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Employers Holdings Inc (NYSE:EIG)
Q2 2021 Earnings Call
Jul 23, 2021, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2021 Employers Holdings, Inc. Earnings Conference Call. [Operator Instructions]

I would now like to turn the conference over to your host, Ms. Lori Brown, General Counsel.

Lori A. Brown -- Executive Vice President, General Counsel

Thank you, Katrina. Good morning and welcome everyone to the Second Quarter 2021 Earnings Call for Employers. Today's call is being recorded and webcast from the Investors section of our website where a replay will be available following the call. Presenting today on the call will be Kathy Antonello, our Chief Executive Officer, and Mike Paquette, our Chief Financial Officer.

Statements made during this conference call that are not based on historical facts are considered forward-looking statements. These statements are made in reliance on the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Although we believe the expectations expressed in our forward-looking statements are reasonable, risks and uncertainties could cause actual results to be materially different from our expectations, including the risks set forth in our filings with the Securities and Exchange Commission. All remarks made during the call are current only at the time of the call and will not be updated to reflect subsequent developments.

The Company also uses its website as a means of disclosing material non-public information and for complying with the disclosure obligation under SEC's Regulation FD. Such disclosures will be included in the Investors section of the Company's website. Accordingly, investors should monitor that portion of the Company's website in addition to following the Company's press releases, SEC filings, public conference calls, and webcasts.

In our earnings press release and in our remarks or responses to questions, we may use non-GAAP financial metrics. Reconciliations of these non-GAAP metrics to our GAAP results are included in our financial supplement as an attachment to our earnings press release, our investor presentation, and any other materials available in the investors section on our website.

Now, I will turn the call over to Kathy.

Katherine H. Antonello -- President and Chief Executive Officer

Thank you, Lori, and thanks to everyone for joining us today. On today's call, Mike and I will outline our financial results for the second quarter of 2021 and discuss our observations of the current workers' compensation market. Employers continues to perform well, given the challenges faced by our policyholders throughout the pandemic. With businesses now reopened and restrictions largely lifted, we are experiencing year-over-year increases in new business submissions, quotes and binds and are encouraged by the rebound we experienced during the second quarter of 2021.

Our second quarter gross written premiums were up 5% year-over-year and we closed the period with yet another record number of policies in force. More so than ever, we remain confident that rising payrolls and new business opportunities will bring further growth to our top line. Our year-over-year new business premium for the first half of 2021 is down slightly driven by pandemic-related shutdowns in January and February. However, our second quarter new business premium was up over 40% relative to 2020 as both the labor force participation rate and unemployment rate continued to improve. The policy retention rate on our renewal book remains very strong at 94% year-to-date, although this strength was offset to some degree by lower average policy sizes and modest rate decreases.

Overall, our year-over-year renewal premium was down 10% for the first half of 2021 and 8% for the second quarter. We continue to see declines in frequency for lost time claims and have maintained our current accident year loss and LAE ratio on voluntary business at 63.6%, down from 65.5% a year ago and 64.3% at year-end.

While we experienced favorable loss reserve development of $10 million on accident years 2017 and prior, our second quarter results were tempered by $8 million of adverse loss reserve development associated with two catastrophic non-COVID claims that occurred in late 2020. Our second quarter expenses decreased by 21% from those of the first quarter of 2021 and are down 17% year-over-year in line with our expectations. The decrease in our expenses was primarily a result of targeted expense savings, employee departures and lower variable expenses that fluctuate directly with earned premium.

With that, Mike will now provide a further discussion of our financial results and then I will return to provide my closing remarks. Mike?

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

Thank you, Kathy. During the second quarter, we delivered a 3.8% annualized return on adjusted equity and a combined ratio of 98.8% within our largest operating segment Employers. These modest operating results were largely the result of lower earned premium and net investment income as well as two unusual prior-year large loss adjustments. For the quarter, our net premiums earned were $137 million, a decrease of 10% year-over-year. While our written premiums for the first half were down 9%, our second quarter premium writings were up 5%, which demonstrates that our policyholders have endured the pandemic and small businesses are actively shopping for workers' compensation coverage. Our losses and loss adjustment expenses were $84 million, an increase of 15%. We recognized $2 million of net favorable prior-year loss reserve development on voluntary business during the current period versus $24 million a year ago. The increase in losses and loss adjustment expenses was primarily due to the two catastrophic non-COVID claims that we previously mentioned.

