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Eastern Insurance Holdings 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q
Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

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

the Securities Exchange Act of 1934

for the Quarterly Period Ended March 31, 2011,

or

Transition report pursuant to Section 13 or 15(d) Of the Exchange Act

for the Transition Period from              to             

No. 001-32899

(Commission File Number)

 

 

EASTERN INSURANCE HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

PENNSYLVANIA   20-2653793

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

25 Race Avenue, Lancaster, Pennsylvania   17603
(Address of principal executive offices)   (Zip Code)

(717) 396-7095

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (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  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

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

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

 

COMMON STOCK (No par Value)  

Number of Shares Outstanding as of May 3, 2011

8,411,192

(Title of Class)   (Outstanding Shares)

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         

Page

      

PART I - FINANCIAL INFORMATION

     3   
   Item 1.   

Financial Statements (Unaudited)

     3   
   Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     16   
   Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

     27   
   Item 4.   

Controls and Procedures

     28   

PART II - OTHER INFORMATION

     29   
   Item 1.   

Legal Proceedings

     29   
   Item 1A.   

Risk Factors

     29   
   Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

     29   
   Item 3.   

Defaults Upon Senior Securities

     29   
   Item 4.   

Submission of Matters to Vote of Security Holders

     29   
   Item 5.   

Other Information

     29   
   Item 6.   

Exhibits

     30   

 

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Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except share data)

 

     March 31
2011
    December 31
2010
 

ASSETS

    

Investments:

    

Fixed income securities, at estimated fair value (amortized cost, $118,262; $124,201)

   $ 121,104      $ 127,474   

Convertible bonds, at estimated fair value (amortized cost, $16,278; $16,481)

     18,441        18,140   

Equity securities, at estimated fair value (cost, $19,785; $17,002)

     24,555        20,880   

Other long-term investments, at estimated fair value (cost, $10,290; $10,271)

     11,986        11,435   
                

Total investments

     176,086        177,929   

Cash and cash equivalents

     47,596        45,855   

Accrued investment income

     1,143        1,195   

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

     56,626        46,402   

Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses

     12,997        12,285   

Deferred acquisition costs

     9,152        7,721   

Deferred income taxes, net

     629        721   

Federal income taxes recoverable

     83        918   

Intangible assets

     5,909        6,163   

Goodwill

     10,752        10,752   

Other assets

     14,663        12,723   
                

Total assets

   $ 335,636      $ 322,664   
                

LIABILITIES

    

Reserves for unpaid losses and loss adjustment expenses

   $ 98,766      $ 95,963   

Unearned premium reserves

     66,955        53,485   

Advance premium

     175        482   

Accounts payable and accrued expenses

     15,238        15,707   

Ceded reinsurance balances payable

     9,200        7,371   

Segregated portfolio cell dividend payable

     13,393        13,355   

Policyholder dividends payable

     1,633        1,590   
                

Total liabilities

     205,360        187,953   
                

Commitments and contingencies (Note 9)

    

SHAREHOLDERS’ EQUITY

    

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

     —          —     

Common capital stock, par value $0, auth. shares – 20,000,000; issued – 11,784,514 and 11,784,514, respectively; outstanding – 8,445,111 and 8,964,344, respectively

     —          —     

Unearned ESOP compensation

     (3,927     (4,111

Additional paid in capital

     114,855        114,472   

Treasury stock, at cost (3,339,403 and 2,820,170 shares, respectively)

     (47,368     (40,835

Retained earnings

     62,641        61,364   

Accumulated other comprehensive income, net

     4,075        3,821   
                

Total shareholders’ equity

     130,276        134,711   
                

Total liabilities and shareholders’ equity

   $ 335,636      $ 322,664   
                

See accompanying notes to unaudited consolidated financial statements.

 

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Table of Contents

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

For the Three Months Ended March 31, 2011 and 2010

(Unaudited, in thousands, except per share data)

 

     For the Three Months
Ended March 31,
 
     2011      2010  

REVENUE

     

Net premiums earned

   $ 29,877       $ 25,340   

Net investment income

     1,025         1,047   

Change in equity interest in limited partnerships

     551         259   

Net realized investment gains

     830         812   

Other revenue

     183         146   
                 

Total revenue

     32,466         27,604   
                 

EXPENSES

     

Losses and loss adjustment expenses incurred

     19,345         17,147   

Acquisition and other underwriting expenses

     3,418         3,284   

Other expenses

     5,894         5,025   

Amortization of intangibles

     254         321   

Policyholder dividend expense

     308         178   

Segregated portfolio dividend expense

     526         183   
                 

Total expenses

     29,745         26,138   
                 

Income from continuing operations before income taxes

     2,721         1,466   

Income tax expense from continuing operations

     841         521   
                 

Net income from continuing operations

   $ 1,880       $ 945   
                 

Discontinued operations (Note 3):

     

Income from discontinued operations before income taxes

     —           1,218   

Income tax expense

     —           261   
                 

Net income from discontinued operations

     —           957   
                 

Net income

   $ 1,880       $ 1,902   
                 

Other comprehensive income:

     

Unrealized holding gains arising during period, net of tax of $265 and $957

     492         1,778   

Amortization of unrecognized benefit plan amounts, net of tax of $2 and $1

     2         3   

Less: Reclassification adjustment for gains included in net income, net of tax of $129 and $310

     240         575   
                 

Other comprehensive income

     254         1,206   
                 

Comprehensive income

   $ 2,134       $ 3,108   
                 
     Three
Months
Ended
March 31,
2011
     Three
Months
Ended
March 31,
2010
 

Earnings per share (See Note 4):

     

Basic earnings per share:

     

Income from continuing operations

   $ 0.22       $ 0.10   

Income from discontinued operations

   $ —         $ 0.10   

Diluted earnings per share:

     

Income from continuing operations

   $ 0.22       $ 0.10   

Income from discontinued operations

   $ —         $ 0.10   

Cash dividends per share

   $ 0.07       $ 0.07   

See accompanying notes to unaudited consolidated financial statements

 

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Table of Contents

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the Three Months Ended March 31, 2011 and 2010

(Unaudited, in thousands, except share data)

 

    Outstanding Shares     Common
Capital
Stock
    Unearned
ESOP
Compensation
    Additional
Paid-In
Capital
    Treasury
Stock
    Retained
Earnings
   

Accumulated

Other

    Total  
    Series A
Preferred
Stock
    Common
Capital
Stock
              Comprehensive
Income,
Net of Tax
   

Balance, January 1, 2011

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

ESOP shares released

    —          —          —          184        29        —          —          —          213   

Equity awards

    —          —          —          —          354        —          —          —          354   

Repurchase of common stock

    —          (519,233     —          —          —          (6,533     —          —          (6,533

Shareholder dividend

    —          —          —          —          —          —          (603     —          (603

Net income

    —          —          —          —          —          —          1,880        —          1,880   

Other comprehensive income, net of tax

    —          —          —          —          —          —          —          254        254   
                                                                       

