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) | | 2020 | | 2019 | | 2020 | | 2019 |
| Service cost for benefits earned | | $ | 10,874 | | | $ | 8,464 | | | $ | 21,747 | | | $ | 16,927 | |
| Interest cost on benefits obligation | | 9,394 | | | 9,826 | | | 18,789 | | | 19,653 | |
| Expected return on plan assets | | (12,353) | | | (11,871) | | | (24,706) | | | (23,742) | |
| Prior service cost amortization | | 335 | | | 348 | | | 671 | | | 697 | |
| Net actuarial loss amortization | | 3,031 | | | 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) | 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.
During the nine months ended September 30, 2017, we purchased 58,129 shares
Table of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $7.0 million. Of this amount, we purchased 3,785 shares for $0.4 million, or $111.55 per share, for stock-based awards in conjunction with our equity compensation plan. We purchased 7,460 shares for $0.9 million, or $121.46 per share, to fund the rabbi trust for the outside director deferred compensation plan. The remaining 46,884 shares were purchased at a total cost of $5.7 million, or $122.40 per share, for the vesting of stock-based awards in the long-term incentive plan.Contents
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 ended | | | Three months ended | |
| | | | | | | | | | | | | | | | | | June 30, 2020 | | | June 30, 2019 | |
| (in thousands) | | Three months ended | | Three months ended | (in thousands) | | Before Tax | Income Tax | Net | | Before Tax | Income Tax | Net |
| Investment securities: | | Investment securities: | | | | |
AOCI (loss), beginning of period (1) | | AOCI (loss), beginning of period (1) | | $ | (27,761) | | $ | 0 | | $ | (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 gains | | Realized investment gains | | (355) | | (75) | | (280) | | | (1,239) | | (260) | | (979) | |
| Impairment losses | | Impairment losses | | 17 | | 4 | | 13 | | | 84 | | 18 | | 66 | |
| | | September 30, 2017 | | September 30, 2016 | |
| OCI | | OCI | | 40,026 | | 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 period | | AOCI (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 costs | | Amortization of prior service costs | | 336 | | 70 | | 266 | | | 348 | | 73 | | 275 | |
| Amortization of net actuarial loss | | Amortization of net actuarial loss | | 3,031 | | 637 | | 2,394 | | | 1,210 | | 254 | | 956 | |
| OCI | | OCI | | 3,367 | | 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 securities | | 40,026 | | 2,575 | | 37,451 | | | 3,265 | | 686 | | 2,579 | |
| Pension and other postretirement plans | | 0 |
| 0 |
| 0 |
| | 0 |
| 0 |
| 0 |
| Pension and other postretirement plans | | 3,367 | | 707 | | 2,660 | | | 1,558 | | 327 | | 1,231 | |
| OCI (loss) | | (256 | ) | (89 | ) | (167 | ) | | 545 |
| 190 |
| 355 |
| |
| OCI | | OCI | | 43,393 | | 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 ended | | | Six months ended | |
| | | June 30, 2020 | | | June 30, 2019 | |
| (in thousands) | | (in thousands) | | Before Tax | Income Tax | Net | | Before Tax | Income Tax | Net |
| Investment securities: | | Investment securities: | | | | |
| AOCI (loss), beginning of period | | AOCI (loss), beginning of period | | $ | 5,664 | | $ | 1,189 | | $ | 4,475 | | | $ | (9,169) | | $ | (1,926) | | $ | (7,243) | |
| OCI before reclassifications | | OCI before reclassifications | | 4,671 | | 981 | | 3,690 | | | 13,194 | | 2,771 | | 10,423 | |
| Realized investment gains | | Realized investment gains | | (970) | | (204) | | (766) | | | (3,157) | | (663) | | (2,494) | |
| Impairment losses | | Impairment losses | | 2,900 | | 609 | | 2,291 | | | 162 | | 34 | | 128 | |
| | OCI | | OCI | | 6,601 | | 1,386 | | 5,215 | | | 10,199 | | 2,142 | | 8,057 | |
