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EX-32.1 - EXHIBIT 32-1 - Employers Holdings, Inc.ex32_1.htm
EX-21.1 - SUBSIDIARIES AS OF 12-31-2010 - Employers Holdings, Inc.ex21_1.htm
EX-10.18 - SEPARATION AND RELEASE AGREEMENT - Employers Holdings, Inc.ex10_18.htm
EX-31.1 - EXHIBIT 31-1 - Employers Holdings, Inc.ex31_1.htm
EX-31.2 - EXHIBIT 31-2 - Employers Holdings, Inc.ex31_2.htm
EX-32.2 - EXHIBIT 32-2 - Employers Holdings, Inc.ex32_2.htm
EX-23.1 - CONSENT OF INDEPENDANT REGISTERD PUBLIC ACOOUNTING FIRM - Employers Holdings, Inc.ex23_1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 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, 2010

OR

 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
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
(IRS Employer
Identification No.)

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
Common Stock, $0.01 par value per share
Name of each exchange on which registered
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   x No  o

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  o  No  x

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  x  No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, 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  xNo  o

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.  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a small reporting company. See definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x
Accelerated filer  o
Non-accelerated filer  o
Smaller reporting company  o

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2010 was $613,703,664
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o    No  x
Class
Common Stock, $0.01 par value per share
February 18, 2011
38,467,790 shares outstanding
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Definitive Proxy Statement relating to the 2011 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
3
       
   
PART I
 
       
Item 1
 
Business
4
Item 1A
 
Risk Factors
21
Item 1B
 
Unresolved Staff Comments
30
Item 2
 
Properties
30
Item 3
 
Legal Proceedings
30
Item 4
 
(Removed and Reserved)
30
       
   
PART II
 
       
Item 5
 
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
31
Item 6
 
Selected Financial Data
34
Item 7
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
37
Item 7A
 
Quantitative and Qualitative Disclosures About Market Risk
58
Item 8
 
Financial Statements and Supplementary Data
60
Item 9
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
97
Item 9A
 
Controls and Procedures
97
Item 9B
 
Other Information
97
       
   
PART III
 
       
Item 10
 
Directors, Executive Officers and Corporate Governance
98
Item 11
 
Executive Compensation
98
Item 12
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
98
Item 13
 
Certain Relationships and Related Transactions, and Director Independence
98
Item 14
 
Principal Accountant Fees and Services
98
       
   
PART IV
 
       
Item 15
 
Exhibits and Financial Statement Schedules
99
       
       
       

 
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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, loss reserves, acquisitions, competition, and rate increases with respect to our business and the insurance industry in general. 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.”
 
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 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, the Company acknowledges that it is 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.
 
 
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PART I
 
 
Item 1.  Business
 
General
 
Employers Holdings, Inc. (EHI) is a Nevada holding company and is the successor to EIG Mutual Holding Company (EIG), 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. We had 699 full-time employees at December 31, 2010 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 “stable” financial outlook.
 
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, and Proxy Statement for our Annual Meeting 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 standing 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 this material and other information that we file electronically with the SEC.
 
Description of Business
 
We are a specialty provider of workers' compensation insurance focused on select small businesses engaged 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 a statutory system that generally requires an employer to provide coverage for its employees' medical, disability, vocational rehabilitation, and death benefit costs for work-related injuries or illnesses. We market and sell our products primarily through independent agents and brokers and through our strategic partnerships and alliances, including our principal strategic partners, ADP, Inc. (ADP) and Anthem Blue Cross of California (Anthem). We operate as a single reportable segment and conduct operations in 30 states and the District of Columbia, with approximately half of our business in California.
 
In July 2010, we announced the reorganization of our operations to eliminate duplicative services and better align resources with business activity and growth opportunities. We combined our four regional operating units into two units, Eastern and Western, with the Strategic Partnerships and Alliances unit remaining structurally unchanged. In connection with these efforts and with general cost control efforts, we eliminated approximately 160 positions. These changes to our workforce were substantially completed during the third quarter of 2010.
 
In the first quarter of 2010, we restructured our operations to reduce staffing levels to reflect activity levels in our insurance operations at that time.
 
On October 31, 2008, we acquired 100% of the outstanding common stock of AmCOMP Incorporated (the Acquisition). The Acquisition included two insurance subsidiaries and three other subsidiaries: EIG Services, Inc. (formerly Pinnacle Administrative Company), Pinnacle Benefits, Inc. and AmSERV, Inc. The acquired insurance subsidiaries, Employers Preferred Insurance Company and Employers Assurance Company (formerly AmCOMP Preferred Insurance Company and AmCOMP Assurance Corporation, respectively), are mono-line workers’ compensation insurance companies focused on small sized businesses engaged in low to medium hazard industries.
 
We had net premiums written of $313.1 million and $368.3 million, total revenues of $415.6 million and $495.9 million and net income of $62.8 million and $83.0 million for the years ended December 31, 2010 and 2009, respectively. At December 31, 2010, we had total assets of $3.48 billion. Our combined ratio on a statutory basis, a measurement of underwriting profitability, was 109.8% for the year ended December 31, 2010 (elsewhere in this report, unless otherwise
 
 
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stated, the term “combined ratio” refers to a calculation based on U.S. generally accepted accounting principles (GAAP)). Our combined ratio on a statutory basis for the five years ended December 31, 2009 was 86.3%, compared to the industry composite statutory combined ratio of 108.1% for the same five-year period (calculated by A.M. Best for individual companies that have more than 50% of their business in workers' compensation). Companies with lower combined ratios than their peers generally experience greater profitability.
 
Our insurance subsidiaries are domiciled in the following states:
 
 
State of Domicile
Employers Insurance Company of Nevada (EICN)
Nevada
Employers Compensation Insurance Company (ECIC)
California
Employers Preferred Insurance Company (EPIC)
Florida
Employers Assurance Company (EAC)
Florida
 
Products and Services
 
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.
 
Total direct premiums written for the workers’ compensation industry (excluding governmental writers) were approximately $35.0 billion and $39.0 billion in 2009 and 2008, respectively, according to A.M. Best. A.M. Best reported that we were the seventeenth largest writer of non-governmental workers’ compensation insurance in the United States in 2009.
 
Disciplined Underwriting
 
Our underwriting guidelines are designed to minimize underwriting of classes and subclasses of business which have historically demonstrated claims severity that do not meet our target risk profiles. 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 is a critical element of our culture and has allowed us to offer competitive prices, diversify our risks, and achieve profitable growth.
 
The following table compares our statutory losses and loss adjustment expenses (LAE) ratio, a measure which relates inversely to our underwriting profitability, to the statutory industry composite losses and LAE ratio reported by A.M. Best (calculated for U.S. insurance companies having more than 50% of their premiums generated by workers' compensation insurance products) for the past five years as of December 31, 2009 (the most recent information available):
 
Statutory Losses and LAE Ratio
 
Year
 
EMPLOYERS
   
A.M. Best
 
2005
    58.3 %     79.7 %
2006
    37.9       77.1  
2007
    46.5       77.7  
2008
    47.1       78.6  
2009
    57.5       86.1  
2010
    66.2       N/A  
 
Our underwriting strategy is to focus on disciplined underwriting and continue to pursue profitable growth opportunities across market cycles. We carefully monitor market trends to assess new business opportunities that we expect will meet our pricing and risk standards.
 
 
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We execute our underwriting processes through automated systems and experienced underwriters with specific knowledge of local markets. 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 undesirable classes and subclasses of business while increasing the number of policies underwritten to targeted small businesses in low to medium hazard industries.
 
Loss Control
 
Our loss control professionals provide consultation to policyholders to assist them in preventing losses and containing costs once claims occur. They also assist our underwriting personnel in evaluating potential and current policyholders and are an important part of our underwriting and loss control strategies.
 
Premium Audit
 
We conduct premium audits on our policyholders annually upon the policy expiration. 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 interim audits on certain classes of business if unusual claims are filed or concerns are raised regarding projected annual payrolls, which could result in substantial variances at final audit.
 
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.
 
Our claims department also provides claims management services for those claims incurred by the Nevada State Industrial Insurance System (the Fund) and assumed by EICN and subject to a 100% retroactive reinsurance agreement (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.
 
We maintain an exclusive medical provider network in Nevada. We make every appropriate effort to direct injured workers into this network for medical treatments. We utilize networks affiliated with Anthem and Coventry Health Care, Inc. in other states. In addition to our medical networks, we work closely with local vendors, including attorneys, medical professionals, and investigators, to bring local expertise to our reported claims. We pay special attention to reducing costs in each region 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 issued to insureds. Our fraud and subrogation efforts are handled through dedicated units.
 
Information Technology
 
Core Operating Systems
 
We have an efficient, cost-effective and scalable infrastructure that complements our geographic reach and business model. We have developed a highly automated underwriting system. This technology allows for the electronic submission, review, and quoting of insurance applications applying our underwriting standards and guidelines. This policy administration system reduces transaction costs and provides for more efficient and timely processing of applications for small policies that meet our underwriting standards. We believe this approach saves our independent agents and brokers considerable time in processing customer applications and maintains our competitiveness in our target markets. In January 2009, we implemented a new claims system that was designed to improve efficiency and enhance our ability to support claims processing. We will continue to invest in technology and systems across our business to maximize efficiency and create increased capacity that will allow us to lower our expense ratios while growing premiums. In January 2010, EPIC and EAC were successfully converted to both our policy and claims administration systems and their legacy systems were discontinued.
 
 
6

 
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 have two data centers that act as production facilities and as disaster recovery sites for each other. In addition, we utilize an offsite data storage facility.
 
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 that are underwritten on the basis of individual risk characteristics, as opposed to following an occupational class-based underwriting approach, that allow us to generate loss ratios that are consistently better than the industry average. For example, while we insure many physician offices, our underwriting guidelines generally exclude offices that we believe have a higher risk profile, such as psychiatrist offices and drug treatment centers.
 
