Erie Indemnity Company — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless noted. Erie Indemnity acts as attorney-in-fact and service provider for Erie Insurance Exchange, its sole customer. Its principal earnings source is a management fee based on Exchange premiums.
Financial performance
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Operating revenue | $653.5 | $638.7 | $1,927.2 | $1,880.6 |
| Operating income | $96.2 | $105.9 | $273.1 | $288.6 |
| Net income | $89.2 | $94.2 | $230.5 | $257.2 |
| Diluted Class A EPS | $1.71 | $1.80 | $4.41 | $4.92 |
| Total investment income | $16.4 | $13.6 | $18.8 | $33.1 |
- Q3 operating revenue rose 2.3%, but operating income fell 9.1% and net income fell 5.3%. Nine-month operating revenue increased 2.5%, while operating income declined 5.4% and net income declined 10.4%.
- Operating margin, calculated as operating income divided by total operating revenue, was approximately 14.7% in Q3 2020 versus 16.6% in Q3 2019; for nine months it was 14.2% versus 15.3%.
- Policy issuance and renewal management fee revenue increased 2.1% in Q3 and 1.9% year to date. Exchange direct and affiliated assumed premiums written increased 2.0% to $2.0 billion in Q3 and 1.9% to $5.8 billion year to date. The stated management fee rate was 25% overall; revenue is allocated between policy and administrative services.
- Policy issuance and renewal costs rose 5.0% in Q3 and 3.6% year to date, outpacing related revenue growth. The filing cites higher commissions, agent incentives, personnel costs, technology spending and other expenses. Administrative-service reimbursements are recorded gross with matching costs and do not affect operating income.
- Q3 investment income increased 20.8%, mainly from realized gains; nine-month investment income decreased 43.1%, reflecting weaker limited partnership results, lower realized gains and net investment income, and higher impairment losses. Nine-month impairment losses recognized in earnings were $3.2 million versus $0.2 million in 2019.
Cash flow, balance sheet and liquidity
- For the first nine months, operating cash flow was $234.5 million versus $237.9 million. Investing cash outflow was $218.6 million versus $32.2 million, largely due to investment purchases; financing cash outflow was $136.3 million versus $127.2 million, primarily reflecting dividends. Cash and equivalents declined by $120.4 million to $216.4 million.
- At September 30, total assets were $2.16 billion, total liabilities $912.1 million and shareholders’ equity $1.25 billion. Current assets were $792.9 million and current liabilities $606.5 million.
- Balance-sheet borrowings totaled approximately $96.4 million, including current and long-term amounts. The $100 million revolving credit facility had no borrowings; $99.1 million remained available after letters of credit. The term loan carries a fixed 4.35% rate and is amortized over 28 years. The company reported compliance with debt covenants.
- Management cited $216.4 million of cash, the revolving facility and approximately $644.8 million of unpledged investment assets as sources of liquidity. Investments with fair value of $124.6 million were pledged for the revolving line and $126.2 million for the term loan.
- Quarterly Class A dividends declared were $0.965 per share, up from $0.90 a year earlier; nine-month dividends paid totaled $134.8 million. No shares were repurchased under the public repurchase program during the first nine months, and $17.8 million of authorization remained.
Material changes, outlook and risks
- COVID-19-related financial market volatility weighed on investments in Q1; markets substantially recovered in Q2 and Q3. The company reported no significant business-process interruption, with more than 90% of its workforce working remotely.
- Exchange new-business premiums grew 10.4% in Q3, while total policies in force grew 1.7% year over year. Previously announced auto rate reductions are expected to constrain premiums and management fees: through Q3 they reduced Exchange premiums by an estimated $41 million and Indemnity fees by $10 million; the filing estimated further Q4 reductions of $49 million and $12 million, respectively, with remaining effects extending into 2021.
- Management said the pandemic’s duration and financial impact remain uncertain. Risks include constrained premium growth, recession and policy cancellations, agent and technology costs, investment volatility and impairment, cybersecurity and business-continuity risks, and possible changes in claims, regulation or consumer behavior. No formal earnings or revenue guidance is provided.
- The Exchange is the company’s sole customer and a major source of revenue and receivables: net receivables from the Exchange and affiliates were $501.2 million. The Exchange’s A.M. Best financial strength rating was A+ with a stable outlook, affirmed July 8, 2020; its statutory policyholders’ surplus was $10.0 billion at September 30, 2020.
- A long-running lawsuit alleges Indemnity improperly retained policy installment, late and reinstatement charges, with plaintiffs citing approximately $308 million in alleged charges. Related federal litigation was dismissed and affirmed on appeal; the state-court Sullivan matter remained pending. The company said it has meritorious defenses and does not expect its litigation accruals to be material, but outcomes remain uncertain.
- Effective January 1, 2020, the company adopted the current expected credit loss standard, recording a $1.1 million after-tax reduction to opening retained earnings. Management said adoption had no material impact on the financial statements.
Most important facts for investors to verify
- Whether Exchange premium growth, policy retention and new-business trends can offset the announced rate reductions and pandemic-related economic pressures.
- Whether operating expenses—especially agent incentives, compensation and technology—continue to grow faster than policy-related revenue.
- How investment income, impairment charges and portfolio valuations evolve amid market and interest-rate volatility, including the increase in Level 3 securities.
- Whether liquidity remains adequate if cash generation weakens or investment assets become harder to sell, and whether debt covenants continue to be met.
- Developments in the Sullivan lawsuit and any material changes in litigation exposure, COVID-19 impacts or Exchange credit quality.