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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SeptemberJune 30, 20172020
OR
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from___to___
Commission file number 0-24000

ERIE INDEMNITY COMPANY
(Exact name of registrant as specified in its charter)

PENNSYLVANIAPennsylvania25-0466020
(State or other jurisdiction of(I.R.S.IRS Employer
incorporation or organization)Identification No.)

100 Erie Insurance Place, Erie, PennsylvaniaErie,16530Pennsylvania16530
(Address of principal executive offices)(Zip Code)

(814) 870-2000814870-2000
(Registrant’s telephone number, including area code)

Not applicable
(Former name, former address and former fiscal year, if changed since last report)
 
Securities registered pursuant to Section 12(b) of the Act:
Class A common stock,stated value $0.0292 per shareERIENASDAQ Stock Market, LLC
(Title of each class)(Trading Symbol)(Name of each exchange on which registered)
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 ☒ No ☐
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 ☒ No ☐
Yes [X]   No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filerAccelerated filerNon-accelerated filer
Smaller reporting companyEmerging growth company
Large accelerated filer [X]            Accelerated filer [  ]        Non-accelerated filer [  ]
                                    (Do not check if a smaller reporting company)
Smaller reporting company [  ]        Emerging growth company [  ]    
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Act. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
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 46,189,068 at October 13, 2017.July 24, 2020.
 
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 2,542 at October 13, 2017.

July 24, 2020.


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PART I. FINANCIAL INFORMATION


ITEM 1.
ITEM 1. FINANCIAL STATEMENTS


ERIE INDEMNITY COMPANY
STATEMENTS OF OPERATIONS (UNAUDITED)
(dollars in thousands, except per share data)

Three months endedSix months ended
June 30,June 30,
2020201920202019
Operating revenue  
Management fee revenue - policy issuance and renewal services, net
$483,795  $480,513  $927,545  $911,496  
Management fee revenue - administrative services, net14,813  14,195  29,584  28,146  
Administrative services reimbursement revenue151,965  146,095  303,519  288,575  
Service agreement revenue6,446  6,907  13,108  13,599  
Total operating revenue657,019  647,710  1,273,756  1,241,816  
Operating expenses
Cost of operations - policy issuance and renewal services413,865  405,005  793,357  770,509  
Cost of operations - administrative services151,965  146,095  303,519  288,575  
Total operating expenses565,830  551,100  1,096,876  1,059,084  
Operating income91,189  96,610  176,880  182,732  
Investment income
Net investment income7,373  8,030  15,742  16,547  
Net realized investment gains (losses)6,526  1,302  (4,280) 3,805  
Net impairment losses recognized in earnings(17) (84) (3,070) (162) 
Equity in (losses) earnings of limited partnerships(2,329) 404  (6,034) (743) 
Total investment income11,553  9,652  2,358  19,447  
Interest expense, net 272   721  
Other (expense) income(258) 48  (624) 95  
Income before income taxes102,482  106,038  178,609  201,553  
Income tax expense20,505  18,284  37,306  38,488  
Net income$81,977  $87,754  $141,303  $163,065  
Net income per share  
Class A common stock – basic$1.76  $1.88  $3.03  $3.50  
Class A common stock – diluted$1.57  $1.68  $2.70  $3.12  
Class B common stock – basic and diluted$264  $283  $455  $525  
Weighted average shares outstanding – Basic  
Class A common stock46,187,808  46,188,994  46,188,299  46,188,668  
Class B common stock2,542  2,542  2,542  2,542  
Weighted average shares outstanding – Diluted  
Class A common stock52,302,981  52,314,700  52,313,667  52,313,371  
Class B common stock2,542  2,542  2,542  2,542  
Dividends declared per share  
Class A common stock$0.965  $0.90  $1.93  $1.80  
Class B common stock$144.75  $135.00  $289.50  $270.00  
  Three months ended Nine months ended
  September 30, September 30,
  2017 2016 2017 2016
Operating revenue      
  
Management fee revenue, net $435,214
 $411,139
 $1,268,591
 $1,195,262
Service agreement revenue 7,278
 7,267
 21,781
 21,756
Total operating revenue 442,492
 418,406
 1,290,372
 1,217,018
         
Operating expenses        
Commissions 248,677
 232,455
 720,538
 676,963
Salaries and employee benefits 60,499
 53,265
 181,013
 161,579
All other operating expenses 52,480
 50,431
 158,407
 142,797
Total operating expenses 361,656
 336,151
 1,059,958
 981,339
Operating income 80,836
 82,255
 230,414
 235,679
         
Investment income        
Net investment income 5,970
 5,331
 18,184
 14,884
Net realized investment gains 899
 718
 1,539
 29
Net impairment losses recognized in earnings 0
 0
 (182) (345)
Equity in earnings (losses) of limited partnerships 1,537
 (1,723) 1,899
 (279)
Total investment income 8,406
 4,326
 21,440
 14,289
Interest expense, net 377
 
 800
 
Income before income taxes 88,865
 86,581
 251,054
 249,968
Income tax expense 30,322
 29,205
 86,108
 85,388
Net income $58,543
 $57,376
 $164,946
 $164,580
         
         
Earnings Per Share      
  
Net income per share      
  
Class A common stock – basic $1.26
 $1.23
 $3.54
 $3.53
Class A common stock – diluted $1.12
 $1.09
 $3.15
 $3.14
Class B common stock – basic $189
 $185
 $531
 $530
Class B common stock – diluted $189
 $185
 $531
 $529
         
Weighted average shares outstanding – Basic      
  
Class A common stock 46,188,949
 46,188,980
 46,186,109
 46,188,971
Class B common stock 2,542
 2,542
 2,542
 2,542
         
Weighted average shares outstanding – Diluted      
  
Class A common stock 52,316,876
 52,411,303
 52,342,450
 52,442,697
Class B common stock 2,542
 2,542
 2,542
 2,542
         
Dividends declared per share      
  
Class A common stock $0.7825
 $0.7300
 $2.3475
 $2.1900
Class B common stock $117.375
 $109.500
 $352.125
 $328.500

See accompanying notes to Financial Statements. See Note 10,12, "Accumulated Other Comprehensive Income (Loss)", for amounts reclassified out of accumulated other comprehensive income (loss) into the Statements of Operations. 

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ERIE INDEMNITY COMPANY
STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in thousands)

 Three months ended Nine months endedThree months endedSix months ended
 September 30, September 30,June 30,June 30,
 2017 2016 2017 20162020201920202019
Net income $58,543
 $57,376
 $164,946
 $164,580
Net income$81,977  $87,754  $141,303  $163,065  
        
Other comprehensive income, net of tax      
  
Other comprehensive income, net of tax  
Change in unrealized holding (losses) gains on available-for-sale securities (167) 355
 2,446
 6,846
        
Change in unrealized holding gains on available-for-sale securitiesChange in unrealized holding gains on available-for-sale securities37,451  2,579  5,215  8,057  
Amortization of prior service costs and net actuarial loss on pension and other postretirement plansAmortization of prior service costs and net actuarial loss on pension and other postretirement plans2,660  1,231  5,320  2,463  
Total other comprehensive income, net of taxTotal other comprehensive income, net of tax40,111  3,810  10,535  10,520  
Comprehensive income $58,376
 $57,731
 $167,392
 $171,426
Comprehensive income$122,088  $91,564  $151,838  $173,585  
 
See accompanying notes to Financial Statements. See Note 10,12, "Accumulated Other Comprehensive Income (Loss)", for amounts reclassified out of accumulated other comprehensive income (loss) into the Statements of Operations.

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ERIE INDEMNITY COMPANY
STATEMENTS OF FINANCIAL POSITION
(dollars in thousands, except per share data)

June 30,December 31,
20202019
Assets(Unaudited)
Current assets:
Cash and cash equivalents$257,738  $336,739  
Available-for-sale securities27,409  32,810  
Equity securities1,416  2,381  
Receivables from Erie Insurance Exchange and affiliates, net506,690  468,636  
Prepaid expenses and other current assets60,668  44,943  
Federal income taxes recoverable 462  
Accrued investment income5,317  5,433  
Total current assets859,238  891,404  
Available-for-sale securities, net777,416  697,891  
Equity securities73,973  64,752  
Limited partnership investments15,463  26,775  
Fixed assets, net246,572  221,379  
Agent loans, net58,602  60,978  
Deferred income taxes, net18,895  17,186  
Other assets32,702  35,875  
Total assets$2,082,861  $2,016,240  
Liabilities and shareholders' equity
Current liabilities:
Commissions payable$282,436  $262,963  
Agent bonuses60,264  96,053  
Accounts payable and accrued liabilities137,745  134,957  
Dividends payable44,940  44,940  
Contract liability36,625  35,938  
Deferred executive compensation9,674  10,882  
Federal income taxes payable15,441   
Current portion of long-term borrowings1,998  1,979  
Total current liabilities589,123  587,712  
Defined benefit pension plans161,458  145,659  
Long-term borrowings94,849  95,842  
Contract liability18,826  18,435  
Deferred executive compensation9,571  13,734  
Other long-term liabilities14,895  21,605  
Total liabilities888,722  882,987  
Shareholders’ equity
Class A common stock, stated value $0.0292 per share; 74,996,930 shares authorized; 68,299,200 shares issued; 46,189,068 shares outstanding1,992  1,992  
Class B common stock, convertible at a rate of 2,400 Class A shares for one Class B share, stated value $70 per share; 3,070 shares authorized; 2,542 shares issued and outstanding178  178  
Additional paid-in-capital16,487  16,483  
Accumulated other comprehensive loss(106,333) (116,868) 
Retained earnings2,427,905  2,377,558  
Total contributed capital and retained earnings2,340,229  2,279,343  
Treasury stock, at cost; 22,110,132 shares held(1,162,546) (1,158,910) 
Deferred compensation16,456  12,820  
Total shareholders’ equity1,194,139  1,133,253  
Total liabilities and shareholders’ equity$2,082,861  $2,016,240  

See accompanying notes to Financial Statements. 
5
  September 30, December 31,
  2017 2016
Assets (Unaudited)  
Current assets:    
Cash and cash equivalents $184,628
 $189,072
Available-for-sale securities 65,318
 56,138
Receivables from Erie Insurance Exchange and affiliates 428,500
 378,540
Prepaid expenses and other current assets 35,797
 30,169
Federal income taxes recoverable 0
 5,260
Accrued investment income 6,435
 6,337
Total current assets 720,678
 665,516
     
Available-for-sale securities 683,948
 657,153
Limited partnership investments 49,451
 58,159
Fixed assets, net 75,370
 69,142
Deferred income taxes, net 47,558
 53,889
Note receivable from Erie Family Life Insurance Company 25,000
 25,000
Other assets 29,424
 20,096
Total assets $1,631,429
 $1,548,955
     
Liabilities and shareholders' equity    
Current liabilities:    
Commissions payable $236,056
 $210,559
Agent bonuses 93,448
 114,772
Accounts payable and accrued liabilities 99,331
 88,153
Dividends payable 36,441
 36,441
Deferred executive compensation 12,794
 19,675
Federal income taxes payable 5,331
 0
Total current liabilities 483,401
 469,600
     
Defined benefit pension plans 208,528
 221,827
Employee benefit obligations 330
 756
Deferred executive compensation 12,777
 13,233
Long-term borrowings 49,734
 24,766
Other long-term liabilities 1,509
 1,863
Total liabilities 756,279
 732,045
     
Shareholders’ equity    
Class A common stock, stated value $0.0292 per share; 74,996,930 shares authorized; 68,299,200 shares issued; 46,189,068 shares outstanding 1,992
 1,992
Class B common stock, convertible at a rate of 2,400 Class A shares for one Class B share, stated value $70 per share; 3,070 shares authorized; 2,542 shares issued and outstanding 178
 178
Additional paid-in-capital 16,470
 16,300
Accumulated other comprehensive loss (118,935) (121,381)
Retained earnings 2,121,535
 2,065,911
Total contributed capital and retained earnings 2,021,240
 1,963,000
Treasury stock, at cost; 22,110,132 shares held (1,155,396) (1,155,846)
Deferred compensation 9,306
 9,756
Total shareholders’ equity 875,150
 816,910
Total liabilities and shareholders’ equity $1,631,429
 $1,548,955

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ERIE INDEMNITY COMPANY
STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED)
Three and six months ended June 30, 2020 and 2019
(dollars in thousands, except per share data)
Class A common stockClass B common stockAdditional paid-in-capitalAccumulated other comprehensive (loss) incomeRetained earningsTreasury stockDeferred compensationTotal shareholders' equity
Balance, December 31, 2019$1,992  $178  $16,483  $(116,868) $2,377,558  $(1,158,910) $12,820  $1,133,253  
Cumulative effect adjustment (1)
(1,075) (1,075) 
Net income59,326  59,326  
Other comprehensive loss(29,576) (29,576) 
Dividends declared:
Class A $0.965 per share(44,572) (44,572) 
Class B $144.75 per share(368) (368) 
Net purchase of treasury stock (2)
   
Deferred compensation(772) 772   
Balance, March 31, 2020$1,992  $178  $16,487  $(146,444) $2,390,869  $(1,159,682) $13,592  $1,116,992  
Net income81,977  81,977  
Other comprehensive income40,111  40,111  
Dividends declared:
Class A $0.965 per share(44,573) (44,573) 
Class B $144.75 per share(368) (368) 
Net purchase of treasury stock (2)
   
Deferred compensation(3,568) 3,568   
Rabbi trust distribution (3)
704  (704)  
Balance, June 30, 2020$1,992  $178  $16,487  $(106,333) $2,427,905  $(1,162,546) $16,456  $1,194,139  

Class A common stockClass B common stockAdditional paid-in-capitalAccumulated other comprehensive (loss) incomeRetained earningsTreasury stockDeferred compensationTotal shareholders' equity
Balance, December 31, 2018$1,992  $178  $16,459  $(130,284) $2,231,417  $(1,157,625) $11,535  $973,672  
Net income75,311  75,311  
Other comprehensive income6,710  6,710  
Dividends declared:
Class A $0.90 per share(41,570) (41,570) 
Class B $135.00 per share(343) (343) 
Net purchase of treasury stock (2)
24  ��24  
Deferred compensation(1,154) 1,154   
Balance, March 31, 2019$1,992  $178  $16,483  $(123,574) $2,264,815  $(1,158,779) $12,689  $1,013,804  
Net income87,754  87,754  
Other comprehensive income3,810  3,810  
Dividends declared:
Class A $0.90 per share(41,570) (41,570) 
Class B $135.00 per share(344) (344) 
Net purchase of treasury stock (2)
   
Deferred compensation(443) 443   
Rabbi trust distribution (3)
922  (922)  
Balance, June 30, 2019$1,992  $178  $16,483  $(119,764) $2,310,655  $(1,158,300) $12,210  $1,063,454  
(1)The cumulative effect adjustment is related to the implementation of new credit loss allowance accounting guidance effective January 1, 2020. See Note 2. "Significant Accounting Policies".
(2)Net purchases of treasury stock in 2020 and 2019 include the repurchase of our Class A common stock in the open market that were subsequently distributed to satisfy stock based compensation awards.
(3)Distributions of our Class A shares were made from the rabbi trust to a retired director in 2020 and 2019.

See accompanying notes to Financial Statements.



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ERIE INDEMNITY COMPANY
STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)

Six months ended
June 30,
20202019
Cash flows from operating activities
Management fee received$937,962  $902,958  
Administrative services reimbursements received279,689  296,390  
Service agreement fee received13,108  13,599  
Net investment income received18,217  16,799  
Limited partnership distributions532  1,292  
Commissions paid to agents(448,622) (434,599) 
Agents bonuses paid(100,185) (108,540) 
Salaries and wages paid(100,360) (101,765) 
Employee benefits paid(15,962) (22,085) 
General operating expenses paid(133,422) (117,915) 
Administrative services expenses paid(298,046) (291,136) 
Income taxes paid(25,625) (39,863) 
Interest paid(4) (719) 
Net cash provided by operating activities127,282  114,416  
Cash flows from investing activities
Purchase of investments:
Available-for-sale securities(198,192) (615,384) 
Equity securities(44,407)  
Limited partnerships(19) (9) 
Other investments(603) (124) 
Proceeds from investments:
Available-for-sale securities sales68,977  430,596  
Available-for-sale securities maturities/calls58,722  261,902  
Equity securities35,684   
Limited partnerships577  2,450  
Purchase of fixed assets(37,426) (34,260) 
Loans to agents(2,313) (6,947) 
Collections on agent loans3,577  3,991  
Net cash (used in) provided by investing activities(115,423) 42,215  
Cash flows from financing activities
Dividends paid to shareholders(89,881) (83,824) 
Net payments on long-term borrowings(979) (962) 
Net cash used in financing activities(90,860) (84,786) 
Net (decrease) increase in cash and cash equivalents(79,001) 71,845  
Cash and cash equivalents, beginning of period336,739  266,417  
Cash and cash equivalents, end of period$257,738  $338,262  
Supplemental disclosure of noncash transactions
Transfer of investments from limited partnerships to equity securities$4,188  $ 
Operating lease assets obtained in exchange for new operating lease liabilities$3,440  $33,136  
Liability incurred to purchase fixed assets$814  $14,980  
  Nine months ended
  September 30,
  2017 2016
Cash flows from operating activities    
Management fee received $1,225,966
 $1,155,234
Service agreement fee received 21,781
 21,756
Net investment income received 23,593
 19,643
Limited partnership distributions 2,993
 7,222
Decrease in reimbursements collected from affiliates (7,335) (11,893)
Commissions paid to agents (597,700) (565,490)
Agents bonuses paid (118,862) (110,503)
Salaries and wages paid (128,071) (119,991)
Pension contribution and employee benefits paid (62,837) (37,341)
General operating expenses paid (167,985) (133,729)
Income taxes paid (70,504) (69,357)
Interest paid (705) 
Net cash provided by operating activities 120,334
 155,551
     
Cash flows from investing activities    
Purchase of investments:    
Available-for-sale securities (292,702) (269,237)
Limited partnerships (330) (449)
Proceeds from investments:    
Available-for-sale securities sales 120,418
 67,415
Available-for-sale securities maturities/calls 146,434
 96,851
Trading securities 
 5,171
Limited partnerships 7,986
 12,404
Net purchase of fixed assets (18,036) (10,415)
Net (distributions) collections on agent loans (4,185) 1,622
Net cash used in investing activities (40,415) (96,638)
     
Cash flows from financing activities    
Dividends paid to shareholders (109,324) (101,989)
Net proceeds from long-term borrowings 24,961
 
Net cash used in financing activities (84,363) (101,989)
     
Net decrease in cash and cash equivalents (4,444) (43,076)
Cash and cash equivalents, beginning of period 189,072
 182,889
Cash and cash equivalents, end of period $184,628
 $139,813

See accompanying notes to Financial Statements.

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NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
 
Note 1.  Nature of Operations
 
Erie Indemnity Company ("Indemnity", "we", "us", "our") is a publicly held Pennsylvania business corporation that has since its incorporation in 1925 served as the attorney-in-fact for the subscribers (policyholders) at the Erie Insurance Exchange ("Exchange").  The Exchange, which also commenced business in 1925, is a Pennsylvania-domiciled reciprocal insurer that writes property and casualty insurance. We function solely as the management company and all insurance operations are performed by the Exchange.
 
Our primary function as attorney-in-fact is to perform certainpolicy issuance and renewal services for the Exchange relating to the sales, underwriting, and issuance of policies on behalf of the subscribers at the Exchange. ThisWe also act as attorney-in-fact on behalf of the Exchange with respect to all claims handling and investment management services, as well as the service provider for all claims handling, life insurance, and investment management services for its insurance subsidiaries, collectively referred to as "administrative services". Acting as attorney-in-fact in these 2 capacities is done in accordance with a subscriber’ssubscriber's agreement (a limited power of attorney) executed individually by each subscriber (policyholder), which appoints us as their common attorney-in-fact to transact certain business on their behalf.  Pursuant to the subscriber’ssubscriber's agreement and for its servicesacting as attorney-in-fact in these 2 capacities, we earn a management fee calculated as a percentage of the direct and affiliated assumed premiums written by the Exchange.


The policy issuance and renewal services we provide to the Exchange are related to the sales, underwriting and issuance of policies. The sales related services we provide include agent compensation and certain sales and advertising support services. Agent compensation includes scheduled commissions to agents based upon premiums written as well as additional commissions and bonuses to agents, which are earned by achieving targeted measures. The underwriting services we provide include underwriting and policy processing. The remaining services we provide include customer service and administrative support. We also provide information technology services that support all the functions listed above. Included in these expenses are allocations of costs for departments that support these policy issuance and renewal functions.


By virtue of its legal structure as a reciprocal insurer, the Exchange does not have the ability to enterany employees or officers. Therefore, it enters into contractual relationships by and thereforethrough an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and arranges for the provision of all claimsIndemnity. Claims handling services investmentinclude costs incurred in the claims process, including the adjustment, investigation, defense, recording and payment functions. Life insurance management services include costs incurred in the management and certainprocessing of life insurance business. Investment management services are related to investment trading activity, accounting and all other common overhead and service department functions and serves asattributable to the common pay agent.investment of funds. Included in these expenses are allocations of costs for departments that support these administrative functions. The amounts Indemnity incurs in this capacityincurred for these services are reimbursed to Indemnity fromat cost in accordance with the Exchange at cost.subscriber's agreement and the service agreements. State insurance regulations require that intercompany service agreements and any material amendments be approved in advance by the state insurance department.


Our results of operations are tied to the growth and financial condition of the Exchange. If any events occurred that impaired the Exchange’s ability to grow or sustain its financial condition, including but not limited to reduced financial strength ratings, disruption in the independent agency relationships, significant catastrophe losses, or products not meeting customer demands, the Exchange could find it more difficult to retain its existing business and attract new business. A decline in the business of the Exchange almost certainly would have as a consequence a decline in the total premiums paid and a correspondingly adverse effect on the amount of the management fees we receive. We also have an exposure to a concentration of credit risk related to the unsecured receivables due from the Exchange for its management fee.fee and cost reimbursements. See Note 12,13, "Concentrations of Credit Risk" contained within.