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
   
2010
   
Percentage
of 2010 Total
   
2009
   
Percentage
of 2009 Total
   
2008
   
Percentage
of 2008 Total
 
     
(in thousands, except percentages)
 
A     $ 45,537       14.2 %   $ 45,683       11.9 %   $ 46,838       10.1 %
B       74,435       23.2       82,086       21.3       94,080       20.2  
C       120,656       37.6       137,973       35.8       157,481       33.8  
D       47,906       14.9       54,582       14.2       63,206       13.6  
E       24,592       7.7       43,036       11.2       61,936       13.3  
F       7,531       2.3       20,131       5.2       39,410       8.5  
G       480       0.1       1,534       0.4       2,657       0.5  
Total
    $ 321,137       100 %   $ 385,025       100.0 %   $ 465,608       100.0 %
 
The following table sets forth our in-force premiums for our top ten types of insureds and as a percentage of our total in-force premiums as of December 31, 2010:
 
Employer Classifications
 
Hazard
Group Level
   
In-force
Premiums
   
Percentage
of Total
 
         
(in thousands, except percentages)
 
Restaurants
    A     $ 36,026       11.2 %
Physician and physician office clerical
    C       28,673       8.9  
Automobile service or repair center and drivers
    D       25,696       8.0  
Store:  Wholesale not otherwise classified
    B       14,756       4.6  
College:  Professional employees and clerical
    B       9,758       3.0  
Store:  Retail not otherwise classified
    B       8,583       2.7  
Hotel:  All other employees and salespersons, drivers
    B       6,416       2.0  
Machine shops not otherwise classified
    D       6,379       2.0  
Clerical office employees not otherwise classified
    C       5,999       1.9  
Stores:  Groceries and provisions - retail
    C       5,326       1.7  
Total
          $ 147,612       46.0 %

 
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We currently write business in 30 states and the District of Columbia and are licensed to write business in seven additional states. 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 from time-to-time may differ from national trends. State legislation, local competition, economic and employment trends, climate and environmental changes, and workers’ compensation medical costs trends can be material to our financial results.
 
As of December 31, 2010, our policyholders had average annual in-force premiums of approximately $7,200. 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.
 
Our total in-force premiums and number of policies in-force by state are shown in the table below as of December 31:
 
   
2010
   
2009
   
2008
 
State
 
Premium
In-force
   
Policies
In-force
   
Premium
In-force
   
Policies
In-force
   
Premium
In-force
   
Policies
In-force
 
   
(dollars in thousands)
 
California
  $ 172,621       29,244     $ 180,474       27,812     $ 203,694       27,942  
Illinois
    18,617       932       19,389       801       17,885       689  
Nevada
    16,940       3,596       24,050       4,119       38,971       5,221  
Florida
    15,071       1,963       27,964       2,630       46,248       3,115  
Wisconsin
    14,573       764       24,125       922       29,040       892  
Other
    83,315       8,061       109,023       7,870       129,770       7,740  
Total
  $ 321,137       44,560     $ 385,025       44,154     $ 465,608       45,599  
 
The following trends affected our workers compensation business from 2008 through 2010:
 
 
The decrease in premium in-force reflects the impacts of the recession, which has particularly affected certain classes of small business, including contractors and restaurants, and declining payrolls due to reduced employment and work hours, closures of small businesses and our continued focus on profitable underwriting despite aggressive pricing in a highly competitive market; and
 
 
The increase in total policies in-force in 2010 reflects our efforts to continue to grow our business profitably across market cycles, partially offset by declines in certain states, including Nevada and Florida, as a result of the continuing effects of the recession and our continued focus on disciplined underwriting.
 
We cannot be certain how these trends will ultimately impact our consolidated financial position and results of operations as we continue to emphasize disciplined pricing objectives and underwriting guidelines; however, we believe we are well positioned to continue to grow profitably in the future.
 
Premiums for all of our policies 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 employee’s 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, which may be made in certain circumstances, to increase or decrease the policy premium. Schedule rating adjustments are made at the discretion of the underwriter based on individual risk characteristics of the insured and subject to maximum amounts as established in our premium rate filings.
 
Our premium rates are determined by our actuaries for each state in which we do business, except in “administered pricing” states, where premium rates are set by state insurance regulators, primarily Florida and Wisconsin. In California, where approximately half of our premiums are earned, the Workers’ Compensation Insurance Rating Bureau (WCIRB) recommends claims cost benchmarks to be used by companies in determining their premium rates. The California Commissioner of Insurance (California Commissioner) also adopts and publishes his own claims cost benchmark. The benchmark rates are advisory rates that cover expected loss costs, but do not contain an element to cover operating expenses or profit. We are not required to use these benchmark rates.
 
 
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The WCIRB recommended a 22.8% increase in the claims cost benchmark effective January 1, 2010. This recommendation was based upon an evaluation of March 31, 2009 loss experience, which produced an indicated increase in the claims cost benchmark of 16.0%, reflecting increased medical costs. The recommendation also indicated an increase of 5.8% directly attributable to additional costs arising from several Workers’ Compensation Appeals Board decisions. The California Commissioner rejected the WCIRB recommendation and left the claims cost benchmark unchanged. In April 2010, the WCIRB submitted an analysis of premium and loss experience as of December 31, 2009, indicating a 21.1% increase in the claims cost benchmark, but did not make a recommendation to the California Commissioner. Subsequently, the WCIRB recommended a 29.6% increase in the January 1, 2011 claims cost benchmark, based on an evaluation of March 31, 2010 loss experience. The WCIRB amended its August filing in September 2010 to recommend a 27.7% increase in the claims cost benchmark in lieu of the 29.6% increase based on an analysis of June 30, 2010 loss experience. In November 2010 the California Commissioner rejected the recommendation of the WCIRB and left the claims cost benchmark unchanged.
 
We set our premium rates in California based upon actuarial analyses of current and anticipated loss trends with a goal of maintaining underwriting profitability. We reduced our filed premium rates in California from 2003 through 2008 due to favorable loss costs trends originating from the 2003 and 2004 legislative reforms (see “Workers’ Compensation Reform Legislation”). Due to increasing loss costs, primarily medical cost inflation, we increased our filed premium rates by a cumulative 28.3% since February 1, 2009.
 
The following table sets forth the percentage increases to our filed California rates effective for new and renewal policies incepting on or after the dates shown.
 
Effective Date
 
Premium Rate Change
Filed in California
 
February 1, 2009
    10.0 %
August 15, 2009
    10.5  
March 15, 2010
    3.0  
March 15, 2011
    2.5  
 
In October 2010, the Florida Insurance Commissioner (Florida Commissioner) approved a 7.8% increase in workers’ compensation rates to be effective January 1, 2011 for new and renewal business. The increase followed a 6.8% decrease in Florida for new and renewal policies incepting on or after January 1, 2010.
 
In Nevada, we filed for a 6.7% rate decrease for new and renewal policies incepting on or after March 1, 2010.
 
Workers’ Compensation Reform Legislation
 
California enacted three key pieces of workers' compensation legislation in 2003 and 2004 that reformed medical determinations of injuries or illness, established medical fee schedules, allowed for the use of medical provider panels, modified benefit levels, changed the proof needed to file claims, and reformed many additional areas of the workers' compensation benefits and delivery system. Workers' compensation insurers in California responded to these reforms, which have reduced claim costs, by reducing their rates through 2008.
 
In Florida, legislation was enacted effective in 2003 to reverse a trend of increasing workers’ compensation costs in the state. These reforms have reduced claim costs and resulted in subsequent rate decreases. In October 2008, a Florida Supreme Court decision materially impacted the statutory caps on attorney fees that were part of the 2003 reforms; however, during 2009, the Florida Legislature restored the statutory caps on attorney fees. Through January 2010, there was a cumulative 63.2% rate decrease since the reforms of 2003.
 
Losses and LAE Reserves and Loss Development
 
We are directly liable for losses and LAE under the terms of 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, as of any given date, is inherently uncertain. Loss reserve estimates represent a significant risk to the business, which we attempt to mitigate by continually reviewing loss cost trends and by attempting to set ourpremium rates to adequately cover anticipated costs. We minimize the estimation risk by performing a comprehensive review of our loss reserves.
 
 
9

 
The amount by which revised estimated losses, measured subsequently by reference to payments and additional information, differs from those originally reported for a period is known as “development.” Development is favorable when losses ultimately settle for less than the amount reserved or subsequent estimates indicate a basis for reducing loss reserves on open claims. Development is unfavorable when losses ultimately settle for more than the levels at which they were reserved or subsequent estimates indicate a basis for reserve increases on open claims. Favorable or unfavorable development of loss reserves is reflected on our consolidated statements of income under the line item “losses and LAE” in the period in which the change is made.
 
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 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.
 
The following tables show changes in the historical loss reserves, on a gross basis and net of reinsurance, for each of the eleven years ended December 31, 2010 for EICN and ECIC, and for each of the years ended December 31, 2010, 2009, and 2008, for EPIC and EAC. These tables are presented on a GAAP basis. The paid and reserve data in the following tables is presented on a calendar year basis.
 
The top line of each table shows the net and gross reserves for unpaid losses and LAE recorded at each year-end. Such amount represents an estimate of unpaid losses and LAE occurring in that year as well as future payments on claims occurring in prior years. The upper portion of these tables (net and gross cumulative amounts paid, respectively) present the cumulative amounts paid during subsequent years on those losses for which reserves were carried as of each specific year. The lower portions (net and gross reserves re-estimated, respectively) show the re-estimated amounts of the previously recorded reserves based on experience as of the end of each succeeding year. The re-estimated amounts change as more information becomes known about the actual losses for which the initial reserve was carried. An adjustment to the carrying value of unpaid losses for a prior year will also be reflected in the adjustments for each subsequent year. For example, an adjustment made in the 2000 year will be reflected in the re-estimated ultimate net loss for each subsequent year. The gross cumulative redundancy, or deficiency, line represents the cumulative change in estimates since the initial reserve was established. It is equal to the difference between the initial reserve and the latest re-estimated reserve amount. A redundancy means that the original estimate was higher than the current estimate. A deficiency means that the current estimate is higher than the original estimate.
 
