Erie Indemnity Company — Q1 2021 Form 10-Q
Reporting period: Three months ended March 31, 2021; comparisons are with Q1 2020 unless otherwise noted. Dollar amounts are in millions except per-share data. Erie Indemnity serves as attorney-in-fact and service provider to the Erie Insurance Exchange, its sole customer. Its principal earnings source is a management fee tied to Exchange premiums; administrative-service costs are reimbursed at cost.
Financial results
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Total operating revenue | $630.2 | $616.7 | +2.2% |
| Operating income | $76.1 | $85.7 | -11.2% |
| Total investment income (loss) | $18.0 | $(9.2) | Improved |
| Income before taxes | $92.6 | $76.1 | +21.6% |
| Net income | $73.6 | $59.3 | +24.0% |
| Class A diluted EPS | $1.41 | $1.13 | +24.0% |
| Operating cash flow | $33.5 | $20.1 | +$13.4 |
Operating revenue included $153.5 million of administrative-services reimbursements, with an equal amount of expense and no operating-income contribution. Policy issuance and renewal management-fee revenue rose 2.7% to $455.7 million, while its operating income fell 13.6% to $61.2 million. Operating expenses overall grew faster than revenue. The reported operating margin was approximately 12.1%, versus 13.9% in Q1 2020; these margins include the gross presentation of reimbursed administrative costs.
Investment results swung from a $9.2 million loss to $18.0 million of income. Net investment income was $17.1 million, supported in part by $9.0 million of limited-partnership earnings versus $3.7 million of losses a year earlier. Net realized gains were $0.8 million versus losses of $10.8 million, and impairment recoveries were $0.1 million versus losses of $3.1 million.
Balance sheet, debt and liquidity
- At March 31, 2021, cash and cash equivalents were $135.2 million, total assets $2.10 billion, and shareholders’ equity $1.21 billion.
- Total borrowings were approximately $95.4 million, comprising $2.1 million current and $93.3 million long-term. The company had no revolving-line borrowings; $99.1 million remained available under its $100 million facility, which expires in October 2023. The term loan carries a fixed 4.35% rate.
- Operating cash flow was $33.5 million; investing activities used $10.8 million and financing activities used $48.7 million, primarily for shareholder dividends. Cash declined $26.0 million during the quarter.
- Available-for-sale securities had a fair value of $918.3 million. Management cited cash, marketable securities and the credit line as liquidity sources, while noting that market volatility could limit securities sales or require discounts.
Material changes and management commentary
- Exchange direct and affiliated assumed premiums written rose 1.7% to $1.88 billion. Policies in force increased 2.8%, while average premium per policy declined 1.5%; new-business premiums increased 19.7%.
- Management said 2020 auto rate reductions are expected to reduce Exchange premiums by a further approximately $55 million and Indemnity management-fee revenue by approximately $14 million in Q2 2021. The prior rate reductions had a similar estimated impact in Q1 2021.
- Policy issuance costs rose 5.5% to $400.5 million, driven by commissions, information technology and administrative costs. Management also cited increased agent incentive costs, partly associated with lower auto-claim frequency and improved agent profitability.
- COVID-19’s duration and financial effects remain uncertain. Management reported no significant operating disruption to date, with more than 90% of employees working remotely, and stated that it was monitoring risks and conducting stress scenarios. No formal earnings guidance was provided.
- The Exchange and its property-and-casualty subsidiaries were rated A+ “Superior,” with a stable outlook affirmed in July 2020. Exchange statutory policyholders’ surplus was $11.3 billion at March 31, 2021.
Risks, contingencies and unusual items
- Indemnity’s results depend heavily on the Exchange’s premium growth, financial condition and ability to retain policyholders. The company also has concentrated unsecured receivables from the Exchange and affiliates of $481.5 million, net of a $0.6 million expected-credit-loss allowance.
- Market and interest-rate movements affect investment values and income. Net unrealized gains on fixed maturities, net of deferred taxes, decreased to $14.5 million from $23.3 million at year-end 2020.
- A loan-participation program had $15.1 million of loans executed, including $6.5 million funded by Indemnity; its maximum potential guarantee exposure was $1.5 million. Payments were current at quarter-end.
- The company reported ordinary-course litigation and said accrued legal matters were not expected to be material. In the long-running Sullivan lawsuit, the state court dismissed the plaintiffs’ second amended complaint with prejudice in December 2020. Related federal litigation had previously been dismissed and affirmed on appeal. No subsequent events requiring adjustment or additional disclosure were identified.
- There were no material changes to previously disclosed risk factors, no material off-balance-sheet obligations, and management concluded disclosure controls were effective.
Important facts for investors to verify
- Whether Exchange premium growth offsets the expected Q2 management-fee impact from auto rate reductions and any further rate or regulatory changes.
- Whether policy issuance expense growth, agent incentives and technology costs continue to outpace policy-fee revenue growth.
- How much of the net-income improvement is repeatable, given the significant year-over-year swing in investment and limited-partnership results.
- Developments in COVID-19-related driving and claims trends, Exchange policy retention, and the Exchange’s financial strength.
- Future changes in the large Exchange-related receivable, investment valuation and liquidity, and the company’s litigation or agent-loan guarantee exposure.