XNYS:EIG Employers Holdings Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549


FORM 10-Q

R  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended June 30, 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: 001-33245

EMPLOYERS HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Nevada
(State or other jurisdiction
of incorporation or organization)
 
04-3850065
(I.R.S. Employer
Identification Number)
 
 
 
10375 Professional Circle, Reno, Nevada  89521
(Address of principal executive offices and zip code)
(888) 682-6671
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer R
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No R
 
Class
 
July 31, 2012
Common Stock, $0.01 par value per share
 
30,811,413 shares outstanding




 
 
Page
No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2



PART IFINANCIAL INFORMATION
Item 1.  Consolidated Financial Statements
Employers Holdings, Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands, except share data)
 
 
As of
 
As of
 
 
June 30,
2012
 
December 31,
2011
Assets
 
(unaudited)
 
 
Available for sale:
 
 
 
 
Fixed maturity securities at fair value (amortized cost $1,742,607 at June 30, 2012
and $1,706,216 at December 31, 2011)
 
$
1,892,648

 
$
1,852,699

Equity securities at fair value (cost $80,247 at June 30, 2012 and $64,962 at
December 31, 2011)
 
122,262

 
98,046

Total investments
 
2,014,910

 
1,950,745

Cash and cash equivalents
 
208,791

 
252,300

Restricted cash and cash equivalents
 
7,141

 
6,299

Accrued investment income
 
19,331

 
19,537

Premiums receivable (less bad debt allowance of $6,046 at June 30, 2012 and $5,546 at December 31, 2011)
 
216,719

 
160,443

Reinsurance recoverable for:
 
 

 


Paid losses
 
9,654

 
10,729

Unpaid losses
 
920,047

 
940,840

Funds held by or deposited with reinsureds
 
3,395

 
1,102

Deferred policy acquisition costs
 
40,742

 
37,524

Federal income taxes recoverable
 
1,117

 
1,993

Deferred income taxes, net
 
25,443

 
22,140

Property and equipment, net
 
12,099

 
11,360

Intangible assets, net
 
11,122

 
11,728

Goodwill
 
36,192

 
36,192

Other assets
 
13,576

 
18,812

Total assets
 
$
3,540,279

 
$
3,481,744

 
 
 
 
 
Liabilities and stockholders’ equity
 
 

 
 

Claims and policy liabilities:
 
 

 
 

Unpaid losses and loss adjustment expenses
 
$
2,281,789

 
$
2,272,363

Unearned premiums
 
257,779

 
194,933

Policyholders’ dividends accrued
 
3,096

 
3,838

Total claims and policy liabilities
 
2,542,664

 
2,471,134

Commissions and premium taxes payable
 
35,523

 
28,905

Accounts payable and accrued expenses
 
14,845

 
14,994

Deferred reinsurance gain—LPT Agreement
 
345,210

 
353,194

Notes payable
 
122,000

 
122,000

Other liabilities
 
25,386

 
17,331

Total liabilities
 
3,085,628

 
3,007,558

 
 
 
 
 
Commitments and contingencies
 


 


 
 
 
 
 
Stockholders’ equity:
 
 

 
 

Common stock, $0.01 par value; 150,000,000 shares authorized; 54,069,136 and 53,948,442 shares issued and 30,947,550 and 32,996,809 shares outstanding at June 30, 2012 and December 31, 2011, respectively
 
541

 
540

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

 

Additional paid-in capital
 
321,262

 
318,989

Retained earnings
 
366,089

 
358,693

Accumulated other comprehensive income, net
 
124,836

 
116,719

Treasury stock, at cost (23,121,586 shares at June 30, 2012 and 20,951,633 shares at December 31, 2011)
 
(358,077
)
 
(320,755
)
Total stockholders’ equity
 
454,651

 
474,186

Total liabilities and stockholders’ equity
 
$
3,540,279

 
$
3,481,744

See accompanying unaudited notes to the consolidated financial statements.

3



Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
(in thousands, except per share data)
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2012
 
2011
 
2012

2011
Revenues
 
(unaudited)
 
(unaudited)
Net premiums earned
 
$
118,955

 
$
88,128

 
$
228,855

 
$
170,555

Net investment income
 
18,297

 
20,306

 
36,682

 
40,799

Realized gains on investments, net
 
945

 
1,102

 
2,723

 
1,336

Other income
 
114

 
3

 
195

 
123

Total revenues
 
138,311

 
109,539

 
268,455

 
212,813

 
 
 
 
 
 
 
 
 
Expenses
 
 

 
 

 
 
 
 
Losses and loss adjustment expenses
 
88,293

 
64,150

 
169,216

 
123,571

Commission expense
 
16,147

 
11,119

 
29,676

 
21,400

Policyholder dividends
 
803

 
914

 
1,650

 
1,926

Underwriting and other operating expenses
 
29,513

 
26,200

 
61,655

 
51,878

Interest expense
 
858

 
908

 
1,760

 
1,825

Total expenses
 
135,614

 
103,291

 
263,957

 
200,600

 
 
 
 
 
 
 
 
 
Net income before income taxes
 
2,697

 
6,248

 
4,498


12,213

Income tax benefit
 
(2,309
)
 
(2,003
)
 
(6,730
)
 
(4,383
)
Net income
 
$
5,006

 
$
8,251

 
$
11,228

 
$
16,596


 
 
 
 
 
 
 
 
Comprehensive income
 
 
 
 
 
 
 
 
Unrealized gains during the period (net of taxes of $2,070 and $10,794 for the three months ended June 30, 2012 and 2011, respectively, and $5,324 and $9,264 for the six months ended June 30, 2012 and 2011, respectively)
 
$
3,844

 
$
18,866

 
$
9,888

 
$
16,022

Less: reclassification adjustment for realized gains in net income (net of taxes of $331 and $386 for the three months ended June 30, 2012 and 2011, respectively, and $952 and $468 for the six months ended June 30, 2012 and 2011, respectively)
 
614

 
716

 
1,771


868

Other comprehensive income, net of tax
 
3,230

 
18,150

 
8,117

 
15,154

 
 
 
 
 
 
 
 