10

 
 
   
2000
 
2001
 
2002
 
2003
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
   
(in thousands)
Net reserves for losses
     and LAE
                                         
Originally estimated
  $ 936,000   $ 887,000   $ 908,326   $ 962,457   $ 1,089,814   $ 1,208,481   $ 1,209,652   $ 1,217,069   $ 1,430,128   $ 1,373,153   $ 1,323,686
Net cumulative amounts paid
     as of:
                                                             
One year later
    108,748     81,022     80,946     91,130     96,661     106,859     109,129     127,912     214,499     206,653      
Two years later
    161,721     120,616     130,386     150,391     161,252     175,531     186,014     219,496     342,174            
Three years later
    191,453     149,701     165,678     193,766     207,868     229,911     249,059     295,646                  
Four years later
    215,015     173,204     194,400     226,127     247,217     279,405     302,863                        
Five years later
    235,613     194,980     218,453     255,851     285,388     321,060                              
Six years later
    255,772     215,507     242,143     288,039     317,489                                    
Seven years later
    275,750     235,653     269,341     315,180                                          
Eight years later
    294,760     260,036     292,791                                                
Nine years later
    318,262     280,809                                                      
Ten years later
    338,059                                                            
Net reserves re-estimated
     as of:
                                                             
One year later
    896,748     875,522     847,917     924,878     1,011,759     1,101,352     1,149,641     1,151,246   $ 1,378,767     1,359,023      
Two years later
    885,221     781,142     805,058     886,711     975,765     1,049,628     1,085,358     1,100,706     1,352,021            
Three years later
    800,959     742,272     779,373     884,426     954,660     1,004,589     1,035,028     1,079,913                  
Four years later
    766,204     719,912     788,262     877,151     927,382     970,671     1,010,407                        
Five years later
    743,997     730,112     788,481     858,617     900,588     949,446                              
Six years later
    754,447     730,456     776,329     839,430     883,388                                    
Seven years later
    754,462     720,155     763,988     826,608                                          
Eight years later
    745,665     712,717     755,793                                                
Nine years later
    744,085     707,037                                                      
Ten years later
    739,822                                                            
Net cumulative redundancy:
    196,178     179,963     152,533     135,849     206,426     259,035     199,245     137,156     78,105     14,129     0
Gross reserves –
     December 31
    2,326,000     2,226,000     2,212,368     2,193,439     2,284,542     2,349,981     2,307,755     2,269,710     2,506,478     2,425,658     2,279,729
Reinsurance recoverable,
     gross
  1,390,000     1,339,000     1,304,042     1,230,982     1,194,728     1,141,500     1,098,1032     1,052,641     1,076,350     1,052,505     956,043
Net reserves – December 31
    936,000     887,000     908,326     962,457     1,089,814     1,208,481     1,209,652     1,217,069     1,430,128     1,373,153     1,323,686
Gross re-estimated reserves
    2,062,283     1,979,480     1,986,694     2,011,945     2,027,187     2,053,869     2,074,466     2,110,230     2,405,837     2,373,479     2,279,729
Re-estimated reinsurance
     recoverables
    1,322,461     1,272,442     1,230,901     1,185,337     1,143,799     1,104,422     1,064,059     1,030,317     1,053,816     1,014,456     956,043
Net re-estimated reserves
    739,822     707,037     755,793     826,608     883,388     949,446     1,010,407     1,079,913     1,352,021     1,359,023     1,323,686
                                                                   
Gross reserves for losses
     and LAE
                                                             
Originally estimated
    2,326,000     2,226,000     2,212,368     2,193,439     2,284,542     2,349,981     2,307,755     2,269,710     2,506,478     2,425,658     2,279,729
Gross cumulative amounts
     paid as of:
                                                             
One year later
    160,978     128,066     128,462     137,968     142,632     152,006     152,879     170,626     258,412     269,771      
Two years later
    260,995     215,176     224,740     243,203     252,379     264,430     272,478     304,146     449,206            
Three years later
    338,243     291,099     306,006     331,731     342,748     361,524     377,459     422,862                  
Four years later
    408,643     360,535     379,881     407,845     424,811     452,955     473,828                        
Five years later
    475,174     427,307     447,687     480,283     504,918     537,175                              
Six years later
    540,329     490,296     514,091     554,408     579,585                                    
Seven years later
    602,371     553,103     583,226     624,114                                          
Eight years later
    664,042     619,373     649,241                                                
Nine years later
    729,432     682,656                                                      
Ten years later
    791,739                                                            
Gross reserves re-estimated
     as of:
                                                             
One year later
    2,280,978     2,211,566     2,121,867     2,148,829     2,178,514     2,233,077     2,233,176     2,200,689     2,470,746     2,373,479      
Two years later
    2,266,495     2,089,850     2,072,205     2,088,437     2,138,648     2,170,292     2,162,695     2,148,399     2,405,837            
Three years later
    2,157,647     2,049,340     2,024,790     2,084,764     2,110,481     2,119,764     2,110,615     2,110,230                  
Four years later
    2,121,397     2,000,560     2,032,553     2,072,428     2,078,223     2,084,854     2,074,466                        
Five years later
    2,072,866     2,009,608     2,028,211     2,050,124     2,050,937     2,053,869                              
Six years later
    2,082,409     2,009,480     2,012,943     2,030,945     2,027,187                                    
Seven years later
    2,082,287     1,997,550     2,000,610     2,011,945                                          
Eight years later
    2,072,850     1,990,116     1,986,694                                                
Nice years later
    2,071,274     1,979,480                                                      
Ten years later
    2,062,283                                                            
Gross cumulative
     redundancy:
  $ 263,717   $ 246,520   $ 225,674   $ 181,494   $ 257,355   $ 296,112   $ 233,289   $ 159,480   $ 100,640   $ 52,179   $ 0
                                                                   
 
11

 
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. Reinsurance agreements may be proportional in nature, under which the assuming company shares proportionally in the premiums and losses of the ceding company. This arrangement is known as quota share reinsurance. Reinsurance agreements may also be structured so that the assuming company indemnifies the ceding company against all or a specified portion of losses on underlying insurance policies in excess of a specified amount, which is called an “attachment level” or “retention” in return for a premium, usually determined as a percentage of the ceding company's primary insurance premiums. This arrangement is known as excess of loss reinsurance. Excess of loss reinsurance may be written in layers, in which a reinsurer or group of reinsurers accepts a band of coverage 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 credit risk of a reinsurers' insolvency. In accordance with general industry practices, we purchase excess of loss reinsurance to protect against the impact of large individual, irregularly-occurring losses, and aggregate catastrophic losses from natural perils and terrorism. Such reinsurance reduces the magnitude of such losses on 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, 2010 and 12:01 a.m. July 1, 2011. The reinsurance program consists of one treaty covering excess of loss and catastrophic loss events in five layers of coverage. Our reinsurance coverage is $195.0 million in excess of our $5.0 million retention on a per occurrence basis, subject to a $2.0 million annual aggregate deductible and certain exclusions. 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 2007 (TRIPRA). 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 agreements include 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 obligatory reinsurance agreements; 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 or civil unrest other than terrorism; certain workers’ compensation business covering persons employed in Minnesota; 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. Any risks written outside the reinsurance program require executive review and approval.
 
The agreements provide 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 provide 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.
 
LPT Agreement
 
In 1999, Nevada enacted Senate Bill 37 (SB37).That bill stated that the Fund could take retroactive credit as an asset or a reduction of liability, amounts ceded to (reinsured with) assuming insurers with security based on discounted reserves for losses related to periods beginning before July 1, 1995, at a rate not to exceed 6%.
 
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 for loss and outstanding loss under the covered policies have closed, the agreement is commuted, or terminated, upon the mutual agreement of the parties, or the reinsurer's aggregate maximum limit of liability is exhausted, whichever occurs earlier. The LPT Agreement does not provide for any additional termination terms. The LPT Agreement substantially reduced the Fund's exposure to losses for pre-July 1, 1995 Nevada insured risks. 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.
 
 
12

 
Under the LPT Agreement, the Fund initially ceded $1.525 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 $846.7 million, and $888.4 million, as of December 31, 2010 and 2009, respectively. Losses and LAE paid with respect to the LPT Agreement totaled approximately $530.7 million and $489.0 million through December 31, 2010 and 2009, 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 individual trusts that require 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, 2010 and 2009 was $962.1 million and $883.6 million, respectively.
 
The reinsurers currently party to the LPT Agreement include ACE Bermuda Insurance Limited, XL Reinsurance Limited, and National Indemnity Company. The contract provides that during the term of the agreement all reinsurers need to maintain a rating of no less than “A-” as determined by A.M. Best.
 
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 in our consolidated balance sheet. This gain is amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries, and the amortization is reflected in losses and LAE in our consolidated financial statements.
 
We are also 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. Since the inception of the agreement, we have recognized approximately $26 million in contingent profit commission. Increases and decreases in the estimated contingent profit commission are reflected in our commission expense in the period that the estimate is revised.
 
Recoverability of Reinsurance
 
Reinsurance makes the assuming reinsurer liable to the ceding company to the extent of the reinsurance. It does not, however, discharge the ceding company from its primary liability to its policyholders in the event the reinsurer is unable to meet its obligations under such reinsurance. We monitor the financial strength of our reinsurers and we do not believe that we are currently exposed to any material credit risk through our reinsurance arrangements because our reinsurance is recoverable from generally large, well-capitalized reinsurance companies. At December 31, 2010, $962.1 million was in a trust account for reinsurance related to the LPT Agreement and an additional $11.6 million, not related to the LPT Agreement, was collateralized by cash or letter of credit.
 
In 2010, we re-negotiated the terms of a reinsurance agreement with Clarendon National Insurance Company (Clarendon), which resulted in the release and return of funds held by Clarendon to us in the amount of $74.6 million. We placed $47.1 million in trust for the benefit of Clarendon to support the liabilities under the reinsurance agreement.

 
13

 
The following table provides certain information regarding our ceded reinsurance recoverables as of December 31, 2010.
 