Coronavirus ("COVID-19") pandemic
On March 11, 2020, the outbreak of the coronavirus ("COVID-19") was declared a global pandemic. The significant volatility in the financial markets, economic disruption and uncertainty resulting from the COVID-19 pandemic that began in the first quarter of 2020 continues to evolve and the pandemic’s ultimate impact and duration remain highly uncertain at this report.time. The Exchange’s previously announced rate reductions that become effective in the second half of 2020, coupled with the uncertain economic conditions, will likely continue to constrain the Exchange’s premium growth which would impact our management fee revenue.The Exchange’s underwriting profitability has improved largely due to declines in claims frequency.The extent and duration of changes in consumer behavior and driving patterns and the resulting impact to the Exchange’s growth and financial condition remain uncertain.



The economic conditions resulting from the COVID-19 pandemic may negatively impact the collectability of the Exchange’s premiums receivable, however no such impact has been noted through the date of this report. While our investment portfolio

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was negatively impacted by the volatility in the financial markets in the first quarter of 2020, market conditions partially recovered in the second quarter of 2020. We are unable to predict the duration or extent of the business disruption or the financial impact given the ongoing development of the pandemic and its impacts on the economy and financial markets.


Note 2.  Significant Accounting Policies


Basis of presentation
The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the ninesix months ended SeptemberJune 30, 20172020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.2020. For further information, refer to the financial statements and footnotes included in our Form 10-K for the year ended December 31, 20162019 as filed with the Securities and Exchange Commission on February 23, 2017.27, 2020.


Use of estimates
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.


Recently issuedadopted accounting standards
In March 2017, the FASB issued ASU 2017-07, "Compensation-Retirement Benefits", which requires the service cost component of net benefit costs to be reported with other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit costs are required to be presented separately from the service cost component and outside of income from operations. This amendment also allows only the service cost component to be eligible for capitalization when applicable. The guidance is effective for interim and annual periods beginning after December 15, 2017. While the presentation of the costs within the Statements of Operations will change, we do not expect a material impact on our financial statements or related disclosures.

In March 2017, the FASB issued ASU 2017-08, "Receivables-Nonrefundable Fees and Other Costs", which shortens the amortization period for certain purchased callable debt securities held at a premium from maturity date to the earliest call date. ASU 2017-08 is effective for interim and annual reporting periods beginning after December 31, 2018. The guidance should be applied using a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Early adoption is permitted, including adoption in an interim period. We do not expect the adoption of this guidance to have a material impact on our financial statements.

In June 2016, the FASBFinancial Accounting Standards Board issued ASUAccounting Standards Update ("ASU") 2016-13, "Financial Instruments-Credit Losses", which requires financial assets measured at amortized cost to be presented at the net amount expected to be collected through the use of a new forward-looking current expected credit loss model and credit losses relating to available-for-sale debt securities to be recognized through an allowance for credit losses. ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019. Early adoption for interim and annual periods beginning after December 15, 2018 is permitted. We have evaluated the impact ofadopted this guidance, which applies to our receivable from Erie Insurance Exchange and affiliates, agent loans and investments, on our invested assets.January 1, 2020.

For assets measured at amortized cost for which a current expected credit loss allowance was required, we adopted the guidance using the modified-retrospective approach. At January 1, 2020, we recorded current expected credit loss allowances related to agent loans of $0.8 million and receivables from Erie Insurance Exchange and affiliates of $0.6 million. This resulted in the recording of a cumulative effect adjustment, net of taxes, to retained earnings of $1.1 million. Our available-for-sale investments are not measured at amortized cost, which are the investments thatand therefore do not require the use of a newcurrent expected credit loss model. Our available-for-sale debt securities will continueAny credit losses, however, are required to be monitored for credit losses which would be reflectedrecorded as an allowance for credit losses rather than a reduction of the carrying value of the asset. The other material financial assets subject to thisFor available-for-sale securities, we adopted the guidance include our receivables from Erie Insurance Exchange and affiliates. Given the financial strength of the Exchange, demonstrated by its strong surplus position and industry ratings, it is unlikely these receivables would have significant, if any, credit loss exposure. We do not expect a material impact on our financial statements or related disclosures as a result of this guidance.

In February 2016, the FASB issued ASU 2016-02, "Leases", which requires lessees to recognize assets and liabilities arising from operating leases on the statement of financial position and to disclose key information about leasing arrangements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Leases are required to be recognized and measured at the beginning of the earliest period presented using a modified retrospective approach. Early adoption is permitted. We expect to adopt ASU 2016-02 as of January 1, 2019 using the modified retrospective method. Under existing guidance, we recognize lease expense as a componentprospective approach and recorded an initial allowance for credit losses of operating expenses in the Statements of Operations. We are in the process of evaluating our existing lease contracts to determine the impact to our financial statements and disclosures.


In January 2016, the FASB issued ASU 2016-01, "Financial Instruments-Overall".  ASU 2016-01 revises the accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured$0.6 million at fair value.  ASU 2016-01 is effective for interim and annual reporting periods beginning after December 15, 2017. As of September 30, 2017, we do not own any equity security investments, therefore theMarch 31, 2020. The adoption of this guidance would have no impact to our financial statements. We will continue to monitor our investment portfolio as we may enter into investments in equity securities; however, at this time we do not expect that recognizing the change in fair value of future equity investments through net income instead of accumulated other comprehensive income would be material.
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers". ASU 2014-09 requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period with early application permitted beginning in the first interim period in 2017. We expect to adopt the ASU 2014-09 as of January 1, 2018 under the modified retrospective method where the cumulative effect is recognized at the date of initial application. Our evaluation is ongoing and not complete. We performed an analysis in accordance with the steps identified in the new guidance around the recognition, measurement, and presentation of management fee revenue. We determined that service fee revenue is not within the scope of the new guidance. We have preliminarily concluded that adoption of this guidance willstandard did not have a material impact on our Statements of Financial Position, net income or net cash flows.

Investments
Available-for-sale securities Fixed maturity debt securities and redeemable preferred stock are classified as available-for-sale and reported at fair value with unrealized investment gains and losses, net of income taxes, recognized in other comprehensive income. Available-for-sale securities with a remaining maturity of 12 months or less and any security that we intend to sell as of the reporting date are classified as current assets.

Available-for-sale securities in an unrealized loss position are evaluated to determine whether the impairment is a result of credit loss or other factors. If we have the intent to sell or it's more likely than not that we would be required to sell the security before recovery of the amortized cost basis, the entire impairment is recognized in earnings. Securities that have experienced a decline in fair value that we do not intend to sell, and that we will not be required to sell before recovery, are evaluated to determine if the decline in fair value is credit related. Impairment resulting from a credit loss is recognized in earnings with a corresponding allowance on the balance sheet. Future recoveries of credit loss result in an adjustment to the allowance and earnings in the period the credit conditions improve. Factors considered in the evaluation of credit loss include the extent to which fair value is less than cost and fundamental factors specific to the issuer such as financial condition, changes in credit ratings, near and long-term business prospects and other factors, as well as the likelihood of recovery of the amortized cost of the security. If the qualitative review indicates credit impairment, the allowance for credit loss is measured as the amount that the security’s amortized cost exceeds the present value of cash flows expected to be collected and is limited to the amount that fair value is below amortized cost.

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Realized gains and losses and investment income Realized gains and losses on sales of available-for-sale and equity securities are recognized in income based upon the specific identification method and reported as net realized investment gains (losses). Interest income is recognized as earned and includes amortization of premium and accretion of discount.  Income is recognized based on the constant effective yield method, which includes periodically updated prepayment assumptions obtained from third party data sources on our prepaying securities.  The effective yield for prepaying securities is recalculated on a retrospective basis.  Dividend income is recognized at the ex-dividend date. Both interest and dividend income are reported as net investment income. We do not record an allowance for credit losses on accrued investment income as any amount deemed uncollectible is reversed from interest income in the period the expected payment defaults.

Agent loans
Agent loans, the majority of which are senior secured, are carried at unpaid principal balance with interest recorded in investment income as earned. The current portion of agent loans is recorded in prepaid expenses and other current assets. The adoption of ASU 2016-13 on January 1, 2020 requires the recording of a current expected credit loss allowance on these loans. The allowance is estimated using available loss history and/or external loss rates based on comparable loan losses and considers current conditions and forecasted information. When establishing the expected credit loss allowance upon implementation of ASU 2016-13, a cumulative effect adjustment was recorded to beginning retained earnings. Future changes to the allowance will be recognized in earnings as adjustments to net impairment losses. Prior to the adoption of ASU 2016-13, we did not record an allowance for credit losses as the majority of these loans are senior secured and have had insignificant default amounts.

Other assets
Other assets include operating lease assets and other long-term prepaid assets. The determination of whether an arrangement is a lease, and the related lease classification, is made at inception of a contract. Our leases are classified as operating leases. Operating lease assets and liabilities are recorded at inception based on the present value of the future minimum lease payments over the lease term at commencement date. When an implicit rate for the lease is not available, we use our incremental borrowing rate based on the information available at commencement date to determine the present value of future payments. Lease terms include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Most of our lease contracts contain lease and non-lease components. Non-lease components are expensed as incurred. Operating lease assets are included in other assets, and the current and noncurrent portions of the operating lease liabilities are included in accounts payable and accrued expenses and other long-term liabilities, respectively.

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Note 3.  Revenue

Themajority of our revenue is derived from the subscriber’s agreement between us and the subscribers (policyholders) at the Exchange. Pursuant to the subscriber’s agreement, we earn a management fee calculated as a percentage, not to exceed 25%, of all direct and affiliated assumed written premiums of the Exchange.

We allocate a portion of our management fee revenue, recognition patterncurrently 25% of the direct and affiliated assumed written premiums of the Exchange, between the 2 performance obligations we have under the subscriber’s agreement. The first performance obligation is to provide policy issuance and renewal services to the subscribers (policyholders) at the Exchange, and the second is to act as attorney-in-fact on behalf of the Exchange, as well as the service provider for its insurance subsidiaries, with respect to all administrative services. The transaction price, including management fee revenue and administrative service reimbursement revenue, is allocated based on the estimated standalone selling prices developed using industry information and other available information for similar services. We update the transaction price allocation annually based upon the most recent information available or more frequently if there have been significant changes in any components considered in the transaction price. In 2020, we are reviewing our financial statements. We are also reviewing agreementstransaction price allocation quarterly to consider the most current economic conditions related to the amountsCOVID-19 pandemic. These reviews have resulted in no material change to the allocation.

The first performance obligation is to provide policy issuance and renewal services that result in executed insurance policies between the Exchange or one of its insurance subsidiaries and the subscriber (policyholder). Our customer, the subscriber (policyholder), receives economic benefits when substantially all the policy issuance or renewal services are complete and an insurance policy is issued or renewed by the Exchange or one of its insurance subsidiaries. It is at the time of policy issuance or renewal that the allocated portion of revenue is recognized.

The Exchange, by virtue of its legal structure as a reciprocal insurer, does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services in accordance with the subscriber's agreement. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. Collectively, these services represent a second performance obligation under the subscriber’s agreement and the service agreements. The revenue allocated to this performance obligation is recognized over time as these services are provided. The portion of revenue not yet earned is recorded as a contract liability in the Statements of Financial Position. The administrative services expenses we incur and the related reimbursements we receive as reimbursementsare recorded gross in the Statements of Operations.

Indemnity records a receivable from the Exchange for management fee revenue when the premium is written or assumed by the Exchange. Indemnity collects the management fee from the Exchange when the Exchange collects the premiums from the subscribers (policyholders). As the Exchange issues policies with annual terms only, cash collections generally occur within one year.

A constraining estimate exists around the management fee received as consideration related to the potential for management fee to be returned if a policy were to be cancelled mid-term. Management fees are returned to the Exchange when policyholders cancel their insurance coverage mid-term and unearned premiums are refunded to them. We maintain an estimated allowance to reduce the management fee to its subsidiaries, such as claims-related expenses, investmentestimated net realizable value to account for the potential of mid-term policy cancellations based on historical cancellation rates. In 2020, our historical cancellation rates were adjusted to include the potential for increased cancellations given the current economic conditions related to the COVID-19 pandemic. This resulted in a $3.5 million increase in the allowance for the three months ended March 31, 2020 and other overhead expenses. Whilean additional $0.9 million increase in the expenses are reimbursedallowance for the three months ended June 30, 2020 for a cumulative increase of $4.4 million for the six months ended June 30, 2020. The increases to us at actual cost, we are evaluating if there is athe allowance were $2.0 million and $2.9 million for the three and six months ended June 30, 2019 primarily driven by premium growth.

This estimated allowance has been allocated between the 2 performance obligation that would requireobligations consistent with the revenue allocation proportions.

The following table disaggregates revenue by our 2 performance obligations:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Management fee revenue - policy issuance and renewal services, net$483,795  $480,513  $927,545  $911,496  
Management fee revenue - administrative services, net14,813  14,195  29,584  28,146  
Administrative services reimbursement revenue151,965  146,095  303,519  288,575  
Total administrative services$166,778  $160,290  $333,103  $316,721  
11

Table of revenue under this guidance. Additionally, we are evaluating the impact of the new disclosure requirements.Contents



Note 3.4.  Earnings Per Share
 
Class A and Class B basic earnings per share and Class B diluted earnings per share are calculated under the two-class method. The two-class method allocates earnings to each class of stock based upon its dividend rights.  Class B shares are convertible into Class A shares at a conversion ratio of 2,400 to 1. See Note 9,11, "Capital Stock".


Class A diluted earnings per share are calculated under the if-converted method, which reflects the conversion of Class B shares to Class A shares. Diluted earnings per share calculations include the dilutive effect of assumed issuance of stock-based awards under compensation plans that have the option to be paid in stock using the treasury stock method.


A reconciliation of the numerators and denominators used in the basic and diluted per-share computations is presented as follows for each class of common stock:
Three months ended June 30,
20202019
(dollars in thousands, except per share data)Allocated net income (numerator)Weighted shares (denominator)Per-share amountAllocated net income (numerator)Weighted shares (denominator)Per-share amount
Class A – Basic EPS:
Income available to Class A stockholders$81,306  46,187,808  $1.76  $87,036  46,188,994  $1.88  
Dilutive effect of stock-based awards 14,373  —   24,906  —  
Assumed conversion of Class B shares671  6,100,800  —  718  6,100,800  —  
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares$81,977  52,302,981  $1.57  $87,754  52,314,700  $1.68  
Class B – Basic and diluted EPS:
Income available to Class B stockholders$671  2,542  $264  $718  2,542  $283  
Six months ended June 30,
20202019
(dollars in thousands, except per share data)Allocated net income (numerator)Weighted shares (denominator)Per-share amountAllocated net income (numerator)Weighted shares (denominator)Per-share amount
Class A – Basic EPS:
Income available to Class A stockholders$140,146  46,188,299  $3.03  $161,730  46,188,668  $3.50  
Dilutive effect of stock-based awards 24,568  —   23,903  —  
Assumed conversion of Class B shares1,157  6,100,800  —  1,335  6,100,800  —  
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares$141,303  52,313,667  $2.70  $163,065  52,313,371  $3.12  
Class B – Basic and diluted EPS:
Income available to Class B stockholders$1,157  2,542  $455  $1,335  2,542  $525  

  Three months ended September 30,
  2017 2016
(dollars in thousands, except per share data) Allocated net income (numerator) Weighted shares (denominator) Per-share amount Allocated net income (numerator) Weighted shares (denominator) Per-share amount
Class A – Basic EPS:            
Income available to Class A stockholders $58,064
 46,188,949
 $1.26
 $56,906
 46,188,980
 $1.23
Dilutive effect of stock-based awards 0
 27,127
 
 0
 121,523
 
Assumed conversion of Class B shares 479
 6,100,800
 
 470
 6,100,800
 
Class A – Diluted EPS:            
Income available to Class A stockholders on Class A equivalent shares $58,543
 52,316,876
 $1.12
 $57,376
 52,411,303
 $1.09
Class B – Basic EPS:            
Income available to Class B stockholders $479
 2,542
 $189
 $470
 2,542
 $185
Class B – Diluted EPS:            
Income available to Class B stockholders $479
 2,542
 $189
 $469
 2,542
 $185
12
  Nine months ended September 30,
  2017 2016
(dollars in thousands, except per share data) Allocated net income (numerator) Weighted shares (denominator) Per-share amount Allocated net income (numerator) Weighted shares (denominator) Per-share amount
Class A – Basic EPS:  
  
  
  
  
  
Income available to Class A stockholders $163,596
 46,186,109
 $3.54
 $163,233
 46,188,971
 $3.53
Dilutive effect of stock-based awards 0
 55,541
 
 0
 152,926
 
Assumed conversion of Class B shares 1,350
 6,100,800
 
 1,347
 6,100,800
 
Class A – Diluted EPS:  
  
  
  
  
  
Income available to Class A stockholders on Class A equivalent shares $164,946
 52,342,450
 $3.15
 $164,580
 52,442,697
 $3.14
Class B – Basic EPS:  
  
  
  
  
  
Income available to Class B stockholders $1,350
 2,542
 $531
 $1,347
 2,542
 $530
Class B – Diluted EPS:            
Income available to Class B stockholders $1,350
 2,542
 $531
 $1,346
 2,542
 $529


Note 4.5. Fair Value
 
Financial instruments carried at fair value
Our available-for-sale and tradingequity 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 tradingequity securities are based upon 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 virtually all of our prices are obtained from third party sources, we also perform an internal pricing review on outliers, which include securities with price changes inconsistent with current market conditions. Financial instruments are categorized based upon the following characteristics or inputs to the valuation techniques:

Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.


Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.


Level 3 – Unobservable inputs for the asset or liability.
 
Estimates of fair values for our investment portfolio are obtained primarily from a nationally recognized pricing service.  Our Level 1 category includes those securities are valued using an exchange traded price provided by the pricing service. The methodologies used by the pricingPricing service that support avaluations for Level 2 classification of a financial instrumentsecurities 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 upon proprietary models and are used when observable inputs are not available or in illiquid markets.
 
Although virtually all of our prices are obtained from third party sources, we also perform internal pricing reviews, including evaluating the methodology and inputs used to ensure that we determine the proper classification level of the financial instrument and reviewing securities with price changes that vary significantly from current market conditions or independent price sources.  Price variances are investigated and corroborated by market data and transaction volumes. We have reviewed the pricing methodologies of our pricing service as well as other observable inputs and believe that the prices adequately consider market activity in determining fair value. 

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 upon corroborating information and our knowledge and monitoring of market conditions such as a disparity in price of comparable securities and/or non-binding broker quotes.  In other circumstances, certain securities are internally priced because prices are not provided by the pricing service.
 
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 that we determine the proper classification level 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 as well as other observable inputs, such as data, and transaction volumes and believe that their prices adequately consider market activity in determining fair value.  Our review process continues to evolve based upon accounting guidance and requirements.
When a price from the pricing service is not available, values are determined by obtaining broker/dealer quotes and/or market comparables. When available, we obtain multiple quotes for the same security. The ultimate value for these securities is determined based upon our best estimate of fair value using corroborating market information. Our evaluation includes the considerationAs of benchmark yields, reported trades, issuer spreads, two-sided markets, benchmarkJune 30, 2020, nearly all of our available-for-sale and equity securities bids, offers, and reference data.were priced using a third party pricing service.