Commission expenses were $18 million, a decrease of 6%. The decrease was primarily due to lower earned premiums. Underwriting and general administrative expenses were $37 million, a decrease of 17% year-over-year. Decreases in our fixed expenses, such as compensation and professional fees, resulted from targeted expense savings and employee reductions and departures and decreases in our variable expenses such as premium taxes, assessments, and bad debt expense resulted from decreases in earned premium. From a reporting segment perspective, our Employers segment had underwriting income of $2 million for the quarter versus $18 million a year ago and its combined ratios were 98.8% and 88% respectively. Our Cerity segment had an underwriting loss of just over $2 million for the quarter down from an underwriting loss of $4 million a year ago. We are enthusiastic about Cerity's premium writings, which have consistently increased over the past several months.

Turning to investments. Our net investment income was $18 million for the quarter, consistent with that of the first quarter, but down 9% year-over-year. The decrease year-over-year was primarily due to lower interest rates impacting bond yields. At quarter-end, our fixed maturities had a duration of 3.7 and an average credit quality of A+, and our equity securities and other investments represented 11% of the total investment portfolio.

Our net income this quarter was favorably impacted by $11 million of net after-tax unrealized gains from equity, securities and other investments, which are reflected on our income statement and our stockholders' equity and our book value per share this quarter were each favorably impacted by $10 million of after-tax unrealized gains from fixed maturity securities, which are reflected on our balance sheet.

And finally, during the quarter, we repurchased $10 million of our common stock at an average price of $41.72 per share and on July 21, our Board authorized a new share repurchase authority in the amount of $50 million.

And now, I'll turn the call back to Kathy.

Katherine H. Antonello -- President and Chief Executive Officer

Thanks, Mike. Our Cerity operating segment, which offers digital workers' compensation insurance solutions, directly to consumers, continues to gather momentum and now has $1 million of in-force premium, all within our targeted low hazard groups. A through D. We are encouraged by Cerity's success during the first half of 2021 and continue to believe that its technological and intellectual capabilities will support our future growth initiatives and provide direct access to workers' compensation insurance for businesses seeking an online experience.

For the remainder of the year, we will be focused on improving our economies of scale by capitalizing on emerging labor market improvements while continuing to maintain underwriting discipline and actively managing our expenses. Our balance sheet and capital position are very strong and are highly supportive of these key initiatives. As a monoline workers' compensation rider specializing in America's small businesses, we can react to the favorable trends we're seeing appropriately and efficiently and remain confident that we are well-positioned for continued success.

And with that, operator, we will now take questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question is from Mark Hughes from Truist. Your line is open.

Mark Hughes -- Truist Securities -- Analyst

Yeah. Thank you very much. Hi, Kathy. Hi, Mike.

Katherine H. Antonello -- President and Chief Executive Officer

Hi, Mark.

Mark Hughes -- Truist Securities -- Analyst

The reserve development in the quarter, could you talk about what happened -- just the general nature of those claims and how you, in the first instance, misjudged them?

Katherine H. Antonello -- President and Chief Executive Officer

Yeah. Can you just repeat the very last part? The first instance of what?

Mark Hughes -- Truist Securities -- Analyst

Yeah. How you originally set the reserve being too low. What was the reason for that?

Katherine H. Antonello -- President and Chief Executive Officer

Okay. Yeah. Sure. Thanks for that question. So these were two very different and unrelated accidents that were not in any way related to COVID. They happened near the end of 2020 and with any -- as with any claims of this nature and size, it does take time to analyze the claim and understand what the lifetime value of claims of this nature can be.

I'll say that claims of this size for us are very infrequent but when they do occur, we try to be very diligent in increasing our reserves as soon as possible, as soon as we have enough information to do that to reflect the lifetime value of the claim. In that way we're in a great position so that we don't expect any impact on future periods.

Mark Hughes -- Truist Securities -- Analyst

Were these accounts in hindsight at higher hazard than you might have expected or this is just a freak accident?

Katherine H. Antonello -- President and Chief Executive Officer

Not at all. These were -- yeah, I would use your words, freak accidents, they were not expected, they were not work-from-home accidents. As we've mentioned already, they're non-COVID related. Very difficult to underwrite for these types of claims. And we -- you're going to have to expect to see these every so often. But like I said, they're very infrequent.

