FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For quarter ended June 30, 1996
Commission file number 0-24000
ERIE INDEMNITY COMPANY
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 25-0466020
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Erie Insurance Place, Erie, Pennsylvania 16530
(Address of principal executive offices) (Zip Code)
(814) 870-2000
Registrant's telephone number, including area code
Not applicable
Former name, former address and former fiscal year, if changed since last
report.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter periods
that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No ___
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practical date.
Class A Common Stock, no par value, with a stated value of
$.0292 per share-- 67,032,000 shares as of August 1, 1996.
Class B Common Stock, no par value, with a stated value of
$70.00 per share-- 3,070 shares as of August 1, 1996.
The common stock is the only class of stock the Registrant is presently
authorized to issue.
1
INDEX
ERIE INDEMNITY COMPANY
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Financial Position--June 30, 1996 and
December 31, 1995
Consolidated Statements of Operations--Three and Six months ended
June 30, 1996 and 1995
Consolidated Statements of Cash Flows--Three and Six months ended
June 30, 1996 and 1995
Notes to Consolidated Financial Statements--June 30, 1996
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
2
PART I. FINANCIAL INFORMATION
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
June 30, December 31,
ASSETS 1996 1995
--------------- ----------
(Unaudited)
INVESTMENTS
Fixed Maturities:
Available-for-Sale (amortized cost of
$276,169,628 and $229,922,533,
respectively) $ 281,006,542 $ 241,960,567
Equity Securities (cost of $89,314,150 and
$71,421,388, respectively) 102,471,293 81,139,076
Real Estate Mortgage Loans 6,379,154 4,432,361
Other Invested Assets 6,971,899 5,142,585
--------------------- ---------------------
Total Investments $ 396,828,888 $ 332,674,589
Cash and Cash Equivalents 33,419,599 56,856,983
Equity in Erie Family Life
Insurance Company 25,046,768 27,880,363
Accrued Interest and Dividends 5,623,419 4,980,154
Premiums Receivable from Policyholders 105,550,187 99,534,004
Reinsurance Recoverable, Non-affiliates 177,534 160,988
Deferred Policy Acquisition Costs 9,604,755 9,011,734
Receivables from Erie Insurance Exchange
and Affiliates 454,093,299 451,777,577
Note Receivable from Erie Family
Life Insurance Company 15,000,000 15,000,000
Property and Equipment 8,797,068 8,241,937
Federal Income Taxes Recoverable 1,794,363 932,379
Deferred Income Taxes 990,624 185,282
Other Assets 16,584,657 15,195,754
--------------------- ---------------------
Total Assets $ 1,073,511,161 $ 1,022,431,744
===================== =====================
(Continued)
See Notes to Consolidated Financial Statements.
3
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
June 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1995
------------- ----------
(Unaudited)
LIABILITIES
Losses and Loss Adjustment Expenses $ 362,368,269 $ 357,334,127
Unearned Premiums 216,239,919 202,806,574
Accounts Payable 4,976,702 5,839,745
Accrued Commissions 75,628,592 72,697,864
Accrued Payroll and Payroll Taxes 5,859,236 8,093,690
Accrued Vacation and Sick Pay 7,988,620 6,740,212
Deferred Compensation 1,405,595 1,739,216
Dividends Payable 5,622,141 5,624,375
Benefit Plans Liability 6,680,253 7,491,700
--------------------- ---------------------
Total Liabilities 686,769,327 668,367,503
--------------------- ---------------------
SHAREHOLDERS' EQUITY
Capital Stock
Class A Common, stated value $.0292
per share; authorized 74,996,930 1,955,100 1,955,100
Class B Common, stated value $70.00
per share; authorized 3,070 214,900 214,900
Additional Paid-In Capital 7,830,000 7,830,000
Net Unrealized Gain on Available-for-Sale
Securities (net of deferred taxes) 11,600,404 17,643,443
Retained Earnings 365,141,430 326,420,798
--------------------- ---------------------
Total Shareholders' Equity 386,741,834 354,064,241
--------------------- ---------------------
Total Liabilities and
Shareholders' Equity $ 1,073,511,161 $ 1,022,431,744
===================== =====================
See Notes to Consolidated Financial Statements.