Balance, March 31, 2011

    —          8,445,111        —        $ (3,927   $ 114,855      $ (47,368   $ 62,641      $ 4,075      $ 130,276   
                                                                       
    Series A
Preferred
Stock
    Common
Capital
Stock
    Common
Capital
Stock
    Unearned
ESOP
Compensation
    Additional
Paid-In
Capital
    Treasury
Stock
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income,
Net of Tax
    Total  

Balance, January 1, 2010

    —          9,691,257        —        $ (4,859   $ 113,049      $ (32,666   $ 73,038      $ 5,303      $ 153,865   

ESOP shares released

    —          —          —          184        25        —          —          —          209   

Equity awards

    —          —          —          —          368        —          —          —          368   

Shareholder dividend

    —          —          —          —          —          —          (678     —          (678

Net income

    —          —          —          —          —          —          1,902        —          1,902   

Other comprehensive income, net of tax

    —          —          —          —          —          —          —          1,206        1,206   
                                                                       

Balance, March 31, 2010

    —          9,691,257        —        $ (4,675   $ 113,442      $ (32,666   $ 74,262      $ 6,509      $ 156,872   
                                                                       

See accompanying notes to unaudited consolidated financial statements

 

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Table of Contents

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31, 2011 and 2010

(Unaudited, in thousands)

 

     2011     2010  

Cash flows from operating activities:

    

Net income from continuing operations

   $ 1,880      $ 945   

Adjustments to reconcile net income from continuing operations to net cash provided by operating activities:

    

Depreciation and amortization

     159       172   

Amortization of bond premium/discount

     85        124   

Net realized investment gains

     (914     (812

Change in equity interest in limited partnerships

     (551     (259

Deferred tax expense

     24        272   

Stock compensation

     583        541   

Intangible asset amortization

     254        321   

Changes in assets and liabilities:

    

Accrued investment income

     52        (75

Premiums receivable

     (10,224     (8,611

Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses

     (712     (506

Deferred acquisition costs

     (1,431     (1,123

Other assets

     (1,923     (996

Reserves for unpaid losses and loss adjustment expenses

     2,803        (233

Unearned and advance premium

     13,163        10,555   

Ceded reinsurance balances payable

     1,829        1,260   

Accounts payable and accrued expenses

     (465     (1,004

Segregated portfolio cell dividend payable

     (106     431   

Policyholder dividends payable

     43        (10

Federal income taxes recoverable/payable

     835        1,050   
                

Net cash provided by operating activities – continuing operations

     5,384        2,042   

Net cash used in operating activities – discontinued operations

     —          (283
                

Net cash provided by operating activities

     5,384        1,759   
                

Cash flows from investing activities:

    

Purchase of fixed income securities

     (6,532     (19,640

Purchase of equity securities

     (2,908     (998

Proceeds from sale of fixed income securities

     8,917        15,099   

Proceeds from maturities/calls of fixed income securities

     4,045        5,468   

Proceeds from sale of equity securities

     162        1,236   

Purchase of equipment, net

     (175 )     (71
                

Net cash provided by investing activities – continuing operations

     3,509        1,094   

Net cash used in investing activities – discontinued operations

     —          (7,890
                

Net cash provided by (used in) investing activities

     3,509        (6,796
                

Cash flows from financing activities:

    

Repurchase of common stock

     (6,533     —     

Shareholder dividend

     (603     (678

Repayment of loan principal

     —          (250

Income taxes related to stock compensation

     (16     36   
                

Net cash used in financing activities

     (7,152     (892
                

Net increase (decrease) in cash and cash equivalents

     1,741        (5,929

Cash and cash equivalents, beginning of period

     45,855        50,437   

Reclassification to discontinued operations

     —          7,755   
                

Cash and cash equivalents, end of period

   $ 47,596      $ 52,263   
                

See accompanying notes to unaudited consolidated financial statements.

 

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Table of Contents

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

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

1. Background and Nature of Operations

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

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

2. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and 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, being normal, recurring adjustments, necessary for a fair statement of the financial position and results of operations of the Company for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. These financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto as of and for the year ended December 31, 2010 included in the Company’s Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission on March 4, 2011.

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

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

Use of Estimates

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

Recent Accounting Pronouncements

Deferred Acquisition Costs

In October 2010, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance related to the accounting for costs related to the acquisition or renewal of insurance contracts. The new guidance provides specific types of costs that should be capitalized in connection with the acquisition or renewal of insurance contracts. Those costs include incremental direct costs of contract acquisition incurred in connection with independent third parties and certain costs related to activities performed by the insurer for the contract, including underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. Under the new guidance, costs incurred by an entity related to unsuccessful acquisition or renewal efforts must be charged to expense as incurred. The new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 and is to be applied prospectively. Retrospective application to all prior periods upon the date of adoption is permitted, but not required. Early adoption is permitted but only at the beginning of an entity’s annual reporting period. The Company currently capitalizes and defers commissions and related expenses, premium taxes and certain underwriting personnel salaries. The Company expects to adopt this new

 

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Table of Contents

guidance effective January 1, 2012 and apply it retrospectively to prior periods for purposes of consistency across all periods presented. Upon adoption, the Company expects to reduce the amount of acquisition costs capitalized related to certain underwriting personnel salaries to give effect to unsuccessful acquisition or renewal activities. Management does not expect the adoption of the new guidance to have a material effect on the Company’s financial condition or results of operations.

3. Discontinued Operations

On December 9, 2010, EIHI completed the sale of Eastern Atlantic RE (“Atlantic RE”). Atlantic RE was a Cayman Islands reinsurance company formed for the purpose of transferring certain assets and liabilities related to EIHI’s run-off specialty reinsurance segment as part of the sale. As a result of the sale, the results of operations for the portion of the run-off specialty reinsurance segment that was transferred to Atlantic RE have been reflected as discontinued operations for the three months ended March 31, 2010. The portion of the run-off specialty reinsurance segment that was not sold has been reclassified to the corporate/other segment. For the three months ended March 31, 2010, the run-off specialty reinsurance segment reported net premiums earned and revenue of $6 and $496, respectively. The run-off specialty reinsurance segment reported income before income taxes of $422 for the three months ended March 31, 2010.

On June 21, 2010, EIHI completed the sale of Eastern Life and Health Insurance Company (“Eastern Life”). As a result of the sale, Eastern Life’s operations, which were reported as the group benefits insurance segment, have been reflected as discontinued operations for the three months ended March 31, 2010. For the three months ended March 31, 2010, the group benefits insurance segment reported net premiums earned and revenue of $9,176 and $9,872, respectively. The group benefits insurance segment reported income before income taxes of $791 for the three months ended March 31, 2010.

