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EX-32.2 - EXHIBIT 32.2 - Employers Holdings, Inc.eig-ex322_2017331.htm
EX-32.1 - EXHIBIT 32.1 - Employers Holdings, Inc.eig-ex321_2017331.htm
EX-31.2 - EXHIBIT 31.2 - Employers Holdings, Inc.eig-ex312_2017331.htm
EX-31.1 - EXHIBIT 31.1 - Employers Holdings, Inc.eig-ex311_2017331.htm
EX-10.3 - EXHIBIT 10.3 - Employers Holdings, Inc.ex103_rsuagreementx33117.htm
EX-10.2 - EXHIBIT 10.2 - Employers Holdings, Inc.ex102_psuagreementx33117.htm
EX-10.1 - EXHIBIT 10.1 - Employers Holdings, Inc.ex101_tbergemploymentagree.htm
EX-3.1 - EXHIBIT 3.1 - Employers Holdings, Inc.ex31_amendedandrestatedbyl.htm


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549


FORM 10-Q

R  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended March 31, 2017

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
(I.R.S. Employer
Identification Number)
 
 
 
10375 Professional Circle, Reno, Nevada  89521
(Address of principal executive offices and zip code)
(888) 682-6671
(Registrant’s telephone number, including area code)
 
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 R 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 R No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer R
Accelerated filer o
Non-accelerated filer o
  Smaller reporting company o
 
 
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No R
Class
 
April 20, 2017
Common Stock, $0.01 par value per share
 
32,278,012 shares outstanding




 
 
Page
No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2



PART IFINANCIAL INFORMATION
Item 1.  Consolidated Financial Statements
Employers Holdings, Inc. and Subsidiaries
Consolidated Balance Sheets
(in millions, except share data)
 
 
As of
 
As of
 
 
March 31,
2017
 
December 31,
2016
Assets
 
(unaudited)
 
 
Available for sale:
 
 
 
 
Fixed maturity securities at fair value (amortized cost $2,350.6 at March 31, 2017 and $2,305.9 at December 31, 2016)
 
$
2,395.3

 
$
2,344.4

Equity securities at fair value (cost $117.6 at March 31, 2017 and $116.1 at December 31, 2016)
 
199.8

 
192.2

Short-term investments at fair value (amortized cost $15.4 at March 31, 2017 and $16.0 at December 31, 2016)
 
15.4

 
16.0

Total investments
 
2,610.5


2,552.6

Cash and cash equivalents
 
58.6

 
67.2

Restricted cash and cash equivalents
 
4.1

 
3.6

Accrued investment income
 
20.1

 
20.6

Premiums receivable (less bad debt allowance of $9.4 at March 31, 2017 and $9.8 at December 31, 2016)
 
323.8

 
304.7

Reinsurance recoverable for:
 
 
 
 
Paid losses
 
8.1

 
8.7

Unpaid losses
 
572.9

 
580.0

Deferred policy acquisition costs
 
48.1

 
44.3

Deferred income taxes, net
 
52.1

 
59.4

Property and equipment, net
 
23.9

 
22.2

Intangible assets, net
 
8.1

 
8.2

Goodwill
 
36.2

 
36.2

Contingent commission receivable—LPT Agreement
 
31.1

 
31.1

Other assets
 
36.0

 
34.6

Total assets
 
$
3,833.6

 
$
3,773.4

 
 
 
 
 
Liabilities and stockholders’ equity
 
 

 
 

Claims and policy liabilities:
 
 

 
 

Unpaid losses and loss adjustment expenses
 
$
2,298.2

 
$
2,301.0

Unearned premiums
 
330.8

 
310.3

Total claims and policy liabilities
 
2,629.0

 
2,611.3

Commissions and premium taxes payable
 
49.3

 
48.8

Accounts payable and accrued expenses
 
21.0

 
24.2

Unsettled purchases of investments
 
18.0

 

Deferred reinsurance gain—LPT Agreement
 
171.9

 
174.9

Notes payable
 
32.0

 
32.0

Other liabilities
 
44.9

 
41.6

Total liabilities
 
$
2,966.1

 
$
2,932.8

Commitments and contingencies
 


 


Stockholders’ equity:
 
 

 
 

Common stock, $0.01 par value; 150,000,000 shares authorized; 56,373,568 and 56,226,277 shares issued and 32,276,213 and 32,128,922 shares outstanding at March 31, 2017 and December 31, 2016, respectively
 
$
0.6

 
$
0.6

Preferred stock, $0.01 par value; 25,000,000 shares authorized; none issued
 

 

Additional paid-in capital
 
372.7

 
372.0

Retained earnings
 
795.4

 
777.2

Accumulated other comprehensive income, net of tax
 
82.5

 
74.5

Treasury stock, at cost (24,097,355 shares at March 31, 2017 and December 31, 2016)
 
(383.7
)
 
(383.7
)
Total stockholders’ equity
 
867.5

 
840.6

Total liabilities and stockholders’ equity
 
$
3,833.6

 
$
3,773.4

See accompanying unaudited notes to the consolidated financial statements.

3



Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
(in millions, except per share data)
 
 
Three Months Ended
 
 
March 31,
 
 
2017

2016
Revenues
 
(unaudited)
Net premiums earned
 
$
175.3

 
$
172.6

Net investment income
 
18.8

 
17.8

Net realized gains on investments
 
2.2

 
1.5

Other income
 

 
0.1

Total revenues
 
196.3

 
192.0

Expenses
 
 
 
 
Losses and loss adjustment expenses
 
109.0

 
107.3

Commission expense
 
21.5

 
20.3

Underwriting and other operating expenses
 
35.9

 
36.3

Interest expense
 
0.4

 
0.4

Total expenses
 
166.8

 
164.3

Net income before income taxes
 
29.5

 
27.7

Income tax expense
 
6.3

 
5.9

Net income
 
$
23.2

 
$
21.8

Comprehensive income
 
 
 
 
Unrealized gains during the period (net of tax expense of $5.1 and $11.2 for the three months ended March 31, 2017 and 2016, respectively)
 
$
9.4

 
$
20.8

Reclassification adjustment for realized gains in net income (net of taxes of $0.8 and $0.5 for the three months ended March 31, 2017 and 2016, respectively)
 
(1.4
)

(1.0
)
Other comprehensive income, net of tax
 
8.0

 
19.8

Total comprehensive income
 
$
31.2

 
$
41.6

 
 
 
 
 
Net realized gains on investments
 
 
 
 
Net realized gains on investments before credit related impairments
 
$
2.4

 
$
6.8

Other than temporary impairment recognized in earnings
 
(0.2
)
 
(5.3
)
Net realized gains on investments
 
$
2.2

 
$
1.5

 
 
 
 
 
Earnings per common share (Note 10):
 
 
 
 
Basic
 
$
0.72

 
$
0.67

Diluted
 
$
0.70

 
$
0.66

Cash dividends declared per common share and eligible RSUs and PSUs
 
$
0.15

 
$
0.09

See accompanying unaudited notes to the consolidated financial statements.

