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Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

Quarterly Report pursuant to Section 13 or 15(d) of

the Securities Exchange Act of 1934

for the Quarterly Period Ended June 30, 2012,

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 No. 001-32899

 

 

EASTERN INSURANCE HOLDINGS, INC.

 

 

 

Incorporated in Pennsylvania  

I.R.S. Employer

Identification No.

20-2653793

25 Race Avenue, Lancaster, Pennsylvania

17603-3179

(717) 396-7095

 

 

 

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 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

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

Indicate by check mark if the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Title of Each Class

 

Number of Shares Outstanding as of August 1, 2012

Common Stock, No Par Value   7,910,609 (Outstanding Shares)

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page  

PART I – FINANCIAL INFORMATION

     3   

Item 1. Financial Statements (Unaudited)

     3   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     22   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     36   

Item 4. Controls and Procedures

     36   

PART II – OTHER INFORMATION

     37   

Item 1. Legal Proceedings

     37   

Item 1A. Risk Factors

     37   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     37   

Item 3. Defaults Upon Senior Securities

     38   

Item 4. Mine Safety Disclosures

     38   

Item 5. Other Information

     38   

Item 6. Exhibits

     38   

 

2


Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except share data)

 

     June 30
2012
    December 31
2011
 

ASSETS

    

Investments:

    

Fixed income securities, at estimated fair value (amortized cost, $137,404; $128,619)

   $ 142,311      $ 133,422   

Convertible bonds, at estimated fair value (amortized cost, $17,231; $16,856)

     18,163        17,574   

Equity securities, at estimated fair value (cost, $18,972; $16,566)

     20,563        17,629   

Other long-term investments, at estimated fair value (cost, $8,100; $8,100)

     10,657        10,209   
  

 

 

   

 

 

 

Total investments

     191,694        178,834   

Cash and cash equivalents

     42,574        52,448   

Accrued investment income

     1,041        972   

Premiums receivable (net of allowance, $331; $225)

     68,630        56,443   

Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses

     18,690        15,720   

Deferred acquisition costs

     9,977        9,206   

Deferred income taxes, net

     1,849        1,768   

Federal income taxes recoverable

     1,427        731   

Intangible assets

     4,733        5,137   

Goodwill

     10,752        10,752   

Other assets

     14,498        13,668   
  

 

 

   

 

 

 

Total assets

   $ 365,865      $ 345,679   
  

 

 

   

 

 

 

LIABILITIES

    

Reserves for unpaid losses and loss adjustment expenses

   $ 111,521      $ 106,077   

Unearned premium reserves

     76,582        63,432   

Advance premium

     284        747   

Accounts payable and accrued expenses

     17,925        18,892   

Ceded reinsurance balances payable

     10,432        10,265   

Segregated portfolio cell dividend payable

     16,467        15,774   

Policyholder dividends payable

     2,103        2,233   
  

 

 

   

 

 

 

Total liabilities

     235,314        217,420   
  

 

 

   

 

 

 

Commitments and contingencies (Note 10)

    

SHAREHOLDERS’ EQUITY

    

Series A preferred stock, par value $0, auth. shares – 5,000,000; no shares issued and outstanding

     —          —     

Common capital stock, par value $0, auth. shares – 20,000,000; issued – 11,927,714 and 11,786,014, respectively; outstanding – 7,910,609 and 7,935,446, respectively

     —          —     

Unearned ESOP compensation

     (2,991     (3,364

Additional paid in capital

     116,772        116,272   

Treasury stock, at cost (4,017,105 and 3,850,568 shares, respectively)

     (56,532     (54,109

Retained earnings

     70,112        66,910   

Accumulated other comprehensive income, net

     3,190        2,550   
  

 

 

   

 

 

 

Total shareholders’ equity

     130,551        128,259   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 365,865      $ 345,679   
  

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

3


Table of Contents

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

For the Three and Six Months Ended June 30, 2012 and 2011

(Unaudited, in thousands, except per share data)

 

     For the Three Months Ended
June 30,
    For the Six Months  Ended
June 30,
 
     2012     2011     2012      2011  

REVENUE

         

Net premiums earned

   $ 38,735      $ 32,207      $ 75,221       $ 62,085   

Net investment income

     1,064        908        2,014         1,934   

Change in equity interest in limited partnerships

     118        95        448         646   

Net realized investment (losses) gains

     (1,203     975        488         1,805   

Other revenue

     71        79        155         262   
  

 

 

   

 

 

   

 

 

    

 

 

 

Total revenue

     38,785        34,264        78,326         66,732   
  

 

 

   

 

 

   

 

 

    

 

 

 

EXPENSES

         

Losses and loss adjustment expenses incurred

     25,571        20,818        48,486         40,164   

Acquisition and other underwriting expenses

     4,473        3,308        9,905         6,726   

Other expenses

     6,208        6,044        11,896         11,933   

Amortization of intangibles

     202        254        403         508   

Policyholder dividend expense

     39        306        223         619   

Segregated portfolio dividend expense

     389        663        1,385         1,188   
  

 

 

   

 

 

   

 

 

    

 

 

 

Total expenses

     36,882        31,393        72,298         61,138   
  

 

 

   

 

 

   

 

 

    

 

 

 

Income before income taxes

     1,903        2,871        6,028         5,594   

Income tax expense

     557        881        1,760         1,722   
  

 

 

   

 

 

   

 

 

    

 

 

 

Net income

   $ 1,346      $ 1,990      $ 4,268       $ 3,872   
  

 

 

   

 

 

   

 

 

    

 

 

 

Other comprehensive (loss) income

         

Unrealized holding gains arising during period, net of tax of $5, $465, $498 and $730

     10        863        924         1,355   

Amortization of unrecognized benefit plan amounts, net of tax of $2, $2, $5, and $3

     5        3        9         5   

Less: Reclassification adjustment for gains included in net income, net of tax of $84, $451, $155, and $580

     155        886        293         1,126   
  

 

 

   

 

 

   

 

 

    

 

 

 

Other comprehensive (loss) income

     (140     (20     640         234   
  

 

 

   

 

 

   

 

 

    

 

 

 

Comprehensive income

   $ 1,206      $ 1,970      $ 4,908       $ 4,106   
  

 

 

   

 

 

   

 

 

    

 

 

 

 

Earnings per share (See Note 3):

   Three Months Ended
June 30
     Six Months Ended
June 30
 
   2012      2011      2012      2011  

Basic earnings per share

   $ 0.18       $ 0.25       $ 0.55       $ 0.47   

Diluted earnings per share

   $ 0.17       $ 0.25       $ 0.54       $ 0.47   

Cash dividends per share

   $ 0.07       $ 0.07       $ 0.14       $ 0.14   

See accompanying notes to unaudited consolidated financial statements.

 

4


Table of Contents

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the Three and Six Months Ended June 30, 2012

(Unaudited, in thousands, except share data)

Three Months Ended June 30, 2012

 

    Outstanding Shares                                            
    Series A
Preferred
Stock
    Common
Capital
Stock
    Common
Capital
Stock
    Unearned
ESOP
Compensation
    Additional
Paid-In
Capital
    Treasury
Stock
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
Net of Tax
    Total  

Balance, April 1, 2012

    —          8,064,146        —        $ (3,178   $ 116,475      $ (54,109   $ 69,268      $ 3,330      $ 131,786   

ESOP shares released

    —          —          —          187        108        —          —          —          295   

Equity awards

    —          13,000       —          —          189        —          —          —          189   

Income taxes related to equity awards

    —          —          —          —          —          —          —          —          —     

Repurchase of common stock

    —          (166,537     —          —          —          (2,423     —          —          (2,423

Shareholder dividend

    —          —          —          —          —          —          (502     —          (502

Net income

    —          —          —          —          —          —          1,346        —          1,346   

Other comprehensive loss, net of tax

    —          —          —          —          —          —          —          (140     (140
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2012

    —          7,910,609        —        $ (2,991   $ 116,772      $ (56,532   $ 70,112      $ 3,190      $ 130,551   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended June 30, 2012

 

    Outstanding Shares                                            
    Series A
Preferred
Stock
    Common
Capital
Stock
    Common
Capital
Stock
    Unearned
ESOP
Compensation
    Additional
Paid-In
Capital
    Treasury
Stock
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
Net of Tax
    Total  

Balance, January 1, 2012

    —          7,935,446        —        $ (3,364   $ 116,272      $ (54,109   $ 66,910      $ 2,550      $ 128,259   

ESOP shares released

    —          —          —          373       188        —          —          —          561   

Equity awards

    —          141,700       —          —          309        —          —          —          309   

Income taxes related to equity awards

    —          —          —          —          3        —          —          —          3   

Repurchase of common stock

    —          (166,537     —          —          —          (2,423     —          —          (2,423

Shareholder dividend

    —          —          —          —          —          —          (1,066     —          (1,066

Net income

    —          —          —          —          —          —          4,268        —          4,268   

Other comprehensive income, net of tax

    —          —          —          —          —          —          —          640        640   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2012

    —          7,910,609        —        $ (2,991   $ 116,772      $ (56,532   $ 70,112      $ 3,190      $ 130,551   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements

 

5


Table of Contents

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the Three and Six Months Ended June 30, 2011

(Unaudited, in thousands, except share data)

Three Months Ended June 30, 2011

 

    Outstanding Shares                                            
    Series A
Preferred
Stock
    Common
Capital
Stock
    Common
Capital
Stock
    Unearned
ESOP
Compensation
    Additional
Paid-In
Capital
    Treasury
Stock
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
Net of Tax
    Total  

Balance, April 1, 2011

    —          8,445,111        —        $ (3,927   $ 114,855      $ (47,368   $ 62,641      $ 4,075      $ 130,276   

ESOP shares released

    —          —          —          186        50        —          —          —          236   

Equity awards

    —          —          —          —          365        —          —          —          365   

Income taxes related to equity awards

    —          —          —          —          (7 )     —          —          —          (7 )

Repurchase of common stock

    —          (212,341     —          —          —          (2,793     —          —          (2,793

Shareholder dividend

    —          —          —          —          —          —          (513     —          (513

Net income

    —          —          —          —          —          —          1,990        —          1,990   

Other comprehensive loss, net of tax

    —          —          —          —          —          —          —          (20     (20
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

    —          8,232,770        —        $ (3,741   $ 115,263      $ (50,161   $ 64,118      $ 4,055      $ 129,534   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended June 30, 2011

 

    Outstanding Shares                                            
    Series A
Preferred
Stock
    Common
Capital
Stock
    Common
Capital
Stock
    Unearned
ESOP
Compensation
    Additional
Paid-In
Capital
    Treasury
Stock
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
Net of Tax
    Total  

Balance, January 1, 2011

    —          8,964,344        —        $ (4,111   $ 114,472      $ (40,835   $ 61,364      $ 3,821      $ 134,711   

ESOP shares released

    —          —          —          370        79        —          —          —          449   

Equity awards

    —          —          —          —          735        —          —          —          735   

Income taxes related to equity awards

    —          —          —          —          (23 )     —          —          —          (23 )

Repurchase of common stock

    —          (731,574     —          —          —          (9,326     —          —          (9,326

Shareholder dividend

    —          —          —          —          —          —          (1,118     —          (1,118

Net income

    —          —          —          —          —          —          3,872        —          3,872   

Other comprehensive income, net of tax

    —          —          —          —          —          —          —          234        234   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

    —          8,232,770        —        $ (3,741   $ 115,263      $ (50,161   $ 64,118      $ 4,055      $ 129,534   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements

 

6


Table of Contents

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Months Ended June 30, 2012 and 2011

(Unaudited, in thousands)

 

     2012     2011  

Cash flows from operating activities:

    

Net income

   $ 4,268      $ 3,872   

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

    

Depreciation and amortization

     388        347   

Amortization of bond premium/discount

     547        273   

Net realized investment gains

     (488     (1,918

Change in equity interest in limited partnerships

     (448     (646

Deferred tax (benefit) expense

     (347     686   

Stock compensation

     870        1,184   

Intangible asset amortization

     403        508   

Changes in assets and liabilities:

    

Accrued investment income

     (69     141   

Premiums receivable

     (12,187     (8,367

Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses

     (2,970     (177

Deferred acquisition costs

     (771     (1,502

Other assets

     (1,456     (1,777

Reserves for unpaid losses and loss adjustment expenses

     5,444        4,674   

Unearned and advance premium

     12,687        11,611   

Ceded reinsurance balances payable

     167        1,711   

Accounts payable and accrued expenses

     (954     557   

Segregated portfolio cell dividend payable

     983        828   

Policyholder dividends payable

     (130     251   

Federal income taxes recoverable/payable

     (696     (441
  

 

