UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PERSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2011

 

 

 

Commission file number 0-24000

 

 

ERIE INDEMNITY COMPANY

 

 

(Exact name of registrant as specified in its charter)

 

 

 

PENNSYLVANIA

 

25-0466020

 

 

(State or other jurisdiction of

 

(I.R.S. Employer

 

 

incorporation or organization)

 

Identification No.)

 

 

 

 

 

 

 

100 Erie Insurance Place, Erie, Pennsylvania

 

16530

 

 

(Address of principal executive offices)

 

(Zip Code)

 

 

 

(814) 870-2000

 

 

(Registrant’s telephone number, including area code)

 

 

 

Not applicable

 

 

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

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  X   No __

 

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 of 1934 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  X   No __

 

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

 

Large Accelerated Filer   X 

Accelerated Filer ___

Non-Accelerated Filer ___

Smaller Reporting Company ___

 

 

(Do not check if a smaller
reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes         No   X

 

The number of shares outstanding of the registrant’s Class A Common Stock as of the latest practicable date, with no par value and a stated value of $0.0292 per share, was 48,681,828 at July 22, 2011.

 

The number of shares outstanding of the registrant’s Class B Common Stock as of the latest practicable date, with no par value and a stated value of $70 per share, was 2,546 at July 22, 2011.

 



 

PART I.

FINANCIAL INFORMATION

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

Consolidated Statements of Operations – Three and Six months ended June 30, 2011 and 2010

 

 

 

Consolidated Statements of Financial Position – June 30, 2011 and December 31, 2010

 

 

 

Consolidated Statements of Comprehensive Income – Three and Six months ended June 30, 2011 and 2010

 

 

 

Consolidated Statements of Cash Flows – Six months ended June 30, 2011 and 2010

 

 

 

Notes to Consolidated Financial Statements – June 30, 2011

 

 

Item 2.

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

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

 

Item 4.

Controls and Procedures

 

 

 

 

PART II.

OTHER INFORMATION

 

 

Item 1A.

Risk Factors

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

Item 5.

Other Information

 

 

Item 6.

Exhibits

 

 

 

 

 

SIGNATURES

 

2



 

PART I.  FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

ERIE INDEMNITY COMPANY

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(dollars in millions, except per share data)

 

 

 

 

Three months ended
June 30,

 

 

Six months ended
June 30,

 

 

 

2011

 

2010

 

 

2011

 

2010

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

Premiums earned

 

 

$  1,047

 

$      989

 

 

 

$2,077

 

$1,967

 

Net investment income

 

 

113

 

108

 

 

 

218

 

212

 

Net realized investment gains (losses)

 

 

39

 

(213

)

 

 

188

 

(88

)

Net impairment losses recognized in earnings

 

 

0

 

(4

)

 

 

0

 

(6

)

Equity in earnings of limited partnerships

 

 

38

 

27

 

 

 

110

 

30

 

Other income

 

 

8

 

9

 

 

 

17

 

17

 

Total revenues

 

 

1,245

 

916

 

 

 

2,610

 

2,132

 

Benefits and expenses

 

 

 

 

 

 

 

 

 

 

 

 

Insurance losses and loss expenses

 

 

1,170

 

737

 

 

 

1,876

 

1,498

 

Policy acquisition and underwriting expenses

 

 

249

 

230

 

 

 

496

 

457

 

Total benefits and expenses

 

 

1,419

 

967

 

 

 

2,372

 

1,955

 

(Loss) income from operations before income taxes and noncontrolling interest

 

 

(174

)

(51

)

 

 

238

 

177

 

Provision for income taxes

 

 

(67

)

(20

)

 

 

71

 

46

 

Net (loss) income

 

 

$   (107

)

$      (31

)

 

 

$  167

 

$  131

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less: Net (loss) income attributable to noncontrolling interest in consolidated entity - Exchange

 

 

(159

)

(80

)

 

 

71

 

35

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to Indemnity

 

 

$       52

 

$       49

 

 

 

$    96

 

$    96

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings Per Share

 

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to Indemnity per share

 

 

 

 

 

 

 

 

 

 

 

 

Class A common stock – basic

 

 

$    1.05

 

$    0.96

 

 

 

$    1.93

 

$    1.87

 

Class A common stock – diluted

 

 

$   0.94

 

$   0.86

 

 

 

$   1.72

 

$  1.68

 

Class B common stock – basic and diluted

 

 

$158.33

 

$138.21

 

 

 

$291.07

 

$271.03

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding attributable to Indemnity – Basic

 

 

 

 

 

 

 

 

 

 

 

 

Class A common stock

 

 

49,250,061

 

51,013,358

 

 

 

49,518,069

 

51,099,071

 

Class B common stock

 

 

2,546

 

2,546

 

 

 

2,546

 

2,546

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding attributable to Indemnity– Diluted

 

 

 

 

 

 

 

 

 

 

 

 

Class A common stock

 

 

55,436,976

 

57,197,603

 

 

 

55,704,984

 

57,282,684

 

Class B common stock

 

 

2,546

 

2,546

 

 

 

2,546

 

2,546

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per share

 

 

 

 

 

 

 

 

 

 

 

 

Class A common stock

 

 

$   0.515

 

$    0.48

 

 

 

$    1.03

 

$    0.96

 

Class B common stock

 

 

$   77.25

 

$  72.00

 

 

 

$154.50

 

$144.00

 

 

See accompanying notes to Consolidated Financial Statements.

 

3



 

ERIE INDEMNITY COMPANY

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

(dollars in millions, except per share data)

 

 

 

June 30,

 

December 31,

 

 

2011

 

2010

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Investments – Indemnity

 

 

 

 

 

Available-for-sale securities, at fair value:

 

 

 

 

 

Fixed maturities (amortized cost of $516 and $257, respectively)

 

$     525

 

$      264

 

Equity securities (cost of $19 and $20, respectively)

 

20

 

24

 

Trading securities, at fair value (cost of $24 and $21, respectively)

 

30

 

28

 

Limited partnerships (cost of $199 and $202, respectively)

 

224

 

216

 

Other invested assets

 

1

 

1

 

Investments – Exchange

 

 

 

 

 

Available-for-sale securities, at fair value:

 

 

 

 

 

Fixed maturities (amortized cost of $6,929 and $6,863, respectively)

 

7,380

 

7,279

 

Equity securities (cost of $538 and $503, respectively)

 

610

 

570

 

Trading securities, at fair value (cost of $1,974 and $1,773, respectively)

 

2,513

 

2,306

 

Limited partnerships (cost of $1,076 and $1,083, respectively)

 

1,166

 

1,108

 

Other invested assets

 

19

 

19

 

Total investments

 

12,488

 

11,815

 

 

 

 

 

 

 

Cash and cash equivalents (Exchange portion of $61 and $120, respectively)

 

109

 

430

 

Premiums receivable from policyholders - Exchange

 

1,017

 

942

 

Reinsurance recoverable - Exchange

 

198

 

201

 

Deferred acquisition costs - Exchange

 

484

 

467

 

Other assets (Exchange portion of $316 and $357, respectively)

 

427

 

489

 

Total assets

 

$14,723

 

$14,344

 

Liabilities and shareholders’ equity

 

 

 

 

 

Liabilities

 

 

 

 

 

Indemnity liabilities

 

 

 

 

 

Deferred income taxes

 

$         1

 

$       26

 

Other liabilities

 

390

 

382

 

Exchange liabilities

 

 

 

 

 

Losses and loss expense reserves

 

3,791

 

3,584

 

Life policy and deposit contract reserves

 

1,637

 

1,603

 

Unearned premiums

 

2,196

 

2,082

 

Deferred income taxes

 

250

 

257

 

Other liabilities

 

76

 

76

 

Total liabilities

 

8,341

 

8,010

 

 

 

 

 

 

 

Indemnity’s shareholders’ equity

 

 

 

 

 

Class A common stock, stated value $0.0292 per share; authorized 74,996,930 shares; 68,289,600 shares issued; 48,753,558 and 50,054,506 shares outstanding, respectively

 

2

 

2

 

Class B common stock, convertible at a rate of 2,400 Class A shares for one Class B share, stated value $70 per share; 2,546 shares authorized, issued and outstanding, respectively

 

0

 

0

 

Additional paid-in-capital

 

16

 

8

 

Accumulated other comprehensive loss

 

(63

)

(53

)

Retained earnings

 

1,872

 

1,827

 

Total contributed capital and retained earnings

 

1,827

 

1,784

 

Treasury stock, at cost, 19,536,042 and 18,235,094 shares, respectively

 

(961

)

(872

)

Total Indemnity shareholders’ equity

 

866

 

912

 

 

 

 

 

 

 

Noncontrolling interest in consolidated entity – Exchange

 

5,516

 

5,422

 

Total equity

 

6,382

 

6,334

 

Total liabilities, shareholders’ equity and noncontrolling interest

 

$14,723

 

$14,344

 

 

See accompanying notes to Consolidated Financial Statements. See Note 14, “Indemnity Supplemental Information,” for supplemental consolidating statements of financial position information.

 

4



 

ERIE INDEMNITY COMPANY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(in millions)

 

 

 

Three months ended 
June 30,

 

Six months ended
June 30,

 

 

2011

 

2010

 

 

2011

 

2010

Accumulated other comprehensive loss:

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period – Indemnity

 

$  (63

)

$(37

)

 

$(53

)

$ (43

)

 

 

 

 

 

 

 

 

 

 

 

Gross unrealized holding gains on investments arising during period

 

4

 

7

 

 

3

 

14

 

Unrealized gains transferred to noncontrolling interest - (See Note 1)

 

 

 

 

(13

)

 

Reclassification adjustment for gross (gains) losses included in net income

 

(4

)

0

 

 

(5

)

3

 

Unrealized holding gains (losses) on investments

 

0

 

7

 

 

(15

)

17

 

Income tax (expense) benefit related to unrealized gains (losses)

 

 

(2

)

 

5

 

(6

)

Change in other comprehensive income, net of tax – Indemnity

 

0

 

5

 

 

(10

)

11

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period – Indemnity

 

$  (63

)

$(32

)

 

$(63

)

$ (32

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in other comprehensive income (loss), net of tax – Indemnity

 

$     0

 

$   5

 

 

$(10

)

$  11

 

Change in other comprehensive income, net of tax – Exchange

 

$   17

 

$ 26

 

 

$ 23

 

$  71

 

Change in other comprehensive income, net of tax – Erie Insurance Group

 

$   17

 

$ 31

 

 

$ 13

 

$  82

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

Net (loss) income – Erie Insurance Group

 

$(107

)

$(31

)

 

$167

 

$131

 

Change in other comprehensive income, net of tax – Erie Insurance Group

 

17

 

31

 

 

13

 

82

 

Unrealized gains transferred to noncontrolling interest, net of tax - (See Note 1)

 

 

 

 

9

 

 

Total comprehensive (loss) income – Erie Insurance Group

 

(90

)

0

 

 

189

 

213

 

Less: Noncontrolling interest in consolidated entity – Exchange

 

(142

)

(54

)

 

(94

)

106

 

Total comprehensive income - Indemnity

 

$  52

 

$ 54

 

 

$ 95

 

$107

 

 

See accompanying notes to Consolidated Financial Statements.

 

5



 

ERIE INDEMNITY COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in millions)

 

 

 

Six months ended
June 30,

 

 

2011

 

2010

Cash flows from operating activities

 

 

 

 

 

Premiums collected

 

$ 2,115

 

$ 2,011

 

Net investment income received

 

224

 

217

 

Limited partnership distributions

 

67

 

48

 

Service agreement fee received

 

17

 

17

 

Commissions and bonuses paid to agents

 

(313

)

(290

)

Losses paid

 

(1,409

)

(1,216

)

Loss expenses paid

 

(214

)

(212

)

Other underwriting and acquisition costs paid

 

(274

)

(278

)

Income taxes paid

 

(13

)

(85

)

Net cash provided by operating activities

 

200

 

212

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Purchase of investments:

 

 

 

 

 

Fixed maturities

 

(1,159

)

(930

)

Preferred stock

 

(71

)

(112

)

Common stock

 

(823

)

(546

)

Limited partnerships

 

(69

)

(59

)

Sales/maturities of investments:

 

 

 

 

 

Fixed maturity sales

 

398

 

359

 

Fixed maturity calls/maturities

 

474

 

509

 

Preferred stock

 

53

 

66

 

Common stock

 

739

 

538

 

Sale of and returns on limited partnerships

 

57

 

15

 

Disposal (purchase) of property and equipment

 

3

 

(21

)

Net collections on agent loans

 

1

 

1

 

Net cash used in investing activities

 

(397

)

(180

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Annuity and supplementary contract deposits and interest

 

51

 

61

 

Annuity and supplementary contract surrenders and withdrawals

 

(40

)

(39

)

Universal life deposits and interest

 

18

 

21

 

Universal life surrenders

 

(11

)

(19

)

Purchase of treasury stock

 

(90

)

(17

)

Dividends paid to shareholders

 

(52

)

(50

)

Net cash used in financing activities

 

(124

)

(43

)

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(321

)

(11

)

Cash and cash equivalents at beginning of period

 

430

 

234

 

Cash and cash equivalents at end of period

 

$   109

 

$   223

 

 

See accompanying notes to Consolidated Financial Statements. See Note 14, “Indemnity Supplemental Information,” for supplemental cash flow information.

 

6



 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Note 1.  Nature of Operations

 

Erie Indemnity Company (“Indemnity”) is a publicly held Pennsylvania business corporation that has been the managing attorney-in-fact for the subscribers (policyholders) at the Erie Insurance Exchange (“Exchange”) since 1925.  The Exchange is a subscriber owned, Pennsylvania-domiciled reciprocal insurer that writes property and casualty insurance.

 

Indemnity’s primary function is to perform certain services for the Exchange relating to the sales, underwriting and issuance of policies on behalf of the Exchange.  This is done in accordance with a subscriber’s agreement (a limited power of attorney) executed by each subscriber (policyholder), which appoints Indemnity as their common attorney-in-fact to transact business on their behalf and to manage the affairs of the Exchange.  Pursuant to the subscriber’s agreement and for its services as attorney-in-fact, Indemnity earns a management fee calculated as a percentage of the direct premiums written by the Exchange and the other members of the Property and Casualty Group (defined below), which are assumed by the Exchange under an intercompany pooling arrangement.

 

Indemnity has the power to direct the activities of the Exchange that most significantly impact the Exchange’s economic performance by acting as the common attorney-in-fact and decision maker for the subscribers (policyholders) at the Exchange.

 

Through December 31, 2010, Indemnity also operated as a property and casualty insurer through its wholly owned subsidiaries, Erie Insurance Company (“EIC”), Erie Insurance Company of New York (“ENY”) and Erie Insurance Property and Casualty Company (“EPC”).  EIC, ENY and EPC, together with the Exchange and its wholly owned subsidiary, Flagship City Insurance Company (“Flagship”), are collectively referred to as the “Property and Casualty Group”.  The Property and Casualty Group operates in 11 Midwestern, Mid-Atlantic and Southeastern states and the District of Columbia.  On December 31, 2010, Indemnity sold all of the outstanding capital stock of its wholly owned property and casualty subsidiaries to the Exchange.

 

Erie Family Life Insurance Company (“EFL”) is an affiliated life insurance company that underwrites and sells individual and group life insurance policies and fixed annuities.  On March 31, 2011, Indemnity sold its 21.6% ownership interest in EFL to the Exchange.  There was no gain or loss resulting from this sale as Indemnity is the primary decision maker for the Exchange.

 

All property and casualty and life insurance operations are now owned by the Exchange, and Indemnity will continue to function solely as the management company.

 

The consolidated financial statements of Erie Indemnity Company reflect the results of Indemnity and its variable interest entity, the Exchange, which we refer to collectively as the “Erie Insurance Group” (“we,” “us,” “our”).

 

“Indemnity shareholder interest” refers to the interest in Erie Indemnity Company owned by the Class A and Class B shareholders.  “Noncontrolling interest” refers to the interest in the Erie Insurance Exchange held for the subscribers (policyholders).

 

Note 2.  Significant Accounting Policies

 

Basis of presentation

The accompanying consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of Indemnity together with its affiliate companies in which Indemnity holds a majority voting or economic interest.

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of our financial position, results of operations and cash flows for the interim periods have been included.  Operating results for the six month period ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.  The accompanying consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010 as filed with the Securities and Exchange Commission on February 24, 2011.

 

7



 

Principles of consolidation

We consolidate the Exchange as a variable interest entity for which Indemnity is the primary beneficiary.  All intercompany accounts and transactions have been eliminated in consolidation.  The required presentation of noncontrolling interests is reflected in the consolidated financial statements.  Noncontrolling interests represent the ownership interests of the Exchange, all of which is held by parties other than Indemnity (i.e. the Exchange’s subscribers (policyholders)).  Noncontrolling interests also include the Exchange subscribers’ ownership interest in EFL.

 

Presentation of assets and liabilities – While the assets of the Exchange are presented separately in the Consolidated Statements of Financial Position, the Exchange’s assets can only be used to satisfy the Exchange’s liabilities or for other unrestricted activities.  Accounting Standards Codification (“ASC”) 810, Consolidation, does not require separate presentation of the Exchange’s assets.  However, because the shareholders of Indemnity have no rights to the assets of the Exchange and, conversely, the Exchange has no rights to the assets of Indemnity, we have presented the invested assets of the Exchange separately on the Consolidated Statements of Financial Position along with the remaining consolidated assets reflecting the Exchange’s portion parenthetically.  Liabilities are required under ASC 810, Consolidation, to be presented separately for the Exchange on the Consolidated Statements of Financial Position as the Exchange’s creditors do not have recourse to the general credit of Indemnity.

 

Rights of shareholders of Indemnity and subscribers (policyholders) of the Exchange – The shareholders of Indemnity, through the management fee, have a controlling financial interest in the Exchange; however, they have no other rights to or obligations arising from assets and liabilities of the Exchange.  The shareholders of Indemnity own its equity but have no rights or interest in the Exchange’s (noncontrolling interest) income or equity.  The noncontrolling interest equity represents the Exchange’s equity held for the interest of the subscribers (policyholders), who have no rights or interest in the Indemnity shareholder interest income or equity.

 

All intercompany assets, liabilities, revenues and expenses between Indemnity and the Exchange have been eliminated in the Consolidated Statements of Financial Position.

 

Adopted accounting pronouncements

In January 2010, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06, Improving Disclosures about Fair Value Measurements.  This guidance updated the disclosures in ASC 820, Fair Value Measurements and Disclosures.  The additional disclosures include the amounts and reasons for significant transfers between the levels in the fair value hierarchy, the expansion of fair market disclosures by each class of assets, disclosure of the policy for recognition of level transfers, and disclosure of the valuation techniques used for all Level 2 and Level 3 assets.  These disclosures were effective for periods beginning after December 15, 2009 and have been included in Note 6, “Fair Value.”  An additional disclosure requirement to present purchases, sales, issuances, and settlements of Level 3 activity on a gross basis became effective with periods beginning after December 15, 2010.  The additional disclosures required by this guidance have been included in Note 6.

 

Pending accounting pronouncements

In October 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts.  This guidance modifies the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal insurance contracts.  The amendments in this update specify that the costs are limited to incremental direct costs that result directly from successful contract transactions and would not have been incurred by the insurance entity had the contract transactions not occurred.  These costs must be directly related to underwriting, policy issuance and processing, medical and inspection and sales force contract selling.  The amendments also specify that advertising costs only should be included as deferred acquisition costs if the direct-response advertising criteria are met.  ASU 2010-26 is effective for interim and annual reporting periods beginning after December 15, 2011 with either prospective or retrospective adoption permitted.  Although we have not performed a detailed analysis, the adoption method and impact of this update on the Company’s financial position, cash flows, or results of operations is expected to be immaterial.

 

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurements.  This guidance changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements and certain other changes to converge with the fair value guidance of the International Accounting Standards Board.  The amendments in this update detail the requirements specific to measuring the fair value of an instrument classified in a reporting entity’s shareholders’ equity.  The amendments also clarify that a reporting entity should disclose quantitative information about the observable inputs used in the fair value measurement categorized

 

8



 

within Level 3 of the fair value hierarchy.  ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011.  We do not expect the adoption of this new guidance to have a material impact on our consolidated financial statements.

 

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income.  This guidance eliminates the option to present components of other comprehensive income as part of the statement of changes in shareholders’ equity.  The amendments in this update specify an entity has the option to present the total comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  The disclosures required remain the same.  In both options, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income.  ASU 2011-05 is effective for fiscal years beginning after December 15, 2011.  We do not expect the adoption of this new guidance to have a material impact on our consolidated financial statements.

 

Note 3.  Earnings Per Share

 

Basic earnings per share are calculated under the two-class method, which allocates earnings to each class of stock based on its dividend rights.  Class B shares are convertible into Class A shares at a conversion ratio of 2,400 to 1.  Class A diluted earnings per share are calculated under the if-converted method, which reflects the conversion of Class B shares and the effect of potentially dilutive outstanding employee stock-based awards and awards vested and not yet vested related to the outside directors’ stock compensation plan.  Vested shares related to the outside directors’ compensation plan were included in the table below for the first time at December 31, 2010.  The June 30, 2010 amounts have been updated to include these shares.  This had no impact on previously reported diluted earnings per share.

 

A reconciliation of the numerators and denominators used in the basic and diluted per-share computations is presented as follows for each class of Indemnity common stock:

 

 

 

Indemnity Earnings Per Share Calculation

 

(dollars in millions,

 

Three months ended June 30,

 

except per share data)

 

2011

 

2010

 

 

 

Allocated

 

Weighted

 

Per-

 

Allocated

 

Weighted

 

Per-

 

 

 

net income

 

shares

 

share

 

net income

 

shares

 

share

 

 

 

(numerator)

 

(denominator)

 

amount

 

(numerator)

 

(denominator)

 

amount

 

Class A – Basic EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to Class A stockholders

 

$52

 

49,250,061

 

$    1.05

 

$49

 

51,013,358

 

$    0.96

 

Dilutive effect of stock awards

 

0

 

76,515

 

 

0

 

73,845

 

 

Assumed conversion of Class B shares

 

0

 

6,110,400

 

 

0

 

6,110,400

 

 

Class A – Diluted EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to Class A stockholders

 

 

 

 

 

 

 

 

 

 

 

 

 

on Class A equivalent shares

 

$52

 

55,436,976

 

$    0.94

 

$49

 

57,197,603

 

$    0.86

 

Class B – Basic and diluted EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to Class B stockholders

 

$  0

 

2,546

 

$158.33

 

$  0

 

2,546

 

$138.21

 

 

 

 

Indemnity Earnings Per Share Calculation

 

(dollars in millions,

 

Six months ended June 30,

 

except per share data)

 

2011

 

2010

 

 

 

Allocated

 

Weighted

 

Per-

 

Allocated

 

Weighted

 

Per-

 

 

 

net income

 

shares

 

share

 

net income

 

Shares

 

share

 

 

 

(numerator)

 

(denominator)

 

amount

 

(numerator)

 

(denominator)

 

amount

 

Class A – Basic EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to Class A stockholders

 

$95

 

49,518,069

 

$    1.93

 

$95

 

51,099,071

 

$    1.87

 

Dilutive effect of stock awards

 

0

 

76,515

 

 

0

 

73,213

 

 

Assumed conversion of Class B shares

 

1

 

6,110,400

 

 

1

 

6,110,400

 

 

Class A – Diluted EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to Class A stockholders

 

 

 

 

 

 

 

 

 

 

 

 

 

on Class A equivalent shares

 

$96

 

55,704,984

 

$    1.72

 

$96

 

57,282,684

 

$    1.68

 

Class B – Basic and diluted EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to Class B stockholders

 

$  1

 

2,546

 

$291.07

 

$  1

 

2,546

 

$271.03

 

 

9



 

Included in the diluted earnings per share calculations for the second quarter and first half of 2011 and 2010, respectively, were 6,400 and 11,200 shares of stock-based awards not yet vested, 63,433 and 50,748 shares of awards vested related to our outside directors’ stock compensation plan, and 6,682 and 10,612 shares of awards not yet vested related to our outside directors’ stock compensation plan.

 

Note 4.  Variable Interest Entity

 

Erie Insurance Exchange

The Exchange is a reciprocal insurance exchange domiciled in Pennsylvania, for which Indemnity serves as attorney-in-fact.  Indemnity holds a variable interest in the Exchange due to the absence of decision-making capabilities by the equity owners (subscribers/policyholders) of the Exchange and due to the significance of the management fee the Exchange pays to Indemnity as its decision maker.  As a result, Indemnity is deemed to have a controlling financial interest in the Exchange and is considered to be its primary beneficiary.

