Erie Indemnity Company — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; unaudited. Erie Indemnity acts as attorney-in-fact for Erie Insurance Exchange (the Exchange), its sole customer. Its main earnings source is a management fee tied to the Exchange’s premiums; administrative-service reimbursements are generally passed through at cost.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Operating revenue | $647.7m | $621.5m | $1,241.8m | $1,193.6m |
| Operating income | $96.6m | $95.3m | $182.7m | $172.9m |
| Total investment income | $9.7m | $6.2m | $19.4m | $12.4m |
| Net income | $87.8m | $79.7m | $163.1m | $145.5m |
| Diluted Class A EPS | $1.68 | $1.52 | $3.12 | $2.78 |
- Q2 revenue rose 4.2%, operating income 1.3%, and net income 10.1% year over year. For the first half, those measures increased 4.0%, 5.7%, and 12.1%, respectively.
- Policy issuance and renewal management-fee revenue increased 5.7% in Q2 and 5.9% in the first half, alongside Exchange direct and affiliated assumed written-premium growth of 5.6% and 5.8%. The management fee rate was 25% in both years; revenue allocation assigned 24.2% to policy services and 0.8% to administrative services.
- Q2 policy-service costs rose 6.7%, faster than related revenue; higher commissions, personnel costs, and technology spending contributed. Administrative reimbursements and matching expenses were $146.1m in Q2 and $288.6m for the first half, with no operating-income effect.
- Investment income increased, supported by higher net investment income and realized gains. Q2 realized gains were $1.3m versus a $0.03m loss in 2018; first-half gains were $3.8m versus a $0.5m loss. Limited partnerships recorded a $0.7m first-half loss, with results reported on a lag.
- Reported operating margin, calculated as operating income divided by total operating revenue, was approximately 14.9% in Q2 2019 versus 15.3% in Q2 2018; first-half margin was approximately 14.7% versus 14.5%. Administrative reimbursements are included gross in both revenue and expenses.
Cash flow, balance sheet, debt, and liquidity
- First-half operating cash flow was $114.4m, compared with $41.6m in 2018; investing activities provided $42.2m versus using $5.7m. Financing used $84.8m, including $83.8m of dividends. Cash increased $71.8m to $338.3m.
- At June 30, total assets were $1.89bn, total liabilities $826.2m, and shareholders’ equity $1.06bn. Current assets were $937.2m and current liabilities $535.4m.
- Long-term borrowings were $96.9m and the current portion was $1.9m. No revolving-line borrowings were outstanding; $99.1m of the $100m facility remained available, subject to letters of credit. The company reported covenant compliance. Certain investments were pledged as collateral.
- Available-for-sale securities were $689.1m, down from $748.5m at year-end 2018; cash rose from $266.4m. The company reported $387.3m of unpledged liquid investments available as a potential funding source, in addition to cash and its credit line.
- The Exchange-related receivable was $483.3m, up from $449.9m at year-end. Management cited the Exchange’s financial strength and historical lack of credit losses, but the company has significant customer and credit-risk concentration.
Outlook, risks, and notable items
- No specific earnings or revenue guidance was provided. Management said the Exchange plans to pursue premium growth through agency-force expansion and market penetration; future fees remain dependent on Exchange premiums, retention, and its financial condition.
- Exchange year-over-year policies in force grew 2.7% in Q2, compared with 3.5% in Q2 2018. New-business premiums declined 1.1% and new-business policies fell 7.4%, while renewal premiums increased 6.6%. Management cited retention and higher average premium per policy as supporting growth.
- A $4.1m income-tax benefit from settlement of an uncertain tax position reduced the effective tax rate by 3.8 percentage points in Q2 and 2.0 points for the first half. This benefited reported earnings.
- Risks include dependence on the Exchange, premium and retention trends, catastrophe losses, agency relationships, technology and cyber disruption, investment-market volatility and liquidity, and litigation. Exchange and subsidiary financial-strength ratings were affirmed at A+ with a stable outlook in June 2019.
- The Sullivan lawsuit over service charges remains pending in state court; the company says it has meritorious defenses. Separate federal Beltz II and Ritz suits were dismissed, and the Ritz dismissal was not appealed. The company says litigation accruals are appropriate and any excess exposure is not expected to be material, while noting outcomes cannot be assured.
- Operating lease accounting adoption recognized $32.7m of lease assets and $32.1m of liabilities at January 1, 2019, with no material earnings or cash-flow impact. The company also disclosed a new $36.1m software, services, and maintenance contract payable over three years, and $9.9m of limited-partnership commitments.
Important facts for investors to verify
- Whether Exchange premium growth, retention, and new-business trends sustain management-fee growth.
- Whether rising policy-service expenses—particularly technology, personnel, and commissions—affect operating profitability.
- The durability of investment income and realized gains, including the impact of market volatility and lagged partnership reporting.
- Developments in the Sullivan litigation and the extent of any potential exposure.
- Collection and concentration risk related to the $483.3m receivable from the Exchange and affiliates, and liquidity available after collateral pledges and planned commitments.
- The effect of the $4.1m tax benefit when assessing the underlying tax rate and earnings trend.