Erie Indemnity Company — 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2010. The consolidated statements include Erie Indemnity (“Indemnity”) and the Erie Insurance Exchange (“Exchange”), whose policyholder interests are presented as noncontrolling interests. Exchange assets are not available to satisfy Indemnity’s obligations. Comparative periods were retrospectively adjusted for a 2010 consolidation accounting change; management said it did not change Indemnity shareholder net income or equity.
Financial results
| Metric ($ millions, except per-share data and ratios) | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Total revenue | 1,357 | 1,286 | 3,489 | 3,130 |
| Net income, consolidated | 275 | 252 | 406 | 272 |
| Net income attributable to Indemnity | 54 | 40 | 150 | 84 |
| Indemnity diluted Class A EPS | $0.94 | $0.69 | $2.62 | $1.46 |
| Operating income attributable to Indemnity (non-GAAP) | 51 | 38 | 146 | 87 |
| Net investment income | 110 | 102 | 322 | 324 |
| Net realized investment gains | 205 | 251 | 117 | 304 |
| Limited partnership earnings (losses) | 28 | (37) | 58 | (324) |
| Impairment losses recognized in earnings | 0 | (16) | (6) | (99) |
| Operating cash flow | — | — | 465 | 713 |
Q3 revenue growth reflected higher earned premiums, investment income and positive limited-partnership results. The $205 million of Q3 realized gains was largely driven by Exchange common-stock valuation adjustments. Nine-month net income also benefited from improved limited-partnership results and lower impairments. Indemnity’s operating income is a company-defined non-GAAP measure; it excludes realized investment gains and losses, impairments, and related taxes.
Underwriting and operating metrics
- Property and Casualty Group direct written premiums rose 5.2% in Q3 to $1.062 billion and 4.2% for nine months to $3.098 billion. Policies in force and modest average-premium increases supported growth; policy retention was 90.6%.
- Group underwriting income was $12 million in Q3 versus $16 million; the nine-month underwriting loss narrowed to $48 million from $55 million. The combined ratio was 98.7% in Q3 versus 98.1%, and 101.7% for nine months versus 101.9%.
- Q3 losses and loss expenses increased 12.4% to $690 million, while acquisition and underwriting expenses declined 13.5% to $288 million. Nine-month catastrophe losses were $245 million versus $111 million and contributed 8.3 versus 3.8 combined-ratio points. Favorable prior-year reserve development was $76 million in Q3 and $148 million year to date.
- Management operations income before tax increased to $58 million in Q3 from $48 million, and to $173 million for nine months from $153 million. Gross margin was 21.1% for Q3 versus 18.1%; nine-month margin was 21.7% versus 19.9%, including a $5 million favorable court ruling. Excluding that item, nine-month margin was 21.0%.
- EFL reported pretax income of $16 million for Q3 versus $8 million and $37 million for nine months versus $8 million. Improved investment results contributed; Q3 2009 included a $19 million reversal of a deferred-tax valuation allowance.
Financial position, liquidity and capital
- At September 30, 2010, consolidated assets were $14.158 billion, investments $11.711 billion, cash and cash equivalents $312 million, and total liabilities $7.932 billion. Indemnity shareholder equity was $958 million; Exchange noncontrolling interest was $5.268 billion.
- Cash increased $78 million over the nine months, ending at $312 million. Operating cash flow fell from $713 million to $465 million, principally because the company paid $105 million of income taxes versus a $161 million recovery in 2009, and paid more losses. Investing cash use was $301 million versus $591 million; financing cash use was $86 million versus $44 million.
- No borrowings were outstanding on Indemnity’s $100 million credit line or Exchange’s $200 million revolving line; the facilities were covenant-compliant. Indemnity stated it had about $2.3 billion of more liquid investments, cash and cash equivalents available across the consolidated group, while emphasizing that the entities’ assets and capital are separate.
- There was no conventional debt balance identified in the supplied filing text; insurance reserves and policyholder obligations are substantial liabilities. The filing reports $3.613 billion of consolidated loss and loss expense reserves and $1.600 billion of life policy and deposit contract reserves.
- Limited-partnership investment commitments totaled $532 million: $60 million for Indemnity and $472 million for the Exchange. Indemnity had $58 million of authorization remaining under its $100 million share repurchase program. It repurchased 950,601 shares for $46 million in the first nine months and paid $74 million in dividends.
Outlook, changes, risks and unusual items
- Management expected pricing actions to produce a net increase in 2010 direct written premiums, while noting that exposure reductions and business mix could affect average premiums. It provided no specific earnings guidance.
- After quarter-end, on November 4, 2010, Indemnity agreed to sell its three property-and-casualty subsidiaries to the Exchange for GAAP book value, with estimated net cash proceeds of $290–$300 million and a planned closing by December 31, 2010, subject to regulatory approval and other conditions. Indemnity also agreed to sell its 21.6% EFL interest, with estimated net proceeds of $55–$60 million and planned completion by March 31, 2011. The proposed structure leaves Indemnity as the management company and moves insurance operations to the Exchange. A deferred tax liability of approximately $17 million was expected in Q4 2010 related to the EFL sale. The sales’ gains or losses would be recorded directly in Indemnity equity because of common control.
- Management cited competition, regional concentration, reliance on the Exchange and independent agents, pricing and reserve-estimation uncertainty, catastrophe frequency and severity, economic conditions, interest rates, investment liquidity and litigation among principal risks. Some fixed-income holdings and limited partnerships may be illiquid; partnership results are generally reported on a one-quarter lag.
- The company expected a $91 million tax refund from a capital-loss carryback related to 2009 that had not been received by September 30. Ordinary-course litigation was not expected to materially affect consolidated financial condition, operations or cash flows. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Confirm the final closing, regulatory approvals, purchase-price adjustments and actual proceeds for both announced sales, including the expected EFL-related tax charge.
- Assess whether underwriting performance can improve: the nine-month combined ratio remained above 100%, catastrophe losses rose materially, and Q3 current-accident-year loss trends worsened in personal lines.
- Separate recurring operating performance from volatile investment gains, impairments and lagged limited-partnership valuations; review underlying portfolio exposures and valuation assumptions.
- Track loss-reserve adequacy, especially massive-injury claims, and the sustainability of favorable prior-year reserve releases.
- Evaluate liquidity and capital at Indemnity and the Exchange separately, including the $532 million partnership commitments, investment liquidity, credit-line collateral and the expected tax refund.