subsidiaries of
$927.9 million and $892.4 million, and the GAAP-basis equity of the Company of $1,018.2 million and $947.7 million as of
December 31, 2018 and 2017, 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 Company has recovered amounts in excess of the original consideration paid. The special surplus
funds are also reduced by the amount of extraordinary dividends as approved by the Nevada Division of Insurance. Under SAP,
the surplus notes are recorded as a separate component of surplus. Under SAP, changes to the estimated contingent profit commission
under the LPT Agreement are reflected in commission expense in the period that the estimate is revised.
Insurance Company Dividends and Regulatory Requirements and Restrictions
The ability of EHI to pay dividends on the Company's common stock and to pay other expenses will be dependent to a significant
extent upon the ability of the Nevada domiciled insurance company, EICN, the California domiciled insurance company, ECIC,
and the Florida domiciled insurance companies, EPIC and EAC, to pay dividends to their immediate holding company, Employers
Group, Inc. (EGI) and, in turn, the ability of EGI to pay dividends to EHI. The amount of dividends each of the Company's
subsidiaries may pay to their immediate parent is limited by the laws of its respective state of domicile.
Nevada law limits the payment of cash dividends by EICN to its parent by providing that payments cannot be made except from
available and accumulated surplus, otherwise unrestricted (unassigned), and derived from realized net operating profits and realized
and unrealized capital gains. A stock dividend may be paid out of any available surplus. A cash or stock dividend prohibited by
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
81
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 lesser 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, 2018, EICN had positive unassigned surplus of $195.3 million. During 2018, EICN paid an
ordinary dividend in the amount of $17.7 million to its parent company, EGI. As a result of that payment, EICN can pay $2.1
million of dividends through January 25, 2019 and $19.8 million thereafter without regulatory approval, provided that no dividends
are paid prior to January 25, 2019.
Under Florida law, without regulatory approval, EPIC and EAC may pay dividends if they do not exceed the greater of: the lesser
of 10% of surplus or net income, not including realized capital gains, plus a 2-year carry forward; 10% of surplus, with dividends
payable limited to unassigned funds minus 25% of unrealized capital gains; or, the lesser of 10% of surplus or net investment
income plus a 3-year carry forward with dividends payable limited to unassigned funds minus 25% of unrealized capital gains.
During 2018, EAC paid an ordinary dividend in the amount of $18.9 million to its parent company, EGI. As a result of that payment,
EAC can pay $0.9 million of dividends through May 18, 2019 and $19.8 million thereafter without regulatory approval from the
Florida Office of Insurance Regulation (FOIR), provided that no dividends are paid prior to May 18, 2019. During 2018, EPIC
did not pay any dividends. The maximum dividends that may be paid in 2019 by EPIC without prior regulatory approval from the
FOIR is $19.0 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 net
written premium to policyholder surplus ratio exceeds 1.5 to 1; (b) ECIC will not exceed a ratio of net written premium to
policyholder surplus of 2 to 1 without approval of the California DOI; (c) if at any time ECIC's policyholder surplus decreases to
80% or less than the September 30, 2008 balance, ECIC shall cease issuing new policies in California, but may continue to renew
existing policies until it has (i) received a capital infusion to bring its surplus position to the same level as that as of September
30, 2008 and (ii) submitted a new business plan to the California DOI; (d) ECIC will maintain a risk based capital (RBC) level
of at least 350% of the authorized control level; (e) should ECIC fail to comply with any commitments listed herein, ECIC will
consent to any request by the California DOI to cease issuing new policies in California, but may continue to renew existing
policies until such time that as ECIC is able to achieve full compliance with each commitment; and (f) the obligations listed shall
only terminate with the written consent of the California DOI. During the years ended December 31, 2018, 2017, and 2016, ECIC
was in compliance with these requirements.
Additionally, the California Insurance Holding Company System Regulatory Act limits the ability of ECIC to pay dividends to
its parent. California law provides that, absent prior approval of the California Insurance Commissioner, dividends may only be
declared from earned surplus. For purpose of this statute, earned surplus excludes amounts (1) derived from net appreciation in
the value of assets not yet realized, or (2) derived from an exchange of assets, unless the assets received are currently realizable
in cash. In addition, California law provides that the appropriate insurance regulatory authorities in the state of California must
approve (or, within a 30-day notice period, not disapprove) any dividend that, together with all other such dividends paid during
the preceding 12 months, exceeds the greater of: (a) 10% of the paying company's statutory surplus as regards to policyholders at
the preceding December 31; or (b) 100% of net income for the preceding year. During 2018, ECIC paid an ordinary dividend in
the amount of $48.4 million to its parent company, EGI. As a result of that payment, ECIC can pay $8.8 million of dividends
through September 5, 2019 and $57.2 million thereafter without prior regulatory approval, provided that no dividends are paid
prior to September 5, 2019.
EPIC and EAC are subject to regulation by the Florida Department of Financial Services (FDFS). Florida statute Section 624.408
requires EPIC and EAC to maintain minimum capital and surplus of the greater of $4.0 million or 10% of total liabilities. Florida
statute Section 624.4095 requires EPIC and EAC to maintain a ratio of written premiums, defined as 1.25 times written premiums,
to surplus of no greater than 10-to-1 for gross written premiums and 4-to-1 for net written premiums. During the years ended
December 31, 2018, 2017, and 2016, EPIC and EAC were in compliance with these statutes.
Additionally, EICN, ECIC, EPIC, and EAC are required to comply with 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, 2018, 2017, and 2016, EICN, ECIC, EPIC, and EAC each had total adjusted
capital above all regulatory action levels.
82
16. Accumulated Other Comprehensive (Loss) Income
Accumulated other comprehensive (loss) income is comprised of unrealized (losses) gains on investments classified as available-
for-sale, net of deferred tax expense. Beginning in 2018, with the adoption of ASU No. 2016-01, the Company's investments in
equity securities at fair value are no longer considered to be AFS and are reported at fair value with unrealized gains and losses
included in Net realized and unrealized (losses) gains on investments on the Company's Consolidated Statements of Comprehensive
Income. Prior to 2018, investments in equity securities at fair value were classified as AFS and changes in fair value were excluded
from earnings and reported in accumulated other comprehensive (loss) income. The following table summarizes the components
of Accumulated other comprehensive (loss) income:
Net unrealized (losses) gains on investments, before taxes
Deferred tax benefit (expense) on net unrealized (losses) gains
Total accumulated other comprehensive (loss) income
17. Employee Benefit and Retirement Plans
Years Ended December 31,
2018
2017
(in millions)
(17.3) $
3.6
(13.7) $
136.0
(28.6)
107.4
$
$
The Company maintains a 401(k) defined contribution plan covering all eligible Company employees (the Employers 401(k)
Plan). Under the Employers 401(k) Plan, the Company's safe harbor matching consists of 100% matching contribution on salary
deferrals up to 3% of compensation and then 50% matching contribution on salary deferrals from 3% to 5% of compensation. The
Company's matching contribution to the Employers 401(k) Plan was $2.0 million, $1.9 million, and $1.9 million for the years
ended December 31, 2018, 2017, and 2016, respectively.
18. Earnings Per Common Share
Basic earnings per share, which includes no dilution from outstanding stock-based awards, is computed by dividing net income
by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential
dilutive impact of all outstanding stock-based awards on earnings per share. Diluted earnings per share includes common shares
assumed issued under the “treasury stock method,” which reflects the potential dilution that would occur if outstanding RSUs and
PSUs vested, and stock options were to be exercised.
Commencing in 2017, certain stock-based compensation awards are eligible to receive dividend equivalents on awards that fully
vest or become payable. These awards are not considered participating securities for the purposes of determining earnings per
share.
The following table presents the net income and the weighted average shares outstanding used in the earnings per share common
share calculations.
Net income
Weighted average number of shares outstanding–basic
Effect of dilutive securities:
$
2018
Years Ended December 31,
2017
(in millions, except share data)
141.3
32,884,828
101.2
32,501,576
$
$
2016
106.7
32,434,580
Stock options
PSUs
RSUs
Dilutive potential shares
Weighted average number of shares outstanding–diluted
97,810
268,030
60,669
426,509
33,311,337
208,602
271,738
78,844
559,184
33,060,760
246,562
222,594
73,099
542,255
32,976,835
83
Diluted earnings per share excludes those outstanding stock options and any other common stock equivalents in periods where
the inclusion of such stock options and common stock equivalents would be anti-dilutive. The following table presents the number
of stock options, PSUs and RSUs that were excluded from the Company's calculation of diluted earnings per share.
Stock options excluded as the exercise price was greater than the average market price
Stock options excluded under the treasury method, as the potential proceeds on settlement
or exercise was greater than the value of shares acquired
19. Selected Quarterly Financial Data (Unaudited)
Quarterly results for the years ended December 31, 2018 and 2017 were as follows:
Years Ended December 31,
2018
2017
2016
—
—
—
—
—
89,221
2018 Quarters Ended
Net premiums earned
Net realized and unrealized (losses) gains on
investments
Losses and loss adjustment expenses
Commission expense
Underwriting and other operating expenses
Income tax expense
Net income
Earnings per common share:
Basic
Diluted
Net premiums earned
Net realized gains on investments
Losses and loss adjustment expenses
Commission expense
Underwriting and other operating expenses
Other expenses
Income tax expense
Net income
Earnings per common share:
Basic
Diluted
Significant Quarterly Adjustments
March 31
$
176.6
June 30
September 30
(in millions, except per share data)
192.9
$
178.0
$
(8.0)
95.4
23.7
39.2
3.8
25.6
0.78
0.77
5.7
87.8
24.5
40.1
8.8
42.5
1.29
1.28
15.6
106.6
24.8
38.8
10.7
47.6
1.45
1.43
2017 Quarters Ended
$
March 31
175.3
2.2
109.0
21.5
35.9
—
6.3
23.2
0.72
0.70
$
June 30
September 30
(in millions, except per share data)
187.9
$
4.1
116.9
23.7
33.6
7.5
7.0
21.9
171.7
1.1
106.1
21.5
32.6
—
7.8
24.8
0.76
0.75
0.67
0.66
December 31
$
183.6
(26.4)
86.9
21.2
40.4
4.9
25.6
0.78
0.77
December 31
$
181.6
—
85.2
24.7
37.8
—
21.7
31.3
0.96
0.94
Changes in Net unrealized (losses) gains on investments in 2018 were due to volatility in equity markets. Beginning in 2018,
equity securities at fair value are no longer classified as AFS and changes in fair value are included in Net realized and unrealized
(losses) gains on investments on the Company's Consolidated Statements of Comprehensive Income. Additionally, Income tax
expense was impacted by the volatility in Net unrealized (losses) gains on investments, affecting net income for each quarter of
2018.
The first quarter of 2018 was impacted by: (1) favorable prior accident year loss development of $12.4 million, which decreased
losses and LAE by the same amount; (2) the inclusion of $12.9 million in net unrealized losses on equity securities during the
period.
84
The second quarter of 2018 was impacted by: (1) favorable prior accident year loss development of $16.5 million, which decreased
losses and LAE by the same amount; (2) favorable development in the estimated reserves ceded under the LPT Agreement that
resulted in a $2.2 million LPT Reserve Adjustment and a $0.5 million LPT Contingent Commission Adjustment, which decreased
losses and LAE by the same amount; and (3) the inclusion of $3.5 million in net unrealized gains on equity securities.
The third quarter of 2018 was impacted by: (1) favorable prior accident year loss development of $11.9 million, which decreased
losses and LAE by the same amount; and (2) the inclusion of $11.2 million in net unrealized gains on equity securities during the
period.