 
Total comprehensive income
 
$
8,236

 
$
26,401

 
$
19,345

 
$
31,750

 
 
 
 
 
 
 
 
 
Earnings per common share (Note 10):
 
 
 
 
 
 
 
 
Basic
 
$
0.16

 
$
0.21

 
$
0.35

 
$
0.43

Diluted
 
$
0.16

 
$
0.21

 
$
0.35

 
$
0.43

Cash dividends declared per common share
 
$
0.06

 
$
0.06

 
$
0.12

 
$
0.12

 
 
 
 
 
 
 
 
 
Realized gains on investments, net
 
 
 
 
 
 
 
 
Net realized gains on investments before credit related impairments on fixed maturity securities
 
$
1,005

 
$
1,102

 
$
3,252

 
$
1,336

Other than temporary impairment, credit losses recognized in earnings
 
(60
)
 

 
(529
)
 

Portion of impairment recognized in other comprehensive income
 

 

 

 

Realized gains on investments, net
 
$
945

 
$
1,102

 
$
2,723

 
$
1,336


See accompanying unaudited notes to the consolidated financial statements.

4



Employers Holdings, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
 
 
Six Months Ended
 
 
June 30,
 
 
2012
 
2011
Operating activities
 
(unaudited)
Net income
 
$
11,228

 
$
16,596

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

 
 

Depreciation and amortization
 
2,787

 
3,387

Stock-based compensation
 
2,542

 
1,756

Amortization of premium on investments, net
 
3,400

 
3,937

Allowance for doubtful accounts
 
500

 
(870
)
Deferred income tax expense
 
(7,675
)
 
(2,186
)
Realized gains on investments, net
 
(2,723
)
 
(1,336
)
Realized losses on retirement of assets
 
334

 
121

Change in operating assets and liabilities:
 
 

 
 

Accrued investment income
 
206

 
1,066

Premiums receivable
 
(56,776
)
 
(38,942
)
Reinsurance recoverable for paid and unpaid losses
 
21,868

 
23,084

Funds held by or deposited with reinsureds
 
(2,293
)
 
1,155

Federal income taxes recoverable
 
876

 
(2,344
)
Unpaid losses and loss adjustment expenses
 
9,426

 
(24,198
)
Unearned premiums
 
62,846

 
35,561

Accounts payable, accrued expenses and other liabilities
 
7,906

 
2,377

Deferred reinsurance gain – LPT Agreement
 
(7,984
)
 
(8,781
)
Other
 
7,893

 
2,329

Net cash provided by operating activities
 
54,361

 
12,712

Investing activities
 
 

 
 

Purchase of fixed maturities
 
(183,315
)
 
(61,495
)
Purchase of equity securities
 
(23,768
)
 
(2,096
)
Proceeds from sale of fixed maturities
 
69,722

 
96,993

Proceeds from sale of equity securities
 
8,916

 
2,181

Proceeds from maturities and redemptions of investments
 
76,091

 
49,457

Proceeds from sale of fixed assets
 
75

 

Capital expenditures and other
 
(3,326
)
 
(2,603
)
Restricted cash and cash equivalents (used in) provided by investing activities
 
(842
)
 
11,817

Net cash (used in) provided by investing activities
 
(56,447
)
 
94,254

Financing activities
 
 

 
 

Acquisition of treasury stock
 
(37,322
)
 
(21,060
)
Cash transactions related to stock-based compensation
 
(279
)
 
764

Dividends paid to stockholders
 
(3,822
)
 
(4,613
)
Net cash used in financing activities
 
(41,423
)
 
(24,909
)
Net (decrease) increase in cash and cash equivalents
 
(43,509
)
 
82,057

Cash and cash equivalents at the beginning of the period
 
252,300

 
119,825

Cash and cash equivalents at the end of the period
 
$
208,791

 
$
201,882

 See accompanying unaudited notes to the consolidated financial statements.

5



Employers Holdings, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
 (Unaudited)
1. Basis of Presentation and Summary of Operations
Employers Holdings, Inc. (EHI) is a Nevada holding company. Through its wholly owned insurance subsidiaries, Employers Insurance Company of Nevada (EICN), Employers Compensation Insurance Company (ECIC), Employers Preferred Insurance Company (EPIC), and Employers Assurance Company (EAC), EHI is engaged in the commercial property and casualty insurance industry, specializing in workers' compensation products and services. Unless otherwise indicated, all references to the “Company” refer to EHI, together with its subsidiaries.
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) necessary for a fair presentation of the Company’s consolidated financial position and results of operations for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. These financial statements have been prepared consistent with the accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
The Company considers an operating segment to be any component of its business whose operating results are regularly reviewed by the Company’s chief operating decision makers to make decisions about resources to be allocated to the segment and assess its performance based on discrete financial information. Currently, the Company has one operating segment, workers’ compensation insurance and related services.
Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period. As a result, actual results could differ from these estimates. The most significant areas that require management judgment are unpaid losses and loss adjustment expenses (LAE), reinsurance recoverables, premium revenue, deferred income taxes, investments, and goodwill and intangible assets.
Reclassifications
Certain prior period information has been reclassified to conform to the current period presentation.
2. Deferred Policy Acquisition Costs (DAC)
In October 2010, the Financial Accounting Standards Board (FASB) issued guidance on Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts that became effective in 2012. This guidance changed the definition of acquisition costs which may be capitalized to specify costs that relate directly to the successful acquisition of new or renewal insurance contracts, including underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. It also defines incremental direct costs that must be capitalized as costs that result directly from contract transactions that are essential to contract issuance, which would not have been incurred had the contract transaction not occurred. All other costs are expensed as incurred. Capitalized costs are amortized over the life of the contract.
The Company adopted this standard on a prospective basis on January 1, 2012. Under the new guidance, the Company capitalized acquisition costs totaling $23.1 million and $45.2 million for the three and six months ended June 30, 2012, respectively. Under the previous guidance, the amount capitalized would have been $26.8 million and $52.5 million for the same periods. The total effect of implementing this guidance was a $3.7 million and $7.3 million decrease in the amount capitalized and a $1.5 million and $2.1 million decrease in the amortization expense for the three and six months ended June 30, 2012, respectively. The total amortization expense was $21.2 million and $42.0 million for the three and six months ended June 30, 2012, respectively. The net effect of implementing this guidance was a $2.2 million and $5.2 million increase in underwriting and other operating expense for the three and six months ended June 30, 2012, respectively. The Company expects that the total impact of this new guidance for 2012 will be approximately $7 million in increased underwriting and other operating expenses.