4
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended
June 30 June 30
-------------------------------------------------------------------------------
MANAGEMENT OPERATIONS: 1996 1995 1996 1995
Management Fee Revenue $ 117,422,334 $ 108,113,793 $ 225,711,056 $ 213,331,176
Service Agreement Revenue 1,165,928 1,056,167 2,431,445 2,180,697
Other Operating Revenue 308,964 343,737 619,331 665,966
----------------- ----------------- ------------------ ------------------
Total Revenues from Management Operations 118,897,226 109,513,697 228,761,832 216,177,839
Cost of Management Operations 85,452,651 78,788,021 164,629,301 159,135,303
----------------- ----------------- ------------------ ------------------
Net Revenues From
Management Operations 33,444,575 30,725,676 64,132,531 57,042,536
----------------- ----------------- ------------------ ------------------
INSURANCE UNDERWRITING OPERATIONS:
Premiums Earned 25,007,216 22,984,344 49,559,413 44,807,537
Losses and Loss Adjustment Expenses Incurred 19,242,498 18,335,526 42,813,941 36,375,905
Policy Acquisition and Other
Underwriting Expenses 7,021,831 6,591,747 13,819,741 12,172,844
----------------- ----------------- ------------------ ------------------
Total Losses and Expenses 26,264,329 24,927,273 56,633,682 48,548,749
----------------- ----------------- ------------------ ------------------
Underwriting Loss (1,257,113) (1,942,929) (7,074,269) (3,741,212)
----------------- ----------------- ------------------ ------------------
INVESTMENT OPERATIONS:
Equity in Earnings of Erie Family
Life Insurance Company 954,122 683,019 1,533,509 1,350,425
Interest and Dividends 5,927,799 4,864,870 11,934,014 9,483,142
Realized Gain on Investments 601,233 460,571 1,084,161 378,019
----------------- ----------------- ------------------ ------------------
Total Revenues from Investment Operations 7,483,154 6,008,460 14,551,684 11,211,586
----------------- ----------------- ------------------ ------------------
Income Before Income Taxes 39,670,616 34,791,207 71,609,946 64,512,910
Provision for Income Taxes 13,204,272 11,675,475 21,645,525 21,300,303
----------------- ----------------- ------------------ ------------------
Net Income $ 26,466,344 $ 23,115,732 $ 49,964,421 $ 43,212,607
================= ================= ================== ==================
Earnings per Share:
Net Income per Share $ 0.36 $ 0.31 $ 0.67 $ 0.58
================= ================= ================== ==================
Dividends Declared per Share:
Class A $ 0.0833 $ 0.065 $ 0.1666 $ 0.13
----------------- ----------------- ------------------ ------------------
Class B $ 12.50 $ 9.75 $ 25.00 $ 19.50
----------------- ----------------- ------------------ ------------------
See Notes to Consolidated Financial Statements.
5
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended Six Months Ended
June 30, 1996 June 30, 1995
------------------ ----------------
CASH FLOW FROM OPERATING ACTIVITIES
Net income $ 49,964,421 $ 43,212,607
Depreciation and amortization 595,043 437,720
Deferred income tax expense (benefit) 552,189 (815,526)
Adjustment to reconcile net income
to net cash provided by (used in)
operating activities:
Realized gain on investments (1,084,161) (378,019)
Amortization of bond discount (127,110) (109,108)
Undistributed earnings of equity investee (766,939) (887,189)
(Decrease) increase in deferred compensation (333,621) 29,214
Increase in accrued interest and dividends (643,265) (936,983)
Increase in receivables (8,348,451) (42,870,141)
Increase in policy acquisition costs (593,021) (1,368,192)
Increase in other assets (1,289,452) (693,968)
Decrease in accounts payable and
accrued expenses (2,660,536) (775,831)
Increase in prepaid federal income taxes (861,984) 0
Increase in accrued commissions 2,930,728 3,492,542
Increase in income taxes payable 0 4,248,069
Increase in loss reserves 5,034,142 10,661,759
Increase in unearned premiums 13,433,345 17,970,989
------------------ -----------------
Net cash provided by operating
activities 55,801,328 31,217,943
CASH FLOW FROM INVESTING ACTIVITIES
Purchase of investments:
Fixed maturities (64,349,206) (49,365,405)
Equity securities (25,963,817) (15,616,270)
Mortgage loans (1,968,775) 0
Other invested assets (2,780,390) (1,438,246)
Sales/maturities of investments:
Fixed maturities 18,566,901 4,930,764
Equity securities 8,595,623 1,954,870
Mortgage loans 22,481 548,089
Other invested assets 1,055,491 51,000
(Continued)
See Notes to Consolidated Financial Statements.
