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 September 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 October 1,
1996.
Class B Common Stock, no par value, with a stated value of
$70.00 per share-- 3,070 shares as of October 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--September 30, 1996 and
December 31, 1995
Consolidated Statements of Operations--Three and Nine months ended
September 30, 1996 and 1995
Consolidated Statements of Cash Flows--Three and Nine months ended
September 30, 1996 and 1995
Notes to Consolidated Financial Statements--September 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
September 30, December 31,
ASSETS 1996 1995
------------------- ----------
(Unaudited)
INVESTMENTS
Fixed Maturities:
Available-for-Sale (amortized cost of
$285,579,200 and $229,922,533,
respectively) $ 291,615,552 $ 241,960,567
Equity Securities (cost of $105,379,148 and
$71,421,388, respectively) 118,315,355 81,139,076
Real Estate Mortgage Loans 6,356,907 4,432,361
Other Invested Assets 7,131,548 5,142,585
-----------------------------------------------
Total Investments $ 423,419,362 $ 332,674,589
Cash and Cash Equivalents 24,188,659 56,856,983
Equity in Erie Family Life
Insurance Company 25,983,079 27,880,363
Accrued Interest and Dividends 5,966,774 4,980,154
Premiums Receivable from Policyholders 111,079,857 99,534,004
Reinsurance Recoverable, Non-affiliates 172,190 160,988
Deferred Policy Acquisition Costs 9,883,853 9,011,734
Receivables from Erie Insurance Exchange
and Affiliates 486,187,134 451,777,577
Note Receivable from Erie Family
Life Insurance Company 15,000,000 15,000,000
Property and Equipment 8,392,636 8,241,937
Federal Income Taxes Recoverable 2,196,292 932,379
Deferred Income Taxes 174,010 185,282
Other Assets 19,125,553 15,195,754
--------------------- ---------------------
Total Assets $ 1,131,769,399 $ 1,022,431,744
===================== =====================
(Continued)
See Notes to Consolidated Financial Statements.
3
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
September 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1995
----------------------------------------------
(Unaudited)
LIABILITIES
Losses and Loss Adjustment Expenses $ 382,912,905 $ 357,334,127
Unearned Premiums 226,273,129 202,806,574
Accounts Payable 5,081,485 5,839,745
Accrued Commissions 77,234,503 72,697,864
Accrued Payroll and Payroll Taxes 7,902,933 8,093,690
Accrued Vacation and Sick Pay 7,282,375 6,740,212
Deferred Compensation 1,449,516 1,739,216
Dividends Payable 5,624,420 5,624,375
Benefit Plans Liability 6,866,127 7,491,700
--------------------- ---------------------
Total Liabilities 720,627,393 668,367,503
--------------------- ---------------------
SHAREHOLDERS' EQUITY
Capital Stock
Class A Common, stated value $.0292
per share; authorized 74,996,930 shares;
issued and outstanding 67,032,000 shares 1,955,100 1,955,100
Class B Common, stated value $70.00
per share; authorized 3,070 shares;
Issued and outstanding 3,070 shares 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) 12,440,442 17,643,443
Retained Earnings 388,701,564 326,420,798
--------------------- ---------------------
Total Shareholders' Equity 411,142,006 354,064,241
--------------------- ---------------------
Total Liabilities and
Shareholders' Equity $ 1,131,769,399 $ 1,022,431,744
===================== =====================
See Notes to Consolidated Financial Statements.