Mark Hughes -- Truist Securities -- Analyst

And then could you talk about the new business, definitely up year-over-year? How about [Phonetic] on a two-year basis and how do you see that trajectory progressing from here? Is it continuing to get better just a little body language there?

Katherine H. Antonello -- President and Chief Executive Officer

It's definitely continuing to get better. Our in-force policy count grew during the second quarter by about 2.5% or 2,500 claims and that's on a countrywide basis. We also saw an increase in California. And I can tell you that the growth that we saw in policies was across most policy size bands.

We're also starting to see the average policy size increase and we're seeing growth across a lot of states, Florida, Georgia, New Jersey, Illinois, California. So it's not so much in pockets anymore like we were seeing during the pandemic. So we are very encouraged by the continued increase in policies and we're seeing some increases in average policy sizes.

Mark Hughes -- Truist Securities -- Analyst

And then on frequency, you mentioned the frequency was still down. Can you give us some sense of how frequency is looking now versus earlier in the year versus last year, just roughly speaking?

Katherine H. Antonello -- President and Chief Executive Officer

Yeah. So last year's frequency was sort of an anomaly, right, with the shutdowns that occurred and we saw some very significant frequency decreases. We're continuing to see frequency drop on both premium and payroll basis. And we are -- and I can tell you, we've looked at it even relative to 2019 and it's down relative to 2019. So looking at it from that perspective, frequency is definitely continuing to drop.

Mark Hughes -- Truist Securities -- Analyst

And then -- and I apologize for going on, but I did want to get this done [Phonetic]. The expense run rate, you obviously had a good improvement this quarter. Does this fully reflect the expense savings you anticipate? And then secondly, just on pricing in California or outside of California, what are you seeing there now [Phonetic]?

Katherine H. Antonello -- President and Chief Executive Officer

Mike, do you want to take the expense question and then I'll jump back with the California?

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

So with expenses, Mark, we're at $37 million for the quarter. The fixed aspect of that should be constant going forward for the balance of the year, but the variable component, which is again premium taxes, policyholder dividends, bad debt assessments, will fluctuate with the level of earned premium.

So when you take a look at what happened from the first quarter of this year to the second, it was about a decrease of $9.7 million of which about $6 million of that was the decrease in fixed expenses and $3.7 million was the decrease in variable by virtue of that change in earned premium. So the $37 million is an appropriate run rate at that level of earned premium that we had in the second quarter, but it will fluctuate a bit by virtue of the variable expenses.

Katherine H. Antonello -- President and Chief Executive Officer

Yeah. And in regard to California, California remains at about 45% of our book. On the last earnings call, I did mention that we reduced rates in California effective February 1. And then again in certain territories, we made further reductions effective June 1. So the combination of the lower rates and the less restrictions on business that are happening in California right now, we've seen significant increases in our submissions, quotes and binds. And in the second quarter, California new business relative to the second quarter of 2020 was up by about 80%. So we're seeing some significant increases there in California.

Mark Hughes -- Truist Securities -- Analyst

Thank you very much.

Katherine H. Antonello -- President and Chief Executive Officer

Thank you.

Operator

[Operator Instructions] Our next question is from Bob Farnam from Boenning & Scattergood. Your line is open.

Bob Farnam -- Boenning & Scattergood -- Analyst

Yeah. Hi there and good morning. So with the small business customers that you have, can you give us an idea of staffing and what kind of -- what percentage they are at relative to where they were, the full run rate? Obviously, you hear a lot of anecdotes about small businesses having trouble hiring people. So I'm just kind of curious what kind of payroll percentage wise they've gotten back to relative to last year or the year before.

Katherine H. Antonello -- President and Chief Executive Officer

Yeah. So we're hearing all the same anecdotal information that you are and you can see it when you're out about small businesses are having trouble hiring. And so you would expect that that would impact their payrolls in the short run. When it comes to what we're seeing from an audit perspective, our audit premiums are, on average, still coming in, on average, as return premiums.

So that would indicate that our audits of small businesses, their payrolls are down relative to what we wrote the policy at originally. And that would be just for those small businesses that are -- that were not in a position to endorse the policies down during the period, which a lot of them did. But we would expect with everything that we're seeing that that it is going to change, businesses are going to open up. We're hopeful that this fall, the small businesses will start to staff up. And definitely not a hockey stick, but we are seeing improvements. I would say, month over month it's getting better and better.

