EIG-6.30.2013-10Q


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 June 30, 2013

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, or a smaller 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 R
Accelerated filer o
Non-accelerated filer o
Smaller reporting company 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
 
July 31, 2013
Common Stock, $0.01 par value per share
 
31,002,391 shares outstanding




TABLE OF CONTENTS
 
 
Page
No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2



PART IFINANCIAL INFORMATION
Item 1.  Consolidated Financial Statements
Employers Holdings, Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands, except share data)
 
 
As of
 
As of
 
 
June 30,
2013
 
December 31,
2012
Assets
 
(unaudited)
 
 
Available for sale:
 
 
 
 
Fixed maturity securities at fair value (amortized cost $1,989,823 at June 30, 2013 and $1,869,142 at December 31, 2012)
 
$
2,070,027

 
$
2,024,428

Equity securities at fair value (cost $85,559 at June 30, 2013 and $81,067 at December 31, 2012)
 
140,369

 
125,086

Total investments
 
2,210,396

 
2,149,514

Cash and cash equivalents
 
97,060

 
140,661

Restricted cash and cash equivalents
 
4,602

 
5,353

Accrued investment income
 
19,786

 
19,356

Premiums receivable (less bad debt allowance of $6,730 at June 30, 2013 and $5,957 at December 31, 2012)
 
285,329

 
223,011

Reinsurance recoverable for:
 
 

 
 
Paid losses
 
9,458

 
9,467

Unpaid losses
 
801,149

 
805,386

Deferred policy acquisition costs
 
45,608

 
38,852

Deferred income taxes, net
 
51,291

 
26,231

Property and equipment, net
 
15,489

 
14,680

Intangible assets, net
 
10,106

 
10,558

Goodwill
 
36,192

 
36,192

Contingent commission receivable—LPT Agreement
 
20,948

 
19,141

Other assets
 
10,061

 
12,937

Total assets
 
$
3,617,475

 
$
3,511,339

 
 
 
 
 
Liabilities and stockholders’ equity
 
 

 
 

Claims and policy liabilities:
 
 

 
 

Unpaid losses and loss adjustment expenses
 
$
2,291,261

 
$
2,231,540

Unearned premiums
 
317,735

 
265,149

Total claims and policy liabilities
 
2,608,996

 
2,496,689

Commissions and premium taxes payable
 
42,611

 
40,825

Accounts payable and accrued expenses
 
15,758

 
19,522

Deferred reinsurance gain—LPT Agreement
 
274,183

 
281,043

Notes payable
 
112,000

 
112,000

Other liabilities
 
41,987

 
21,879

Total liabilities
 
3,095,535

 
2,971,958

Commitments and contingencies
 


 


Stockholders’ equity:
 
 

 
 

Common stock, $0.01 par value; 150,000,000 shares authorized; 54,371,465 and 54,144,453 shares issued and 30,998,491 and 30,771,479 shares outstanding at June 30, 2013 and December 31, 2012, respectively
 
544

 
541

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

 

Additional paid-in capital
 
331,977

 
325,991

Retained earnings
 
464,210

 
445,850

Accumulated other comprehensive income, net
 
87,759

 
129,549

Treasury stock, at cost (23,372,974 shares at June 30, 2013 and December 31, 2012)
 
(362,550
)
 
(362,550
)
Total stockholders’ equity
 
521,940

 
539,381

Total liabilities and stockholders’ equity
 
$
3,617,475

 
$
3,511,339

See accompanying unaudited notes to the consolidated financial statements.

3



Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
(in thousands, except per share data)
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013

2012
Revenues
 
(unaudited)
 
(unaudited)
Net premiums earned
 
$
159,953

 
$
118,955

 
$
307,928

 
$
228,855

Net investment income
 
17,645

 
18,297

 
35,050

 
36,682

Realized gains on investments, net
 
3,866

 
945

 
4,660

 
2,723

Other income
 
144

 
114

 
247

 
195

Total revenues
 
181,608

 
138,311

 
347,885

 
268,455

Expenses
 
 

 
 

 
 
 
 
Losses and loss adjustment expenses
 
112,638

 
87,809

 
220,910

 
168,327

Commission expense
 
20,127

 
16,621

 
38,520

 
30,437

Underwriting and other operating expenses
 
32,249

 
30,316

 
63,789

 
63,305

Interest expense
 
797

 
858

 
1,605

 
1,760

Total expenses
 
165,811

 
135,604

 
324,824

 
263,829

Net income before income taxes
 
15,797

 
2,707

 
23,061

 
4,626

Income tax expense (benefit)
 
1,209

 
(2,309
)
 
983

 
(6,730
)
Net income
 
$
14,588

 
$
5,016

 
$
22,078

 
$
11,356


 
 
 
 
 
 
 
 
Earnings per common share (Note 10):
 
 
 
 
 
 
 
 
Basic
 
$
0.47

 
$
0.16

 
$
0.71

 
$
0.35

Diluted
 
$
0.46

 
$
0.16

 
$
0.70

 
$
0.35

Cash dividends declared per common share
 
$
0.06

 
$
0.06

 
$
0.12

 
$
0.12

 
 
 
 
 
 
 
 
 
Comprehensive income
 
 
 
 
 
 
 
 
Unrealized gains (losses) during the period (net of tax expense (benefit) of $(20,886) and $2,070 for the three months ended June 30, 2013 and 2012, respectively, and $(20,870) and $5,324 for the six months ended June 30, 2013 and 2012, respectively)
 
$
(38,787
)
 
$
3,844

 
$
(38,761
)
 
$
9,888

Reclassification adjustment for realized gains in net income (net of taxes of $1,353 and $331 for the three months ended June 30, 2013 and 2012, respectively, and $1,631 and $952 for the six months ended June 30, 2013 and 2012, respectively)
 