4



Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
For the Three Months Ended March 31, 2017 and 2016
(Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Additional Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income, Net
 
Treasury Stock at Cost
 
Total Stockholders' Equity
 
Shares
 
Amount
 
 
 
 
 
 
(in millions, except share data)
Balance, January 1, 2017
56,226,277

 
$
0.6

 
$
372.0

 
$
777.2

 
$
74.5

 
$
(383.7
)
 
$
840.6

Stock-based compensation

 

 
2.0

 

 

 

 
2.0

Stock options exercised
37,005

 

 
0.6

 

 

 

 
0.6

Vesting of restricted and performance stock units, net of shares withheld to satisfy minimum tax withholding
110,286

 

 
(1.9
)
 

 

 

 
(1.9
)
Dividends declared

 

 

 
(5.0
)
 

 

 
(5.0
)
Net income for the period
 
 

 

 
23.2

 

 

 
23.2

Change in net unrealized gains on investments, net of taxes of $(4.3)
 
 

 

 

 
8.0

 

 
8.0

Balance, March 31, 2017
56,373,568

 
$
0.6

 
$
372.7

 
$
795.4

 
$
82.5

 
$
(383.7
)
 
$
867.5

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, January 1, 2016
55,589,454

 
$
0.6

 
$
357.2

 
$
682.0

 
$
83.6

 
$
(362.6
)
 
$
760.8

Stock-based compensation

 

 
1.8

 

 

 

 
1.8

Stock options exercised
262,239

 

 
4.0

 

 

 

 
4.0

Vesting of restricted and performance stock units, net of shares withheld to satisfy minimum tax withholding
42,595

 

 
(0.6
)
 

 

 

 
(0.6
)
Acquisition of common stock

 

 

 

 

 
(1.0
)
 
(1.0
)
Dividends declared

 

 

 
(2.9
)
 

 

 
(2.9
)
Net income for the period
 
 

 

 
21.8

 

 

 
21.8

Change in net unrealized gains on investments, net of taxes $(10.7)
 
 

 

 

 
19.8

 

 
19.8

Balance, March 31, 2016
55,894,288

 
$
0.6

 
$
362.4

 
$
700.9

 
$
103.4

 
$
(363.6
)
 
$
803.7


See accompanying notes to the consolidated financial statements.

5



Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(in millions)
 
 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
Operating activities
 
(unaudited)
Net income
 
$
23.2

 
$
21.8

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
2.1

 
2.2

Stock-based compensation
 
1.9

 
1.8

Amortization of premium on investments, net
 
3.6

 
3.7

Allowance for doubtful accounts
 
(0.4
)
 
(2.6
)
Deferred income tax expense
 
3.0

 
1.7

Net realized gains on investments
 
(2.2
)
 
(1.5
)
Other
 
(0.3
)
 
0.1

Change in operating assets and liabilities:
 
 

 
 

Premiums receivable
 
(18.7
)
 
(11.4
)
Reinsurance recoverable on paid and unpaid losses
 
7.7

 
6.6

Federal income taxes
 
3.2

 
4.1

Unpaid losses and loss adjustment expenses
 
(2.8
)
 
(5.6
)
Unearned premiums
 
20.5

 
14.8

Payables and other liabilities
 
(3.1
)
 
(4.0
)
Deferred reinsurance gain—LPT Agreement
 
(3.0
)
 
(3.1
)
Other
 
(4.0
)
 
(7.0
)
Net cash provided by operating activities
 
30.7

 
21.6

Investing activities
 
 

 
 

Purchase of fixed maturity securities
 
(138.3
)
 
(102.5
)
Purchase of equity securities
 
(5.6
)
 
(32.6
)
Purchase of short-term investments
 
(7.9
)
 

Proceeds from sale of fixed maturity securities
 
27.3

 
42.4

Proceeds from sale of equity securities
 
5.8

 
26.3

Proceeds from maturities and redemptions of fixed maturity securities
 
63.3

 
61.5

Proceeds from maturities of short-term investments
 
8.5

 

Net change in unsettled investment purchases and sales
 
18.0

 

Capital expenditures and other
 
(3.5
)
 
(0.2
)
Change in restricted cash and cash equivalents
 
(0.5
)
 
(1.7
)
Net cash used in investing activities
 
(32.9
)
 
(6.8
)
Financing activities
 
 

 
 

Acquisition of common stock
 

 
(1.0
)
Cash transactions related to stock-based compensation
 
(1.3
)
 
3.4

Stockholder dividends paid
 
(5.0
)
 
(2.9
)
Payments on notes payable and capital leases
 
(0.1
)
 
(0.1
)
Net cash used in financing activities
 
(6.4
)
 
(0.6
)
Net (decrease) increase in cash and cash equivalents
 
(8.6
)
 
14.2

Cash and cash equivalents at the beginning of the period
 
67.2

 
56.6

Cash and cash equivalents at the end of the period
 
$
58.6

 
$
70.8

 See accompanying unaudited notes to the consolidated financial statements.

