Business Context and Reporting Period
Company: Erie Indemnity Company (Erie Indemnity)
Reporting Period: Fiscal year ended December 31, 2009
Business Model: Erie Indemnity serves as the managing attorney-in-fact for the Erie Insurance Exchange, a reciprocal insurer. It earns management fees (capped at 25% of direct written premiums) for providing sales, underwriting, and policy issuance services. The company operates three segments: management operations, insurance underwriting operations (via a 5.5% participation in the Property and Casualty Group pool), and investment operations.
Key Financial Metrics
| Metric | 2009 | 2008 |
|---|---|---|
| Operating Revenue | $1,156.3 million | $1,137.2 million |
| Net Income | $108.5 million | $69.2 million |
| Diluted EPS (Class A) | $1.89 | $1.19 |
| Management Fee Revenue | $965.1 million | $949.8 million |
| Underwriting Income | $1.6 million | $13.3 million |
| GAAP Combined Ratio | 99.2% | 93.6% |
| Investment Loss (Unaffiliated) | ($36.0 million) | ($63.1 million) |
| Total Assets | $2,666.5 million | $2,613.4 million |
| Shareholders' Equity | $902.0 million | $791.9 million |
| Cash and Cash Equivalents | $76.5 million | $61.1 million |
Material Changes vs. Prior Period
- Net Income Growth: Net income increased 56.7% to $108.5 million, driven primarily by a significant improvement in investment operations compared to the severe losses in 2008.
- Investment Performance: Net investment loss narrowed to $36.0 million from $63.1 million. Impairment charges dropped to $12.1 million from $69.5 million. However, equity in losses from limited partnerships was $76.1 million (vs. $5.7 million gain in 2008), largely due to real estate market declines.
- Underwriting Deterioration: Underwriting income fell 87.7% to $1.6 million. The GAAP combined ratio worsened to 99.2% from 93.6%. This was due to a higher current accident year loss ratio and a write-off of $2.8 million related to uncollectible involuntary reinsurance premiums in North Carolina.
- Premium Growth: Direct written premiums for the Property and Casualty Group increased 1.6% to $3.9 billion, driven by a 3.5% increase in policies in force, though average premium per policy declined 1.9%.
Guidance, Outlook, and Risks
- Management Fee Rate: The Board set the 2010 management fee rate at the maximum 25%.
- Premium Outlook: Management expects pricing actions in 2010 to result in a net increase in direct written premiums, though economic recovery delays could impact average premiums.
- Accounting Change: Effective Q1 2010, the company will consolidate the Erie Insurance Exchange's financial statements due to new FASB guidance on variable interest entities (VIEs). This will materially change the presentation of assets, liabilities, and revenues, though net income attributable to shareholders will remain unchanged.
- Key Risks:
- Concentration Risk: Significant receivables ($1.1 billion, or 41.8% of total assets) are due from the Exchange.
- Investment Volatility: Continued exposure to market volatility, particularly in limited partnerships (real estate) and fixed income securities.
- Reserve Uncertainty: Significant judgment is required for massive injury reserves (pre-1986 auto and workers' compensation), which are sensitive to medical inflation and mortality assumptions.
Investor Verification Checklist
- Consolidation Impact: Verify the specific impact of the Q1 2010 consolidation of the Exchange on reported revenue and asset totals.
- Limited Partnership Valuation: Review the lag in reporting for limited partnerships; 2009 results do not reflect Q4 2009 market conditions, which may lead to further deterioration in 2010.
- Reserve Adequacy: Monitor the development of massive injury reserves, specifically the sensitivity to medical inflation assumptions (8% grading down to 5%) and mortality tables.
- Receivable Concentration: Assess the credit risk associated with the $1.1 billion receivable from the Exchange, which represents a significant portion of total assets.
- Underwriting Trends: Track the combined ratio in 2010 to ensure the 99.2% level does not worsen further due to inflation or catastrophe losses.