Reinsurer
 
A.M.
Best
Rating(1)
   
Total
Paid
   
Total Unpaid Losses and LAE, net
   
Total
         
(in thousands)
ACE Bermuda Insurance Limited
    A +   $ 1,079     $ 84,674     $ 85,753
Ace Property & Casualty Insurance Company
    A +           1,568       1,568
Alterra Bermuda Limited
    A       623       5,379       6,002
American Healthcare Indemnity Co
    B +           2,684       2,684
Aspen Insurance UK Limited
    A       231       2,493       2,724
Continental Casualty Company
    A             180       180
Everest Reinsurance Company
    A +     56       4,504       4,560
Finial Reinsurance
    A  -           5,204       5,204
Hannover Rueckversicherung-AG
    A       462       5,552       6,014
Munich Reinsurance America, Inc
    A +     240       11,127       11,367
National Indemnity Company
    A ++     5,934       465,709       471,643
National Union Fire Insurance Company of Pittsburgh
    A       151       2,229       2,380
Odyssey America Reinsurance Corp
    A             502       502
PartnerRe Group
    A  -           1,796       1,796
ReliaStar Life Insurance Company
    A       199       2,833       3,032
St. Paul Fire & Marine Insurance Company
    A +     16       4,151       4,167
Swiss Reinsurance America Company
    A       1,071       11,541       12,612
Tokio Marine & Nichido Fire Ins Ltd (US)
    A ++     150       6,077       6,227
Westport Insurance Company
    A       241       1,479       1,720
XL Re Limited
    A       3,776       296,360       300,136
Lloyds Syndicates
    A       5       24,024       24,029
All Other
 
Various
      181       15,977       16,158
Total
          $ 14,415     $ 956,043     $ 970,458

(1)
A.M. Best's highest financial strength ratings for insurance companies are “A++” and “A+” (superior) and “A” and “A−” (excellent).
 
We review the aging of our reinsurance recoverables on a quarterly basis. At December 31, 2010, 4.2% of our reinsurance recoverables on paid losses were greater than 90 days overdue.
 
Inter-Company Reinsurance Pooling Agreement
 
Our insurance subsidiaries are parties to an inter-company pooling agreement for statutory reporting purposes. Under this agreement, the results of underwriting operations of each company are transferred to and combined with those of the others and the combined results are then reapportioned. The allocations under the pooling agreement are as follows:
 
 
EICN – 53%
 
ECIC – 27%
 
EPIC – 10%
 
EAC – 10%
 
Transactions under the pooling agreement are eliminated on consolidation and have no impact on our consolidated GAAP financial statements.
 
Investments
 
As of December 31, 2010, the total amortized cost of our investment portfolio was $1.95 billion and the fair market value of the portfolio was $2.08 billion. These investments provide a source of income, although short-term changes in interest rates and our current investment strategies affect the amount of investment income we earn and the fair value of our portfolio. Our investment strategy balances consideration of duration, yield, and credit risk.
 
 
14

 
We seek to maximize total investment returns within the constraints of prudent portfolio management. The asset allocation is reevaluated by the Finance Committee of the Board of Directors on a quarterly basis. We employ Conning Asset Management (Conning) as our independent investment manager. Conning follows our written investment guidelines based upon strategies approved by our Board of Directors. We also utilize Conning’s investment advisory services. These services include investment accounting and company modeling using Dynamic Financial Analysis (DFA). The DFA tool is utilized in developing a tailored set of portfolio targets and objectives, which in turn, is used in constructing an optimal portfolio.
 
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 Financial Condition and Results of Operations—Critical Accounting Policies—Investments” and “Item 7A—Quantitative and Qualitative Disclosures about Market Risk.”
 
Marketing and Distribution
 
We market and sell our workers' compensation insurance products through independent local, regional and national agents and brokers, and through our strategic partnerships and alliances, including our principal partners ADP and Anthem. We do not delegate underwriting authority to agents or brokers or to our strategic distribution partners that sell our insurance.
 
Independent Insurance Agents and Brokers
 
We establish and maintain strong, long-term relationships with independent 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 field underwriters work closely with independent agencies to market and underwrite our business, regularly visiting their offices and participating in presentations to customers. This results in enhanced understanding of the businesses and risks we underwrite and the needs of prospective customers.
 
We marketed and sold our insurance products through approximately 2,610, 2,290, and 2,350 independent insurance agencies as of December 31, 2010, 2009, and 2008, respectively. This represents an increase in our network of insurance agencies of approximately 14% in 2010 as we continue to execute our growth strategy. Those agencies produced $247.8 million, $309.5 million, and $381.9 million, or 77.1%, 80.4%, and 82.0% of our in-force premiums as of December 31, 2010, 2009, and 2008, respectively.
 
Our largest agency accounted for 1.2%, 0.7%, and 1.2% of our in-force premiums as of December 31, 2010, 2009, and 2008, respectively.
 
Strategic Partnerships and Alliances
 
We have developed important strategic relationships with companies that have established sales forces and common markets to expand our reach to alternative distribution channels. Since 2002, we have jointly marketed our workers’ compensation insurance products with ADP’s payroll services and with Anthem’s group health insurance plans. In 2010, we expanded our relationship with ADP to offer our products in 30 states and expanded our relationship with Anthem beyond California into Colorado. Additionally, we have entered into other strategic partnerships and alliances with payroll service providers and insurance brokerages, including the launch of a new program in conjunction with Hiscox USA to deliver our workers’ compensation insurance direct to small businesses online in 17 states. These relationships have allowed us to access new customers and to write attractive business in an efficient manner and we are actively pursuing additional strategic partnership and alliance opportunities.
 
Policies underwritten through our strategic partnerships and alliances generated $71.0 million, $72.3 million, and $78.9 million, or 22.1%, 18.8%, and 16.9% of our in-force premiums as of December 31, 2010, 2009, and 2008, respectively.
 
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 their insurance agency and field sales staff primarily to small businesses in 30 states. The majority of business written is 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.
 
 
15

 
ADP utilizes innovative methods to market workers' compensation insurance including the Pay-by-Pay® (PBP) program. An advantage of ADP’s PBP program is that the policyholder is not required to pay a deposit at the inception of thepolicy. The workers' compensation premium is deducted each time ADP processes the policyholders’ payrolls along with their appropriate federal, state, and local taxes. These characteristics of the PBP program enable us to competitively price the workers' compensation insurance written as a part of that program.
 
Our relationship with ADP is non-exclusive; however, we believe we are a key strategic partner of ADP for our selected markets and classes of business. Our agreement with ADP may be terminated without cause upon 120 days notice.
 
Anthem.  The Integrated MediCompSM joint marketing program is based on two agreements, a small group health insurance plan (for businesses with 1 to 50 employees) and a large group health insurance plan (for businesses with 51 to 250 employees). This exclusive relationship allows us to combine Anthem’s group health and our workers' compensation product through a single bill. In California, Anthem’s life and health agents can sell our workers’ compensation product. Integrated MediComp also offers policyholders a discount on workers’ compensation premiums. We believe that, in general, when businesses purchase this combination of coverage, their employees make fewer workers' compensation claims because those employees are insured for non-work related illnesses or injuries and thus are less likely to seek treatment for a non-work related illness or injury through their employers' workers' compensation insurance policy. Another key benefit to this program is the increased satisfaction from employees who are able to use the same medical network for occupational and non-occupational illness and injury. As the largest group health carrier in California, Anthem has negotiated favorable rates with its medical providers and associated facilities, which we benefit from through reduced claims costs. We pay Anthem fees that are a percentage of premiums received for services provided under the Integrated MediComp program.
 
The small group and large group agreements automatically renew for one-year periods unless terminated by either party with at least 60 days notice prior to the expiration of the current term. These agreements have automatically renewed through January 1, 2012 and July 1, 2011, respectively.
 
Direct Business
 
We write a small amount of business that comes to us directly without using an agent or broker or one of our strategic distribution relationships. This direct business is a legacy of our assumption of the assets and liabilities of the Fund. Although we do not market any direct business, we intend to maintain this book of business because it is very well known by our underwriters and is profitable. Policies underwritten directly generated $2.3 million, $3.2 million, and $4.8 million of our in-force premiums at December 31, 2010, 2009, and 2008, respectively.
 
Competition and Market Conditions
 
Competition in the workers’ compensation insurance business is based upon price and quality of services.  The insurance industry is highly competitive, and there is significant competition in the national workers’ compensation industry. We compete with other specialty workers' compensation carriers, state agencies, multi-line insurance companies, professional employer organizations, third-party administrators, self-insurance funds, and state insurance pools. Many of our competitors are significantly larger, are more widely known, and/or possess considerably greater financial resources. Our three primary competitors in California are the California State Compensation Insurance Fund, Berkshire Hathaway Insurance Group, and Republic Indemnity Company of America.
 
Our competitive advantages include our strong reputation in the markets in which we operate, excellent claims service, experienced and professional independent agents and brokers, and our strategic partnerships and alliances. We also strive to maintain the high quality of our care management services, and to provide consultation services to our agents and insureds on loss prevention and loss reduction strategies. We also compete on price, based on our actuarial analysis of current and anticipated loss cost trends, as appropriate.
 
The workers' compensation sector continued to see average medical and indemnity claims costs rise as claim frequency declined in 2009, while partial year data for 2010 is indicating an increase in claim frequency.
 
Currently, the industry is experiencing decreasing operating margins caused primarily by a combination of increased price competition and decreasing premiums due to continued downward rate pressure and lower payrolls. We continue to have concerns related to the volatility and uncertainty in the financial markets and current economic conditions, including the high rate of unemployment. We believe that overall market conditions, while challenging, still allow for profitable operations.
 
 
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Regulation
 
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, 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 Division of Insurance (Nevada DOI), ECIC is required to register with the California Department of Insurance (California DOI), and EPIC and EAC are required to register with the Florida Office of Insurance Regulation (Florida OIR). Under these laws, the respective state insurance departments may examine us at any time, require disclosure of material transactions and require prior notice for, or approval of, certain transactions.
 