6



Employers Holdings, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
 (Unaudited)
1. Basis of Presentation and Summary of Operations
Employers Holdings, Inc. (EHI) is a Nevada holding company. Through its wholly owned insurance subsidiaries, Employers Insurance Company of Nevada (EICN), Employers Compensation Insurance Company (ECIC), Employers Preferred Insurance Company (EPIC), and Employers Assurance Company (EAC), EHI is engaged in the commercial property and casualty insurance industry, specializing in workers' compensation products and services. Unless otherwise indicated, all references to the “Company” refer to EHI, together with its subsidiaries.
In 1999, the Nevada State Industrial Insurance System (the Fund) entered into a retroactive 100% quota share reinsurance agreement (the LPT Agreement) through a loss portfolio transfer transaction with third party reinsurers. The LPT Agreement commenced on June 30, 1999 and will remain in effect until all claims under the covered policies have closed, the LPT Agreement is commuted or terminated, upon the mutual agreement of the parties, or the reinsurers' aggregate maximum limit of liability is exhausted, whichever occurs first. The LPT Agreement does not provide for any additional termination terms. On January 1, 2000, EICN assumed all of the assets, liabilities and operations of the Fund, including the Fund's rights and obligations associated with the LPT Agreement. See Note 7.
The Company accounts for the LPT Agreement as retroactive reinsurance. Upon entry into the LPT Agreement, an initial deferred reinsurance gain (the Deferred Gain) was recorded as a liability on the Company’s Consolidated Balance Sheets. The Company is entitled to receive a contingent profit commission under the LPT Agreement. The contingent profit commission is estimated based on both actual paid results to date and projections of expected paid losses under the LPT Agreement and is recorded as an asset in the accompanying Consolidated Balance Sheets.
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) necessary for a fair presentation of the Company’s consolidated financial position and results of operations for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. These financial statements have been prepared consistent with the accounting policies described in the Company’s Form 10-K for the year ended December 31, 2016 (Annual Report).
The Company considers an operating segment to be any component of its business whose operating results are regularly reviewed by the Company’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance based on discrete financial information. Currently, the Company has one operating segment, workers’ compensation insurance and related services.
Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. As a result, actual results could differ from these estimates. The most significant areas that require management judgment are the estimate of unpaid losses and loss adjustment expenses (LAE), evaluation of reinsurance recoverables, recognition of premium revenue, recoverability of deferred income taxes, and valuation of investments.
Reclassifications
Certain prior period information has been reclassified to conform to the current period presentation. See Note 2.
2. New Accounting Standards
Recently Adopted Accounting Standards
In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) Number 2016-09, Compensation - Stock Compensation (Topic 718) that impacted the net tax benefits on the Company's stock-based compensation. The Company elected to early adopt this standard in the third quarter of 2016 with an effective date of January 1, 2016. Adoption of this standard resulted in a $0.8 million reduction to Income tax expense and a corresponding increase to Net income for the three months ended March 31, 2016 and increased basic and diluted earnings per share by $0.02 for the same period. This standard also requires that assumed proceeds under the treasury stock method be modified to exclude the excess tax benefits that would have been recognized in Additional paid-in capital. Additionally, this standard requires that excess tax benefits from stock-based

7



compensation be reported as cash flows from operating activities, as opposed to financing activities. This update resulted in a change in presentation in the Consolidated Statements of Cash Flows.
Recently Issued Accounting Standards
In January 2017, the FASB issued ASU Number 2017-04, Intangibles-Goodwill and Other (Topic 350). This update simplifies the measurement of goodwill by eliminating the performance of Step 2 in the goodwill impairment testing. This update allows the testing to be performed by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge when the carrying amount exceeds fair value. Additionally, this update eliminated the requirements of any reporting unit with a zero or negative carrying value to perform Step 2, but requires disclosure of the amount of goodwill allocated to a reporting unit with zero or negative carrying amount of net assets. This update becomes effective for fiscal years beginning after December 15, 2019. The Company does not expect this update to have a material impact to its consolidated financial condition and results of operations.
In March 2017, the FASB issued ASU Number 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20). This update shortens the amortization period on callable debt securities held at a premium to the earliest call date, which now closely aligns the amortization period of premiums and discounts to expectations incorporated in the market pricing on callable debt securities. This update becomes effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, and early adoption is permitted. The Company has not yet estimated the full impact that the adoption will have on its consolidated financial condition and results of operations.
3. Fair Value of Financial Instruments
The carrying value and the estimated fair value of the Company’s financial instruments were as follows:
 
 
March 31, 2017
 
December 31, 2016
 
 
Carrying Value
 
Estimated Fair Value
 
Carrying Value
 
Estimated Fair Value
 
 
(in millions)
Financial assets
 
 
 
 
 
 
 
 
Investments
 
$
2,610.5

 
$
2,610.5

 
$
2,552.6

 
$
2,552.6

Cash and cash equivalents
 
58.6

 
58.6

 
67.2

 
67.2

Restricted cash and cash equivalents
 
4.1

 
4.1

 
3.6

 
3.6

Financial liabilities
 
 

 
 

 
 
 
 
Notes payable
 
$
32.0

 
$
34.5

 
$
32.0

 
$
33.0

Assets and liabilities recorded at fair value on the Company's Consolidated Balance Sheets are categorized based upon the levels of judgment associated with the inputs used to measure their fair value. Level inputs are defined as follows:
Level 1 - Inputs are unadjusted quoted market prices for identical assets or liabilities in active markets at the measurement date.
Level 2 - Inputs other than Level 1 prices that are observable for similar assets or liabilities through corroboration with market data at the measurement date.
Level 3 - Inputs that are unobservable that reflect management's best estimate of what willing market participants would use in pricing the assets or liabilities at the measurement date.
The Company uses third party pricing services to assist with its investment accounting function. The ultimate pricing source varies depending on the investment security and pricing service used, but investment securities valued on the basis of observable inputs (Levels 1 and 2) are generally assigned values on the basis of actual transactions. Securities valued on the basis of pricing models with significant unobservable inputs or nonbinding broker quotes are classified as Level 3. The Company performs quarterly analyses on the prices it receives from third parties to determine whether the prices are reasonable estimates of fair value, including confirming the fair values of these securities through observable market prices using an alternative pricing source, as it is ultimately management’s responsibility to ensure that the fair values reflected in the Company’s consolidated financial statements are appropriate. If differences are noted in these analyses, the Company may obtain additional information from other pricing services to validate the quoted price.
The Company bases all of its estimates of fair value for assets on the bid prices, when available, as they represent what a third-party market participant would be willing to pay in an arm's length transaction.
For securities not actively traded, third party pricing services may use quoted market prices of similar instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, broker quotes, benchmark yields, credit spreads, default rates,

8



and prepayment speed assumptions. There were no adjustments to prices obtained from third party pricing services as of March 31, 2017 and December 31, 2016 that were material to the consolidated financial statements.
These methods of valuation will only produce an estimate of fair value if there is objectively verifiable information to produce a valuation. If objectively verifiable information is not available, the Company would be required to produce an estimate of fair value using some of the same methodologies, making assumptions for market-based inputs that are unavailable.
The Company's estimates of fair value for its financial liabilities are based on a combination of the variable interest rates for notes with similar durations to discount the projection of future payments on notes payable. The fair value measurements for notes payable have been determined to be Level 2 at each of the periods presented.
Each of the Company's insurance operating subsidiaries is a member of the Federal Home Loan Bank (FHLB) of San Francisco. Members are required to purchase stock in the FHLB in addition to maintaining collateral deposits that back any funds advanced. Investment in FHLB stock is recorded at cost, as purchases and sales of these securities are at par value with the issuer. The FHLB stock is considered a restricted security and is periodically evaluated for impairment based on the ultimate recovery of par value. Due to the nature of FHLB stock, its carrying value approximates fair value and was determined by the Company to be Level 3 at each of the periods presented.
Certain of the Company's privately placed asset-backed securities are designated as Level 3 primarily due to restrictions on resale. Third party pricing based on actual transactions are typically not available for these securities due to the limited nature of observable pricing inputs.
The following table presents the items in the Company's Consolidated Balance Sheets that are stated at fair value and the corresponding fair value measurements.
 