The fourth quarter of 2018 was impacted by: (1) favorable prior accident year loss development of $25.4 million, which decreased
losses and LAE by the same amount; and (2) the inclusion of $27.4 million in net unrealized losses on equity securities during
the period.
The second quarter of 2017 was favorably impacted by a $2.1 million gain from EHI's purchase of a $12.0 million note payable.
The third quarter of 2017 was negatively impacted by a write-off of $7.5 million of previously capitalized costs relating to the
development of information technology capabilities that had not yet been placed in service.
The fourth quarter of 2017 was impacted by: (1) favorable prior accident year loss development of $18.0 million; (2) a reduction
in our current accident year loss provision rate that reduced Losses and LAE by $10.6 million; and (3) $7.0 million in additional
income tax expense from a revaluation of the Company's net deferred tax asset resulting from Enactment.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of
1934, as amended (the Exchange Act)) designed to provide reasonable assurance that the information required to be reported in
the Exchange Act filings is recorded, processed, summarized and reported within the time periods specified and pursuant to SEC
regulations, including controls and procedures designed to ensure that this information is accumulated and communicated to
management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding
the required disclosure. It should be noted that, because of inherent limitations, our disclosure controls and procedures, however
well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the disclosure controls
and procedures are met.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness
of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, our Chief
Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at a
reasonable level of assurance as of December 31, 2018.
Management's Report on Internal Control Over Financial Reporting
Management's report regarding internal control over financial reporting is set forth in Item 8 of this report under the caption
“Management's Report on Internal Control over Financial Reporting” and incorporated herein by reference.
Attestation Report of Independent Registered Public Accounting Firm
The attestation report of the Company's independent registered public accounting firm regarding internal control over financial
reporting is set forth in Item 8 of this report under the caption “Report of Independent Registered Public Accounting Firm on
Internal Control Over Financial Reporting” and incorporated herein by reference.
Changes in Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) in the
Exchange Act) during the fourth fiscal quarter of the year to which this report relates that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
None.
85
Item 10. Directors, Executive Officers, and Corporate Governance
PART III
The information required by Item 10 with respect to our executive officers and key employees is included under the caption
“Executive Officers of the Registrant” in our Proxy Statement for the 2019 Annual Meeting and is incorporated herein by reference.
The information required by Item 10 with respect to our Directors is included under the caption “Election of Directors” in our
Proxy Statement for the 2019 Annual Meeting of Stockholders and is incorporated herein by reference.
The information required by Item 10 with respect to compliance with Section 16 of the Exchange Act is included under the caption
“Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement for the 2019 Annual Meeting of Stockholders
and is incorporated herein by reference.
The information required by Item 10 with respect to our audit committee and our audit committee financial expert is included
under the caption “The Board of Directors and its Committees - Audit Committee” in our Proxy Statement for the 2019 Annual
Meeting of Stockholders and is incorporated herein by reference.
The information required by Item 10 with respect to our Code of Business Conduct and Ethics and our Code of Ethics for Senior
Financial Officers is posted on our website at www.employers.com in the Investors section under “Governance.” We will post
information regarding any amendment to, or waiver from, our Code of Business Conduct and Ethics on our website in the Investor
section under Governance.
Item 11. Executive Compensation
The information required by Item 11 is included under the captions “Compensation Discussion and Analysis,” “Compensation
Committee Report” and “Compensation Committee Interlocks and Insider Participation” in our Proxy Statement for the 2019
Annual Meeting of Stockholders and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain information required by Item 12 is included under the captions “Security Ownership of Certain Beneficial Owners and
Management” and “Compensation Discussion and Analysis” in our Proxy Statement for the 2019 Annual Meeting of Stockholders
and is incorporated herein by reference.
Equity and Incentive Plan
The following table gives information about our common stock that may be issued upon the exercise of options, warrants, and
rights under all of our existing equity compensation plans as of December 31, 2018. We do not have any plans not approved by
our stockholders. Our equity compensation plans are discussed further in Note 14 in the Notes to our Consolidated Financial
Statements, which are included herein.
Plan Category
Equity compensation plans approved by
stockholders(1):
Stock options
RSUs(2)
PSUs(3)
Equity compensation plans not approved
by stockholders
Total
(a)
Number of securities
to be issued upon
exercise of outstanding
options, warrants, and
rights
(b)
Weighted-average
exercised price of
outstanding options,
warrants, and
rights(4)
(c)
Number of securities
remaining available for
further issuance
under compensation plans
(excluding securities
reflected in column (a))
190,256
250,300
291,616
—
732,172
$
$
23.71
—
23.71
3,276,190
3,025,890
2,734,274
—
2,734,274
(1) The Plan is administered by the Compensation Committee of the Board of Directors, which is authorized to grant, at its discretion, awards
to officers, employees, non-employee directors, consultants, and independent contractors. The maximum number of common shares currently
being reserved for grants of awards under the Plan was 5,500,000 shares, prior to reductions for grants made.
The Plan provides for the grant of stock options (both incentive stock options and nonqualified stock options), stock appreciation rights,
shares of restricted stock, RSUs, PSUs, and other stock-based awards. As of December 31, 2018, the only incentive awards outstanding
under the Plan were nonqualified stock options, RSUs, and PSUs.
86
(2) RSUs are phantom (as opposed to actual) shares of common stock which, depending on the individual award, vest in equal tranches over
one- to four-year periods, subject to the recipient maintaining a continuous relationship with the Company through the applicable vesting
date.
(3) PSUs are phantom (as opposed to actual) shares of common stock, which are subject to a performance period of two years followed by an
additional one-year vesting period, subject to the recipient maintaining a continuous relationship with the Company through the applicable
vesting date. PSU awards are subject to certain performance goals with payouts that range from 0% to 200% of the target awards. The
values shown in the table above represent the aggregate number of PSUs based on the expectation of the Company achieving an 200% of
target rate for the 2016 PSUs, a 200% of target rate for the 2017 PSUs, and a 125% of target rate for the 2018 PSUs.
(4) Holders of RSUs and PSUs are not entitled to voting rights. Commencing in 2017, employees who were awarded RSUs and PSUs are
entitled to receive dividend equivalents for eligible awards, payable in cash, when the underlying award vests and becomes payable. RSUs
and PSUs do not require the payment of an exercise price, accordingly, there is no weighted average exercise price for these awards.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is included under the captions “Certain Relationships and Related Transactions” and “Director
Independence” in our Proxy Statement for the 2019 Annual Meeting of Stockholders and is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
The information required by Item 14 with respect to the fees and services of Ernst & Young LLP, our independent registered public
accounting firm, is included under the caption “Audit Matters” in our Proxy Statement for the 2019 Annual Meeting of Stockholders
and is incorporated herein by reference.
87
Item 15. Exhibits and Financial Statement Schedules
The following consolidated financial statements are filed in Item 8 of Part II of this report:
PART IV
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2018 and 2017
Consolidated Statements of Comprehensive Income for each of the three years ended December 31, 2018, 2017
and 2016
Consolidated Statements of Stockholders' Equity for each of the three years ended December 31, 2018, 2017
and 2016
Consolidated Statements of Cash Flows for each of the three years ended December 31, 2018, 2017 and 2016
Notes to Consolidated Financial Statements
Financial Statement Schedules:
Schedule II. Condensed Financial Information of Registrant
Page
51
52
53
54
55
57
89
Pursuant to Rule 7-05 of Regulation S-X, Financial Statement Schedules I, III, IV, V, and VI have been omitted as the
information to be set forth therein is included in the notes to the audited consolidated financial statements.
88
Schedule II. Condensed Financial Information of Registrant
Employers Holdings, Inc.
Condensed Balance Sheets
Assets
Investments:
Investment in subsidiaries
Fixed maturity securities at fair value (amortized cost $24.2 at December 31, 2018 and
$40.2 at December 31, 2017)
Equity securities at fair value (cost $40.0 at December 31, 2018)
Short-term investments at fair value (amortized cost $25.0 at December 31, 2018 and $3.7
at December 31, 2017)
Total investments
Cash and cash equivalents
Accrued investment income
Intercompany receivable
Federal income taxes receivable
Deferred income taxes, net
Other assets
Total assets
Liabilities and stockholders' equity
Accounts payable and accrued expenses
Intercompany payable
Deferred income taxes, net
Other liabilities
Total liabilities
Stockholders' equity:
Common stock, $0.01 par value; 150,000,000 shares authorized; 56,975,675 and
56,695,174 shares issued and 32,765,792 and 32,597,819 shares outstanding at
December 31, 2018 and 2017, respectively
Preferred stock, $0.01 par value; 25,000,000 shares authorized; none issued
Additional paid-in capital
Retained earnings
Accumulated other comprehensive (loss) income, net of tax
Treasury stock, at cost (24,209,883 shares at December 31, 2018 and 24,097,355 shares
at December 31, 2017)
Total stockholders' equity
Total liabilities and stockholders' equity
89
December 31,
2018
2017
(in millions, except share data)
$
873.8
$
849.6
24.6
38.7
25.0
962.1
41.3
0.3
0.3
22.7
—
0.9
1,027.6
5.0
—
0.4
4.0
9.4
$
$
0.6
—
388.8
1,030.7
(13.7)
(388.2)
1,018.2
1,027.6
$
$
$
$
41.4
—
3.7
894.7
39.6
0.3
—
4.2
14.5
0.8
954.1
4.5
1.9
—
—
6.4
0.6
—
381.2
842.2
107.4
(383.7)
947.7
954.1
Employers Holdings, Inc.
Condensed Statements of Income
2018
Years Ended December 31,
2017
(in millions, except per share data)
2016
Revenues
Net investment income
Net realized and unrealized gains on investments
Total revenues
Expenses
Other operating expenses
Total expenses
Loss before income taxes and equity in earnings of subsidiaries
Income tax benefit
Net loss before equity in earnings of subsidiaries
Equity in earnings of subsidiaries
Net income
Earnings per common share:
Basic
Diluted
Cash dividends declared per common share
$
$
$
$
$
$
2.5
0.8
3.3
$
1.3
—
1.3
17.5
17.5
(14.2)
(4.3)
(9.9)
151.2
141.3
4.30
4.24
0.80
$
$
$
$
15.2
15.2
(13.9)
(5.8)
(8.1)
109.3
101.2
3.11
3.06
0.60
$
$
$
$
1.9
8.0
9.9
13.8
13.8
(3.9)
(3.5)
(0.4)
107.1
106.7
3.29
3.24
0.36
90
Employers Holdings, Inc.
