Management s Discussion and Analysis of Statutory-Basis Financial Condition and Results of Operations As of and for the Year Ended December 31, 2013
The following discussion and analysis of Eastern Alliance Insurance Company s ( Eastern Alliance or the Company ) statutory-basis financial condition and results of operations should be read in conjunction with the statutory-basis financial statements of the Company and accompanying notes thereto. Some of the information contained in this discussion and analysis constitutes forwardlooking statements that involve risks and uncertainties; therefore, actual results may differ materially from the results described in, or implied by, the forward-looking statements contained herein. Overview The Company is an indirect, wholly-owned subsidiary of Eastern Insurance Holdings, Inc. ( EIHI ) and is a member of the Eastern Alliance Insurance Group ( EAIG ). EAIG is comprised of Global Alliance Holdings, Inc. ( Global Alliance ), Eastern Alliance, Allied Eastern Indemnity Company ( Allied Eastern ), Eastern Advantage Assurance Company ( Eastern Advantage ), and Employers Alliance, Inc. ( Employers Alliance ). EAIG offers workers compensation insurance products to employer groups in the Mid-Atlantic, Midwest, Southeast and Gulf South regions of the continental United States. EAIG s insurance products include guaranteed cost policies, policyholder dividend policies, retrospectively-rated policies, deductible policies and alternative market programs. EAIG also provides claims administration and risk management services to self-insured property/casualty customers through Employers Alliance. EAIG markets its products through independent agents, and Eastern Alliance is currently licensed in 30 states. Effective September 19, 2013, Employers Security Insurance Company ( Employers Security ) was merged into and with Eastern Alliance. Eastern Alliance s admitted assets, liabilities, capital and surplus and results of operations as of and for the year ended December 31, 2012 have been restated to reflect the merger with Employers Security. On January 1, 2014, EIHI was acquired by, and became a wholly-owned subsidiary of, ProAssurance Corporation. Eastern Alliance, Allied Eastern and Eastern Advantage continue to be wholly-owned subsidiaries of EIHI. EAIG s alternative market program business is ceded 100% to Eastern Re Ltd., SPC ( Eastern Re ), an affiliated segregated portfolio cell reinsurance company domiciled in the Cayman Islands, under quota share reinsurance agreements with each segregated portfolio cell established at Eastern Re. In addition, EAIG cedes 100% of its business with an experience modification factor of 1.25 or higher at the policy effective date to Eastern Re under a High Modification Quota Share Reinsurance Agreement ( High Mod Agreement ). 1
Eastern Alliance, Allied Eastern, and Eastern Advantage have entered into an inter-company pooling reinsurance agreement (the pooling agreement ). Eastern Alliance is the lead company and all business subject to the pooling agreement is ceded by the pool members to Eastern Alliance and then retroceded by Eastern Alliance to the pool members based on a predetermined pooling percentage. EAIG s alternative market and High Modification business are not subject to the pooling agreement. As of December 31, 2013 and 2012, the pooled business was allocated based on the following percentages: 2013 2012 Company Participation Percentage Participation Percentage Eastern Alliance 74.0% 61.0% Allied Eastern 13.0% 13.0% Eastern Advantage 13.0% 13.0% Employers Security 13.0% Statutory-Basis Results of Operations Net Income The Company reported net income of $6.7 million for the year ended December 31, 2013, compared to net income of $5.4 million for the same period in 2012. The increase in net income primarily reflects a decrease in current federal income tax expense, partially offset by an increase in the combined ratio. The decrease in current federal income tax expense primarily reflects the use of company payment patterns to discount loss reserves for tax purposes. This change was made during the compilation of the 2012 federal income tax return and reflected in the 2013 tax provision. The Company s ratios were as follows for the years ended December 31, 2013 and 2012: 2013 2012 Loss ratio 70.8 % 68.6 % Expense ratio 23.9 % 25.5 % Policyholder dividend ratio 0.9 % 0.6 % Combined ratio 95.6 % 94.7 % 2