13

The following tables present our fair value measurements on a recurring basis by asset class and level of input:input as of: 
June 30, 2020
(in thousands)TotalLevel 1Level 2Level 3
Available-for-sale securities:
Corporate debt securities$469,655  $2,104  $462,635  $4,916  
Residential mortgage-backed securities119,599   119,599   
Commercial mortgage-backed securities106,542   88,476  18,066  
Collateralized debt obligations96,288   96,029  259  
Other debt securities12,741   12,741   
Total available-for-sale securities804,825  2,104  779,480  23,241  
Equity securities - nonredeemable preferred and common stock:
Financial services sector60,149  20,943  39,206   
Utilities sector7,712  4,259  3,453   
Communications sector3,894  3,894    
Consumer sector2,599  892  912  795  
Energy sector1,035   1,035   
Total equity securities75,389  29,988  44,606  795  
Total$880,214  $32,092  $824,086  $24,036  

December 31, 2019
(in thousands)TotalLevel 1Level 2Level 3
Available-for-sale securities:
Corporate debt securities$454,880  $2,683  $443,873  $8,324  
Residential mortgage-backed securities125,343   125,343   
Commercial mortgage-backed securities67,541   64,220  3,321  
Collateralized debt obligations77,856   77,856   
Other debt securities5,081   5,081   
Total available-for-sale securities730,701  2,683  716,373  11,645  
Equity securities - nonredeemable preferred and common stock:
Financial services sector53,513  14,927  38,586   
Utilities sector6,818  3,190  3,628   
Communications sector3,433  3,433    
Energy sector1,881   1,881   
Industrial sector980   980   
Consumer sector508   508   
Total equity securities67,133  21,550  45,583   
Total$797,834  $24,233  $761,956  $11,645  




















14
  At September 30, 2017
  Fair value measurements using:
(in thousands)
 
 Total 
Quoted prices in
active markets for identical assets
Level 1
 
Observable inputs
Level 2
 
Unobservable inputs
Level 3
Available-for-sale securities:        
U.S. treasury $11,834
 $0
 $11,834
 $0
States & political subdivisions 261,966
 0
 261,966
 0
Foreign government securities 507
 0
 507
 0
Corporate debt securities 346,372
 0
 338,457
 7,915
Residential mortgage-backed securities 25,719
 0
 25,719
 0
Commercial mortgage-backed securities 34,331
 0
 34,331
 0
Collateralized debt obligations 62,381
 0
 62,381
 0
Other debt securities 6,156
 0
 6,156
 0
Total fixed maturities 749,266
 0
 741,351
 7,915
Total available-for-sale securities 749,266
 0
 741,351
 7,915
Other investments (1)
 4,338
 
 
 
Total $753,604
 $0
 $741,351
 $7,915


  At December 31, 2016
  Fair value measurements using:
(in thousands)
 
 Total Quoted prices in
active markets for identical assets
Level 1
 Observable inputs
Level 2
 Unobservable inputs
Level 3
Available-for-sale securities:        
U.S. treasury $5,031
 $0
 $5,031
 $0
Government sponsored entities 2,026
 0
 2,026
 0
States & political subdivisions 253,132
 0
 253,132
 0
Corporate debt securities 322,948
 0
 313,596
 9,352
Residential mortgage-backed securities 16,102
 0
 16,102
 0
Commercial mortgage-backed securities 36,849
 0
 36,849
 0
Collateralized debt obligations 69,253
 0
 69,253
 0
Other debt securities 2,000
 0
 2,000
 0
Total fixed maturities 707,341
 0
 697,989
 9,352
Common stock 5,950
 5,950
 0
 0
Total available-for-sale securities 713,291
 5,950
 697,989
 9,352
Other investments (1)
 4,412
 
 
 
Total $717,703
 $5,950
 $697,989
 $9,352

(1)Other investments measured at fair value represent real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option using the net asset value practical expedient. These amounts are not required to be categorized in the fair value hierarchy. The investments can never be redeemed with the funds. Instead, distributions are received when liquidationTable of the underlying assets of the funds occur. It is estimated that the underlying assets will generally be liquidated between 5 and 10 years from the inception of the funds. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner. Fair value is based on our proportionate share of the NAV based on the most recent partners' capital statements received from the general partners, which is generally one quarter prior to our balance sheet date. These values are then analyzed to determine if the NAV represents fair value at our balance sheet date, with adjustment being made where appropriate. We consider observable market data and perform a review validating the appropriateness of the NAV at each balance sheet date. It is likely that all of the investments will be redeemed at a future date for an amount different than the NAV of our ownership interest in partners' capital as of September 30, 2017 and December 31, 2016. During the nine months ended September 30, 2017, no contributions were made and distributions totaling $0.3 million were received from these investments. During the year ended December 31, 2016, no contributions were made and distributions totaling $0.9 million were received from these investments. There were no unfunded commitments related to the investments as of September 30, 2017, and $0.3 million as of December 31, 2016.Contents



We review the fair value hierarchy classifications each reporting period.  Transfers between hierarchy levels may occur due to changes in the available market observable inputs.  Transfers in and out of level classifications are reported as having occurred at the beginning of the quarter in which the transfers occurred.

There were no transfers between Level 1 and Level 2 for the three and nine months ended September 30, 2017 and 2016, respectively.


Level 3 Assets – 2020 Quarterly Change:

(in thousands) 
Beginning balance at March 31, 2020
Included in earnings(1)
Included
in other
comprehensive
income
PurchasesSales
Transfers into
Level 3(2)
Transfers out of Level 3(2)
Ending balance at June 30, 2020
Available-for-sale securities:        
Corporate debt securities$12,056  $(2) $867  $783  $(115) $1,142  $(9,815) $4,916  
Commercial mortgage-backed securities7,383  (34) 268  6,891  (201) 4,334  (575) 18,066  
Collateralized debt obligations  12  247     259  
Total available-for-sale securities19,439  (36) 1,147  7,921  (316) 5,476  (10,390) 23,241  
Nonredeemable preferred stock (25)  820     795  
Total Level 3 securities$19,439  $(61) $1,147  $8,741  $(316) $5,476  $(10,390) $24,036  
(in thousands)
 
 Beginning balance at June 30, 2017 
Included in earnings(1)
 
Included
in other comprehensive
income
 Purchases Sales 
Transfers into Level 3(2)
 
Transfers out of Level 3(2)
 Ending balance at September 30, 2017
Available-for-sale securities:                
Corporate debt securities $9,295
 $24
 $(60) $539
 $(1,240) $2,633
 $(3,276) $7,915
Total fixed maturities 9,295
 24
 (60) 539
 (1,240) 2,633
 (3,276) 7,915
Total available-for-sale securities 9,295
 24
 (60) 539
 (1,240) 2,633
 (3,276) 7,915
Total Level 3 assets $9,295
 $24
 $(60) $539
 $(1,240) $2,633
 $(3,276) $7,915



Level 3 Assets – 2020 Year-to-Date Change:

(in thousands) 
Beginning balance at December 31, 2019
Included in earnings(1)
Included
in other
comprehensive
income
PurchasesSales
Transfers into
Level 3(2)
Transfers out of Level 3(2)
Ending balance at June 30, 2020
Available-for-sale securities:        
Corporate debt securities$8,324  $ $(511) $2,501  $(542) $8,037  $(12,898) $4,916  
Commercial mortgage-backed securities3,321  (42) 120  7,203  (287) 8,891  (1,140) 18,066  
Collateralized debt obligations  12  247     259  
Total available-for-sale securities11,645  (37) (379) 9,951  (829) 16,928  (14,038) 23,241  
Nonredeemable preferred stock (25)  820     795  
Total Level 3 securities$11,645  $(62) $(379) $10,771  $(829) $16,928  $(14,038) $24,036  
(in thousands)
 
 Beginning balance at December 31, 2016 
Included in earnings(1)
 
Included
in other comprehensive
income
 Purchases Sales 
Transfers into Level 3(2)
 
Transfers out of Level 3(2)
 Ending balance at September 30, 2017
Available-for-sale securities:                
Corporate debt securities $9,352
 $3
 $(108) $4,520
 $(4,372) $8,444
 $(9,924) $7,915
Total fixed maturities 9,352
 3
 (108) 4,520
 (4,372) 8,444
 (9,924) 7,915
Total available-for-sale securities 9,352
 3
 (108) 4,520
 (4,372) 8,444
 (9,924) 7,915
Total Level 3 assets $9,352
 $3
 $(108) $4,520
 $(4,372) $8,444
 $(9,924) $7,915



Level 3 Assets – 2019 Quarterly Change:
(in thousands)Beginning balance at March 31, 2019
Included in earnings(1)
Included
in other
comprehensive
income
PurchasesSales
Transfers into
Level 3(2)
Transfers out of Level 3(2)
Ending balance at June 30, 2019
Available-for-sale securities:
Corporate debt securities$11,523  $(20) $23  $ $(5,841) $2,581  $(1,893) $6,373  
Residential mortgage-backed securities915   15   (26)  (908)  
Commercial mortgage-backed securities1,182  15  (8)  (1,065) 2,551  (124) 2,551  
Total Level 3 available-for-sale securities$13,620  $(1) $30  $ $(6,932) $5,132  $(2,925) $8,924  






15

(in thousands)
 
 Beginning balance at June 30, 2016 
Included in earnings(1)
 
Included
in other
comprehensive
income
 Purchases Sales 
Transfers into Level 3(2)
 
Transfers out of Level 3(2)
 Ending balance at September 30, 2016
Available-for-sale securities:                
Corporate debt securities $8,851
 $22
 $38
 $3,217
 $(318) $2,514
 $(4,135) $10,189
Commercial mortgage-backed securities 1,003
 0
 0
 0
 0
 0
 (1,003) 0
Collateralized debt obligations 1,200
 0
 7
 3,000
 0
 2,114
 (1,200) 5,121
Total fixed maturities 11,054
 22
 45
 6,217
 (318) 4,628
 (6,338) 15,310
Total available-for-sale securities 11,054
 22
 45
 6,217
 (318) 4,628
 (6,338) 15,310
Total Level 3 assets $11,054
 $22
 $45
 $6,217
 $(318) $4,628
 $(6,338) $15,310
Table of Contents

Level 3 Assets – 2019 Year-to-Date Change:
(in thousands)Beginning balance at December 31, 2018
Included in earnings(1)
Included
in other
comprehensive
income
PurchasesSales
Transfers into
Level 3(2)
Transfers out of Level 3(2)
Ending balance at June 30, 2019
Available-for-sale securities:
Corporate debt securities$12,577  $(9) $291  $734  $(6,272) $7,394  $(8,342) $6,373  
Residential mortgage-backed securities  15  921  (32)  (908)  
Commercial mortgage-backed securities 13  (8) 478  (1,065) 3,257  (124) 2,551  
Total Level 3 available-for-sale securities$12,577  $ $298  $2,133  $(7,369) $10,651  $(9,374) $8,924  
(in thousands)
 
 Beginning balance at December 31, 2015 
Included in earnings(1)
 
Included
in other
comprehensive
income
 Purchases Sales 
Transfers into Level 3(2)
 
Transfers out of Level 3(2)
 Ending balance at September 30, 2016
Available-for-sale securities:                
Corporate debt securities $69
 $67
 $119
 $11,887
 $(924) $5,470
 $(6,499) $10,189
Commercial mortgage-backed securities 0
 0
 3
 1,000
 0
 0
 (1,003) 0
Collateralized debt obligations 8,577
 4
 (5) 7,722
 (54) 2,114
 (13,237) 5,121
Total fixed maturities 8,646
 71
 117
 20,609
 (978) 7,584
 (20,739) 15,310
Total available-for-sale securities 8,646
 71
 117
 20,609
 (978) 7,584
 (20,739) 15,310
Total Level 3 assets $8,646
 $71
 $117
 $20,609
 $(978) $7,584
 $(20,739) $15,310
(1)These amounts are reported as net investment income and net realized investment gains (losses) for each of the periods presented above.
(1)These amounts are reported in the Statements of Operations as net investment income and net realized investment gains (losses) for the each of the periods presented above.
(2)Transfers into and/or (out) of Level 3 are primarily attributable to the availability of market observable information and the re-evaluation of the observability of pricing inputs.

(2)Transfers into and/or (out) of Level 3 are primarily attributable to the availability of market observable information and the re-evaluation of the observability of pricing inputs.



Quantitative and Qualitative Disclosures about Unobservable Inputs


WhenInvestments totaling $6.0 million and $1.3 million at June 30, 2020 and December 31, 2019, respectively, were priced using a non-binding broker quote wasas the only pricing input available, the security wasand were classified within Level 3. UseThe quantitative detail of non-binding broker quotes totaled $7.9 million at September 30, 2017. Thethe unobservable inputs are notsupporting these quotes is neither provided nor reasonably available to us.  Our Level 3 assets are not material in total and, with the exception of the tables above, additional Level 3 disclosures are not provided. 


Financial instruments not carried at fair value
The following table presents ourthe carrying values and fair values of financial instruments categorized as Level 3 in the fair value
hierarchy that are recorded at carrying value as of:
June 30, 2020December 31, 2019
(in thousands)Carrying valueFair valueCarrying valueFair value
Agent loans (1)
$65,450  $63,030  $67,696  $71,602  
Long-term borrowings (2)
97,101  117,604  98,080  101,888  
(1)The discount rate used to calculate fair value measurements on a recurring basis by pricing source:at June 30, 2020 is reflective of an increase in the BB+ financial yield curve due to the market volatility resulting from the COVID-19 pandemic.
(in thousands) At September 30, 2017
  Total Level 1 Level 2 Level 3
Fixed maturities:        
Priced via pricing services $749,266
 $0
 $741,351
 $7,915
Total fixed maturities 749,266
 0
 741,351
 7,915
Other investments:        
Priced via unobservable inputs (1)
 4,338
 
 
 
Total other investments 4,338
 
 
 
Total $753,604
 $0
 $741,351
 $7,915


(1)Other investments measured at fair value represent real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option using the net asset value practical expedient. These amounts are not required to be categorized in the fair value hierarchy. The fair value of these investments is based on the NAV information provided by the general partner.

There were no assets measured at(2)The discount rate used to calculate fair value onat June 30, 2020 is reflective of a nonrecurring basis duringdecline in U.S. Treasury bond yields due to the nine months ended September 30, 2017.market volatility resulting from the COVID-19 pandemic.






16

Note 5.6.  Investments
 
Available-for-sale securities
See Note 5, "Fair Value" for additional fair value disclosures. The following tables summarize the cost and fair value, net of credit loss allowance, of our available-for-sale securities:securities as of:
June 30, 2020
 (in thousands)Amortized costGross unrealized gainsGross unrealized lossesEstimated fair value
Corporate debt securities$461,398  $14,508  $6,251  $469,655  
Residential mortgage-backed securities115,631  3,970   119,599  
Commercial mortgage-backed securities104,403  3,390  1,251  106,542  
Collateralized debt obligations98,603  281  2,596  96,288  
Other debt securities12,435  355  49  12,741  
Total available-for-sale securities, net$792,470  $22,504  $10,149  $804,825  

  At September 30, 2017
 (in thousands) 
Amortized
cost
 Gross unrealized gains Gross unrealized losses Estimated fair value
Available-for-sale securities:        
U.S. treasury $11,878
 $0
 $44
 $11,834
States & political subdivisions 254,835
 7,809
 678
 261,966
Foreign government securities 501
 6
 0
 507
Corporate debt securities 345,003
 2,201
 832
 346,372
Residential mortgage-backed securities 25,388
 404
 73
 25,719
Commercial mortgage-backed securities 34,892
 73
 634
 34,331
Collateralized debt obligations 62,193
 207
 19
 62,381
Other debt securities 6,119
 37
 0
 6,156
Total fixed maturities 740,809
 10,737
 2,280
 749,266
Total available-for-sale securities $740,809
 $10,737
 $2,280
 $749,266

December 31, 2019
(in thousands)Amortized costGross unrealized gainsGross unrealized lossesEstimated fair value
Corporate debt securities$450,295  $6,289  $1,704  $454,880  
Residential mortgage-backed securities124,337  1,056  50  125,343  
Commercial mortgage-backed securities67,210  479  148  67,541  
Collateralized debt obligations78,059  44  247  77,856  
Other debt securities5,049  71  39  5,081  
Total available-for-sale securities, net$724,950  $7,939  $2,188  $730,701  



  At December 31, 2016
(in thousands) 
Amortized
cost
 Gross unrealized gains Gross unrealized losses Estimated fair value
Available-for-sale securities:        
U.S. treasury $5,093
 $0
 $62
 $5,031
Government sponsored entities 2,004
 22
 0
 2,026
States & political subdivisions 249,312
 6,113
 2,293
 253,132
Corporate debt securities 321,041
 3,293
 1,386
 322,948
Residential mortgage-backed securities 16,232
 61
 191
 16,102
Commercial mortgage-backed securities 37,723
 59
 933
 36,849
Collateralized debt obligations 68,998
 351
 96
 69,253
Other debt securities 2,000
 0
 0
 2,000
Total fixed maturities 702,403
 9,899
 4,961
 707,341
Common stock 6,152
 0
 202
 5,950
Total available-for-sale securities $708,555
 $9,899
 $5,163
 $713,291
The amortized cost and estimated fair value of fixed maturitiesavailable-for-sale securities at SeptemberJune 30, 20172020 are shown below by remaining contractual term to maturity.  Mortgage-backed securities are allocated based upon 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.
June 30, 2020
AmortizedEstimated
(in thousands)costfair value
Due in one year or less$24,154  $24,233  
Due after one year through five years362,607  372,299  
Due after five years through ten years129,547  128,334  
Due after ten years276,162  279,959  
Total available-for-sale securities (1)
$792,470  $804,825  
(1)The contractual maturities of our available-for-sale securities are included in the table. However, given our intent to sell certain impaired securities, these securities are classified as current assets in our Statements of Financial Position at June 30, 2020.















17

  At September 30, 2017
(in thousands) Amortized Estimated
  cost fair value
Due in one year or less $65,085
 $65,208
Due after one year through five years 332,904
 337,986
Due after five years through ten years 239,042
 242,425
Due after ten years 103,778
 103,647
Total fixed maturities $740,809
 $749,266



Available-for-sale securities in a gross unrealized loss position are as follows.  Data is provided by lengthTable of time for securities in a gross unrealized loss position.Contents
  At September 30, 2017
(in thousands) Less than 12 months 12 months or longer Total
  
Fair
value
 Unrealized losses 
Fair
value
 Unrealized losses 
Fair
 value
 Unrealized losses No. of holdings
Available-for-sale securities:              
U.S. treasury $11,835
 $44
 $0
 $0
 $11,835
 $44
 4
States & political subdivisions 49,278
 449
 7,280
 229
 56,558
 678
 26
Corporate debt securities 108,828
 619
 19,951
 213
 128,779
 832
 255
Residential mortgage-backed securities 5,553
 19
 5,771
 54
 11,324
 73
 10
Commercial mortgage-backed securities 12,793
 106
 11,019
 528
 23,812
 634
 21
Collateralized debt obligations 16,426
 19
 0
 0
 16,426
 19
 8
Total fixed maturities 204,713
 1,256
 44,021
 1,024
 248,734
 2,280
 324
Total available-for-sale securities $204,713
 $1,256
 $44,021
 $1,024
 $248,734
 $2,280
 324
Quality breakdown of fixed maturities:              
Investment grade $152,341
 $745
 $42,020
 $533
 $194,361
 $1,278
 113
Non-investment grade 52,372
 511
 2,001
 491
 54,373
 1,002
 211
Total fixed maturities $204,713
 $1,256
 $44,021
 $1,024
 $248,734
 $2,280
 324


  At December 31, 2016
(in thousands) Less than 12 months 12 months or longer Total
  
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
No. of
holdings
Available-for-sale securities:              
U.S. treasury $5,031
 $62
 $0
 $0
 $5,031
 $62
 1
States & political subdivisions 84,611
 2,293
 0
 0
 84,611
 2,293
 40
Corporate debt securities 112,453
 987
 8,692
 399
 121,145
 1,386
 155
Residential mortgage-backed securities 7,451
 60
 4,974
 131
 12,425
 191
 13
Commercial mortgage-backed securities 26,509
 437
 4,319
 496
 30,828
 933
 28
Collateralized debt obligations 27,470
 75
 4,208
 21
 31,678
 96
 15
Total fixed maturities 263,525
 3,914
 22,193
 1,047
 285,718
 4,961
 252
Common stock 5,950
 202
 0
 0
 5,950
 202
 1
Total available-for-sale securities $269,475
 $4,116
 $22,193
 $1,047
 $291,668
 $5,163
 253
Quality breakdown of fixed maturities:              
Investment grade $239,041
 $3,605
 $16,061
 $399
 $255,102
 $4,004
 136
Non-investment grade 24,484
 309
 6,132
 648
 30,616
 957
 116
Total fixed maturities $263,525
 $3,914
 $22,193
 $1,047
 $285,718
 $4,961
 252
The abovebelow securities have been evaluated and determined to be temporary impairmentsdeclines in fair value for which we expect to recover our entire principal plus interest.  The primary componentsfollowing table presents available-for-sale securities based on length of this analysis includetime in a general reviewgross unrealized loss position as of:
June 30, 2020
Less than 12 months12 months or longerTotal
(dollars in thousands)Fair
value
Unrealized
losses
Fair
value
Unrealized
losses
Fair
value
Unrealized
losses
No. of
holdings
Corporate debt securities$81,468  $4,358  $8,058  $1,893  $89,526  $6,251  494  
Residential mortgage-backed securities1,407     1,407    
Commercial mortgage-backed securities30,808  1,251    30,808  1,251  47  
Collateralized debt obligations75,876  2,070  13,721  526  89,597  2,596  92  
Other debt securities2,780  49    2,780  49   
Total available-for-sale securities$192,339  $7,730  $21,779  $2,419  $214,118  $10,149  643  
Quality breakdown of available-for-sale securities:
Investment grade$135,419  $3,849  $13,721  $526  $149,140  $4,375  170  
Non-investment grade56,920  3,881  8,058  1,893  64,978  5,774  473  
Total available-for-sale securities$192,339  $7,730  $21,779  $2,419  $214,118  $10,149  643  

December 31, 2019
Less than 12 months12 months or longerTotal
(dollars in thousands)Fair
value
Unrealized
losses
Fair
value
Unrealized
losses
Fair
value
Unrealized
losses
No. of
holdings
Corporate debt securities$25,804  $342  $15,699  $1,362  $41,503  $1,704  158  
Residential mortgage-backed securities16,712  50    16,712  50   
Commercial mortgage-backed securities21,981  147  372   22,353  148  30  
Collateralized debt obligations20,889  33  41,010  214  61,899  247  49  
Other debt securities2,350  39    2,350  39   
Total available-for-sale securities$87,736  $611  $57,081  $1,577  $144,817  $2,188  246  
Quality breakdown of available-for-sale securities:
Investment grade$76,315  $287  $46,390  $218  $122,705  $505  100  
Non-investment grade11,421  324  10,691  1,359  22,112  1,683  146  
Total available-for-sale securities$87,736  $611  $57,081  $1,577  $144,817  $2,188  246  


Credit loss allowance on investments
As of market conditionsJune 30, 2020, the current expected credit loss allowance on agent loans is $1.0 million and financial performance of the issuer along with the extent and duration at which fair valuecredit loss allowance on available-for-sale securities is less than cost.  Any 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.$0.4 million.