 

   

 

 

 

Net cash provided by operating activities

     5,241        11,815   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchase of fixed income securities

     (28,511     (22,473

Purchase of equity securities

     (7,207     (6,999

Proceeds from sale of fixed income securities

     13,308        17,755   

Proceeds from maturities/calls of fixed income securities

     6,062        7,921   

Proceeds from equity securities

     5,122        3,852   

Purchase of equipment, net

     (403     (543
  

 

 

   

 

 

 

Net cash used in investing activities

     (11,629     (487
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Repurchase of common stock

     (2,423     (9,326

Shareholder dividend

     (1,066     (1,118

Income taxes related to equity awards

     3        (23
  

 

 

   

 

 

 

Net cash used in financing activities

     (3,486     (10,467
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (9,874     861   

Cash and cash equivalents, beginning of period

     52,448        45,855   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 42,574      $ 46,716   
  

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

7


Table of Contents

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

(Unaudited, dollars in thousands except share and per share data)

1. Background and Nature of Operations

Eastern Insurance Holdings, Inc. (“EIHI”) is an insurance holding company offering workers’ compensation insurance and reinsurance products through its direct and indirect wholly-owned subsidiaries, Global Alliance Holdings, Ltd. (“Global Alliance”), Eastern Alliance Insurance Company (“Eastern Alliance”), Allied Eastern Indemnity Company (“Allied Eastern”), Eastern Advantage Assurance Company (“Eastern Advantage”), Employers Security Insurance Company (“Employers Security”), Employers Alliance, Inc. (“Employers Alliance”), Eastern Re Ltd., SPC (“Eastern Re”), and Eastern Services Corporation (“Eastern Services”), collectively referred to as the “Company.”

The Company currently operates in three segments: workers’ compensation insurance, segregated portfolio cell reinsurance, and corporate/other.

2. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the U.S. Securities and Exchange Commission. 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, being normal, recurring adjustments, necessary for a fair statement of the financial position and results of operations of the Company 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 should be read in conjunction with the Company’s audited financial statements and notes thereto as of and for the year ended December 31, 2011 included in the Company’s Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission on March 12, 2012.

All inter-company transactions and related account balances have been eliminated in consolidation.

Certain amounts in the prior year consolidated financial statements have been reclassified to conform to the current year presentation.

Use of Estimates

The preparation of the unaudited interim consolidated financial statements requires management to make estimates and assumptions that affect the amount of reported assets and liabilities and disclosures of contingent assets and liabilities as of the date of the unaudited interim consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. The most significant estimates in the unaudited interim consolidated financial statements include reserves for unpaid losses and loss adjustment expenses (“LAE”), earned but unbilled premium, deferred acquisition costs, return premiums under reinsurance contracts, and current and deferred income taxes. Actual results could differ from these estimates.

Recent Accounting Pronouncements

Presentation of Comprehensive Income

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 requires entities to present net income and comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. The option to present items of other comprehensive income in the statement of changes in equity was eliminated. ASU 2011-05 was effective for public entities as of the beginning of a fiscal year that began after December 15, 2011 (including interim periods) and is effective for nonpublic entities for fiscal years ending after December 15, 2012 and interim and annual periods thereafter. Early adoption was permitted and retrospective application is required. The Company adopted ASU 2011-05 effective January 1, 2012. The Company presents comprehensive income in the consolidated statement of operations and comprehensive income; therefore, the adoption of ASU 2011-05 did not change the Company’s presentation of comprehensive income.

 

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Fair Value Measurement and Disclosure Requirements

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurements and Disclosures - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.” ASU 2011-04 clarifies the application of existing fair value measurement and disclosure requirements, changes certain principles related to measuring fair value, and requires additional disclosures about fair value measurements. ASU 2011-04 was effective for periods beginning after December 15, 2011. The Company adopted ASU 2011-04 effective January 1, 2012. The adoption of ASU 2011-04 did not affect the Company’s financial condition or results of operations.

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

In October 2010, the FASB issued ASU 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”). ASU 2010-26 provides specific types of costs that should be capitalized in connection with the acquisition or renewal of insurance contracts. Those costs include incremental direct costs of contract acquisition incurred in connection with independent third parties and certain costs related to activities performed by the insurer for the contract, including underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. Under ASU 2010-26, costs incurred by an entity related to unsuccessful acquisition or renewal efforts must be charged to expense as incurred. ASU 2010-26 was effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 and is to be applied prospectively. Retrospective application to all prior periods upon the date of adoption was permitted, but not required. The Company adopted ASU 2010-26 effective January 1, 2012 and applied it prospectively. As a result of adoption, the Company expensed certain underwriting salaries totaling approximately $219,000 ($142,000, net of tax) and $945,000 ($614,000, net of tax) for the three and six months ended June 30, 2012, respectively, that would have been capitalized under the previous accounting guidance to give effect to unsuccessful acquisition or renewal activities. If the new accounting guidance had been adopted effective January 1, 2011, the Company would have recognized additional expense related to underwriting salaries totaling $439,000 ($285,000, net of tax) and $938,000 ($610,000, net of tax) for the three and six months ended June 30, 2011, respectively.

3. Earnings Per Share

Basic earnings per share are computed by dividing net income (loss) by the weighted average number of shares outstanding for the respective period. Diluted earnings per share are computed by dividing net income (loss) by the weighted average number of shares outstanding for the period, including dilutive potential common shares outstanding for the period.

Consolidated net income, basic shares outstanding, diluted shares outstanding, basic earnings per share, diluted earnings per share and cash dividends per share for the three and six months ended June 30, 2012 and 2011 were as follows (unaudited, in thousands, except share and per share data):

 

    Three Months Ended
June 30, 2012
    Three Months Ended
June 30, 2011
    Six Months Ended
June 30, 2012
    Six Months Ended
June 30, 2011
 

Net income for basic and diluted earnings per share

  $ 1,346      $ 1,990      $ 4,268      $ 3,872   

Less: Dividends declared – common and unvested restricted share units

    (502     (513     (1,066     (1,118
 

 

 

   

 

 

   

 

 

   

 

 

 

Undistributed earnings

    844        1,477        3,202        2,754   

Percent allocated to common shareholders

    98.0     99.3     98.1     99.3
 

 

 

   

 

 

   

 

 

   

 

 

 
    827        1,467        3,141        2,735   

Add: Dividends declared – common shares

    492        511        1,046        1,110   
 

 

 

   

 

 

   

 

 

   

 

 

 
  $ 1,319      $ 1,978      $ 4,187      $ 3,845   
 

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for basic earnings per share

    7,526,286        7,881,326        7,565,051        8,106,057   

Effect of dilutive securities

    137,202        107,235        136,866        104,876   
 

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for diluted earnings per common share

    7,663,488        7,988,561        7,701,917        8,210,933   
 

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per share

  $ 0.18      $ 0.25      $ 0.55      $ 0.47   

Diluted earnings per share

  $ 0.17      $ 0.25      $ 0.54      $ 0.47   

Cash dividends per share

  $ 0.07      $ 0.07      $ 0.14      $ 0.14   

 

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The following table provides a summary of the equity awards that were not included in the Company’s earnings per share calculation because to do so would have been anti-dilutive (unaudited):

 

    Three Months Ended
June 30, 2012
    Three Months Ended
June 30, 2011
    Six Months Ended
June 30, 2012
    Six Months Ended
June 30, 2011
 

Total outstanding equity awards

    1,369,497        1,031,765        1,369,497        1,031,765   

Dilutive equity awards

    (137,202     (107,235     (136,866     (104,876
 

 

 

   

 

 

   

 

 

   

 

 

 

Equity awards excluded from earnings per share calculation

    1,232,295        924,530        1,232,631        926,889   

4. Stock-Based Compensation

On February 24, 2012, the Company granted non-qualified stock options and restricted stock awards to certain employees and directors. Stock options and restricted stock awards granted totaled 218,500 and 128,700, respectively, and were issued under the Company’s 2006 Stock Incentive Plan. The closing price of the Company’s common stock on the grant date was $14.45. The terms of the stock options and restricted stock are consistent with prior grants issued by the Company. On May 18, 2012, the Company issued an additional 13,000 restricted stock awards with a grant date fair value of $14.68.

5. Fair Value Measurements

The Company’s assets and liabilities that are measured at fair value on a recurring basis are segregated between those assets and liabilities that are valued based on quoted prices (unadjusted) in active markets for identical assets or liabilities, which the reporting entity can access at the measurement date (Level 1), direct or indirect observable inputs other than Level 1 quoted prices (Level 2), or unobservable inputs to the extent that observable inputs are not available (Level 3).

The following is a description of the Company’s categorization of the inputs used in the recurring fair value measurements of its financial assets included in its consolidated balance sheets as of June 30, 2012 and December 31, 2011:

Level 1—Represents financial assets whose fair value is determined based upon observable unadjusted quoted market prices for identical financial assets in active markets that the Company has the ability to access. An example of a Level 1 input utilized to measure fair value includes the closing price of one share of common stock on an active exchange market. The Company considers U.S. Treasuries and equity securities as Level 1 assets.

Level 2—Represents financial assets whose fair value is determined based upon: quoted market prices for similar assets in active markets; quoted market prices for identical assets in inactive markets; inputs other than quoted market prices that are observable for the asset such as interest rates or yield curves; or other inputs derived principally from or corroborated from other observable market information. An example of a Level 2 input utilized to measure fair value, specifically for the Company’s fixed income portfolio, is “matrix pricing.” “Matrix pricing” relies on observable inputs from active markets other than quoted market prices including, but not limited to, benchmark securities and yields, latest reported trades, quotes from brokers or dealers, issuer spreads, bids, offers, and other relevant reference data to determine fair value. “Matrix pricing” is used to measure the fair value of fixed income securities where obtaining individual quoted market prices is impractical. The Company considers U.S. Government agencies, municipal bonds, corporate bonds, mortgage-backed securities, collateralized mortgage obligations, asset-backed securities, and convertible bonds as Level 2 assets.

Level 3—Represents financial assets whose fair value is determined based upon inputs that are unobservable, including the Company’s own determinations of the assumptions that a market participant would use in pricing the asset.

 

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The following table provides a summary of the fair value measurements of the Company’s fixed income securities, convertible bonds, and equity securities, as of June 30, 2012 (unaudited) and December 31, 2011, excluding the segregated portfolio cell reinsurance segment (in thousands):

 

            Fair Value Measurements at Reporting
Date Using
 
     6/30/12      Level 1      Level 2      Level 3  

Fixed income securities – available for sale:

        

U.S. Treasuries and government agencies

   $ 15,505       $ 11,073       $ 4,432       $ —     

States, municipalities, and political subdivisions

     48,102         —           48,102         —     

Corporate securities

     18,704         —           18,704         —     

Residential mortgage-backed securities

     19,432         —           19,432         —     

Commercial mortgage-backed securities

     167         —           167         —     

Collateralized mortgage obligations

     12,251         —           12,251         —     

Other structured securities

     1,026         —           1,026         —     

Convertible bonds

     18,163         —           18,163         —     

Equity securities – available for sale

     13,627         13,627         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 146,977       $ 24,700       $ 122,277       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

            Fair Value Measurements at Reporting
Date Using
 
     12/31/11      Level 1      Level 2      Level 3  

Fixed income securities – available for sale:

           

U.S. Treasuries and government agencies

   $ 16,143       $ 9,676       $ 6,467       $ —     

States, municipalities, and political subdivisions

     42,316         —           42,316         —     

Corporate securities

     21,509         —           21,509         —     

Residential mortgage-backed securities

     22,360         —           22,360         —     

Commercial mortgage-backed securities

     206         —           206         —     

Collateralized mortgage obligations

     5,876         —           5,876         —     

Other structured securities

     1,023         —           1,023         —     

Convertible bonds

     17,574         —           17,574         —     

Equity securities – available for sale

     12,939         12,939         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 139,946       $ 22,615       $ 117,331       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

There were no transfers between Level 1 and Level 2 securities for the three and six months ended June 30, 2012.

