As filed with the Securities and Exchange Commission on September 20, 2002.
Registration No. 333-___________
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM S-3
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Erie Indemnity Company
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(Exact name of registrant as specified in 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
814-870-2000
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(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Jan R. Van Gorder, Esquire
Senior Executive Vice President,
Secretary and General Counsel
Erie Indemnity Company
100 Erie Insurance Place
Erie, Pennsylvania 16530
814-870-2000
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(Name, address, including zip code, and telephone
number, including area code, of agent for service)
Copies to:
Frederick W. Dreher, Esquire Andrew S. Rowen, Esquire
Richard L. Cohen, Esquire John Evangelakos, Esquire
Duane Morris LLP Sullivan & Cromwell
4200 One Liberty Place 125 Broad Street
Philadelphia, Pennsylvania 19103 New York, New York 10004
215-979-1234 212-558-4000
Approximate date of commencement of proposed sale to public: As soon as
practicable after this registration statement becomes effective.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [_]
If any of the securities being registered on this Form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_] _________________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. [_]
CALCULATION OF REGISTRATION FEE
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Proposed Proposed
Title of each class Amount maximum maximum
of securities to be to be offering aggregate Amount of
registered registered price per unit offering price(1) registration fee
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Class A common stock, 4,600,000 $43.095 $198,237,000 $18,238
no par value shares
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- ----------------
(1) Estimated pursuant to Rule 457(c) under the Securities Act of 1933,
solely for the purpose of calculating the registration fee, based on the
average of the high and low sales prices of the Class A common stock of
the registrant on the NASDAQ Stock Market(SM) on September 16, 2002.
The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant shall
file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
[LEFT SIDE OF PROSPECTUS COVER]
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THE
SELLING SHAREHOLDER MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION
STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
PRELIMINARY PROSPECTUS IS NOT AN OFFER TO SELL NOR DOES IT SEEK AN OFFER TO BUY
THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION. DATED SEPTEMBER 20, 2002.
[LOGO]
Shares
ERIE INDEMNITY COMPANY
Class A Common Stock
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Shares of our Class A common stock, which are non-voting, are being offered
by the selling shareholder named in this prospectus. We will not receive any
proceeds from the sale of shares.
Our Class A common stock is quoted on the NASDAQ Stock Market(SM) under the
symbol "ERIE". The last reported sale price of our Class A common stock on
September 19, 2002 was $44.25 per share.
INVESTING IN OUR CLASS A COMMON STOCK INVOLVES CERTAIN RISKS. SEE THE
SECTION OF THIS PROSPECTUS ENTITLED "RISK FACTORS" BEGINNING ON PAGE 14.
--------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY
BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
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Per Share Total
--------- -----
Initial price to public
Underwriting discount
Proceeds, before expenses, to selling shareholder
The underwriters have an option to purchase up to additional
shares of Class A common stock from the selling shareholder at the public
offering price, less the underwriting discount, within 30 days from the date of
this prospectus.
--------------
The underwriters expect to deliver the shares against payment in New York,
New York on or about , 2002.
GOLDMAN, SACHS & CO. CREDIT SUISSE FIRST BOSTON
--------------
Prospectus dated __________, 2002.
PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS SOME OF THE INFORMATION CONTAINED IN THIS PROSPECTUS.
THIS SUMMARY DOES NOT CONTAIN ALL OF THE INFORMATION THAT YOU SHOULD CONSIDER
BEFORE INVESTING IN OUR CLASS A COMMON STOCK. ALL FINANCIAL INFORMATION,
OPERATING STATISTICS AND RATIOS IN THIS PROSPECTUS ARE BASED ON GENERALLY
ACCEPTED ACCOUNTING PRINCIPLES UNLESS OTHERWISE NOTED. UNLESS THE CONTEXT
INDICATES OTHERWISE, ALL REFERENCES IN THIS PROSPECTUS TO "WE", "US", "OUR" OR
THE "COMPANY" INCLUDE ERIE INDEMNITY COMPANY AND ITS WHOLLY OWNED SUBSIDIARIES,
ERIE INSURANCE COMPANY, ERIE INSURANCE COMPANY OF NEW YORK AND ERIE INSURANCE
PROPERTY & CASUALTY COMPANY. AS USED IN THIS PROSPECTUS, THE "EXCHANGE" REFERS
TO ERIE INSURANCE EXCHANGE, AND "ERIE INSURANCE GROUP" REFERS TO THE COMPANY,
THE EXCHANGE, ITS SUBSIDIARY, FLAGSHIP CITY INSURANCE COMPANY, AND ITS
AFFILIATE, ERIE FAMILY LIFE INSURANCE COMPANY. YOU SHOULD READ THE ENTIRE
PROSPECTUS CAREFULLY.
OUR COMPANY
We operate predominantly as a provider of management services to Erie
Insurance Exchange (the "Exchange") and also as an underwriter of insurance
through our subsidiaries. We have served since 1925 as the attorney-in-fact, or
management company, for the policyholders of the Exchange, an unincorporated
association that is a reciprocal insurance exchange. The financial results of
the Exchange are not consolidated with ours. The Exchange and its property and
casualty subsidiary and our three property and casualty subsidiaries
(collectively, the "Property and Casualty Group") write personal and commercial
lines property and casualty coverages exclusively through approximately 8,000
independent agents and pool their underwriting results.
For our services as attorney-in-fact, we charge the Exchange a management
fee calculated as a percentage, currently 25%, of the direct written premiums of
the Property and Casualty Group. Management fees accounted for approximately 77%
of our revenues for the six months ended June 30, 2002. For the first six months
of 2002, 69% of direct premiums written by the Property and Casualty Group were
personal lines, while 31% were commercial lines. We also own 21.6% of the common
stock of Erie Family Life Insurance Company, an affiliated life insurance
company, of which the Exchange owns 53.5% and public shareholders, including our
directors, own 24.9%. Erie Family Life Insurance Company enables our independent
agents to distribute a more comprehensive portfolio of insurance products to
customers. At June 30, 2002, we had total assets of $2.1 billion and
shareholders' equity of $920 million. Our net income was $92.0 million for the
six months ended June 30, 2002 and $122.3 million for the year ended December
31, 2001.
We believe we are the only publicly-traded reciprocal management company in
the country. Several other private property and casualty companies, such as USAA
and Farmers Insurance Group (owned by Zurich Financial Services Group), also
operate as reciprocals with separate management arrangements. Our earnings are
largely generated by fees based on premiums written directly by the Property and
Casualty Group. We therefore have a
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direct incentive to preserve the financial condition of the Exchange. The
underwriting risk and capital costs of the property and casualty insurance
business are largely borne by the Exchange, which had $2.5 billion of statutory
surplus at June 30, 2002. Through the pool, our property and casualty
subsidiaries currently assume 5.5% of the Property and Casualty Group's
underwriting results, and therefore we also have a direct incentive to manage
the overall underwriting business as effectively as possible.
ERIE INSURANCE GROUP
ORGANIZATIONAL CHART
-------------------
| Shareholders |
| |
-------------------
|
------------------- ------------------------------
| | | |
| Erie Indemnity | Attorney-in-Fact | |
| |------- for Policyholders ------- | Erie Insurance Exchange* |
| Company | | |
| | | |
------------------- ------------------------------
| |
----------------------------------------- ------------------------
| | | | |
| | | | |
100% 100% 21.6% 53.5% 100%
| | | | |
------------------ ------------------ -------------------- ------------------
| | | | | | | |
| | |Erie Insurance* | | | | |
| Erie Insurance*| | Property & | | Erie Family Life | | Fagship City* |
| Company | | Casualty | | Insurance | | Insurance |
| | | Company | | Company | | Company |
| | | | | | | |
------------------ ------------------ -------------------- ------------------
|
|
100%
|
|
------------------
| |
|Erie Insurance* |
| Company of |
| New York |
| |
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* Denotes a member of the Property and Casualty Group
The Property and Casualty Group seeks to insure standard and preferred
risks in primarily private passenger automobile, homeowners and small commercial
lines, including workers' compensation policies. We believe the Property and
Casualty Group has differentiated its products from standard industry products
by providing additional coverages, which enhance our agents' marketing efforts.
Our agency force consists of over 1,700 independent agencies comprised of
approximately 8,000 agents in 11 Midwestern, Mid-
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Atlantic and Southeastern states (Illinois, Indiana, Maryland, New York, North
Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and Wisconsin)
and the District of Columbia. Our independent agents play a significant role as
underwriters and service providers and are major contributors to our success.
We have reported increasing net operating income for 14 consecutive years.
Our growth has primarily been driven by an expansion of the Property and
Casualty Group's business into new territories, the appointment of new agencies,
high policy and agency retention rates and, recently, increased premium rates.
. Since 1997, we have entered Illinois and Wisconsin and expect to begin
operating in Minnesota in the third quarter of 2004.
. In 2001, we continued our planned expansion of our independent agency
force by appointing 247 agencies. Since 1997, we have increased the overall
number of agencies representing the Property and Casualty Group by 60%.
. We have a very stable base of policyholders, with one of the best
policy retention rates in the property and casualty insurance industry. Our
retention rate of 90.9% in 2001 compared favorably to an average of 82.6%
for a core benchmark group consisting largely of regional property and
casualty carriers, according to a 2001 Ward Group benchmark study.
. We are achieving premium rate increases as a result of the current
favorable market conditions in both commercial and personal property and
casualty lines, which are generally referred to within the industry as
"hard market conditions". We have benefited from these hard market
conditions and for the twelve months ended June 30, 2002 experienced
average premium per policy increases of 5.7% for personal automobile
insurance policies, 15.8% for commercial lines policies and 8.3% across all
lines. Management believes increases in premium rates are likely to
continue in 2002 and 2003. Generally, our profit margins from management
operations have increased during periods of premium rate increases.
As a result of these growth initiatives and market conditions, the Property
and Casualty Group had over 3.3 million insurance policies in force as of June
30, 2002, a 10.8% increase from June 30, 2001. Personal lines policies in force
grew by 10.3% during the twelve months ended June 30, 2002, while commercial
lines policies increased 13.8% over the same period.
We have built our reputation in the industry and among insurance consumers,
agents and others on our commitment to be "Above all in sERvIcE(SM)". Customer
satisfaction surveys independently conducted by a nationally recognized research
firm have ranked the Property and Casualty Group:
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. No. 1 for homeowners insurance in 2001, the first year this survey was
conducted; and
. No. 2 for private passenger automobile insurance in 2001 and 2000.
Each member of the Property and Casualty Group is rated A++ (Superior) by
A.M. Best Company, Inc. ("A.M. Best"), its highest financial strength rating,
which was held by only 2.8% of the property and casualty insurance groups rated
by A.M. Best as of July 11, 2002.
OUR OPERATING SEGMENTS
Our financial results are segmented into management operations and property
and casualty insurance underwriting operations. Through management operations,
we provide management services and take no underwriting risk. This segment is
the largest contributor to our earnings, providing pre-tax income of $141.9
million for the six months ended June 30, 2002 and $186.3 million for 2001. In
the property and casualty insurance underwriting operations, we take
underwriting risk through our insurance subsidiaries. This segment had a pre-tax
loss of $4.4 million for the six months ended June 30, 2002 and $3.4 million for
2001.
MANAGEMENT OPERATIONS
For services performed in our role as attorney-in-fact for the
policyholders of the Exchange, we charge the Exchange a management fee
calculated as a percentage of the direct written premiums by the Exchange and
the other members of the Property and Casualty Group. The management fee is
compensation for (i) acting as attorney-in-fact for the policyholders of the
Exchange, (ii) managing the business and affairs of the Exchange and (iii)
paying certain general administrative expenses not part of the settlement of
losses or the management of investments, which are the responsibility of the
Exchange. We recognize as income management fees due from the Exchange when the
premiums are written because at that time we have performed substantially all of
the services we are required to perform, including sales, underwriting and
policy issuance activities. Currently such fees are not paid to us by the
Exchange until it collects the premiums. Management fees received from the
Exchange accounted for approximately 77% of our revenues in the six months ended
June 30, 2002 and approximately 78% of our revenues in 2001. The management fee
charged to the Exchange is set by, and may be changed at the discretion of, our
board of directors. The fee rate has been at its maximum permitted level of 25%
since 1999 and was 24.25% in 1998 and 24% in 1997.
We also receive a service agreement fee from the Exchange as compensation
for the management and administration of its voluntary assumed reinsurance
business from non-affiliated insurers. The fee is determined by our management
and has been at a rate of 7% of voluntary assumed written reinsurance premium
since 1995. We also collect service charges
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from policyholders who pay their premiums in installments on policies written by
the Property and Casualty Group.
We also earn investment income on the cash flow from management
operations, which is invested in our investment portfolio. We report our share
of earnings from our 21.6% investment in Erie Family Life Insurance Company as
part of the investment income of our management operations segment.
PROPERTY AND CASUALTY INSURANCE UNDERWRITING OPERATIONS
Our property and casualty insurance underwriting operations segment
consists of our three property and casualty insurance subsidiaries that
participate in an intercompany pooling arrangement with the Exchange. The pool
also includes reinsurance assumed by the Exchange from non-affiliated entities.
Under the pooling arrangement, all property and casualty insurance
business of the five property and casualty insurance companies that comprise the
Property and Casualty Group is pooled within the Exchange as the pooling entity.
Our insurance subsidiaries, Erie Insurance Company and Erie Insurance Company of
New York, share in the underwriting results of the pool through retrocession.
Erie Insurance Company has a 5.0% participation, Erie Insurance Company of New
York has a 0.5% participation and the Exchange has a 94.5% participation in the
pooled underwriting results. These participation percentages are determined by
our board of directors. Pooling participation percentages have not changed since
1995.
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PROPERTY AND CASUALTY GROUP
POOLING ARRANGEMENT
CEDED FROM RETROCEDED TO
- -----------------------------
| | --------------------
| Erie Insurance Exchange ------- | | ------------------
| | | | | | |
- ----------------------------- | | | 94.5% | Erie Insurance |
| | |-------------| Exchange |
- ----------------------------- | | | | |
| | | | | ------------------
| Flagship City ------- | |
| Insurance Company | | | |
| | | | |
- ----------------------------- | | |
| | | ------------------
- ----------------------------- | | | | |
| | 100% | Property and | 5.0% | Erie Insurance|
| Erie Insurance Company --------------| Casualty |-------------| Company |
| | | | Group Pool | | |
- ----------------------------- | | | | |
| | | ------------------
- ----------------------------- | | |
| | | | |
| Erie Insurance Company | | | |
| of New York ------- | | ------------------
| | | | | | |
- ----------------------------- | | | 0.5% | Erie Insurance|
| | |-------------| Company |
- ----------------------------- | | | | of New York |
| | | | | | |
| Erie Insurance Property | | | | ------------------
| & Casualty Company ------- | |
| | --------------------
- -----------------------------
Erie Insurance Company and Erie Insurance Company of New York also have an
all-lines aggregate excess of loss reinsurance agreement with the Exchange that
limits the amount of their annual net losses arising from their pool
participation. The liabilities and related premiums ceded to the Exchange
pursuant to the aggregate excess of loss reinsurance agreement are not subject
to the intercompany pooling arrangement.
The Property and Casualty Group sells personal and commercial lines
policies through independent agencies. Commercial lines policies are marketed to
small- and medium-sized businesses. Premium revenues from our property and
casualty insurance underwriting operations accounted for approximately 15% of
our revenues in the six months ended June 30, 2002 and 17% of our revenues in
2001.
We also earn investment income on the cash from property and casualty
insurance underwriting operations, which is invested in our investment
portfolio.
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OUR COMPETITIVE ADVANTAGES
We believe that our competitive advantages come from:
. OUR COMMITTED, LOYAL AND PRODUCTIVE INDEPENDENT AGENCY FORCE. We seek
to develop long-term business relationships with high-quality independent
agencies. Prior to allowing an agency to represent us, we undertake a
rigorous selection process that seeks agency principals who meet our high
standards and operate their agencies in line with our business philosophy.
We believe our independent agency force has been loyal to us and that the
Property and Casualty Group is the preferred carrier for most of the
independent agencies that represent us. Average annual written premium
volume per agency is approximately $1.7 million for our agencies.
. OUR FOCUS ON QUALITY SERVICE. Service to the policyholder and agent
has been a tradition of the Erie Insurance Group since its founding more
than 77 years ago. Erie Insurance Group has consistently been recognized as
a provider of quality service. Customer satisfaction surveys independently
conducted by a nationally recognized research firm ranked the Property and
Casualty Group No. 1 for homeowners insurance in 2001, the first year this
survey was conducted, and No. 2 for private passenger automobile insurance
in 2001 and 2000. Our claims force is comprised predominantly of our own
employees who are trained in our service-oriented claims settlement
philosophy.
. OUR COMPETITIVE PRODUCTS AND PRICING. A key to attracting a highly
effective sales force of independent agents and enhancing the Property and
Casualty Group's ability to attract customers is a portfolio of
competitively priced products. These products include many additional
coverages that we believe differentiate the Property and Casualty Group's
products in the marketplace.
. OUR LOW-COST OPERATION. Expense management is one of our founding
traditions and is an important part of our culture. We believe our
operations are among the most cost-efficient in the property and casualty
industry. In addition, our organizational structure is relatively flat and
combines the advantages of centralized common services with field marketing
and claims services. Our average agency annual written premium volume of
$1.7 million allows us to keep our agency training, marketing and support
costs low. The Property and Casualty Group's five-year statutory average
loss adjustment and underwriting expense ratio for the period from 1997 to
2001 is 37.2%, which compares favorably to A.M. Best's property and
casualty industry composite average of 40.3%. The Property and Casualty
Group's underwriting expense ratio includes the management fee paid to us
of 25% of direct premiums written. The actual cost of
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management operations is less than the 25% management fee, which results in
a profit for our shareholders. If the actual cost of management operations
were used to compute the underwriting expense ratio, consistent with
industry-reported results, the loss adjustment and underwriting expense
ratio would be 30.7%, which compares even more favorably to industry
averages. In a 2001 benchmarking study completed by Ward Group, our
productivity, as measured by the ratio of full time equivalent employees to
gross premiums written, is over 40% better than our core benchmark group.
. UNIQUE CORPORATE STRUCTURE. The Erie Insurance Group's operating
structure allows for:
-- A LONG-TERM MANAGEMENT APPROACH TO OUR BUSINESS. We aim to
nurture our relationships with policyholders, agents and
employees to create long-term shareholder value. Each of our
principal executive officers has been with us for over 20 years
and is committed to this long-term view of the business.
-- LOWER EARNINGS VOLATILITY AND LOWER CAPITAL NEEDS. Since the bulk
of the insurance risk of the Property and Casualty Group remains
with the Exchange, we do not experience the same earnings
volatility or have the same capital needs as competing property
and casualty insurance carriers.
-- A LONG-TERM INVESTMENT HORIZON. Since most of the capital and
reserves necessary to support the Property and Casualty Group's
insurance underwriting business are held by the Exchange, which
is not a publicly-owned entity, we are able to use long-term
total return strategies to invest the Exchange's assets. Though
recent equity market results have had a significant negative
effect on the value of the Exchange's investment portfolio, the
Exchange's investment strategy of investing in equity securities
has created substantial surplus capacity over an extended period
of time. From January 1, 1995 to June 30, 2002, the
Exchange's equity investments generated a pre-tax compound annual
return of 14.5% compared to a pre-tax compound annual return of
12.6% for the Standard & Poor's 500 Index. This surplus level
gives us the capacity to grow premiums. For the twelve months
ended June 30, 2002, the Exchange's ratio of net premiums written
to surplus was approximately 1.13:1.
STRATEGY
The Erie Insurance Group's overall strategy includes providing attractive
property and casualty insurance products at competitive prices, coupled with
high-quality service. The Erie Insurance Group distributes these products
exclusively through independent insurance agents whose insurance and
underwriting expertise, local market knowledge and
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commitment to service have been key drivers of our growth. The Erie Insurance
Group's strategy includes:
. Organic growth through (i) a careful agency selection process in which
the Property and Casualty Group seeks to be the primary property and
casualty underwriter for each agency, (ii) a thoughtful expansion into
favorable states and (iii) increased market penetration in existing
operating territories.
. Quality service to policyholders and to agents in claims handling,
underwriting and other service activities.
. Achieving underwriting profits for the Property and Casualty Group by
focusing on standard and preferred risks and by setting and adhering to
consistent underwriting standards.
. A business model designed to provide the advantages of localized
marketing and claims servicing with the economies of scale derived from
centralized management and administration.
THE OFFERING
Class A common stock offered ............... 4,000,000 shares of our Class A
common stock, which is
non-voting, are being offered by
the Selling Shareholder named
below.
Class A common stock outstanding after
this offering .............................. 63,677,106 shares
Class B common stock outstanding after
this offering .............................. 3,050 shares
Class B common stock conversion ratio ...... One share of Class B common
stock may be converted into
2,400 shares of Class A common
stock.
Class A common stock outstanding after
this offering assuming conversion .......... 70,997,106 shares
Dividend history ........................... We declared cash dividends of
$0.17 per share of Class A
common stock for each of the
first three quarters of 2002 and
$25.50 per share of Class B
common stock for each of the
first three quarters of 2002.
The cash
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dividends for the first two quarters have
been paid.
We have paid regular quarterly cash
dividends since 1942. Our board of
directors considers the declaration of
cash dividends on a quarterly basis. The
payment of future dividends, if any, will
be at the discretion of our board of
directors and will depend upon many
factors, including:
. our earnings;
. our financial position;
. our capital requirements and
those of our subsidiaries; and
. our ability to receive dividends
from our subsidiaries, which is
subject to regulatory
limitations.
There can be no assurance as to the
declaration of future dividends.
Use of proceeds ................... We will not receive any of the proceeds
from this offering of our Class A common
stock. The Selling Shareholder identified
below will receive all the net proceeds
from the sale of these shares.
NASDAQ Stock Market(SM) symbol .... ERIE
The above information assumes that the over-allotment option covering an
additional 600,000 shares granted by the Selling Shareholder to the Underwriters
will not be exercised.
The above information is based on the number of shares outstanding as of
August 31, 2002.
SELLING SHAREHOLDER
Black Interests Limited Partnership (the "Selling Shareholder") is offering
4.0 million shares. The Selling Shareholder has also granted the underwriters a
30-day option to
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purchase up to an additional 600,000 shares to cover over-allotments. Samuel P.
Black, III is the managing general partner of the Selling Shareholder and has
the right to vote the shares held by it. Mr. Black has been a director of our
Company since 1997 and succeeded his father, who served as a director during
various periods from 1930 to 1997. Mr. Black is also an officer and principal
shareholder of an insurance agency that receives insurance commissions in the
ordinary course of business from the insurance companies we manage, in
accordance with the insurance companies' standard commission schedules and
agents' contracts.
A majority of the proceeds of the shares being offered as described in this
prospectus will be used by the Selling Shareholder to pay estate taxes and other
estate-related expenses arising from the recent death of Mr. Black's mother and
to make a charitable bequest.
CORPORATE INFORMATION
We were incorporated in Pennsylvania in 1925. Our principal executive
offices are located at 100 Erie Insurance Place, Erie, Pennsylvania 16530, and
our telephone number is (814) 870-2000. Our website is located at
www.erieinsurance.com. The information on this website is not a part of this
prospectus.
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SUMMARY HISTORICAL FINANCIAL INFORMATION
The summary consolidated financial data presented below as of or for the
years ended December 31, 1997 through 2001 is derived from our audited financial
statements. Our consolidated financial statements as of December 31, 2000 and
2001 and for each of the years in the three-year period ended December 31, 2001,
and our independent auditors' report thereon, are included elsewhere in this
prospectus and incorporated by reference herein. See "Where To Find More
Information/Incorporation by Reference". The summary consolidated financial data
presented below as of or for the six-month periods ended June 30, 2001 and 2002
is derived from our unaudited consolidated financial statements included
elsewhere in this prospectus and incorporated by reference herein. See "Where To
Find More Information/Incorporation by Reference". Our results of operations for
the six months ended June 30, 2002 are not necessarily indicative of our results
of operations that may be expected for the year ending December 31, 2002. In the
opinion of our management, all adjustments, consisting only of normal recurring
accruals, considered necessary for a fair presentation have been included. The
financial data set forth below is only a summary and should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere herein.
Six Months Ended
June 30, Year Ended December 31,
--------------------- ----------------------------------------------------------
(amounts in thousands, except per share data) 2002 2001 2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ---------- ---------- ----------
(unaudited)
OPERATING DATA:
Net revenue from management operations $ 123,649 $ 96,304 $ 184,568 $ 158,746 $ 148,518 $ 145,243 $ 134,201
Underwriting (loss) gain (9,661) (5,324) (20,463) (10,402) (3,539) 567 (2,259)
Net revenue from investment operations 23,549 30,927 18,771 75,594 63,776 50,547 42,978
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income before income taxes $ 137,537 $ 121,907 $ 182,876 $ 223,938 $ 208,755 $ 196,357 $ 174,920
Provision for income taxes 45,510 39,992 60,615 71,545 65,649 61,806 56,339
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income $ 92,027 $ 81,915 $ 122,261 $ 152,393 $ 143,106 $ 134,551 $ 118,581
========== ========== ========== ========== ========== ========== ==========
Operating income (1) $ 95,005 $ 80,144 $ 142,983 $ 141,364 $ 133,521 $ 129,895 $ 114,801
========== ========== ========== ========== ========== ========== ==========
PER SHARE DATA:
Net income per share $ 1.29 $ 1.15 $ 1.71 $ 2.12 $ 1.95 $ 1.81 $ 1.59
Operating income per share 1.34 1.12 2.00 1.96 1.82 1.75 1.54
Weighted average shares outstanding 71,162 71,402 71,342 71,954 73,487 74,400 74,400
FINANCIAL POSITION:
Investments (2) $ 959,374 $ 878,187 $ 885,650 $ 853,146 $ 785,258 $ 709,417 $ 566,118
Receivables from the Exchange and affiliates 726,608 604,172 640,655 532,009 470,969 467,794 469,708
Total assets 2,088,329 1,809,577 1,935,566 1,680,599 1,518,794 1,454,062 1,292,544
Shareholders' equity 919,642 839,958 865,255 779,015 697,599 655,223 539,383
Book value per share $ 12.94 $ 11.77 $ 12.15 $ 10.91 $ 9.62 $ 8.81 $ $7.25
- ----------------
(1) Operating income excludes net realized gain (loss) on investments and
related federal income taxes.
(2) Includes investment in Erie Family Life Insurance Company.
-13-
RISK FACTORS
YOU SHOULD CONSIDER CAREFULLY THE RISKS AND UNCERTAINTIES DESCRIBED BELOW AND
THE OTHER INFORMATION IN THIS PROSPECTUS, INCLUDING OUR FINANCIAL STATEMENTS AND
RELATED NOTES, BEFORE DECIDING TO INVEST IN SHARES OF OUR CLASS A COMMON STOCK.
IF ANY OF THE FOLLOWING RISKS OR UNCERTAINTIES ACTUALLY OCCUR, OUR BUSINESS,
FINANCIAL CONDITION AND OPERATING RESULTS WOULD LIKELY SUFFER. IN THAT EVENT,
THE MARKET PRICE OF OUR CLASS A COMMON STOCK COULD DECLINE AND YOU COULD LOSE
ALL OR PART OF THE MONEY YOU PAID TO BUY OUR CLASS A COMMON STOCK.
RISKS RELATING TO OUR BUSINESS AND OUR RELATIONSHIPS WITH THIRD PARTIES
IF THE MANAGEMENT FEE RATE PAID TO US BY THE EXCHANGE IS REDUCED, IF THERE
IS A SIGNIFICANT DECREASE IN THE AMOUNT OF PREMIUMS WRITTEN BY THE EXCHANGE OR
IF WE DO NOT CONTROL THE COSTS OF PROVIDING SERVICES TO THE EXCHANGE, OUR
REVENUES AND PROFITABILITY COULD BE MATERIALLY ADVERSELY AFFECTED.
We are dependent upon management fees paid to us by the Exchange, which
represent our principal source of revenue. During the three years ended December
31, 2001, management fees from the Exchange constituted an average of
approximately 74% of our revenues. We receive these fees pursuant to
attorney-in-fact agreements with the policyholders of the Exchange. Under those
agreements, the management fee rate we receive is determined by our board of
directors and may not exceed 25% of the direct written premiums by the Exchange
and the premiums it assumes from affiliates within the Property and Casualty
Group. Since 1999, the management fee rate has been 25%. In 1998 and 1997, the
management fee rate was 24.25% and 24%, respectively.
Our board of directors generally sets the management fee rate each December
for the following year. However, at their discretion, the rate can be changed at
any time. The factors our board of directors consider in setting the management
fee rate include our financial position in relation to the Exchange and the
long-term needs of the Exchange for capital and surplus to support its continued
growth and competitiveness. The Exchange's capital and surplus could become
impaired due to a number of factors, including those discussed under "-- Risks
Relating to the Business of the Property and Casualty Group" and "-- Risks
Relating to the Property and Casualty Insurance Industry" below. In light of the
strong growth of the Exchange's premium base and the recent decline in the
policyholders' surplus of the Exchange, the management fee rate for 2003 could
be reduced at our board's December 2002 meeting.
If our board of directors were to determine that the management fee rate
should be reduced, our revenues and profitability could be materially adversely
affected. For example, a 1% reduction in the management fee rate during the six
months ended June 30, 2002 would have resulted in a reduction in our net
revenues of $15.4 million, or 12.4%, and a reduction in our net income per share
of $0.14, or 10.9%. A similar decrease of 1% during 2001 would
-14-
have resulted in a reduction in our net revenues of $25.4 million, or 13.8%, and
a reduction in our net income per share of $0.23, or 13.5%.
Our management fee revenue from the Exchange is calculated by multiplying
the management fee rate by the direct premiums written by the Exchange and the
premiums it assumes from the Property and Casualty Group. Accordingly, any
reduction in direct premiums written by the Exchange and the premiums it assumes
from the Property and Casualty Group would have a proportional negative effect
on our revenues and net income.
Pursuant to our attorney-in-fact agreements with the policyholders of the
Exchange, we are required to perform a number of sales, underwriting and
management and administrative services associated with the issuance of insurance
policies for the Exchange to earn our management fee, regardless of the cost to
us of providing those services. We could lose money or be less profitable if our
cost of providing those services increases significantly.
BECAUSE OUR BOARD OF DIRECTORS MUST BALANCE FIDUCIARY OBLIGATIONS TO
POLICYHOLDERS OF THE EXCHANGE AND TO OUR SHAREHOLDERS, OUR BOARD OF DIRECTORS
MUST MAKE DECISIONS THAT ARE NOT SOLELY IN THE INTERESTS OF OUR SHAREHOLDERS.
As attorney-in-fact, we are contractually required to provide management
and administrative services to the Exchange, which has no board of directors or
governing body of its own. In such capacity, we also have a fiduciary duty to
the policyholders of the Exchange to protect their interests. Likewise, we have
a fiduciary duty to our shareholders. Certain issues arise that may create
conflicts of interest between these fiduciary duties. Among such potential
conflicts of interest are:
. We set the management fee rate and service agreement fee rate paid by
the Exchange to us and decide the percentage participation rate of our
property and casualty subsidiaries in the pool.
. We make judgments about the allocation of costs between the Exchange
and the Company in accordance with intercompany agreements and the
attorney-in-fact agreement with the policyholders of the Exchange.
. Management must devote attention to the business interests of both the
Exchange and us.
. The Exchange may enter into other transactions and contractual
relationships with the Company and its subsidiaries.
. State regulators could challenge the reasonableness of the
transactions between us and the Exchange because of potential or actual
conflicts of interest.
-15-
As a consequence, our board of directors must make decisions or take
actions that are not solely in the interests of our shareholders. If, for
example, there should be a need to strengthen the surplus of the Exchange, our
board of directors may decide to reduce the management fee rate and/or that a
capital contribution should be made by us to the Exchange in the form of a
surplus note or some other form. Under such circumstances, we may be required to
provide such capital to the Exchange at a lower rate of return than would be
available with other investments or at no return at all. Payments of interest
and repayment of principal on a surplus note are subject to prior approval of
the Pennsylvania Department of Insurance, which may not approve such payments.
We may also find it necessary to fund additional surplus for the Exchange by
issuing additional shares of our capital stock, resulting in dilution of
existing shareholders' interest.
WE ARE SUBJECT TO CREDIT RISK TO THE EXCHANGE BECAUSE OUR MANAGEMENT FEES
FROM THE EXCHANGE ARE NOT PAID IMMEDIATELY WHEN EARNED AND OUR INSURANCE
SUBSIDIARIES ARE SUBJECT TO CREDIT RISK TO THE EXCHANGE BECAUSE THE EXCHANGE
ASSUMES A HIGHER INSURANCE RISK UNDER AN INTERCOMPANY POOLING ARRANGEMENT THAN
IS PROPORTIONAL TO ITS DIRECT BUSINESS CONTRIBUTION TO THE POOL.
We recognize as income management fees due from the Exchange when the
premiums are written because at that time we have performed substantially all of
the services we are required to perform, including sales, underwriting and
policy issuance activities, but currently such fees are not paid to us by the
Exchange until it collects the premiums. As a result, we hold receivables for
management fees due us and for premiums written but not yet collected by the
Exchange. As of June 30, 2002, the management fee receivable owed by the
Exchange was approximately $183 million.
The Exchange and two of our wholly owned subsidiaries, Erie Insurance
Company and Erie Insurance Company of New York, are parties to an intercompany
pooling arrangement. Under this pooling arrangement, our insurance subsidiaries
cede 100% of their property and casualty underwriting business to the Exchange,
which retrocedes 5% of the pooled business to Erie Insurance Company and 0.5% to
Erie Insurance Company of New York. In 2001, only approximately 81.4% of the
pooled direct property and casualty business was originally generated by the
Exchange and its subsidiary, while 94.5% of the pooled business is retroceded to
the Exchange under the intercompany pooling arrangement. Accordingly, the
Exchange assumes a higher insurance risk than is proportional to the insurance
business it contributes to the pool. In 2001, our subsidiaries wrote 18.6% of
the direct premiums, while assuming only 5.5% of the risk. This poses a credit
risk to our subsidiaries participating in the pool because they are still
responsible ultimately to the policyholders for policies they have written if
the Exchange does not meet its obligations.
-16-
OUR FINANCIAL CONDITION MAY SUFFER BECAUSE OF DECLINES IN THE VALUE OF THE
MARKETABLE SECURITIES THAT CONSTITUTE A SIGNIFICANT PORTION OF OUR ASSETS.
At June 30, 2002, we had investments in marketable securities of
approximately $823 million and investments in limited partnerships of
approximately $87 million. In addition, we have outstanding commitments to
invest up to an additional $110 million in limited partnerships, including in
partnerships for U.S. and foreign private equity real estate and fixed income
investments. All of our marketable security investments are subject to market
volatility. Our fixed income securities investments are exposed to price risk
and to risk from changes in interest rates as well as credit risk related to the
issuer. Generally, we do not hedge our exposure to interest rate risk as we have
the ability to hold fixed income securities to maturity. Our marketable
securities have exposure to price risk and the volatility of the equity markets
and general economic conditions. The stock market decline in 2002 has reduced
the value of our marketable securities by $12.7 million during the first six
months of 2002 compared to $93,000 during the first six months of 2001. To the
extent that future market volatility negatively impacts our investments, our
results of operations will be negatively impacted.
THE TWO INDIVIDUAL TRUSTEES OF OUR CONTROLLING SHAREHOLDERS, THE H.O. HIRT
TRUSTS, HAVE SIGNIFICANTLY DIFFERING VIEWS ON A NUMBER OF MATTERS RELATING TO
THE COMPANY; SUCH DISAGREEMENTS MAY HAVE AN ADVERSE EFFECT ON OUR BUSINESS AND
ON THE VALUE OF OUR CLASS A COMMON STOCK.
Two trusts established by our founder, H.O. Hirt (the "H.O. Hirt Trusts"),
own 76.7% of our Class B common stock, which is the only class of stock that can
vote for the election of directors and has the ability to determine the outcome
of all other matters that require shareholder approval, except those matters
pertaining only to the rights of the holders of our Class A common stock. The
corporate trustee of the H.O. Hirt Trusts is Bankers Trust Company of New York
("Bankers Trust") and the two individual trustees of the H.O. Hirt Trusts are F.
William Hirt and Susan Hirt Hagen, who are brother and sister and the children
of H.O. Hirt. Any determination by the H.O. Hirt Trusts requires a vote of two
of the three trustees and, because the H.O. Hirt Trusts control 76.7% of our
Class B common stock, any such determination will be controlling in a
shareholder vote. Mrs. Hagen and Mr. Hirt disagree on a number of matters
relating to corporate governance, the appointment of a successor corporate
trustee and the financial condition of the Exchange. Mrs. Hagen has recently
raised concerns regarding a number of such matters, including: the role of the
H.O. Hirt Trusts as controlling shareholders in the governance of the Company;
the propriety of a corporate trustee of the H.O. Hirt Trusts engaging in
insurance brokerage activities; the ability of a holder of Class B common stock
to nominate candidates for election as directors of the Company; the
restructuring of our board of directors so that a majority of the directors are
independent of management; the restructuring of the committees of our board of
-17-
directors to provide a more meaningful role for directors who do not have
ongoing business relationships with us; the desirability of more liquidity and
increased institutional investor interest in the Company and the allocation of
expenses between the Exchange and us.
Mrs. Hagen has in the past commenced litigation against us in connection
with corporate governance matters and has participated in litigation involving
the H.O. Hirt Trusts brought by each of the trustees of the H.O. Hirt Trusts and
by other beneficiaries of the H.O. Hirt Trusts. In addition, on two occasions in
the recent past, Mr. Hirt brought a suit, which was subsequently withdrawn,
seeking the removal of Mrs. Hagen as an individual trustee. The effect of these
disagreements and concerns and possible future disagreements between Mrs. Hagen
and Mr. Hirt on us and the value of our Class A common stock cannot be
predicted.
MRS. HAGEN, WHO IS A MEMBER OF OUR BOARD OF DIRECTORS, A TRUSTEE AND A
BENEFICIARY OF THE H.O. HIRT TRUSTS AND A BENEFICIAL OWNER OF APPROXIMATELY
26.3% OF OUR CLASS A COMMON STOCK, IS OPPOSED TO OUR PARTICIPATION IN THIS
OFFERING BECAUSE SHE BELIEVES THERE MAY BE A BETTER ALTERNATIVE FOR US AND MAY
TAKE ADDITIONAL ACTIONS TO OPPOSE THIS OFFERING.
The concerns that Mrs. Hagen has expressed to our board of directors about
this offering include:
. the amount of time and effort required of our officers to prepare a
registration statement relating to this offering and to assist in the
marketing of the shares offered hereby instead of fully concentrating their
efforts on business and financial issues confronting Erie Insurance Group;
. the liability of our directors and the H.O. Hirt Trusts if the
registration statement, including this prospectus, were determined to
contain a material misstatement or a material omission and the
indemnification by us of the underwriters for certain potential liabilities
under federal securities laws related to this offering;
. our present independent auditors;
. the impact of the offering on our ability to attract independent
director candidates during this offering because of the potential liability
associated therewith;
. doubts whether a public offering would unlock any long-term value for
our shareholders;
. concerns that increased public holdings of our Class A common stock
will attract institutional investors; and
. her opinion that a below-market purchase by us of the shares being
offered by the Selling Shareholder would be more advantageous to us.
-18-
Our board of directors considered Mrs. Hagen's concerns at meetings held on
August 16, 2002 and September 9, 2002. At each meeting, Mrs. Hagen was the only
member of our board of directors present to vote against proceeding with this
offering. We are unable to predict whether Mrs. Hagen or any other trustee or
any other beneficiary of the H.O. Hirt Trusts may take additional actions to
oppose this offering.
DECISIONS BY THE CORPORATE TRUSTEE OF THE H.O. HIRT TRUSTS OR THE DEATH OF
EITHER OF THE INDIVIDUAL TRUSTEES COULD MATERIALLY ALTER OUR MANAGEMENT,
STRATEGIC DIRECTION, OPERATING PHILOSOPHY OR OTHER MATTERS MATERIAL TO US.
Bankers Trust tendered its resignation as corporate trustee of the H.O.
Hirt Trusts on March 3, 1999, 36 days after it had been appointed. The selection
of a new corporate trustee of the H.O. Hirt Trusts to replace Bankers Trust is
pending before Orphan's Court in Erie County, Pennsylvania. We cannot predict or
estimate when a replacement corporate trustee will be chosen to replace Bankers
Trust or who it will be. Because any action of the H.O. Hirt Trusts requires a
vote of two of the three trustees and because Mrs. Hagen and Mr. Hirt have
significantly differing views, the vote of the corporate trustee has been, and
will likely continue to be, determinative of the actions of the H.O. Hirt
Trusts. Also, if an individual trustee dies, under the terms of the H.O. Hirt
Trusts, the surviving individual trustee, the corporate trustee and our board of
directors may select a replacement individual trustee or, if no successor is
selected within 30 days, the remaining trustees and the Company shall petition
the Court of Common Pleas of Erie County, Pennsylvania to fill said vacancy
under the trust agreement. Mr. Hirt is 76 years old and Mrs. Hagen is 67 years
old. Decisions by the existing trustees or replacement trustees, including
supporting a slate of directors put forth by Mrs. Hagen or another shareholder,
could materially alter our management, strategic direction, operating philosophy
or other matters material to us. It is impossible to determine how these
decisions may affect the value of the Company and therefore our Class A common
stock.
RISKS RELATING TO THE BUSINESS OF THE PROPERTY AND CASUALTY GROUP
THE PROPERTY AND CASUALTY GROUP CONDUCTS BUSINESS IN ONLY 11 STATES AND THE
DISTRICT OF COLUMBIA, WITH A CONCENTRATION OF BUSINESS IN OHIO, MARYLAND,
VIRGINIA AND, PARTICULARLY, PENNSYLVANIA. ANY SINGLE CATASTROPHE OCCURRENCE OR
OTHER CONDITION DISPROPORTIONATELY AFFECTING LOSSES IN THESE STATES COULD
ADVERSELY AFFECT THE RESULTS OF OPERATIONS OF MEMBERS OF THE PROPERTY AND
CASUALTY GROUP.
The Property and Casualty Group conducts business in only 11 states and the
District of Columbia, primarily in the Mid-Atlantic, Midwestern and Southeastern
portions of the United States. A substantial portion of this business is private
passenger and commercial automobile, homeowners and workers' compensation
insurance in Ohio, Maryland, Virginia and, particularly, Pennsylvania. As a
result, a single catastrophe occurrence, destructive weather pattern, general
economic trend, terrorist attack, regulatory development or other condition
disproportionately affecting one or more of the states in which the Property and
-19-
Casualty Group conducts substantial business could materially adversely
affect the results of operations of members of the Property and Casualty Group.
Common catastrophe events include hurricanes, earthquakes, tornadoes, wind and
hail storms, fires and explosions.
THE OPERATING RESULTS OF THE EXCHANGE ARE SUBJECT TO GREATER VARIABILITY
BECAUSE THE PROPERTY AND CASUALTY GROUP HAS GENERALLY NOT MAINTAINED REINSURANCE
COVERAGE IN RECENT YEARS.
In recent years, the Property and Casualty Group has not purchased treaty
reinsurance, including catastrophe reinsurance, because management concluded,
during our periodic assessment of the Property and Casualty Group's catastrophe
exposure, that the benefits of such coverage were outweighed by the costs of the
coverage in light of the Exchange's substantial surplus and its ratio of net
premiums written to surplus. Because the Exchange has a 94.5% participation in
the Property and Casualty Group's underwriting results and provides reinsurance
for the 5.5% participation in the underwriting results of our subsidiaries, the
Exchange's financial condition could be adversely affected by insurance losses
to a greater extent than if reinsurance coverage were maintained. Management is
currently evaluating the desirability of purchasing reinsurance in light of
recent catastrophes and terrorist attacks.