Net investment income
Interest and dividend income are recognized as earned and recorded to net investment income.  Investment income, net of expenses, was generated from the following portfolios:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Available-for sale securities$5,670  $5,488  $11,458  $11,649  
Equity securities901  141  1,757  282  
Cash equivalents and other1,115  2,660  3,089  5,125  
Total investment income7,686  8,289  16,304  17,056  
Less: investment expenses313  259  562  509  
Investment income, net of expenses$7,373  $8,030  $15,742  $16,547  





18

(in thousands) Three months ended September 30, Nine months ended September 30,
  2017 2016 2017 2016
Fixed maturities $4,234
 $5,245
 $16,358
 $14,629
Equity securities 0
 50
 49
 132
Cash equivalents and other 1,936
 366
 2,852
 1,011
Total investment income 6,170
 5,661
 19,259
 15,772
Less: investment expenses 200
 330
 1,075
 888
Net investment income $5,970
 $5,331
 $18,184
 $14,884
Realized investment gains (losses)
Realized gains and losses on sales of securities are recognized in income based upon the specific identification method. Realized gains (losses) on investments were as follows:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Available-for-sale securities:  
Gross realized gains$1,721  $2,062  $2,795  $4,320  
Gross realized losses(1,366) (823) (1,825) (1,163) 
Net realized gains on available-for-sale securities355  1,239  970  3,157  
Equity securities (1)
6,170  63  (5,252) 648  
Miscellaneous    
Net realized investment gains (losses)$6,526  $1,302  $(4,280) $3,805  
(in thousands) Three months ended September 30, Nine months ended September 30,
  2017 2016 2017 2016
Available-for-sale securities:  
  
  
  
Fixed maturities:  
  
  
  
Gross realized gains $1,621
 $603
 $2,708
 $1,175
Gross realized losses (722) (27) (1,116) (1,819)
Net realized gains (losses) 899
 576
 1,592
 (644)
Equity securities: 

  
  
  
Gross realized losses 0
 0
 (145) (34)
Net realized losses 0
 0
 (145) (34)
Trading securities: 

  
  
  
Common stock: 

  
  
  
Gross realized gains 0
 121
 0
 707
Increases in fair value(1)
 0
 21
 0
 0
Net realized gains 0
 142
 0
 707
Miscellaneous: 

 

 

 

Gross realized gains 0
 0
 94
 0
Gross realized losses 0
 0
 (2) 0
Net realized gains 0
 0
 92
 0
Net realized investment gains $899
 $718
 $1,539
 $29
(1)While our investment portfolio was negatively impacted in the first quarter of 2020 primarily due to the financial market volatility resulting from the COVID-19 pandemic, market conditions partially recovered in the second quarter of 2020, resulting in significant gains in the three months ended June 30, 2020.
(1)The fair value of our common stocks is determined based upon exchange traded prices provided by a nationally recognized pricing service.

Net impairment losses
The componentsportion of other-than-temporary impairments on investments werenet unrealized gains and losses recognized during the reporting period related to equity securities held at the reporting date is calculated as follows:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Equity securities:
Net gains (losses) recognized during the period (1)
$6,170  $63  $(5,252) $648  
Less: net gains (losses) recognized on securities sold1,357   (2,157)  
Net unrealized gains (losses) recognized on securities held at reporting date$4,813  $63  $(3,095) $648  
(in thousands) Three months ended September 30, Nine months ended September 30,
  2017 2016 2017 2016
Fixed maturities $0

$0
 $(182) $(345)
Total other-than-temporary impairments 0

0
 (182) (345)
Portion recognized in other comprehensive income 0

0
 0
 0
Net impairment losses recognized in earnings $0

$0
 $(182) $(345)
(1)While our investment portfolio was negatively impacted in the first quarter of 2020 primarily due to the financial market volatility resulting from the COVID-19 pandemic, market conditions partially recovered in the second quarter of 2020, resulting in significant gains in the three months ended June 30, 2020.


In considering if fixed maturityNet impairments losses recognized in earnings
Upon adoption of ASU 2016-13 on January 1, 2020, impairments on available-for-sale securities were credit-impaired, some of thethat are deemed to be credit related are recognized in earnings with a corresponding available-for-sale security allowance. All unrealized losses related to factors considered include: potential for the default of interest and/or principal, level of subordination, collateral of the issue, compliance with financial covenants,other than credit ratings and industry conditions.  We haveare recorded in other comprehensive income. Prior to January 1, 2020, we had the intent to sell all credit-impaired fixed maturityavailable-for-sale securities; therefore, the entire amount of the impairment charges werewas included in earnings and no non-credit impairments were recognized in other comprehensive income.


Limited partnerships
The majority of our limited partnership holdings are considered investment companies where the general partners record assets at fair value. These limited partnerships are recorded using the equity method of accounting and are generally reported on a one-quarter lag; therefore, our year-to-date limited partnership results through September 30, 2017 are comprised of partnership financial results for the fourth quarter of 2016 and the first two quarters of 2017.  Given the lag in reporting, our limited partnership results do not reflect the market conditions of the third quarter of 2017. We also own some real estate limited partnerships that do not meet the criteria of an investment company. These partnerships prepare audited financial statements on a cost basis. We have elected to report these limited partnerships under the fair value option, which is based on the NAV from our partner's capital statement reflecting the general partner's estimate of fair value for the fund's underlying assets. Fair value provides consistency in the evaluation and financial reporting for these limited partnerships and limited partnerships accounted for under the equity method. Cash contributions made to and distributions received from the partnerships are recorded in the period in which the transaction occurs.

Amounts included in equity in earnings of limited partnerships by method of accounting are included below:
(in thousands) Three months ended September 30, Nine months ended September 30,
  2017 2016 2017 2016
         
Equity in earnings (losses) of limited partnerships accounted for under the equity method $1,305
 $(1,778) $1,704
 $(436)
Change in fair value of limited partnerships accounted for under the fair value option 232
 55
 195
 157
Equity in earnings (losses) of limited partnerships $1,537
 $(1,723) $1,899
 $(279)


The following table summarizes limited partnership investments by sector:

(in thousands) At September 30, 2017 At December 31, 2016
Private equity $33,478
 $35,228
Mezzanine debt 4,797
 6,010
Real estate 6,838
 12,509
Real estate - fair value option 4,338
 4,412
Total limited partnership investments $49,451
 $58,159


See also Note 13, "Commitments2, "Significant Accounting Policies".

Impairments on available-for-sale securities and Contingencies" for investment commitments related to limited partnerships.agent loans were as follows:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Available-for-sale securities:
Intent to sell$ $84  $2,242  $162  
Credit impaired17  —  658  —  
Total available-for-sale securities17  84  2,900  162  
Agent loans - expected credit losses —  170  —  
Net impairment losses recognized in earnings$17  $84  $3,070  $162  

19


Note 7.  Leases

The following table summarizes our lease assets and liabilities as of:
(in thousands)June 30, 2020December 31, 2019
Operating lease assets$19,267  $22,401  
Operating lease liabilities - current$11,216  $11,289  
Operating lease liabilities - long-term7,664  10,665  
Total operating lease liabilities$18,880  $21,954  


We currently have leases for real estate, technology equipment, copiers, and vehicles. Our largest operating lease asset at June 30, 2020 of $9.2 million is for office space leased from the Exchange, including the home office. Under this lease, rent is based on rental rates of like property and all operating expenses are the responsibility of the tenant (Indemnity). The lease agreement expires December 31, 2021.

Operating lease costs for the three months ended June 30, 2020 and 2019 were $3.3 million and $3.6 million, respectively, and $6.7 million and $7.2 million for the six months ended June 30, 2020 and 2019, respectively. Of this amount, the Exchange and its subsidiaries reimbursed us $1.4 million and $1.6 million for the three months ended June 30, 2020 and 2019, respectively, and $2.8 million and $3.1 million for the six months ended June 30, 2020 and 2019, respectively, which represents the allocated share of lease costs supporting administrative services activities.


20

Note 6.8.  Borrowing Arrangements
 
Bank line of credit
As of SeptemberJune 30, 2017,2020, we have access to a $100 million bank revolving line of credit with a $25 million letter of credit sublimit that expires on November 3, 2020.October 30, 2023. As of SeptemberJune 30, 2017,2020, a total of $99.1 million remains available under the facility due to $0.9 million outstanding letters of credit, which reduce the availability for letters of credit to $24.1 million.  We had no0 borrowings outstanding on our line of credit as of SeptemberJune 30, 2017.  Bonds2020.  Investments with a fair value of $109.5$124.4 million were pledged as collateral on the line at SeptemberJune 30, 2017.2020. The securitiesinvestments pledged as collateral have no trading restrictions and are reported as available-for-sale securities in the Statements of Financial Positionand cash and cash equivalents as of SeptemberJune 30, 2017.2020. The bank requiresbanks require compliance with certain covenants, which include leverage ratios and debt restrictions, for our line of credit.  We are in compliance with all bank covenants at SeptemberJune 30, 2017.2020.


Term loan credit facility
On November 7,In 2016, we entered into a credit agreement for a $100 million senior secured draw term loan credit facility ("Credit Facility") for the acquisition of real property and construction of an office building that will serve as part of our principal headquarters. Under the agreement, $25 million will be drawn on DecemberOn January 1, 2016, June 1, 2017, December 1, 2017, and June 1, 2018 ("Draw Period"). During the Draw Period, we will make monthly interest only payments under2019, the Credit Facility and thereafter the Credit Facility convertsconverted to a fully-amortized term loan with monthly payments of principal and interest at a fixed rate of 4.35% over a period of 28 years. Borrowings under the Credit Facility will bear interest at a fixed rate of 4.35%. In addition, we are required to pay a quarterly commitment fee of 0.08% on the unused portion of the Credit Facility during the Draw Period. Total draws against the facility are $50 million as of September 30, 2017. BondsInvestments with a fair value of $109.7$126.1 million were pledged as collateral for the facility and are reported as available-for-sale securities in the Statements of Financial Positionand cash and cash equivalents as of SeptemberJune 30, 2017.2020. The bank requires compliance with certain covenants, which include leverage ratios, debt restrictions and minimum net worth, for our Credit Facility. We are in compliance with all covenants at SeptemberJune 30, 2017.2020.

Amounts drawnThe remaining unpaid balance from the Credit Facility areis reported at carrying value on our Statements of Financial Position, net of unamortized loan origination and commitment fees. TheSee Note 5, "Fair Value" for the estimated fair value of this borrowing at September 30, 2017 was $47.9 million. The estimated fair value was determined using estimates based upon interest rates and credit spreads and are classified as Level 3 in the fair value hierarchy as of September 30, 2017.these borrowings.

Annual principal payments
The scheduled maturityfollowing table sets forth future principal payments:
(in thousands)
YearPrincipal payments
2020$1,000  
20212,019  
20222,109  
20232,226  
20242,302  
Thereafter87,445  

21




Note 7.9.  Postretirement Benefits
 
Pension plans
Our pension plans consist of a noncontributory defined benefit pension plan covering substantially all employees and an unfunded supplemental employee retirement plan for certain members of executive and senior management. Although we are the sponsor of these postretirement plans and record the funded status of these plans, the Exchange reimbursesand its subsidiaries reimburse us for approximately 58% of the annual benefit expense of these plans, which represents pension benefits for our employees performing claims and life insurance functionsadministrative services and their allocated share of service department costs.costs for employees in departments that support the administrative functions.
A $19.0 million contribution was made to the defined benefit pension plan in the first quarter of 2017. An additional $20.0 million contribution was made to the plan in the third quarter of 2017.

Prior to 2003, the employee pension plan purchased annuities from Erie Family Life Insurance Company ("EFL"), a wholly owned subsidiary of the Exchange, for certain plan participants that were receiving benefit payments under the pension plan. These are nonparticipating annuity contracts under which EFL has unconditionally contracted to provide specified benefits to beneficiaries; however, the pension plan remains the primary obligor to the beneficiaries. A contingent liability of $19.7 million at September 30, 2017 exists in the event EFL does not honor the annuity contracts.
The cost of our pension plans are as follows:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Service cost for benefits earned$10,874  $8,464  $21,747  $16,927  
Interest cost on benefits obligation9,394  9,826  18,789  19,653  
Expected return on plan assets(12,353) (11,871) (24,706) (23,742) 
Prior service cost amortization335  348  671  697  
Net actuarial loss amortization3,031  1,278  6,062  2,556  
Pension plan cost (1)
$11,281  $8,045  $22,563  $16,091  
(in thousands) Three months ended September 30, Nine months ended September 30,
  2017 2016 2017 2016
Service cost for benefits earned $7,777
 $7,050
 $23,330
 $21,150
Interest cost on benefits obligation 8,569
 8,281
 25,706
 24,844
Expected return on plan assets (10,317) (9,880) (30,950) (29,640)
Prior service cost amortization 218
 174
 654
 522
Net actuarial loss amortization 2,325
 2,029
 6,975
 6,084
Pension plan cost (1)
 $8,572
 $7,654
 $25,715
 $22,960
(1)The components of pension plan costs other than the service cost component are included in the line item "Other (expense) income" in the Statements of Operations after reimbursements from the Exchange and its subsidiaries.
(1)Pension plan costs represent the total cost before reimbursements to Indemnity from the Exchange and EFL.




Note 8.10.  Income Taxes


TheIncome tax expense is provided on an interim basis based upon our estimate of the annual effective income tax rate, adjusted each quarter for discrete items. Our effective tax rates differ fromrate was 20.0% and 20.9% for the statutory federalthree and six months ended June 30, 2020, respectively. The $6.8 million valuation allowance that was recognized on our net deferred tax assets at March 31, 2020, primarily related to unrealized losses on our investments, was released as of June 30, 2020 driven by the partial recovery experienced in market conditions in the second quarter of 2020. Of the total, $5.8 million was recorded in other comprehensive income and $1.0 million was recorded as an income tax benefit. The amount recognized as an income tax benefit decreased the effective tax rate by 0.9% for the three months ended June 30, 2020. Our effective tax rate was 17.2% and 19.1% for the three and six months ended June 30, 2019, respectively. Impacting our effective tax rate in the three and six months ended June 30, 2019 was the settlement of 35% primarily due to permanent differences foran uncertain tax exempt interest income.position, which reduced our effective tax rate by 3.8% and 2.0%, respectively.





Note 9.11.  Capital Stock
 
Class A and B common stock
Holders of Class B shares may, at their option, convert their shares into Class A shares at the rate of 2,400 Class A shares per Class B share.  There were no0 shares of Class B common stock converted into Class A common stock during the ninesix months ended SeptemberJune 30, 20172020 and the year ended December 31, 2016.2019. There is no provision for conversion of Class A shares to Class B shares, and Class B shares surrendered for conversion cannot be reissued.

Stock repurchases
In October 2011, our Board of Directors approved a continuation of the current stock repurchase program for a total of $150 million, with no time limitation.  There were no0 shares repurchased under this program during the ninesix months ended SeptemberJune 30, 20172020 and the year ended December 31, 2016.2019. We had approximately $17.8 million of repurchase authority remaining under this program at SeptemberJune 30, 2017.2020.
22
During the nine months ended September 30, 2017, we purchased 58,129 shares


In 2016, we purchased 15,093 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $1.5 million. Of this amount, we purchased 7,432 shares for $0.7 million, or $99.23 per share, to fund the rabbi trust for the outside director deferred compensation plan. The remaining 7,661 shares were purchased at a total cost of $0.8 million, or $98.20 per share, for the vesting of stock-based awards in the long-term incentive plan.



Note 10.12.  Accumulated Other Comprehensive Income (Loss)
 
Changes in accumulated other comprehensive income ("AOCI") (loss) by component, including amounts reclassified to other comprehensive income ("OCI") (loss) and the related line item in the Statements of Operations where net income is presented, are as follows:
Three months endedThree months ended
June 30, 2020June 30, 2019
(in thousands) Three months ended Three months ended(in thousands)Before TaxIncome TaxNetBefore TaxIncome TaxNet
Investment securities:Investment securities:
AOCI (loss), beginning of period (1)
AOCI (loss), beginning of period (1)
$(27,761) $ $(27,761) $(2,235) $(470) $(1,765) 
OCI before reclassifications (1)
OCI before reclassifications (1)
40,364  2,646  37,718  4,420  928  3,492  
Realized investment gainsRealized investment gains(355) (75) (280) (1,239) (260) (979) 
Impairment lossesImpairment losses17   13  84  18  66  
 September 30, 2017 September 30, 2016
OCIOCI40,026  2,575  37,451  3,265  686  2,579  
AOCI (loss), end of period (1)
AOCI (loss), end of period (1)
$12,265  $2,575  $9,690  $1,030  $216  $814  
 Before Tax
Income Tax
Net
 Before Tax
Income Tax
Net
Investment securities:    
AOCI, beginning of period $7,974
$2,791
$5,183
 $13,875
$4,857
$9,018
OCI before reclassifications 643
225
418
 1,121
392
729
Realized investment gains (899)(314)(585) (576)(202)(374)
OCI (loss) (256)(89)(167) 545
190
355
AOCI, end of period $7,718
$2,702
$5,016
 $14,420
$5,047
$9,373
Pension and other postretirement plans:Pension and other postretirement plans:
AOCI (loss), beginning of periodAOCI (loss), beginning of period$(150,233) $(31,550) $(118,683) $(154,190) $(32,381) $(121,809) 
      
Pension and other postretirement plans: (1)
    
AOCI (loss), beginning of period $(190,695)$(66,744)$(123,951) $(152,910)$(53,519)$(99,391)
Amortization of prior service costsAmortization of prior service costs336  70  266  348  73  275  
Amortization of net actuarial lossAmortization of net actuarial loss3,031  637  2,394  1,210  254  956  
OCIOCI3,367  707  2,660  1,558  327  1,231  
AOCI (loss), end of period $(190,695)$(66,744)$(123,951) $(152,910)$(53,519)$(99,391)AOCI (loss), end of period$(146,866) $(30,843) $(116,023) $(152,632) $(32,054) $(120,578) 
      
Total    Total
AOCI (loss), beginning of period $(182,721)$(63,953)$(118,768) $(139,035)$(48,662)$(90,373)AOCI (loss), beginning of period$(177,994) $(31,550) $(146,444) $(156,425) $(32,851) $(123,574) 
Investment securities (256)(89)(167) 545
190
355
Investment securities40,026  2,575  37,451  3,265  686  2,579  
Pension and other postretirement plans 0
0
0
 0
0
0
Pension and other postretirement plans3,367  707  2,660  1,558  327  1,231  
OCI (loss) (256)(89)(167) 545
190
355
OCIOCI43,393  3,282  40,111  4,823  1,013  3,810  
AOCI (loss), end of period $(182,977)$(64,042)$(118,935) $(138,490)$(48,472)$(90,018)AOCI (loss), end of period$(134,601) $(28,268) $(106,333) $(151,602) $(31,838) $(119,764) 
Six months endedSix months ended
June 30, 2020June 30, 2019
(in thousands)(in thousands)Before TaxIncome TaxNetBefore TaxIncome TaxNet
Investment securities:Investment securities:
AOCI (loss), beginning of periodAOCI (loss), beginning of period$5,664  $1,189  $4,475  $(9,169) $(1,926) $(7,243) 
OCI before reclassificationsOCI before reclassifications4,671  981  3,690  13,194  2,771  10,423  
Realized investment gainsRealized investment gains(970) (204) (766) (3,157) (663) (2,494) 
Impairment lossesImpairment losses2,900  609  2,291  162  34  128  
OCIOCI6,601  1,386  5,215  10,199  2,142  8,057  
AOCI (loss), end of periodAOCI (loss), end of period$12,265  $2,575  $9,690  $1,030  $216  $814  
Pension and other postretirement plans:Pension and other postretirement plans:
AOCI (loss), beginning of periodAOCI (loss), beginning of period$(153,600) $(32,257) $(121,343) $(155,749) $(32,708) $(123,041) 
Amortization of prior service costsAmortization of prior service costs672  141  531  697  146  551  
Amortization of net actuarial lossAmortization of net actuarial loss6,062  1,273  4,789  2,420  508  1,912  
OCIOCI6,734  1,414  5,320  3,117  654  2,463  
AOCI (loss), end of periodAOCI (loss), end of period$(146,866) $(30,843) $(116,023) $(152,632) $(32,054) $(120,578) 
TotalTotal
AOCI (loss), beginning of periodAOCI (loss), beginning of period$(147,936) $(31,068) $(116,868) $(164,918) $(34,634) $(130,284) 
Investment securitiesInvestment securities6,601  1,386  5,215  10,199  2,142  8,057  
Pension and other postretirement plansPension and other postretirement plans6,734  1,414  5,320  3,117  654  2,463  
OCIOCI13,335  2,800  10,535  13,316  2,796  10,520  
AOCI (loss), end of periodAOCI (loss), end of period$(134,601) $(28,268) $(106,333) $(151,602) $(31,838) $(119,764) 

(in thousands) Nine months ended Nine months ended
  September 30, 2017 September 30, 2016
  Before Tax
Income Tax
Net
 Before Tax
Income Tax
Net
Investment securities:        
AOCI, beginning of period $3,954
$1,384
$2,570
 $3,888
$1,361
$2,527
OCI before reclassifications 5,029
1,760
3,269
 9,509
3,328
6,181
Realized investment (gains) losses (1,447)(506)(941) 678
237
441
Impairment losses 182
64
118
 345
121
224
OCI 3,764
1,318
2,446
 10,532
3,686
6,846
AOCI, end of period $7,718
$2,702
$5,016
 $14,420
$5,047
$9,373
         
Pension and other postretirement plans: (1)
        
AOCI (loss), beginning of period $(190,695)$(66,744)$(123,951) $(152,910)$(53,519)$(99,391)
AOCI (loss), end of period $(190,695)$(66,744)$(123,951) $(152,910)$(53,519)$(99,391)
         
Total        
AOCI (loss), beginning of period $(186,741)$(65,360)$(121,381) $(149,022)$(52,158)$(96,864)
Investment securities 3,764
1,318
2,446
 10,532
3,686
6,846
Pension and other postretirement plans 0
0
0
 0
0
0
OCI 3,764
1,318
2,446
 10,532
3,686
6,846
AOCI (loss), end of period $(182,977)$(64,042)$(118,935) $(138,490)$(48,472)$(90,018)
(1)There are no comprehensive income items or amounts reclassified out of accumulated other comprehensive loss related to postretirement plan items during interim periods.