The estimated fair values of the Company’s investments in fixed income securities, convertible bonds, and equity securities are based on prices provided by an independent, nationally recognized pricing service. The prices provided by the independent pricing service are based on quoted market prices, when available, non-binding broker quotes, or matrix pricing. The independent pricing service provides a single price or quote per security, and the Company did not adjust security prices during the three or six months ended June 30, 2012 and 2011. Management has controls in place to validate the reasonableness of fair values provided by the independent pricing service, including testing the fair value of a sample of securities on a quarterly basis by comparing fair values from different pricing sources. Fixed income securities include U.S. Treasuries, agencies backed by the U.S. Government, municipal bonds, corporate bonds, mortgage-backed securities, collateralized mortgage obligations, and asset-backed securities.

The Company’s fixed income securities and convertible bonds consist primarily of publicly traded securities for which there are observable inputs and/or broker quotes. Most fixed income security prices provided by the independent pricing service are based on observable inputs and, therefore, are classified as Level 2 securities. The Company does not hold any fixed income securities for which pricing was based on significant unobservable inputs; therefore, the Company has not classified any of its fixed income securities as Level 3 securities.

The Company’s equity securities consist primarily of exchange traded funds for which there is an active market and quoted market prices; therefore, the Company has classified its exchange traded funds as Level 1 securities. The estimated fair values of the Company’s exchange traded funds are based on net asset value (“NAV”) per share. The Company’s exchange traded funds include a large value fund, a large growth fund, a foreign large value fund, a foreign large growth fund, a foreign large blend fund, and two diversified emerging markets funds.

Other long-term investments include the Company’s interest in various limited partnerships, including a low volatility multi-strategy fund of funds, a natural resource limited partnership, a structured finance opportunity fund, and an open-ended

 

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investment fund. The Company records its investment in the limited partnerships using the equity method. The carrying value of the Company’s limited partnership investments are based on the Company’s allocable share of the limited partnerships’ NAV. Changes in the Company’s investments are based on statements received directly from the limited partnership and/or the limited partnership’s administrator. The estimated fair values of the underlying investments in the limited partnerships may be based on Level 1, Level 2, or Level 3 inputs, or a combination thereof.

As of June 30, 2012 and December 31, 2011, the estimated fair values of the Company’s limited partnership investments, by investment strategy, were as follows (unaudited, in thousands):

 

     6/30/12      12/31/11  

Multi-strategy fund of funds

   $ 5,782       $ 5,578   

Natural resources

     1,240         1,262   

Structured finance opportunity fund

     2,989         2,769   

Open-ended investment fund

     646         600   
  

 

 

    

 

 

 

Total

   $ 10,657       $ 10,209   
  

 

 

    

 

 

 

The activity in the Company’s limited partnership investments for the three and six months ended June 30, 2012 and 2011 was as follows (unaudited, in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Balance, beginning of period

   $ 10,539       $ 11,986       $ 10,209       $ 11,435   

Contributions

     —           —           —           —     

Withdrawals

     —           —           —           —     

Unrealized change in interest

     118         95         448         646   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

   $ 10,657       $ 12,081       $ 10,657       $ 12,081   
  

 

 

    

 

 

    

 

 

    

 

 

 

The change in interest in the Company’s limited partnership investments is included in the change in equity interest in limited partnerships in the consolidated statements of operations and comprehensive income (loss).

6. Investments

The following tables provide the amortized cost and estimated fair value of the Company’s fixed income and equity securities as of June 30, 2012 and December 31, 2011 (unaudited, in thousands):

 

June 30, 2012

   Cost or
Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair

Value
 

U.S. Treasuries and government agencies

   $ 18,459       $ 535       $ —        $ 18,994   

States, municipalities, and political subdivisions

     45,513         2,608         (19     48,102   

Corporate securities

     41,616         724         (1     42,339   

Residential mortgage-backed securities

     18,537         895         —          19,432   

Commercial mortgage-backed securities

     148         19         —          167   

Collateralized mortgage obligations

     12,129         153         (31     12,251   

Other structured securities

     1,002         24         —          1,026   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed income securities

     137,404         4,958         (51     142,311   

Equity securities

     18,972         1,760         (169     20,563   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed income and equity securities

   $ 156,376       $ 6,718       $ (220   $ 162,874   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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December 31, 2011

   Cost or
Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair

Value
 

U.S. Treasuries and government agencies

   $ 15,524       $ 619       $ —        $ 16,143   

States, municipalities, and political subdivisions

     39,904         2,416         (4     42,316   

Corporate securities

     44,748         752         (2     45,498   

Residential mortgage-backed securities

     21,499         861         —          22,360   

Commercial mortgage-backed securities

     187         19         —          206   

Collateralized mortgage obligations

     5,753         134         (11     5,876   

Other structured securities

     1,004         19         —          1,023   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed income securities

     128,619         4,820         (17     133,422   

Equity securities

     16,566         1,546         (483     17,629   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed income and equity securities

   $ 145,185       $ 6,366       $ (500   $ 151,051   
  

 

 

    

 

 

    

 

 

   

 

 

 

Corporate securities include an investment in a fixed income mutual fund, held by the segregated portfolio cell reinsurance segment, with a cost and estimated fair value of $23,592 and $23,635, respectively, as of June 30, 2012. The fixed income mutual fund’s investment objective is to provide a total return that is consistent with the preservation of capital through investing in high grade U.S. Dollar fixed income securities with a maximum maturity not exceeding five years.

Other structured securities include other asset-backed securities collateralized by auto loan receivables, equipment and manufactured homes.

The gross unrealized losses and estimated fair value of fixed income and equity securities, excluding those securities in the segregated portfolio cell reinsurance segment, classified as a available-for-sale by category and length of time an individual security has been in a continuous unrealized position as of June 30, 2012 and December 31, 2011 are as follows (unaudited, in thousands):

 

    Less Than 12 Months     12 Months or More     Total  

June 30, 2012

  Estimated
Fair
Value
    Gross
Unrealized
Losses
    # of
Securities
    Estimated
Fair
Value
    Gross
Unrealized
Losses
    # of
Securities
    Estimated
Fair
Value
    Gross
Unrealized
Losses
    # of
Securities
 

States, municipalities, and political subdivisions

  $ 2,398      $ (19     13      $ —        $ —          —        $ 2,398      $ (19     13   

Corporate securities

    409        (1     2        —          —          —          409        (1     2   

Collateralized mortgage obligations

    4,051        (27     7        217        (4     2        4,268        (31     9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed income securities

    6,858        (47     22        217        (4 )     2        7,075        (51     24   

Equity securities

    2,978        (169     2        —          —          —          2,978        (169     2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed income and equity securities

  $ 9,836      $ (216     24      $ 217     $ (4 )     2      $ 10,053      $ (220     26   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Note: The Company has excluded the segregated portfolio cell reinsurance segment’s gross unrealized losses from the above table because changes in the estimated fair value of the segregated portfolio cell reinsurance segment’s fixed income and equity securities inures to the segregated portfolio cell dividend participant and, accordingly, is included in the segregated portfolio cell dividend payable and the related segregated portfolio dividend expense in the Company’s consolidated balance sheets and consolidated statement of operations and comprehensive income (loss), respectively. Management believes the exclusion of the segregated portfolio cell reinsurance segment from this disclosure provides a more transparent understanding of gross unrealized losses in the Company’s fixed income and equity security portfolios that could impact its consolidated financial position or results of operations.

 

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Table of Contents
    Less Than 12 Months     12 Months or More     Total  

December 31, 2011

  Estimated
Fair
Value
    Gross
Unrealized
Losses
    # of
Securities
    Estimated
Fair
Value
    Gross
Unrealized
Losses
    # of
Securities
    Estimated
Fair
Value
    Gross
Unrealized
Losses
    # of
Securities
 

States, municipalities, and political subdivisions

  $ 1,604      $ (4     4      $ —        $ —          —        $ 1,604      $ (4     4   

Collateralized mortgage obligations

    375        (11     2        —          —          —          375        (11     2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed income securities

    1,979        (15     6        —          —          —          1,979        (15     6   

Equity securities

    3,302        (374     6        —          —          —          3,302        (374     6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed income and equity securities

  $ 5,281      $ (389     12      $ —        $ —          —        $ 5,281      $ (398     12   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Management has evaluated the unrealized losses related to its fixed income securities and determined that they are primarily due to a fluctuation in interest rates and not to credit issues of the issuer or the underlying assets in the case of asset-backed securities. The Company does not intend to sell the fixed income securities and it is not more likely than not that the Company will be required to sell the fixed income securities before recovery of their amortized cost bases, which may be maturity; therefore, management does not consider the fixed income securities to be other–than-temporarily impaired as of June 30, 2012.

Management has evaluated the unrealized losses related to its equity securities and determined that they are primarily related to the current market conditions and not due to underlying issues related to the issuer or the industry in which the issuer operates. The equity securities have been in an unrealized loss position for less than twelve months, and none of the securities had an estimated fair value less than 80% of its cost basis. The Company does not intend to sell the equity securities and it is not more likely than not that the Company will be required to sell the equity securities before recovery of their cost bases; therefore, management does not consider the equity securities to be other-than-temporarily impaired as of June 30, 2012.

The Company recognized an other-than-temporary impairment of $87,000 related to one equity security during the three and six months ended June 30, 2012. The impairment was a result of the security being in an unrealized loss position for more than 12 months. The Company did not recognize any other-than-temporary impairments for the three and six months ended June 30, 2011.

 

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7. Reserves for Unpaid Losses and Loss Adjustment Expenses

The following table provides a summary of the activity in the Company’s reserves for unpaid losses and LAE for the three and six months ended June 30, 2012 and 2011 (unaudited, in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012      2011  

Balance, beginning of period

   $ 107,773      $ 98,766      $ 106,077       $ 95,963   

Reinsurance recoverables on unpaid losses and LAE

     13,685        9,062        11,805         7,864   
  

 

 

   

 

 

   

 

 

    

 

 

 

Net balance, beginning of period

     94,088        89,704        94,272         88,099   

Incurred related to:

         

Current year

     25,821        20,924        48,328         40,384   

Prior year

     (250     (106     158         (220
  

 

 

   

 

 

   

 

 

    

 

 

 

Total incurred

     25,571        20,818        48,486         40,164   

Paid related to:

         

Current year

     8,839        7,735        12,065         10,558   

Prior year

     13,838        10,634        33,711         25,552   
  

 

 

   

 

 

   

 

 

    

 

 

 

Total paid

     22,677        18,369        45,776         36,110   
  

 

 

   

 

 

   

 

 

    

 

 

 

Net balance, end of period

     96,982        92,153        96,982         92,153   

Reinsurance recoverables on unpaid losses and LAE

     14,539        8,484        14,539         8,484   
  

 

 

   

 

 

   

 

 

    

 

 

 

Balance, end of period

   $ 111,521      $ 100,637      $ 111,521       $ 100,637   
  

 

 

   

 

 

   

 

 

    

 

 

 

Incurred losses by segment were as follows for the three and six months ended June 30, 2012 and 2011, respectively (unaudited, in thousands):

Three Months Ended June 30, 2012

 

June 30, 2012

   Workers’
Compensation
Insurance
Segment
    Segregated
Portfolio Cell
Reinsurance
Segment
    Total  

Incurred related to:

      

Current year, gross of discount

   $ 20,586      $ 6,136      $ 26,722   

Current period discount

     (698     (203     (901

Prior year, gross of discount

     —          (1,014     (1,014

Accretion of prior period discount

     661        103        764   
  

 

 

   

 

 

   

 

 

 

Total incurred

   $ 20,549      $ 5,022      $ 25,571   
  

 

 

   

 

 

   

 

 

 

Three Months Ended June 30, 2011

 

June 30, 2011

   Workers’
Compensation
Insurance
Segment
    Segregated
Portfolio Cell
Reinsurance
Segment
    Total  

Incurred related to:

      

Current year, gross of discount

   $ 16,927      $ 4,840      $ 21,767   

Current period discount

     (665     (178     (843

Prior year, gross of discount

     —          (732     (732

Accretion of prior period discount

     452        174        626   
  

 

 

   

 

 

   

 

 

 

Total incurred

   $ 16,714      $ 4,104      $ 20,818   
  

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Six Months Ended June 30, 2012

 

June 30, 2012

   Workers’
Compensation
Insurance
Segment
    Segregated
Portfolio Cell
Reinsurance
Segment
    Total  

Incurred related to:

      

Current year, gross of discount

   $ 39,435      $ 11,057      $ 50,492   

Current period discount

     (1,750     (414     (2,164

Prior year, gross of discount

     —          (1,580     (1,580

Accretion of prior period discount

     1,430        308        1,738   
  

 

 

   

 

 

   

 

 

 

Total incurred

   $ 39,115      $ 9,371      $ 48,486   
  

 

 

   

 

 

   

 

 

 

Six Months Ended June 30, 2011

 

June 30, 2011

   Workers’
Compensation
Insurance
Segment
    Segregated
Portfolio Cell
Reinsurance
Segment
    Total  

Incurred related to:

      

Current year, gross of discount

   $ 32,912      $ 9,223      $ 42,135   

Current period discount

     (1,345     (406     (1,751

Prior year, gross of discount

     —          (1,431     (1,431

Accretion of prior period discount

     789        422        1,211   
  

 

 

   

 

 

   

 

 

 

Total incurred

   $ 32,356      $ 7,808      $ 40,164   
  

 

 

   

 

 

   

 

 

 

The Company recognized favorable development in its segregated portfolio cell reinsurance segment of $1,014 and $1,580 for the three and six months ended June 30, 2012, compared to favorable development of $732 and $1,431 for the same periods in 2011. The favorable development primarily reflects the impact of claim settlements for amounts at, or less than, previously established case and IBNR reserves. Prior period reserve development in the segregated portfolio cell reinsurance segment results in an increase or decrease in the segment’s losses and LAE incurred, and a corresponding decrease or increase in the segregated portfolio cell dividend expense.