4. Earnings Per Share

Basic earnings per share are computed by dividing net (loss) income by the weighted average number of shares outstanding for the respective period. Diluted earnings per share are computed by dividing net (loss) income by the weighted average number of shares outstanding for the period, including dilutive potential common shares outstanding for the period. For the three months ended March 31, 2011 and 2010, there were 955,452 and 814,879 stock options and restricted stock awards , respectively, that were not included in the Company’s earnings per share calculation because to do so would have been anti-dilutive.

 

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Consolidated net (loss) income, basic shares outstanding, diluted shares outstanding, basic earnings per share, diluted earnings per share and cash dividends per share for the three months ended March 31, 2011 and 2010 were as follows (unaudited, in thousands, except share and per share data):

 

     Three Months
Ended
March 31, 2011
    Three Months
Ended
March 31, 2010
 

Net income for basic and diluted earnings per share

   $ 1,880      $ 1,902   

Less: Dividends declared – common and unvested restricted share units

     (603     (678
                

Undistributed earnings

     1,277        1,224   

Percent allocated to common shareholders

     99.3     98.3
                
     1,268        1,204   

Add: Dividends declared – common shares

     599        667   
                
   $ 1,867      $ 1,871   
                

Denominator for basic earnings per share

     8,334,511        9,065,183   

Effect of dilutive securities

     96,944        36,539   
                

Denominator for diluted earnings per common share

     8,431,455        9,101,722   
                

Basic earnings per share:

    

Income from continuing operations

   $ 0.22      $ 0.10   

Income from discontinued operations

   $ —        $ 0.10   

Diluted earnings per share:

    

Income from continuing operations

   $ 0.22      $ 0.10   

Income from discontinued operations

   $ —        $ 0.10   

Cash dividends per share

   $ 0.07      $ 0.07   

5. Fair Value Measurements

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

The following is a description of the Company’s categorization of the inputs used in the recurring fair value measurements of its financial assets included in its consolidated balance sheet as of March 31, 2011:

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

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

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

 

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The following table provides a summary of the fair value measurements of the Company’s fixed income securities, convertible bonds, and equity securities, as of March 31, 2011 and December 31, 2010, excluding the segregated portfolio cell reinsurance segment (unaudited, in thousands):

 

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

Fixed income securities – available for sale:

           

U.S. Treasuries and government agencies

   $ 18,506       $ 9,784       $ 8,722       $ —     

States, municipalities, and political subdivisions

     32,283         —           32,283         —     

Corporate securities

     15,032         —           15,032         —     

Residential mortgage-backed securities

     26,284         —           26,284         —     

Commercial mortgage-backed securities

     243         —           243         —     

Collateralized mortgage obligations

     6,521         —           6,521         —     

Other structured securities

     452         —           452         —     

Convertible bonds

     18,441         —           18,441         —     

Equity securities – available for sale

     20,227         16,608         3,619         —     
                                   

Total

   $ 137,989       $ 26,392       $ 111,597       $ —     
                                   
            Fair Value Measurements at Reporting
Date Using
 
     12/31/10      Level 1      Level 2      Level 3  

Fixed income securities – available for sale:

           

U.S. Treasuries and government agencies

   $ 23,344       $ 9,272       $ 14,072       $ —     

States, municipalities, and political subdivisions

     32,621         —           32,621         —     

Corporate securities

     16,006         —           16,006         —     

Residential mortgage-backed securities

     25,759         —           25,759         —     

Commercial mortgage-backed securities

     289         —           289         —     

Collateralized mortgage obligations

     7,220         —           7,220         —     

Other structured securities

     773         —           773         —     

Convertible bonds

     18,140         —           18,140         —     

Equity securities – available for sale

     16,753         13,228         3,525         —     
                                   

Total

   $ 140,905       $ 22,500       $ 118,405       $ —     
                                   

The estimated fair values of the Company’s investments in fixed income securities, convertible bonds, and equity securities are based on prices provided by an independent, nationally recognized pricing service. Approximately 99.0% of the Company’s fixed income and equity security prices are obtained from the independent pricing service. The prices provided by the independent pricing service are based on quoted market prices, when available, non-binding broker quotes, or matrix pricing. The independent pricing service provides a single price or quote per security and the Company does not adjust security prices. The Company obtains an understanding of the methods, models and inputs, used by the independent pricing service, and has controls in place to validate that amounts provided represent current exit values. The Company’s controls include, but are not limited to, initial and ongoing evaluation of the methodologies used by the independent pricing service as well as comparing the fair value estimates to the Company’s knowledge of the current market. Fixed income securities include U.S. Treasuries, agencies backed by the U.S. Government, municipal bonds, mortgage-backed securities, collateralized mortgage obligations, asset-backed securities, and corporate bonds.

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

The Company’s equity securities consist primarily of mutual fund instruments for which there is an active market and quoted market prices; therefore, the Company has classified its mutual fund investments as Level 1 securities. The Company holds an investment in an international equity fund that is not traded on an active exchange market and, therefore, is considered a Level 2 security. Approximately 94.1% of the international equity fund’s underlying investments were considered Level 1 securities as of December 31, 2010, the most recent date for which the Company has audited financial statements of the fund.

 

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Other long-term investments include the Company’s interest in various limited partnerships, including a low volatility multi-strategy fund of funds, two natural resource limited partnerships, a structured finance opportunity fund, an open-ended investment fund and a real estate limited partnership. The Company records its investment in the limited partnerships using the equity method. The carrying value of the Company’s limited partnership investments are based on the Company’s allocable share of the limited partnership’s net asset value. Changes in the Company’s investments are based on statements received directly from the limited partnership and/or the limited partnership’s administrator. The estimated fair values of the underlying investments in the limited partnerships may be based on Level 1, Level 2, or Level 3 inputs, or a combination thereof.

As of March 31, 2011 (unaudited) and December 31, 2010, the estimated fair values of the Company’s limited partnership investments, by investment strategy, were as follows (in thousands):

 

     3/31/11      12/31/10  

Multi-strategy fund of funds

   $ 5,616       $ 5,351   

Natural resources

     2,701         2,515   

Structured finance opportunity fund

     3,021         2,892   

Open-ended investment fund

     648         629   

Real estate

     —           48   
                 

Total

   $ 11,986       $ 11,435   
                 

The activity in the Company’s limited partnership investments for the three months ended March 31, 2011 and 2010 was as follows (unaudited, in thousands):

 

     3/31/11      3/31/10  

Balance, beginning of period

   $ 11,435       $ 8,197   

Contributions

     —           —     

Withdrawals

     —           —     

Change in interest

     551         259   
                 

Balance, end of period

   $ 11,986       $ 8,456   
                 

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

6. Investments

The following tables provide the amortized cost and estimated fair value of the Company’s fixed income and equity securities as of March 31, 2011 and December 31, 2010 (unaudited, in thousands):

 