Note 11. Related Party

Office lease
We lease certain office space from(1)As of June 30, 2020, the Exchange includingvaluation allowance that was recognized on the home office and three field office facilities.  On April 28, 2017, after securing approval from the Pennsylvania Insurance Department, a new home office lease was executed between the Exchange and Indemnity, which was retroactive to January 1, 2017, when the prior lease expired.  Under the new lease, rent is based on rental rates of like property in Erie, Pennsylvania and all operating expenses including utilities, cleaning, repairs, real estate taxes, property insurance and leasehold improvements will be the responsibility of the tenant (Indemnity).  This lease agreement expires December 31, 2021.  Under the previous lease, rents were determined considering returns on invested capital and included building operating and overhead costs.  Rent costs and related operating expenses of shared facilities are allocated between Indemnity, Exchange and EFL based upon usage or square footage occupied. Total rent and operating expenses are estimated at $17.4 million for 2017 and totaled $14.3 million in 2016.  In 2016, reimbursements from the Exchange and EFLdeferred tax asset primarily related to the useunrealized losses on our investments at March 31, 2020 was fully released.
23



Note 12.13. Concentrations of Credit Risk


Financial instruments could potentially expose us to concentrations of credit risk, including unsecured receivables from the Exchange. A large majority of our revenue and receivables are from the Exchange and its affiliates. See also Note 1, "Nature of Operations". ManagementNet management fee amounts and other reimbursements due from the Exchange and its affiliates were $428.5$506.7 million and $378.5$468.6 million at SeptemberJune 30, 20172020 and December 31, 2016,2019, respectively. Given the financial strength of the Exchange and historical experience of no credit losses, we previously did not record a credit loss allowance to these receivables. Upon adoption of ASU 2016-13, we recorded an allowance for current expected credit losses of $0.6 million related to the receivables from the Exchange and affiliates. See also Note 2, "Significant Accounting Policies". There was 0 change to this allowance for the three and six months ended June 30, 2020.




Note 13.14.  Commitments and Contingencies
 
We have contractual commitments to invest up to $16.4 million related to our limited partnership investments at September 30, 2017.  These commitments are split among private equity securities of $6.6 million, mezzanine debt securities of $8.2 million, and real estate activities of $1.6 million.  These commitments will be funded as required by the limited 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 financial condition, results of operations, or cash flows.  Legal fees are expensed as incurred.  We believe that our accruals for legal proceedings are appropriate and, individually and in the aggregate, are not expected to be material to our financial condition, results of operations, or cash flows.


We review all litigation on an ongoing basis when making accrual and disclosure decisions.  For certain legal proceedings, we cannot reasonably estimate losses or a range of loss, if any, 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.  In the event that a legal proceeding results in a substantial judgment against, or settlement by, us, there can be no assurance that any resulting liability or financial commitment would not have a material adverse effect on the financial condition, results of operations, or cash flows.




Note 14. 15. Subsequent Events
 
No items were identified in this period subsequent to the financial statement date that required adjustment or additional disclosure.



24


ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 Erie Indemnity Company ("Indemnity", "we", "us", "our").  This discussion should be read in conjunction with the historical financial statements and the related notes thereto included in Part I, 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, 2016,2019, as contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 23, 2017.27, 2020.
 
 
INDEX
 


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, 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:

potential impacts of the COVID-19 pandemic on the growth and financial condition of the Erie Insurance Exchange ("Exchange");
potential impacts of the COVID-19 pandemic on our operations, the business operations of our customers and/or independent agents, or our third-party vendor operations;
dependence upon our 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 and investments in new technology and systems;
credit risk from the Exchange;
dependence upon our relationship with the Exchange and the growth of the Exchange, including:
general business and economic conditions;
factors affecting insurance industry competition;
dependence upon the independent agency system; and
ability to maintain our reputation for customer service;
general business and economic conditions;
factors affecting insurance industry competition;
dependence upon the independent agency system; and
ability to maintain our reputation for customer service;
dependence upon our relationship with the Exchange and the financial condition of the Exchange, including:
the Exchange’s ability to maintain acceptable financial strength ratings;
factors affecting the quality and liquidity of the Exchange’s investment portfolio;
changes in government regulation of the insurance industry;
emerging claims and coverage issues in the industry; and
severe weather conditions or other catastrophic losses, including terrorism;
the Exchange's ability to maintain acceptable financial strength ratings;
factors affecting the quality and liquidity of the Exchange's investment portfolio;
changes in government regulation of the insurance industry;
emerging claims and coverage issues in the industry; and
severe weather conditions or other catastrophic losses, including terrorism;
costs of providing policy issuance and renewal services to the Exchange under the subscriber's agreement;
ability to attract and retain talented management and employees;
ability to maintain uninterrupted business operationsensure system availability and effectively manage technology initiatives;
difficulties with technology or data security breaches, including cyber attacks;
ability to maintain uninterrupted business operations;
25

factors affecting the quality and liquidity of our investment portfolio;

our ability to meet liquidity needs and access capital; and
outcome of pending and potential litigation.


A forward-looking statement speaks only as of the date on which it is made and reflects our analysis only as of that date.  We undertake 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 STANDARDS
 
See Part I, Item 1. "Financial Statements - Note 2, Significant Accounting Policies, of Notes to Financial Statements" contained within this report for a discussion of recently adopted as well as other recently issued accounting standards and the impact on our financial statements if known.




OPERATING OVERVIEW
 
Overview
We serve as the attorney-in-fact for the subscribers (policyholders) at the Exchange, a reciprocal insurer that writes personal and commercial property and casualty insurance. Our primary function as attorney-in-fact is to perform certainpolicy issuance and renewal services relating to the sales, underwriting and issuance of policies on behalf of the subscribers at the Exchange. We also act as attorney-in-fact on behalf of the Exchange, as well as the service provider for its insurance subsidiaries, with respect to all administrative services.

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 servicesacting as attorney-in-fact in these two capacities, we earn a management fee calculated as a percentage of the direct and affiliated assumed premiums written by the Exchange.


Our earnings are primarily driven by the management fee revenue generated for the services we provide relating to certainthe Exchange. The policy issuance and renewal services we provide to the Exchange are related to the sales, underwriting and issuance of policies for the Exchange.policies. The sales related services we provide to the Exchange include agent compensation and certain sales and advertising support services. Agent compensation includes scheduled commissions to agents based upon premiums written as well as additional commissions and bonuses to agents, which are earned by achieving targeted measures. Agent compensation generally comprises approximately two-thirds of our policy issuance and renewal expenses. The underwriting services we provide include underwriting and policy processing. The remaining services we provide include customer service and administrative support. We also provide information technology services that support all the functions listed above. Included in these expenses are allocations of costs for departments that support these policy issuance and renewal functions.


By virtue of its legal structure as a reciprocal insurer, the Exchange does not have the ability to enterany employees or officers. Therefore, it enters into contractual relationships by and thereforethrough an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and arranges for the provision of all claimsIndemnity. Claims handling services investmentinclude costs incurred in the claims process, including the adjustment, investigation, defense, recording and payment functions. Life insurance management services include costs incurred in the management and certainprocessing of life insurance business. Investment management services are related to investment trading activity, accounting and all other common overhead and service department functions and serves asattributable to the common pay agent.investment of funds. Included in these expenses are allocations of costs for departments that support these administrative functions. The amounts Indemnity incurs in this capacityincurred for these services are reimbursed to Indemnity fromat cost in accordance with the Exchange at cost.subscriber's agreement and the service agreements. State insurance regulations require that intercompany service agreements and any material amendments be approved in advance by the state insurance department.


Our results of operations are tied to the growth and financial condition of the Exchange as the Exchange is our sole customer, and our earnings are largely generated from management fees based on the direct and affiliated assumed premiums written by the Exchange. The Exchange generates revenue by insuring preferred and standard risks, with personal lines comprising 71% of the 20162019 direct and affiliated assumed written premiums and commercial lines comprising the remaining 29%.  The principal personal lines products are private passenger automobile and homeowners.  The principal commercial lines products are commercial multi-peril, commercial automobile and workers compensation.



26

Coronavirus ("COVID-19") pandemic
On March 11, 2020, the outbreak of the coronavirus ("COVID-19") was declared a global pandemic. The significant volatility in the financial markets, economic disruption and uncertainty resulting from the COVID-19 pandemic that began in the first quarter of 2020 continues to evolve and the pandemic’s ultimate impact and duration remain highly uncertain at this time.

The uncertainty of the COVID-19 pandemic has caused our sole customer, the Exchange, to experience growth constraints, which impacts our management fee revenue. The Exchange experienced declines in new business in the second quarter of 2020 due to business disruptions and recessionary conditions. Continued impacts of the COVID-19 pandemic will likely be incurred in the second half of 2020 and may continue until such time as the spread of the virus is contained. The Exchange previously announced rate reductions that will reduce its premiums and our management fee revenue beginning in the second half of 2020. Also, there may be other market and/or regulatory pressures that could impact the Exchange’s operations. In the first half of 2020, within our cost of operations, we incurred increased agent incentive costs as lower claim frequency resulted in improved agent profitability. We have incurred additional technology costs in support of remote working conditions for our employees. These expenses, among others, could continue to increase as the full extent and duration of the pandemic’s impacts remain uncertain. While the financial market volatility had a negative impact on our investment portfolio in the first quarter of 2020, markets did experience a partial recovery in the second quarter of 2020, contributing to realized and unrealized gains during this period. We could experience future losses and/or impairments to the portfolio given the pandemic’s impacts on market conditions. We have provided additional disclosure of these impacted areas throughout our Management’s Discussion and Analysis that follows. A broader discussion of the potential future impacts has also been disclosed in the Financial Condition, Liquidity and Capital Resources, and Part II. Item 1A. "Risk Factors" related to COVID-19 contained within this report.

We have a dedicated internal committee comprised of management from various finance disciplines reviewing our risk positions on an ongoing basis as circumstances are evolving.  The committee is reviewing risk scenarios and performing stress tests, including the review of cash flow trends, liquidity requirements and other forms of risk quantification. This provides tools for management, as well as our Risk Committee of the Board of Directors, to assess risks and prioritize key issues.

While we were not required to close our physical locations under the state mandated closure of nonessential services, out of concern for the health and safety of our employees, over 90% of our workforce has been working remote since about March 12, 2020. We have had no significant interruption to our core business processes or systems to date. We have had no significant changes to our financial close or reporting processes or related internal controls, nor do we anticipate any significant future challenges at this time. We have a separate dedicated committee developing a return to the office plan that will be implemented when it becomes feasible and safe.
27

Financial Overview
 Three months ended September 30, Nine months ended September 30,Three months ended June 30,Six months ended June 30,
(dollars in thousands, except per share data) 2017 2016 % Change 2017 2016 % Change(dollars in thousands, except per share data)20202019% Change20202019% Change
 (Unaudited)   (Unaudited)   (Unaudited)(Unaudited)
Total operating revenue $442,492
 $418,406
 5.8
% $1,290,372
 $1,217,018
 6.0
%
Total operating expenses 361,656
 336,151
 7.6
 1,059,958
 981,339
 8.0
 
Operating income 80,836
 82,255
 (1.7) 230,414
 235,679
 (2.2) Operating income$91,189  $96,610  (5.6) %$176,880  $182,732  (3.2) %
Total investment income 8,406
 4,326
 94.3
 21,440
 14,289
 50.0
 Total investment income11,553  9,652  19.7  2,358  19,447  (87.9) 
Interest expense, net 377
 
 NM
 800
 
 NM
 Interest expense, net 272  NM 721  NM
Other (expense) incomeOther (expense) income(258) 48  NM(624) 95  NM
Income before income taxes 88,865
 86,581
 2.6
 251,054
 249,968
 0.4
 Income before income taxes102,482  106,038  (3.4) 178,609  201,553  (11.4) 
Income tax expense 30,322
 29,205
 3.8
 86,108
 85,388
 0.8
 Income tax expense20,505  18,284  12.1  37,306  38,488  (3.1) 
Net income $58,543
 $57,376
 2.0
% $164,946
 $164,580
 0.2
%Net income$81,977  $87,754  (6.6) %$141,303  $163,065  (13.3) %
Net income per share - diluted $1.12
 $1.09
 2.2
% $3.15
 $3.14
 0.4
%
Net income per share – dilutedNet income per share – diluted$1.57  $1.68  (6.6) %$2.70  $3.12  (13.3) %
NM = not meaningful




Total operating revenue increasedOperating income decreased in both the thirdsecond quarter and ninesix months ended SeptemberJune 30, 20172020, compared to the same periods in 2016, driven by management2019, as growth in operating expenses outpaced the growth in operating revenues. Management fee revenue growth. The two components of managementfor policy issuance and renewal services increased 0.7% to $483.8 million in the second quarter and 1.8% to $927.5 million for the six months ended June 30, 2020, respectively. Management fee revenue areis based upon the management fee rate we charge, and the direct and affiliated assumed premiums written by the Exchange. The management fee rate was 25% for both 20172020 and 2016.2019. The direct and affiliated assumed premiums written by the Exchange increased 5.8%0.5% to $1.7$2.0 billion in the thirdsecond quarter of 2017,2020 and increased 1.9% to $3.9 billion for the six months ended June 30, 2020, compared to the thirdsame periods in 2019.

Cost of operations for policy issuance and renewal services increased 2.2% to $413.9 million and 3.0% to $793.4 million in the second quarter of 2016, and increased 6.0% to $5.1 billion for the ninesix months ended SeptemberJune 30, 2017,2020, compared to the ninesame periods in 2019, primarily due to higher agent incentives driven by lower claims frequency.

Management fee revenue for administrative services increased 4.4% to $14.8 million in the second quarter of 2020 and increased 5.1% to $29.6 million for the six months ended SeptemberJune 30, 2016.

Total operating expenses increased 7.6% in the third quarter of 2017,2020, compared to the thirdsame periods in 2019. The administrative services reimbursement revenue and corresponding cost of operations increased both total operating revenue and total operating expenses by $152.0 million in the second quarter of 2016, driven by higher commissions2020 and personnel costs. Total operating expenses increased 8.0%$303.5 million for the ninesix months ended SeptemberJune 30, 2017, compared2020, but had no net impact on operating income.

While our investment portfolio was negatively impacted by the significant disruption to the nine months ended September 30, 2016, driven by higher commissions, personnel costs and information technology-related professional fees.

Gross margin from operations was 18.3% and 19.7%financial markets in the third quartersfirst quarter of 2017 and 2016, respectively, and 17.9% and 19.4% for2020, market conditions partially recovered in the nine months ended September 30, 2017 and 2016, respectively.

second quarter of 2020. Total investment income increased $4.1$1.9 million in the thirdsecond quarter of 2017,2020 compared to the thirdsecond quarter of 2016,2019 primarily driven by higher earnings froman increase in net realized gains of $5.2 million partially offset by an increase in losses of limited partnerships. Total investmentpartnerships of $2.7 million. Investment income increased $7.2decreased $17.1 million forduring the ninesix months ended SeptemberJune 30, 2017,2020 compared to the ninesix months ended SeptemberJune 30, 2016,2019 primarily driven by higher net investment income, as well as higher earnings fromrealized losses of $4.3 million, impairment losses of $3.1 million and limited partnerships and realized investment gains.partnership losses of $6.0 million.


General Conditions and Trends Affecting Our Business
Economic conditions
Unfavorable changes in economic conditions, including declining consumer confidence, inflation, high unemployment, and the threat of recession, among others, may lead the Exchange’s customers to modify coverage, not renew policies, or even cancel policies, which could adversely affect the premium revenue of the Exchange, and consequently our management fee.  Further, unanticipated increased inflation costs including medical cost inflation, construction and auto repair cost inflation, and tort issues mayThe extent to which economic conditions could impact the estimated loss reservesExchange’s operations and future premium rates. If any of these items impactedour management fee was exacerbated with the financial condition or continuing operationsCOVID-19 pandemic. The extent and duration of the Exchange, it could have an impactimpacts to economic conditions remain uncertain as the pandemic continues to evolve. See Financial Condition, Liquidity and Capital Resources, and Part II, Item 1A. "Risk Factors" contained within this report for a discussion of the potential impacts of the COVID-19 pandemic on our financial results.operations.

Financial market volatility
Our portfolio of fixed maturity, equity security, and limited partnership investments is subject to market volatility, especially in periods of instability in the worldwide financial markets.  Over time, net investment income could also be impacted by volatility and by the general level of interest rates, which impact reinvested cash flow from the portfolio and business operations. Depending upon market conditions, which are unpredictable and remain uncertain, considerable fluctuation could exist in the fair value of our investment portfolio and reported total investment income, which could have an adverse impact on our financial condition, results of operations, and cash flows. Significant volatility has been seen in the global financial markets since the outbreak of the COVID-19 pandemic. The extent of the impact on our invested assets cannot be estimated with a high

28


degree of certainty at this time given the ongoing developments of this pandemic and the related impacts on the financial markets.




RESULTS OF OPERATIONS
 
We earn management fee revenue from providing services relating to the sales, underwriting, and issuance of policies on behalf of the Exchange as a result of its attorney-in-fact relationship.   A summary of the financial results of these operations is as follows: 
 Three months ended September 30, Nine months ended September 30,
(dollars in thousands)20172016% Change 20172016% Change
 (Unaudited)   (Unaudited)  
Management fee revenue, net$435,214
$411,139
5.9
% $1,268,591
$1,195,262
6.1
%
Service agreement revenue7,278
7,267
0.2
  21,781
21,756
0.1
 
Total operating revenue442,492
418,406
5.8
  1,290,372
1,217,018
6.0
 
Total operating expenses361,656
336,151
7.6
  1,059,958
981,339
8.0
 
Operating income$80,836
$82,255
(1.7)% $230,414
$235,679
(2.2)%
Gross margin18.3%19.7%(1.4)pts. 17.9%19.4%(1.5)pts.

Management fee revenue
ManagementWe have two performance obligations in the subscriber’s agreement, providing policy issuance and renewal services and acting as attorney-in-fact for the Exchange, as well as the service provider for its insurance subsidiaries, with respect to all administrative services. We earn management fees for acting as the attorney-in-fact for the subscribers at the Exchange in these two capacities, and allocate our revenues between our performance obligations.

The management fee revenue is based uponcalculated by multiplying all direct and affiliated assumed premiums written by the Exchange andby the management fee rate, which is determined by our Board of Directors at least annually.  The management fee rate was set at 25%, the maximum rate, for both 20172020 and 2016.2019.  Changes in the management fee rate can affect our revenue and net income significantly. ManagementThe transaction price, including management fee revenue and administrative service reimbursement revenue, is calculated by multiplyingallocated based on the management fee rate byestimated standalone selling prices developed using industry information and other available information for similar services. We update the direct and assumed premiums written bytransaction price allocation annually based upon the Exchange.  most recent information available or more frequently if there have been significant changes in any components considered in the transaction price. In 2020, we are reviewing our transaction price allocation quarterly to consider the most current economic conditions related to the COVID-19 pandemic. These reviews have resulted in no material change to the allocation.

The following table presents the calculationallocation and disaggregation of management fee revenue:revenue for our two performance obligations: 
Three months ended June 30,Six months ended June 30,
(dollars in thousands)20202019% Change20202019% Change
(Unaudited)(Unaudited)
Policy issuance and renewal services
Direct and affiliated assumed premiums written by the Exchange$2,002,753  $1,993,593  0.5  %$3,850,431  $3,778,113  1.9  %
Management fee rate24.2 %24.2 %24.2 %24.2 %
Management fee revenue484,666  482,449  0.5  931,804  914,303  1.9  
Change in allowance for management fee returned on cancelled policies (1)
(871) (1,936) 55.0  (4,259) (2,807) (51.7) 
Management fee revenue - policy issuance and renewal services, net$483,795  $480,513  0.7  %$927,545  $911,496  1.8  %
Administrative services
Direct and affiliated assumed premiums written by the Exchange$2,002,753  $1,993,593  0.5  %$3,850,431  $3,778,113  1.9  %
Management fee rate0.8 %0.8 %0.8 %0.8 %
Management fee revenue16,022  15,949  0.5  30,803  30,225  1.9  
Change in contract liability (2)
(1,184) (1,742) 32.0  (1,183) (2,052) 42.3  
Change in allowance for management fee returned on cancelled policies (1)
(25) (12) NM(36) (27) (32.1) 
Management fee revenue - administrative services, net14,813  14,195  4.4  29,584  28,146  5.1  
Administrative services reimbursement revenue151,965  146,095  4.0  303,519  288,575  5.2  
Total revenue from administrative services$166,778  $160,290  4.0  %$333,103  $316,721  5.2  %
 Three months ended September 30, Nine months ended September 30,
(dollars in thousands)20172016% Change 20172016% Change
 (Unaudited)   (Unaudited)  
Direct and assumed premiums written by the Exchange$1,739,654
$1,643,755
5.8% $5,085,562
$4,795,446
6.0%
Management fee rate25%25%   25%25%  
Management fee revenue, gross434,914
410,939
5.8  1,271,391
1,198,862
6.0 
Change in allowance for management fee returned on cancelled policies(1)
300
200
NM  (2,800)(3,600)NM 
Management fee revenue, net of allowance$435,214
$411,139
5.9% $1,268,591
$1,195,262
6.1%
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.

(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. This estimated allowance has been allocated between the two performance obligations consistent with the revenue allocation proportion. In the three and six months ended June 30, 2020 the increase in the allowance for management fee returned on cancelled policies was driven by the potential for a greater number of mid-term cancellations as a result of the COVID-19 pandemic.

(2)Management fee revenue - administrative services is recognized over time as the services are performed. See Part I, Item 1. "Financial Statements - Note 3, Revenue, of Notes to Financial Statements" contained within this report.

29

Direct and affiliated assumed premiums written by the Exchange
Direct and affiliated assumed premiums include premiums written directly by the Exchange and premiums assumed from its wholly owned property and casualty subsidiaries. Direct and affiliated assumed premiums written by the Exchange increased 5.8%0.5% to $1.7$2.0 billion in the thirdsecond quarter of 20172020 compared to the thirdsecond quarter of 2016,2019, driven by increases in both policies in force and average premium per policy.  Year-over-year policies in force for all lines of business increased 3.4%1.1% in the thirdsecond quarter of 2017 as the result of2020 driven by continuing strong policyholder retention, and an increase in new policies written, compared to 3.3%2.7% in the thirdsecond quarter of 2016.2019.  The year-over-year average premium per policy for all lines of business increased 2.6%2.2% at SeptemberJune 30, 2017,2020, compared to 2.7%3.4% at SeptemberJune 30, 2016.2019.