| AOCI (loss), end of period | | AOCI (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 period | | AOCI (loss), beginning of period | | $ | (153,600) | | $ | (32,257) | | $ | (121,343) | | | $ | (155,749) | | $ | (32,708) | | $ | (123,041) | |
| | Amortization of prior service costs | | Amortization of prior service costs | | 672 | | 141 | | 531 | | | 697 | | 146 | | 551 | |
| Amortization of net actuarial loss | | Amortization of net actuarial loss | | 6,062 | | 1,273 | | 4,789 | | | 2,420 | | 508 | | 1,912 | |
| OCI | | OCI | | 6,734 | | 1,414 | | 5,320 | | | 3,117 | | 654 | | 2,463 | |
| AOCI (loss), end of period | | AOCI (loss), end of period | | $ | (146,866) | | $ | (30,843) | | $ | (116,023) | | | $ | (152,632) | | $ | (32,054) | | $ | (120,578) | |
| | | | | | |
| Total | | Total | |
| AOCI (loss), beginning of period | | AOCI (loss), beginning of period | | $ | (147,936) | | $ | (31,068) | | $ | (116,868) | | | $ | (164,918) | | $ | (34,634) | | $ | (130,284) | |
| Investment securities | | Investment securities | | 6,601 | | 1,386 | | 5,215 | | | 10,199 | | 2,142 | | 8,057 | |
| Pension and other postretirement plans | | Pension and other postretirement plans | | 6,734 | | 1,414 | | 5,320 | | | 3,117 | | 654 | | 2,463 | |
| OCI | | OCI | | 13,335 | | 2,800 | | 10,535 | | | 13,316 | | 2,796 | | 10,520 | |
| AOCI (loss), end of period | | AOCI (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.
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.
| |
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;
•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.
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.
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) | | 2020 | | 2019 | | % Change | | | 2020 | | 2019 | | % 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 income | | 11,553 | | | 9,652 | | | 19.7 | | | 2,358 | | | 19,447 | | | (87.9) | | |
| Interest expense, net | | 377 |
| | — |
| | NM |
| | 800 |
| | — |
| | NM |
| | Interest expense, net | | 2 | | | 272 | | | NM | | 5 | | | 721 | | | NM | |
| Other (expense) income | | Other (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 taxes | | 102,482 | | | 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 expense | | 20,505 | | | 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 – diluted | | Net 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
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) | 2017 | 2016 | % Change | | 2017 | 2016 | % Change |
| | (Unaudited) | | | | (Unaudited) | | |
| Management fee revenue, net | $ | 435,214 |
| $ | 411,139 |
| 5.9 |
| % | | $ | 1,268,591 |
| $ | 1,195,262 |
| 6.1 |
| % |
| Service agreement revenue | 7,278 |
| 7,267 |
| 0.2 |
| | | 21,781 |
| 21,756 |
| 0.1 |
| |
| 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 | ) | % |
| Gross margin | 18.3 | % | 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) | 2020 | 2019 | % Change | | | 2020 | 2019 | % 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 rate | 24.2 | % | 24.2 | % | | | | 24.2 | % | 24.2 | % | | |
| Management fee revenue | 484,666 | | 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 rate | 0.8 | % | 0.8 | % | | | | 0.8 | % | 0.8 | % | | |
| Management fee revenue | 16,022 | | 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, net | 14,813 | | 14,195 | | 4.4 | | | | 29,584 | | 28,146 | | 5.1 | | |
| Administrative services reimbursement revenue | 151,965 | | 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) | 2017 | 2016 | % Change | | 2017 | 2016 | % 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 rate | 25 | % | 25 | % | | | | 25 | % | 25 | % | | |
| Management fee revenue, gross | 434,914 |
| 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.
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 revenue – The 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.