(2,513
)
 
(614
)
 
(3,029
)

(1,771
)
Other comprehensive income (loss), net of tax
 
(41,300
)
 
3,230

 
(41,790
)
 
8,117

 
 
 
 
 
 
 
 
 
Total comprehensive income (loss)
 
$
(26,712
)
 
$
8,246

 
$
(19,712
)
 
$
19,473

 
 
 
 
 
 
 
 
 
Realized gains on investments, net
 
 
 
 
 
 
 
 
Net realized gains on investments before credit related impairments on fixed maturity securities
 
$
3,934

 
$
1,005

 
$
4,728

 
$
3,252

Other than temporary impairment, credit losses recognized in earnings
 
(68
)
 
(60
)
 
(68
)
 
(529
)
Realized gains on investments, net
 
$
3,866

 
$
945

 
$
4,660

 
$
2,723

See accompanying unaudited notes to the consolidated financial statements.

4



Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
 
 
Six Months Ended
 
 
June 30,
 
 
2013
 
2012
Operating activities
 
(unaudited)
Net income
 
$
22,078

 
$
11,356

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
2,800

 
2,787

Stock-based compensation
 
4,169

 
2,542

Amortization of premium on investments, net
 
4,310

 
3,400

Deferred income tax expense
 
(2,558
)
 
(7,675
)
Realized gains on investments, net
 
(4,660
)
 
(2,723
)
Excess tax benefits from stock-based compensation
 
(349
)
 

Other
 
549

 
449

Change in operating assets and liabilities:
 
 

 
 

Premiums receivable
 
(63,091
)
 
(56,776
)
Reinsurance recoverable for paid and unpaid losses
 
4,246

 
21,868

Federal income taxes
 
2,848

 
876

Unpaid losses and loss adjustment expenses
 
59,721

 
9,426

Unearned premiums
 
52,586

 
62,846

Accounts payable, accrued expenses and other liabilities
 
15,389

 
7,166

Deferred reinsurance gain—LPT Agreement
 
(6,860
)
 
(8,276
)
Contingent commission receivable—LPT Agreement
 
(1,807
)
 
(597
)
Other
 
(4,179
)
 
7,306

Net cash provided by operating activities
 
85,192

 
53,975

Investing activities
 
 

 
 

Purchase of fixed maturities
 
(211,889
)
 
(181,836
)
Purchase of equity securities
 
(18,190
)
 
(23,303
)
Proceeds from sale of fixed maturities
 
706

 
34,560

Proceeds from sale of equity securities
 
18,357

 
8,451

Proceeds from maturities and redemptions of investments
 
86,326

 
110,160

Proceeds from sale of fixed assets
 
139

 
75

Capital expenditures and other
 
(3,206
)
 
(3,326
)
Restricted cash and cash equivalents provided by (used in) investing activities
 
751

 
(842
)
Net cash used in investing activities
 
(127,006
)
 
(56,061
)
Financing activities
 
 

 
 

Acquisition of treasury stock
 

 
(37,322
)
Cash transactions related to stock-based compensation
 
1,572

 
(279
)
Dividends paid to stockholders
 
(3,708
)
 
(3,822
)
Excess tax benefits from stock-based compensation
 
349

 

Net cash used in financing activities
 
(1,787
)
 
(41,423
)
Net decrease in cash and cash equivalents
 
(43,601
)
 
(43,509
)
Cash and cash equivalents at the beginning of the period
 
140,661

 
252,300

Cash and cash equivalents at the end of the period
 
$
97,060

 
$
208,791

 See accompanying unaudited notes to the consolidated financial statements.

5



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.
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 Annual Report on Form 10-K for the year ended December 31, 2012.
The Company considers an operating segment to be any component of its business whose operating results are regularly reviewed by the Company’s chief operating decision makers to make decisions about resources to be allocated to the segment and assess its performance based on discrete financial information. Currently, the Company has one operating segment, workers’ compensation insurance and related services.
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, as well as the reported amounts of revenues and expenses during the reporting period. As a result, actual results could differ from these estimates. The most significant areas that require management judgment are the estimate of unpaid losses and loss adjustment expenses (LAE), evaluation of reinsurance recoverables, recognition of premium revenue, deferred income taxes, investments, and the valuation of goodwill and intangible assets.
Reclassifications
Certain prior period information has been reclassified to conform to the current period presentation.
2. New Accounting Standards
In February 2013, the Financial Accounting Standards Board issued Accounting Standards Update Number 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (Topic 220). This update requires companies to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. This update became effective prospectively for reporting periods beginning after December 15, 2012. The Company adopted this update beginning in the first quarter of 2013. The adoption of this new guidance did not have a material impact on the Company's consolidated financial condition or results of operations.

6



3. Fair Value of Financial Instruments
The carrying value and the estimated fair value of the Company’s financial instruments were as follows:
 
 
June 30, 2013
 
December 31, 2012
 
 
Carrying Value
 
Estimated Fair Value
 
Carrying Value
 
Estimated Fair Value
 
 
(in thousands)
Financial assets
 
 
 
 
 
 
 
 
Investments
 
$
2,210,396

 
$
2,210,396

 
$
2,149,514

 
$
2,149,514

Cash and cash equivalents
 
97,060

 
97,060

 
140,661

 
140,661

Restricted cash and cash equivalents
 
4,602

 
4,602

 
5,353

 
5,353

Financial liabilities
 
 

 
 

 
 
 
 