 
March 31, 2017
 
December 31, 2016
 
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
 
 
(in millions)
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$

 
$
133.7

 
$

 
$

 
$
127.4

 
$

U.S. Agencies
 

 
15.0

 

 

 
12.8

 

States and municipalities
 

 
817.5

 

 

 
851.6

 

Corporate securities
 

 
985.7

 

 

 
956.7

 

Residential mortgage-backed securities
 

 
302.9

 

 

 
258.0

 

Commercial mortgage-backed securities
 

 
94.9

 

 

 
95.5

 

Asset-backed securities
 

 
40.2

 
5.4

 

 
35.4

 
7.0

Total fixed maturity securities
 
$

 
$
2,389.9

 
$
5.4

 
$

 
$
2,337.4

 
$
7.0

Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
Industrial and miscellaneous
 
$
174.2

 
$

 
$

 
$
167.2

 
$

 
$

Non-redeemable preferred (FHLB stock)
 

 

 
4.9

 

 

 
4.9

Other
 
20.7

 

 

 
20.1

 

 

Total equity securities
 
$
194.9

 
$

 
$
4.9

 
$
187.3

 
$

 
$
4.9

Short-term investments
 
$

 
$
15.4

 
$

 
$

 
$
16.0

 
$

Certain cash equivalents, principally money market securities, are measured at fair value using the net asset value (NAV) per share. The following table presents cash equivalents at NAV and total cash and cash equivalents carried at fair value on the Company's Consolidated Balance Sheets.
 
March 31, 2017

 
December 31, 2016
 
(in millions)
Cash and cash equivalents at fair value
$
23.6

 
$
9.7

Cash equivalents measured at NAV, which approximates fair value
35.0

 
57.5

Total cash and cash equivalents
$
58.6

 
$
67.2


9



The following table provides a reconciliation of the beginning and ending balances that are measured using Level 3 inputs for the three months ended March 31, 2017 and 2016.
 
 
Level 3 Securities
 
 
2017
 
2016
 
 
(in millions)
Beginning balance, January 1
 
$
11.9

 
$

Transfers in (out) of Level 3 (1)
 
(1.4
)
 

Purchases and sales, net
 
(0.2
)
 
5.3

Ending balance, March 31
 
$
10.3

 
$
5.3

(1)
Transferred from Level 3 to Level 2 because observable market data became available for the securities.
4. Investments
The cost or amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the Company’s investments were as follows:
 
 
Cost or Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
 
(in millions)
At March 31, 2017
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
130.5

 
$
3.4

 
$
(0.2
)
 
$
133.7

U.S. Agencies
 
14.2

 
0.8

 

 
15.0

States and municipalities
 
794.2

 
28.3

 
(5.0
)
 
817.5

Corporate securities
 
969.1

 
19.8

 
(3.2
)
 
985.7

Residential mortgage-backed securities
 
301.5

 
4.2

 
(2.8
)
 
302.9

Commercial mortgage-backed securities
 
95.4

 
0.4

 
(0.9
)
 
94.9

Asset-backed securities
 
45.7

 
0.1

 
(0.2
)
 
45.6

Total fixed maturity securities
 
2,350.6

 
57.0

 
(12.3
)
 
2,395.3

Equity securities
 
 
 
 
 
 
 
 
Industrial and miscellaneous
 
102.0

 
73.0

 
(0.8
)
 
174.2

Non-redeemable preferred (FHLB stock)
 
4.9

 

 

 
4.9

Other
 
10.7

 
10.0

 

 
20.7

Total equity securities
 
117.6

 
83.0

 
(0.8
)
 
199.8

Short-term investments
 
15.4

 

 

 
15.4

Total investments
 
$
2,483.6

 
$
140.0

 
$
(13.1
)
 
$
2,610.5

At December 31, 2016
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
124.1

 
$
3.5

 
$
(0.2
)
 
$
127.4

U.S. Agencies
 
11.9

 
0.9

 

 
12.8

States and municipalities
 
833.0

 
24.7

 
(6.1
)
 
851.6

Corporate securities
 
942.3

 
18.9

 
(4.5
)
 
956.7

Residential mortgage-backed securities
 
255.9

 
4.7

 
(2.6
)
 
258.0

Commercial mortgage-backed securities
 
96.1

 
0.4

 
(1.0
)
 
95.5

Asset-backed securities
 
42.6

 

 
(0.2
)
 
42.4

Total fixed maturity securities
 
2,305.9

 
53.1

 
(14.6
)
 
2,344.4

Equity securities
 
 
 
 
 
 
 
 
Industrial and miscellaneous
 
100.5

 
67.4

 
(0.7
)
 
167.2

Non-redeemable preferred (FHLB stock)
 
4.9

 

 

 
4.9

Other
 
10.7

 
9.4

 

 
20.1

Total equity securities
 
116.1

 
76.8

 
(0.7
)
 
192.2

Short-term investments
 
16.0

 

 

 
16.0

Total investments
 
$
2,438.0

 
$
129.9

 
$
(15.3
)
 
$
2,552.6


10



The amortized cost and estimated fair value of the Company's fixed maturity securities at March 31, 2017, by contractual maturity, are shown below. Expected maturities differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
Amortized Cost
 
Estimated Fair Value
 
 
(in millions)
Due in one year or less
 
$
180.5

 
$
181.8

Due after one year through five years
 
874.7

 
899.4

Due after five years through ten years
 
600.4

 
615.5

Due after ten years
 
252.4

 
255.2

Mortgage and asset-backed securities
 
442.6

 
443.4

Total
 
$
2,350.6

 
$
2,395.3

The following is a summary of investments that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or greater as of March 31, 2017 and December 31, 2016.
 
