TRINET GROUP, INC. Operational Highlights Our consolidated results for 2019 reflect our continued progress in attracting new customers to our industry-oriented (vertical) products, serving our existing customers and improving our brand awareness through marketing. Our customers are our focus, and we are investing in our processes to ensure a stronger customer experience. We expect this investment will further enhance our value to our customers, support retention and provide further efficiency and scale for our operations. We started this work in 2018 and expect this to continue in the near-term. During 2019 we: • experienced an improvement in retention as a result of our customer service
initiatives,
• benefited from our clients growing their WSEs,
• saw an increase in new sales, which delivered additional revenue growth,
• continued to experience our WSEs increasing their participation, or
enrollment, in our insurance offerings,
• experienced increased severity of health costs per enrollee overall, but
particularly within a national carrier, and
• delivered profitable growth.
Our efforts to build a successful and enduring company include building and leveraging a strong national brand presence. Our branding strategy, Incredible Starts Here, is being augmented with our current campaign: People Matter. We place our customers at the center of what we do, including placing our customers at the center of our marketing. Performance Highlights These operational achievements drove the financial performance improvements noted below in 2019 when compared to 2018:$3.9B $268M $929M Total revenues Operating income Net Service Revenue * 10 % increase 7 % increase 4 % increase$212M $2.99 $236M Net income Diluted EPS Adjusted Net income * 10 % increase 13 % increase 8 % increase * Non-GAAP measure
Our results for WSEs and payroll and payroll tax payments in 2019 when compared to the prior year were:
324,927 340,017$41.7B Average WSE Total WSE Payroll and payroll tax payments 2 % increase 4% increase 11 % increase During 2019, our average WSEs and total WSEs grew primarily as a result of new clients, continued hiring in the installed base and lower client attrition. In addition, our WSE growth and increased participation in our health services resulted in a 10% increase in total revenues. We also experienced higher insurance costs, due to an increase in medical cost trend, that resulted in reduced NSR growth of 4%. Net income increased 10% and adjusted net income increased 8%. 33
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Results of Operations The following table summarizes our results of operations for the three years endedDecember 31, 2019 , 2018 and 2017. For details of the critical accounting judgments and estimates that could affect the Results of Operations, see the Critical Accounting Judgments and Estimates section within MD&A. Year Ended December 31, % Change (in millions, except operating metrics data) 2019 2018 2017 2019 vs. 2018 2018 vs. 2017 Income Statement Data: Professional service revenues$ 530 $ 487 $ 458 9 % 6 % Insurance service revenues 3,326 3,016 2,817 10 7 Total revenues 3,856 3,503 3,275 10 7 Insurance costs 2,927 2,610 2,466 12 6 Operating expenses 661 642 592 3 8
Total costs and operating expenses 3,588 3,252 3,058
10 6
Operating income 268 251 217 7 15
Other income (expense):
Interest expense, bank fees and (5 ) 10
other (21 ) (22 ) (20 )
Interest income 23 12 3 92 300
Income before provision for income 12 21
taxes 270 241 200
Income taxes 58 49 22 18 128
Net income $ 212 $ 192 $ 178 10 % 8 %
Non-GAAP measures (1):
Net Service Revenues $ 929 $ 893 $ 809 4 % 10 %
Net Insurance Service Revenues 399 406 351 (2 ) 16
Adjusted EBITDA 378 347 285 9 22
Adjusted Net income 236 218 142 8 53
Operating Metrics:
Average WSEs 324,927 317,104 324,679 2 % (2 )%
Total WSEs 340,017 325,616 325,370 4 -
Total WSEs payroll and payroll taxes
processed (in millions) $ 41,682 $ 37,666 $ 37,115 11 1
(1) Refer to Non-GAAP measures definitions and reconciliations from GAAP
measures in Part II, Item 6. Selected Financial Data.
A discussion regarding our financial condition and results of operations for
2018 compared to 2017 can be found under Part II, Item 7. Management's
Discussion and Analysis in our Annual Report on Form 10-K for the year ended
December 31, 2018 , filed with the SEC on February 14, 2019 .