6



3. Fair Value of Financial Instruments
The carrying value and the estimated fair value of the Company’s financial instruments were as follows:
 
 
June 30, 2012
 
December 31, 2011
 
 
Carrying Value
 
Estimated Fair Value
 
Carrying Value
 
Estimated Fair Value
 
 
(in thousands)
Financial assets
 
 
 
 
 
 
 
 
Investments
 
$
2,014,910

 
$
2,014,910

 
$
1,950,745

 
$
1,950,745

Cash and cash equivalents
 
208,791

 
208,791

 
252,300

 
252,300

Restricted cash and cash equivalents
 
7,141

 
7,141

 
6,299

 
6,299

Financial liabilities
 
 

 
 

 
 
 
 
Notes payable
 
122,000

 
127,325

 
122,000

 
130,447

The Company's estimates of fair value for financial liabilities are based on a combination of the variable interest rates for the Company's existing line of credit and notes with similar durations to discount the projection of future payments on notes payable, and have been determined to be Level 2 fair value measurements, as defined below. Assets and liabilities recorded at fair value on the consolidated balance sheets are categorized based upon the levels of judgment associated with the inputs used to measure their fair value. Level inputs are defined as follows:
Level 1 - Inputs are unadjusted quoted market prices for identical assets or liabilities in active markets at the measurement date.
Level 2 - Inputs other than Level 1 prices that are observable for similar assets or liabilities through corroboration with market data at the measurement date.
Level 3 - Inputs that are unobservable that reflect management's best estimate of what market participants would use in pricing the assets or liabilities at the measurement date.
The following methods and assumptions were used to determine the fair value of each class of assets and liabilities recorded at fair value in the consolidated balance sheets.
Fair value of available-for-sale fixed maturity and equity securities is based on quoted market prices, where available, and is obtained primarily from third party pricing services, who generally use Level 1 or Level 2 inputs. The Company obtains a quoted price for each security from third party pricing services. The quoted prices are derived through recently reported trades for identical or similar securities. For securities not actively traded, the third party pricing services may use quoted market prices of similar instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, broker quotes, benchmark yields, credit spreads, default rates, and prepayment speeds. The Company also performs quarterly analysis on the prices received from third party pricing services to determine whether the prices are reasonable estimates of fair value, including confirming the fair values of these securities through observable market prices using an alternative pricing source. If unusual fluctuations are noted in this review, the Company may obtain additional information from other pricing services to validate the quoted price. There were no adjustments to prices obtained from third party pricing services as of June 30, 2012 or December 31, 2011 that were material to the consolidated financial statements.
If quoted market prices and an estimate determined by using objectively verifiable information are unavailable, the Company produces an estimate of fair value based on internally developed valuation techniques, which, depending on the level of observable market inputs, will render the fair value estimate as Level 2 or Level 3. The Company bases all of its estimates of fair value for assets on the bid price as it represents what a third party market participant would be willing to pay in an arm's length transaction.
These methods of valuation will only produce an estimate of fair value if there is objectively verifiable information to produce a valuation. If objectively verifiable information is not available, the Company would be required to produce an estimate of fair value using some of the same methodologies, making assumptions for market based inputs that are unavailable.
Most estimates of fair value for fixed maturity securities are based on estimates using objectively verifiable information and are included in the amount disclosed in Level 2 of the hierarchy. The fair value estimates for determining Level 3 fair value include the Company's assumptions about risk assessments and market participant assumptions based on the best information available, including quotes from market makers and other broker/dealers recognized as market participants, using standard or trade derived inputs, new issue data, monthly payment information, cash flow generation, prepayment speeds, spread adjustments, or rating updates.

7



The following table presents the items on the accompanying consolidated balance sheets that are stated at fair value and the fair value measurements.
 
 
June 30, 2012
 
December 31, 2011
 
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
 
 
(in thousands)
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$

 
$
150,778

 
$

 
$

 
$
137,365

 
$

U.S. Agencies
 

 
101,880

 

 

 
108,448

 

States and municipalities
 

 
784,617

 

 

 
789,636

 

Corporate securities
 

 
551,651

 

 

 
501,669

 

Residential mortgage-backed securities
 

 
257,462

 

 

 
281,511

 

Commercial mortgage-backed securities
 

 
30,574

 

 

 
21,665

 

Asset-backed securities
 

 
15,686

 

 

 
12,405

 

Total fixed maturity securities
 

 
1,892,648

 

 

 
1,852,699

 

Equity securities
 
$
122,262

 
$

 
$

 
$
98,046

 
$

 
$

4. Investments
The cost or amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the Company’s investments were as follows:
 
 
Cost or Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
 
(in thousands)
At June 30, 2012
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
136,989

 
$
13,797

 
$
(8
)
 
$
150,778

U.S. Agencies
 
95,411

 
6,469

 

 
101,880

States and municipalities
 
716,929

 
68,054

 
(366
)
 
784,617

Corporate securities
 
509,341

 
42,498

 
(188
)
 
551,651

Residential mortgage-backed securities
 
238,950

 
18,915

 
(403
)
 
257,462

Commercial mortgage-backed securities
 
29,615

 
959

 

 
30,574

Asset-backed securities
 
15,372

 
314

 

 
15,686

Total fixed maturity securities
 
1,742,607

 
151,006

 
(965
)
 
1,892,648

Equity securities
 
80,247

 
43,281

 
(1,266
)
 
122,262

Total investments
 
$
1,822,854

 
$
194,287

 
$
(2,231
)
 
$
2,014,910

At December 31, 2011
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
122,144

 
$
15,222

 
$
(1
)
 
$
137,365

U.S. Agencies
 
101,520

 
6,942

 
(14
)
 