Notes payable
 
112,000

 
114,261

 
112,000

 
118,207

The Company's estimates of fair value for financial liabilities are based on a combination of the variable interest rates for the Company's existing line of credit and other notes with similar durations to discount the projection of future payments on notes payable, and have been determined to be Level 2 fair value measurements, as defined below.
Assets and liabilities recorded at fair value on the 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 market participants would use in pricing the assets or liabilities at the measurement date.
The following methods and assumptions were used to determine the fair value of each class of assets and liabilities recorded at fair value in the consolidated balance sheets.
Fair value of available-for-sale fixed maturity and equity securities is based on quoted market prices, where available, and is obtained primarily from third party pricing services, which generally use Level 1 or Level 2 inputs. The Company obtains a quoted price for each security from third party pricing services. The quoted prices are derived through recently reported trades for identical or similar securities. For securities not actively traded, the third party pricing services may use quoted market prices of similar instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, broker quotes, benchmark yields, credit spreads, default rates, and prepayment speeds. The Company also performs a quarterly analysis on the prices received from third party pricing services to determine whether the prices are reasonable estimates of fair value, including confirming the fair values of these securities through observable market prices using an alternative pricing source. If differences are noted in this review, the Company may obtain additional information from other pricing services to validate the quoted price. There were no adjustments to prices obtained from third party pricing services as of June 30, 2013 or December 31, 2012 that were material to the consolidated financial statements.
If quoted market prices and an estimate determined by using objectively verifiable information are unavailable, the Company produces an estimate of fair value based on internally developed valuation techniques, which, depending on the level of observable market inputs, will render the fair value estimate as Level 2 or Level 3. The Company bases all of its estimates of fair value for assets on the bid price as it represents what a third party market participant would be willing to pay in an arm's length transaction.
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.
Estimates of fair value for fixed maturity securities are based on estimates using objectively verifiable information and are included in the amount disclosed in Level 2 of the hierarchy. The fair value estimates for determining Level 3 fair value include the Company's assumptions about risk assessments and market participant assumptions based on the best information available, including quotes from market makers and other broker/dealers recognized as market participants, using standard or trade derived inputs, new issue data, monthly payment information, cash flow generation, prepayment speeds, spread adjustments, or rating updates.

7



The following table presents the items on the accompanying consolidated balance sheets that are stated at fair value and the fair value measurements.
 
 
June 30, 2013
 
December 31, 2012
 
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
 
 
(in thousands)
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$

 
$
152,085

 
$

 
$

 
$
152,490

 
$

U.S. Agencies
 

 
89,031

 

 

 
93,967

 

States and municipalities
 

 
754,833

 

 

 
758,516

 

Corporate securities
 

 
746,808

 

 

 
676,243

 

Residential mortgage-backed securities
 

 
239,025

 

 

 
252,852

 

Commercial mortgage-backed securities
 

 
51,433

 

 

 
56,120

 

Asset-backed securities
 

 
36,812

 

 

 
34,240

 

Total fixed maturity securities
 

 
2,070,027

 

 

 
2,024,428

 

Equity securities
 
$
140,369

 
$

 
$

 
$
125,086

 
$

 
$

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 thousands)
At June 30, 2013
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
143,294

 
$
8,830

 
$
(39
)
 
$
152,085

U.S. Agencies
 
85,104

 
3,930

 
(3
)
 
89,031

States and municipalities
 
713,702

 
45,248

 
(4,117
)
 
754,833

Corporate securities
 
725,567

 
31,031

 
(9,790
)
 
746,808

Residential mortgage-backed securities
 
231,561

 
10,260

 
(2,796
)
 
239,025

Commercial mortgage-backed securities
 
53,618

 
423

 
(2,608
)
 
51,433

Asset-backed securities
 
36,977

 
94

 
(259
)
 
36,812

Total fixed maturity securities
 
1,989,823

 
99,816

 
(19,612
)
 
2,070,027

Equity securities
 
85,559

 
55,114

 
(304
)
 
140,369

Total investments
 
$
2,075,382

 
$
154,930

 
$
(19,916
)
 
$
2,210,396

At December 31, 2012
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
138,839

 
$
13,651

 
$

 
$
152,490

U.S. Agencies
 
88,202

 
5,765

 

 
93,967

States and municipalities
 
689,776

 
68,740

 

 
758,516

Corporate securities
 
627,047

 
49,461

 
(265
)
 
676,243

Residential mortgage-backed securities
 
236,461

 
16,488

 
(97
)
 
252,852

Commercial mortgage-backed securities
 
54,755

 
1,410

 
(45
)
 
56,120

Asset-backed securities
 
34,062

 
211

 
(33
)
 
34,240

Total fixed maturity securities
 
1,869,142

 
155,726

 
(440
)
 
2,024,428

Equity securities
 
81,067

 
45,399

 
(1,380
)
 
125,086

Total investments
 
$
1,950,209

 
$
201,125

 
$
(1,820
)
 
$
2,149,514


8



The amortized cost and estimated fair value of fixed maturity securities at June 30, 2013, 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 thousands)
Due in one year or less
 
$
151,956

 
$
154,046

Due after one year through five years
 
751,560

 
784,120

Due after five years through ten years
 
583,868

 
614,269

Due after ten years
 
180,283

 
190,322

Mortgage and asset-backed securities
 
322,156

 
327,270

Total
 
$
1,989,823

 
$
2,070,027


9



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 June 30, 2013 and December 31, 2012.
 