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Operating Metrics
Worksite Employees (WSE)
Average WSE growth is a volume measure we use to monitor the performance of our
business. Average WSEs increased 2% in 2019. Throughout 2019, we experienced
reduced attrition resulting from our customer service initiatives, continued
hiring in our installed based, primarily in our Professional Services and
Technology verticals, and stronger new sales performance.
Total WSEs can be used to estimate our beginning WSEs for the next period and,
as a result, can be used as an indicator of our potential future success in
growing our business and retaining clients.
Anticipated revenues for future periods can diverge from the revenue expectation
derived from Average WSEs or Total WSEs due to pricing differences across our HR
solutions and services and the degree to which clients and WSEs elect to
participate in our solutions during future periods. In addition to focusing on
growing our Average WSE and Total WSE counts, we also focus on pricing
strategies, product participation and product differentiation to expand our
revenue opportunities. We report the impact of client and WSE participation
differences as a change in mix.
We are focused on growing our WSE base, including by pursuing acquisitions where
appropriate, while we improve our customer service experience and continue to
manage attrition.
Payroll and payroll taxes processed
Payroll and payroll taxes processed, which includes recurring payrolls and
non-recurring bonus payrolls, benefits, and associated payroll taxes may also be
used as an indicator of our PSR growth.
[[Image Removed: wsea04.jpg]]
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Total Revenues Our revenues consist of professional service revenues (PSR) and insurance service revenues (ISR). PSR represents fees charged to clients for processing payroll-related transactions on behalf of our clients, access to our HR expertise, employment and benefit law compliance services, and other HR-related services. ISR consists of insurance-related billings and administrative fees collected from clients and withheld from WSEs for workers' compensation insurance and health benefit insurance plans provided by third-party insurance carriers. Monthly total revenues per Average WSE is a measure we use to monitor the success of our product and service pricing strategies. This measure increased 8% during 2019 compared to 2018. We also use the following measures to further analyze changes in total revenue: • Volume - the percentage change in period over period Average WSEs,
• Rate - the combined weighted average percentage changes in service fees for
each vertical product and changes in service fees associated with each
insurance service offering, and
• Mix - the change in composition of Average WSEs within our verticals combined
with the composition of our enrolled WSEs within our insurance service
offerings.
[[Image Removed: revenue.jpg]]
The volume increase in 2019 was primarily driven by WSE growth, especially in
our Professional Services and Technology verticals. The changes in rate and mix
during 2019, were primarily driven by increases in insurance service fees and
increased health plan enrollment in our insurance service offerings.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Operating Income Our operating income consists of total revenues less insurance costs and OE. Our insurance costs include insurance premiums for coverage provided by insurance carriers, reimbursement of claims payments made by insurance carriers or third-party administrators, and changes in accrued costs related to contractual obligations with our workers' compensation and health benefit carriers. Our OE consists primarily of our corporate employees' compensation related expenses, which includes payroll, payroll taxes, SBC, bonuses, commissions and other payroll-and benefits-related costs. The table below provides a view of the changes in components of operating income on a year-over-year basis. (in millions)$251 2018 Operating Income Higher total revenues are a result of increases in
insurance service
+353 fees and health plan enrollment in our insurance service offerings
combined with growth in PSR.
-317 Higher insurance costs primarily as a result of an increase in
medical cost trend and health plan participation, or enrollment.
Higher OE primarily as a result of growth in our corporate employee
-19 compensation costs to support initiatives to improve customer
experience, enhance product offerings, and improve processes.
$268 2019 Operating Income
Professional Service Revenues
Our clients are billed either based on a fee per WSE per month per transaction
or on a percentage of the WSEs' payroll. For those clients that are billed on a
percentage of WSEs' payroll, as our clients' payrolls increase, our fees also
increase.