4
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
-----------------------------------------------------------------------
MANAGEMENT OPERATIONS: 1996 1995 1996 1995
Management Fee Revenue $ 115,620,834 $ 109,769,195 $ 341,331,890 $ 323,100,371
Service Agreement Revenue 1,333,576 1,214,564 3,765,021 3,395,261
Other Operating Revenue 312,324 324,265 931,655 990,231
----------------- ----------------- ------------------ -------------
Total Revenues from Management Operations 117,266,734 111,308,024 346,028,566 327,485,863
Cost of Management Operations 81,549,000 79,610,180 246,178,301 238,745,483
----------------- ----------------- ------------------ -------------
Net Revenues From
Management Operations 35,717,734 31,697,844 99,850,265 88,740,380
----------------- ----------------- ------------------ -------------
INSURANCE UNDERWRITING OPERATIONS:
Premiums Earned 25,740,991 24,075,923 75,300,404 68,883,460
Losses and Loss Adjustment Expenses Incurred 21,286,647 17,951,201 64,100,588 54,327,106
Policy Acquisition and Other
Underwriting Expenses 7,171,992 6,860,930 20,991,733 19,033,774
----------------- ----------------- ------------------ -------------
Total Losses and Expenses 28,458,639 24,812,131 85,092,321 73,360,880
----------------- ----------------- ------------------ -------------
Underwriting Losses (2,717,648) (736,208) (9,791,917) (4,477,420)
----------------- ----------------- ------------------ -------------
INVESTMENT OPERATIONS:
Equity in Earnings of Erie Family
Life Insurance Company 982,370 1,500,169 2,515,879 2,850,594
Interest and Dividends 6,549,490 5,459,449 18,483,504 14,942,591
Realized Gain on Investments 2,281,202 2,513,988 3,365,363 2,892,007
----------------- ----------------- ------------------ -------------
Total Revenues from Investment Operations 9,813,062 9,473,606 24,364,746 20,685,192
----------------- ----------------- ------------------ -------------
Income Before Income Taxes 42,813,148 40,435,242 114,423,094 104,948,152
Provision for Income Taxes 13,626,362 13,165,789 35,271,887 34,466,092
----------------- ----------------- ------------------ -------------
Net Income $ 29,186,786 $ 27,269,453 $ 79,151,207 $ 70,482,060
================= ================= ================== =============
Net Income per Share $ .39 $ .37 $ 1.06 $ .95
================= ================= ================== =============
Dividends Declared per Share:
Class A $ 0.0833 $ 0.065 $ 0.25 $ 0.195
----------------- ----------------- ------------------ -------------
Class B $ 12.50 $ 9.75 $ 37.50 $ 29.25
----------------- ----------------- ------------------ -------------
See Notes to Consolidated Financial Statements.
5
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended Nine Months Ended
September 30, 1996 September 30, 1995
------------------ ------------------
CASH FLOW FROM OPERATING ACTIVITIES
Net income $ 79,151,207 $ 70,482,060
Depreciation and amortization 889,914 660,204
Deferred income tax expense (benefit) 1,026,328 (681,464)
Adjustment to reconcile net income
to net cash provided by (used in)
operating activities:
Realized gain on investments (3,365,363) (2,892,007)
Amortization of bond discount (194,091) (164,805)
Undistributed earnings of equity investee (1,493,955) (2,155,770)
(Decrease) increase in deferred compensation (289,700) 93,690
Increase in accrued interest and dividends (986,620) (1,377,271)
Increase in receivables (45,966,612) (30,714,587)
Increase in policy acquisition costs (872,119) (1,670,995)
Increase in other assets (2,475,008) (1,622,353)
(Decrease) increase in accounts payable and
accrued expenses (1,032,427) 2,720,745
Increase in prepaid federal income taxes (1,263,913) 0
Increase in prepaid pension (1,377,002) 0
Increase in accrued commissions 4,536,639 5,984,442
Increase in income taxes payable 0 4,881,719
Increase in loss reserves 25,578,778 12,836,109
Increase in unearned premiums 23,466,555 29,761,143
------------------ -----------------
Net cash provided by operating
activities 75,332,611 86,140,860
CASH FLOW FROM INVESTING ACTIVITIES
Purchase of investments:
Fixed maturities (87,014,797) (55,058,129)
Equity securities (48,633,780) (30,062,129)
Mortgage loans (1,968,775) 0
Other invested assets (3,094,093) (1,454,262)
Sales/maturities of investments:
Fixed maturities 31,889,829 12,191,386
Equity securities 17,481,773 18,133,207
Mortgage loans 44,817 558,748
Other invested assets 1,209,545 80,332
(Continued)
See Notes to Consolidated Financial Statements.
