Business Context and Reporting Period
Company: Erie Indemnity Company (Erie Indemnity)
Reporting Period: Quarter and six months ended June 30, 2010
Business Overview: Erie Indemnity serves as the managing attorney-in-fact for the Erie Insurance Exchange (Exchange), a reciprocal insurer. Effective January 1, 2010, the company adopted new accounting guidance (ASC 810) requiring the retrospective consolidation of the Exchange as a Variable Interest Entity (VIE). Consequently, the Exchange's results are now presented as a noncontrolling interest within the consolidated financial statements. The group operates through four segments: Management Operations, Property and Casualty (P&C) Insurance, Life Insurance, and Investment Operations.
Key Financial Metrics
| Metric (in millions) | 3 Months Ended June 30, 2010 |
3 Months Ended June 30, 2009 |
6 Months Ended June 30, 2010 |
6 Months Ended June 30, 2009 |
|---|---|---|---|---|
| Total Revenues | $916 | $1,149 | $2,132 | $1,844 |
| Premiums Earned | $989 | $964 | $1,967 | $1,921 |
| Net Investment Income | $108 | $105 | $212 | $222 |
| Net Realized Investment (Losses)/Gains | $(213) | $208 | $(88) | $53 |
| Total Benefits and Expenses | $967 | $891 | $1,955 | $1,926 |
| Net Income (Loss) | $(31) | $271 | $131 | $20 |
| Net Income Attributable to Indemnity | $49 | $33 | $96 | $44 |
| EPS (Class A, Diluted) | $0.86 | $0.57 | $1.68 | $0.76 |
| Operating Cash Flow (6 Months) | $212 | $471 | $212 | $471 |
| Total Assets | $13,570 | N/A | $13,570 | $13,287 |
| Total Liabilities | $7,701 | N/A | $7,701 | $7,562 |
Material Changes vs. Prior Period
- Accounting Change: The most significant change is the consolidation of the Exchange. While this increased reported total revenues and assets, it did not change the net income attributable to Indemnity shareholders. The Exchange's net income is now classified as noncontrolling interest.
- Investment Performance: Net realized investment losses of $213 million in Q2 2010 contrasted sharply with gains of $208 million in Q2 2009. This was primarily driven by valuation adjustments on common stock trading portfolios ($242 million loss in Q2 2010 vs. $247 million gain in Q2 2009).
- Underwriting Results: The P&C combined ratio for the six months ended June 30, 2010, was 103.2%, an improvement of 0.7 points from 103.9% in the prior year. However, catastrophe losses increased significantly to $193 million in the first half of 2010 (9.9 points to the combined ratio) compared to $87 million in 2009 (4.6 points).
- Limited Partnerships: Equity in earnings of limited partnerships improved dramatically to $30 million for the six months ended June 30, 2010, compared to losses of $287 million in the same period in 2009, reflecting improved market conditions in private equity and mezzanine debt.
- Cash Flow: Operating cash flow decreased to $212 million in the first half of 2010 from $471 million in 2009, primarily due to an $85 million payment of federal income taxes in 2010 versus a $162 million recovery in 2009.
Guidance, Outlook, and Risks
- Outlook: Management expects pricing actions to result in a net increase in direct written premiums in 2010, though exposure reductions and business mix changes may impact average premiums. The company plans to appoint approximately 120 new agencies in 2010.
- Capital Management: In April 2010, the Board approved a $100 million stock repurchase program through June 30, 2011. Approximately $85 million of authority remained at June 30, 2010. Dividends were increased by 6.7% in 2010.
- Liquidity: The company maintains $300 million in available lines of credit ($100 million for Indemnity, $200 million for the Exchange), with no borrowings outstanding. Management believes liquidity is sufficient to meet obligations despite market volatility.
- Risks: Key risks include the frequency and severity of claims, natural disasters (catastrophes), exposure to environmental claims, fluctuations in interest rates, and the quality and liquidity of the investment portfolio. The company notes that limited partnership earnings are reported on a one-quarter lag.
Investor Verification Checklist
- Consolidation Impact: Verify the distinction between "Net Income" (consolidated) and "Net Income Attributable to Indemnity" to understand the true earnings available to shareholders post-consolidation of the Exchange.
- Investment Volatility: Review the composition of "Net Realized Investment (Losses)/Gains," specifically the valuation adjustments on trading securities, which caused significant volatility in reported earnings.
- Catastrophe Exposure: Assess the impact of the $193 million in catastrophe losses in the first half of 2010 on the combined ratio and future reserve adequacy.
- Limited Partnership Lag: Note that limited partnership results reported for Q2 2010 reflect Q1 2010 market conditions due to reporting lags; verify if Q2 2010 market conditions have materially changed.
- Deferred Tax Assets: Confirm the realization of the $101 million net deferred tax asset and the status of the estimated $88 million tax refund from capital loss carry-backs.