Erie Indemnity Company — FY 2019 Form 10-K
Reporting period: Year ended December 31, 2019; comparative figures are primarily for FY 2018. The company serves as attorney-in-fact and service provider to Erie Insurance Exchange, its sole customer. Its principal earnings source is a management fee tied to the Exchange’s premiums written.
Financial performance and position
| Metric | FY 2019 | FY 2018 | Change |
|---|---|---|---|
| Operating revenue | $2.477 billion | $2.382 billion | +4.0% |
| Operating expenses | $2.120 billion | $2.038 billion | +4.0% |
| Operating income | $357.3 million | $344.3 million | +3.8% |
| Investment income | $40.0 million | $25.8 million | +54.9% |
| Income before taxes | $396.7 million | $371.3 million | +6.8% |
| Net income | $316.8 million | $288.2 million | +9.9% |
| Diluted Class A EPS | $6.06 | $5.51 | +9.9% |
| Operating cash flow | $364.5 million | $263.6 million | +$100.9 million |
- Operating margin was approximately 14.4% of reported operating revenue; net margin was approximately 12.8%.
- Exchange direct and affiliated assumed premiums written increased 5.2% to $7.486 billion. Policy-in-force growth was 1.8%, average premium per policy rose 3.2%, and retention was 90.0% versus 90.1%.
- Policy issuance and renewal operating income rose 3.2% to $300.1 million. Related costs increased 5.5%, including a 16.0% increase in information technology expense.
- Reported revenue and expense include administrative-service reimbursements of $582.0 million, recorded gross with matching costs and no operating-income impact. This presentation began with ASC 606 adoption in 2018 and affects comparisons with 2017.
- Cash and equivalents were $336.7 million at year-end. Total assets were $2.016 billion and shareholders’ equity was $1.133 billion. Receivables from the Exchange and affiliates were $468.6 million, or 23.2% of assets.
- Long-term borrowings were $97.8 million, including $2.0 million current. The $100 million revolving credit facility had no borrowings; $99.1 million was available after letters of credit. The company reported compliance with covenants.
- Dividends declared per Class A share rose to $3.665 from $3.42. There were no repurchases under the public repurchase program in 2019; approximately $17.8 million of authorization remained.
Quarterly detail and material changes
- Fourth-quarter 2019 operating revenue was $596.7 million, operating expenses $528.0 million, and net income $59.6 million. Fourth-quarter 2018 figures were $576.5 million, $501.7 million, and $62.3 million, respectively.
- Investment income increased by $14.2 million for the year, reflecting higher net investment income and realized gains; 2018 had reported net realized investment losses.
- The effective federal corporate tax rate was 21%. A 2019 settlement of an uncertain tax position reduced tax expense by $4.0 million and the effective tax rate by 1.0%.
- Operating cash flow increased partly because no pension contribution was made in 2019; an accelerated $80 million pension contribution had been made in 2018. Investing cash use rose to $124.6 million, including increased investment purchases and headquarters construction spending. Financing cash use increased to $169.6 million, including higher dividends and term-loan principal payments.
- The fixed-maturity portfolio was $730.7 million; 84% was investment grade, compared with 80% in 2018. The portfolio was rebalanced away from municipal bonds and short-term Treasuries toward corporate debt, structured securities, and preferred stock.
Outlook, risks, contingencies, and unusual items
- The Board set the 2020 management fee rate at 25%, the agreement’s maximum, unchanged from 2019. Management expected Exchange pricing actions to result in a net increase in direct written premiums in 2020, while noting that coverage reductions or business-mix changes could affect results.
- Management stated that operating cash needs were expected to be met from operations and that liquidity was sufficient for 2020. The headquarters building was expected to be completed in 2020; $88.9 million of an expected $113 million total cost had been paid by year-end.
- Management expected its share of net pension benefit costs to increase from $13.2 million in 2019 to approximately $19.1 million in 2020, primarily reflecting the lower discount rate. The defined-benefit plan’s projected obligation exceeded plan assets by $146.8 million at year-end.
- Key risks include dependence on the Exchange and the Board-set fee rate, insurance competition and independent-agent distribution, catastrophe losses, emerging claims, investment-market and interest-rate risk, cyber and technology disruption, and regulatory change. Approximately 22% of the company’s investment portfolio had LIBOR exposure with maturities beyond December 31, 2021; the impact of transition was uncertain.
- Policyholders’ allegations in the Sullivan state-court case seek approximately $308 million related to service charges and request an accounting of intercompany transactions. The company disputes the claims; a motion seeking dismissal remained pending. The related Beltz II federal case was dismissed and that dismissal was affirmed on appeal. The company said legal accruals were not expected to be material, but certain proceedings’ losses could not be reasonably estimated.
- Ernst & Young issued an unqualified audit opinion and reported effective internal control over financial reporting. The audit identified proportional cost allocation for administrative-service reimbursements as a critical audit matter; the reimbursements totaled $582 million.
Important facts for investors to verify
- Confirm the Exchange’s premium growth, retention, and underwriting performance, and how these affect Indemnity’s fee revenue and operating costs.
- Review the sustainability of the 25% management fee rate and the governance and regulatory oversight of related-party fees, reimbursements, and cost allocations.
- Assess the quality and liquidity of investments, non-investment-grade exposure, LIBOR transition exposure, and sensitivity to interest rates and credit markets.
- Track developments in the Sullivan litigation, including any ruling on the pending dismissal motion and any change to the company’s loss assessment.
- Monitor pension funding, 2020 benefit costs, headquarters completion costs, and available liquidity after debt service, dividends, and other commitments.