Bob Farnam -- Boenning & Scattergood -- Analyst

Okay. And then related to that, loss trends. So as the employees come back and you may have some less experienced employees getting hired, your current accident year loss ratio is around -- loss ratio is around 64%. What impact do you have -- what impact do you see going forward as the economy opens on that expense ratio -- on that loss ratio?

Katherine H. Antonello -- President and Chief Executive Officer

Yeah. I mean, that has definitely been a concern coming out of prior recessions we saw back in 2009 and 2010. And we are incorporating that into our estimates. And so it's -- but right now we're not seeing anything that gives us pause or gives us any concern as far as frequency increasing as a result of new hires and so forth, but it's something that we're keeping an eye on.

Bob Farnam -- Boenning & Scattergood -- Analyst

Okay. Fair enough. I have a couple of questions on Cerity. Given that you are excited about the top line, I wanted to talk about the expenses at Cerity. You had about $15 million of expenses over the last 12 months for that $1million or so of premium. With your original plan for Cerity, how long did you foresee this taking to break even?

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

So, Bob, I'll take that. Because Cerity is a new concept, it's very difficult to accurately produce the breakeven and you can see that in insurtechs today. I'm not aware of any insurtech that has broken even in the few years in which they've operated. But we're seeing steady progress. We're staying in our lane. We're not reaching outside of the hazard classes that we seek. The amount of premium that we've written in the first six months, so this is a big multiple of the inception to-date premium we wrote through the beginning of this year.

So we're focused more on managing the expenses, not starving the engine, staying in our lane and showing consistent, stable growth that keeps a reasonable loss ratio and the expense ratio will fix itself in time. It's, again, very difficult to predict when that will break even. But keep in mind, we did not go out and buy a $50 million, $75 million, $100 million insurtech that would not have been perfect for our business, would have required us to tweak that a little bit and that also wouldn't have been profitable for some time.

So we're very enthused by what we see. We're going to stay the course. We're trying to make it as efficient as possible. But I don't have a current estimate as to breakeven.

Bob Farnam -- Boenning & Scattergood -- Analyst

So how about -- in terms of the expenses, so $15 million of expenses over the last 12 months. Going forward how much -- I'm trying to figure out how much of that is start-up costs versus how much of that is kind of continuing fixed costs for the business? I understand you probably don't have a whole lot of variable costs in there right now because the premium is still kind of small relative to the expense base. But just maybe give us an idea of what that expense -- what type of expenses we should be looking for going forward as this thing starts to settle in.

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

Sure. And that's a difficult question. You're right on the variable expenses, there is not a lot. Advertising and marketing are probably one -- are the ones that you could call kind of semi-variable because you get for what you give. But we have platform costs, we have -- and those will run out in just a couple of years. But the true expense -- and by the way, we're not running at $15 million right now on a run rate for 2021. It's much less than that. But -- it's difficult for us to do that. We may have an opportunity to plug Cerity into another entity to provide the easy workers' comp solution for that and that may mean more expense going forward. All I can say is we're being very diligent about our expense. A lot of that is fixed, not variable. Some will run off in just a couple of years. And we're not at $15 million for right now. We're probably running at about $12 million for this year and that's down from last year.

Bob Farnam -- Boenning & Scattergood -- Analyst

Okay. Yeah. So I'm just trying to figure out like how long this is going to be a drag on earnings because it's -- obviously you've gotten the premium up to $1 million but still trying to cover the cost of -- $12 million coming up in the next -- for this year, it's a long way to go. So I'm just trying to get an idea what you can tell shareholders in terms of -- at some point, this is going to start -- to start making money you're going to have to pull the plug on it. So I don't know if you've had thoughts on either -- have you had thoughts on pulling the plug on it at all?

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

Right now we're very encouraged by what we see. We knew this was not going to be an overnight thing. And as long as we have solid consistent growth and we stay in our lane, we are enthused.

Bob Farnam -- Boenning & Scattergood -- Analyst

Okay. All right. Thanks for that, Mike.

Operator

[Operator Instructions] We have a follow-up from Mark Hughes from Truist. Your line is open.

Mark Hughes -- Truist Securities -- Analyst

Yeah. Thank you. The audit premium this quarter, can you say what that was? It sounds like it was the net return. And then refresh me on what it was in the first quarter.