6
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Continued)
Six Months Ended Six Months Ended
June 30, 1996 June 30, 1995
------------------ ----------------
CASH FLOW FROM INVESTING ACTIVITIES (Continued)
Purchase of property and equipment $ (886,009) $ (72,377)
Purchase of computer software (264,164) (529,614)
Loans to Agents (553,772) (2,793,805)
Collections on Agent loans 535,675 465,610
------------------ -----------------
Net cash used in investing activities (67,989,962) (61,865,384)
CASH FLOW FROM FINANCING ACTIVITIES
Dividends paid to shareholders (11,248,750) (8,774,027)
------------------ -----------------
Net cash used in financing activities (11,248,750) (8,774,027)
------------------ -----------------
Net decrease in cash and cash
equivalents (23,437,384) (39,421,468)
Cash and cash equivalents at beginning of period 56,856,983 52,110,474
------------------ -----------------
Cash and cash equivalents at end of period $ 33,419,599 $ 12,689,006
================== =================
Supplemental disclosures of cash flow information:
Cash paid during the six months ended June 30, 1996 and 1995 for income taxes
was $23,980,834 and $20,214,243, respectively.
See Notes to Consolidated Financial Statements.
7
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six-month period ended June 30, 1996
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1996. For further information, refer to the financial
statements and footnotes thereto included in the Company's Form 10-K for the
year ended December 31, 1995.
NOTE B -- RECLASSIFICATIONS
Certain amounts as previously reported in the 1995 financial statements have
been reclassified to conform to the current year's presentation.
NOTE C -- EARNINGS PER SHARE
At the Annual Meeting of the Company's shareholders held on May 1, 1996, the
number of authorized shares of the Company's Class A Common Stock was increased
pursuant to a vote of the shareholders from 24,996,920 to 74,996,930 shares and
a three-for-one (3:1) stock split was effected. Thus, earnings per share is
based on the weighted average number of Class A shares outstanding of 67,032,000
(as retroactively stated in 1995), plus giving effect to the conversion of the
weighted average number of Class B shares outstanding (3,070 in 1996 and 1995)
at a rate of 2,400 Class A shares for one Class B share as set out in the
Articles of Incorporation. Equivalent shares outstanding total 74,400,000.
NOTE D -- INVESTMENTS
Fixed maturities are classified as held-to-maturity when the Company has the
positive intent and ability to hold the securities to maturity. Held-to-maturity
securities are stated at amortized cost. The amortized cost of fixed maturities
classified as held-to-maturity is adjusted for amortization of premiums and
accretion of discounts to maturity. The Company currently holds no
held-to-maturity securities.
Fixed maturities determined by management not to be held-to-maturity and
marketable equity securities are classified as available-for-sale. Marketable
equity securities consist primarily of common and nonredeemable preferred stocks
while fixed maturities consist of bonds and notes. Available-for-sale securities
are stated at fair value, with the unrealized gains and losses, net of tax,
reported as a separate component of shareholders' equity. Management determines
the appropriate classification of fixed maturities at the time of purchase and
reevaluates such designation as of each balance sheet date.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
The following is a summary of available-for-sale securities:
Available-for-Sale Securities
Gross Gross
Amortized Unrealized Unrealized Fair
(In Thousands) Cost Gains Losses Value
June 30, 1996
U.S. Treasuries $ 7,001 $ 157 $ 137 $ 7,021
Obligations of States
and Political Subdivisions 31,063 840 115 31,788
Special Revenue 164,707 4,063 483 168,287
Public Utilities 7,934 56 43 7,947
Industrial and Miscellaneous 65,465 1,470 971 65,964
------------- ------------ ----------- -------------
Total Fixed Maturities $ 276,170 $ 6,586 $ 1,749 $ 281,007
------------- ------------ ----------- -------------
Common Stock $ 35,453 $ 14,341 $ 1,165 $ 48,629
Preferred Stock 53,861 728 747 53,842
------------- ------------ ----------- -------------
Total Equity Securities $ 89,314 $ 15,069 $ 1,912 $ 102,471
------------- ------------ ----------- -------------
$ 365,484 $ 21,655 $ 3,661 $ 383,478
============= ============ =========== =============
Available-for-Sale Securities
Gross Gross
Amortized Unrealized Unrealized Fair
(In Thousands) Cost Gains Losses Value
December 31, 1995
U.S. Treasuries $ 6,991 $ 324 $ 1 $ 7,314
Obligations of States and
Political Subdivisions 25,024 1,122 26,146
Special Revenue 160,678 7,387 168,065
Public Utilities 7,939 103 47 7,995
Industrial and Miscellaneous 29,291 3,157 7 32,441
------------- ------------ ----------- -------------
Total Fixed Maturities $ 229,923 $ 12,093 $ 55 $ 241,961
------------- ------------ ----------- -------------
Common Stock $ 27,178 $ 10,637 $ 1,110 $ 36,705
Preferred Stock 44,243 1,227 1,036 44,434
------------- ------------ ----------- -------------
Total Equity Securities $ 71,421 $ 11,864 $ 2,146 $ 81,139
------------- ------------ ----------- -------------
$ 301,344 $ 23,957 $ 2,201 $ 323,100
============= ============ =========== =============
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
Deferred income taxes decreased by $1,358,000 at June 30, 1996 and were reduced
by $7,106,000 at December 31, 1995, related to the change in unrealized gains
(losses) on available-for-sale securities.