 
June 30, 2013
 
December 31, 2012
 
 
Estimated Fair Value
 
Gross Unrealized Losses
 
Number of Issues
 
Estimated Fair Value
 
Gross Unrealized Losses
 
Number of Issues
 
 
(dollars in thousands)
Less than 12 months:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
12,107

 
$
(39
)
 
5

 
$

 
$

 

U.S. Agencies
 
3,025

 
(3
)
 
1

 

 

 

States and municipalities
 
96,389

 
(4,117
)
 
26

 

 

 

Corporate securities
 
292,305

 
(9,664
)
 
110

 
36,338

 
(265
)
 
12

Residential mortgage-backed securities
 
80,475

 
(2,785
)
 
36

 
14,629

 
(28
)
 
6

Commercial mortgage-backed securities
 
33,254

 
(2,608
)
 
10

 
10,432

 
(45
)
 
4

Asset-backed securities
 
28,903

 
(259
)
 
13

 
16,714

 
(33
)
 
5

Total fixed maturity securities
 
546,458

 
(19,475
)
 
201

 
78,113

 
(371
)
 
27

Equity securities
 
10,005

 
(268
)
 
38

 
11,645

 
(1,207
)
 
35

Total less than 12 months
 
$
556,463

 
$
(19,743
)
 
239

 
$
89,758

 
$
(1,578
)
 
62

 
 
 
 
 
 
 
 
 
 
 
 
 
12 months or greater:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
Corporate securities
 
$
2,460

 
$
(126
)
 
1

 
$

 
$

 

Residential mortgage-backed securities
 
511

 
(11
)
 
17

 
2,341

 
(69
)
 
17

Total fixed maturity securities
 
2,971

 
(137
)
 
18

 
2,341

 
(69
)
 
17

Equity securities
 
331

 
(36
)
 
2

 
456

 
(173
)
 
4

Total 12 months or greater
 
$
3,302

 
$
(173
)
 
20

 
$
2,797

 
$
(242
)
 
21

 
 
 
 
 
 
 
 
 
 
 
 
 
Total available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
12,107

 
$
(39
)
 
5

 
$

 
$

 

U.S. Agencies
 
3,025

 
(3
)
 
1

 

 

 

States and municipalities
 
96,389

 
(4,117
)
 
26

 

 

 

Corporate securities
 
294,765

 
(9,790
)
 
111

 
36,338

 
(265
)
 
12

Residential mortgage-backed securities
 
80,986

 
(2,796
)
 
53

 
16,970

 
(97
)
 
23

Commercial mortgage-backed securities
 
33,254

 
(2,608
)
 
10

 
10,432

 
(45
)
 
4

Asset-backed securities
 
28,903

 
(259
)
 
13

 
16,714

 
(33
)
 
5

Total fixed maturity securities
 
549,429

 
(19,612
)
 
219

 
80,454

 
(440
)
 
44

Equity securities
 
10,336

 
(304
)
 
40

 
12,101

 
(1,380
)
 
39

Total available-for-sale
 
$
559,765

 
$
(19,916
)
 
259

 
$
92,555

 
$
(1,820
)
 
83

Based on reviews of the fixed maturity securities, the Company determined that unrealized losses as of June 30, 2013 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 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 cost, or maturity.
Based on reviews of the equity securities as of June 30, 2013, the Company recognized an impairment of $0.1 million in the fair value of one equity security as a result of the severity and duration of the change in fair value of that security.

10



Realized gains on investments, net, 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
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013

2012
 
2013

2012
 
 
(in thousands)
Realized gains on investments, net
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
Gross gains
 
$
1

 
$
592

 
$
1

 
$
2,295

Gross losses
 

 

 

 
(5
)
Realized gains on fixed maturity securities, net
 
$
1

 
$
592

 
$
1

 
$
2,290

Equity securities
 
 
 
 
 
 
 
 
Gross gains
 
$
3,933

 
$
613

 
$
4,977

 
$
1,161

Gross losses
 
(68
)
 
(260
)
 
(318
)
 
(728
)
Realized gains on equity securities, net
 
$
3,865

 
$
353

 
$
4,659

 
$
433

Total
 
$
3,866

 
$
945

 
$
4,660

 
$
2,723

 
 
 
 
 
 
 
 
 
Change in unrealized gains (losses)
 
 

 
 

 
 
 
 
Fixed maturity securities
 
$
(62,851
)
 
$
8,015

 
$
(75,082
)
 
$
3,558

Equity securities
 
(687
)
 
(3,047
)
 
10,790

 
8,931

Total
 
$
(63,538
)
 
$
4,968

 
$
(64,292
)
 
$
12,489

Net investment income was as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013
 
2012
 
 
(in thousands)
Fixed maturity securities
 
$
17,280

 
$
18,045

 
$
34,526

 
$
36,289

Equity securities
 
947

 
777

 
1,783

 
1,424

Cash equivalents and restricted cash
 
28

 
94

 
63

 
223

 
 
18,255

 
18,916

 
36,372

 
37,936

Investment expenses
 
(610
)
 
(619
)
 
(1,322
)
 
(1,254
)
Net investment income
 
$
17,645

 
$
18,297

 
$
35,050

 
$
36,682

The Company is required by various state laws and regulations to keep securities or letters of credit in depository accounts with certain states in which it does business. As of June 30, 2013 and December 31, 2012, securities having a fair value of $592.1 million and $530.6 million, respectively, were on deposit. These laws and regulations govern not only the amount, but also the types of securities that are eligible for deposit. The deposits are limited to fixed maturity securities in all states. Additionally, certain reinsurance contracts require Company funds to be held in trust for the benefit of the ceding reinsurer to secure the outstanding liabilities assumed by the Company. The fair value of fixed maturity securities held in trust for the benefit of ceding reinsurers at June 30, 2013 and December 31, 2012 was $32.0 million and $35.0 million, respectively. Pursuant to the Amended Credit Facility, a portion of the Company's debt was secured by fixed maturity securities and restricted cash and cash equivalents that had a fair value of $107.2 million and $110.4 million at June 30, 2013 and December 31, 2012, respectively.
5. Income Taxes
Income tax expense for interim periods is measured using an estimated effective tax rate for the annual period. The following is a reconciliation of the federal statutory income tax rate to the Company’s effective tax rates for the periods presented.
 
