Business context and reporting period
Erie Indemnity Company’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2019. The company acts as attorney-in-fact for policyholders of Erie Insurance Exchange, its sole customer, providing policy issuance and renewal services and administrative services. Its principal earnings source is a management fee tied to the Exchange’s premiums written; administrative-service reimbursements are recorded gross with corresponding expenses and generally do not affect operating income.
Financial performance
Amounts below are in millions of dollars except per-share data. Comparisons are with the corresponding 2018 period.
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Total operating revenue | $638.7 | $612.1 | $1,880.6 | $1,805.7 |
| Operating income | $105.9 | $96.7 | $288.6 | $269.6 |
| Total investment income | $13.6 | $8.4 | $33.1 | $20.8 |
| Net income | $94.2 | $80.4 | $257.2 | $225.9 |
| Diluted Class A EPS | $1.80 | $1.54 | $4.92 | $4.32 |
| Net cash from operating activities | Not reported for the quarter | $237.9 | $174.3 |
- Q3 revenue rose 4.3%, operating income 9.5%, and net income 17.1%; nine-month revenue rose 4.1%, operating income 7.1%, and net income 13.9%. Diluted Class A EPS increased 17.0% for Q3 and 13.9% year to date.
- Operating margin on reported total operating revenue was approximately 16.6% in Q3 2019 versus 15.8% in Q3 2018. This measure includes pass-through administrative reimbursements and expenses.
- Management-fee revenue for policy issuance and renewal services increased 5.1% in Q3 and 5.6% year to date, reflecting Exchange premium growth. The company reported a 25% overall management fee rate; its revenue allocation assigned 24.2% of premiums to policy services and 0.8% to administrative services.
- Exchange direct and affiliated assumed premiums written increased 5.2% to $2.0 billion in Q3 and 5.6% to $5.7 billion for nine months. Q3 policies in force grew 2.2%; average premium per policy rose 3.4%. New-business premiums fell 3.7%, as new policies written declined 8.9%.
- Q3 total investment income rose 61.4%, mainly from stronger limited-partnership earnings and realized gains. Nine-month investment income rose 58.9%, with higher realized gains and net investment income. These results include investment-market effects, and partnership results are generally reported on a one-quarter lag.
Financial position, cash flow and liquidity
- At September 30, 2019, total assets were $1.975 billion, liabilities $855.3 million, and shareholders’ equity $1.119 billion, compared with $1.778 billion, $804.7 million, and $973.7 million, respectively, at December 31, 2018.
- Cash and cash equivalents were $344.9 million, up from $266.4 million at year-end. Receivables from the Exchange and affiliates were $498.0 million, versus $449.9 million. Available-for-sale securities were $680.6 million, compared with $748.5 million; the portfolio shift included sales of municipal securities and reinvestment in corporate debt, structured securities and preferred stock.
- Nine-month operating cash flow was $237.9 million, investing cash outflow $32.2 million, and financing cash outflow $127.2 million; cash increased $78.5 million. The stronger operating cash flow mainly reflected no pension contribution in 2019 and lower agent bonuses. In 2018, the company made an $80 million accelerated pension contribution.
- Borrowings totaled approximately $98.3 million carrying value, primarily the term loan, with scheduled amortization at a fixed 4.35% rate. There were no borrowings under the $100 million revolving credit line; $99.1 million remained available after letters of credit. The company reported compliance with credit-facility covenants.
- Cash dividends paid were $125.7 million for the first nine months. Regular quarterly dividends per share increased 7.1% for 2019 compared with 2018. The public repurchase program had approximately $17.8 million of authority remaining; no shares were repurchased under that program in the period.
Changes, outlook and risks
- Policy-service operating income increased 10.0% in Q3 and 7.1% year to date. Costs rose 4.0% and 5.2%, respectively, primarily from commissions, technology investment and, year to date, personnel costs. Nine-month information-technology expense increased 16.3%.
- The nine-month effective tax rate was 19.9%, versus 21.7% in 2018. A $4.1 million tax benefit from settlement of an uncertain tax position reduced the 2019 nine-month rate by 1.3 percentage points.
- The filing provides no specific numerical earnings or revenue guidance. Management said the Exchange plans to pursue premium growth through agency-force expansion and greater market penetration, while maintaining underwriting discipline.
- Key risks include dependence on the Exchange’s growth, financial condition and ratings; catastrophe losses; agency relationships and competition; technology disruption or cybersecurity events; investment-market and interest-rate volatility; liquidity constraints in some investments; and litigation. The Exchange and its property-and-casualty subsidiaries were rated A+ Superior with a stable outlook as of June 2019.
- A $36.1 million software, services and maintenance contract was executed in June 2019, payable over three years. Limited-partnership investment commitments were $9.8 million. The headquarters construction project was expected to cost $100 million; $78.9 million had been paid by September 30.
- Litigation remains a contingency: plaintiffs in the Sullivan state-court case allege approximately $308 million in retained service charges and seek related relief. The company says it has meritorious defenses; its motion to enforce a federal judgment and dismiss the case remained pending. The separate Beltz II and Ritz federal suits were dismissed, and the Ritz plaintiff did not appeal. The company states litigation accruals and potential excess exposure are not expected to be material, while noting outcomes cannot be assured.
- There were no material changes to previously disclosed risk factors, no material off-balance-sheet obligations, and no subsequent events requiring adjustment or additional disclosure. Adoption of lease accounting in 2019 recognized lease assets and liabilities but had no material impact on operations or net cash flows.
Important facts for investors to verify
- Whether Exchange premium growth continues, particularly given slower policy-in-force growth and lower Q3 new-business premiums, and how that translates into management-fee revenue.
- The company’s exposure to its sole customer: $498.0 million of receivables from the Exchange and affiliates, and the Exchange’s ongoing financial strength, ratings and ability to pay.
- Whether investment-income growth is sustainable, including the effects of realized gains, market volatility, interest rates and lagged limited-partnership reporting.
- Progress on technology and headquarters spending, related commitments, and the effect of higher operating costs on margins.
- Developments in the Sullivan litigation and any change in the company’s assessment of potential loss or disclosure.