 
March 31, 2017
 
December 31, 2016
 
 
Estimated Fair Value
 
Gross Unrealized Losses
 
Number of Issues
 
Estimated Fair Value
 
Gross Unrealized Losses
 
Number of Issues
 
 
(in millions, except number of issues data)
Less than 12 months:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
32.8

 
$
(0.2
)
 
16

 
$
33.3

 
$
(0.2
)
 
14

States and municipalities
 
120.7

 
(5.0
)
 
32

 
200.9

 
(6.1
)
 
50

Corporate securities
 
228.9

 
(2.8
)
 
215

 
289.5

 
(4.1
)
 
101

Residential mortgage-backed securities
 
165.2

 
(2.8
)
 
59

 
137.5

 
(2.6
)
 
51

Commercial mortgage-backed securities
 
50.5

 
(0.9
)
 
21

 
48.0

 
(1.0
)
 
21

Asset-backed securities
 
23.8

 
(0.2
)
 
22

 
30.1

 
(0.2
)
 
20

Total fixed maturity securities
 
621.9

 
(11.9
)
 
365

 
739.3

 
(14.2
)
 
257

Equity securities
 
13.1

 
(0.7
)
 
29

 
13.6

 
(0.6
)
 
28

Total less than 12 months
 
$
635.0

 
$
(12.6
)
 
394

 
$
752.9

 
$
(14.8
)
 
285

 
 
 
 
 
 
 
 
 
 
 
 
 
12 months or greater:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
Corporate securities
 
$
16.4

 
$
(0.4
)
 
6

 
$
15.2

 
$
(0.4
)
 
5

Total fixed maturity securities
 
16.4

 
(0.4
)
 
6

 
15.2

 
(0.4
)
 
5

Equity securities
 
1.5

 
(0.1
)
 
3

 
1.7

 
(0.1
)
 
5

Total 12 months or greater
 
$
17.9

 
$
(0.5
)
 
9

 
$
16.9

 
$
(0.5
)
 
10

 
 
 
 
 
 
 
 
 
 
 
 
 
Total available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
32.8

 
$
(0.2
)
 
16

 
$
33.3

 
$
(0.2
)
 
14

States and municipalities
 
120.7

 
(5.0
)
 
32

 
200.9

 
(6.1
)
 
50

Corporate securities
 
245.3

 
(3.2
)
 
221

 
304.7

 
(4.5
)
 
106

Residential mortgage-backed securities
 
165.2

 
(2.8
)
 
59

 
137.5

 
(2.6
)
 
51

Commercial mortgage-backed securities
 
50.5

 
(0.9
)
 
21

 
48.0

 
(1.0
)
 
21

Asset-backed securities
 
23.8

 
(0.2
)
 
22


30.1

 
(0.2
)
 
20

Total fixed maturity securities
 
638.3

 
(12.3
)
 
371

 
754.5

 
(14.6
)
 
262

Equity securities
 
14.6

 
(0.8
)
 
32

 
15.3

 
(0.7
)
 
33

Total available-for-sale
 
$
652.9

 
$
(13.1
)
 
403

 
$
769.8

 
$
(15.3
)
 
295


11



The Company determined that unrealized losses on fixed maturities for the three months ended March 31, 2017 were primarily the result of changes in prevailing interest rates and not the credit quality of the issuers. The fixed maturity securities whose total fair value was less than amortized cost were not determined to be other-than-temporarily impaired given the lack of severity and duration of the impairment, the credit quality of the issuers, the Company’s intent to not sell the securities, and a determination that it is not more likely than not that the Company will be required to sell the securities until fair value recovers to above amortized cost, or principal value upon maturity.
The Company recognized impairments of $0.2 million (consisting of one security) during the three months ended March 31, 2017. The other-than-temporary impairment recognized during this period related to an equity security and was the result of the severity and duration of the change in fair value of this security. Certain unrealized losses on equity securities were not considered to be other-than-temporary due to the financial condition and near-term prospects of the issuers, and the Company's intent to hold the securities until fair value recovers to above cost.
Net realized gains on investments and the change in unrealized gains (losses) on fixed maturity and equity securities are determined on a specific-identification basis and were as follows:
 
 
Three Months Ended
 
 
March 31,
 
 
2017

2016
 
 
(in millions)
Net realized gains on investments
 
 
 
 
Fixed maturity securities
 
 
 
 
Gross gains
 
$
0.5

 
$
0.2

Gross losses
 

 
(0.1
)
Net realized gains on fixed maturity securities
 
$
0.5

 
$
0.1

Equity securities
 
 
 
 
Gross gains
 
$
1.9

 
$
7.2

Gross losses
 
(0.2
)
 
(5.8
)
Net realized gains on equity securities
 
$
1.7

 
$
1.4

Total
 
$
2.2

 
$
1.5

 
 
 
 
 
Change in unrealized gains
 
 

 
 

Fixed maturity securities
 
$
6.2

 
$
29.3

Equity securities
 
6.1

 
1.2

Total
 
$
12.3

 
$
30.5

Net investment income was as follows:
 
 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
 
 
(in millions)
Fixed maturity securities
 
$
17.8

 
$
16.7

Equity securities
 
1.8

 
1.9

Cash equivalents and restricted cash
 
0.1

 

Gross investment income
 
19.7

 
18.6

Investment expenses
 
(0.9
)
 
(0.8
)
Net investment income
 
$
18.8

 
$
17.8

The Company is required by various state laws and regulations to hold securities or letters of credit in depository accounts with certain states in which it does business. These laws and regulations govern not only the amount but also the types of securities that are eligible for deposit. As of March 31, 2017 and December 31, 2016, securities having a fair value of $1,175.7 million and $1,009.7 million, respectively, were on deposit.
Certain reinsurance contracts require the Company's funds to be held in trust for the benefit of the ceding reinsurer to secure the outstanding liabilities assumed by the Company. The fair value of fixed maturity securities and restricted cash and cash equivalents held in trust for the benefit of ceding reinsurers at March 31, 2017 and December 31, 2016 was $27.6 million and $27.2 million, respectively.

12



5. Income Taxes
Income tax expense for interim periods is measured using an estimated effective tax rate for the annual period. The Company's effective tax rate was 21.4% and 21.3% for the three months ended March 31, 2017 and 2016, respectively. For each of these periods, tax-advantaged investment income, LPT Reserve Adjustments, Deferred Gain amortization, and certain other adjustments served to reduce our effective income tax rate below the U.S. statutory rate of 35%.
6. Liability for Unpaid Losses and Loss Adjustment Expenses 
The following table represents a reconciliation of changes in the liability for unpaid losses and LAE.
 