March 31, 2011

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

U.S. Treasuries and government agencies

   $ 18,077       $ 452       $ (23   $ 18,506   

States, municipalities, and political subdivisions

     30,997         1,333         (47     32,283   

Corporate securities

     35,939         1,002         (126     36,815   

Residential mortgage-backed securities

     26,117         347         (180     26,284   

Commercial mortgage-backed securities

     228         15         —          243   

Collateralized mortgage obligations

     6,445         94         (18     6,521   

Other structured securities

     459         —           (7     452   
                                  

Total fixed income securities

     118,262         3,243         (401     121,104   

Equity securities

     19,785         4,808         (38     24,555   
                                  

Total fixed income and equity securities

   $ 138,047       $ 8,051       $ (439   $ 145,659   
                                  

 

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December 31, 2010

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

U.S. Treasuries and government agencies

   $ 22,775       $ 575       $ (6   $ 23,344   

States, municipalities, and political subdivisions

     31,282         1,428         (89     32,621   

Corporate securities

     36,462         1,130         (124     37,468   

Residential mortgage-backed securities

     25,474         415         (130     25,759   

Commercial mortgage-backed securities

     272         17         —          289   

Collateralized mortgage obligations

     7,177         117         (74     7,220   

Other structured securities

     759         18         (4     773   
                                  

Total fixed income securities

     124,201         3,700         (427     127,474   

Equity securities

     17,002         3,906         (28     20,880   
                                  

Total fixed income and equity securities

   $ 141,203       $ 7,606       $ (455   $ 148,354   
                                  

Other structured securities include other asset-backed securities collateralized by home equity loans, credit card receivables and manufactured homes.

The gross unrealized losses and estimated fair value of fixed income and equity securities, excluding those securities in the segregated portfolio cell reinsurance segment, classified as a available-for-sale by category and length of time an individual security has been in a continuous unrealized position as of March 31, 2011 (unaudited, in thousands) and December 31, 2010 are as follows (in thousands):

 

     Less Than 12 Months     12 Months or More      Total  

March 31, 2011

   Estimated
Fair
Value
     Gross
Unrealized
Losses
    Estimated
Fair
Value
     Gross
Unrealized
Losses
     Estimated
Fair
Value
     Gross
Unrealized
Losses
 

U.S. Treasuries and government agencies

   $ 5,146       $ (23   $ —         $ —         $ 5,146       $ (23

States, municipalities, and political subdivisions

     3,577         (48     —           —           3,577         (48

Corporate securities

     2,572         (32     —           —           2,572         (32

Residential mortgage-backed securities

     13,701         (180     —           —           13,701         (180

Collateralized mortgage obligations

     1,680         (18     —           —           1,680         (18

Other structured securities

     443         (7     —           —           443         (7
                                                    

Total fixed income securities

     27,119         (308     —           —           27,119         (308

Equity securities

     48         (4     —           —           48         (4
                                                    

Total fixed income and equity securities

   $ 27,167       $ (312   $ —         $ —         $ 27,167       $ (312
                                                    

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

 

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     Less Than 12 Months     12 Months or More     Total  

December 31, 2010

   Estimated
Fair
Value
     Gross
Unrealized
Losses
    Estimated
Fair
Value
     Gross
Unrealized
Losses
    Estimated
Fair
Value
     Gross
Unrealized
Losses
 

U.S. Treasuries and government agencies

   $ 860       $ (6   $ —         $ —        $ 860       $ (6

States, municipalities, and political subdivisions

     5,914         (89     —           —          5,914         (89

Corporate securities

     2,508         (25     —           —          2,508         (25

Residential mortgage-backed securities

     10,921         (130     —           —          10,921         (130

Collateralized mortgage obligations

     1,700         (19     722         (55     2,422         (74

Other structured securities

     446         (4     —           —          446         (4
                                                   

Total fixed income securities

     22,349         (273     722         (55     23,071         (328
                                                   

As of March 31, 2011, the Company held 52 fixed income securities with gross unrealized losses totaling $308. Management has evaluated the unrealized losses related to those fixed income securities and determined that they are primarily due to the current liquidity issues in the fixed income markets or to a fluctuation in interest rates and not to credit issues of the issuer or the underlying assets in the case of asset-backed securities. The Company does not intend to sell the fixed income securities and it is not more likely than not that the Company will be required to sell the fixed income securities before recovery of their amortized cost bases, which may be maturity; therefore, management does not consider the fixed income securities to be other-than-temporarily impaired as of March 31, 2011.

As of March 31, 2011, the Company held one equity security with a gross unrealized loss of $4.

There were no other-than-temporary impairments for the three months ended March 31, 2011. The Company recognized other-than-temporary impairments of $15 for the three months ended March 31, 2010.

7. Reserves for Unpaid Losses and Loss Adjustment Expenses

The following table provides a summary of the activity in the Company’s reserves for unpaid losses and LAE for the three months ended March 31, 2011 and 2010 (unaudited, in thousands):

 

     2011     2010  

Balance, beginning of period

   $ 95,963      $ 89,509   

Reinsurance recoverables on unpaid losses and LAE

     7,864        8,512   
                

Net balance, beginning of period

     88,099        80,997   

Incurred related to:

    

Current year

     19,459        16,435   

Prior year

     (114     712   
                

Total incurred

     19,345        17,147   

Paid related to:

    

Current year

     2,822        2,930   

Prior year

     14,918        13,751   
                

Total paid

     17,740        16,681   
                

Net balance, end of period

     89,704        81,463   

Reinsurance recoverables on unpaid losses and LAE

     9,062        8,181   
                

Balance, end of period

   $ 98,766      $ 89,644   
                

 

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Incurred losses by segment were as follows for the three months ended March 31, 2011 and 2010, respectively (unaudited, in thousands):

 

March 31, 2011

   Workers’
Compensation
Insurance
Segment
    Segregated
Portfolio Cell
Reinsurance
Segment
    Total  

Incurred related to:

      

Current year, gross of discount

   $ 15,985      $ 4,382      $ 20,367   

Current period discount

     (680     (228     (908

Prior year, gross of discount

     —          (699     (699

Accretion of prior period discount

     337        248        585   
                        

Total incurred

   $ 15,642      $ 3,703      $ 19,345   
                        

March 31, 2010

   Workers’
Compensation
Insurance
Segment
    Segregated
Portfolio Cell
Reinsurance
Segment
    Total  

Incurred related to:

      

Current year, gross of discount

   $ 12,770      $ 4,515      $ 17,285   

Current period discount

     (634     (216     (850

Prior year, gross of discount

     —          (733     (733

Accretion of prior period discount

     704        741        1,445   
                        

Total incurred

   $ 12,840      $ 4,307      $ 17,147   
                        

The Company’s results of operations include favorable development in its segregated portfolio cell reinsurance segment of $699 for the three months ended March 31, 2011, compared to favorable development of $733 for the same period in 2010. The favorable development primarily reflects the impact of claim settlements for amounts at, or less than, previously established case and IBNR reserves.

8. Segment Information

The Company currently operates in three business segments. Prior to the sale of Atlantic RE and Eastern Life, the Company’s operations included a run-off specialty reinsurance segment and a group benefits insurance segment. The components of the run-off specialty reinsurance segment that were not transferred to Atlantic RE have been included in the corporate/other segment for the three months ended March 31, 2011 and 2010.