108,448

States and municipalities
 
719,431

 
70,391

 
(186
)
 
789,636

Corporate securities
 
467,470

 
35,745

 
(1,546
)
 
501,669

Residential mortgage-backed securities
 
262,961

 
19,154

 
(604
)
 
281,511

Commercial mortgage-backed securities
 
20,756

 
910

 
(1
)
 
21,665

Asset-backed securities
 
11,934

 
471

 

 
12,405

Total fixed maturity securities
 
1,706,216

 
148,835

 
(2,352
)
 
1,852,699

Equity securities
 
64,962

 
34,639

 
(1,555
)
 
98,046

Total investments
 
$
1,771,178

 
$
183,474

 
$
(3,907
)
 
$
1,950,745


8



The amortized cost and estimated fair value of fixed maturity securities at June 30, 2012, by contractual maturity, are shown below. Expected maturities differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
Amortized Cost
 
Estimated Fair Value
 
 
(in thousands)
Due in one year or less
 
$
92,460

 
$
94,062

Due after one year through five years
 
608,596

 
649,520

Due after five years through ten years
 
540,681

 
606,228

Due after ten years
 
216,933

 
239,116

Mortgage and asset-backed securities
 
283,937

 
303,722

Total
 
$
1,742,607

 
$
1,892,648


9



The following is a summary of investments that have been in a continuous unrealized loss position for less than 12 months and for 12 months or greater as of June 30, 2012 and December 31, 2011.
 
 
June 30, 2012
 
December 31, 2011
 
 
Estimated Fair Value
 
Gross Unrealized Losses
 
Number of Issues
 
Estimated Fair Value
 
Gross Unrealized Losses
 
Number of Issues
 
 
(dollars in thousands)
Less than 12 months:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
13,893

 
$
(8
)
 
5

 
$
5,076

 
$
(1
)
 
2

U.S. Agencies
 

 

 

 
11,124

 
(14
)
 
3

States and municipalities
 
29,189

 
(366
)
 
8

 
5,094

 
(185
)
 
1

Corporate securities
 
19,834

 
(175
)
 
10

 
64,846

 
(1,481
)
 
30

Residential mortgage-backed securities
 
164

 
(2
)
 
15

 
4,916

 
(20
)
 
14

Commercial mortgage-backed securities
 

 

 

 
1,464

 
(1
)
 
1

Total fixed maturity securities
 
63,080

 
(551
)
 
38

 
92,520

 
(1,702
)
 
51

Equity securities
 
13,621

 
(1,223
)
 
46

 
12,443

 
(1,462
)
 
57

Total less than 12 months
 
$
76,701

 
$
(1,774
)
 
84

 
$
104,963

 
$
(3,164
)
 
108

 
 
 
 
 
 
 
 
 
 
 
 
 
12 months or greater:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
States and municipalities
 

 

 

 
1,049

 
(1
)
 
1

Corporate securities
 
1,070

 
(13
)
 
1

 
1,024

 
(65
)
 
1

Residential mortgage-backed securities
 
2,572

 
(401
)
 
5

 
2,692

 
(584
)
 
5

Total fixed maturity securities
 
3,642

 
(414
)
 
6

 
4,765

 
(650
)
 
7

Equity securities
 
444

 
(43
)
 
7

 
452

 
(93
)
 
4

Total 12 months or greater
 
$
4,086

 
$
(457
)
 
13

 
$
5,217

 
$
(743
)
 
11

 
 
 
 
 
 
 
 
 
 
 
 
 
Total available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasuries
 
$
13,893

 
$
(8
)
 
5

 
$
5,076

 
$
(1
)
 
2

U.S. Agencies
 

 

 

 
11,124

 
(14
)
 
3

States and municipalities
 
29,189

 
(366
)
 
8

 
6,143

 
(186
)
 
2

Corporate securities
 
20,904

 
(188
)
 
11

 
65,870

 
(1,546
)
 
31

Residential mortgage-backed securities
 
2,736

 
(403
)
 
20

 
7,608

 
(604
)
 
19

Commercial mortgage-backed securities
 

 

 

 
1,464

 
(1
)
 
1

Total fixed maturity securities
 
66,722

 
(965
)
 
44

 
97,285

 
(2,352
)
 
58

Equity securities
 
14,065

 
(1,266
)
 
53

 
12,895

 
(1,555
)
 
61

Total available-for-sale
 
$
80,787

 
$
(2,231
)
 
97

 
$
110,180

 
$
(3,907
)
 
119

Based on reviews of the fixed maturity securities, the Company determined that unrealized losses as of June 30, 2012 were primarily the result of changes in prevailing interest rates and not the credit quality of the issuers. The fixed maturity securities whose total fair value was less than amortized cost were not determined to be other-than-temporarily impaired given the severity and duration of the impairment, the credit quality of the issuers, the Company’s intent to not sell the securities, and a determination that it is not more likely than not that the Company will be required to sell the securities until fair value recovers to above cost, or to maturity.

10



Based on reviews of the equity securities as of June 30, 2012, the Company recognized total impairments of $0.5 million in the fair values of seven equity securities as a result of the severity and duration of the change in fair values of those securities.
Realized gains on investments, net and the change in unrealized gains (losses) on fixed maturity and equity securities are determined on a specific-identification basis and were as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2012
 
2011
 
2012

2011
 
 
(in thousands)
Realized gains on investments, net
 
 
 
 
 
 
 
 
Fixed maturity securities
 
 
 
 
 
 
 
 
Gross gains
 
$
592

 
$
866

 
$
2,295

 
$
932

Gross losses
 

 
(55
)
 
(5
)
 
(148
)
Realized gains on fixed maturity securities, net
 
$
592

 
$
811

 
$
2,290

 
$
784

Equity securities
 
 
 
 
 
 
 
 
Gross gains
 
$
613

 
$
291

 
$
1,161

 
$
555

Gross losses
 
(260
)
 

 
(728
)
 
(3
)
Realized gains on equity securities, net
 
$
353

 
$
291

 
$
433

 
$
552

Total
 
$
945

 
$
1,102

 
$
2,723

 
$
1,336

 
 