 

Consolidation of the Exchange’s financial results is required given the significance of the management fee to the Exchange and because Indemnity has the power to direct the activities of the Exchange that most significantly impact the Exchange’s economic performance.  The Exchange’s anticipated economic performance is the product of its underwriting results combined with its investment results.  The fees paid to Indemnity under the subscriber’s agreement impact the anticipated economic performance attributable to the Exchange’s results.  Indemnity earns a management fee from the Exchange for the services it provides as attorney-in-fact.  Indemnity’s management fee revenues are based on all premiums written or assumed by the Exchange.  Indemnity’s Board of Directors determines the management fee rate to be paid by the Exchange to Indemnity.  This rate cannot exceed 25% of the direct and affiliated assumed written premiums of the Exchange, as defined by the subscriber’s agreement signed by each policyholder.  Management fee revenues and management fee expenses are eliminated upon consolidation.

 

The shareholders of Indemnity have no rights to the assets of the Exchange and no obligations arising from the liabilities of the Exchange.  Indemnity has no obligation related to any underwriting and/or investment losses experienced by the Exchange.  Indemnity would however be adversely impacted if the Exchange incurred significant underwriting and/or investment losses.  If the surplus of the Exchange were to decline significantly from its current level, its financial strength ratings could be reduced and as a consequence the Exchange could find it more difficult to retain its existing business and attract new business.  A decline in the business of the Exchange would have an adverse effect on the amount of the management fees Indemnity receives.  In addition, a decline in the surplus of the Exchange from its current level may impact the management fee rate received by Indemnity.  Indemnity also has an exposure to a concentration of credit risk related to the unsecured receivables due from the Exchange for its management fee. If any of these events occurred, Indemnity’s financial position, financial performance and/or cash flows could be adversely impacted.

 

On December 31, 2010, Indemnity sold all of the outstanding capital stock of its wholly owned subsidiaries to the Exchange.  On March 31, 2011, Indemnity sold its 21.6% ownership interest in EFL to the Exchange.  Under this new structure, all property and casualty and life insurance operations are owned by the Exchange, and Indemnity will continue to function as the management company.  There was no impact on the existing reinsurance pooling agreement between the Exchange and EIC or ENY as a result of the sales, nor was there any impact to the subscribers (policyholders) of the Exchange, to the Exchange’s independent insurance agents, or to Indemnity’s employees.

 

Indemnity has not provided financial or other support to the Exchange for the reporting periods presented.  At June 30, 2011, there are no explicit or implicit arrangements that would require Indemnity to provide future financial support to the Exchange.  Indemnity is not liable if the Exchange was to be in violation of its debt covenants or was unable to meet its obligation for unfunded commitments to limited partnerships.

 

10



 

Note 5. Segment Information

 

Our reportable segments include management operations, property and casualty insurance operations, life insurance operations and investment operations.  Accounting policies for segments are the same as those described in the summary of significant accounting policies.  See Item 8. “Financial Statements and Supplementary Data, Note 2, Significant Accounting Policies,” in our Annual Report on Form 10-K for the year ended December 31, 2010 as filed with the Securities and Exchange Commission on February 24, 2011.  Assets are not allocated to the segments but rather are reviewed in total for purposes of decision-making.  No single customer or agent provides 10% or more of revenues.

 

Our management operations segment consists of serving as attorney-in-fact for the Exchange.  Indemnity operates in this capacity solely for the Exchange.  We evaluate profitability of our management operations segment principally on the gross margin from management operations.  Indemnity earns management fees from the Exchange for providing sales, underwriting and policy issuance services.  Management fee revenue, which is eliminated in consolidation, is calculated as a percentage not to exceed 25% of all the direct premiums written by the Exchange and the other members of the Property and Casualty Group, which are assumed by the Exchange under an intercompany pooling arrangement.  The Property and Casualty Group issues policies with annual terms only.  Management fees are recorded upon policy issuance or renewal, as substantially all of the services required to be performed by Indemnity have been satisfied at that time.  Certain activities are performed and related costs are incurred by us subsequent to policy issuance in connection with the services provided to the Exchange; however, these activities are inconsequential and perfunctory.  Although these management fee revenues and expenses are eliminated in consolidation, the amount of the fee directly impacts the allocation of our consolidated net income between noncontrolling interest, which bears the management fee expense and represents the interests of the Exchange subscribers (policyholders), and Indemnity’s interest, which earns the management fee revenue and represents Indemnity shareholder interest in net income.

 

Our property and casualty insurance operations segment includes personal and commercial lines.  Personal lines consist primarily of personal auto and homeowners and are marketed to individuals.  Commercial lines consist primarily of commercial multi-peril, commercial auto and workers compensation and are marketed to small- and medium-sized businesses.  Our property and casualty policies are sold by independent agents.  Our property and casualty insurance underwriting operations are conducted through the Exchange and its subsidiaries and include assumed voluntary reinsurance from nonaffiliated domestic and foreign sources, assumed involuntary and ceded reinsurance business.  The Exchange exited the assumed voluntary reinsurance business effective December 31, 2003, and therefore unaffiliated reinsurance includes only run-off activity of the previously assumed voluntary reinsurance business.  We evaluate profitability of the property and casualty operations principally based on net underwriting results represented by the combined ratio.

 

Our life insurance operations segment includes traditional and universal life insurance products and fixed annuities marketed to individuals using the same independent agency force utilized by our property and casualty operations.  We evaluate profitability of the life insurance segment principally based on segment net income, including investments, which for segment purposes are reflected in the investment operations segment.  At the same time, we recognize that investment-related income is integral to the evaluation of the life insurance segment because of the long duration of life products.  For the second quarters of 2011 and 2010, investment activities on life insurance related assets generated revenues of $27 million and $25 million, respectively, resulting in EFL reporting income before income taxes of $12 million and $11 million, respectively, before intercompany eliminations. For the six months ended June 30, 2011 and 2010, investment activities on life insurance related assets generated revenues of $54 million and $52 million, respectively, resulting in EFL reporting income before taxes of $25 million and $21 million, respectively, before intercompany eliminations.

 

The investment operations segment performance is evaluated based on appreciation of assets, rate of return and overall return.  Investment-related income for the life operations is included in the investment segment results.

 

11



 

The following tables summarize the components of the Consolidated Statements of Operations by reportable business segments:

 

 

 

Erie Insurance Group

(in millions)

 

For the three months ended June 30, 2011

 

 

Management
operations

Property
and
casualty
insurance
operations

Life
insurance
operations

Investment
operations

Eliminations

Consolidated

Premiums earned/life policy revenue

 

 

 

 

$1,030

 

 

$18

 

 

 

 

 

$  (1

)

 

$1,047

 

 

Net investment income

 

 

 

 

 

 

 

 

 

 

$115

 

 

(2

)

 

113

 

 

Net realized investment gains

 

 

 

 

 

 

 

 

 

 

39

 

 

 

 

 

39

 

 

Net impairment losses recognized in earnings

 

 

 

 

 

 

 

 

 

 

0

 

 

 

 

 

0

 

 

Equity in earnings of limited partnerships

 

 

 

 

 

 

 

 

 

 

38

 

 

 

 

 

38

 

 

Management fee revenue

 

$285

 

 

 

 

 

 

 

 

 

 

 

(285

)

 

 

 

Service agreement and other revenue

 

9

 

 

 

 

 

(1

)

 

 

 

 

 

 

 

8

 

 

Total revenues

 

294

 

 

1,030

 

 

17

 

 

192

 

 

(288

)

 

1,245

 

 

Cost of management operations

 

230

 

 

 

 

 

 

 

 

 

 

 

(230

)

 

 

 

Insurance losses and loss expenses

 

 

 

 

1,147

 

 

25

 

 

 

 

 

(2

)

 

1,170

 

 

Policy acquisition and underwriting expenses

 

 

 

 

298

 

 

7

 

 

 

 

 

(56

)

 

249

 

 

Total benefits and expenses

 

230

 

 

1,445

 

 

32

 

 

 

 

(288

)

 

1,419

 

 

Income (loss) before income taxes

 

64

 

 

(415

)

 

(15

)

 

192

 

 

 

 

(174

)

 

Provision (benefit) for income taxes

 

22

 

 

(145

)

 

(5

)

 

61

 

 

 

 

(67

)

 

Net income (loss)

 

$42

 

 

$(270

)

 

$(10

)

 

$131

 

 

$   –

 

 

$(107

)

 

 

 

 

Erie Insurance Group

(in millions)

 

For the three months ended June 30, 2010

 

 

Management
operations

 

Property
and
casualty
insurance
operations

 

Life
insurance
operations

 

Investment
operations

 

Eliminations

 

Consolidated

Premiums earned/life policy revenue

 

 

 

 

$974

 

 

$16

 

 

 

 

 

$  (1

)

 

$ 989

 

 

Net investment income

 

 

 

 

 

 

 

 

 

 

$110

 

 

(2

)

 

108

 

 

Net realized investment losses

 

 

 

 

 

 

 

 

 

 

(213

)

 

 

 

 

(213

)

 

Net impairment losses recognized in earnings

 

 

 

 

 

 

 

 

 

 

(4

)

 

 

 

 

(4

)

 

Equity in earnings of limited partnerships

 

 

 

 

 

 

 

 

 

 

27

 

 

 

 

 

27

 

 

Management fee revenue

 

$270

 

 

 

 

 

 

 

 

 

 

 

(270

)

 

 

 

Service agreement and other revenue

 

9

 

 

 

 

 

0

 

 

 

 

 

 

 

 

9

 

 

Total revenues (losses)

 

279

 

 

974

 

 

16

 

 

(80

)

 

(273

)

 

916

 

 

Cost of management operations

 

217

 

 

 

 

 

 

 

 

 

 

 

(217

)

 

 

 

Insurance losses and loss expenses

 

 

 

 

717

 

 

22

 

 

 

 

 

(2

)

 

737

 

 

Policy acquisition and underwriting expenses

 

 

 

 

275

 

 

9

 

 

 

 

 

(54

)

 

230

 

 

Total benefits and expenses

 

217

 

 

992

 

 

31

 

 

 

 

(273

)

 

967

 

 

Income (loss) before income taxes

 

62

 

 

(18

)

 

(15

)

 

(80

)

 

 

 

(51

)

 

Provision (benefit) for income taxes

 

21

 

 

(7

)

 

(5

)

 

(29

)

 

 

 

(20

)

 

Net income (loss)

 

$  41

 

 

$ (11

)

 

$ (10

)

 

$ (51

)

 

$   –

 

 

$  (31

)

 

 

12



 

 

 

Erie Insurance Group

(in millions)

 

For the six months ended June 30, 2011

 

 

Management
operations

 

Property
and
casualty
insurance
operations

 

Life
insurance
operations

 

Investment
operations

 

Eliminations

 

Consolidated

Premiums earned/life policy revenue

 

 

 

 

$2,044

 

 

$34

 

 

 

 

 

$  (1

)

 

$2,077

 

 

Net investment income

 

 

 

 

 

 

 

 

 

 

$223

 

 

(5

)

 

218

 

 

Net realized investment gains

 

 

 

 

 

 

 

 

 

 

188

 

 

 

 

 

188

 

 

Net impairment losses recognized in earnings

 

 

 

 

 

 

 

 

 

 

0

 

 

 

 

 

0

 

 

Equity in earnings of limited partnerships

 

 

 

 

 

 

 

 

 

 

110

 

 

 

 

 

110

 

 

Management fee revenue

 

$536

 

 

 

 

 

 

 

 

 

 

 

(536

)

 

 

 

Service agreement and other revenue

 

17

 

 

 

 

 

0

 

 

 

 

 

 

 

 

17

 

 

Total revenues

 

553

 

 

2,044

 

 

34

 

 

521

 

 

(542

)

 

2,610

 

 

Cost of management operations

 

441

 

 

 

 

 

 

 

 

 

 

 

(441

)

 

 

 

Insurance losses and loss expenses

 

 

 

 

1,830

 

 

49

 

 

 

 

 

(3

)

 

1,876

 

 

Policy acquisition and underwriting expenses

 

 

 

 

580

 

 

14

 

 

 

 

 

(98

)

 

496

 

 

Total benefits and expenses

 

441

 

 

2,410

 

 

63

 

 

 

 

(542

)

 

2,372

 

 

Income (loss) before income taxes

 

112

 

 

(366

)

 

(29

)

 

521

 

 

 

 

238

 

 

Provision (benefit) for income taxes

 

39

 

 

(128

)

 

(10

)

 

170

 

 

 

 

71

 

 

Net income (loss)

 

$73

 

 

$(238

)

 

$(19

)

 

$351

 

 

$    –

 

 

$167

 

 

 

 

 

Erie Insurance Group

(in millions)

 

For the six months ended June 30, 2010

 

 

Management
operations

 

Property
and
casualty
insurance
operations

 

Life
insurance
operations

 

Investment
operations

 

Eliminations

 

Consolidated

Premiums earned/life policy revenue

 

 

 

 

$1,936

 

 

$32

 

 

 

 

 

$  (1

)

 

$1,967

 

 

Net investment income

 

 

 

 

 

 

 

 

 

 

$217

 

 

(5

)

 

212

 

 

Net realized investment losses

 

 

 

 

 

 

 

 

 

 

(88

)

 

 

 

 

(88

)

 

Net impairment losses recognized in earnings

 

 

 

 

 

 

 

 

 

 

(6

)

 

 

 

 

(6

)

 

Equity in earnings of limited partnerships

 

 

 

 

 

 

 

 

 

 

30

 

 

 

 

 

30

 

 

Management fee revenue

 

$507

 

 

 

 

 

 

 

 

 

 

 

(507

)

 

 

 

Service agreement and other revenue

 

17

 

 

 

 

 

0

 

 

 

 

 

 

 

 

17

 

 

Total revenues

 

524

 

 

1,936

 

 

32

 

 

153

 

 

(513

)

 

2,132

 

 

Cost of management operations

 

409

 

 

 

 

 

 

 

 

 

 

 

(409

)

 

 

 

Insurance losses and loss expenses

 

 

 

 

1,455

 

 

46

 

 

 

 

 

(3

)

 

1,498

 

 

Policy acquisition and underwriting expenses

 

 

 

 

540

 

 

18

 

 

 

 

 

(101

)

 

457

 

 

Total benefits and expenses

 

409

 

 

1,995

 

 

64

 

 

 

 

(513

)

 

1,955

 

 

Income (loss) before income taxes

 

115

 

 

(59

)

 

(32

)

 

153

 

 

 

 

177

 

 

Provision (benefit) for income taxes

 

39

 

 

(21

)

 

(11

)

 

39

 

 

 

 

46

 

 

Net income (loss)

 

$76

 

 

$   (38

)

 

$(21

)

 

$114

 

 

$    –

 

 

$  131

 

 

 

See the “Results of the Erie Insurance Group’s operations by interest” table in the Management’s Discussion and Analysis for the composition of income attributable to Indemnity and income attributable to the noncontrolling interest (Exchange).

 

13



 

Note 6. Fair Value

 

The 2010 fair value information within this note has been conformed to this current presentation.

 

Our available-for-sale and trading securities are recorded at fair value, which is the price that would be received to sell the asset in an orderly transaction between willing market participants as of the measurement date. Valuation techniques used to derive the fair value of our available-for-sale and trading securities are based on observable and unobservable inputs.  Observable inputs reflect market data obtained from independent sources. Unobservable inputs reflect our own assumptions regarding fair market value for these securities.  Although the majority of our prices are obtained from third party sources, we also perform an internal pricing review for securities with low trading volumes in the current market conditions.  Financial instruments are categorized based upon the following characteristics or inputs to the valuation techniques:

 

Level 1             Quoted prices for identical instruments in active markets not subject to adjustments or discounts.

 

Level 2             Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 

Level 3             Instruments whose significant value drivers are unobservable and reflect management’s estimate of fair value based on assumptions used by market participants in an orderly transaction as of the valuation date.

 

The following table represents the fair value measurements on a recurring basis for our consolidated available-for-sale and trading securities by asset class and level of input at June 30, 2011:

 

 

 

Erie Insurance Group

 

 

June 30, 2011

 

 

Fair value measurements using:

(in millions)

 

Total

 

Quoted prices in
active markets for
identical assets
Level 1

 

Significant
observable inputs
Level 2

 

Significant
unobservable
inputs
Level 3

 

Indemnity

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government & agencies

 

$        8

 

$        0

 

$       8

 

$ 0

 

States & political subdivisions

 

222

 

0

 

222

 

0

 

Corporate debt securities

 

257

 

0

 

257

 

0

 

Other debt securities

 

10

 

0

 

10

 

0

 

Commercial mortgage-backed securities (CMBS)

 

24

 

0

 

24

 

0

 

Collateralized debt obligations (CDO)

 

4

 

0

 

0

 

4

 

Total fixed maturities

 

525

 

0

 

521

 

4

 

Nonredeemable preferred stock

 

20

 

9

 

11

 

0

 

Total available-for-sale securities

 

545

 

9

 

532

 

4

 

Trading securities:

 

 

 

 

 

 

 

 

 

Common stock

 

30

 

30

 

0

 

0

 

Total trading securities

 

30

 

30

 

0

 

0

 

Total – Indemnity

 

$    575

 

$     39

 

$   532

 

$ 4

 

Exchange

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government & agencies

 

$      67

 

$     11

 

$    56

 

$ 0

 

States & political subdivisions

 

1,438

 

0

 

1,434

 

4

 

Foreign government securities

 

21

 

0

 

21

 

0

 

Corporate debt securities

 

5,428

 

12

 

5,405

 

11

 

Other debt securities

 

61

 

0

 

56

 

5

 

Residential mortgage-backed securities (RMBS)

 

222

 

0

 

222

 

0

 

Commercial mortgage-backed securities (CMBS)

 

72

 

0

 

72

 

0

 

Collateralized debt obligations (CDO)

 

71

 

0

 

41

 

30

 

Total fixed maturities

 

7,380

 

23

 

7,307

 

50

 

Nonredeemable preferred stock

 

610

 

195

 

408

 

7

 

Total available-for-sale securities

 

7,990

 

218

 

7,715

 

57

 

Trading securities:

 

 

 

 

 

 

 

 

 

Common stock

 

2,513

 

2,500

 

0

 

13

 

Total trading securities

 

2,513

 

2,500

 

0

 

13

 

Total – Exchange

 

$10,503

 

$2,718

 

$7,715

 

$70

 

Total – Erie Insurance Group

 

$11,078

 

$2,757

 

$8,247

 

$74

 

 

14



 

Level 3 Assets – Quarterly Change:

 

 

 

Erie Insurance Group

 

 

 

(in millions)

 

Beginning
balance at
March 31, 2011

 

Included
in
earnings
(1)

 

Included
in other
comprehensive
income

 

Purchases

 

Sales

 

Transfers
in and (out)
of
Level 3
(2)

 

Ending
balance at
June 30,
2011

Indemnity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collateralized debt obligations (CDO)

 

$  4

 

$0

 

$ 0

 

 

$0

 

$0

 

$0

 

$  4

Total fixed maturities

 

4

 

0

 

0

 

 

0

 

0

 

0

 

4

Total available-for-sale securities

 

4

 

0

 

0

 

 

0

 

0

 

0

 

4

Trading securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

0

 

0

 

0

 

 

0

 

0

 

0

 

0

Total trading securities

 

0

 

0

 

0

 

 

0

 

0

 

0

 

0

Total Level 3 assets – Indemnity

 

$  4

 

$0

 

$ 0

 

 

$0

 

$0

 

$0

 

$  4

Exchange

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

States & political subdivisions

 

$  4

 

$0

 

$ 0

 

 

$0

 

$0

 

$0

 

$  4

Corporate debt securities

 

11

 

0

 

0

 

 

0

 

0

 

0

 

11

Other debt securities

 

5

 

0

 

0

 

 

0

 

0

 

0

 

5

Collateralized debt obligations (CDO)

 

30

 

0

 

0

 

 

0

 

0

 

0

 

30

Total fixed maturities

 

50

 

0

 

0

 

 

0

 

0

 

0

 

50

Nonredeemable preferred stock

 

8

 

0

 

(1

)

 

0

 

0

 

0

 

7

Total available-for-sale securities

 

58

 

0

 

(1

)

 

0

 

0

 

0

 

57

Trading securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

13

 

0

 

0

 

 

0

 

0

 

0

 

13

Total trading securities

 

13

 

0

 

0

 

 

0

 

0

 

0

 

13

Total Level 3 assets – Exchange

 

$71

 

$0

 

$(1

)

 

$0

 

$0

 

$0

 

$70

Total Level 3 assets – Erie Insurance Group

 

$75

 

$0

 

$(1

)

 

$0

 

$0

 

$0

 

$74

 

(1)          Includes losses as a result of other-than-temporary impairments and accrual of discount and amortization of premium.  These amounts are reported in the Consolidated Statements of Operations. There were no unrealized gains included in earnings for the three months ended June 30, 2011 on Level 3 securities.

 

(2)          Transfers in and out of Level 3 are attributable to changes in the availability of market observable information for individual securities within the respective categories. Transfers in and out of levels are recognized at the start of the period.

 

15



 

Level 3 Assets – Year-to-Date Change:

 

 

 

Erie Insurance Group

 

 

 

(in millions)

 

Beginning
balance at
December 31,
2010

 

Included
in
earnings
(1)

 

Included
in other
comprehensive
income

 

Purchases

 

Sales

 

Transfers
in and (out)
of
Level 3
(2)

 

Ending
balance at
June 30,
2011

Indemnity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collateralized debt obligations (CDO)

 

$  4

 

$0

 

$ 0

 

 

$0

 

$0

 

$0

 

$  4

Total fixed maturities

 

4

 

0

 

0

 

 

0

 

0

 

0

 

4

Total available-for-sale securities

 

4

 

0

 

0

 

 

0

 

0

 

0

 

4

Trading securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

0

 

0

 

0

 

 

0

 

0

 

0

 

0

Total trading securities

 

0

 

0

 

0

 

 

0

 

0

 

0

 

0

Total Level 3 assets – Indemnity

 

$  4

 

$0

 

$ 0

 

 

$0

 

$0

 

$0

 

$  4

Exchange

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

States & political subdivisions

 

$  4

 

$0

 

$ 0

 

 

$0

 

$0

 

$0

 

$  4

Corporate debt securities

 

11

 

0

 

0

 

 

0

 

0

 

0

 

11

Other debt securities

 

10

 

0

 

0

 

 

0

 

5

 

0

 

5

Collateralized debt obligations (CDO)

 

30

 

0

 

0

 

 

0

 

0

 

0

 

30

Total fixed maturities

 

55

 

0

 

0

 

 

0

 

5

 

0

 

50

Nonredeemable preferred stock

 

7

 

0

 

0

 

 

0

 

0

 

0

 

7

Total available-for-sale securities

 

62

 

0

 

0

 

 

0

 

5

 

0

 

57

Trading securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

12

 

1

 

0

 

 

0

 

0

 

0

 

13

Total trading securities

 

12

 

1

 

0

 

 

0

 

0

 

0

 

13

Total Level 3 assets – Exchange

 

$74

 

$1

 

$0

 

 

$0

 

$5

 

$0

 

$70

Total Level 3 assets – Erie Insurance Group

 

$78

 

$1

 

$0

 

 

$0

 

$5

 

$0

 

$74

 

(1)          Includes losses as a result of other-than-temporary impairments and accrual of discount and amortization of premium.  These amounts are reported in the Consolidated Statements of Operations. There was $1 million in unrealized gains included in earnings for the six months ended June 30, 2011 on Level 3 securities.

 

(2)          Transfers in and out of Level 3 are attributable to changes in the availability of market observable information for individual securities within the respective categories.  Transfers in and out of levels are recognized at the start of the period.

 

There were no significant transfers between levels 1 and 2 for the six months ended June 30, 2011.