Change of Control
 
Under Nevada insurance law and our amended and restated articles of incorporation that became effective on February 5, 2007, for a period of five years following February 5, 2007, no person may acquire or offer to acquire beneficial ownership of five percent or more of any class of our voting securities without prior approval by the Nevada Commissioner of Insurance (Nevada Commissioner) of an application for acquisition. Under Nevada insurance law, the Nevada Commissioner may not approve an application for such acquisition unless the Commissioner finds that: (a) the acquisition will not frustrate the plan of conversion as approved by our members and the Commissioner; (b) the Board of Directors of EICN has approved the acquisition or extraordinary circumstances not contemplated in the plan of conversion have arisen which would warrant approval of the acquisition; and (c) the acquisition is consistent with the purpose of relevant Nevada insurance statutes to permit conversions on terms and conditions that are fair and equitable to the members eligible to receive consideration. Accordingly, as a practical matter, any person seeking to acquire us within five years after February 5, 2007 may only do so with the approval of our Board of Directors. In December 2007, the Nevada Commissioner approved our application to waive any beneficial ownership over 5% if the excess was caused by the 2007 stock repurchase program.
 
In addition, the insurance laws of California, Florida, and Nevada generally require that any person seeking to acquire control of a domestic insurance company obtain the prior approval of the insurance commissioner. Insurance laws in many states in which we are licensed contain provisions that require pre-notification to the insurance commissioner of a change in control of a non-domestic insurance company licensed in those states. “Control” is generally presumed to exist through the direct or indirect ownership of ten percent or more of the voting securities of a domestic insurance company or of any entity that controls a domestic insurance company. Generally, other states’ insurance laws require prior notification to the insurance department of those states of a change of control of a non-domiciliary insurance company licensed to transact insurance in that state. Because we have insurance subsidiaries domiciled in California, Florida, and Nevada, any future transaction that would constitute a change in control of us would generally require the party seeking to acquire control to obtain the prior approval of the California Commissioner, the Florida Commissioner, and Nevada Commissioner, and may require pre-notification of the change of control.
 
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. As an insurance holding company, we, as well as our insurance subsidiaries, are subject to regulation by the states in which our insurance subsidiaries are domiciled or transact 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, and periodically examine market conduct.
 
 
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Detailed annual and quarterly financial statements, prepared in accordance with statutory accounting practices, 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 DOI, Florida OIR, and Nevada DOI periodically examine the statutory financial statements of their respective domiciliary insurance companies. In 2009, California and Nevada completed exams for ECIC and EICN, respectively. There were no material findings.
 
In Florida, workers’ compensation insurance companies are subject to statutes related to excessive profits. Florida excessive profits are calculated based upon a statutory formula that is applied over rolling three year periods. Workers’ compensation insurers are required to file annual excessive profit forms and to return any “Florida excessive profits” to policyholders in the form of a cash refund or credit toward the future purchase of insurance.
 
In addition, 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. Laws and regulations that limit cancellation and non-renewal and that subject program withdrawals to prior approval requirements may restrict our ability to exit unprofitable markets.
 
Premium Rate Restrictions
 
State laws regulate not only the amounts and types of workers' compensation benefits that must be paid to injured workers, but in some instances the premium rates that we may charge to insure businesses for those liabilities. In administered pricing states, including Florida, Wisconsin, and Idaho, premium rates are set by state insurance regulators and are adjusted periodically. Idaho also allows insurance companies to file rates that deviate upwards or downwards from the benchmark rates set by the insurance regulators.
 
In the vast majority of states, workers' compensation insurers have flexibility to offer rates that reflect the risk assumed by the insurer based on each employer's profile. These states are referred to as “loss cost” states. Most states in which we currently operate, including California, are loss cost states. In loss cost states, the state first approves a set of loss costs that provide for expected loss and, in most cases, LAE payments, which are prepared by an insurance rating bureau (for example, the WCIRB in California). An insurer then selects a factor, known as a loss cost multiplier, to apply to loss costs to determine its rates. In these states, regulators permit pricing flexibility primarily through: (a) the selection of the loss cost multiplier; and (b) schedule rating modifications that allow an insurer to adjust premiums upward or downward for specific risk characteristics of the policyholder such as:
 
 
type of work;
 
on-site medical facilities;
 
level of employee safety;
 
use of safety equipment; and
 
policyholder management practices.
 
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 law 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 our common stock and to pay other expenses will be dependent to a significant extent upon the ability of our Nevada domiciled insurance company, EICN, and our Florida domiciled insurance company, EPIC, to pay dividends to their immediate holding company, Employers Group, Inc. (EGI) and, in turn, the ability of EGI to pay dividends to EHI. Additional information regarding financial, dividend, and investment restrictions is set forth in Note 16 in the Notes to our Consolidated Financial Statements, included elsewhere in this report.
 
 
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Guaranty Fund Assessments
 
All of the states where our insurance subsidiaries are licensed to transact business require property and casualty insurers doing business within the respective state to participate as member insurers in a guaranty association, which is organized to pay contractual benefits owed pursuant to insurance policies issued by insolvent or failed insurers. These associations levy assessments, up to prescribed limits, on all member insurers in a particular state on the basis of the proportionate share of the premium written by member insurers.
 
In California, unpaid workers' compensation liabilities from insolvent insurers are the responsibility of the California Insurance Guarantee Association (CIGA). We pass CIGA assessments on to our policyholders, via a surcharge based upon the estimated annual premium at the policy's inception. We have recorded an asset of $6.2 million as of December 31, 2010, for assessments paid to CIGA that includes prepaid policy surcharges to be collected in the future from policyholders. We also write workers' compensation insurance in other states with similar obligations as those in California. In these states, we are directly responsible for payment of the assessment. We recorded an estimate of $2.1 million and $4.5 million for our expected liability for guaranty fund assessments at December 31, 2010 and 2009, respectively.
 
Pooling Arrangements
 
As a condition to conduct business in some states, including California, 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 due, for example, to their prior loss experiences.
 
The National Association of Insurance Commissioners (NAIC)
 
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, to a lesser extent, other states in which they conduct business, the NAIC is influential in determining the form in which such 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, 2010, 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 commissioners as to certain aspects of an insurer’s business. None of our insurance subsidiaries are currently subject to any action by any state regulator with respect to IRIS ratios.
 
Statutory Accounting and Solvency Regulations
 
State regulation of insurance company financial transactions and financial condition are based on statutory accounting principles (SAP). SAP differs in a number of ways from GAAP, which governs the financial reporting of most other businesses.  SAP financial statements are generally more conservative than GAAP financial statements, reflecting lower asset balances, higher liability balances and lower equity.
 
 
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State insurance regulators closely monitor the financial condition of insurance companies reflected in SAP financial statements 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.
 
Privacy Regulations
 
In 1999, the United States Congress enacted the Gramm-Leach-Bliley Act, which, among other things, protects consumers from the unauthorized dissemination of certain personal non-public financial information. Subsequently, a majority of states adopted additional regulations to address privacy issues. These laws and regulations apply to all financial institutions, including insurance and finance companies, and require us to maintain appropriate procedures for managing and protecting certain personal information of our customers and to fully disclose our privacy practices to our customers. In 2000, the NAIC adopted the Privacy of Consumer Financial and Health Information Model Regulation, which assisted states in promulgating regulations to comply with the Gramm-Leach-Bliley Act. In 2002, to further facilitate the implementation of the Gramm-Leach-Bliley Act, the NAIC adopted the Standards for Safeguarding Customer Information Model Regulation. Our insurance subsidiaries have established policies and procedures to comply with the Gramm-Leach-Bliley-related state privacy requirements.
 
Federal Legislative Changes
 
The Terrorism Risk Insurance Act of 2002 (the 2002 Act) was enacted in November 2002. The principal purpose of the 2002 Act was to create a role for the Federal government in the provision of insurance for losses sustained in connection with foreign terrorism. Prior to the Act, insurance (except for workers' compensation insurance) and reinsurance for losses arising out of acts of terrorism were largely unavailable from private insurance and reinsurance companies.
 
The 2002 Act was extended by TRIPRA, with the inclusion of some adjustments. The workers' compensation laws of the various states generally do not permit the exclusion of coverage for losses arising from terrorism or nuclear, biological, and chemical or radiological attacks. In addition, we are not able to limit our losses arising from any one catastrophe or any one claimant. Our reinsurance policies exclude coverage for losses arising out of nuclear, biological, chemical or radiological attacks. Under TRIPRA, federal protection is currently provided to the insurance industry for events, including acts of foreign and domestic terrorism, that result in an industry loss of at least $100 million in 2007 through 2014. In the event of a qualifying industry loss (which must occur out of an act of terrorism certified as such by the Secretary of the Treasury), each insurance company is responsible for a deductible of 20% of direct earned premiums in the previous year, with the federal government responsible to reimburse each company for 85% of the insurer’s loss up to the insurer’s proportionate share of the $100 billion industry aggregate limit in any one year. Accordingly, events may not be covered by, or may result in losses exceeding the capacity of our reinsurance protection and any protection offered by the TRIPRA or any subsequent legislation.
 
Small businesses constitute a large portion of our policies, and we monitor the geographic concentration of our policyholders to help mitigate the risk of loss from terrorist acts. The impact of any future terrorist acts is 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.
 
Current economic conditions have also raised the possibility of future legislative and regulatory actions, in addition to the enactment of the Emergency Economic Stabilization Act of 2008 (EESA) and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which could further impact our business. We cannot predict whether or when such actions may occur, or what effect, if any, such actions could have on our business, results of operations, and financial condition.
 
The Patient Protection and Affordable Care Act, as amended by the Healthcare and Education Reconciliation Act (Affordable Care Act), was enacted in March 2010. We cannot predict what affect, if any, the implementation of the provisions of the Affordable Care Act, which will continue through 2014, will have on our business, results of operations, or financial condition.
 
 
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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 in this annual report. The risks facing our company include, but are not limited to, those described below. The occurrence of one or more of these events could significantly and adversely affect our business, prospects, financial condition, results of operations, cash flows and stock price and you could lose all or part of your investment.
 