 
 
 
 
 
 
 
Change in unrealized gains (losses)
 
 

 
 

 
 
 
 
Fixed maturity securities
 
$
8,015

 
$
28,395

 
$
3,558

 
$
19,458

Equity securities
 
(3,047
)
 
163

 
8,931

 
4,492

Total
 
$
4,968

 
$
28,558

 
$
12,489

 
$
23,950

Net investment income was as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(in thousands)
Fixed maturity securities
 
$
18,019

 
$
20,349

 
$
36,237

 
$
40,893

Equity securities
 
777

 
469

 
1,424

 
918

Cash equivalents and restricted cash
 
120

 
91

 
275

 
196

 
 
18,916

 
20,909

 
37,936

 
42,007

Investment expenses
 
(619
)
 
(603
)
 
(1,254
)
 
(1,208
)
Net investment income
 
$
18,297

 
$
20,306

 
$
36,682

 
$
40,799

The Company is required by various state laws and regulations to keep securities or letters of credit in depository accounts with the states in which it does business. As of June 30, 2012 and December 31, 2011, securities having a fair value of $528.4 million and $522.6 million, respectively, were on deposit. These laws and regulations govern not only the amount, but also the types of securities that are eligible for deposit. The deposits are limited to fixed maturity securities in all states. Additionally, certain reinsurance contracts require Company funds to be held in trust for the benefit of the ceding reinsurer to secure the outstanding liabilities assumed by the Company. The fair value of securities held in trust for reinsurance at June 30, 2012 and December 31, 2011 was $34.4 million and $40.3 million, respectively. A portion of the Company's debt was secured by fixed maturity securities and restricted cash and cash equivalents that had a fair value of $114.5 million and $126.7 million at June 30, 2012 and December 31, 2011, respectively.

11



5. Income Taxes
Income tax expense for interim periods is measured using an estimated effective tax rate for the annual period. The following is a reconciliation of the federal statutory income tax rate to the Company’s effective tax rates for the periods presented.
 
 
Six Months Ended
 
 
June 30,
 
 
2012
 
2011
Expense computed at statutory rate
 
35.0
 %
 
35.0
 %
Dividends received deduction and tax-exempt interest
 
(110.6
)
 
(46.3
)
LPT Agreement
 
(73.6
)
 
(25.0
)
Other
 
(0.4
)
 
0.4

Effective tax rate
 
(149.6
)%
 
(35.9
)%
6. Liability for Unpaid Losses and Loss Adjustment Expenses 
The following table represents a reconciliation of changes in the liability for unpaid losses and LAE.
 
 
Six Months Ended
 
 
June 30,
 
 
2012
 
2011
 
 
(in thousands)
Unpaid losses and LAE, gross of reinsurance, at beginning of period
 
$
2,272,363

 
$
2,279,729

Less reinsurance recoverables for unpaid losses and LAE
 
940,840

 
956,043

Net unpaid losses and LAE at beginning of period
 
1,331,523

 
1,323,686

Losses and LAE, net of reinsurance, related to:
 
 

 
 

Current period
 
176,145

 
131,885

Prior periods
 
1,054

 
467

Total net losses and LAE incurred during the period
 
177,199

 
132,352

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

 
 

Current period
 
18,520

 
15,367

Prior periods
 
128,460

 
121,694

Total net payments for losses and LAE during the period
 
146,980

 
137,061

Ending unpaid losses and LAE, net of reinsurance
 
1,361,742

 
1,318,977

Reinsurance recoverable for unpaid losses and LAE
 
920,047

 
936,554

Unpaid losses and LAE, gross of reinsurance, at end of period
 
$
2,281,789

 
$
2,255,531

Total net losses and LAE included in the above table excludes the impact of the amortization of the deferred reinsurance gain—LPT Agreement (Deferred Gain) (Note 7).
The increase in the estimates of incurred losses and LAE attributable to insured events for prior periods was entirely related to the Company's assigned risk business.
7. LPT Agreement
The Company is party to a 100% quota share retroactive reinsurance agreement (LPT Agreement) under which $1.5 billion in liabilities for losses and LAE related to claims incurred by EICN prior to July 1, 1995 were reinsured for consideration of $775.0 million. The LPT Agreement provides coverage up to $2.0 billion. The initial Deferred Gain resulting from the LPT Agreement was recorded as a liability in the accompanying consolidated balance sheets and is being amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries. The Company amortized $8.0 million and $8.8 million of the Deferred Gain for the six months ended June 30, 2012 and 2011, respectively. Any adjustments to the Deferred Gain are recorded in losses and LAE incurred in the accompanying consolidated statements of comprehensive income. No adjustments occurred in the current period. The remaining Deferred Gain was $345.2 million and $353.2 million as of June 30, 2012 and December 31, 2011, respectively, and is included in the accompanying consolidated balance sheets. The estimated remaining liabilities subject to the LPT Agreement were $789.3 million and $807.5 million as of June 30, 2012 and December 31, 2011, respectively. Losses and LAE paid with respect to the LPT Agreement totaled $588.2 million and $569.9 million through June 30, 2012 and December 31, 2011, respectively.

12



8. Accumulated Other Comprehensive Income, net
Accumulated other comprehensive income is comprised of unrealized gains on investments classified as available-for-sale, net of deferred tax expense. The following table summarizes the components of accumulated other comprehensive income, net:
 
 
June 30, 2012
 
December 31, 2011
 
 
(in thousands)
Net unrealized gain on investments, before taxes
 
$
192,056

 
$
179,567

Deferred tax expense on net unrealized gains
 
(67,220
)
 
(62,848
)
Total accumulated other comprehensive income, net
 
$
124,836

 
$
116,719

9. Stock-Based Compensation
The Company awarded stock options, restricted stock units (RSUs) and performance share awards (PSAs) to certain officers and Directors of the Company as follows:
 
Number Awarded
 
Fair Value on Date of Grant
 
Exercise Price
 
Aggregate Fair Value on Date of Grant
 
 
 
 
 
 
 
(in millions)
March 2012
 
 
 
 
 
 
 