Premiums generated from new business increased 14.2%decreased 18.6% to $222$190 million in the thirdsecond quarter of 2017, compared to an increase of 3.9% to $194 million2020 driven by shelter-at-home orders, changes in consumer behavior and driving patterns and mandatory business closures resulting from the COVID-19 pandemic. Year-over-year average premium per policy on new business decreased 0.4% at June 30, 2020 and new business polices written decreased 12.7% in the thirdsecond quarter of 2016.  Underlying2020. In the trend insecond quarter of 2019, premiums generated from new business premiums was a 9.2% increase in new business policies written in the third quarter of 2017, compareddecreased 1.1% to a 1.1% increase in the third quarter of 2016, while the$233 million. While year-over-year average premium per policy on new business increased 4.6%6.4% at SeptemberJune 30, 2017, compared to 1.9% at September 30, 2016.2019, new business polices written decreased 7.4% in the second quarter of 2019. Premiums generated from renewal business increased 4.7%3.0% to $1.5$1.8 billion in the thirdsecond quarter of 2017,2020, compared to an increase of 5.7% to $1.4 billion6.6% in the thirdsecond quarter of 2016.2019.  Underlying the trend in renewal business premiums was an increase in year-over-year average premium per policy of 2.4%2.5% at SeptemberJune 30, 2017,2020 compared to 2.8%2.9% at SeptemberJune 30, 2016, and steady policy retention ratios.2019, respectively. 



Personal lines – Total personal lines premiums written increased 6.5%0.7% to $1.3$1.4 billion in the thirdsecond quarter of 2017, from $1.2 billion in2020 compared to the thirdsecond quarter of 2016,2019, driven by an increase of 3.5%1.1% in total personal lines policies in force and an increase of 3.2%1.7% in the total personal lines year-over-year average premium per policy. The impacts of the COVID-19 pandemic, including changes in consumer behavior and driving patterns, among others, impacted new personal policies written, which decreased 10.5% in the second quarter of 2020. These impacts were experienced primarily in April and May of 2020, with declines of 23.9% and 13.4%, respectively, while in June 2020 new personal policies written increased 7.0%. In the second quarter of 2019, new personal policies written decreased by 8.9%.


Commercial lines – Total commercial lines premiums written increased 4.0%decreased 0.1% to $457$579 million in the thirdsecond quarter of 2017, from $440 million in2020 compared to the thirdsecond quarter of 2016,2019, driven by a 2.7%1.2% increase in total commercial lines policies in force and a 1.6%3.3% increase in the total commercial lines year-over-year average premium per policy. New commercial business polices written decreased 24.1% in the second quarter of 2020. The significant decrease in 2020 was the result of the disruptions to businesses, including mandatory business closures, and economic conditions resulting from the COVID-19 pandemic. April and May of 2020 experienced larger declines, with new commercial business policies written decreasing 36.1% and 24.2%, respectively, while June of 2020 decreased 2.7%. In the second quarter of 2019, new commercial policies written increased 1.4%.

Future trends-premium revenueThe Exchange plans to continue its efforts to grow premiums and improve its competitive position in the marketplace.  Expanding the size of its 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 books of business.

Changes in premium levels attributable to the growth in policies in force and rate changes directly affect the profitability of the Exchange and have a direct bearing on our management fee. OurThe COVID-19 pandemic may have a negative impact on the Exchange's premiums, and therefore our management fees, given recessionary economic conditions and related declines in consumer activity and demand for certain services, as well as the potential for sustained changes in driving patterns. In response to reduced exposure given lower driving activity, and to provide financial relief to policyholders as a result of the COVID-19 pandemic, the Exchange previously announced $200 million in personal and commercial auto rate reductions that will take effect at the time of policy initiations or renewal, beginning July 1, 2020. These rate reductions will reduce the Exchange's 2020 premiums written by approximately $90 million, which will result in an estimated $23 million reduction in our 2020 management fee revenue. The remaining portion of these rate reductions will impact both the Exchange's premium written and our management fee revenue in 2021. Future premiums could also be impacted by potential regulatory changes resulting from the COVID-19 pandemic.

Through a careful agency selection process, the Exchange plans to continue its effort to expand the size of its agency force to increase market penetration in existing operating territories to contribute to future growth. While our agents initially experienced business declines resulting from disruptions created by the COVID-19 pandemic, there have been no significant disruptions in their operations. The continued focus on underwriting disciplineimpacts of the COVID-19 pandemic could make it difficult for our independent agents to write new business and retain existing business and/or constrain our ability to recruit new agents.

The extent of the maturing of pricing sophistication models has contributedimpact to the Exchange's growthpremiums and our management fee cannot be estimated with a high degree of certainty at this time given the ongoing developments related to this pandemic. See also Part II. Item 1A. "Risk Factors" contained within this report.



30

Policy issuance and renewal services
Three months ended June 30,Six months ended June 30,
(dollars in thousands)20202019% Change20202019% Change
(Unaudited)(Unaudited)
Management fee revenue - policy issuance and renewal services, net$483,795  $480,513  0.7  %$927,545  $911,496  1.8  %
Service agreement revenue6,446  6,907  (6.7) 13,108  13,599  (3.6) 
490,241  487,420  0.6  940,653  925,095  1.7  
Cost of policy issuance and renewal services413,865  405,005  2.2  793,357  770,509  3.0  
Operating income - policy issuance and renewal services$76,376  $82,415  (7.3) %$147,296  $154,586  (4.7) %


Policy issuance and renewal services
We allocate a portion of the management fee, which currently equates to 24.2% of the direct and affiliated assumed premiums written by the Exchange, for providing policy issuance and renewal services. This portion of the management fee is recognized as revenue when the policy is issued or renewed because it is at that time that the services we provide are substantially complete and the executed insurance policy is transferred to the customer. The increase in new policiesmanagement fee revenue for policy issuance and renewal services was driven by the increase in force, steady policy retention ratios,the direct and increased average premium per policy.affiliated assumed premiums written by the Exchange discussed previously.


Service agreement revenue
Service agreement revenue includes service charges we collect from subscribers/policyholders for providing extended payment terms on policies written and assumed by the Exchange, and late payment and policy reinstatement fees.  The service charges are fixed dollar amounts per billed installment.  Service agreement revenue totaled $7.3 millionThe decrease in both the third quarter of 2017 and 2016, and $21.8 million for both the nine months ended September 30, 2017 and 2016.  While policies in force continue to grow, service agreement revenue remains flat. Thisfor the three and six months ended 2020 reflects the continued shift in policies to the monthly direct debit payment plan, which doesplans that do not incur service charges and the no-fee single payment plan, which offersor offer a premium discount for certain payment methods.  The shift to these plans is driven by the consumers’ desire to avoid paying service charges and to take advantage of the discount in pricing offered for paid-in-full policies.


Cost of operationspolicy issuance and renewal services
Three months ended June 30,Six months ended June 30,
(dollars in thousands)2020
2019 (1)
% Change20202019% Change
(Unaudited)(Unaudited)
Commissions:
Total commissions$278,478  $273,256  1.9  %$530,474  $516,238  2.8  %
Non-commission expense:
Underwriting and policy processing$39,891  $40,220  (0.8) %$81,243  $78,445  3.6  %
Information technology43,155  40,847  5.7  85,313  79,994  6.7  
Sales and advertising15,770  14,193  11.1  27,245  25,202  8.1  
Customer service8,631  8,319  3.8  17,210  16,336  5.4  
Administrative and other27,940  28,170  (0.8) 51,872  54,294  (4.5) 
Total non-commission expense135,387  131,749  2.8  262,883  254,271  3.4  
Total cost of policy issuance and renewal services$413,865  $405,005  2.2  %$793,357  $770,509  3.0  %
 Three months ended September 30, Nine months ended September 30,
(in thousands)20172016% Change 20172016% Change
 (Unaudited)  (Unaudited) 
Commissions:       
Total commissions$248,677
$232,455
7.0% $720,538
$676,963
6.4 %
Non-commission expense:       
Underwriting and policy processing$36,060
$33,946
6.2% $108,115
$102,108
5.9 %
Information technology32,688
31,114
5.1
 102,850
87,714
17.3
Sales and advertising15,722
14,869
5.7
 46,375
46,872
(1.1)
Customer service7,083
5,381
31.6
 20,661
18,689
10.5
Administrative and other21,426
18,386
16.5
 61,419
48,993
25.4
Total non-commission expense112,979
103,696
9.0
 339,420
304,376
11.5
Total cost of operations$361,656
$336,151
7.6% $1,059,958
$981,339
8.0 %
(1)Three months ended June 30, 2019 amounts have been reclassified between categories to conform to the current period presentation.




Commissions – Commissions increased $16.2$5.2 million in the thirdsecond quarter of 20172020 and $43.6$14.2 million for the ninesix months ended SeptemberJune 30, 2017,2020 compared to the same respective periods in 2016. The increases were2019, primarily driven by the 5.8% and 6.0% increases in direct and assumed premiums written by the Exchange for the third quarter and nine months ended September 30, 2017, respectively. The remaining portion of the increases were due to higher agent incentive costs related to profitable growth, compared to the same respective periods in 2016.compensation. The estimated agent incentive payoutpayouts at SeptemberJune 30, 2017 is2020 are based on actual underwriting results for the two prior years and current year-to-date actual results and forecasted results for the remainder of 2017.2020. Therefore, fluctuations in the current quarter underwriting results can impact the estimated incentive payout on a quarter-to-quarter basis. The Exchange experienced a significant decrease in automobile claims frequency and related loss expense beginning in March 2020 that continued through the second quarter of 2020 driven by the impacts of the COVID-19 pandemic. If a sustained period of lower claims frequency and loss expenses occurs, our agent compensation could increase related to the profitability component of the agent incentive bonuses. While lower than historical comparative periods, the Exchange's claims frequency began to trend upward in June

31

2020. Growth in direct and affiliated assumed premiums written by the Exchange of 0.5% in the second quarter of 2020 and 1.9% for the six months ended June 30, 2020 also contributed to the increase in commission expenses compared to the same periods in 2019.

Non-commission expense – Non-commission expense increased $9.3$3.6 million in the thirdsecond quarter of 20172020 compared to the second quarter of 2019. Information technology costs increased $2.3 million driven by increases in hardware and software costs primarily to support remote work capabilities for our employees and professional fees. Sales and advertising costs increased $1.6 million primarily driven by a new program to support agent charitable giving in response to the COVID-19 pandemic. Personnel costs in all categories increased slightly as increases in salaries and wages resulting from higher vacation accruals were partially offset by lower medical expenses due to the COVID-19 pandemic.

Non-commission expense increased $8.6 million in the six months ended June 30, 2020 compared to the same period in 2016.2019. Information technology costs increased $5.3 million primarily due to increases in hardware and software costs, professional fees, and personnel costs. Underwriting and policy processing costsexpense increased $2.1$2.8 million primarily due to increases in personnel costs. Sales and advertising costs increased $2.0 million primarily driven by personnel costs and underwriting report costs. Information technology costs increased $1.6 million primarily duea new program to increased personnel costs and hardware and software costs, somewhat offset by lower professional fees. Customer service costs increased $1.7 million

primarily duesupport agent charitable giving in response to increased credit card processing fees.the COVID-19 pandemic. Administrative and other expenses increased $3.0costs decreased $2.4 million primarily driven by increased personnel costs.

Non-commission expense increased $35.0 million for the ninechange in the company stock price, which experienced a lower increase during the six months ended SeptemberJune 30, 20172020 compared to the same period in 2016. Underwriting and policy processing costs increased $6.0 million primarily due to increased2019. Increased personnel costs in all categories included higher vacation accruals as employees took less vacation in the first six months as a result of the COVID-19 pandemic.

Administrative services
Three months ended June 30,Six months ended June 30,
(dollars in thousands)20202019% Change20202019% Change
(Unaudited)(Unaudited)
Management fee revenue - administrative services, net$14,813  $14,195  4.4  %$29,584  $28,146  5.1  %
Administrative services reimbursement revenue151,965  146,095  4.0  303,519  288,575  5.2  
Total revenue allocated to administrative services166,778  160,290  4.0  333,103  316,721  5.2  
Administrative services expenses
Claims handling services131,474  127,296  3.3  263,777  251,495  4.9  
Investment management services8,353  8,402  (0.6) 17,410  17,185  1.3  
Life management services12,138  10,397  16.7  22,332  19,895  12.2  
Operating income - administrative services$14,813  $14,195  4.4  %$29,584  $28,146  5.1  %


Administrative services
We allocate a portion of the management fee, which currently equates to 0.8% of the direct and underwriting report costs. Information technology costs increased $15.1 million primarily due to increased professional fees, personnel costs and hardware and software costs. Customer service costs increased $2.0 million primarily due to increased personnel costs and credit card processing fees. Administrative and other expenses increased $12.4 million primarily driven by increased personnel costs, including higher incentive plan costs and pension expenses.  The incentive plan cost increase was drivenaffiliated assumed premiums written by the long-term incentive plan dueExchange, to the increaseadministrative services. This portion of the management fee is recognized as revenue over a four-year period representing the time over which the services are provided. We also report reimbursed costs as revenues, which are recognized monthly as services are provided. The administrative services expenses we incur and the related reimbursements we receive are recorded gross in the company stock price duringStatements of Operations.

Cost of administrative services
By virtue of its legal structure as a reciprocal insurer, the first nine monthsExchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of 2017.  Additionally, the employee incentive plan program was expandedExchange with respect to additional employee groups beginningits administrative services in 2017.accordance with the subscriber's agreement. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. The amounts incurred for these services are reimbursed to Indemnity at cost in accordance with the subscriber's agreement and the service agreements.  We record these reimbursements due from the Exchange and its insurance subsidiaries as a receivable.

32
Gross margin

The gross margin in the third quarter

Total investment income
A summary of the results of our investment operations is as follows:
Three months ended June 30,Six months ended June 30,
(dollars in thousands)20202019% Change20202019% Change
(Unaudited)(Unaudited)
Net investment income$7,373  $8,030  (8.2) %$15,742  $16,547  (4.9) %
Net realized investment gains (losses)6,526  1,302  NM(4,280) 3,805  NM
Net impairment losses recognized in earnings(17) (84) (79.1) (3,070) (162) NM
Equity in (losses) earnings of limited partnerships(2,329) 404  NM(6,034) (743) NM
Total investment income$11,553  $9,652  19.7  %$2,358  $19,447  (87.9) %
(in thousands) Three months ended September 30, Nine months ended September 30,
  2017 2016 % Change 2017 2016 % Change
  (Unaudited)    (Unaudited)   
Net investment income $5,970
 $5,331
 12.0% $18,184
 $14,884
 22.2%
Net realized investment gains 899
 718
 25.4  1,539
 29
 NM 
Net impairment losses recognized in earnings 0
 0
 0.0  (182) (345) 47.3 
Equity in earnings (losses) of limited partnerships 1,537
 (1,723) NM  1,899
 (279) NM 
Total investment income $8,406
 $4,326
 94.3% $21,440
 $14,289
 50.0%

NM = not meaningful



Net investment income
Net investment income primarily includes interest and dividends on our fixed maturity and equity security portfolios, net of investment expenses.
Net investment income increaseddecreased by $0.6$0.7 million in the thirdsecond quarter of 2017,2020 and $0.8 million for the six months ended June 30, 2020, compared to the third quarter of 2016, and increased by $3.3 million for the nine months ended September 30, 2017, compared to the nine months ended September 30, 2016.same periods in 2019. The increase in net investment income inresults from both periods waswere primarily due to an increase in thedecreased income generated from cash and cash equivalents driven by lower rates and invested balances, and yields of fixed maturity securities.somewhat offset by increased preferred stock dividends resulting from higher invested balances.


Net realized investmentsinvestment gains (losses)
A breakdown of our net realized investment gains (losses) is as follows:
Three months ended June 30,Six months ended June 30,
(in thousands)2020201920202019
Securities sold:(Unaudited)(Unaudited)
Available-for-sale securities$355  $1,239  $970  $3,157  
Equity securities(1,840)  (2,528)  
Equity securities change in fair value8,010  63  (2,724) 648  
Miscellaneous    
Net realized investment gains (losses)$6,526  $1,302  $(4,280) $3,805  
(in thousands) Three months ended September 30, Nine months ended September 30,
  2017 2016 2017 2016
Securities sold: (Unaudited) (Unaudited)
Fixed maturities $899
 $576
 $1,592
 $(644)
Equity securities 0
 0
 (145) (34)
Common stock trading securities 0
 121
 0
 707
Common stock increases in fair value(1)
 0
 21
 0
 0
Miscellaneous 0
 0
 92
 0
Net realized investment gains (2)
 $899
 $718
 $1,539
 $29



(1)The fair value of our common stocks is determined based upon exchange traded prices provided by a nationally recognized pricing service.
(2)See Part I, Item 1. "Financial Statements - Note 5, Investments, of Notes to Financial Statements" contained within this report for additional disclosures regardingMarket value adjustments of equity securities are recognized in net realized investment gains.

Net realized investment gains and(losses) in the Statements of Operations. While net realized gains of $6.5 million in the second quarter of 2020 reflected a partial financial market recovery, net realized losses include gains and losses resulting fromof $4.3 million for the salessix months ended June 30, 2020 reflect an overall decrease as a result of our fixed maturity or equity securities, as well as changesthe COVID-19 pandemic driven by the significant volatility in fair valuethe first quarter of common stocks designated as trading securities. 


2020. Net realized gains of $0.9 million during the thirdsecond quarter of 2017 reflectedand six months ended June 30, 2019 were primarily driven by gains from sales of fixed maturity securities, while net realized gains of $0.7 million during the third quarter 2016 resulted from gains on sales of fixed maturity securities and common stock. Net realized gains of $1.5 million for the nine months ended September 30, 2017 primarily reflected gains from sales of fixed maturity securities, partially offset by losses from sales of equity securities, while net realized gains for the nine months ended September 30, 2016 primarily reflected gains from the sale of common stock, partially offset by losses from sales of fixed maturityavailable-for-sale securities.


Net impairment losses recognized in earnings
There were no impairment lossesImprovements in market conditions during the thirdsecond quarter of 2017 or 2016.2020 resulted in lower impairment losses. Net impairment losses were $0.2 million and $0.3 million forrecognized on available-for-sale securities during the ninesix months ended SeptemberJune 30, 2017 and 2016, respectively. Impairments were primarily related to2020 include $2.2 million of securities in an unrealized loss position where we determined the loss was other-than-temporary based on credit factors. In 2017, impairments also included securities in an unrealized loss position that we intendedhad intent to sell prior to expected recovery of our amortized cost basis.basis and $0.7 million of credit impairment losses. The remaining impairments include the change in the current expected credit loss allowance related to our agent loans. The COVID-19 pandemic's impact on financial markets contributed to higher impairment losses on our available-for-sale securities during the first six months of 2020 compared to the same period in 2019.


Equity in (losses) earnings (losses) of limited partnerships
The components of equity in earnings of limited partnerships are as follows:
(in thousands) Three months ended September 30, Nine months ended September 30,
  2017 2016 2017 2016
  (Unaudited) (Unaudited)
Private equity $594
 $(443) $822
 $(2,240)
Mezzanine debt 387
 (120) 274
 (26)
Real estate 556
 (1,160) 803
 1,987
Total equity in earnings (losses) of limited partnerships $1,537
 $(1,723) $1,899
 $(279)
Limited partnership earnings pertain to investments in U.S.results for both the second quarter and foreign private equity, mezzanine debt, and real estate partnerships.  Valuation adjustments are recorded to reflect the changes in fair value of the underlying investments held by the limited partnerships.  These adjustments are recorded as a component of equity in earnings of limited partnerships in the Statements of Operations.

Limited partnership earnings tend to be cyclical based upon 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 Septembersix months ended June 30, 2017 reflect investment valuation changes resulting from the financial markets and the economy in the fourth quarter of 2016 and the first two quarters of 2017.

Equity in earnings of limited partnerships increased by $3.3 million in the third quarter of 2017,2020 compared to the thirdsecond quarter of 2016, and increased by $2.2 million for the ninesix months ended SeptemberJune 30, 2017, compared2019 were due primarily to increased losses in the nine months ended September 30, 2016. The increase in earnings during both periods was primarily due to higher earnings across all sectors, except for real estate for the nine months ended September 30, 2017, which decreased compared to the nine months ended September 30, 2016.private equity sector.


Financial condition of Erie Insurance Exchange
Serving in the capacity of attorney-in-fact for the Exchange, we are dependent on the growth and financial condition of the Exchange, who is our sole customer. The strength of the Exchange and its wholly owned subsidiaries is rated annually by A.M. Best Company. Higher ratings of insurance companies generally indicateCompany through assessing its financial stability and a strong ability to pay claims. The ratings are generally based upon factors relevant to policyholders and are not directed toward return to investors. The Exchange and each of its property and casualty subsidiaries are rated A+ "Superior". On July 12, 2017,, the outlook for the financial strength rating was affirmed as stable.According to A.M. Best, this second highest financial strength rating, categorywhich is assigned to those companies that in A.M. Best’s opinion, have achieved superior overall performance when compared to the standards established by A.M. Best and have a superior ability to
33

meet obligations to policyholders over the long term. On July 8, 2020, the outlook for the financial strength rating was affirmed as stable.As of December 31, 2016,2019, only approximately 11%12% of insurance groups, in which the Exchange is included, are rated A+ or higher, and the Exchange is included in that group.higher.