 

16



 

The following table represents the fair value measurements on a recurring basis for our consolidated available-for-sale and trading securities by asset class and level of input at December 31, 2010:

 

 

 

Erie Insurance Group

 

 

December 31, 2010

 

 

Fair value measurements using:

(in millions)

 

Total

 

Quoted prices in
active markets for
identical assets
Level 1

 

Significant
observable inputs
Level 2

 

Significant
unobservable
inputs
Level 3

Indemnity

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

U.S. government & agencies

 

$

25

 

$

25

 

$

0

 

$0

States & political subdivisions

 

197

 

0

 

197

 

0

Corporate debt securities

 

38

 

0

 

38

 

0

Collateralized debt obligations (CDO)

 

4

 

0

 

0

 

4

Total fixed maturities

 

264

 

25

 

235

 

4

Nonredeemable preferred stock

 

24

 

11

 

13

 

0

Total available-for-sale securities

 

288

 

36

 

248

 

4

Trading securities:

 

 

 

 

 

 

 

 

Common stock

 

28

 

28

 

0

 

0

Total trading securities

 

28

 

28

 

0

 

0

Total – Indemnity

 

$

316

 

$

64

 

$

248

 

$4

Exchange

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

U.S. government & agencies

 

$

87

 

$

12

 

$

75

 

$0

States & political subdivisions

 

1,471

 

0

 

1,467

 

4

Foreign government securities

 

21

 

0

 

21

 

0

Corporate debt securities

 

5,263

 

12

 

5,240

 

11

Other debt securities

 

57

 

0

 

47

 

10

Residential mortgage-backed securities (RMBS)

 

224

 

0

 

224

 

0

Commercial mortgage-backed securities (CMBS)

 

86

 

0

 

86

 

0

Collateralized debt obligations (CDO)

 

70

 

0

 

40

 

30

Total fixed maturities

 

7,279

 

24

 

7,200

 

55

Nonredeemable preferred stock

 

570

 

166

 

397

 

7

Total available-for-sale securities

 

7,849

 

190

 

7,597

 

62

Trading securities:

 

 

 

 

 

 

 

 

Common stock

 

2,306

 

2,294

 

0

 

12

Total trading securities

 

2,306

 

2,294

 

0

 

12

Total – Exchange

 

$

10,155

 

$

2,484

 

$

7,597

 

$74

Total – Erie Insurance Group

 

$

10,471

 

$

2,548

 

$

7,845

 

$78

 

17



 

Level 3 Assets – Quarterly Change:

 

 

 

Erie Insurance Group

(in millions)

 

Beginning
balance at
March 31, 2010

 

Included
in
earnings
(1)

 

Included
in other
comprehensive income

 

Purchases,
sales and
adjustments

 

Transfers
in and (out)
of
Level 3
(2)

 

Ending
balance at
June 30,
2010

Indemnity

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

2

 

$0

 

$0

 

 

$0

 

$

0

 

 

$ 2

Collateralized debt obligations (CDO)

 

9

 

0

 

1

 

 

0

 

(2

)

 

8

Total fixed maturities

 

11

 

0

 

1

 

 

0

 

(2

)

 

10

Nonredeemable preferred stock

 

2

 

0

 

(1

)

 

0

 

0

 

 

1

Total available-for-sale securities

 

13

 

0

 

0

 

 

0

 

(2

)

 

11

Trading securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

0

 

0

 

0

 

 

0

 

0

 

 

0

Total trading securities

 

0

 

0

 

0

 

 

0

 

0

 

 

0

Total Level 3 assets – Indemnity

 

$

13

 

$0

 

$0

 

 

$0

 

$

(2

)

 

$11

Exchange

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

9

 

$0

 

$0

 

 

$0

 

$

0

 

 

$ 9

Other debt securities

 

5

 

0

 

0

 

 

0

 

0

 

 

5

Collateralized debt obligations (CDO)

 

70

 

1

 

3

 

 

0

 

(21

)

 

53

Total fixed maturities

 

84

 

1

 

3

 

 

0

 

(21

)

 

67

Nonredeemable preferred stock

 

5

 

0

 

(1

)

 

0

 

0

 

 

4

Total available-for-sale securities

 

89

 

1

 

2

 

 

0

 

(21

)

 

71

Trading securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

10

 

0

 

0

 

 

0

 

0

 

 

10

Total trading securities

 

10

 

0

 

0

 

 

0

 

0

 

 

10

Total Level 3 assets – Exchange

 

$

99

 

$1

 

$2

 

 

$0

 

$

(21

)

 

$81

Total Level 3 assets – Erie Insurance Group

 

$

112

 

$1

 

$2

 

 

$0

 

$

(23

)

 

$92

 

(1)          Includes losses as a result of other-than-temporary impairments and accrual of discount and amortization of premium.  These amounts are reported in the Consolidated Statements of Operations. There were no unrealized gains included in earnings for the three months ended June 30, 2010 on Level 3 securities.

 

(2)          Transfers in and out of Level 3 are attributable to changes in the availability of market observable information for individual securities within the respective categories. Transfers in and out of levels are recognized at the start of the period.

 

18



 

Level 3 Assets – Year-to-Date Change:

 

 

 

Erie Insurance Group

 

(in millions)

 

Beginning
balance at
December 31,
2009

 

Included
in
earnings 
(1)

 

Included
in other
comprehensive
income

 

Purchases,
sales and
adjustments

 

Transfers
in and (out)
of
Level 3 
(2)

 

Ending
balance at
June 30,
2010

 

Indemnity

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$ 2

 

$0

 

$0

 

$0

 

$  0

 

$ 2

 

Collateralized debt obligations (CDO)

 

8

 

0

 

1

 

0

 

(1)

 

8

 

Total fixed maturities

 

10

 

0

 

1

 

0

 

(1)

 

10

 

Nonredeemable preferred stock

 

1

 

0

 

0

 

0

 

0

 

1

 

Total available-for-sale securities

 

11

 

0

 

1

 

0

 

(1)

 

11

 

Trading securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

0

 

0

 

0

 

0

 

0

 

0

 

Total trading securities

 

0

 

0

 

0

 

0

 

0

 

0

 

Total Level 3 assets – Indemnity

 

$11

 

$0

 

$1

 

$0

 

$ (1)

 

$11

 

Exchange

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$17

 

$0

 

$0

 

$0

 

$ (8)

 

$ 9

 

Other debt securities

 

5

 

0

 

0

 

0

 

0

 

5

 

Collateralized debt obligations (CDO)

 

49

 

1

 

6

 

0

 

(3)

 

53

 

Total fixed maturities

 

71

 

1

 

6

 

0

 

(11)

 

67

 

Nonredeemable preferred stock

 

4

 

0

 

0

 

0

 

0

 

4

 

Total available-for-sale securities

 

75

 

1

 

6

 

0

 

(11)

 

71

 

Trading securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

9

 

1

 

0

 

0

 

0

 

10

 

Total trading securities

 

9

 

1

 

0

 

0

 

0

 

10

 

Total Level 3 assets – Exchange

 

$84

 

$2

 

$6

 

$0

 

$(11)

 

$81

 

Total Level 3 assets – Erie Insurance Group

 

$95

 

$2

 

$7

 

$0

 

$(12)

 

$92

 

 

(1)          Includes losses as a result of other-than-temporary impairments and accrual of discount and amortization of premium.  These amounts are reported in the Consolidated Statements of Operations. There was $1 million in unrealized gains included in earnings for the six months ended June 30, 2010 on Level 3 securities.

 

(2)          Transfers in and out of Level 3 are attributable to changes in the availability of market observable information for individual securities within the respective categories.  Transfers in and out of levels are recognized at the start of the period.

 

There were no significant transfers between levels 1 and 2 for the six months ended June 30, 2010.

 

Estimates of fair values for our investment portfolio are obtained primarily from a nationally recognized pricing service.  Our Level 1 category includes those securities valued using an exchange traded price provided by the pricing service.  The methodologies used by the pricing service that support a Level 2 classification of a financial instrument include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data.  Pricing service valuations for Level 3 securities are based on proprietary models and are used when observable inputs are not available in illiquid markets.  In limited circumstances we adjust the price received from the pricing service when, in our judgment, a better reflection of fair value is available based on corroborating information and our knowledge and monitoring of market conditions.  At June 30, 2011, we adjusted some prices received by the pricing service to reflect an alternate fair market value based on observable market data such as a disparity in price of comparable securities and/or non-binding broker quotes.

 

19



 

The following table displays the number and values of these adjustments at June 30, 2011:

 

 

 

Erie Insurance Group

 

(dollars in millions)

 

Number of
holdings

 

Value of
securities
using pricing
service

 

Value of
securities used in
the financial
statements

 

Exchange

 

2

 

$4.7

 

$4.8

 

Total – Erie Insurance Group

 

 

 

$4.7

 

$4.8

 

 

We perform continuous reviews of the prices obtained from the pricing service.  This includes evaluating the methodology and inputs used by the pricing service to ensure we determine the proper level classification of the financial instrument.  Price variances, including large periodic changes, are investigated and corroborated by market data.  We have reviewed the pricing methodologies of our pricing service and believe that their prices adequately consider market activity in determining fair value.

 

When a price from the pricing service is not available, values are determined by obtaining non-binding broker quotes and/or market comparables.  When available, we obtain multiple quotes for the same security.  The ultimate value for these securities is determined based on our best estimate of fair value using corroborating market information.  Our evaluation includes the consideration of benchmark yields, reported trades, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data.

 

For certain structured securities in an illiquid market, there may be no prices available from a pricing service and no comparable market quotes available.  In these situations, we value the security using an internally-developed risk-adjusted discounted cash flow model.

 

20



 

The following table sets forth the fair value of the consolidated fixed maturity and preferred and common stock securities by pricing source:

 

 

 

Erie Insurance Group

 

(in millions)

 

June 30, 2011

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Indemnity

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

Priced via pricing services

 

$    521

 

$      0

 

$   521

 

$ 0

 

Priced via market comparables/non-binding broker quote (1)

 

0

 

0

 

0

 

0

 

Priced via internal modeling (2)

 

4

 

0

 

0

 

4

 

Total fixed maturity securities

 

525

 

0

 

521

 

4

 

Preferred stock securities:

 

 

 

 

 

 

 

 

 

Priced via pricing services

 

18

 

9

 

9

 

0

 

Priced via market comparables/non-binding broker quote (1)

 

2

 

0

 

2

 

0

 

Priced via internal modeling (2)

 

0

 

0

 

0

 

0

 

Total preferred stock securities

 

20

 

9

 

11

 

0

 

Common stock securities:

 

 

 

 

 

 

 

 

 

Priced via pricing services

 

30

 

30

 

0

 

0

 

Priced via market comparables/non-binding broker quote (1)

 

0

 

0

 

0

 

0

 

Priced via internal modeling (2)

 

0

 

0

 

0

 

0

 

Total common stock securities

 

30

 

30

 

0

 

0

 

Total available-for-sale/trading securities – Indemnity

 

$    575

 

$    39

 

$   532

 

$ 4

 

Exchange

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

Priced via pricing services

 

$ 7,232

 

$    23

 

$7,209

 

$ 0

 

Priced via market comparables/non-binding broker quote (1)

 

98

 

0

 

98

 

0

 

Priced via internal modeling (2)

 

50

 

0

 

0

 

50

 

Total fixed maturity securities

 

7,380

 

23

 

7,307

 

50

 

Preferred stock securities:

 

 

 

 

 

 

 

 

 

Priced via pricing services

 

577

 

188

 

389

 

0

 

Priced via market comparables/non-binding broker quote (1)

 

33

 

7

 

19

 

7

 

Priced via internal modeling (2)

 

0

 

0

 

0

 

0

 

Total preferred stock securities

 

610

 

195

 

408

 

7

 

Common stock securities:

 

 

 

 

 

 

 

 

 

Priced via pricing services

 

2,500

 

2,500

 

0

 

0

 

Priced via market comparables/non-binding broker quote (1)

 

0

 

0

 

0

 

0

 

Priced via internal modeling (2)

 

13

 

0

 

0

 

13

 

Total common stock securities

 

2,513

 

2,500

 

0

 

13

 

Total available-for-sale/trading securities – Exchange

 

$10,503

 

$2,718

 

$7,715

 

$70

 

Total available-for-sale/trading securities – Erie Insurance Group

 

$11,078

 

$2,757

 

$8,247

 

$74

 

 

(1)     All broker quotes obtained for securities were non-binding. When a non-binding broker quote was the only price available, the security was classified as Level 3.

 

(2)     Internal modeling using a discounted cash flow model was performed on 11 fixed maturities and 3 common equity securities representing 0.5% of the total portfolio of the Erie Insurance Group.

 

We have no assets that were measured at fair value on a nonrecurring basis during the six months ended June 30, 2011.

 

21



 

Note 7.  Investments

 

The 2010 investment information within this note has been conformed to this current presentation.

 

The following tables summarize the cost and fair value of our available-for-sale securities at June 30, 2011 and December 31, 2010:

 

 

 

Erie Insurance Group

 

 

 

June 30, 2011

 

(in millions)

 

Amortized

 

Gross unrealized

 

Gross unrealized

 

Estimated

 

 

 

cost

 

gains

 

losses

 

fair value

 

Indemnity

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government & agencies

 

$      8

 

$     0

 

$  0

 

$      8

 

States & political subdivisions

 

214

 

8

 

0

 

222

 

Corporate debt securities

 

256

 

1

 

0

 

257

 

Other debt securities

 

10

 

0

 

0

 

10

 

Commercial mortgage-backed securities (CMBS)

 

24

 

0

 

0

 

24

 

Collateralized debt obligations (CDO)

 

4

 

0

 

0

 

4

 

Total fixed maturities

 

516

 

9

 

0

 

525

 

Nonredeemable preferred stock

 

19

 

1

 

0

 

20

 

Total available-for-sale securities – Indemnity

 

$   535

 

$    10

 

$  0

 

$   545

 

Exchange

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government & agencies

 

$     65

 

$     2

 

$  0

 

$     67

 

States & political subdivisions

 

1,385

 

56

 

3

 

1,438

 

Foreign government securities

 

20

 

1

 

0

 

21

 

Corporate debt securities

 

5,051

 

383

 

6

 

5,428

 

Other debt securities

 

59

 

2

 

0

 

61

 

Residential mortgage-backed securities (RMBS)

 

212

 

10

 

0

 

222

 

Commercial mortgage-backed securities (CMBS)

 

68

 

4

 

0

 

72

 

Collateralized debt obligations (CDO)

 

69

 

7

 

5

 

71

 

Total fixed maturities

 

6,929

 

465

 

14

 

7,380

 

Nonredeemable preferred stock

 

538

 

74

 

2

 

610

 

Total available-for-sale securities – Exchange

 

$7,467

 

$539

 

$16

 

$7,990

 

Total available-for-sale securities – Erie Insurance Group

 

$8,002

 

$549

 

$16

 

$8,535

 

 

 

 

 

 

 

 

 

 

 

 

 

Erie Insurance Group

 

 

 

December 31, 2010

 

(in millions)

 

Amortized

 

Gross unrealized

 

Gross unrealized

 

Estimated

 

 

 

cost

 

gains

 

Losses

 

fair value

 

Indemnity

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government & agencies

 

$     25

 

$    0

 

$  0

 

$     25

 

States & political subdivisions

 

193

 

6

 

2

 

197

 

Corporate debt securities

 

36

 

2

 

0

 

38

 

Collateralized debt obligations (CDO)

 

3

 

1

 

0

 

4

 

Total fixed maturities

 

257

 

9

 

2

 

264

 

Nonredeemable preferred stock

 

20

 

4

 

0

 

24

 

Total available-for-sale securities – Indemnity

 

$   277

 

$  13

 

$  2

 

$   288

 

Exchange

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. government & agencies

 

$     85

 

$    2

 

$  0

 

$    87

 

States & political subdivisions

 

1,437

 

43

 

9

 

1,471

 

Foreign government securities

 

20

 

1

 

0

 

21

 

Corporate debt securities

 

4,900

 

377

 

14

 

5,263

 

Other debt securities

 

54

 

3

 

0

 

57

 

Residential mortgage-backed securities (RMBS)

 

216

 

9

 

1

 

224

 

Commercial mortgage-backed securities (CMBS)

 

82

 

5

 

1

 

86

 

Collateralized debt obligations (CDO)

 

69

 

6

 

5

 

70

 

Total fixed maturities

 

6,863

 

446

 

30

 

7,279

 

Nonredeemable preferred stock

 

503

 

74

 

7

 

570

 

Total available-for-sale securities – Exchange

 

$7,366

 

$520

 

$37

 

$7,849

 

Total available-for-sale securities – Erie Insurance Group

 

$7,643

 

$533

 

$39

 

$8,137

 

 

22


 


 

The amortized cost and estimated fair value of fixed maturities at June 30, 2011 are shown below by remaining contractual term to maturity.  Mortgage-backed securities are allocated based on their stated maturity dates.  Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

 

Erie Insurance Group

 

(in millions)

 

Amortized

 

Estimated

 

 

 

cost

 

fair value

 

Indemnity

 

 

 

 

 

Due in one year or less

 

$   154

 

$   154

 

Due after one year through five years

 

220

 

224

 

Due after five years through ten years

 

54

 

57

 

Due after ten years

 

88

 

90

 

Total fixed maturities – Indemnity

 

$   516

 

$   525

 

Exchange

 

 

 

 

 

Due in one year or less

 

$   392

 

$   401

 

Due after one year through five years

 

2,469

 

2,622

 

Due after five years through ten years

 

2,798

 

3,019

 

Due after ten years

 

1,270

 

1,338

 

Total fixed maturities – Exchange

 

$6,929

 

$7,380

 

Total fixed maturities – Erie Insurance Group

 

$7,445

 

$7,905

 

 

Fixed maturities and equity securities in a gross unrealized loss position at June 30, 2011 are as follows for Indemnity.  Data is provided by length of time securities were in a gross unrealized loss position.

 

 

 

Erie Insurance Group

 

 

 

June 30, 2011

 

(dollars in millions)

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

No. of

 

Indemnity

 

value

 

losses

 

value

 

losses

 

value

 

losses

 

holdings

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

States & political subdivisions

 

$  24

 

$0

 

$0

 

$0

 

$  24

 

$0

 

11

 

Corporate debt securities

 

78

 

0

 

0

 

0

 

78

 

0

 

12

 

Other debt securities

 

5

 

0

 

0

 

0

 

5

 

0

 

1

 

Commercial mortgage-backed securities (CMBS)

 

24

 

0

 

0

 

0

 

24

 

0

 

4

 

Total fixed maturities – Indemnity

 

131

 

0

 

0

 

0

 

131

 

0

 

28

 

Nonredeemable preferred stock

 

3

 

0

 

0

 

0

 

3

 

0

 

1

 

Total available-for-sale-securities – Indemnity

 

$134

 

$0

 

$0

 

$0

 

$134

 

$0

 

29

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quality breakdown of fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade

 

$131

 

$0

 

$0

 

$0

 

$131

 

$0

 

28

 

Non-investment grade

 

0

 

0

 

0

 

0

 

0

 

0

 

0

 

Total fixed maturities – Indemnity

 

$131

 

$0

 

$0

 

$0

 

$131

 

$0

 

28

 

 

23



 

Fixed maturities and equity securities in a gross unrealized loss position at June 30, 2011 are as follows for the Exchange.  Data is provided by length of time securities were in a gross unrealized loss position.

 

 

 

Erie Insurance Group

 

 

 

June 30, 2011

 

(dollars in millions)

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

No. of

 

Exchange

 

value

 

losses

 

value

 

losses

 

value

 

losses

 

holdings

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government & agencies

 

$  25

 

$0

 

$    0

 

$0

 

$    25

 

$  0

 

3

 

States & political subdivisions

 

122

 

2

 

4

 

1

 

126

 

3

 

28

 

Corporate debt securities

 

362

 

4

 

57

 

2

 

419

 

6

 

75

 

Residential mortgage-backed securities (RMBS)

 

13

 

0

 

3

 

0

 

16

 

0

 

4

 

Commercial mortgage-backed securities (CMBS)

 

5

 

0

 

1

 

0

 

6

 

0

 

2

 

Collateralized debt obligations (CDO)

 

0

 

0

 

32

 

5

 

32

 

5

 

5

 

Total fixed maturities – Exchange

 

527

 

6

 

97

 

8

 

624

 

14

 

117

 

Nonredeemable preferred stock

 

53

 

1

 

20

 

1

 

73

 

2

 

12

 

Total available-for-sale-securities – Exchange

 

$580

 

$7

 

$117

 

$9

 

$697

 

$16

 

129

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quality breakdown of fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade

 

$498

 

$6

 

$  85

 

$7

 

$583

 

$13

 

105

 

Non-investment grade

 

29

 

0

 

12

 

1

 

41

 

1

 

12

 

Total fixed maturities – Exchange

 

$527

 

$6

 

$  97

 

$8

 

$624

 

$14

 

117

 

 

The above securities for Indemnity and the Exchange have been evaluated and determined to be temporary impairments for which we expect to recover our entire principal plus interest.  The primary components of this analysis are a general review of market conditions and financial performance of the issuer along with the extent and duration of which fair value is less than cost.  Any debt securities that we intend to sell or will more likely than not be required to sell before recovery are included in other-than-temporary impairments with the impairment charges recognized in earnings.

 

Fixed maturities and equity securities in a gross unrealized loss position at December 31, 2010 are as follows for Indemnity.  Data is provided by length of time securities were in a gross unrealized loss position.

 

 

 

Erie Insurance Group

 

 

 

December 31, 2010

 

(dollars in millions)

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

No. of

 

Indemnity

 

value

 

losses

 

value

 

losses

 

value

 

losses

 

holdings

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government & agencies

 

$25

 

$0

 

$0

 

$0

 

$25

 

$0

 

1

 

States & political subdivisions

 

39

 

2

 

1

 

0

 

40

 

2

 

20

 

Corporate debt securities

 

31

 

0

 

0

 

0

 

31

 

0

 

3

 

Total fixed maturities – Indemnity

 

95

 

2

 

1

 

0

 

96

 

2

 

24

 

Nonredeemable preferred stock

 

3

 

0

 

0

 

0

 

3

 

0

 

1

 

Total available-for-sale-securities – Indemnity

 

$98

 

$2

 

$1

 

$0

 

$99

 

$2

 

25

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quality breakdown of fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade

 

$95

 

$2

 

$1

 

$0

 

$96

 

$2

 

24

 

Non-investment grade

 

0

 

0

 

0

 

0

 

0

 

0

 

0

 

Total fixed maturities – Indemnity

 

$95

 

$2

 

$1

 

$0

 

$96

 

$2

 

24

 

 

24



 

Fixed maturities and equity securities in a gross unrealized loss position at December 31, 2010 are as follows for the Exchange.  Data is provided by length of time securities were in a gross unrealized loss position.

 

 

 

Erie Insurance Group

 

 

 

December 31, 2010

 

(dollars in millions)

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

No. of

 

Exchange

 

value

 

losses

 

value

 

losses

 

value

 

losses

 

holdings

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government & agencies

 

$  22

 

$  0

 

$   0

 

$  0

 

$     22

 

$  0

 

3

 

States & political subdivisions

 

299

 

8

 

5

 

1

 

304

 

9

 

59

 

Foreign government securities

 

10

 

0

 

0

 

0

 

10

 

0

 

1

 

Corporate debt securities

 

398

 

8

 

144

 

6

 

542

 

14

 

101

 

Residential mortgage-backed securities (RMBS)

 

6

 

0

 

7

 

1

 

13

 

1

 

4

 

Commercial mortgage-backed securities (CMBS)

 

0

 

0

 

12

 

1

 

12

 

1

 

2

 

Collateralized debt obligations (CDO)

 

1

 

0

 

33

 

5

 

34

 

5

 

6

 

Total fixed maturities – Exchange

 

736

 

16

 

201

 

14

 

937

 

30

 

176

 

Nonredeemable preferred stock

 

45

 

2

 

59

 

5

 

104

 

7

 

15

 

Total available-for-sale-securities – Exchange

 

$781

 

$18

 

$260

 

$19

 

$1,041

 

$37

 

191

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quality breakdown of fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade

 

$703

 

$16

 

$155

 

$11

 

$  858

 

$27

 

154

 

Non-investment grade

 

33

 

0

 

46

 

3

 

79

 

3

 

22

 

Total fixed maturities – Exchange

 

$736

 

$16

 

$201

 

$14

 

$  937

 

$30

 

176

 

 

Investment income, net of expenses, was generated from the following portfolios:

 

 

 

Erie Insurance Group

 

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

(in millions)

 

2011

 

2010

 

2011

 

2010

 

Indemnity

 

 

 

 

 

 

 

 

 

Fixed maturities

 

$    4

 

$    9

 

$    7

 

$  17

 

Equity securities

 

0

 

1

 

1

 

2

 

Cash equivalents and other

 

1

 

0

 

1

 

0

 

Total investment income

 

5

 

10

 

9

 

19

 

Less: investment expenses

 

1

 

1

 

1

 

1

 

Investment income, net of expenses – Indemnity

 

$    4

 

$    9

 

$    8

 

$  18

 

Exchange

 

 

 

 

 

 

 

 

 

Fixed maturities

 

$  92

 

$  87

 

$184

 

$173

 

Equity securities

 

24

 

18

 

42

 

34

 

Cash equivalents and other

 

0

 

0

 

0

 

0

 

Total investment income

 

116

 

105

 

226

 

207

 

Less: investment expenses

 

7

 

6

 

16

 

13

 

Investment income, net of expenses – Exchange

 

$109

 

$  99

 

$210

 

$194

 

Investment income, net of expenses – Erie Insurance Group

 

$113

 

$108

 

$218

 

$212

 

 

Dividend income is recognized as earned and recorded to net investment income.