Stock options(1)
242,300

 
$
5.64

 
$
17.02

 
$
1.4

Restricted stock units(1)
79,450

 
17.02

 

 
1.4

Performance share awards(2)
158,900

 
17.02

 

 
2.7

 
 
 
 
 
 
 
 
May 2012
 
 
 
 
 
 
 
Restricted stock units(1)
36,355

 
17.40

 

 
0.6

(1)
The stock options and RSUs were awarded to certain officers of the Company and have a service vesting period of four years after the date awarded and vest 25% on each of the subsequent four anniversaries of the grant date. The stock options and RSUs are subject to accelerated vesting in certain circumstances, such as: death or disability, or in connection with change of control of the Company. The stock options expire seven years from the date of grant.
The RSUs awarded in May 2012 include 27,584 RSUs granted to non-employee Directors of the Company that have a service vesting period of one year from the date awarded.
(2)
The PSAs have a performance period of three years and are subject to certain performance goals, based on the Company's statutory combined ratio, with payouts that range from 0% to 200% of the target awards.
A total of 25,944 and 92,646 stock options were exercised during the six months ended June 30, 2012 and the year ended December 31, 2011, respectively.

13



10. Earnings Per Share
Basic earnings per share includes no dilution and is computed by dividing income applicable to stockholders by the weighted average number of shares outstanding for the period. Diluted earnings per share reflects the potential dilutive impact of all convertible securities on earnings per share. Diluted earnings per share includes shares assumed issued under the “treasury stock method,” which reflects the potential dilution that would occur if outstanding options were to be exercised. The following table presents the net income and the weighted average shares outstanding used in the earnings per common share calculations.
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2012

2011
 
2012

2011
 
 
(in thousands, except share data)
Net income available to stockholders—basic and diluted
 
$
5,006

 
$
8,251

 
$
11,228

 
$
16,596

Weighted average number of shares outstanding—basic
 
31,537,452

 
38,468,113

 
32,093,328

 
38,570,576

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Performance share awards
 
20,229

 

 
8,975

 

Stock options
 
82,385

 
75,880

 
87,747

 
84,941

Restricted stock units
 
45,570

 
52,320

 
52,541

 
66,507

Dilutive potential shares
 
148,184


128,200

 
149,263

 
151,448

Weighted average number of shares outstanding—diluted
 
31,685,636

 
38,596,313

 
32,242,591

 
38,722,024

Diluted earnings per share exclude outstanding options and other common stock equivalents in periods where the inclusion of such options and common stock equivalents would be anti-dilutive. The following table presents options and RSUs that were excluded from diluted earnings per share.
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2012
 
2011
 
2012
 
2011
Options excluded as the exercise price was greater than the average market price
 
934,597

 
1,041,836

 
934,597

 
1,041,836

Options and RSUs excluded under the treasury method, as the potential proceeds on settlement or exercise price was greater than the value of shares acquired
 
654,123

 
453,810

 
555,084

 
453,810


14



Item 2.  Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations
You should read the following discussion and analysis in conjunction with our consolidated financial statements and the related notes thereto included in Item 1 of Part I. Unless otherwise indicated, all references to “we,” “us,” “our,” “the Company” or similar terms refer to Employers Holdings, Inc. (EHI), together with its subsidiaries. The information contained in this quarterly report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this quarterly report and in our other reports filed with the Securities and Exchange Commission (SEC), including our Annual Report on Form 10-K for the year ended December 31, 2011 (Annual Report).
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements if accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed. You should not place undue reliance on these statements, which speak only as of the date of this report. Forward-looking statements include those related to our expected financial position, business, financing plans, litigation, future premiums, revenues, earnings, pricing, investments, business relationships, expected losses, loss reserves, acquisitions, competition, rate increases with respect to our business, and the insurance industry in general. Statements including words such as “expect,” “intend,” “plan,” “believe,” “estimate,” “may,” “anticipate,” “will” or similar statements of a future or forward-looking nature identify forward-looking statements.
We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law. All forward-looking statements address matters that involve risks and uncertainties that could cause actual results to differ materially from historical or anticipated results, depending on a number of factors. These risks and uncertainties include, but are not limited to, those described in our Annual Report and other documents that we have filed with the SEC.
Overview
We are a Nevada holding company. Through our insurance subsidiaries, we provide workers’ compensation insurance coverage to select, small businesses in low to medium hazard industries. Workers’ compensation insurance is provided under a statutory system wherein most employers are required to provide coverage for their employees’ medical, disability, vocational rehabilitation, and/or death benefit costs for work-related injuries or illnesses. We provide workers’ compensation insurance in 31 states and the District of Columbia, with a concentration in California, where over one-half of our business is generated. Our revenues are primarily comprised of net premiums earned, net investment income, and net realized gains on investments.
We target small businesses, as we believe that this market is traditionally characterized by fewer competitors, more attractive pricing, and stronger persistency when compared to the U.S. workers’ compensation insurance industry in general. We believe we are able to price our policies at levels that are competitive and profitable over the long-term. Our underwriting approach is to consistently underwrite small business accounts at appropriate and competitive prices without sacrificing long-term profitability and stability for short-term top-line revenue growth.
Our goal is to maintain our focus on disciplined underwriting and to continue to pursue profitable growth opportunities across market cycles; however, we continue to be affected by the impacts of the 2008-2009 recession. The pace of recovery remains persistently slow and, although total employment and payroll are increasing, we do not believe overall economic conditions will change significantly in the near-term.
We market and sell our workers' compensation insurance products through independent local, regional, and national agents and brokers; through our strategic partnerships and alliances, including our principal partners ADP, Inc. and Anthem Blue Cross of California; and through relationships with national and regional trade groups and associations, including the National Federation of Independent Business.
Results of Operations
Overall, net income was $5.0 million and $11.2 million for the three and six months ended June 30, 2012, respectively, compared to $8.3 million and $16.6 million for the corresponding periods of 2011. We recognized underwriting losses of $15.8 million and $33.3 million for the three and six months ended June 30, 2012, respectively, compared to underwriting losses of $14.3 million and $28.2 million for the same periods of 2011. Underwriting income or loss is determined by deducting losses and LAE, commission expense, policyholder dividends, and underwriting and other operating expenses from net premiums earned. Key factors that affected our financial performance during the three and six months ended June 30, 2012, compared to the same period of 2011, include:
Gross premiums written increased 42% and 40%;
Net premiums earned increased 35% and 34%;
Losses and LAE increased 38% and 37%;