Premiums Net premiums written and earned were as follows for the years ended December 31, 2013 and 2012, respectively: 2013 2012 Traditional premiums written $ 95,379,428 $ 90,922,544 Alternative market premiums written 23,030,423 19,516,979 High modification premiums written 6,254,065 7,162,179 Assumed premium 3,472,858 2,038,406 Total direct and assumed premiums written 128,136,774 119,640,108 Ceded premiums written (35,515,525) (31,748,642) Total net premiums written 92,621,249 87,891,466 Change in net unearned premiums (3,099,304) (6,154,776) Net premiums earned $ 89,521,945 $ 81,736,690 Net premiums earned totaled $89.5 million for the year ended December 31, 2013, compared to net premiums earned of $81.7 million for the same period in 2012. The increase in net premiums earned reflects new business written by EAIG of $31.1 million, average renewal rate increases of 4.7%, and an increase in the renewal retention rate, partially offset by a decrease in audit premium from 2012 to 2013. Audit premium from customers totaled $2.5 million in 2013, compared to $4.3 million in 2012. The renewal retention rate increased from 81.0% in 2012 to 81.9% in 2013. Net Investment Income Earned Net investment income totaled $1.5 million for the year ended December 31, 2013, compared to net investment income of $2.6 million for the same period in 2012. The decrease in net investment income primarily reflects in an increase in amortization, totaling approximately $520,000, related to convertible bonds purchased at a premium. In addition, the incentive fee related to the convertible bond portfolio increased from $32,662 in 2012 to $275,000 in 2013, reflecting the improvement in the convertible portfolio returns. The decrease in net investment income also reflects a decrease in the average book yield from 2.55% in 2012 to 2.18% in 2013. Net Realized Investment Gains (Losses), Gross of Tax Net realized investment gains totaled $2.5 million for the year ended December 31, 2013, compared to net realized investment gains of $2.6 million for the same period in 2012. During 2013, the Company recognized other-than-temporary impairments of $134,884 related to common stock securities that had been in an unrealized loss position for more than twelve months. There were no impairments in 2012. 3
Losses and Loss Adjustment Expenses Losses and loss adjustment expenses incurred totaled $63.3 million for the year ended December 31, 2013, compared to $56.1 million for the same period in 2012. The accident period loss ratio was 66.7% in 2013, compared to 68.5% in 2012. During 2013, the Company recognized unfavorable loss reserve development of $3.7 million, primarily reflecting an increase in incurred losses in the 2011 accident year. Other Underwriting Expenses Incurred Other underwriting expenses totaled $21.4 million for the year ended December 31, 2013, compared to $20.8 million for the same period in 2012. The expense ratio was 23.9% in 2013, compared to 25.3% in 2012. The decrease in the expense ratio primarily reflects an increase in fee-based revenue from alternative market business. Alternative market premiums written increased from $19.5 million in 2012 to $23.0 million in 2013. Other Income (Expense) Other income totaled $88,000 for the year ended December 31, 2013, compared to $93,000 for the same period in 2012. Other income reflects income related to installment fees and handling fees related to deductible policies, partially offset by premium write-offs. Policyholder Dividends Incurred Policyholder dividends totaled $777,000 for the year ended December 31, 2013, compared to $465,000 for the same period in 2012. The 2013 dividends incurred primarily reflect the approval and payment of dividends related to policies with 2011 effective dates. Federal Income Tax Expense (including tax on capital gains) Federal income tax expense totaled $1.4 million for the year ended December 31, 2013, compared to $4.2 million for the same period in 2012. The Company s effective tax rate (including the change in deferred income taxes) was 31.7% for the year ended December 31, 2013, compared to 26.7% for the same period in 2012. The primary difference between the statutory tax rate of 35.0% and the effective tax rate reflects tax exempt income on municipal bond securities, dividends received deduction, and the prior year tax return adjustment. Statutory-Basis Financial Position Admitted assets totaled $221.2 million as of December 31, 2013, compared to $201.7 million as of December 31, 2012. The increase in admitted assets primarily reflects an increase in cash, common stock and other invested assets, premiums receivable, federal income taxes recoverable, and amounts due from affiliates. The increase in cash primarily reflects management s decision to defer investment of excess cash during the fourth quarter of 2013 until the completion of the merger with ProAssurance. The increase in common stock primarily reflects an increase in the estimated fair value during 2013. The increase in other invested assets reflects an additional investment of $1.0 million in a limited partnership interest and an increase in the value of the Company s limited partnership interests from 2012 to 2013. The increase in premiums receivable reflects growth in net premiums written. The increase in federal income taxes recoverable primarily reflect estimated payments made in 2013 and the 2012 federal income tax overpayment. The increase in amounts due from affiliates primarily reflects the timing of inter-company cash settlement. 4
