Business context and reporting period
Erie Indemnity Company filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2011. Indemnity manages the Erie Insurance Exchange as its attorney-in-fact and earns a fee tied to premiums written. The consolidated statements include the Exchange, whose assets and liabilities belong to the Exchange and its policyholders—not Indemnity shareholders.
Comparability is affected by structural changes: Indemnity sold its property-and-casualty subsidiaries to the Exchange at year-end 2010 and sold its 21.6% interest in Erie Family Life Insurance Company (EFL) to the Exchange in March 2011. Indemnity now operates solely as the management company.
Key financial results
Amounts below are in millions of dollars except per-share data and ratios.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Premiums earned | 1,061 | 1,005 | 3,138 | 2,972 |
| Total revenue | 796 | 1,357 | 3,406 | 3,489 |
| Net realized investment gains (losses) | (422) | 205 | (234) | 117 |
| Insurance losses and loss expenses | 848 | 710 | 2,724 | 2,208 |
| Net income (loss), consolidated | (180) | 275 | (13) | 406 |
| Net income attributable to Indemnity | 47 | 54 | 143 | 150 |
| Indemnity diluted Class A EPS | $0.87 | $0.94 | $2.59 | $2.62 |
| Indemnity operating income per diluted Class A share, non-GAAP | $0.93 | $0.89 | $2.57 | $2.55 |
The consolidated loss chiefly reflects Exchange investment mark-to-market losses; the Exchange’s net loss attributable to the noncontrolling interest was $227 million in Q3 and $156 million for the nine months. Indemnity’s shareholder income remained positive. Management defines non-GAAP operating income to exclude realized investment gains and losses, impairments, and related taxes; it should not be treated as GAAP net income.
- Underwriting: Property-and-casualty earned premiums grew 5.7% in Q3 and 5.6% year to date. The combined ratio was 107.7% in Q3 and 114.5% for nine months, versus 98.7% and 101.7%; ratios above 100% indicate underwriting losses. Catastrophe losses were $174 million in Q3 versus $52 million, and $777 million year to date versus $245 million.
- Investment income: Net investment income was $108 million in Q3 and $326 million year to date, compared with $110 million and $322 million. Q3 realized losses of $422 million contrasted with gains of $205 million a year earlier; the Exchange recorded a $450 million common-stock valuation adjustment. Limited-partnership earnings rose to $40 million in Q3 and $150 million year to date, but are generally reported on a one-quarter lag.
- Management operations: Management fee revenue was $280 million in Q3 and $816 million year to date, up 5.2% and 5.5%. The fee rate was 25%, its contractual maximum. Management operations pretax income was $62 million in Q3 and $174 million year to date; gross margin was 21.7% and 20.7%, respectively.
- Cash flow: Consolidated operating cash flow was $225 million for nine months, down from $465 million; investing cash use was $395 million and financing cash use was $184 million. Cash fell to $76 million from $430 million at year-end 2010. Indemnity alone generated $113 million of operating cash flow and ended with $34 million cash.
- Financial position and liquidity: Consolidated assets were $14.263 billion and total liabilities $8.165 billion at September 30, 2011. Indemnity shareholders’ equity was $845 million; Exchange noncontrolling interest was $5.253 billion. No borrowings were outstanding under either credit line. Indemnity had a $100 million line and the Exchange a $200 million line at quarter-end; both were amended or replaced after quarter-end with five-year facilities, and the Exchange’s facility was increased to $300 million. The filing does not provide a clear consolidated total-debt figure.
Changes, outlook, and risks
- Premium growth reflected more policies in force and higher average premiums. Total policies in force rose 2.6% year over year; average premium per policy increased 2.9%. Policy retention was 90.8%.
- Management expected pricing actions to produce a net increase in direct written premiums in 2012, while noting that economic conditions, reduced coverage, exposure changes, and business mix could affect premiums. The filing gives no quantified earnings or revenue guidance.
- Current-year loss ratios excluding catastrophe losses improved year over year, and prior-year reserve development was favorable by $97 million in Q3 and $216 million year to date. Management cited claim closures and better-than-expected severity trends; reserve estimates remain uncertain.
- Risks include catastrophe severity, claims and reserve estimation, reinsurance availability and collectability, investment-market volatility and portfolio liquidity, economic weakness, competition, regulation, dependence on the Exchange and independent agents, and the ability to maintain financial-strength ratings. Indemnity has credit exposure to unsecured Exchange management-fee receivables.
- Limited-partnership investment commitments totaled $433 million ($41 million attributable to Indemnity and $392 million to the Exchange). Litigation arises in the ordinary course; management said pending matters were not expected to be material, though some losses could not be reasonably estimated. The Exchange’s assets are not available to satisfy Indemnity obligations, or vice versa.
- Indemnity repurchased $132 million of stock and paid $77 million in dividends during the first nine months. About $14 million remained under the prior repurchase authorization at quarter-end; the October continuation includes, rather than adds to, remaining authority.
Most important facts for investors to verify
- How much of the investment loss reflects market-value changes in trading common stocks, and how subsequent market movements affected portfolio values.
- Whether catastrophe claims and reserve development continue at levels that materially affect the Exchange’s combined ratio and surplus.
- How the post-sale structure affects the distinction between consolidated results, Indemnity shareholder earnings, and policyholder noncontrolling interest.
- Indemnity’s cash generation and dividend/buyback capacity, considering that Exchange assets and credit facilities are not available to Indemnity.
- Realizability and timing of limited-partnership commitments, given their illiquidity and reporting lag, and any change in the status or expected cost of litigation.