 
Six Months Ended
 
 
June 30,
 
 
2013
 
2012
Expense computed at statutory rate
 
35.0
 %
 
35.0
 %
Dividends received deduction and tax-exempt interest
 
(19.7
)
 
(108.9
)
LPT Agreement
 
(12.0
)
 
(76.2
)
Other
 
1.0

 
4.6

Effective tax rate
 
4.3
 %
 
(145.5
)%

11



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.
 
 
Six Months Ended
 
 
June 30,
 
 
2013
 
2012
 
 
(in thousands)
Unpaid losses and LAE, gross of reinsurance, at beginning of period
 
$
2,231,540

 
$
2,272,363

Less reinsurance recoverables for unpaid losses and LAE
 
805,386

 
940,840

Net unpaid losses and LAE at beginning of period
 
1,426,154

 
1,331,523

Losses and LAE, net of reinsurance, related to:
 
 

 
 

Current period
 
227,926

 
176,145

Prior periods
 
1,651

 
1,054

Total net losses and LAE incurred during the period
 
229,577

 
177,199

Deduct payments for losses and LAE, net of reinsurance, related to:
 
 

 
 

Current period
 
21,843

 
18,520

Prior periods
 
143,776

 
128,460

Total net payments for losses and LAE during the period
 
165,619

 
146,980

Ending unpaid losses and LAE, net of reinsurance
 
1,490,112

 
1,361,742

Reinsurance recoverable for unpaid losses and LAE
 
801,149

 
920,047

Unpaid losses and LAE, gross of reinsurance, at end of period
 
$
2,291,261

 
$
2,281,789

Total net losses and LAE included in the above table excludes the impact of the amortization of the deferred reinsurance gain—LPT Agreement (Deferred Gain) (Note 7).
The increase in the estimates of incurred losses and LAE attributable to insured events for prior periods was primarily related to the Company's assigned risk business.
7. LPT Agreement
The Company is party to a 100% quota share retroactive reinsurance agreement (LPT Agreement) under which $1.5 billion in liabilities for losses and LAE related to claims incurred by EICN prior to July 1, 1995 were reinsured for consideration of $775.0 million. The LPT Agreement provides coverage up to $2.0 billion. The initial Deferred Gain resulting from the LPT Agreement was recorded as a liability in the accompanying consolidated balance sheets as Deferred reinsurance gain–LPT Agreement. The Company is also entitled to receive a contingent profit commission under the LPT Agreement. The contingent profit commission is an amount based on the favorable difference between actual paid losses and LAE and expected paid losses and LAE as established in the LPT Agreement. The Company records its estimate of contingent profit commission in the accompanying consolidated balance sheets as Contingent commission receivable–LPT Agreement and a corresponding liability is recorded on the accompanying consolidated balance sheets in Deferred reinsurance gain–LPT Agreement. The 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 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. There were no adjustments to the estimated reserves ceded under the LPT Agreement in the current period.
The Company amortized $8.7 million and $8.9 million of the Deferred Gain for the six months ended June 30, 2013 and 2012, respectively. The remaining Deferred Gain was $274.2 million and $281.0 million as of June 30, 2013 and December 31, 2012, respectively. The estimated remaining liabilities subject to the LPT Agreement were $655.6 million and $672.3 million as of June 30, 2013 and December 31, 2012, respectively. Losses and LAE paid with respect to the LPT Agreement totaled $621.8 million and $605.1 million through June 30, 2013 and December 31, 2012, respectively.

12



8. Accumulated Other Comprehensive Income, net
Accumulated other comprehensive income, net, 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, net:
 
 
June 30, 2013
 
December 31, 2012
 
 
(in thousands)
Net unrealized gain on investments, before taxes
 
$
135,014

 
$
199,305

Deferred tax expense on net unrealized gains
 
(47,255
)
 
(69,756
)
Total accumulated other comprehensive income, net
 
$
87,759

 
$
129,549

9. Stock-Based Compensation
The Company awarded stock options, restricted stock units (RSUs) and performance share units (PSUs) to certain officers and Directors 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 2013
 
 
 
 
 
 
 
Stock options(1)
162,800

 
$
7.04

 
$
22.24

 
$
1.1

RSUs(1)
73,894

 
22.24

 

 
1.6

PSUs(2)
147,440

 
22.24

 

 
3.3

 
 
 
 
 
 
 
 
May 2013
 
 
 
 
 
 
 
RSUs(1)
14,550

 
24.74

 

 
0.4

(1)
The stock options and RSUs awarded in March 2013 were awarded to certain officers of the Company and vest 25% on March 19, 2014, and each of the subsequent three anniversaries of that date. The stock options and RSUs are subject to accelerated vesting in certain circumstances, such as: death or disability, or in connection with change of control of the Company. The stock options expire seven years from the date of grant.
The RSUs awarded in May 2013 were granted to non-employee Directors of the Company and have a service vesting period of one year from the grant date.
(2)
The PSUs have a performance period of three years and are subject to certain performance goals, based on the Company's statutory combined ratio, with payouts that range from 0% to 200% of the target awards. The values shown in the table represent the target number of PSUs awarded.
A total of 136,047 and 101,261 stock options were exercised during the six months ended June 30, 2013 and the year ended December 31, 2012, respectively.