6
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Continued)
Nine Months Ended Nine Months Ended
September 30, 1996 September 30, 1995
------------------ ------------------
CASH FLOW FROM INVESTING ACTIVITIES (Continued)
Purchase of property and equipment $ (561,281) $ (90,136)
Purchase of computer software (479,332) (772,422)
Loans to Agents (815,178) (2,994,778)
Collections on Agent loans 813,461 725,160
------------------ -----------------
Net cash used in investing activities (91,127,811) (58,743,023)
CASH FLOW FROM FINANCING ACTIVITIES
Dividends paid to shareholders (16,873,124) (13,161,040)
------------------ -----------------
Net cash used in financing activities (16,873,124) (13,161,040)
------------------ -----------------
Net (decrease) increase in cash and cash
equivalents (32,668,324) 14,236,797
Cash and cash equivalents at beginning of period 56,856,983 52,110,474
------------------ -----------------
Cash and cash equivalents at end of period $ 24,188,659 $ 66,347,271
================== =================
Supplemental disclosures of cash flow information:
Cash paid during the nine months ended September 30, 1996 and 1995 for income
taxes was $37,543,743 and $32,565,460, 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 nine-month period ended September 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 -- 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 C -- 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 statement of financial position 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
September 30, 1996
U.S. Treasuries $ 7,006 $ 129 $ 141 $ 6,994
Obligations of States
and Political Subdivisions 25,217 1,008 88 26,137
Special Revenue 160,279 4,657 324 164,612
Public Utilities 9,945 59 54 9,950
Industrial and Miscellaneous 83,132 1,648 857 83,923
------------- ------------ ----------- -------------
Total Fixed Maturities $ 285,579 $ 7,501 $ 1,464 $ 291,616
------------- ------------ ----------- -------------
Common Stock $ 39,560 $ 14,373 $ 1,726 $ 52,207
Preferred Stock 65,819 910 621 66,108
------------- ------------ ----------- -------------
Total Equity Securities $ 105,379 $ 15,283 $ 2,347 $ 118,315
------------- ------------ ----------- -------------
$ 390,958 $ 22,784 $ 3,811 $ 409,931
============= ============ =========== =============
Available-for-Sale Securities
Gross Gross
Amortized Unrealized Unrealized Fair
(In Thousands) Cost Gain 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 $1,015,000 and $7,106,000 at September 30,
1996 and December 31, 1995, respectively, 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 D -- 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:
Nine Months Ended Nine Months Ended
September 30, 1996 September 30, 1995
------------------ ------------------
Revenues $ 60,224,921 $ 58,607,834
Benefits and expenses 42,787,918 39,207,618
------------------ ------------------
Income before income taxes 17,437,003 19,400,216
Income taxes 5,804,800 6,220,453
------------------ ------------------
Net income $ 11,632,203 $ 13,179,763
================== ==================
Dividends paid to
shareholders $ 3,433,504 $ 3,087,000
================== ==================
Net unrealized appreciation
on investment securities
net of deferred taxes $ 681,612 $ 11,017,817
================== ==================
NOTE E -- NOTE RECEIVABLE FROM EFL
On December 29, 1995, EFL issued a surplus note to the Company in return for
cash 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, June, and September of 1996, EFL received such
approval for the accrual/payment of interest totaling $725,625, of which
$483,750 was paid to the Company by EFL at June 30, 1996 and $241,875 was
accrued at September 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 7.0% for the third quarter of 1996 to
$29,186,786, or $.39 per share, from $27,269,453 or $.37 per share, for the
third quarter of 1995. The growth in third quarter net income was driven by
improvement in the management and investment operating segments of the Company.