Condensed Statement of Cash Flows
Operating activities
Net income
Adjustments to reconcile net income to net cash provided by (used in)
2018
Years Ended December 31,
2017
(in millions)
2016
$
141.3
$
101.2
$
106.7
operating activities:
Equity in undistributed earnings of subsidiaries
Net realized and unrealized gains on investments
Stock-based compensation
Amortization of premium on investments, net
Deferred income tax expense
Change in operating assets and liabilities:
Accounts payable and accrued expenses
Federal income taxes
Other assets
Intercompany payables and receivables
Other
Net cash provided by (used in) operating activities
Investing activities
Purchases of fixed maturity securities
Purchases of equity securities
Purchases of short-term securities
Proceeds from sale of fixed maturity securities
Proceeds from maturities and redemptions of investments
Proceeds from sale of equity securities
Net change in unsettled purchases and sales
Capital contributions to subsidiaries
Net cash (used in) provided by investing activities
Financing activities
Acquisition of common stock
Cash transactions related to stock-based compensation
Dividends paid to stockholders
Net cash used in financing activities
(66.7)
(0.8)
9.4
0.2
14.7
0.2
(18.5)
(0.1)
(2.2)
—
77.5
(14.4)
(40.0)
(59.6)
12.0
59.2
—
3.9
(4.2)
(43.1)
(4.2)
(1.8)
(26.7)
(32.7)
(71.5)
—
6.8
0.1
5.3
(0.3)
5.4
(0.1)
1.8
—
48.7
(30.6)
—
(7.9)
5.0
4.5
—
—
(5.6)
(34.6)
—
3.8
(19.7)
(15.9)
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at the beginning of the period
Cash and cash equivalents at the end of the period
1.7
39.6
41.3
$
(1.8)
41.4
39.6
$
$
(107.1)
(8.0)
5.8
0.4
2.9
(0.7)
(7.9)
0.8
0.3
(0.4)
(7.2)
(31.0)
(3.6)
—
—
24.9
88.5
—
(8.0)
70.8
(21.1)
9.0
(11.5)
(23.6)
40.0
1.4
41.4
91
Exhibits:
Exhibit
No.
Description of Exhibit
3.1 Amended and Restated Articles of
Incorporation of Employers Holdings, Inc.
Included
Herewith
X
Incorporated by Reference Herein
Form
File No.
Exhibit
Filing Date
3.2 Amended and Restated Bylaws of Employers
8-K
001-33245
3.1
June 13, 2018
Holdings, Inc.
4.1 Form of Common Stock Certificate
10.1 Quota Share Reinsurance Agreement, dated as
S-1/A 333-139092
S-1/A 333-139092
4.1
10.1
January 18, 2007
January 18, 2007
of June 30, 1999, between State Industrial
Insurance System of Nevada, D.B.A.:
Employers Insurance Company of Nevada and
the various Reinsurers as identified by the
Interests and Liabilities Agreements attached
thereto(1)
10.2 Producer Agreement, dated as of May 1, 2005,
S-1/A 333-139092
10.2
January 18, 2007
10.3
10.4
between Employers Compensation Insurance
Company and Automatic Data Processing
Insurance Agency, Inc.(1)
Joint Marketing and Network Access
Agreement, dated as of January 1, 2006,
between Employers Insurance Company of
Nevada and Blue Cross of California, BC Life
& Health Insurance Company, and
Comprehensive Integrated Marketing Services(1)
Joint Marketing and Network Access
Agreement, dated as of July 1, 2006, between
Employers Insurance Company of Nevada and
Blue Cross of California, BC Life & Health
Insurance Company, and Comprehensive
Integrated Marketing Services(1)
10.5 Confirmation of Irrevocable Letter of Credit
No. 2018-08 between EAC and FHLB SF, dated
March 9, 2018
10.6 Confirmation of Irrevocable Letter of Credit
No. 2018-09 between ECIC and FHLB SF,
dated March 9, 2018
10.7 Confirmation of Irrevocable Letter of Credit
No. 2018-10 between EPIC and FHLB SF,
dated March 9, 2018
S-1/A 333-139092
10.3
January 18, 2007
S-1/A 333-139092
10.4
January 18, 2007
8-K
001-33245
10.1 March 15, 2018
8-K
001-33245
10.2 March 15, 2018
8-K
001-33245
10.3 March 15, 2018
10.8 Form of Letter of Credit and Reimbursement
8-K
001-33245
10.4 March 15, 2018
Agreement
10.9 Amended and Restated Stock Purchase
Agreement among Partner Reinsurance
Company of the U.S., Cerity Group, Inc. and
Employers Holdings, Inc. (solely in its capacity
as Guarantor) dated as of May 23, 2018
10.10 Amendment No. 1 to the Amended and Restated
Stock Purchase Agreement among Partner
Reinsurance Company of the U.S., Cerity
Group, Inc. and Employers Holdings, Inc.
*10.11 Employers Holdings, Inc. Equity and Incentive
Plan Form of Restricted Stock Unit Agreement
for Non-Employee Directors
8-K/A 001-33245
10.1 May 24, 2018
10-Q
001-33245
10.11 October 25, 2018
10-Q
001-33245
10.1
August 7, 2009
*10.12 Restricted Stock Unit Agreement by and
8-K
001-33245
10.1 March 13, 2018
between Employers Holdings, Inc. and Lenard
T. Ormsby, dated and effective March 7, 2018
*10.13 Performance Share Agreement by and between
8-K
001-33245
10.2 March 13, 2018
Employers Holdings, Inc. and Lenard T.
Ormsby, dated and effective March 7, 2018
92
*10.14 Amended and Restated Employment Agreement
8-K
001-33245
10.1
June 30, 2017
by and between Employers Holdings, Inc. and
Tracey L. Berg, dated June 26, 2017, and
effective as of January 1, 2018
*10.15 Amended and Restated Employment Agreement
8-K
001-33245
10.2
June 30, 2017
by and between Employers Holdings, Inc. and
Stephen V. Festa, dated June 26, 2017, and
effective as of January 1, 2018
*10.16. Amended and Restated Employment Agreement
8-K
001-33245
10.3
June 30, 2017
by and between Employers Holdings, Inc. and
John P. Nelson, dated June 26, 2017, and
effective as of January 1, 2018
*10.17 Amended and Restated Employment Agreement
8-K
001-33245
10.4
June 30, 2017
by and between Employers Holdings, Inc. and
Lenard T. Ormsby, dated June 26, 2017, and
effective as of January 1, 2018
*10.18 Amended and Restated Employment Agreement
8-K
001-33245
10.1
November 8, 2018
by and between Employers Holdings, Inc. and
Douglas D. Dirks, dated November 7, 2018 and
effective January 1, 2019
*10.19 Amended and Restated Employment Agreement
8-K
001-33245
10.1
November 8, 2018
10-Q
001-33245
10.2
April 27, 2017
10-Q
001-33245
10.3
April 27, 2017
10-Q
001-33245
10.3
April 30, 2015
8-K
001-3324
10.1 May 22, 2015
by and between Employers Holdings, Inc. and
Michael S. Paquette, dated November 7, 2018
and effective January 1, 2019
*10.20 Employment Agreement by and between
X
Employers Holdings, Inc. and Lori A. Brown,
dated November 8, 2018 and effective January
1, 2019
*10.21 Employers Holdings, Inc. Equity and Incentive
Plan Form of Performance Share Agreement
*10.22 Employers Holdings, Inc. Equity and Incentive
Plan Form of Restricted Stock Unit Agreement
*10.23 Employers Holdings, Inc. Equity and Incentive
Plan Form of Stock Option Agreement
*10.24 Employers Holdings, Inc. Amended and
Restated Equity and Incentive Plan
21.1 Subsidiaries of Employers Holdings, Inc.
23.1 Consent of Ernst & Young LLP, Independent
Registered Public Accounting Firm
31.1 Certification of Douglas D. Dirks Pursuant to
Section 302
31.2 Certification of Michael S. Paquette Pursuant to
Section 302
32.1 Certification of Douglas D. Dirks Pursuant to
Section 906
32.2 Certification of Michael S. Paquette Pursuant to
Section 906
101.INS XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema Document
101.CAL XBRL Taxonomy Extension Calculation
Linkbase Document
101.DEF XBRL Taxonomy Definition Linkbase
Document
101.LAB XBRL Taxonomy Extension Label Linkbase
Document
101.PRE XBRL Taxonomy Extension Presentation
Linkbase Document
————
X
X
X
X
X
X
X
X
X
X
X
X
93
*Represents management contracts and compensatory plans or arrangements.
(1) Confidential treatment has been requested for certain confidential portions of this exhibit; these confidential portions have been omitted
from this exhibit and filed separately with the Securities and Exchange Commission.
94
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Date:
February 28, 2019
EMPLOYERS HOLDINGS, INC.
By:
/s/ Michael S. Paquette
Name: Michael S. Paquette
Title: Executive Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Michael D. Rumbolz
Michael D. Rumbolz
/s/ Douglas D. Dirks
Douglas D. Dirks
/s/ Michael S. Paquette
Michael S. Paquette
/s/ Richard W. Blakey
Richard W. Blakey
/s/ Prasanna G. Dhoré
Prasanna G. Dhoré
/s/ Valerie R. Glenn
Valerie R. Glenn
/s/ Barbara A. Higgins
Barbara A. Higgins
/s/ James R. Kroner
James R. Kroner
/s/ Michael J. McColgan
Michael J. McColgan
/s/ Michael J. McSally
Michael J. McSally
/s/ Jeanne L. Mockard
Jeanne L. Mockard
Chairman of the Board
February 28, 2019
President and Chief Executive Officer, Director
(Principal Executive Officer)
February 28, 2019
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
February 28, 2019
February 28, 2019
February 28, 2019
February 28, 2019
February 28, 2019
February 28, 2019
February 28, 2019
February 28, 2019
February 28, 2019
Director
Director
Director
Director
Director
Director
Director
Director
95
Exhibit 3.1
AMENDED AND RESTATED
ARTICLES OF INCORPORATION
OF
EMPLOYERS HOLDINGS, INC.
ARTICLE I
Section 1.1
The name of this Corporation is Employers Holdings, Inc. (the "Corporation").
Section 2.1
The name and complete business address in the State of Nevada of the Corporation's resident agent
ARTICLE II
for service of process is:
CSC Services of Nevada, Inc.
2215-B Renaissance Drive
Las Vegas, NV 89119
ARTICLE III
Section 3.1
The purpose of the Corporation is to engage in any lawful act or activity for which a corporation
may be organized under Chapter 78 of Title 7 of the Nevada Revised Statutes (the "NRS").
ARTICLE IV
Section 4.1
The total number of shares of stock which the Corporation shall have authority to issue is
175,000,000 shares of capital stock, consisting of (i) 25,000,000 shares of preferred stock, par value $0.01 per share (the
"Preferred Stock"), and (ii) 150,000,000 shares of common stock, par value $0.01 per share (the "Common Stock").
Section 4.2
The shares of Common Stock of the Corporation shall be of one and the same class. The holders of
Common Stock shall have one vote per share of Common Stock on all matters on which holders of Common Stock are entitled
by law to vote.
Section 4.3
The board of directors of the Corporation (the "Board of Directors") is hereby expressly authorized
to provide for the issuance of all or any shares of the Preferred Stock in one or more classes or series, and to fix for each such
class or series such voting powers, full or limited, or no voting powers, and such designations, preferences and relative,
participating, optional or other special rights and such qualifications, limitations or restrictions thereof, as shall be stated and
expressed in the resolution or resolutions adopted by the Board of Directors providing for the issuance of such class or series,
including, without limitation, the authority to provide that any such class or series may be (i) subject to redemption at such time
or times and at such price or prices; (ii) entitled to receive dividends (which may be cumulative or non-cumulative) at such
rates, on such conditions, and at such times, and payable in preference to, or in such relation to, the dividends payable on any
other class or classes or any other series; (iii) entitled to such rights upon the dissolution of, or upon any distribution of the
assets of, the Corporation; or (iv) convertible into, or exchangeable for, shares of any other class or classes of stock, or of any
other series of the same or any other class or classes of stock, of the Corporation at such price or prices or at such rates of
exchange and with such adjustments; all as may be stated in such resolution or resolutions. Except as otherwise expressly
provided in these Amended and Restated Articles of Incorporation (the "Articles of Incorporation") or in the resolution or
resolutions adopted by the Board of Directors providing for the issuance of any class or series of Preferred Stock or to the
extent otherwise specifically required by law (other than NRS § 78.350(1)), no holders of Preferred Stock shall have voting
rights.