Workers’ Compensation Insurance

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

Segregated Portfolio Cell Reinsurance

The Company offers alternative market workers’ compensation solutions to individual companies, groups and associations (referred to as “segregated portfolio cell dividend participants”) through the creation of segregated portfolio cells. The segregated portfolio cells are segregated pools of assets that function as insurance companies within an insurance company. The pool of assets and associated liabilities of each segregated portfolio cell are solely for the benefit of the segregated portfolio cell dividend participants, and the pool of assets of one segregated portfolio cell are statutorily protected from the creditors of the others. This permits the Company to provide customers with a turn-key alternative markets solution that includes program design, fronting, claims administration, risk management, segregated portfolio cell rental, asset management and segregated portfolio management services. The Company outsources the asset management and segregated portfolio cell management services to a third party. The segregated portfolio cell structure provides dividend participants the opportunity to share in both underwriting profit and investment income derived from their respective segregated portfolio cell’s financial results. The segregated portfolio cell reinsurance segment generated fee revenue to the Company’s workers’ compensation insurance and corporate/other segments totaling approximately $1,661 and $1,411 for the three months ended March 31, 2011 and 2010, respectively.

 

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Corporate/Other

The corporate/other segment primarily includes the expenses of the holding company, the third party administration activities of the Company, and the non-segregated portfolio cell reinsurance results of operations of Eastern Re, as well as certain eliminations necessary to reconcile the segment information to the consolidated statements of operations and comprehensive income (loss). The corporate/other segment also includes the Company’s 10% interest in a segregated portfolio cell with an unaffiliated primary carrier that writes insurance coverage for sprinkler contractors. The Company cancelled the non-segregated portfolio cell reinsurance contracts in 1999 on a run-off basis and continues to have exposure for outstanding claims as of March 31, 2011. The Company non-renewed the contract for its 10% interest in the segregated portfolio cell on a run-off basis effective April 1, 2009.

The following table represents the segment results for the three months ended March 31, 2011 (unaudited, in thousands):

 

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

Revenue:

          

Net premiums earned

   $ 23,582       $ 6,295       $ —        $ 29,877   

Net investment income

     877         109         39        1,025   

Change in equity interest in limited partnerships

     468         —           83        551   

Net realized investment gains

     760         37         33        830   

Other revenue

     —           —           183        183   
                                  

Total revenue

     25,687         6,441         338        32,466   
                                  

Expenses:

          

Losses and LAE incurred

     15,642         3,703         —          19,345   

Acquisition and other underwriting expenses

     2,108         1,874         (564     3,418   

Other expenses

     3,697         69         2,128        5,894   

Amortization of intangibles

     —           —           254        254   

Policyholder dividend expense

     308         —           —          308   

Segregated portfolio dividend expense

     —           795         (269     526   
                                  

Total expenses

     21,755         6,441         1,549        29,745   
                                  

Income (loss) from continuing operations before income taxes

     3,932         —           (1,211     2,721   

Income tax expense from continuing operations

     1,276         —           (435     841   
                                  

Net income (loss) from continuing operations

   $ 2,656       $ —         $ (776   $ 1,880   
                                  

Total assets

   $ 291,193       $ 60,239       $ (15,796   $ 335,636   
                                  

 

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The following table represents the segment results for the three months ended March 31, 2010 (unaudited, in thousands):

 

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

Revenue:

          

Net premiums earned

   $ 19,455       $ 5,885       $ —        $ 25,340   

Net investment income

     830         151         66        1,047   

Change in equity interest in limited partnerships

     205         —           54        259   

Net realized investment gains (losses)

     450         565         (203     812   

Other revenue

     —           —           146        146   
                                  

Total revenue

     20,940         6,601         63        27,604   
                                  

Expenses:

          

Losses and LAE incurred

     12,840         4,307         —          17,147   

Acquisition and other underwriting expenses

     1,970         1,792         (478     3,284   

Other expenses

     3,511         66         1,448        5,025   

Amortization of intangibles

     —           —           321        321   

Policyholder dividend expense

     178         —           —          178   

Segregated portfolio dividend expense

     —           436         (253     183   
                                  

Total expenses

     18,499         6,601         1,038        26,138   
                                  

Income (loss) from continuing operations before income taxes

     2,441         —           (975     1,466   

Income tax expense (benefit) from continuing operations

     715         —           (194     521   
                                  

Net income (loss) from continuing operations

   $ 1,726       $ —         $ (781   $ 945   
                                  

Total assets

   $ 252,642       $ 61,732       $ (26,654   $ 287,720   
                                  

9. Commitments and Contingencies

Legal Proceedings

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

10. Subsequent Events

Management performed an evaluation of subsequent events and determined there were no recognized or unrecognized subsequent events that would require an adjustment and/or additional disclosure in the consolidated financial statements as of March 31, 2011.

 

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

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the unaudited interim consolidated financial statements of Eastern Insurance Holdings, Inc. (the “Company”) and the related notes thereto included in Item 1 of this Part 1. The information contained in this quarterly report is not a complete description of the Company’s business or the risks associated with an investment in the Company’s common stock. You should carefully review and consider the various disclosures made by the Company in this quarterly report and in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on March 4, 2011.

Forward-looking Statements

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

 

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

 

   

the ability to carry out our business plans;

 

   

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

 

   

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

 

   

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

 

   

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

 

   

the impact of acts of terrorism and acts of war;

 

   

the effects of terrorist related insurance legislation and laws;

 

   

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

 

   

the cost, availability and collectibility of reinsurance;

 

   

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

 

   

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

 

   

the effects of mergers, acquisitions and dispositions;

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

adverse litigation or arbitration results; and

 

   

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

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

 

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Overview

The Company reported net income from continuing operations of $1.9 million for the three months ended March 31, 2011, compared to net income of $945,000 for the same period in 2010. The combined ratio totaled 97.8% for the three months ended March 31, 2011, compared to a combined ratio of 102.4% for the same period in 2010.

The improvement in the consolidated combined ratio primarily reflects growth in net earned premium and a reduction in the calendar period loss ratio from 67.7% in 2010 to 64.7% in 2011. The increase in net earned premium primarily reflects new business writings, an increase in the renewal retention rate and renewal rate increases, as well as a decrease in premium returned to customers as a result of premium audits. The decrease in the calendar period loss ratio primarily reflects a decrease in the accident period loss ratio in the segregated portfolio cell reinsurance segment. The 2010 accident period loss ratio in the segregated portfolio cell reinsurance segment was negatively impacted by an increase in reported claims in certain segregated portfolio cells.

Principal Revenue and Expense Items

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

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

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

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

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

 

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

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

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

Other expenses. Other expenses consist of general administrative expenses such as salaries, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately. Other expenses also include interest expense related primarily to the Company’s loan payable.