THE BUSINESS AND RESULTS OF OPERATIONS OF MEMBERS OF THE PROPERTY AND
CASUALTY GROUP WILL BE ADVERSELY AFFECTED IF THE INDEPENDENT AGENTS THAT MARKET
THE PROPERTY AND CASUALTY GROUP'S PRODUCTS DO NOT MAINTAIN THEIR CURRENT LEVELS
OF PREMIUM WRITING, FAIL TO COMPLY WITH ESTABLISHED UNDERWRITING GUIDELINES OR
OTHERWISE IMPROPERLY MARKET OUR PRODUCTS.
The Property and Casualty Group markets its insurance products solely
through a network of over 1,700 independent insurance agencies. As a result, the
Property and Casualty Group is wholly dependent upon these agencies, each of
which has the authority to bind members of the Property and Casualty Group to
insurance contracts. To the extent that these agencies' marketing efforts cannot
be maintained at their current levels of volume and quality or they bind members
of the Property and Casualty Group to unacceptable insurance risks, fail to
comply with established underwriting guidelines or otherwise improperly market
our products, the results of operations and business of members of the Property
and Casualty Group will suffer.
THE BUSINESS OF MEMBERS OF THE PROPERTY AND CASUALTY GROUP MAY NOT CONTINUE
TO GROW AND MAY BE MATERIALLY ADVERSELY AFFECTED IF THE PROPERTY AND CASUALTY
GROUP CANNOT RETAIN EXISTING, AND ATTRACT NEW, INDEPENDENT AGENCIES OR IF
INSURANCE CONSUMERS INCREASE USE OF OTHER INSURANCE DELIVERY SYSTEMS.
The continued growth of the business of members of the Property and
Casualty Group is partially dependent upon the Property and Casualty Group's
ability to retain existing, and attract new, independent agencies. The following
factors are among those that may cause the
-20-
growth and retention in the number of independent agencies of the Property and
Casualty Group, and thereby growth in revenue of its members, to be slower than
it otherwise would have been:
. There is significant competition to attract independent agencies;
. Our process to select a new independent agency is intensive and
typically requires from six to nine months;
. The Property and Casualty Group has stringent criteria for new
independent agencies and requires adherence by independent agencies to
consistent underwriting standards; and
. The Property and Casualty Group may be required to reduce agents'
commissions, bonuses and other incentives, thereby reducing our
attractiveness to agencies.
The Property and Casualty Group sells insurance solely through its network
of independent agencies. Our competitors sell insurance through a variety of
delivery methods, including independent agencies, captive agencies, the Internet
and direct sales. To the extent that business migrates to a delivery system
other than independent agencies because of changing consumer preferences, the
business of members of the Property and Casualty Group will be adversely
affected.
THE EXCHANGE HAS INCURRED UNDERWRITING LOSSES IN RECENT YEARS PRIMARILY AS
A RESULT OF REDUCING PREMIUM RATES IN 1998 AND 1999 IN RESPONSE TO COMPETITIVE
CONDITIONS AND DUE TO REINSURANCE LOSSES, INCLUDING LOSSES FROM THE TERRORIST
ATTACK ON THE WORLD TRADE CENTER. TO THE EXTENT THESE UNDERWRITING LOSSES
CONTINUE, THE EXCHANGE'S POLICYHOLDERS' SURPLUS WILL BE FURTHER ADVERSELY
AFFECTED.
In 1997 and 1998, soft market conditions in the property and casualty
insurance industry created severe price competition in commercial and personal
lines of insurance, including private passenger automobile, the Property and
Casualty Group's largest line of business, of which the Exchange has a 94.5%
participation in the underwriting results. These competitive conditions resulted
in slower new policy growth and declines in policy retention rates for the
Property and Casualty Group. Management viewed these competitive effects as a
serious threat to the well-being of the Property and Casualty Group. In 1998,
following discussions with our board of directors, management decided to reduce
premium rates in 1998 and 1999 in order to retain the Property and Casualty
Group's most profitable customers. The 1998 and 1999 premium rate reductions
negatively affected the Property Casualty Group's underwriting results in 2000
and 2001. In 1999, 2000 and 2001, the Property and Casualty Group also incurred
significant underwriting losses from its non-affiliated assumed reinsurance
business, including losses from wind storms in Western
-21-
Europe in late December 1999 and from the World Trade Center terrorist attack in
September 2001.
The Property and Casualty Group has responded to underwriting losses in a
number of ways, including adopting stricter underwriting requirements;
restricting policy coverages; increasing the emphasis on reviewing existing
policies and accounts to determine which risks continue to meet underwriting
guidelines and taking appropriate action regarding those policies and accounts
that do not; continuing the focus on claims strategies to reduce claims
severity, such as reducing claims fraud; raising premium rates on its direct
lines of insurance in light of current hard market conditions; reunderwriting
all of its assumed reinsurance treaties, resulting in the cancellation of a
significant number of treaties and the reduction in total aggregate limits for
other treaties; significantly raising reinsurance premium rates; and excluding
terrorism coverage from all reinsurance treaties entered into in 2002. However,
there can be no assurance that the measures taken or that may be taken by the
Property and Casualty Group will restore the Exchange's underwriting
profitability. To the extent underwriting losses continue, the Exchange's
policyholders' surplus will be further adversely affected.
THE SURPLUS OF THE EXCHANGE HAS DECREASED IN RECENT YEARS, IN PART BECAUSE
OF DECLINES IN THE MARKET VALUE OF ITS MARKETABLE SECURITIES, INCLUDING ITS
SIGNIFICANT PORTFOLIO OF COMMON EQUITY SECURITIES. TO THE EXTENT THESE DECLINES
IN MARKET VALUE CONTINUE, THE EXCHANGE'S POLICYHOLDERS' SURPLUS WILL BE FURTHER
ADVERSELY AFFECTED.
In 1985, the Exchange increased its investments in common equities as a
core element of its investment strategy. Prior to the more recent decline in the
equity markets, the Exchange's common equities portfolio had grown at December
31, 1999 to a market value of $3.8 billion including unrealized appreciation of
$2.6 billion. However, as a result of the recent downturn in the equity markets,
the common equities portfolio of the Exchange has experienced a decline in
value.
At June 30, 2002, the Exchange had investments in marketable securities of
approximately $5.2 billion, which included investments in unaffiliated common
equity securities of approximately $2.4 billion with a cost basis of $1.3
billion. Investments in marketable securities and marketable common equity
securities comprised 78.8% and 37.4%, respectively, of the Exchange's admitted
assets at June 30, 2002. Management believes the Exchange's concentration of
investment in marketable common equity securities is greater than that of most
of its competitors. All of the Exchange's marketable security investments are
subject to market volatility. The Exchange's marketable securities have exposure
to price risk and the volatility of the capital markets and general economic
conditions. The stock market decline in 2002 has reduced the value of the
Exchange's marketable securities by $747.0 million during the first six months
of 2002 compared to $195.4 million during the first six months of 2001.
-22-
To the extent that the Exchange incurs additional investment losses
resulting from declines in the value of its marketable securities, the
Exchange's policyholders' surplus will be further adversely affected.
OUR RECENT EFFORTS TO DEVELOP TECHNOLOGY, INCLUDING INTERNET CAPABILITIES,
TO ENHANCE POLICY ADMINISTRATION AND TO IMPROVE INTERACTION WITH AGENTS MAY BE
MORE COSTLY THAN WE ANTICIPATE, MAY NOT BE COMPLETED DUE TO COST OR TECHNOLOGY
CONSIDERATIONS AND MAY INCREASE OUR EXPOSURE TO BREACHES OF PRIVACY OR SECURITY.
Customers and agents expect rapid turnaround of quotes and endorsements and
efficient services. Failure to meet these service expectations could place the
Erie Insurance Group at a competitive disadvantage. To remain competitive, the
Erie Insurance Group has undertaken an initiative, which we call
"ERIEConnection(SM)", to utilize technology, including the Internet, to automate
certain functions to facilitate quoting, underwriting and the issuing of
policies and provide these services directly to its agents via the Internet.
Such an upgrading of technology requires a sizable financial investment.
Moreover, the effectiveness of certain areas of technology remain unproven. We
completed the first major component of the program during the second quarter of
2002. Through June 30, 2002, the Erie Insurance Group has spent $73 million on
its current technology development efforts. The timing, scope and level of
spending for remaining deliverables under the program are uncertain. Actual
costs to complete our technology initiatives may exceed our anticipated costs
and lead to a reduction in profits or the termination of these technology
initiatives. In addition, use of Internet technology to connect directly with
the Property and Casualty Group's agents increases the risk of security
breaches, which may cause short-term or long-term disruptions to the Property
and Casualty Group's business operations and could lead to further and currently
unanticipated technology costs to prevent and mitigate the effects of such
security breaches.
IF RATINGS ASSIGNED TO MEMBERS OF THE PROPERTY AND CASUALTY GROUP BY
INDUSTRY RATING ORGANIZATIONS WERE SIGNIFICANTLY DOWNGRADED, THE PROPERTY AND
CASUALTY GROUP'S COMPETITIVE POSITION IN THE INSURANCE INDUSTRY WOULD BE
ADVERSELY AFFECTED.
Ratings are a factor in establishing the competitive position of insurance
companies. Members of the Property and Casualty Group receive ratings from A.M.
Best and Standard & Poor's, which are industry-accepted measures of an insurance
company's financial strength and are specifically designed to provide an
independent opinion of an insurance company's financial health and ability to
meet ongoing obligations to policyholders. Members of the Property and Casualty
Group are also rated by Weiss Ratings, Inc., which is a consumer-oriented rating
company that issues ratings designed to provide an independent opinion of an
insurance company's financial strength. Ratings are not recommendations to buy,
sell or hold our common stock and are subject to change. Each member of the
Property and Casualty Group currently has an A++ (superior) rating from A.M.
Best. Each member of the Property and Casualty Group has a rating of AApi from
Standard & Poor's. The subscript "pi"
-23-
means the rating was based on publicly available information of the Exchange.
The Exchange's rating from Weiss Ratings, Inc. was downgraded from A to B- in
July 2002, while Erie Insurance Company's rating was downgraded from B+ to B. At
that time, our other insurance subsidiaries maintained their B ratings from
Weiss Ratings, Inc.
If the Exchange or any other member of the Property and Casualty Group were
to incur underwriting losses or reductions in surplus for an extended period of
time, the ratings of such entity may be downgraded. A significant downgrade in
these ratings would reduce the competitive position of the affected member by
making it more difficult to attract profitable business in the highly
competitive property and casualty insurance market.
RISKS RELATING TO THE PROPERTY AND CASUALTY INSURANCE INDUSTRY
THE PROPERTY AND CASUALTY GROUP FACES SIGNIFICANT EXPOSURE TO TERRORISM.
The tragic World Trade Center terrorist attack resulted in staggering
losses for the insurance industry and has caused uncertainty in the insurance
and reinsurance markets. No governmental action has been taken or appears
imminent to reduce the exposure of insurers to terrorism. Accordingly, the
industry has been compelled to re-examine policy language and to address the
potential for future threats of terrorist events and losses. The Property and
Casualty Group's personal and commercial property and casualty insurance
policies were not priced to cover the risk of terrorist attacks and losses such
as those suffered in the World Trade Center terrorist attack. The Property and
Casualty Group has withdrawn from some coverages and exposures, including
terrorism, where permitted by state regulators. However, even in states where
withdrawal has been permitted, the Property and Casualty Group is still exposed
to terrorism under several lines, including personal lines and workers'
compensation, and, in most states, losses caused by an ensuing fire. It is
difficult to predict the protection afforded by the changes permitted to be made
by the Property and Casualty Group and to measure the risks associated with
possible future terrorist attacks or the success of industry initiatives to
limit exposure to such events or losses. We could incur large unexpected losses
if future terrorist attacks occur.
EVEN EXCLUDING TERRORISM EXPOSURE, THE PROPERTY AND CASUALTY GROUP FACES
THE THREAT OF SUBSTANTIAL CATASTROPHE LOSSES.
The Property and Casualty Group has experienced, and can be expected in the
future to experience, catastrophe losses that may have a material adverse impact
on our results of operations and financial condition. Catastrophes can be caused
by various events, including hurricanes, earthquakes, tornadoes, wind, hail,
fires, explosions and man-made disasters. The incidence and severity of
catastrophes are inherently unpredictable. The extent of losses from a
catastrophe is a function of two factors: the total amount of insured exposure
in the area affected by the event and the severity of the event. Most
catastrophes are localized to small geographic areas; however, events such as
hurricanes, hail and ice storms have the
-24-
potential to produce significant damage in large, heavily populated areas. For
the Property and Casualty Group, areas of major potential hurricane loss include
major metropolitan centers in the eastern United States and areas of major
potential ice storm or hail loss include major metropolitan centers in the
Mid-Atlantic and Midwestern states. Although catastrophes can cause losses in a
variety of property and casualty lines, homeowners insurance has in the past
generated the vast majority of catastrophe-related claims. The Property and
Casualty Group's proportion of its total homeowners insurance exposure in
Mid-Atlantic states having major catastrophe exposure is higher than many of its
competitors. The Property and Casualty Group currently has no reinsurance
coverage to mitigate the loss from catastrophes.
INCREASED LITIGATION AGAINST THE INDUSTRY, WILLINGNESS OF COURTS TO EXPAND
COVERED CAUSES OF LOSS, RISING JURY AWARDS, INCREASING MEDICAL COSTS AND THE
ESCALATION OF LOSS SEVERITY MAY CONTRIBUTE TO INCREASED COSTS AND TO THE
DETERIORATION OF RESERVE POSITIONS OF MEMBERS OF THE PROPERTY AND CASUALTY
GROUP.
Loss severity for the Property and Casualty Group continues to increase,
principally driven by larger court judgments and increasing medical costs in
recent years. In addition, many legal actions and proceedings have been brought
on behalf of classes of complainants, which can increase the size of judgments.
The propensity of policyholders to litigate and the willingness of courts to
expand causes of loss and the size of awards may render loss reserves inadequate
for current and future losses. Loss reserves are liabilities established by
insurers and reinsurers to reflect the estimated cost of loss payments and the
related loss adjustment expenses that the insurer or reinsurer will ultimately
be required to pay in respect of insurance or reinsurance it has written.
The Property and Casualty Group has exposure to mold claims for which there
has recently been a sharp increase in the industry generally, although the
Property and Casualty Group has not to date experienced a sharp increase in such
claims. Sometimes referred to as "sick building syndrome", tenants claiming to
suffer illnesses caused by mold may seek financial compensation from building
owners. Businesses also may claim loss-of-use business income interruption
losses. Homeowners have also been submitting claims based on mold that has
occurred from water damage. To the extent these trends continue, members of the
Property and Casualty Group may need to increase reserves and their
profitability may be adversely affected.
CHANGES IN APPLICABLE LAWS, REGULATIONS OR CHANGES IN THE WAY REGULATORS
ADMINISTERING THOSE LAWS OR REGULATIONS VIEW RELATED PARTY TRANSACTIONS COULD
MATERIALLY ADVERSELY CHANGE THE PROPERTY AND CASUALTY GROUP'S OPERATING
ENVIRONMENT AND INCREASE ITS EXPOSURE TO LOSS OR PUT IT AT A COMPETITIVE
DISADVANTAGE.
Property and casualty insurers are subject to extensive supervision in the
states in which they do business. This regulatory oversight includes, by way of
example, matters
-25-
relating to licensing and examination, rate setting, market conduct, policy
forms, limitations on the nature and amount of certain investments,
claims practices, mandated participation in involuntary markets and guaranty
funds, reserve adequacy, insurer solvency, transactions between affiliates, the
amount of dividends that may be paid and restrictions on underwriting standards.
Such regulation and supervision are primarily for the benefit and protection of
policyholders and not for the benefit of shareholders. For instance, members of
the Property and Casualty Group are subject to involuntary participation in
specified markets in various states in which it operates, and the rate levels
the Property and Casualty Group is permitted to charge do not always correspond
with the underlying costs associated with the coverage issued.
The National Association of Insurance Commissioners ("NAIC") and state
insurance regulators are re-examining existing laws and regulations,
specifically focusing on insurance company investments, issues relating to the
solvency of insurance companies, risk-based capital guidelines, interpretations
of existing laws and the development of new laws. Changes in state laws and
regulations, as well as changes in the way state regulators view related party
transactions in particular, could materially change the operating environment
for the Property and Casualty Group and significantly increase the amount of
loss to which the Property and Casualty Group is exposed after an insurance
policy has been issued.
From time to time, the automobile insurance industry in particular has been
under pressure from certain state regulators, legislators and special interest
groups to reduce, freeze or set rates at levels that do not, in our management's
view, correspond with underlying costs, including initiatives to roll back
automobile and other personal lines rates. This activity has adversely affected,
and may in the future adversely affect, the profitability of the Property and
Casualty Group's automobile insurance line of business in various states because
increasing costs of litigation and medical treatment, combined with rising
automobile repair costs, continue to increase the costs of providing automobile
insurance coverage. Adverse legislative and regulatory activity constraining the
Property and Casualty Group's ability to price automobile insurance coverage
adequately may occur in the future. The impact of the automobile insurance
regulatory environment on the results of operations of members of the Property
and Casualty Group in the future is not predictable.
The state insurance regulatory framework recently has come under increased
federal scrutiny. Congress is considering legislation that would create an
optional federal charter for insurers. Federal chartering has the potential to
create an uneven playing field for insurers. Federally chartered companies could
be subject to different regulatory requirements than state chartered insurers in
areas such as market conduct oversight, solvency regulation, guaranty fund
participation and premium tax burdens. If this occurs, federally chartered
insurers may obtain a competitive advantage over state licensed carriers.
Federal chartering also raises the specter of a matrix of regulation and costly
duplicative, or conflicting, federal and state requirements. Specific federal
regulatory developments include the potential
-26-
partial repeal of the McCarran-Ferguson Act, which currently exempts the
insurance industry from antitrust scrutiny. The partial repeal of the
McCarran-Ferguson Act poses a threat to current industry practices.
MEMBERS OF THE PROPERTY AND CASUALTY GROUP ARE SUBJECT TO ASSESSMENT,
DEPENDING UPON THEIR MARKET SHARE OF A GIVEN LINE OF BUSINESS, TO ASSIST IN THE
PAYMENT OF UNPAID CLAIMS AND RELATED COSTS OF INSOLVENT INSURANCE COMPANIES;
SUCH ASSESSMENTS COULD SIGNIFICANTLY AFFECT THE FINANCIAL CONDITION OF ANY
ASSESSED MEMBER.
Members of the Property and Casualty Group are obligated to pay assessments
under the guaranty fund laws of the various states in which they are licensed.
Generally, under these laws, an insurer is subject to assessment, depending upon
its market share of a given line of business, to assist in the payment of unpaid
claims and related costs of insolvent insurance companies. The number and
magnitude of future insurance company failures in the states in which the
Property and Casualty Group does business cannot be predicted, but resulting
assessments levied on members of the Property and Casualty Group could
significantly affect the financial condition of members of the Property and
Casualty Group.
PREMIUM RATES AND RESERVES MUST BE ESTABLISHED BY MEMBERS OF THE PROPERTY
AND CASUALTY GROUP FROM FORECASTS OF THE ULTIMATE COSTS EXPECTED TO ARISE FROM
RISKS UNDERWRITTEN DURING THE POLICY PERIOD; A MEMBER'S PROFITABILITY COULD BE
ADVERSELY AFFECTED TO THE EXTENT SUCH PREMIUM RATES OR RESERVES ARE TOO LOW.
One of the distinguishing features of the property and casualty insurance
industry in general is that its products are priced before its costs are known,
as premium rates are generally determined before losses are reported.
Accordingly, premium rates must be established from forecasts of the ultimate
costs expected to arise from risks underwritten during the policy period and may
not prove to be adequate. Further, property and casualty insurers establish
reserves for losses and loss adjustment expenses based upon estimates, and it is
possible that the ultimate liability will exceed these estimates because of the
future development of known losses, the existence of losses that have occurred
but are currently unreported and larger than historical settlements on pending
and unreported claims. The process of estimating reserves is inherently
judgmental and can be influenced by factors that are subject to variation. If
pricing or reserves established by a member of the Property and Casualty Group
are not sufficient, such member's profitability may be adversely impacted.
SUBSTANTIAL PREMIUM RATE INCREASES ARE DRAWING NEW ENTRANTS AND NEW CAPITAL
TO THE REINSURANCE MARKETS, WHICH MAY INCREASE COMPETITION AMONG PROPERTY AND
CASUALTY INSURERS AND MAY CAUSE A REDUCTION IN OUR REVENUES.
Property and casualty market conditions in the wake of the World Trade
Center terrorist attack have been characterized by closer adherence to
underwriting standards, higher deductibles, reduced coverages and limits, more
restrictive terms and conditions and
-27-
higher premium rates. As a result of these changes in the industry, substantial
new capital has entered the property and casualty insurance market. A
substantial portion of the new capital is dedicated to building the capacity of
new offshore reinsurers. This increased capital could result in lower prices for
reinsurance, which in turn would allow primary insurers to offer more
competitive prices or more favorable insurance terms and conditions or increase
capacity. Increased competition among insurers and reinsurers could also allow
the Property and Casualty Group's competitors to relax their underwriting
standards. If substantial premium rate increases were to continue, additional
new capital would likely be attracted, which would further promote the effects
of increased competition.
RISKS RELATING TO OUR CLASS A COMMON STOCK
THE PRICE OF OUR CLASS A COMMON STOCK MAY BE ADVERSELY AFFECTED BY ITS LOW
TRADING VOLUME.
The trading market for our Class A common stock is marked by limited
liquidity. Reported average daily trading volume in our Class A common stock for
the period January 1, 2002 through August 15, 2002 was approximately 32,000
shares. Of our 63.6 million shares of Class A common stock outstanding at July
17, 2002, approximately 29 million shares are available for public sale, with
the remainder held by a small number of significant shareholders. Since 1999, we
have had a stock repurchase program that authorized us to repurchase up to $120
million of our outstanding Class A common stock through December 31, 2002.
Approximately $101.9 million of Class A common stock has been repurchased under
the program to date, which has had the effect of stabilizing the price of our
Class A common stock. The program has been suspended in connection with this
offering of Class A common stock, and as a result there may be an adverse effect
on the market price of our Class A common stock.
HOLDERS OF CLASS A COMMON STOCK HAVE LIMITED VOTING RIGHTS, AND TWO
SHAREHOLDERS OF OUR CLASS B COMMON STOCK, THE H.O. HIRT TRUSTS, HAVE THE ABILITY
TO DETERMINE THE OUTCOME OF ALL MATTERS SUBMITTED FOR SHAREHOLDER APPROVAL,
EXCEPT THOSE MATTERS PERTAINING ONLY TO THE RIGHTS OF THE HOLDERS OF CLASS A
COMMON STOCK.
Our Class A common stock cannot vote for the election of directors and
generally can only vote on matters pertaining to the rights of holders of Class
A common stock. Generally, voting control of the Company is vested in the 3,050
outstanding shares of Class B common stock. The H.O. Hirt Trusts together own
2,340 shares, or 76.7%, of the outstanding Class B common stock and can
therefore together elect the entire board of directors and determine the outcome
of all matters submitted for approval of our shareholders, except those matters
pertaining only to the rights of the holders of Class A common stock.
-28-
THE VALUE OF OUR CLASS A COMMON STOCK MAY BE ADVERSELY AFFECTED BECAUSE THE
ABILITY OF OUR PRINCIPAL SHAREHOLDERS TO VOTE IN FAVOR OF A TRANSACTION THAT
WOULD RESULT IN A CHANGE OF CONTROL IS LIMITED.
The vote of the H.O. Hirt Trusts will determine the outcome of any matter
submitted for shareholder approval, except those matters pertaining only to the
rights of the holders of Class A common stock. The trust agreement governing the
H.O. Hirt Trusts provide that at least two of the three trustees, including the
corporate trustee, would be required to vote in favor of a transaction under
which we would be acquired and such action, by the terms of the trust
agreements, would be permitted only if required to maintain the health of the
Exchange. This may prevent anyone from acquiring us in a transaction that
shareholders, other than the H.O. Hirt Trusts, may consider to be in their best
interests and may consequently have a negative effect on the price of our Class
A common stock.
-29-
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus and the documents incorporated by reference into this
prospectus contain "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. These statements include certain discussions relating to underwriting,
premium and investment income volume, business strategies, profitability and
business relationships and our other business activities during 2002 and beyond.
In some cases, you can identify forward-looking statements by terms such as
"may", "will", "should", "could", "would", "expect", "plan", "intend",
"anticipate", "believe", "estimate", "project", "predict", "potential" and
similar expressions. These forward-looking statements reflect our current views
about future events, are based on assumptions and are subject to known and
unknown risks and uncertainties that may cause results to differ materially from
those anticipated in those statements. Many of the factors that will determine
future events or achievements are beyond our ability to control or predict. Such
factors include, but are not limited to, the following:
. the occurrence of future terrorist attacks;
. the impact of the World Trade Center terrorist attack on the Property
and Casualty Group, on the insurance and reinsurance industry and on the
future coverage for terrorist acts and on the economy in general;
. the impact of potential governmental intervention in the insurance and
reinsurance industry in the aftermath of the World Trade Center terrorist
attack and uncertainties relating to governmental responses to the attack;
. further development of losses from the World Trade Center terrorist
attack;
. the occurrences of natural or man-made catastrophes, such as
earthquakes, hurricanes and other severe weather-related events, with a
frequency or severity exceeding our estimates, particularly in
Pennsylvania, the District of Columbia and the other 10 states in which the
Property and Casualty Group operates;
. price declines in the equity and fixed income market;
. defaults by issuers of fixed income securities or the bankruptcy of
issuers of equity securities;
. a severe drop or rise in interest rates;
. any lowering or loss of the financial ratings of the insurers that
comprise the Property and Casualty Group;
-30-
. loss of the services of any one of our executive officers;
. general business and economic conditions;
. the loss of current policyholders or the inability to obtain new
policyholders;
. the ability to retain existing insurance agencies and attract new
independent agencies;
. the adequacy of loss reserves; and
. changes in regulations and tax laws affecting cost, availability or
demand for our products.
The forward-looking statements contained in this prospectus reflect our
views and assumptions only as of the date of this prospectus. Except as required
by law, we assume no responsibility for updating any forward-looking statements.
You should read this prospectus and the documents that we reference in this
prospectus and have filed as exhibits to the registration statement of which
this prospectus is a part, completely and with the understanding that our actual
future results may be materially different from what we expect.
We qualify all of our forward-looking statements by these cautionary
statements.
-31-
PRICE RANGE OF OUR CLASS A COMMON STOCK AND DIVIDEND HISTORY
Prices for our Class A common stock are quoted on the NASDAQ Stock
Market(SM) under the symbol "ERIE". The following table presents for the periods
indicated the high and low closing prices for our Class A common stock as
reported by the NASDAQ Stock Market(SM) and the cash dividends declared.
Price Range Cash Dividends
-------------------------
2000: High Low Declared
-------- ------------- ----------------
First Quarter ......................... $32.44 $26.50 $0.1350
Second Quarter ........................ 32.50 27.50 0.1350
Third Quarter ......................... 32.00 29.19 0.1350
Fourth Quarter ........................ 30.00 24.00 0.1525
Price Range Cash Dividends
-------------------------
2001: High Low Declared
-------- ------------- ----------------
First Quarter ......................... $30.00 $26.50 $0.1525
Second Quarter ........................ 36.12 27.54 0.1525
Third Quarter ......................... 39.55 32.70 0.1525
Fourth Quarter ........................ 40.63 36.91 0.1700
Price Range Cash Dividends
-------------------------
2002: High Low Declared
-------- ------------- ----------------
First Quarter ......................... $40.82 $37.65 $0.1700
Second Quarter ........................ 45.49 40.44 0.1700
Third Quarter
(through September 19) ............... 44.50 37.45 0.1700
The last reported sale price of our Class A common stock on September 19,
2002 was $44.25. As of June 30, 2002, there were 1,076 holders of record of our
Class A common stock.
We have paid regular quarterly cash dividends since 1942. Our board of
directors considers the declaration of cash dividends on a quarterly basis. The
payment of future dividends, if any, will be at the discretion of our board of
directors and will depend upon many factors, including:
. our earnings;
. our financial position;
. our capital requirements and those of our subsidiaries; and
. our ability to receive dividends from our subsidiaries, which is
subject to regulatory limitations.
Therefore, there can be no assurance as to the declaration of future dividends.
-32-
Although a potential source of cash for the payment of dividends to our
shareholders is dividends from our insurance subsidiaries, our insurance
subsidiaries have never paid us a dividend. Our insurance subsidiaries are
subject to state laws that restrict their ability to pay dividends.
CAPITALIZATION
The following table sets forth our capitalization as of June 30, 2002. We
will not receive any proceeds from the sale of the shares of Class A common
stock being offered hereby.
(amounts in thousands) June 30, 2002
-------------
Long-term debt ..................................................................... ---
Shareholders' equity:
Class A common stock, stated value .............................................. $ 1,955
$0.0292 per share; authorized 74,996,930 shares;
issued 67,032,000 shares and outstanding 63,694,299 shares
Class B common stock, stated value .............................................. 215
$70 per share; authorized 3,070 shares;
issued and outstanding 3,070 shares
Additional paid-in capital ...................................................... 7,830
Accumulated other comprehensive income .......................................... 25,286
Retained earnings ............................................................... 983,600
-----------
Contributed capital and retained earnings ............................... $ 1,018,886
Treasury stock, at cost (3,337,701 shares) ......................................... (99,244)
-----------
Total capitalization .................................................... $ 919,642
===========
-33-
SELECTED HISTORICAL FINANCIAL INFORMATION OF THE COMPANY
The selected consolidated financial data presented below as of or for the
years ended December 31, 1997 through 2001 is derived from our audited financial
statements. Our consolidated financial statements as of December 31, 2000 and
2001 and for each of the years in the three-year period ended December 31, 2001,
and our independent auditors' report thereon, are included elsewhere in this
prospectus and incorporated by reference herein. See "Where To Find More
Information/Incorporation by Reference". The selected consolidated financial
data presented below as of or for the six-month periods ended June 30, 2001 and
2002 are derived from our unaudited consolidated financial statements included
elsewhere in this prospectus and incorporated by reference herein. See "Where To
Find More Information/Incorporation by Reference". Our results of operations for
the six months ended June 30, 2002 are not necessarily indicative of our results
of operations that may be expected for the year ending December 31, 2002. In the
opinion of our management, all adjustments, consisting only of normal recurring
accruals, considered necessary for a fair presentation have been included. The
financial data set forth below is only a summary and should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere herein.
Six Months Ended
June 30, Year Ended December 31,
--------------------- ---------------------------------------------------------
(amounts in thousands, except per share data) 2002 2001 2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ---------- ---------- ----------
(unaudited)
OPERATING DATA:
Net revenue from management operations $ 123,649 $ 96,304 $ 184,568 $ 158,746 $ 148,518 $ 145,243 $ 134,201
Underwriting (loss) gain (9,661) (5,324) (20,463) (10,402) (3,539) 567 (2,259)
Net revenue from investment operations 23,549 30,927 18,771 75,594 63,776 50,547 42,978
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income before income taxes 137,537 $ 121,907 $ 182,876 $ 223,938 $ 208,755 $ 196,357 $ 174,920
Provision for income taxes 45,510 39,992 60,615 71,545 65,649 61,806 56,339
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income $ 92,027 $ 81,915 $ 122,261 $ 152,393 $ 143,106 $ 134,551 $ 118,581
========== ========== ========== ========== ========== ========== ==========
Operating income (1) $ 95,005 $ 80,144 $ 142,983 $ 141,364 $ 133,521 $ 129,895 $ 114,801
========== ========== ========== ========== ========== ========== ==========
PER SHARE DATA:
Net income per share $ 1.29 $ 1.15 $ 1.71 $ 2.12 $ 1.95 $ 1.81 $ 1.59
Operating income per share 1.34 1.12 2.00 1.96 1.82 1.75 1.54
Dividends declared per Class A share 0.34 0.305 0.6275 0.5575 0.4950 0.4425 0.3925
Dividends declared per Class B share 51.00 45.75 94.125 83.625 74.250 66.375 58.875
Weighted average shares outstanding 71,162 71,402 71,342 71,954 73,487 74,400 74,400
FINANCIAL POSITION:
Investments (2) $ 959,374 $ 878,187 $ 885,650 $ 853,146 $ 785,258 $ 709,417 $ 566,118
Receivables from the Exchange and affiliates 726,608 604,172 640,655 532,009 470,969 467,794 469,708
Total assets 2,088,329 1,809,577 1,935,566 1,680,599 1,518,794 1,454,062 1,292,544
Shareholders' equity 919,642 839,958 865,255 779,015 697,599 655,223 539,383
Book value per share $ 12.94 $ 11.77 $ 12.15 $ 10.91 $ 9.62 $ 8.81 $ 7.25
Cumulative shares repurchased
at December 31/June 30 3,338 3,018 3,196 2,976 1,900 0 0
- ----------------
(1) Operating income excludes net realized gain (loss) on investments and
related federal income taxes.
(2) Includes investment in Erie Family Life Insurance Company.
-34-
SELECTED HISTORICAL FINANCIAL INFORMATION OF THE EXCHANGE
The selected financial data of the Exchange presented below as of and
for the years ended December 31, 1997 through 2001 is derived from financial
statements prepared in accordance with statutory accounting principles that were
audited by our independent auditors. The selected financial data below as of and
for the six months ended June 30, 2001 and 2002 are derived from the Exchange's
unaudited financial statements prepared in accordance with statutory accounting
principles. In the opinion of management, all adjustments consisting only of
normal recurring accruals, considered necessary for a fair presentation have
been included. The financial data set forth below is only a summary. More
information about the Exchange can be found in "Erie Insurance Exchange". The
Annual Statements filed by the Exchange with the Insurance Department of the
Commonwealth of Pennsylvania are available for inspection without charge at the
Department's offices at Strawberry Square, Harrisburg, Pennsylvania. The
financial statements of the Exchange included in these annual statements are
prepared in accordance with Statutory Accounting Principles required by the NAIC
Accounting Practices and Procedures Manual, as modified to include prescribed or
permitted practices of the Commonwealth of Pennsylvania.
Six Months Ended
June 30, Year Ended December 31,
----------------------- -------------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
---------- ---------- ---------- ----------- ---------- ---------- ----------
(unaudited)
OPERATING DATA:
Premiums earned $1,386,306 $1,172,885 $2,422,600 $2,161,034 $2,039,791 $1,971,525 $1,877,270
Loss and loss adjustment expenses 1,117,656 921,690 2,150,749 1,714,487 1,509,895 1,372,705 1,375,643
Insurance underwriting and other expenses 466,004 353,401 766,304 624,622 576,031 568,149 520,648
---------- ---------- ---------- ----------- ---------- ---------- ----------
Net underwriting (loss) income $ (197,354) $ (102,206) $ (494,453) $ (178,075) $ (46,135) $ 30,671 $ (19,021)
Investment income (loss), net 39,161 130,552 (421,754) 347,582 428,874 378,845 365,393
Federal income tax expense (benefit) (36,184) (1,838) (300,257) 42,433 102,339 102,917 86,627
---------- ---------- ---------- ----------- ---------- ---------- ----------
Net income (loss) $ (122,009) $ 30,184 $ (615,950) $ 127,074 $ 280,400 $ 306,599 $ 259,745
========== ========== ========== ========== ========== ========== ==========
FINANCIAL POSITION:
Cash and invested assets $5,686,009 $6,298,901 $5,990,511 $6,357,658 $6,860,008 $5,604,496 $4,670,320
Total assets 6,571,174 6,977,695 6,998,794 6,969,746 7,415,176 6,174,590 5,204,856
Claims and unearned premium reserves 3,481,631 2,812,585 3,200,836 2,654,300 2,463,806 2,388,958 2,328,230
Total liabilities 4,060,211 3,430,235 3,953,243 2,847,861 2,660,713 2,582,998 2,490,465
Policyholders' surplus (1)(2) 2,510,963 3,547,460 3,045,551 4,121,885 4,754,462 3,591,592 2,714,391
- ------------
(1) Periods beginning after January 1, 2001 are computed taking into
consideration changes in statutory accounting principles required by the
NAIC Accounting Practices and Procedures Manual. An adjustment made on
January 1, 2001 as a result of such changes decreased policyholders'
surplus by $523.8 million.
(2) Under a practice prescribed by the Commonwealth of Pennsylvania, unearned
premium reserves are reduced (and policyholders' surplus increased) by the
amount of the management fee ultimately payable by the Exchange to us
correlating to premiums not yet earned at the respective financial
statement date. At December 31, 2001, this amount was $240.9 million.
-35-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL
CONDITION AND RESULTS OF OPERATIONS IN CONJUNCTION WITH THE "SELECTED HISTORICAL
FINANCIAL INFORMATION OF THE COMPANY" AND THE CONSOLIDATED FINANCIAL STATEMENTS,
AND THE RELATED NOTES, INCLUDED ELSEWHERE IN THIS PROSPECTUS AND INCORPORATED BY
REFERENCE HEREIN.
GENERAL
We operate predominantly as a provider of management services to Erie
Insurance Exchange (the "Exchange") and also as an underwriter of insurance
through our subsidiaries. We have served since 1925 as the attorney-in-fact, or
management company, for the policyholders of the Exchange, an unincorporated
association that is a reciprocal insurance exchange. The financial results of
the Exchange are not consolidated with ours. The Exchange and its property and
casualty subsidiary and our three property and casualty subsidiaries
(collectively, the "Property and Casualty Group") write personal and commercial
lines property and casualty coverages exclusively through approximately 8,000
independent agents and pool their underwriting results. For our services as
attorney-in-fact, we charge the Exchange a management fee calculated as a
percentage, currently 25%, of the direct written premiums of the Property and
Casualty Group.
Under the pooling arrangement, all property and casualty insurance
business of the five property and casualty insurance companies that comprise the
Property and Casualty Group is pooled within the Exchange as the pooling entity.
Our insurance subsidiaries, Erie Insurance Company and Erie Insurance Company of
New York, share in the underwriting results of the pool through retrocession.
Erie Insurance Company has a 5.0% participation, Erie Insurance Company of New
York has a 0.5% participation and the Exchange has a 94.5% participation in the
pooled underwriting results. These participation percentages are determined by
our board of directors. We also own 21.6% of the common stock of Erie Family
Life Insurance Company, an affiliated life insurance company, of which the
Exchange owns 53.5% and public shareholders, including its officers and
directors, own 24.9%.
OPERATING RESULTS
SIX MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2001
FINANCIAL OVERVIEW
Our consolidated net income for the six months ended June 30, 2002
increased 12.3% to $92.0 million, from $81.9 million during the same period in
2001. Net revenue from management operations grew as a result of a 22.8%
increase in direct written premiums of the Property and Casualty Group. Results
of our insurance underwriting operations declined in the first half of 2002
compared to the same period in 2001 as a result of wind
-36-
storm-related catastrophe losses and increased technology spending related to
our eCommerce initiative. In addition, charges of $10.7 million were taken for
impaired investments contributing to net realized losses on investments in the
first half of 2002.
For the six months ended June 30, 2002, operating income (net income
excluding net realized (losses) gains and related federal income taxes)
increased 18.5% to $95.0 million, from $80.1 million reported for the same
period in 2001. Our operating income per share increased to $1.34 per share in
the first half of 2002 from $1.12 per share for the same period in 2001, an
increase of 18.9%.
We have benefited during this period, and expect to continue to
benefit, from premium increases by the Property and Casualty Group that have
resulted from pricing actions approved by regulators through June 30, 2002.
These premium increases accounted for $49.4 million in increased premiums for
the Property and Casualty Group for the six months ended June 30, 2002. The
majority of the anticipated increase stems from the private passenger and
commercial automobile lines of business as well as the homeowner line of
business.
ANALYSIS OF MANAGEMENT OPERATIONS
Our management fee revenue for serving as attorney-in-fact for the
policyholders of the Exchange increased 22.8% to $384.8 million for the six
months ended June 30, 2002, from $313.5 million for the same period in 2001.
The direct written premium of the Property and Casualty Group upon
which our management fee revenue is calculated grew 22.8% to $1,539.3 million
during the first six months of 2002, from $1,254.0 million for the same period
in 2001. Increases in average premium per policy, improvements in new policy
growth and continuing favorable policy retention rates were all contributing
factors in the growth of direct written premium.
The average premium per policy increased 8.4% to $855 for the rolling
twelve months ended June 30, 2002, from $789 for the same period ended June 30,
2001. In private passenger automobile, which accounted for 52.2% of the direct
written premiums of the Property and Casualty Group and over 1.5 million
policies in force, the average premium per policy increased 5.7% to $1,000 for
the rolling twelve months ended June 30, 2002, from $946 during the same period
ended June 30, 2001.
Continued growth in the number of new policies also drove the gains
experienced in the Property and Casualty Group's direct written premium.
Personal lines new business premium grew 45.4% for the first six months of 2002
to $170.0 million, from $116.9 million, while commercial lines new premium grew
58.3% to $107.2 million, from $67.8 million, during the same period in 2001.
Policies in force increased at an annualized rate of 10.8% to 3,304,624 at June
30, 2002, from 2,983,645 at June 30, 2001.
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Policy retention remained strong at 90.9% and 91.0% for the periods
ended June 30, 2002 and 2001, respectively, for all lines of business combined.
Changes in the management fee rate can affect our revenue and net
income significantly. If our board of directors had reduced the management fee
rate 1% (from 25% to 24%) for the six-month periods ended June 30, 2002 and
2001, the decrease would have resulted in a reduction of our management fee
revenue of $15.4 million and $12.5 million, respectively. The net income per
share impact would have been a reduction of $0.14 and $0.11 for the six-month
periods ended June 30, 2002 and 2001, respectively.
Service agreement revenue grew by 14.1% to $15.1 million for the six
months ended June 30, 2002, from $13.3 million for the same period in 2001.
Service agreement revenue includes service charges we collect from
policyholders who pay premiums in installments on policies written by the
Property and Casualty Group. Such service charges amounted to $9.0 million and
$7.7 million for the six months ended June 30, 2002 and 2001, respectively. This
increase during the first six months of 2002 is attributable to an increase in
the number of policies for which premiums are paid in installments.
Service agreement revenue also includes service income received from
the Exchange as compensation for the management and administration of voluntary
assumed reinsurance from non-affiliated insurers. These fees totaled $6.1
million and $5.5 million for the six months ended June 30, 2002 and 2001 on net
voluntary assumed reinsurance premiums of $88.3 million and $79.7 million,
respectively. During the 2002 reinsurance renewal season, the Exchange has been
obtaining significant rate increases on contracts it is renewing. However, the
Exchange is reducing its aggregate exposure in non-affiliated voluntary assumed
reinsurance by not renewing unprofitable business, excluding terrorism coverage
and restricting exposure on certain types of risks. This reduction affects the
level of service income received from the Exchange because the fee is based on a
percentage of non-affiliated assumed reinsurance premiums.
The cost of management operations increased 19.9% for the first six
months of 2002 to $276.3 million, from $230.4 million during the same period in
2001. Commissions to independent agents are the largest component of the cost of
management operations, and include scheduled commissions earned by independent
agents on premiums written, as well as promotional incentives for agents and
agent contingency awards. Commission costs totaled $196.7 million for the first
six months of 2002, a 23.5% increase over the $159.2 million reported in the
same period of 2001. Growth in commission costs was slightly greater than the
growth in direct premium written in the first six months of 2002, primarily due
to increased accelerated commissions as well as an accrual for a promotional
incentive contest for agents that will run through 2002.