15



Underwriting and other operating expenses increased 13% and 19%; and
Income tax benefit increased to $2.3 million and $6.7 million during the three and six months ended June 30, 2012, respectively, compared to $2.0 million and $4.4 million for the corresponding periods of 2011.
Additionally, the Financial Accounting Standards Board issued guidance that, beginning in 2012, changed the definition of policy acquisition costs which may be capitalized. Our underwriting and other operating expenses increased $2.2 million and $5.2 million during the three and six months ended June 30, 2012 as a result of this change (see Note 2 in the Notes to Consolidated Financial Statements for additional information). We expect that the total impact for 2012 will be approximately $7 million in increased underwriting and other operating expenses.
We measure our performance by our ability to increase stockholders’ equity, including the impact of the deferred reinsurance gain–LPT Agreement (Deferred Gain), over the long-term. The following table shows our stockholders' equity including the Deferred Gain, stockholders' equity on a GAAP basis, and number of common shares outstanding at:
 
 
June 30, 2012
 
December 31, 2011
 
 
(in thousands, expect share data)
Stockholders' equity including the Deferred Gain(1)

 
$
799,861

 
$
827,380

GAAP stockholders' equity
 
$
454,651

 
$
474,186

Common shares outstanding
 
30,947,550

 
32,996,809

(1)
Stockholders' equity, including the Deferred Gain, is a non-GAAP measure that is defined as total stockholders' equity plus the Deferred Gain, which we believe is an important supplemental measure of our capital position.
The comparative components of net income are set forth in the following table:
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2012
 
2011
 
2012

2011
 
 
(in thousands)
Gross premiums written
 
$
153,094

 
$
107,830

 
$
295,888

 
$
211,057

Net premiums written
 
$
150,364

 
$
105,566

 
290,728

 
206,692

 
 
 
 
 
 
 
 
 
Net premiums earned
 
$
118,955

 
$
88,128

 
$
228,855

 
$
170,555

Net investment income
 
18,297

 
20,306

 
36,682

 
40,799

Realized gains on investments
 
945

 
1,102

 
2,723

 
1,336

Other income
 
114

 
3

 
195

 
123

Total revenues
 
138,311


109,539

 
268,455

 
212,813

 
 
 
 
 
 
 
 
 
Losses and LAE
 
88,293

 
64,150

 
169,216

 
123,571

Commission expense
 
16,147

 
11,119

 
29,676

 
21,400

Policyholder dividends
 
803

 
914

 
1,650

 
1,926

Underwriting and other operating expenses
 
29,513

 
26,200

 
61,655

 
51,878

Interest expense
 
858

 
908

 
1,760

 
1,825

Income tax benefit
 
(2,309
)
 
(2,003
)
 
(6,730
)
 
(4,383
)
Total expenses
 
133,305

 
101,288

 
257,227

 
196,217

Net income
 
$
5,006

 
$
8,251

 
$
11,228

 
$
16,596

Less impact of the Deferred Gain
 
$
3,828

 
$
4,262

 
$
7,984

 
$
8,782

Net income before impact of the Deferred Gain(1)
 
$
1,178

 
$
3,989

 
$
3,244

 
$
7,814

(1)
We define net income before impact of the Deferred Gain as net income less: (a) amortization of Deferred Gain and (b) adjustments to LPT Agreement ceded reserves. Deferred Gain reflects the unamortized gain from our LPT Agreement. Under GAAP, this gain is deferred and is being amortized using the recovery method, whereby the amortization is determined by the proportion of actual reinsurance recoveries to total estimated recoveries, and the amortization is reflected in losses and LAE. We periodically reevaluate the remaining direct reserves subject to the LPT Agreement. Our reevaluation results in corresponding adjustments, if needed, to reserves, ceded reserves, reinsurance recoverables, and the Deferred Gain, with the net effect being an increase or decrease, as the case may be, to net income. Net income before impact of the Deferred Gain is not a measurement of financial performance under GAAP, but rather reflects the difference in accounting treatment between statutory and GAAP, and should not be considered in isolation or as an alternative to net income before income taxes, net income, or any other measure of performance derived in accordance with GAAP.

16



We present net income before impact of the Deferred Gain because we believe that it is an important supplemental measure of operating performance to be used by analysts, investors and other interested parties in evaluating us. The LPT Agreement was a non-recurring transaction and the Deferred Gain does not result in ongoing cash benefits. Consequently, we believe this presentation is useful in providing a meaningful understanding of our operating performance. In addition, we believe this non-GAAP measure, as we have defined it, is helpful to our management in identifying trends in our performance because the excluded item has limited significance on our current and ongoing operations.
Net Premiums Earned
Net premiums earned increased 35.0% and 34.2% for the three and six months ended June 30, 2012, compared to the corresponding periods in 2011. These increases are primarily due to increasing policy count as we continue to execute our strategy.
The following table shows the percentage change in our in-force premium, policy count, average policy size, payroll exposure upon which our premiums are based, and net rate.
 