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

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

Key Financial Measures

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

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

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

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

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

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

 

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Critical Accounting Policies and Estimates

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

Reserves for Unpaid Losses and LAE

The Company establishes reserves for unpaid losses and LAE for its workers’ compensation, segregated portfolio cell reinsurance and run-off specialty reinsurance products, which are estimates of future payments of reported and unreported claims for losses and related expenses. The adequacy of the Company’s reserves for unpaid losses and LAE are inherently uncertain because the ultimate amount that the Company may pay under many of the claims incurred as of the balance sheet date will not be known for many years. Establishing reserves continues to be a complex and imprecise process, requiring the use of informed estimates and judgments. The Company’s estimates and judgments may be revised as additional experience and other data becomes available and are reviewed, as new or improved methodologies are developed, or as current laws change. Any such revisions could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in the Company’s results of operations in the period in which the estimates are changed. Estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. If ultimate losses, net of reinsurance, prove to be substantially higher than the amounts recorded as of March 31, 2011, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

The Company discounts its workers’ compensation reserves, using a discount rate of approximately 3.0%. As of March 31, 2011 and December 31, 2010, the Company’s reserves for unpaid losses and LAE were reduced by $5.0 million and $4.6 million, respectively, related to the effects of discounting.

The Company’s reserves for unpaid losses and LAE in its workers’ compensation insurance, segregated portfolio cell reinsurance and corporate/other segments as of March 31, 2011 (unaudited) and December 31, 2010 are summarized below (in thousands):

 

March 31, 2011

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

Case/tabular reserves

   $ 40,516      $ 12,040      $ —         $ 52,556   

Case incurred development, IBNR, and unallocated LAE reserves

     29,865        11,436        797         42,098   

Amount of discount

     (3,778     (1,173     —           (4,951
                                 

Net reserves

     66,603        22,303        797         89,703   

Reinsurance recoverables on unpaid losses and LAE

     5,668        3,395        —           9,063   
                                 

Reserves for unpaid losses and LAE

   $ 72,271      $ 25,698      $ 797       $ 98,766   
                                 

 

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December 31, 2010

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

Case/tabular reserves

   $ 35,758      $ 11,618      $ —         $ 47,376   

Case incurred development, IBNR, and unallocated LAE reserves

     32,124        12,369        862         45,355   

Amount of discount

     (3,435     (1,198     —           (4,633
                                 

Net reserves

     64,447        22,789        862         88,098   

Reinsurance recoverables on unpaid losses and LAE

     4,464        3,401        —           7,865   
                                 

Reserves for unpaid losses and LAE

   $ 68,911      $ 26,190      $ 862       $ 95,963   
                                 

“Other Than Temporary” Investment Impairments

Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of comprehensive income (loss) and, accordingly, have no effect on net income. When, in the opinion of management, a decline in the fair value of an investment below its cost or amortized cost is considered to be “other-than-temporary,” such investment is written down to its fair value. The amount written down is recorded in earnings as a realized loss on investments. Generally, the determination of other-than-temporary impairment includes, in addition to other relevant factors, a presumption that if the market value is below cost by a significant amount for a period of time, a write down is necessary. Notwithstanding this presumption, the determination of other-than-temporary impairment requires judgment about future prospects for an investment and is therefore a matter of inherent uncertainty. For the three months ended March 31, 2011, the Company recognized other-than-temporary impairments of $0, compared to $15,000 for the same period in 2010. As of March 31, 2011, the Company held securities with gross unrealized losses of $312,000, excluding those securities in the segregated portfolio cell reinsurance segment, of which $0 were in an unrealized loss position for more than 12 months. Adverse investment market conditions, poor operating results of underlying issuers, or the passage of time with respect to equity securities in an unrealized loss position, could result in impairment charges in the future. The Company generally applies the following standards in determining whether the decline in fair value of an investment is other-than-temporary:

Equity securities. An equity security is considered impaired when one of the following conditions exist: 1) an equity security’s market value is less than 80.0% of its cost for a continuous period of six months, 2) an equity’s security’s market value is less than 50.0% of its cost, regardless of the amount of time the security’s market value has been below cost, and 3) an equity security’s market value has been less than cost for a continuous period of 12 months, regardless of the magnitude of the decline in market value. Equity securities that are in an unrealized loss position, but do not meet the above quantitative thresholds, are evaluated to determine if the decline in market value is other than temporary.

The Company did not recognize any other-than-temporary impairments related to its equity securities for the three months ended March 31, 2011.

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

 

   

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

 

   

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

 

   

The security has a market value below 80.0% of amortized cost due to deterioration in credit quality.

 

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The Company did not recognize any other-than-temporary impairments related to its fixed income securities for the three months ended March 31, 2011.

Limited partnerships. A limited partnership investment is generally written down if the Company is unable to hold or otherwise intends to sell its interest in the limited partnership at a loss, or if management has received information that suggests the Company will be unable to recover its original investment in the limited partnership. The amount written down is recorded in the change in equity interest in other long-term investments in the consolidated statement of operations. There were no other-than-temporary impairments related to the Company’s limited partnership interests for the three months ended March 31, 2011 or 2010.

Goodwill

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

Goodwill is assigned to one or more reporting units at the date of acquisition. The Company has allocated 100% of the goodwill recorded on its consolidated balance sheet as of March 31, 2011 to its workers’ compensation insurance segment. The goodwill impairment test, performed as of September 30 of each year, is a two-step test. The first step identifies whether there is potential impairment by comparing the fair value of a reporting unit to the carrying amount, including goodwill. If the fair value of a reporting unit is less than its carrying amount, the second step of the impairment test is required to measure the amount of any impairment loss.

We did not evaluate goodwill for impairment as of March 31, 2011 as no events occurred or circumstances changed that would have more likely than not reduced the fair value of the workers’ compensation insurance segment below its carrying amount since September 30, 2010.

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

Deferred Income Taxes

The temporary differences between the tax and book bases of assets and liabilities are recorded as deferred income taxes. Management evaluates the recoverability of the net deferred tax asset based on historical trends of generating taxable income or losses, as well as expectations of future taxable income or loss. As of March 31, 2011, the Company recorded a net deferred tax asset of $629,000. Management expects that the net deferred tax asset is fully recoverable. If this assumption were to change, any amount of the net deferred tax asset that the Company could not expect to recover would be provided for as an allowance and would be reflected as an increase in income tax expense in the period in which it was established.

As of March 31, 2011, the Company has not recognized any future tax benefit related to its foreign operations at Eastern Re. The unrecognized tax benefit, which represents the excess of the tax basis over the amount for financial reporting (i.e., outside basis difference) of Eastern Re, was $11,433 as of March 31, 2011. The outside basis difference primarily arises from losses at Eastern Re recognized for financial statement purposes, which have not yet been recognized for tax purposes. Management presently believes that the Company will not be able to recognize these tax benefits in the foreseeable future and, therefore, has not recognized the future tax benefits as of March 31, 2011.