Gains made in the Company's management and investment operations were partially
offset by the increase in underwriting losses during this period due partly to
losses related to Hurricane Fran in the third quarter of 1996.
For the nine months ended September 30, 1996, consolidated net income increased
12.3% to $79,151,207 or $1.06 per share, from $70,482,060 or $.95 per share
earned in the same period in 1995. The growth in net income for the nine months
ended September 30, 1996 resulted from gains in the management and investment
operating segments while the insurance underwriting results lagged the 1995
underwriting results.
RESULTS OF OPERATIONS
Analysis of Management Operations
For the third 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 5.3% to $115,620,834 from
$109,769,195 for the third quarter 1995. The management fee charged by the
Company is a percentage of direct and affiliated assumed written premiums of the
Exchange, which increased 7.1% during the third quarter of 1996. The rate of
growth in management fee revenue, from direct and affiliated assumed written
premiums, was less than the growth in direct and affiliated assumed written
premiums as the management fee rate charged the Exchange in the third quarter of
1996 was 24% while the rate charged in the third quarter of 1995 was 24.5%. The
Board of Directors reduced the management fee rate to 24% for the period April
1, 1996 through December 31, 1996. Management fee revenue derived from the
Company serving as attorney-in-fact for the Exchange increased 5.6% to
$341,331,890 in the first nine months of 1996 compared to $323,100,371 for the
same period in 1995.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
The cost of management operations increased 2.4% to $81,549,000 for the three
months ended September 30, 1996 from $79,610,180 for the same period in 1995.
For the nine months ended September 30, 1996 cost of management operations
increased 3.1% from the same period in 1995.
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 3.9% to $53,814,304 for the third
quarter of 1996, compared to $51,776,371 in the third quarter of 1995. For the
nine months ended September 30, 1996, commission costs increased 5.3% to
$161,242,187 from $153,107,055. The growth in premiums on a quarterly and
year-to-date basis are 7.1% and 7.7%, respectively. Commissions are down due to
lower agent contingency bonus costs resulting from poor underwriting results.
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 $16,861,733 for the three month period ended September 30, 1996,
compared to $17,067,809 for the same period in 1995, a decline of 1.2%.
Personnel costs rose 1.9% to $53,039,001 for the nine months ended September 30,
1996 from $52,069,178 for the respective period in 1995.
Net revenues from the Company's management operations rose 12.7% to $35,717,734
for the three months ended September 30, 1996 compared to $31,697,844 for the
same period in 1995. This continued growth in quarterly results contributed to
the 12.5% increase in net revenues from management operations for the nine
months ended September 30, 1996. The gross margin from management operations
(net revenue divided by total revenue), improved to 30.5% in the third quarter
of 1996, from 28.5% for the third quarter of 1995. For the nine months ended
September 30, 1996, the gross margin improved to 28.9% from 27.1% 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 and losses from Hurricane Fran in the third quarter of 1996. In
the third quarter of 1996, premiums earned for the Company's property/casualty
insurance subsidiaries grew 6.9% to $25,740,991 compared to $24,075,923 for the
same period in 1995. Losses, loss adjustment expenses and underwriting expenses
incurred increased at a faster pace than premiums earned; up 14.7% for the third
quarter of 1996 amounting to $28,458,639 compared to $24,812,131 for the prior
year's third quarter. Thus, the net underwriting loss worsened in the third
quarter of 1996 to $2,717,648 compared to a loss of $736,208 experienced in the
third quarter of 1995.
Losses experienced from Hurricane Fran in the eastern United States,
particularly North Carolina and other storm-related losses elsewhere in our
operating territories, were partly responsible for the increased underwriting
loss in the three months ended September 30, 1996. Losses from Hurricane Fran
amounted to approximately $1.3 million at the end of the third quarter or about
$.01 per share, after federal income taxes. The third quarter losses, coupled
with the severe winter weather experienced in the eastern United States during
the first three months of 1996, were responsible for the increase in
underwriting losses for the nine months ended September 30, 1996. For the nine
months ended September 30, 1996, the Erie Insurance Company and Erie Insurance
Company of New York's underwriting loss increased to $9,791,917 from a loss of
$4,477,420 for the same period in 1995.