 

25



 

Realized gains (losses) on Indemnity’s investments were as follows:

 

 

 

Erie Insurance Group

 

(in millions)

 

Three months ended
June 30,

 

Six months ended
June 30,

 

Indemnity

 

2011

 

2010

 

2011

 

2010

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

Gross realized gains

 

$2

 

$  1

 

$2

 

$  3

 

Gross realized losses

 

0

 

0

 

0

 

0

 

Net realized gains

 

2

 

1

 

2

 

3

 

Equity securities:

 

 

 

 

 

 

 

 

 

Gross realized gains

 

2

 

1

 

3

 

1

 

Gross realized losses

 

0

 

(1)

 

0

 

(1)

 

Net realized gains

 

2

 

0

 

3

 

0

 

Trading securities:

 

 

 

 

 

 

 

 

 

Common stock:

 

 

 

 

 

 

 

 

 

Gross realized gains

 

1

 

0

 

2

 

1

 

Gross realized losses

 

0

 

0

 

0

 

0

 

Valuation adjustments

 

1

 

(4)

 

0

 

(2)

 

Net realized gains (losses)

 

2

 

(4)

 

2

 

(1)

 

Net realized gains (losses) on investments – Indemnity

 

$6

 

$(3)

 

$7

 

$  2

 

 

Realized gains (losses) on the Exchange’s investments were as follows:

 

 

 

Erie Insurance Group

 

(in millions)

 

Three months ended
June 30,

 

Six months ended
June 30,

 

Exchange

 

2011

 

2010

 

2011

 

2010

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

Gross realized gains

 

$  26

 

$      7

 

$  51

 

$   28

 

Gross realized losses

 

(5)

 

(3)

 

(17)

 

(12)

 

Net realized gains

 

21

 

4

 

34

 

16

 

Equity securities:

 

 

 

 

 

 

 

 

 

Gross realized gains

 

10

 

3

 

16

 

7

 

Gross realized losses

 

0

 

(1)

 

(1)

 

(1)

 

Net realized gains

 

10

 

2

 

15

 

6

 

Trading securities:

 

 

 

 

 

 

 

 

 

Common stock:

 

 

 

 

 

 

 

 

 

Gross realized gains

 

71

 

44

 

127

 

89

 

Gross realized losses

 

(16)

 

(18)

 

(24)

 

(30)

 

Valuation adjustments

 

(53)

 

(242)

 

29

 

(171)

 

Net realized gains (losses)

 

2

 

(216)

 

132

 

(112)

 

Net realized gains (losses) on investments – Exchange

 

$  33

 

$(210)

 

$181

 

$ (90)

 

Net realized gains (losses) on investments – Erie Insurance Group

 

$  39

 

$(213)

 

$188

 

$ (88)

 

 

26



 

The components of other-than-temporary impairments on investments are included below.

 

 

 

Erie Insurance Group

 

(in millions)

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Indemnity

 

 

 

 

 

 

 

 

 

Fixed maturities

 

$0

 

$(1)

 

$0

 

$(1)

 

Equity securities

 

0

 

0

 

0

 

0

 

Total

 

0

 

(1)

 

0

 

(1)

 

Portion recognized in other comprehensive income

 

0

 

0

 

0

 

0

 

Net impairment losses recognized in earnings – Indemnity

 

$0

 

$(1)

 

$0

 

$(1)

 

Exchange

 

 

 

 

 

 

 

 

 

Fixed maturities

 

$0

 

$(2)

 

$0

 

$(4)

 

Equity securities

 

0

 

(1)

 

0

 

(1)

 

Total

 

0

 

(3)

 

0

 

(5)

 

Portion recognized in other comprehensive income

 

0

 

0

 

0

 

0

 

Net impairment losses recognized in earnings – Exchange

 

$0

 

$(3)

 

$0

 

$(5)

 

Net impairment losses recognized in earnings – Erie Insurance Group

 

$0

 

$(4)

 

$0

 

$(6)

 

 

In considering if fixed maturity securities were credit-impaired, some of the factors considered include: potential for the default of interest and/or principal, level of subordination, collateral of the issue, compliance with financial covenants, credit ratings and industry conditions.  We have the intent to sell all credit-impaired fixed maturity securities, therefore the entire amount of the impairment charges were included in earnings and no non-credit impairments were recognized in other comprehensive income.

 

Limited partnerships

Our limited partnership investments are recorded using the equity method of accounting.  As these investments are generally reported on a one-quarter lag, our limited partnership results through June 30, 2011 are comprised of partnership financial results for the first quarter of 2011.  Given the lag in reporting, our limited partnership results do not reflect the market conditions of the second quarter of 2011.  Cash contributions made to and distributions received from the partnerships are recorded in the period in which the transaction occurs.

 

We have provided summarized financial information in the following table for the six months ended June 30, 2011 and for the year ended December 31, 2010.  Amounts provided in the table are presented using the latest available financial statements received from the partnerships.  Limited partnership financial information has been presented based on the investment percentage in the partnerships for the Erie Insurance Group consistent with how management evaluates the investments.

 

27



 

As these investments are generally reported on a one-quarter lag, our limited partnership results through June 30, 2011 include the partnership financial results for the fourth quarter of 2010 and first quarter of 2011.

 

 

 

As of and for the six months ended June 30, 2011

 

(dollars in millions)

 

 

 

 

 

Income (loss)
recognized
due to
valuation

 

 

 

Investment percentage in partnership
for Erie Insurance Group

 

Number of
partnerships

 

Asset
recorded

 

adjustments
by the
partnerships

 

Income
(1oss)
recorded

 

Indemnity

 

 

 

 

 

 

 

 

 

Private equity:

 

 

 

 

 

 

 

 

 

Less than 10%

 

26

 

$    82

 

$  7

 

$  3

 

Greater than or equal to 10% but less than 50%

 

3

 

8

 

(2)

 

3

 

Greater than 50%

 

0

 

0

 

0

 

0

 

Total private equity

 

29

 

90

 

5

 

6

 

Mezzanine debt:

 

 

 

 

 

 

 

 

 

Less than 10%

 

11

 

27

 

(1)

 

3

 

Greater than or equal to 10% but less than 50%

 

3

 

15

 

1

 

0

 

Greater than 50%

 

1

 

2

 

0

 

0

 

Total mezzanine debt

 

15

 

44

 

0

 

3

 

Real estate:

 

 

 

 

 

 

 

 

 

Less than 10%

 

12

 

60

 

2

 

0

 

Greater than or equal to 10% but less than 50%

 

3

 

19

 

1

 

0

 

Greater than 50%

 

4

 

11

 

2

 

(1)

 

Total real estate

 

19

 

90

 

5

 

(1)

 

Total limited partnerships – Indemnity

 

63

 

$  224

 

$10

 

$  8

 

 

 

 

 

 

 

 

 

 

 

Exchange

 

 

 

 

 

 

 

 

 

Private equity:

 

 

 

 

 

 

 

 

 

Less than 10%

 

41

 

$  547

 

$28

 

$25

 

Greater than or equal to 10% but less than 50%

 

3

 

38

 

(7)

 

11

 

Greater than 50%

 

0

 

0

 

0

 

0

 

Total private equity

 

44

 

585

 

21

 

36

 

Mezzanine debt:

 

 

 

 

 

 

 

 

 

Less than 10%

 

16

 

135

 

(2)

 

14

 

Greater than or equal to 10% but less than 50%

 

3

 

41

 

2

 

1

 

Greater than 50%

 

3

 

32

 

(1)

 

1

 

Total mezzanine debt

 

22

 

208

 

(1)

 

16

 

Real estate:

 

 

 

 

 

 

 

 

 

Less than 10%

 

25

 

270

 

17

 

(2)

 

Greater than or equal to 10% but less than 50%

 

5

 

63

 

1

 

0

 

Greater than 50%

 

4

 

40

 

(1)

 

5

 

Total real estate

 

34

 

373

 

17

 

3

 

Total limited partnerships – Exchange

 

100

 

$1,166

 

$37

 

$55

 

Total limited partnerships – Erie Insurance Group

 

 

 

$1,390

 

$47

 

$63

 

 

Per the limited partner financial statements, total partnership assets were $54 billion and total partnership liabilities were $5 billion at June 30, 2011 (as recorded in the March 31, 2011 limited partnership financial statements).  For the six month period comparable to that presented in the preceding table (fourth quarter 2010 and first quarter of 2011), total partnership valuation adjustment gains were $4 billion and total partnership net income was $2 billion.

 

28



 

As these investments are generally reported on a one-quarter lag, our limited partnership results through
December 31, 2010 include the partnership results for the fourth quarter of 2009 and the first three quarters of 2010.

 

 

 

As of and for the year ended December 31, 2010

 

(dollars in millions)

 

 

 

 

 

Income (loss)
recognized
due to
valuation

 

 

 

Investment percentage in partnership
for Erie Insurance Group

 

Number of
partnerships

 

Asset
recorded

 

adjustments
by the
partnerships

 

Income
(1oss)
recorded

 

Indemnity

 

 

 

 

 

 

 

 

 

Private equity:

 

 

 

 

 

 

 

 

 

Less than 10%

 

26

 

$    78

 

$    4

 

$    7

 

Greater than or equal to 10% but less than 50%

 

3

 

8

 

3

 

0

 

Greater than 50%

 

0

 

0

 

0

 

0

 

Total private equity

 

29

 

86

 

7

 

7

 

Mezzanine debt:

 

 

 

 

 

 

 

 

 

Less than 10%

 

11

 

30

 

4

 

3

 

Greater than or equal to 10% but less than 50%

 

3

 

15

 

2

 

(2)

 

Greater than 50%

 

1

 

2

 

0

 

0

 

Total mezzanine debt

 

15

 

47

 

6

 

1

 

Real estate:

 

 

 

 

 

 

 

 

 

Less than 10%

 

12

 

59

 

30

 

(31)

 

Greater than or equal to 10% but less than 50%

 

4

 

14

 

10

 

(10)

 

Greater than 50%

 

4

 

10

 

4

 

(3)

 

Total real estate

 

20

 

83

 

44

 

(44)

 

Total limited partnerships – Indemnity

 

64

 

$  216

 

$  57

 

$(36)

 

 

 

 

 

 

 

 

 

 

 

Exchange

 

 

 

 

 

 

 

 

 

Private equity:

 

 

 

 

 

 

 

 

 

Less than 10%

 

41

 

$  517

 

$  28

 

$  40

 

Greater than or equal to 10% but less than 50%

 

3

 

38

 

10

 

0

 

Greater than 50%

 

0

 

0

 

0

 

(1)

 

Total private equity

 

44

 

555

 

38

 

39

 

Mezzanine debt:

 

 

 

 

 

 

 

 

 

Less than 10%

 

14

 

142

 

12

 

13

 

Greater than or equal to 10% but less than 50%

 

3

 

41

 

2

 

(2)

 

Greater than 50%

 

3

 

31

 

0

 

2

 

Total mezzanine debt

 

20

 

214

 

14

 

13

 

Real estate:

 

 

 

 

 

 

 

 

 

Less than 10%

 

25

 

250

 

(11)

 

10

 

Greater than or equal to 10% but less than 50%

 

6

 

52

 

7

 

(7)

 

Greater than 50%

 

4

 

37

 

15

 

(11)

 

Total real estate

 

35

 

339

 

11

 

(8)

 

Total limited partnerships – Exchange

 

99

 

$1,108

 

$  63

 

$ 44

 

Total limited partnerships – Erie Insurance Group

 

 

 

$1,324

 

$120

 

$   8

 

 

Per the limited partner financial statements, total partnership assets were $58 billion and total partnership liabilities were $10 billion at December 31, 2010 (as recorded in the September 30, 2010 limited partnership financial statements).  For the twelve month period comparable to that presented in the preceding table (fourth quarter of 2009 and first three quarters of 2010), total partnership valuation adjustment gains were $4 billion and total partnership net income was $3 billion.

 

See also Note 12, “Commitments and Contingencies,” for investment commitments related to limited partnerships.

 

29



 

Note 8.  Bank Line of Credit

 

As of June 30, 2011, Indemnity has available a $100 million line of credit that expires on December 31, 2011.  There were no borrowings outstanding on the line of credit as of June 30, 2011.  Bonds with a fair value of $135 million are pledged as collateral on the line at June 30, 2011.

 

As of June 30, 2011, the Exchange has available a $200 million revolving line of credit that expires on September 30, 2012.  There were no borrowings outstanding on the line of credit as of June 30, 2011.  Bonds with a fair value of $263 million are pledged as collateral on the line at June 30, 2011.

 

Securities pledged as collateral on both lines have no restrictions and are reported as available-for-sale fixed maturities in the Consolidated Statements of Financial Position as of June 30, 2011.  The banks require compliance with certain covenants, which include statutory surplus and risk based capital ratios for the Exchange’s line of credit and minimum net worth and leverage ratios for Indemnity’s line of credit.  We are in compliance with all covenants at June 30, 2011.

 

Note 9.  Income Taxes

 

Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the financial statement or tax returns.  Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.  At June 30, 2011, we recorded a net deferred tax liability of $251 million on our Consolidated Statements of Financial Position.  Of this amount, $250 million is attributable to the Exchange and $1 million is attributable to Indemnity.  There was no deferred tax valuation allowance recorded at June 30, 2011.  Our effective tax rate is calculated after consideration of permanent differences related to our investment revenues.  Given that these amounts represent 99% of the total permanent differences, the effective tax rate is approximately 35% for both Indemnity and Exchange when the investment related permanent differences are considered.

 

Note 10.   Postretirement Benefits

 

The liabilities for the plans described in this note are presented in total for all employees of the Erie Insurance Group.  The gross liability for the pension plans is presented in the Consolidated Statements of Financial Position as part of other liabilities.  A portion of annual expenses related to the pension plans is allocated to related entities within the Erie Insurance Group.

 

We offer a noncontributory defined benefit pension plan that covers substantially all employees.  This is the largest benefit plan we offer.  We also offer an unfunded supplemental retirement plan (SERP) for certain members of executive and senior management of the Erie Insurance Group.  The components of net periodic benefit cost for our pension benefits are:

 

(in millions)

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Service cost

 

$ 5

 

$ 4

 

$  9

 

$  8

 

Interest cost

 

5

 

5

 

11

 

10

 

Expected return on plan assets

 

(6)

 

(7)

 

(13)

 

(13)

 

Amortization of prior service cost

 

0

 

0

 

0

 

0

 

Amortization of actuarial loss

 

1

 

1

 

3

 

2

 

Net periodic benefit cost

 

$ 5

 

$ 3

 

$  10

 

$  7

 

 

30



 

Note 11.  Reconciliation of Shareholders’ Equity

 

A reconciliation of shareholders’ equity follows for the year-to-date December 31, 2010 and June 30, 2011:

 

(in millions, except per share data)

 

Indemnity
shareholders’

 

Exchange
noncontrolling

 

 Erie
 Insurance

 

 

 

 

interest

 

 

interest 

 

 

Group 

 

 

Balance at December 31, 2009

 

 

$902

 

 

$4,823

 

 

$5,725

 

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

162

 

 

498

 

 

660

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains on securities

 

 

9

 

 

101

 

 

110

 

 

Reclassification of unrealized gain on sale of P&C affiliated subsidiaries

 

 

(15

)

 

 

 

(15

)

 

Postretirement plans:

 

 

 

 

 

 

 

 

 

 

 

Amortization of prior service cost

 

 

0

 

 

 

 

0

 

 

Amortization of net actuarial loss

 

 

2

 

 

 

 

2

 

 

Net actuarial loss during year

 

 

(6

)

 

 

 

(6

)

 

Loss due to plan changes during year

 

 

0

 

 

 

 

0

 

 

Curtailment/settlement loss arising during year

 

 

0

 

 

 

 

0

 

 

Postretirement plans

 

 

(4

)

 

 

 

(4

)

 

Other comprehensive (loss) income, net of tax

 

 

(10

)

 

101

 

 

91

 

 

Reclassification of unrealized gain on sale of P&C affiliated subsidiaries, net of tax

 

 

15

 

 

 

 

15

 

 

Comprehensive income

 

 

167

 

 

599

 

 

766

 

 

Purchase of treasury stock

 

 

(58

)

 

 

 

(58

)

 

Dividends declared:

 

 

 

 

 

 

 

 

 

 

 

Class A $1.995 per share

 

 

(99

)

 

 

 

(99

)

 

Class B $293.25 per share

 

 

0

 

 

 

 

0

 

 

Balance at December 31, 2010

 

 

$912

 

 

$5,422

 

 

$6,334

 

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

96

 

 

71

 

 

167

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

Unrealized (loss) gains on securities

 

 

(1

)

 

23

 

 

22

 

 

Reclassification of unrealized gain on sale of EFL

 

 

(9

)

 

 

 

(9

)

 

Other comprehensive (loss) income, net of tax

 

 

(10

)

 

23

 

 

13

 

 

Reclassification of unrealized gain on sale of EFL, net of tax

 

 

9

 

 

 

 

9

 

 

Comprehensive income

 

 

95

 

 

94

 

 

189

 

 

Purchase of treasury stock

 

 

(90

)

 

 

 

(90

)

 

Dividends declared:

 

 

 

 

 

 

 

 

 

 

 

Class A - $1.03 per share

 

 

(51

)

 

 

 

(51

)

 

Class B - $154.50 per share

 

 

0

 

 

 

 

0

 

 

Balance at June 30, 2011

 

 

$866

 

 

$5,516

 

 

$6,382

 

 

 

31



 

Note 12.  Commitments and Contingencies

 

Indemnity has contractual commitments to invest up to $43 million related to its limited partnership investments at June 30, 2011.  These commitments are split between private equity securities of $18 million, real estate activities of $13 million and mezzanine debt securities of $12 million.  These commitments will be funded as required by the partnership agreements.

 

The Exchange, including EFL, has contractual commitments to invest up to $434 million related to its limited partnership investments at June 30, 2011.  These commitments are split between private equity securities of $193 million, real estate activities of $117 million and mezzanine debt securities of $124 million.  These commitments will be funded as required by the partnership agreements.

 

We are involved in litigation arising in the ordinary course of conducting business.  In accordance with current accounting standards for loss contingencies and based upon information currently known to us, we establish reserves for litigation when it is probable that a loss associated with a claim or proceeding has been incurred and the amount of the loss or range of loss can be reasonably estimated. When no amount within the range of loss is a better estimate than any other amount, we accrue the minimum amount of the estimable loss.  To the extent that such litigation against us may have an exposure to a loss in excess of the amount we have accrued, we believe that such excess would not be material to our consolidated financial condition, operations or cash flows.  We believe that our accruals for legal proceedings are appropriate and, individually and in the aggregate, are not expected to be material to our consolidated financial condition, operations or cash flows.

 

For certain legal proceedings, we cannot reasonably estimate losses or a range of loss, particularly for proceedings that are in their early stages of development or where the plaintiffs seek indeterminate damages.  Various factors, including, but not limited to, the outcome of potentially lengthy discovery and the resolution of important factual questions, may need to be determined before probability can be established or before a loss or range of loss can be reasonably estimated.  If the loss contingency in question is not both probable and reasonably estimable, we do not establish an accrual and the matter will continue to be monitored for any developments that would make the loss contingency both probable and reasonably estimable.  The outcome of this pending litigation is uncertain, but in our opinion the outcome of each case, individually and in the aggregate, is not expected to be material to our consolidated financial condition, operations or cash flows.  We review all litigation on an ongoing basis when making accrual and disclosure decisions.

 

 

Note 13.  Statutory Information

 

Cash and securities with a carrying value of $14 million were deposited by the property and casualty and life entities with regulatory authorities under statutory requirements at both June 30, 2011 and December 31, 2010.

 

32



 

Note 14.  Indemnity Supplemental Information

 

 

 

 

Consolidating Statement of Financial Position

 

 

 

 

June 30, 2011

 

 

 

 

Indemnity

 

Exchange

 

Reclassifications

 

Erie

 

(in millions)

 

 

shareholder

 

noncontrolling

 

and

 

Insurance

 

 

 

 

interest

 

interest

 

eliminations

 

Group

 

Assets

 

 

 

 

 

 

 

 

 

 

Investments

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities, at fair value:

 

 

 

 

 

 

 

 

 

 

Fixed maturities

 

 

$   525

 

$  7,380

 

$     –

 

 

$  7,905

 

Equity securities

 

 

20

 

610

 

 

 

630

 

Trading securities, at fair value

 

 

30

 

2,513

 

 

 

2,543

 

Limited partnerships

 

 

224

 

1,166

 

 

 

1,390

 

Other invested assets

 

 

1

 

19

 

 

 

20

 

Total investments

 

 

800

 

11,688

 

 

 

12,488

 

Cash and cash equivalents

 

 

48

 

61

 

 

 

109

 

Premiums receivable from policyholders

 

 

 

1,017

 

 

 

1,017

 

Reinsurance recoverable

 

 

 

198

 

 

 

198

 

Deferred acquisition costs

 

 

 

484

 

 

 

484

 

Other assets

 

 

111

 

316

 

 

 

427

 

Receivables from Exchange and other affiliates

 

 

265

 

 

(265

)

 

 

Note receivable from EFL

 

 

25

 

 

(25

)

 

 

Total assets

 

 

$1,249

 

$13,764

 

$(290

)

 

$14,723

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Losses and loss expense reserves

 

 

$      –

 

$  3,791

 

$     –

 

 

$  3,791

 

Life policy and deposit contract reserves

 

 

 

1,637

 

 

 

1,637

 

Unearned premiums

 

 

 

2,196

 

 

 

2,196

 

Deferred income taxes

 

 

1

 

250

 

 

 

251

 

Other liabilities

 

 

382

 

374

 

(290

)

 

466

 

Total liabilities

 

 

383

 

8,248

 

(290

)

 

8,341

 

Shareholders’ equity and noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 

Total Indemnity shareholders’ equity

 

 

866

 

 

 

 

866

 

Noncontrolling interest in consolidated entity – Exchange

 

 

 

5,516

 

 

 

5,516

 

Total equity

 

 

866

 

5,516

 

 

 

6,382

 

Total liabilities, shareholders’ equity and noncontrolling interest

 

 

$1,249

 

$13,764

 

$(290

)

 

$14,723

 

 

33



 

 

 

 

Consolidating Statement of Financial Position

 

 

 

December 31, 2010

 

 

 

Indemnity

 

Exchange

 

Reclassifications

 

Erie

(in millions)

 

 

shareholder

 

noncontrolling

 

and

 

Insurance

 

 

 

interest

 

interest

 

eliminations

 

Group

Assets

 

 

 

 

 

 

 

 

 

 

Investments

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities, at fair value:

 

 

 

 

 

 

 

 

 

 

Fixed maturities

 

 

$   264

 

$  7,279

 

$     –

 

 

$  7,543

 

Equity securities

 

 

24

 

570

 

 

 

594

 

Trading securities, at fair value

 

 

28

 

2,306

 

 

 

2,334

 

Limited partnerships

 

 

216

 

1,108

 

 

 

1,324

 

Other invested assets

 

 

1

 

19

 

 

 

20

 

Total investments

 

 

533

 

11,282

 

 

 

11,815

 

Cash and cash equivalents

 

 

310

 

120

 

 

 

430

 

Premiums receivable from policyholders

 

 

 

942

 

 

 

942

 

Reinsurance recoverable

 

 

 

201

 

 

 

201

 

Deferred acquisition costs

 

 

 

467

 

 

 

467

 

Other assets

 

 

132

 

357

 

 

 

489

 

Receivables from Exchange and other affiliates

 

 

232

 

 

(232

)

 

 

Note receivable from EFL

 

 

25

 

 

(25

)

 

 

Equity in EFL (1)

 

 

80

 

 

(80

)

 

 

Total assets

 

 

$1,312

 

$13,369

 

$(337

)

 

$14,344

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Losses and loss expense reserves

 

 

$       –

 

$  3,584

 

$     –

 

 

$  3,584

 

Life policy and deposit contract reserves

 

 

 

1,603

 

 

 

1,603

 

Unearned premiums

 

 

 

2,082

 

 

 

2,082

 

Deferred income taxes

 

 

26

 

257

 

 

 

283

 

Other liabilities

 

 

374

 

341

 

(257

)

 

458

 

Total liabilities

 

 

400

 

7,867

 

(257

)

 

8,010

 

Shareholders’ equity and noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 

Total Indemnity shareholders’ equity

 

 

912

 

 

 

 

912

 

Noncontrolling interest in consolidated entity – Exchange

 

 

 

5,502

 

(80

)

 

5,422

 

Total equity

 

 

912

 

5,502

 

(80

)

 

6,334

 

Total liabilities, shareholders’ equity and noncontrolling interest

 

 

$1,312

 

$13,369

 

$(337

)

 

$14,344

 

 

(1)          On March 31, 2011, Indemnity sold its 21.6% ownership interest in EFL to the Exchange. (See Note 1, “Nature of Operations”.)

 

 

Note receivable from EFL

Indemnity is due $25 million from EFL in the form of a surplus note that was issued in 2003.  The note may be repaid only out of unassigned surplus of EFL.  Both principal and interest payments are subject to prior approval by the Pennsylvania Insurance Commissioner.  The note bears an annual interest rate of 6.7% and will be payable on demand on or after December 31, 2018, with interest scheduled to be paid semi-annually, subject to prior approval by the Pennsylvania Insurance Commissioner.  EFL accrued interest to Indemnity of $0.4 million in each of the second quarters ended June 30, 2011 and 2010.