 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
 
 
(in millions)
Unpaid losses and LAE, gross of reinsurance, at beginning of period
 
$
2,301.0

 
$
2,347.5

Less reinsurance recoverable, excluding bad debt allowance, on unpaid losses and LAE
 
580.0

 
628.2

Net unpaid losses and LAE at beginning of period
 
1,721.0

 
1,719.3

Losses and LAE, net of reinsurance, incurred during the period related to:
 
 

 
 

Current period
 
111.9

 
110.7

Prior periods
 

 
(0.3
)
Total net losses and LAE incurred during the period
 
111.9

 
110.4

Paid losses and LAE, net of reinsurance, related to:
 
 

 
 

Current period
 
4.7

 
4.7

Prior periods
 
102.9

 
104.5

Total net paid losses and LAE during the period
 
107.6

 
109.2

Ending unpaid losses and LAE, net of reinsurance
 
1,725.3

 
1,720.5

Reinsurance recoverable, excluding bad debt allowance, on unpaid losses and LAE
 
572.9

 
621.4

Unpaid losses and LAE, gross of reinsurance, at end of period
 
$
2,298.2

 
$
2,341.9

Total net losses and LAE included in the above table excludes the impact of the aggregate of amortization of the deferred reinsurance gain—LPT Agreement, LPT Reserve Adjustments, and LPT Contingent Commission Adjustments, which totaled $2.9 million and $3.1 million for the three months ended March 31, 2017 and 2016, respectively (Note 7).
The change in incurred losses and LAE attributable to prior periods was related to the Company's assigned risk business for the three months ended March 31, 2016.
7. LPT Agreement
The Company is party to the LPT Agreement under which $1,525.0 million in liabilities for losses and LAE related to claims incurred by the Fund prior to July 1, 1995 were reinsured for consideration of $775.0 million. The LPT Agreement provides coverage up to $2,000.0 million. The Company records its estimate of contingent profit commission in the accompanying Consolidated Balance Sheets as Contingent commission receivable–LPT Agreement and a corresponding liability is recorded in the accompanying Consolidated Balance Sheets in Deferred reinsurance gain–LPT Agreement. The Deferred Gain is being amortized using the recovery method. Amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries over the life of the LPT Agreement, except for the contingent profit commission, which is amortized through June 30, 2024, the date through which the Company is entitled to receive a contingent profit commission under the LPT Agreement. The amortization is recorded in losses and LAE incurred in the accompanying consolidated statements of comprehensive income. Any adjustments to the Deferred Gain are recorded in losses and LAE incurred in the accompanying consolidated statements of comprehensive income.
The Company amortized $2.9 million and $3.1 million of the Deferred Gain for the three months ended March 31, 2017 and 2016, respectively. The remaining Deferred Gain was $171.9 million and $174.9 million as of March 31, 2017 and December 31, 2016, respectively. The estimated remaining liabilities subject to the LPT Agreement were $458.6 million and $465.5 million as of March 31, 2017 and December 31, 2016, respectively. Losses and LAE paid with respect to the LPT Agreement totaled $729.6 million and $722.7 million from inception through March 31, 2017 and December 31, 2016, respectively.

13



8. Accumulated Other Comprehensive Income
Accumulated other comprehensive income is comprised of unrealized gains on investments classified as available-for-sale, net of deferred tax expense. The following table summarizes the components of accumulated other comprehensive income:
 
 
March 31, 2017
 
December 31, 2016
 
 
(in millions)
Net unrealized gain on investments, before taxes
 
$
126.9

 
$
114.6

Deferred tax expense on net unrealized gains
 
(44.4
)
 
(40.1
)
Total accumulated other comprehensive income
 
$
82.5

 
$
74.5

9. Stock-Based Compensation
The Company awarded restricted stock units (RSUs) and performance share units (PSUs) to certain employees of the Company as follows:
 
Number Awarded
 
Weighted Average Fair Value on Date of Grant
 
Weighted Average Exercise Price
 
Aggregate Fair Value on Date of Grant
 
 
 
 
 
 
 
(in millions)
March 2017
 
 
 
 
 
 
 
RSUs(1)
72,020

 
37.60

 

 
2.7

PSUs(2)
97,440

 
37.60

 

 
3.7

(1)
The RSUs awarded in March 2017 were awarded to certain employees of the Company and vest 25% on March 15, 2018, and each of the subsequent three anniversaries of that date. The RSUs are subject to accelerated vesting in certain circumstances, including but not limited to: death, disability, retirement, or in connection with change of control of the Company.
(2)
The PSUs awarded in March 2017 were awarded to certain employees of the Company and have a performance period of two years followed by an additional one year vesting period. The PSU awards are subject to certain performance goals with payouts that range from 0% to 200% of the target awards. The value shown in the table represents the aggregate number of PSUs awarded at the target level.
Commencing in 2017, employees who were awarded RSUs and PSUs are entitled to receive dividend equivalents for eligible awards, payable in cash, when the underlying award vests and becomes payable. If the underlying award does not vest or is forfeited, any dividend equivalents with respect to the underlying award will also fail to become payable and will be forfeited.
A total of 37,005, 262,239, and 586,132 stock options were exercised during the three months ended March 31, 2017 and 2016, and the year ended December 31, 2016, respectively.

14



10. Earnings Per Share
Basic earnings per share excludes dilution and is computed by dividing income applicable to stockholders by the weighted average number of shares outstanding for the period. Diluted earnings per share reflects the potential dilutive impact of all convertible securities on earnings per share. Diluted earnings per share includes shares that are assumed to be issued under the “treasury stock method,” which reflects the potential dilution that would occur if outstanding RSUs and PSUs had vested and options were to be exercised.
Commencing in 2017, certain stock-based compensation awards are eligible to receive dividend equivalents on awards that fully vest or become payable. These awards are not considered participating securities for the purposes of determining earnings per share.
The following table presents the net income and the weighted average number of shares outstanding used in the earnings per common share calculations.
 
 
Three Months Ended
 
 
March 31,
 
 
2017

2016
 
(in millions, except share data)
Net income available to stockholders—basic and diluted
 
$
23.2

 
$
21.8

Weighted average number of shares outstanding—basic
 
32,327,784

 
32,413,818

Effect of dilutive securities:
 
 
 
 
PSUs
 
309,891

 
151,031

Stock options
 
225,664

 
304,073

RSUs
 
102,028

 
86,310

Dilutive potential shares
 
637,583

 
541,414

Weighted average number of shares outstanding—diluted
 
32,965,367

 
32,955,232

Diluted earnings per share excludes outstanding options and other common stock equivalents in periods where the inclusion of such options and common stock equivalents would be anti-dilutive. The following table presents options, PSUs, and RSUs that were excluded from diluted earnings per share.
 