The Generally Accepted Accounting Principles (GAAP) combined ratio for the
Company's property/casualty insurance operations was 110.6% for the three months
ended September 30, 1996 compared to a ratio of 103.1% for the same period in
1995. During the nine months ended September 30, 1996 the GAAP combined ratio
was 113% compared to 106.5% for the same period in 1995. The GAAP combined ratio
is the ratio of acquisition and underwriting expenses, loss and loss adjustment
expenses incurred to premiums earned.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Catastrophes are an inherent risk of the property/casualty insurance business,
which can have a material impact on year-to-year fluctuations in the Company's
property/casualty insurance underwriting operating results. The Company
experienced two such catastrophes during 1996, with the severe winter weather in
the first quarter accounting for $4.1 million of underwriting losses and
expenses and Hurricane Fran in the third quarter accounting for $1.3 million of
underwriting losses and expenses. Combined, these two catastrophes accounted for
approximately $.05 per share, after federal income taxes. The Company
continually reviews its methods for estimating its liability for losses and loss
adjustment expenses, which includes an estimate for losses incurred but not
reported. Such liabilities are necessarily based on estimates and, while
management believes the amount is adequate, the ultimate liability may be in
excess of or less than amounts provided.
Analysis of Investment Operations
Total revenues from investment operations for the third quarter of 1996
increased by 3.6% to $9,813,062 from $9,473,606 posted in the third quarter of
1995. The Company's 21.6% investment in an affiliated life insurer, Erie Family
Life Insurance Company (EFL) declined 34.5% in the third quarter of 1996. The
Company's investment earnings were a direct result of EFL's net income declining
to $4,542,003 from $6,936,055 for the three months ended September 30, 1996 and
1995, respectively. This decline was a result of EFL recognizing fewer
non-recurring capital gains during the third quarter of 1996. Partially
offsetting this decline is a 20% increase in interest and dividend income of the
Company for the third quarter of 1996.
Total revenues from investment operations for the nine months ended September
30, 1996 increased 17.8% to $24,364,746 from $20,685,192 for the same period in
1995. A 23.7% increase in dividend and interest income, as well as approximately
$3 million of non-recurring realized capital gains on investments, fueled the
growth in revenues from investment operations in the first nine months of 1996.
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 September 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 $434 million, or 38.4%, 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 September 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.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
At September 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 $10.8 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 nine months ended September 30, 1996
and 1995, were $75,332,611 and $86,140,860 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 September 30, 1996
and 1995, totaled $5,624,420 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, second or third 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 September 30, 1996 and
December 31, 1995 of $174,010 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 September 30, 1996 and December 31, 1995, the Company's receivables from its
affiliates totaled $486,187,134 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.
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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 September 30,
1996 and December 31, 1995 are as follows:
September 30, 1996 December 31, 1995
------------------ -----------------
Exchange-Management Fee and
Expense Reimbursements $ 116,456,045 $ 105,612,765
EFL-Expense Reimbursements 631,813 1,392,365
Exchange-Reinsurance Recoverable
from Losses and Unearned
Premium Balances Ceded 369,099,276 344,772,447
------------------- -----------------
$ 486,187,134 $ 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. However,
commission expenses which are a cost of management operations, will also be
reduced proportionally with the reduction in 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.
"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 "Results of Operations - Analysis of Insurance
Operations", "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.
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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
September 30, 1996.
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 November 11, 1996 \s\ Stephen A. Milne
---------------------------------
Stephen A. Milne, President & CEO
\s\ Thomas M. Sider
----------------------------------
Thomas M. Sider, Executive Vice
President & CFO
16