Reinsurance Recoverables

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

 

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Recent Accounting Pronouncements

Deferred Acquisition Costs

In October 2010, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance related to the accounting for costs related to the acquisition or renewal of insurance contracts. The new guidance provides specific types of costs that should be capitalized in connection with the acquisition or renewal of insurance contracts. Those costs include incremental direct costs of contract acquisition incurred in connection with independent third parties and certain costs related to activities performed by the insurer for the contract, including underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. Under the new guidance, costs incurred by an entity related to unsuccessful acquisition or renewal efforts must be charged to expense as incurred. The new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 and is to be applied prospectively. Retrospective application to all prior periods upon the date of adoption is permitted, but not required. Early adoption is permitted but only at the beginning of an entity’s annual reporting period. The Company currently capitalizes and defers commissions and related expenses, premium taxes and certain underwriting personnel salaries. The Company expects to adopt this new guidance effective January 1, 2012 and apply it retrospectively to prior periods for purposes of consistency across all periods presented. Upon adoption, the Company expects to reduce the amount of acquisition costs capitalized related to certain underwriting personnel salaries to give effect to unsuccessful acquisition or renewal activities. Management does not expect the adoption of the new guidance to have a material effect on the Company’s financial condition or results of operations.

THREE MONTHS ENDED MARCH 31, 2011 COMPARED TO THREE MONTHS ENDED MARCH 31, 2010

RESULTS OF OPERATIONS

The major components of consolidated revenue were as follows for the three months ended March 31, 2011 and 2010 (unaudited, in thousands):

 

     2011      2010  

Net premiums written

   $ 43,348       $ 36,414   
                 

Net premiums earned

   $ 29,877       $ 25,340   

Net investment income

     1,025         1,047   

Change in equity interest in limited partnerships

     551         259   

Net realized investment gains

     830         812   

Other revenue

     183         146   
                 

Consolidated revenue

   $ 32,466       $ 27,604   
                 

The increase in consolidated revenue primarily reflects the increase in net premiums written from 2010 to 2011 and the increase in the Company’s equity interest in limited partnerships.

The components of consolidated net income, by segment, for the three months ended March 31, 2011 and 2010 were as follows (unaudited, in thousands):

 

     2011     2010  

Workers’ compensation insurance

   $ 2,656      $ 1,726   

Segregated portfolio cell reinsurance

     —          —     

Corporate/other

     (776     (781
                

Consolidated net income from continuing operations

   $ 1,880      $ 945   
                

The increase in consolidated net income from continuing operations primarily reflects the decrease in the combined ratio in the workers’ compensation insurance segment.

 

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WORKERS’ COMPENSATION INSURANCE

The following table represents the operations of the workers’ compensation insurance segment for the three months ended March 31, 2011 and 2010 (unaudited, in thousands):

 

     2011     2010  

Revenue:

    

Direct premiums written

   $ 46,601      $ 38,874   

Reinsurance premiums assumed

     332        265   

Ceded premiums written

     (13,967     (11,640
                

Net premiums written

     32,966        27,499   

Change in unearned premiums

     (9,384     (8,044
                

Net premiums earned

     23,582        19,455   

Net investment income

     877        830   

Change in equity interest in limited partnerships

     468        205   

Net realized investment gains

     760        450   
                

Total revenue

   $ 25,687      $ 20,940   
                

Expenses:

    

Losses and LAE incurred

   $ 15,642      $ 12,840   

Acquisition and other underwriting expenses

     2,108        1,970   

Other expenses

     3,697        3,511   

Policyholder dividend expense

     308        178   
                

Total expenses

     21,755        18,499   
                

Income before income taxes

     3,932        2,441   

Income tax expense

     1,276        715   
                

Net income

   $ 2,656      $ 1,726   
                

The workers’ compensation insurance ratios were as follows for the three months ended March 31, 2011 and 2010:

 

     2011     2010  

Loss and LAE ratio

     66.3     66.0

Expense ratio

     24.6     28.2

Policyholders’ dividend ratio

     1.3     0.9
                

Combined ratio

     92.2     95.1
                

Premiums

The increase in direct premiums written primarily reflects new business sales of $9.4 million, an increase in the renewal retention rate, a decrease in return audit premium to customers, and renewal rate increases of 3.9%. The renewal retention rate increased from 88.0% in 2010 to 90.4% in 2011. For the three months ended March 31, 2011, the Company returned premium to customers totaling $134,000 in the aggregate related to its traditional and alternative market books of business, compared to $590,000 of return premium to customers for the same period in 2010, a difference of $456,000. The Company recognized additional premium from customers of $272,000 related to its traditional book of business for the three months ended March 31, 2011, compared to $382,000 of return premium to customers for the same period in 2010, a difference of $654,000.

Net Investment Income

Net investment income was consistent from 2010 to 2011. The average yield on the fixed income portfolio was 3.34% as of March 31, 2011, compared to 3.46% as of March 31, 2010.

Net Realized Investment Losses

The increase in net realized investment gains primarily reflects an increase in the estimated fair value of the Company’s convertible bond portfolio.

 

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Losses and LAE

The increase in the calendar period loss and LAE ratio primarily reflects an increase in the accident period loss ratio from 2010 to 2011, partially offset by additional audit premium in 2011, compared to return audit premium in 2010. The calendar period loss and LAE ratio was impacted by additional audit premium to the Company of $272,000 for the three months ended March 31, 2011, which decreased the 2011 loss and LAE ratio by 0.8 points compared to return audit premium to policyholders of $382,000 for the same period in 2010, which increased the 2010 loss and LAE ratio by 1.3 points. There was no prior year reserve development recognized in 2011 or 2010.

Acquisition and Other Underwriting Expenses

The acquisition and other underwriting expense ratio decreased from 10.1% in 2010 to 8.9% in 2011. The decrease primarily reflects the improvement in audit premium from 2010 to 2011 and a decrease in the Security Fund accrual. During the first quarter of 2011, management received financial information from the Security Fund that reported a fund balance in excess of the $500 million minimum fund balance. Based on the fund balance, management determined that an assessment based on 2011 premium is not probable and, therefore, a liability related to the Security Fund was not recorded as of March 31, 2011. If the financial condition of the Security Fund were to deteriorate significantly, a liability may be recorded in future periods.

Other Expenses

The other expense ratio decreased from 18.0% in 2010 to 15.7% in 2011. The decrease primarily reflects the impact of the increase in net premiums earned.

Policyholder Dividends

The increase in the policyholder dividend expense reflects the loss experience of dividend paying policies. For the three months ended March 31, 2011 and 2010, 10.6% and 12.4%, respectively, of all policies were written on a dividend policy basis.

Tax Expense

The effective tax rate for the three months ended March 31, 2011 and 2010 was 32.5% and 29.3%, respectively. The primary difference between the statutory rate of 35.0% and the effective tax rate primarily reflects tax-exempt income on municipal bond securities.