Section 4.4
Subject to the requirements of applicable law, the Corporation shall have the power to issue and sell
all or any part of any shares of any class of stock herein or hereafter authorized to such persons, and for such consideration, as
the Board of Directors shall from time to time, in its discretion, determine, whether or not greater consideration could be
received upon the issue or sale of the same number of shares of another class, and as otherwise permitted by law. Subject to the
requirements of applicable law, the Corporation shall have the power to purchase any shares of any class of stock herein or
hereafter authorized from such persons, and for such consideration, as the Board of Directors shall from time to time, in its
discretion, determine, whether or not less consideration could be paid upon the purchase of the same number of shares of
another class, and as otherwise permitted by law.
Section 5.1
The following provisions are inserted for the management of the business and the conduct of the
affairs of the Corporation, and for further definition, limitation and regulation of the powers of the Corporation and of its
directors and stockholders:
ARTICLE V
Board of Directors.
(a)
(b)
The business and affairs of the Corporation shall be managed under the direction of the
The Board of Directors shall consist of not less than one person, and the exact number of
directors constituting the Board of Directors shall be fixed from time to time by resolution adopted by a majority of the Whole
Board. The term “Whole Board” shall mean the total number of authorized directors whether or not there exist any vacancies
or unfilled seats in previously authorized directorships.
(c)
Prior to the 2019 Annual Meeting of Stockholders, the directors shall be divided into three
classes, designated Class I, Class II and Class III. The terms of office of the classes of directors shall be as follows: the Class I
directors shall hold office for a term expiring at the 2019 Annual Meeting of Stockholders; the Class II directors shall hold
office for a term expiring at the 2020 Annual Meeting of Stockholders; and the Class III directors shall hold office for a term
expiring at the 2021 Annual Meeting of Stockholders. Commencing with the 2019 Annual Meeting of Stockholders, successors
to the class of directors whose terms expire at each succeeding annual meeting of stockholders shall be elected to hold office
for terms expiring at the next succeeding annual meeting of stockholders. The division of directors into classes shall terminate
upon the election of directors at the 2021 Annual Meeting of Stockholders, at which time all directors shall be elected to hold
office for terms expiring at the next succeeding annual meeting of stockholders.
(d)
A director shall hold office until the annual meeting for the year in which his or her term
expires and until his or her successor shall be elected and shall qualify, subject, however, to prior death, resignation, retirement,
disqualification or removal from office.
(e)
Subject to the terms of any one or more classes or series of Preferred Stock, any vacancy on
the Board of Directors that results from an increase in the number of directors shall be filled by the vote of a majority of the
Board of Directors then in office, provided that a quorum is present, and any other vacancy occurring on the Board of Directors
may be filled by the vote of a majority of the Board of Directors then in office, even if less than a quorum, or by a sole
remaining director. Until the 2021 Annual Meeting of Stockholders, any director elected to fill a vacancy resulting from an
increase in the number of directors of a class shall hold office for a term that shall coincide with the remaining term of that
class. Following the 2021 Annual Meeting of Stockholders, any director elected to fill a vacancy resulting from an increase in
the number of directors shall hold office for a term expiring at the next succeeding annual meeting of stockholders. Any
director elected to fill a vacancy not resulting from an increase in the number of directors shall have the same remaining term
as that of his or her predecessor. In no case will a decrease in the number of directors shorten the term of any incumbent
directors. Notwithstanding the foregoing, whenever the holders of any one or more classes or series of Preferred Stock issued
by the Corporation shall have the right, voting separately by class or series, to elect directors at an annual or special meeting of
stockholders, the election, term of office, filling of vacancies and other features of such directorships shall be governed by the
terms of these Articles of Incorporation applicable thereto.
(f)
In addition to the powers and authority hereinbefore or by statute expressly conferred upon
them, the directors are hereby empowered to exercise all such powers and do all such acts and things as may be exercised or
done by the Corporation, subject, nevertheless, to the provisions of the NRS and these Articles of Incorporation.
ARTICLE VI
Section 6.1
The Corporation shall indemnify its directors and officers to the fullest extent authorized or
permitted by law, as now or hereafter in effect, and such right to indemnification shall continue as to a person who has ceased
to be a director or officer of the Corporation and shall inure to the benefit of his or her heirs, executors and personal and legal
representatives; provided, however, that, except for proceedings to enforce rights to indemnification, the Corporation shall not
be obligated to indemnify any director or officer (or his or her heirs, executors or personal or legal representatives) in
connection with a proceeding (or part thereof) initiated by such person unless such proceeding (or part thereof) was authorized
or consented to by the Board of Directors. The right to indemnification conferred by this Article VI shall include the right to be
paid by the Corporation the expenses incurred in defending or otherwise participating in any proceeding in advance of its final
disposition upon receipt of an undertaking by or on behalf of the director or officer to repay amounts advanced if it is ultimately
determined that such person is not entitled to indemnification.
Section 6.2
The Corporation may, to the extent authorized from time to time by the Board of Directors, provide
rights to indemnification and to the advancement of expenses to employees and agents of the Corporation similar to those
conferred in this Article VI to directors and officers of the Corporation.
Section 6.3
The rights to indemnification and to the advancement of expenses conferred in this Article VI shall
not be exclusive of any other right which any person may have or hereafter acquire under these Articles of Incorporation, the
bylaws of the Corporation (the “Bylaws”), any statute, agreement, vote of stockholders or disinterested directors or otherwise.
The Corporation is authorized to provide indemnification of agents (as defined in NRS § 78.7502) through Bylaw provisions,
agreements with agents, vote of stockholders or disinterested directors, or otherwise, to the fullest extent permissible under
Nevada law.
Section 6.4
Any amendment, alteration, change, repeal or modification of any provision of this Article VI shall
not adversely affect any rights to indemnification or to the advancement of expenses of a director, officer, employee or agent of
the Corporation existing at the time of such amendment, alteration, change, repeal or modification with respect to any acts or
omissions occurring prior to such amendment, alteration, change, repeal or modification.
Section 7.1
The liability of directors of the Corporation for monetary damages shall be eliminated to the fullest
extent permissible under Nevada law.
ARTICLE VII
Section 8.1
The Corporation expressly opts-out of, and elects not to be governed by, the "Acquisition of
Controlling Interest" provisions contained in NRS §§ 78.378 through 78.3793 inclusive, as permitted under NRS § 78.378(1).
ARTICLE VIII
ARTICLE IX
Section 9.1
Unless otherwise required by law, special meetings of the stockholders of the Corporation may be
called only by the Chairman of the Board of Directors, the President, or a majority of the Board of Directors. The ability of the
stockholders to call a special meeting of stockholders is hereby specifically denied.
Section 9.2
Any action required or permitted to be taken by the stockholders of the Corporation must be effected
at a duly called annual or special meeting of stockholders of the Corporation, and the ability of the stockholders to consent in
writing to the taking of any action without a meeting is hereby specifically denied.
ARTICLE X
Section 10.1
The Corporation expressly reserves the right to amend, alter, change, repeal or modify any provision
of these Articles of Incorporation from time to time in such manner and for such purposes as may at the time be permitted by
law or as now or hereafter prescribed in these Articles of Incorporation and all rights conferred upon stockholders are granted
subject to such reservation, provided, however, that in addition to any requirement of law and any other provisions of these
Articles of Incorporation or any resolution or resolutions of the Board of Directors adopted pursuant to Article IV of these
Articles of Incorporation (and notwithstanding the fact that a lesser percentage may be specified by law, these Articles of
Incorporation or any such resolution or resolutions), the affirmative vote of the holders of sixty-six and two-thirds percent
(66-2/3%) or more of the combined voting power of the then outstanding shares of stock of the Corporation entitled to vote
generally in the election of directors of the Corporation, voting together as a single class, shall be required to amend, alter,
change or repeal, or adopt any provision as part of these Articles of Incorporation inconsistent with the purpose or intent of,
Articles V, VI, VII or IX of these Articles of Incorporation or this Article X of these Articles of Incorporation.
Exhibit 10.20
EMPLOYMENT AGREEMENT
This Employment Agreement (this “Agreement”) by and between Employers Holdings, Inc., a Nevada corporation (the
“Company”) and Lori A. Brown (the “Employee”) is entered into as of the 8th day of November, 2018, effective as of January 1,
2019 (the “Effective Date”). Effective as of the Effective Date, this Agreement shall replace and supersede, in its entirety, any
prior employment agreement or agreements between the Employee and the Company (the “Prior Agreements”) and the Prior
Agreements shall be of no force or effect.
RECITALS
A. The Employee has knowledge and experience applicable to the position of Executive Vice President, Chief Legal
Officer and General Counsel.
B. The Company desires to continue to employ the Employee to perform certain services for the Company, its parent, if
any, and their respective subsidiaries and affiliates (the “Company Affiliates”), as may be required or requested of the Employee
in her position or positions with the Company and the Company Affiliates, and the Employee desires to continue to be so employed
by the Company and to perform such services for the Company and the Company Affiliates.
In consideration of the premises above and mutual covenants and promises set forth herein, and other good and valuable
consideration, the receipt and sufficiency of which are mutually acknowledged, the parties agree as follows:
1.
Employment.
TERMS
The Company agrees to continue to employ the Employee and the Employee accepts such continued employment upon
the terms and conditions specified herein. The Employee agrees to continue to devote substantially all of her time and effort during
working hours in the performance of the duties called for herein and agrees that any other non-employment related duties (i.e.,
industry related groups, service on boards, etc.) will not be allowed to materially interfere with the performance of the duties called
for herein.
2.
Term.
The term of this Agreement shall commence on the Effective Date, and shall continue for two (2) years until December
31, 2020 (the “Initial Term”) and, thereafter, shall automatically terminate unless the Company gives written notice to the Employee
no later than six (6) months prior to the expiration of the Initial Term or any Additional Term (as defined below), as applicable,
of an intent to renew this Agreement for successive two (2) year periods (each two (2) year period, an “Additional Term;” the
Initial Term and any Additional Terms, collectively the “Term”); subject, however to earlier termination of the Employee's
employment with the Company in accordance with this Agreement (the date of termination of this Agreement or, if earlier,
termination of the Employee’s employment, the “Termination Date”). The expiration of this Agreement at the end of the Term,
in and of itself, shall not constitute, nor be construed or interpreted as, a termination of the Employee's employment that would
make her eligible for benefits or payments under this Agreement. This Agreement shall expire upon the termination of the
Employee's employment for any reason, subject to the provisions of subsection 10(h) below.
3.
Services and Duties.
The Employee shall serve as Executive Vice President, Chief Legal Officer and General Counsel and/or such other position
or positions as may be mutually agreed upon by the parties from time to time, and shall perform such duties as may be assigned
by the Chief Executive Officer from time to time. At the request of the Board of Directors of the Company (the “Board”), the
Employee shall also serve as a director of the Company and/or one or more of the Company Affiliates at no additional compensation.
The Employee agrees that upon the termination of her employment with the Company, she shall resign from the Board and any
and all boards of the Company Affiliates effective on the Termination Date.
4.
Compensation and Benefits.
(a)
During the Term, the Company shall pay to the Employee an annual salary of not less than $350,000 (“Base
Salary”), which amount shall be paid according to the Company’s regular payroll practices. The Company agrees
to review the Base Salary on an annual basis and adjust the salary to comply with the executive compensation
policy in effect at the time of the review. Any adjustment made to the annual salary will establish the new Base
Salary for the Employee. All payments made pursuant to this Agreement, including but not limited to this
subsection 4(a), shall be reduced by and subject to withholding for all federal, state, and local taxes and any
other withholding required by applicable laws and regulations.