 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
Options excluded as the exercise price was greater than the average market price
 

 

Options, PSUs and RSUs excluded under the treasury method as the potential proceeds on settlement or exercise price were greater than the value of shares acquired
 

 
80,800


15



Item 2.  Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations
You should read the following discussion and analysis in conjunction with our consolidated financial statements and the related notes thereto included in Item 1 of Part I. Unless otherwise indicated, all references to “we,” “us,” “our,” “the Company,” or similar terms refer to EHI, together with its subsidiaries. The information contained in this quarterly report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this quarterly report and in our other reports filed with the Securities and Exchange Commission (SEC), including our Annual Report.
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, strategic initiatives, expected losses, accident year loss estimates, loss experience, loss reserves, acquisitions, competition, the impact of changes in interest rates, rate increases with respect to our business, 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 described in our Annual Report and other documents that we have filed with the SEC.
Overview
We are a Nevada holding company. Through our insurance subsidiaries, we provide workers’ compensation insurance coverage to select, small businesses in low to medium hazard industries. Workers’ compensation insurance is provided under a statutory system wherein most employers are required to provide coverage for their employees’ medical, disability, vocational rehabilitation, and/or death benefit costs for work-related injuries or illnesses. We provide workers’ compensation insurance in 36 states and the District of Columbia, with a concentration in California, where over one-half of our business is generated. Our revenues are primarily comprised of net premiums earned, net investment income, and net realized gains on investments.
We target small businesses, as we believe that this market is traditionally characterized by fewer competitors, more attractive pricing, and stronger persistency when compared to the U.S. workers’ compensation insurance industry in general. We believe we are able to price our policies at levels that are competitive and profitable over the long-term given our expertise in underwriting this market segment. Our underwriting approach is to consistently underwrite small business accounts at appropriate and competitive prices without sacrificing long-term profitability and stability for short-term top-line revenue growth.
Our strategy is to pursue profitable growth opportunities across market cycles and maximize total investment returns within the constraints of prudent portfolio management. We pursue profitable growth opportunities by focusing on disciplined underwriting and claims management, utilizing medical provider networks designed to produce superior medical and indemnity outcomes, establishing and maintaining strong, long-term relationships with independent insurance agencies, and developing important alternative distribution channels. We continue to execute a number of ongoing business initiatives, including: focusing on internal and customer-facing business process excellence; accelerating the settlement of open claims; diversifying our risk exposure across geographic markets; utilizing a multi-company pricing platform; utilizing territory-specific pricing; and leveraging data-driven strategies to target, price, and underwrite profitable classes of business across all of our markets.
There is significant competition in the national workers' compensation industry that is based on price and quality of services. We compete with other specialty workers' compensation carriers, state agencies, multi-line insurance companies, professional employer organizations, self-insurance funds, and state insurance pools.
Pricing on our 2017 first quarter renewals showed an overall price decrease of 1.8% versus the rate levels on such business in effect a year ago. Despite the competitive market conditions we currently face, through our efforts thus far in 2017, we believe that we have continued to write attractive business in new and existing states and have strengthened our relationships with our business partners. As a result, given the strength of our balance sheet, the strong execution of our underwriting, claims, and investment strategies, and our active capital management, we believe that we are well positioned for the current market cycle.
Results of Operations
A primary measure of our performance is our ability to increase our Adjusted stockholders' equity over the long-term. We believe that this measure is important to our investors, analysts, and other interested parties who benefit from having an objective and

16



consistent basis for comparison with other companies within our industry. The following table shows a reconciliation of our stockholders' equity on a GAAP basis to our Adjusted stockholders' equity.
 
 
March 31, 2017
 
December 31, 2016
 
 
(in millions, except share data)
GAAP stockholders' equity
 
$
867.5

 
$
840.6

Deferred reinsurance gain–LPT Agreement
 
171.9

 
174.9

Less: Accumulated other comprehensive income, net
 
82.5

 
74.5

Adjusted stockholders' equity(1)
 
$
956.9

 
$
941.0

(1)
Adjusted stockholders' equity is a non-GAAP measure consisting of total GAAP stockholders' equity plus the Deferred Gain, less Accumulated other comprehensive income, net.
Our net income was $23.2 million and $21.8 million for the three months ended March 31, 2017 and 2016, respectively, and our underwriting income was $8.9 million and $8.7 million for the same periods, respectively. Underwriting income or loss is determined by deducting losses and LAE, commission expense, and underwriting and other operating expenses from net premiums earned.
The components of net income are set forth in the following table:
 
 
Three Months Ended
 
 
March 31,
 
 
2017

2016
 
(in millions)
Gross premiums written
 
$
197.6

 
$
190.7

Net premiums written
 
$
196.1

 
$
188.7

 
 
 
 
 
Net premiums earned
 
$
175.3

 
$
172.6

Net investment income
 
18.8

 
17.8

Net realized gains on investments
 
2.2

 
1.5

Other income
 

 
0.1

Total revenues
 
196.3

 
192.0

 
 
 
 
 
Losses and LAE
 
109.0

 
107.3

Commission expense
 
21.5

 
20.3

Underwriting and other operating expenses
 
35.9

 
36.3

Interest expense
 
0.4

 
0.4

Income tax expense
 
6.3

 
5.9

Total expenses
 
173.1

 
170.2

Net income
 
$
23.2

 
$
21.8

Less amortization of the Deferred Gain related to losses
 
$
2.4

 
$
2.6

Less amortization of the Deferred Gain related to contingent commission
 
0.5

 
0.5

Net income before impact of the LPT Agreement(1)
 
$
20.3

 
$
18.7

(1)
We define net income before impact of the LPT Agreement as net income before the impact of: (a) amortization of Deferred Gain; (b) adjustments to the LPT Agreement ceded reserves; and (c) adjustments to the Contingent commission receivable–LPT Agreement. The Deferred Gain reflects the unamortized gain from the LPT Agreement. Under GAAP, this gain is deferred and is being amortized using the recovery method in which amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries over the life of the LPT Agreement, except for the contingent profit commission, which is amortized through June 30, 2024. The amortization is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT Agreement and the expected losses and LAE subject to the contingent profit commission under the LPT Agreement. Our reevaluation results in corresponding adjustments, if needed, to reserves, ceded reserves, contingent commission receivable, and the Deferred Gain, with the net effect being an increase or decrease to our net income. Net income before impact of the LPT Agreement is not a measurement of financial performance under GAAP, but rather reflects a difference in accounting treatment between statutory and GAAP, and should not be considered in isolation or as an alternative to net income before income taxes or net income, or any other measure of performance derived in accordance with GAAP.
We present net income before impact of the LPT Agreement because we believe that it is an important supplemental measure of our ongoing operating performance to be used by analysts, investors, and other interested parties in evaluating us. The LPT Agreement was a non-recurring transaction under which the Deferred Gain does not affect our ongoing operations, and, consequently, we believe this presentation is useful in providing a meaningful understanding of our operating performance. In addition, we believe this non-GAAP measure, as we