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Accelerated commissions are offered to newly recruited agents in
addition to normal commission schedules. For the six months ended June 30, 2002,
additional charges for accelerated commission costs totaled $4.4 million,
compared to $3.3 million for the same period one year ago due to an increase in
the number of agents. For the six months ended June 30, 2002, the accrual
recorded for a sales incentive contest was $1.2 million. There was no similar
sales contest in 2001.
The cost of management operations, excluding commission costs,
increased 11.7% for the six months ended June 30, 2002 to $79.6 million, from
$71.2 million for the same period in 2001. These costs include amounts related
to information technology hardware and infrastructure from our eCommerce
initiative launched in June 2001. For the first half of 2002, these costs
totaled $2.3 million, compared to $0.1 million in the same period in 2001.
Personnel costs also increased as employment grew by 7.1%, driven by
strong policy sales growth. In addition, temporary labor costs were incurred to
assist with a company-wide rollout of personal computers. As a result, salaries,
wages, benefits and payroll taxes for the first half of 2002 increased 9.2% to
$46.8 million, from $42.8 million for the same period in 2001.
Our gross margin from management operations (net revenue divided by
total revenue) increased to 30.9% in the first six months of 2002, compared to
the gross margin of 29.5% reported in the same period of 2001.
ANALYSIS OF INSURANCE UNDERWRITING OPERATIONS
The underwriting loss from the insurance underwriting operations of
Erie Insurance Company and Erie Insurance Company of New York, which together
assume a 5.5% share of the direct and non-affiliate assumed underwriting results
of the Property and Casualty Group under the intercompany pooling arrangement,
increased to $9.7 million during the first six months of 2002 compared to an
underwriting loss of $5.3 million during the same period in 2001. Losses of $3.5
million resulting from spring storm-related catastrophes were partly responsible
for the increased underwriting loss for 2002. The per share impact, after
federal income taxes, was about $0.03 per share for the first six months of
2002. The underwriting results for the first six months of 2002 also reflect
increased underwriting expenses related to our eCommerce technology program and
assigned risk buyout program costs. In addition, our share of catastrophe losses
was $3.9 million for the six months ended June 30, 2002, compared to $0.1
million for the same period in 2001.
Our insurance subsidiaries' share of the Property and Casualty Group's
direct business generated net underwriting losses of $10.5 million and $4.8
million for the six months ended June 30, 2002 and 2001, respectively. The
firming of automobile insurance pricing in 2001 by the industry in response to
deteriorating loss cost trends allowed the Property and Casualty Group to begin
raising automobile insurance prices in order to improve underwriting
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profitability. For one-year policies, which is all we write, rate increases
generally take 24 months to be reflected fully in earned premium.
In late 2001, we took measures to improve the underwriting results from
our non-affiliated voluntary assumed reinsurance book of business. The effects
of these measures will be to lower our exposure to loss by excluding terrorism
coverage on certain contracts, not renewing unprofitable contracts and, at the
same time, raising pricing substantially. Pricing in the reinsurance marketplace
has firmed considerably since the World Trade Center terrorist attack and we are
obtaining significant price increases in our 2002 contract renewals.
Our insurance subsidiaries' share of the Property and Casualty Group's
unaffiliated voluntary net assumed reinsurance business generated net
underwriting income of $0.8 million and a net underwriting loss of $0.5 million
in the first six months of 2002 and 2001, respectively. There was no additional
reserve development in 2002 relating to our insurance subsidiaries' 5.5% share
of the Property and Casualty Group's estimated incurred reinsurance loss of $150
million from the World Trade Center terrorist attack. Through June 30, 2002,
loss payments made by the Property and Casualty Group related to the terrorist
attack have totaled $30.4 million with an additional $119.6 million established
as reserves for case and incurred but not reported claims. Incurred but not
reported claims are claims for indemnity against losses that have been incurred
by an insurer or reinsurer that have not yet been reported to the insurer or
reinsurer and include future developments on losses that have been reported to
the insurer or reinsurer.
A dispute concerning whether the World Trade Center terrorist attack
should be considered one or two insurable events is currently being litigated.
Our $150 million estimated incurred loss, which was recorded in the third
quarter of 2001, anticipates that the World Trade Center terrorist attack is
considered one event. If the attack is considered as two events, the total
potential exposure for the Property and Casualty Group would increase between
$50 million and $75 million. The effect on us, as a result, would be an
additional loss of between $2.7 million and $4.1 million out of this amount.
Taking into consideration the excess of loss reinsurance agreement, the net
impact of such potential additional losses would be minimal to our results of
operations or financial condition.
An all-lines aggregate excess of loss reinsurance agreement with the
Exchange limits the ultimate net losses of Erie Insurance Company and Erie
Insurance Company of New York. Under the reinsurance agreement, once Erie
Insurance Company and Erie Insurance Company of New York sustain ultimate net
losses and allocated loss expenses in an accident year that exceed an amount
equal to 72.5% of Erie Insurance Company's and Erie Insurance Company of New
York's net premiums earned, the Exchange will be liable for 95% of the amount of
such excess up to, but not exceeding, an amount equal to 95% of 15% of Erie
Insurance Company's and Erie Insurance Company of New York's net premium earned.
Erie Insurance Company and Erie Insurance Company of New York retain the
remaining 5% of such layer as well as ultimate net losses and allocated loss
expenses in excess of 87.5% of Erie
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Insurance Company's and Erie Insurance Company of New York's net premiums
earned. Erie Insurance Company and Erie Insurance Company of New York pay a
premium to the Exchange equal to 1.01% of their net premium earned, subject to a
minimum premium of $800,000 for each annual period. Net premiums means gross
premiums net of reinsurance premiums. The premium paid to the Exchange for the
agreement totaled $0.9 million for each of the six-month periods ended June 30,
2002 and 2001. Recoveries during the first six months of 2002 amounted to $1.6
million, compared to recoveries of $0.6 million for the same period one year
ago. No cash payments have been made between the companies in 2002 for
recoveries under this agreement since the recoveries are recorded based on
reserved but not yet paid losses.
During 2001, we and all member companies of the Property and Casualty
Group entered into a cost-sharing agreement for information technology
development. This agreement describes how member companies of the Property and
Casualty Group will share the costs to be incurred for the development of new
customer relationship management and Internet-enabled property and casualty
policy administration system. This agreement provides that the application
development costs and the related enabling technology costs, such as technical
infrastructure and architectural tools, will be shared among the property and
casualty insurance companies in a manner consistent with the sharing of
insurance transactions under the existing intercompany pooling arrangement.
These technology costs are included in our policy acquisition and other
underwriting expenses. Our share of eCommerce initiative expenses covered under
the cost sharing agreement amounted to $2.1 million and $0.2 million for the
six-month periods ended June 30, 2002 and 2001, respectively. These shared costs
will continue to be incurred in future periods as the program proceeds.
As part of the eCommerce initiative, a significant portion of our
information technology staff have been deployed to work on the eCommerce
program. As such, certain overhead expenses of these employees are currently
being allocated to the Property and Casualty Group under the cost sharing
agreement. However, once the eCommerce program is completed and staff are
reassigned to non-eCommerce tasks, many of these overhead costs will again be
recognized by us in our cost of management operations.
We experienced an increase in costs associated with assigned risk
buyout programs during the first six months of 2002. The costs in the first six
months of 2002 were $0.5 million, compared to $40,000 for the same period in
2001. The buyout programs include Limited Assignment Distribution ("LAD")
agreements, which cover personal automobile risks, and Commercial Limited
Assignment Distribution ("CLAD") agreements, which cover commercial automobile
risks. The Property and Casualty Group has a CLAD program in Pennsylvania and
both LAD and CLAD programs in New York, Illinois, Virginia, West Virginia and
Tennessee. These programs provide that a servicing carrier perform all
administrative functions relative to the assigned risk policies, including
collecting premiums and making payments for losses and loss adjustment expenses.
The Property and Casualty
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Group makes payments to the servicing carrier, which includes an administrative
fee, as well as a fee for rate inadequacy costs above the collected premium.
The increase in LAD/CLAD expense is almost exclusively attributable to
the buy-out program in the State of New York, which had costs of $0.5 million,
compared to $40,000 during the first six months of 2002 and 2001, respectively.
The rise in costs in New York State is the result of significant increases in
both the population of assigned risk policies and the deteriorating rate
adequacy of the New York State residual market. A residual market consists of
consumers who are unable to purchase insurance in the voluntary market due to a
variety of factors. In addition, the Property and Casualty Group's market share
in the state has increased, resulting in additional assigned risk policies being
allocated to the Property and Casualty Group.
The combined ratio computed under generally accepted accounting
principles ("GAAP") for our property and casualty insurance underwriting
operations was 112.4% and 108.1% for the six months ended June 30, 2002 and
2001, respectively. The GAAP combined ratio represents the ratio of loss, loss
adjustment, acquisition and other underwriting expenses and dividends incurred
to premiums earned. This ratio was affected by 2.6 combined ratio points related
to eCommerce expenses and by 5.1 combined ratio points related to catastrophe
losses in the first six months of 2002. The GAAP combined ratio for our
property/casualty operations, excluding eCommerce costs and catastrophe losses,
was 104.7% for the six months ended June 30, 2002.
ANALYSIS OF INVESTMENT OPERATIONS
Our net revenue from investment operations for the first six months of
2002 declined 23.9% to $23.5 million, from $30.9 million in the same period of
2001. As a result of impairment charges taken in the first half of 2002, we
realized net losses on investments of $4.6 million, compared to realized gains
of $2.7 million in the same period of 2001. The impairment charges were for
fixed maturity and non-redeemable preferred stock investments, which totaled
$10.7 million. Net realized losses included charges related to the WorldCom
Group securities totaling $5.7 million.
For the six months ended June 30, 2002, our net investment income
increased 9.5% to $26.8 million, compared to $24.5 million for the same period
one year ago. The growth in net investment income was offset by cash outflows we
used to repurchase shares of our Class A common stock. Increases in investments
in taxable bonds contributed to the growth in net investment income for the
first six months of 2002.
Our equity in earnings of limited partnerships totaled $0.3 million and
$1.5 million for the six months ended June 30, 2002 and 2001, respectively.
Private equity and fixed income limited partnerships realized losses of $3.2
million for the six months ended June 30, 2002, compared to earnings of almost
$0.6 million for the same period in 2001. Our earnings from
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real estate limited partnerships were $3.5 million for the six months ended June
30, 2002, compared to earnings of $0.9 million for the same period in 2001. Our
June 30, 2002 earnings included impairment charges totaling almost $1.4 million
in private equity limited partnerships where we considered declines in value to
be other than temporary.
Our share of the earnings of Erie Family Life Insurance Company totaled
$1.0 million during the first six months of June 30, 2002, down from the $2.2
million recorded for the same period in 2001. The decrease in the level of
earnings from our investment in Erie Family Life Insurance Company is related to
impairment charges recorded on investments by Erie Family Life Insurance Company
totaling $9.0 million, which resulted in net realized losses for Erie Family
Life Insurance Company. Our investment in Erie Family Life Insurance Company is
accounted for under the equity method of accounting.
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
FINANCIAL OVERVIEW
Our consolidated net income in 2001 was $122.3 million, a decrease of
19.8% from net income of $152.4 million in 2000, which in turn represented an
increase of 6.5% from net income of $143.1 million in 1999. Gains made in our
management operations, including a 15.1% increase in management fee revenue in
2001 over 2000 and a 7.5% increase in 2000 over 1999, were outpaced by losses
experienced in our insurance underwriting operations and reduced levels of
income from investment operations in 2001. In 2000, gains in our management and
investment operations outpaced losses experienced in our insurance underwriting
operations. Our 2001 underwriting loss resulted from increased losses in the
direct business of our property and casualty subsidiaries, primarily in private
passenger and commercial automobile and workers' compensation insurance, as well
as assumed reinsurance losses, some of which relate to the World Trade Center
terrorist attack. We recognized $31.9 million in net realized losses from
investments in 2001 on the sale of securities and related charges for other than
temporary impairments of equity securities and limited partnerships. There were
no similar impairments in 2000 or 1999. Our 2000 underwriting loss stemmed from
increased losses in private passenger automobile and several commercial lines of
business. Revenue from our investment operations increased 18.5% in 2000 from
1999 as our cash flows were reinvested for higher returns and our equity
earnings in limited partnerships grew substantially over 1999.
Our operating income (net income excluding realized gains/losses and
related federal income taxes) increased by 1.1% in 2001, to $143.0 million from
$141.4 million in 2000, and 5.9% in 2000 from $133.5 million in 1999. Operating
income per share for 2001 was $2.00 per share, an increase of 2.0% from $1.96
per share in 2000, which in turn represented an increase of 8.1% from $1.82 per
share in 1999. Operating income in 2001 reflected a third quarter after-tax
charge of $3.8 million, or $0.06 per share, from the World Trade Center
terrorist attack and a fourth quarter after-tax charge of $6.9 million, or
almost $0.10 a share, for severance
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charges related to the retirement of our chief executive officer. Our operating
income in 2000 reflected adverse developments on assumed reinsurance losses from
the catastrophic wind storms that devastated Europe in December 1999, which
resulted in a loss of $1.4 million, or $0.01 per share, after federal income
taxes.
ANALYSIS OF MANAGEMENT OPERATIONS
Our net revenue from management operations rose 16.3% to $184.6 million
in 2001 from $158.7 million in 2000 and 6.9% in 2000 from $148.5 million in
1999. Gross margins from management operations were 27.9% in 2001 compared to
gross margins of 27.6% in 2000 and 28.1% in 1999.
Our management fee revenue rose $83.3 million, or 15.1%, to $635.0
million in 2001 from $551.6 million in 2000 and $38.3 million, or 7.5%, in 2000
from $513.4 million in 1999. The direct and affiliated assumed premiums of the
Exchange grew 15.1% in 2001 to $2,539.9 million from $2,206.6 million in 2000
and grew by 7.5% in 2000 from $2,053.5 million in 1999. Increases in average
premium per policy, improvements in new policy growth and favorable policy
retention rates were all contributing factors in the growth. Firming pricing in
2001 for commercial and personal insurance allowed the Property and Casualty
Group to price its products more favorably while maintaining their competitive
advantage in the marketplace. The year-to-year growth rate of direct written
premium in the fourth quarter was 18.9%, up from 14.8% growth in the third
quarter, 14.0% growth in the second quarter and 12.8% growth in the first
quarter of 2001.
The average premium per policy increased 6.1% to $817 in 2001 from $770
in 2000, and 0.9% in 2000 from $763 in 1999. For private passenger automobile
(which accounted for 54.6% of the direct written premiums of Property and
Casualty Group during 2001 with over 1.4 million policies in force), the average
premium per policy increased 3.1% to $967 in 2001 from $938 in 2000, and
decreased 1.6% in 2000 from $954 in 1999.
Continued improvement in new policy growth also drove the gains
experienced in the Property and Casualty Group's direct written premiums.
Policies in force increased 8.5% to 3.1 million in 2001 from 2.9 million in
2000, and 6.5% in 2000, from 2.7 million in 1999. Policy retention remained
strong at 90.9%, 91.0% and 90.5% during 2001, 2000 and 1999, respectively, for
all lines of business combined.
Changes in the management fee rate can affect our revenue and net
income significantly. If our board of directors had decreased the management fee
rate 1% (from 25% to 24%) for 2001, 2000 and 1999, the decrease would have
resulted in a reduction of our management fee revenues of $25.4 million, $22.1
million and $20.5 million, respectively, and a per share reduction in net income
of $0.23, $0.20 and $0.18, respectively.
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Our service agreement revenue grew 20.2% to $27.2 million in 2001 from
$22.7 million in 2000, and 46.8% in 2000 from $15.4 million in 1999. Service
agreement revenue earned for the management and administration of the Exchange's
voluntary assumed reinsurance from non-affiliated insurers, totaled $11.3
million, $10.1 million and $8.2 million on net voluntary assumed reinsurance
premiums of $160.7 million, $145.0 million and $116.6 million for 2001, 2000 and
1999, respectively.
Service charges we collect from policyholders who pay premiums in
installments on policies written by the Property and Casualty Group amounted to
$16.0 million, $12.5 million and $7.3 million in 2001, 2000 and 1999,
respectively. The 2001 and 2000 growth was positively affected by service charge
increases from $2 to $3 per installment for policies renewing in most states
beginning in the second quarter of 2000.
The cost of management operations rose 14.9% to $477.6 million in 2001,
from $415.6 million in 2000, and 9.3% in 2000 from $380.3 million in 1999.
Commissions to independent agents, which are the largest component of the cost
of management operations, include scheduled commissions earned by independent
agents on premiums written, as well as promotional incentives for agents and
agent contingency awards. Agent contingency awards are based upon a three-year
average of the underwriting profitability of the direct business written and
serviced within the Property and Casualty Group by the independent agent.
Commission costs rose 14.3% to $323.1 million in 2001, from $282.7 million in
2000, and 7.5% in 2000 from $263.1 million in 1999. Commission costs grew at a
slower rate relative to the growth in direct premiums written in 2001 as a
result of lower accruals for agent contingency awards compared to 2000. The
provision for agent contingency awards totaled $15.7 million, $18.3 million and
$19.9 million in 2001, 2000 and 1999, respectively. Commission costs, excluding
agent contingency awards, increased 16.2% in 2001 compared to 2000, and 9.0% in
2000 compared to 1999, which is in line with the increase in direct written
premiums.
Cost of our management operations, excluding commission costs,
increased 16.4% in 2001 to $154.6 million, from $132.8 million in 2000, and
increased 13.3% in 2000 from $117.2 million in 1999, due primarily to increases
in personnel costs. Our personnel costs totaled $94.4 million, $79.3 million and
$69.5 million in 2001, 2000 and 1999, respectively. A portion of the 2001
increase in personnel costs resulted from recognition of the severance
obligation related to the retirement of our president and chief executive
officer on January 18, 2002. We recorded a severance charge in the fourth
quarter 2001 of $10.7 million. Personnel costs, excluding the severance charge,
rose 5.5% in 2001 due to increases in employee pay rates and staffing levels.
Increases in 2000 over 1999 were attributable to pay rate increases and the
introduction of an incentive compensation program for branch sales employees.
During 2001, we also incurred information technology infrastructure
expenditures related to our eCommerce program that were not subject to the
cost-sharing agreement for information technology. These eCommerce program costs
were included in the cost of management operations and totaled $1.6 million in
2001.
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ANALYSIS OF INSURANCE UNDERWRITING OPERATIONS
We recorded underwriting losses of $20.5 million, $10.4 million and
$3.5 million in 2001, 2000 and 1999, respectively. The underwriting results in
2001 reflect higher losses experienced in private passenger automobile, and
commercial automobile and workers' compensation lines of business, as well as
losses from assumed reinsurance.
Premiums earned increased 11.3% to $137.6 million in 2001, from $123.7
million in 2000, and 5.5% in 2000 from $117.2 million in 1999. The average
premium per policy of the Property and Casualty Group was $817, $770 and $763 in
2001, 2000 and 1999, respectively. Losses and loss adjustment expenses incurred
increased 17.7%, to $117.2 million in 2001 from $99.6 million in 2000, and 13.5%
in 2000 from $87.7 million in 1999.
Our property and casualty insurance subsidiaries' share of the Property
and Casualty Group's direct business generated net underwriting losses of $16.4
million, $6.1 million and $0.5 million in 2001, 2000 and 1999, respectively. In
2001, the Property and Casualty Group continued to experience a decrease in loss
frequency, although loss severity continued to rise. The higher loss costs in
2001 also include adverse development of prior accident year losses amounting to
$5.9 million, net of reinsurance recoveries. In 1998 and 1999, the Property and
Casualty Group lowered prices in the private passenger automobile lines of
insurance in response to extremely competitive market conditions and improving
loss trends in automobile insurance. The firming of automobile pricing in 2001
by the industry in response to deteriorating loss cost trends allowed the
Property and Casualty Group to begin raising automobile insurance prices in
order to improve underwriting profitability. Because all policies issued by the
Property and Casualty Group are for a one-year term, it will take 24 months
before the full impact of 2001 rate increases are recognized in earned premiums
of Erie Insurance Group.
Our insurance subsidiaries' unaffiliated voluntary assumed reinsurance
business generated net underwriting losses of $4.1 million, $4.3 million and
$3.0 million in 2001, 2000 and 1999, respectively. Our 5.5% share of the
Property and Casualty Group's estimated incurred reinsurance losses of $150
million from the World Trade Center terrorist attack contributed to the
increased loss in 2001. Our share of these losses totaled $8.3 million in 2001.
During 2001, our property and casualty insurance subsidiaries, Erie
Insurance Company and Erie Insurance Company of New York recorded $7.2 million
in reinsurance recoveries under the excess of loss reinsurance agreement with
the Exchange. Of the total recoveries in 2001, $6.5 million related to accident
year 2001, including the losses related to the World Trade Center terrorist
attack, with the balance pertaining to the 1999 accident year. The total
recoverable reduced our loss and loss adjustment expenses in 2001. No cash
payments were made between the companies in 2001 for these recoveries since the
recoveries
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were recorded based on reserved but yet unpaid losses. No such recoveries were
recognized in calendar years 2000 or 1999.
Under the cost sharing agreement for information technology
development, our policy acquisition and other underwriting expenses include our
property and casualty insurance subsidiaries' share of costs related to our
eCommerce initiative totaling $1.3 million for 2001. No such costs were incurred
in 2000 or 1999.
The 2001 combined ratio for our property and casualty insurance
underwriting operations calculated under GAAP was 114.9%, compared to 108.4% in
2000 and 103.0% in 1999. During 2001, 2000 and 1999, the Company's share of
catastrophe losses from direct business amounted to $1.6 million, $2.1 million
and $4.4 million, respectively. The GAAP combined ratio for 2001, 2000 and 1999,
excluding catastrophe losses on direct business, was 113.7, 106.7 and 99.3,
respectively.
During 2001, we received notification of the insolvency of the Reliance
Insurance Group. As a result, the Property and Casualty Group companies recorded
an estimated assessment of $36.8 million, before consideration of potential
premium tax recoveries of $5.9 million. Our share of this assessment was $1.7
million and was recorded in the policy acquisition and other underwriting
expenses during the fourth quarter of 2001. This estimate was based upon
preliminary data relating to this insolvency and is subject to change as more
information becomes available.
ANALYSIS OF INVESTMENT OPERATIONS
Our net revenue from investment operations in 2001 decreased by 75.2%
to $18.8 million, compared to $75.6 million in 2000, compared to an increase of
18.5% in 2000 from $63.8 million in 1999. In 2001, the equity markets declined
and recovery was further slowed by the World Trade Center terrorist attack. As a
result, we experienced declines in value in our investment portfolios over the
past year. Net realized losses totaled $31.9 million in 2001 compared to
realized gains of $17.0 million in 2000 and $14.7 million in 1999. We recognized
realized losses in 2001 as a result of the sale of securities and charges for
other than temporary impairments of preferred stock and limited partnerships.
The sale of investments in a loss position in 2001 was part of a proactive
year-end tax selling strategy. Net realized losses from sales of securities
totaled $27.3 million, of which we recovered $9.6 million in federal income
taxes paid in 1998, 1999 and 2000. Of this total realized loss, $4.5 million
relate to sales of securities of Enron Corporation and its related legal
entities. Impairment charges of investments with declines in value considered by
management to be other than temporary totaled $4.6 million in 2001 and $1.3
million in 2000. There were no such impairment charges recorded in 1999.
Net investment income rose 3.1% to $49.9 million in 2001 and 11.7% to
$48.4 million in 2000 from $43.3 million in 1999. The growth in investment
income for 2001, 2000 and 1999
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was offset by cash outflows we used to repurchase $93.4 million of our Class A
common stock through December 31, 2001.
Our equity in losses of limited partnerships were $7,000 in 2001,
compared to earnings of $4.7 million and $0.6 million in 2000 and 1999,
respectively. Private equity and fixed income limited partnerships investments
we held realized losses of $1.4 million in 2001 compared to earnings of $2.8
million in 2000 and losses of $0.3 million in 1999. Earnings on our real estate
limited partnerships were $1.4 million in 2001, compared to $1.9 million in 2000
and $0.9 million in 1999.
Our share of the earnings of Erie Family Life Insurance Company totaled
$0.8 million in 2001, down from $5.5 million in 2000 and $5.0 million in 1999.
The decrease in level of earnings from our investment in Erie Family Life
Insurance Company is related to Erie Family Life Insurance Company's sales of
investments in 2001 resulting in net realized losses on that company's statement
of operations.
FINANCIAL CONDITION
JUNE 30, 2002 AND 2001
At June 30, 2002 and 2001, our investment portfolio of investment-grade
bonds, common stock, preferred stock and cash and cash equivalents totaled $843
million and $774 million, respectively, representing 40.4% and 42.8% of our
total assets.
At June 30, 2002 and 2001, the carrying value of our fixed maturity
investments represented 69.3% and 62.4%, respectively, of our total invested
assets. Our fixed maturity investments consisted of 98.0% and 96.2% of
high-quality marketable bonds and redeemable preferred stock, all of which were
rated at investment-grade levels (above Ba/BB), at June 30, 2002 and 2001,
respectively. Included in this investment-grade category at June 30, 2002 were
$249 million, or 39.2%, and at June 30, 2001 were $207 million, or 39.8%,
respectively, of the highest quality bonds and redeemable preferred stock rated
Aaa/AAA or Aa/AA or bonds issued by the United States government.
At June 30, 2002, the net unrealized gain on fixed maturities, net of
deferred taxes, amounted to $7.7 million, compared to $9.0 million at June 30,
2001.
At June 30, 2002 and 2001, equity securities held by the Company
included net unrealized gains of $14.5 million and $12.0 million, respectively,
net of deferred taxes.
At June 30, 2002, our limited partnership investments increased to
$87.0 million from $73.0 million at June 30, 2001. Fixed income and real estate
limited partnerships comprised 42.8% and 30.6% of the total limited partnerships
at June 30, 2002 and 2001, respectively, while private equity limited
partnerships comprised 57.2% and 69.4%, respectively.
-48-
DECEMBER 31, 2001, 2000 AND 1999
At December 31, 2001, 2000 and 1999, our investment portfolio of
investment-grade bonds, common stock, preferred stock and cash and cash
equivalents totaled $824.6 million, $758.4 million and $714.5 million
respectively, representing 42.6%, 46.1% and 47.1%, respectively, of our total
assets.
At December 31, 2001, 2000 and 1999, the carrying value of our fixed
maturity investments represented 66.6%, 65.6% and 64.9% of our total invested
assets, respectively.
Our fixed maturity investments consisted 96.9%, 96.9% and 97.9% of
high-quality, marketable bonds and redeemable preferred stock, all of which were
rated at investment-grade levels (above Ba/BB), at December 31, 2001, 2000 and
1999, respectively. Included in this investment-grade category at December 31,
2001 were $230.2 million, or 41.1%, at December 31, 2000, $220.8 million or
41.5%, and at December 31, 1999, $225.7 million or 46.5%, of the highest quality
bonds and redeemable preferred stock rated Aaa/AAA or Aa/AA or bonds issued by
the United States government.
At December 31, 2001, the net unrealized gain on fixed maturities, net
of deferred taxes, amounted to $10.7 million, compared to $4.8 million at
December 31, 2000 and a net realized loss of $2.5 million at December 31, 1999.
At December 31, 2001, 2000 and 1999, equity securities held by the
Company included net unrealized gains of $22.1 million, $12.7 million and $28.5
million, respectively, net of deferred taxes.
During 2001, limited partnership investments increased to $81.6 million
from $68.2 million at December 31, 2000 and $39.1 million at December 31, 1999.
Fixed income and real estate limited partnerships, which comprised 34.5%, 28.6%
and 49.9% of the total limited partnerships at December 31, 2001, 2000 and 1999,
respectively, produced a predictable earnings stream while private equity
limited partnerships, which comprised 65.5%, 71.4% and 50.1% of the total
limited partnerships, tend to provide a less predictable earnings stream but the
potential for greater long-term returns.
COVERED LOSSES AND LOSS RESERVES
Loss reserves are set at full expected cost, except for loss reserves
for workers' compensation that were discounted at 2.5% in 2001 and 2000.
Inflation is implicitly provided for in the reserving function through analysis
of costs, trends and reviews of historical reserving results.
The insurance companies we own and manage are exposed to new claims on
files previously closed and to larger than historical settlements on pending and
unreported
-49-
claims. We are exposed to increased losses by virtue of our 5.5% participation
in the intercompany reinsurance pooling arrangement with the Exchange.
The Property and Casualty Group's $150 million loss estimate
anticipates that the World Trade Center terrorist attack is considered one
event. If the attack comes to be considered two events, the total potential
exposure for the Property and Casualty Group would increase between $50 million
and $75 million. The effect on the Company, as a result, would be additional
losses between $2.7 million and $4.1 million. Taking into consideration the
excess of loss reinsurance agreement, the net impact of such potential
additional losses to us would be minimal.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
Our exposure to changes in interest rates is concentrated in our
investment portfolio. We monitor this exposure through periodic reviews of asset
and liability positions. Estimates of cash flows and the impact of interest rate
fluctuations relating to the investment portfolio are monitored regularly.
Generally, we do not hedge our exposure to interest rate risk, as we have the
ability to hold fixed maturity investments to maturity.
EQUITY PRICE RISK
Our portfolio of marketable equity securities, which is carried on the
Consolidated Statements of Financial Position at estimated fair value, has
exposure to price risk, the risk of potential loss in estimated fair value
resulting from an adverse change in prices. Our objective is to earn competitive
relative returns by investing in a diverse portfolio of high-quality, liquid
securities. Portfolio characteristics are analyzed regularly and market risk is
actively managed through a variety of techniques. Portfolio holdings are
diversified across industries; concentrations in any one company or industry are
limited by parameters established by our management and our board of directors.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measure of an entity's ability to secure enough cash to
meet its contractual obligations and operating needs as they arise. Our major
sources of funds from operations are the net cash flow generated from management
operations, the net cash flow from our property and casualty insurance
subsidiaries' 5.5% participation in the underwriting results of the Property and
Casualty Group and investment income from affiliated and nonaffiliated
investments.
We generate sufficient net positive cash flow from our operations to
fund our commitments and build our investment portfolio, thereby increasing
future investment returns. We maintain a high degree of liquidity in our
investment portfolio in the form of
-50-
readily marketable fixed maturities, equity securities and short-term
investments. Net cash flows provided by operating activities in 2001, 2000 and
1999, were $148.6 million, $130.6 million and $137.0 million, respectively.
Management fee and expense reimbursements due at December 31 from the
Exchange were $147.3 million, $118.0 million and $ 104.3 million in 2001, 2000
and 1999, respectively. A receivable from Erie Family Life Insurance Company for
expense reimbursements totaled $2.3 million at December 31, 2001, compared to
$2.0 million at December 31, 2000 and $1.5 million at December 31, 1999. We also
have a receivable due from the Exchange for reinsurance recoverable from losses
and unearned premium balances ceded to the intercompany reinsurance pool. Such
amounts totaled $491.1 million, $412.0 million and $365.2 million at December
31, 2001, 2000 and 1999, respectively.
We established a stock repurchase program in 1999 pursuant to which we
may repurchase as much as $120 million of our Class A common stock through
December 31, 2002. In 2001, 220,000 shares were repurchased at a total cost of
$7.7 million. From its inception through June 30, 2002, 3,337,701 shares have
been repurchased at a total cost of $101.9 million. We have suspended the stock
repurchase program in connection with this offering of Class A common stock.
Dividends declared to shareholders totaled $40.4 million, $36.2 million
and $32.8 million in 2001, 2000 and 1999, respectively. There are no regulatory
restrictions on the payment of dividends to our shareholders, although there are
state law restrictions on the payment of dividends from our insurance
subsidiaries to us.
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 liabilities at December 31, 2001,
2000 and 1999 of $12.9 million, $7.2 million and $11.8 million, respectively.
The primary reason for the increase in the deferred tax liability in 2001 is an
increase in unrealized gains from available-for-sale securities and limited
partnerships in 2001 of $18.0 million resulting in an increase in deferred tax
liability of $6.3 million. Management believes it is likely that we will have
sufficient taxable income in future years to realize the benefits of the gross
deferred tax assets.
-51-
BUSINESS
We operate predominantly as a provider of management services to the
Exchange and also as an underwriter of insurance through our subsidiaries. We
have served since 1925 as the attorney-in-fact, or management company, for the
policyholders of the Exchange, an unincorporated association that is a
reciprocal insurance exchange. The financial results of the Exchange are not
consolidated with ours. The Property and Casualty Group writes personal and
commercial lines property and casualty coverages exclusively through
approximately 8,000 independent agents and pool their underwriting results.
For our services as attorney-in-fact, we charge the Exchange a
management fee calculated as a percentage, currently 25%, of the direct written
premiums of the Property and Casualty Group. Management fees accounted for
approximately 77% of our revenues for the six months ended June 30, 2002. For
the first six months of 2002, 69% of direct premiums written by the Property and
Casualty Group were personal lines, while 31% were commercial lines. We also own
21.6% of the common stock of Erie Family Life Insurance Company, an affiliated
life insurance company, of which the Exchange owns 53.5% and public
shareholders, including our directors, own 24.9%. Erie Family Life Insurance
Company enables our independent agents to distribute a more comprehensive
portfolio of insurance products to customers. At June 30, 2002, we had total
assets of $2.1 billion and shareholders' equity of $920 million. Our net income
was $92.0 million for the six months ended June 30, 2002 and $122.3 million for
the year ended December 31, 2001.
We believe we are the only publicly-traded reciprocal management
company in the country. Several other private property and casualty companies,
such as USAA and Farmers Insurance Group (owned by Zurich Financial Services
Group), also operate as reciprocals with separate management arrangements. Our
earnings are largely generated by fees based on premiums written directly by the
Property and Casualty Group. We therefore have a direct incentive to preserve
the financial condition of the Exchange. The underwriting risk and capital costs
of the property and casualty insurance business are largely borne by the
Exchange, which had $2.5 billion of statutory surplus at June 30, 2002. Through
the pool, our property and casualty subsidiaries currently assume 5.5% of the
Property and Casualty Group's underwriting results, and therefore we also have a
direct incentive to manage the overall underwriting business as effectively as
possible.
-52-
ERIE INSURANCE GROUP
ORGANIZATIONAL CHART
--------------------
| Shareholders |
| |
--------------------
|
-------------------- -------------------------------
| Erie Indemnity | Attorney-in-Fact | |
| |--------- for Policyholders ------- | Erie Insurance Exchange* |
| Company | | |
| | | |
-------------------- -------------------------------
| |
-------------------------------------------- ---------------------------
| | | | |
| | | | |
100% 100% 21.6% 53.5% 100%
| | | | |
- ------------------ ------------------ ------------------- -------------------
| | |Erie Insurance* | | | | |
| Erie Insurance*| | Property & | |Erie Family Life | | Flagship City* |
| Company | | Casualty | | Insurance | | Insurance |
| | | Company | | Company | | Company |
| | | | | | | |
- ------------------ ------------------ ------------------- -------------------
|
|
100%
|
|
- ------------------
|Erie Insurance* |
| Company of |
| New York |
| |
- ------------------
* Denotes a member of the Property and Casualty Group
The Property and Casualty Group seeks to insure standard and preferred
risks in primarily private passenger automobile, homeowners and small commercial
lines, including workers' compensation policies. We believe the Property and
Casualty Group has differentiated its products from standard industry products
by providing additional coverages, which enhance our agents' marketing efforts.
Our agency force consists of over 1,700 independent agencies comprised of
approximately 8,000 agents in 11 Midwestern, Mid-Atlantic and Southeastern
states (Illinois, Indiana, Maryland, New York, North Carolina, Ohio,
Pennsylvania, Tennessee, Virginia, West Virginia and Wisconsin) and the District
of Columbia. Our independent agents play a significant role as underwriters and
service providers and are major contributors to our success.
We have reported increasing net operating income for 14 consecutive
years. Our growth has primarily been driven by an expansion of the Property and
Casualty Group's
-53-
business into new territories, the appointment of new agencies, high policy and
agency retention rates and, recently, increased premium rates.
. Since 1997, we have entered Illinois and Wisconsin and expect to
begin operating in Minnesota in the third quarter of 2004.
. In 2001, we continued our planned expansion of our independent
agency force by appointing 247 agencies. Since 1997, we have increased
the overall number of agencies representing the Property and Casualty
Group by 60%.
. We have a very stable base of policyholders, with one of the best
policy retention rates (the percentage of existing policyholders who
renew their policies) in the property and casualty insurance industry.
Our retention rate of 90.9% in 2001 compared favorably to an average of
82.6% for a core benchmark group consisting largely of regional
property and casualty carriers, according to a 2001 Ward Group
benchmark study.
. We are achieving premium rate increases as a result of the current
favorable market conditions in both commercial and personal property
and casualty lines, which are generally referred to within the industry
as "hard market conditions". We have benefited from these hard market
conditions and for the twelve months ended June 30, 2002 experienced
average premium per policy increases of 5.7% for personal automobile
insurance policies, 15.8% for commercial lines policies and 8.3% across
all lines. Management believes increases in premium rates are likely to
continue in 2002 and 2003. Generally, our profit margins from
management operations have increased during periods of premium rate
increases.
As a result of these growth initiatives and market conditions, the
Property and Casualty Group had over 3.3 million insurance policies in force as
of June 30, 2002, a 10.8% increase from June 30, 2001. Personal lines policies
in force grew by 10.3% during the twelve months ended June 30, 2002, while
commercial lines policies increased 13.8% over the same period.
We have built our reputation in the industry and among insurance
consumers, agents and others on our commitment to be "Above all in sERvIcE(SM)".
Customer satisfaction surveys independently conducted by a nationally recognized
research firm have ranked the Property and Casualty Group:
. No. 1 for homeowners insurance in 2001, the first year this survey
was conducted; and
. No. 2 for private passenger automobile insurance in 2001 and 2000.
-54-
Each member of the Property and Casualty Group is rated A++ (Superior)
by A.M. Best, its highest financial strength rating, which was held by only 2.8%
of the property and casualty insurance groups rated by A.M. Best as of July 11,
2002.
OUR COMPETITIVE ADVANTAGES
We believe that our competitive advantages come from:
. OUR COMMITTED, LOYAL AND PRODUCTIVE INDEPENDENT AGENCY FORCE. We
seek to develop long-term business relationships with high-quality
independent agencies. Prior to allowing an agency to represent us, we
undertake a rigorous selection process that seeks agency principals who
meet our high standards and operate their agencies in line with our
business philosophy. We believe our independent agency force has been
loyal to us and that the Property and Casualty Group is the preferred
carrier for most of the independent agencies that represent us. Average
annual written premium volume per agency is approximately $1.7 million
for our agencies.
. OUR FOCUS ON QUALITY SERVICE. Service to the policyholder and agent
has been a tradition of the Erie Insurance Group since its founding
more than 77 years ago. Erie Insurance Group has consistently been
recognized as a provider of quality service. Customer satisfaction
surveys independently conducted by a nationally recognized research
firm ranked the Property and Casualty Group No. 1 for homeowners
insurance in 2001, the first year this survey was conducted, and No. 2
for private passenger automobile insurance in 2001 and 2000. Our claims
force is comprised predominantly of our own employees who are trained
in our service-oriented claims settlement philosophy.
. OUR COMPETITIVE PRODUCTS AND PRICING. A key to attracting a highly
effective sales force of independent agents and enhancing the Property
and Casualty Group's ability to attract customers is a portfolio of
competitively priced products. These products include many additional
coverages that we believe differentiate the Property and Casualty
Group's products in the marketplace.
. OUR LOW-COST OPERATION. Expense management is one of our founding
traditions and is an important part of our culture. We believe our
operations are among the most cost-efficient in the property and
casualty industry. In addition, our organizational structure is
relatively flat and combines the advantages of centralized common
services with field marketing and claims services. Our average agency
annual written premium volume of $1.7 million allows us to keep our
agency training, marketing and support costs low. The Property and
Casualty Group's five-year statutory average loss adjustment and
underwriting expense ratio for the period from 1997 to 2001 is 37.2%,
which compares favorably to A.M. Best's property and casualty industry
composite average of 40.3%. The loss adjustment expense ratio is the
ratio of
-55-
loss adjustment expenses (the expenses incurred in settling a claim)
incurred, including estimates thereof for claims incurred but not
reported, to net premiums earned, and an underwriting expense ratio is
the ratio of underwriting expenses incurred to net premiums earned. The
Property and Casualty Group's underwriting expense ratio includes the
management fee paid to us of 25% of direct premiums written. The actual
cost of management operations is less than the 25% management fee,
which results in a profit for our shareholders. If the actual cost of
management operations were used to compute the underwriting expense
ratio, consistent with industry-reported results, the loss adjustment
and underwriting expense ratio would be 30.7%, which compares even more
favorably to industry averages. In a 2001 benchmarking study completed
by Ward Group, our productivity, as measured by the ratio of full time
equivalent employees to gross premiums written (total insurance
premiums written during a given period), is over 40% better than our
core benchmark group.
. UNIQUE CORPORATE STRUCTURE. The Erie Insurance Group's operating
structure allows for:
-- A LONG-TERM MANAGEMENT APPROACH TO OUR BUSINESS. We aim to
nurture our relationships with policyholders, agents and
employees to create long-term shareholder value. Each of our
principal executive officers has been with us for over 20
years and is committed to this long-term view of the
business.
-- LOWER EARNINGS VOLATILITY AND LOWER CAPITAL NEEDS. Since the
bulk of the insurance risk of the Property and Casualty
Group remains with the Exchange, we do not experience the
same earnings volatility or have the same capital needs as
competing property and casualty insurance carriers.
-- A LONG-TERM INVESTMENT HORIZON. Since most of the capital
and reserves necessary to support the Property and Casualty
Group's insurance underwriting business are held by the
Exchange, which is not a publicly-owned entity, we are able
to use long-term total return strategies to invest the
Exchange's assets. Though recent equity market results have
had a significant negative effect on the value of the
Exchange's investment portfolio, the Exchange's investment
strategy of investing in equity securities has created
substantial surplus capacity over an extended period of
time. From January 1, 1995 to June 30, 2002, the Exchange's
equity investments generated a pre-tax compound annual
return of 14.5% compared to a pre-tax compound annual return
of 12.6% for the Standard & Poor's 500 Index. This surplus
level gives us the capacity to grow premiums. For the twelve
months ended June 30, 2002, the ratio of the Exchange's net
premiums written to its surplus was approximately 1.13:1.
-56-
STRATEGY
The Erie Insurance Group's overall strategy includes providing
attractive property and casualty insurance products at competitive prices,
coupled with high-quality service. The Erie Insurance Group distributes these
products exclusively through independent insurance agents whose insurance and
underwriting expertise, local market knowledge and commitment to service have
been key drivers of our growth. The Erie Insurance Group's strategy includes:
. Organic growth through (i) a careful agency selection process in
which the Property and Casualty Group seeks to be the primary property
and casualty underwriter for each agency, (ii) a thoughtful expansion
into favorable states and (iii) increased market penetration in
existing operating territories.
. Quality service to policyholders and to agents in claims handling,
underwriting and other service activities.
. Achieving underwriting profits for the Property and Casualty Group
by focusing on standard and preferred risks and by setting and adhering
to consistent underwriting standards.
. A business model designed to provide the advantages of localized
marketing and claims servicing with the economies of scale derived from
centralized management and administration.