Risks Related to Our Business
 
Difficult conditions in the economy and capital markets may adversely affect our profitability, financial condition and results of operations.
 
The significant financial market volatility experienced worldwide during 2008 and 2009 continued into 2010. Although the U.S. and other foreign governments have taken various actions to stabilize the financial markets, it is uncertain whether those actions will be effective over the long-term. Therefore, the financial market volatility could continue, resulting in a prolonged negative economic impact.
 
We cannot predict future market conditions or their impact on our stock price, investment portfolio, or our workers' compensation business. In addition, continuing financial market volatility and economic downturn could have a material adverse affect on our insureds, agents, claimants, reinsurers, vendors, and competitors. Depending on financial market conditions, we could incur additional realized and unrealized losses in the future in our investment portfolio, which could have an adverse effect on our results of operations and financial condition. Reduced employment and payrolls have contributed to the decline in our premium. Selection of customers is more complex as certain businesses are facing unprecedented challenges in sustaining their operations. Over time we expect that recovery from the recession will improve hiring and payroll trends, but we cannot predict when this will occur.
 
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 in 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.
 
Several factors contribute to the 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 the 2003 and 2004 legislative reforms in California and the 2003 legislative reforms in Florida. 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 to establish our best estimate of reserves for losses and LAE. The interpretation of historical data can be impacted by external forces, principally legislative changes, medical cost inflation, economic fluctuations, judicial decisions, and legal trends. 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. 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.
 
Our estimates of incurred losses and LAE attributable to insured events of prior years have decreased for past accident years because actual losses and LAE paid and current projections of unpaid losses and LAE were less than we originally anticipated. These estimates are established by management utilizing actuarial indications based upon our historical and industry 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. While we have generally had favorable developments over the past five years, the inherent uncertainty in our liability for losses and LAE could result in favorable or unfavorable developments in the future.
 
 
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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. As of December 31, 2010, 53.8% of our in-force premiums were generated in California. Accordingly, we are particularly affected by regulation in California. The passage of any form of rate regulation in California could impair our ability to operate profitably in California, and any such impairment could have a material adverse effect on our financial condition and results of operations. Insurance regulators have broad regulatory powers designed to protect policyholders and claimants, not stockholders or other investors. Regulations vary from state to state, but typically address or include:
 
 
standards of solvency, including risk-based capital 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;
 
mandates that may affect wage replacement and medical care benefits paid under the workers' compensation system;
 
requirements for the handling and reporting of claims;
 
procedures for adjusting claims, which can affect the cost of a claim;
 
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, and other purposes;
 
limitations on our ability to transact business with affiliates;
 
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;
 
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.
 
In addition, 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. 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.
 
Legislation and regulation also 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 regulations. Since healthcare costs are the largest component of our loss costs, we may be impacted by changes in healthcare legislation, such as the Affordable Care Act. Also, the unprecedented events in the financial markets have re-opened discussions regarding 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. 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.
 
 
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If we fail to price our insurance policies appropriately, our business competitiveness, financial condition, or 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 could put us at risk for mispricing our policies. For example, when initiating coverage on a policyholder, we must rely on the information provided by the policyholder or the policyholder's previous insurer(s) to properly estimate future claims expense. If the claims information is not accurately stated, we may under price our policies by using claims estimates that are too low. In order to set premium rates accurately, we must utilize an appropriate pricing model which correctly assesses risks based on their individual characteristics and takes into account actual and projected industry characteristics. As a result, our business, financial condition, and results of operations could be materially adversely affected.
 
Our concentration in California ties our performance to the business, economic, demographic, natural perils, and regulatory conditions in that state.
 
Our business is concentrated in California, where we generated 53.8% of our in-force premiums as of December 31, 2010. Accordingly, unfavorable business, economic, demographic, competitive, or regulatory conditions in California could negatively impact our business.
 
California has been greatly affected by the overall economic downturn, tightening of the credit markets, and the resulting impacts on the residential real estate markets. California is also experiencing budget deficits. The economic condition of the state has resulted in high unemployment and decreased payrolls. In addition, many California businesses are dependent on tourism revenues, which are, in turn, dependent on a robust economy. The downturn in the national economy and 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 or insolvency of a significant number of small businesses could also have a material adverse effect on our financial condition or results of operations. In addition, California is exposed to climate and environmental changes, natural perils such as earthquakes, along with the possibility of pandemics or terrorist acts. Accordingly, we could suffer losses as a result of catastrophic events in this state. Because our business is concentrated in this manner, we may be exposed to economic and regulatory risks or risk from natural perils that are greater than the risks associated with greater geographic diversification.
 
We rely on independent insurance agents and brokers.
 
We market and sell our insurance products primarily 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. The loss of a number of our independent agents and brokers or the failure or inability of these agents to successfully market our insurance programs could have a material adverse effect on our business, financial condition and results of operations. 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.
 
We rely on our principal strategic partners.
 
We have agreements with two principal strategic partners, ADP and Anthem, to market and service our insurance products through their sales forces and insurance agencies. The in-force premiums for ADP and Anthem were 9.5% and 11.6%, respectively, of total in-force premiums as of December 31, 2010. Our agreement with ADP is not exclusive, and ADP may terminate the agreement without cause upon 120 days notice. Although our distribution agreements with Anthem are exclusive, Anthem may terminate its agreements with us if the A.M. Best financial strength rating of ECIC is downgraded and we are not able to provide coverage through a carrier with an A.M. Best financial strength rating of “B++” or better. Anthem may also terminate its agreements with us without cause upon 60 days notice. The termination of any of our principal strategic partnership agreements, our failure to maintain good relationships with our principal strategic partners, or their 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 our principal strategic partners may face financial difficulties, reputational issues, or problems with respect to their own products and services, which may lead to decreased sales of our products and services. Moreover, if either of our principal strategic partners consolidates or aligns itself with another company or changes its products that are currently offered with our workers' compensation insurance product, we may lose business or suffer decreased revenues.
 
 
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We are also subject to credit risk with respect to ADP and Anthem, as they collect premiums on our behalf for the workers' compensation products that are marketed together with their 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) 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−” 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. Insurance 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 strategic partners.
 
In view of the difficulties experienced recently by many financial institutions, including our competitors in the insurance industry, we believe that it is possible that external rating agencies, such as A.M. Best, may increase their scrutiny of financial institutions, increase the frequency and scope of their reviews, request additional information from the companies that they rate, including additional information regarding the valuation of investment securities held, and may adjust upward the capital and other requirements employed in their models for maintenance of certain rating levels. We cannot predict what actions rating agencies may take, or what actions we may take in response to the actions of rating agencies.
 
One of our strategic partners, Anthem, requires that we offer workers’ compensation coverage through a carrier with a financial strength rating of “B++” or better by A.M. Best. We currently offer this coverage through our subsidiary, ECIC. Our inability to offer such coverage could cause a reduction in the number of policies we write. If ECIC's financial strength rating were downgraded, and we were not able to enter into an agreement to provide coverage through a carrier rated “B++” or better by A.M. Best, Anthem could terminate its distribution agreements with us. We cannot assure you that we would be able to enter such an agreement if our rating was downgraded.
 
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, 2010, we had $970.5 million of reinsurance recoverables for paid and unpaid losses and LAE of which $14.4 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, 2010, we entered into a new reinsurance program that is effective through June 30, 2011. The reinsurance program consists of one treaty covering excess of loss and catastrophic loss events in five layers of coverage. Our reinsurance coverage is $195.0 million in excess of our $5.0 million retention on a per occurrence basis, subject to a $2.0 million annual aggregate deductible and 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 upon terms satisfactory to us. If we are unable to renew or replace our reinsurance agreements upon terms satisfactory to us, our net liability on individual risks would increase and we would have greater exposure to catastrophic losses, which could have a material adverse affect on our financial condition and results of operations.
 
 
24

 
In addition, we are subject to credit risk with respect to our reinsurers, and they may also refuse to pay or may delay payment of losses we cede to them. We remain liable to our policyholders even if we are unable to make recoveries to which we believe we are entitled 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 to which we are entitled, see “Item 1—Business —Reinsurance.” The inability of any of our reinsurers to meet its financial obligations could have a material adverse affect 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 party to such transaction.
 
On January 1, 2000, our Nevada insurance subsidiary assumed all of the assets, liabilities and operations of the Fund, including losses incurred by the Fund prior to such date. Our Nevada insurance subsidiary 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.” 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 party to such transaction. With the exception of certain losses assumed from the Fund, these recoverables are unsecured. If we are unable to collect on these reinsurance recoverables, our financial condition and results of operations could be materially adversely affected. As of December 31, 2010, the estimated remaining liabilities subject to the LPT Agreement were approximately $846.7 million.
 
The reinsurers under the LPT Agreement agreed to assume responsibilities 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. Similarly, if the credit rating of any of the third party reinsurers that are party to the LPT Agreement were to fall below ‘‘A−’’ as determined by A.M. Best or one of the reinsurers becomes insolvent, we would be responsible for replacing any such reinsurer or would be liable for the claims that otherwise would have been transferred to such reinsurer. For example, in 2002, the rating of one of the original reinsurers under the LPT Agreement, Gerling Global International Reinsurance Company Ltd. (Gerling), dropped below the mandatory ‘‘A−’’ A.M. Best rating to ‘‘B+.’’ Accordingly, we entered into an agreement to replace Gerling with National Indemnity Company (NICO) at a cost to us of $32.8 million. We can give no assurance that circumstances requiring us to replace one or more of the current reinsurers under the LPT Agreement will not occur in the future, that we will be successful in replacing such reinsurer or reinsurers in such circumstances, or that the cost of such replacement or replacements will not have a material adverse effect on our results of operations or financial condition.
 
The LPT Agreement also required the reinsurers to each 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, 2010 was approximately $962.1 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, with a value of $729.3 million at December 31, 2010, in a trust to secure the reinsurer's obligation of $472.6 million. The value of this collateral is subject to fluctuations in the market price of such stock. The other reinsurers have placed treasury and fixed maturity securities in trusts to collateralize their obligations.
 