13



10. Earnings Per Share
Basic earnings per share includes no dilution and is computed by dividing income applicable to stockholders by the weighted average number of shares outstanding for the period. Diluted earnings per share reflects the potential dilutive impact of all convertible securities on earnings per share. Diluted earnings per share includes shares assumed issued under the “treasury stock method,” which reflects the potential dilution that would occur if outstanding options were to be exercised. The following table presents the net income and the weighted average shares outstanding used in the earnings per common share calculations.
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013

2012
 
2013

2012
 
 
(in thousands, except share data)
Net income available to stockholders—basic and diluted
 
$
14,588

 
$
5,016

 
$
22,078

 
$
11,356

Weighted average number of shares outstanding—basic
 
31,079,713

 
31,537,452

 
30,997,552

 
32,093,328

Effect of dilutive securities:
 
 
 
 
 
 
 
 
PSUs
 
209,795

 
20,229

 
167,388

 
8,975

Stock options
 
296,893

 
82,385

 
279,405

 
83,547

RSUs
 
55,215

 
45,570

 
71,399

 
56,741

Dilutive potential shares
 
561,903


148,184

 
518,192

 
149,263

Weighted average number of shares outstanding—diluted
 
31,641,616

 
31,685,636

 
31,515,744

 
32,242,591

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 and RSUs that were excluded from diluted earnings per share.
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013
 
2012
Options excluded as the exercise price was greater than the average market price
 

 
934,597

 

 
934,597

Options and RSUs excluded under the treasury method as the potential proceeds on settlement or exercise price was greater than the value of shares acquired
 
162,800

 
654,123

 
511,477

 
555,084


14



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 Employers Holdings, Inc. (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 on Form 10-K for the year ended December 31, 2012 (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, expected losses, 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 31 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. 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 goal is to maintain our focus on disciplined underwriting and to continue to pursue profitable growth opportunities across market cycles; however, we continue to be affected by persistently low investment yields and continuing high levels of unemployment nationally. We do not believe overall economic conditions will change significantly in the near-term.
We market and sell our workers' compensation insurance products through independent local, regional, and national agents and brokers; through our strategic partnerships and alliances, including our principal partners ADP, Inc. and Anthem Blue Cross of California; and through relationships with national, regional, and local trade groups and associations.
Results of Operations
Overall, net income was $14.6 million and $22.1 million for the three and six months ended June 30, 2013, respectively, compared to $5.0 million and $11.4 million for the corresponding periods of 2012. We recognized underwriting losses of $5.1 million and $15.3 million for the three and six months ended June 30, 2013, respectively, compared to underwriting losses of $15.8 million and $33.2 million for the same periods of 2012. Underwriting income or loss is determined by deducting losses and LAE, commission expense, and underwriting and other operating expenses from net premiums earned. Key factors that affected our financial performance during the three and six months ended June 30, 2013, compared to the same periods of 2012, include:
Gross premiums written increased 24.2% and 23.4%;
Net premiums earned increased 34.5% and 34.6%;
Losses and LAE increased 28.3% and 31.2%;
Underwriting and other operating expenses increased 6.4% and 0.8%;

15



Income tax expenses increased $3.5 million and $7.7 million; and
Unrealized gains on investments, net of deferred tax expense, decreased $44.5 million and $49.9 million.
A primary measure of our performance is our ability to increase stockholders’ equity, including the impact of the Deferred reinsurance gain–LPT Agreement (Deferred Gain), over the long-term; however, during periods of rising interest rates, the fair value of the fixed income component of our investment portfolio may be negatively impacted, thereby reducing stockholders' equity. During the second quarter of 2013, the unrealized gain in our portfolio, net of deferred tax expense, declined by $41.3 million, principally as a result of the upward movement in interest rates during the quarter. The following table shows our stockholders' equity including the Deferred Gain, stockholders' equity on a GAAP basis, and number of common shares outstanding.
 
 
June 30, 2013
 
December 31, 2012
 
 
(in thousands, except share data)
Stockholders' equity including the Deferred Gain(1)
 
$
796,123

 
$
820,424

GAAP stockholders' equity
 
$
521,940

 
$
539,381

Common shares outstanding
 
30,998,491

 
30,771,479

(1)
Stockholders' equity, including the Deferred Gain, is a non-GAAP measure that is defined as total stockholders' equity plus the Deferred Gain, which we believe is an important supplemental measure of our capital position.
The comparative components of net income are set forth in the following table:
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013

2012
 
 
(in thousands)
Gross premiums written
 
$
190,068

 
$
153,094

 
$
365,031

 
$
295,888

Net premiums written
 
186,996

 
150,364

 
359,022

 
290,728

 
 
 
 
 
 
 
 
 
Net premiums earned
 
$
159,953

 
$
118,955

 
$
307,928

 
$
228,855

Net investment income
 
17,645

 
18,297

 
35,050

 
36,682

Realized gains on investments, net
 
3,866

 
945

 
4,660

 
2,723

Other income
 
144

 
114

 
247

 
195

Total revenues
 
181,608


138,311

 
347,885

 
268,455

 
 
 
 
 
 
 
 
 
Losses and LAE
 
112,638

 
87,809

 
220,910

 
168,327

Commission expense
 
20,127

 
16,621

 
38,520

 
30,437

Underwriting and other operating expenses
 
32,249

 
30,316

 
63,789

 
63,305

Interest expense
 
797

 
858

 
1,605

 
1,760

Income tax expense (benefit)
 
1,209

 
(2,309
)
 
983

 
(6,730
)
Total expenses
 
167,020

 
133,295

 
325,807

 
257,099

Net income
 
$
14,588

 
$
5,016

 
$
22,078

 
$
11,356

Less amortization of the Deferred Gain related to losses
 
$
3,275

 
$
3,828

 
$
6,580

 
$
7,984

Less amortization of the Deferred Gain related to contingent commission
 
406

 
256

 
788

 
525

Less impact of LPT Contingent Commission Adjustments(1)
 
