Erie Indemnity Company — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are with December 31, 2016. Amounts are in U.S. dollars. Erie Indemnity is the attorney-in-fact and management company for Erie Insurance Exchange; it does not conduct the Exchange’s insurance operations. Its principal revenue is a fee based on premiums written by the Exchange.
Key financial results
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Management fee revenue, net | $392.1 million | $367.5 million | +6.7% |
| Total operating revenue | $399.3 million | $374.7 million | +6.6% |
| Operating expenses | $332.8 million | $307.1 million | +8.4% |
| Net revenue from operations | $66.5 million | $67.7 million | -1.7% |
| Operating gross margin | 16.7% | 18.1% | -1.4 percentage points |
| Total investment income | $6.6 million | $2.6 million | Increased |
| Income before taxes | $73.0 million | $70.2 million | +3.9% |
| Net income | $47.9 million | $45.9 million | +4.3% |
| Class A diluted EPS | $0.91 | $0.87 | +4.5% |
| Operating cash flow | $(35.1) million | $(21.8) million | More cash used |
Financial position and liquidity
- At March 31, cash and cash equivalents were $110.4 million, total assets $1.490 billion, and shareholders’ equity $829.9 million.
- Available-for-sale securities totaled $719.9 million at fair value; total investments, including limited partnerships, were $774.5 million.
- Long-term borrowings were carried at $24.8 million. The company had drawn $25 million of its $100 million secured term facility and had no borrowings on its revolving credit line. The line had $99.1 million available, subject to its terms and collateral arrangements.
- Cash decreased $78.7 million to $110.4 million during the quarter. Investing activities used $7.1 million and financing activities used $36.5 million, including $36.4 million of shareholder dividends.
- The company reported $16.2 million of remaining limited-partnership investment commitments. It said operating cash needs are expected to be met from operations and that it believes it has sufficient liquidity; it also cited cash, its credit line, and unpledged investments as funding sources.
Material changes and management commentary
- Exchange direct and assumed premiums written rose 6.7% to $1.573 billion; the management fee rate remained at 25%. Growth reflected more policies in force and higher average premiums. New-business premiums rose 12.2%; renewal premiums rose 5.9%.
- Operating expenses grew faster than revenue. Commissions increased 5.6%; non-commission expenses rose 14.2%, notably information technology costs (+22.6%) and administrative and other costs (+45.5%). Management cited professional fees, underwriting costs, personnel and incentive compensation, pension expense, and deferred-compensation earnings.
- Net income grew despite lower operating revenue from operations, principally because total investment income was higher. Net investment income increased 28.2%, and reported realized investment results moved from a $1.1 million loss to a $0.5 million gain. Limited-partnership results are generally reported with a one-quarter lag.
- The company increased regular quarterly Class A and Class B dividends by 7.2% for 2017 versus 2016. Class A dividends declared were $0.7825 per share. No shares were repurchased under the public repurchase program in the quarter; about $17.8 million of authority remained.
- A new home-office lease with the Exchange was executed April 28, 2017, retroactive to January 1, 2017, and runs through December 31, 2021. Rent is based on comparable local properties, with operating costs borne by Indemnity; total 2017 rent and operating expenses were estimated at $17.4 million.
Risks, contingencies, and outlook
- Indemnity depends on the Exchange as its sole customer. Its results are exposed to Exchange premium growth, agency relationships, financial strength, catastrophe losses, and the Exchange’s ability to retain and attract policyholders. Receivables from the Exchange and affiliates were $392.3 million.
- Investment values and income are exposed to market and interest-rate volatility; some fixed-income securities may be illiquid, and limited partnerships are less liquid. The company reported $9.8 million of Level 3 available-for-sale securities.
- Litigation remains pending over alleged retention of policy service charges. Plaintiffs allege approximately $308 million in charges should have been paid to the Exchange and seek other relief. Motions to dismiss were pending in the state and federal matters. The company says it has meritorious defenses and intends to defend the claims; it states that litigation accruals are not expected to be material, while noting that some potential losses cannot be reasonably estimated.
- A contingent $20.5 million liability exists if Erie Family Life Insurance Company does not honor certain annuity contracts associated with the pension plan. The company also reported a defined-benefit pension liability of $211.4 million.
- No specific earnings or revenue guidance was provided. Management described continued Exchange efforts to grow premiums and improve competitive position. It cautioned that actual results may differ due to economic conditions, costs, technology or cybersecurity issues, investment markets, liquidity needs, and litigation.
Important facts for investors to verify
- Whether Exchange premium and policy growth continue to support fee revenue, and whether expense growth moderates enough to stabilize operating margins.
- The causes and sustainability of investment-income improvement, including the one-quarter reporting lag for limited partnerships.
- Cash conversion and liquidity needs, including the scheduled term-loan draws, collateral pledges, and the $16.2 million of investment commitments.
- Developments in the service-charge litigation, including the status of pending dismissal motions and any change in the company’s assessment of potential losses.
- The financial and operating effects of the new related-party office lease and the company’s substantial dependence on the Exchange.