Our vertical approach provides us the flexibility to offer our clients in
different industries with varied services at different prices, which we believe
potentially reduces the value of solely using Average WSE and Total WSE counts
as indicators of future potential revenue performance.
We also analyze changes in PSR with the following measures:
• Volume - the percentage change in period over period Average WSEs,
• Rate - the weighted average percentage change in fees for each vertical, and
• Mix - the change in composition of Average WSEs across our verticals.
[[Image Removed: psra11.jpg]] The increase in PSR during 2019 reflects the result of our vertical pricing strategy and ongoing change in the mix of our WSEs. We continued to experience WSE growth, especially in our Professional Services and Technology verticals, while ourMain Street vertical continued to shrink, but at a reduced rate when compared to 2018. 37
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Insurance Service Revenues ISR consists of insurance services-related billings and administrative fees collected from clients and withheld from WSE payroll for health benefits and workers' compensation insurance provided by third-party insurance carriers. We use the following measures to analyze changes in ISR: • Volume - the percentage change in period over period Average WSEs,
• Rate - the weighted average percentage change in fees associated with each of
our insurance service offerings, and
• Mix - all other changes including the composition of our enrolled WSEs within
our insurance service offerings (health plan enrollment).
[[Image Removed: isra16.jpg]] The growth in ISR during 2019 primarily resulted from changes in rate, due to higher insurance service fees per plan participant and changes in mix, due to higher health plan enrollment. Insurance Costs Insurance costs include insurance premiums for coverage provided by insurance carriers, reimbursement of claims payments made by insurance carriers or third-party administrators, and changes in accrued costs related to contractual obligations with our workers' compensation and health benefit carriers. We use the following measures to analyze changes in insurance costs: • Volume - the percentage change in period over period Average WSEs,
• Rate - the weighted average percentage change in cost trend associated with
each of our insurance service offerings, and
• Mix - all other changes including the composition of our enrolled WSEs within
our insurance service offerings (health plan enrollment).
[[Image Removed: isca17.jpg]]
38
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MANAGEMENT'S DISCUSSION AND ANALYSIS
The increase in insurance cost rates during 2019 was primarily driven by: • Increased severity of health costs per enrollee (medical cost trend) of 10.5%
- 11.5% in 2019, particularly within one national carrier, arising from a
shift in pharmaceutical utilization from brand name drugs to higher cost
specialty drugs, combined with elevated health costs in a portion of this
business, partially offset by lower health administrative costs.
• Partially offset by an
costs.
We continued to experience favorable prior year development on our accrued
workers' compensation costs of
Net Service Revenues
NSR provides us with a comparable basis of revenues on a net basis, acts as the
basis to allocate resources to different functions and helps us evaluate the
effectiveness of our business strategies by each business function.
[[Image Removed: nsr11.jpg]]
The primary drivers to the changes in our NSR are presented below.
[[Image Removed: nsr2.jpg]]
NIM was 12% for 2019 representing a decrease of 1% from 2018, due to insurance
costs rate increases exceeding the ISR rate increases achieved, as discussed
previously.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Operating Expenses OE includes cost of providing services (COPS), sales and marketing (S&M), general and administrative (G&A), systems development and programming (SD&P), and depreciation and amortization expenses (D&A). We manage our operating expenses and allocate resources across different business functions based on a percentage of NSR, which has decreased to 71% in 2019 from 72% in 2018. We had approximately 2,900 corporate employees as ofDecember 31, 2019 in 54 offices across theU.S. Our corporate employees' compensation-related expenses represent a majority of our operating expenses. Compensation costs for our corporate employees include payroll, payroll taxes, SBC, bonuses, commissions and other payroll- and benefits-related costs. Compensation-related expense represented 63% of our OE in 2019 and 61% in 2018. During the year endedDecember 31, 2019 , we experienced operating expense growth of 3% when compared to the same period in 2018. We expect our OE to increase in the foreseeable future due to our continued efforts to improve our customer service experience and our systems and processes. During the year endedDecember 31, 2019 , the percent of OE to total revenues was 17%, compared to 18% in 2018.