OUR OPERATING SEGMENTS
Our financial results are segmented into management operations and
property and casualty insurance underwriting operations. Through management
operations, we provide management services and take no underwriting risk. This
segment is the largest contributor to our earnings, providing pre-tax income of
$141.9 million for the six months ended June 30, 2002 and $186.3 million for
2001. In the property and casualty insurance underwriting operations, we take
underwriting risk through our insurance subsidiaries. This segment had a pre-tax
loss of $4.4 million for the six months ended June 30, 2002 and $3.4 million for
2001.
The following table summarizes the revenue we receive and the costs we
incur in connection with these two segments:
-57-
ERIE INDEMNITY COMPANY
OPERATING SEGMENT SUMMARY
(amounts in thousands)
Six Months Year
Income Ended Ended
Segment Statement Item Description June 30, 2002 December 31, 2001
- ----------- -------------------------- ------------------------------- ------------- -----------------
(unaudited)
MANAGEMENT Management fee revenue Direct premium written by the $ 384,827 $ 634,966
OPERATIONS Property and Casualty Group x
management fee rate (currently
25%)
+
Service agreement revenue Reinsurance premiums assumed 15,118 27,247
from non-affiliates x service
agreement rate (currently 7%)
and per installment charge for
premiums paid on an installment
basis (currently $3)
-
Cost of management Cost of sales, including (276,296) (477,645)
operations commissions, underwriting,
policy issuance and administration
+/-
Net revenue from investment Investment income and realized 18,238 1,700
operations (2) gains (losses) generated by
assets retained in management
operations plus a 21.6% ownership
interest in Erie Family Life
Insurance Company
= ----------- -----------
Segment income before income taxes $ 141,887 $ 186,268
----------- -----------
PROPERTY AND Premiums earned 5.5% of the Property and $ 77,653 $ 137,648
CASUALTY Casualty Group earned premiums
INSURANCE -
UNDERWRITING Losses and loss adjustment 5.5% of the Property and (63,387) (117,201)
OPERATIONS (1) expense Casualty Group losses and loss
adjustment expense
- 5.5% of the Property and (23,927) (40,910)
Policy acquisition and other Casualty Group policy
underwriting expense acquisition and other
underwriting expense
+/-
Net revenue from Investment income and realized 5,311 17,071
investment operations (3) gains (losses) generated by
assets of our property and
casualty subsidiaries
= ----------- -----------
Segment (loss) before income taxes $ (4,350) $ (3,392)
----------- -----------
TOTAL Total income before income taxes $ 137,537 $ 182,876
=========== ===========
- ---------------
(1) Includes the effect of the all-lines aggregate excess of loss agreement
currently in place with the Exchange.
(2) Includes realized capital losses of $0.8 million for the six months ended
June 30, 2002 and $30.7 million for 2001.
(3) Includes realized capital losses of $3.8 million for the six months ended
June 30, 2002 and $1.1 million for 2001.
-58-
OUR MANAGEMENT OPERATIONS
For services performed in our role as attorney-in-fact for the
policyholders of the Exchange, we charge the Exchange a management fee
calculated as a percentage of the direct written premiums by the Exchange and
the other members of the Property and Casualty Group. The management fee is
compensation for (i) acting as attorney-in-fact for the policyholders of the
Exchange, (ii) managing the business and affairs of the Exchange and (iii)
paying certain general administrative expenses not part of the settlement of
losses or the management of investments, which are the responsibility of the
Exchange. We recognize as income management fees due from the Exchange when the
premiums are written because at that time we have performed substantially all of
the services we are required to perform, including sales, underwriting and
policy issuance activities, but currently such fees are not paid to us by the
Exchange until it collects the premiums. Management fees received from the
Exchange accounted for approximately 77% of our revenues for the six months
ended June 30, 2002 and approximately 78% of our revenues in 2001. The
management fee rate charged to the Exchange is set by and may be changed at the
discretion of our board of directors. The fee has been at its maximum permitted
level of 25% since 1999 and was 24.25% in 1998 and 24% in 1997. Our board of
directors generally sets the management fee rate each December for the following
year.
We also receive a service agreement fee from the Exchange, at the rate
of 7% of voluntary assumed written premium since 1995, as compensation for the
management and administration of its voluntary assumed reinsurance business from
non-affiliated insurers. Reinsurance is an arrangement in which an assuming
company indemnifies an insurer or reinsurer (a "ceding company") against all or
a portion of the insurance or reinsurance risks underwritten by the ceding
company under one or more policies. Service agreement revenue is earned when
reinsurance premiums are written because substantially all of the services we
are required to perform have been completed at that time. We also collect
service charges from policyholders who pay their premiums in installments on
policies written by the Property and Casualty Group. The service agreement rate
and service charge amount are periodically evaluated by management and are
subject to change.
-59-
ERIE INDEMNITY COMPANY
MANAGEMENT OPERATIONS FINANCIAL RESULTS
Six Months
Ended
June 30, Year Ended December 31,
------------------------ -----------------------------------------------------------
(amounts in thousands, except percentages) 2002 2001 2001 2000 1999 1998 1997
------------ ----------- ---------- ------------ ----------- ----------- -----------
(unaudited)
Exchange direct and affiliated assumed
premium written (pool) $ 1,539,307 $1,253,987 $2,539,863 $2,206,583 $2,053,501 $2,017,103 $1,948,343
MANAGEMENT FEE RATE 25.00% 25.00% 25.00% 25.00% 25.00% 24.25% 24.00%
Management fee revenue $ 384,827 $ 313,497 $ 634,966 $ 551,646 $ 513,375 $ 489,147 $ 467,603
Service agreement revenue 15,118 13,250 27,247 22,662 15,441 13,879 7,026
------------ ---------- ----------- ----------- ----------- ----------- -----------
Total revenue from management operations $ 399,945 $ 326,747 $ 662,213 $ 574,308 $ 528,816 $ 503,026 $ 474,629
Cost of management operations 276,296 230,443 477,645 415,562 380,298 357,783 340,428
Net revenue from investment operations (1) 18,238 21,201 1,700 57,213 47,011 33,660 29,410
============ ========== ========== =========== ========== ========== ===========
Income before income taxes $ 141,887 $ 117,505 $ 186,268 $ 215,959 $ 195,529 $ 178,903 $ 163,611
============ ========== =========== =========== ============----------- ===========
- --------------
(1) Includes realized gains (losses) of: $ (810) $ 2,111 $ (30,735) $ 16,469 $ 14,408 $ 6,363 $ 5,551
The direct written premiums of the Property and Casualty Group have a
direct impact on the Company's management fee revenue and, consequently, the
Company's management operations. The following table sets forth our management
fee revenue by state and by line of business for the year ended December 31,
2001:
ERIE INDEMNITY COMPANY
MANAGEMENT FEE REVENUE BY STATE AND LINE OF BUSINESS FOR 2001
(amounts in thousands) All other
Private Commercial Commercial Workers' Lines of
State Passenger Auto Homeowners Multi Peril Compensation Business Total
- ------------------- --------- ----------- ---------- ----------- ------------ ----------- ---------
Pennsylvania $193,280 $23,004 $ 50,042 $27,319 $26,801 $ 7,806 $328,252
Maryland 40,521 6,869 12,689 6,383 6,311 2,671 75,444
Ohio 29,094 4,312 9,619 7,123 0 1,697 51,845
Virginia 22,413 5,404 7,695 6,254 6,993 1,958 50,717
North Carolina 11,948 4,718 6,171 5,255 3,993 1,384 33,469
West Virginia 18,070 2,644 4,115 2,757 0 838 28,424
Indiana 13,309 1,721 5,742 2,846 2,041 845 26,504
New York 10,319 1,887 2,654 3,010 1,645 494 20,009
Tennessee 3,712 1,378 1,450 1,830 1,278 386 10,034
Illinois 3,075 645 1,048 1,667 1,010 223 7,668
District of Columbia 548 108 247 510 595 117 2,125
Wisconsin 191 52 68 63 78 23 475
-------- ------- -------- ------- ------- ------- --------
Total $346,480 $52,742 $101,540 $65,017 $50,745 $18,442 $634,966
======== ======= ======== ======= ======= ======= ========
The following table sets forth our management fee revenue by line of
business and percentage growth for each of the five years ended December 31,
2001:
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ERIE INDEMNITY COMPANY
MANAGEMENT FEE REVENUE BY LINE OF BUSINESS 2001 - 1997
(amounts in thousands, except percentages)
All other
Private Commercial Commercial Workers' Lines of Percent
Year Passenger Auto Homeowners Multi Peril Compensation Business Total Increase
- ---- --------- ---------- ---------- ----------- ------------ -------- ----- --------
2001 $346,480 $52,742 $101,540 $65,017 $50,745 $18,442 $634,966 15.1%
2000 313,703 43,318 88,743 50,401 39,914 15,567 551,646 7.5
1999 305,346 37,663 80,377 42,646 33,363 13,980 513,375 5.0
1998 304,026 33,555 69,845 36,096 31,409 14,216 489,147 4.6
1997 295,424 32,796 60,443 31,384 32,906 14,649 467,602 5.6
The following table sets forth the Property and Casualty Group's
percentage of management fees by state for each of the five years ended December
31, 2001.
ERIE INDEMNITY COMPANY
PERCENTAGE OF MANAGEMENT FEES BY STATE 2001-1997
State 2001 2000 1999 1998 1997
- ------------------------------- ---- ---- ---- ---- ----
Pennsylvania 51.7% 53.9% 55.6% 58.1% 59.3%
Maryland 11.9 11.9 11.9 11.7 12.0
Ohio 8.2 8.0 7.9 7.6 7.4
Virginia 8.0 8.0 8.1 8.1 8.3
North Carolina 5.3 4.6 4.1 3.3 2.7
West Virginia 4.4 4.6 4.6 4.6 4.6
Indiana 4.2 4.0 3.9 3.8 3.7
New York 3.1 2.7 2.2 1.4 0.8
Tennessee 1.6 1.4 1.3 1.2 1.0
Illinois 1.2 0.6 0.2 0.0 0.0
District of Columbia 0.3 0.3 0.2 0.2 0.2
Wisconsin 0.1 0.0 0.0 0.0 0.0
----- ----- ----- ----- -----
Total direct premiums written 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
The cost of management operations includes all independent agent
commission expenses as well as personnel and benefit costs, underwriting and
policy issuance costs and other administrative expenses of the Company.
The largest component of the cost of management operations is the cost
of our independent agent commissions and other incentives to our independent
agents. Included in commission costs is the cost of scheduled commissions earned
on premiums written, agency contingency awards based on the three-year average
underwriting profitability of the business written with us, accelerated
commissions earned by start-up agencies and promotional incentives to agents.
Personnel and benefit costs related to the sales, underwriting and
issuance of policies and the administrative staff of the Company are the second
largest cost of management operations. Expenses other than personnel and benefit
costs related to the underwriting and
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issuance of new business vary with the number of new policies. Underwriting
reports, printing, postage and other cost of materials necessary for the
underwriting and issuance of policies are included in the cost of management
operations.
Additional costs are incurred for general administrative expenses of
the Company including the cost of office facilities, travel, telephone and
communication costs, the cost of data processing and information technology and
other miscellaneous expenses. Beginning in 2001, the Company initiated its
eCommerce program and committed to new information technology infrastructure
expenditures as part of the program. These eCommerce infrastructure expenditures
are included in the cost of management operations, and non-infrastructure costs
of the eCommerce program are included in the insurance underwriting segment.
We also earn investment income in this business segment on the cash
flow from management operations, which is invested in our investment portfolio.
We also report our share of earnings from our 21.6% investment in Erie Family
Life Insurance Company as part of the investment income of our management
operations segment.
PROPERTY AND CASUALTY INSURANCE UNDERWRITING OPERATIONS
Our property and casualty insurance underwriting operation consists of
our three property and casualty insurance subsidiaries that participate in an
intercompany pooling arrangement with the Exchange. The pool also includes
reinsurance assumed by the Exchange from non-affiliated entities. The table
below presents a financial summary of results of the property and casualty
insurance operations of the Property and Casualty Group.
ERIE INDEMNITY COMPANY
PROPERTY AND CASUALTY INSURANCE UNDERWRITING OPERATIONS
Six Months Ended
June 30, Year Ended December 31,
---------------- -------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
------- ------- -------- -------- -------- -------- --------
(unaudited)
Premiums earned $77,653 $66,091 $137,648 $123,708 $117,224 $112,939 $107,350
Net revenue from investment operations (1) 5,311 9,726 17,071 18,381 16,765 16,887 13,569
------- ------- -------- -------- -------- -------- --------
Total revenues $82,964 $75,817 $154,719 $142,089 $133,989 $129,826 $120,919
Losses and loss adjustment expenses 63,387 53,057 117,201 99,564 87,719 79,881 79,970
Policy acquisition and underwriting expenses 23,927 18,358 40,910 34,546 33,044 32,491 29,639
------- ------- -------- -------- -------- -------- --------
Total losses and expenses $87,314 $71,415 $158,111 $134,110 $120,763 $112,372 $109,609
------- ------- -------- -------- -------- -------- --------
Income (loss) before income taxes $(4,350) $ 4,402 $ (3,392) $ 7,979 $ 13,226 $ 17,454 $ 11,310
======= ======= ======== ======== ======== ======== ========
_______________
(1) Includes realized gains (losses) of: $(3,771) $ 613 $ (1,144) $ 499 $ 337 $ 800 $ 264
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Under the pooling arrangement, all property and casualty insurance
business of the five property and casualty insurance companies that comprise the
Property and Casualty Group is pooled within the Exchange as the pooling entity.
Our insurance subsidiaries, Erie Insurance Company and Erie Insurance Company of
New York, share in the underwriting results of the pool through retrocession.
Erie Insurance Company has a 5.0% participation, Erie Insurance Company of New
York has a 0.5% participation and the Exchange has a 94.5% participation in the
pooled underwriting results. These participation percentages are determined by
our board of directors. Pooling participation percentages have not changed since
1995.
PROPERTY AND CASUALTY GROUP
POOLING ARRANGEMENT
CEDED FROM RETROCEDED TO
- ------------------------------
| | --------------------
| Erie Insurance Exchange ------- | | ------------------
| | | | | | |
- ------------------------------ | | | 94.5% | Erie Insurance |
| | |-------------| Exchange |
- ------------------------------ | | | |-----------------
| | | | |
| Flagship City ------- | |
| Insurance Company | | | |
| | | | |
- ------------------------------ | | |
| | | ------------------
- ------------------------------ | | | | |
| | 100% | Property and | 5.0% | Erie Insurance |
| Erie Insurance Company --------------| Casualty |-------------| Company |
| | | | Group Pool | | |
- ------------------------------ | | | | |
| | | ------------------
- ------------------------------ | | |
| | | | |
| Erie Insurance Company | | | |
| of New York ------- | | ------------------
| | | | | | |
- ------------------------------ | | | 0.5% | Erie Insurance |
| | |-------------| Company |
- ------------------------------ | | | | of New York |
| | | | | | |
| Erie Insurance Property | | | | ------------------
| & Casualty Company ------- | |
| | --------------------
- ------------------------------
Erie Insurance Company and Erie Insurance Company of New York have an
all-lines aggregate excess of loss reinsurance agreement with the Exchange that
limits the amount of their annual net losses. Excess of loss reinsurance is
reinsurance that indemnifies the reinsured against all or a specified portion of
losses on underlying insurance policies in excess of a specified amount. Under
the reinsurance agreement, once Erie Insurance Company and Erie Insurance
Company of New York sustain ultimate net losses and allocated loss expenses in
an accident year that exceed an amount equal to 72.5% of Erie
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Insurance Company's and Erie Insurance Company of New York's net premiums
earned, the Exchange will be liable for 95% of the amount of such excess up to,
but not exceeding, an amount equal to 95% of 15% of Erie Insurance Company's and
Erie Insurance Company of New York's net premium earned. Erie Insurance Company
and Erie Insurance Company of New York retain the remaining 5% of such layer as
well as ultimate net losses and allocated loss expenses in excess of 87.5% of
Erie Insurance Company's and Erie Insurance Company of New York's net premiums
earned.
The Property and Casualty Group sells personal and commercial lines
policies through independent agencies. Commercial lines policies are marketed to
small- and medium-sized businesses. Premium revenues from our property and
casualty insurance underwriting operations accounted for approximately 15% of
our revenues in the six months ended June 30, 2002 and 17% of our revenues in
2001.
The Property and Casualty Group has exposure to reinsurance that the
Exchange assumes from unaffiliated insurers, placed principally through
unaffiliated brokers. The Exchange engages in this assumed reinsurance business,
which represented net premiums written of $82.6 million for the six months ended
June 30, 2002 and $158.1 million for the year ended December 31, 2001, in each
case net of retrocessions, in order to geographically diversify the overall
insurance risk to the Property and Casualty Group. The assumed business, which
is included in the pooling arrangement, consists predominately of property lines
excess of loss treaties. In 2002, management tightened underwriting standards,
limited coverages, excluded terrorism coverage and, consistent with market
conditions, increased rates for this business. Treaties are generally renewed
annually and management evaluates each treaty for profitability and continuing
desirability of the customer relationship during the renewal process.
We also earn investment income in this business segment on the cash
flow from property and casualty insurance underwriting operations, which is
invested in our investment portfolio.
The following table sets forth certain data for the Property and
Casualty Group compared to industry composites for the five years ended December
31, 2001.
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PROPERTY AND CASUALTY GROUP
FIVE-YEAR COMPARISON VS. INDUSTRY COMPOSITE
Net Premiums
Written Growth Loss Ratio Operating Expense Ratio (2)
--------------------- ------------------- --------------------------------------
Erie As Erie As
Erie Industry (1) Erie Industry (1) Reported Adjusted (3) Industry
------ ------------ ---- ------------ -------- ------------ --------
2001 14.8% 9.1% 78.1% 75.4% 39.7% 33.5% 39.7%
2000 8.3 5.7 69.8 68.5 36.8 30.6 40.4
1999 2.6 2.0 65.5 65.4 36.1 29.6 41.1
1998 4.4 1.6 59.2 63.4 38.2 31.7 40.7
1997 5.6 3.0 65.1 60.6 34.6 28.0 39.4
5-year compound
annual growth
rate or average 7.2% 4.2% 68.0% 66.9% 37.2% 30.7% 40.3%
Policyholder
Dividend Ratio Combined Ratio
--------------------- ----------------------------------------
Erie As Erie As
Erie Industry (1) Reported Adjusted (3) Industry (1)
------ ------------ -------- ------------ ------------
2001 0.6% 0.8% 118.4% 112.2% 115.9%
2000 0.8 1.5 107.4 101.2 110.3
1999 0.4 1.3 102.0 95.5 107.8
1998 0.6 1.9 98.0 91.5 106.0
1997 0.9 1.8 100.6 94.0 101.9
5-year compound
annual growth
rate or average 0.7% 1.4% 105.9% 99.4% 108.6%
- ---------------
(1) A.M. Best's Aggregates and Averages, 2002 Edition.
(2) Includes loss adjustment and underwriting expenses.
(3) Includes the actual costs of management operations and not the full amount
of the management fee earned by us.
DISTRIBUTION
Our insurance products are marketed primarily in the Midwest,
Mid-Atlantic and Southeast regions through over 1,700 insurance agencies that
are comprised of approximately 8,000 agents. The Property and Casualty Group
members we manage are licensed to do business in 16 states and in the District
of Columbia and, at June 30, 2002, operated in 11 states (Illinois, Indiana,
Maryland, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia,
West Virginia and Wisconsin) and the District of Columbia. The Property and
Casualty Group maintains branch offices throughout these states. Management
expects to begin operating in Minnesota in the third quarter of 2004.
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PROPERTY AND CASUALTY GROUP
STATES OF OPERATION
Year Began
State Writing % of Total
- ----- ---------- ----------
Pennsylvania 1925 52% [GRAPHIC OMITTED - Map of
Maryland 1953 12 eastern half of United
Ohio 1968 8 States highlighting active
Virginia 1955 8 states of operation, the
North Carolina 1991 5 home office, branch offices
West Virginia 1963 4 and field offices.]
Indiana 1978 4
New York 1995 3
Tennessee 1987 2
Illinois 1999 1
District of Columbia 1953 Less than 1%
Wisconsin 2001 Less than 1%
In 2001, we continued our ongoing expansion of our independent agency force
by appointing 247 agencies. Since 1997, we have increased the overall number of
agencies representing the Property and Casualty Group by 60%. Partially due to
growth in the number of agents, the Property and Casualty Group has achieved
rapid growth in premiums. As of June 30, 2002, the Property and Casualty Group
had over 3.3 million insurance policies in force, a 10.8% increase from June 30,
2001. Personal lines policies in force grew by 10.3% during the twelve months
ended June 30, 2002, while commercial lines increased 13.8% over the same
period.
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PROPERTY AND CASUALTY GROUP
12-MONTH ROLLING AVERAGE POLICY GROWTH RATES BY LINE OF BUSINESS
Twelve Months Ended
---------------------------------------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30, March 31, December 31,
2002 2002 2001 2001 2001 2001 2000
---------- --------- ------------ ------------- -------- --------- ------------
PERSONAL LINES:
Private passenger auto 9.4% 8.3% 7.1% 6.3% 5.9% 5.3% 4.9%
Homeowners 11.4 10.1 9.0 8.4 8.1 7.7 7.5
All other personal lines 10.3 9.5 8.9 8.9 8.5 8.1 7.9
Total personal lines 10.3 9.1 8.0 7.3 6.9 6.4 6.1
COMMERCIAL LINES:
Commercial auto 11.6 10.7 9.7 8.8 7.9 7.0 5.8
Commercial multi-peril 16.0 14.5 13.6 13.1 12.7 12.6 12.1
Workers' compensation 11.9 10.8 10.3 9.6 9.5 8.7 8.4
All other commercial
lines 11.7 10.7 9.9 9.0 8.9 8.0 7.1
Total commercial lines 13.8 12.6 11.7 11.0 10.6 10.1 9.4
Total 10.8 9.6 8.5 7.8 7.4 6.9 6.5
In addition, the Property and Casualty Group experiences above average
retention rates. We believe our overall policy retention rate of 90.9% is among
the highest for regional property and casualty insurers.
PROPERTY AND CASUALTY GROUP
12-MONTH ROLLING AVERAGE POLICY RETENTION RATES BY LINE OF BUSINESS
Twelve Months Ended
---------------------------------------------------------------------------------------------------
June 30, March 31, December 31, September 30, June 30, March 31, December 31,
2002 2002 2001 2001 2001 2001 2000
---------- --------- ------------ ------------- -------- --------- ------------
Private passenger
automobile 92.35% 92.26% 92.24% 92.22% 92.25% 92.24% 92.31%
Commercial automobile 91.12 90.86 90.53 90.16 90.35 90.29 89.80
Homeowners 90.35 90.24 90.29 90.43 90.68 90.71 90.75
Commercial multi-peril 88.69 88.50 88.04 88.35 88.44 88.59 88.14
Workers' compensation 89.46 89.34 88.43 88.53 88.76 89.06 88.48
All other lines 88.39 88.21 88.07 87.95 88.00 87.75 87.64
Total 90.92 90.80 90.85 90.89 91.01 91.03 91.01
Careful selection of our independent agencies is a key strategy of our
Company. We strive to be the primary writing company with our agents. In order
to enhance our agency relationships and the likelihood of receiving the most
desirable underwriting opportunities, we have ongoing, direct communications
with our agency force. We believe our independent agency force has been loyal to
us and that the Property and Casualty Group is the preferred carrier for most of
the independent agencies that carry us. Average agency annual written premium
volume is $1.7 million for all of our agencies. Agents have access to
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a number of company-sponsored venues designed to promote sharing of ideas,
concerns and suggestions with the senior management of Erie Insurance Group with
the goal of improving communications and service. These efforts have resulted in
outstanding agency penetration and the ability to sustain long-term agency
partnerships.
Our agents receive commissions for premiums written, as well as promotional
incentives and contingency awards. Agent contingency awards are based upon a
three-year average of the underwriting profitability of the direct business
written and serviced within the Erie Insurance Group by the independent agent.
Commission costs rose 14.3% to $323.1 million in 2001 from $282.7 million in
2000 and 7.3% in 2000 from $263.1 million in 1999. Commission costs grew at a
slower rate relative to the growth in direct premiums written in 2001 as a
result of lower accruals for agent contingency awards compared to 2000. The
provision for agent contingency awards totaled $15.7 million, $18.3 million and
$19.9 million in 2001, 2000 and 1999, respectively. Commission costs, excluding
agent contingency awards, increased 16.2% in 2001, in line with the increase in
direct written premiums.
PRODUCTS
The Property and Casualty Group underwrites a broad range of insurance for
risks. In 2001, personal lines comprised 72.6% of direct and affiliated assumed
premium revenue while commercial lines constituted the remaining 27.4%. The core
products in the personal lines are private passenger automobile (75.2%) and
homeowners (22.0%) while the core commercial lines consist principally of
multi-peril (37.0%), automobile (30.3%) and workers' compensation (29.2%).
The Property and Casualty Group issues policies that contain many features
not offered as standard coverages by many of our competitors. These "extras" are
a major selling feature for our agents. Some examples of these features include:
. full replacement cost coverage with no loss cap on the percentage of
insured value in our full-cost replacement homeowners policy;
. waiver of collision deductible in an automobile claim involving two
insureds of the Property and Casualty Group;
. coverage for transportation expense that begins immediately after a
collision;
. coverage for locksmith services for keys locked in cars;
. coverage for cost of replacing a deployed airbag;
. coverage for losses due to theft, loss or other unauthorized use of a
credit card; and
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. coverage for theft, misplacement or loss of jewelry.
The growth rate of policies in force and policy retention trends impact
the Company's management and property and casualty operating segments.
PROPERTY AND CASUALTY GROUP
POLICIES IN FORCE AND 12-MONTH ROLLING AVERAGE POLICY RETENTION RATE BY LINE OF
BUSINESS
At June 30, At December 31,
--------------------- ---------------------------------------------------------
(amounts in thousands, except 2002 2001 2001 2000 1999 1998 1997
percentages) --------- ----------- -------- -------- ---------- ---------- ----------
POLICIES IN FORCE:
Personal lines 2,829 2,566 2,724 2,517 2,368 2,255 2,174
Commercial lines 476 418 386 349 322 304 291
Total policies in force 3,305 2,984 3,110 2,866 2,690 2,559 2,465
POLICY RETENTION PERCENTAGES:
Personal policy retention percentages 91.3% 91.5% 91.3% 91.5% 91.0% 90.4% 90.9%
Commercial policy retention percentages 88.4 87.7 87.7 87.3 86.5 85.6 85.6
Total policy retention percentages 90.9 91.0 90.9 91.0 90.5 89.4 89.7
UNDERWRITING
The Commercial Underwriting Division (Commercial Property and
Commercial Automobile Underwriting and Risk Management) and the Personal Lines
Underwriting Division (Personal Property and Personal Automobile Underwriting)
of the Property and Casualty Group perform underwriting and processing
functions, provide advice, instruction and guidance to the agency force
regarding underwriting philosophy and assist other divisions in developing
quality products at competitive prices to promote growth and profitability.
We strive to maintain our position in the insurance industry as a
leading writer of profitable personal and commercial automobile insurance by
assessing and selecting standard and preferred risks. The Property and Casualty
Group also seeks to maintain its position in the insurance industry as a leading
writer of profitable personal and commercial property and liability lines by
evaluating and selecting those policies believed to be good quality risks. The
Property and Casualty Group "reunderwrites" by reviewing existing policies and
accounts to determine which risks continue to meet underwriting qualifications
and taking appropriate action regarding these policies or accounts. Loss control
services are offered to policyholders via the Company's dedicated team of loss
control personnel. Risk management services offered to policyholders include
hazard identification and analysis, loss control program development, and
establishment of safety committees and risk management training programs.
To assure maintenance of acceptable underwriting results, we conduct an
annual review of all of our agencies to identify those that do not meet our
underwriting performance
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expectations. Agencies failing to meet our profitability criteria are subject to
a detailed review. This review, conducted by senior members of management from
our home and field office claims, marketing, underwriting and customer service
areas, focuses on the factors affecting the property casualty underwriting
results for the agency. The review process includes an evaluation of the
underwriting and reunderwriting practices of the agency, completeness and
accuracy of applications submitted, staffing levels and adequacy of training of
agency staff and adherence by the agency to our business practice, underwriting
and service standards. The review team and the agency jointly develop an action
plan to improve agency processes and procedures designed to improve the
underwriting profitability of the agency. We then monitor the agency's progress
and underwriting performance and may take additional measures, including
reducing commissions, and/or terminating the agency if underwriting
profitability continues to be unacceptable.
CLAIMS
We realize that an insurance policy is also a promise of service. We
use our own trained adjusters wherever possible, to assure that claims are
settled quickly and fairly by personnel who know the coverages in our policies
and understand our service philosophy.
Our claims services include:
. Prompt response standards, generally the same day, for contact with
an insured after a loss is reported;
. A toll-free number for our claims call center where Company-trained
personnel handle reporting of losses after normal business hours and on
weekends and holidays;
. An automobile glass repair and replacement program for automobile
claims designed to simplify and speed the claims process and permit the
insured to decide who should do the repair or replacement; and
. A direct repair program for automobile claims that allows insureds to
select their own body shop and use one of numerous participating body
shops that bill us directly for the repair costs less any deductible.
These and other claims services we offer have resulted in our
reputation for fast, fair and courteous claim services and the service awards we
have received from independent consumer organizations.
TECHNOLOGY
In 2001, we began a comprehensive program of eCommerce initiatives in
support of the Erie Insurance Group's agency force and back office policy
underwriting, issuance and administration. The eCommerce program is intended to
improve service and efficiency, as
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well as result in increased sales. We completed the first major component
(network and desktop hardware deployment) of the program during the second
quarter of 2002. Also, the Company completed the release of the new web
interface to a limited number of agents and employees in July 2002. In August
2002, the eCommerce program took advantage of a significant business opportunity
to partner with Accenture, a well-known provider of information technology
services and solutions, to develop our eCommerce system called
ERIEConnection(SM). We have engaged Accenture to be the chief integrator and
manager of the eCommerce program and to provide the program with software
applications that meet the needs of the program. Management believes this new
approach, in partnership with Accenture, will allow the eCommerce program to
meet budget goals set for the program.
FINANCIAL RATINGS
Insurance companies are rated by rating agencies to provide insurance
consumers and investors with meaningful information on the rated companies.
Higher ratings generally indicate financial stability and a stronger ability to
pay claims. The ratings are generally based upon factors relevant to
policyholders and are not directed toward return to investors.
The Exchange, Flagship City Insurance Company, Erie Insurance Company,
Erie Insurance Company of New York and Erie Insurance Property & Casualty
Company all have current ratings of A++ (superior) from A.M. Best with respect
to their financial strength. Only 2.8% of the property and casualty insurance
groups rated by A.M. Best held this rating as of July 11, 2002. Erie Family Life
Insurance Company has an A+ (superior) rating. In evaluating an insurer's
financial and operating performance, A.M. Best reviews the insurer's
profitability, leverage and liquidity as well as the insurer's book of business,
the adequacy and soundness of its reinsurance, the quality and estimated market
value of its assets, the adequacy of its loss reserves and the experience and
competency of its management. We believe that the A.M. Best rating of A++
(superior) for the Property and Casualty Group's products is an important factor
in marketing our property and casualty insurance to agents and customers. Each
member of the Property and Casualty Group, except Erie Insurance Company of New
York, has been rated AApi or its equivalent by Standard & Poor's since 1998.
Erie Insurance Company of New York has been rated AApi by Standard & Poor's
since 2000. The "pi" designation means that the rating is based on public
information.
INVESTMENTS
Our investment strategy takes a long-term perspective emphasizing
investment quality, diversification and investment returns providing liquidity
for our short and long-term commitments. Investments are managed on a total
return approach that focuses on both current income and capital appreciation. At
June 30, 2002, our investment portfolio increased to over $915 million,
representing 43.8% of total assets. For the six months ended June 30, 2002, net
investment income was $26.8 million. Net investment income totaled $49.9 million
in 2001, compared to $48.4 million in 2000, and $43.3 million in 1999.
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ERIE INDEMNITY COMPANY
TOTAL INVESTMENTS AT MARKET VALUE
At June 30, At December 31,
-------------------- ---------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- -------- -------- --------
(unaudited)
INVESTMENTS:
Fixed maturities $634,205 $519,843 $559,873 $531,546 $485,522 $441,353 $349,973
Equity securities
Preferred stock 146,655 139,967 130,007 109,081 99,584 112,574 84,963
Common stock 41,922 94,574 63,791 95,365 115,799 90,230 80,170
Limited partnerships (1) 86,883 72,953 81,596 68,242 39,116 17,494 7,932
Real estate mortgage loans 5,634 5,762 5,700 6,581 8,230 8,287 8,392
-------- -------- -------- -------- -------- -------- --------
Total Investments $915,299 $833,099 $840,967 $810,815 $748,251 $669,938 $531,430
======== ======== ======== ======== ======== ======== ========
- --------------
(1) Includes other invested assets.
ERIE INDEMNITY COMPANY
TOTAL INVESTMENTS AT COST
At June 30, At December 31,
-------------------- ---------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- -------- -------- --------
(unaudited)
INVESTMENTS:
Fixed maturities $622,297 $506,024 $543,423 $524,172 $489,394 $421,102 $333,136
Equity securities
Preferred stock 144,622 140,294 127,725 110,555 106,625 109,355 79,361
Common stock 21,599 75,746 32,002 74,413 64,870 60,622 64,762
Limited partnerships (1) 87,160 73,096 79,668 60,661 37,402 17,494 7,932
Real estate mortgage loans 5,634 5,762 5,700 6,581 8,230 8,287 8,392
-------- -------- -------- -------- -------- -------- --------
Total Investments $881,312 $800,922 $788,518 $776,382 $706,521 $616,860 $493,583
======== ======== ======== ======== ======== ======== ========
- --------------
(1) Includes other invested assets.
Management considers all fixed maturities and marketable equity securities
available-for-sale. These securities are stated at fair value, with the
unrealized gains and losses, net of deferred tax, reported as a separate
component of accumulated other comprehensive income in shareholders' equity.
When a decline in the value of investments is considered to be other than
temporary by management, the investments are written down in the Consolidated
Statements of Operations to their realizable value.
For common equity securities (including equity limited partnerships) where
the decline in market value is more than 20% below cost for a period exceeding
six months, there is a presumption of impairment. Management considers market
conditions, industry characteristics and the fundamental operating results of
the issuer before deciding to sell the investment at a loss or to recognize an
impairment charge to operations. For common equity securities that have declined
more than 20% below cost for a period exceeding twelve
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months, the position is either sold or recognized as impaired and a charge to
operations is recognized as realized losses through the Consolidated Statements
of Operations.
For fixed maturity investments, our management analyzes all positions
individually whose market value have declined below cost for a period exceeding
six months. Management considers market conditions, industry characteristics and
the fundamental operating results of the issuer to determine if the decline is
due to changes in interest rates, changes relating to a decline in credit
quality, or other issues specifically affecting the investment. Positions that
have incurred market price decline of over 20% for a period greater than six
months where the creditworthiness of the issuer indicates a decline that is
other than temporary are either sold or recognized as impaired and reflected as
a charge to the Company's operations.
If the Company's policy for determining the recognition of impaired
positions were different, the Company's Consolidated Statements of Financial
Position and results of operations could be significantly impacted. Management
believes its investment valuation philosophy and accounting practices result in
appropriate and timely measurement of value and recognition of impairment.
Our investments include a 21.6% common stock interest in Erie Family Life
Insurance Company of $44.1 million at June 30, 2002, which is accounted for
under the equity method of accounting. Dividends paid to our company for the six
months ended June 30, 2002 and 2001 totaled over $828,000 and $766,000,
respectively. Related to this investment, we are also due $15 million in
principal in the form of a surplus note. The note bears an annual interest rate
of 6.45% and all payments of interest and principal on the note may be repaid
only out of unassigned surplus of Erie Family Life Insurance Company and are
subject to prior approval by the Pennsylvania Insurance Commissioner. Interest
of the surplus note is scheduled to be paid semi-annually. The note will be
payable on demand on or after December 31, 2005.
FIXED INCOME SECURITIES
At June 30, 2002, the carrying value of fixed income securities accounted
for 69.3% of total invested assets. The Company's investment strategy achieves a
balanced maturity schedule in order to moderate the effect on investment income
in the event of interest rate declines in a year in which a large amount of
securities are scheduled to be redeemed or mature.
-73-
ERIE INDEMNITY COMPANY
FIXED MATURITY SECURITIES AT MARKET VALUE
At June 30, At December 31,
--------------------- ---------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
--------- ---------- ---------- ---------- ---------- --------- ---------
(unaudited)
FIXED MATURITIES:
U.S. treasuries and government agencies $ 11,748 $ 11,646 $ 11,713 $ 11,612 $ 11,051 $ 13,707 $ 13,200
State and political subdivisions 46,832 44,011 44,121 51,959 53,118 51,600 44,771
Special revenue 111,800 108,398 113,418 114,566 122,096 139,235 123,901
Public utilities 38,065 27,072 26,270 23,564 20,318 13,416 7,331
U.S. industrial and miscellaneous 367,543 281,691 319,308 266,061 227,176 203,695 156,582
Foreign 43,479 32,385 27,476 29,914 20,743 7,047 4,188
-------- -------- -------- -------- -------- -------- --------
Total bonds $619,467 $505,203 $542,306 $497,676 $454,502 $428,700 $349,973
Redeemable preferred stock 14,738 14,640 17,567 33,870 31,020 12,653 --
-------- -------- -------- -------- -------- -------- --------
Total fixed maturities $634,205 $519,843 $559,873 $531,546 $485,522 $441,353 $349,973
======== ======== ======== ======== ======== ======== ========
ERIE INDEMNITY COMPANY
FIXED MATURITY SECURITIES AT AMORTIZED COST
At June 30, At December 31,
--------------------- ---------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
--------- ---------- ---------- ---------- ---------- --------- ---------
FIXED MATURITIES: (unaudited)
U.S. treasuries and government agencies $ 11,254 $ 11,213 $ 11,211 $ 11,216 $ 11,029 $ 13,018 $ 12,771
State and political subdivisions 44,559 42,157 42,392 50,337 52,064 48,307 41,931
Special revenue 107,790 104,527 110,267 110,855 120,170 132,025 116,052
Public utilities 37,870 26,493 25,150 23,221 20,909 13,116 7,171
U.S. industrial and miscellaneous 361,616 276,150 311,757 267,231 232,458 195,296 150,666
Foreign 44,904 32,083 26,634 30,082 21,593 7,149 4,545
-------- -------- -------- -------- -------- -------- --------
Total bonds $607,993 $492,623 $527,411 $492,942 $458,223 $408,911 $333,136
Redeemable preferred stock 14,304 13,401 16,012 31,230 31,171 12,191 --
-------- -------- -------- -------- -------- -------- --------
Total fixed maturities $622,297 $506,024 $543,423 $524,172 $489,394 $421,102 $333,136
======== ======== ======== ======== ======== ======== ========
At June 30, 2002, the Company's fixed maturity investments consist of
98.0% of high-quality, marketable bonds and redeemable preferred stock, all of
which were rated at investment-grade levels (above Ba/BB). Included in this
investment-grade category are $248.8 million or 40.0% of the highest quality
bonds and redeemable preferred stock rated Aaa/AAA or Aa/AA or bonds issued by
the United States government. Generally, the fixed maturities in the Company's
portfolio are rated by external agencies. Management classifies all fixed
maturities as available-for-sale securities, allowing the Company to meet its
liquidity needs and provide greater flexibility for its investment managers to
appropriately respond to changes in market conditions or strategic direction.
-74-
ERIE INDEMNITY COMPANY
FIXED MATURITY SECURITIES BY CREDIT QUALITY
(amounts in thousands, except percentages) At June 30, 2002
---------------------------------------------
Moody's Equivalent Estimated Fair
Description Amortized Cost Market Value % of carry
----------- -------------- ------------ ----------
Aaa/Aa/A $389,875 $404,786 63.8%
Baa 219,296 216,938 34.2
Ba/BB 9,301 9,241 1.5
B 2,595 2,010 0.3
In or near default 1,230 1,230 0.2
-------- -------- -----
Total $622,297 $634,205 100.0%
======== ======== =====
ERIE INDEMNITY COMPANY
FIXED MATURITY SECURITIES TERM TO MATURITY
(amounts in thousands, except percentages) At June 30, 2002
---------------------------------------------
Moody's Equivalent Estimated Fair
Description Amortized Cost Market Value % of carry
----------- -------------- ------------ ----------
Due in less than one year $ 39,856 $ 40,618 6.4%
Due in 1-5 years 172,046 175,338 27.7
Due in 5-10 years 234,773 239,266 37.7
Due after 10 years 175,622 178,983 28.2
-------- -------- -----
Total $622,297 $634,205 100.0%
======== ======== =====
EQUITY SECURITIES
Equity securities (common stock and non-redeemable preferred stock) are
carried on the Consolidated Statements of Financial Position at market value.
The Company's non-redeemable preferred stock portfolio provides a source of
highly predictable current income that is competitive with investment-grade
bonds. Non-redeemable preferred stocks generally provide for fixed rates of
return that, while not guaranteed, resemble fixed income securities and are paid
before common stock dividends. Common stock provides capital appreciation
potential within the portfolio. Common stock investments inherently provide no
assurance of producing income because dividends are not guaranteed.
-75-
ERIE INDEMNITY COMPANY
EQUITY SECURITIES AT MARKET VALUE
At June 30, At December 31,
--------------------- ----------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- -------- -------- --------
(unaudited)
COMMON STOCK:
U.S. industrials and miscellaneous $ 38,789 $ 85,732 $ 59,709 $ 86,605 $103,132 $ 83,563 $ 71,191
U.S. banks, trusts and insurance 2,377 4,402 4,082 3,798 7,156 3,488 6,517
Foreign 756 4,440 -- 4,962 5,511 3,179 2,462
NONREDEEMABLE PREFERRED STOCK:
U.S. industrial and miscellaneous 90,970 91,505 91,647 61,134 56,662 60,463 27,914
U.S. banks, trusts and insurance 25,097 20,382 15,565 22,125 36,694 45,338 50,248
Foreign 21,555 28,080 20,416 25,822 6,228 6,773 4,155
Public utilities 9,033 -- 2,379 -- -- -- 2,646
-------- -------- -------- -------- -------- -------- --------
Total $188,577 $234,541 $193,798 $204,446 $215,383 $202,804 $165,133
======== ======== ======== ======== ======== ======== ========
ERIE INDEMNITY COMPANY
EQUITY SECURITIES AT COST
At June 30, At December 31,
--------------------- ----------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- -------- -------- --------
(unaudited)
COMMON STOCK:
U.S. industrials and miscellaneous $ 19,391 $ 65,240 $ 28,718 $ 63,662 $ 56,035 $ 53,914 $ 58,415
U.S. banks, trusts and insurance 1,791 3,651 3,284 3,651 3,887 3,522 3,138
Foreign 417 6,855 -- 7,100 4,948 3,186 3,209
NONREDEEMABLE PREFERRED STOCK:
U.S. industrial and miscellaneous 90,870 92,948 91,185 62,266 61,109 59,858 25,909
U.S. banks, trusts and insurance 24,226 20,103 14,685 22,094 38,708 42,807 46,901
Foreign 20,475 27,243 19,485 26,195 6,808 6,690 3,932
Public utilities 9,051 -- 2,370 -- -- -- 2,619
-------- -------- -------- -------- -------- -------- --------
Total $166,221 $216,040 $159,727 $184,968 $171,495 $169,977 $144,123
======== ======== ======== ======== ======== ======== ========
LIMITED PARTNERSHIPS
The Company's limited partnership investments include U.S. and foreign
private equity, real estate and fixed income investments. During the first six
months of 2002, limited partnership investments increased $5.3 million to $86.8
million. Fixed income and real estate limited partnerships, which comprise 42.8%
of the total limited partnerships, produce a predictable earnings stream while
private equity partnerships, which comprise 57.2% of the total limited
partnerships, tend to provide a less predictable earnings stream but the
potential for greater long-term returns.