 

34



 

(in millions)

 

Income
attributable to
Indemnity shareholder interest

 

 

 

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

Percent

 

2011

 

2010

 

2011

 

2010

 

Management operations:

 

 

 

 

 

 

 

 

 

 

 

Management fee revenue, net

 

100.0%

 

$285

 

$270

 

$536

 

$507

 

Service agreement revenue

 

100.0%

 

9

 

9

 

17

 

17

 

Total revenue from management operations

 

 

 

294

 

279

 

553

 

524

 

Cost of management operations

 

100.0%

 

230

 

217

 

441

 

409

 

Income from management operations before taxes

 

 

 

64

 

62

 

112

 

115

 

Property and casualty insurance operations: (2)

 

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

5.5%

 (2)

 

53

 

 

106

 

Losses and loss expenses

 

5.5%

 (2)

 

40

 

 

80

 

Policy acquisition and other underwriting expenses

 

5.5%

 (2)

 

15

 

 

30

 

Loss from property and casualty insurance operations before taxes

 

 

 

 

(2

)

 

(4

)

Life insurance operations: (1)

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

21.6%

 (3)

 

9

 

10

 

18

 

Total benefits and expenses

 

21.6%

 (3)

 

6

 

7

 

13

 

Income from life insurance operations before taxes

 

 

 

 

3

 

3

 

5

 

Investment operations:

 

 

 

 

 

 

 

 

 

 

 

Net investment income (2)

 

 

 

4

 

9

 

8

 

18

 

Net realized gains (losses) on investments (2)

 

 

 

6

 

(3

)

7

 

2

 

Net impairment losses recognized in earnings (2)

 

 

 

0

 

(1

)

0

 

(1

)

Equity in earnings of limited partnerships

 

 

 

7

 

6

 

18

 

6

 

Income from investment operations before taxes (2)

 

 

 

17

 

11

 

33

 

25

 

Income from operations before income taxes

 

 

 

81

 

74

 

148

 

141

 

Provision for income taxes

 

 

 

29

 

25

 

52

 

45

 

Net income

 

 

 

$  52

 

$  49

 

$  96

 

$  96

 

 

(1)          Earnings on life insurance related invested assets are integral to the evaluation of the life insurance operations because of the long duration of life products. On that basis, for presentation purposes, the life insurance operations in the table above include life insurance related investment results. However, the life insurance investment results are included in the investment operations segment discussion in Note 5, “Segment Information”.

 

(2)          Prior to and through December 31, 2010, the underwriting results retained by EIC and ENY and the investment results of EIC, ENY and EPC accrued to the Indemnity shareholder interest. Due to the sale of Indemnity’s property and casualty subsidiaries to the Exchange on December 31, 2010, all property and casualty underwriting results and all investment results for these companies accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after December 31, 2010. (See Note 1, “Nature of Operations”.)

 

(3)          Prior to and through March 31, 2011, Indemnity retained a 21.6% ownership interest in EFL, which accrued to the Indemnity shareholder interest, and the Exchange retained a 78.4% ownership interest in EFL, which accrued to the interest of the subscribers (policyholders) of the Exchange or noncontrolling interest. Due to the sale of Indemnity’s 21.6% ownership interest in EFL to the Exchange on March 31, 2011, 100% of the life insurance results of EFL accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after March 31, 2011. (See Note 1, “Nature of Operations”.)

 

35



 

Direct method of cash flows

Indemnity’s components of direct cash flows as presented in the Consolidated Statements of Cash Flows are as follows for the six months ended June 30:

 

 

 

Indemnity

 

(in millions)

 

Six months ended
June 30,

 

 

 

2011

 

2010

 

Management fee received

 

$

521

 

$

467

 

Service agreement fee received

 

17

 

17

 

Premiums collected (1)

 

 

109

 

Net investment income received (1)

 

13

 

23

 

Limited partnership distributions

 

10

 

7

 

Decrease in reimbursements collected from affiliates

 

(18

)

(11

)

Commissions and bonuses paid to agents

 

(313

)

(290

)

Salaries and wages paid

 

(62

)

(56

)

Employee benefits paid

 

(11

)

(20

)

Losses paid (1)

 

 

(67

)

Loss expenses paid (1)

 

 

(11

)

Other underwriting and acquisition costs paid (1)

 

 

(30

)

General operating expenses paid

 

(68

)

(59

)

Income taxes paid

 

(28

)

(37

)

Net cash provided by operating activities

 

61

 

42

 

Net cash used in investing activities

 

(181

)

(17

)

Net cash used in financing activities

 

(142

)

(67

)

Net decrease in cash

 

(262

)

(42

)

Cash and cash equivalents at beginning of period

 

310

 

76

 

Cash and cash equivalents at end of period

 

$

48

 

$

34

 

 

(1)          Prior to and through December 31, 2010, the underwriting results retained by EIC and ENY and the investment results of EIC, ENY and EPC accrued to the Indemnity shareholder interest. Due to the sale of Indemnity’s property and casualty subsidiaries to the Exchange on December 31, 2010, all property and casualty underwriting results and all investment results for these companies accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after December 31, 2010. (See Note 1, “Nature of Operations”.)

 

 

Note 15.  Capital Stock

 

Stock repurchase program

In December 2010, our Board of Directors approved a continuation of the current stock repurchase program for a total of $150 million, with no time limitation.  Indemnity had approximately $56 million of repurchase authority remaining under this program at June 30, 2011.

 

 

Note 16.  Subsequent Events

 

We have evaluated for recognized and nonrecognized subsequent events through the date of financial statement issuance.  No items were identified in this period subsequent to the financial statement date that required adjustment or disclosure.

 

36



 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion of financial condition and results of operations highlights significant factors influencing the Erie Insurance Group (“we,” “us,” “our”).  This discussion should be read in conjunction with the historical financial information and the related notes thereto included in Item 1. “Financial Statements” of this Quarterly Report on Form 10-Q and with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the year ended December 31, 2010 contained in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 24, 2011.

 

 

INDEX

 

 

 

Page Number

Cautionary statement regarding forward-looking information

 

37

Recent accounting pronouncements

 

38

Operating review

 

39

Results of operations

 

45

Management operations

 

45

Property and casualty insurance operations

 

47

Life insurance operations

 

51

Investment operations

 

52

Financial condition

 

54

Investments

 

54

Liabilities

 

58

Impact of inflation

 

59

Liquidity and capital resources

 

59

Critical accounting estimates

 

62

 

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

 

“Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995:

Statements contained herein that are not historical fact are forward-looking statements and, as such, are subject to risks and uncertainties that could cause actual events and results to differ, perhaps materially, from those discussed herein.  Forward-looking statements relate to future trends, events or results and include, without limitation, statements and assumptions on which such statements are based that are related to our plans, strategies, objectives, expectations, intentions and adequacy of resources.  Examples of forward-looking statements are discussions relating to premium and investment income, expenses, operating results, agency relationships, and compliance with contractual and regulatory requirements.  Forward-looking statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict.  Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements.  Among the risks and uncertainties, in addition to those set forth in our filings with the Securities and Exchange Commission, that could cause actual results and future events to differ from those set forth or contemplated in the forward-looking statements include the following:

 

Risk factors related to the Erie Indemnity Company (“Indemnity”) shareholder interest:

 

·                  dependence on Indemnity’s relationship with the Exchange and the management fee under the agreement with the subscribers at the Exchange;

·                  costs of providing services to the Exchange under the subscriber’s agreement;

·                  ability to attract and retain talented management and employees;

·                  ability to maintain the uninterrupted operations of our business, including our information technology systems;

·                  factors affecting the quality and liquidity of our investment portfolio;

·                  credit risk from the Exchange;

·                  ability to meet liquidity needs and access capital; and

·                  outcome of pending and potential litigation against us.

 

37



 

Risk factors related to the non-controlling interest owned by the Erie Insurance Exchange (“Exchange”), which includes the Property and Casualty Group and EFL:

 

·                  general business and economic conditions;

·                  dependence on the independent agency system;

·                  ability to maintain our reputation for superior customer service;

·                  factors affecting price competition;

·                  government regulation of the insurance industry, including approval of rate increases and rating factors such as credit and prior experience, and required processes related to underwriting and claims handling;

·                  the uncertain role of the federal government, and the ongoing role of the states, in regulating the property/casualty or life insurance industries;

·                  premium rates and reserves must be established from forecasts of ultimate costs;

·                  emerging claims, coverage issues in the industry, and changes in reserve estimates related to the property and casualty business;

·                  changes in reserve estimates related to the life business;

·                  severe weather conditions or other catastrophic losses, including terrorism;

·                  ability to acquire reinsurance coverage and collectability from reinsurers;

·                  factors affecting the quality and liquidity of our investment portfolio;

·                  ability to meet liquidity needs and access capital;

·                  ability to maintain acceptable financial strength rating;

·                  outcome of pending and potential litigation against us; and

·                  dependency on service provided by Indemnity.

 

A forward-looking statement speaks only as of the date on which it is made and reflects Indemnity’s analysis only as of that date.  Indemnity undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changes in assumptions, or otherwise.

 

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

See Item 1. “Financial Statements - Note 2, Significant Accounting Policies,” contained within this report for a discussion of adopted and/or pending accounting pronouncements, all of which are not expected to have a material impact on our future financial condition, results of operations or cash flows.

 

38



 

OPERATING OVERVIEW

 

Overview

The Erie Insurance Group represents the consolidated results of Indemnity and the results of its variable interest entity, the Exchange.  The Erie Insurance Group operates predominantly as a property and casualty insurer through its regional insurance carriers that write a broad range of personal and commercial coverages.  Our property and casualty insurance companies include the Exchange and its wholly owned subsidiaries, Erie Insurance Company (“EIC”), Erie Insurance Company of New York (“ENY”), Erie Insurance Property and Casualty Company (“EPC”) and Flagship City Insurance Company (“Flagship”).  These entities operate collectively as the “Property and Casualty Group.”  The Erie Insurance Group also operates as a life insurer through the Exchange’s wholly owned subsidiary, Erie Family Life Insurance Company (“EFL”), which underwrites and sells individual and group life insurance policies and fixed annuities.

 

The Exchange is a reciprocal insurance exchange, which is an unincorporated association of individuals, partnerships and corporations that agree to insure one another.  Each applicant for insurance to the Exchange signs a subscriber’s agreement, which contains an appointment of Indemnity as their attorney-in-fact to transact the business of the Exchange on their behalf.

 

Pursuant to the subscriber’s agreement and for its services as attorney-in-fact, Indemnity earns a management fee calculated as a percentage of the direct premiums written by the Exchange and the other members of the Property and Casualty Group, which are assumed by the Exchange under an intercompany pooling arrangement.

 

Indemnity shareholder interest includes Indemnity’s equity and income, but not the equity or income of the Exchange.  The Exchange’s equity, which is comprised of its retained earnings and accumulated other comprehensive income, is held for the interest of its subscribers (policyholders) and meets the definition of a noncontrolling interest, which is reflected as such in our consolidated financial statements.

 

“Indemnity shareholder interest” refers to the interest in Erie Indemnity Company owned by the Class A and Class B shareholders.  “Noncontrolling interest” refers to the interest in the Erie Insurance Exchange held for the interest of the subscribers (policyholders).

 

Indemnity shareholder interest in income generally comprises:

 

·                  a management fee of up to 25% of all property and casualty insurance premiums written or assumed by the Exchange, less the costs associated with the sales, underwriting and issuance of these policies;

·                  a 5.5% interest in the net underwriting results of the property and casualty insurance operations through December 31, 2010(1);

·                  a 21.6% equity interest in the net earnings of EFL through March 31, 2011(2);

·                  net investment income and results on investments that belong to Indemnity(1); and

·                  other income and expenses, including income taxes, that are the responsibility of Indemnity.

 

The Exchange’s or the noncontrolling interest in income generally comprises:

 

·                  a 94.5% interest in the net underwriting results of the property and casualty insurance operations through December 31, 2010 (1);

·                  a 78.4% equity interest in the net earnings of EFL through March 31, 2011(2);

·                  net investment income and results on investments that belong to the Exchange and its subsidiaries, which include Flagship through December 31, 2010(1) and EFL; and

·                  other income and expenses, including income taxes, that are the responsibility of the Exchange and its subsidiaries.

 

(1)          Prior to and through December 31, 2010, the underwriting results retained by EIC and ENY and the investment results of EIC, ENY and EPC accrued to the Indemnity shareholder interest.  Due to the sale of Indemnity’s property and casualty subsidiaries to the Exchange on December 31, 2010, all property and casualty underwriting results and all investment results for these companies accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after December 31, 2010.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

(2)          Prior to and through March 31, 2011, Indemnity retained a 21.6% ownership interest in EFL, which accrued to the Indemnity shareholder interest, and the Exchange retained a 78.4% ownership interest in EFL, which accrued to the interest of the subscribers (policyholders) of the Exchange or noncontrolling interest.  Due to the sale of Indemnity’s 21.6% ownership interest in EFL to the Exchange on March 31, 2011, 100% of the life insurance results of EFL accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after March 31, 2011.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

39



 

Results of the Erie Insurance Group’s operations by interest (Unaudited)

The following tables represent a breakdown of the composition of the income attributable to Indemnity and the income attributable to the noncontrolling interest (Exchange) for the three and six months ended June 30, 2011.  For purposes of this discussion, EFL’s investments are included in the life insurance operations.

 

(in millions)

 

Indemnity shareholder
interest

 

Noncontrolling interest
(Exchange)

 

Eliminations of
related party
transactions

 

Erie Insurance Group

 

 

 

 

 

Three months
ended
June 30,

 

 

 

Three months ended
June 30,

 

Three months ended
June 30,

 

Three months ended
June 30,

 

 

 

Percent

 

2011

 

2010

 

Percent

 

2011

 

2010

 

2011

 

2010

 

2011

 

2010

 

Management operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Management fee revenue, net

 

100.0

%

$285

 

$270

 

 

 

$    –

 

$    –

 

$(285

)

$(270

)

$    –

 

$     –

 

Service agreement revenue

 

100.0

%

9

 

9

 

 

 

 

 

 

 

9

 

9

 

Total revenue from management operations

 

 

 

294

 

279

 

 

 

 

 

(285

)

(270

)

9

 

9

 

Cost of management operations

 

100.0

%

230

 

217

 

 

 

 

 

(230

)

(217

)

 

 

Income from management operations before taxes

 

 

 

64

 

62

 

 

 

 

 

(55

)

(53

)

9

 

9

 

Property and casualty insurance operations: (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

5.5%

 (2)

 

53

 

94.5% (2)

 

1,030

 

921

 

 

 

1,030

 

974

 

Losses and loss expenses

 

5.5%

 (2)

 

40

 

94.5% (2)

 

1,147

 

677

 

(2

)

(2

)

1,145

 

715

 

Policy acquisition and other underwriting expenses

 

5.5%

 (2)

 

15

 

94.5% (2)

 

298

 

261

 

(56

)

(54

)

242

 

222

 

(Loss) income from property and casualty insurance operations before taxes

 

 

 

 

(2

)

 

 

(415

)

(17

)

58

 

56

 

(357

)

37

 

Life insurance operations: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

21.6%

 (3)

 

9

 

78.4% (3)

 

44

 

32

 

(1

)

(1

)

43

 

40

 

Total benefits and expenses

 

21.6%

 (3)

 

6

 

78.4% (3)

 

32

 

24

 

0

 

0

 

32

 

30

 

Income from life insurance operations before taxes

 

 

 

 

3

 

 

 

12

 

8

 

(1

)

(1

)

11

 

10

 

Investment operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net investment income (2)

 

 

 

4

 

9

 

 

 

88

 

78

 

(2

)

(2

)

90

 

85

 

Net realized gains (losses) on investments (2)

 

 

 

6

 

(3

)

 

 

30

 

(213

)

 

 

36

 

(216

)

Net impairment losses recognized in earnings (2)

 

 

 

0

 

(1

)

 

 

0

 

(1

)

 

 

0

 

(2

)

Equity in earnings of limited partnerships

 

 

 

7

 

6

 

 

 

30

 

20

 

 

 

37

 

26

 

Income (loss) from investment operations before taxes (2)

 

 

 

17

 

11

 

 

 

148

 

(116

)

(2

)

(2

)

163

 

(107

)

Income (loss) from operations before income taxes and noncontrolling interest

 

 

 

81

 

74

 

 

 

(255

)

(125

)

 

 

(174

)

(51

)

Provision for income taxes

 

 

 

29

 

25

 

 

 

(96

)

(45

)

 

 

(67

)

(20

)

Net income (loss)

 

 

 

$  52

 

$  49

 

 

 

$ (159

)

$  (80

)

$    –

 

$   –

 

$ (107

)

$  (31

)

 

(1)      Earnings on life insurance related invested assets are integral to the evaluation of the life insurance operations because of the long duration of life product.  On that basis, for presentation purposes, the life insurance operations in the table above include life insurance related investment results.  However, the life insurance investment results are included in the investment operations segment discussion as part of the Exchange’s investment results.

 

(2)      Prior to and through December 31, 2010, the underwriting results retained by EIC and ENY and the investment results of EIC, ENY and EPC accrued to the Indemnity shareholder interest.  Due to the sale of Indemnity’s property and casualty subsidiaries to the Exchange on December 31, 2010, all property and casualty underwriting results and all investment results for these companies accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after December 31, 2010.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

(3)      Prior to and through March 31, 2011, Indemnity retained a 21.6% ownership interest in EFL, which accrued to the Indemnity shareholder interest, and the Exchange retained a 78.4% ownership interest in EFL, which accrued to the interest of the subscribers (policyholders) of the Exchange or noncontrolling interest.  Due to the sale of Indemnity’s 21.6% ownership interest in EFL to the Exchange on March 31, 2011, 100% of the life insurance results of EFL  accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after March 31, 2011.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

40



 

(in millions)

 

Indemnity shareholder
interest

 

Noncontrolling interest
(Exchange)

 

Eliminations of
related party
transactions

 

Erie Insurance Group

 

 

 

 

 

Six months
ended
June 30,

 

 

 

Six months ended
June 30,

 

Six months ended
June 30,

 

Six months ended
June 30,

 

 

 

Percent

 

2011

 

2010

 

Percent

 

2011

 

2010

 

2011

 

2010

 

2011

 

2010

 

Management operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Management fee revenue, net

 

100.0

%

$536

 

$507

 

 

 

$     –

 

$     –

 

$(536

)

$(507

)

$     –

 

$     –

 

Service agreement revenue

 

100.0

%

17

 

17

 

 

 

 

 

 

 

17

 

17

 

Total revenue from management operations

 

 

 

553

 

524

 

 

 

 

 

(536

)

(507

)

17

 

17

 

Cost of management operations

 

100.0

%

441

 

409

 

 

 

 

 

(441

)

(409

)

 

 

Income from management operations before taxes

 

 

 

112

 

115

 

 

 

 

 

(95

)

(98

)

17

 

17

 

Property and casualty insurance operations: (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

5.5%

 (2)

 

106

 

94.5%

 (2)

2,044

 

1,830

 

 

 

2,044

 

1,936

 

Losses and loss expenses

 

5.5%

 (2)

 

80

 

94.5%

 (2)

1,830

 

1,375

 

(3

)

(3

)

1,827

 

1,452

 

Policy acquisition and other underwriting expenses

 

5.5%

 (2)

 

30

 

94.5%

 (2)

580

 

511

 

(98

)

(100

)

482

 

441

 

(Loss) income from property and casualty insurance operations before taxes

 

 

 

 

(4

)

 

 

(366

)

(56

)

101

 

103

 

(265

)

43

 

Life insurance operations: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

21.6%

 (3)

10

 

18

 

78.4%

 (3)

78

 

66

 

(1

)

(1

)

87

 

83

 

Total benefits and expenses

 

21.6%

 (3)

7

 

13

 

78.4%

 (3)

56

 

50

 

0

 

(1

)

63

 

62

 

Income from life insurance operations before taxes

 

 

 

3

 

5

 

 

 

22

 

16

 

(1

)

0

 

24

 

21

 

Investment operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net investment income (2)

 

 

 

8

 

18

 

 

 

169

 

153

 

(5

)

(5

)

172

 

166

 

Net realized gains (losses) on investments (2)

 

 

 

7

 

2

 

 

 

174

 

(98

)

 

 

181

 

(96

)

Net impairment losses recognized in earnings (2)

 

 

 

0

 

(1

)

 

 

0

 

(3

)

 

 

0

 

(4

)

Equity in earnings of limited partnerships

 

 

 

18

 

6

 

 

 

91

 

24

 

 

 

109

 

30

 

Income from investment operations before taxes (2)

 

 

 

33

 

25

 

 

 

434

 

76

 

(5

)

(5

)

462

 

96

 

Income from operations before income taxes and noncontrolling interest

 

 

 

148

 

141

 

 

 

90

 

36

 

 

 

238

 

177

 

Provision for income taxes

 

 

 

52

 

45

 

 

 

19

 

1

 

 

 

71

 

46

 

Net income

 

 

 

$  96

 

$  96

 

 

 

$   71

 

$  35

 

$     –

 

$     –

 

$ 167

 

$ 131

 

 

(1)            Earnings on life insurance related invested assets are integral to the evaluation of the life insurance operations because of the long duration of life products.  On that basis, for presentation purposes, the life insurance operations in the table above include life insurance related investment results.  However, the life insurance investment results are included in the investment operations segment discussion as part of the Exchange’s investment results.

 

(2)            Prior to and through December 31, 2010, the underwriting results retained by EIC and ENY and the investment results of EIC, ENY and EPC accrued to the Indemnity shareholder interest.  Due to the sale of Indemnity’s property and casualty subsidiaries to the Exchange on December 31, 2010, all property and casualty underwriting results and all investment results for these companies accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after December 31, 2010.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

(3)            Prior to and through March 31, 2011, Indemnity retained a 21.6% ownership interest in EFL, which accrued to the Indemnity shareholder interest, and the Exchange retained a 78.4% ownership interest in EFL, which accrued to the interest of the subscribers (policyholders) of the Exchange or noncontrolling interest.  Due to the sale of Indemnity’s 21.6% ownership interest in EFL to the Exchange on March 31, 2011, 100% of the life insurance results of EFL accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after March 31, 2011.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

Net income in the second quarter of 2011 was impacted by adverse results in our property and casualty insurance operations compared to the second quarter of 2010.  The Exchange’s property and casualty insurance operation’s losses were higher due to a significant increase in catastrophe losses, offset somewhat by favorable development on prior accident years and a 5.9% increase in earned premium, which was driven by an increase in policies in force and modest increases in average premium per policy.  Our investment operations were positively impacted primarily by realized gains on investments, compared to losses in the second quarter of 2010, and increased equity in earnings on limited partnerships.

 

41


 


 

Reconciliation of operating income to net income (unaudited)

We believe that an investor’s understanding of our performance related to the Indemnity shareholder interest is enhanced by the disclosure of operating income, a non-GAAP financial measure.  Our method of calculating this measure may differ from those used by other companies, and therefore comparability may be limited.

 

Indemnity defines operating income as income generated from management operations, life insurance operations (1), property and casualty insurance underwriting operations (2), net investment income (2), and equity in earnings or losses of limited partnerships, net of related federal income taxes.  It does not include realized capital gains and losses, impairment losses and related federal income taxes.

 

Indemnity uses operating income to evaluate the results of its operations.  It reveals trends that may be obscured by the net effects of realized capital gains and losses including impairment losses.  Realized capital gains and losses including impairment losses, may vary significantly between periods and are generally driven by business decisions and economic developments such as capital market conditions which are not related to our ongoing operations.  We believe it is useful for investors to evaluate these components separately and in the aggregate when reviewing our performance.  We are aware that the price to earnings multiple commonly used by investors as a forward-looking valuation technique uses operating income as the denominator.  Operating income should not be considered as a substitute for net income prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and does not reflect Indemnity’s overall profitability.

