Erie Indemnity Company — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Financial statements are unaudited and report the consolidated Erie Insurance Group: Indemnity plus the Erie Insurance Exchange, which is presented as a noncontrolling interest. The Exchange’s insurance assets and liabilities are not available to Indemnity shareholders.
Business context
Indemnity manages sales, underwriting and policy issuance for the subscriber-owned Exchange and earns a fee tied to the Property and Casualty Group’s written premiums. The Exchange owns the property, casualty and life insurance operations. Indemnity’s shareholder results therefore differ substantially from consolidated Group results.
Key financial results
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $1,426 million | $1,577 million | $4,535 million | $4,574 million |
| Consolidated net income | $108 million | $267 million | $320 million | $734 million |
| Net income attributable to Indemnity | $47 million | $46 million | $142 million | $127 million |
| Indemnity diluted Class A EPS | $0.90 | $0.87 | $2.71 | $2.41 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $549 million | $689 million |
- Premiums earned increased 9.2% in Q3 to $1.355 billion and 9.1% for the nine months to $3.962 billion. Net investment income rose to $115 million for Q3 from $109 million and to $335 million year to date from $316 million.
- Net realized investment results swung to an $85 million loss in Q3 2014 from a $191 million gain in Q3 2013. For the nine months, realized gains were $104 million versus $501 million.
- Property and casualty earned premiums grew 9.2% in both periods. The combined ratio was 97.1% in Q3 2014 versus 98.1%; year to date it was 106.3% versus 98.7%. A ratio above 100% indicates underwriting loss: the Group reported a $249 million nine-month underwriting loss, compared with $46 million income a year earlier.
- Indemnity management operations income before tax was $62 million in Q3 versus $60 million, and $188 million for nine months versus $168 million. Management fee revenue grew 8.8% in Q3 and 8.5% year to date, reflecting premium growth; the fee rate remained at its 25% maximum. Management-operations gross margin was 16.5% in Q3 versus 17.7%, and 17.5% year to date versus 17.1%.
- At September 30, total assets were $17.578 billion, liabilities $9.742 billion and total equity $7.836 billion, including $7.065 billion of Exchange noncontrolling interest and $771 million of Indemnity equity. Cash and equivalents were $379 million; the filing reports no outstanding borrowings on either revolving credit facility. Available capacity was $98.2 million for Indemnity and $298.9 million for the Exchange.
- Nine-month cash flow: operating activities provided $549 million; investing used $533 million; financing used $89 million. Cash declined $73 million to $379 million. Indemnity declared dividends of $1.905 per Class A share for the nine-month period and repurchased $19.5 million of shares under its program.
Material changes and management commentary
- Consolidated net income fell 60% in Q3 and 56% for the nine months, principally reflecting much weaker investment results. Q3 Exchange investment results included an $85 million realized loss, driven mainly by a decline in common-stock fair value; the prior-year quarter had substantial gains.
- Insurance underwriting was pressured year to date by higher catastrophe losses ($388 million versus $142 million) and increased non-catastrophe weather claims, including severe winter weather, alongside large commercial property claims. Q3 catastrophe losses were lower than the prior-year quarter ($51 million versus $70 million); management cited large commercial claims and less favorable prior-year reserve development as offsets to that improvement.
- Premium growth reflected increases in policies in force and average premium per policy. Overall year-over-year policy retention was 90.5%, compared with 90.7% at September 2013.
- Operating cash flow declined from 2013, mainly due to higher claims, agent commissions and other underwriting costs and lower limited-partnership distributions. Management said operating cash needs were expected to be met from operations and described available liquidity sources, while noting that market volatility could impair asset sales.
Outlook, risks and contingencies
- The Group expected to begin writing personal auto, homeowners and personal excess liability policies in Kentucky in Q4 2014; EFL also expected to begin offering life and annuity products there. The filing gives no numerical earnings or premium guidance.
- At September 30, the Group had $479 million of contractual limited-partnership investment commitments: $162 million private equity, $203 million mezzanine debt and $114 million real estate. These commitments are funded as required by partnership agreements.
- Insurance reserves are estimates subject to changes in claims severity, inflation, legal developments, weather and reserve experience. Gross property and casualty reserves were $3.933 billion; the Group identified lifetime medical claims as a source of potential reserve variability.
- An audit of unclaimed-property compliance was ongoing. EFL’s lawsuit brought by West Virginia’s State Treasurer had been dismissed with prejudice, but the State appealed. The company said additional death-claim payments, escheatment and possible fines were probable, but it could not reasonably estimate the loss range.
- Two related policyholder lawsuits concern alleged retention of installment, late and reinstatement service charges, with plaintiffs alleging approximately $308 million in amounts at issue. The Sullivan matter was before the Pennsylvania Insurance Department, with briefing scheduled through December 19, 2014 and oral argument scheduled for January 6, 2015. An appeal in the related Beltz matter remained pending. The company disputed the allegations and said it would defend them.
- Indemnity and Exchange had respective limited-partnership commitments of $25 million and $454 million. The filing states that Indemnity has no obligation to support Exchange losses and that there were no arrangements requiring future financial support. Their assets and credit facilities are separate.
Important facts for investors to verify
- Whether the sharp year-over-year investment-result swing, particularly valuation changes in Exchange common stocks, persists or reverses.
- Claims trends and reserve adequacy, including catastrophe losses, commercial claims and prior-year development; monitor the combined ratio against 100%.
- Progress and economics of the planned Kentucky expansion, and whether premium growth continues alongside retention and pricing trends.
- Developments in the service-charge lawsuits and unclaimed-property audit, including any estimable exposure or regulatory outcome.
- Liquidity and capital available separately to Indemnity and the Exchange, including funding of partnership commitments and the distinction between consolidated results and Indemnity shareholder earnings.