The Company has outstanding commitments to invest up to $110 million
related to these limited partnership investments at June 30, 2002. These
commitments will be funded as required through the end of the respective
investment periods, which typically span three to five years and generally
expire in 2005. At June 30, 2002, the total commitment to fund
-76-
limited partnerships that invest in private equity securities is $82 million,
real estate activities $16 million and fixed income securities $12 million. At
June 30, 2002, no one commitment exceeded $7.5 million, or 6.8%, of the
outstanding commitment amount. The Company has sufficient cash flows from
operations to meet these partnership commitments.
DERIVATIVES
During 2001, we entered into several foreign currency forward contracts
that are by definition derivatives. The purpose of these contracts is to
partially hedge future capital calls related to our limited partnership
commitments. However, under accounting rules, these contracts are not considered
hedges. The forward contracts have no cash requirements at the inception of the
arrangement. At June 30, 2002, the notional amount of the contracts outstanding
totaled $1.7 million. For the quarter ended June 30, 2002, changes in value
totaling $89,000 were recognized currently in earnings as realized gains in the
Consolidated Statements of Operations. Gains on these contracts totaled $99,000
for the six months ended 2002 and $46,000 in 2001.
SECURITIES LENDING PROGRAM
Our Company participates in a securities lending program whereby
certain securities from its portfolio are loaned to other institutions for short
periods of time through a lending agent. A fee is paid to us by the borrower.
Collateral, comprised of cash and government securities, is maintained by the
lending agent. The Company has an indemnification agreement with the lending
agent in the event a borrower becomes insolvent or fails to return securities.
The Company had loaned securities with a market value of $17.4 million and $44.9
million secured by collateral of $18.0 million and $45.9 million at June 30,
2002 and 2001, respectively. The loaned securities are maintained on the
Consolidated Statements of Financial Position as a part of invested assets. We
have incurred no losses on the loan program since its inception.
RESERVES FOR OUR PROPERTY AND CASUALTY SUBSIDIARIES
Loss reserves are established to account for the estimated ultimate
costs of loss and loss adjustment expenses for claims that have been reported
but not yet settled and claims that have been incurred but not yet reported. The
estimated loss reserve for reported claims is based primarily upon a
case-by-case evaluation of the type of risk involved and knowledge of the
circumstances surrounding each claim and the insurance policy provisions
relating to the type of loss. Estimates of reserves for unreported claims and
loss settlement expenses are determined on the basis of historical information
by line of business as adjusted to current conditions. Inflation is implicitly
provided for in the reserving function through analysis of costs, trends and
reviews of historical reserving results.
-77-
The process of estimating the liability for unpaid losses and loss
adjustment expenses is inherently judgmental and can be influenced by factors
subject to variation. Possible sources of variation include claim frequency and
severity, changing rates of inflation as well as changes in other economic
conditions, judicial trends and legislative changes. It is unlikely that future
losses and loss adjustment expenses will develop exactly as projected. We
continually refine reserves as experience develops and new information becomes
known. We reflect adjustments to reserves in the results of operations in the
periods in which the estimates are changed. With the exception of reserves
relating to certain workers' compensation cases, which have been discounted at
2.5% since 1998, loss reserves are not discounted.
The following table sets forth the development of our property and
casualty subsidiaries' net reserves for unpaid losses and loss adjustment
expense from 1992 through 2001, the period that our property and casualty
subsidiaries have assumed underwriting activity under the intercompany pool. The
table has been computed on a statutory basis to better reflect our results under
the intercompany pooling arrangement and does not include the anticipated
salvage and subrogation to be recovered on these losses in the future, but does
include salvage and subrogation collected in subsequent periods.
-78-
PROPERTY AND CASUALTY SUBSIDIARIES OF ERIE INDEMNITY COMPANY
NET RESERVES FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Year Ended December 31,
--------------------------------------------------------------------------------------------
(amounts in millions) 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992
------ ------ ------ ------ ------ ------ ------ ------ ------ -------
Reserve for unpaid losses
and loss adjustment expense $122.3 $105.7 $98.1 $94.4 $92.5 $87.7 $82.0 $71.3 $67.2 $62.7
------
DEVELOPMENT OF LIABILITY AS OF:
One year later 111.9 104.4 93.7 90.2 88.5 79.7 67.0 61.8 59.0
-----
Two years later 106.4 95.5 89.7 88.7 81.5 67.3 59.3 55.9
-----
Three years later 97.2 90.4 88.2 82.8 71.1 60.6 53.9
----
Four years later 90.9 87.6 83.3 72.2 66.0 56.4
----
Five years later 88.1 82.4 73.5 67.5 61.1
----
Six years later 83.5 72.4 68.9 63.0
----
Seven years later 73.5 68.3 64.4
----
Eight years later 69.3 63.9
----
Nine years later 64.8
----
Cumulative (deficiency) ( 6.2) ( 8.3) ( 2.8) 1.6 ( 0.4) ( 1.5) ( 2.2) ( 2.1) ( 2.1)
====== ===== ===== ==== ===== ===== ===== ===== =====
excess
CUMULATIVE AMOUNT OF
LIABILITY PAID THROUGH:
One year later $ 41.2 $38.9 $33.6 $31.3 $32.6 $29.3 $22.1 $24.2 $22.0
------
Two years later $59.2 $52.4 $48.3 $48.7 $44.7 $36.2 $34.9 $34.2
-----
Three years later $63.9 $59.2 $57.8 $53.9 $44.7 $42.2 $39.3
-----
Four years later $65.5 $63.5 $59.4 $49.8 $46.5 $43.3
-----
Five years later $67.4 $62.5 $53.2 $49.1 $45.6
-----
Six years later $64.8 $55.0 $51.3 $47.1
-----
Seven years later $56.5 $52.6 $48.5
-----
Eight years later $53.7 $49.4
-----
Nine years later $50.2
-----
Additional information with respect to the reserve activity of our property and
casualty subsidiaries may be found at Notes to Consolidated Financial Statements
- -- Note 2 -- Significant Accounting Policies on page F-12.
The top line shows the estimated liability that was recorded at the end
of each of the indicated years for all current and prior year unpaid losses and
loss expenses. The upper portion of the table shows re-estimations of the
original recorded reserve as of the end of each successive year. The estimate is
increased or decreased as payments are made and more information becomes known
about the development of remaining unpaid claims. The lower portion of the table
shows the cumulative amount paid in succeeding years for losses incurred prior
to the Statement of Financial Position date. The cumulative deficiency or
redundancy represents the aggregate amount by which original estimates of
reserves as of that year-end have changed in subsequent years. An excess in
reserves means that reserves
-79-
established in prior years exceeded actual losses and loss adjustment expenses
or were reevaluated at less than the originally reserved amount. A deficiency in
reserves means that the reserves established in prior years were less than
actual losses and loss adjustment expenses or were reevaluated at more than the
originally reserved amount.
We do not discount reserves except for workers' compensation reserves
on a non-tabular basis. The reserves are discounted at a risk-adjusted 2.5%
interest rate as permitted by the Insurance Department of the Commonwealth of
Pennsylvania. The discount rates used are based upon the Property and Casualty
Group's historical workers' compensation payout pattern. Our reserve liability,
as a result of this discounting, is reduced by $2.4 million, $1.5 million, $1.4
million and $1.6 million at December 31, 2001, 2000, 1999 and 1998,
respectively. We did not discount reserves before 1998.
The 2001 unpaid losses and loss adjustment expenses reserve of $122.3
million includes the Property and Casualty Group's share of estimated incurred
losses from the unaffiliated reinsurance business stemming from the September
11th attack on the World Trade Center. Incurred losses are the total losses
sustained by an insurer or reinsurer under its policies or contracts, whether
paid or unpaid, and include a provision for incurred but not reported losses.
The portion of World Trade Center losses recorded by our property and casualty
subsidiaries after giving effect to recoveries from the excess of loss agreement
with the Exchange was $5.8 million, or $0.06 per share after taxes. The Property
and Casualty Group is exposed to both direct and reinsurance losses arising from
possible future terrorist actions.
Adverse development on loss reserves established for the year ended
December 31, 2000 was the result of an increase in loss severity experienced by
the Property and Casualty Group's direct business related to its automobile
liability and workers' compensation lines of business. Adverse development on
loss reserves established for the year ended December 31, 1999 was the result of
an increase in loss severity experienced by the Property and Casualty Group on
its direct business and additional losses on its voluntary assumed reinsurance
business related to the late December 1999 European wind storms.
REINSURANCE OF THE PROPERTY AND CASUALTY GROUP
In recent years, the Property and Casualty Group has not purchased
treaty reinsurance, including catastrophe reinsurance, because management
concluded, during our periodic assessment of the Property and Casualty Group's
catastrophe exposure, that the benefits of such coverage were outweighed by the
costs of such coverage in light of the Exchange's substantial surplus and its
ratio of net premiums written to surplus. Treaty reinsurance is an agreement
between a ceding company and a reinsurer reinsuring a specified type or category
of risk defined in the agreement. Under a typical reinsurance treaty, the ceding
company is obligated to offer and the reinsurer is obligated to accept a
specified portion of all such type or category of risk originally insured or
reinsured by the ceding company. Because the Exchange has a 94.5%
-80-
participation in the Property and Casualty Group's underwriting results and
provides reinsurance for the 5.5% participation in the underwriting results of
our subsidiaries, the Exchange's financial condition could be adversely affected
by insurance losses to a greater extent than if reinsurance coverage were
maintained. We do maintain facultative reinsurance on individual risks that
exceed our current risk retention guidelines. Facultative reinsurance is the
reinsurance of part or all of the insurance provided by a single policy
negotiated on a contract-by-contract basis. Management is currently reviewing
the desirability of purchasing treaty reinsurance in light of recent
catastrophes and terrorist attacks.
BUSINESS VOLATILITY
The Company's management fee is earned when premiums are written as
substantially all of the services performed by the Company, including sales,
underwriting and policy issuance are completed. Historically, due to policy
renewal and sales patterns, writings are strongest in the second and third
quarters of the calendar year. While loss and loss adjustment expenses are not
entirely predictable, historically such costs have been greater during the third
and fourth quarters, influenced by the weather in the geographic regions where
the Property and Casualty Group operates.
The profitability of the property and casualty insurance business can
be influenced by many external factors some of which include rate competition,
the severity and frequency of claims, terrorist actions, natural disasters,
state regulation of premium rates, other competitive factors, defaults of
reinsurers, investment market conditions, general business conditions, court
decisions that define and may expand the extent of coverage and the amount of
compensation due for injuries and losses.
COMPETITION
The property and casualty markets in which the Property and Casualty
Group operates are highly competitive. Property and casualty insurers generally
compete on the basis of customer service, price, brand recognition, coverages
offered, claim handling ability, financial stability and geographic coverage. In
addition, because the insurance products of the Property and Casualty Group are
marketed exclusively through independent insurance agents, these agents have the
opportunity to represent more than one company. The Property and Casualty Group,
thus, potentially faces competition within its appointed agencies based on
product, price and service relationships.
Market competition bears directly on the price charged for insurance
products and services, subject to the regulatory limitations. Growth is driven
by a company's ability to provide insurance services at a price that is
reasonable and acceptable to the customer. In addition, the marketplace is
affected by available capacity of the insurance industry. Industry surplus
expands and contracts primarily in conjunction with profit levels generated by
the industry. Growth is the product of a company's ability to retain existing
customers
-81-
and to attract new customers as well as movement in the average premium per
policy charged by the Property and Casualty Group. Firming pricing in 2001 and
the first six months of 2002 and a return to "hard market" conditions,
particularly for commercial and personal insurance, have allowed the Property
and Casualty Group to raise premium rates or maintain current premium rates to
gain competitive advantage in the insurance marketplace.
We follow several strategies in managing the property and casualty
insurers of the Property and Casualty Group that our management believes will
result in underwriting performance that exceeds those of the property and
casualty industry in general. First, we employ an underwriting philosophy and
product mix targeted to produce an Property and Casualty Group-wide underwriting
profit, i.e., a combined ratio of less than 100% on a long-term basis, through
careful risk selection, rational pricing and prompt fair claims settlement
practices. The careful selection of risks allows for lower claims frequency and
loss severity, thereby enabling insurance to be offered at favorable prices. The
Property and Casualty Group, as well as the property and casualty industry in
general, experienced increased loss severity in private passenger automobile,
homeowners and commercial lines in 2001 and the first six months of 2002. As a
result, the loss and loss adjustment expense of the Property and Casualty Group
outpaced premiums earned. The firming of automobile pricing in the second half
of 2001 along with deteriorating loss cost trends have allowed us to begin
raising automobile insurance premium rates to mitigate underwriting losses. All
policies issued by the Property and Casualty Group are for a one-year term.
Therefore, the impact of the rate increases will take 24 months before the full
impact is recognized in the premium revenues of the Company.
Second, management focuses on consistently providing superior service
to policyholders and agents in both underwriting and claims handling. The
Property and Casualty Group's ability to provide superior customer service is
reflected in its policy retention and new policy growth rates. Policy retention
remained excellent at 90.9%, 90.9%, 91.0% and 90.5% for the twelve months ended
June 30, 2002 and the years ended December 31, 2001, 2000 and 1999,
respectively, for all lines of business combined. Continued improvement in new
policy growth drove the gains experienced in the Property and Casualty Group's
direct written premium. Policies in force increased at an annualized rate of
10.8% to 3.3 million at June 30, 2002, 8.5% to 3.1 million in 2001 from 2.9
million in 2000 and 6.5% in 2000 from 2.7 million in 1999.
Third, we maintain a business model designed to provide the advantages
of localized marketing and claims servicing with the economies of scale from
centralized accounting, administrative, underwriting, investment, information
management and other support services.
Finally, the Property and Casualty Group carefully selects the
independent agencies that represent it and seeks to be the lead company with its
agents in order to enhance the agency relationship and the likelihood of
receiving the most desirable underwriting
-82-
opportunities from its agents. The Property and Casualty Group has ongoing,
direct communications with its agency force. Agents have access to a number of
company-sponsored venues designed to promote sharing of ideas, concerns and
suggestions with the senior management of the Property and Casualty Group with
the goal of improving communications and service. These efforts have resulted in
outstanding agency penetration and the ability to sustain long-term agency
partnerships.
GOVERNMENT REGULATION
The property and casualty insurers we manage are subject to supervision
and regulation in the states in which they transact business. The primary
purpose of such supervision and regulation is the protection of policyholders.
The extent of such regulation varies, but generally derives from state statutes
that delegate regulatory, supervisory and administrative authority to state
insurance departments. Accordingly, the authority of the state insurance
departments includes the establishment of standards of solvency that must be met
and maintained by insurers, the licensing to do business of insurers and agents,
the nature of the limitations on investments, the approval of premium rates for
property and casualty insurance, the provisions that insurers must make for
current losses and future liabilities, the deposit of securities for the benefit
of policyholders, the approval of policy forms, notice requirements for the
cancellation of policies and the approval of certain changes in control. In
addition, many states have enacted variations of competitive rate-making laws
that allow insurers to set certain premium rates for certain classes of
insurance without having to obtain the prior approval of the state insurance
department. State insurance departments also conduct periodic examinations of
the affairs of insurance companies and require the filing of annual and other
reports relating to the financial condition of insurance companies.
The Property and Casualty Group may be required, under the solvency or
guaranty laws of the various states in which they are licensed, to pay
assessments to fund policyholder losses or liabilities of insolvent insurance
companies. Depending on state law, insurers can be assessed an amount that is
generally equal to between 1% and 2% of premiums written for the relevant lines
of insurance in that state each year to pay the claims of an insolvent insurer.
Certain states permit these assessments, or a portion thereof, to be recorded as
an offset to future premium taxes. The Property and Casualty Group has made
accruals for their portion of assessments related to such insolvencies to the
extent they can be estimated, based upon the most current information furnished
by the guaranty associations.
The Property and Casualty Group is also required to participate in
various involuntary insurance programs for automobile insurance, as well as
other property and casualty lines, in states in which such companies operate.
These involuntary programs provide various insurance coverages to individuals or
other entities that otherwise are unable to purchase such coverage in the
voluntary market. These programs include joint underwriting associations,
assigned risk plans, fair access to insurance requirements ("FAIR")
-83-
plans, reinsurance facilities and windstorm plans. Legislation establishing
these programs generally provides for participation in proportion to voluntary
premium writings of related lines of business in that state. Generally, state
law requires participation in such programs as a condition to doing business in
that state. The loss ratio on insurance written under involuntary programs has
traditionally been greater than the loss ratio on insurance in the voluntary
market; however, the impact of these involuntary programs on the Property and
Casualty Group has been immaterial.
Most states have enacted legislation that regulates insurance holding
company systems. Each insurance company in the holding company system is
required to register with the insurance supervisory authority of its state of
domicile and furnish information regarding the operations of companies within
the holding company system that may materially affect the operations, management
or financial condition of the insurers within the system. Pursuant to these
laws, the respective insurance departments may examine us and the Property and
Casualty Group at any time, require disclosure of material transactions with the
insurers and us as an insurance holding company and require prior approval of
certain transactions between us and the Property and Casualty Group.
All transactions within the holding company system affecting the
insurers we manage are filed with the applicable insurance departments and must
be fair and reasonable. Approval of the applicable insurance commissioner is
required prior to the consummation of transactions affecting the control of an
insurer. In some states, the acquisition of 10% or more of the outstanding
common stock of an insurer or its holding company is presumed to be a change in
control.
As a public company, we are subject to the corporate governance
standards set forth in the recently enacted Sarbanes-Oxley Act of 2002 and other
recent changes to the federal securities laws, as well as any rules or
regulations that may be promulgated by the Securities and Exchange Commission or
the Nasdaq Stock Market(SM). Compliance with these standards, rules and
regulations, as well as with accelerated filing requirements that have recently
been enacted, impose additional administrative costs and burdens on us.
FINANCIAL REGULATION
Our property and casualty insurance subsidiaries are required to file
financial statements prepared in accordance with statutory accounting principles
("SAP"). The adjustments necessary to reconcile the net income and shareholders'
equity of our property and casualty insurance subsidiaries' prepared in
accordance with SAP to net income and shareholders' equity prepared in
accordance with GAAP are as follows:
-84-
ERIE INDEMNITY COMPANY SUBSIDIARIES
GAAP RECONCILIATION OF NET INCOME
Six Months Ended
June 30, Year Ended December 31,
-------------------- ------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
--------- --------- ----------- ---------- ---------- ---------- ---------
(unaudited)
SAP net income (loss) ........................... $ (4,918) $ 2,532 $ (4,929) $ 5,091 $ 9,546 $ 14,663 $ 8,446
ADJUSTMENTS:
Deferred policy acquisition costs ............. 3,097 2,210 3,816 1,798 542 580 742
Deferred income taxes ......................... 1,467 (292) 1,392 32 226 (1,855) 1,409
Federal alternative minimum tax credit
recoverable ............................... 0 0 0 188 0 795 (1,815)
Salvage and subrogation ....................... 0 0 312 221 158 12 94
Incurred premium adjustment ................... (2,097) (1,210) (1,816) (798) (542) (580) (742)
Other ......................................... 95 152 83 10 (59) (3) (78)
-------- -------- -------- -------- -------- -------- --------
GAAP net income (loss) .......................... $ (2,356) $ 3,392 $ (1,142) $ 6,542 $ 9,871 $ 13,612 $ 8,056
======== ======== ======== ======== ======== ======== ========
ERIE INDEMNITY COMPANY SUBSIDIARIES
GAAP RECONCILIATION OF SHAREHOLDERS' EQUITY
At June 30, At December 31,
-------------------- ------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
--------- --------- ----------- ---------- ---------- ---------- ---------
(unaudited)
SAP shareholders' equity ........................ $ 88,073 $ 99,400 $ 92,128 $ 89,637 $ 81,709 $ 74,348 $ 60,628
ADJUSTMENTS:
Deferred policy acquisition costs ............. 20,115 15,412 17,018 13,202 11,405 10,863 10,284
Difference between GAAP and SAP deferred
income taxes .............................. (1,598) (2,023) (354) 3,569 3,350 4,143 5,998
Federal alternative maximum tax credit
recoverable ............................... 0 0 0 0 0 (1,020) (1,815)
Salvage and subrogation ....................... 3,661 3,349 3,661 3,349 3,128 2,970 2,957
Statutory reserves ............................ 0 0 0 865 2,656 2,619 1,823
Incurred premium adjustment ................... (16,115) (13,412) (14,018) (12,202) (11,405) (10,863) (10,284)
Unrealized gains net of deferred taxes ........ 5,625 4,271 4,722 2,331 38 7,653 6,697
Other ......................................... 330 160 223 7 (3) 0 8
-------- -------- -------- -------- -------- -------- --------
GAAP shareholders' equity ....................... $100,091 $107,157 $103,380 $100,758 $ 90,878 $ 90,713 $ 76,296
======== ======== ======== ======== ======== ======== ========
Effective January 1, 2001, the NAIC adopted the Codification of
Statutory Accounting Principles (Codification) as the NAIC-supported basis of
accounting. Codification resulted in changes to the SAP-based financial
statements of our property and casualty insurance subsidiaries, the most
significant of which was the recording of statutory deferred taxes for certain
of the property and casualty insurance subsidiaries. The total cumulative
adjustment increased the statutory surplus of our property and casualty
insurance subsidiaries by $4.4 million as of January 1, 2001.
The NAIC has adopted risk-based capital ("RBC") standards that require
insurance companies to calculate and report statutory capital and surplus needs
based on a formula measuring underwriting, investment and other business risks
inherent in an individual
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company's operations. These RBC standards have not affected the operation of our
property and casualty insurance subsidiaries and affiliates because each of them
has statutory capital and surplus in excess of RBC requirements.
ERIE INSURANCE EXCHANGE
GENERAL
Erie Insurance Exchange was organized in Pennsylvania in 1925 as a
reciprocal insurance exchange. A reciprocal insurance exchange is a group of
individuals, corporations or entities who, as subscribers, agree to exchange
contracts of insurance (policies) and share insurance risks among themselves,
and whose affairs are managed by an attorney-in-fact appointed at the time of
application for insurance. The Exchange pays us a management fee of 25% of
direct and assumed premiums written as compensation for (i) acting as the
attorney-in-fact for the Exchange, (ii) managing the business and affairs of the
Exchange and (iii) paying certain general administrative expenses not part of
the settlement of losses or the management of investments. We recognize as
income management fees due from the Exchange when the premiums are written
because at that time we have performed substantially all of the services we are
required to perform including sales, underwriting and policy issuance
activities, but currently such fees are not paid to us by the Exchange until it
collects the premiums.
Flagship City Insurance Company is a Pennsylvania-based, wholly owned
subsidiary of Erie Insurance Exchange that writes Pennsylvania assigned risk
automobile and workers' compensation business.
The principal entity in the Erie Insurance Group, the Exchange wrote
$2.0 billion in direct premiums in 2001 and is the 26th largest writer of
property and casualty insurance in the United States as measured by direct
premiums according to A.M. Best. Premiums written in Pennsylvania accounted for
59% of the Exchange's direct written premiums in 2001. Under the pooling
arrangement in place between the Property and Casualty Group, all property and
casualty business is ceded to the Exchange. This pooling arrangement provides
for Erie Insurance Company and Erie Insurance Company of New York to share
proportionately through retrocession in the results of the Property and Casualty
Group, except for the provisions of the excess of loss reinsurance agreement
discussed below. Erie Insurance Company's and Erie Insurance Company of New
York's proportionate share of the reinsurance pool is 5.0% and 0.5% percent,
respectively.
The Exchange has A.M. Best's highest rating of A++ (superior). On a
statutory basis, the Exchange had total assets of $6.6 billion, total
liabilities of $4.1 billion and policyholders' surplus of $2.5 billion, as of
June 30, 2002. The Exchange owns a 53.5% stake in Erie Family Life Insurance
Company, an affiliated life insurance and annuity provider.
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The selected financial data of the Exchange presented below as of and
for the years ended December 31, 1997 through 2001 are derived from annual
statements prepared in accordance with statutory accounting principles that were
audited by our independent auditors. The financial statements of the Exchange
included in these annual statements are prepared in accordance with Statutory
Accounting Principles required by the NAIC Accounting Practices and Procedures
Manual, as modified to include prescribed or permitted practices of the
Commonwealth of Pennsylvania. The selected financial data below as of and for
the six months ended June 30, 2001 and 2002 is derived from the Exchange's
unaudited financial statements prepared in accordance with statutory accounting
principles. In the opinion of management, all adjustments consisting only of
normal recurring accruals, considered necessary for a fair presentation have
been included. The financial data set forth below is only a summary.
ERIE INSURANCE EXCHANGE
SELECTED FINANCIAL INFORMATION
Six Months Ended
June 30, Year Ended December 31,
----------------------- -------------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
---------- ---------- ---------- ----------- ---------- ---------- ----------
(unaudited)
INCOME STATEMENT INFORMATION:
Net premiums earned $1,386,306 $1,172,885 $2,422,600 $2,161,034 $2,039,791 $1,971,525 $1,877,270
Loss and loss adjustment expenses 1,117,656 921,690 2,150,749 1,714,487 1,509,895 1,372,705 1,375,643
Insurance underwriting and other expenses 466,004 353,401 766,304 624,622 576,031 568,149 520,648
---------- ---------- ---------- ----------- ---------- ---------- ----------
Net underwriting (loss) income $ (197,354) $ (102,206) $ (494,453) $ (178,075) $ (46,135) $ 30,671 $ (19,021)
Investment income (loss), net 39,161 130,552 (421,754) 347,582 428,874 378,845 365,393
Federal income tax expense (benefit) (36,184) (1,838) (300,257) 42,433 102,339 102,917 86,627
---------- ---------- ---------- ----------- ---------- ---------- ----------
Net income (loss) $ (122,009) $ 30,184 $ (615,950) $ 127,074 $ 280,400 $ 306,599 $ 259,745
========== ========== ========== ========== ========== ========== ==========
BALANCE SHEET INFORMATION:
Cash and invested assets $5,686,009 $6,298,901 $5,990,511 $6,357,658 $6,860,008 $5,604,496 $4,670,320
Total assets 6,571,174 6,977,695 6,998,794 6,969,746 7,415,176 6,174,590 5,204,856
Claims and unearned premium reserves 3,481,631 2,812,585 3,200,836 2,654,300 2,463,806 2,388,958 2,328,230
Total liabilities 4,060,211 3,430,235 3,953,243 2,847,861 2,660,713 2,582,998 2,490,465
Policyholders' surplus (1)(2) 2,510,963 3,547,460 3,045,551 4,121,885 4,754,462 3,591,592 2,714,391
- ------------
(1) Periods beginning after January 1, 2001 are computed taking into
consideration changes in statutory accounting principles required by the
NAIC Accounting Practices and Procedures Manual. An adjustment made on
January 1, 2001 as a result of such changes decreased policyholders'
surplus by $523.8 million.
(2) Under a practice prescribed by the Commonwealth of Pennsylvania, unearned
premium reserves are reduced (and policyholders' surplus increased) by the
amount of the management fee ultimately payable by the Exchange to us
correlating to premiums not yet earned at the respective financial
statement date. At December 31, 2001, this amount was $240.9 million.
PERFORMANCE OF THE EXCHANGE
OVERVIEW OF FINANCIAL RESULTS
The Exchange has a 94.5% participation in the underwriting results of
the Property and Casualty Group.
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In 1997 and 1998, soft market conditions in the property and casualty
insurance industry created severe price competition in commercial and personal
lines of insurance, including private passenger automobile, the Property and
Casualty Group's largest line of business. Lower pricing on private passenger
automobile insurance was driven by changing driver demographics, safer cars,
tougher drunk driving laws and other factors that reduced automobile insurance
loss costs. Emerging forms of distribution, including direct response writers
who spent a considerable amount of money on advertising in order to build brand
awareness, intensified competition. Competitors targeted the Property and
Casualty Group's private passenger automobile policyholders by offering them
lower insurance rates. Management believed the loss of these customers would
have adversely affected the Property and Casualty Group since its policyholder
base would have included a greater percentage of drivers with higher loss costs.
Higher average premium rates would then be required to be charged to these less
profitable policyholders, which would have exacerbated the competitive rate
problem. These competitive conditions resulted in slower new policy growth and
declines in policy retention rates for the Property and Casualty Group.
Management viewed these competitive effects as a serious threat to the
well-being of the Property and Casualty Group.
Following discussions with our board of directors in 1998, management
decided to reduce premium rates in 1998 and 1999 to remain price competitive in
order to retain the Property and Casualty Group's most profitable customers.
Management discussed with our board that one effect of these pricing actions
would be to reduce underwriting profitability, with a consequent reduction in
surplus. All policies issued by the Property and Casualty Group are for a
one-year term. Therefore, it takes one year for a rate change to be effective
and another year to be recognized fully in the underwriting results of the
Property and Casualty Group. As a result, the 1998 and 1999 premium rate
reductions negatively affected the Property and Casualty Group's underwriting
results in 2000 and 2001. We believe the lower, more competitive private
passenger automobile premium rates have been an important factor in stronger new
policy growth and a return to traditional retention rates for the Property and
Casualty Group in 2002.
The Property and Casualty Group has responded to underwriting losses in
its direct business in light of changing competitive positions in a number of
ways, including:
. adopting stricter underwriting requirements;
. restricting policy coverages;
. increasing the emphasis on reviewing existing policies and accounts
to determine which risks continue to meet underwriting guidelines and
taking appropriate action regarding those policies and accounts that do
not;
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. continuing the focus on claims strategies to reduce claims severity,
such as reducing claims fraud; and
. raising premium rates on its direct lines of business.
The Property and Casualty Group began raising premium rates on its
direct lines of insurance in 2001, and has continued to file and receive
approval for significant premium rate increases for 2002 and 2003. Through
September 1, 2002, the calendar year impact of premium rate increases approved
by regulators, filed and unapproved by regulators and anticipated filings not
yet filed amounted to $124 million for 2002 and $129 million for 2003. In most
instances, a combination of these measures has been employed to address
underwriting losses in a particular line of business or line of business within
a particular state.
Since it takes one year for rate changes to become effective and
another year to be recognized fully in the underwriting results of the Property
and Casualty Group, management believes increased pricing, together with these
other measures, will help to reduce the Property and Casualty Group's
underwriting losses for future accident years, excluding catastrophe losses, as
long as increases in loss costs do not exceed the effect of the measures taken.
The Property and Casualty Group continually monitors its accident year loss
costs and takes actions designed to lower or offset its loss costs.
In 1999, 2000, and 2001, the Property and Casualty Group also incurred
significant underwriting losses from its non-affiliated assumed reinsurance
business. In late December 1999, significant assumed reinsurance losses were
incurred from severe wind storms in Western Europe, which also affected incurred
losses in 2000 as a result of adverse loss reserve development related to these
storms. In 2001, the Property and Casualty Group incurred a $150 million loss
from assumed reinsurance related to the World Trade Center terrorist attack.
Other significant losses were incurred in 2000 and 2001 by the Property and
Casualty Group from non-affiliated assumed reinsurance.
The Property and Casualty Group has also taken action to respond to
underwriting losses in its non-affiliated assumed reinsurance business. In 2002,
the Property and Casualty Group reunderwrote all of its assumed reinsurance
treaties. A significant number of treaties were cancelled, and total aggregate
limits on the treaties written were reduced significantly. Reinsurance premium
rates also were increased significantly, rising 40% to 50%. Finally, terrorism
coverage was specifically excluded from all reinsurance treaties entered into in
2002. Management believes these measures will significantly improve the 2002
accident year results for the non-affiliated assumed reinsurance business of the
Property and Casualty Group.
In 1985, the Exchange increased its investments in common equities as a
core element of its investment strategy. Prior to the more recent decline in the
equity markets, the Exchange's common equities portfolio had grown at December
31, 1999 to a market value of $3.8 billion including unrealized appreciation of
$2.6 billion. However, as a result of the
-89-
recent downturn in the equity markets, the common equities portfolio of the
Exchange has experienced a decline in value. From its inception in 1985 through
June 30, 2002, the the common equities portfolio of the Exchange has produced
returns, inclusive of realized and unrealized gains (net of losses) and dividend
income, in excess of $1.8 billion.
At June 30, 2002, the Exchange had investments in marketable securities
of approximately $5.2 billion, which included investments in unaffiliated common
equity securities of approximately $2.4 billion with a cost basis of $1.3
billion. Investments in marketable securities and marketable common equity
securities comprised 78.8% and 37.4%, respectively, of the Exchange's admitted
assets at June 30, 2002. Management believes the Exchange's concentration of
investment in marketable common equity securities is greater than that of most
of its competitors. All of the Exchange's marketable security investments are
subject to market volatility. The Exchange's marketable securities have exposure
to price risk and the volatility of the capital markets and general economic
conditions. The stock market decline in 2002 has reduced the value of the
Exchange's marketable securities by $747.0 million during the first six months
of 2002, compared to $195.4 million during the first six months of 2001.
Management believes that the Exchange's focus on investments in common
equities has produced a higher rate of return since 1985 than the Exchange would
have realized if its investment portfolio had included a lesser amount of common
equities.
SIX MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2001
The Exchange recorded a net loss of $122.0 million in the first six
months of 2002, compared to net income of $30.2 million for the same period in
2001. Premiums earned increased 18.2% for the six months ended June 30, 2002, to
$1.4 billion from $1.2 billion for the same period in 2001. The strong premium
growth was outpaced by greater loss and underwriting expenses in 2002. The
Exchange also recognized $74.8 million in net realized losses from investments
in 2002 on the sale of securities and related charges for impairments in
investment values.
The underwriting loss recorded by the Exchange totaled $197.4 million
in the first six months of 2002, compared to a loss of $102.2 million for the
same period in 2001. Catastrophe losses were partly responsible for the
increased losses and totaled $67.8 million for the six months ended June 30,
2002, compared to $2.0 million for the same period in 2001. Losses resulting
from spring wind and hail storm related events and categorized as catastrophes
by the Property and Casualty Group totaled $59.7 million in 2002. Increased
underwriting expenses also contributed to the increased underwriting loss in the
first six months of 2002 when compared to 2001. Included in the underwriting
expenses are the Exchange's share of eCommerce initiative expenses covered under
the technology cost sharing agreement that totaled $35.3 million for the six
months ended June 30, 2002 compared to $3.3 million for the same period in 2001.
-90-
Net investment income totaled $39.2 million and $130.6 million for the
six months ended June 30, 2002 and 2001, respectively. Investment income from
interest, dividends and rent increased 15.2 percent to $114.0 million for the
first half of 2002 from $99.0 million for the same period in 2001. Realized
losses on investments totaled $74.8 million in the first six months of 2002,
compared to realized gains of $31.6 million in 2001. Impairment charges of
investments with declines in value considered by management to be other than
temporary totaled $82.5 million for the six months ended June 30, 2002,
including $14.1 million related to securities of WorldCom Group. There were no
such charges recorded in the first half of 2001.
Unrealized capital losses, net of deferred taxes, totaled $439.4
million and $141.7 million for the six months ended June 30, 2002 and 2001,
respectively. In the first six months of 2002, the Exchange's policyholders'
surplus declined by $534.6 million. Policyholders' surplus totaled $2.5 billion
at June 30, 2002.
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
The Exchange recorded a net loss of $616.0 million in 2001, compared to
net income of $127.1 million in 2000 and $280.4 million in 1999. Premiums earned
increased 12.1% in 2001, to $2.4 billion from $2.2 billion in 2000, and 5.9% in
2000 from $2.0 billion in 1999. While the premium growth was strong, the
Exchange incurred greater losses and loss adjustment expenses in 2001. The
Exchange also recognized $622.1 million in net realized losses from investments
in 2001 on the sale of securities and related charges for impairments in
investment values.
The underwriting loss during 2001 was $494.5 million, compared to
losses of $178.1 million recorded in 2000 and $46.1 million recorded in 1999.
The 2001 underwriting loss largely resulted from significant premium rate
reductions implemented in 1998 and 1999 in response to the intensely competitive
conditions in the private passenger automobile lines of business and higher
claims severity in private passenger and commercial automobile and workers'
compensation insurance, as well as losses from assumed reinsurance, some of
which relate to the September 11th terrorist attack on the World Trade Center.
The Exchange's estimated incurred losses from the World Trade Center terrorist
attack assumes that the attack is considered one event. The Exchange's potential
exposure would increase between approximately $47 million and $71 million if the
attack is considered two events. The 2000 underwriting results were negatively
impacted by the adverse loss development experienced in the Exchange's
reinsurance operations, specifically adverse loss development during calendar
year 2000 from end of December 1999 European wind storms.
Net investment losses totaled $421.8 million in 2001 compared to net
investment income of $347.6 million in 2000 and $428.9 million in 1999.
Investment income from interest, dividends and rent declined 7.8% to $200.4
million in 2001 from $217.3 in 2000 and increased 3.4% in 2000 from $210.2
million in 1999. Investment income dropped in 2001, due to reduced earnings from
limited partnership investments and interest rate declines on the
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Exchange's bond portfolio. Realized losses on investments totaled $622.1 million
in 2001, compared to realized gains of $130.2 million in 2000 and $218.7 million
in 1999. The Exchange recognized realized losses in 2001 as a result of the sale
of securities and charges for other than temporary impairments of common and
preferred stock and limited partnership investments. The sale on investments in
a loss position in 2001 was part of a proactive year-end tax selling strategy.
Net realized losses from the sales of securities totaled $583.1 million, of
which the Exchange recovered $197.6 million in federal income taxes paid in
1998, 1999 and 2000. Of this total realized loss, $21.0 million related to sales
of securities of Enron Corporation and its related legal entities. Impairment
charges of investments with declines in value considered by management to be
other than temporary totaled $44.9 million in 2001 and $7.6 million in 2000.
There were no such charges recorded in 1999.
Effective January 1, 2001, the Exchange adopted changes in statutory
accounting principles required by the NAIC Accounting Practices and Procedures
Manual, with deviations for practices prescribed or permitted by state insurance
commissioners. Adoption of these new accounting standards resulted in changes to
the Exchange's statutory-basis financial statements. The cumulative effect of
adoption reduced statutory surplus by $523.8 million at January 1, 2001. The
most significant portion of the surplus adjustment was the establishment of a
liability for deferred taxes, which reduced surplus by $538.8 million at that
date, the majority of which resulted from deferred taxes on unrealized capital
gains on the common stock investments of the Exchange.
Underwriting losses combined with net realized capital losses and the
cumulative effect of adopting codified statutory accounting principles resulted
in a reduction to policyholders' surplus of $1.1 billion. Policyholders' surplus
totaled $3.0 billion at December 31, 2001.
ERIE FAMILY LIFE INSURANCE COMPANY
Erie Family Life Insurance Company markets individual and group life
insurance policies, including universal life, annuity and disability income
products. Erie Family Life Insurance Company markets its products through the
Property and Casualty Group's agency system, enabling our independent agents to
distribute a more comprehensive portfolio of insurance products to our
customers. Erie Family Life Insurance Company is owned 21.6% by us, 53.5% by the
Exchange and the remaining 24.9% by public shareholders, who are predominantly
directors, agents and employees of the Company. Erie Family Life Insurance
Company trades on the OTC Bulletin Board under the symbol "ERIF".
As of June 30, 2002, Erie Family Life Insurance Company had GAAP assets
of $1,192.3 million and shareholders' equity of $201.8 million. For the six
months ended June 30, 2002, Erie Family Life Insurance Company had net operating
income, excluding realized gains, of $9.1 million.
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MANAGEMENT
DIRECTORS
Our board of directors currently consists of 12 members, each of whom
is elected annually to serve for a term of one year and until the election of
the director's successor. In July 2002, we increased the number of board seats
to 13, and there is currently one vacancy on the board. Certain information as
to our directors is as follows:
Name Age Director Since
---------------------------- -------- --------------------------
Samuel P. Black, III 60 1997
J. Ralph Borneman, Jr. 63 1992
Patricia A. Garrison-Corbin 54 2000
Susan Hirt Hagen 67 1980
F. William Hirt 76 1965
Samuel P. Katz 52 2000
Claude C. Lilly, III 55 2000
Jeffrey A. Ludrof 42 2002
Henry N. Nassau 47 2000
John M. Petersen 73 1979
Jan R. Van Gorder 54 1990
Robert C. Wilburn 58 1999
Samuel P. Black, III is President, Treasurer and Secretary of Samuel P.
Black & Associates, Inc., an insurance agency with which he has been associated
since 1973. Mr. Black is also the managing general partner and a limited partner
of Black Interests Limited Partnership, the selling shareholder.
J. Ralph Borneman, Jr. has been President and Chief Executive Officer
of Body-Borneman Associates, Inc., an insurance agency, and President of
Body-Borneman, Ltd. and Body-Borneman, Inc., insurance agencies, since 1967. Mr.
Borneman is also a director of National Penn Bancshares.
Patricia A. Garrison-Corbin is a founder, and has been President and
Chief Executive Officer since 1986, of P.G. Corbin & Company, Inc., a firm that
provides financial advisory and investment management services for
municipalities. She is also a director of P.G. Corbin Asset Management, Inc.
Susan Hirt Hagen was Managing Partner of Hagen, Herr & Peppin, group
relations consultants, from 1990 to 1999. Mrs. Hagen is a co-trustee of the H.O.
Hirt Trusts.
-93-
F. William Hirt has been Chairman of the Board of the Company since
1993. Mr. Hirt is a co-trustee of the H.O. Hirt Trusts.
Samuel P. Katz has been Chief Executive Officer of Greater Philadelphia
First, a business leadership civic organization, since July 2000. He is also a
founder, and has been President since 1997, of EnterSport Capital Advisors,
Inc., a private investment and consulting firm and Managing Partner of
Wynnefield Capital Advisors, Inc., a fund manager of a private equity venture
fund since 1997.
Claude C. Lilly, III has been Dean, Belk College of Business
Administration, University of North Carolina, Charlotte, since 1998, and James
H. Harris Chair of Risk Management and Insurance, Belk College of Business
Administration, University of North Carolina, Charlotte, since 1997.
Jeffrey A. Ludrof has been President and Chief Executive Officer of the
Company since May 2002. Mr. Ludrof was Executive Vice President-Insurance
Operations of the Company from 1999 to May 2002, and was a Senior Vice President
of the Company from 1994 to 1999.
Henry N. Nassau has been Managing Director, General Counsel and
Secretary of Internet Capital Group, Inc., an internet holding company, since
1999. He was a partner of Dechert for 12 years prior thereto and Chairman of the
Business Department of that law firm for his last 18 months at the firm. Mr.
Nassau is a director of various companies associated with Internet Capital
Group, Inc., various companies associated with Albert Abela Corporation and of
Bliley Technologies, Inc.
John M. Petersen, who retired from the Company in 1995 and currently
serves as an equity investment consultant to the Company, was President of the
Company from 1990 to 1995, Chief Executive Officer of the Company from 1993 to
1995 and Treasurer and Chief Financial Officer of the Company from 1992 to 1995.
Mr. Petersen is a director of Spectrum Control.
Jan R. Van Gorder has been Senior Executive Vice President, Secretary
and General Counsel of the Company since 1990. Mr. Van Gorder served as Acting
President and Chief Executive Officer from January 2002 to May 2002.