Mortgage loans on real estate are recorded at unpaid balances, adjusted for
amortization of premium or discount. A valuation allowance is provided for
impairment in net realizable value based on periodic valuations. The change in
the allowance is reflected on the income statement in realized gain (loss) on
investments.
NOTE E -- SUMMARIZED INCOME STATEMENT INFORMATION OF AFFILIATE
The Company has a 21.6% investment in Erie Family Life Insurance Company (EFL)
and accounts for this investment using the equity method. The following
represents summarized income statement information for EFL:
Six Months Ended Six Months Ended
June 30, 1996 June 30, 1995
------------------ ----------------
Revenues $ 39,454,745 $ 35,870,185
Benefits and expenses 28,238,142 26,481,816
------------------ ------------------
Income before income taxes 11,216,603 9,388,369
Income taxes 4,126,403 3,144,661
------------------ ------------------
Net income $ 7,090,200 $ 6,243,708
================== ==================
Dividends paid to
shareholders $ 2,252,252 $ 2,016,000
================== ==================
NOTE F -- NOTE RECEIVABLE FROM EFL
On December 29, 1995, EFL issued a surplus note to the Company in return for a
cash sum of $15 million. The note bears an annual interest rate of 6.45% and all
payments of interest and principal of the note may be repaid only out of
unassigned surplus of EFL and are subject to prior approval of the Pennsylvania
Insurance Commissioner. In March and June of 1996, EFL received such approval
for the accrual/payment of interest totaling $483,750, which was paid to the
Company by EFL at June 30, 1996.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
financial statements and related notes found on pages 3 through 10, since they
contain important information that is helpful in evaluating the Company's
operating results and financial condition.
OPERATING RESULTS
Financial Overview
Consolidated net income rose by 14.5% for the second quarter of 1996 to
$26,466,344, or $.36 per share, from $23,115,732 or $.31 per share, for the
second quarter of 1995. The growth in second quarter net income was driven by
improvement in all of the Company's principle operating segments. Gains made in
the Company's management and investment operations were further supported by a
reduction in underwriting losses during the second quarter.
For the six months ended June 30, 1996, consolidated net income increased 15.6%
to $49,964,421 or $.67 per share, from $43,212,607 or $.58 per share earned in
the same period in 1995. The growth in net income for the six months ended June
30, 1996 resulted from gains in the management and investment operating segments
while the insurance underwriting results lagged the 1995 underwriting results
due to losses from severe winter weather in the first quarter of 1996.
RESULTS OF OPERATIONS
Analysis of Management Operations
For the second quarter 1996 management fee revenue derived from the management
operations of the Company, which serves as attorney-in-fact for the Erie
Insurance Exchange (the Exchange), increased 8.6% to $117,422,334 from
$108,113,793 for the second quarter 1995. Management fee revenue increased 5.8%
to $225,711,056 in the first six months of 1996 compared to $213,331,176 for the
same period in 1995. In June of 1995, a separate service arrangement was
effected between the Company and the Exchange. Under this arrangement, the
Company began receiving a service fee of 7% on voluntary reinsurance premiums
assumed from non-affiliated insurers and the Exchange assumed the responsibility
for the payment of brokerage commissions on all voluntary assumed premiums from
unaffiliated companies. This arrangement resulted in a one-time retroactive
adjustment that reduced the management fee revenue of the second quarter of 1995
by $3,213,000 and reduced the commission expenses incurred in the second quarter
of 1995 by $3,607,000.