[[Image Removed: oe1a11.jpg]]
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MANAGEMENT'S DISCUSSION AND ANALYSIS
We analyze and present our OE based upon the business functions COPS, S&M, G&A and SD&P and depreciation and amortization. The charts below provide a view of the expenses of the business functions. Dollars are presented in millions and percentages represent year-over-year change. [[Image Removed: oe2a11.jpg]] (in millions)$642 2018 Operating Expense COPS increased in 2019, driven by increases in compensation related
+16 expenses to support initiatives to improve our customer experience, our
systems and processes, and to enhance our productofferings. We also
experienced an increase in the volume of EPLI claim expenses.
S&M increased in 2019, driven by an increase in headcount and
+8 amortization of deferred commissions expense related to our growth in
new sales.
-5 G&A decreased in 2019, driven by a decrease in compensation related
expenses and professional fees.
-6 SD&P decreased in 2019, primarily due to a decrease in compensation
related expenses and professional fees.
+6 D&A increased in 2019, primarily as a result of our investments in
technology to support our customer service initiatives.
$661 2019 Operating Expenses
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MANAGEMENT'S DISCUSSION AND ANALYSIS
We break out the expenses that make up our OE in the chart below: [[Image Removed: oe3a11.jpg]] Other Income (Expense) Other income (expense) consists primarily of interest and dividend income from investments and interest expense under our credit facility. [[Image Removed: oe4a11.jpg]] Interest income increased to$23 million in 2019 due to a change in our investment strategy initiated in the second quarter of 2018 to improve our interest income. Our investment strategy has improved our interest income, net income, Adjusted Net Income and Adjusted EBITDA, year-over-year. Interest expense, bank fees and other, remained consistent year-over-year. Provision for Income Taxes Our effective tax rate (ETR) was 21% and 20% for the years endedDecember 31, 2019 and 2018, respectively. The change in ETR was driven by a 3% increase primarily from one-time expenses associated with SBC, partially offset by a 2% decrease from a one-time benefit associated with prior year tax expense and changes in the valuation allowance. 42
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Liquidity and Capital Resources
Liquidity
Liquidity is a measure of our ability to access sufficient cash flows to meet
the short-term and long-term cash requirements of our business operations. We
believe that we have sufficient liquidity and capital resources to satisfy
future requirements and meet our obligations to our clients, creditors and debt
holders.
Included in our balance sheets are assets and liabilities resulting from
transactions directly or indirectly associated with WSEs, including payroll and
related taxes and withholdings, our sponsored workers' compensation and health
insurance programs, and other benefit programs. Although we are not subject to
regulatory restrictions, we distinguish and manage our corporate assets and
liabilities separately from those current assets and liabilities held by us to
satisfy our employer obligations associated with our WSEs as follows:
December 31,
2019 2018
(in millions) Corporate WSE Total Corporate WSE Total
Current assets:
Cash and cash equivalents $ 213 $ - $ 213 $ 228 $ - $ 228
Investments 68 - 68 54 - 54
Restricted cash, cash equivalents
and investments 15 1,165 1,180 15 927 942
Other current assets 45 365 410 36 386 422
Total current assets $ 341 $ 1,530 $ 1,871 $ 333 $ 1,313 $ 1,646
Total current liabilities $ 113 $ 1,530 $ 1,643 $ 112 $ 1,313 $ 1,425
Working capital $ 228 $ - $ 228 $ 221 $ - $ 221
To meet various U.S. state licensing requirements and maintain accreditation by
the ESAC, we are subject to various minimum working capital and net worth
requirements. As of December 31, 2019 , we believe we have fully complied in all
material respects with all applicable state regulations regarding minimum net
worth, working capital and all other financial and legal requirements. Further,
we have maintained positive working capital throughout each of the periods
covered by the financial statements.