Robert C. Wilburn has been President and Chief Executive Officer of the
Gettysburg National Battlefield Museum Foundation since 2000, and Distinguished
Service Professor, Carnegie Mellon University, since 1999. Mr. Wilburn was
President and Chief Executive Officer of the Colonial Williamsburg Foundation
from 1992 to 1999.
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EXECUTIVE OFFICERS
The following table sets forth certain information regarding executive
officers of companies that comprise Erie Insurance Group, each of whom has
served with us for more than 20 years.
Name Age Positions
- ----------------------- ------- -------------------------------------------
Jeffrey A. Ludrof 42 President and Chief Executive Officer since
May 2002
Jan R. Van Gorder 54 Senior Executive Vice President, Secretary
and General Counsel since 1990
Philip A. Garcia 46 Executive Vice President and Chief Financial
Officer since 1997
John J. Brinling, Jr. 55 Executive Vice President, Erie Family Life
Insurance Company, since 1990
-95-
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
J. Ralph Borneman, Jr. and Samuel P. Black, III, two of our directors, are
also officers and principal shareholders of insurance agencies that receive
insurance commissions in the ordinary course of business from the insurance
companies we manage in accordance with the insurance companies' standard
commission schedules and agents' contracts. During 2001, the Borneman agencies
were paid $3,761,503 and the Black agencies were paid $517,923 in commissions
for insurance business placed with the insurance companies we managed. In 1999,
2000 and 2001, Mr. Borneman, in his capacity as an insurance agent, received a
commission of $4,500 in connection with a workers' compensation insurance policy
covering our employees that he placed with Fireman's Fund Insurance Company,
based on competitive bids. The policy was placed with another insurance carrier
as of January 1, 2002, and Mr. Borneman will not receive any commission from the
placement of this policy.
John M. Petersen, a director and a former President and Chief Executive
Officer who retired on December 31, 1995 and who served as Chief Investment
Officer for Erie Insurance Group companies for many years, is a party to a
consulting arrangement with us. Under the consulting arrangement, which is
terminable on 30 days notice by either party, Mr. Petersen provides investment
services with respect to the common stock investments of us, our pension trust,
the Exchange and Erie Family Life Insurance Company. As compensation for his
services, Mr. Petersen receives a fee of 0.15 of 1%, on an annualized basis, of
the fair market value of the common equities portfolios he manages. We also pay
for all necessary and reasonable expenses incurred by Mr. Petersen in rendering
the services he provides. The payments to Mr. Petersen in 2001 for services he
rendered to the Exchange, us, our pension trust and Erie Family Life Insurance
Company were $4,584,610, $177,956, $135,723 and $93,632, respectively, or a
total of $4,991,921.
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PRINCIPAL SHAREHOLDERS
The following table sets forth as of June 30, 2002, and as adjusted to
reflect the sale of the shares of Class A common stock offered by the Selling
Shareholder, the amount and percentage of our outstanding Class A common stock
beneficially owned by (i) each person who is known by us to own beneficially
more than 5% of our Class A common stock, (ii) each director of the Company,
(iii) each of our five highest-paid executive officers in 2001 and (iv) all of
our officers and directors as a group.
At June 30, 2002 Pro Forma At June 30, 2002 for Offering
---------------------------------- ---------------------------------------
Shares Percent of Shares Percent of
Name of Individual Beneficially Outstanding Shares Being Beneficially Outstanding
or Identity of Group Owned (9)(10) Class A stock (11) Offered Owned (9)(10) Class A stock (11)
-------------------- ------------- ------------------ ------------ ------------- ------------------
5% HOLDERS:
SELLING SHAREHOLDER:
Black Interests Limited Partnership (1) 8,726,250 13.70% 4,000,000 4,726,250 7.42%
Erie, Pennsylvania
OTHER SHAREHOLDERS:
Samuel P. Black & Associates, Inc. (1) 24,000 -- -- 24,000 --
Erie, Pennsylvania
Samuel P. Black, III (1) 129,750 -- -- 129,750 --
Erie, Pennsylvania
Hagen Family Limited Partnership (2)(3) 10,092,900 15.84% -- 10,092,900 15.84%
Erie, Pennsylvania
Susan Hirt Hagen (2)(3)(4) 6,658,800 10.45% -- 6,658,800 10.45%
Erie, Pennsylvania
Hirt Family Limited Partnership (5) 11,830,000 18.57% -- 11,830,000 18.57%
Erie, Pennsylvania
F. William Hirt (4)(5) 892,340 1.40% -- 892,340 1.40%
Erie, Pennsylvania
DIRECTORS (6):
J. Ralph Borneman, Jr. 50,000 -- -- 50,000 --
Patricia A. Garrison-Corbin 100 -- -- 100 --
Samuel P. Katz 500 -- -- 500 --
Claude C. Lilly, III 500 -- -- 500 --
Jeffrey A. Ludrof 2,305 -- -- 2,305 --
Henry N. Nassau 600 -- -- 600 --
John M. Petersen (7) 2,140,037 3.36% -- 2,140,037 3.36%
Jan R. Van Gorder 123,667 -- 123,667 --
Robert C. Wilburn 2,000 -- -- 2,000 --
EXECUTIVE OFFICERS (8):
Philip A. Garcia 91,175 -- -- 91,175 --
All Directors and Executive Officers
as a group (14 persons) 40,764,924 63.98% 4,000,000 36,764,924 57.74%
- -------------
(1) Mr. Black is President of Samuel P. Black & Associates, Inc. and the
managing general partner and a limited partner of Black Interests Limited
Partnership. Mr. Black has the right to vote the shares held by Samuel P.
Black & Associates Inc. and Black Interests Limited Partnership. If all of
the 390 shares of Class B common stock beneficially owned by the Black
Interests Limited Partnership were converted into Class A common stock, the
maximum number of shares of Class A common stock that the Black Interests
Limited Partnership could be deemed to own would be 9,662,250 shares of
Class A common stock, or 14.96% of the then outstanding shares of Class A
common stock.
(2) Mrs. Hagen owns 300 shares of Class A common stock directly, 6,658,500
shares of Class A common stock indirectly through a personal trust of which
Mrs. Hagen is the sole trustee and 10,092,900 shares of Class A common
stock indirectly through the Hagen Family Limited Partnership, of which
Mrs. Hagen and her husband, Thomas B. Hagen, are limited partners. Under
the position of
-97-
the SEC described in footnote (10), the maximum number of shares of Class A
common stock that Mrs. Hagen and Thomas B. Hagen together could be deemed
to own beneficially is 16,756,800 shares of Class A common stock, or 26.31%
of the outstanding shares of Class A common stock. Mr. and Mrs. Hagen
together could also be deemed the beneficial owners of an additional
2,846,400 shares of Class A common stock issuable upon the conversion of
the 1,186 shares of Class B common stock they together could be deemed to
own beneficially by Mrs. Hagen being the beneficial owner of the shares
held by one of the H.O. Hirt Trusts. If all 1,186 shares of Class B common
stock Mr. and Mrs. Hagen together could be deemed to own beneficially were
converted into Class A common stock, the maximum number of shares of Class
A common stock that Mr. and Mrs. Hagen together could be deemed to own
beneficially would be 19,603,200 shares of Class A common stock, or 30.77%
of the then outstanding shares of Class A common stock. Thomas B. Hagen
disclaims beneficial ownership of the shares of Class A common stock and
Class B common stock owned by Mrs. Hagen.
(3) Excludes 5,100 shares of Class A common stock owned by Thomas B. Hagen,
Mrs. Hagen's husband. Mrs. Hagen disclaims beneficial ownership of these
shares.
(4) There are two H.O. Hirt Trusts, one for the benefit of Mr. Hirt and one for
the benefit of Mrs. Hagen. Each of the H.O. Hirt Trusts is the record owner
of 1,170 shares of Class B common stock, or 38.11% of the outstanding
shares of Class B common stock. The trustees of the H.O. Hirt Trusts as of
the date of this prospectus are Mr. Hirt, Mrs. Hagen and Bankers Trust
Company. Mr. Hirt and Mrs. Hagen, who are brother and sister, are each the
beneficial owner of 1,170 shares of Class B common stock held by the H.O.
Hirt Trust of which each is the beneficiary and, as Co-Trustees, along with
Bankers Trust Company, have shared voting power over the 2,340 shares of
Class B common stock held by the H.O. Hirt Trusts.
(5) Mr. Hirt owns 892,340 shares of Class A common stock directly, and
11,830,000 shares of Class A common stock indirectly through the Hirt
Family Limited Partnership of which Mr. Hirt is the general and a limited
partner. Under the rules of the SEC described in footnote (10), the maximum
number of shares of Class A common stock that Mr. Hirt could be deemed to
own beneficially is 12,722,340 shares of Class A common stock, or 19.97% of
the outstanding shares of Class A common stock. Mr. Hirt could also be
deemed the beneficial owner of an additional 2,856,000 shares of Class A
common stock issuable upon the conversion of the 1,170 shares of Class B
common stock he is deemed to own beneficially as beneficiary of the shares
held by one of the H.O. Hirt Trusts. If all 1,190 shares of Class B common
stock Mr. Hirt could be deemed to own beneficially were converted in to
Class A common stock, the maximum number of shares of Class A common stock
that Mr. Hirt could be deemed to own beneficially would be 15,578,340
shares of Class A common stock, or 24.46% of the then outstanding shares of
Class A common stock.
(6) Excludes directors listed under "5% Holders".
(7) Mr. Petersen disclaims beneficial ownership of 120,000 shares of Class A
common stock owned by his wife, Gertrude E. Petersen, which have not been
included in the total listed herein. However, the total includes 200,000
shares held in the Petersen Family Limited Partnership of which Mr.
Petersen is the general partner.
(8) Excludes executive officers listed under "Directors".
(9) Information furnished by the named persons.
(10) Under the rules of the SEC, a person is deemed to be the beneficial owner
of securities if the person has, or shares, "voting power" (which includes
the power to vote, or to direct the voting of, such securities) or
"investment power" (which includes the power to dispose, or to direct the
disposition, of such securities). Under these rules, more than one person
may be deemed to be the beneficial owner of the same securities. Securities
beneficially owned also include securities owned jointly, in whole or in
part, or individually by the person's spouse, minor children or other
relatives who share the same home. The information set forth in the above
table includes all shares of Class A common stock over which the named
individuals, individually or together, share voting power or investment
power, adjusted, however to eliminate the reporting of shares more than
once in order not to overstate the aggregate beneficial ownership of such
persons and to reflect shares as to which the named individuals disclaim
beneficial ownership. The table does not reflect shares of Class A common
stock issuable upon conversion of shares of Class B common stock, each of
which is currently convertible into 2,400 shares of Class A common stock.
(11) Less than 1% unless otherwise indicated.
-98-
THE H.O. HIRT TRUSTS
The H.O. Hirt Trusts own 76.7% of our Class B common stock, which is the
only class of stock that can vote for the election of directors and most other
matters. The trustees of the H.O. Hirt Trusts are Bankers Trust and F. William
Hirt and Susan Hirt Hagen, who are brother and sister. Any determination by the
H.O. Hirt Trusts requires a vote of two of the three trustees and, because the
H.O. Hirt Trusts control 76.7% of our Class B voting stock, any such
determination will control the outcome of any matter submitted for shareholder
approval, except those matters pertaining only to the rights of the holders of
Class A common stock.
CERTAIN RECENT LITIGATION INVOLVING THE H.O. HIRT TRUSTS OR THE INDIVIDUAL
TRUSTEES OF THE H.O. HIRT TRUSTS AND THE COMPANY
LEGAL PROCEEDINGS RELATING TO THE APPOINTMENT OF A SUCCESSOR CORPORATE
TRUSTEE TO BANKERS TRUST
On March 3, 1999, Bankers Trust filed a petition with the Orphans' Court
Division of the Court of Common Pleas of Erie County, Pennsylvania (the
"Court"), requesting that the Court accept its resignation as corporate trustee
of the H.O. Hirt Trusts. Two successor corporate trustee candidates, one
supported by Mr. Hirt and one supported by Mrs. Hagen, have presented testimony
to the Court in this matter. Subsequent to that testimony, Laurel Hirt, Mr.
Hirt's daughter and a contingent beneficiary of the H.O. Hirt Trusts, filed a
petition requesting that the Court also consider a third successor corporate
trustee candidate not supported by Mr. Hirt. Mr. Hirt has made a filing
objecting to Ms. Hirt's petition that is pending. Mrs. Hagen has not stated a
position on Ms. Hirt's petition.
In a related matter, Mr. Hirt and Mrs. Hagen were subject to a February 23,
2000 order issued by the Court to finalize certain matters relating to a
so-called "funding plan" for the payment of the fees and costs of the successor
corporate co-trustee and to make application to the Internal Revenue Service for
a private letter ruling on the tax treatment of the finalized "funding plan". On
June 13, 2002, the Court granted a petition filed by the trustees of the H.O.
Hirt Trusts that permits the H.O. Hirt Trusts, under certain circumstances, to
sell shares owned by the H.O. Hirt Trusts in order to fund the fees and expenses
of the corporate trustee. Ms. Hirt has filed a notice of appeal with respect to
this decision.
PETITION FOR DECLARATORY JUDGMENT FILED BY BANKERS TRUST
On May 6, 1999, Bankers Trust, in its capacity as corporate trustee of the
H.O. Hirt Trusts, filed a petition with the Court seeking a determination
whether Section 1405(c)(4) of the Pennsylvania Insurance Holding Companies Act
provides the exclusive means by which persons may be nominated and elected to
the Company's board of directors or whether shareholders independently have the
power to nominate and elect to the board of directors
-99-
persons other than those nominated by the nominating committee of the board of
directors. Mrs. Hagen supported the petition, which was opposed by the Company
and Mr. Hirt. On July 15, 1999, the Court dismissed the petition for lack of
ripeness.
LITIGATION REGARDING NOMINATIONS OF CANDIDATES FOR ELECTION AS DIRECTORS BY
THE HOLDERS OF CLASS B COMMON STOCK
On March 9, 2000, Mrs. Hagen commenced litigation in the Court in which she
sought relief in the form of an order that (i) the nominating committee of the
Company's board of directors does not have the exclusive right to nominate
candidates for election as directors of the Company by shareholders, (ii) any
holder of Class B common stock may nominate directly candidates for election as
directors of the Company by shareholders and vote on those nominees and (iii)
Mrs. Hagen has the right to submit nominees to a vote of Class B shareholders at
annual meetings. On April 5, 2001, a Stipulation among Mrs. Hagen, Bankers Trust
and the Company was filed with the Court whereby these three parties agreed to
accept as a final adjudication of this matter an April 24, 2000 ruling by the
Court granting a preliminary injunction, as requested by Mrs. Hagen, allowing
the nomination by holders of Class B common stock directly of candidates for
director in addition to those nominated by the nominating committee. The
Stipulation is not binding on any other parties other than the signatories to
the Stipulation.
-100-
SELLING SHAREHOLDER
Black Interests Limited Partnership (the "Selling Shareholder") is
offering approximately 4.0 million shares. The Selling Shareholder has also
granted the underwriters a 30-day option to purchase up to approximately 600,000
shares to cover over-allotments. Samuel P. Black, III is the managing general
partner of the partnership and has the right to vote the shares held by it. Mr.
Black has been a director of our Company since 1997 and succeeded his father who
served as a director during various periods from 1930 to 1997. Mr. Black is also
an officer and principal shareholder of an insurance agency that receives
insurance commissions in the ordinary course of business from the insurance
companies we manage in accordance with the insurance companies' standard
commission schedules and agents' contracts.
A majority of the proceeds of the shares being offered as described in
this prospectus will be used by the Selling Shareholder to pay estate taxes and
other estate-related expenses arising from the recent death of the mother of
Samuel P. Black, III and to make a charitable bequest.
-101-
DESCRIPTION OF CAPITAL STOCK
As of June 30, 2002, our authorized capital stock consisted of
74,996,930 shares of Class A common stock, of which 63,694,299 shares were
outstanding and 3,070 shares of Class B common stock, of which 3,070 shares were
outstanding. Our shares of Class A common stock do not have the right to vote on
matters submitted to a vote of shareholders, except in the instance where
applicable law permits shares of Class A common stock to vote as a class in
regard to any change in the rights, preferences and privileges of our Class A
common stock.
If a dividend is declared and paid on our Class B common stock, each
share of Class A common stock is entitled to the declaration and payment of a
dividend, at the same time and on the same record date, in an amount at least
equal to 2/3 of 1% of the dividend per share paid on our Class B common stock.
In addition, shares of Class A common stock are entitled to receive dividends,
if declared by our board of directors out of funds legally available therefor,
without any requirement that a simultaneous dividend be declared on our Class B
common stock.
Holders of Class A common stock have the preemptive right to subscribe
for and purchase, pro rata according to the number of shares held, any shares of
Class A common stock we offer for sale for a cash consideration upon such terms
as are fixed by our board of directors. This preemptive right does not apply to
conversion of our Class B common stock into our Class A common stock. Our Class
B common stock is convertible into our Class A common stock at the rate of 2,400
shares of Class A common stock for each share of Class B common stock and cannot
be reissued following conversion or retirement.
In the event of our liquidation, dissolution or winding-up, holders of
Class A common stock and Class B common stock are entitled to share ratably in
any assets available for distribution to shareholders and, in such event, each
share of Class B common stock would be treated as if it had been converted into
2,400 shares of Class A common stock.
The ownership of more than a majority of our Class B common stock by
the H.O. Hirt Trusts, which by its terms authorize a change of control
transaction only if it is required to maintain the health of the Exchange, can
be expected to have the effect of preventing a change in control of us.
Our By-laws provide that each director shall perform their duties in
good faith, in a manner the director reasonably believes to be in our best
interests and with such care, including reasonable inquiry, skill and diligence,
as a person of ordinary prudence would use under similar circumstances. Our
By-laws further provide, as permitted by Pennsylvania law, that a director shall
not have any personal liability, as such, for monetary damages for any action
taken by the director unless (i) the director has breached or failed to perform
the director's duties as stated above and (ii) the breach or failure constitutes
self-dealing, willful
-102-
misconduct or recklessness. This limitation on liability is not applicable to
the liability of a director pursuant to any criminal statute or for the payment
of taxes pursuant to local, state or federal law.
SHARES ELIGIBLE FOR FUTURE SALE
The market price of our Class A common stock could drop due to sales of
a large number of shares of our Class A common stock or the perception that such
sales could occur. These factors could also make it more difficult to raise
funds through future offerings of common stock.
After the offering described in this prospectus, 63,694,299 shares of
Class A common stock will be outstanding, which, except for any shares held by
"affiliates" of the Company as defined in Rule 144 under the Securities Act of
1933, are freely tradable without registration under the Securities Act of 1933.
Shares held by affiliates can be sold in compliance with Rule 144, pursuant to
another exemption from registration or by registering such shares for resale
under the Securities Act of 1933.
In general, under Rule 144 as currently in effect, any person who is an
affiliate or certain persons whose shares are aggregated with our affiliate, is
entitled to sell, within any three-month period, a number of shares that does
not exceed the greater of:
. 1% of the number of then-outstanding shares of Class A common
stock; and
. the average weekly trading volume in the Class A common stock
during the four calendar weeks preceding the date on which the notice
of such sale on Form 144 is filed with the Securities and Exchange
Commission or, if on such notice is required to be filed, the date of
receipt of the order to execute the transaction by the broker or the
date of execution of the transaction directly with a market maker.
-103-
UNDERWRITING
The Company, the Selling Shareholder and the Underwriters named below
(the "Underwriters") have entered into an underwriting agreement with respect to
the shares being offered. Subject to certain conditions, each Underwriter has
severally agreed to purchase the number of shares indicated in the following
table. Goldman, Sachs & Co. and Credit Suisse First Boston Corporation are
acting as the representatives of the Underwriters.
Underwriters Number of Shares
------------ ----------------
Goldman, Sachs & Co. ......................................
Credit Suisse First Boston Corporation ....................
---------
Total ............................................ 4,000,000
=========
Under the terms and conditions of the underwriting agreement, the
Underwriters are committed to take and pay for all of the shares being offered,
if any are taken, other than the shares covered by the option described below,
unless and until this option is exercised.
The Selling Shareholder has granted the Underwriters an option,
exercisable for 30 days after the date of this prospectus, to purchase up to
approximately 600,000 additional shares at the public offering price listed on
the cover page of this prospectus, less underwriting discounts and commissions.
To the extent the option is exercised, each Underwriter will become obligated,
subject to certain conditions, to purchase approximately the same percentage of
the additional shares as the number listed next to each Underwriter's name in
the preceding table bears to the total number of shares listed next to the names
of all Underwriters in the preceding table.
The following table shows the per share and total underwriting
discounts and commissions to be paid to each Underwriter by the Selling
Shareholder. Such amounts are shown assuming both no exercise and full exercise
of the Underwriters' option to purchase 600,000 additional shares.
Paid by the Selling Shareholder No Exercise Full Exercise
------------------------------- ----------- -------------
Per Share ......................................... $ $
Total ............................................. $ $
Shares sold by the Underwriters to the public will initially be offered
at the initial price to public set forth on the cover of this prospectus. Any
shares sold by the Underwriters to securities dealers may be sold at a discount
of up to $_____ per share from the initial price to the public. Any such
securities dealers may resell any shares purchased from Underwriters to certain
other brokers or dealers at a discount of up to $_____ per share from the
initial price
-104-
to the public. If all the shares are not sold at the initial price to the
public, the representatives may change the offering price and the other selling
terms.
The Company, certain of its directors and officers, the Selling Shareholder
and certain other shareholders have agreed not to dispose of or hedge any of
their shares or securities convertible into or exchangeable for shares of common
stock of the Company during the period from the date of this prospectus
continuing through the date 90 days after the date of this prospectus, except
with the prior written consent of Goldman, Sachs & Co. This agreement does not
apply to any existing employee benefit plans of the Company. See "Shares
Eligible for Future Sale" for a discussion of certain transfer restrictions.
In connection with this offering, the Underwriters may purchase and sell
shares of the Class A common stock in the open market. These transactions may
include short sales, stabilizing transactions and purchases to cover positions
created by short sales. Shorts sales involve the sale by the Underwriters of a
greater number of shares than they are required to purchase in the offering.
"Covered" short sales are sales made in an amount not greater than the
Underwriters' option to purchase additional shares from the Selling Shareholder
in the offering. The Underwriters may close out any covered short position by
either exercising their option to purchase additional shares or purchasing
shares in the open market. In determining the source of shares to close out the
covered short position, the Underwriters will consider, among other things, the
price of shares available for purchase in the open market as compared to the
price at which they may purchase shares through the overallotment option.
"Naked" short sales are any sales in excess of such option. The Underwriters
must close out any naked short position by purchasing shares in the open market.
A naked short position is more likely to be created if the Underwriters are
concerned that there may be downward pressure on the price of the Class A common
stock in the open market after pricing that could adversely affect investors who
purchase in the offering. Stabilizing transactions consist of various bids for
or purchases of the Class A common stock made by the Underwriters in the open
market prior to the completion of the offering.
Purchases to cover a short position and stabilizing transactions may have
the effect of preventing or retarding a decline in the market price of the
Company's Class A common stock, and together with the imposition of the penalty
bid, may stabilize, maintain or otherwise affect the market price of the common
stock. As a result, the price of the Class A common stock may be higher than the
price that otherwise might exist in the open market. If these activities are
commenced, they may be discontinued at any time. These transactions may be
effected on the NASDAQ National Market System, in the over-the-counter market or
otherwise.
The Selling Shareholder estimates that the total expenses of this offering,
excluding underwriting discounts and commissions, will be approximately $_____.
-105-
The Company and the Selling Shareholder have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933.
-106-
VALIDITY OF COMMON STOCK
Certain legal matters with respect to the validity of the Class A common
stock will be passed upon for us by Duane Morris LLP, Philadelphia,
Pennsylvania. Certain legal matters with respect to the validity of the Class A
common stock will be passed upon for the Underwriters by Sullivan & Cromwell,
New York, New York, in reliance on the opinion of Duane Morris LLP with respect
to Pennsylvania law.
EXPERTS
The financial statements included in this Registration Statement have been
so included on the report of Malin, Bergquist & Company, LLP, independent
auditors, given on the authority of said firm as experts in auditing and
accounting.
The audit committee of our board of directors annually considers the
selection of our independent auditors. On September 10, 2002, the audit
committee selected Ernst & Young, LLP as our independent auditors for the fiscal
year ending December 31, 2003.
-107-
WHERE TO FIND MORE INFORMATION/INCORPORATION BY REFERENCE
We file reports, proxy statements and other information with the Securities
and Exchange Commission. Our SEC filings are also available over the Internet at
the SEC's web site at http://www.sec.gov. You may also read and copy any
document we file at the SEC's public reference rooms in Washington, D.C., New
York, New York and Chicago, Illinois. Please call the SEC at 1-800-SEC-0330 for
more information about the public reference rooms.
The SEC allows us to "incorporate by reference" the information we file
with them, which means:
. incorporated documents are considered part of the prospectus;
. we can disclose important information to you by referring you to those
documents; and
. information that we file with the SEC will automatically update and
supersede the prospectus.
We are incorporating by reference the documents listed below that were
filed with the SEC under the Securities Exchange Act of 1934:
. Annual Report on Form 10-K for the year ended December 31, 2001;
. Definitive proxy statement filed under Section 14 of the Securities
Exchange Act of 1934 in connection with the shareholders' meetings held on
April 30, 2002 and April 24, 2001;
. Quarterly Reports on Form 10-Q for the quarters ended March 31, 2002
and June 30, 2002; and
. Current Reports on Form 8-K filed January 23, 2002, May 8, 2002, July
24, 2002 and September 13, 2002.
We also incorporate by reference each of the following documents that we
will file with the SEC after the date of the prospectus but before the end of
the offering:
. Reports filed under Sections 13(a) and (c) of the Securities Exchange
Act of 1934;
. Definitive proxy or information statements filed under Section 14 of
the Securities Exchange Act of 1934 in connection with any subsequent
shareholders' meeting; and
. Any reports filed under Section 15(d) of the Securities Exchange Act
of 1934.
-108-
You may request a copy of these filings, at no cost, by contacting us at
the following address or phone number:
Erie Indemnity Company
Attn: Jan R. Van Gorder,
Senior Executive Vice President,
Secretary and General Counsel
100 Erie Insurance Place
Erie, Pennsylvania 16530
Tel: (814) 870-2000
http://www.erieinsurance.com
You should rely only on the information incorporated by reference or
provided in this prospectus or any supplement. We have not authorized anyone
else to provide you with different information. The Selling Shareholder will not
make an offer of these shares in any state where the offer is not permitted. You
should not assume that the information in this prospectus or any supplement is
accurate as of any date other than the date on the front of these documents.
This prospectus is part of a Registration Statement on Form S-3 we filed
with the SEC (Registration No. 333-____________).
-109-
ERIE INDEMNITY COMPANY
INDEX TO FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report ........................................................ F-2
Consolidated Statements of Financial Position as of
December 31, 2001 and 2000 ........................................................ F-3
Consolidated Statements of Operations for the years ended
December 31, 2001, 2000 and 1999 .................................................. F-5
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2001, 2000 and 1999 .................................................. F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999 .................................................. F-8
Notes to Consolidated Financial Statements .......................................... F-9
Unaudited Consolidated Statement of Financial Position as of June 30, 2002 .......... F-44
Unaudited Consolidated Statements of Operations for the
six-month periods ended June 30, 2002 and 2001 .................................... F-46
Unaudited Consolidated Statements of Comprehensive Income for the
six-month periods ended June 30, 2002 and 2001 .................................... F-47
Unaudited Consolidated Statements of Cash Flows for the
six-month periods ended June 30, 2002 and 2001 .................................... F-48
Notes to Unaudited Consolidated Financial Statements (Unaudited) .................... F-49
F-1
INDEPENDENT AUDITORS' REPORT
ON THE CONSOLIDATED FINANCIAL STATEMENTS
To the Board of Directors and Shareholders
Erie Indemnity Company
Erie, Pennsylvania
We have audited the accompanying Consolidated Statements of Financial Position
of Erie Indemnity Company and subsidiaries as of December 31, 2001 and 2000, and
the related Consolidated Statements of Operations, Shareholders' Equity, and
Cash Flows for each of the three years in the period ended December 31, 2001.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Erie Indemnity
Company and subsidiaries as of December 31, 2001 and 2000, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2001 in conformity with accounting principles generally
accepted in the United States of America.
Erie, Pennsylvania
February 7, 2002
MALIN, BERGQUIST & COMPANY LLP
F-2
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
As of December 31, 2001 and 2000
(Dollars in thousands)
ASSETS 2001 2000
--------------- ----------------
Investments:
Fixed maturities at fair value
(amortized cost of $543,423
and $524,172, respectively) $ 559,873 $ 531,546
Equity securities at fair value (cost of
$159,727 and $184,968, respectively) 193,798 204,446
Limited partnerships (cost of $79,668
and $60,661, respectively) 81,596 68,242
Real estate mortgage loans 5,700 6,581
--------------- ----------------
Total investments $ 840,967 $ 810,815
Cash and cash equivalents 88,213 38,778
Accrued investment income 9,138 9,087
Premiums receivable from Policyholders 186,175 156,269
Prepaid federal income taxes 14,056 3,604
Reinsurance recoverable from Erie Insurance Exchange 491,055 412,050
Note receivable from Erie Family Life Insurance Company 15,000 15,000
Other receivables from Erie Insurance Exchange and affiliates 149,600 119,959
Reinsurance recoverable from non-affiliates 372 712
Deferred policy acquisition costs 17,018 13,202
Property and equipment 14,635 13,856
Equity in Erie Family Life Insurance Company 44,683 42,331
Other assets 64,654 44,936
--------------- ----------------
Total assets $ 1,935,566 $ 1,680,599
=============== ================
See accompanying notes to consolidated financial statements.
F-3
ERIE INDEMNITY COMPANY
LIABILITIES AND SHAREHOLDERS' EQUITY 2001 2000
-------------- ---------------
LIABILITIES
Unpaid losses and loss adjustment expenses $ 557,278 $ 477,879
Unearned premiums 311,969 263,855
Commissions payable and accrued 110,121 96,823
Accounts payable and accrued expenses 46,164 30,476
Deferred income taxes 12,945 7,161
Dividends payable 10,930 9,839
Employee benefit obligations 20,904 15,551
-------------- ---------------
Total liabilities $ 1,070,311 $ 901,584
-------------- ---------------
SHAREHOLDERS' EQUITY
Capital stock
Class A common, stated value $.0292 per
share; authorized 74,996,930 shares; 67,032,000
shares issued; 63,836,323 and 64,056,323 shares
outstanding in 2001 and 2000, respectively $ 1,955 $ 1,955
Class B common, stated value $70 per
share; authorized 3,070 shares;
3,070 shares issued and outstanding 215 215
Additional paid-in capital 7,830 7,830
Accumulated other comprehensive income 35,222 23,182
Retained earnings 913,406 831,552
-------------- ---------------
Total contributed capital and retained earnings $ 958,628 $ 864,734
Treasury stock, at cost, 3,195,677 shares in
2001 and 2,975,677 in 2000 ( 93,373) ( 85,719)
-------------- ---------------
Total shareholders' equity $ 865,255 $ 779,015
-------------- ---------------
Total liabilities and shareholders' equity $ 1,935,566 $ 1,680,599
============== ===============
See accompanying notes to consolidated financial statements.
F-4
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2001, 2000 and 1999
(Amounts in thousands, except per share data)
2001 2000 1999
-------------- -------------- --------------
MANAGEMENT OPERATIONS:
Management fee revenue $ 634,966 $ 551,646 $ 513,375
Service agreement revenue 27,247 22,662 15,441
-------------- -------------- --------------
Total revenue from management operations $ 662,213 $ 574,308 $ 528,816
Cost of management operations 477,645 415,562 380,298
-------------- -------------- --------------
Net revenue from management operations $ 184,568 $ 158,746 $ 148,518
-------------- -------------- --------------
INSURANCE UNDERWRITING OPERATIONS:
Premiums earned $ 137,648 $ 123,708 $ 117,224
-------------- -------------- --------------
Losses and loss adjustment expenses incurred $ 117,201 $ 99,564 $ 87,719
Policy acquisition and other underwriting expenses 40,910 34,546 33,044
-------------- -------------- --------------
Total losses and expenses $ 158,111 $ 134,110 $ 120,763
-------------- -------------- --------------
Underwriting loss ($ 20,463) ($ 10,402) ($ 3,539)
-------------- -------------- --------------
INVESTMENT OPERATIONS:
Net investment income $ 49,884 $ 48,401 $ 43,344
Net realized (losses) gains on investments ( 31,879) 16,968 14,746
Equity in earnings of Erie Family Life Insurance
Company 773 5,492 5,045
Equity in (losses) earnings of limited partnerships ( 7) 4,733 641
-------------- -------------- --------------
Net revenue from investment operations $ 18,771 $ 75,594 $ 63,776
-------------- -------------- --------------
Income before income taxes $ 182,876 $ 223,938 $ 208,755
Provision for income taxes 60,615 71,545 65,649
-------------- -------------- --------------
NET INCOME $ 122,261 $ 152,393 $ 143,106
============== ============== ==============
Net income per share $ 1.71 $ 2.12 $ 1.95
============== ============== ==============
Weighted average shares outstanding 71,342 71,954 73,487
============== ============== ==============
See accompanying notes to consolidated financial statements.
F-5
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
Total
Shareholders' Comprehensive Retained
Equity Income Earnings
-------------- -------------- ---------------
Balance, January 1, 1999 $ 655,223 $ $ 605,045
Comprehensive income
Net income 143,106 $ 143,106 143,106
Unrealized depreciation of investments, net of tax ( 13,597) ( 13,597)
--------------
Comprehensive income $ 129,509
==============
Purchase of treasury stock ( 54,330)
Dividends declared:
Class A $.495 per share ( 32,575) ( 32,575)
Class B $74.25 per share ( 228) ( 228)
-------------- ---------------
Balance, December 31, 1999 $ 697,599 $ 715,348
-------------- ---------------
Comprehensive income
Net income 152,393 $ 152,393 152,393
Unrealized depreciation of investments, net of tax ( 3,399) ( 3,399)
--------------
Comprehensive income $ 148,994
==============
Purchase of treasury stock ( 31,389)
Dividends declared:
Class A $.5575 per share ( 35,932) ( 35,932)
Class B $83.625 per share ( 257) ( 257)
-------------- ---------------
Balance, December 31, 2000 $ 779,015 $ 831,552
-------------- ---------------
Comprehensive income
Net income 122,261 $ 122,261 122,261
Unrealized appreciation of investments, net of tax 14,890 14,890
Minimum pension liability adjustment, net of tax ( 2,850) ( 2,850)
--------------
Comprehensive income $ 134,301
==============
Purchase of treasury stock ( 7,654)
Dividends declared:
Class A $.6275 per share ( 40,119) ( 40,119)
Class B $94.125 per share ( 288) ( 288)
-------------- ---------------
Balance, December 31, 2001 $ 865,255 $ 913,406
============== ===============
F-6
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
Accumulated
Other
Comprehensive Class A Class B Additional Treasury
Income Common Common Paid-in-Capital Stock
----------------- ------------- ---------------- ---------------- ------------
$ 40,178 $ 1,955 $ 215 $ 7,830 $ 0
( 13,597)
( 54,330)
----------------- ------------- ---------------- ---------------- ------------
$ 26,581 $ 1,955 $ 215 $ 7,830 ($ 54,330)
----------------- ------------- ---------------- ---------------- ------------
( 3,399)
( 31,389)
----------------- ------------- ---------------- ---------------- ------------
$ 23,182 $ 1,955 $ 215 $ 7,830 ($ 85,719)
----------------- ------------- ---------------- ---------------- ------------
14,890
( 2,850)
( 7,654)
----------------- ------------- ---------------- ---------------- ------------
$ 35,222 $ 1,955 $ 215 $ 7,830 ($ 93,373)
================= ============= ================ ================ ============
See accompanying notes to consolidated financial statements.
F-7
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2001, 2000 and 1999
(Dollars in thousands)
2001 2000 1999
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 122,261 $ 152,393 $ 143,106
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 2,350 2,745 1,766
Deferred income tax expense (benefit) 1,013 ( 2,112) ( 1,311)
Amortization of deferred policy acquisition costs 24,276 22,793 22,507
Realized loss (gain) on investments 31,879 ( 16,968) ( 14,746)
Equity in losses (income) from limited partnerships 7 ( 4,733) ( 641)
Net amortization of bond (discount) premium ( 199) ( 43) 80
Undistributed earnings of Erie Family Life 0 ( 4,020) ( 3,696)
Dividends received in excess of undistributed
earnings - Erie Family Life 821 0 0
Deferred compensation 294 642 1,212
Increase in accrued investment income ( 51) ( 1,089) ( 745)
Increase in receivables ( 138,213) ( 76,240) ( 6,274)
Policy acquisition costs deferred ( 28,092) ( 24,591) ( 23,049)
Increase in prepaid expenses and other assets ( 14,460) ( 939) ( 6,185)
Increase in accounts payable and
accrued expenses 16,362 8,068 3,343
Increase in commissions payable and accrued 13,298 3,950 7,868
Increase in income taxes recoverable ( 10,452) ( 629) ( 466)
Increase in loss reserves 79,398 44,984 6,730
Increase in unearned premiums 48,115 26,403 7,469
------------ ------------ ------------
Net cash provided by operating activities $ 148,607 $ 130,614 $ 136,968
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments:
Fixed maturities ($ 235,854) ($ 153,029) ($ 162,769)
Equity securities ( 67,549) ( 54,649) ( 71,637)
Mortgage loans 0 0 ( 66)
Limited partnership investments ( 28,380) ( 24,753) ( 20,667)
Sales/maturities of investments:
Fixed maturity sales 109,634 61,333 30,927
Fixed maturity calls/maturities 80,223 59,570 64,094
Equity securities 90,589 55,596 84,187
Mortgage loans 882 1,649 123
Limited partnership sales or distributions 6,634 6,227 1,368
Purchase of property and equipment ( 2,014) ( 308) ( 444)
Purchase of computer software ( 1,113) ( 1,032) ( 4,194)
Loans to agents ( 7,612) ( 1,781) ( 3,459)
Collections on agent loans 2,358 1,719 2,582
------------ ------------ ------------
Net cash used in investing activities ($ 52,202) ($ 49,458) ($ 79,955)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid to shareholders ($ 39,316) ($ 35,203) ($ 32,049)
Purchase of treasury stock ( 7,654) ( 31,389) ( 54,330)
------------ ------------ ------------
Net cash used in financing activities ($ 46,970) ($ 66,592) ($ 86,379)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents $ 49,435 $ 14,564 ($ 29,366)
Cash and cash equivalents at beginning of year 38,778 24,214 53,580
------------ ------------ ------------
Cash and cash equivalents at end of year $ 88,213 $ 38,778 $ 24,214
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the years ended December 31, 2001, 2000 and 1999 for income
taxes was $70,751, $74,286 and $67,495, respectively.
See accompanying notes to consolidated financial statements.
F-8
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 1. NATURE OF BUSINESS
Erie Indemnity Company (Company), formed in 1925, is the
attorney-in-fact for the Erie Insurance Exchange (Exchange), a
reciprocal insurance exchange. The Company earns a management fee for
management services provided to the Exchange and its affiliates. The
Exchange is a Pennsylvania domiciled property/casualty insurer rated A++
Superior by A. M. Best. The Exchange is the 23rd largest insurer in the
United States based on net premiums written for all lines of business.
See also Note 10.
The Company's property/casualty insurance subsidiaries also share
proportionately in the results of all property/casualty insurance
underwriting operations of the Exchange. The Exchange, Erie Insurance
Company (EIC), a wholly-owned subsidiary of the Company, and the Erie
Insurance Company of New York (EINY), a wholly-owned subsidiary of the
EIC, are part of an intercompany pooling agreement. Under this
agreement, EIC and EINY cede 100% of their property/casualty insurance
business, including property/casualty insurance operations assets and
liabilities, to the Exchange. Erie Insurance Property & Casualty
Company, a wholly-owned subsidiary of the Company, and Flagship City
Insurance Company, owned by the Exchange, participate in a quota share
agreement, where all insurance business is ceded to the Exchange. The
Exchange retrocedes to EIC and EINY a specified percentage (5% for EIC
and .5% for EINY during 2001, 2000 and 1999) of all pooled
property/casualty insurance business, including insurance operations
assets and liabilities. Insurance ceded by EIC, EINY, Erie Insurance
Property & Casualty Company and Flagship City Insurance Company, to the
Exchange does not relieve EIC and EINY from their primary liability as
the original insurers. See also Note 12.
The Exchange, EIC and EINY together with the Erie Insurance Property &
Casualty Company and the Flagship City Insurance Company as well as the
Erie Family Life Insurance Company (EFL) operate collectively as the
"Erie Insurance Group (EIG)."
The property/casualty insurers of the Erie Insurance Group operate in 11
states and the District of Columbia. Business consists, to a large
extent, of private passenger and commercial automobile, homeowners and
workers' compensation insurance in Pennsylvania, Ohio, West Virginia,
Maryland and Virginia.
F-9
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
---------------------
The accompanying consolidated financial statements have been prepared
in conformity with accounting principles generally accepted in the
United States of America that differ from statutory accounting
practices prescribed or permitted for insurance companies by
regulatory authorities. See also Note 13.
Principles of consolidation
---------------------------
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in
consolidation. The 21.6% equity ownership of EFL is not consolidated
but accounted for under the equity method of accounting.
Reclassifications
-----------------
Certain amounts reported in prior years have been reclassified to
conform to the current year's financial statement presentation.
Use of estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Investments and cash equivalents
--------------------------------
Fixed maturities and marketable equity securities are classified as
available-for-sale. Equity securities consist primarily of common and
nonredeemable preferred stocks while fixed maturities consist of
bonds, notes and redeemable preferred stock. Available-for-sale
securities are stated at fair value, with the unrealized gains and
losses, net of deferred tax, reflected in shareholders' equity in
accumulated other comprehensive income. There are no securities
classified
F-10
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
as "trading" or "held-to-maturity." Realized gains and losses on
sales of investments, are recognized in income on the specific
identification method. Interest and dividend income is recorded as
earned.
Limited partnerships include U.S. and foreign private equity, real
estate and fixed income investments. The private equity limited
partnerships invest primarily in small- to medium-sized companies.
Limited partnerships are recorded using the equity method, which
approximates the Company's share of the carrying value of the
partnership. Unrealized gains and losses on private equity limited
partnerships are reflected in shareholders' equity in accumulated
other comprehensive income, net of deferred taxes. The Company has
not guaranteed any of the partnership liabilities.
When a decline in value of investments is considered to be
other-than-temporary by Company management, the investments are
written down to realizable value. The write down is made on an
individual security or limited partnership basis and is considered a
realized loss in the Consolidated Statements of Operations.
Mortgage loans on commercial real estate are recorded at unpaid
balances, adjusted for amortization of premium or discount. A
valuation allowance would be provided for impairment in net
realizable value based on periodic valuations as needed.
Cash equivalents are principally comprised of investments in bank
money market funds and approximate fair value.
Derivatives
-----------
Financial Accounting Standards Board Statement of Financial
Accounting Standards (FAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (FAS 133) became effective for
fiscal years beginning after June 15, 1999. Sections of FAS 133 were
subsequently amended by FAS 138 "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" (an amendment of FAS 133
which became effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000). FAS 133 and FAS 138 establish
accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
and for
F-11
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
hedging activities. The accounting for changes in the fair value of a
derivative, i.e. gains and losses, depends on the intended use of the
derivative and the resulting designation.