 

The following table reconciles operating income and net income for the Indemnity shareholder interest: (1) (2)

 

 

 

Indemnity Shareholder Interest

 

(in millions, except per share data)

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 

2011

 

 

2010

 

 

2011

 

 

2010

 

 

 

 

(Unaudited)

 

(Unaudited)

 

 

Operating income attributable to Indemnity

 

$   48

 

 

$   51

 

 

$   91

 

 

$   95

 

 

Net realized gains (losses) and impairments on investments

 

6

 

 

(4

)

 

7

 

 

1

 

 

Income tax (expense) benefit

 

(2

)

 

2

 

 

(2

)

 

0

 

 

Realized gains (losses) and impairments, net of income taxes

 

4

 

 

(2

)

 

5

 

 

1

 

 

Net income attributable to Indemnity

 

$   52

 

 

$   49

 

 

$   96

 

 

$   96

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Per Indemnity Class A common share-diluted:

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income attributable to Indemnity

 

$0.87

 

 

$0.89

 

 

$1.64

 

 

$1.66

 

 

Net realized gains (losses) and impairments on investments

 

0.10

 

 

(0.07

)

 

0.12

 

 

0.02

 

 

Income tax (expense) benefit

 

(0.03

)

 

0.04

 

 

(0.04

)

 

0.00

 

 

Realized gains (losses) and impairments, net of income taxes

 

0.07

 

 

(0.03

)

 

0.08

 

 

0.02

 

 

Net income attributable to Indemnity

 

$0.94

 

 

$0.86

 

 

$1.72

 

 

$1.68

 

 

 

(1)          Prior to and through March 31, 2011, Indemnity retained a 21.6% ownership interest in EFL, which accrued to the Indemnity shareholder interest, and the Exchange retained a 78.4% ownership interest in EFL, which accrued to the interest of the subscribers (policyholders) of the Exchange or noncontrolling interest.  Due to the sale of Indemnity’s 21.6% ownership interest in EFL to the Exchange on March 31, 2011, 100% of the life insurance results of EFL accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after March 31, 2011.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

(2)          Prior to and through December 31, 2010, the underwriting results retained by EIC and ENY and the investment results of EIC, ENY and EPC accrued to the Indemnity shareholder interest.  Due to the sale of Indemnity’s property and casualty subsidiaries to the Exchange on December 31, 2010, all property and casualty underwriting results and all investment results for these companies accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after December 31, 2010.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

42



 

Summary of results – Indemnity shareholder interest

 

Three months ended June 30, 2011

 

·                Net income attributable to Indemnity per share-diluted was $0.94 per share in the second quarter of 2011 compared to net income per share-diluted of $0.86 per share in the second quarter of 2010.  The second quarter 2010 net income amount includes $0.10 per share related to operations sold to the Exchange.

 

·                Operating income attributable to Indemnity per share-diluted (excluding net realized gains or losses, impairments on investments and related taxes) was $0.87 per share in the second quarter of 2011 compared to $0.89 in the second quarter of 2010.  The second quarter 2010 operating income amount includes $0.09 per share related to operations sold to the Exchange.

 

Six months ended June 30, 2011

 

·                Net income attributable to Indemnity per share-diluted increased to $1.72 per share for the six months ended June 30, 2011 from net income per share-diluted of $1.68 per share for the six months ended June 30, 2010.  The net income for 2011 and 2010 includes $0.02 and $0.21 per share, respectively, related to operations sold to the Exchange.

 

·                Operating income attributable to Indemnity per share-diluted (excluding net realized gains or losses, impairments on investments and related taxes) was $1.64 per share in the first half of 2011 compared to $1.66 in the first half of 2010.  The 2011 and 2010 operating income amounts include $0.02 and $0.18 per share, respectively, related to operations sold to the Exchange.

 

Operating Segments

Our reportable segments include management operations, property and casualty insurance operations, life insurance operations and investment operations.

 

Management operations

Management operations generate internal management fee revenue, which accrues to the Indemnity shareholder interest, as Indemnity provides services relating to the sales, underwriting and issuance of policies on behalf of the Exchange.  Management fee revenue is based upon all premiums written or assumed by the Exchange and the management fee rate, which is not to exceed 25%.  Our Board of Directors establishes the management fee rate at least annually, generally in December for the following year, and considers factors such as the relative financial strength of Indemnity and the Exchange and projected revenue streams.  The management fee rate was set at 25% for both 2011 and 2010. Management fee revenue is eliminated upon consolidation.

 

Property and casualty insurance operations

The property and casualty insurance industry is highly cyclical, with periods of rising premium rates and shortages of underwriting capacity followed by periods of substantial price competition and excess capacity.  The cyclical nature of the insurance industry has a direct impact on the direct written premiums of the Property and Casualty Group.

 

The property and casualty insurance business is driven by premium growth, the combined ratio and investment returns.  The property and casualty insurance operation’s premium growth strategy focuses on growth by expansion of existing operations including a careful agency selection process and increased market penetration in existing operating territories.  Expanding the size of our existing agency force of almost 2,100 independent agencies, with over 9,500 licensed representatives, will contribute to future growth as new agents build their books of business with the Property and Casualty Group.

 

The property and casualty insurance operations insure standard and preferred risks while adhering to a set of consistent underwriting standards.  Nearly 50% of premiums are derived from personal auto, 20% from homeowners and 30% from commercial lines.  Pennsylvania, Maryland and Virginia made up 63% of the property and casualty lines insurance business 2010 direct written premium.

 

Members of the Property and Casualty Group pool their underwriting results under an intercompany pooling agreement.  Under the pooling agreement, the Exchange retains a 94.5% interest in the net underwriting results of

 

43



 

the Property and Casualty Group, while EIC retains a 5.0% interest and ENY retains a 0.5% interest.  Prior to and through December 31, 2010, the underwriting results retained by EIC and ENY accrued to the Indemnity shareholder interest.  Due to the sale of Indemnity’s property and casualty subsidiaries to the Exchange on December 31, 2010, all property and casualty underwriting results accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after December 31, 2010.

 

The combined ratio, expressed as a percentage, is the key measure of underwriting profitability traditionally used in the property and casualty insurance industry.  It is the sum of the ratio of losses and loss expenses to premiums earned (loss ratio) plus the ratio of policy acquisition and other underwriting expenses to premiums earned (expense ratio).  When the combined ratio is less than 100%, underwriting results are generally considered profitable; when the combined ratio is greater than 100%, underwriting results are generally considered unprofitable.

 

Factors affecting loss and loss expenses include the frequency and severity of losses, the nature and severity of catastrophic losses, the quality of risks underwritten and underlying claims and settlement expenses.

 

Investments held by the Property and Casualty Group are reported in the investment operations segment, separate from the underwriting business.

 

Life insurance operations

EFL generates revenues through sales of its individual and group life insurance policies and fixed annuities.  These products provide our property and casualty agency force an opportunity to cross-sell both personal and commercial accounts.  EFL’s profitability depends principally on the ability to develop, price and distribute insurance products, attract and retain deposit funds, generate investment returns and manage expenses.  Other drivers include mortality and morbidity experience, persistency experience to enable the recovery of acquisition costs, maintenance of interest spreads over the amounts credited to deposit funds and the maintenance of strong ratings from rating agencies.

 

Earnings on life insurance related invested assets are integral to the evaluation of the life insurance operations because of the long duration of life products.  On that basis, for presentation purposes in the Management’s Discussion and Analysis, the life insurance operations include life insurance related investment results.  However, for presentation purposes in the segment footnote, the life insurance investment results are included in the investment operations segment discussion as part of the Exchange’s investment results.

 

Investment operations

We generate revenues from our fixed maturity, equity security and alternative investment portfolios to support our underwriting business.  The portfolios are managed with the objective of maximizing after-tax returns on a risk-adjusted basis.  Management actively evaluates the portfolios for impairments.  We record impairment writedowns on investments in instances where the fair value of the investment is substantially below cost, and we conclude that the decline in fair value is other-than-temporary.

 

Our investment operations reflected the improvement experienced in the financial markets in the second quarter of 2011.  Realized gains totaled $39 million in the second quarter of 2011 compared to realized losses of $213 million in the same period in 2010.  In the second quarter of 2011 there were no impairments of securities compared to $4 million in the second quarter of 2010.  Our alternative investments benefited from the improved financial market conditions in the first quarter of 2011.  The upturn across all markets had a significant impact on the portfolios of our partnerships.  Equity in earnings of limited partnerships was $38 million in the second quarter of 2011 compared to $27 million in the second quarter of 2010.  The valuation adjustments in the limited partnerships are based on financial statements received from our general partners, which are generally received on a quarter lag.  As a result, the second quarter 2011 partnership earnings do not reflect the valuation changes from the second quarter of 2011, but reflect conditions from the first quarter of 2011.

 

General conditions and trends affecting our business

Economic conditions

Although the financial markets have shown signs of improvement recently, overall economic conditions remain uncertain.  Unfavorable changes in economic conditions, including declining consumer confidence, inflation, high unemployment and recession, among others, may lead the Property and Casualty Group’s customers to modify coverage, not renew policies, or even cancel policies, which could adversely affect the premium revenue of the Property and Casualty Group, and consequently Indemnity’s management fee.  These conditions could also impair

 

44


 


 

the ability of customers to pay premiums when due, and as a result, the Property and Casualty Group’s reserves and write-offs could increase.  Our key challenge is to generate profitable revenue growth in a highly competitive market that continues to experience the effects of uncertain economic conditions.

 

Market volatility

Our portfolio of fixed income, preferred and common stocks and limited partnerships are subject to market volatility especially in periods of instability in the worldwide financial markets.  Depending upon market conditions, which are unpredictable and remain uncertain, considerable fluctuation could exist in our reported total investment income, which could have an adverse impact on our financial condition, results of operations and cash flows.

 

RESULTS OF OPERATIONS

 

The information that follows is presented on a segment basis prior to eliminations.

 

Management operations

Management fee revenue is earned by Indemnity from services relating to the sales, underwriting and issuance of policies on behalf of the Exchange as a result of its attorney-in-fact relationship, and is eliminated upon consolidation.

 

 

 

Erie Insurance Group

 

(dollars in millions)

 

Three months ended June 30,

 

Six months ended June 30,

 

 

2011

 

2010

 

% Change

 

2011

 

2010

 

% Change

Indemnity

 

(Unaudited)

 

 

 

 

(Unaudited)

 

 

 

Management fee revenue

 

$285

 

$270

 

5.1

 %

 

$536

 

$507

 

5.6

 %

Service agreement revenue

 

9

 

9

 

(2.8

)

 

17

 

17

 

(2.1

)

Total revenue from management operations

 

294

 

279

 

4.9

 

 

553

 

524

 

5.4

 

Cost of management operations

 

230

 

217

 

5.4

 

 

441

 

409

 

7.7

 

Income from management operations –Indemnity (1)

 

$  64

 

$  62

 

3.0

 %

 

$112

 

$115

 

(2.9

)%

Gross margin

 

21.6

%

22.0

%

(0.4

)pts.

 

20.2

%

21.9

%

(1.7

)pts.

 

(1)          Indemnity retains 100% of the income from management operations.

 

Management fee revenue

Management fee revenue is based upon all premiums written or assumed by the Exchange and the management fee rate, which is determined by our Board of Directors at least annually.  Management fee revenue is calculated by multiplying the management fee rate by the direct premiums written by the Exchange and the other members of the Property and Casualty Group, which are assumed by the Exchange under an intercompany pooling agreement.  The following table presents the calculation of management fee revenue.

 

 

 

Erie Insurance Group

 

(dollars in millions)

 

Three months ended June 30,

 

Six months ended June 30,

 

 

2011

 

2010

 

% Change

 

 

2011

 

2010

 

% Change

Indemnity

 

(Unaudited)

 

 

 

 

(Unaudited)

 

 

 

Property and Casualty Group direct written premiums

 

$1,144

 

$1,088

 

5.3

%

 

$2,152

 

$2,036

 

5.7

%

Management fee rate

 

25.00

%

25.00

%

 

 

 

25.00

%

25.00

%

 

 

Management fee revenue, gross

 

$   286

 

$   271

 

5.3

%

 

$    538

 

$   509

 

5.7

%

Change in allowance for management fee returned on cancelled policies(1)

 

(1

)

(1

)

NM

 

 

(2

)

(2

)

NM

 

Management fee revenue, net of allowance

 

$  285

 

$   270

 

5.1

%

 

$   536

 

$   507

 

5.6

%

 

NM = not meaningful

 

(1)          Management fees are returned to the Exchange when policies are cancelled mid-term and unearned premiums are refunded.  We record an estimated allowance for management fees returned on mid-term policy cancellations.

 

45



 

Direct written premiums of the Property and Casualty Group increased 5.3% in the second quarter of 2011, compared to the second quarter of 2010, due to a 2.9% increase in policies in force and modest increases in average premium.  The year-over-year average premium per policy for all lines of business increased 2.7% at June 30, 2011, compared to a decrease of 0.5% at June 30, 2010.  The policy retention ratio was 90.8% at June 30, 2011, compared to 90.7% at December 31, 2010 and 90.5% at June 30, 2010.  See the “Property and casualty insurance operations” segment that follows for a complete discussion of property and casualty direct written premiums.

 

The management fee rate was set at 25%, the maximum rate, for both 2011 and 2010. Changes in the management fee rate can affect the segment’s revenue and net income significantly.

 

Service agreement revenue

Service agreement revenue includes service charges Indemnity collects from policyholders for providing extended payment terms on policies written by the Property and Casualty Group and late payment and policy reinstatement fees.   The service charges are fixed dollar amounts per billed installment. Service agreement revenue totaled $9 million in the second quarter of 2011 and 2010, and $17 million for the six months ended June 30, 2011 and 2010.

 

Cost of management operations

 

 

 

Erie Insurance Group

 

(in millions)

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2011

 

2010

 

% Change

 

2011

 

2010

 

% Change

 

Indemnity

 

(Unaudited)

 

 

 

(Unaudited)

 

 

 

Commissions

 

$157

 

$149

 

5.8

%

 

$295

 

$277

 

6.4

%

 

Non-commission expense

 

73

 

68

 

4.5

 

 

146

 

132

 

10.6

 

 

Total cost of management operations

 

$230

 

$217

 

5.4

%

 

$441

 

$409

 

7.7

%

 

 

Commissions – Commissions increased $8 million in the second quarter of 2011, compared to the second quarter of 2010, primarily as a result of the 5.3% increase in direct written premiums of the Property and Casualty Group.

 

For the six months ended June 30, 2011, commissions increased $18 million compared to the six months ended June 30, 2010, driven primarily by the 5.7% increase in direct written premiums of the Property and Casualty Group.

 

Non-commission expense – Non-commission expense increased $5 million in the second quarter of 2011, compared to the second quarter of 2010.  Personnel costs increased $2 million primarily as a result of increases in salaries and benefits.  Professional fees increased $2 million and software expenses increased $1 million related to our technology initiatives.

 

The gross margin for the second quarter of 2011 was 21.6% compared to 22.0% recorded in the same period in 2010.

 

For the six months ended June 30, 2011, non-commission expense increased $14 million compared to the six months ended June 30, 2010.  Personnel costs increased $7 million primarily as a result of increases in salaries and benefits, while the 2010 expenses included a $5 million reduction for a favorable court ruling.

 

The gross margin of 21.9% for the six months ended June 30, 2010 was positively impacted by a $5 million reduction for a favorable court ruling.  Excluding this adjustment, the gross margin would have been 21.0%, compared to 20.2% for the six months ended June 30, 2011.  The lower gross margin in the first half of 2011 was a result of expense growth slightly outpacing revenue growth.

 

46



 

Property and casualty insurance operations

The Property and Casualty Group operates in 11 Midwestern, Mid-Atlantic and Southeastern states and the District of Columbia and primarily writes private passenger automobile, homeowners, commercial multi-peril, commercial automobile, and workers compensation lines of insurance.

 

 

 

Property and Casualty Group

 

 

 

Three months ended June 30,

 

 

Six months ended June 30,

 

(dollars in millions)

 

2011 

 

2010 

 

% Change

 

2011 

 

2010 

 

% Change

 

 

(Unaudited)

 

 

 

 

(Unaudited)

 

 

 

Direct written premium

 

$1,144

 

$1,088

 

5.3

%

 

$2,152

 

$2,036

 

5.7

%

Reinsurance – assumed and ceded

 

(4

)

(4

)

(0.8

)

 

(8

)

(6

)

(23.8

)

Net written premium

 

1,140

 

1,084

 

5.3

 

 

2,144

 

2,030

 

5.7

 

Change in unearned premium

 

110

 

110

 

0.0

 

 

100

 

94

 

6.6

 

Net premiums earned

 

1,030

 

974

 

5.9

 

 

2,044

 

1,936

 

5.6

 

Losses and loss expenses

 

1,147

 

717

 

59.9

 

 

1,830

 

1,455

 

25.8

 

Policy acquisition and other underwriting expenses

 

298

 

276

 

8.1

 

 

580

 

541

 

7.1

 

Total losses and expenses

 

1,445

 

993

 

45.4

 

 

2,410

 

1,996

 

20.7

 

Underwriting loss – Erie Insurance Group

 

$  (415

)

$   (19

)

NM

 

 

$  (366

)

$   (60

)

NM

 

Underwriting loss – Indemnity (1)

 

$       –

 

$     (2

)

 

 

 

$       –

 

$     (4

)

 

 

Underwriting loss – Exchange (1)

 

$  (415

)

$   (17

)

 

 

 

$  (366

)

$   (56

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss and loss expense ratio

 

111.2

%

73.7

%

37.5

 pts.

 

89.5

%

75.2

%

14.3

 pts.

Policy acquisition and other underwriting expense ratio

 

29.0

 

28.1

 

0.9

 

 

28.4

 

28.0

 

0.4

 

Combined ratio

 

140.2

%

101.8

%

38.4

 pts.

 

117.9

%

103.2

%

14.7

 pts.

 

NM = not meaningful

 

(1)          Prior to and through December 31, 2010, the underwriting results retained by EIC and ENY accrued to the Indemnity shareholder interest.  Due to the sale of Indemnity’s property and casualty subsidiaries to the Exchange on December 31, 2010, all property and casualty underwriting results accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after December 31, 2010.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

We measure profit or loss for our property and casualty insurance segment based upon underwriting results, which represents net premiums earned less losses and loss expenses and policy acquisition and other underwriting expenses on a pre-tax basis.  Loss and combined ratios are key performance indicators that we use to assess business trends and to make comparisons to industry results. Investment results of our underwriting business are included in our investment operations segment.

 

Direct written premiums

Direct written premiums of the Property and Casualty Group increased 5.3% to over $1.1 billion in the second quarter of 2011 from the second quarter of 2010, driven by an increase in policies in force and modest increases in average premium per policy.  Year-over-year policies in force for all lines of business increased by 2.9% in the second quarter of 2011 as the result of continuing strong policyholder retention, compared to an increase of 3.5% in the second quarter of 2010.  The year-over-year average premium per policy for all lines of business increased 2.7% at June 30, 2011, compared to a decrease of 0.5% at June 30, 2010.  The combined impact of these increases in the second quarter of 2011 was seen primarily in our renewal business premiums.

 

Premiums generated from new business decreased 2.8% to $121 million in the second quarter of 2011, compared to an increase of 6.5%, or $124 million, in the second quarter of 2010.  Underlying the trend in new business premiums was a decrease in new business policies in force of 4.1%, in the second quarter of 2011, compared to an increase of 6.9% in the second quarter of 2010, while the year-over-year average premium per policy on new business increased 6.3% at June 30, 2011, compared to a decrease of 0.1% at June 30, 2010.

 

Premiums generated from renewal business increased 6.3% to $1.0 billion in the second quarter of 2011, compared to an increase of 3.9%, or $963 million, in the second quarter of 2010.  Underlying the trend in renewal business premiums was an increase in renewal business policies in force of 3.9% in the second quarter of 2011, compared to 3.0% in the second quarter of 2010, and an increase in the renewal business year-over-year average premium per policy of 2.1% at June 30, 2011, compared to a decline of 0.5% at June 30, 2010.  The Property and Casualty Group’s year-over-year policy retention ratio was 90.8% at June 30, 2011, and 90.7% at December 31, 2010, and 90.5% at June 30, 2010.

 

47



 

Personal linesTotal personal lines premiums written increased 4.4% to $826 million in the second quarter of 2011, from $792 million in the second quarter of 2010, driven by an increase of 2.7% in both the total personal lines policies in force and year-over-year average premium per policy.

 

New business premiums written on personal lines decreased 5.9% in the second quarter of 2011, compared to an increase of 4.7% in the second quarter of 2010.  Personal lines new business policies in force decreased 5.9% in the second quarter of 2011, compared to an increase of 6.3% in the second quarter of 2010, while the year-over-year average premium per policy on personal lines new business increased 3.6% at June 30, 2011, compared to 0.6% at June 30, 2010.

 

·                Private passenger auto new business premiums written decreased 4.9% in the second quarter of 2011, compared to an increase of 3.3% in the second quarter of 2010.  New business policies in force for private passenger auto decreased 5.1% in the second quarter of 2011, compared to an increase of 5.0% in the second quarter of 2010, while the new business year-over-year average premium per policy for private passenger auto increased 2.4% at June 30, 2011, compared to 1.4% at June 30, 2010.

 

·                Homeowners new business premiums written decreased 10.0% in the second quarter of 2011, compared to an increase of 9.3% in the second quarter of 2010.  New business policies in force for homeowners decreased 8.9% in the second quarter of 2011, compared to an increase of 9.0% in the second quarter of 2010.  The new business year-over-year average premium per policy for homeowners increased 4.4% at June 30, 2011, compared to 1.0% at June 30, 2010.

 

Renewal premiums written on personal lines increased 5.5% in the second quarter of 2011, compared to 5.6% in the second quarter of 2010, driven by a modest increase in average premium per policy and steady policy retention trends.  The year-over-year average premium per policy on personal lines renewal business increased 2.5% at June 30, 2011, compared to 1.5% at June 30, 2010.  The personal lines year-over-year policy retention ratio was 91.6% at June 30, 2011, 91.5% at December 31, 2010, and 91.3% at June 30, 2010.

 

·                Private passenger auto renewal premiums written increased 2.4% in the second quarter of 2011, compared to 4.9% in the second quarter of 2010.  The year-over-year average premium per policy on private passenger auto renewal business increased 1.8% at June 30, 2011, compared to 1.1% at June 30, 2010.  The private passenger auto year-over-year policy retention ratio was 91.7% at June 30, 2011, compared to 91.8% at December 31, 2010 and June 30, 2010.

 

·                Homeowners renewal premiums written increased 11.6% in the second quarter of 2011, compared to 6.9% in the second quarter of 2010.  The year-over-year average premium per policy on homeowners renewal business increased 6.4% at June 30, 2011, compared to 3.7% at June 30, 2010, while the homeowners year-over-year policyholder retention ratio was 91.5% at June 30, 2011, 91.2% at December 31, 2010, and 90.9% at June 30, 2010.

 

Commercial linesTotal commercial lines premiums written increased 7.6%, to $319 million in the second quarter of 2011 from $296 million in the second quarter of 2010, driven by a 3.9% increase in total commercial lines policies in force and a 1.9% increase in the total commercial lines year-over-year average premium per policy.

 

New business premiums written on commercial lines increased 2.7% in the second quarter of 2011, compared to 9.9% in the second quarter of 2010.  Commercial lines new business policies in force increased 3.8% in the second quarter of 2011, compared to 9.6% in the second quarter of 2010, while the year-over-year average premium per policy on commercial lines new business increased 6.7% at June 30, 2011, compared to a decrease of 3.0% at June 30, 2010.

 

Renewal premiums for commercial lines increased 8.5% in the second quarter of 2011, compared to a decrease of 0.8% in the second quarter of 2010.  The improvement seen in the commercial lines renewal premiums was driven by a modest increase in the average premium per policy combined with steady policy retention trends, the combined impact of which was seen primarily in the workers compensation and commercial multi-peril lines of business.  The year-over-year average premium per policy on commercial lines renewal business increased 1.1% at June 30, 2011, compared to a decline of 5.2% at June 30, 2010.  The workers compensation and commercial multi-peril year-over-year average premium per policy on renewal business increased 2.3% and 2.1%, respectively, at June 30, 2011, compared to decreases of 13.8% and 2.1%, respectively, at June 30, 2010.  Contributing to the lower average premium per policy in the second quarter of 2010 were shifts in the mix of our book of business and lower exposures for the workers compensation and commercial auto lines of business.  The year-over-year policy retention ratio for commercial lines was 85.5% at June 30, 2011, 85.3% at December 31, 2010, and 85.2% at June 30, 2010.

 

48



 

Future trends–premium revenue – We plan to continue our efforts to grow Property and Casualty Group premiums and improve our competitive position in the marketplace, which have a direct bearing on Indemnity’s management fee.  Expanding the size of our agency force through a careful agency selection process and increased market penetration in our existing operating territories will contribute to future growth as existing and new agents build their book of business with the Property and Casualty Group.  At June 30, 2011, we had a total of 2,096 agencies with 9,511 licensed representatives.  Our continued focus on underwriting discipline and the maturing of our pricing segmentation model has contributed to the Property and Casualty Group’s ability to retain existing and attract new policyholders resulting in growth in new policies in force and steady retention ratios.  We expect our pricing actions to result in a net increase in direct written premium in 2011, however, exposure reductions and changes in our mix of business as a result of economic conditions could impact the average premium written by the Property and Casualty Group, as customers may continue to reduce coverages.

 

Current year losses and loss expenses

The current accident year loss and loss expense ratio, excluding catastrophe losses, was 65.0% in the second quarter of 2011 compared to 67.9% in the second quarter of 2010, and 65.9% in the first half of 2011 compared to 69.0% in the first half of 2010.

 

The personal lines loss and loss expense ratio related to the current accident year, excluding catastrophe losses, was 65.2% in the second quarter of 2011 compared to 67.4% in the second quarter of 2010, and 66.4% in the first half of 2011 compared to 69.1% in the first half of 2010.