There was no development in the workers’ compensation insurance segment in 2012 or 2011.

8. Segment Information

The Company currently operates in three business segments.

Workers’ Compensation Insurance

The Company offers traditional workers’ compensation insurance coverage to employers, primarily in the Mid-Atlantic, Southeast and Midwest regions of the continental United States. The Company’s workers’ compensation products include guaranteed cost policies, policyholder dividend policies, retrospectively-rated policies, deductible policies and alternative market programs.

Segregated Portfolio Cell Reinsurance

The Company offers alternative market workers’ compensation solutions to individual companies, groups and associations (referred to as “segregated portfolio cell dividend participants”) through the creation of segregated portfolio cells. The segregated portfolio cells are segregated pools of assets that function as insurance companies within an insurance company. The pool of assets and associated liabilities of each segregated portfolio cell are solely for the benefit of the segregated portfolio cell dividend participants, and the pool of assets of one segregated portfolio cell are statutorily protected from the creditors of the others. This permits the Company to provide customers with a turn-key alternative markets solution that includes program design, fronting, claims administration, risk management, segregated portfolio cell rental, asset management and segregated portfolio management services. The Company outsources the asset management and segregated portfolio cell management services to a third party. The segregated portfolio cell structure provides dividend participants the opportunity to share in both underwriting profit and investment income derived from their respective segregated portfolio cell’s financial results.

 

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Table of Contents

The following table provides the fee revenue generated by the segregated portfolio cell reinsurance segment and included in the Company’s workers’ compensation insurance and corporate/other segments for the three and six months ended June 30, 2012 and 2011, respectively (unaudited, in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Workers’ compensation insurance segment

   $ 1,033       $ 727       $ 2,864       $ 1,824   

Corporate/other segment

     310         490         435         1,054   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,343       $ 1,217       $ 3,299       $ 2,878   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company is a preferred shareholder in certain of the segregated portfolio cells. For those segregated portfolio cells in which the Company participates, the Company shares in the operating and investment results of those cells and recognizes its share of the segregated portfolio dividend in the consolidated statements of operations and comprehensive income.

The Company’s share of the segregated portfolio dividend, which is included in the corporate/other segment, was as follows for the three and six months ended June 30, 2012 and 2011, respectively (unaudited, in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Segregated portfolio dividend income

   $ 234       $ 270       $ 523       $ 540   
  

 

 

    

 

 

    

 

 

    

 

 

 

Corporate/Other

The corporate/other segment primarily includes the expenses of the holding company, the third party administration activities of the Company, and the results of operations of Eastern Re, as well as certain eliminations necessary to reconcile the segment information to the consolidated statements of operations and comprehensive income. The Company cancelled the remaining reinsurance contracts at Eastern Re in 1999 on a run-off basis and continues to have exposure for outstanding claims as of June 30, 2012. The corporate/other segment also includes the Company’s 10% interest in a segregated portfolio cell with an unaffiliated primary carrier that writes insurance coverage for sprinkler contractors, known as “SprinklerPro”. The Company non-renewed the contract for its 10% interest in SprinklerPro on a run-off basis effective April 1, 2009. The Company commuted the SprinklerPro contract during the second quarter of 2012 and recognized a realized loss of $641,000 related to the commutation.

 

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Table of Contents

The following table represents the segment results for the three months ended June 30, 2012 (unaudited, in thousands):

 

     Workers’
Compensation
Insurance
    Segregated
Portfolio Cell
Reinsurance
     Corporate/
Other
    Total  

Revenue:

         

Net premiums earned

   $ 30,641      $ 8,094       $ —        $ 38,735   

Net investment income

     839        86         139        1,064   

Change in equity interest in limited partnerships

     103        —           15        118   

Net realized investment (losses) gains

     (608     7         (602     (1,203

Other revenue

     —          —           71        71   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total revenue

     30,975        8,187         (377     38,785   
  

 

 

   

 

 

    

 

 

   

 

 

 

Expenses:

         

Losses and LAE incurred

     20,549        5,022         —          25,571   

Acquisition and other underwriting expenses

     2,329        2,454         (310     4,473   

Other expenses

     5,140        65         1,003        6,208   

Amortization of intangibles

     —          —           202        202   

Policyholder dividend expense

     16        23         —          39   

Segregated portfolio dividend expense

     —          623         (234     389   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total expenses

     28,034        8,187         661        36,882   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

     2,941        —           (1,038     1,903   

Income tax expense (benefit)

     726        —           (169     557   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ 2,215      $ —         $ (869   $ 1,346   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 320,731      $ 67,221       $ (22,087   $ 365,865   
  

 

 

   

 

 

    

 

 

   

 

 

 

The following table represents the segment results for the three months ended June 30, 2011 (unaudited, in thousands):

 

     Workers’
Compensation
Insurance
     Segregated
Portfolio Cell
Reinsurance
     Corporate/
Other
    Total  

Revenue:

          

Net premiums earned

   $ 25,119       $ 7,088       $ —        $ 32,207   

Net investment income

     883         143         (118     908   

Change in equity interest in limited partnerships

     73         —           22        95   

Net realized investment gains

     879         30         66        975   

Other revenue

     —           —           79        79   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total revenue

     26,954         7,261         49        34,264   
  

 

 

    

 

 

    

 

 

   

 

 

 

Expenses:

          

Losses and LAE incurred

     16,714         4,104         —          20,818   

Acquisition and other underwriting expenses

     1,667         2,131         (490     3,308   

Other expenses

     4,036         85         1,923        6,044   

Amortization of intangibles

     —           —           254        254   

Policyholder dividend expense

     298         8         —          306   

Segregated portfolio dividend expense

     —           933         (270     663   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total expenses

     22,715         7,261         1,417        31,393   
  

 

 

    

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

     4,239         —           (1,368     2,871   

Income tax expense (benefit)

     1,369         —           (488     881   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ 2,870       $ —         $ (880   $ 1,990   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

   $ 291,494       $ 60,525       $ (14,658   $ 337,361   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

The following table represents the segment results for the six months ended June 30, 2012 (unaudited, in thousands):

 

     Workers’
Compensation
Insurance
     Segregated
Portfolio Cell
Reinsurance
     Corporate/
Other
    Total  

Revenue:

          

Net premiums earned

   $ 59,637       $ 15,584       $ —        $ 75,221   

Net investment income

     1,636         174         204        2,014   

Change in equity interest in limited partnerships

     362         —           86        448   

Net realized investment gains (losses)

     596         467         (575     488   

Other revenue

     —           —           155        155   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total revenue

   $ 62,231       $ 16,225       $ (130   $ 78,326   
  

 

 

    

 

 

    

 

 

   

 

 

 

Expenses:

          

Losses and LAE incurred

     39,115         9,371         —          48,486   

Acquisition and other underwriting expenses

     5,595         4,745         (435     9,905   

Other expenses

     9,699         164         2,033        11,896   

Amortization of intangibles

     —           —           403        403   

Policyholder dividend expense

     186         37         —          223   

Segregated portfolio dividend expense

     —           1,908         (523     1,385   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total expenses

     54,595         16,225         1,478        72,298   
  

 

 

    

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

     7,636         —           (1,608     6,028   

Income tax expense (benefit)

     2,274         —           (514     1,760   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ 5,362       $ —         $ (1,094   $ 4,268   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

   $ 320,731       $ 67,221       $ (22,087   $ 365,865   
  

 

 

    

 

 

    

 

 

   

 

 

 

The following table represents the segment results for the six months ended June 30, 2011 (unaudited, in thousands):

 

     Workers’
Compensation
Insurance
     Segregated
Portfolio Cell
Reinsurance
     Corporate/
Other
    Total  

Revenue:

          

Net premiums earned

   $ 48,701       $ 13,384       $ —        $ 62,085   

Net investment income

     1,760         252         (78     1,934   

Change in equity interest in limited partnerships

     542         —           104        646   

Net realized investment gains

     1,640         67         98        1,805   

Other revenue

     —           —           262        262   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total revenue

   $ 52,643       $ 13,703       $ 386      $ 66,732   
  

 

 

    

 

 

    

 

 

   

 

 

 

Expenses:

          

Losses and LAE incurred

     32,356         7,808         —          40,164   

Acquisition and other underwriting expenses

     3,775         4,005         (1,054     6,726   

Other expenses

     7,733         149         4,051        11,933   

Amortization of intangibles

     —           —           508        508   

Policyholder dividend expense

     606         13         —          619   

Segregated portfolio dividend expense

     —           1,728         (540     1,188   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total expenses

     44,470         13,703         2,965        61,138   
  

 

 

    

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

     8,173         —           (2,579     5,594   

Income tax expense (benefit)

     2,644         —           (922     1,722   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ 5,529       $ —         $ (1,657   $ 3,872   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

   $ 291,494       $ 60,525       $ (14,658   $ 337,361   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

9. Segregated Portfolio Cell Reinsurance Segment

The segregated portfolio cell reinsurance segment’s assets and liabilities as of June 30, 2012 (unaudited) and December 31, 2011, which are included in the Company’s consolidated balance sheets, were as follows:

 

     June 30
2012
     December 31
2011
 

ASSETS

     

Investments:

     

Fixed income securities, at estimated fair value (amortized cost, $27,081; $23,991)

   $ 27,124       $ 23,989   

Equity securities, at estimated fair value (cost, $6,887; $4,305)

     6,935         4,690   
  

 

 

    

 

 

 

Total investments

     34,059         28,679   

Cash and cash equivalents

     4,194         8,696   

Reinsurance recoverable on paid and unpaid losses and LAE

     4,980         2,517   

Deferred acquisition costs

     4,603         3,746   

Other assets

     4,643         3,938   

Due from affiliates, net

     14,742         11,699   
  

 

 

    

 

 

 

Total assets

   $ 67,221       $ 59,275   
  

 

 

    

 

 

 

LIABILITIES

     

Reserves for unpaid losses and LAE

   $ 27,462       $ 24,762   

Unearned premium reserves

     17,102         13,458   

Accounts payable and accrued expenses

     111         153   

Segregated portfolio cell dividend payable

     16,467         15,774   

Policyholder dividends payable

     102         66   

Due to affiliates, net

     5,952         5,037   
  

 

 

    

 

 

 

Total liabilities

     67,196         59,250   
  

 

 

    

 

 

 

SHAREHOLDERS’ EQUITY

     

Preferred stock outstanding

     25         25   
  

 

 

    

 

 

 

Total shareholders’ equity

     25         25   
  

 

 

    

 

 

 

Total liabilities and shareholders’ equity

   $ 67,221       $ 59,275   
  

 

 

    

 

 

 

10. Commitments and Contingencies

Legal Proceedings

The Company is subject to legal proceedings and claims that arise in the ordinary course of its business and have not been finally adjudicated. Although there can be no assurance as to the ultimate disposition of these matters, it is the opinion of the Company’s management, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the Company’s results of operations or financial condition.

AIG Arbitration Update

The arbitration proceedings initiated by the Company against AIG Companies are on-going and there has been no further action in 2012 related to the arbitration process.

