Business context and reporting period
Erie Indemnity Company’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2014. Indemnity manages the subscriber-owned Erie Insurance Exchange and earns a fee tied to premiums written. The consolidated statements include the Exchange as a variable interest entity; Exchange results and equity largely belong to policyholders and are reported as noncontrolling interest. Accordingly, consolidated results are not the same as earnings attributable to Indemnity shareholders.
Financial performance and position
Amounts below are in millions of dollars except per-share data and ratios.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Premiums earned | $1,319 | $1,215 | $2,607 | $2,390 |
| Total revenue | $1,598 | $1,426 | $3,109 | $2,997 |
| Insurance losses and loss expenses | $1,126 | $861 | $2,160 | $1,703 |
| Net income, consolidated | $103 | $177 | $212 | $467 |
| Net income attributable to Indemnity | $49 | $44 | $95 | $81 |
| Indemnity Class A diluted EPS | $0.94 | $0.84 | $1.82 | $1.54 |
- Consolidated net income fell despite higher premiums and revenue, primarily reflecting substantially higher catastrophe and other claims. Indemnity shareholder earnings rose because its management operations grew; most Exchange underwriting results accrue to policyholders, not Indemnity shareholders.
- Exchange property-and-casualty earned premiums increased 8.7% in Q2 and 9.1% for the first half. Direct written premiums grew 8.8% and 8.3%, respectively.
- The P&C combined ratio was 114.0% in Q2 versus 99.1% a year earlier, and 111.1% for the first half versus 99.0%. Ratios above 100% indicate an underwriting loss. Current-year catastrophe losses were $244 million in Q2 and $337 million year to date, versus $45 million and $72 million in the comparable periods.
- Indemnity management-operations gross margin improved to 18.2% in Q2 from 17.3%, and to 18.0% for the first half from 16.7%. Its management fee rate remained at the contractual maximum of 25%.
- Investment results were mixed: consolidated net realized investment gains were $133 million in Q2 versus $61 million, but $189 million for the first half versus $310 million. The filing attributes much of the Q2 increase to larger fair-value gains on common stocks. Net investment income increased to $111 million in Q2 from $104 million and to $220 million for the first half from $207 million.
- Operating cash flow was $245 million for the first half, down from $330 million; investing cash flow was negative $332 million and financing cash flow negative $65 million. Cash and cash equivalents fell to $300 million from $452 million at year-end 2013.
- At June 30, total assets were $17.46 billion, total liabilities $9.64 billion, and total equity $7.82 billion, including $755 million of Indemnity shareholders’ equity and $7.07 billion of Exchange noncontrolling interest. Bank borrowings were zero; Indemnity had $98.2 million and the Exchange $298.9 million available under separate revolving facilities. The filing reports no outstanding bank debt.
Changes, outlook, risks and contingencies
- Management cited unusually high catastrophe losses, including a large May hailstorm in Pennsylvania, as the main driver of the deterioration in P&C underwriting. Non-catastrophe weather claims and several large commercial property claims also raised first-half loss ratios. Prior-year reserve development was favorable overall by $22 million for the first half, but assumed reinsurance development was adverse by $10 million.
- Management said it expects operating cash needs to be met from operations and believes funding sources are sufficient for 2014. It plans to expand P&C and life operations into Kentucky by the first quarter of 2015, or earlier if possible. The filing provides no earnings or revenue guidance.
- Risks include catastrophe severity, reserve-estimation uncertainty, investment-market and interest-rate volatility, potentially illiquid investments, reinsurance collectability, and Indemnity’s reliance on the Exchange for fees and receivables. Indemnity states it has no right to Exchange assets or credit facilities.
- Limited-partnership commitments totaled up to $471 million: $26 million for Indemnity and $445 million for the Exchange. These commitments are to be funded as required by partnership agreements.
- Unclaimed-property audits are ongoing. EFL’s West Virginia unclaimed-property lawsuit was dismissed with prejudice, but the state appealed. The company says additional claims, escheatment payments, or fines are probable, but it cannot reasonably estimate a loss range.
- Separate lawsuits allege Indemnity improperly retained policy service and late fees, with plaintiffs alleging approximately $308 million and seeking an accounting. The matter is before the Pennsylvania Insurance Department; the company disputes the claims and intends to defend them. A related federal action against directors was dismissed without prejudice, and an appeal was pending.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the first half. It identified no subsequent event requiring adjustment or disclosure.
Most important facts for investors to verify
- Whether catastrophe losses and the combined ratio normalize, and how claims trends affect reserves and underwriting profitability.
- How much reported investment income depends on volatile realized and fair-value gains, including the one-quarter reporting lag for most limited-partnership results.
- The distinction between consolidated Exchange results and earnings and assets attributable to Indemnity shareholders.
- Developments in the service-fee litigation, unclaimed-property matters, and the associated unquantified exposures.
- Funding of the $471 million limited-partnership commitments, cash-flow trends, and continued availability of the separately held credit facilities.