Excluding this one-time 1995 retroactive adjustment of $3,213,000 from
management fee revenue would produce a 5.4% growth rate in management fee
revenue during the second quarter of 1996 derived from the direct and affiliated
assumed written premium of the Exchange. The direct and affiliated assumed
written premium of the Exchange, on which management fee is based, increased
7.6% during the second quarter of 1996. The rate of growth in the management fee
revenue was less than the rate of growth in the direct and assumed premium
written because the management fee rate charged the Exchange in the second
quarter of 1996 as determined by the Company's Board of Directors was 24% while
the rate charged in the second quarter of 1995 was 24.5%.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
The cost of management operations increased 8.5% to $85,452,651 for the three
months ended June 30, 1996 from $78,788,021 for the same period in 1995. As
mentioned previously, commission expenses incurred, which are a component of
cost of management operations, were reduced by $3,607,000 in the second quarter
of 1995 related to a retroactive adjustment. Excluding this retroactive
adjustment, cost of management operations would have increased by 3.7% for the
second quarter of 1996.
The Company is responsible for the payment of commissions to the independent
Agents who sell insurance products for the Company's subsidiaries and the
Exchange, and its subsidiary, Flagship City Insurance Company, as enumerated in
the subscriber's agreement with the Exchange. The Agents receive commissions
based on fixed percentage fee schedules with different commission rates by line
of insurance. Also included in commission expense are the costs of promotional
incentives for Agents and Agent profit-sharing bonuses. Agent profit-sharing
bonuses are based upon the underwriting profitability of the insurance written
and serviced by the Agent within the Erie Insurance Group of companies.
Commissions are the largest component of the cost of management operations.
The Company's commission costs increased 13.8% to $56,326,492 for the second
quarter of 1996, compared to $49,500,138 in the second quarter of 1995. This
increase was effected by the 1995 retroactive adjustment discussed previously,
in the amount of $3,607,000. Thus, commission costs would have increased 6.1%.
For the six months ended June 30, 1996, commission costs increased 6% to
$107,427,883 from $101,330,684. The increases experienced in commission costs on
a quarterly and year-to-date basis are consistent with the growth in premiums
written of 7.6% and 8.0%, respectively.
Personnel costs, including salaries, employee benefits, and payroll taxes, are
the second largest component in cost of operations, after commissions. The
Company's personnel costs, net of those reimbursed by affiliated companies,
totaled $17,795,069 for the three month period ended June 30, 1996, compared to
$17,374,606 for the same period in 1995, an increase of 2.4%. Personnel costs
rose 3.4% to $36,177,268 for the six months ended June 30, 1996 from $35,001,294
for the respective period in 1995.
Net revenues from the Company's management operations rose 8.8% to $33,444,575
for the three months ended June 30, 1996 compared to $30,725,676 for the same
period in 1995. This continued growth in quarterly results contributed to the
12.4% increase in net revenues from management operations for the six months
ended June 30, 1996. The gross margin from management operations (net revenue
divided by total revenue), which was 28.1% in the second quarter of 1996, was
consistent with the gross margin reported in the second quarter of 1995. For the
six months ended June 30, 1996, the gross margin improved to 28% from 26.4% for
the same period in 1995.
Analysis of Insurance Operations
The insurance underwriting operations of the Company's wholly-owned subsidaries,
Erie Insurance Company and Erie Insurance Company of New York, which share
proportionally in the property/casualty underwriting results of the Erie
Insurance Group, were impacted negatively by severe winter weather in the first
quarter of 1996. In the second quarter of 1996, premiums earned for the
Company's property/casualty insurance subsidiaries grew 8.8% to $25,007,216
compared to $22,984,344 for the same period in 1995. Losses, loss adjustment
expenses and underwriting expenses incurred increased at a lesser rate than
premiums earned; up 5.4% for the second quarter of 1996 amounting to $26,264,329
compared to $24,927,273 for the prior year's second quarter. The net
underwriting loss reported in the second quarter amounted to $1,257,113 and
improved from the net underwriting loss of $1,942,929 experienced in the second
quarter of 1995.