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, 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, dividends or payment plans, services or commissions to independent agents, brokers and other distributors,
 
 
25

 
we could lose market share or have to reduce our premium 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 in each of the states in which we currently operate 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. 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 companies generally tends to follow this cyclical market pattern. We believe the workers’ compensation industry is currently experiencing increased price competition and excess underwriting capacity. This results in lower rate levels and smaller profit margins.
 
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. We have experienced significant increased price competition in our target markets since 2003. 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 and financial condition 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 an independent asset manager that operates 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 spread risk, credit risk, and equity price risk. For more information regarding market, interest rate, credit risk, or equity price 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” 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 falling interest rates, deterioration in the credit of companies 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 policyholders’ surplus.
 
 
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The valuation of our investments, including the determination of the amount of impairments, include estimates and assumptions  and could result in changes to investment valuations that may adversely affect our financial condition and results of operations.
 
Our estimates of fair value for our investments are based upon the inputs used in the valuation and give the highest priority to quoted prices in active markets and require that observable inputs be used in the valuations when available. In determining the level of the hierarchy in which the valuation is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company’s significant market assumptions. 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 our entire investment portfolio, 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 our management has accurately assessed the level of impairments in determining the other-than-temporary impairments reflected in our financial statements and additional impairments may need to be taken in the future. Historical trends may not be indicative of future impairments. Additional information regarding the determination impairments on our investments is set forth under “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations —Investments.”
 
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 and 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, dilution to our stockholders could result and the securities may have rights, preferences, and privileges senior to the 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, or results of operations could be materially adversely affected.
 
The capital and credit markets continue to experience volatility and disruption that have negatively affected market liquidity conditions. In some cases, the markets have produced downward pressure on stock prices and limited the availability of credit for certain issuers without regard to those issuers’ underlying financial strength. As a result, we may 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.
 
We have outstanding indebtedness, which could impair our financial strength ratings and adversely affect our ability to react to changes in our business and fulfill our debt obligations.
 
Our indebtedness could have significant consequences, including:
 
 
·
making it more difficult for us to satisfy our financial obligations;
 
·
limiting our ability to borrow additional amounts to fund working capital, capital expenditures, debt service requirements, the execution of our business strategy, acquisitions, and other purposes;
 
·
affecting the way we manage our business due to restrictive covenants;
 
·
requiring us to provide collateral which restricts our use of funds;
 
·
requiring us to use a portion of our cash flow from operations to pay principal and interest on our debt; and
 
·
making us more vulnerable to adverse changes in general economic and industry conditions, and limiting our flexibility to plan for, and react quickly to, changing conditions.
 
 
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We rely on our information technology and telecommunication systems, and the failure of 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 new and renewal business, provide customer service, administer and make payments on claims, facilitate collections, and to 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. Our information technology and telecommunications systems interface with and depend on third-party systems; and we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions.
 
Certain events outside of our control could render our systems inoperable such that we would be unable to service our agents, insureds, and injured workers, or meet certain regulatory requirements. If such an event were to occur and our systems were unable to be restored or secured within a reasonable timeframe, our results of operations and financial condition could be adversely affected. Additionally, 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 possible liability.
 
Acts of terrorism and 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, the TRIPRA, 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 the TRIPRA (see “Item 1—Business—Regulation—Federal Legislative Changes”) and could suffer substantial losses as a result.
 
Our operations also expose us to claims arising out of 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 states in which we operate could expose us to potentially substantial losses and, accordingly, could have a material adverse effect on our financial condition and results of operations.
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 obligations on outstanding debt, to pay stockholder dividends and to make other payments, depends on the surplus and earnings of our subsidiaries and their ability to pay dividends or to advance or repay funds, 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, see “Item 1—Business—Regulation—Financial, Dividend and Investment Restrictions” and Note 16 in the Notes to our Consolidated Financial Statements. 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.
 
 
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Administrative proceedings or legal actions involving our insurance subsidiaries could have a material adverse effect on our business, financial condition or results of operations.
 
Our insurance subsidiaries are involved in various administrative proceedings and legal actions in the normal course of their insurance operations. Our subsidiaries have responded to the actions and intend to defend against these claims. These claims concern issues including eligibility for workers' compensation insurance coverage or benefits, the extent of injuries, wage determinations, and disability ratings. 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 expertise, knowledge of our markets, and relationships with the independent agents and brokers that sell our products.
 
Our success depends in substantial part upon our ability to attract and retain qualified executive officers, experienced underwriting 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 Douglas D. Dirks, our President and Chief Executive Officer, and William E. Yocke, our Executive Vice President and Chief Financial Officer. Many of our regional and local officers are also critical 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 do not maintain key man life insurance for our executives or senior management team. If we were to lose the services of members of our management team or key regional or local officers, 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 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 established 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 surcharge mechanisms. 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.
 
Insurance laws of Nevada, California, Florida, and other applicable states, certain provisions of our charter documents, and Nevada corporation law could prevent or delay a change of control that could be beneficial to us and our stockholders.
 
Under Nevada insurance law and our amended and restated articles of incorporation that became effective upon completion of the conversion, for a period of five years following February 5, 2007 or, if earlier, until such date as we no longer directly or indirectly own a majority of the outstanding voting stock of EICN, no person may directly or indirectly acquire or offer to acquire in any manner beneficial ownership of 5% or more of any class of our voting securities without the prior approval of the Nevada Commissioner, see “Item 1—Business—Regulation—Change of Control.”
 
Additionally, we have insurance subsidiaries domiciled in California and Florida. The insurance laws of California and Florida require prior approval from the California DOI and the Florida OIR for any change of control of the subsidiary domiciled in their respective states. Insurance laws in many other states also contain provisions that require pre-notification to the insurance commissioners of a change in control of a non-domestic insurance company licensed in those states. 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, while 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. Because we have insurance subsidiaries domiciled in California, Florida, and Nevada, any future transaction that would constitute a change in control of us would generally require the party acquiring control to obtain the prior approval of the
 
 
29

 
California Commissioner, Florida Commissioner and the Nevada Commissioner and may require pre-notification in those states that have adopted pre-notification provisions upon a change of control. Obtaining 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 beneficial 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 in their best interests. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect Directors and take other corporate actions. In particular, our amended and restated articles of incorporation and amended and restated by-laws include provisions:
 
 
dividing our Board of Directors into three classes;
 
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 or for proposing matters that can be acted upon by stockholders at the stockholder meetings;
 
prohibiting stockholder action by written consent, thereby limiting stockholder action to that taken at a meeting of our stockholders; and
 
providing our Board of Directors with exclusive authority to adopt or amend our by-laws.
 
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.
 
Item 1B.  Unresolved Staff Comments
 
None.
 
Item 2.  Properties
 
Our principal executive offices are 79,533 square feet located in leased premises in Reno, Nevada. In addition to serving as our corporate headquarters, it also serves as a branch office providing services in marketing, loss control, and underwriting related support. As of February 1, 2011, we leased 308,042 square feet of total office space in 13 states. We also own a 15,120 square foot building in Carson City, Nevada, which is used as a storage facility. We believe that our existing office space is adequate for our current needs and we will continue to enter into or exit lease agreements to address future space requirements, as necessary.
 
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. 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.  (Removed and Reserved)
 
 
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PART II
 
 
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Market Information and Holders
 
Our common stock has been listed on the New York Stock Exchange (NYSE) under the symbol “EIG” since our IPO on January 31, 2007. Prior to that time, there was no public market for our common stock.
 
The table below sets forth the reported high and low sales prices for our common stock for each quarterly period as reported by the NYSE during the last two fiscal years.
 
2009
 
High
   
Low
 
First quarter
  $ 16.44     $ 8.25  
Second quarter
    13.90       8.00  
Third quarter
    15.94       11.99  
Fourth quarter
    16.73       13.90  
                 
2010
 
High
   
Low
 
First quarter
  $ 15.75     $ 12.31  
Second quarter
    17.27       14.09  
Third quarter
    16.87       13.92  
Fourth quarter
    17.75       15.16  
 
There were 1,690 holders of record as of February 18, 2011.
 
Limitations on Acquisitions of Common Stock
 
Under Nevada insurance law and our amended and restated articles of incorporation that became effective on completion of the conversion, for a period of five years following February 5, 2007 or, if earlier, until such date as EHI no longer directly or indirectly owns a majority of the outstanding voting stock of EICN, no person may directly or indirectly acquire or offer to acquire in any manner beneficial ownership of five percent or more of any class of voting securities of EHI without the prior approval by the Nevada Commissioner of an application for acquisition under Section 693A.500 of the Nevada Revised Statutes. Under Nevada insurance law, the Nevada Commissioner may not approve an application for such acquisition unless the Commissioner finds that: (a) the acquisition will not frustrate the plan of conversion as approved by our members and the Commissioner; (b) our Board of Directors has approved the acquisition or extraordinary circumstances not contemplated in the plan of conversion have arisen which would warrant approval of the acquisition; and (c) the acquisition is consistent with the purpose of relevant Nevada insurance statutes to permit conversions on terms and conditions that are fair and equitable to the members eligible to receive consideration. Accordingly, as a practical matter, any person seeking to acquire us within five years after February 5, 2007 may only do so with the approval of the Board of Directors of EICN. Furthermore, any person or entity who individually or together with an affiliate (as defined by applicable law) seeks to directly or indirectly acquire in any manner, at any time, beneficial ownership of 5% or more of any class of our voting securities will be subject to certain requirements, including the prior approval of the proposed acquisition by certain state insurance regulators, depending upon the circumstances involved. Any such acquisition without prior satisfaction of applicable regulatory requirements may be deemed void under state law.
 