During the first quarter of 2012, the Company received quarterly claims data from AIG Companies that reflected unfavorable claim development under the reinsurance treaties. The Company is unable to substantiate the reliability of the claims data reported by AIG Companies and, as a result, has not adjusted its consolidated financial statements for the amounts reported by AIG Companies. The Company continues to believe it has adequately reserved the claims at issue and that it is entitled to audit the books and records of AIG Companies to examine the bases of certain paid losses and loss reserves ceded by AIG Companies to the Company. It is reasonably possible that the final outcome of the arbitration could go against the Company, which could result in a material, adverse effect on the Company’s results of operations and financial condition.

 

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Table of Contents

11. Subsequent Events

Management performed an evaluation of subsequent events through the issuance date of the consolidated financial statements and determined there were no recognized or unrecognized subsequent events that would require an adjustment and/or additional disclosure in the consolidated financial statements as of June 30, 2012.

 

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Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the unaudited interim consolidated financial statements of Eastern Insurance Holdings, Inc. (the “Company”) and the related notes thereto included in Item 1 of this Part 1. The information contained in this quarterly report is not a complete description of the Company’s business or the risks associated with an investment in the Company’s common stock. You should carefully review and consider the various disclosures made by the Company in this quarterly report and in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on March 12, 2012.

Forward-looking Statements

The Company may from time to time make written or oral “forward-looking statements,” including statements contained in the Company’s filings with the U.S. Securities and Exchange Commission (including this Quarterly Report on Form 10-Q and the exhibits hereto), in its reports to shareholders and in other communications by the Company, which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements include statements with respect to the Company’s beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond the Company’s control). The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements:

 

   

the ability to carry out our business plans;

 

   

future economic conditions in the regional and national markets in which we compete that are less favorable than expected;

 

   

the effect of legislative, judicial, economic, demographic and regulatory events in the states in which we do business;

 

   

the ability to obtain licenses and enter new markets successfully and capitalize on growth opportunities either through mergers or the expansion of our producer network;

 

   

financial market conditions, including, but not limited to, changes in interest rates and the credit and equity markets causing a reduction of investment income or investment gains, an acceleration of the amortization of deferred policy acquisition costs, reduction in the value of our investment portfolio or a reduction in the demand for our products;

 

   

the impact of acts of terrorism and acts of war;

 

   

the effects of terrorist related insurance legislation and laws;

 

   

changes in general economic conditions, including inflation, unemployment, interest rates and other factors;

 

   

the cost, availability and collectibility of reinsurance;

 

   

estimates and adequacy of loss reserves and trends in losses and LAE;

 

   

heightened competition, including specifically the intensification of price competition, increased underwriting capacity and the entry of new competitors and the development of new products by new and existing competitors;

 

   

the effects of mergers, acquisitions and dispositions;

 

   

changes in the coverage terms selected by insurance customers, including higher deductibles and lower limits;

 

   

changes in the underwriting criteria that we use resulting from competitive pressures;

 

   

our inability to obtain regulatory approval of, or to implement, premium rate increases;

 

   

the potential impact on our reported earnings that could result from the adoption of future accounting standards issued by the FASB or other standard setting bodies;

 

   

our inability to carry out marketing and sales plans, including, among others, development of new products or changes to existing products and acceptance of the new or revised products in the market;

 

   

unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations;

 

   

adverse litigation or arbitration results including, without limitation, the AIG Arbitration; and

 

   

adverse changes in applicable laws, regulations or rules governing insurance holding companies and insurance companies, and tax or accounting matters including limitations on premium levels, increases in minimum capital and reserves, and other financial viability requirements, and changes that affect the cost of, or demand for our products.

 

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Table of Contents

The Company cautions that the foregoing list of important factors is not exclusive. Readers are also cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this report. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

Overview

The Company reported net income of $1.3 million and $4.3 million for the three and six months ended June 30, 2012, compared to net income of $2.0 million and $3.9 million for the same periods in 2011. The Company’s consolidated combined ratio was 94.2% and 94.3% for the three and six months ended June 30, 2012, compared to 95.4% and 96.6% for the same periods in 2011.

The Company’s results of operations for the three and six months ended June 30, 2012, when compared to the same periods in 2011, reflect the following:

 

   

Net premiums earned increased 20.3% and 21.2% for the three and six months ended June 30, 2012, compared to the same period in 2011. The increase primarily reflects new business writings, an increase in audit premium and renewal rate increases, partially offset by a decrease in the renewal retention rate.

 

   

Net realized investment (losses) gains for the three and six months ended June 30, 2012 include a realized loss of $641,000 related to the commutation of the SprinklerPro contract during the second quarter. The estimated fair value of the Company’s convertible bond portfolio decreased $808,000 for the three months ended June 30, 2012, compared to a decrease of $392,000 for the same period in 2011.

 

   

The decrease in the consolidated expense ratio from 29.8% and 30.9% for the three and six months ended June 30, 2011, respectively, to 28.1% and 29.5% for the same periods in 2012 primarily reflects the increase in net premiums earned and a decrease in stock compensation expense, partially offset by the change in accounting related to deferred acquisition costs. Effective January 1, 2012, the Company adopted ASU 2010-26, which resulted in a decrease in the amount of underwriting salaries capitalized and deferred over the life of the underlying workers’ compensation insurance policies. The change in accounting resulted in the Company expensing underwriting salaries of approximately $219,000 ($142,000, net of tax) and $945,000 ($614,000, net of tax) for the three and six months ended June 30, 2012 that would have been capitalized and deferred prior to the adoption of ASU 2010-26. The adoption of ASU 2012-26 increased the Company’s consolidated expense ratio by 0.6 and 1.3 percentage points for the three and six months ended June 30, 2012, respectively.

Principal Revenue and Expense Items

The Company derives its revenue primarily from net premiums earned, including assumed premiums earned, net investment income and net realized investment gains.

Direct and net premiums written. Direct premiums written is the sum of both direct premiums and assumed premiums before the effect of ceded reinsurance. Direct premiums written include all premiums billed during a specific policy period. Net premiums written is the difference between direct premiums written and premiums ceded or paid to reinsurers (ceded premiums written). In the segregated portfolio cell reinsurance segment, assumed premiums are derived from insurance contracts written by the Company and ceded to the segregated portfolio cells.

Net premiums earned. Net premiums earned are the earned portion of the Company’s net premiums written. Premiums are earned over the term of the related policies. At the end of each accounting period, the portion of the premiums that are not yet earned are included in unearned premiums and are realized as revenue in subsequent periods over the remaining term of the policy. The Company’s workers’ compensation policies typically have a term of twelve months. Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the insured’s records is conducted after policy expiration, to make a final determination of applicable premiums. Included with net premiums earned is an estimate for earned but unbilled (“EBUB”) premiums. The Company can estimate EBUB premiums because it keeps track, by policy, of how much additional premium is billed in final audit invoices to estimate the probable additional amount that it has earned but not yet billed as of the balance sheet date.

 

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Net investment income and realized gains and losses on investments. The Company invests its surplus and the funds supporting its insurance liabilities (including unearned premiums and unpaid losses and LAE) in cash, cash equivalents, fixed income securities, convertible bonds, equity securities, and limited partnership investments. Investment income includes interest earned on invested assets, including the impact of premium amortization and discount accretion. Realized gains and losses on invested assets are reported separately from net investment income. The Company recognizes realized gains when invested assets are sold for an amount greater than their cost or amortized cost (in the case of fixed income securities) and recognizes realized losses when investment securities are written down as a result of an other than temporary impairment or sold for an amount less than their cost or amortized cost. Realized gains and losses also include the change in fair value of convertible bonds.

Other revenue. Other revenue includes fees earned for claim administration and risk management services provided to self-insured property/casualty customers. There are other revenue items that the Company recognizes on a segmental basis that are eliminated in consolidation. Such items consist primarily of fees paid by the segregated portfolio cells to other entities within the consolidated group. The segregated portfolio cells recognize an expense for such items (included as part of its ceding commission) and a corresponding revenue item is recognized by the affiliate providing the service. For segment reporting purposes, such revenue items primarily include claims administration, risk management, and cell rental fees. Fronting fees are included in acquisition and other underwriting expenses as an offset to the direct costs incurred. For segment reporting purposes, such fees are recognized ratably over the period in which the service is provided, which generally corresponds to the earned portion of net premiums written for the underlying policies.

The Company’s expenses consist primarily of losses and LAE, acquisition and other underwriting expenses, other expenses, policyholder dividends, and income taxes:

Losses and LAE. Losses and LAE represent the largest expense item and include: (1) claim payments made, (2) estimates for future claim payments and changes in those estimates for prior periods, and (3) costs associated with investigating, defending and adjusting claims.

Acquisition and other underwriting expenses. In the workers’ compensation insurance segment, expenses incurred to underwrite risks are referred to as acquisition and other underwriting expenses, which consist of commissions, premium taxes, assessments and fees and other underwriting expenses incurred in acquiring, writing and administering the Company’s business. In the segregated portfolio cell reinsurance segment, acquisition and other underwriting expenses consist of ceding commissions incurred under the respective reinsurance agreements. Ceding commissions received in the workers’ compensation insurance segment are netted against acquisition and other underwriting expenses.

Other expenses. Other expenses consist of general administrative expenses such as salaries, stock compensation, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately.

Policyholder dividend expense. Policyholder dividends represent the amount of dividends incurred during the period that are expected to be returned to policyholders. The dividend expense is based on the loss experience of the underlying workers’ compensation insurance policy.

Income tax expense. EIHI and certain of its subsidiaries pay federal, state and local income taxes. Income tax expense includes an amount for both current and deferred income taxes. Current income tax expense includes an amount for the Company’s current year federal income tax liability and any adjustments related to differences between the prior year federal income tax estimate and the actual income tax expense reported in the federal income tax return. Deferred tax expense represents the change in the Company’s net deferred tax asset, exclusive of the tax effect related to changes in unrealized gains and losses in the Company’s investment portfolio and changes in the unrecognized amounts related to the Company’s benefit plan liabilities.

Key Financial Measures

The Company evaluates its insurance operations by monitoring certain key measures of growth and profitability. The Company measures growth by monitoring changes in direct premiums written and net premiums written. The Company measures underwriting profitability by examining loss, expense, policyholder dividend expense and combined ratios. On a segmental basis, the Company measures a segment’s operating results by examining net income, diluted earnings per share, and return on average equity.

Loss ratio. The loss ratio is the ratio (expressed as a percentage) of losses and LAE incurred to net premiums earned and measures the underwriting profitability of a company’s insurance business. The Company measures the loss ratio on an accident year and calendar year loss basis to measure underwriting profitability. An accident year loss ratio measures losses and LAE for insured events occurring in a particular year, regardless of when they are reported, as a percentage of net

 

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premiums earned during that year. A calendar year loss ratio measures losses and LAE for insured events occurring during a particular year and the change in loss reserves from prior accident years as a percentage of net premiums earned during that year.

Expense ratio. The expense ratio is the ratio (expressed as a percentage) of the sum of the acquisition and other underwriting expenses and other expenses to net premiums earned and measures the Company’s operational efficiency in producing, underwriting and administering its insurance business.

Policyholder dividend expense ratio. The policyholder dividend expense ratio is the ratio (expressed as a percentage) of policyholder dividend expense to net premiums earned and measures the impact of the Company’s policyholder dividend policies on its workers’ compensation insurance and segregated portfolio cell reinsurance segments.

Combined ratio. The combined ratio is the sum of the loss ratio, expense ratio and policyholder dividend expense ratio and measures the Company’s overall underwriting profit. If the combined ratio is below 100%, the Company is making an underwriting profit. If the Company’s combined ratio is at or above 100%, the Company is not profitable without investment income and may not be profitable if investment income is insufficient.

Net income, diluted earnings per share, and return on average equity. The Company uses net income and diluted earnings per share to measure its profits and return on average equity to measure its effectiveness in utilizing shareholders’ equity to generate net income. In determining return on average equity for a given year, net income is divided by the average of the beginning and ending shareholders’ equity for that year.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. The Company is required to make estimates and assumptions in certain circumstances that affect amounts reported in the consolidated financial statements and related footnotes. The Company evaluates these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that is believed to be reasonable under the circumstances. There can be no assurance that actual results will conform to the estimates and assumptions and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. The Company believes the following policies are the most sensitive to estimates and judgments.