1,024

 
227

 
1,299

 
363

Net income before impact of the LPT Agreement(2)
 
$
9,883

 
$
705

 
$
13,411

 
$
2,484

(1)
Any adjustment to the contingent profit commission under the LPT Agreement results in a cumulative adjustment to the Deferred Gain, which is also recognized in losses and LAE incurred in the consolidated statement of income and comprehensive income, such that the Deferred Gain reflects the balance that would have existed had the revised contingent profit commission been recognized at the inception of the LPT Agreement (LPT Contingent Commission Adjustments).
(2)
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 LPT Agreement ceded reserves; and (c) adjustments to contingent commission receivable–LPT Agreement. Deferred Gain reflects the unamortized gain from our LPT Agreement. Under GAAP, this gain is deferred and is being amortized using the recovery method. Amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries over the life of the LPT Agreement, except for the contingent profit commission, which is amortized through June 30, 2024. The amortization is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT Agreement and the expected losses and LAE subject to the contingent profit commission under the LPT Agreement. Our reevaluation results in corresponding adjustments, if needed, to reserves,

16



ceded reserves, contingent commission receivable, and the Deferred Gain, with the net effect being an increase or decrease, as the case may be, to net income. 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 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 effect our ongoing operations, and, consequently, we believe this presentation is useful in providing a meaningful understanding of our operating performance. In addition, we believe this non-GAAP measure, as we have defined it, is helpful to our management in identifying trends in our performance because the excluded item has limited significance on our current and ongoing operations.
Net Premiums Earned
Net premiums earned increased 34.5% and 34.6% for the three and six months ended June 30, 2013, compared to the corresponding periods in 2012. These increases were primarily due to increasing policy count, increasing average policy size, and higher net rate.
The following table shows the percentage change in our in-force premium, policy count, average policy size, payroll exposure upon which our premiums are based, and net rate.
 
As of June 30, 2013
 
Year-to-Date Increase
 
Year-Over-Year Increase
In-force premiums
9.8
%
 
23.9
%
In-force policy count
3.9

 
15.2

Average in-force policy size
5.6

 
7.5

In-force payroll exposure
4.1

 
12.4

Net rate(1)
5.5

 
10.1

(1)
Net rate, defined as total premium in-force divided by total insured payroll exposure, is a function of a variety of factors, including rate changes, underwriting risk profiles and pricing, and changes in business mix related to economic and competitive pressures.
Our in-force premiums and number of policies in-force by select states were as follows:
 
 
June 30, 2013
 
December 31, 2012
 
June 30, 2012
 
December 31, 2011
State
 
Premiums
In-force
 
Policies
In-force
 
Premiums
In-force
 
Policies
In-force
 
Premiums
In-force
 
Policies
In-force
 
Premiums
In-force
 
Policies
In-force
 
 
(dollars in thousands)
California
 
$
349,253

 
47,659

 
$
317,890

 
46,829

 
$
274,379

 
42,577

 
$
221,910

 
36,867

Illinois
 
31,583

 
3,284

 
30,555

 
3,302

 
28,816

 
3,125

 
24,744

 
2,433

Georgia
 
25,329

 
3,566

 
22,985

 
3,150

 
19,882

 
2,628

 
16,393

 
2,050

Florida
 
19,041

 
3,117

 
17,676

 
2,918

 
16,909

 
2,723

 
15,226

 
2,399

Nevada
 
16,001

 
3,847

 
15,522

 
3,876

 
15,748

 
3,845

 
14,639

 
3,718

Other
 
148,583

 
21,459

 
132,714

 
19,739

 
120,473

 
17,073

 
101,009

 
13,226

Total
 
$
589,790

 
82,932

 
$
537,342

 
79,814

 
$
476,207

 
71,971

 
$
393,921

 
60,693

Our strategic partnerships and alliances generated $134.8 million and $109.5 million, or 22.9% and 23.0%, of our in-force premiums as of June 30, 2013 and 2012, 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 expand our existing relationships and actively seek new partnerships and alliances.
In September 2012, the California legislature passed Senate Bill No. 863 (SB 863), which was subsequently signed into law. SB 863 includes a number of reforms to California's workers' compensation system, including increases to permanent disability benefits offset by reforms designed to reduce costs in the system. According to the Workers' Compensation Insurance Rating Bureau, the cost savings are expected to be achieved through a number of measures, including: the creation of a new dispute resolution process outside of the Workers' Compensation Appeals Board for medical treatments and billing issues; new controls on liens; and calls for new fee schedules for physicians, interpreters, ambulatory surgery centers, and home health care.
Any cost savings associated with SB 863 will be dependent on the implementation of the provisions of the bill and are not included in our current rate filings. We will evaluate SB 863's mandated regulations as they are adopted and will adjust our rate filings as indicated. We can offer no assurance that SB 863 will result in any cost savings for us or any indication as to when, if ever, any cost savings might occur.

