Business Context and Reporting Period
Company: Erie Indemnity Company (Indemnity) and its consolidated variable interest entity, the Erie Insurance Exchange (Exchange), collectively the Erie Insurance Group.
Reporting Period: Quarterly period ended June 30, 2011 (Q2 2011) and the six months ended June 30, 2011 (YTD 2011).
Operational Structure: Indemnity serves as the attorney-in-fact for the Exchange, earning a management fee (capped at 25% of direct premiums). As of December 31, 2010, Indemnity sold its property and casualty subsidiaries to the Exchange. On March 31, 2011, Indemnity sold its 21.6% ownership interest in Erie Family Life Insurance Company (EFL) to the Exchange. Consequently, Indemnity now functions solely as a management company, while all insurance operations (P&C and Life) are owned by the Exchange (Noncontrolling Interest).
Key Financial Metrics
| Metric (in millions) | Q2 2011 | Q2 2010 | YTD 2011 | YTD 2010 |
|---|---|---|---|---|
| Total Revenues | $1,245 | $916 | $2,610 | $2,132 |
| Premiums Earned | $1,047 | $989 | $2,077 | $1,967 |
| Net Investment Income | $113 | $108 | $218 | $212 |
| Net Realized Investment Gains | $39 | $(213) | $188 | $(88) |
| Insurance Losses & Expenses | $1,170 | $737 | $1,876 | $1,498 |
| Net Income (Loss) - Consolidated | $(107) | $(31) | $167 | $131 |
| Net Income - Indemnity Shareholders | $52 | $49 | $96 | $96 |
| EPS (Class A, Diluted) | $0.94 | $0.86 | $1.72 | $1.68 |
| Total Assets | $14,723 | N/A | $14,723 | $14,344 |
| Cash & Equivalents | $109 | N/A | $109 | $430 |
| Operating Cash Flow (YTD) | N/A | N/A | $200 | $212 |
Material Changes vs. Prior Period
- Underwriting Results: The consolidated group reported a net loss of $107 million in Q2 2011 compared to a loss of $31 million in Q2 2010. This deterioration was driven primarily by a significant increase in catastrophe losses ($537 million in Q2 2011 vs. $80 million in Q2 2010), which contributed 52.1 points to the loss ratio. The P&C combined ratio worsened to 140.2% in Q2 2011 from 101.8% in Q2 2010.
- Investment Performance: Investment results improved significantly due to market recovery. Net realized investment gains were $39 million in Q2 2011, a reversal from losses of $213 million in Q2 2010. Equity in earnings of limited partnerships increased to $38 million in Q2 2011 from $27 million in Q2 2010.
- Premium Growth: Direct written premiums increased 5.3% in Q2 2011, driven by a 2.9% increase in policies in force and a 2.7% increase in average premium per policy.
- Structural Changes: The sale of Indemnity's P&C subsidiaries (Dec 2010) and EFL interest (March 2011) shifted the majority of underwriting and investment results to the Noncontrolling Interest (Exchange). Indemnity's income is now derived primarily from management fees and its own investment portfolio.
Guidance, Outlook, and Risks
- Management Commentary: Management notes that while financial markets have shown improvement, economic conditions remain uncertain. The company expects pricing actions to result in a net increase in direct written premium in 2011, though exposure reductions due to economic conditions could impact average premiums.
- Outlook: The company plans to continue growing premiums through agency expansion and market penetration. Favorable prior year loss reserve development ($60 million in Q2 2011) helped offset current year catastrophe losses.
- Risks:
- Catastrophes: Weather-related events (hail, tornado, wind) significantly impacted Q2 2011 results.
- Market Volatility: Investment portfolios are subject to market fluctuations, particularly in fixed income and limited partnerships.
- Reserve Uncertainty: Massive injury claim reserves (approx. $371 million net) carry the greatest potential for variation due to medical cost inflation and litigation outcomes.
- Liquidity: While the company has $100 million (Indemnity) and $200 million (Exchange) in lines of credit and significant liquid assets, market volatility could impair the ability to sell fixed income securities without discounts.
Investor Verification Checklist
- Catastrophe Exposure: Verify the adequacy of catastrophe reinsurance coverage given the $537 million loss in Q2 2011.
- Reserve Development: Monitor the stability of massive injury claim reserves, which represent a significant portion of P&C liabilities.
- Management Fee Dependency: Confirm the stability of the 25% management fee rate and its sensitivity to Exchange surplus levels.
- Investment Portfolio Quality: Review the composition of Level 3 assets ($74 million total) and the impact of market volatility on unrealized gains/losses.
- Capital Allocation: Track the execution of the $150 million stock repurchase program (approx. $56 million remaining authority as of June 30, 2011) and dividend sustainability.