 
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Stockholder Dividends
 
Our Board of Directors has authorized the payment of a quarterly dividend of $0.06 per share of common stock to our stockholders of record in every quarter since the second quarter of 2007. Any determination to 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 subsidiaries and their ability to pay dividends and/or other statutorily permissible payments to us, in particular the ability of EICN and EPIC to pay dividends to EGI and, in turn, the ability of EGI to pay dividends to EHI;
 
our results of operations and cash flows;
 
our financial position and capital requirements;
 
general business conditions;
 
any legal, tax, regulatory, and contractual restrictions on the payment of dividends; and
 
any other factors our Board of Directors deems relevant.
 
Following is a summary of dividends paid to stockholders by EHI:
 
Dividends Declared
 
First
   
Second
   
Third
   
Fourth
2009
  $ 0.06     $ 0.06     $ 0.06     $ 0.06
2010
  $ 0.06     $ 0.06     $ 0.06     $ 0.06
 
On February 23, 2011, the EHI Board of Directors (Board of Directors) declared a $0.06 dividend per share, payable March 23, 2011, to stockholders of record on March 9, 2011. It is currently expected that cash dividends will continue to be paid in the future.
 
Issuer Purchases of Equity Securities
 
The following table summarizes the repurchase of our common stock for the quarter ended December 31, 2010:
 
Period
 
Total
Number of
Shares
Purchased
   
Average
Price
Paid Per
Share (1)
   
Total Number
of Shares Purchased
as Part of Publicly
Announced
Programs
   
Approximate
Dollar Value of
Shares that May Yet be Purchased Under the Program (2)
                     
(in millions)
October 1 – October 31, 2010
        $           $
November 1 – November 30, 2010
    429,843       16.10       429,843       93.1
December 1 – December 31, 2010
    437,306       17.07       437,306       85.6
Total Repurchases
    867,149       16.59       867,149        

(1)
Includes fees and commissions paid on stock repurchases.
 
(2)
On November 3, 2010, the Board of Directors authorized a share repurchase program for up to $100 million of the Company's common stock (the 2011 Program). We expect that shares may be purchased at prevailing market prices from November 8, 2010 through June 30, 2012 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 2011 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.
 
In November 2009, the Board of Directors authorized a share repurchase program for $50 million of the Company’s common stock from January 1, 2010 through December 31, 2010 (the 2010 Program). Through September 30, 2010, we repurchased a total of 3,291,709 shares of common stock under the 2010 Program at an average price of $15.19 per share, including commissions, for a total of $50.0 million.
 
 
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Performance Graph
 
Our common stock has been listed on the NYSE since our intial public offering on January 31, 2007. The following graph compares the cumulative total return on $100 invested in the common stock of EHI, ticker symbol EIG, for the period commencing on January 31, 2007 and ending on December 31, 2010 with the cumulative total return on $100 invested in each of the Standard and Poor’s 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 Security Exchange Act of 1934, except to the extent that we specifically incorporate it by reference into such filing.
 
performance graph
         
 
 
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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 Financial Condition and Results of Operations’’ and the consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K.
 
   
Years Ended December 31,
 
   
2010
   
2009
   
2008(1)
   
2007
   
2006
 
Income Statement Data
 
(in thousands, except per share amounts and ratios)
 
Revenues:
                             
Net premiums earned
  $ 321,786     $ 404,247     $ 328,947     $ 346,884     $ 392,986  
Net investment income
    83,032       90,484       78,062       78,623       68,187  
Realized gains (losses) on investments, net
    10,137       791       (11,524 )     180       54,277  
Other income
    649       413       1,293       4,236       4,800  
Total revenues
    415,604       495,935       396,778       429,923       520,250  
Net income before income taxes
    66,322       92,298       112,051       150,886       254,292  
Income tax expense
    3,523       9,277       10,266       30,603       82,722  
Net income
  $ 62,799     $ 83,021     $ 101,785     $ 120,283     $ 171,570  
Earnings per common share(2)
                                       
Basic
  $ 1.52     $ 1.81     $ 2.07     $ 2.19          
Diluted
    1.51       1.80       2.07       2.19          
Pro forma earnings per common share -basic and diluted-(2)
                            2.32     $ 3.43  
                                         
Selected Operating Data
                                       
Gross premiums written(3)
  $ 322,277     $ 379,949     $ 318,392     $ 351,847     $ 386,796  
Net premiums written(4)
    313,098       368,290       308,317       339,720       372,224  
Combined ratio(5)
    106.8 %     98.0 %     85.9 %     80.4 %     67.7 %
Net income before impact of the deferred reinsurance gain—
     LPT Agreement(6)(7)(8)
  $ 44,566     $ 65,014     $ 83,364     $ 102,249     $ 152,197  
Earnings per common share before impact of LPT(6)
                                       
Basic
  $ 1.08     $ 1.42     $ 1.69                  
Diluted
    1.07       1.41       1.69                  
Pro forma earnings per common share—basic and
     diluted before impact of LPT(2)(8)
                          $ 1.98     $ 3.04  
Dividends declared
    0.24       0.24       0.24       0.18        
 
34

 
 
   
As of December 31,
   
2010
   
2009
   
2008(1)
   
2007
   
2006
Balance Sheet Data
 
(in thousands, except per share amounts and ratios)
Cash and cash equivalents
  $ 119,825     $ 188,883     $ 197,429     $ 144,384     $ 74,039
Total investments
    2,080,494       2,029,560       2,042,941       1,726,280       1,715,673
Reinsurance recoverable on paid and unpaid losses
    970,458       1,064,843       1,087,738       1,061,551       1,107,900
Total assets
    3,480,120       3,676,653       3,825,098       3,264,309       3,266,840
Unpaid losses and loss adjustment expense
    2,279,729       2,425,658       2,506,478       2,269,710       2,307,755
Deferred reinsurance gain—LPT Agreement(6)(7)
    370,341       388,574       406,581       425,002       443,036
Notes payable
    132,000       132,000       182,000            
Total liabilities
    2,990,004       3,178,254       3,380,370       2,884,856       2,963,063
Total equity
    490,116       498,399       444,728       379,453       303,777
                                       
Other Financial Data
                                     
Total equity including deferred reinsurance gain —
     LPT Agreement(6)(7)(9)
  $ 860,457     $ 886,973     $ 851,309     $ 804,455     $ 746,813

(1)
The income statement data for the year ended December 31, 2008 includes the operating results of AmCOMP from November 1, 2008 through December 31, 2008. The balance sheet data as of December 31, 2008 includes the assets and liabilities acquired from AmCOMP (see Note 4 in the Notes to our Consolidated Financial Statements which are included elsewhere in this report).
 
 
(2)
For 2007, the pro forma earnings per common share –basic– was calculated using the net income for the 12 months ended December 31, 2007, as presented on the accompanying consolidated statements of income. The weighted average shares outstanding was calculated using those shares available to eligible members in the conversion (50,000,002) for the period prior to the IPO, and the actual weighted average shares outstanding for the period after the IPO. Earnings per common share –diluted– is based on the pro forma weighted shares outstanding – basic – adjusted by the number of additional common shares that would have been outstanding had potentially dilutive common shares been issued and reduced by the number of common shares that could have been purchased from the proceeds of the potentially dilutive shares. Outstanding options have been excluded from the diluted earnings per share for the pro forma year ended December 31, 2007, because their inclusion would be anti-dilutive. Although there were 8,665 dilutive potential common shares at December 31, 2007, they did not impact the pro forma earnings per share number as shown.  (See Note 19 in the Notes to our Consolidated Financial Statements.)
 
For 2006, the pro forma earnings per common share – basic and diluted – is presented to depict the impact of our conversion described above, as prior to the conversion we did not have any outstanding common shares. The pro forma earnings per common share –basic and diluted– was computed using only the shares of the our common stock issued to eligible members in the conversion (50,000,002), and does not include any shares issued to new investors in connection with our IPO or the impact of the cash elections made by eligible members. We had no common stock equivalents outstanding for the periods presented prior to 2007 that would create a dilutive effect on pro forma earnings per share.
 
(3)
Gross premiums written is the sum of both 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 and a previous fronting facility. (See Note 10 in the Notes to our Consolidated Financial Statements.)
 
(4)
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.)
 
(5)
Combined ratio is the sum of the losses and LAE expense, the commission expense, dividends to policyholders, and the underwriting and other operating expenses, all divided by net earned premiums. Because we only have one operating segment, holding company expenses are included in the combined ratio.
 
(6)
In connection with our January 1, 2000 assumption of the assets, liabilities and operations of the Fund, our Nevada insurance subsidiary 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 exposure to losses for pre-July 1, 1995 Nevada insured risks. Pursuant to the
 
 
35

 
LPT Agreement, the Fund initially ceded $1.525 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.
 
(7)
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, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries, and the amortization is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT Agreement. Our reevaluation results in corresponding adjustments, if needed, to reserves, ceded reserves, reinsurance recoverables and the deferred reinsurance gain, with the net effect being an increase or decrease, as the case may be, to net income.
 
(8)
We define net income before impact of the deferred reinsurance gain—LPT Agreement as net income less: (a) amortization of deferred reinsurance gain—LPT Agreement and (b) adjustments to LPT Agreement ceded reserves. For 2006, we define pro forma earnings per share –basic and diluted– before impact of the LPT Agreement as net income before impact of the deferred reinsurance gain—LPT Agreement divided by the common shares issued in our conversion (50,000,002).  These are not measurements of financial performance under GAAP, but rather reflect the difference in accounting treatment between statutory 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 deferred reinsurance gain—LPT Agreement because we believe that it is an important supplemental measure of operating performance to be used by analysts, investors, and other interested parties in evaluating us. We present pro forma earnings per share –basic and diluted– before impact of the deferred reinsurance gain—LPT Agreement because we believe that it is an important supplemental measure of performance by outstanding common share issued in our conversion.
 
The LPT Agreement was a non-recurring transaction which does not result in ongoing cash benefits 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 item excluded has limited significance in our current and ongoing operations.
 
The table below shows the reconciliation of net income to net income before impact of the deferred reinsurance gain – LPT Agreement for the periods presented:
 
   
Years Ended December 31,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
   
(in thousands)
 
Net income
  $ 62,799     $ 83,021     $ 101,785     $ 120,283     $ 171,570