Reserves for Unpaid Losses and LAE

The Company establishes reserves for unpaid losses and LAE for its workers’ compensation, and segregated portfolio cell reinsurance products, which are estimates of future payments of reported and unreported claims for losses and related expenses. The adequacy of the Company’s reserves for unpaid losses and LAE are inherently uncertain because the ultimate amount that the Company may pay under many of the claims incurred as of the balance sheet date will not be known for many years. Establishing reserves continues to be a complex and imprecise process, requiring the use of informed estimates and judgments. The Company’s estimates and judgments may be revised as additional experience and other data becomes available and are reviewed, as new or improved methodologies are developed, or as current laws change. Any such revisions could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in the Company’s results of operations in the period in which the estimates are changed. Estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. If ultimate losses, net of reinsurance, prove to be substantially higher than the amounts recorded as of June 30, 2012, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

The Company discounts its workers’ compensation reserves, using a discount rate of approximately 3.0%. As of June 30, 2012 and December 31, 2011, the Company’s reserves for unpaid losses and LAE were reduced by $6.0 million and $5.7 million, respectively, related to the effects of discounting.

 

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The Company’s reserves for unpaid losses and LAE in its workers’ compensation insurance, segregated portfolio cell reinsurance and corporate/other segments as of June 30, 2012 (unaudited) and December 31, 2011 are summarized below (in thousands):

 

June 30, 2012

   Workers’
Compensation
Insurance
Segment
    Segregated
Portfolio Cell
Reinsurance
Segment
    Corporate/Other      Total  

Case reserves

   $ 44,588      $ 8,883      $ —         $ 53,471   

Case incurred development, IBNR, and unallocated LAE reserves

     34,835        14,486        206         49,527   

Amount of discount

     (4,848     (1,168     —           (6,016
  

 

 

   

 

 

   

 

 

    

 

 

 

Net reserves

     74,575        22,201        206         96,982   

Reinsurance recoverables on unpaid losses and LAE

     9,278        5,261        —           14,539   
  

 

 

   

 

 

   

 

 

    

 

 

 

Reserves for unpaid losses and LAE

   $ 83,853      $ 27,462      $ 206       $ 111,521   
  

 

 

   

 

 

   

 

 

    

 

 

 

December 31, 2011

   Workers’
Compensation
Insurance
    Segregated
Portfolio Cell
Reinsurance
    Corporate/Other      Total  

Case/tabular reserves

   $ 39,380      $ 10,229      $ —         $ 49,609   

Case incurred development, IBNR, and unallocated LAE reserves

     37,249        12,931        206         50,386   

Amount of discount

     (4,527     (1,196     —           (5,723
  

 

 

   

 

 

   

 

 

    

 

 

 

Net reserves

     72,102        21,964        206         94,272   

Reinsurance recoverables on unpaid losses and LAE

     9,007        2,798        —           11,805   
  

 

 

   

 

 

   

 

 

    

 

 

 

Reserves for unpaid losses and LAE

   $ 81,109      $ 24,762      $ 206       $ 106,077   
  

 

 

   

 

 

   

 

 

    

 

 

 

Unrealized investment gains or losses on investments carried at estimated fair value, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of accumulated other comprehensive income (loss) and, accordingly, have no effect on net income. When, in the opinion of management, a decline in the fair value of an investment below its cost or amortized cost is considered to be “other-than- temporary,” such investment is written down to its fair value at the balance sheet date. The amount written down is recorded as a realized loss in the consolidated statements of operations and comprehensive income (loss). Generally, the determination of other-than-temporary impairment includes, in addition to other relevant factors, a presumption that if the market value is below cost by a significant amount for a period of time, a write-down is necessary. Notwithstanding this presumption, the determination of other-than-temporary impairment requires judgment about future prospects for an investment and is therefore a matter of inherent uncertainty. The Company recognized other-than-temporary impairments, excluding impairments in the segregated portfolio cell reinsurance segment, of $87,000 during the three and six months ended June 30, 2012. There were no impairments during the three and six months ended June 30, 2011. There were no other-than-temporary impairments in the segregated portfolio cell reinsurance segment during the three and six months ended June 30, 2012. Other-than-temporary impairments in the segregated portfolio cell reinsurance segment totaled $0 and $1,000 for the three and six months ended June 30, 2011, respectively.

The Company generally applies the following standards in determining whether the decline in fair value of an investment is other-than-temporary:

Equity securities. An equity security is considered impaired when one of the following conditions exist: 1) an equity security’s market value is less than 80% of its cost for a continuous period of 6 months, 2) an equity security’s market value is less than 50% of its cost, regardless of the amount of time the security’s market value has been below cost, and 3) an equity security’s market value has been less than cost for a continuous period of 12 months or more, regardless of the magnitude of the decline in market value. Equity securities that are in an unrealized loss position, but do not meet the above quantitative thresholds are evaluated to determine if the decline in market value is other than temporary.

The Company recognized an other-than-temporary impairment of $87,000 related to one equity security during the three and six months ended June 30, 2012. The impairment was a result of the security being in an unrealized loss position for more than 12 months. The Company did not recognize any other-than-temporary impairments related to its equity security portfolio during the three and six months ended June 30, 2011.

As of June 30, 2012, the Company held equity securities, excluding equity securities in the segregated portfolio cell reinsurance segment, with gross unrealized losses of $169,000, none of which were in an unrealized loss position for more than twelve months. The Company does not intend to sell the equity securities and it is not more likely than not that the Company will be required to sell the equity securities before recovery of their cost bases; therefore, management does not consider the equity securities to be other-than-temporarily impaired as of June 30, 2012. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.

 

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Fixed income securities. A fixed income security is considered to be other-than-temporarily impaired when the security’s estimated fair value is less than its amortized cost basis and 1) the Company intends to sell the security, 2) it is more likely than not that the Company will be required to sell the security before recovery of the security’s amortized cost basis, or 3) the Company believes it will be unable to recover the entire amortized cost basis of the security (i.e., a credit loss has occurred). When the Company determines a credit loss has been incurred, but the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of the security’s amortized cost basis, the portion of the other-than-temporary impairment that is credit related is recorded as a realized loss in the consolidated statements of operations and comprehensive income (loss), and the portion of the other-than-temporary impairment that is not credit related is included in other comprehensive income (loss). A fixed income security is reviewed for potential credit loss if any of the following situations occur:

 

   

A review of the financial condition and prospects of the issuer indicates that the security should be evaluated;

 

   

Moody’s or Standard & Poor’s rate the security below investment grade; or

 

   

The security has a market value below 80% of amortized cost due to deterioration in credit quality.

There were no other-than-temporary impairments related to the Company’s fixed income security portfolio during the three and six months ended June 30, 2012 or 2011.

As of June 30, 2012, the Company held fixed income securities, excluding fixed income securities in the segregated portfolio cell reinsurance segment, with gross unrealized losses of $51,000, of which $4,000 were in an unrealized loss position for more than twelve months. Management has evaluated the unrealized losses related to those fixed income securities and determined that they are primarily due to a fluctuation in interest rates and not to credit issues of the issuer or the underlying assets in the case of asset-backed securities. The Company does not intend to sell the fixed income securities and it is not more likely than not that the Company will be required to sell the fixed income securities before recovery of their amortized cost bases, which may be maturity; therefore, management does not consider the fixed income securities to be other–than-temporarily impaired as of June 30, 2012. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.

Limited partnerships. A limited partnership investment is generally written down if the Company is unable to hold or otherwise intends to sell its interest in the limited partnership at a loss, or if management has received information that suggests the Company will be unable to recover its original investment in the limited partnership. The amount written down is recorded in the change in equity interest in limited partnerships in the consolidated statement of operations and comprehensive income (loss).

There were no other-than-temporary impairments related to the Company’s limited partnership investments during the three and six months ended June 30, 2012 or 2011.

Goodwill

In accordance with the requirements of ASC 350, Intangibles – Goodwill and Other, goodwill is not amortized but is tested for impairment at the reporting unit level, which is at the operating segment level or one level below an operating segment. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. Goodwill is required to be tested for impairment annually and between annual tests if events or circumstances change, such as adverse changes in the business climate, that would more likely than not reduce the fair value of the reporting unit below its carrying value.

Goodwill is assigned to one or more reporting units at the date of acquisition. The Company has allocated 100% of the goodwill recorded on its consolidated balance sheet as of June 30, 2012 to its workers’ compensation insurance segment.

The Company performs its annual goodwill impairment test as of September 30. The Company adopted Accounting Standards Update No. 2011-08 (“ASU 2011-08”), “Testing Goodwill for Impairment”, effective September 30, 2011. Under ASU 2011-08, the Company assessed certain qualitative factors to determine if it was more likely than not that the fair value of the workers’ compensation insurance segment was less than its carrying amount. As a result of this assessment, it was determined that it was not more likely than not that fair value of the workers’ compensation insurance segment was less than its carrying amount; therefore, the performance of the two-step impairment test was not required.

We did not evaluate goodwill for impairment as of June 30, 2012 as no events occurred or circumstances changed that would have more likely than not reduced the fair value of the workers’ compensation insurance segment below its carrying amount since September 30, 2011.

 

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In the event the operating results of the Company’s workers’ compensation insurance segment were to be adversely impacted by a significant loss of business or higher than expected losses and LAE, management’s internal forecast may need to be re-evaluated, which could result in a fair value that is less than the carrying value of the workers’ compensation insurance segment and the need to recognize a goodwill impairment.

Deferred Income Taxes

The temporary differences between the tax and book bases of assets and liabilities are recorded as deferred income taxes. Management evaluates the recoverability of the net deferred tax asset based on historical trends of generating taxable income or losses, as well as expectations of future taxable income or loss. As of June 30, 2012, the Company recorded a net deferred tax asset of $1.8 million. Management expects that the net deferred tax asset is fully recoverable. If this assumption were to change, any amount of the net deferred tax asset that the Company could not expect to recover would be provided for as an allowance and would be reflected as an increase in income tax expense in the period in which it was established.

As of June 30, 2012, the Company has not recognized any future tax benefit related to its foreign operations at Eastern Re. The unrecognized tax benefit, which represents the excess of the tax basis over the amount for financial reporting (i.e., outside basis difference) of Eastern Re, was $11.0 million as of June 30, 2012. The outside basis difference primarily arises from losses at Eastern Re recognized for financial statement purposes, which have not yet been recognized for tax purposes. Management presently believes that the Company will not be able to recognize these tax benefits in the foreseeable future and, therefore, has not recognized the future tax benefits as of June 30, 2012.

Reinsurance Recoverables

Amounts recoverable from the Company reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts. Reinsurance balances recoverable on paid and unpaid loss and loss adjustment expenses are reported separately as assets, instead of being netted with the appropriate liabilities, because reinsurance does not relieve the Company of its legal liability to its policyholders. Reinsurance balances recoverable are subject to credit risk associated with the particular reinsurer. Additionally, the same uncertainties associated with estimating unpaid losses and loss adjustment expenses affect the estimates for the ceded portion of these liabilities. The Company continually monitors the financial condition of its reinsurers.

Recent Accounting Pronouncements

Presentation of Comprehensive Income

In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 requires entities to present net income and comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. The option to present items of other comprehensive income in the statement of changes in equity was eliminated. ASU 2011-05 was effective for public entities as of the beginning of a fiscal year that began after December 15, 2011 (including interim periods) and is effective for nonpublic entities for fiscal years ending after December 15, 2012 and interim and annual periods thereafter. Early adoption was permitted and retrospective application is required. The Company adopted ASU 2011-05 effective January 1, 2012. The Company presents comprehensive income in the consolidated statement of operations and comprehensive income; therefore, the adoption of ASU 2011-05 did not change the Company’s presentation of comprehensive income.

Fair Value Measurement and Disclosure Requirements

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurements and Disclosures - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.” ASU 2011-04 clarifies the application of existing fair value measurement and disclosure requirements, changes certain principles related to measuring fair value, and requires additional disclosures about fair value measurements. ASU 2011-04 was effective for periods beginning after December 15, 2011. The Company adopted ASU 2011-04 effective January 1, 2012. The adoption of ASU 2011-04 did not affect the Company’s financial condition or results of operations.