The Company will provide an annual incentive (the “Annual Incentive”) to the Employee during the Term based
on the Employee’s and the Company’s performance, as determined by the Board (or a committee thereof) in its
sole discretion. In this regard, the Board (or a committee thereof) shall set an annual incentive target of not less
than fifty-five percent (55%) of Base Salary, and the Annual Incentive shall be paid in accordance with the
Company’s regular practice for its senior officers, as in effect from time to time. To the extent not duplicative
of the specific benefits provided herein, the Employee shall be eligible to participate in all incentive compensation,
retirement, supplemental retirement and deferred compensation plans, policies and arrangements that are
provided generally to other senior officers of the Company at a level (in terms of the amount and types of benefits
and incentive compensation that the Employee has the opportunity to receive and the terms thereof) determined
in the sole discretion of the Board (or a committee thereof).
The Employee agrees that the amounts payable and benefits provided under this Agreement, including but not
limited to any amounts payable or benefits provided under this Section 4 and Section 7 constitute good, valuable
and separate consideration for the non-competition, assignment and release of liability provisions contained
herein. The Employee acknowledges that she is aware of the effect of the non-competition, assignment and
release of liability provisions contained herein and agrees that the amounts payable and benefits provided under
this Agreement, including but not limited to the amounts payable and benefits provided under this Section 4 and
Section 7, if any, constitute sufficient consideration for her agreement to these provisions.
In addition to the compensation called for in this Agreement, the Employee shall be entitled to receive any and
all employee benefits and perquisites as the Company from time to time in its discretion determines to offer. In
addition, the Employee shall be entitled to the applicable relocation and moving benefits described in Appendix
A attached hereto.
(b)
(c)
(d)
5.
Insurance.
The Employee agrees to submit to physical examinations at reasonable times as requested by the Company for the purpose
of the Company’s obtaining life insurance on the life of the Employee for the benefit of the Company; provided, however, that
the Company shall bear the costs for such examinations and shall pay all premiums on any life insurance obtained as a result of
such examinations. The Employee further agrees to submit to drug testing in accordance with the Company's policies and
procedures.
6.
Termination.
(a)
The Company, at any time, may terminate this Agreement and the Employee's employment immediately for
“Cause.” Cause is defined as:
(i)
A material breach of this Agreement by the Employee;
(ii)
Failure or inability of the Employee to obtain or maintain any required licenses or certificates;
(iii) Willful violation by the Employee of any law, rule or regulation, including but not limited to any material
insurance law or regulation, which violation may, as determined by the Company, adversely affect the
ability of the Employee to perform her duties hereunder or may subject the Company to liability or
negative publicity; or
(iv)
Conviction or commission of or the entry of a guilty plea or plea of no contest to any felony or to any
other crime involving moral turpitude.
(b)
The Employee may terminate this Agreement and her employment with the Company immediately for “Good
Reason,” which shall mean the occurrence of any of the following events with respect to which the Employee
has notified the Company of the existence thereof within no more than ninety (90) days of the initial existence
thereof and which is not cured by the Company within thirty (30) days of the Company’s receipt of written
notice from the Employee of the events alleged to constitute such Good Reason:
(i)
A material diminution in the Employee’s base compensation;
(ii)
A material diminution in the Employee’s authority, duties or responsibilities; or
(iii)
Any other action or inaction that constitutes a material breach by the Company of this Agreement.
(c)
The Company may also terminate this Agreement and the Employee's employment upon the occurrence of one
or more of the following events or reasons, subject to applicable law (or, in the case of subsection 6(c)(i) below,
termination of this Agreement and the Employee's employment will be automatic):
(i)
(ii)
Death of the Employee;
The Employee is deemed to be disabled in accordance with the policies of the Company or the law or
if the Employee is unable to perform the essential job functions of the Employee’s position with the
Company, with or without reasonable accommodation, for a period of more than 100 business days in
any 120 consecutive business day period. The Employee is entitled to any and all short term or long
term disability programs, like any other employee, in accordance with the terms of such programs and
the policies of the Company; or
(iii)
At any time for any other reason or no reason in the sole and absolute discretion of the Company.
7.
Payments Upon Termination.
(a)
Qualifying Termination and Severance Pay. If the Company terminates the Employee's employment prior to
the expiration of the Term but other than during the CIC Period (as defined below) for any reason other than as
specified above in subsection 6(a) for Cause, subsection 6(c)(i) by reason of the death of the Employee, or
subsection 6(c)(ii) for disability, or if the Employee terminates her employment for Good Reason pursuant to
subsection 6(b), the Employee shall receive the following severance pay (the “Severance Pay”):
(i)
(ii)
In lieu of any further salary payments to the Employee for periods subsequent to the Termination Date
and in lieu of any severance benefit otherwise payable to the Employee, an amount equal to two (2)
times Base Salary, payable in equal bi-weekly installments on the Company’s regular payroll dates as
in effect on the Termination Date, for twenty four (24) months following such Termination Date, with
payments commencing on the payroll date applicable to the first full payroll period occurring following
the Applicable Release Period (as defined below), which first payment date shall be no later than sixty
(60) days following the Termination Date; provided, however, that (A) such payments shall be delayed
to the extent required under subsection 7(c)(iv) or Section 26 below and (B) the amount of the first
payment shall be equal to the total amount of bi-weekly installments that would have been paid had
the first payment been made on the first full payroll date occurring following the Termination Date,
with each subsequent payment equal to the bi-weekly installment. The payments shall be subject to
normal payroll deductions.
Continuation of the medical, dental and vision insurance coverage in effect on the Termination Date
for a period of eighteen (18) months following the Termination Date with the Company paying the
employer portion of the premium and the Employee paying the employee portion, including dependents
if applicable, of the premium during such eighteen (18) month period, provided that the Employee
elects to continue such insurance coverage under the Consolidated Omnibus Budget Reconciliation
Act of 1986, as amended (“COBRA”). The Employee is solely responsible for taking the actions
necessary to exercise her rights under COBRA for the insurance coverage the Employee has in effect,
including coverage for dependents if applicable, on the Termination Date.
(b)
Severance Pay as Liquidated Damages. The parties agree, in the event of a material breach of this Agreement
by the Company with respect to which the Employee has given notice and that is not cured, in either case, in
accordance with subsection 6(b), following which the Employee terminates her employment for Good Reason,
that actual damages are speculative and that the amount of the Severance Pay or, if applicable, the CIC Severance
Pay (as defined below) set forth herein is liquidated damages and is a reasonable estimate of what damages
would be for a material breach of this Agreement.
(c)
Conditions to Severance Pay or CIC Severance Pay; the Applicable Release Period. The Employee agrees and
acknowledges that the following must be satisfied by the Employee before she is entitled to the Severance Pay
or, if applicable, the CIC Severance Pay, as provided in subsections (i), (ii) and (iii) herein:
(i)
(ii)
(iii)
(iv)
That the Employee returns any and all equipment, software, data, property and information of the
Company or the Company Affiliates, including documents and records or copies thereof relating in any
way to any proprietary information of the Company or any of the Company Affiliates whether prepared
by the Employee or any other person or entity. That the Employee further agrees that she shall not
retain any proprietary information of the Company or any of the Company Affiliates after the
Termination Date;
That the Employee executes a separation agreement and release of claims, in a form to be determined
by the Company in its sole discretion, which releases the Company and the Company Affiliates from
liability for any and all claims, complaints and causes of action, whether based in law or equity, arising
from, related to or associated with the Employee’s employment by the Company or under this Agreement
and that such release has become effective and non-revocable no later than sixty (60) days following
the Termination Date (such deadline, the “Release Deadline”). If the release of claims does not become
effective by the Release Deadline, the Employee will forfeit any rights to severance or benefits under
this Agreement. In no event will severance payments or benefits be paid or provided until the release
of claims becomes effective and irrevocable. That the Employee further acknowledges and agrees that
she has not made and will not make any assignment of any claim, cause or right of action, or any right
of any kind whatsoever, arising from, related to or associated with the employment of the Employee
by the Company; and
That the Employee reaffirms the covenants contained herein, in writing, including, but not limited to,
the covenants set forth in Section 10.
Notwithstanding anything in this Agreement to the contrary, in any case where the first and last days
of the applicable release and nonrevocability periods provided for in the separation agreement and
release of claims (the “Applicable Release Period”) are in two separate taxable years, any payments
required to be made to the Employee under this Agreement that are treated as deferred compensation
for purposes of section 409A of the Internal Revenue Code of 1986, as amended (the “Code”) and the
regulations and guidance promulgated thereunder (“Section 409A”) shall be made in the later taxable
year, as soon as practicable, but in no event later than thirty (30) days following the conclusion of the
Applicable Release Period. In addition to the foregoing, the Applicable Release Period shall conclude
no later than sixty (60) days following the Termination Date.
Voluntary Termination by the Employee. The Employee may terminate her employment and this Agreement for
reasons other than those identified in subsection 6(b) upon not less than sixty (60) days prior written notice. If
the Employee terminates her employment and this Agreement pursuant to this subsection 7(d), she shall be
entitled only to the following:
(i)
Any unpaid salary through the Termination Date; and
(ii)
Payment for any accrued and unused vacation as of the Termination Date.
Qualifying Change in Control Termination. If, before the expiration of the Term, the Company terminates the
Employee's employment within the period commencing six (6) months prior to and ending eighteen (18) months
following a Change in Control (as defined below), such period referred to herein as the “CIC Period,” for any
reason other than as specified above in subsection 6(a) for Cause, subsection 6(c)(i) for the death of the Employee,
or subsection 6(c)(ii) for disability, or if the Employee terminates her employment and this Agreement for Good
Reason pursuant to subsection 6(b), the Employee shall receive the severance pay set forth in subsections (i)
and (ii) below (the “CIC Severance Pay”), provided that if the Employee’s employment is terminated during
the six (6) month period prior to a Change in Control, the Employee shall be entitled to CIC Severance Pay only
if such termination (x) was by the Company other than for Cause but at the request or direction of any person
that has entered into an agreement with the Company the consummation of which would constitute a Change
(d)
(e)
in Control, (y) was by the Employee for Good Reason and the circumstance or event that constitutes Good
Reason occurred at the request or direction of such person or (z) was by the Company without Cause and the
Employee reasonably demonstrates that such termination was otherwise in connection with or in anticipation
of a Change in Control; and if the Employee is not entitled to CIC Severance Pay hereunder, then the Employee's
termination of employment will not be deemed to have occurred during the CIC Period for purposes of subsection
7(a):
(i)
(ii)
In lieu of any further salary payments to the Employee for periods subsequent to the Termination Date
and in lieu of any severance benefit otherwise payable to the Employee, a lump sum cash payment
equal to two (2) times the sum of (A) Base Salary and (B) (i) if the Change in Control occurs in 2019,
$192,500, and (ii) if the Change in Control occurs in 2020, the average of $192,500 and the annual
bonus amount earned by the Employee for 2019. Such payment shall be made as soon as practicable
(but in no event later than sixty (60) days) following the Termination Date; provided, however, that
such payment shall be delayed to the extent required under subsection 7(c)(iv) or Section 26 below;
and
Continuation of the medical, dental and vision insurance coverage in effect on the Employee's
Termination Date for a period of eighteen (18) months following the Termination Date with the Company
paying the employer portion of the premium and the Employee paying the employee portion, including
dependents if applicable, of the premium during such eighteen (18)-month period, provided that the
Employee elects to continue such insurance coverage under COBRA. The Employee is solely
responsible for taking the actions necessary to exercise her rights under COBRA for the insurance
coverage the Employee has in effect, including coverage for dependents if applicable, on the Termination
Date.