The financial statements of the Exchange are prepared in accordance with statutory accounting principles prescribed by the Commonwealth of Pennsylvania. Financial statements prepared under statutory accounting principles focus on the solvency of

the insurer and generally provide a more conservative approach than under GAAP.U.S. generally accepted accounting principles. Statutory direct written premiums of the Exchange and its wholly owned property and casualty subsidiaries grew 6.0%1.9% to $5.1$3.9 billion for the ninesix months ended SeptemberJune 30, 2017 from $4.8 billion for2020 compared to the ninesix months ended SeptemberJune 30, 2016.2019. These premiums, along with investment income, are the major sources of cash that support the operations of the Exchange. Policyholders’ surplus determined under statutory accounting principles was $8.4$9.4 billion at SeptemberJune 30, 2017, $7.72020, $9.5 billion at December 31, 2016,2019, and $7.6$9.0 billion at SeptemberJune 30, 2016.2019. The Exchange and its wholly owned property and casualty subsidiaries' year-over-year policy retention ratio continues to be high at 89.6%89.9% at SeptemberJune 30, 2017, and 89.8%2020, 90.0% at December 31, 20162019, and September90.2% at June 30, 2016.2019.



We have prepared our financial statements considering the financial strength of the Exchange based on its AM Best rating and strong level of surplus. We are monitoring risks related to the COVID-19 pandemic on an ongoing basis and believe that the Exchange falls within defined risk tolerances. However, see Part II. Item 1A. "Risk Factors" for possible outcomes that could impact that determination.

34

FINANCIAL CONDITION
 
The financial market conditions resulting from the COVID-19 pandemic partially recovered in the second quarter of 2020 which resulted in a favorable impact on our investment portfolio; however, we could experience further reductions in the market value of our investment portfolio as long as market conditions remain volatile in response to the developments of this pandemic and the related economic impacts.

Investments
Our investment portfolio is managed with the objective of maximizing after-tax returns on a risk-adjusted basis. The following table presents the carrying value of our investments as of: 
 
Distribution
(dollars in thousands)June 30, 2020% to totalDecember 31, 2019% to total
(Unaudited)  
Fixed maturities$804,825  83 %$730,701  82 %
Equity securities:
Preferred stock73,973   64,752   
Common stock1,416   2,381   
Limited partnerships15,463   26,775   
Agent loans (1)
65,450   67,696   
Other investments2,046   1,430   
Total investments$963,173  100 %$893,735  100 %
(1)The current portion of investments
  Carrying value at   Carrying value at  
(dollars in thousands) September 30, 2017 % to total December 31, 2016 % to total
  (Unaudited)  
  
Fixed maturities $749,266
 94% $707,341
 90%
Common stock 0
 0
 5,950
 1
Limited partnerships:        
Private equity 33,478
 4
 35,228
 5
Mezzanine debt 4,797
 1
 6,010
 1
Real estate 11,176
 1
 16,921
 3
Real estate mortgage loans (1)
 156
 0
 213
 0
Total investments $798,873
 100% $771,663
 100%
(1)    Real estate mortgageagent loans areis included with Otherprepaid expenses and other current assets in the Statements of Financial Position.

We continually review our investment portfolio to evaluate positions that might incur other-than-temporary declines in value. We record impairment write-downs 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, which includes consideration for intent to sell.  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 is included in earnings and no impairments are recorded in other comprehensive income.  For available-for-sale equity securities, a charge is recorded in the Statements of Operations for positions that have experienced other-than-temporary impairments.  (See the "Results of Operations" section contained within this report for further information.)  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 maturity portfolio that is of high quality and well diversified within each market sector.  This investment strategy also achieves a balanced maturity schedule.  Our fixed maturity portfolio is managed with the goal of achieving reasonable returns while limiting exposure to risk. Our municipal bond portfolio accounts for $262.0 million, or 35%, of the total fixed maturity portfolio at September 30, 2017.  The overall credit rating of the municipal portfolio without consideration of the underlying insurance is AA+.


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.  Net unrealized gains on fixed maturities, net of deferred taxes, amounted to $5.5totaled $9.8 million at SeptemberJune 30, 2017,2020, compared to $3.2net unrealized gains of $4.5 million at December 31, 2016.2019.


The following table presents a breakdown of the fair value of our fixed maturity portfolio by industry sector and rating: rating as of:
(in thousands)
June 30, 2020 (1)
AAAAAABBBNon- investment
grade
Fair
value
 (Unaudited)
Basic materials$ $ $3,300  $1,152  $6,948  $11,400  
Communications 8,910  8,696  8,305  16,928  42,839  
Consumer 3,256  19,773  56,455  32,864  112,348  
Diversified   1,057  497  1,554  
Energy 4,207  4,707  14,016  11,848  34,778  
Financial 1,021  59,803  100,623  10,389  171,836  
Industrial  10,182  10,271  12,490  32,943  
Structured securities (2)
126,862  174,840  24,716  8,752   335,170  
Technology 3,140  10,197  14,073  7,976  35,386  
Utilities  3,923  16,815  5,833  26,571  
Total$126,862  $195,374  $145,297  $231,519  $105,773  $804,825  
(1)Ratings are supplied by S&P, Moody’s, and Fitch.  The table is based upon the lowest rating for each security.
(2)Structured securities include residential and commercial mortgage-backed securities, collateralized debt obligations, and asset-backed securities.





35

  At September 30, 2017
(in thousands) (Unaudited)
Industry Sector AAA AA A BBB 
Non- investment
grade
 
Fair
value
Basic materials $0
 $0
 $0
 $0
 $15,558
 $15,558
Communications 0
 0
 4,018
 7,683
 24,777
 36,478
Consumer 0
 1,064
 4,651
 33,576
 48,210
 87,501
Diversified 0
 0
 0
 0
 347
 347
Energy 0
 1,006
 3,002
 12,035
 17,221
 33,264
Financial 0
 3,996
 24,981
 57,283
 17,968
 104,228
Government-municipal 105,004
 148,164
 8,798
 0
 0
 261,966
Industrial 0
 0
 7,035
 3,388
 22,671
 33,094
Structured securities(2)
 70,879
 32,202
 12,073
 5,415
 8,018
 128,587
Technology 0
 3,987
 0
 6,056
 14,814
 24,857
U.S. treasury 0
 11,834
 0
 0
 0
 11,834
Utilities 0
 0
 3,995
 4,997
 2,560
 11,552
Total $175,883
 $202,253
 $68,553
 $130,433
 $172,144
 $749,266
Equity securities
(1)
RatingsEquity securities consist of nonredeemable preferred and common stock and are supplied by S&P, Moody’s, and Fitch.  The table is based upon the lowest rating for each security.
(2)Structured securities include residential mortgage-backed securities, commercial mortgage-backed securities, collateralized debt obligations, and asset-backed securities.


Common stock
At December 31, 2016, equity securities carried at a fair value of $5.9 million classified as available-for-sale included certain exchange traded funds with underlying holdings of fixed maturity securities. These securities met the criteria of a common stock under U.S. GAAP, and were included onin the Statements of Financial Position as available-for-sale equity securities. Changeswith all changes in unrealized gains and losses on these securities were reflected in other comprehensive income.  the Statements of Operations.

The net unrealized loss on thesefollowing table presents an analysis of the fair value of our nonredeemable preferred and common stock securities net of deferred taxes, was $0.1 million at December 31, 2016. There were no holdings in these securitiesby sector as of September 30, 2017.of:

Limited partnerships
At September 30, 2017, investments in limited partnerships decreased from the investment levels at December 31, 2016.  Changes in partnership values are a function of contributions and distributions, adjusted for market value changes in the underlying investments. The decrease in limited partnership investments was primarily due to net distributions received from the partnerships. We have made no new limited partnership commitments since 2006, and the balance of limited partnership investments is expected to decline over time as additional distributions are received. The results from our limited partnerships are based upon financial statements received from our general partners, which are generally received on a quarter lag.  As a result, the market values and earnings recorded during 2017 reflect the partnership activity experienced in the fourth quarter of 2016 and the first two quarters of 2017.
(in thousands)June 30, 2020December 31, 2019
Preferred stockCommon stockPreferred stockCommon stock
(Unaudited)
Communication$2,478  $1.416  $1,052  $2,381  
Consumer2,599   508   
Energy1,035   1,881   
Financial services60,149   53,513   
Industrial  980   
Utilities7,712   6,818   
Total$73,973  $1,416  $64,752  $2,381  

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LIQUIDITY AND CAPITAL RESOURCES
 
We continue to monitor the sufficiency of our liquidity and capital resources given the potential impact of the COVID-19 pandemic. We did not see a significant impact on our sources or uses of cash in the first half of 2020. However, we may experience future reductions in our management fee revenue if the Exchange’s premium growth is constrained. Also, future disruptions in the markets could occur which may affect our liquidity position. There is potential that the funding requirements for our costs of operations will increase related to agent compensation and technology costs, among others. If our normal operating and investing cash activities were to become insufficient to meet future funding requirements, we believe we have sufficient access to liquidity through our cash position, liquid marketable securities and our $100 million line of credit that does not expire until October 2023. See broader discussions of potential risks to our operations in the Operating Overview and Part II. Item 1A. "Risk Factors" contained within this report.

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 management fee revenue and income from investments.  Cash provided from these sources is used primarily to fund the costs of our management 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, aremay be illiquid.  Volatility in these markets could limitimpair 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 sources other than the liquidation of securities.securities, even if market volatility persists throughout 2020.
 
Cash flow activities
The following table provides condensed cash flow information for the ninesix months ended SeptemberJune 30:
(in thousands) 2017 2016(in thousands)20202019
 (Unaudited)(Unaudited)(Unaudited)
Net cash provided by operating activities $120,334
 $155,551
Net cash provided by operating activities$127,282  $114,416  
Net cash used in investing activities (40,415) (96,638)
Net cash (used in) provided by investing activitiesNet cash (used in) provided by investing activities(115,423) 42,215  
Net cash used in financing activities (84,363) (101,989)Net cash used in financing activities(90,860) (84,786) 
Net decrease in cash and cash equivalents $(4,444) $(43,076)
Net (decrease) increase in cash and cash equivalentsNet (decrease) increase in cash and cash equivalents$(79,001) $71,845  
 
 
Net cash provided by operating activities was $120.3$127.3 million in the first ninesix months of 2017,2020, compared to $155.6$114.4 million in the first ninesix months of 2016.  Decreased2019. Increased cash provided by operating activities forin the first ninesix months of 20172020 was primarily due to higher commissionsan increase of $35.0 million in management fee received driven by growth in direct and bonusesaffiliated assumed premiums written by the Exchange and a decrease in income taxes paid to agents, general operating expenses paid and pension contributions,of $14.2 million driven by lower taxable income compared to the first nine monthssame period in 2019. Offsetting the increase in cash provided by operating activities was a decrease in administrative services reimbursement received of 2016. Cash$16.7 million and an increase in cash paid for agent commissions and bonuses increased $40.6of $14.0 million to $716.6 million in the first nine months of 2017 due to higher scheduled commissions driven by premium growth and higher bonus award payments resulting from profitable underwriting results. Cash paid for general operating expenses increased $34.3 million to $168.0 million in the first ninesix months of 2017 driven by higher information technology-related professional fees and hardware and software costs. We contributed $19.0 million to our pension plan in the first quarter of 2017 and an additional $20.0 million in the third quarter of 2017, compared to $17.4 million in the first quarter of 2016.  Our funding policy is generally to contribute an amount equal to the greater of the target normal cost for the plan year or the amount necessary to fund the plan to 100% plus interest to the date the contribution is made.  We are reimbursed approximately 58% of the net periodic benefit cost of the pension plans from the Exchange, which represents pension benefits for our employees performing claims and life insurance functions and their share of service department costs. Somewhat offsetting the decrease in cash provided in first nine months of 2017 was an increase in management fee revenue received, reflecting the increase in direct and assumed premiums written by the Exchange,2020 compared to the first nine months of 2016. At September 30, 2017, we recorded a net deferred tax asset of $47.6 million.  There was no deferred tax valuation allowance recorded at September 30, 2017.same period in 2019.

Net cash used in investing activities totaled $40.4was $115.4 million in the first ninesix months of 2017,2020, compared to $96.6net cash provided by investment activities of $42.2 million in the same period in 2019. In the first ninesix months of 2016. The decrease in cash used for the first nine months2019, we generated more proceeds from investment sales and maturities/calls, which were somewhat offset by higher purchases of 2017,available-for-sale securities due to portfolio rebalancing compared to the first nine months of 2016, wassame period in 2020. Fixed asset purchases increased $3.2 million over the prior year driven by more cash being generated fromincreases in technology investments, partially offset by decreases in costs related to the sales, maturities and calls of available-for-sale securities. Also impacting our future investing activities are limited partnership commitments, which totaled $16.4 million at September 30, 2017, and will be funded as required byhome office expansion. We have a commitment for the partnerships’ agreements.  Of this amount, the total remaining commitment to fund limited partnerships that invest in private equity securities was $6.6 million, mezzanine debt securities was $8.2 million and real estate activities was $1.6 million. Additionally, we have committed to incur future costs related to the construction of the building that will serve as part of our principal headquarters,headquarters. Of the total expected cost of $114 million, which is not expected to exceed $100 million and is beingwas funded primarily by the senior secured draw term loan credit facility, $100.5 million of the same amount.costs have been paid as of June 30, 2020.


Net cash used in financing activities totaled $84.4$90.9 million in the first ninesix months of 2017,2020, compared to $102.0$84.8 million in the first ninesix months of 2016.2019. The decreaseincrease in cash used was due to the scheduled draw on the senior secured draw term loan credit facility of $25 million on June 1, 2017, offset by an increase in cashdividends paid for dividends to shareholders. Dividends paid to shareholders totaled $89.9 million in the first six months of 2020 and $83.8 million in the first six months of 2019. We increased both our Class A and Class B shareholder regular quarterly dividends by 7.2% for 2017,2020, compared to 2016.2019.  There are no regulatory restrictions on the payment of dividends to our shareholders. Future financing activities willalso include the cash draws required underprincipal payments
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due annually over the

term of the senior secured draw term loan credit facility, of which $1.0 million will increasebe paid during the cash provided by financing activities by another $25 million in 2017 and $25 million in 2018, while principal payments will not commence until 2019.remainder of 2020.

No sharesThere were no repurchases of our Class A nonvoting common stock were repurchased in the first ninesix months of 20172020 and 20162019 in conjunction with our stock repurchase program. In October 2011, our Board of Directors approved a continuation of the current stock repurchase program for a total of $150 million with no time limitation.  This repurchase authority includes, and is not in addition to, any unspent amounts remaining under the prior authorization.  We had approximately $17.8 million of repurchase authority remaining under this program at SeptemberJune 30, 2017,2020, based upon trade date.


InDuring the first ninesix months of 2017,ended June 30, 2020, we purchased 26,410 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program for certain stock-based incentive plans. In January 2017,at a total cost of $4.6 million. Of this amount, we purchased 3,7851,787 shares for $0.4$0.3 million, or $111.55$165.82 per share, for stock-based awards in conjunction with our equity compensation plan,plan. We purchased 3,216 shares for which the shares were delivered to plan participants in January 2017. In February, May and August 2017, we purchased 2,662, 2,604 and 2,194 shares, respectively,$0.5 million, or $162.53 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The remaining 21,407 shares were purchased in February for $0.3at a total cost of $3.8 million, or $118.69$178.34 per share, were transferred to fund the rabbi trust in March 2017. Thefor the incentive compensation deferral plan. All shares purchased in May for $0.3 million, or $118.43 per share, were transferred todelivered as of June 30, 2020.

During the rabbi trust in May 2017. The shares purchased in August for $0.3 million, or $128.42 per share, were transferred to the rabbi trust in August 2017. Insix months ended June 2017,30, 2019, we purchased 46,884 shares for $5.7 million, or $122.40 per share, for the vesting of stock-based awards under the long-term incentive plan, which were delivered to plan participants in June 2017.

In the first nine months of 2016, we purchased11,964 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program for certain stock-based incentive plans. In May and August 2016,at a total cost of $2.0 million. Of this amount, we purchased 2,041 and 2,7133,246 shares respectively,for $0.4 million, or $132.35 per share, for stock-based awards in conjunction with our equity compensation plan. We purchased 4,465 shares for $0.9 million, or $190.59 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The remaining 4,253 shares were purchased in May for $0.2at a total cost of $0.7 million, or $94.73$175.64 per share, were transferred to fund the rabbi trust in May 2016. The shares purchased in August for $0.3 million, or $99.28 per share, were transferred to the rabbi trust in August 2016. In May and June 2016, we purchased 7,661 shares for $0.8 million, or $98.20 per share, for the vesting of stock-based awards under the long-term incentive plan, whichcompensation deferral plan. All shares were delivered to plan participants inas of June 2016.30, 2019.


Capital Outlook
We regularly prepare forecasts evaluating the current and future cash requirements for both normal and extreme risk events.events, including the current COVID-19 pandemic.  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.


Outside of our normal operating and investing cash activities, future funding requirements could be met through:
1) cash and cash equivalents, which total approximately $184.6$257.7 million at SeptemberJune 30, 2017,2020, 2) a $100 million bank revolving line of credit, and 3) liquidation of unpledged assets held in our investment portfolio, including preferred and common stock and investment grade bonds, which totaled approximately $357.9$532.3 million at SeptemberJune 30, 2017.2020.  Volatility in the financial markets could impair our ability to sell certain fixed income securities or cause such securities to sell at deep discounts.  Additionally, we have the ability to curtail or modify discretionary cash outlays such as those related to shareholder dividends and share repurchase activities.

As of SeptemberJune 30, 2017,2020, we have access to a $100 million bank revolving line of credit with a $25 million letter of credit sublimit that expires on November 3, 2020.October 30, 2023. As of SeptemberJune 30, 2017,2020, a total of $99.1 million remains available under the facility due to $0.9 million outstanding letters of credit, which reduce the availability for letters of credit to $24.1 million.  We had no borrowings outstanding on our line of credit as of SeptemberJune 30, 2017. Bonds2020. Investments with a fair value of $109.5$124.4 million were pledged as collateral on the line at SeptemberJune 30, 2017. These securities2020. The investments pledged as collateral have no trading restrictions and are reported as available-for-sale securities and cash and cash equivalents in the Statements of Financial Position.  The bank requiresbanks require compliance with certain covenants, which include leverage ratios and debt restrictions.  We were in compliance with our bank covenants at SeptemberJune 30, 2017.2020.


Off-Balance Sheet Arrangements and Contractual Obligations
On July 10, 2017, we agreed to the guaranteed maximum price terms of an agreement with our construction manager for the construction of the office building that will serve as part of our principal headquarters. The total cost of the project will not exceed $100 million, which amount is subject to change based on agreed-upon changes to the scope of work. The expected date for substantial completion of the project is January 2020.

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. As of June 30, 2020, there were no material changes to our future contractual obligations or guarantees, other thanas previously reported in our Annual Report on Form 10-K for the unused portion of the senior secured draw term loan credit facility and limited partnership investment commitments.

Surplus Note
We hold a surplus note for $25 million from EFL that is payable on demand on or afteryear ended December 31, 2018; however, no principal or interest payments may be made without prior approval by the Pennsylvania Insurance Commissioner.  Interest payments are scheduled to be paid semi-annually. For each2019.

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TRANSACTIONS/AGREEMENTS WITH RELATED PARTIES

Leased Property
On April 28, 2017, after securing approval from the Pennsylvania Insurance Department, a new home office lease was executed between the Exchange and Indemnity, which was retroactive to January 1, 2017, when the prior lease expired.  Under the new lease, rent is based on rental rates of like property in Erie, Pennsylvania and all operating expenses including utilities, cleaning, repairs, real estate taxes, property insurance and leasehold improvements will be the responsibility of the tenant (Indemnity). Under the previous lease, rents were determined considering returns on invested capital and included building operating and overhead costs.  Rent costs and related operating expenses of shared facilities are allocated between Indemnity, Exchange and EFL based upon usage or square footage occupied.


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 investment valuation and retirement benefit plans for employees.  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, 20162019 of our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 23, 2017.27, 2020.  See Part I, Item 1. "Financial Statements - Note 4,5, Fair Value, of Notes to Financial Statements" contained within this report for additional information on our valuation of investments.




ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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, interest rates, and other risk exposures for the year ended December 31, 20162019 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 23, 2017.27, 2020.


There have beenWhile there were no material changes that impactto our portfolio or reshape our periodic investment reviews of asset allocationsreported market risks during the ninesix months ended SeptemberJune 30, 2017.  2020, there were significant disruptions in the financial markets during the first quarter of 2020 that have affected prices for many securities due to increased economic uncertainty resulting from the COVID-19 pandemic. While increased economic uncertainty remains, market conditions partially recovered in the second quarter of 2020, including improved liquidity and tightening of credit spreads.

For a recent discussion of conditions surrounding our investment portfolio, see the "Operating Overview", "Results of Operations", and "Financial Condition" discussions contained in Part I, Item 2. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" contained within this report.




ITEM 4.CONTROLS AND PROCEDURES
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 ninesix months ended SeptemberJune 30, 20172020 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 1.LEGAL PROCEEDINGS

ITEM 1. LEGAL PROCEEDINGS

State Court Lawsuit Against Erie Indemnity Company
Erie Indemnity Company (“Indemnity”("Indemnity") was named as a defendant in a complaint filed on August 1, 2012 by alleged subscribers of the Erie Insurance Exchange (the “Exchange”"Exchange") in the Court of Common Pleas Civil Division of Fayette County, Pennsylvania captioned Erie Insurance Exchange, an unincorporated association, by Joseph S. Sullivan and Anita Sullivan, Patricia R. Beltz, and Jenna L. DeBord, trustees ad litem v. Erie Indemnity Co. (the "Sullivan" lawsuit).