Policy issuance and renewal services
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended June 30, | | | | | Six months ended June 30, | | | |
| (dollars in thousands) | 2020 | 2019 | % Change | | | 2020 | 2019 | % 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 revenue | 6,446 | | 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 services | 413,865 | | 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) | % Change | | | 2020 | 2019 | % 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 technology | 43,155 | | 40,847 | | 5.7 | | | | 85,313 | | 79,994 | | 6.7 | | |
| Sales and advertising | 15,770 | | 14,193 | | 11.1 | | | | 27,245 | | 25,202 | | 8.1 | | |
| Customer service | 8,631 | | 8,319 | | 3.8 | | | | 17,210 | | 16,336 | | 5.4 | | |
| Administrative and other | 27,940 | | 28,170 | | (0.8) | | | | 51,872 | | 54,294 | | (4.5) | | |
| Total non-commission expense | 135,387 | | 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) | 2017 | 2016 | % Change | | 2017 | 2016 | % 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 technology | 32,688 |
| 31,114 |
| 5.1 |
| | 102,850 |
| 87,714 |
| 17.3 |
|
| Sales and advertising | 15,722 |
| 14,869 |
| 5.7 |
| | 46,375 |
| 46,872 |
| (1.1 | ) |
| Customer service | 7,083 |
| 5,381 |
| 31.6 |
| | 20,661 |
| 18,689 |
| 10.5 |
|
| Administrative and other | 21,426 |
| 18,386 |
| 16.5 |
| | 61,419 |
| 48,993 |
| 25.4 |
|
| Total non-commission expense | 112,979 |
| 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 | % |
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
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) | 2020 | 2019 | % Change | | | 2020 | 2019 | % Change | |
| (Unaudited) | | | | | (Unaudited) | | | |
| Management fee revenue - administrative services, net | $ | 14,813 | | $ | 14,195 | | 4.4 | | % | | $ | 29,584 | | $ | 28,146 | | 5.1 | | % |
| Administrative services reimbursement revenue | 151,965 | | 146,095 | | 4.0 | | | | 303,519 | | 288,575 | | 5.2 | | |
| Total revenue allocated to administrative services | 166,778 | | 160,290 | | 4.0 | | | | 333,103 | | 316,721 | | 5.2 | | |
| Administrative services expenses | | | | | | | | | |
| Claims handling services | 131,474 | | 127,296 | | 3.3 | | | | 263,777 | | 251,495 | | 4.9 | | |
| Investment management services | 8,353 | | 8,402 | | (0.6) | | | | 17,410 | | 17,185 | | 1.3 | | |
| Life management services | 12,138 | | 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.
Gross margin
The gross margin in the third quarter
Total investment income
A summary of the results of our investment operations is as follows:
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| | Three months ended June 30, | | | | | | | | | | | | Six months ended June 30, | | | | | |
| (dollars in thousands) | | 2020 | 2019 | | % Change | | | | | | | | | 2020 | | 2019 | | % 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) | | % |
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| (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:
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| | | | | | | | | | | | |
| | Three months ended June 30, | | | | Six months ended June 30, | | | | | | |
| (in thousands) | | 2020 | | 2019 | | 2020 | | 2019 | | | | |
| | | | | | | | | | | | |
| Securities sold: | | (Unaudited) | | | | (Unaudited) | | | | | | |
| Available-for-sale securities | | $ | 355 | | | $ | 1,239 | | | $ | 970 | | | $ | 3,157 | | | | | |
| Equity securities | | (1,840) | | | 0 | | | (2,528) | | | 0 | | | | | |
| | | | | | | | | | | | |
| Equity securities change in fair value | | 8,010 | | | 63 | | | (2,724) | | | 648 | | | | | |
| Miscellaneous | | 1 | | | 0 | | | 2 | | | 0 | | | | | |
| Net realized investment gains (losses) | | $ | 6,526 | | | $ | 1,302 | | | $ | (4,280) | | | $ | 3,805 | | | | | |
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| (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:
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| (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
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.