For derivatives not designated as a hedging instrument, the gain or
loss is recognized in earnings in the period of change. Credit risk
is managed by entering into transactions using a bank counterparty
with a high credit rating. See also Note 3.
Fair value of financial instruments
-----------------------------------
Fair values of available-for-sale securities are based on quoted
market prices, where available, or dealer quotations. The carrying
amounts reported in the Consolidated Statements of Financial Position
approximate fair value. The carrying value of receivables and
liabilities arising in the ordinary course of business approximates
fair value.
Deferred policy acquisition costs
---------------------------------
Commissions and other costs of acquiring insurance that vary with,
and are primarily related to, the production of new and renewal
business are deferred and amortized over the terms of the policies or
reinsurance treaties to which they relate. The amount of costs to be
deferred would be reduced to the extent future policy premiums and
anticipated investment income would not exceed related losses,
expenses and Policyholder dividends. There have been no reduction in
costs deferred in any of the years presented. Amortization expense,
which is included in policy acquisition and other underwriting
expenses of insurance underwriting operations, equaled $24,276,
$22,793 and $22,507 in 2001, 2000 and 1999, respectively.
Insurance liabilities
---------------------
Losses incurred refer to amounts paid or expected to be paid for loss
events which have occurred through the balance sheet date. The cost
of investigating, resolving and processing claims are referred to as
"loss adjustment expenses". A liability is established for the total
unpaid cost of losses and loss adjustment expenses, including events
occurring in current
F-12
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
and prior years. Losses are reported on the Consolidated Statements
of Operations in insurance underwriting operations.
The liability for losses and loss adjustment expenses includes an
amount determined from loss reports and individual cases and an
amount, based on past experience, for losses incurred but not
reported. Inflation is provided for in the reserving function through
analysis of costs, trends and reviews of historical reserving
results. Such liabilities are necessarily based on estimates and,
while management believes the amount is appropriate, the ultimate
liability may differ from the amounts provided. The methods for
making such estimates and for establishing the resulting liability
are continually reviewed, and any adjustments considered necessary
are reflected in current earnings. Loss reserves, as permitted by
insurance department statute, are set at full expected cost except
for loss reserves for workers' compensation which have been
discounted at 2.5% in 2001 and 2000. Unpaid losses and loss
adjustment expenses in the Consolidated Statements of Financial
Position were reduced by $2,390 and $1,509 at December 31, 2001 and
2000, respectively, due to discounting. The reserves for losses and
loss adjustment expenses are reported net of receivables for salvage
and subrogation of $3,661 and $3,349 at December 31, 2001 and 2000,
respectively.
Environment-related claims
--------------------------
In establishing the liability for unpaid losses and loss adjustment
expenses related to environmental claims, management considers facts
currently known and the current state of the law and coverage
litigation. Liabilities are recognized for known claims (including
the cost of related litigation) when sufficient information has been
developed to indicate the involvement of a specific insurance policy,
and management can reasonably estimate its liability. In addition,
liabilities have been established to cover additional exposures on
both known and unasserted claims. Estimates of the liabilities are
reviewed and updated continually. The total amount of the Company's
property/casualty insurance subsidiaries' share of paid losses and
loss reserves pertaining to environment-related claims is immaterial.
F-13
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Liability for guaranty fund and other assessments
-------------------------------------------------
The Company's property/casualty insurance subsidiaries may be
required, under the solvency or guaranty laws of the various states
in which they are licensed, to pay assessments up to prescribed
limits to fund Policyholder losses or liabilities of insolvent
insurance companies. The liability for guaranty fund or other
assessments is recorded when the event obligating the Company has
occurred and the amount can be reasonably estimated. The estimated
liability for guaranty fund and other assessments at December 31,
2001 and 2000 totaled $2,383 and $592, respectively. During 2001, the
Company received notification of the insolvency of Reliance Insurance
Company. It is expected this insolvency will result in guaranty fund
liabilities to be assessed the Company's property/casualty insurance
subsidiaries. The Company has recorded an estimated liability that
has been charged to operations in the current period based on
preliminary data relating to this insolvency. The estimated liability
for the Reliance insolvency is $2,024 at December 31, 2001.
Certain states permit these assessments, or a portion thereof, to be
recovered as an offset to future premium taxes. When an assessment
can be recovered, an asset is established on a basis consistent with
the credits to be realized under applicable state law. During 2001,
the Company's property/casualty insurance subsidiaries recorded an
asset of $559 related to these recoverable credits which will be
recovered in accordance with state law which ranges between a 5 and
10 year period. These liabilities and corresponding recoverable
assets are presented gross on the Consolidated Statement of Financial
Position.
Reinsurance
-----------
The insurance underwriting operations segment in the Consolidated
Statements of Operations is presented net of reinsurance activities.
Gross losses and expenses incurred are reduced for amounts expected
to be recovered under reinsurance agreements. Reinsurance
transactions are recorded gross on the Consolidated Statements of
Financial Position. Estimated reinsurance recoverables and
receivables for ceded unearned premiums are recorded as assets with
liabilities recorded for related unpaid
F-14
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
losses and expenses and unearned premiums. Reinsurance premiums are
recognized as revenue on a pro rata basis over the policy term.
Income taxes
------------
Provisions for income taxes include deferred taxes resulting from
changes in cumulative temporary differences between the tax bases and
financial statement bases of assets and liabilities. Deferred taxes
are provided on the liability method, whereby deferred tax assets are
recognized for deductible temporary differences and deferred tax
liabilities are recognized for taxable temporary differences.
Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of enactment.
Property and equipment
----------------------
Property and equipment are stated at cost. Improvements and
replacements are capitalized, while expenditures for maintenance and
repairs are charged to expense as incurred.
Depreciation of property and equipment is computed using straight
line and accelerated methods over the estimated useful lives of the
assets. The costs and accumulated depreciation and amortization of
property sold or retired are removed from the accounts and gains or
losses, if any, are reflected in earnings for the year.
Property and equipment as of December 31 is summarized as follows:
2001 2000
--------- ---------
Land $ 737 $ 737
Buildings 5,879 5,863
Leasehold improvements 518 322
Computer software 18,836 17,723
Computer equipment 5,416 3,706
Transportation equipment 544 450
--------- ---------
$ 31,930 $ 28,801
Less accumulated depreciation 17,295 14,945
--------- ---------
$ 14,635 $ 13,856
========= =========
F-15
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Software development costs, primarily salaries and benefits, totaling
$7,842 and $7,797, are included in property and equipment at December
31, 2001 and 2000, respectively. Software development costs
capitalized during 2001 and 2000 amounted to $45 and $499,
respectively. These costs are amortized on a straight-line basis over
the expected life of the applications once the software is ready for
intended use. Software amortization related to these costs totaled
$2,007, $1,697 and $199 in 2001, 2000 and 1999, respectively.
During 2001, the Company entered into various operating lease
agreements for computer equipment. These leases contain various early
termination provisions which allow the Company to cancel the leases
generally after three years from inception of the lease. The total
projected commitment for these leases at December 31, 2001,
approximates $10,051 through the year 2004. Of this total,
approximately $5,075 will be reimbursed to the Company from its
affiliates. The total rental expense for 2001 was $165.
Revenue recognition
-------------------
In 2000, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." SAB 101 states revenue should not be recognized until it
is realized or realizable and earned. Cited in SAB 101 are certain
criteria that generally should be met to determine when revenue is
realized or realizable and earned. The Company periodically evaluates
its revenue recognition practices in relation to the requirements of
SAB 101. Management believes the revenue recognition practices are in
compliance with the provisions of SAB 101.
Recognition of management fee revenue
-------------------------------------
A management fee is charged the Exchange by the Company for
management of the affairs of the Exchange. The fee is recorded as
revenue, calculated as a percentage of Exchange direct and affiliated
assumed premiums written. The management fees are recognized upon
policy issuance or renewal. The Exchange issues policies with annual
terms only.
F-16
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Recognition of premium revenues and losses
------------------------------------------
Property and liability premiums are generally recognized as revenue
on a pro rata basis over the policy term. Unearned premiums represent
the unexpired portion of premiums written.
Losses and loss adjustment expenses are recorded as incurred.
Premiums earned and losses and loss adjustment expenses incurred are
reflected in the Consolidated Statements of Operations net of amounts
ceded to the Exchange. See also Note 12.
Earnings per share
------------------
Earnings per share is based on the weighted average number of Class A
shares outstanding, giving effect to the conversion of the weighted
average number of Class B shares outstanding at a rate of 2,400 Class
A shares for one Class B share. The total weighted average number of
Class A equivalent shares outstanding (including conversion of Class
B shares) was 71,342,329, 71,954,402, and 73,486,572 during 2001,
2000 and 1999, respectively.
F-17
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 3. INVESTMENTS
The following tables summarize the cost and market value of
available-for-sale securities at December 31, 2001 and 2000:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
December 31, 2001
-----------------
Fixed Maturities:
-----------------
U.S. treasuries &
government agencies $ 11,211 $ 502 $ 0 $ 11,713
States & political subdivisions 42,392 1,817 88 44,121
Special revenue 110,267 3,496 345 113,418
Public utilities 25,150 1,156 36 26,270
U. S. industrial &
miscellaneous 311,757 8,989 1,438 319,308
Foreign 26,634 859 17 27,476
----------- ----------- ----------- -----------
Total bonds $ 527,411 $ 16,819 $ 1,924 $ 542,306
Redeemable preferred stock 16,012 1,555 0 17,567
----------- ----------- ----------- -----------
Total fixed maturities $ 543,423 $ 18,374 $ 1,924 $ 559,873
----------- ----------- ----------- -----------
Equity Securities:
------------------
Common stock:
U. S. banks, trusts &
insurance companies $ 3,284 $ 814 $ 16 $ 4,082
U. S. industrial &
miscellaneous 28,718 31,570 579 59,709
Nonredeemable
preferred stock:
Public Utilities 2,370 12 3 2,379
U. S. banks, trusts &
insurance companies 14,685 938 58 15,565
U. S. industrial &
miscellaneous 91,185 2,573 2,111 91,647
Foreign 19,485 1,039 108 20,416
----------- ----------- ----------- -----------
Total equity securities $ 159,727 $ 36,946 $ 2,875 $ 193,798
----------- ----------- ----------- -----------
Total available-for-sale
securities $ 703,150 $ 55,320 $ 4,799 $ 753,671
=========== =========== =========== ===========
F-18
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 3. INVESTMENTS (CONTINUED)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
December 31, 2000
-----------------
Fixed Maturities:
-----------------
U.S. treasuries &
government agencies $ 11,216 $ 420 $ 24 $ 11,612
States & political subdivisions 50,337 1,656 34 51,959
Special revenue 110,855 3,779 68 114,566
Public utilities 23,221 550 207 23,564
U. S. industrial &
miscellaneous 267,231 4,770 5,940 266,061
Foreign 30,082 238 406 29,914
----------- ----------- ----------- -----------
Total bonds $ 492,942 $ 11,413 $ 6,679 $ 497,676
Redeemable preferred stock 31,230 3,341 701 33,870
----------- ----------- ----------- -----------
Total fixed maturities $ 524,172 $ 14,754 $ 7,380 $ 531,546
----------- ----------- ----------- -----------
Equity Securities:
------------------
Common stock:
U. S. banks, trusts &
insurance companies $ 3,651 $ 422 $ 275 $ 3,798
U. S. industrial &
miscellaneous 63,662 38,286 15,343 86,605
Foreign 7,100 581 2,719 4,962
Nonredeemable
preferred stock:
U. S. banks, trusts &
insurance companies 22,094 97 66 22,125
U. S. industrial &
miscellaneous 62,266 1,987 3,119 61,134
Foreign 26,195 217 590 25,822
----------- ----------- ----------- -----------
Total equity securities $ 184,968 $ 41,590 $ 22,112 $ 204,446
----------- ----------- ----------- -----------
Total available-for-sale
securities $ 709,140 $ 56,344 $ 29,492 $ 735,992
=========== =========== =========== ===========
F-19
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 3. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of fixed maturities at
December 31, 2001, by remaining contractual term to maturity, are shown
below.
Amortized Estimated
Cost Fair Value
----------- -----------
Due in one year or less $ 37,241 $ 37,787
Due after one year through five years 162,766 167,265
Due after five years through ten years 160,105 165,194
Due after ten years 183,311 189,627
----------- -----------
$ 543,423 $ 559,873
=========== ===========
Changes in unrealized gains (losses) consist of the following for the
years ended December 31:
2001 2000 1999
------------ ------------ ------------
Equity securities $ 14,593 ($ 24,410) $ 11,061
Fixed maturities 9,076 11,246 ( 24,123)
Limited partnerships ( 5,651) 5,930 1,616
Equity in unrealized gains (losses)
of Erie Family Life
Insurance Company 4,890 2,005 ( 9,473)
Deferred federal income tax (liability)
benefit ( 8,018) 1,830 7,322
------------ ------------ ------------
Increase (decrease) in unrealized gains $ 14,890 ($ 3,399) ($ 13,597)
============ ============ ============
Sources of net investment income for the years ended December 31 are as
follows:
2001 2000 1999
------------ ------------ ------------
Fixed maturities $ 36,569 $ 34,445 $ 30,547
Equity securities 11,022 11,034 10,104
Cash equivalents and other 3,034 3,416 3,222
------------ ------------ ------------
Total investment income $ 50,625 $ 48,895 $ 43,873
Investment expense 741 494 529
------------ ------------ ------------
Net investment income $ 49,884 $ 48,401 $ 43,344
============ ============ ============
F-20
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 3. INVESTMENTS (CONTINUED)
Following are the components of net realized (loss) gain on investments
as reported on the Consolidated Statements of Operations. The securities
impairment charge in 2001 related primarily to preferred stocks in the
equipment leasing and agricultural industry segments. The limited
partnership impairment charge resulted from one private equity
partnership that had investments of preferred stock in the eCommerce
industry and common stock in the customer relationship software
industry. The securities impairment charge in 2000 resulted from
preferred stocks in the financial services industry.
2001 2000 1999
------------ ----------- -----------
Fixed maturities:
----------------
Gross realized gains $ 4,216 $ 2,921 $ 712
Gross realized losses ( 7,941) ( 311) ( 87)
------------ ----------- -----------
Net realized (losses) gains ($ 3,725) $ 2,610 $ 625
------------ ----------- -----------
Equity securities:
-----------------
Gross realized gains $ 4,997 $ 18,070 $ 18,437
Gross realized losses ( 28,563) ( 2,445) ( 4,316)
Impairment charge ( 1,855) ( 1,267) 0
------------ ----------- -----------
Net realized (losses) gains ($ 25,421) $ 14,358 $ 14,121
------------ ----------- -----------
Limited partnership impairment charge ($ 2,733) $ 0 $ 0
------------ ----------- -----------
Net realized (losses) gains on
investments ($ 31,879) $ 16,968 $ 14,746
============ =========== ===========
The components of equity in (losses) earnings of limited partnerships as
reported on the Consolidated Statements of Operations for the years
ended December 31 are as follows:
2001 2000 1999
------------ ----------- -----------
Private equity ($ 2,013) $ 1,464 ($ 354)
Real estate 1,424 1,926 905
Fixed income 582 1,343 90
------------ ----------- -----------
Total equity in (losses) earnings of limited
partnerships ($ 7) $ 4,733 $ 641
============ =========== ===========
See also Note 14 for investment commitments related to partnerships.
F-21
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 3. INVESTMENTS (CONTINUED)
The Company participates in a securities lending program whereby certain
securities from its portfolio are loaned to other institutions for short
periods of time through a lending agent. The Company maintains control
over the securities. A fee is paid to the Company by the borrower.
Collateral, comprised of cash and government securities, that exceeds the
market value of the loaned securities is maintained by the lending agent.
The Company has an indemnification agreement with the lending agent in
the event a borrower becomes insolvent or fails to return securities. The
Company had loaned securities with a market value of $46,771 and $31,776
and secured collateral of $48,804 and $33,468 at December 31, 2001 and
2000, respectively. The borrower of the securities is not permitted to
sell or replace the security on loan. The Company maintains the loaned
securities on its Consolidated Statements of Financial Position as part
of its invested assets. The Company has incurred no losses on the loan
program since the program's inception.
During 2001, the Company entered into several foreign currency forward
contracts related to its limited partnership investments, which are by
definition derivatives. These contracts were not designated as hedges as
the primary purpose is to generate profits from short-term market
movements. The forward contracts have no cash requirements at the
inception of the arrangement. At December 31, 2001, the notional amount
of the contracts outstanding totaled $1,869. Changes in value, totaling
$8 in 2001, have been recognized currently in earnings as realized gains
in the Consolidated Statements of Operations.
F-22
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 4. COMPREHENSIVE INCOME
Comprehensive income is defined as any change in equity from transactions
and other events originating from nonowner sources. The components of
other comprehensive income follow for the years ended December 31:
2001 2000 1999
---------- ---------- ----------
Unrealized holding (losses) gains on securities
arising during period ($ 8,971) $ 11,739 ($ 6,173)
Less: losses (gains) included in net income 31,879 ( 16,968) ( 14,746)
---------- ---------- ----------
Net unrealized holding gains (losses) arising
during period 22,908 ( 5,229) ( 20,919)
Income tax (liability) benefit related to unrealized
gains or losses ( 8,018) 1,830 7,322
---------- ---------- ----------
Net appreciation (depreciation) of
investments 14,890 ( 3,399) ( 13,597)
Minimum pension liability adjustment (See also Note 6) ( 4,384) 0 0
Tax asset related to pension liability
adjustment 1,534 0 0
---------- ---------- ----------
Net pension liability adjustment ( 2,850) 0 0
---------- ---------- ----------
Other comprehensive income (loss), net of tax $ 12,040 ($ 3,399) ($ 13,597)
========== ========== ==========
F-23
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 5. EQUITY IN ERIE FAMILY LIFE INSURANCE COMPANY
The Company owns 21.6% of EFL's common shares outstanding, which is
accounted for using the equity method of accounting. EFL is a
Pennsylvania-domiciled life insurance company operating in ten states and
the District of Columbia.
The following represents condensed financial information for EFL on a
Generally Accepted Accounting Principles (GAAP) basis:
2001 2000 1999
---------- ---------- ----------
Investments $ 869,723 $ 881,069 $ 817,460
Total assets 1,120,483 1,020,343 954,532
Liabilities 914,724 824,623 783,429
Shareholders' equity 205,759 195,720 171,103
Revenues 89,514 115,373 102,924
Net income 2,738 25,390 23,325
Comprehensive income (loss) 17,410 31,421 ( 5,191)
Dividends paid to shareholders 7,229 6,662 6,096
The Company's share of EFL's net unrealized gains or (losses) on
securities, as reflected in shareholders' equity, is $3,983, $801 and
($502) at December 31, 2001, 2000 and 1999, respectively.
F-24
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS
Pension plans
-------------
The Company's pension plans consist of: (1) a noncontributory-defined
benefit pension plan covering substantially all Employees of the
Company, (2) an unfunded supplemental employee retirement plan (SERP)
for its senior and executive officers and (3) an unfunded pension
plan for its outside directors. Information about the plans follows
for the years ended December 31:
2001 2000
---------- ----------
Net periodic benefit cost:
Service cost $ 6,837 $ 6,329
Interest cost 8,325 7,705
Expected return on plan assets ( 13,709) ( 12,322)
Amortization of prior service cost 844 989
Recognized net actuarial gain ( 2,583) ( 2,303)
Amortization of unrecognized initial net asset ( 234) ( 234)
---------- ----------
Net periodic benefit cost $ 520 $ 164
========== ==========
Change in benefit obligation:
Benefit obligation at January 1 $ 116,693 $ 104,588
Service cost 6,837 6,329
Interest cost 8,325 7,705
Amendments 55 611
Actuarial loss (gain) 14,523 ( 2,114)
Benefits paid ( 1,729) ( 426)
---------- ----------
Benefit obligation at December 31 $ 144,704 $ 116,693
========== ==========
Change in plan assets:
Fair value of plan assets at January 1 $ 171,636 $ 160,385
Actual return on plan assets ( 31,413) 11,688
Employer contributions (refunds) 9,271 ( 12)
Benefits paid ( 1,729) ( 425)
---------- ----------
Fair value of plan assets at December 31 $ 147,765 $ 171,636
========== ==========
Reconciliation of funded status:
Funded status at December 31 $ 3,061 $ 54,943
Unrecognized net actuarial loss (gain) 10,986 ( 51,342)
Unrecognized prior service cost 5,236 6,025
Unrecognized initial net asset ( 469) ( 701)
---------- ----------
Net amount recognized on Consolidated
Statements of Financial Position $ 18,814 $ 8,925
========== ==========
Amounts recognized in the consolidated statements
of financial position consist of:
Prepaid benefit cost $ 25,451 $ 15,096
Accrued benefit liability ( 13,686) ( 8,656)
Intangible asset 2,665 2,485
Accumulated other comprehensive income 4,384 0
---------- ----------
Net amount recognized at year end $ 18,814 $ 8,925
========== ==========
Weighted-average assumptions as of December 31:
Employee pension plan:
Discount rate 7.00% 7.50%
Expected return on plan assets 8.25 8.25
Rate of compensation increase 5.00 5.00
SERP:
Discount rate 7.00% 7.50%
Rate of compensation increase 6.00-7.25 5.00
F-25
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS (CONTINUED)
The amendment amounts relate primarily to two additional participants
being added to the SERP for each of the years 2001 and 2000.
The Employee pension plan has assets that include cash, treasury
bonds, corporate bonds, common and preferred stocks and mortgages.
An additional minimum pension liability of $4,384 resulted in 2001 due
to changes in discount rates, the rate of compensation increase and
certain other assumptions of the SERP. The additional pension
liability was recorded as a reduction to shareholders' equity as
accumulated other comprehensive income, net of deferred income taxes.
The Company's funding policy regarding the Employee pension plan is to
contribute amounts sufficient to meet ERISA funding requirements plus
such additional amounts as may be determined to be appropriate.
The Employee pension plan purchases individual annuities periodically
from EFL to settle retiree benefit payments. Such purchases equaled
$4,513, $5,627 and $5,322 in 2001, 2000 and 1999, respectively. These
are non-participating annuity contracts under which EFL has
unconditionally contracted to provide specified benefits to
beneficiaries in return for a fixed premium from the plan. However,
the plan remains the primary obligor to the beneficiaries and a
contingent liability exists in the event EFL could not honor the
annuity contracts. The benefit obligation has been reduced for these
annuities purchased for retirees.
The projected benefit obligation, accumulated benefit obligation, and
fair value of plan assets for the pension plans with accumulated
benefit obligations in excess of plan assets (SERP and the pension
plan for outside directors) were $20,348, $13,686 and $0 respectively,
as of December 31, 2001, and $12,696, $8,656 and $0, respectively, as
of December 31, 2000.
Post-retirement benefits other than pensions
--------------------------------------------
The Company provides post-retirement medical coverage for eligible
retired Employees and eligible dependents. To be eligible for
benefits, an employee must be 60 years old and have 15 years of
continuous full-time service. The benefits are provided from
retirement to age 65. The benefits are unfunded as
F-26
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS (CONTINUED)
the Company pays the obligations when due. The cash payments for such
benefits were $379, $161 and $121 in 2001, 2000 and 1999,
respectively. Actuarially determined costs are recognized over the
period the Employee provides service to the Company. Information about
this plan follows for the years ended December 31:
2001 2000
--------- ---------
Net periodic benefit cost:
Service cost $ 400 $ 400
Interest cost 389 385
Amortization of prior service cost ( 36) ( 37)
Recognized net actuarial gain ( 50) ( 27)
-------- --------
Net periodic benefit cost $ 703 $ 721
======== ========
Change in benefit obligation:
Benefit obligation at January 1 $ 5,803 $ 4,745
Service cost 400 400
Interest cost 389 385
Actuarial loss 919 434
Benefits paid ( 379) ( 161)
-------- --------
Benefit obligation at December 31 $ 7,132 $ 5,803
======== ========
Reconciliation of Funded status:
Funded status at December 31 ($ 7,132) ($ 5,803)
Unrecognized net actuarial loss (gain) 244 ( 726)
Unrecognized prior service costs ( 330) ( 366)
-------- --------
Net liability recognized on Consolidated Statements
of Financial Position ($ 7,218) ($ 6,895)
======== ========
The weighted average discount rate used to measure the accumulated
post-retirement benefit obligation was 7.0% and 7.50% in 2001 and
2000, respectively. The December 31, 2001, accumulated benefit
obligation was based on a 10.0% increase in the cost of covered health
care benefits during 2001. The expected health care cost trend rate
assumption for 2002 is 10.0%. This rate is assumed to decrease
gradually to 5.5% per year in 2006 and to remain at that level
thereafter.
F-27
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS (CONTINUED)
2001 2000
-------- --------
Effect on total of service and interest cost components:
1% Increase $ 126 $ 126
1% Decrease ( 106) ( 106)
Effect on post-retirement benefit obligation:
1% Increase $ 1,023 $ 814
1% Decrease ( 871) ( 695)
Employee savings plan
---------------------
The Company has an Employee Savings Plan for its Employees. Beginning
January 2001, the maximum percentage that eligible participants were
permitted to contribute to the plan was increased to 15%. The Company
match was also changed to 100% of the participant contributions up to
3% of compensation and 50% of participant contributions over 3% and up
to 5% of compensation. Additionally, regular part-time Employees are
eligible to participate in the plan. Prior to 2001, eligible
participants were permitted to make contributions of 1% to 8% of
compensation to the plan on a pre-tax salary reduction basis. The
Company matched one-half of the participant contributions up to 6% of
compensation. All full-time Employees were eligible to participate in
the plan. The Company's matching contributions to the plan in 2001,
2000 and 1999 were $5,329, $3,499 and $3,245, respectively. Employees
are permitted to invest a portion of employer contributions in the
Class A common stock of the Company. The plan acquires shares in the
open market necessary to meet the obligations of the plan.
Management incentive plans and deferred compensation
----------------------------------------------------
The Company has separate annual and long-term incentive plans and a
deferred compensation plan, which are available for key management
employees. The deferred compensation plan is an unfunded arrangement
for a select group of management and highly compensated employees of
the Company. Those participating in this plan can select hypothetical
investment funds for their deferrals and are credited with interest
based on the investment results. The incentive plans are available to
key management employees and link awards to current year and
three-year performance period targets. The awards are settled with
cash and Company stock. The
F-28
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS (CONTINUED)
Company purchases its stock in the open market when awards are settled
in stock. The Company accrues estimated compensation expense in the
applicable performance period based on its best estimate of the
achievement of the performance targets. Expense recorded in 2001, 2000
and 1999 relating to these incentive and deferred compensation plans
equaled $3,424, $3,445 and $3,352, respectively. Actual payments
totaled $2,441 and $1,590 in 2001 and 2000, respectively. There were
no payments in 1999. The Company also has a deferred compensation plan
for certain of its outside directors. Expenses recorded in 2001, 2000,
and 1999 with related (losses) earnings amounted to ($70), $78 and
$241, respectively. The losses in the current year were a result of
the performance of the investments that comprise the plan assets.
Health and dental benefits
--------------------------
The Company has self-funded health and dental care plans for all of
its Employees and eligible dependents. Estimated unpaid claims
incurred are accrued as a liability at December 31, 2001 and 2000.
Operations were charged $19,826, $17,456 and $14,756 in 2001, 2000 and
1999, respectively, for the cost of health and dental care provided
under these plans.
All liabilities for the above mentioned plans are presented in this
note in total for all employees of the Erie Insurance Group. The gross
liability is presented in the Consolidated Statements of Financial
Position as employee benefit obligations with amounts expected to be
recovered from the Company's affiliates included in other assets.
NOTE 7. INCOME TAXES
The provision for income taxes consists of the following for the years
ended December 31:
2001 2000 1999
---------- ---------- -----------
Federal income taxes:
Currently due $ 59,602 $ 73,657 $ 66,960
Deferred 1,013 ( 2,112) ( 1,311)
---------- ---------- ----------
Total $ 60,615 $ 71,545 $ 65,649
========== ========== ==========
F-29
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS (CONTINUED)
A reconciliation of the provision for income taxes with amounts
determined by applying the statutory federal income tax rates to
pre-tax income is as follows:
2001 2000 1999
---------- --------- ---------
Income tax at statutory rates $ 64,007 $ 78,378 $ 73,051
Tax-exempt interest ( 2,729) ( 3,046) ( 3,229)
Dividends received deduction ( 2,398) ( 2,160) ( 2,064)
Other 1,735 ( 1,627) ( 2,109)
---------- --------- ---------
Provision for income taxes $ 60,615 $ 71,545 $ 65,649
========== ========= =========
Temporary differences and carryforwards, which give rise to deferred
tax assets and liabilities, are as follows for the years ended
December 31:
2001 2000
--------- ---------
Deferred tax assets:
Loss reserve discount $ 4,580 $ 3,965
Unearned premiums 4,960 4,286
Employee benefit plan obligations 4,800 4,111
Severance benefits 3,801 0
Write downs of securities 1,606 443
Other 1,525 1,212
--------- ---------
Total deferred tax assets $ 21,272 $ 14,017
--------- ---------
Deferred tax liabilities:
Deferred policy acquisition costs $ 5,956 $ 4,621
Unrealized gains 16,822 12,051
Pension and other benefits 7,021 2,438
Other 4,418 2,068
--------- ---------
Total deferred tax liabilities $ 34,217 $ 21,178
--------- ---------
Net deferred income tax liability $ 12,945 $ 7,161
========= =========
The Company, as a corporate attorney-in-fact for a reciprocal insurer,
is not subject to state corporate taxes.
F-30
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 8. CAPITAL STOCK
Class A and B shares
--------------------
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 for each Class
B share. There is no provision for conversion of Class A shares to
Class B shares and Class B shares surrendered for conversion cannot be
reissued. Each share of Class A common stock outstanding at the time
of the declaration of any dividend upon shares of Class B common stock
shall be entitled to a dividend payable at the same time, at the same
record date, and in an amount at least equal to 2/3 of 1% of any
dividend declared on each share of Class B common stock. The Company
may declare and pay a dividend in respect of Class A common stock
without any requirement that any dividend be declared and paid in
respect of Class B common stock. Sole voting power is vested in Class
B common stock except insofar as any applicable law shall permit Class
A common stock to vote as a class in regards to any changes in the
rights, preferences and privileges attaching to Class A common stock.
Stock repurchase plan
---------------------
Beginning in 1999, the Company established a stock repurchase program.
The Company may repurchase as much as $120 million of its outstanding
Class A common stock through December 31, 2002. Treasury shares are
recorded on the Consolidated Statements of Financial Position at cost.
In 2001 there were 220,000 shares repurchased at a total cost of
$7,654, or an average price per share of $34.79. Since its inception,
3,195,677 shares have been repurchased at a total cost of $93,373, or
an average price per share of $29.22. The Company may purchase the
shares from time to time in the open market or through privately
negotiated transactions, depending on prevailing market conditions and
alternative uses of the Company's capital.
F-31
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 9. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of beginning and ending
loss and loss adjustment expense liability balances for the Company's
wholly-owned property/casualty insurance subsidiaries:
2001 2000 1999
---------- ---------- -----------
Total unpaid losses and loss
adjustment expenses at January 1, gross $ 477,879 $ 432,895 $ 426,165
Less reinsurance recoverables 375,567 337,911 334,708
---------- ---------- ----------
Net balance at January 1 102,312 94,984 91,457
Incurred related to:
Current accident year 111,258 93,416 88,422
Prior accident years 5,943 6,148 ( 703)
---------- ---------- ----------
Total incurred 117,201 99,564 87,719
Paid related to:
Current accident year 59,637 53,251 50,560
Prior accident years 41,203 38,985 33,632
---------- ---------- ----------
Total paid 100,840 92,236 84,192
---------- ---------- ----------
Net balance at December 31 118,673 102,312 94,984
Plus reinsurance recoverables 438,605 375,567 337,911
---------- ---------- ----------
Total unpaid losses and loss adjustment
expenses at December 31, gross $ 557,278 $ 477,879 $ 432,895
========== ========== ==========
Included in the 2001 losses and loss adjustment expenses incurred
related to current accident year of $111,258 are the Company's share
of estimated incurred losses of the Erie Insurance Group's reinsurance
business stemming from the September 11/th/ attack on the World Trade
Center of $8,250. Partially offsetting these losses is an aggregate
excess of loss reinsurance agreement between the Exchange and the
Company's property/casualty insurance subsidiaries. See also Note 12.
This agreement reduces the net retention of these losses recorded by
the Company to $5,839. Current loss estimates are based on the
assumption that the attack will be considered one event. If the attack
comes to be considered two events, the total potential exposure for
EIG would increase between $50,000 and $75,000. The effect on the
Company
F-32
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 9. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
would be additional losses between $2,750 and $4,125. Taking into
consideration the excess of loss reinsurance agreement, the net impact
of such potential additional losses would be minimal to the Company.
The property/casualty insurers are exposed to both direct and
reinsurance losses arising from possible future terrorist actions and
other catastrophic events.
The 2001 incurred losses related to prior accident years of $5,943 are
due primarily to adverse development of losses in the private
passenger auto liability and workers' compensation lines of business
and are generally the result of ongoing analysis of recent loss
development trends. These losses are reflected in the insurance
underwriting operations segment of the Consolidated Statements of
Operations.
The 2000 incurred losses related to prior accident years of $6,148 are
due to adverse development of reinsurance losses from the catastrophic
storms in Europe in December 1999, combined with increased loss
severity in private passenger automobile and in commercial lines of
business.
NOTE 10. RELATED PARTY TRANSACTIONS
Management fee
--------------
A management fee is charged to the Exchange for management services
provided by the Company. The fee is a percentage of Exchange direct
and affiliated assumed premiums written. The percentage rate is
adjusted periodically within specified limits by the Company's Board
of Directors. The management fee charged the Exchange was 25% for each
year from 1999 to 2001.
In December 2001, the Board of Directors elected to maintain the 25%
management fee rate for all of 2002. The Company's Board of Directors
may change the management fee rate at its discretion, but it may not
exceed 25%.
F-33
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 10. RELATED PARTY TRANSACTIONS (CONTINUED)
eCommerce Program and Related Information Technology Infrastructure
-------------------------------------------------------------------
During 2001, the Erie Insurance Group undertook a series of
initiatives to develop its eCommerce capabilities. In connection with
this program, the Company and the property/casualty insurance
Companies of the Erie Insurance Group entered into a Cost Sharing
Agreement for Information Technology Development (Agreement). The
Agreement describes how member companies of the Erie Insurance Group
will share the costs to be incurred for the development of new
Internet enabled property/casualty policy administration and customer
relationship management systems. The Agreement provides that the cost
of the systems and the related enabling technology costs, such as
required infrastructure and architectural tools, will be shared among
the property/casualty insurance companies in a manner consistent with
the sharing of insurance transactions under the existing intercompany
pooling agreement. See also Note 12. These costs are included in the
policy acquisition and other underwriting expenses in the Consolidated
Statements of Operations. The Company's share of these costs, incurred
by the Company's property/casualty insurance subsidiaries totaled
$1,315 for the year ended December 31, 2001.
Certain other costs of the eCommerce Program are related to
information technology hardware and are not included under the
Agreement. These costs are included in the cost of management
operations in the Consolidated Statement of Operations. The Company's
share of these infrastructure costs amounted to $1,589 for the year
ended December 31, 2001.
Service agreement revenue
-------------------------
A service agreement fee is charged to the Exchange to compensate the
Company for its management of non-affiliated assumed reinsurance
business on behalf of the Exchange. The Company receives a fee of 7%
of voluntary reinsurance premiums assumed from non-affiliated insurers
and is responsible for accounting, underwriting, and operating
expenses in connection with the administration of this business.
Service agreement fee revenue amounted to $11,251, $10,149 and $8,158
in 2001, 2000 and 1999, respectively.
Also included in service agreement revenue are service charges
collected from Policyholders for providing extended payment terms on
policies written by the insurers managed by the Company. In June 2000,
this administrative fee
F-34
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 10. RELATED PARTY TRANSACTIONS (CONTINUED)
collected from Policyholders increased from $2 to $3 per installment
for policies renewing in most states. Service charge revenue amounted
to $15,996, $12,513 and $7,283 in 2001, 2000 and 1999, respectively.
Expense reimbursements
----------------------
The Company pays for and is reimbursed by the Exchange for expenses
incurred in connection with adjustment of claims and administrative
services and by EFL for administrative expenses. Reimbursements are
made to the Company from these affiliates monthly. The amounts of such
expense reimbursements were as follows for the years ended December
31:
2001 2000 1999
---------- ---------- ----------
Erie Insurance Exchange $ 162,549 $ 142,519 $ 136,045
Erie Family Life 18,545 18,631 14,740
---------- ---------- ----------
Total reimbursements $ 181,094 $ 161,150 $ 150,785
========== ========== ==========
Office leases
-------------
The Company occupies certain office facilities owned by the Exchange
and EFL. The Company leases office space on a year-to-year basis from
the Exchange. Rent expenses under these leases totaled $10,842,
$10,703 and $10,320 in 2001, 2000 and 1999, respectively. The Company
has a lease commitment until 2008 with EFL for a branch office.
Rentals paid to EFL under this lease totaled $311 in 2001, $309 in
2000 and $303 in 1999.
Note receivable from EFL
------------------------
The Company is due $15 million from EFL in the form of a surplus note.
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. Interest on the surplus note is
scheduled to be paid semi-annually. The note will be payable on demand
on or after December 31, 2005. During 2001, 2000 and 1999, EFL paid
interest to the Company totaling $968 each year.
F-35
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 10. RELATED PARTY TRANSACTIONS (CONTINUED)
Structured settlements with EFL
-------------------------------
The Erie Insurance Group affiliated property/casualty insurance
companies periodically purchase annuities from EFL in connection with
the structured settlement of claims. The Company's pro-rata share
(5.5%) of such annuities purchased equaled $708, $889 and $1,282 in
2001, 2000 and 1999, respectively.
NOTE 11. RECEIVABLES FROM ERIE INSURANCE EXCHANGE AND
CONCENTRATIONS OF CREDIT RISK
Financial instruments, which potentially expose the Company to
concentrations of credit risk, include unsecured receivables from the
Exchange. Most all of the Company's revenue and receivables are from
the Exchange and affiliates.
Management fee and expense reimbursements due from the Exchange were
$147,344 and $117,962 in 2001 and 2000, respectively. A receivable
from EFL for expense reimbursements totaled $2,256 at December 31,
2001 compared to $1,997 at December 31, 2000. The Company also has a
receivable due from the Exchange for reinsurance recoverable from
losses and unearned premium balances ceded to the pool totaling
$491,055 and $412,050 in 2001 and 2000, respectively.
Premiums receivable from Policyholders at December 31, 2001 and 2000
equaled $186,175 and $156,269, respectively. A significant amount of
these receivables are ceded to the Exchange as part of the
intercompany pooling agreement. At December 31, 2001, the Exchange's
statutory total assets totaled almost $7 billion and Policyholders'
surplus totaled $3 billion.
NOTE 12. REINSURANCE
EIC and EINY have an intercompany reinsurance pooling agreement with
the Exchange, whereby EIC and EINY cede all of their direct
property/casualty insurance to the Exchange, except for the annual
premium under the all-lines aggregate excess of loss reinsurance
agreement discussed below. EIC and EINY then assume 5% and 0.5%,
respectively, of the total of the Exchange's insurance business
(including the business assumed from EIC and EINY). The companies
settle accounts between them by payment of amounts due within 30 days
after the end of each quarterly accounting period.
F-36
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 12. REINSURANCE (CONTINUED)
EIC and EINY have in effect an all-lines aggregate excess of loss
reinsurance agreement with the Exchange. Under this agreement, EIC and
EINY reinsure their net retained share of the intercompany reinsurance
pool such that once EIC and EINY have sustained ultimate net losses in
any applicable accident year that exceed an amount equal to 72.5% of
EIC and EINY's net premiums earned in that period, the Exchange will
be liable for 95% of the amount of such excess, up to but not
exceeding, an amount equal to 95% of 15% of EIC and EINY's net premium
earned. Losses equal to 5% of the net ultimate net loss in excess of
the retention under the contract are retained net by EIC and EINY. The
annual premium is subject to a minimum premium of $950. This
reinsurance treaty is excluded from the intercompany pooling
agreement. The annual premium paid to the Exchange for the agreement
totaled $1,423, $1,268 and $1,199 in 2001, 2000 and 1999 respectively.
Recoveries during 2001 amounted to $7,241, of which $6,506 relates to
the 2001 accident year. The balance of the recoveries under this
agreement recorded in 2001 related to the 1999 accident year. There
were no loss recoveries by EIC or EINY under the agreement for 2000 or
1999.
To the extent the Exchange assumes reinsurance business from
nonaffiliated sources, the Company participates because of its pooling
agreement with the Exchange. Similarly, the Company also participates
in the business ceded from the Exchange. Reinsurance premiums,
commissions, expense reimbursements and reserves related to
reinsurance business are accounted for on bases consistent with those
used in accounting for the original policies issued and the terms of
the reinsurance contracts. Premiums ceded to the Exchange have been
reported as a reduction of premium income. The Company's property and
liability reinsurance assumed from foreign insurance companies is
accounted for using the periodic method, whereby premiums are
recognized as revenue over the policy term, and claims, including an
estimate of claims incurred but not reported, are recognized as they
occur. The amount of reinsurance business assumed from foreign
insurance companies is not significant.
Reinsurance contracts do not relieve the Company from its primary
obligations to Policyholders. A contingent liability exists with
respect to reinsurance receivables in the event reinsurers are unable
to meet their obligations under the reinsurance agreements.
F-37
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 12. REINSURANCE (CONTINUED)
The following summarizes insurance and reinsurance activities for the
Company:
2001 2000 1999
------------- ------------ -------------
Premiums Earned:
Direct $ 432,307 $ 377,570 $ 351,228
Assumed nonaffiliates 7,391 4,824 5,380
Ceded to Erie Insurance Exchange ( 439,698) ( 382,394) ( 356,608)
Assumed from Erie Insurance Exchange 137,648 123,708 117,224
------------- ------------ -------------
Net $ 137,648 $ 123,708 $ 117,224
============= ============ =============
Losses and Loss Adjustment Expenses
Incurred:
Direct $ 374,440 $ 325,644 $ 264,177
Assumed nonaffiliates 14,262 3,956 6,512
Ceded to Erie Insurance Exchange ( 388,702) ( 329,600) ( 270,689)
Assumed from Erie Insurance Exchange 117,201 99,564 87,719
------------- ------------ -------------
Net $ 117,201 $ 99,564 $ 87,719
============= ============ =============
NOTE 13. STATUTORY INFORMATION
The statutory financial statements of Erie Insurance Property &
Casualty Company and EIC are prepared in accordance with accounting
practices prescribed by the Pennsylvania Insurance Department. EINY
prepares its statutory financial statements in accordance with
accounting practices prescribed by the New York Insurance Department.
Prescribed Statutory Accounting Practices (SAP) include state laws,
regulations, and general administration rules, as well as a variety of
publications from the National Association of Insurance Commissioners
(NAIC). The NAIC adopted the Codification of Statutory Accounting
Practices (Codification), effective January 1, 2001, as the
NAIC-supported basis of accounting. The Codification was approved with
a provision allowing for prescribed or permitted accounting practices
to be determined by each states' insurance commissioner. Accordingly,
such discretion will continue to allow prescribed or permitted
accounting practices that may differ from state to state. The New York
State Insurance Department did not adopt the deferred tax provisions
of Codification, thus no deferred taxes are recorded on the EINY
statutory financial statements.