Working capital for WSEs activities
We designate funds to ensure that we have adequate current assets to satisfy our
current obligations associated with WSEs. We manage our WSE payroll and benefits
obligations through collections of payments from our clients which generally
occurs two to three days in advance of client payroll dates. We regularly review
our short-term obligations associated with our WSEs (such as payroll and related
taxes, insurance premium and claim payments) and designate funds required to
fulfill these short-term obligations, which we refer to as PFC. PFC is included
in current assets as restricted cash, cash equivalents and investments.
We manage our sponsored benefit and workers' compensation insurance obligations
by maintaining collateral funds in restricted cash, cash equivalents and
investments. These collateral amounts are generally determined at the beginning
of each plan year and we may be required by our insurance carriers to adjust our
collateral balances when facts and circumstances change. We regularly review our
collateral balances with our insurance carriers and anticipate funding further
collateral in the future based upon our capital requirements. We classify our
restricted cash, cash equivalents and investments as current and noncurrent
assets to match against the anticipated timing of payment of claims.
Working capital for corporate purposes
We use our available cash and cash equivalents to satisfy our operational and
regulatory requirements and to fund capital expenditures. We believe that we can
meet our present and reasonably foreseeable operating cash needs and future
commitments through existing liquid assets, continuing cash flows from corporate
operating activities, our borrowing capacity under our revolving credit facility
and the potential issuance of debt or equity securities.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Cash Flows
The following table presents our cash flow activities for the stated periods:
Year Ended December 31,
(in millions) 2019 2018
Corporate WSE Total Corporate WSE Total
Net cash provided by (used in):
Operating activities $ 233 $ 238 $ 471 $ 234 $ (338 ) $ (104 )
Investing activities (191 ) 3 (188 ) (200 ) - (200 )
Financing activities (176 ) - (176 ) (85 ) - (85 )
Net increase (decrease) in cash and cash $ (134 ) $ 241 $ 107 $ (51 ) $ (338 ) $ (389 )
equivalents, unrestricted and restricted
Cash and cash equivalents, unrestricted and
restricted:
Beginning of period $ 425 $ 924 $ 1,349 $ 476 $ 1,262 $ 1,738
End of period $ 291 $ 1,165 $ 1,456 $ 425 $ 924 $ 1,349
Net increase (decrease) in cash and cash
equivalents:
Unrestricted $ (15 ) $ - $ (15 ) $ (108 ) $ - $ (108 )
Restricted (119 ) 241 122 57 (338 ) (281 )
Operating Activities
Components of net cash (used in) provided by operating activities are as
follows:
Year Ended December 31,
(in millions) 2019 2018
Net income $ 212 $ 192
Depreciation and amortization 57 46
Noncash lease expense 16 -
Stock based compensation expense 41 44
Payment of interest (19 ) (17 )
Income tax payments, net (62 ) (49 )
Changes in deferred taxes (7 ) 1
Changes in other operating assets (36 ) (44 )
Changes in other operating liabilities 31 61
Net cash provided by operating activities - Corporate
$ 234 Collateral (paid to) refunded from insurance carriers, net 6 26 Changes in other operating assets 15 (27 ) Changes in other operating liabilities 217 (337 )
Net cash (used in) provided by operating activities - WSE
$ (338 ) Net cash (used in) provided by operating activities$ 471
Year-over-year change in net cash used in operating activities for WSE purposes was primarily driven by timing of client payments, payments of payroll and payroll taxes, and collateral funding and insurance claim activities. We expect the changes in restricted cash and cash equivalents to correspond to WSE cash provided by (or used in) operations as we manage our obligations associated with WSEs through restricted cash.
Corporate operating cash flows in 2019 remained consistent to 2018.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Investing Activities
Cash used in investing activities for the periods presented below primarily
consisted of purchases of investments and capital expenditures, partially offset
by proceeds from the sale and maturity of investments.
