Employers Holdings Leveraging The Reopening (NYSE:EIG)

Slips and trips

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Employment and job growth are looking pretty good for the time being, and while the workers’ compensation insurance market is quite competitive, operating conditions look basically favorable for Employers Holdings (NYSE:EIG) right now. Premiums have been growing nicely, and while I do have some concerns that loss frequency will increase, I think management is generally conservative with underwriting.

The shares haven’t done all that much since my last write-up, and comparisons to other large underwriters like Hartford (HIG) and W. R. Berkley (WRB) are of limited value given very different business mixes, and likewise with Amerisafe (AMSF), which is also a pure workers’ comp underwriter, but focuses on higher-risk groups. I do still see fair value in the mid-$40’s on the basis of both near-term ROE (P/BV) and long-term core earnings growth, but that makes this a relatively middling prospect today.

Recovery Driving Premium Growth

Employers was hit hard by the pandemic, as the company writes a lot of its business in California and in industries like restaurants and hotels, and those were industries where employment was hit hard by California’s stricter lockdown policies. That drove a sharp decline in premiums in 2020 and the recovery only really began in earnest over the last two quarters of 2021, with net premiums up over 15% and 14% respectively.

I expect further growth in 2022 as employers continue to look to expand their businesses, and that should drive both increased production/policies in force, as well as successful premium audits (a process, basically, where payrolls are examined to check whether actual employment matched what was anticipated for the policy).

I also see opportunities for further growth from organic expansion. Management has recently started underwriting for occupations like commercial janitorial, HVAC contracting, and landscaping, and management believes there are still several attractive expansion opportunities in its core hazard groups of A to C, where it writes about 80% of its business (hazard groups reflect underwriting risk, with A through C seen as low to medium risk). Historically, the company has only targeted about 5% of the overall market, so I don’t think the company is likely to run out of expansion opportunities in the near future.

Competition And Loss Severity

While larger workers’ comp underwriters talked about modest price declines in the workers’ comp market, Employers saw around 5% rate declines on renewal across its book of business. Management characterized competition as generally rational, but with a few underwriters looking to grow market share by lowballing on price.

That’s likely going to prove to be a mistake. Loss severity (the size of payouts) has stayed fairly consistent, but the industry has benefited from a meaningful decline in loss frequency (down 20% for Employers on a two-year stack) that seems unlikely to continue. While workers’ comp underwriters are always looking for ways to reduce accident frequency, I don’t see any structural reason why frequency should remain so low on a frequency-to-premium basis, particularly when the job market is likely recruiting less experienced workers into the workforce.

I’d also note that many insurers have gotten more cautious about the market. W. R. Berkley isn’t expanding their workers’ comp business beyond the growth in employment at existing clients, and other underwriters have likewise expressed caution regarding the profitability of the business at today’s rates.

The situation for Employers is a little different, as the company focuses on small businesses where there is less competition from larger underwriters. I also believe Employers is taking relatively conservative initial loss picks, and I’d note that the company has a long track record of lower-than-industry losses in its book.

The Outlook

Employers’ expense ratio has been running above its long-term average for a couple of years now, and I believe that’s largely due to challenges related to the pandemic and the decision to invest in the business – both through IT investments (including a new claims system) and its Cerity business.

Cerity is quite small today, generating less than $2M in premiums for the entire year of 2021, and currently generates a noticeable drag on earnings (an underwriting loss of almost $13M despite minimal incurred losses) as it is sub-scale. Cerity offers small businesses (very small, typically) a way to buy insurance directly online – saving them the hassle and cost of working through agents. To service this market, Employers has to have an IT infrastructure/user experience that includes some “hand-holding”, but I think this could be a meaningful growth opportunity for the company as it scales up and awareness of the business grows among its targeted customer base.

Ongoing IT investments are likewise a “pay now, benefit later” proposition for the company. Employers has gained a competitive advantage over the years by building a quoting system that can price business with very quick turnarounds, and I believe the new claims system will likewise benefit the company over time by enabling faster claims processing and payment.

I expect net premiums earned to reaccelerate with the recovery in the labor force, and that should drive better operating leverage in the coming years. Increasing loss frequency is a watch item, but one that I believe management is on top of today. Investment earnings (portfolio income and realized gains) are likely to weaken, as I don’t see the gains of recent years repeating.

I’m looking for long-term core earnings growth more on the lower end of the mid-single-digits now, and I’m not completely confident that the company can get to double-digit ROE again within five years. The company got close on an adjusted annualized basis in the fourth quarter, but I think premium growth is likely to slow and losses are likely to increase. With that, I think ROEs in the range of 6% are likely over the next two years.

The Bottom Line

Between discounted core earnings and a ROE-driven price/BV approach, I think Employers shares should trade around $44 to $45. While the 0.95x book value multiple I use is below the average for other significant workers’ comp underwriters, so too is Employers’ ROE. If the company can drive net earned premium growth, improved operating leverage, and keep losses under control (grow underwriting income, in other words), that ROE could expand faster than I expect and drive a higher multiple (and share price).

All in all, this seems like a mixed prospect, with the upside in the shares more okay than great. I like the leverage to the reacceleration of the economy and organic growth opportunities, but I’m concerned about pricing in the market and the risk of increasing loss frequency (and severity). While this could be a pretty decent long-term holding given its leverage to small businesses, I’d like a little more margin of error today.

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