(f)
Definition of Change in Control. For purposes of this Agreement, a “Change in Control” shall be deemed to
have occurred if the event set forth in any one of the following paragraphs shall have occurred:
(i)
(ii)
(iii)
(iv)
Any one person, or more than one person acting as a group, acquires ownership of stock of the Company
that, together with stock held by such person or group, constitutes more than 50% of the total fair market
value or total voting power of the stock of the Company; or
Any one person, or more than one person acting as a group, acquires (or has acquired during the twelve
(12)-month period ending on the date of the most recent acquisition by such person or persons)
ownership of stock of the Company possessing 35% or more of the total voting power of the stock of
the Company; or
A majority of members of the Board is replaced during any twelve (12)-month period by directors
whose appointment or election is not endorsed by a majority of the members of the Board before the
date of the appointment or election; or
Any one person or group acquires (or has acquired during the immediately preceding twelve (12)-
month period ending on the date of the most recent acquisition) assets of the Company with an aggregate
gross fair market value of not less than forty percent (40%) of the aggregate gross fair market value of
the assets of the Company immediately prior to such acquisition. For this purpose, gross fair market
value shall mean the fair value of the affected assets determined without regard to any liabilities
associated with such assets.
Notwithstanding the foregoing, (1) a “Change in Control” shall not be deemed to have occurred by virtue of the
consummation of any transaction or series of integrated transactions immediately following which the holders of the
common stock of the Company immediately prior to such transaction or series of transactions continue to have substantially
the same proportionate ownership in an entity that owns all or substantially all of the assets of the Company immediately
following such transaction or series of transactions, and (2) a “Change in Control” shall not be deemed to have occurred
as result of any secondary offering of Company common stock to the general public through a registration statement filed
with the Securities and Exchange Commission. The Board shall determine whether a Change in Control has occurred
hereunder in a manner consistent with the provisions of Section 409A.
(g)
No Duplication of Payments or Benefits. Notwithstanding any provision of this Agreement to the contrary, the
Employee shall not be eligible to receive any payments or benefits under both subsections 7(a) and 7(e); but
(h)
rather, to the extent the conditions set forth in subsection 7(a) and subsection 7(e) are satisfied, the Employee
shall be eligible to receive payments and benefits under only subsection 7(e).
Golden Parachute (Section 280G) Safe Harbor.
(i)
If it is determined that any payment or benefit received or to be received by the Employee, whether
pursuant to this Agreement or otherwise (the “Severance Payments”), is a “parachute payment” within
the meaning of section 280G of the Code (all such payments and benefits, including the Severance
Payments as applicable hereinafter called the “Total Payments”) that will be subject (in whole or part)
to the tax imposed under section 4999 of the Code (the “Excise Tax”), then if (A) the Total Payments
exceed the largest amount that would result in no portion of the Total Payments being subject to the
Excise Tax (the “Safe Harbor”), and (B) the reduction of the Total Payments to an amount equal to the
Safe Harbor would provide the Employee with a greater after-tax amount than would be provided to
the Employee if the Total Payments were not reduced, then the amounts payable to the Employee under
this Agreement shall be reduced (but not below zero) to the Safe Harbor. If the Severance Payments
are reduced pursuant to this subsection, then the non-cash portion of the Total Payments shall first be
reduced, and the cash portion of the Total Payments shall thereafter be reduced (in each case in reverse
order beginning with payments or benefits that are to be paid or provided the farthest in time from the
Change in Control), so that the amount of the Total Payments is equal to the Safe Harbor. Any reduction
pursuant to the preceding sentence shall take precedence over the provisions of any other plan, program,
agreement or arrangement governing the Employee’s rights and entitlements to any benefits or
compensation.
(ii)
(iii)
(iv)
For purposes of determining whether any of the Total Payments will be subject to the Excise Tax and
the amount of such Excise Tax, (A) no portion of the Total Payments shall be taken into account which,
in the opinion of tax counsel (“Tax Counsel”) selected by the Board in existence immediately prior to
the Change in Control, does not constitute a “parachute payment” within the meaning of section 280G(b)
(2) of the Code, including by reason of section 280G(b)(4)(A) of the Code, (B) the Severance Payments
shall be reduced only to the extent necessary so that the Total Payments (other than those referred to
in clause (A)) in their entirety constitute reasonable compensation for services actually rendered within
the meaning of section 280G(b)(4)(B) of the Code or are otherwise not subject to disallowance as
deductions by reason of section 280G of the Code, in the opinion of Tax Counsel, and (C) the value of
any non-cash benefit or any deferred payment or benefit included in the Total Payments shall be
determined by the Company's independent auditor in accordance with the principles of sections 280G(d)
(3) and (4) of the Code. If the Employee disputes the Company's calculations (in whole or in part), the
reasonable opinion of Tax Counsel with respect to the matter in dispute shall prevail.
In the event that a change is finally determined to be required in the amount of taxes paid by, or withheld
on behalf of, the Employee, then appropriate adjustments will be made under this Agreement such that
the net amount that is payable to the Employee reflects the intent of the parties pursuant to this
Agreement. If the Company owes the Employee an additional payment under this subsection, such
payment shall be made to the Employee promptly, but in no event more than sixty (60) days following
the date the underpayment is finally determined, but no later than the calendar year following the
calendar year in which the underpayment is finally determined. If the Employee owes an amount to
the Company pursuant to this Section, then the Employee shall repay such amount to the Company
promptly, but in no event more than sixty (60) days following the date that the overpayment by the
Company is finally determined, but no later than the calendar year following the calendar year in which
the overpayment is finally determined. Any repayment pursuant to this subsection (either by the
Company or the Employee) shall include applicable interest on the amount of such repayment at 120%
of the rate provided in section 1274(b)(2)(B) of the Code.
The Employee and the Company shall each reasonably cooperate with the other in connection with
any administrative or judicial proceedings concerning the existence or amount of liability for Excise
Tax with respect to the Total Payments. The Company also shall pay to the Employee all legal fees
and expenses incurred by the Employee in connection with any tax audit or proceeding to the extent
attributable to the application of section 4999 of the Code to any payment or benefit provided hereunder.
Such payments shall be made within sixty (60) business days after delivery of the Employee's written
request for payment accompanied with such evidence of fees and expenses incurred as the Company
reasonably may require (but in no event shall any such payment be made after the end of the calendar
year following the calendar year in which the expenses were incurred), provided that no such payment
shall be made in respect of fees or expenses incurred by the Employee after the later of the tenth (10th)
anniversary of the effective date of the Employee's termination with the Company or the Employee's
death and, provided further, that, upon the Employee’s “separation from service” (as such term is defined
under Section 409A) with the Company, in no event shall any additional such payments be made prior
to the date that is six (6) months after the date of the Employee’s “separation from service” to the extent
such payment delay is required under section 409A(a)(2)(B) of the Code.
8.
Licensing.
The Employee has obtained and possesses, or will obtain and possess, and will maintain throughout the Term hereof, all
licenses, approvals, permits, and authorization (the “Licenses”) necessary to perform the Employee’s duties hereunder. Any costs,
attorneys’ fees, investigation fees or other expenses incurred in connection with obtaining or maintaining such Licenses shall be
borne by the Company, provided that payment of such fees or costs by the Company shall be made no later than the end of the
year following the year in which the expenses were incurred. The Employee warrants that the Employee is fully eligible, under
all standards and requirements, to obtain, possess, and maintain such Licenses and that the Employee will commit no acts during
the Term hereof that would jeopardize or eliminate the Employee’s ability to possess or maintain such Licenses.
9.
Rules and Regulations.
The Employee shall observe, enforce, and comply with the policies, philosophies, strategies, rules, and regulations of
the Company, as they may be promulgated and/or modified from time to time, and shall carry out and perform the orders, directions,
and policies of the Company, as they may be stated and/or amended from time to time, either orally or in writing. A violation of
this Section 9 by the Employee is a material breach of this Agreement.
10.
Restrictive Covenants.
In consideration of the amounts payable and benefits provided under Section 4, and, if applicable, Section 7, the other
compensation paid hereunder, and other good and valuable consideration, the receipt and sufficiency of which is acknowledged
by the parties, the parties agree to the following provisions of this Section 10:
(a)
(b)
Non-Competition. The Employee understands and agrees that the Company and the Company Affiliates do
business throughout the State of Nevada and other states. The Employee further understands and agrees that
she is a high ranking officer of the Company and will have access to confidential and trade secret information
and goodwill of the Company and the Company Affiliates that will allow the Employee to unfairly compete
with the Company and the Company Affiliates justifying this restriction. If the Employee's employment is
terminated (by either the Employee or the Company), during the Term, for any reason other than as specified
above in subsection 6(c)(i) by reason of the death of the Employee, then for a period of eighteen (18) months
commencing on the Termination Date, the Employee agrees that, without the written permission of the Company,
she will not hold the same or a similar position (whether as owner, partner, controlling stockholder, controlling
investor, employee, adviser, consultant, or otherwise) in any business that is in direct competition with the
business being conducted by the Company or any of the Company Affiliates as of the Termination Date, in
Nevada or in any other state in which the Company is conducting such business (the “Non-Compete Area”) as
of the Termination Date.
Non-Solicitation. Without limiting the generality of the foregoing, the Employee agrees that for a period of
eighteen (18) months following the Employee's Termination Date (for any reason, by either the Employee or
the Employer), she will not, without the prior written consent of the Company, directly or indirectly solicit or
attempt to solicit, within the Non-Compete Area, (i) any business from any person or entity that the Company
or any of the Company Affiliates called upon, solicited, or conducted business with as of such Termination Date,
provided that the Employee was aware of the Company’s business with such person or entity, (ii) any persons
or entities that have been customers of the Company or any of the Company Affiliates or (iii) recruit or solicit
any person who has been or is an employee of the Company or any of the Company Affiliates, during the
preceding one (1)-year period from the Termination Date. Nothing in this Section 10(b) prohibits the Employee
from the placement of general advertisements and/or participation at job fairs or recruiting workshops that are
not specifically targeted toward any employee or customer of the Company.
(c)
In the event the Employee violates subsection 10(a) or 10(b), the applicable period of time during which the
respective restriction applies will automatically be extended for the period of time from which the Employee
began such violation until she permanently ceases such violation. If any provision of these covenants is invalid
in whole or in part, it will be limited, whether as to time, area covered, or otherwise as and to the extent required
for its validity under the applicable law and as so limited, will be enforceable.
Confidential Information. The Employee acknowledges that she has had or will have access to the confidential
information of the Company and the Company Affiliates (including, but not limited to, records regarding sales,
price and cost information, marketing plans, customer names, customer lists, sales techniques, distribution plans
or procedures, and other material relating to the business conducted by the Company and the Company Affiliates),
proprietary, or trade secret information (the “Confidential Information”), and agrees, subject to her right to
engage in Protected Activity as defined herein, never to use the Confidential Information other than for the sole
benefit of the Company and the Company Affiliates and further agrees to never disclose such Confidential
Information (except as may be required by regulatory authorities or as may be required by law) to any entity or
person that is not an officer of the Company or a Company Affiliate at the time of such disclosure, without the
prior written consent of the Company. The Employee further acknowledges that this covenant to maintain
Confidential Information is necessary to protect the goodwill and proprietary interests of the Company and the
Company Affiliates and the restriction against the disclosure of Confidential Information is reasonable in light
of the consideration and other value the Employee has received or will receive pursuant to this Agreement and
otherwise pursuant to her employment by the Company.