Year Ended December 31,
(in millions) 2019 2018
Investments:
Purchases of investments $ (302 ) $ (258 )
Proceeds from sale and maturity of investments 159 101
Cash used in investments $ (143 ) $ (157 )
Capital expenditures:
Software and hardware $ (34 ) $ (30 )
Office furniture, equipment and leasehold improvements (11 ) (13 )
Cash used in capital expenditures $ (45 ) $ (43 )
Cash used in investing activities $ (188 ) $ (200 )
Investments
We invest a portion of available cash in investment-grade securities with effective maturities less than five years that are classified on our balance sheets as investments. As ofDecember 31, 2019 , we had approximately$193 million in investments. We also invest funds held as collateral to satisfy our long-term obligation towards workers' compensation liabilities. These investments are classified on our balance sheets as restricted cash, cash equivalents and investments. We review the amount and the anticipated holding period of these investments regularly in conjunction with our estimated long-term workers' compensation liabilities and anticipated claims payment trend. As ofDecember 31, 2019 , we held approximately$1.8 billion in cash, cash equivalents and investments, of which$213 million is unrestricted. Refer to Note 2 in Part II, Item 8. Financial Statements and Supplemental Data, in this Form 10-K for a summary of these funds. Capital Expenditures During 2019, we continued to make investments in software and hardware and we enhanced our existing products and technology platform. We also incurred expenses related to the build out of our corporate headquarters and our technology and client service centers. We expect capital investments in our software and hardware to continue in the future. Financing Activities Net cash used in financing activities in the years endedDecember 31, 2019 and 2018 consisted of our debt and equity-related activities. Year Ended December 31, (in millions) 2019 2018
Financing activities
Repurchase of common stock, net of issuance
(22 ) (22 )
Net proceeds from issuance of debt - 6
Cash used in financing activities $ (176 ) $ (85 )
In June 2018 we entered into a $425 million term loan A (our 2018 Term Loan)
under our new credit agreement (2018 Credit Agreement). The proceeds of the 2018
Term Loan were used to repay our previously outstanding term loans. Refer to
Note 9 in Part II, Item 8. Financial Statements and Supplemental Data, in this
Form 10-K for more details.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
We repurchase shares to return value to our stockholders and to offset dilution from the issuance of stock under our equity-based incentive plan and employee purchase plan. Refer to Note 12 in Part II, Item 8. Financial Statements and Supplemental Data, in this Form 10-K for more details. InFebruary 2020 , our board of directors authorized a$300 million incremental increase to our ongoing stock repurchase program initiated inMay 2014 . We use this program to return value to our stockholders and to offset dilution from the issuance of stock under our equity-based incentive plan and employee purchase plan. Capital Resources As ofDecember 31, 2019 ,$392 million was outstanding under our 2018 Term Loan. Our 2018 Credit Agreement includes a$250 million revolving credit facility (our 2018 Revolver), which will be used solely for working capital and other general corporate purposes. The 2018 Revolver includes capacity for a$20 million swingline facility. Letters of credit issued pursuant to the revolving credit facility reduce the amount available for borrowing under the 2018 Revolver. AtDecember 31, 2019 , we had$16 million of letters of credit outstanding and remaining capacity of$234 million under the 2018 Revolver. Each of our 2018 Term Loan and our 2018 Revolver mature inJune 2023 and bear interest, at our option, either at a LIBOR rate, or the prime lending rate, plus an applicable margin subject to change in the future based on our leverage ratio, as set forth in our 2018 Credit Agreement. Our 2018 Credit Agreement contains customary affirmative and restrictive financial covenants and representations and warranties that are customary for facilities of this type, including restrictions on indebtedness, liens, investments, mergers, dispositions, prepayment of indebtedness (other than our 2018 Term Loan and our 2018 Revolver), dividends, distributions and transactions with affiliates, as well as minimum interest coverage and maximum total leverage ratio requirements. We were in