Erie Indemnity Company — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Erie Indemnity serves as attorney-in-fact and management company for Erie Insurance Exchange; the Exchange is its sole customer and writes the insurance business.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total operating revenue | $572.2 million | $399.3 million | +43.3% |
| Operating income | $77.6 million | $66.9 million | +15.9% |
| Total investment income | $6.2 million | $6.6 million | -6.5% |
| Income before taxes | $83.2 million | $73.0 million | +14.1% |
| Income tax expense | $17.5 million | $25.1 million | -30.4% |
| Net income | $65.8 million | $47.9 million | +37.4% |
| Diluted EPS, Class A | $1.26 | $0.91 | +37.6% |
| Dividends declared per Class A share | $0.84 | $0.7825 | +7.3% |
- Revenue and operating drivers: Exchange direct and assumed written premiums rose 7.0% to $1.683 billion. Policy issuance and renewal management-fee revenue, net, increased 3.6% to $406.0 million. Policy issuance and renewal costs rose 4.9% to $348.6 million, and related operating income declined 3.7% to $64.5 million.
- Presentation comparability: ASC 606 adoption caused administrative-services reimbursements and their corresponding costs to be reported gross: $146.0 million each in Q1 2018, with no net operating-income effect. It also allocated management-fee revenue between policy services and administrative services. Consequently, headline revenue and expense growth are not directly comparable with 2017.
- Margins: Reported operating margin was approximately 13.6% of revenue versus 16.8% a year earlier, but the gross presentation change makes this comparison less informative. Policy issuance and renewal operating income was $64.5 million, down from $66.9 million.
- Investments: Net investment income rose 14.0% to $6.8 million, but realized investment losses of $0.5 million and limited-partnership losses of $0.2 million contributed to the 6.5% decline in total investment income. Comprehensive income was $60.3 million, including a $5.4 million after-tax unrealized investment loss.
- Cash flow: Operating cash used was $40.2 million versus $35.1 million; investing cash used was $16.7 million versus $7.1 million; financing cash used was $39.1 million versus $36.5 million. Cash fell $96.1 million to $119.6 million. Higher pension contributions and agent commissions and bonuses were key operating cash outflows.
- Balance sheet and liquidity: At March 31, cash and cash equivalents were $119.6 million; current assets, $720.7 million; current liabilities, $447.6 million; total assets, $1.573 billion; and shareholders’ equity, $840.2 million. Receivables from the Exchange and affiliates were $415.3 million.
- Debt and funding: Long-term borrowings had a $74.7 million carrying value; $75 million had been drawn under a $100 million construction term facility. No revolving-line borrowings were outstanding, and $99.1 million remained available, subject to facility terms. The company reported compliance with debt covenants.
Material changes, outlook and risks
- ASC 606: Adopted January 1, 2018 using the modified retrospective method. It established a $48.5 million contract liability and a $10.2 million deferred tax asset and reduced opening retained earnings by $38.3 million. Administrative-services management fees are recognized over four years; policy-services fees are generally recognized when policies are issued or renewed.
- Tax: The federal corporate rate fell from 35% to 21% effective January 1, 2018. Lower taxes materially supported net-income growth; management noted that tax estimates could change as guidance develops. Employee bonuses included approximately $4.8 million awarded in connection with tax savings.
- Exchange growth: Premium growth reflected increases in policies in force and average premium per policy. Management said the Exchange plans to pursue premium growth, strengthen its competitive position, and expand its agency force while maintaining underwriting discipline. The company did not provide specific full-year financial guidance.
- Liquidity and commitments: Management expects operating cash needs to be met from operations and cited cash, available credit and unpledged investments as additional funding sources. An $80 million accelerated pension contribution was approved: $40 million was contributed in Q1 and another $40 million in April. Remaining limited-partnership commitments were $14.3 million. Headquarters construction is expected to cost $100 million; $31.1 million had been incurred by quarter-end.
- Key risks: Results depend on Exchange premium growth, financial condition and ratings; the company also cites agency relationships, catastrophic losses, insurance regulation, credit concentration in Exchange receivables, investment-market volatility and liquidity, technology and cybersecurity, and litigation.
- Legal matters: The filing describes ongoing lawsuits concerning retained service charges and alleged excessive management fees. A complaint alleges approximately $308 million of service and related charges; another alleges excessive management fees. The company says it has meritorious defenses and intends to defend the matters. It states litigation accruals are not expected to be material, while noting that some potential losses cannot be reasonably estimated.
- Other items: A contingent $19.0 million liability relates to pension-plan annuity contracts if Erie Family Life does not honor them. No material subsequent events requiring adjustment or additional disclosure were identified.
Important facts for investors to verify
- How much of reported revenue growth reflects Exchange premium growth versus ASC 606 allocation and gross presentation of reimbursements.
- The trend in core policy-services profitability, given costs grew faster than policy-services revenue in Q1.
- Cash needs following the accelerated pension contributions, construction spending, dividends and agent lending; confirm availability and conditions on credit facilities.
- Developments in the Sullivan, Beltz II and Ritz lawsuits, including potential exposure and whether any loss becomes probable and estimable.
- Exchange premium growth, policy retention and financial strength, given the company’s dependence on one customer and $415.3 million of affiliate receivables.
- Investment valuation and market exposure, including unrealized losses and limited-partnership results reported on a quarter lag.