From and following the Employee's termination of employment, the Employee agrees to cooperate with the
Company and the Company Affiliates in any litigation, administrative proceeding, investigation or audit
involving any matters with which the Employee has knowledge of from her employment with the Company.
The Company shall reimburse the Employee for reasonable expenses, including reasonable compensation for
services rendered at his hourly rate of compensation as of the Termination Date, incurred in providing such
assistance and approved by the Company. The Company shall reimburse the Employee for such expenses
incurred in accordance with the policies and procedures of the Company, but in no event no later than the end
of the year following the year in which the expenses were incurred.
In the event of a violation of this Section 10, the Company and the Company Affiliates shall be entitled to any
form of relief at law or equity, and the parties agree and acknowledge that injunctive relief is an appropriate,
but not exclusive, remedy to enforce the provisions hereof. The existence of any claim or cause of action of the
Employee against the Company, whether predicated on this Agreement or otherwise, shall not constitute a defense
of the Company’s enforcement of the covenants set forth in this Section 10. The Employee hereby submits to
the jurisdiction of the courts of the State of Nevada and federal courts therein for the purposes of any actions or
proceedings instituted by the Company to enforce its rights under this Agreement, to seek money damages or
seek injunctive relief. The Employee further acknowledges and agrees (i) that the obligations contained in
Section 10 of this Agreement are necessary to protect the interests of the Company and the Company Affiliates,
(ii) that the restrictions contained herein are fair, do not unreasonably restrict the Employee's further employment
and business opportunities, and are commensurate with the compensation arrangements set out in this Agreement
and (iii) that such compensation arrangements constitute separate consideration for the obligations set forth in
this Section 10. The covenants contained in Section 10 shall each be construed as an agreement independent
of any other provisions of this Agreement. Both parties intend to make the covenants of Section 10 binding
only to the extent that it may be lawfully done under existing applicable laws. If a court of competent jurisdiction
decides any part of any covenant is overly broad, thereby making the covenant unenforceable, the parties agree
that such court shall substitute a reasonable, judicially enforceable limitation in place of the offensive part of
the covenant and as so modified the covenant shall be as fully enforceable as set forth herein by the parties
themselves in the modified form.
The Employee acknowledges that it is possible that the corporate structure of the Company could change during
the Term. The Employee hereby acknowledges and affirms that the Company may assign its rights under this
Agreement, including but not limited to its rights to enforce the covenants set forth in this Section 10, to a third-
party without the approval of or additional consideration to the Employee. The Employee acknowledges and
agrees that the consideration called for herein is good and sufficient consideration for the Company's right to
assign its rights under this Agreement.
Subsections 10(a) through (g), inclusive, of this Agreement shall survive either termination of the employment
relationship and/or termination of this Agreement for the full period set forth in subsections 10(a) through (g),
inclusive.
(d)
(e)
(f)
(g)
(h)
11.
Work for Hire.
The Employee agrees that any work, invention, idea or report that she produces or that results from or is suggested by
the work the Employee does on behalf of the Company or any of the Company Affiliates is “work for hire” (hereinafter referred
to as “Work”) and will be the sole property of the Company. The Employee agrees to sign any documents, during or after
employment that the Company deems necessary to confirm its ownership of the Work, and the Employee agrees to cooperate with
the Company to allow the Company to take advantage of its ownership of such Work.
12.
Assignment of Agreement.
The Employee agrees that her services are unique and personal and that, accordingly, the Employee may not assign her
rights or delegate her duties or obligations under this Agreement. The Company may assign its rights, duties, and obligations under
this Agreement to any successor to its business. This Agreement shall inure to the benefit of and be binding upon the Company’s
successors and assigns.
13.
Indemnification of the Employee.
The Company shall indemnify the Employee and hold her harmless for acts or decisions made by her in good faith while
performing services for the Company or any of the Company Affiliates to the maximum extent allowed by law. The Company
shall also use its reasonable efforts to obtain coverage for her under any insurance policy now in force or hereinafter obtained
during Term covering the officers and directors of the Company against lawsuits, subject to the business judgment of the Board.
The Company shall pay all expenses, including attorneys’ fees of an attorney selected and retained by the Company to represent
the Employee, actually and necessarily incurred by the Employee in connection with the defense of such act, suit, or proceeding
and in connection with any related appeal, including the cost of court settlements, provided that, to the extent required by Section
409A, any such payment by the Company shall be made no later than the end of the year following the year in which the expenses
were incurred.
14.
Notices.
Any notice, document, or other communication that either party may be required or may desire to give to the other party
shall be in writing, and any such notice may be given or delivered personally or by mail or facsimile. Any such notices given or
delivered personally shall be given or delivered by hand to an officer of the entity to which they are being given or delivered or
the individual, as the case may be, and shall be deemed given or delivered when so given or delivered by hand. Any such notices
given or delivered by facsimile will be deemed given or delivered upon receipt by the sender of a successful facsimile transmission
to the facsimile number below, and any such notices given or delivered by mail shall be deemed given or delivered three (3) days
after it is deposited in the U.S. mail, certified or registered mail, return receipt requested, with all postage and fees prepaid, addressed
to the person or entity in question as follows:
If to the Employee:
Lori A. Brown
To the address (or facsimile number, if applicable) on record with the Company
If to the Company:
Chief Executive Officer
Employers Holdings, Inc.
10375 Professional Circle
Reno, Nevada 89521-4802
Fax: (775) 886-5499
or, in either case, to such other address as either party may have previously notified the other pursuant to the provisions of this
Section 14.
15.
Severability.
In the event that any provision hereof shall be declared by a court of competent jurisdiction to be void or voidable as
contrary to law or public policy, such declaration shall not affect the continuing validity or enforceability of any other provisions
hereof insofar as it may be reasonable and practicable to continue to enforce such other provision in the absence of the provision
which shall have been declared to be void and voidable.
16.
Remedy for Breach.
Both parties recognize that the services to be performed by the Employee are special and unique. The Company will
have the right to seek and obtain damages and any available equitable remedies for the Employee’s breach of this Agreement. The
Employee's remedy for any breach of this Agreement is strictly limited to the Severance Pay or CIC Severance Pay, as the case
may be, called for herein.
17.
Mitigation of Damages.
The Employee shall not be required to mitigate damages or the amount of any payment provided under this Agreement
by obtaining other employment or otherwise after the termination of employment hereunder, and any amounts earned by the
Employee, whether from self-employment or other employment shall not reduce the amount of any Severance Pay or CIC Severance
Pay, as the case may be, called for herein.
18.
Attorneys' Fees and Costs.
In any claim or dispute between the parties arising out of or associated with this Agreement or the breach thereof or
otherwise arising out of or associated with the Employee’s employment by the Company, the prevailing party shall be entitled to
recover all reasonable attorneys' fees, expenses, and costs thereof or associated therewith, provided that, to the extent required by
Section 409A, any such payment by the Company shall be made no later than the end of the year following the year in which such
fees, expenses and costs were incurred. The term “prevailing party” means the party obtaining substantially the relief sought via
litigation or through an action in arbitration.
19.
Integration, Amendment, and Waiver.
This Agreement and such other written agreements referenced in this Agreement (other than the Prior Agreements),
constitute the entire agreement between the parties pertaining to the subject matter contained in it except as expressly provided
herein, and supersedes all prior agreements, representations, assurances, and understandings of the parties, including the Prior
Agreements. No amendment of, addition to, or modification of this Agreement shall be binding unless executed in writing by the
parties. Any term or provision of this Agreement may be waived in a signed writing at any time by the party that is entitled to the
benefit thereof, provided, however, that any waiver shall apply only to the specific event or omission waived and shall not constitute
a continuing waiver. Any term or provision of this Agreement may be amended or supplemented at any time by a written instrument
executed by all the parties hereto.
20.
Captions.
The captions and section headings of this Agreement are for convenience and reference only, and shall have no effect on
the interpretation or construction of this Agreement.
21.
Applicable Law.
The substantive laws of the State of Nevada shall govern the validity, construction, interpretation, performance, and effect
of this Agreement, without regard to the conflicts of laws provisions thereof.
22.
Arbitration.
Any controversy, cause of action or claim related to or arising out of or in connection with the Employee’s employment
with the Company, including but not limited to termination of such employment or under this Agreement, other than an action to
enforce the provisions of Section 10 herein or the breach thereof, shall be settled by arbitration according to the rules of the
American Arbitration Association applicable to disputes arising in Nevada and under Nevada law. Any party to the arbitration
may enter judgment upon the award rendered by the arbitrator in any court having jurisdiction thereof. The arbitrator shall not
be entitled to amend or alter the terms of this Agreement. Notwithstanding this Section 22, the Company shall be entitled to seek
any available equitable remedy for enforcement of provisions of this Agreement.
23.
Authorization.
The Company and the Employee, individually and severally, represent and warrant to the other party that it has the
authorization, power and right to deliver, execute and fully perform the obligations under this Agreement in accordance with its
terms. The Employee represents and warrants to the Company that there is no restriction or limitation, by reason of this Agreement
or otherwise, upon the Employee’s right or ability to enter into this Agreement and fulfill her obligations under this Agreement.
24.
Acknowledgment.
The Employee acknowledges that she has been given a reasonable period of time to study this Agreement before signing
it. The Employee certifies that she has fully read, and has received an explanation of, and completely understands the terms,
nature, and effect of this Agreement. The Employee further acknowledges that she is executing this Agreement freely, knowingly,
and voluntarily and that the Employee’s execution of this Agreement is not the result of any fraud, duress, mistake, or undue
influence whatsoever. In executing this Agreement, the Employee does not rely on any inducements, promises, or representations
by the Company or any person other than the terms and conditions of this Agreement.
25.
Protected Activity Not Prohibited.
The Employee understands that nothing in this Agreement shall in any way limit or prohibit the Employee from engaging in any
Protected Activity. For purposes of this Agreement, “Protected Activity” shall mean filing a charge, complaint, or report with, or
otherwise communicating, cooperating, or participating in any investigation or proceeding that may be conducted by, any federal,
state or local government agency or commission, including the Securities and Exchange Commission, the Equal Employment
Opportunity Commission, the Occupational Safety and Health Administration, and the National Labor Relations Board (the
“Government Agencies”). The Employee understands that in connection with such Protected Activity, the Employee is permitted
to disclose documents or other information as permitted by law, and without giving notice to, or receiving authorization from, the
Company. Notwithstanding the foregoing, the Employee agrees to take all reasonable precautions to prevent any unauthorized
use or disclosure of any information that may constitute Company confidential information to any parties other than the Government
Agencies. The Employee further understands that “Protected Activity” does not include the disclosure of any Company attorney-
client privileged communications. Any language in any other agreement between the Company and the Employee regarding the
Employee’s right to engage in Protected Activity that conflicts with, or is contrary to, this paragraph is superseded by this Agreement.
In addition, pursuant to the Defend Trade Secrets Act of 2016, the Employee is notified that an individual will not be held criminally
or civilly liable under any federal or state trade secret law for the disclosure of a trade secret that (i) is made in confidence to a
federal, state, or local government official (directly or indirectly) or to an attorney solely for the purpose of reporting or investigating
a suspected violation of law, or (ii) is made in a complaint or other document filed in a lawsuit or other proceeding, if (and only
if) such filing is made under seal. In addition, an individual who files a lawsuit for retaliation by an employer for reporting a
suspected violation of law may disclose the trade secret to the individual’s attorney and use the trade secret information in the
court proceeding, if the individual files any document containing the trade secret under seal and does not disclose the trade secret,
except pursuant to court order.
26.
Section 409A.