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

In October 2010, the FASB issued ASU 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”). ASU 2010-26 provides specific types of costs that should be capitalized in connection with the acquisition or renewal of insurance contracts. Those costs include incremental direct costs of contract acquisition incurred in connection with independent third parties and certain costs related to activities performed by the insurer for the contract, including underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. Under ASU

 

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2010-26, costs incurred by an entity related to unsuccessful acquisition or renewal efforts must be charged to expense as incurred. ASU 2010-26 was effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 and is to be applied prospectively. Retrospective application to all prior periods upon the date of adoption was permitted, but not required. The Company adopted ASU 2010-26 effective January 1, 2012 and applied it prospectively. As a result of adoption, the Company expensed certain underwriting salaries totaling approximately $219,000 ($142,000, net of tax) and $945,000 ($614,000, net of tax) for the three and six months ended June 30, 2012, respectively, that would have been capitalized under the previous accounting guidance to give effect to unsuccessful acquisition or renewal activities. The adoption of ASU 2012-26 increased the Company’s consolidated expense ratio by 0.6 and 1.3 percentage points for the three and six months ended June 30, 2012, respectively. If the new accounting guidance had been adopted effective January 1, 2011, the Company would have recognized additional expense related to underwriting salaries totaling $439,000 ($285,000, net of tax) and $938,000 ($610,000, net of tax) for the three and six months ended June 30, 2011, respectively, which would have increased the Company’s consolidated expense ratio by 1.4 and 1.5 percentage points, respectively.

RESULTS OF OPERATIONS

The major components of consolidated revenue were as follows for the three and six months ended June 30, 2012 and 2011 (unaudited, in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012     2011      2012      2011  

Net premiums written

   $ 36,754      $ 30,411       $ 88,371       $ 73,757   
  

 

 

   

 

 

    

 

 

    

 

 

 

Net premiums earned

   $ 38,735      $ 32,207       $ 75,221       $ 62,085   

Net investment income

     1,064        908         2,014         1,934   

Change in equity interest in limited partnerships

     118        95         448         646   

Net realized investment (losses) gains

     (1,203     975         488         1,805   

Other revenue

     71        79         155         262   
  

 

 

   

 

 

    

 

 

    

 

 

 

Consolidated revenue

   $ 38,785      $ 34,264       $ 78,326       $ 66,732   
  

 

 

   

 

 

    

 

 

    

 

 

 

The increase in consolidated revenue from 2011 to 2012 primarily reflects the increase in net premiums earned, partially offset by a decrease in net realized investment (losses) gains. The decrease in net realized investment (losses) primarily reflects a decline in the fair value of the convertible bond portfolio and a realized loss related to the commutation of the Company’s participation in the SprinklerPro program during the second quarter of 2012.

The components of consolidated net income, by segment, for the three and six months ended June 30, 2012 and 2011 were as follows (unaudited, in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Workers’ compensation insurance

   $ 2,215      $ 2,870      $ 5,362      $ 5,529   

Segregated portfolio cell reinsurance

     —          —          —          —     

Corporate / other

     (869     (880     (1,094     (1,657
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated net income

   $ 1,346      $ 1,990      $ 4,268      $ 3,872   
  

 

 

   

 

 

   

 

 

   

 

 

 

The decrease in net income in the workers’ compensation insurance segment from 2011 to 2012 primarily reflects the decrease in net realized investment (losses) gains and a slight increase in the combined ratio.

The decrease in the net loss in the corporate/other segment primarily reflects a change in the Company’s internal organizational structure and a decrease in stock compensation expense, partially offset by the realized loss related to the commutation of the SprinklerPro contract.

 

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WORKERS’ COMPENSATION INSURANCE

The following table represents the operations of the workers’ compensation insurance segment for the three and six months ended June 30, 2012 and 2011 (unaudited, in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Revenue:

        

Direct premiums written

   $ 39,515      $ 32,947      $ 95,174      $ 79,548   

Reinsurance premiums assumed

     938        819        1,473        1,151   

Ceded premiums written

     (10,746     (9,890     (27,503     (23,858
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

     29,707        23,876        69,144        56,841   

Change in unearned premiums

     934        1,243        (9,507     (8,140
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

     30,641        25,119        59,637        48,701   

Net investment income

     839        883        1,636        1,760   

Change in equity interest in limited partnerships

     103        73        362        542   

Net realized investment (losses) gains

     (608     879        596        1,640   

Other revenue

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     30,975        26,954        62,231        52,643   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses:

        

Losses and LAE incurred

     20,549        16,714        39,115        32,356   

Acquisition and other underwriting expenses

     2,329        1,667        5,595        3,775   

Other expenses

     5,140        4,036        9,699        7,733   

Policyholder dividend expense

     16        298        186        606   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     28,034        22,715        54,595        44,470   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     2,941        4,239        7,636        8,173   

Income tax expense

     726        1,369        2,274        2,644   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 2,215      $ 2,870      $ 5,362      $ 5,529   
  

 

 

   

 

 

   

 

 

   

 

 

 

The workers’ compensation insurance ratios were as follows for the three and six months ended June 30, 2012 and 2011:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Loss and LAE ratio

     67.1     66.5     65.6     66.4

Expense ratio

     24.4     22.7     25.6     23.7

Policyholder dividend expense ratio

     0.1     1.2     0.3     1.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     91.6     90.4     91.5     91.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Premiums

The increase in direct premiums written primarily reflects new business sales of $20.1 million, an increase in audit premium and renewal rate increases of 3.9%, partially offset by a decrease in the renewal retention rate. For the three and six months ended June 30, 2012, the Company recognized audit premium from customers totaling $1.1 million and $2.0 million, respectively, in the aggregate related to its traditional and alternative market books of business, compared to audit premium from customers of $595,000 and $461,000 for the same periods in 2011, respectively. The Company’s traditional book of business recognized audit premium from customers of $864,000 and $1.9 million for the three and six months ended June 30, 2012, compared to audit premium from customers of $331,000 and $603,000 for the same periods in 2011, respectively. In addition to audit premium from customers, the Company increased its EBUB estimate by $250,000 for the three and six months ended June 30, 2012. The renewal retention rate decreased from 88.1% in 2011 to 84.1% in 2012. The decrease in the renewal retention rate primarily reflects the loss of six accounts with total annual premiums of approximately $3.6 million in 2012.

 

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Table of Contents

Net Investment Income

The decrease in net investment income primarily reflects a decrease in dividend income and the decrease in the average yield on the fixed income portfolio. The decrease in dividend income primarily reflects the decrease in the Company’s equity security holdings from 2011 to 2012. The average yield on the fixed income portfolio was 2.93% as of June 30, 2012, compared to 3.28% as of June 30, 2011.

Net Realized Investment (Losses) Gains

Net realized investment (losses) gains for the three months ended June 30, 2012 include a decrease in the Company’s convertible bond portfolio of $808,000, compared to a decrease of $392,000 for the same period in 2011. Net realized investment gains for the three and six months ended June 30, 2011 include a realized gain of $959,000 related to the sale of an interest in an international equity fund that experienced an other-than-temporary write down prior to 2011.

Losses and LAE

The increase in the calendar period loss ratio for the three months ended June 30, 2012, compared to the same period in 2011, reflects an increase in the accident period loss ratio, partially offset by the impact of audit premium, which reduced the 2012 loss and LAE ratio by 2.5 percentage points, compared to a reduction of 0.9 percentage points in 2011. The decrease in the calendar period loss and LAE ratio for the six months ended June 30, 2012, compared to the same period in 2011, primarily reflects the impact of audit premium, which reduced the 2012 loss and LAE ratio by 2.4 percentage points, compared to a reduction of 0.9 percentage points in 2011. There was no prior year reserve development recognized in 2012 or 2011.

Acquisition and Other Underwriting Expenses and Other Expenses

The acquisition and other underwriting expense ratio was 7.6% and 9.4% for the three and six months ended June 30, 2012, respectively, compared to 6.6% and 7.8% for the same periods in 2011. The increase primarily reflects the change in accounting for deferred acquisition costs, which increased the expense ratio for the three and six months ended June 30, 2012 by 0.7 and 1.6 percentage points, respectively.

The other expense ratio was 16.8% and 16.3% for the three and six months ended June 30, 2012, respectively, compared to 16.1% and 15.9% for the same periods in 2011. The increase in the other expense ratio primarily reflects an increase in audit and legal fees and the write-off of a customer receivable balance, partially offset by an increase in net premiums earned.

Policyholder Dividends

The increase in the policyholder dividend expense primarily reflects the loss experience of dividend paying policies. For the six months ended June 30, 2012 and 2011, 11.1% and 12.2%, respectively, of all policies were written on a dividend policy basis.

Tax Expense

The effective tax rate for the three and six months ended June 30, 2012 was 24.7% and 29.8%, respectively, compared to an effective tax rate of 32.3% and 32.4% for the same periods in 2011. The primary difference between the statutory rate of 35.0% and the effective tax rate reflects tax-exempt income on municipal bond securities

 

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Table of Contents

SEGREGATED PORTFOLIO CELL REINSURANCE

The following table represents the operations of the segregated portfolio cell reinsurance segment for the three and six months ended June 30, 2012 and 2011 (unaudited, in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Revenue:

        

Reinsurance premiums assumed

   $ 8,145      $ 7,516      $ 21,335      $ 18,759   

Ceded premiums written

     (1,098     (981     (2,108     (1,843
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

     7,047        6,535        19,227        16,916   

Change in unearned premiums

     1,047        553        (3,643     (3,532
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

     8,094        7,088        15,584        13,384   

Net investment income

     86        143        174        252   

Net realized investment gains (losses)

     7        30        467        67   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     8,187        7,261        16,225        13,703   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses:

        

Losses and LAE incurred

     5,022        4,104        9,371        7,808   

Acquisition and other underwriting expenses

     2,454        2,131        4,745        4,005   

Other expenses

     65        85        164        149   

Policyholder dividend expense

     23        8        37        13   

Segregated portfolio dividend expense (1)

     623        933        1,908        1,728   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     8,187        7,261        16,225        13,703   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (1)

   $ —        $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The workers’ compensation insurance and corporate/other segments provide services to the segregated portfolio cell reinsurance segment. The fees paid by the segregated portfolio cell reinsurance segment for these services are included in the revenue of the segment providing the service. The segregated portfolio cell reinsurance segment records the fees associated with these services as ceding expense, which is included in its underwriting expenses. The difference between total revenue for the segregated portfolio cell reinsurance segment for each period and the sum of losses and LAE incurred, underwriting expenses, policyholder dividend expenses and other expenses is accrued as a segregated portfolio dividend expense. As a result, the segregated portfolio cell reinsurance segment has no net income for the period presented in this table.

The segregated portfolio cell reinsurance ratios were as follows for the three and six months ended June 30, 2012 and 2011:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Loss and LAE ratio

     62.0     57.9     60.1     58.3

Expense ratio

     31.1     31.3     31.5     31.0

Policyholder dividend expense ratio

     0.3     0.1     0.2     0.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     93.4     89.3     91.8     89.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Reinsurance Premiums Assumed

The increase in reinsurance premiums assumed primarily reflects new business sales of $2.8 million, an increase in audit premium, renewal rate increases of 4.0%, and an increase in the renewal retention rate. For the three and six months ended June 30, 2012, the Company recognized audit premium from customers totaling $282,000 and $88,000, respectively, compared to audit premium from customers of $264,000 and audit premium returned to customers of $142,000 for the same periods in 2011, respectively. The renewal retention rate was 90.8% in 2011, compared to 92.2% in 2012.

 

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Table of Contents

Net Investment Income

The decrease in net investment income primarily reflects the sale of the segregated cells’ fixed income securities and reinvestment of the proceeds into a fixed income mutual fund during the fourth quarter of 2011. The fixed income mutual fund invests in high grade U.S. Dollar fixed income securities with maturities not exceeding five years.

Net Realized Investment Gains (Losses)

Net realized investment gains (losses) primarily reflect investment sale activity in 2012 and 2011.

Losses and LAE

The increase in the calendar period loss and LAE ratio primarily reflects an increase in the accident period loss ratio, partially offset by the impact of audit premium and an increase in favorable loss reserve development on prior accident periods. Audit premium decreased the loss and LAE ratio 2.3 and 0.4 percentage points for the three and six months ended June 30, 2012, respectively, compared to decreasing the loss and LAE ratio by 2.2 percentage points for the three months ended June 30, 2011 and increasing the loss and LAE ratio by 0.6 percentage points for the six months ended June 30, 2011. The accident period loss ratio was 74.6% and 70.3% for the three and six months ended June 30, 2012, respectively, compared to an accident period loss ratio of 68.2% and 69.0% for the same periods in 2011, respectively. The increase in the accident period loss ratio primarily reflects the emergence of increased claim activity in two of the segregated portfolio cells during the second quarter of 2012. Favorable loss reserve development totaled $1.0 million and $1.6 million for the three and six months ended June 30, 2012, respectively, compared to favorable development of $732,000 and $1.4 million for the same periods in 2011, respectively.