F-38
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 13. STATUTORY INFORMATION (CONTINUED)
Codification resulted in changes to the Company's statutory-basis
financial statements, the most significant of which was the recording
of statutory deferred taxes for EIC and Erie Insurance Property &
Casualty Company. The total cumulative adjustment increased the
surplus of the Company's property/casualty insurance subsidiaries by
$4,446 as of January 1, 2001.
Accounting principles used to prepare statutory financial statements
differ from those used to prepare financial statements on the basis of
generally accepted accounting principles. Consolidated balances
including amounts reported by the property/casualty insurance
subsidiaries on the statutory basis would be as follows:
2001 2000 1999
----------- ----------- -----------
Shareholders' equity at December 31, $ 854,003 $ 767,894 $ 688,802
Net income for the year ended December 31, 118,475 150,942 142,615
The amount of dividends the Company's Pennsylvania-domiciled
property/casualty subsidiaries, EIC and Erie Insurance Property &
Casualty Company, can pay without the prior approval of the
Pennsylvania Insurance Commissioner is limited by Pennsylvania
regulation to not more than the greater of: (a) 10% of its statutory
surplus as reported on its last annual statement, or (b) the net
income as reported on its last annual statement. The amount of
dividends that the Erie Insurance Company's New York-domiciled
property/casualty subsidiary, EINY, can pay without the prior approval
of the New York Superintendent of Insurance is limited to the lesser
of: (a) 10% of its statutory surplus as reported on its last annual
statement, or (b) 100% of its adjusted net investment income during
such period. At December 31, 2001, the maximum dividend the Company
could receive from its property/casualty insurance subsidiaries was
$5,491. No dividends were paid to the Company from its
property/casualty insurance subsidiaries in 2001 or 2000.
The amount of dividends EFL, a Pennsylvania-domiciled life insurer,
can pay to its shareholders without the prior approval of the
Pennsylvania Insurance Commissioner is limited by statute to the
greater of: (a) 10% of its statutory surplus as regards Policyholders
as shown on its last annual statement on file with the commissioner,
or (b) the net income as reported for the period
F-39
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 13. STATUTORY INFORMATION (CONTINUED)
covered by such annual statement, but shall not include pro rata
distribution of any class of the insurer's own securities.
Accordingly, the Company's share of the maximum dividend payout which
may be made in 2002 without prior Pennsylvania Commissioner approval
is $2,295. Dividends to the Company totaled $1,594 in 2001 and $1,472
in 2000.
NOTE 14. COMMITMENTS
The Company has outstanding commitments to invest up to $124,000 in
limited partnerships at December 31, 2001. These commitments will be
funded as required through the end of the respective investment
periods, which typically span 3 to 5 years expiring in 2005. At
December 31, 2001, the total commitment to fund limited partnerships
that invest in private equity securities is $87,000, real estate
activities $22,000 and fixed income securities $15,000. At December
31, 2001, no one partnership commitment exceeded $7.5 million, or 6%,
of the outstanding commitment amount.
During 2001, the Company entered into contracts to provide services
related to the eCommerce program with various external vendors. The
total outstanding commitment for these contracts at December 31, 2001,
was $16,146, of which approximately $12,943 will be reimbursed to the
Company by the Exchange. The majority of these committed services at
December 31, 2001, are expected to be performed in 2002.
NOTE 15. SEGMENT INFORMATION
The Company operates its business as two reportable segments -
management operations and property/casualty insurance operations.
Accounting policies for segments are the same as those described in
the summary of significant accounting policies. See also Note 2.
Assets are not allocated to the segments and are reviewed in total by
management for purposes of decision making. No single customer or
agent provides 10% or more of revenues for the Exchange.
The Company's principal operations consist of serving as
attorney-in-fact for the Exchange, which constitute its management
operations. The Company's property/casualty insurance operations arise
through direct business of its
F-40
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 15. STATUTORY INFORMATION (CONTINUED)
subsidiaries and by virtue of the pooling agreement between its
subsidiaries and the Exchange, which includes assumed reinsurance from
nonaffiliated domestic and foreign sources. Insurance provided in the
property/casualty operations consists of personal and commercial lines
and is sold by independent agents. Personal lines are marketed to
individuals and commercial lines are marketed to small and
medium-sized businesses. The performance of the personal lines and
commercial lines is evaluated based upon the underwriting results as
determined under SAP for the total pooled business of the Group.
Summarized financial information for these operations is presented
below.
2001 2000 1999
------------ ------------ ------------
Management operations:
---------------------
Revenue:
Management fee revenue $ 634,966 $ 551,646 $ 513,375
Service agreement revenue 27,247 22,662 15,441
------------ ------------ ------------
Total revenue from management operations 662,213 574,308 528,816
Net revenue from investment operations 1,700 57,213 47,011
------------ ------------ ------------
Total revenue $ 663,913 $ 631,521 $ 575,827
============ ============ ============
Income before taxes $ 186,267 $ 215,959 $ 195,529
============ ============ ============
Net income $ 123,403 $ 145,851 $ 133,235
============ ============ ============
Property/casualty operations:
----------------------------
Revenue:
Premiums earned:
Commercial lines $ 34,970 $ 28,456 $ 25,147
Personal lines 97,078 89,369 87,334
Reinsurance 8,866 7,880 6,185
------------ ------------ ------------
Total premiums earned (SAP) 140,914 125,705 118,666
GAAP adjustments ( 3,266) ( 1,997) ( 1,442)
------------ ------------ ------------
Total premiums earned (GAAP) 137,648 123,708 117,224
Net revenue from investment operations 17,071 18,381 16,765
------------ ------------ ------------
Total revenue $ 154,719 $ 142,089 $ 133,989
============ ============ ============
Expense:
Losses and expenses:
Commercial lines $ 41,417 $ 31,914 $ 26,726
Personal lines 107,851 92,012 85,512
Reinsurance 12,970 12,203 9,225
------------ ------------ ------------
Total losses and expenses (SAP) 162,238 136,129 121,463
GAAP adjustments ( 4,127) ( 2,019) ( 700)
------------ ------------ ------------
Total losses and expenses (GAAP) $ 158,111 $ 134,110 $ 120,763
============ ============ ============
(Loss) income before taxes ($ 3,391) $ 7,979 $ 13,226
============ ============ ============
Net (loss) income ($ 1,142) $ 6,542 $ 9,871
============ ============ ============
F-41
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
First Second Third Fourth
Quarter Quarter Quarter Quarter
---------- ---------- ---------- ----------
2001
- ----
Net revenue from management operations $ 43,200 $ 53,104 $ 55,044 $ 33,220
Underwriting loss ( 3,538) ( 1,786) ( 10,589) ( 4,550)
Net revenue (loss) from investment operations 12,196 18,731 6,994 ( 19,150)
---------- ---------- ---------- ----------
Income before income taxes 51,858 70,049 51,449 9,520
========== ========== ========== ==========
Net income $ 34,785 $ 47,129 $ 34,430 $ 5,917
========== ========== ========== ==========
Net income per share $ 0.49 $ 0.66 $ 0.48 $ 0.08
========== ========== ========== ==========
Comprehensive income $ 36,407 $ 45,414 $ 31,081 $ 21,399
========== ========== ========== ==========
2000
- ----
Net revenue from management operations $ 36,618 $ 43,310 $ 44,417 $ 34,401
Underwriting loss ( 3,203) ( 1,590) ( 2,742) ( 2,867)
Net revenue from investment operations 19,515 20,658 18,986 16,435
---------- ---------- ---------- ----------
Income before income taxes 52,930 62,378 60,661 47,969
========== ========== ========== ==========
Net income $ 36,185 $ 42,518 $ 41,192 $ 32,498
========== ========== ========== ==========
Net income per share $ 0.50 $ 0.59 $ 0.58 $ 0.45
========== ========== ========== ==========
Comprehensive income $ 50,036 $ 35,093 $ 41,565 $ 22,300
========== ========== ========== ==========
1999
- ----
Net revenue from management operations $ 34,367 $ 40,587 $ 41,945 $ 31,619
Underwriting (loss) gain ( 607) 1,113 ( 1,580) ( 2,465)
Net revenue from investment operations 14,770 16,177 16,450 16,379
---------- ---------- ---------- ----------
Income before income taxes 48,530 57,877 56,815 45,533
========== ========== ========== ==========
Net income $ 33,407 $ 39,225 $ 38,425 $ 32,049
========== ========== ========== ==========
Net income per share $ 0.45 $ 0.53 $ 0.53 $ 0.44
========== ========== ========== ==========
Comprehensive income $ 31,897 $ 32,180 $ 26,295 $ 39,137
========== ========== ========== ==========
During the fourth quarter of 2001, the Company realized net losses on the sale
of impaired securities and realized charges for other-than-temporary impairments
of equity securities and limited partnerships totaling $29,153. Realized losses
resulted in an after-tax earnings per share reduction of $0.27. The investment
sales were part of a proactive year-end tax planning strategy and will produce
the recovery of approximately $9.6 million of federal income taxes paid in 1998,
1999 and 2000. Also contributing to the fourth quarter 2001 decline in net
income per share were charges for a severance benefit stemming from the
F-42
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (CONTINUED)
retirement of the president and CEO of the Erie Insurance Group. The Company's
share of charges related to this severance were approximately $0.10 per share,
after taxes.
F-43
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(Dollars in thousands)
June 30, December 31,
ASSETS 2002 2001
------------------ ------------------
(Unaudited)
INVESTMENTS
- -----------
Fixed maturities at fair value
(amortized cost of $622,297 and
$543,423, respectively) $ 634,205 $ 559,873
Equity securities at fair value (cost of $166,221
and $159,727, respectively) 188,577 193,798
Limited partnerships (cost of $87,160 and
$79,668, respectively) 86,883 81,596
Real estate mortgage loans 5,634 5,700
------------------ ------------------
Total investments $ 915,299 $ 840,967
Cash and cash equivalents 34,367 88,213
Accrued investment income 10,628 9,138
Premiums receivable from Policyholders 224,505 186,175
Prepaid federal income tax 0 14,056
Reinsurance recoverable from Erie Insurance
Exchange 535,540 491,055
Note receivable from Erie Family Life
Insurance Company 15,000 15,000
Other receivables from Erie Insurance
Exchange and affiliates 191,068 149,600
Reinsurance recoverable non-affiliates 366 372
Deferred policy acquisition costs 20,115 17,018
Property and equipment 14,308 14,635
Equity in Erie Family Life Insurance Company 44,075 44,683
Other assets 83,058 64,654
------------------ ------------------
Total assets $ 2,088,329 $ 1,935,566
================== ==================
(Continued)
See Notes to Consolidated Financial Statements.
F-44
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(Dollars in thousands)
June 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 2002 2001
----------------- -----------------
(Unaudited)
LIABILITIES
-----------
Unpaid losses and loss adjustment expenses $ 599,143 $ 557,278
Unearned premiums 363,611 311,969
Commissions payable and accrued 126,550 110,121
Accounts payable and accrued expenses 41,492 46,164
Federal income tax payable 5,123 0
Deferred income taxes 6,028 12,945
Dividends payable 10,906 10,930
Employee benefit obligations 15,834 20,904
----------------- -----------------
Total liabilities $ 1,168,687 $ 1,070,311
----------------- -----------------
SHAREHOLDERS' EQUITY
--------------------
Capital Stock
Class A common, stated value $.0292 per
share; authorized 74,996,930 shares;
67,032,000 shares issued; 63,694,299 and
63,836,323 shares outstanding in 2002 and
2001, respectively $ 1,955 $ 1,955
Class B common, stated value $70 per
share; authorized 3,070 shares;
3,070 shares issued and outstanding 215 215
Additional paid-in capital 7,830 7,830
Accumulated other comprehensive income 25,286 35,222
Retained earnings 983,600 913,406
----------------- -----------------
Total contributed capital and retained earnings $ 1,018,886 $ 958,628
Treasury stock, at cost 3,337,701 shares
in 2002 and 3,195,677 shares in 2001 ( 99,244) ( 93,373)
----------------- -----------------
Total shareholders' equity $ 919,642 $ 865,255
----------------- -----------------
Total liabilities and shareholders' equity $ 2,088,329 $ 1,935,566
================= =================
See Notes to Consolidated Financial Statements.
F-45
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Six Months Ended
June 30
------------------------------
2002 2001
(Amounts in thousands, except per share data)
MANAGEMENT OPERATIONS:
Management fee revenue $ 384,827 $ 313,497
Service agreement revenue 15,118 13,250
---------- ----------
Total revenue from management operations $ 399,945 $ 326,747
Cost of management operations 276,296 230,443
---------- ----------
Net revenue from management operations $ 123,649 $ 96,304
---------- ----------
INSURANCE UNDERWRITING OPERATIONS:
Premiums earned $ 77,653 $ 66,091
---------- ----------
Losses and loss adjustment expenses incurred 63,387 53,057
Policy acquisition and other underwriting expenses 23,927 18,358
---------- ----------
Total losses and expenses 87,314 71,415
---------- ----------
Underwriting loss ($ 9,661) ($ 5,324)
---------- ----------
INVESTMENT OPERATIONS:
Net investment income $ 26,837 $ 24,508
Net realized (loss) gain on investments ( 4,581) 2,725
Equity in earnings of Erie Family
Life Insurance Company 986 2,186
Equity in earnings of limited partnerships 307 1,508
---------- ----------
Net revenue from investment operations $ 23,549 $ 30,927
---------- ----------
Income before income taxes $ 137,537 $ 121,907
Provision for income taxes 45,510 39,992
---------- ----------
Net income $ 92,027 $ 81,915
========== ==========
Net income per share $ 1.29 $ 1.15
========== ==========
Weighted average shares outstanding 71,162 71,402
Dividends declared per share:
Class A $ 0.34 $ 0.305
Class B 51.00 45.75
See Notes to Consolidated Financial Statements.
F-46
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Six Months Ended
June 30
---------------------------------------------------
2002 2001
(Dollars in thousands)
Net Income $ 92,027 $ 81,915
----------------------- ------------------
Unrealized losses on securities:
Unrealized holding (losses) gains arising
during period ( 24,182) 2,582
Less: Losses (gains) included in net income 4,581 ( 2,725)
----------------------- ------------------
Net unrealized holding losses
arising during period ( 19,601) ( 143)
Income tax benefit related to
unrealized losses 6,860 50
----------------------- ------------------
Net depreciation of investments ( 12,741) ( 93)
Minimum pension liability adjustment 4,315 0
Less: Tax asset related to pension
liability adjustment ( 1,510) 0
----------------------- ------------------
Net pension liability adjustment 2,805 0
----------------------- ------------------
Other comprehensive loss, net of tax ( 9,936) ( 93)
----------------------- ------------------
Comprehensive income $ 82,091 $ 81,822
======================= ==================
See Notes to Consolidated Financial Statements.
F-47
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
---------------------- ------------------
(Amounts in thousands, except per share data)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 92,027 $ 81,915
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,921 1,533
Deferred income tax (benefit) expense ( 1,966) 2,425
Amortization of deferred policy acquisition costs 13,832 11,680
Equity in income of limited partnerships ( 307) ( 1,508)
Realized loss (gain) on investments 4,581 ( 2,725)
Net amortization of bond discount ( 288) ( 109)
Undistributed earnings of Erie Family Life
Insurance Company ( 127) ( 1,389)
Deferred compensation 456 261
(Increase) decrease in accrued investment income ( 1,490) 172
Increase in receivables ( 124,278) ( 92,250)
Policy acquisition costs deferred ( 16,929) ( 13,890)
Increase in prepaid expenses and other assets ( 18,064) ( 11,407)
(Decrease) increase in accounts payable and accrued ( 5,883) 5,312
expenses
Increase in commissions payable and accrued 16,428 5,080
Increase in income taxes payable 19,180 6,655
Increase in loss reserves 41,865 23,186
Increase in unearned premiums 51,641 29,512
--------------------- ----------------------
Net cash provided by operating activities $ 72,599 $ 44,453
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments:
Fixed maturities ($ 175,188) ($ 99,975)
Equity securities ( 34,308) ( 29,466)
Limited partnership investments ( 22,138) ( 13,267)
Sales/maturities of investments:
Fixed maturity sales 51,937 51,170
Fixed maturity calls/maturities 42,120 46,152
Equity securities 25,779 22,029
Mortgage loans 66 819
Limited partnership sales or distributions 14,953 2,348
Purchase of property and equipment ( 1,272) ( 1,640)
Purchase of computer software ( 322) ( 484)
Loans to agents ( 1,672) ( 1,356)
Collections on agent loans 1,328 1,230
--------------------- ---------------------
Net cash used in investing activities ($ 98,717) ($ 22,440)
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid to shareholders ($ 21,857) ($ 19,675)
Purchase of treasury stock ( 5,871) ( 1,210)
--------------------- ---------------------
Net cash used in financing activities ($ 27,728) ($ 20,885)
--------------------- ---------------------
Net (decrease) increase in cash and cash equivalents ( 53,846) 1,128
Cash and cash equivalents at beginning of period 88,213 38,778
--------------------- ---------------------
Cash and cash equivalents at end of period $ 34,367 $ 39,906
===================== =====================
Supplemental disclosures of cash flow information:
- -------------------------------------------------
Income tax payments $ 38,867 $ 31,552
See Notes to Consolidated Financial Statements.
F-48
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
All dollar amounts are in thousands except per share data
NOTE A -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements, which include the
accounts of the Erie Indemnity Company and its wholly owned subsidiaries, Erie
Insurance Company (EIC), Erie Insurance Company of New York (EINY) and Erie
Insurance Property & Casualty Company, have been prepared in accordance with
accounting principles generally accepted in the United States of America 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 (GAAP) for
complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the six-month period
ended June 30, 2002 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2002. For further information, refer
to the consolidated financial statements and footnotes thereto included in the
Company's Form 10-K for the year ended December 31, 2001 as filed with the
Securities and Exchange Commission on March 12, 2002.
NOTE B -- RECLASSIFICATIONS
Certain amounts previously reported in the 2001 financial statements have been
reclassified to conform to the current period's presentation. Such
reclassifications were minor in nature and did not impact earnings.
NOTE C -- EARNINGS PER SHARE
Earnings per share is based on the weighted average number of Class A shares
outstanding (63,794,175 and 64,034,046 at June 30, 2002 and 2001, respectively),
giving effect to the conversion of the weighted average number of Class B shares
outstanding (3,070 in 2002 and 2001) at a rate of 2,400 Class A shares for one
Class B share. For the six months ended June 30, 2002 weighted average
equivalent shares outstanding were 71,162,175 compared to 71,402,046 for the six
months ended June 30, 2001.
NOTE D -- INVESTMENTS
Management considers all fixed maturities and marketable equity securities
available-for-sale. Marketable equity securities consist primarily of common and
non redeemable preferred stocks while fixed maturities consist of bonds, notes
and redeemable preferred stock. Management determines the appropriate
classification of fixed maturities at the time of purchase and
F-49
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE D -- INVESTMENTS (CONTINUED)
reevaluates such designation as of each statement of financial position date.
Available-for-sale securities are stated at fair value, with the unrealized
gains and losses, net of deferred tax, reported as a separate component of
accumulated other comprehensive income in shareholders' equity. When a decline
in the value of investments is considered to be other than temporary by
management, the investments are written down to their realizable value. Such
write downs are made directly on an individual security basis and are considered
a realized loss on investments in the Consolidated Statements of Operations. In
the first six months of 2002 the Company recognized impairment charges totaling
$10,693 relating to long term fixed maturities and non redeemable preferred
stock.
The following is a summary of available-for-sale securities:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
June 30, 2002
- -------------
Fixed maturities:
- -----------------
U.S. treasuries & government
agencies $ 11,254 $ 494 $ 0 $ 11,748
States & political subdivisions 44,559 2,273 0 46,832
Special revenue 107,790 4,042 32 111,800
Public utilities 37,870 879 684 38,065
U.S. industrial & miscellaneous 361,616 11,232 5,305 367,543
Foreign 44,904 740 2,165 43,479
----------- ----------- ----------- -----------
Total bonds $ 607,993 $ 19,660 $ 8,186 $ 619,467
Redeemable preferred stock 14,304 434 0 14,738
----------- ----------- ----------- -----------
Total fixed maturities $ 622,297 $ 20,094 $ 8,186 $ 634,205
----------- ----------- ----------- -----------
Equity securities:
- -----------------
Common stock:
U.S. banks, trusts &
insurance companies $ 1,791 $ 751 $ 165 $ 2,377
U.S. industrial &
miscellaneous 19,391 19,722 324 38,789
Foreign 417 339 0 756
Non redeemable
preferred stock:
Public utilities 9,051 59 77 9,033
U.S. banks, trusts &
insurance companies 24,226 1,057 186 25,097
U.S. industrial &
miscellaneous 90,870 3,030 2,930 90,970
Foreign 20,475 1,147 67 21,555
----------- ----------- ----------- -----------
Total equity securities $ 166,221 $ 26,105 $ 3,749 $ 188,577
----------- ----------- ----------- -----------
Total available-for-sale securities $ 788,518 $ 46,199 $ 11,935 $ 822,782
=========== =========== =========== ===========
F-50
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE D - INVESTMENTS (CONTINUED)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
December 31, 2001
- -----------------
Fixed maturities:
- ----------------
U.S. treasuries & government agencies $ 11,211 $ 502 $ 0 $ 11,713
States & political subdivisions 42,392 1,817 88 44,121
Special revenue 110,267 3,496 345 113,418
Public utilities 25,150 1,156 36 26,270
U.S. industrial & miscellaneous 311,757 8,989 1,438 319,308
Foreign 26,634 859 17 27,476
---------- ---------- ---------- ----------
Total bonds $ 527,411 $ 16,819 $ 1,924 $ 542,306
Redeemable preferred stock 16,012 1,555 0 17,567
---------- ---------- ---------- ----------
Total fixed maturities $ 543,423 $ 18,374 $ 1,924 $ 559,873
---------- ---------- ---------- ----------
Equity securities:
- ------------------
Common stock:
U.S. banks, trusts &
insurance companies $ 3,284 $ 814 $ 16 $ 4,082
U.S. industrial &
miscellaneous 28,718 31,570 579 59,709
Nonredeemable
preferred stock:
Public utilities 2,370 12 3 2,379
U.S. banks, trusts &
insurance companies 14,685 938 58 15,565
U.S. industrial &
miscellaneous 91,185 2,573 2,111 91,647
Foreign 19,485 1,039 108 20,416
---------- ---------- ---------- ----------
Total equity securities $ 159,727 $ 36,946 $ 2,875 $ 193,798
---------- ---------- ---------- ----------
Total available-for-sale
securities $ 703,150 $ 55,320 $ 4,799 $ 753,671
========== ========== ========== ==========
The Company participates in a securities lending program whereby certain
securities from its portfolio are loaned to other institutions for short periods
of time through a lending agent. The Company maintains control over the
securities. A fee is paid to the Company by the borrower. Collateral, comprised
of cash and government securities, that exceeds the market value of the loaned
securities is maintained by the lending agent. The Company has an
indemnification agreement with the lending agent in the event a borrower becomes
insolvent or fails to return securities. The Company had loaned securities with
a market value of $17,400 and $44,900 secured by collateral of $18,002 and
$45,900 at June 30, 2002 and 2001,
F-51
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE D -- INVESTMENTS (CONTINUED)
respectively. The Company maintains the loaned securities on its Consolidated
Statements of Financial Position as part of its invested assets. The Company has
incurred no losses on the loan program since the program's inception.
The components of net realized (loss) gain on investments as reported on the
Consolidated Statements of Operations are included below. The securities that
were recognized as impaired during the second quarter of 2002 were in the
telecommunications industry segment.
Six Months Ended
June 30
----------------------------------
2002 2001
Fixed maturities:
----------------
Gross realized gains $ 2,873 $ 2,640
Gross realized losses ( 53) (187)
Impairment charge ( 8,366) 0
-------------- ---------
Net realized (loss) gain ($ 5,546) $ 2,453
-------------- ---------
Equity securities:
- -----------------
Gross realized gains $ 7,570 $ 3,857
Gross realized losses ( 4,278) (3,585)
Impairment charge ( 2,327) 0
-------------- ---------
Net realized gain $ 965 $ 272
-------------- ---------
Net realized (loss) gain on
investments ($ 4,581) $ 2,725
============== =========
Limited partnerships include U.S. and foreign private equity, real estate and
fixed income investments. The private equity limited partnerships invest in
small-to medium-sized companies. Limited partnerships are recorded using the
equity method, which approximates the Company's share of the carrying value of
the partnership. Unrealized gains and losses on private equity limited
partnerships are reflected in shareholders' equity in accumulated other
comprehensive income, net of deferred taxes. The Company has not guaranteed any
of the partnership liabilities.
Limited partnerships that have declined in value below cost and for which the
decline is considered to be other than temporary by management are written down
to realizable value. Such write downs are made directly on an individual limited
partnership basis and are considered a loss in the Equity in Earnings of Limited
Partnerships on the Consolidated Statements of Operations. The components of
Equity in Earnings of Limited Partnerships as
F-52
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE D -- INVESTMENTS (CONTINUED)
reported on the Consolidated Statements of Operations are included below. For
the year 2002 impairment charges related to limited partnerships were $1,381.
Six Months Ended
June 30
---------------------------------------
2002 2001
---------------------------------------
Private equity ($ 3,257) $ 588
Real estate 3,480 862
Fixed income 84 58
------------ ---------
Total equity in earnings of
limited partnerships $ 307 $ 1,508
============ =========
During 2001, the Company entered into several foreign currency forward contracts
which are by definition derivatives. The purpose of these contracts is to
partially hedge future capital calls related to the Company's limited
partnership commitments. However, under accounting rules, these contracts are
not considered hedges. The forward contracts have no cash requirements at the
inception of the arrangement. At June 30, 2002, the notional amount of the
contracts outstanding totaled $1,659. For the six months, gains on these
contracts totaled $99 for 2002 and $46 in 2001.
F-53
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE E -- SUMMARIZED FINANCIAL STATEMENT INFORMATION OF AFFILIATE
The Company owns 21.6% of Erie Family Life Insurance Company (EFL) common shares
outstanding and accounts for this investment using the equity method of
accounting. EFL is a Pennsylvania domiciled life insurance company operating in
10 states and the District of Columbia. Dividends paid to the Company for the
six months ended June 30, 2002 and 2001 totaled $828 and $766, respectively.
The following represents unaudited condensed financial statement information for
EFL on a GAAP basis:
Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
---------------------- ----------------------
Revenues $ 55,714 $ 54,130
Benefits and expenses 47,470 40,227
---------------------- ----------------------
Income before income taxes 8,244 13,903
Income taxes 2,852 4,805
---------------------- ----------------------
Net income $ 5,392 $ 9,098
====================== ======================
Comprehensive income $ 1,992 $ 16,431
====================== ======================
Dividends paid to shareholders $ 3,827 $ 3,544
====================== ======================
Net unrealized appreciation on investment
securities at June 30, net of deferred taxes $ 14,959 $ 11,020
====================== ======================
NOTE F -- NOTE RECEIVABLE FROM ERIE FAMILY LIFE INSURANCE COMPANY
The Company is due $15,000 from EFL in the form of a surplus note. The note
bears an annual interest rate of 6.45% and all payments of interest and
principal on the note may be repaid only out of unassigned surplus of EFL and
are subject to prior approval by the Pennsylvania Insurance Commissioner.
Interest on the surplus note is scheduled to be paid semi-annually. The note
will be payable on demand on or after December 31, 2005. EFL paid $968 in the
first half of 2002 and 2001 to the Company.
NOTE G -- TREASURY STOCK
The Company has in place a stock repurchase plan, under which the Company may
repurchase as much as $120 million of its outstanding Class A common stock
through December 31, 2002. Treasury shares are recorded on the Consolidated
Statements of Financial Position at cost.
F-54
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE H -- COMMITMENTS
The Company has outstanding commitments to invest up to $110,232 in limited
partnerships at June 30, 2002. These commitments will be funded as required
through the end of the respective investment periods, which typically span 3 to
5 years expiring in 2005. At June 30, 2002, the total commitment to fund limited
partnerships that invest in private equity securities is $82,026, real estate
activities $16,272 and fixed income securities $11,934. At June 30, 2002, no one
partnership commitment exceeded $7.5 million, or 6.8%, of the outstanding
commitment amount.
During 2001, the Company entered into several contracts for services related to
the eCommerce program with various external vendors. The total outstanding
commitment for these contracts at June 30, 2002, was $12.5 million, of which
approximately $9.0 million will be reimbursed to the Company by the Erie
Insurance Exchange (Exchange). The majority of these committed services are
expected to be performed in 2002.
NOTE I -- STOCK COMPENSATION PLAN
In June, 2002, the Company's Board of Directors, at the recommendation of the
Executive Compensation Committee, approved a stock compensation plan for its
outside directors. The purpose of this plan is to further align the interests of
directors with shareholders by providing for a portion of annual compensation
for the directors' services in shares of the Company's Class A common stock.
Each director vests in the grant 25% every three months over the course of a
year. The Company accounts for the fair value of its grants under those plans in
accordance with Financial Accounting Standards (FAS) Statement No. 123,
"Accounting for Stock-Based Compensation." The annual charge to the Company
related to this plan totals $165.
NOTE J -- SEGMENT INFORMATION
The Company operates its business as two reportable segments - management
operations and property/casualty insurance operations. Accounting policies for
segments are the same as described in the summary of significant accounting
policies Note 2, of the Company's Annual Report on Form 10-K for the year ended
December 31, 2001 as filed with the Securities and Exchange Commission on March
12, 2002. The Company's principal operations consist of
F-55
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE J -- SEGMENT INFORMATION (CONTINUED)
serving as attorney-in-fact for the Exchange, which constitutes its management
operations. The Company's property/casualty insurance operations arise through
direct business of its subsidiaries and by virtue of the intercompany pooling
agreement between its subsidiaries and the Exchange which includes assumed
reinsurance from non-affiliated domestic and foreign sources.
Insurance provided in the property/casualty insurance operations consist of
personal and commercial lines and is sold by independent agents. The performance
of the personal and commercial lines is evaluated based upon the underwriting
results as determined under statutory accounting practices (SAP) for the total
pooled business of the Erie Insurance Group. Assets are not allocated to
segments and are reviewed in total by management for purposes of decision
making. No single customer or agent provides 10% or more of revenues for the
Erie Insurance Group.
F-56
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE J -- SEGMENT INFORMATION (CONTINUED)
Summarized financial information for these operations is presented below:
Six Months Ended
June 30
----------------------------
2002 2001
Management operations:
- ---------------------
Revenue:
Management fee revenue $ 384,827 $ 313,497
Service agreement revenue 15,118 13,250
--------- ---------
Total revenue from management
operations 399,945 326,747
Net revenue from investment
operations 18,238 21,201
--------- ---------
Total revenue $ 418,183 $ 347,948
========= =========
Income before taxes $ 141,887 $ 117,505
========= =========
Net income $ 94,383 $ 78,523
========= =========
Property/casualty insurance operations:
- ---------------------------------------
Revenue:
Premiums earned:
Commercial lines $ 21,981 $ 16,585
Personal lines 54,012 47,359
Reinsurance 3,757 3,357
--------- ---------
Total premiums earned (SAP) 79,750 67,301
GAAP adjustments ( 2,097) ( 1,210)
--------- ---------
Total premiums earned (GAAP) 77,653 66,091
Net revenue from investment
operations 5,311 9,726
--------- ---------
Total revenue $ 82,964 $ 75,817
========= =========
Expense:
Losses and expenses:
Commercial lines $ 24,903 $ 18,465
Personal lines 62,592 51,302
Reinsurance 2,916 3,858
--------- ---------
Total losses and expenses
(SAP) 90,411 73,625
GAAP adjustments ( 3,097) ( 2,210)
--------- ---------
Total losses and expenses
(GAAP) $ 87,314 $ 71,415
========= =========
(Loss) income before taxes ($ 4,350) $ 4,402
========= =========
Net (loss) income ($ 2,356) $ 3,392
========= =========
F-57
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE J -- SEGMENT INFORMATION (CONTINUED)
The following table presents the management fee revenue by line of business:
Six Months Ended %
June 30 Change
-------------------------- -----------------------
2002 2001
Private passenger auto $ 201,844 $ 170,094 18.7%
Commercial auto 34,185 26,956 26.8
Homeowner 56,313 47,457 18.7
Commercial multi-peril 45,372 32,482 39.7
Workers' compensation 35,778 27,151 31.8
All other lines of
business 11,335 9,357 21.1
------------ --------- ------
Total $ 384,827 $ 313,497 22.8%
============ ========= =======
The growth rate of policies in force and policy retention trends (the percentage
of current Policyholders who have renewed their policies) directly impact the
Company's management and property/casualty insurance operating segments. Below
is a summary of each by line of business for the Erie Insurance Group's
property/casualty insurance business.
F-58
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Growth rate of policies in force for Erie Insurance Group property/casualty
- ---------------------------------------------------------------------------
insurance operations:
- ---------------------
All other
Private 12 mth. 12 mth. personal 12 mth. Total
passenger growth growth lines of growth personal
Date auto rate Homeowner rate business rate Lines
---- ---- ---- --------- ---- -------- ---- -----
12/31/2000 1,337,280 4.9% 986,654 7.5% 146,682 7.9% 2,470,616
03/31/2001 1,356,651 5.3 1,003,517 7.7 149,438 8.1 2,509,606
06/30/2001 1,382,419 5.9 1,029,339 8.1 154,029 8.5 2,565,787
09/30/2001 1,408,092 6.3 1,053,014 8.4 157,419 8.9 2,618,525
12/31/2001 1,432,747 7.1 1,075,816 9.0 159,702 8.9 2,668,265
03/31/2002 1,469,617 8.3 1,104,806 10.1 163,560 9.5 2,737,983
06/30/2002 1,512,335 9.4 1,146,639 11.4 169,952 10.3 2,828,926
12 mth. 12 mth. 12 mth. 12 mth. Total
CML* growth CML* growth Workers' growth All other growth CML*
Date auto rate multi-peril rate comp rate CML* rate Lines
---- ---- ---- ----------- ---- ---- ---- ---- ---- -----
12/31/2000 87,567 5.8% 195,137 12.1% 47,156 8.4% 65,077 7.1% 394,937
03/31/2001 89,388 7.0 200,671 12.6 48,104 8.7 66,309 8.0 404,472
06/30/2001 91,794 7.9 208,388 12.7 49,711 9.5 67,964 8.9 417,857
09/30/2001 94,204 8.8 215,039 13.1 50,984 9.6 70,048 9.0 430,275
12/31/2001 96,100 9.7 221,635 13.6 52,033 10.3 71,539 9.9 441,307
03/31/2002 98,926 10.7 229,784 14.5 53,320 10.8 73,392 10.7 455,422
06/30/2002 102,447 11.6 241,760 16.0 55,607 11.9 75,884 11.7 475,698
Policy retention trends for Erie Insurance Group property/casualty insurance
- ----------------------------------------------------------------------------
operations:
- -----------
Private All other
passenger CML* CML* Workers' lines of
Date auto auto Homeowner multi-peril comp. business Total
--------- --------- --------- --------- ----------- --------- -------- -----
12/31/00 92.31% 89.80% 90.75% 88.14% 88.48% 87.64% 91.01%
03/31/01 92.24 90.29 90.71 88.59 89.06 87.75 91.03
06/30/01 92.25 90.35 90.68 88.44 88.76 88.00 91.01
09/30/01 92.22 90.16 90.43 88.35 88.53 87.95 90.89
12/31/01 92.24 90.53 90.29 88.04 88.43 88.07 90.85
03/31/02 92.26 90.86 90.24 88.50 89.34 88.21 90.80
06/30/02 92.35 91.12 90.35 88.69 89.46 88.39 90.92
*CML = Commercial
F-59
================================================================================
No dealer, salesperson or other person is authorized to give any
information or to represent anything not contained in this prospectus. You must
not rely on any unauthorized information or representations. This prospectus is
an offer to sell only the shares offered hereby, but only under circumstances
and in jurisdictions where it is lawful to do so. The information contained in
this prospectus is current as of its date.
-----------
Shares
ERIE INDEMNITY COMPANY
CLASS A COMMON STOCK
--------------
PROSPECTUS
--------------
GOLDMAN, SACHS & CO.
CREDIT SUISSE FIRST BOSTON
Representatives of the Underwriters
TABLE OF CONTENTS
Page
----
Prospectus Summary ........................... 2
Risk Factors ................................. 14
Cautionary Note Regarding
Forward-Looking Statements ................. 30
Price Range of Our Class A Common
Stock and Dividend History ................. 32
Capitalization ............................... 33
Selected Historical Financial
Information of the Company ................. 34
Selected Historical Financial
Information of the Exchange ................ 35
Management's Discussion and
Analysis of Financial Condition
and Results of Operations .................. 36
Business ..................................... 52
Erie Insurance Exchange ...................... 86
Erie Family Life Insurance Company ........... 92
Management ................................... 93
Certain Relationships and
Related Transactions ..................... 96
Principal Shareholders ....................... 97
Selling Shareholder .......................... 101
Description of Capital Stock ................. 102
Shares Eligible for Future Sale .............. 103
Underwriting ................................. 104
Validity of Common Stock ..................... 107
Experts ...................................... 107
Where To Find More Information/
Incorporation by Reference ................. 108
Index to Financial Statements ................ F-1
================================================================================
PART II
Item 14. Other Expenses Of Issuance And Distribution.
- ------- -------------------------------------------
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the registrant in connection
with the sale of the Class A common stock being registered. All amounts are
estimates except the registration fee.
Commission registration fee $ 18,238
NASD filing fee 20,324
Printing and engraving costs *
Legal fees and expenses *
Accounting fees and expenses *
Blue sky filing fees and expenses *
Transfer agent and registrar fees and expenses *
Miscellaneous expenses *
--------
$
========
* To be filed by amendment.
All expenses other than the Commission registration fee and NASD filing
fee are estimated. The selling shareholder identified in this registration
statement is obligated to reimburse the registrant for the above listed
expenses.
Item 15. Indemnification of Directors and Officers.
- ------- -----------------------------------------
Pennsylvania law provides that a Pennsylvania corporation may indemnify
directors, officers, employees and agents of the corporation against liabilities
they may incur in such capacities for any action taken or any failure to act,
whether or not the corporation would have the power to indemnify the person
under any provision of law, unless such action or failure to act is determined
by a court to have constituted recklessness or willful misconduct. Pennsylvania
law also permits the adoption of a bylaw amendment, approved by shareholders,
providing for the elimination of a director's liability for monetary damages for
any action taken or any failure to take any action unless (i) the director has
breached or failed to perform the duties of his office and (ii) the breach or
failure to perform constitutes self-dealing, willful misconduct or recklessness.
The Bylaws of the registrant provide for (i) indemnification of
directors, officers, employees and agents of the registrant and its subsidiaries
and (ii) the elimination of a director's liability for monetary damages, to the
fullest extent permitted by Pennsylvania law.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers or controlling persons of
the registrant pursuant to the foregoing provisions, the registrant has been
informed that, in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Securities Act of
1933 and is therefore unenforceable.
II-1
Item 16. Exhibits.
- ------- --------
Exhibit No. Exhibit Description
------------- ------------------------------------------------------
1** Underwriting Agreement
4.1* Form of Registrant's Class A Common Stock Certificate
4.2* Form of Registrant's Class B Common Stock Certificate
5** Opinion of Duane Morris LLP
23.1 Consent of Malin, Bergquist & Company LLP
23.2** Consent of Duane Morris LLP (Included in Exhibit 5)
24 Powers of Attorney (Included on the signature pages)
- --------------------
* Such exhibit is incorporated by reference to the like numbered exhibit
in Registrant's Form 10 Registration Statement Number 0-24000 filed
with the Securities and Exchange Commission on May 2, 1994.
** To be filed by amendment.
Item 17. Undertakings.
- ------- ------------
A. The undersigned registrant hereby undertakes:
1. To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement:
(a) To include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933;
(b) To reflect in the prospectus any facts or events arising
after the effective date of the Registration Statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the Registration
Statement; notwithstanding the foregoing, any increase or decrease in the volume
of securities offered (if the total dollar value of securities offered would not
exceed that which was registered) and any deviation from the low or high
II-2
and of the estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b) if, in the
aggregate, the changes in volume and price represent no more than a 20% change
in the maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective Registration Statement; and
(c) To include any material information with respect to the plan
of distribution not previously disclosed in the Registration Statement or any
material change to such information in the Registration Statement;
Provided, however, that paragraphs A.1 a and A.1 b do not apply if the
information required to be included in a post-effective amendment by those
paragraphs is contained in periodic reports filed with or furnished to the
Commission by the registrant pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 that are incorporated by reference in the Registration
Statement.
2. That, for the purpose of determining any liability under the
Securities Act of 1933; each such post-effective amendment shall be deemed to be
a new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
3. To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the termination of
the offering.
B. The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 that is incorporated by reference in the Registration
Statement shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
C. Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Commission, such
indemnification is against public policy as expressed in the Securities Act of
1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act of 1933 and will be governed by the final adjudication of such issue.
II-3
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form S-3 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Erie, Commonwealth of Pennsylvania, on September 20,
2002.
ERIE INDEMNITY COMPANY
By: /s/ Jeffrey A. Ludrof
-------------------------------------
Jeffrey A. Ludrof,
President and Chief Executive Officer
Know all men by these presents, that each person whose signature
appears below constitutes and appoints Jeffrey A. Ludrof, Philip A. Garcia and
Jan R. Van Gorder, and each or either of them, as such person's true and lawful
attorneys-in-fact and agents, with full power of substitution, for such person,
and in such person's name, place and stead, in any and all capacities to sign
any or all amendments or post-effective amendments to this Registration
Statement, and to file the same, with all exhibits thereto and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents full power and authority to do and
perform each and every act and thing requisite and necessary to be done in and
about the premises, as fully to all intents and purposes as such person might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them or their substitutes, may lawfully
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
Signature Title Date
- -------------------------- ----------------------------------------------- -------------------
/s/ Jeffrey A. Ludrof President, Chief Executive Officer and Director September 20, 2002
- --------------------------
Jeffrey A. Ludrof (principal executive officer)
/s/ Philip A. Garcia Executive Vice President and Chief Financial September 20, 2002
- --------------------------
Philip A. Garcia Officer (principal financial officer)
II-4
/s/ Timothy G. NeCastro Senior Vice President and Controller (principal September 20, 2002
- --------------------------------
Timothy G. NeCastro accounting officer)
/s/ Samuel P. Black, III Director September 20, 2002
- --------------------------------
Samuel P. Black, III
/s/ J. Ralph Borneman, Jr. Director September 20, 2002
- --------------------------------
J. Ralph Borneman, Jr.
/s/ Patricia A. Garrison-Corbin Director September 20, 2002
- --------------------------------
Patricia A. Garrison-Corbin
________________________________ Director September , 2002
Susan Hirt Hagen
/s/ F. William Hirt Chairman of the Board and Director September 20, 2002
- --------------------------------
F. William Hirt
/s/ Samuel P. Katz Director September 20, 2002
- --------------------------------
Samuel P. Katz
/s/ Claude C. Lilly, III Director September 20, 2002
- --------------------------------
Claude C. Lilly, III
/s/ Henry N. Nassau Director September 20, 2002
- --------------------------------
Henry N. Nassau
/s/ John M. Petersen Director September 20, 2002
- --------------------------------
John M. Petersen
II-5
/s/ Jan R. Van Gorder Senior Executive Vice President, Secretary, September 20, 2002
- --------------------------
Jan R. Van Gorder General Counsel and Director
/s/ Robert C. Wilburn Director September 20, 2002
- --------------------------
Robert C. Wilburn
II-6