Erie Indemnity Company — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; balance-sheet figures are as of March 31, 2020. Comparisons are with Q1 2019 unless otherwise noted. Amounts are in U.S. dollars; financial statement amounts below are shown in millions.
Business context
Erie Indemnity acts as attorney-in-fact for policyholders of Erie Insurance Exchange and provides administrative services to the Exchange and its insurance subsidiaries. The Exchange is Indemnity’s sole customer. Indemnity’s principal earnings source is a management fee tied to Exchange premiums; administrative service cost reimbursements are reported as both revenue and expense and have no net effect on operating income.
Key financial results
| Metric | Q1 2020 | Q1 2019 / prior date | Change |
|---|---|---|---|
| Total operating revenue | $616.7 million | $594.1 million | +3.8% |
| Operating income | $85.7 million | $86.1 million | -0.5% |
| Operating margin | 13.9% | 14.5% | Down 0.6 percentage points |
| Total investment loss | $(9.2) million | $9.8 million income | Turned to loss |
| Income before taxes | $76.1 million | $95.5 million | -20.3% |
| Net income | $59.3 million | $75.3 million | -21.2% |
| Class A diluted EPS | $1.13 | $1.44 | -21.2% |
| Net cash from operations | $20.1 million | $24.2 million | Down $4.2 million |
Operating margin is calculated as operating income divided by reported total operating revenue, which includes reimbursed administrative costs. Policy issuance and renewal services operating income was $70.9 million, down 1.7%; its margin was approximately 15.7%, versus 16.5% in Q1 2019.
- Management fee revenue for policy issuance and renewal services, net, increased 3.0% to $443.8 million. Exchange direct and affiliated assumed premiums written rose 3.5% to $1.85 billion; the fee rate was 25% overall, allocated as 24.2% to policy services and 0.8% to administrative services.
- Policy issuance and renewal costs rose 3.8% to $379.5 million, primarily from higher commissions and personnel costs. Administrative service management fee revenue increased 5.9% to $14.8 million; reimbursed costs and matching revenue were each $151.6 million.
- Investment results reflected $10.8 million in realized investment losses, $3.1 million in impairment losses, and $3.7 million in limited partnership losses. Net investment income was $8.4 million, down 1.7%.
- Comprehensive income was $29.8 million, compared with $82.0 million, including a $29.6 million other comprehensive loss in Q1 2020, mainly from unrealized losses on available-for-sale securities.
Financial position, liquidity and debt
- Cash and cash equivalents were $228.6 million, down from $336.7 million at December 31, 2019. Current assets were $810.1 million and current liabilities $541.7 million (current ratio approximately 1.50).
- Total assets were $1.96 billion; shareholders’ equity was $1.12 billion. Receivables from the Exchange and affiliates were $482.2 million, a material concentration of credit exposure.
- Cash flow from investing was a use of $82.7 million, versus a source of $63.8 million in Q1 2019, reflecting investment purchases and other activity. Financing used $45.4 million, mainly for $44.9 million of dividends. Cash declined $108.1 million during the quarter.
- Borrowings totaled approximately $97.3 million, including the current portion. The $100 million revolving credit facility had no borrowings outstanding; $99.1 million remained available, subject to its letter-of-credit use. The term loan carries a fixed 4.35% rate. The company reported compliance with debt covenants.
- Class A quarterly dividends declared increased to $0.965 per share from $0.90. No shares were repurchased under the public repurchase program; approximately $17.8 million of authorization remained.
Outlook, risks and unusual items
- COVID-19: Management said core operations had not been significantly disrupted through the filing date, with more than 90% of the workforce working remotely. It warned that recessionary conditions, lower premium growth, market volatility, and possible higher operating costs could affect results; the duration and financial impact were not reliably estimable.
- Premium relief and fee outlook: The Exchange announced planned $200 million personal and commercial auto rate reductions, pending regulatory approval, expected to reduce its 2020 premiums written by about $90 million and Indemnity’s 2020 management fees by about $23 million. Further effects were expected in 2021. The Exchange also announced a policyholder dividend that does not directly affect Indemnity.
- Investments: COVID-related market volatility drove $33.4 million of unrealized losses on fixed maturities through other comprehensive income and $10.7 million of equity-security losses through earnings. Fixed maturities moved from a $4.5 million net unrealized gain at year-end 2019 to a $27.7 million net unrealized loss at March 31, 2020. Further market-value declines or impairments were possible.
- Credit and tax accounting: Adoption of the expected-credit-loss standard resulted in a $1.1 million after-tax adjustment to opening retained earnings. At quarter-end, the company reported a $0.6 million allowance on Exchange and affiliate receivables and a $0.6 million allowance on available-for-sale securities. A $6.8 million deferred-tax valuation allowance was recorded, primarily related to investment losses.
- Litigation: Ordinary-course litigation accruals were described as appropriate and not expected to be material. A long-running Pennsylvania case alleges Indemnity improperly retained service and installment charges, with plaintiffs claiming approximately $308 million; proceedings remained unresolved. The separate Beltz II federal case had been dismissed and that dismissal affirmed on appeal.
- Other: The company reported no material off-balance-sheet obligations and no significant change in internal controls. It cautioned that quarterly results are not necessarily indicative of full-year results and provided no general earnings guidance.
Most important facts for investors to verify
- Regulatory approval, timing and realized premium and management-fee effects of the Exchange’s auto rate reductions, including the estimated $23 million 2020 fee impact.
- Subsequent Exchange premium trends, policy retention, new business, cancellations and the sustainability of Q1 growth.
- Investment portfolio valuation, credit quality, impairment allowances and any further realized or unrealized losses as markets evolve.
- Indemnity’s concentrated receivable exposure to the Exchange and the Exchange’s capacity to pay; monitor the announced $8.8 billion Exchange policyholders’ surplus at March 31, 2020.
- Cash generation, dividend sustainability, capital spending and continued access to liquid investments and the revolving credit facility.
- Developments in the service-charge litigation and any changes to the company’s assessment of legal exposure.