As subsequently amended, the complaint alleges that, beginning on September 1, 1997, Indemnity retained “Service Charges”"Service Charges" (installment fees) and “Added"Added Service Charges”Charges" (late fees and policy reinstatement charges) on policies written by Exchange and its insurance subsidiaries, which allegedly should have been paid to Exchange, in the amount of approximately $308 million. In addition to their claim for monetary relief on behalf of Exchange, Plaintiffs seek an accounting of all so-called intercompany transactions between Indemnity and Exchange from 1996 to date. Plaintiffs allege that Indemnity breached its contractual, fiduciary, and equitable duties by retaining Service Charges and Added Service Charges that should have been retained by Exchange. Plaintiffs bring these same claims under three separate derivative-type theories. First, Plaintiffs purport to bring suit as members of Exchange on behalf of Exchange. Second, Plaintiffs purport to bring suit as trustees ad litem on behalf of Exchange. Third, Plaintiffs purport to bring suit on behalf of Exchange pursuant to Rule 1506 of the Pennsylvania Rules of Civil Procedure, which allows shareholders to bring suit derivatively on behalf of a corporation or similar entity.


Indemnity filed a motion in the state court in November 2012 seeking dismissal of the lawsuit. On December 19, 2013, the court granted Indemnity’s motion in part, holding that the Pennsylvania Insurance Holding Company Act “provides"provides the [Pennsylvania Insurance] Department with special competence to address the subject matter of plaintiff’s claims”claims" and referring “all issues”"all issues" in the Sullivan lawsuit to the Pennsylvania Insurance Department (the “Department”"Department") for “its"its views and any determination." The court stayed all further proceedings and reserved decision on all other grounds for dismissal raised by Indemnity. Plaintiffs sought reconsideration of the court’s order, and on January 13, 2014, the court entered a revised order affirming its prior order and clarifying that the Department “shall"shall decide any and all issues within its jurisdiction." On January 30, 2014, Plaintiffs asked the court to certify its order to permit an immediate appeal to the Superior Court of Pennsylvania and to stay any proceedings in the Department pending completion of any appeal. On February 18, 2014, the court issued an order denying Plaintiffs’ motion. On March 20, 2014, Plaintiffs filed a petition for review with the Superior Court, which was denied by the Superior Court on May 5, 2014.


The Sullivan matter was assigned to an Administrative Judge within the Department for determination. The parties agreed that an evidentiary hearing was not required, entered into a stipulated record, and submitted briefing to the Department. Oral argument was held before the Administrative Judge on January 6, 2015. On April 29, 2015, the Department issued a declaratory opinion and order: (1) finding that the transactions between Exchange and Indemnity in which Indemnity retained or received revenue from installment and other service charges from Exchange subscribers complied with applicable insurance laws and regulations and that Indemnity properly retained charges paid by Exchange policyholders for certain installment premium payment plans, dishonored payments, policy cancellations, and policy reinstatements; and (2) returning jurisdiction over the matter to the Fayette County Court of Common Pleas.


On May 26, 2015, Plaintiffs appealed the Department’s decision to the Pennsylvania Commonwealth Court. Oral argument was held before the Commonwealth Court en banc on December 9, 2015. On January 27, 2016, the Commonwealth Court issued an opinion vacating the Department’s ruling and directing the Department to return the case to the Court of Common Pleas, essentially holding that the primary jurisdiction referral of the trial court was improper at this time because the allegations of the complaint do not implicate the special competency of the Department.


On February 26, 2016, Indemnity filed a petition for allowance of appeal to the Pennsylvania Supreme Court seeking further review of the Commonwealth Court opinion. On March 14, 2016, Plaintiffs filed an answer opposing Indemnity’s petition for allowance of appeal; and, on March 28, 2016, Indemnity sought permission to file a reply brief in further support of its petition for allowance of appeal. On August 10, 2016, the Pennsylvania Supreme Court denied Indemnity’s petition for allowance of appeal; and the Sullivan lawsuit returned to the Court of Common Pleas of Fayette County.


On September 12, 2016, Plaintiffs filed a motion to stay the Sullivan lawsuit pending the outcome of the Federal Court Lawsuit they filed against Indemnity and former and current Directors of Indemnity on July 8, 2016. (See below.) Indemnity filed an opposition to Plaintiff’s motion to stay on September 19, 2016; and filed amended preliminary objections seeking dismissal of the Sullivan lawsuit on September 20, 2016. The motion to stay and the amended preliminary objections remain pending. On June 27, 2018, Plaintiffs filed a motion for a status conference in the Sullivan lawsuit.

40


On July 30, 2018, the Court held a status conference and thereafter lifted the stay of proceedings. On September 28, 2018, Indemnity filed a Motion to Enforce the Federal Judgment in the Beltz II lawsuit, seeking dismissal of the Sullivan lawsuit with prejudice. On October 26, 2018, Plaintiffs filed an opposition to that Motion; and Indemnity filed a reply in further support on November 5, 2018. Oral argument was held on Indemnity’s Motion to Enforce the Federal Judgment on November 20, 2018 and on July 30, 2019. The Motion to Enforce the Federal Judgment remains pending.

Indemnity believes that it continues to have meritorious legal and factual defenses to the Sullivan lawsuit and intends to vigorously defend against all allegations and requests for relief.


Federal Court Lawsuit Against Erie Indemnity Company and Directors
On February 6, 2013, a lawsuit was filed in the United States District Court for the Western District of Pennsylvania, captioned Erie Insurance Exchange, an unincorporated association, by members Patricia R. Beltz, Joseph S. Sullivan and Anita Sullivan, and Patricia R. Beltz, on behalf of herself and others similarly situate v. Richard L. Stover; J. Ralph Borneman, Jr.; Terrence W. Cavanaugh; Jonathan Hirt Hagen; Susan Hirt Hagen; Thomas B. Hagen; C. Scott Hartz; Claude C. Lilly, III; Lucian L. Morrison; Thomas W. Palmer; Martin P. Sheffield; Elizabeth H. Vorsheck; and Robert C. Wilburn (the Beltz"Beltz" lawsuit), by alleged policyholders of Exchange who are also the plaintiffs in the Sullivan lawsuit. The individuals named as defendants in the Beltz lawsuit were the then-current Directors of Indemnity.


As subsequently amended, the Beltz lawsuit asserts many of the same allegations and claims for monetary relief as in the Sullivan lawsuit. Plaintiffs purport to sue on behalf of all policyholders of Exchange, or, alternatively, on behalf of Exchange itself. Indemnity filed a motion to intervene as a Party Defendant in the Beltz lawsuit in July 2013, and the Directors filed a motion to dismiss the lawsuit in August 2013. On February 10, 2014, the court entered an order granting Indemnity’s motion to intervene and permitting Indemnity to join the Directors’ motion to dismiss; granting in part the Directors’ motion to dismiss; referring the matter to the Department to decide any and all issues within its jurisdiction; denying all other relief sought in the Directors’ motion as moot; and dismissing the case without prejudice. To avoid duplicative proceedings and expedite the Department’s review, the Parties stipulated that only the Sullivan action would proceed before the Department and any final and non-appealable determinations made by the Department in the Sullivan action will be applied to the Beltz action.


On March 7, 2014, Plaintiffs filed a notice of appeal to the United States Court of Appeals for the Third Circuit. Indemnity filed a motion to dismiss the appeal on March 26, 2014. On November 17, 2014, the Third Circuit deferred ruling on Indemnity’s motion to dismiss the appeal and instructed the parties to address that motion, as well as the merits of Plaintiffs’ appeal, in the parties’ briefing. Briefing was completed on April 2, 2015. In light of the Department’s April 29, 2015 decision in Sullivan, the Parties then jointly requested that the Beltz appeal be voluntarily dismissed as moot on June 5, 2015. The Third Circuit did not rule on the Parties’ request for dismissal and instead held oral argument as scheduled on June 8, 2015. On July 16, 2015, the Third Circuit issued an opinion and judgment dismissing the appeal. The Third Circuit found that it lacked appellate jurisdiction over the appeal, because the District Court’s February 10, 2014 order referring the matter to the Department was not a final, appealable order.


On July 8, 2016, the Beltz plaintiffs filed a new action labeled as a “Verified"Verified Derivative And Class Action Complaint”Complaint" in the United States District Court for the Western District of Pennsylvania. The action is captioned Patricia R. Beltz, Joseph S. Sullivan, and Anita Sullivan, individually and on behalf of all others similarly situated, and derivatively on behalf of Nominal Defendant Erie Insurance Exchange v. Erie Indemnity Company; Kaj Ahlmann; John T. Baily; Samuel P. Black, III; J. Ralph Borneman, Jr.; Terrence W. Cavanaugh; Wilson C. Cooney; LuAnn Datesh; Patricia A. Goldman; Jonathan Hirt Hagen; Thomas B. Hagen; C. Scott Hartz; Samuel P. Katz; Gwendolyn King; Claude C. Lilly, III; Martin J. Lippert; George R. Lucore; Jeffrey A. Ludrof; Edmund J. Mehl; Henry N. Nassau; Thomas W. Palmer; Martin P. Sheffield; Seth E. Schofield; Richard L. Stover; Jan R. Van Gorder; Elizabeth A. Hirt Vorsheck; Harry H. Weil; and Robert C. Wilburn (the "Beltz IIII" lawsuit). The individual defendants are all present or former Directors of Indemnity (the “Directors”"Directors").


The allegations of the Beltz II lawsuit arise from the same fundamental, underlying claims as the Sullivan and prior Beltz litigation, i.e., that Indemnity improperly retained Service Charges and Added Service Charges. The Beltz II lawsuit alleges that the retention of the Service Charges and Added Service Charges was improper because, for among other reasons, that retention constituted a breach of the Subscriber’s Agreement and an Implied Covenant of Good Faith and Fair Dealing by Indemnity, breaches of fiduciary duty by Indemnity and the other defendants, conversion by Indemnity, and unjust enrichment by defendants Jonathan Hirt Hagen, Thomas B. Hagen, and Elizabeth A. Hirt Vorsheck, and Samuel P. Black, III, at the expense of Exchange. The Beltz II lawsuit requests, among other things, that a judgment be entered against the Defendants certifying the action as a class action pursuant to Rule 23 of the Federal Rules of Civil Procedure; declaring Plaintiffs as representatives of the Class and Plaintiffs’ counsel as counsel for the Class; declaring the conduct alleged as unlawful, including, but not limited to, Defendants’ retention of the Service Charges and Added Service Charges; enjoining Defendants from continuing to retain the Service Charges and Added Service Charges; and awarding compensatory and punitive damages and interest.

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On September 23, 2016, Indemnity filed a motion to dismiss the Beltz II lawsuit. On September 30, 2016, the Directors filed their own motions to dismiss the Beltz II lawsuit. On July 17, 2017, the Court granted Indemnity’s and the Directors’ motions to dismiss the Beltz II lawsuit, dismissing the case in its entirety. The Court ruled that “the"the Subscriber’s Agreement does not govern the separate and additional charges at issue in the Complaint”Complaint" and, therefore, dismissed the breach of contract claim against Indemnity for failure to state a claim. The Court also ruled that the remaining claims, including the claims for breach of

fiduciary duty against Indemnity and the Directors, are barred by the applicable statutes of limitation or fail to state legally cognizable claims. On August 14, 2017, Plaintiffs filed a notice of appeal to the United States Court of Appeals for the Third Circuit.


Indemnity believes it has meritorious legal and factual defenses and intends to vigorously defend against all allegations and requestsOn May 10, 2018, the United States Court of Appeals for relief in the Third Circuit affirmed the District Court’s dismissal of the Beltz II lawsuit. On May 24, 2018, Plaintiffs filed a petition seeking rehearing of their appeal before the Third Circuit. The Directors have advised IndemnityThird Circuit denied that they intend to vigorously defend against the claims in the Beltz II lawsuit and have sought indemnification and advancement of expenses from the Company in connection with the Beltz II lawsuit.petition on June 14, 2018.


For additional information on contingencies, see Part I, Item 1. "Financial Statements - Note 13,14, Commitments and Contingencies, of Notes to Financial Statements".

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ITEM 1A.RISK FACTORS
ITEM 1A. RISK FACTORS
 
There have been no material changes fromOur business involves various risks and uncertainties, including, but not limited to those discussed in this section. The risks and uncertainties described in the risk factors previously disclosedbelow, or any additional risk outside of those discussed below, could have a material adverse effect on our business, financial condition, operating results, cash flows, or liquidity if they were to develop into actual events. This information should be considered carefully together with the other information contained in this report and in other reports and materials we file periodically with the Securities and Exchange Commission ("SEC").

The risk factors listed below should be read in conjunction with the risk factors included in our Annual Report on Form 10-K for the fiscal year ended December 31, 20162019 as filed with the SecuritiesSEC on February 27, 2020. These risk factors address risks specific to the COVID-19 pandemic and related economic conditions. While we believe the risk factors in our Form 10-K filed with the SEC on February 27, 2020 generally address the risks of a pandemic on our business, we have included these disclosures to provide additional details specific to the COVID-19 pandemic.

Serving as the attorney-in-fact in the reciprocal insurance exchange structure results in the Exchange Commissionbeing our sole customer. We have an interest in the growth and financial condition of the Exchange as our earnings are largely generated from management fees based on February 23, 2017.the direct and affiliated assumed premiums written by the Exchange. If the impacts of the COVID-19 pandemic impair the Exchange’s ability to grow or its financial condition, it could have a material adverse effect on our business, financial condition, results of operations, or cash flows.



On March 11, 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic. The significant volatility in the financial markets, economic disruption and uncertainty resulting from the COVID-19 pandemic that began in the first quarter of 2020 continues to evolve and the pandemic’s ultimate impact and duration remain highly uncertain at this time. Efforts to contain the spread of the virus included the closure of nonessential businesses and stay at home orders. The resulting effects, including a decline in consumer activity, lower demand for certain services, high unemployment, and payroll declines may cause customers to modify coverages, not renew or cancel policies, which may have a negative impact on the Exchange’s written premiums, and therefore our management fees. While certain coverage modifications were experienced in the first half of 2020, primarily related to reduced usage/mileage in the private passenger automobile line of business, the modifications did not result in a material impact to the Exchange’s written premiums, however, the extent and duration of the effects on future customer demand and buying practices remains uncertain. A specific action taken by the Exchange both in response to changes in exposure as less driving occurs and to provide financial relief to the policyholders will result in a certain reduction to Exchange written premiums. In a Form 8-K filed with the SEC on April 9, 2020, the Exchange and its subsidiaries announced an estimated $200 million in personal and commercial auto rate reductions effective beginning July 1, 2020 at the time of new policy issuance or policy renewal. The estimated impact of these rate reductions on 2020 premiums written by the Exchange is a reduction of approximately $90 million, which will result in an estimated $23 million reduction in our management fee revenue. The remaining reduction will impact both the Exchanges’ written premium and our management fee revenue in 2021. An additional action taken by the Exchange that does not impact Indemnity was the announcement of a policyholder dividend to be paid directly to personal and commercial auto policyholders equal to approximately 30% of their premium for two months. Longer term, there could be sustained changes in driving patterns if working remotely becomes more common and accepted, potentially having a negative impact on premium revenues.

The Exchange is represented by independent agencies that serve as its sole distribution channel. The economic impact of the pandemic on independent agents’ business operations or systems capabilities could make it difficult for independent agents to write new business and retain existing business and/or constrain the ability to recruit new agents, thereby impeding premium growth. Additionally, if independent agents are not able to work remotely or are affected by an outbreak of the virus, this could adversely impact their operations and their ability to write new business and provide service to existing policyholders. More broadly, independent agents may face challenges sustaining their own business operations and financial conditions as small businesses faced with deteriorating economic conditions that could result in business closure thereby reducing the agency force of the Exchange. Further, the COVID-19 pandemic could be an accelerant to shifting consumer behaviors toward increased digital interactions.

The unknown risks related to the COVID-19 pandemic may cause additional uncertainty in the process of estimating loss and loss adjustment expense reserves. For example, the behavior of claimants and policyholders may change in unexpected ways, the disruption to the court system may impact the timing and amounts of claims settlements, and the actions taken by governmental bodies, both legislative and regulatory, in reaction to COVID-19 and their related impacts are hard to predict. As a result, the Exchange's estimated level of loss and loss adjustment expense reserves may change.

The Exchange’s financial condition could be impacted by delays in collecting premiums from customers due to economic hardships. Potential regulatory actions including temporary suspension of policy cancellations for the nonpayment of premiums
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and relaxing due dates for premium payments could also have a negative impact to the Exchange. If there were legislative action to retroactively mandate coverage irrespective of terms, exclusions or other conditions included in business interruption policies that would otherwise preclude coverage, this would have a significant impact on the financial condition, results of operations and cash flows of the Exchange.

The Exchange and its subsidiaries have been named as defendants in a number of pandemic-related lawsuits and, therefore, are subject to the risks and uncertainties of such litigation. There is also a risk that the Exchange could suffer reputational harm if any actions taken are not viewed as sufficient responses to the pandemic by customers or consumer organizations.

While the Exchange’s investment portfolio was negatively impacted by the significant disruption to financial markets in the first quarter of 2020 as a result of the COVID-19 pandemic, market conditions partially recovered in the second quarter of 2020. The value of the Exchange’s invested assets could be adversely impacted and there is potential for further impairments on its investment portfolio as long as market conditions remain volatile in response to the developments of this pandemic and the related economic impacts.

The duration and extent of the impact on the Exchange’s business, financial condition, results of operations and cash flows cannot be estimated with a high degree of certainty at this time given the ongoing developments of this pandemic and the related impacts on the economy and financial markets.

The effect of the COVID-19 pandemic on our operations, the business operations of our customers and/or independent agents, or our third-party vendor operations, could have a material adverse effect on our business, financial condition, results of operations, or cash flows.

If the COVID-19 pandemic results in conditions that constrain the Exchange’s ability to grow its written premiums, our management fee revenue could be negatively impacted. We expect that certain expenses within our cost of operations will increase as a result of the pandemic, including but not limited to agent compensation, technology costs, and potentially healthcare costs, among others. Our agent incentive bonuses include a profitability component. If claims frequency and loss expenses continue to decline, the profitability component of our agent incentive bonuses will continue to improve, increasing our agent compensation costs. Technology costs may increase as a result of supporting remote work capabilities for our employees. There is a potential for increased healthcare costs for treatments of the COVID-19 virus if a significant number of our employees and/or their dependents were to become infected. Also, future pension costs could increase as a result of a lower discount rate or investment returns related to the adverse market conditions caused by the COVID-19 pandemic.

Our business continuity plans were implemented upon the outbreak of this pandemic, including transitioning the vast majority of our employees and third-party contractors to remote work capabilities. We have had no significant interruption to our core business processes or systems to date. We have processes in place with our critical third-party vendors to understand impacts on their business and their business continuity plans. We have had no significant interruption to any third-party vendor business processes or systems to date. No significant challenges have been identified in our, or our third-party vendor’s ongoing business continuity plans, however if future challenges were to arise, this could result in an adverse effect on our business, financial condition, results of operations or cash flows. Also, while we have not experienced any delays in internal initiatives to date, future challenges could arise that impact the timing and execution of certain initiatives. Having shifted to remote working arrangements, we also face a heightened risk of cybersecurity attacks or data security incidents and are more dependent on internet and telecommunications access and capabilities. If we experience difficulties with technology, data and network security, outsourcing relationships or cloud-based technology, our ability to conduct our business could be negatively impacted.

Indemnity’s workforce providing services for the Exchange are largely concentrated in Erie, Pennsylvania. If a significant outbreak affects the labor force in this area, or if a significant operating function had a high level of infections at one time, it could impact the policy acquisition, underwriting, claims and/or support services provided to the policyholders of the Exchange and/or our independent agents.

With the increasing number of COVID-19 related disputes, there is a risk that Indemnity could become subject to pandemic related litigation. It is also possible that changes in economic conditions and steps taken by federal, state and local governments in response to COVID-19 could require an increase in taxes at the federal, state and local levels, which would adversely impact our results of operations.

While Indemnity’s investment portfolio was negatively impacted by the significant disruption to financial markets in the first quarter of 2020 as a result of the COVID-19 pandemic, market conditions partially recovered in the second quarter of 2020. The value of our invested assets could be adversely impacted and there is potential for further impairments in our investment
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portfolio as long as market conditions remain volatile in response to the developments of this pandemic and the related economic impacts.

The duration and extent of the impact on our business, financial condition, results of operations and cash flows cannot be estimated with a high degree of certainty at this time given the ongoing developments of this pandemic and the related impacts on the economy and financial markets.


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

Issuer Purchases of Equity Securities
In October 2011,, our Board of Directors approved a continuation of the current stock repurchase program, authorizing repurchases for a total of $150$150 million with no time limitation.  This repurchase authority included, and was not in addition to, any unspent amounts remaining under the prior authorization. There were no repurchases of our Class A common stock under this program during the quartersix months ending SeptemberJune 30, 2017.2020. We had approximately $17.8 million of repurchase authority remaining under this program at SeptemberJune 30, 2017.2020.


During the quarter ending SeptemberJune 30, 2017,2020, we purchased 2,19419,456 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $3.6 million. We purchased 45 shares for $8 thousand, or $172.12 per share, in May 2020 and 17,818 shares for $3.3 million, or $184.42 per share, in June 2020 to fund the rabbi trust for the incentive compensation deferral plan. The shares were transferred to the rabbi trust in May and June 2020. The remaining 1,593 shares were purchased in May 2020 at a total cost of $0.3 million, or $128.42$172.12 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. TheseThe shares were transferred to the rabbi trust in August 2017.May 2020.

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ITEM 6. EXHIBITS
ITEM 6.ExhibitEXHIBITS

NumberDescription of Exhibit
Exhibit
Number31.1*Description of Exhibit
10.1*
10.2*
31.1*
31.2*
32*
101.INS*Inline XBRL Instance Document.Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH*Inline XBRL Taxonomy Extension Schema Document.
101.CAL*Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF*Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB*Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE*Inline XBRL Taxonomy Extension Presentation Linkbase Document.
104*Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).



* Filed herewith.



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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:October 26, 2017July 30, 2020By:/s/ Timothy G. NeCastro
Timothy G. NeCastro, President & CEO
By:/s/ Gregory J. Gutting
Gregory J. Gutting, Executive Vice President & CFO

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