Notwithstanding anything to the contrary in this Agreement, the payment of consideration, compensation, and benefits
pursuant to this Agreement shall be interpreted and administered in a manner intended to avoid the imposition of additional taxes
under Section 409A. Notwithstanding any provision to the contrary in this Agreement or otherwise, no payment or distribution
under this Agreement or otherwise that constitutes an item of “deferred compensation” under Section 409A and becomes payable
by reason of the termination of the Employee’s employment hereunder shall be made to the Employee unless and until the
termination of the Employee’s employment constitutes a “separation from service” (as such term is defined in Section 409A).
In addition, no such payment or distribution of deferred compensation shall be made to the Employee prior to the earlier
of (a) the expiration of the six (6) month period (the “Six Month Period”) measured from the date of the Employee’s “separation
from service” (as such term is defined in Section 409A), and (b) the date of the Employee’s death, if the Employee is deemed at
the time of such separation from service to be a “specified employee” within the meaning of that term under Section 409A (the
“Six Month Delay”) and if such delayed commencement is otherwise required to avoid an “additional tax” under section 409A(a)
(1)(B) of the Code. All payments and benefits that are delayed pursuant to the immediately preceding sentence shall be paid to
the Employee in a lump sum upon expiration of such six (6) month period (or if earlier, upon the Employee’s death).
Notwithstanding the foregoing provisions, to the extent permitted under Section 409A, any separate payment or benefit
under this Agreement or otherwise shall not be “deferred compensation” subject to Section 409A and the Six Month Delay to the
extent provided in the exceptions in Treasury Regulation section 1.409A-1(b)(4) and (b)(9) and any other applicable exception or
provision under Section 409A. Further, each individual installment payment that becomes payable under this Agreement and each
payment of the Severance Pay or if applicable, the CIC Severance Pay shall be a “separate payment” under Section 409A.
Specifically, to the extent the provisions of Treasury Regulation section 1.409A-1(b)(9) are applicable to the Severance Pay or if
applicable, the CIC Severance Pay, the portion of such severance pay set forth in respectively, subsection 7(a)(i) or subsection
7(e)(i) above that is less than the limit prescribed under Treasury Regulation section 1.409A-1(b)(9)(iii)(A) (or any successor
provision) (the “Separation Pay Amount”) shall be payable to the Employee in the manner prescribed in subsection 7(a)(i) or
subsection 7(e)(i), as applicable, without regard to the Six Month Delay. Following the Six Month Delay, (1) to the extent applicable,
the Employee shall receive a lump sum cash payment equal to the Severance Pay or CIC Severance Pay, as applicable, she otherwise
would have received during the Six Month Period (absent the Six Month Delay) less the Separation Pay Amount and (2) the
Employee shall receive the remainder of her Severance Pay or CIC Severance Pay, as applicable, in the manner prescribed by
subsection 7(a) or subsection 7(e), as applicable.
IN WITNESS WHEREOF, the parties have executed this Agreement effective as of the Effective Date.
COMPANY:
EMPLOYEE:
By:
/s/ Douglas D. Dirks
Douglas D. Dirks
Chief Executive Officer
By:
/s/ Lori A. Brown
Lori A. Brown
Appendix A: Relocation Benefits
The Company will provide assistance with relocation to Reno, Nevada. Relocation assistance includes the following:
• Movement of household goods and vehicles from your current residence to Reno, Nevada through a professional mover
including packing, unpacking and professional storage of household goods for up to six (6) months;
• Reimbursement of reasonable expenses necessary to facilitate your relocation, such as airfare or driving expenses, hotel costs
and meals for the trip from your current residence;
• Reimbursement of temporary housing living expenses (rent, deposit, utilities) up to 12 months;
•
•
If as a result of your relocation to the Reno, Nevada area, you choose to sell your current home in San Ramon, California,
the Company will pay realtor fees (not to exceed six percent (6%) of the sales price). The Company will also reimburse you
for any closing costs related to the sale of your current house, in the aggregate up to $5,000;
If as a result of your relocation to the Reno, Nevada area, you choose to buy a home in the Reno, Nevada area, the Company
will reimburse you for standard closing costs (excluding financing related costs) for the purchase of a home in the Reno area;
• Reimbursement of sales and use tax charged to you by the Nevada Department of Motor Vehicles when registering the vehicles
owned by you as of January 1, 2019, upon your relocation to Reno Nevada. The reimbursement shall be limited to no more
than $2,500, in the aggregate.
• To the extent that the reimbursement of any of the relocation expenses described in this Appendix A (the “Relocation Expenses”)
results in taxable income to you (after taking into account any and all offsetting deductions), the Company will pay you an
additional amount (the “Relocation Gross-Up”) such that the net after-tax amount of the reimbursement of the Relocation
Expenses and the Relocation Gross-Up (at your then-current combined state and federal marginal income tax rates, taking
into account the deductibility of state and local income taxes for federal income tax purposes and all other applicable
deductions) is equal to the Relocation Expenses. Notwithstanding the foregoing, the Relocation Gross-Up shall not exceed
$100,000. The Company will not gross-up any income associated with any profit resulting from the sale of your current
house. Any tax gross-up payment will be paid to you no later than the end of the taxable year next following the taxable year
in which you remit the related taxes.
All relocation expenses must be incurred before December 31, 2020.
Any and all reimbursements and allowances payable to the Employee pursuant to this Agreement, including this Appendix, shall
be conditioned on the submission by the Employee of all expense reports and other documentation reasonably required by the
Company under any applicable expense reimbursement policy or otherwise, and shall be paid to the Employee promptly following
receipt of such expense reports and documentation, but in no event later than the last day of the calendar year following the calendar
year in which the Employee incurred the reimbursable expenses. Any amount of expenses eligible for reimbursement, allowance
or in-kind benefit provided, during a calendar year shall not affect the amount of expenses eligible for reimbursement, or in-kind
benefit to be provided, during any other calendar year. The right to any reimbursement or in-kind benefit pursuant to this Agreement
shall not be subject to liquidation or exchange for any other benefit.
EMPLOYERS HOLDINGS, INC.
SUBSIDIARIES AS OF DECEMBER 31, 2018
Exhibit 21.1
Name
Employers Group, Inc.
Employers Insurance Company of Nevada
Elite Insurance Services, Inc.
Employers Compensation Insurance Company
Employers Preferred Insurance Company
Employers Assurance Company
EIG Services, Inc.
Jurisdiction of Organization
Nevada
Nevada
Nevada
California
Florida
Florida
Florida
Exhibit 23.1
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the Registration Statement on Form S-3 (No. 333-218288) of Employers Holdings,
Inc. and Registration Statements on Form S-8 (Nos. 333-168563 and 333-152900) pertaining to the Amended and Restated Equity
and Incentive Plan of Employers Holdings, Inc. of our reports dated February 28, 2019, with respect to the consolidated financial
statements and schedule of Employers Holdings, Inc. and Subsidiaries and the effectiveness of internal control over financial
reporting of Employers Holdings, Inc. and Subsidiaries included in this Annual Report (Form 10-K) for the year ended December 31,
2018.
/s/ Ernst & Young LLP
San Francisco, California
February 28, 2019
41Exhibit 31.1
I, Douglas D. Dirks, certify that:
1.
I have reviewed this annual report on Form 10-K of Employers Holdings, Inc.;
CERTIFICATIONS
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods
presented in this report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in
Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons
performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: February 28, 2019
/s/ Douglas D. Dirks
Douglas D. Dirks
President and Chief Executive Officer
Employers Holdings, Inc.
Exhibit 31.2
I, Michael S. Paquette, certify that:
1.
I have reviewed this annual report on Form 10-K of Employers Holdings, Inc.;
CERTIFICATIONS
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods
presented in this report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in
Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons
performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: February 28, 2019
/s/ Michael S. Paquette
Michael S. Paquette
Executive Vice President and Chief Financial Officer
Employers Holdings, Inc.
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1
In connection with the Form 10-K of Employers Holdings, Inc. (the Company) for the year ended December 31, 2018, as filed
with the Securities and Exchange Commission on the date hereof (the Report), the undersigned hereby, certifies, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results
of operations of the Company.
Date: February 28, 2019
/s/ Douglas D. Dirks
Douglas D. Dirks
President and Chief Executive Officer
Employers Holdings, Inc.
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2
In connection with the Form 10-K of Employers Holdings, Inc. (the Company) for the year ended December 31, 2018, as filed
with the Securities and Exchange Commission on the date hereof (the Report), the undersigned hereby, certifies, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results
of operations of the Company.
Date: February 28, 2019
/s/ Michael S. Paquette
Michael S. Paquette
Executive Vice President and Chief Financial Officer
Employers Holdings, Inc.
Employers Holdings, Inc. as of March 1, 2019
Employers Holdings, Inc.
and Subsidiaries
Directors
Douglas D. Dirks
President and Chief Executive Officer
Michael S. Paquette
Executive Vice President, Chief Financial Officer
Stephen V. Festa
Executive Vice President, Chief Operating Officer
Tracey L. Berg
Executive Vice President, Chief Innovation Officer
John P. Nelson
Executive Vice President, Chief Administrative Officer
Lori A. Brown
Executive Vice President, Chief Legal Officer &
General Counsel
C. Ronald Kullman, Jr.
Senior Vice President, Chief Risk Officer
Aaron P. Mikulsky
Senior Vice President, Business Process and
Policyholder Services
Lawrence S. Rogers
Senior Vice President, Chief Underwriting Officer
Jeffrey C. Shaw
Senior Vice President, Chief Information Officer
Barry J. Vogt
Senior Vice President, Chief Claims Officer
Thomas M. Warden
Senior Vice President, Chief Data Analytics Officer
Raymond F. Wise, Jr.
Senior Vice President, Chief Sales Officer
Shareholder Inquiries
Michael S. Paquette
Executive Vice President, Chief Financial Officer
mpaquette@employers.com
775-327-2562
Company Information
Employers Holdings, Inc.
10375 Professional Circle
Reno, NV 89521-4802
888-682-6671
Michael D. Rumbolz
Chair of the Board
Richard W. Blakey
Chair – Compensation Committee
Prasanna G. Dhoré
Chair – Risk Committee
Douglas D. Dirks
President and Chief Executive Officer
Valerie R. Glenn
Chair – Governance Committee
Barbara A. Higgins
Director
James R. Kroner
Chair – Finance Committee
Michael J. McColgan
Director
Michael J. McSally
Chair – Audit Committee
Jeanne L. Mockard
Director
Transfer Agent
EQ Shareowner Services
1110 Centre Pointe Curve, Suite 101
Mendota Heights, MN 55120-4100
800-468-9716
Independent Auditors
Ernst & Young LLP
560 Mission Street, Suite 1600
San Francisco, CA 94105
Annual Meeting
Thursday, May 23, 2019 - 9:00 a.m.
10375 Professional Circle
Reno, NV 89521-4802
CORPORATE HEADQUARTERS
10375 Professional Circle
Reno, NV 89521-4802
www.employers.com
Employers Holdings, Inc. is a holding company with subsidiaries that are specialty providers of workers’ compensation
insurance and services focused on select, small businesses engaged in low-to-medium hazard industries. The
company, through its subsidiaries, operates in 45 states and the District of Columbia. The company’s insurance
subsidiaries are rated A- (Excellent) by the A.M. Best Company.
Copyright © 2019 EMPLOYERS. All rights reserved. Insurance offered through Employers Compensation Insurance
Company, Employers Insurance Company of Nevada, Employers Preferred Insurance Company and Employers
Assurance Company. Coverage not available in all jurisdictions.