compliance with the covenants and restrictions under our 2018 Credit Agreement atDecember 31, 2019 . Contractual Obligations The following table summarizes our significant contractual obligations as ofDecember 31, 2019 : Payments Due by Period (in millions) Total Less than 1 year 1-3 years 3-5 years More than 5 years Debt obligations (1)$ 392 $ 22$ 44 $ 326 $ - Workers' compensation obligations (2) 217 66 49 34 68 Operating lease obligations (3) 74 19 21 15 19 Purchase obligations (4) 60 34 22 4 - Uncertain tax positions (5) 7 1 6 - - Total$ 750 $ 142$ 142 $ 379 $ 87 (1) Includes principal and the projected interest payments of our term loans, see Note 9 in Part II, Item 8. Financial Statements and Supplementary Data of this Form 10-K, for details. (2) Represents estimated payments that are expected to be made to carriers for various workers' compensation program under the contractual obligations. These obligations include the costs of reimbursing the carriers for paying claims within the deductible layer in accordance with the workers' compensation insurance policy as well as other liabilities. (3) Includes various facilities and equipment leases under various operating lease agreements. (4) Our purchase obligations primarily consist of software licenses, consulting and maintenance agreements, and sales and marketing events pertaining to various contractual agreements. (5) Our uncertain tax positions primarily pertain to tax credits and other related reserves, including interest and penalties. In the normal course of business, we make representations and warranties that guarantee the performance of services under service arrangements with clients. Historically, there have been no material losses related to such guarantees. In addition, we have entered into indemnification agreements with our officers and directors, which require us to defend and, if necessary, indemnify these individuals for certain pending or future legal claims as they relate to their services provided to us. Such indemnification obligations are not included in the table above. 46
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Off-Balance Sheet Arrangements As ofDecember 31, 2019 , we did not have any material off-balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources within the meaning of Item 303(a)(4) of Regulation S-K. Critical Accounting Judgments and Estimates Our consolidated financial statements are prepared in accordance with GAAP, which require us to make estimates, judgments, and assumptions that affect reported amounts of assets, liabilities, revenues and expenses, and the related disclosures of contingent assets and liabilities. These estimates are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Some of the assumptions are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, our consolidated financial statements could be materially affected. For additional information about our accounting policies, refer to Note 1 in Part II, Item 8. Financial Statements and Supplementary Data, of this Form 10-K. The following items require significant estimation or judgment: Insurance Costs We purchase fully insured workers' compensation and health benefits coverage for our employees and WSEs. As part of these insurance policies, we bear claims costs up to a defined deductible amount and as a result, we establish accrued insurance costs including both known claims filed and estimates for incurred but not reported claims. We use external actuaries to evaluate, review and recommend estimates of our accrued workers' compensation and health insurance costs. The accrued costs studies performed by these qualified external actuaries analyze historical claims data to develop a range of our potential ultimate costs using loss development, expected loss ratio and frequency/severity methods in accordance with Actuarial Standards of Practice. These methods are applied to classes of the claims data organized by policy year and risk class. Key judgments and evaluations in arriving at loss estimates by class and the accrued costs selection overall include: • the selection of method used and the relative weights given to selecting the
method used for each policy year,
• the underlying assumptions of LDF used in these models,
• the effect of any changes to the insurers' claims handling and payment
processes,
• evaluation of medical and indemnity cost trends, costs from changes in the
risk exposure being evaluated and any applicable changes in legal, regulatory
or judicial environment.