For the six months ended June 30, 1996, the Erie Insurance Company and Erie
Insurance Company of New York's underwriting loss was $7,074,269 compared to a
loss of $3,741,212 for the same period in 1995. The severe winter weather in the
eastern United States during the first quarter of 1996 was primarily responsible
for this increase.
12
The GAAP combined ratio for the Company's property/casualty insurance operations
was 114.3% for the six months ended June 30, 1996 compared to a ratio of 108.3%
for the same period in 1995. However, there was improvement in the GAAP combined
ratio during the second quarter of 1996 to 105% from 108.4% for the second
quarter of 1995. The GAAP combined ratio is the ratio of acquisition and
underwriting expenses, loss and loss adjustment expenses incurred to premiums
earned.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Analysis of Investment Operations
Total revenues from investment operations for the second quarter of 1996
increased by 24.5% to $7,483,154 from $6,008,460 posted in the second quarter of
1995. Total revenues from investment operations for the six months ended June
30, 1996 increased 29.8% to $14,551,684 from $11,211,586 for the same period in
1995. A 26% increase in dividend and interest income, as well as approximately
$1 million of non-recurring realized capital gains on investments, fueled the
growth in revenues from investment operations in the first six months of 1996.
The Company also benefited from its 21.6% investment in an affiliated life
insurer, Erie Family Life Insurance Company (EFL). This investment is accounted
for under the equity method of accounting. Consequently, the Company's
investment earnings were a direct result of EFL's net income of $7,090,200 and
$6,243,708 at June 30, 1996 and 1995, respectively. The earnings recognized from
the investment in EFL increased to $1,533,509 for the six months ended June 30,
1996 from $1,350,425 for the same period in 1995, as EFL's taxes, licenses and
fees decreased due to the timing of payments of state life insurance guaranty
fund assessments through June 30, 1996 as compared to June 30, 1995.
FINANCIAL CONDITION
Investments
The Company's investment strategy takes a long-term perspective emphasizing
investment quality, diversification and superior investment returns. Investments
are managed on a total return approach that focuses on current income and
capital appreciation. The Company's investments are also liquid in order to meet
the short- and long-term commitments of the Company. At June 30, 1996, the
Company's investment portfolio of investment-grade bonds, common stock and
preferred stock, all of which are readily marketable, and cash and short-term
investments, totaled $417 million, or 39%, of total assets. These resources
provide the liquidity the Company requires to meet demands on its funds.
The total investments of the Company consist of investments in fixed maturities,
common stock, preferred stock, real estate mortgage loans and other invested
assets. At June 30, 1996, 97% of total investments were invested in fixed
maturities and equity securities. Mortgage loans and other invested assets
represented only 3% of total investments at that date. Mortgage loans and real
estate investments have the potential for higher returns, but also carry more
risk, including less liquidity and greater uncertainty in the rate of return.
Consequently, these investments have been kept to a minimum by the Company.
The Company's investments are subject to certain risks, including interest rate
and reinvestment risk. Fixed maturity and preferred stock security values
generally fluctuate inversely with movements in interest rates. The Company's
corporate and municipal bond investments may contain call and sinking fund
features which may result in early redemptions. Declines in interest rates could
cause early redemptions or prepayments which could require the Company to
reinvest at lower rates.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
At June 30, 1996, the Company's five largest investments in corporate debt
securities totaled $10.8 million, none of which individually exceeded $2.5
million. These investments had a market value of $10.9 million.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measure of the Company's ability to secure enough cash to meet
its contractual obligations and operating needs. The Company's major sources of
funds from operations are the net cash flow generated from management operations
as the attorney-in-fact for the Exchange, the net cash flow from the Erie
Insurance Company's 5% and the Erie Insurance Company of New York's .5%
participation in the underwriting results of the reinsurance pool with the
Exchange, and the Company's investment income from affiliated and non-affiliated
investments. With respect to the management fee cash flow, funds are generally
released from the Exchange to the Company on a premiums collected basis, as the
Company incurs commission expense on premiums collected rather than written
premiums. The Company generates sufficient net positive cash flow from its
operations which is used to fund its commitments and to build its investment
portfolio, thereby increasing future investment returns. The Company also
maintains a high degree of liquidity in its investment portfolio in the form of
readily marketable fixed maturities, common stocks and short-term investments.
The Company's consolidated statements of cash flows indicate that net cash flows
provided by operating activities for the six months ended June 30, 1996 and
1995, were $55,801,328 and $31,217,943 respectively. Those statements also
classify the other sources and uses of cash by investing activities and
financing activities.