 

The commercial lines loss and loss expense ratio related to the current accident year, excluding catastrophe losses, was 64.3% in the second quarter of 2011 compared to 68.3% in the second quarter of 2010, and 64.4% in the first half of 2011 compared to 68.8% in the first half of 2010.

 

Catastrophe losses

Catastrophes are an inherent risk of the property and casualty insurance business and can have a material impact on our insurance underwriting results.  In addressing this risk, we employ what we believe are reasonable underwriting standards and monitor our exposure by geographic region.  The Property and Casualty Group’s definition of catastrophes includes those weather-related or other loss events that we consider significant to our geographic footprint which, individually or in the aggregate, may not reach the level of a national catastrophe as defined by the Property Claim Service (PCS).  The Property and Casualty Group maintains sufficient property catastrophe reinsurance coverage from unaffiliated reinsurers and no longer participates in the voluntary assumed reinsurance business, which lowers the variability of the underwriting results of the Property and Casualty Group.

 

Catastrophe losses, as defined by the Property and Casualty Group, totaled $537 million in the second quarter of 2011, compared to $80 million in the second quarter of 2010, and contributed 52.1 points and 8.1 points to the loss ratios at June 30, 2011 and 2010, respectively.  In the second quarter of 2011, the states of Tennessee, North Carolina, Pennsylvania and Ohio experienced an increase in storm activity including hail, tornado and wind storms resulting in an increase in claims compared to the second quarter of 2010.  Catastrophe losses incurred for the first half of 2011 and 2010 totaled $602 million and $193 million, respectively, and contributed 29.5 points and 9.9 points to the combined ratio, respectively.

 

49



 

Prior year loss reserve development

The following table provides the details of our property and casualty insurance operation’s prior year loss reserve development by type of business:

 

(in millions)

 

Erie Insurance Group

 

 

 

Three months ended
June 30,

 

 

Six months ended
June 30,

 

 

 

2011

 

2010

 

 

2011

 

2010

 

Prior year loss development:

 

(Unaudited)

 

 

(Unaudited)

 

Direct business including salvage and subrogation

 

$(50

)

$(13

)

 

$(111

)

$(56

)

Assumed reinsurance business

 

(7

)

(8

)

 

(4

)

(11

)

Ceded reinsurance business

 

(3

)

(1

)

 

(4

)

(5

)

Total prior year loss development

 

$(60

)

$(22

)

 

$(119

)

$(72

)

 

Negative amounts represent a redundancy (decrease in reserves), while positive amounts represent a deficiency (increase in reserves).

 

Direct business including salvage and subrogation – Favorable development of prior accident years, including the effects of salvage and subrogation recoveries, improved the combined ratio by 4.9 points in the second quarter of 2011, compared to 1.3 points in the second quarter of 2010.  The favorable development in the second quarter of 2011 was primarily driven by better than expected severity trends on uninsured/underinsured motorist bodily injury and improved annual claim cost expectations on massive injury lifetime medical benefits in the personal auto line of business, the death of one and the closing of two massive injury lifetime medical benefits claims in the workers compensation line of business, and better than expected severity trends on liability claims in the commercial multi-peril line of business.  In the second quarter of 2010, the favorable development was primarily driven by improved severity trends in the workers compensation and commercial multi-peril lines of business.

 

Favorable development of prior accident years, including the effects of salvage and subrogation recoveries, improved the combined ratio by 5.4 points in the first half of 2011, compared to 2.9 points in the first half of 2010.  The favorable development in the first half of 2011 was primarily driven by better than expected severity trends on uninsured/ underinsured motorist bodily injury, improved annual claim cost expectations on massive injury lifetime medical benefits and the closing of one massive injury lifetime medical benefits claim in the personal auto line of business, better than expected severity trends on liability claims in the commercial multi-peril and homeowners lines of business, and the closing of four massive injury lifetime medical benefits claims in the workers compensation line of business.  In the first half of 2010, the favorable development was primarily driven by improved severity trends in the commercial multi-peril and workers compensation lines of business, improvements in frequency trends on automobile bodily injury and uninsured/underinsured motorist bodily injury and closing of two claims in the personal auto line of business, and the settlement of one large claim in the homeowners line of business.

 

Assumed reinsurance – The Property and Casualty Group experienced favorable development of prior accident year loss reserves on its assumed reinsurance business totaling $7 million in the second quarter of 2011, compared to $8 million in the second quarter of 2010.  For the first half of 2011, favorable development of prior accident year loss reserves on assumed reinsurance totaled $4 million, compared to $11 million in the first half of 2010.  The favorable development in 2011 and 2010 was due to less than anticipated growth in involuntary reinsurance.

 

Ceded reinsurance – The Property and Casualty Group’s increase in ceded reinsurance reserves, which is reflected as favorable development of prior accident year loss reserves, totaled $3 million in the second quarter of 2011, compared to $1 million in the second quarter of 2010, and $4 million in the first half of 2011, compared to $5 million in the first half of 2010.  In the first half of 2011 and 2010, the increase was primarily from development in the business catastrophe liability and commercial multi-peril lines of business.

 

Policy acquisition and other underwriting expenses

Our expense ratio remained relatively flat, increasing only 0.9 points in the second quarter of 2011 primarily as a result of less deferrable costs compared to the second quarter of 2010.  The management fee rate was 25% for the periods ending June 30, 2011 and June 30, 2010.

 

50


 


 

Life insurance operations

EFL is a Pennsylvania-domiciled life insurance company which operates in 10 states and the District of Columbia and underwrites and sells individual and group life insurance policies and fixed annuities.

 

 

 

Erie Family Life Insurance Company

 

 

 

Three months ended June 30,

 

Six months ended June 30,

 

(in millions)

 

2011

 

2010

 

% Change

 

2011

 

2010

 

% Change

 

 

 

(Unaudited)

 

 

 

(Unaudited)

 

 

 

Individual life premiums, net of reinsurance

 

$17

 

 

$16

 

 

2.4 %

 

$32

 

 

$31

 

 

2.7 %

 

Group life and other premiums

 

1

 

 

0

 

 

1.2

 

2

 

 

1

 

 

1.7

 

Other revenue

 

(1

)

 

0

 

 

(4.0)

 

0

 

 

0

 

 

6.2

 

Total net policy revenue

 

17

 

 

16

 

 

2.3

 

34

 

 

32

 

 

2.7

 

Net investment income

 

23

 

 

24

 

 

(0.6)

 

46

 

 

47

 

 

(0.4)

 

Net realized gains on investments

 

3

 

 

3

 

 

(3.7)

 

7

 

 

8

 

 

(10.5)

 

Impairment losses recognized in earnings

 

0

 

 

(2

)

 

NM

 

0

 

 

(2

)

 

99.6

 

Equity in earnings (losses) of limited partnerships

 

1

 

 

0

 

 

NM

 

1

 

 

(1

)

 

NM

 

Total revenues

 

44

 

 

41

 

 

7.3

 

88

 

 

84

 

 

5.1

 

Benefits and other changes in policy reserves

 

25

 

 

22

 

 

15.6

 

49

 

 

46

 

 

7.1

 

Amortization of deferred policy acquisition costs

 

4

 

 

4

 

 

(22.2)

 

7

 

 

9

 

 

(25.5)

 

Other operating expenses

 

3

 

 

4

 

 

(11.9)

 

7

 

 

8

 

 

(8.0)

 

Total benefits and expenses

 

32

 

 

30

 

 

6.7

 

63

 

 

63

 

 

0.4

 

Income before income taxes

 

$12

 

 

$11

 

 

8.7 %

 

$25

 

 

$21

 

 

18.7 %

 

Income before taxes – Indemnity (1)

 

$  –

 

 

$  3

 

 

NM

 

$  3

 

 

$  5

 

 

(38.4)%

 

Income before taxes – Exchange (1)

 

$12

 

 

$  8

 

 

38.7 %

 

$22

 

 

$16

 

 

34.5 %

 

 

NM = not meaningful

 

(1)             Prior to and through March 31, 2011, Indemnity retained a 21.6% ownership interest in EFL, which accrued to the Indemnity shareholder interest, and the Exchange retained a 78.4% ownership interest in EFL, which accrued to the interest of the subscribers (policyholders) of the Exchange or noncontrolling interest.  Due to the sale of Indemnity’s 21.6% ownership interest in EFL to the Exchange on March 31, 2011, 100% of the life insurance results of EFL accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after March 31, 2011.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

 

Premiums

Gross policy revenues increased 3.9% to $28 million in the second quarter of 2011, compared to $27 million in the second quarter of 2010.  With the introduction of its new life products, effective June 1, 2011 EFL reinsures new individual life business amounts in excess of its $1 million per life retention limit.  Previously, EFL reinsured 75% of its risk on new term business.  Ceded reinsurance premiums were $12 million and $11 million in the second quarters of 2011 and 2010, respectively.  For the first half of 2011 compared to the first half of 2010, gross policy revenues totaled $55 million and $52 million, respectively, while ceded reinsurance premiums totaled $22 million and $20 million, respectively.

 

Premiums received on annuity and universal life products totaled $25 million in the second quarter of 2011, compared to $29 million in the second quarter of 2010.  Of this amount, annuity and universal life premiums which are recorded as deposits, and therefore not reflected in revenue on the Consolidated Statements of Operations, totaled $21 million and $25 million in the second quarters of 2011 and 2010, respectively.  For the first half of 2011 compared to the first half of 2010, premiums received on annuity and universal life products totaled $49 million and $62 million, respectively, while annuity and universal life deposits totaled $41 million and $54 million, respectively.

 

Investments

Due to continued positive market conditions in the second quarter and first half of 2011, EFL experienced low levels of impairments.  Equity in earnings of limited partnerships also reflected a slight improvement in market conditions in the first quarter of 2011 as limited partnership activity is reported on a one quarter lag.  See additional discussion of investments in the “Investment Operations” segment that follows.

 

Benefits and expenses

The second quarter of 2011 benefits and other changes in policy reserves were impacted by increases in death benefits and interest on annuity deposits compared to the second quarter of 2010.

 

51



 

Investment operations

The investment results related to our life insurance operations are included in the investment operations segment discussion as part of the Exchange’s investment results.

 

 

 

Erie Insurance Group

 

(in millions)

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2011

 

2010

 

% Change

 

2011

 

2010

 

% Change

 

Indemnity

 

(Unaudited)

 

 

 

(Unaudited)

 

 

 

Net investment income (1)

 

$    4

 

 

$     9

 

 

(56%)

 

$    8

 

 

$  18

 

 

(55%)

 

Net realized gains on investments (1)

 

6

 

 

(3

)

 

NM

 

7

 

 

2

 

 

NM

 

Net impairment losses recognized in earnings (1)

 

0

 

 

(1

)

 

NM

 

0

 

 

(1

)

 

NM

 

Equity in earnings of limited partnerships

 

7

 

 

6

 

 

15%

 

18

 

 

6

 

 

NM

 

Net revenue from investment operations – Indemnity (1) (2)

 

$  17

 

 

$    11

 

 

55%

 

$  33

 

 

$  25

 

 

32%

 

Exchange

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net investment income (1)

 

$112

 

 

$ 101

 

 

NM

 

$216

 

 

$199

 

 

8%

 

Net realized gains on investments (1)

 

33

 

 

(210

)

 

NM

 

181

 

 

(90

)

 

NM

 

Net impairment losses recognized in earnings (1)

 

0

 

 

(3

)

 

NM

 

0

 

 

(5

)

 

NM

 

Equity in earnings of limited partnerships

 

31

 

 

21

 

 

49%

 

92

 

 

24

 

 

NM

 

Net revenue from investment operations – Exchange (1) (2)

 

$176

 

 

$  (91

)

 

NM

 

$489

 

 

$128

 

 

NM

 

 

NM = not meaningful

 

(1)        As a result of the sale of Indemnity’s property and casualty insurance subsidiaries, EIC, ENY and EPC, to the Exchange on December 31, 2010, investment revenue and losses generated from these entities will no longer accrue to the Indemnity shareholder interest after this date.  Investment revenue from these entities totaled $7 million in the second quarter of 2010 and $15 million in the first six months of 2010.  These components of investment income now accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, in 2011 and thereafter.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

(2)        The Exchange’s investment results for the second quarter of 2011 and 2010 include net investment revenues from EFL’s operations of $27 million and $25 million, respectively.  The Exchange’s investment results for the first six months of 2011 and 2010 include net investment revenues from EFL’s operations of $54 million and $52 million, respectively.

 

 

Net investment income

Net investment income primarily includes interest and dividends on our fixed maturity and equity security portfolios.  Indemnity net investment income decreased $5 million in the second quarter of 2011 and $10 million in the first half of 2011 compared to 2010.  The Exchange’s net investment income increased $11 million and $17 million for the same respective periods.  These variances were primarily caused by the sale of EIC, ENY, and EPC from Indemnity to the Exchange on December 31, 2010.  These entities generated net investment income of $6 million and $13 million in the second quarter and first half of 2010, respectively.

 

Net realized gains on investments

Indemnity generated realized gains of $6 million in the second quarter of 2011 compared to losses of $3 million in the second quarter of 2010.  The Exchange generated realized gains of $33 million in the second quarter of 2011 compared to losses of $210 million in the same period in 2010.  The realized losses generated in the second quarter of 2010 for Indemnity and the Exchange were primarily due to decreases in the valuation on their common stock portfolios.  EIC, ENY, and EPC generated net realized gains of $2 million and $3 million in the second quarter and first half of 2010, respectively.

 

Net impairment losses recognized in earnings

Exchange impairment losses recognized in earnings decreased $3 million in the second quarter of 2011 and $5 million for the first half of 2011 compared to the same periods in 2010 as a result of improved market conditions.  EIC, ENY, and EPC generated net impairment losses of $1 million in the second quarter and first half of 2010.

 

Equity in earnings of limited partnerships

Indemnity’s equity in earnings of limited partnerships increased $1 million in the second quarter of 2011 and increased $12 million in the first half of 2011 compared to the same periods in 2010 while the Exchange’s equity in earnings of limited partnerships increased $10 million and $68 million, respectively.  The results were due to improved performance in the real estate and private equity sectors.

 

52



 

The breakdown of our net realized gains (losses) on investments is as follows:

 

 

 

Erie Insurance Group

 

(in millions)

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Indemnity

 

(Unaudited)

 

(Unaudited)

 

Securities sold:

 

 

 

 

 

 

 

 

 

Fixed maturities

 

$   2

 

 

$     1

 

 

$   2

 

 

$   3

 

 

Preferred stock equity securities

 

2

 

 

0

 

 

3

 

 

0

 

 

Common stock equity securities

 

1

 

 

0

 

 

2

 

 

1

 

 

Common stock valuation adjustments

 

1

 

 

(4

)

 

0

 

 

(2

)

 

Total net realized gains – Indemnity (1)

 

$   6

 

 

$    (3

)

 

$   7

 

 

$   2

 

 

Exchange

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold:

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities

 

$ 21

 

 

$     4

 

 

$ 34

 

 

$ 16

 

 

Preferred stock equity securities

 

10

 

 

2

 

 

15

 

 

6

 

 

Common stock equity securities

 

55

 

 

26

 

 

103

 

 

59

 

 

Common stock valuation adjustments

 

(53

)

 

(242

)

 

29

 

 

(171

)

 

Total net realized gains – Exchange (1) (2)

 

$ 33

 

 

$(210

)

 

$181

 

 

$(90

)

 

 

(1)           See Item 1. “Financial Statements – Note 7, Investments,” contained within this report for additional disclosures regarding net realized gains (losses) on investments.

 

(2)           The Exchange’s results for the second quarter of 2011 and 2010 include net realized gains from EFL’s operations of $3 million and $3 million, respectively.  The Exchange’s results for the first six months of 2011 and 2010 include net realized gains from EFL of $7 million and $8 million, respectively.

 

 

The components of equity in earnings (losses) of limited partnerships are as follows:

 

 

 

Erie Insurance Group

 

(in millions)

 

Three months ended June 30,

 

Six months ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Indemnity

 

(Unaudited)

 

(Unaudited)

 

Private equity

 

$  4

 

 

$  3

 

 

$11

 

 

$   8

 

 

Real estate

 

2

 

 

0

 

 

4

 

 

(6

)

 

Mezzanine debt

 

1

 

 

3

 

 

3

 

 

4

 

 

Total equity in earnings of limited partnerships – Indemnity

 

$  7

 

 

$  6

 

 

$18

 

 

$   6

 

 

Exchange

 

 

 

 

 

 

 

 

 

 

 

 

 

Private equity

 

$17

 

 

$15

 

 

$57

 

 

$ 37

 

 

Real estate

 

7

 

 

(3

)

 

20

 

 

(25

)

 

Mezzanine debt

 

7

 

 

9

 

 

15

 

 

12

 

 

Total equity in earnings of limited partnerships – Exchange(1)

 

$31

 

 

$21

 

 

$92

 

 

$ 24

 

 

 

NM = not meaningful

 

(1)    The Exchange’s results for the second quarter of 2011 and 2010 include equity in earnings of limited partnerships from EFL of $1 million and $0 million, respectively.  The Exchange’s results for the first six months of 2011 include equity in earnings of limited partnerships from EFL of $1 million compared to losses of $1 million recorded for the first six months of 2010.

 

 

Limited partnership earnings pertain to investments in U.S. and foreign private equity, real estate and mezzanine debt partnerships.  Valuation adjustments are recorded to reflect the fair value of limited partnerships.  These adjustments are recorded as a component of equity in earnings of limited partnerships in the Consolidated Statements of Operations.

 

We experienced an increase in earnings as a result of fair value increases in our private equity and real estate limited partnerships.  Limited partnership earnings tend to be cyclical based on market conditions, the age of the partnership and the nature of the investments.  Generally, limited partnership earnings are recorded on a quarter lag from financial statements we receive from our general partners.  As a consequence, earnings from limited partnerships reported at June 30, 2011 reflect investment valuation changes resulting from the financial markets and the economy in the first quarter of 2011.

 

53



 

FINANCIAL CONDITION

 

Investments

Prior to and through December 31, 2010, the investment results from EIC, ENY and EPC accrued to the Indemnity shareholder interest.  Due to the sale of Indemnity’s property and casualty subsidiaries to the Exchange on December 31, 2010, the investment results for these companies accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after December 31, 2010.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

Our investment strategy takes a long-term perspective emphasizing investment quality, diversification and superior investment returns.  Investments are managed on a total return approach that focuses on current income and capital appreciation.  Our investment strategy also provides for liquidity to meet our short- and long-term commitments.

 

Distribution of investments

 

 

 

Erie Insurance Group

 

(in millions)

 

Carrying value at
June 30,

 

 

Carrying value at
December 31,

 

 

 

 

2011

% to total

 

2010

% to total

 

Indemnity

 

(Unaudited)

 

 

 

 

 

Fixed maturities

 

$    525

 

66

%

 

$     264

 

50

%

 

Equity securities:

 

 

 

 

 

 

 

 

 

 

 

Preferred stock

 

20

 

3

 

 

24

 

4

 

 

Common stock

 

30

 

4

 

 

28

 

5

 

 

Limited partnerships:

 

 

 

 

 

 

 

 

 

 

 

Private equity

 

90

 

11

 

 

86

 

16

 

 

Real estate

 

90

 

11

 

 

83

 

16

 

 

Mezzanine debt

 

44

 

5

 

 

47

 

9

 

 

Real estate mortgage loans

 

1

 

0

 

 

1

 

0

 

 

Total investments – Indemnity

 

$    800

 

100

%

 

$     533

 

100

%

 

Exchange

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities

 

$ 7,380

 

63

%

 

$ 7,279

 

65

%

 

Equity securities:

 

 

 

 

 

 

 

 

 

 

 

Preferred stock

 

610

 

5

 

 

570

 

5

 

 

Common stock

 

2,513

 

22

 

 

2,306

 

20

 

 

Limited partnerships:

 

 

 

 

 

 

 

 

 

 

 

Private equity

 

585

 

5

 

 

555

 

5

 

 

Real estate

 

373

 

3

 

 

339

 

3

 

 

Mezzanine debt

 

208

 

2

 

 

214

 

2

 

 

Policy loans

 

15

 

0

 

 

15

 

0

 

 

Real estate mortgage loans

 

4

 

0

 

 

4

 

0

 

 

Total investments – Exchange

 

$11,688

 

100

%

 

$11,282

 

100

%

 

Total investments – Erie Insurance Group

 

$12,488

 

 

 

 

$11,815

 

 

 

 

 

We continually review our investment portfolio to evaluate positions that might incur other-than-temporary declines in value.  For all investment holdings, general economic conditions and/or conditions specifically affecting the underlying issuer or its industry, including downgrades by the major rating agencies, are considered in evaluating impairment in value.  In addition to specific factors, other factors considered in our review of investment valuation are the length of time the fair value is below cost and the amount the fair value is below cost.

 

We individually analyze all positions with emphasis on those that have, in management’s opinion, declined significantly below cost.  In compliance with impairment guidance for debt securities, we perform further analysis to determine if a credit-related impairment has occurred.  Some of the factors considered in determining whether a debt security is credit impaired include potential for the default of interest and/or principal, level of subordination, collateral of the issue, compliance with financial covenants, credit ratings and industry conditions.  We have the intent to sell all credit-impaired debt securities, therefore the entire amount of the impairment charges are included in earnings and no credit impairments are recorded in other comprehensive income.  For available-for-sale equity

 

54



 

securities, a charge is recorded in the Consolidated Statements of Operations for positions that have experienced other-than-temporary impairments due to credit quality or other factors.  (See the “Investment Operations” section herein for further information.)

 

If our policy for determining the recognition of impaired positions was different, our consolidated results of operations could be significantly impacted.  Management believes its investment valuation philosophy and accounting practices result in appropriate and timely measurement of value and recognition of impairment.

 

Fixed maturities

Under our investment strategy, we maintain a fixed maturities portfolio that is of high quality and well diversified within each market sector.  This investment strategy also achieves a balanced maturity schedule.  The fixed maturities portfolio is managed with the goal of achieving reasonable returns while limiting exposure to risk.  Our municipal bond portfolio accounts for $222 million, or 41%, of the total fixed maturity portfolio for Indemnity and $1.4 billion, or 19%, of the fixed maturity portfolio for the Exchange at June 30, 2011.  The overall credit rating of the municipal portfolio without consideration of the underlying insurance is AA.  Because of the rating downgrades of municipal bond insurers, the underlying insurance does not improve the overall credit rating.

 

Fixed maturities classified as available-for-sale are carried at fair value with unrealized gains and losses, net of deferred taxes, included in shareholders’ equity.  Indemnity’s net unrealized gains on fixed maturities, net of deferred taxes, amounted to $6 million at June 30, 2011 compared to $5 million at December 31, 2010.  At June 30, 2011, the Exchange had net unrealized gains on fixed maturities of $293 million compared to net unrealized gains of $270 million at December 31, 2010.

 

The following tables present a breakdown of the fair value of our fixed maturities portfolio by sector and rating for Indemnity and the Exchange, respectively:

 

 

 

Erie Insurance Group (2)

 

(in millions)

 

At June 30, 2011

 

 

 

(Unaudited)

 

Indemnity

 

 

 

 

 

 

 

 

 

Non-investment

 

Fair

 

Industry Sector

 

AAA

 

AA

 

A

 

BBB

 

grade

 

value

 

Structured securities (1)

 

$ 34

 

$  0

 

$ 0

 

$  0

 

$4

 

$ 38

 

Communications

 

0

 

0

 

0

 

17

 

0

 

17

 

Consumer

 

0

 

0

 

0

 

11

 

0

 

11

 

Energy

 

0

 

0

 

11

 

6

 

0

 

17

 

Financial

 

0

 

49

 

45

 

45

 

0

 

139

 

Government-municipal

 

91

 

93

 

26

 

12

 

0

 

222

 

Industrial

 

0

 

0

 

2

 

5

 

0

 

7

 

Government sponsored entity

 

8

 

0

 

0

 

0

 

0

 

8

 

Technology

 

0

 

0

 

8

 

10

 

0

 

18

 

Utilities

 

0

 

0

 

0

 

48

 

0

 

48

 

Total – Indemnity

 

$133

 

$142

 

$92

 

$154

 

$4

 

$525

 

 

(1)          Structured securities include asset-backed securities, collateral, lease and debt obligations, commercial mortgage-backed securities and residential mortgage-backed securities.

 

(2)          Ratings are supplied by S&P, Moody’s, and Fitch.  The table is based on the lowest rating for each security.