We review and evaluate these judgments and the associated recommendations in concluding the adequacy of accrued costs. Where adjustments are necessary these are recorded in the period in which the adjustments are identified. These accrued costs may vary in subsequent quarters from the amount estimated. Certain assumptions used in estimating these accrued costs are highly judgmental. Our accrued costs, results of operations and financial condition can be materially impacted if actual experience differs from the assumptions used in establishing these accrued costs.Accrued Workers' Compensation Costs Under our policies, we are responsible for reimbursing the insurance carriers for workers' compensation losses up to$1 million per claim occurrence (Deductible Layer). As workers' compensation costs for a particular period are not known for many years after the losses have occurred, these costs represent our best estimate of unpaid claim losses and loss adjustment expenses within the deductible layer in accordance with our insurance policies. We use external actuaries to evaluate, review and recommend accrued workers' compensation costs on a quarterly basis. The data is segmented by class and state and analyzed by policy year, and states where we have small exposure are aggregated into a single grouping. 47
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MANAGEMENT'S DISCUSSION AND ANALYSIS
We use a combination of loss development, expected loss ratio and frequency/severity methods which include the following inputs, assumptions and analytical techniques: • Historical volume and severity of workers' compensation cost experience,
exposure data and industry loss experience related to
policies,
• inputs of WSEs' job responsibilities and location,
• estimates of future cost trends,
• expected loss ratios for the latest accident year or prior accident years,
adjusted for the loss trend, the effect of rate changes and other
quantifiable factors, and
• LDFs to project the reported losses for each accident year to an ultimate
basis.
Final cost settlements may vary materially from the present estimates,
particularly when payments do not occur until well into the future. In our
experience, plan years related to workers' compensation programs may take 10
years or more to be fully settled.
We believe that our estimate of accrued workers' compensation costs is most
sensitive to LDFs given the long reporting and paid development patterns for our
workers' compensation loss costs. Our methods of estimating accrued workers'
compensation costs rely on these LDFs and an estimate of future cost trend.
The following table illustrates the sensitivity of changes in the LDFs on our
year end estimate of insurance costs (in millions of dollars):
Change in loss development factor Change in insurance costs
-5.0% ($33 )
-2.5% ($18 )
+2.5% $19
+5.0% $38
Accrued Health Insurance Costs
We sponsor and administer a number of fully insured, risk-based employee benefit
plans, including group health, dental, vision and life insurance as an employer
plan sponsor under section 3(5) of the ERISA. Approximately 83% of our group
health insurance costs relate to risk-based plans in which we agree to reimburse
our carriers for any claims paid within an agreed-upon per-person deductible
layer up to a maximum aggregate exposure limit per policy. These deductible
dollar limits and maximum limits vary by carrier and year.
Costs covered by these insurance plans generally develop on average within three
to six months so insurance costs and accrued health insurance costs include
estimates of reported losses and claims incurred but not yet paid (IBNP). Data
is grouped and analyzed by insurance carrier.
To estimate accrued health benefits costs we use a number of inputs, assumptions
and analytical techniques:
• historical loss claims payment patterns and medical cost trend rates related
to
• current period claims costs and claims reporting patterns (completion
factors), and
• plan enrollment.
Medical cost trend rates are a significant factor we use in developing our
accrued health insurance costs. Medical cost trends are developed through an
analysis of claims incurred in prior months, provider pricing and indicators of
health care utilization, including pharmacy utilization trends, and outpatient
and inpatient utilization. Many factors may cause medical cost trend to vary
from our estimates.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
The following table illustrates the sensitivity of changes in the medical cost trend on our year end estimate of insurance costs (in millions of dollars): Change in medical cost trend Change in insurance costs
+3.0% $18
+2.0% $12
+1.0% $6
-1.0% $(6)
-2.0% $(12)
-3.0% $(18)
Completion factors are an actuarial estimate based on historical experience and
analysis of current trends, of paid costs to carriers as a percentage of the
expected ultimate costs to carriers. Many factors may cause actual claims
submissions rates from our carriers to vary from our estimated completion
factors, including carrier claims processing patterns, the mix of providers and
the mix of electronic versus manual claims submitted to our carriers.
The following table illustrates the sensitivity of changes in completion factors
on our year end estimate of insurance costs (in millions of dollars):
Change in completion factors Change in insurance costs
-0.75% $14
-0.50% $9
-0.25% $5
+0.25% $(5)
+0.50% $(9)
+0.75% $(14)
Recent Accounting Pronouncements
Refer to Note 1 in Part II, Item 8, Financial Statements and Supplementary Data,
of this Form 10-K for additional information related to recent accounting
pronouncements.
49
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QUANTITATIVE AND QUALITATIVE DISCLOSURES
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