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 | | | | | | | | | | | | | | | | | | | | | | | | | | |
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| | | | | | | | |
| (dollars in thousands) | | June 30, 2020 | | % to total | | December 31, 2019 | | % to total |
| | (Unaudited) | | | | | | |
| Fixed maturities | | $ | 804,825 | | | 83 | % | | $ | 730,701 | | | 82 | % |
| | | | | | | | |
| Equity securities: | | | | | | | | |
| | | | | | | | |
| Preferred stock | | 73,973 | | | 8 | | | 64,752 | | | 7 | |
| Common stock | | 1,416 | | | 0 | | | 2,381 | | | 0 | |
| Limited partnerships | | 15,463 | | | 2 | | | 26,775 | | | 3 | |
Agent loans (1) | | 65,450 | | | 7 | | | 67,696 | | | 8 | |
| Other investments | | 2,046 | | | 0 | | | 1,430 | | | 0 | |
| Total investments | | $ | 963,173 | | | 100 | % | | $ | 893,735 | | | 100 | % |
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(1)The current portion of investments
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| | | 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:
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| (in thousands) | | June 30, 2020 (1) | | | | | | | | | | |
| | AAA | | AA | | A | | BBB | | Non- investment
grade | | Fair
value |
| | (Unaudited) | | | | | | | | | | |
| Basic materials | | $ | 0 | | | $ | 0 | | | $ | 3,300 | | | $ | 1,152 | | | $ | 6,948 | | | $ | 11,400 | |
| Communications | | 0 | | | 8,910 | | | 8,696 | | | 8,305 | | | 16,928 | | | 42,839 | |
| Consumer | | 0 | | | 3,256 | | | 19,773 | | | 56,455 | | | 32,864 | | | 112,348 | |
| Diversified | | 0 | | | 0 | | | 0 | | | 1,057 | | | 497 | | | 1,554 | |
| Energy | | 0 | | | 4,207 | | | 4,707 | | | 14,016 | | | 11,848 | | | 34,778 | |
| Financial | | 0 | | | 1,021 | | | 59,803 | | | 100,623 | | | 10,389 | | | 171,836 | |
| | | | | | | | | | | | |
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| Industrial | | 0 | | | 0 | | | 10,182 | | | 10,271 | | | 12,490 | | | 32,943 | |
Structured securities (2) | | 126,862 | | | 174,840 | | | 24,716 | | | 8,752 | | | 0 | | | 335,170 | |
| Technology | | 0 | | | 3,140 | | | 10,197 | | | 14,073 | | | 7,976 | | | 35,386 | |
| | | | | | | | | | | | |
| Utilities | | 0 | | | 0 | | | 3,923 | | | 16,815 | | | 5,833 | | | 26,571 | |
| Total | | $ | 126,862 | | | $ | 195,374 | | | $ | 145,297 | | | $ | 231,519 | | | $ | 105,773 | | | $ | 804,825 | |
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(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.
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| | | | | | | | | | | | | | | | | | | | | | | | |
| | | 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 |
|
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(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.
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(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.
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| (in thousands) | | June 30, 2020 | | | | December 31, 2019 | | |
| | Preferred stock | | Common stock | | Preferred stock | | Common stock |
| | (Unaudited) | | | | | | |
| Communication | | $ | 2,478 | | | $ | 1.416 | | | $ | 1,052 | | | $ | 2,381 | |
| Consumer | | 2,599 | | | 0 | | | 508 | | | 0 | |
| | | | | | | | |
| Energy | | 1,035 | | | 0 | | | 1,881 | | | 0 | |
| Financial services | | 60,149 | | | 0 | | | 53,513 | | | 0 | |
| | | | | | | | |
| | | | | | | | |
| Industrial | | 0 | | | 0 | | | 980 | | | 0 | |
| | | | | | | | |
| Utilities | | 7,712 | | | 0 | | | 6,818 | | | 0 | |
| Total | | $ | 73,973 | | | $ | 1,416 | | | $ | 64,752 | | | $ | 2,381 | |
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) | | 2020 | | 2019 |
| | | (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 activities | | Net 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 equivalents | | Net (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
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.
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.
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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.
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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.
PART II. OTHER INFORMATION
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.
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 II”II" 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.
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".
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
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
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.
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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.
ITEM 6. EXHIBITS
| Number | | Description of Exhibit |
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Exhibit | | |
Number31.1* | | Description of Exhibit |
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10.1* | | |
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10.2* | | |
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31.1* | | |
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| 31.2* | | |
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| 32* | | |
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| 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. |
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| 101.SCH* | | Inline XBRL Taxonomy Extension Schema Document. |
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| 101.CAL* | | Inline XBRL Taxonomy Extension Calculation Linkbase Document. |
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| 101.DEF* | | Inline XBRL Taxonomy Extension Definition Linkbase Document. |
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| 101.LAB* | | Inline XBRL Taxonomy Extension Label Linkbase Document. |
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| 101.PRE* | | Inline XBRL Taxonomy Extension Presentation Linkbase Document. |
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| 104* | | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). |
* Filed herewith.
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.
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| | | Erie Indemnity Company | |
| | | (Registrant) | |
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| Date: | October 26, 2017July 30, 2020 | By: | /s/ Timothy G. NeCastro | |
| | | Timothy G. NeCastro, President & CEO | |
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| | By: | /s/ Gregory J. Gutting | |
| | | Gregory J. Gutting, Executive Vice President & CFO | |