 

55



 

 

 

Erie Insurance Group (2)

 

(in millions)

 

At June 30, 2011

 

 

 

(Unaudited)

 

Exchange

 

 

 

 

 

 

 

 

 

Non-investment

 

Fair

 

Industry Sector

 

AAA

 

AA

 

A

 

BBB

 

grade

 

value

 

Structured securities (1) 

 

$323

 

$   36

 

$   29

 

$   15

 

$ 23

 

$  426

 

Basic materials

 

0

 

0

 

52

 

168

 

6

 

226

 

Communications

 

0

 

0

 

143

 

339

 

15

 

497

 

Consumer

 

0

 

29

 

210

 

392

 

68

 

699

 

Diversified

 

0

 

0

 

22

 

0

 

0

 

22

 

Energy

 

17

 

11

 

115

 

353

 

38

 

534

 

Financial

 

28

 

297

 

1,235

 

680

 

131

 

2,371

 

Funds

 

0

 

0

 

0

 

6

 

0

 

6

 

Government-municipal

 

431

 

760

 

212

 

33

 

2

 

1,438

 

Industrial

 

0

 

5

 

99

 

200

 

32

 

336

 

U.S. treasury

 

11

 

0

 

0

 

0

 

0

 

11

 

Government sponsored entity

 

54

 

0

 

2

 

0

 

0

 

56

 

Foreign government

 

0

 

0

 

16

 

6

 

0

 

22

 

Technology

 

0

 

0

 

46

 

78

 

0

 

124

 

Utilities

 

0

 

0

 

111

 

439

 

62

 

612

 

Total – Exchange

 

$864

 

$1,138

 

$2,292

 

$2,709

 

$377

 

$7,380

 

 

(1)          Structured securities include asset-backed securities, collateral, lease and debt obligations, commercial mortgage-backed securities and residential mortgage-backed securities.

 

(2)          Ratings are supplied by S&P, Moody’s, and Fitch.  The table is based on the lowest rating for each security.

 

 

Equity securities

Our equity securities consist of common stock and nonredeemable preferred stock.  Investment characteristics of common stock and nonredeemable preferred stock differ substantially from one another.  Our nonredeemable preferred stock portfolio provides a source of current income that is competitive with investment-grade bonds.

 

The following tables present an analysis of the fair value of our non-redeemable preferred and common stock securities by sector for Indemnity and Exchange, respectively.

 

 

 

Erie Insurance Group

 

(in millions)

 

Fair Value at

 

 

 

June 30, 2011

 

December 31, 2010

 

Indemnity

 

(Unaudited)

 

 

 

 

 

Industry sector

 

Preferred
stock

 

Common
stock

 

Preferred
stock

 

Common
stock

 

Communications

 

$ 1

 

$ 2

 

$ 1

 

$ 2

 

Consumer

 

0

 

15

 

0

 

14

 

Diversified

 

0

 

1

 

0

 

0

 

Energy

 

0

 

1

 

0

 

2

 

Financial

 

9

 

6

 

11

 

6

 

Industrial

 

0

 

4

 

2

 

3

 

Technology

 

3

 

1

 

3

 

1

 

Utilities

 

7

 

0

 

7

 

0

 

Total – Indemnity

 

$20

 

$30

 

$24

 

$28

 

 

56



 

 

 

Erie Insurance Group

 

(in millions)

 

Fair Value at

 

 

 

June 30, 2011

 

December 31, 2010

 

Exchange

 

(Unaudited)

 

 

 

 

 

Industry sector

 

Preferred
stock

 

Common
stock

 

Preferred
stock

 

Common
stock

 

Basic materials

 

$  0

 

$  117

 

$  0

 

$  124

 

Communications

 

9

 

211

 

9

 

174

 

Consumer

 

5

 

714

 

5

 

564

 

Diversified

 

0

 

16

 

0

 

12

 

Energy

 

0

 

222

 

0

 

185

 

Financial

 

461

 

316

 

428

 

292

 

Funds

 

0

 

224

 

0

 

309

 

Government

 

1

 

0

 

0

 

0

 

Industrial

 

0

 

359

 

5

 

324

 

Technology

 

15

 

298

 

14

 

295

 

Utilities

 

119

 

36

 

109

 

27

 

Total – Exchange

 

$610

 

$2,513

 

$570

 

$2,306

 

 

 

Our preferred stock equity securities are classified as available-for-sale and are carried at fair value on our Consolidated Statements of Financial Position with all changes in unrealized gains and losses reflected in other comprehensive income.  At June 30, 2011, the unrealized gain on preferred stock classified as available-for-sale securities, net of deferred taxes amounted to $1 million for Indemnity and $47 million for the Exchange compared to a $3 million gain for Indemnity and $44 million gain for the Exchange at December 31, 2010.

 

Our common stock portfolio is classified as a trading portfolio and is measured at fair value with all changes in unrealized gains and losses reflected in our Consolidated Statements of Operations.

 

Limited partnerships

In the second quarter of 2011, investments in limited partnerships remained relatively flat from the investment levels at December 31, 2010.  The changes in partnership value are a function of contributions and distributions, adjusted for market value changes in the underlying investments.  During 2011, the limited partnership market values and partnerships earnings have been generally positive as the recent market conditions continue to show signs of improvement.

 

The components of limited partnership investments are as follows:

 

 

 

Erie Insurance Group

 

(in millions)

 

At June 30,

 

At December 31,

 

 

 

2011

 

2010

 

Indemnity

 

(Unaudited)

 

 

 

Private equity

 

$    90

 

$    86

 

Real estate

 

90

 

83

 

Mezzanine debt

 

44

 

47

 

Total limited partnerships – Indemnity

 

$  224

 

$  216

 

Exchange

 

 

 

 

 

Private equity

 

$  585

 

$  555

 

Real estate

 

373

 

339

 

Mezzanine debt

 

208

 

214

 

Total limited partnerships – Exchange

 

$1,166

 

$1,108

 

 

57



 

Liabilities

 

Property and casualty loss reserves

Loss reserves are established to account for the estimated ultimate costs of loss and loss expenses for claims that have been reported but not yet settled and claims that have been incurred but not reported.  While we exercise professional diligence to establish reserves at the end of each period that are fully reflective of the ultimate value of all claims incurred, these reserves are, by their nature, only estimates and cannot be established with absolute certainty.

 

The factors which may potentially cause the greatest variation between current reserve estimates and the actual future paid amounts are: unforeseen changes in statutory or case law altering the amounts to be paid on existing claim obligations, new medical procedures and/or drugs with costs significantly different from those seen in the past, and claims patterns on current business that differ significantly from historical claims patterns.

 

Loss and loss expense reserves are presented on our Consolidated Statements of Financial Position on a gross basis.  The following table represents the direct and assumed loss and loss expense reserves by major line of business for our property and casualty insurance operations.  The reinsurance recoverable amount represents the related ceded amounts which results in the net liability attributable to the Exchange.

 

As of December 31, 2010, all property and casualty insurance underwriting risk resides with the Exchange.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

 

 

Erie Insurance Group

 

(in millions)

 

At June 30,

 

At December 31,

 

 

 

2011

 

2010

 

Exchange

 

(Unaudited)

 

 

 

Gross reserve liability:

 

 

 

 

 

Personal auto

 

$1,078

 

$1,105

 

Automobile massive injury

 

391

 

440

 

Homeowners

 

436

 

240

 

Workers compensation

 

485

 

481

 

Workers compensation massive injury

 

145

 

154

 

Commercial auto

 

287

 

286

 

Commercial multi-peril

 

629

 

566

 

All other lines of business

 

340

 

312

 

Gross reserves

 

3,791

 

3,584

 

Reinsurance recoverable

 

188

 

188

 

Net reserve liability – Exchange

 

$3,603

 

$3,396

 

 

The reserves that have the greatest potential for variation are the massive injury claim reserves.  The Property and Casualty Group is currently reserving for about 300 claimants requiring lifetime medical care, of which about 120 involve massive injuries.  The reserve carried by the Property and Casualty Group for the massive injury claimants, which includes automobile massive injury and workers compensation massive injury reserves, totaled $371 million at June 30, 2011, which is net of $165 million of anticipated reinsurance recoverables, compared to $428 million at December 31, 2010, which was net of $166 million of anticipated reinsurance recoverables.  The pre-1986 automobile massive injury reserves decreased at June 30, 2011, compared to December 31, 2010, primarily due to improved annual claim cost expectations on massive injury lifetime medical benefits claims and the closing of one massive injury lifetime medical benefits claim. The workers compensation massive injury reserves decreased at June 30, 2011, compared to December 31, 2010, primarily due to the closing of four massive injury lifetime medical benefits claims.

 

Life insurance reserves

EFL’s primary commitment is its obligation to pay future policy benefits under the terms of its life insurance and annuity contracts.  To meet these future obligations, EFL establishes life insurance reserves based on the type of policy, the age, gender and risk class of the insured and the number of years the policy has been in force. EFL also establishes annuity and universal life reserves based on the amount of policyholder deposits (less applicable insurance and expense charges) plus interest earned on those deposits.  Life insurance and annuity reserves are supported primarily by EFL’s long-term, fixed income investments as the underlying policy reserves are generally also of a long-term nature.

 

58



 

IMPACT OF INFLATION

 

Property and casualty insurance premiums are established before losses occur and before loss expenses are incurred, and therefore, before the extent to which inflation may impact such costs is known.  Consequently, in establishing premium rates, we attempt to anticipate the potential impact of inflation, including medical cost inflation, construction and auto repair cost inflation and tort issues.  Medical costs are a broad element of inflation that impacts personal and commercial auto, general liability, workers compensation and commercial multi-peril lines of insurance written by the Property and Casualty Group.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Sources and uses of cash

Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet the short- and long-term cash requirements of its business operations and growth needs.  Our liquidity requirements have been met primarily by funds generated from premiums collected and income from investments.  The insurance operations provide liquidity in that premiums are collected in advance of paying losses under the policies purchased with those premiums.  Cash outflows for the property and casualty business are generally variable since settlement dates for liabilities for unpaid losses and the potential for large losses, whether individual or in the aggregate, cannot be predicted with absolute certainty.  Accordingly, after satisfying our operating cash requirements, excess cash flows are used to build our investment portfolio in order to increase future investment income, which then may be used as a source of liquidity if cash from our insurance operations would not be sufficient to meet our obligations.  Cash provided from these sources is used primarily to fund losses and policyholder benefits, fund the costs of operations including commissions, salaries and wages, pension plans, share repurchases, dividends to shareholders and the purchase and development of information technology.  We expect that our operating cash needs will be met by funds generated from operations.

 

Volatility in the financial markets presents challenges to us as we do occasionally access our investment portfolio as a source of cash.  Some of our fixed income investments, despite being publicly traded, are illiquid.  Volatility in these markets could impair our ability to sell certain of our fixed income securities or cause such securities to sell at deep discounts.  Additionally, our limited partnership investments are significantly less liquid.  We believe we have sufficient liquidity to meet our needs from other sources even if market volatility persists throughout 2011.

 

Cash flow activities – Erie Insurance Group

The following table is a summary of our condensed consolidated cash flows for the six months ended June 30:

 

 

 

Erie Insurance Group

 

(in millions)

 

2011

 

2010

 

 

 

(Unaudited)

 

Net cash provided by operating activities

 

$ 200

 

$ 212

 

Net cash used in investing activities

 

(397)

 

(180)

 

Net cash used in financing activities

 

(124)

 

(43)

 

Net decrease in cash

 

$(321)

 

$ (11)

 

 

Cash flows provided by operating activities totaled $200 million and $212 million in the first six months of 2011 and 2010, respectively.  Decreased cash from operating activities in the first six months of 2011 was primarily driven by increased losses paid to policyholders and commissions paid to agents compared to the first six months of 2010.  Offsetting this decrease in the first six months of 2011 was an increase in premiums collected by the Exchange driven by the increase in premiums written, an increase in limited partnership distributions and net investment income, and less income taxes paid compared to the first six months of 2010.

 

At June 30, 2011, we recorded a net deferred tax liability of $251 million, which included capital loss carry-forwards of $7 million.  There was no valuation allowance at June 30, 2011. We have the ability to carry-back capital losses of $38 million as a result of gains recognized in prior years.  In the second quarter of 2011, we received a tax refund of $82 million related to the carry-back of 2010 capital losses.

 

59



 

Cash flows used in investing activities totaled $397 million and $180 million in the first six months of 2011 and 2010, respectively. In the first half of 2011, we used more cash to purchase certain fixed maturity and common stock investments. This was offset somewhat by an increase in proceeds generated from the sale of common stocks, compared to the first half of 2010.  At June 30, 2011, we had contractual commitments to invest up to $477 million related to our limited partnership investments to be funded as required by the partnerships’ agreements.  Of this amount, the total remaining commitment to fund limited partnerships that invest in private equity securities was $211 million, real estate activities was $130 million and mezzanine debt securities was $136 million.

 

For a discussion of cash flows used in financing activities, see the following “Cash flow activities – Indemnity,” as the primary drivers of financing cash flows related to Indemnity.

 

Cash flow activities – Indemnity

The following table is a summary of cash flows for Indemnity for the six months ended June 30:

 

 

 

Indemnity

 

(in millions)

 

2011

 

2010

 

 

 

(Unaudited)

 

Net cash provided by operating activities

 

$   61

 

$ 42

 

Net cash used in investing activities

 

(181)

 

(17)

 

Net cash used in financing activities

 

(142)

 

(67)

 

Net decrease in cash

 

$(262)

 

$(42)

 

 

See Item 1. “Financial Statements - Note 14, Indemnity Supplemental Information,” contained within this report for more detail on Indemnity cash flows.

 

Indemnity’s cash flows provided by operating activities increased to $61 million in the first six months of 2011, compared to $42 million in the first six months of 2010.  Increased cash from operating activities in the first six months of 2011 was primarily due to an increase in management fee revenue received, offset somewhat by a decrease in net investment income received and increased commissions paid to agents.  Management fee revenues were higher reflecting the increase in premiums written or assumed by the Exchange.  Cash paid for agent commissions and bonuses increased to $313 million in the first six months of 2011, compared to $290 million in the first six months of 2010, as a result of the increase in premiums collected by the Exchange.  Indemnity’s policy for funding its pension plan is generally to contribute an amount equal to the greater of the IRS minimum required contribution or the target normal cost for the year plus interest to the date the contribution is made.  For 2011, Indemnity expects to contribute $15 million in the third quarter, which does exceed the required minimum amount. In 2010, Indemnity’s pension contribution was made in the second quarter and totaled $13 million.  Indemnity is generally reimbursed about 57% of the net periodic benefit cost of the pension plan from its affiliates.

 

At June 30, 2011, Indemnity recorded a net deferred tax liability of $1 million.  There was no valuation allowance at June 30, 2011.  Indemnity has the ability to carry back capital losses of $1 million as a result of gains recognized in prior years.  In the second quarter of 2011, the initial 2010 tax return was filed and Indemnity received a tax refund of $13 million related to the carry-back of 2010 capital losses.  Indemnity’s capital gain and loss strategies take into consideration its ability to offset gains and losses in future periods, carry-back of capital loss opportunities to the three preceding years, and capital loss carry-forward opportunities to apply against future capital gains over the next five years.

 

Net cash used in Indemnity investing activities totaled $181 million in the first half of 2011, compared to $17 million in the first half of 2010.  In the first quarter of 2011, Indemnity received cash consideration from the Exchange of $82 million as a result of the sale of Indemnity’s 21.6% ownership interest in EFL to the Exchange on March 31, 2011, based upon an estimated purchase price.  Final settlement of the transaction was made on April 25, 2011 for a final purchase price of $82 million.  Net after-tax cash proceeds to Indemnity from the sale were $58 million.  Also, on March 18, 2011, a payment of $8 million was made by Indemnity to the Exchange as final settlement of the sale of EIC, ENY and EPC to the Exchange based upon the final purchase price.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

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Indemnity’s first half of 2011 investing activities also included increased cash used to purchase certain fixed maturities, offset somewhat by increased cash from the sale of other fixed maturities compared to the first half of 2010.  Also impacting Indemnity’s future investing activities are limited partnership commitments, which totaled $43 million at June 30, 2011, and will be funded as required by the partnerships’ agreements.  Of this amount, the total remaining commitment to fund limited partnerships that invest in private equity securities was $18 million, real estate activities was $13 million and mezzanine debt securities was $12 million.

 

Net cash used in Indemnity financing activities totaled $142 million and $67 million in the first half of 2011 and 2010, respectively.  The increase in cash used in financing activities in the first half of 2011 was primarily driven by increases in the cash outlay for share repurchases and dividends paid to shareholders.  Indemnity repurchased 0.8 million shares of its Class A nonvoting common stock in conjunction with its stock repurchase program at a total cost of $54 million in the second quarter of 2011.  During the first six months of 2011, shares repurchased under this program totaled 1.3 million at a total cost of $90 million.  During the first six months of 2010, 0.4 million shares were repurchased at a total cost of $20 million.  In December 2010, our Board of Directors approved a continuation of the current stock repurchase program for a total of $150 million.   Indemnity had approximately $56 million of repurchase authority remaining under this program at June 30, 2011.

 

Dividends paid to shareholders totaled $52 million in the first six months of 2011, compared to $50 million in the first six months of 2010.  Indemnity increased both its Class A and Class B shareholder quarterly dividends by 7.3% in 2011, compared to 2010.  There are no regulatory restrictions on the payment of dividends to Indemnity’s shareholders.

 

Capital Outlook

We regularly prepare forecasts evaluating the current and future cash requirements of Indemnity and the Exchange for both normal and extreme risk events.  Should an extreme risk event result in a cash requirement exceeding normal cash flows, we have the ability to meet our future funding requirements through various alternatives available to us.

 

Indemnity – Outside of Indemnity’s normal operating and investing cash activities, future funding requirements could be met through 1) Indemnity’s cash and cash equivalents, which total approximately $48 million at June 30, 2011, 2) a $100 million bank line of credit held by Indemnity, and 3) liquidation of assets held in Indemnity’s investment portfolio, including common stock, preferred stock and investment grade bonds which totaled approximately $571 million at June 30, 2011.  Volatility in the financial markets could impair Indemnity’s ability to sell certain of its fixed income securities or cause such securities to sell at deep discounts. Additionally, Indemnity has the ability to curtail or modify discretionary cash outlays such as those related to shareholder dividends and share repurchase activities.

 

Indemnity had no borrowings under its line of credit at June 30, 2011.  At June 30, 2011, bonds with fair values of $135 million were pledged as collateral.  These securities have no restrictions.  The bank requires compliance with certain covenants, which include minimum net worth and leverage ratios.  Indemnity was in compliance with its bank covenants at June 30, 2011.

 

Prior to and through December 31, 2010, the underwriting results retained by EIC and ENY and the investment results of EIC, ENY and EPC accrued to the Indemnity shareholder interest.  Due to the sale of Indemnity’s property and casualty subsidiaries to the Exchange on December 31, 2010, all property and casualty underwriting results and all investment results for these companies accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, after December 31, 2010.  The net cash provided from these entities by operating activities totaled $10 million for the six months ended June 30, 2010.  These operating cash flows accrue to the interest of the subscribers (policyholders) of the Exchange, or noncontrolling interest, in 2011 and thereafter.  (See Item 1. “Financial Statements - Note 1, Nature of Operations,” contained within this report.)

 

Exchange – Outside of the Exchange’s normal operating and investing cash activities, future funding requirements could be met through 1) the Exchange’s cash and cash equivalents, which total approximately $61 million at June 30, 2011, 2) a $200 million bank revolving line of credit held by the Exchange, and 3) liquidation of assets held in the Exchange’s investment portfolio, including common stock, preferred stock and investment grade bonds which totaled approximately $10.1 billion at June 30, 2011.  Volatility in the financial markets could impair the Exchange’s ability to sell certain of its fixed income securities or cause such securities to sell at deep discounts.

 

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The Exchange had no borrowings under its line of credit at June 30, 2011.  At June 30, 2011, bonds with fair values of $263 million were pledged as collateral.  These securities have no restrictions.  The bank requires compliance with certain covenants, which include statutory surplus and risk based capital ratios.  The Exchange was in compliance with its bank covenants at June 30, 2011.

 

Indemnity has no rights to the assets, capital, or line of credit of the Exchange and, conversely, the Exchange has no rights to the assets, capital, or line of credit of Indemnity.  We believe we have the funding sources available to us to support cash flow requirements in 2011.

 

Off-balance sheet arrangements

Off-balance sheet arrangements include those with unconsolidated entities that may have a material current or future effect on our financial condition or results of operations, including material variable interests in unconsolidated entities that conduct certain activities.  We have no material off-balance sheet obligations or guarantees, other than our limited partnership investment commitments.

 

Surplus notes

Indemnity holds a surplus note for $25 million from EFL that is payable on demand on or after December 31, 2018 with prior approval of the Pennsylvania Insurance Commissioner.  EFL paid interest to Indemnity on the surplus note of $0.8 million through June 30, 2011 and 2010.

 

The Exchange holds a surplus note for $20 million from EFL that is payable on demand on or after December 31, 2025 with prior approval of the Pennsylvania Insurance Commissioner.  EFL paid interest to the Exchange on the surplus note of $0.6 million through June 30, 2011 and 2010.

 

CRITICAL ACCOUNTING ESTIMATES

 

We make estimates and assumptions that have a significant effect on the amounts and disclosures reported in the financial statements.  The most significant estimates relate to the reserves for property/casualty insurance unpaid losses and loss adjustment expenses, life insurance and annuity policy reserves, valuation of investments, deferred acquisition costs related to life insurance and investment-type contracts, deferred taxes and retirement benefits.  While management believes its estimates are appropriate, the ultimate amounts may differ from estimates provided.  Our most critical accounting estimates are described in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for the year ended December 31, 2010 of our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 24, 2011.  See Item 1. “Financial Statements - Note 6, Fair Value,” contained within this report for additional information on our valuation of investments.

 

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our exposure to market risk is primarily related to fluctuations in prices and interest rates.  Quantitative and qualitative disclosures about market risk resulting from changes in prices and interest rates for the year ended December 31, 2010 are included in Item 7A. “Quantitative and Qualitative Disclosures About Market Risk,” of our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 24, 2011.  There have been no material changes that impact our portfolio or reshape our periodic investment reviews of asset allocations during the six months ended June 30, 2011.  For a recent discussion of conditions surrounding our investment portfolio, see the “Operating Overview,” “Investment Operations,” and “Financial Condition, Investments” discussions contained in Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” within this report.

 

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ITEM 4.  CONTROLS AND PROCEDURES

 

We carried out an evaluation, with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.  Our management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, any change in our internal control over financial reporting and determined there has been no change in our internal control over financial reporting during the six months ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1A.  RISK FACTORS

 

There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 as filed with the Securities and Exchange Commission on February 24, 2011.

 

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Issuer Purchases of Equity Securities

 

The following table summarizes Indemnity’s Class A common stock repurchased each month, based upon trade date, during the quarter ended June 30, 2011:

 

 

 

 

 

 

 

 

 

Approximate

 

(dollars in millions, except per

 

 

 

 

 

 

 

Dollar Value

 

share data)

 

 

 

 

 

Total Number of

 

of Shares that

 

 

 

Total Number

 

Average

 

Shares Purchased

 

May Yet Be

 

 

 

of Shares

 

Price Paid

 

as Part of Publicly

 

Purchased

 

Period

 

Purchased

 

Per Share

 

Announced Program

 

Under the Program

 

April 1 – 30, 2011

 

    130,167

 

  $71.74

 

130,167

 

 

 

May  1 – 31, 2011

 

     149,580

 

  $70.97

 

149,580

 

 

 

June  1 – 30, 2011

 

     492,177

 

  $68.58

 

492,177

 

 

 

Total

 

     771,924

 

 

 

771,924

 

$56

 

 

In December 2010, our Board of Directors approved a continuation of the current stock repurchase program, authorizing repurchases for a total of $150 million with no time limitation.

 

ITEM 5.  OTHER INFORMATION

 

As discussed in our 8-K filing with the Securities and Exchange Commission on April 20, 2011, at the 86th Annual Meeting of Shareholders of Erie Indemnity Company held on April 19, 2011, the shareholders approved three (3) amendments to Indemnity’s Articles of Incorporation to: (i) modify the corporate purposes clause; (ii) update the corporate registered address; and (iii) eliminate the requirement of a specific number of directors and provide that the size of the Board shall be governed by the Company’s Bylaws.  Each of the amendments to the Articles of Incorporation was voted on and unanimously approved by the 2,545 votes cast.  A copy of the Amended and Restated Articles of Incorporation of Erie Indemnity Company, dated April 19, 2011, is filed herewith as Exhibit 3.1.

 

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ITEM 6.  EXHIBITS

 

Exhibit

 

 

Number

 

Description of Exhibit

 

 

 

3.1

 

Amended and Restated Articles of Incorporation of Registrant dated April 19, 2011.

 

 

 

31.1

 

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

31.2

 

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

 

 

32

 

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

Erie Indemnity Company

 

 

(Registrant)

 

 

 

 

 

 

Date: August 2, 2011

By:

/s/ Terrence W. Cavanaugh

 

 

Terrence W. Cavanaugh, President & CEO

 

 

 

 

By:

/s/ Marcia A. Dall

 

 

Marcia A. Dall, Executive Vice President & CFO

 

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