17



We set our own premium rates in California based upon actuarial analyses of current and anticipated loss trends with a goal of maintaining underwriting profitability. Due to increasing loss costs, primarily medical cost inflation, we have increased our filed premium rates in California by a cumulative 41.3% since the beginning of 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

September 15, 2011
 
3.9

June 15, 2012
 
6.0

We expect that total premiums in 2013 across our markets will reflect:
overall net rate increases;
decelerating policy count growth; and
increasing average policy size.
Net Investment Income and Realized Gains on Investments, Net
We invest our holding company assets, statutory surplus, and the funds supporting our insurance liabilities, including unearned premiums and unpaid losses and LAE. We invest in fixed maturity securities, equity securities, and cash equivalents. Net investment income includes interest and dividends earned on our invested assets and amortization of premiums and discounts on our fixed maturity securities, less bank service charges and custodial and portfolio management fees. We have established a high quality/short duration bias in our investment portfolio.
Net investment income decreased 3.6% and 4.4% for the three and six months ended June 30, 2013, compared to the same periods of 2012. The decrease was primarily related to decreases in the average pre-tax book yield on invested assets to 3.4% and 3.5% for the three and six months ended June 30, 2013, compared to 3.7% for the same periods of 2012. The tax-equivalent yield on invested assets decreased to 4.2% at June 30, 2013, compared to 4.8% at June 30, 2012.
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 $3.9 million and $4.7 million for the three and six months ended June 30, 2013, respectively, compared to $0.9 million and $2.7 million for the corresponding periods of 2012.
Additional information regarding our Investments is set forth under “—Liquidity and Capital Resources—Investments.”
Combined Ratio
The combined ratio, expressed as a percentage, is a key measurement of underwriting profitability. The combined ratio is the sum of the loss and LAE ratio, the commission expense ratio, and underwriting and other operating expenses ratio. When the combined ratio is below 100%, we have recorded underwriting income, and conversely, when the combined ratio is greater than 100%, we cannot be profitable without investment income. Because we only have one operating segment, holding company expenses are included in our calculation of the combined ratio.
The following table provides the calculation of our calendar year combined ratios.
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013

2012
Loss and LAE ratio
 
70.4
%
 
73.8
%
 
71.7
%
 
73.6
%
Underwriting and other operating expenses ratio
 
20.2

 
25.5

 
20.8

 
27.6

Commission expense ratio
 
12.6

 
14.0

 
12.5

 
13.3

Combined ratio
 
103.2
%
 
113.3
%
 
105.0
%
 
114.5
%

18



Loss and LAE Ratio. Expressed as a percentage, this is the ratio of losses and LAE to net premiums earned.
Losses and LAE represents our largest expense item and includes claim payments made, amortization of the Deferred Gain, estimates for future claim payments and changes in those estimates for current and prior periods, and costs associated with investigating, defending, and adjusting claims. The quality of our financial reporting depends in large part on accurately predicting our losses and LAE, which are inherently uncertain as they are estimates of the ultimate cost of individual claims based on actuarial estimation techniques.
Our indemnity claims frequency (the number of claims expressed as a percentage of payroll) was relatively unchanged for the three and six months ended June 30, 2013, compared to the same periods of 2012, and our loss experience indicates a downward trend in medical and indemnity costs per claim that are reflected in our current accident year loss estimate. We believe our current accident year loss estimate is adequate; however, ultimate losses will not be known with any certainty for many years.
Overall, losses and LAE increased 28.3% and 31.2% for the three and six months ended June 30, 2013, compared to the same periods of 2012. This increase was primarily due to higher net earned premiums in 2013. Prior accident year loss development in both periods was primarily related to our assigned risk business. Our current accident year loss estimates were 73.0% and 74.0% for the three and six months ended June 30, 2013, compared to 77.0% for the three and six months ended June 30, 2012. The decrease in our current accident year loss estimate is primarily the result of net rate increases more than offsetting increases in loss costs.
Excluding the impact from the LPT Agreement, losses and LAE would have been $117.3 million and $92.1 million, or 73.4% and 77.4% of net premiums earned, for the three months ended June 30, 2013 and 2012, respectively. For the six months ended June 30, 2013 and 2012, losses and LAE would have been $229.6 million and $177.2 million, or 74.6% and 77.4% of net premiums earned, respectively.
The table below reflects the losses and LAE reserve adjustments.
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013

2012
 
 
(in thousands)
 
(in thousands)
Prior accident year (unfavorable) loss development, net
 
$
(522
)
 
$
(529
)
 
$
(1,651
)
 
$
(1,054
)
Amortization of the Deferred Gain related to losses
 
3,275

 
3,828

 
6,580

 
7,984

Amortization of the Deferred Gain related to contingent commission
 
406

 
256

 
788

 
525

Impact of LPT Contingent Commission Adjustments
 
1,024

 
227

 
1,299

 
363

Underwriting and Other Operating Expenses Ratio. The underwriting and other operating expenses ratio is the ratio (expressed as a percentage) of underwriting and other operating expenses to net premiums earned and measures an insurance company's operational efficiency in producing, underwriting, and administering its insurance business.
Underwriting and other operating expenses are those costs that we incur to underwrite and maintain the insurance policies we issue, excluding commission. These expenses include premium taxes and certain other general expenses that vary with, and are primarily related to, producing new or renewal business. Other underwriting expenses include policyholder dividends, changes in estimates of future write-offs of premiums receivable, general administrative expenses such as salaries and benefits, rent, office supplies, depreciation, and all other operating expenses not otherwise classified separately. Policy acquisition costs are variable based on premiums earned; however, other operating costs are more fixed in nature and become a smaller percentage of net premiums earned as premiums increase.
Our underwriting and other operating expenses ratio decreased 5.3 and 6.8 percentage points, while our underwriting and other operating expenses increased 6.4% and 0.8% for the three and six months ended June 30, 2013, respectively, compared to the same periods of 2012, primarily due to net premiums earned increasing at a faster rate than our expenses during these periods. During the three months ended June 30, 2013, our compensation related expenses increased $1.8 million, premium taxes and assessments expenses increased $1.2 million and information technology expenses increased $0.7 million, compared to the same period of 2012. During the six months ended June 30, 2013, our compensation related expenses increased $2.7 million, premium taxes and assessments expenses increased $2.4 million and information technology expenses increased $1.1 million, compared to the same period of 2012.