Erie Indemnity Company — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited. Erie Indemnity acts as attorney-in-fact and service provider to Erie Insurance Exchange, its sole customer. It earns management fees primarily based on premiums written by the Exchange; administrative service costs are reimbursed at cost.
Financial results and liquidity
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total operating revenue | $594.1 million | $572.2 million | +3.8% |
| Operating income | $86.1 million | $77.6 million | +11.0% |
| Total investment income | $9.8 million | $6.2 million | +58.9% |
| Income before taxes | $95.5 million | $83.2 million | +14.8% |
| Net income | $75.3 million | $65.8 million | +14.5% |
| Diluted Class A EPS | $1.44 | $1.26 | +14.5% |
| Operating cash flow | $24.2 million | $(40.2) million | Improved |
- Policy issuance and renewal management fee revenue was $431.0 million, up 6.2%; the Exchange’s direct and affiliated assumed premiums written increased 6.0% to $1.785 billion. The management fee rate was 25% overall, allocated 24.2% to policy issuance and renewal services and 0.8% to administrative services.
- Policy issuance and renewal costs increased 4.8% to $365.5 million. Operating margin on total reported revenue was approximately 14.5%, versus 13.6% in Q1 2018; administrative reimbursement revenue and matching costs have no net operating-income impact.
- Investment income growth reflected higher net investment income and realized gains, partly offset by limited partnership losses. Limited partnership results are generally reported on a one-quarter lag.
- Cash and equivalents were $312.0 million at March 31, 2019, versus $266.4 million at year-end. Total assets were $1.799 billion and shareholders’ equity was $1.014 billion.
- Total borrowings were approximately $99.3 million. No revolving-line borrowings were outstanding; $99.1 million remained available after letters of credit. The term loan converted to monthly principal-and-interest payments at a fixed 4.35% rate in January 2019. The company reported covenant compliance.
- Current liabilities were $502.5 million and current assets $962.4 million. Dividends declared were $0.90 per Class A share and $135 per Class B share, each 7.1% higher than the prior-year quarter.
Material changes versus prior period
- Operating income rose as management fee growth outpaced policy issuance and renewal cost growth. The Exchange’s premiums benefited from growth in policies in force and average premium per policy.
- New-business premiums declined 2.5% to $212 million, as new-business policies written fell 7.6%; renewal premiums increased 7.3% to $1.6 billion. Total policies in force increased 3.1%, and retention was 90.2%.
- Operating cash flow improved from an outflow to an inflow, principally because there was no comparable $40 million accelerated pension contribution and agent bonus payments were lower.
- Investing cash flow was $63.8 million, versus an outflow of $16.7 million, reflecting higher investment proceeds. Financing cash outflow increased to $42.4 million, mainly reflecting higher dividends and term-loan principal payments.
- Available-for-sale securities declined to $674.9 million from $748.5 million at year-end, in part as the company continued portfolio rebalancing from municipal bonds toward U.S. Treasuries. Net unrealized losses on fixed maturities narrowed to $1.5 million from $7.0 million.
Outlook, risks and unusual items
- No specific numerical earnings or revenue guidance was provided. Management said the Exchange plans to pursue premium growth through agency expansion and greater market penetration, while maintaining underwriting discipline.
- Results depend heavily on the Exchange’s premium growth, financial condition, ratings, agency relationships and ability to retain policyholders. The Exchange and its property-casualty subsidiaries were rated A+ “Superior,” with a stable outlook last affirmed in June 2018.
- Other cited risks include severe weather and catastrophe losses, economic and claims-cost inflation, competition, interest-rate and investment-market volatility, investment liquidity, cybersecurity and technology disruption, and litigation. A large majority of revenue and receivables is concentrated with the Exchange and its subsidiaries; receivables from them were $456.1 million.
- The company reported $4.4 million of gross unrealized losses on available-for-sale securities, which management assessed as temporary, and a $0.1 million impairment charge in earnings. It stated it intended to sell credit-impaired securities.
- Operating leases were recognized under the newly adopted lease standard; adoption recorded $32.7 million of lease assets and $32.1 million of liabilities at January 1, 2019, with no material earnings or cash-flow impact.
- Legal matters include subscriber lawsuits alleging improper retention of service charges and excessive management fees. A federal lawsuit was dismissed with prejudice in February 2019, but a motion for reconsideration remained pending; a related state-court motion to enforce the federal judgment also remained pending. The company said it believes it has meritorious defenses. It reported no material off-balance-sheet obligations and no material change in previously disclosed risk factors.
Key facts investors should verify
- Whether Exchange premium growth and retention continue, particularly given weaker new-business policy counts.
- Whether expense growth, including commissions, technology spending and incentive compensation, remains below management fee growth.
- Developments in the pending service-charge and management-fee litigation, including any potential exposure not currently estimable.
- Investment portfolio credit quality, liquidity, realized results and the planned sale of remaining municipal bonds; also consider the reporting lag for partnership results.
- Cash requirements for the headquarters project, term-loan amortization and limited partnership commitments, alongside dividend and repurchase decisions.