As of June 30, 2012
 
Year-to-Date Increase
 
Year-Over-Year Increase (Decrease)
In-force premiums
20.9
%
 
37.2
 %
In-force policy count
18.6

 
38.3

Average in-force policy size
1.9

 
(0.8
)
In-force payroll exposure
16.1

 
32.2

Net rate(1)
4.1

 
3.8

(1)
Net rate, defined as total premium in-force divided by total insured payroll exposure, is a function of a variety of factors, including rate changes, underwriting risk profiles and pricing, and changes in business mix related to economic and competitive pressures.
Our in-force premiums and number of policies in-force by select states were as follows:
 
 
June 30, 2012
 
December 31, 2011
 
June 30, 2011
 
December 31, 2010
State
 
Premiums
In-force
 
Policies
In-force
 
Premiums
In-force
 
Policies
In-force
 
Premiums
In-force
 
Policies
In-force
 
Premiums
In-force
 
Policies
In-force
 
 
(dollars in thousands)
California
 
$
274,379

 
42,577

 
$
221,910

 
36,867

 
$
191,684

 
32,987

 
$
172,621

 
29,244

Illinois
 
28,816

 
3,125

 
24,744

 
2,433

 
22,690

 
1,574

 
18,617

 
932

Georgia
 
19,882

 
2,628

 
16,393

 
2,050

 
12,915

 
1,387

 
10,772

 
757

Florida
 
16,909

 
2,723

 
15,226

 
2,399

 
14,885

 
2,212

 
15,071

 
1,963

Nevada
 
15,748

 
3,845

 
14,639

 
3,718

 
15,932

 
3,622

 
16,940

 
3,596

Other
 
120,473

 
17,073

 
101,009

 
13,226

 
89,067

 
10,256

 
87,116

 
8,069

Total
 
$
476,207

 
71,971

 
$
393,921

 
60,693

 
$
347,173

 
52,038

 
$
321,137

 
44,561

Our strategic partnerships and alliances generated $109.5 million and $80.5 million, or 23.0% and 23.2%, of our in-force premiums as of June 30, 2012 and 2011, respectively. We believe that the bundling of products and services through these relationships contributes to higher retention rates than business generated by our independent agents. These relationships also allow us to access new customers that we may not have access to through our independent agent distribution channel. We continue to expand our existing relationships and actively seek new partnerships and alliances.
In April 2011, the Workers' Compensation Insurance Rating Bureau (WCIRB) of California provided an informational filing highlighting the cost drivers that indicated a cumulative 39.8% increase in the claims cost benchmark since January 1, 2009 based on an analysis of December 31, 2010 loss experience. This included deterioration of more than 12 percentage points in the claims cost benchmark since the WCIRB's previous recommendation for a 27.7% increase based on an analysis of June 30, 2010 loss experience. The WCIRB indicated that this further deterioration was due to: (a) continued adverse loss development on the 2009 accident year; (b) high emerging costs on the 2010 accident year, primarily due to increased claims frequency; (c) less optimistic forecasts for statewide wage growth in California; and (d) increased LAE that is likely as a result of certain Workers' Compensation Appeals Board decisions.

17



In August 2011, the WCIRB modified its benchmark for pure premium rates. The WCIRB's pure premium rate filings are now based on the industry average filed pure premium rate, rather than the pure premium rate approved by the California Commissioner of Insurance. The WCIRB submitted its benchmark for the proposed advisory pure premium rate to be effective January 1, 2012. The WCIRB noted that while 2012 projected claims costs continue to be below pre-reform highs and the proposed pure premium rate was slightly less than the industry average filed rate, these rates reflected significant deterioration in projected losses and LAE and less optimistic economic forecasts, compared to the prior year.
In April 2012, the WCIRB submitted its pure premium rate filing recommending an increase in advisory pure premium rates to be effective July 1, 2012. That filing proposed a 4.1% increase over the industry average filed pure premium rate as of January 1, 2012. The filing was based on an analysis of December 31, 2011 experience and reflects increased loss development on the 2010 and 2011 accident years, increased LAE, and lower forecasts of wage growth in California for 2012 and 2013.
We set our own premium rates in California based upon actuarial analyses of current and anticipated loss trends with a goal of maintaining underwriting profitability. Due to increasing loss costs, primarily medical cost inflation, we have increased our filed premium rates in California by a cumulative 41.3% since February 1, 2009.
The following table sets forth the percentage increases to our filed California rates effective for new and renewal policies incepting on or after the dates shown.
Effective Date
 
Premium Rate Change
Filed in California
February 1, 2009
 
10.0
%
August 15, 2009
 
10.5

March 15, 2010
 
3.0

March 15, 2011
 
2.5

September 15, 2011
 
3.9

June 15, 2012
 
6.0

We expect that total premiums in 2012 across our markets will continue to reflect:
overall rate increases;
increasing policy count as we continue to execute our strategy;
increasing average policy size; and
lessened competitive pressures.
Net Investment Income and Realized Gains on Investments
We invest our holding company assets, statutory surplus, and the funds supporting our insurance liabilities, including unearned premiums and unpaid losses and LAE. We invest in fixed maturity securities, equity securities, and cash equivalents. Net investment income includes interest and dividends earned on our invested assets and amortization of premiums and discounts on our fixed maturity securities, less bank service charges and custodial and portfolio management fees. We have established a high quality/short duration bias in our investment portfolio.
Net investment income decreased 9.9% and 10.1% for the three and six months ended June 30, 2012, respectively, compared to the corresponding periods of 2011. The decrease was primarily related to decreases in the average pre-tax book yield on invested assets to 3.7% for the three and six months ended June 30, 2012, compared to 4.2% for the same periods of 2011. The tax-equivalent yield on invested assets decreased to 4.8% at June 30, 2012, compared to 5.2% at June 30, 2011.
Realized gains and losses on our investments are reported separately from our net investment income. Realized gains and losses on investments include the gain or loss on a security at the time of sale compared to its original or adjusted cost (equity securities) or amortized cost (fixed maturity securities). Realized losses are also recognized when securities are written down as a result of an other-than-temporary impairment.
Net realized gains on investments were $0.9 million and $2.7 million for the three and six months ended June 30, 2012, respectively, compared to $1.1 million and $1.3 million for the corresponding periods of 2011.
Additional information regarding our Investments is set forth under “—Liquidity and Capital Resources—Investments.”

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Combined Ratio
The combined ratio, expressed as a percentage, is a key measurement of underwriting profitability. The combined ratio is the sum of the loss and LAE ratio, the commission expense ratio, policyholder dividends ratio, and underwriting and other operating expenses ratio. When the combined ratio is below 100%, we have recorded underwriting income, and conversely, when the combined ratio is greater than 100%, we cannot be profitable without investment income. Because we only have one operating segment, holding company expenses are included in our calculation of the combined ratio.
The following table provides the calculation of our calendar year combined ratios.
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