Katherine H. Antonello -- President and Chief Executive Officer

Yeah. So just a little bit of background. So in the first quarter of 2021, we reduced our audit accruals. It was at zero and we brought it down to negative $2.6 million, $2.7 million. And then for the second quarter of 2021, we brought that accrual back up to zero. So that added $2.6 million in premiums written and earned during the quarter.

As I mentioned earlier, we're continuing to see a mix of positive and negative audit pickups. But they're still weighted more toward audit returns. We feel pretty strongly that indications are that this trend is going to reverse in the coming months as employment, wages and payrolls increase. But in the second quarter of 2021 our audit pickups was about negative $6 million.

I do want to point out too that since the accrual represents the audit premium that's earned, there is going to be a lag between when the economy strengthens and then the increases that we see in both audit pickup and accrual.

Mark Hughes -- Truist Securities -- Analyst

And I'm sorry, I didn't quite follow the differentiation between the negative $6 million and the plus $2.6 million change in the accrual. Could you explain that again?

Katherine H. Antonello -- President and Chief Executive Officer

Yeah. So during the quarter, we brought our audit accrual up from negative $2.6 million to zero. So that was a positive and then our audit pickup was a negative $6 million.

Mark Hughes -- Truist Securities -- Analyst

So that is to say the net was what $3.4 million?

Katherine H. Antonello -- President and Chief Executive Officer

Yeah.

Mark Hughes -- Truist Securities -- Analyst

Negative $3.4 million.

Katherine H. Antonello -- President and Chief Executive Officer

That's right.

Mark Hughes -- Truist Securities -- Analyst

Okay. And then in Q1 if we look at it on a net basis as well, what was that? You guys [Phonetic] had a negative $2.6 million accrual and then what was the -- I guess the underlying number?

Katherine H. Antonello -- President and Chief Executive Officer

I don't have that in front of me, but we can get back with you on that.

Mark Hughes -- Truist Securities -- Analyst

Okay. Yeah, that's fine. And then, Mike, you just mentioned talking about Cerity that you might plug that in with another entity. What were you referring to there?

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

All I'm saying is that both Employers and Cerity can be the workers' comp solution with another carrier offering a full business suite and that optionality exists within Cerity as well as Employers.

Mark Hughes -- Truist Securities -- Analyst

So I'd take that you're talking about just the value of the platform that you've built and the idea of shutting it down, you wouldn't shut it down, you might be able to offer that platform or sell that platform if it came to that that it would provide value in another way. Is that your point?

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

I'm not saying that at all. What I am saying is that we have opportunities from time to time for Employers to provide the workers' comp to another carrier's full business offering and we absolutely have that optionality within Cerity as well. That has nothing to do with shutting it down, that has nothing to do with offering it for sale. It's providing the workers' comp solution to another carriers more fulsome offering.

Mark Hughes -- Truist Securities -- Analyst

Okay. All right. Thanks for that clarification. And then when we think about the 3Q, this may not be a fair question, but you've got, kind of, a comparable year-over-year growth number you're looking at, down 2021 in terms of written premium. This quarter your written premium was up about 5% [Phonetic]. You mentioned that net headwind from the audit premium. Any kind of a direction you like to share for 3Q? Do you think the growth will be similar in terms of written premium, a little faster, a little slower? How do you see it shaping up?

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

We can't predict that, Mark. What we see right now is very encouraging. California is now open for business, but we can't make those type of projections right now. We like what we see right now. The January and February, new business opportunities this year were below our expectations and we've been on a good trajectory since we're very much hoping and expecting that continued trajectory for the balance of the year.

Mark Hughes -- Truist Securities -- Analyst

Thank you.

Operator

I am showing no further questions at this time. I would now like to turn the conference back to Ms. Kathy Antonello, CEO.

Katherine H. Antonello -- President and Chief Executive Officer

Thank you, Katrina. Thank you all for joining us this morning. Enjoy the weekend and I look forward to meeting with you again next quarter.

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

Lori A. Brown -- Executive Vice President, General Counsel

Katherine H. Antonello -- President and Chief Executive Officer

Michael S. Paquette -- Executive Vice President, Chief Financial Officer

Mark Hughes -- Truist Securities -- Analyst

Bob Farnam -- Boenning & Scattergood -- Analyst

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