Liabilities totaled $140.9 million as of December 31, 2013, compared to $131.9 million as of December 31, 2012. The increase in liabilities primarily reflects an increase in loss and LAE reserves and unearned premiums. The increase in loss and LAE reserves primarily reflects the increase in net premiums earned and the aforementioned prior year unfavorable loss reserve development. The increase in unearned premiums primarily reflects the increase in net premiums written. Other changes in individual liability accounts primarily reflect the timing of cash settlement under the pooling agreement. Statutory surplus totaled $80.3 million as of December 31, 2013, compared to $69.8 million as of December 31, 2012. The increase in statutory surplus primarily reflects 2013 net income, an increase in unrealized gains related to the common stock portfolio, and a decrease in non-admitted assets, partially offset by a decrease in the net deferred tax asset. Liquidity and Cash Flow The Company s principal sources of cash include premiums, investment income, and proceeds from the sale and maturity of investments. The Company s principal uses of cash include claim payments, commissions, other underwriting expenses, policyholder dividends and the purchase of investments. The Company s bond portfolio is structured so that bonds mature periodically over time in reasonable relation to current expectations of future claim payments. As of December 31, 2013, the effective duration of EAIG s bond portfolio (excluding convertible bonds) was approximately 3.69 years. Currently, claim payments and operating expenses are made from operating cash flows. The Company does not anticipate having to sell securities in its investment portfolio to fund claims or operating expenses. In the event the sale of investments becomes necessary, the Company may incur losses on those sales, which would adversely affect its results of operations and could reduce net investment income. Statutory-Basis Cash Flows Net cash from operations totaled $12.2 million for the year ended December 31, 2013, compared to $2.4 million for the same period in 2012. The increase in cash from operations primarily reflects the increase in net premiums written, partially offset by the timing of cash settlement under the pooling agreement. Net cash from investments totaled $600,000 for the year ended December 31, 2013, compared to net cash from investments of $(4.7) million for the same period in 2012. Net cash from investments in 2013 and 2012 reflect normal activity in the Company s investment portfolio. Net cash from financing and miscellaneous sources totaled $(3.1) million for the year ended December 31, 2013, compared to net cash from financing and miscellaneous sources of $(1.6) million for the same period in 2012. The decrease in cash from financing and miscellaneous sources primarily reflects the timing of inter-company cash settlement. During 2012, the Company paid a dividend to EIHI totaling $3.0 million. No dividends were paid in 2013. 5
Other Commitments EIHI and Eastern Re, Ltd. SPC ( Eastern Re ) are party to an Amended and Restated Loan Agreement (the Loan Agreement ) with an unaffiliated bank whereby the bank has provided a letter of credit facility up to $15,000,000 and a line of credit up to $10,000,000. EIHI and Eastern Re are listed as borrowers under the Loan Agreement and Eastern Alliance, Allied Eastern, and Eastern Advantage are listed as Guarantors under the Loan agreement. As of December 31, 2013, the bank had provided a letter of credit to Eastern Re in the amount of $14,000,000. There were no outstanding amounts due under the line of credit as of December 31, 2013. The Company has not entered into any additional commitments or guarantees that would require significant cash outlays in the foreseeable future, and management has no plans for significant capital expenditures. 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 December 31, 2013, future effect on the Company statutory-basis financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. 6