Acquisition and Other Underwriting Expenses

The expense ratios are consistent with the contractual ceding commissions for the three and six months ended June 30, 2012 and 2011.

Segregated Portfolio Dividend Expense

The segregated portfolio dividend expense represents the amount of net income or loss in a specific period that may be payable to the segregated portfolio dividend participants.

CORPORATE/OTHER

The following table represents the operations of the corporate/other segment for the three and six months ended June 30, 2012 and 2011 (unaudited, in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Revenue:

        

Net investment income

   $ 139      $ (118   $ 204      $ (78

Change in equity interest in limited partnerships

     15        22        86        104   

Net realized investment (losses) gains

     (602     66        (575     98   

Other revenue

     71        79        155        262   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     (377     49        (130     386   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses:

        

Acquisition and other underwriting expenses

     (310     (490     (435     (1,054

Other expenses

     1,003        1,923        2,033        4,051   

Amortization of intangibles

     202        254        403        508   

Segregated portfolio dividend expense (1)

     (234     (270     (523     (540
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     661        1,417        1,478        2,965   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

     (1,038     (1,368     (1,608     (2,579

Income tax benefit

     (169     (488     (514     (922
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (869   $ (880   $ (1,094   $ (1,657
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Revenue

The decrease in revenue primarily reflects the realized loss related to the commutation of the SprinklerPro program, partially offset by an increase in net investment income. The commutation of the SprinklerPro program resulted in a realized loss of $641,000. Net investment income for the three and six months ended June 30, 2011 reflects a decline in the equity interest in SprinklerPro totaling $228,000 and $376,000, respectively.

Expenses

The decrease in expenses primarily reflects a change in the Company’s internal organizational structure and a decrease in stock compensation expense. Effective January 1, 2012, expenses related to the Company’s executive officers are included in the workers’ compensation insurance segment. Executive expenses included in the corporate/other segment for the three and six months ended June 30, 2011 totaled approximately $440,000 and $1.1 million, respectively. Stock compensation expense totaled $484,000 and $870,000 for the three and six months ended June 30, 2012, compared to $601,000 and $1.2 million for the same periods in 2011. The decrease in stock compensation expense primarily reflects the full vesting of options and restricted stock issued in January 2007, partially offset by the recognition of stock compensation expense related to options and restricted stock issued in 2012.

Income Tax Benefit

The effective tax rate was 16.3% and 32.0% for the three and six months ended June 30, 2012, compared to 35.7% and 35.8% for the same periods in 2011. The increase in the income tax benefit for the six months ended June 30, 2012, compared to the same period in 2011, primarily reflects the Company’s outside basis difference in its foreign operations.

CONSOLIDATED FINANCIAL POSITION

Consolidated assets totaled $365.9 million at June 30, 2012, compared to $345.7 million at December 31, 2011. The increase in consolidated assets primarily reflects an increase in premiums receivable, the reinsurance recoverable, federal income taxes recoverable and other assets. The increase in premiums receivable reflects the increase in direct premiums written and the impact of January 1 renewal business. The increase in the reinsurance recoverable primarily reflects amounts due from reinsurers related to two large claims in the segregated portfolio cell reinsurance segment. The increase in the federal income tax recoverable primarily reflects 2012 estimated payments. The increase in other assets primarily reflects an increase in prepaid reinsurance premiums and deductibles receivable. The increase in prepaid reinsurance premiums reflects January 1 renewals, while the increase in the deductible receivable reflects the timing of claims paid on deductible policies that are due from insureds.

Consolidated liabilities totaled $235.3 million at June 30, 2012, compared to $217.4 million at December 31, 2011. The increase in consolidated liabilities primarily reflects an increase in loss and LAE reserves, unearned premiums, and the segregated portfolio cell dividend payable, partially offset by a decrease in advance premiums and accounts payable and accrued expenses. The increase in loss and LAE reserves primarily reflects the increase in net premiums earned. Unearned premiums are higher as of June 30 as a result of the high volume of workers’ compensation business with a January 1 effective date. The increase in the segregated portfolio cell dividend payable reflects the 2012 results of operations of the segregated portfolio cell reinsurance segment, partially offset by dividends paid to the preferred shareholders of certain segregated cells. The decrease in advance premium primarily reflects the timing of premium receipts prior to the policy effective date, which is typically higher at December 31 due to the volume of January 1 policy renewals. The decrease in accounts payable and accrued expenses primarily reflects the payment of 2011 premium tax liabilities and 2011 employee bonuses, partially offset by an increase in commissions payable.

Consolidated equity totaled $130.6 million at June 30, 2012, compared to $128.3 million at December 31, 2011. The increase in consolidated equity primarily reflects net income for the six months ended June 30, 2012 and an increase in the estimated fair value of the Company’s equity securities, partially offset by common stock repurchases and shareholder dividends.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s principal sources of funds are premiums, investment income, and proceeds from sales and maturities of investments. The Company’s primary use of funds is to pay claims and operating expenses and to purchase investments.

The Company’s investment portfolio is structured so that investments mature periodically over time in reasonable relation to current expectations of future claim payments. Currently, claim payments are made from operating cash flows, with excess cash invested in investment securities. As securities mature, management intends to invest excess cash with appropriate durations to fund anticipated future claim payments. Management does not anticipate having to sell securities in its investment portfolios to fund claims or operating expenses. In the event the sale of securities becomes necessary, the Company may incur losses on those sales, which would adversely affect its results of operations and could reduce net investment income.

 

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Table of Contents

The Company has a $10.0 million revolving line of credit available to provide additional liquidity if needed. The line of credit matures on May 2, 2013 and may be renewed annually for additional periods expiring on May 1 at the lender’s discretion. Outstanding balances under the line of credit bear interest at an adjustable monthly rate equal to LIBOR plus 2.0% per annum. There were no outstanding balances under the line of credit as of June 30, 2012.

Our domestic insurance subsidiaries’ ability to pay dividends to EIHI is limited by the insurance laws and regulations of Pennsylvania and Indiana. The maximum annual dividends that the domestic insurance entities may pay without prior approval from the Pennsylvania Insurance Department and the Indiana Insurance Department is limited to the greater of 10.0% of statutory surplus or 100% of statutory net income for the most recently filed annual statement. Eastern Re must receive approval from the Cayman Islands Monetary Authority before it can pay any dividend to the Company.

CASH FLOWS

Cash flows from continuing operations for the six months ended June 30, 2012 and 2011 were as follows (unaudited, in thousands):

 

     2012     2011  

Cash flows provided by operating activities

   $ 5,241      $ 11,815   

Cash flows used in investing activities

     (11,629     (487

Cash flows used in financing activities

     (3,486     (10,467
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

   $ (9,874   $ 861   
  

 

 

   

 

 

 

Cash flows from operating activities consist primarily of cash receipts and disbursements related to premiums, investment income, claims and related adjustment expenses, operating expenses, policyholder dividends and income taxes. Cash flows from investing activities consist primarily of purchases and sales of investments and purchases of fixed assets. Cash flows from financing activities primarily consist of cash disbursements for repurchases of the Company’s common stock and shareholder dividends.

The decrease in cash flows provided by operating activities from 2011 to 2012 primarily reflects an increase in deposit premiums paid to reinsurers, an increase in estimated federal income tax payments, and an increase in personnel costs, partially offset by an increase in premiums collected.

The increase in cash flows used in investing activities from 2011 to 2012 primarily reflects an increase in fixed income security purchases and a decrease in the sale of fixed income securities. The decrease in the sale of fixed income securities primarily reflects the decrease in common stock repurchases. During 2011, the Company sold fixed income securities in order to repurchase its common stock.

The decrease in cash used in financing activities from 2011 to 2012 primarily reflects the decrease in common stock repurchases.

OFF-BALANCE SHEET ARRANGEMENTS

The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or, as of June 30, 2012, future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

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Table of Contents
Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is subject to market risk with respect to its fixed income investment portfolio. The most significant components of market risk affecting the Company are credit risk and interest rate risk. The Company is also subject to equity risk with respect to its investment in equity securities.

There have been no material changes in the Company’s market risk since December 31, 2011. Additional disclosures related to the Company’s market risk are discussed under “Quantitative and Qualitative Disclosures About Market Risk” in Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 12, 2012.

 

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including the President and Chief Executive Officer, the Executive Vice President, Treasurer and Chief Financial Officer and the Vice President of Finance, we have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a – 15(e) and 15 d – 15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on that evaluation, the President and Chief Executive Officer, the Executive Vice President, Treasurer and Chief Financial Officer and the Vice President of Finance have concluded that, as of the end of such period, these disclosure controls and procedures are effective.

Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a – 15(f) and 15d – 15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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Table of Contents

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

None

 

Item 1A. Risk Factors

There are no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, SEC File No. 001-32899.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

As of June 30, 2012, the Company has repurchased 4,017,105 shares of its common stock. Under the current plan, authorized by the Company’s Board of Directors, the Company may repurchase up to an additional 920,030 shares. The share repurchases will be held as treasury stock and are available for issuance in connection with the Company’s Stock Incentive Plan.

The following table presents information with respect to those purchases of our common stock made during the six months ended June 30, 2012 and 2011.

 

Period

   Total number of
shares purchased
     Average price
paid per share
     Total number of
shares purchased
as part of publicly
announced plans
or programs
     Maximum number
(or approximate
dollar value)
of shares that
may yet be
purchased
under the plans
or programs
 

January 1-31, 2012

     —         $ —           —           1,086,567   

February 1-29, 2012

     —         $ —           —           1,086,567   

March 1-31, 2012

     —         $ —           —           1,086,567   

April 1-30, 2012

     —         $ —           —           1,086,567   

May 1-31, 2012

     166,537       $ 14.49         166,537         920,030   

June 1-30, 2012

     —         $ —           —           920,030   
  

 

 

    

 

 

    

 

 

    

Total

     166,537       $ 14.49         166,537      
  

 

 

    

 

 

    

 

 

    

 

Period

   Total number of
shares purchased
     Average price
paid per share
     Total number of
shares purchased
as part of publicly
announced plans
or programs
     Maximum number
(or approximate
dollar value)
of shares that
may yet be
purchased
under the plans
or programs
 

January 1-31, 2011

     129,110       $ 12.34         129,110         987,855   

February 1-28, 2011

     31,976       $ 13.02         31,976         955,879   

March 1-31, 2011

     360,832       $ 12.57         360,832         595,047   

April 1-30, 2011

     72,948       $ 12.86         72,948         522,099   

May 1-31, 2011

     111,984       $ 13.24         111,984         410,115   

June 1-30, 2011

     26,405       $ 13.21         26,405         383,710   
  

 

 

    

 

 

    

 

 

    

Total

     733,255       $ 12.70         733,255      
  

 

 

    

 

 

    

 

 

    

 

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Table of Contents
Item 3. Defaults Upon Senior Securities

None

 

Item 4. Mine Safety Disclosures

Not applicable.

 

Item 5. Other Information

None

 

Item 6. Exhibits

Exhibits

 

Exhibit

No.

  

Title

    3.1    Articles of Incorporation of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.1 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)
    3.2    Bylaws of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.2 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)
  31.1    Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002
  31.2    Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002
  32.1    Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
  32.2    Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
101    Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011, (ii) the Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and six months ended June 30, 2012 and 2011, (iii) the Consolidated Statements of Changes in Shareholders’ Equity for the three and six months ended June 30, 2012 and 2011, (iv) the Consolidated Statements of Cash Flows for the three and six months ended June 30, 2012 and 2011, and (v) the Notes to Consolidated Financial Statements.(*)

 

(*) To be filed by amendment pursuant to Rule 405(a)(ii).

 

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Table of Contents

SIGNATURES

In accordance with the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

EASTERN INSURANCE HOLDINGS, INC.

(Registrant)

Dated: August 2, 2012   By:  

/s/    Michael L. Boguski        

    Michael L. Boguski,
    President and Chief Executive Officer
Dated: August 2, 2012   By:  

/S/    KEVIN M. SHOOK        

    Kevin M. Shook,
    Executive Vice President, Treasurer and Chief Financial Officer

 

39