Dividends declared to shareholders in the three months ended June 30, 1996 and
1995, totaled $5,622,141 and $4,387,013, respectively. There are state law
restrictions on the payment of dividends from the insurance subsidiaries to the
Company. No dividends were paid to the Company from its property/casualty
insurance subsidiaries during the first or second quarter of 1996.
Temporary differences between the financial statement carrying amounts and tax
bases of assets and liabilities that give rise to deferred tax assets and
liabilities resulted in net deferred tax assets at June 30, 1996 and December
31, 1995 of $990,624 and $185,282, respectively. Management believes it is more
likely than not that the Company will have sufficient taxable income in future
years to realize the benefits of the deferred tax assets.
The Company's property/casualty insurance subsidiaries enjoy a strong capital
position which is demonstrated in their risk-based capital ratios calculated
using the National Association of Insurance Commissioners (NAIC) formula at
December 31, 1995. Such calculations indicated that the Company's
property/casualty insurance subsidiaries' Total Adjusted Capital was
substantially above the Authorized Control Level Risk-Based Capital requirements
of the NAIC since their ratios are all in excess of three to one (3:1) at
December 31, 1995.
At June 30, 1996 and December 31, 1995, the Company's receivables from its
affiliates totaled $454,093,299 and $451,777,577, respectively. These
receivables, primarily due from the Exchange, are a result of the
attorney-in-fact management fee, expense reimbursements and the intercompany
reinsurance pool and potentially expose the Company to concentrations of credit
risk.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
The individual receivable from the Exchange and its affiliates at June 30, 1996
and December 31, 1995 are as follows:
June 30, 1996 December 31, 1995
------------- -----------------
Exchange-Management Fee and
Expense Reimbursements $ 106,935,144 $ 105,612,765
EFL-Expense Reimbursements 585,959 1,392,365
Exchange-Reinsurance Recoverable
from Losses and Unearned
Premium Balances Ceded 346,572,196 344,772,447
-------------- ----------------
$ 454,093,299 $ 451,777,577
============== ================
OTHER MATTERS
On June 24, 1996, the Pennsylvania Workers' Compensation Reform Act was signed
into law. This Act, now known as Act 57, calls for a reduction of workers'
compensation premiums in the state of Pennsylvania by insurance companies that
reflect reform outlined in the Act. This law is expected to reduce the premium
income generated by the Exchange and its affiliated companies, Erie Insurance
Company and Erie Insurance Property & Casualty Company on workers' compensation
business written in the state of Pennsylvania. Any reduction in premiums written
as a consequence of Act 57 will result in reduced management fee revenue for the
Company as its management fee revenue is based on premiums written. The reduced
workers' compensation premiums will also affect the Company's property/casualty
insurance subsidiaries operating results, however, lower premium levels may be
offset by lower loss costs arising from the cost containment provisions of Act
57. The effect of this Act on the overall financial condition of the Company is
not expected to be material.
In late January 1996, Maryland Governor Parris Glendening introduced Senate Bill
216, a comprehensive legislative package intended to reduce automobile insurance
costs and premiums in the state of Maryland. This legislation could have
affected the Company's revenues from management operations and insurance
underwriting operations. However, Senate Bill 216 did not receive significant
support in the Maryland legislature, which adjourned without acting on the
Governor's initiative.
"Safe Harbor" Statement Under the Private Securities Litigation Reform Act of
1995: Statements contained herein expressing the beliefs of management such as
those contained in the "Financial Condition - Investments", and the "Liquidity
and Capital Resources" sections hereof, and the other statements which are not
historical facts contained in this report are forward looking statements that
involve risks and uncertainties. These risks and uncertainties include but are
not limited to: legislative, judicial, and regulatory changes, the impact of
competitive products and pricing, product development, geographic spread of
risk, weather and weather-related events, other types of catastrophic events,
fluctuations of securities markets, and technological difficulties and
advancements.
16
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
The Company did not file any reports on Form 8-K during the three months ended
June 30, 1996.
Exhibit 27. Financial Data Schedule
All other exhibits for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are not applicable, and therefore, have been omitted.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Erie Indemnity Company
(Registrant)
Date: August 7, 1996 /s/ Stephen A. Milne
---------------------------------
Stephen A. Milne, President & CEO
/s/ Thomas M. Sider
----------------------------------
Thomas M. Sider, Executive Vice
President & CFO
17