17



have defined it, is helpful to our management in identifying trends in our performance because the LPT Agreement has limited significance on our current and ongoing operations.
Gross Premiums Written
Gross premiums written were $197.6 million and $190.7 million for the three months ended March 31, 2017 and 2016, respectively. The year-over-year increase was primarily due to a $3.9 million increase in final audit premiums and growth in new business premium. Renewal premium remained relatively flat for the first quarter, year-over-year, with increases in payroll exposure being largely offset by a 1.8% decrease in average rate.
Net Premiums Written
Net premiums written were $196.1 million and $188.7 million for the three months ended March 31, 2017 and 2016, respectively, which included $1.5 million and $1.9 million of reinsurance premiums ceded, respectively.
Net Premiums Earned
Net premiums earned were $175.3 million and $172.6 million for the three months ended March 31, 2017 and 2016, respectively. Net premiums earned are primarily a function of the amount and timing of net premiums previously written.
The following table shows the percentage change in our in-force premiums, policy count, average policy size, and payroll exposure upon which our premiums are based for California, where 56% of our premiums were generated, and for all other states, excluding California:
 
As of March 31, 2017
 
Year-to-Date (Decrease) Increase
 
Year-Over-Year (Decrease) Increase
 
Overall
 
California
 
All Other States
 
Overall
 
California
 
All Other States
In-force premiums
0.3
%
 
(0.3
)%
 
1.0
 %
 
(0.5
)%
 
(1.5
)%
 
0.8
 %
In-force policy count
0.3

 
(1.1
)
 
1.7

 

 
(5.0
)
 
5.3

Average in-force policy size

 
0.8

 
(0.7
)
 
(0.5
)
 
3.7

 
(4.2
)
In-force payroll exposure
1.3

 
1.7

 
1.1

 
0.2

 
0.3

 
0.2

Our in-force premiums and policy count in the LA Area of California declined 10.5% and 13.3%, respectively, year-over-year as of March 31, 2017, while our in-force premiums and policy count in California outside of the LA Area increased 5.0% and 1.0%, respectively, during the same period. The year-over-year decline in overall in-force premiums was driven by lower average rates and the non-renewal of certain policies.
The following table shows our in-force premiums and number of policies in-force for each state with at least five percent of our in-force premiums and all other states combined for the periods presented:
 
 
March 31, 2017
 
December 31, 2016
 
March 31, 2016
 
December 31, 2015
State
 
In-force
Premiums
 
Policies
In-force
 
In-force
Premiums
 
Policies
In-force
 
In-force
Premiums
 
Policies
In-force
 
In-force
Premiums
 
Policies
In-force
 
 
(dollars in millions)
California
 
$
347.2

 
41,657

 
$
348.3

 
42,120

 
$
352.5

 
43,843

 
$
352.2

 
44,080

Florida
 
37.7

 
5,392

 
35.2

 
5,263

 
30.3

 
4,958

 
29.4

 
4,735

Illinois
 
29.9

 
3,073

 
30.6

 
3,106

 
33.1

 
3,264

 
32.5

 
3,286

Other (33 states and D.C.)
 
205.5

 
34,955

 
204.5

 
34,333

 
207.4

 
33,030

 
205.4

 
32,395

Total
 
$
620.3

 
85,077

 
$
618.6

 
84,822

 
$
623.3

 
85,095

 
$
619.5

 
84,496

Our alternative distribution channels that utilize partnerships and alliances generated $158.8 million and $150.3 million, or 25.6% and 24.1%, of our in-force premiums as of March 31, 2017 and 2016, respectively. We believe that the bundling of products and services through these relationships contributes to higher retention rates than business generated by our independent agents. These relationships also allow us to access new customers that we may not have access to through our independent agent distribution channel. We continue to actively seek new partnerships and alliances.
Net Investment Income and Net Realized Gains on Investments
We invest in fixed maturity securities, equity securities, short-term investments, and cash equivalents. Net investment income includes interest and dividends earned on our invested assets and amortization of premiums and discounts on our fixed maturity securities, less bank service charges and custodial and portfolio management fees. We have established a high quality/short duration bias in our investment portfolio.

18



Net investment income increased 5.6% for the three months ended March 31, 2017, compared to the same period of 2016. The increase in net investment income for the three months ended March 31, 2017 was primarily related to an increase in invested assets and a slight change in the mix of invested assets in our investment portfolio. The average pre-tax book yield on invested assets was 3.1% and 3.2% at March 31, 2017 and 2016, respectively, and the average tax-equivalent yield on our invested assets (which adjusts the book yield of our investments in tax-advantaged securities to an equivalent pre-tax book yield) was 3.6% and 3.8%, respectively.
Realized gains and losses on our investments are reported separately from our net investment income. Realized gains and losses on investments include the gain or loss on a security at the time of sale compared to its original or adjusted cost (equity securities) or amortized cost (fixed maturity securities). Realized losses are also recognized when securities are written down as a result of an other-than-temporary impairment.
Net realized gains on investments were $2.2 million and $1.5 million for the three months ended March 31, 2017 and 2016, respectively. The increase in net realized gains on investments year-over-year was related to the sale of equity securities as part of a regular rebalancing of our equity investment portfolio. For the three months ended March 31, 2017, these gains were partially offset by $0.2 million in other-than-temporary impairments of one equity security.
Additional information regarding our Investments is set forth under “—Liquidity and Capital Resources—Investments.”
Losses and LAE, Commission Expenses, and Underwriting and Other Operating Expenses
The combined ratio, a key measurement of underwriting profitability, is the sum of the loss and LAE ratio, the commission expense ratio, and the underwriting and other operating expenses ratio. A combined ratio below 100% indicates that an insurance company is generating an underwriting profit, and conversely, a combined ratio above 100% indicates that an insurance company is generating an underwriting loss.
The following table provides the calculation of our calendar year combined ratios.
 
 
Three Months Ended
 
 
March 31,
 
 
2017

2016
Loss and LAE ratio
 
62.2
%
 
62.2
%
Underwriting and other operating expenses ratio