SEGREGATED PORTFOLIO CELL REINSURANCE

The following table represents the operations of the segregated portfolio cell reinsurance segment for the three months ended March 31, 2011 and 2010 (unaudited, in thousands):

 

     2011     2010  

Revenue:

    

Reinsurance premiums assumed

   $ 11,244      $ 9,702   

Ceded premiums written

     (862     (787
                

Net premiums written

     10,382        8,915   

Change in unearned premiums

     (4,087     (3,030
                

Net premiums earned

     6,295        5,885   

Net investment income

     109        151   

Net realized investment gains

     37        565   
                

Total revenue

   $ 6,441      $ 6,601   
                

Expenses:

    

Losses and LAE incurred

   $ 3,703      $ 4,307   

Acquisition and other underwriting expenses

     1,874        1,792   

Other expenses

     69        66   

Segregated portfolio dividend expense (1)

     795        436   
                

Total expenses

     6,441        6,601   
                

Net income (1)

   $ —        $ —     
                

 

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

The segregated portfolio cell reinsurance ratios were as follows for the three months ended March 31, 2011 and 2010:

 

     2011     2010  

Loss and LAE ratio

     58.8     73.2

Expense ratio

     30.9     31.6
                

Combined ratio

     89.7     104.8
                

Reinsurance Premiums Assumed

The increase in reinsurance premiums assumed primarily reflects new business sales of $1.8 million, an increase in the renewal retention rate, and renewal rate increases of 4.8%, partially offset by an increase in return audit premium to customers. The renewal retention rate increased from 90.0% in 2010 to 91.6% in 2011. For the three months ended March 31, 2011, the Company returned audit premium to customers totaling $406,000, compared to $208,000 of return audit premium to customers for the same period in 2010.

Net Investment Income

The decrease in net investment income primarily reflects a decrease in fixed income securities from 2010 to 2011.

Net Realized Investment Gains (Losses)

The decrease in net realized investment gains primarily reflects a reduction in investment sales activity from 2010 to 2011.

Losses and LAE

The decrease in the calendar period loss and LAE ratio primarily reflects a decrease in the accident period loss ratio, partially offset by decrease in favorable loss reserve development on prior accident periods. The accident period loss ratio was 69.9% and 85.6% for the three months ended March 31, 2011 and 2010, respectively. The 2010 accident period loss ratio reflected an increase in reported claims in certain segregated cells during the first quarter of 2010. Favorable loss reserve development totaled $699,000 and $733,000 for the three months ended March 31, 2011 and 2010, respectively.

Acquisition and Other Underwriting Expenses

The expense ratios are consistent with the contractual ceding commissions for the three months ended March 31, 2011 and 2010.

Segregated Portfolio Dividend Expense

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

CORPORATE/OTHER

The corporate/other segment reported a net loss of $776,000 for the three months ended March 31, 2011, compared to a net loss of $781,000 for the same period in 2010.

CONSOLIDATED FINANCIAL POSITION

Consolidated assets totaled $335.6 million at March 31, 2011, compared to $322.7 million at December 31, 2010. The increase in consolidated assets primarily reflects an increase in premiums receivable and deferred acquisition costs, which are higher as of March 31 as a result of the high volume of workers’ compensation business with a January 1 effective date. The increase is also attributable to an increase in other assets, primarily reflecting an increase in deductible recoverables, prepaid reinsurance premiums and prepaid premium taxes. These increases were partially offset by a decrease in federal income taxes recoverable, which primarily reflects the estimated tax liability based on the Company’s results of operations for the three months ended March 31, 2011.

 

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Consolidated liabilities totaled $205.3 million at March 31, 2011, compared to $188.0 million at December 31, 2010. The increase in consolidated liabilities primarily reflects an increase in unearned premiums and ceded reinsurance balances payable, which are higher as of March 31 as a result of the high volume of workers’ compensation business with a January 1 effective date.

Consolidated equity totaled $130.3 million at March 31, 2011, compared to $134.7 million at December 31, 2010. The decrease in consolidated equity primarily reflects the Company’s stock buyback activity, net income for the three months ended March 31, 2011 and the first quarter 2011 shareholder dividend.

LIQUIDITY AND CAPITAL RESOURCES

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

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

The Company has a $2.6 million line of credit available to provide additional liquidity if needed.

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

CASH FLOWS

Cash flows from continuing operations for the three months ended March 31, 2011 and 2010 were as follows (unaudited, in thousands):

 

     2011     2010  

Cash flows provided by operating activities

   $ 5,384      $ 1,805   

Cash flows provided by investing activities

     3,509        1,094   

Cash flows used in financing activities

     (7,152     (892
                

Net increase in cash and cash equivalents

   $ 1,741      $ 2,007   
                

The increase in cash flows provided by operating activities primarily reflects the increase in direct premiums written. The increase in cash flows from investing activities primarily reflects the sale of investments to fund the Company’s stock buyback program. The increase in cash used in financing activities primarily reflects the stock buyback program.

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 March 31, 2011, future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

 

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There have been no material changes in the Company’s market risk since December 31, 2010. Additional disclosures related to the Company’s market risk are discussed under “Quantitative and Qualitative Disclosures About Market Risk” in Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 8, 2011.

 

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

Changes in Internal Control Over Financial Reporting

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

 

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PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

None

 

Item 1A. Risk Factors

There are no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, SEC File No. 001-32899.

 

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

Issuer Purchases of Equity Securities

The following table presents information with respect to those purchases of our common stock made during the three months ended March 31, 2011. There were no purchases of our common stock during the three months ended March 31, 2010.

 

Period

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

January 1-31, 2011

     129,110       $ 12.34         129,110         988,506   

February 1-28, 2011

     31,976       $ 13.02         31,976         956,530   

March 1-31, 2011

     358,147       $ 12.57         358,147         598,383   
                             

Total

     519,233       $ 12.54         519,233      
                             

 

(a) As of March 31, 2011, the Company may repurchase up to an additional 598,383 shares of its common stock under the current stock buyback program authorized by the Board of Directors.

 

Item 3. Defaults Upon Senior Securities

None

 

Item 4. Submission of Matters to Vote of Security Holders

None

 

Item 5. Other Information

None

 

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Item 6. Exhibits

Exhibits

 

Exhibit
No.

  

Title

  3.1    Articles of Incorporation of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.1 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)
  3.2    Bylaws of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.2 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)
10.12    Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan (Incorporated by reference from Exhibit 4.1 to EIHI’s Registration Statement on Form S-8 filed on April 2, 2007)
21.1    Subsidiaries of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 21 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)
31.1    Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)
31.2    Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)
32.1    Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)
32.2    Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

 

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SIGNATURES

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

 

   

EASTERN INSURANCE HOLDINGS, INC.

(Registrant)

Dated: May 5, 2011     By:  

/s/    Michael L. Boguski

      Michael L. Boguski,
      President and Chief Executive Officer
Dated: May 5, 2011     By:  

/S/    KEVIN M. SHOOK

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

 

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