Erie Indemnity Company — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; balance sheet compared with December 31, 2012. Amounts are in millions except per-share data. The consolidated statements include the Erie Insurance Exchange, whose policyholders’ interest is reported as noncontrolling interest. Indemnity itself primarily manages the Exchange and earns a management fee.
Financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $1,577 | $1,460 | $4,574 | $4,140 |
| Income before tax and noncontrolling interest | $398 | $270 | $1,097 | $734 |
| Consolidated net income | $267 | $184 | $734 | $500 |
| Net income attributable to Indemnity | $46 | $51 | $127 | $130 |
| Indemnity diluted Class A EPS | $0.87 | $0.96 | $2.41 | $2.43 |
| Operating income per diluted Class A share, non-GAAP | $0.86 | $0.93 | $2.40 | $2.38 |
- Consolidated revenue growth reflected higher earned premiums and investment gains. Property and casualty earned premiums increased 9.2% in Q3 and 8.9% year to date.
- Net realized investment gains were $191 in Q3 and $501 year to date, largely associated with Exchange common-stock activity. Net investment income was $109 in Q3 and $316 year to date, down from $326 in the prior-year nine-month period.
- Indemnity’s management fee revenue rose 9.3% in Q3 to $333 and 9.5% year to date to $965. Its management-operation gross margin declined to 17.7% in Q3 from 20.9%, and to 17.1% year to date from 18.8%, as costs grew faster than revenue.
- Property and casualty underwriting improved: combined ratio was 98.1% in Q3 versus 108.9%, and 98.7% year to date versus 105.6%. A ratio below 100% indicates underwriting profit. Lower catastrophe losses and favorable prior-year reserve development contributed.
- Cash from operations was $689 for the first nine months, versus $365 in 2012. Investing cash use was $498; financing cash use was $56. Cash and equivalents ended at $535, compared with $400 at year-end 2012.
Financial position and liquidity
- Total assets were $16,384, up from $15,441 at year-end; total investments were $13,420, compared with $12,814.
- Total liabilities were $9,185 versus $8,650. These include $3,712 of property and casualty loss reserves, $2,654 of unearned premiums, and $1,754 of life policy and deposit reserves.
- Total equity was $7,199, including $657 attributable to Indemnity shareholders and $6,542 of Exchange noncontrolling interest. These consolidated figures should not be read as Indemnity shareholders’ direct access to Exchange assets.
- No borrowings were outstanding on either revolving credit facility. At September 30, approximately $98.2 remained available to Indemnity under its $100 facility and $298.9 to the Exchange under its $300 facility. Subsequent amendments extended both maturities to 2018, lowered borrowing costs, and removed specified financial covenants.
- Limited partnership investment commitments totaled up to $418 ($30 Indemnity and $388 Exchange), payable as required by partnership agreements.
Changes, outlook, and risks
- Consolidated net income increased, but income attributable to Indemnity shareholders fell to $46 for Q3 and $127 for nine months. The Exchange’s improved underwriting and investment results primarily explain the consolidated improvement; most consolidated income is attributable to Exchange policyholders.
- Management cited growth in policies in force and average premium per policy, with Q3 direct written premium up 9.6%. The retention ratio was 90.7% at September 30. The company plans to expand into Kentucky by early 2015; no earnings or premium guidance was provided.
- Catastrophe losses were $70 in Q3 and $142 year to date, versus $114 and $343 in the comparable 2012 periods. Prior-year reserve development was favorable by $44 in Q3 and $19 year to date, but favorable development was lower year to date than in 2012.
- Investment results carry market-price, interest-rate, valuation, and liquidity risks. The Exchange recorded $9 of Q3 impairment losses, principally on an equity security management intended to sell; year-to-date impairments were $10. Limited partnership results are generally reported on a one-quarter lag.
- Two lawsuits allege Indemnity improperly retained policy service and related charges; one seeks approximately $308 and an accounting of intercompany transactions. The cases remain unresolved, and the filing says any loss related to the separate unclaimed-property audit and West Virginia lawsuit cannot presently be reasonably estimated.
- Other principal risks include catastrophe exposure, reserve estimation uncertainty, reinsurance collectability, dependence on the Exchange and independent agents, investment liquidity, and regulatory and competitive conditions. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Investor verification points
- Separate Indemnity shareholder earnings and cash flows from the consolidated Exchange results and policyholder noncontrolling interest.
- Assess whether premium growth can continue without reversing underwriting improvement; review catastrophe losses, reserve development, and the 98.7% year-to-date combined ratio.
- Determine how much of investment gains is repeatable, and review the impact of trading-security fair-value changes, impairments, and lagged partnership reporting.
- Track the service-charge litigation, requested accounting, unclaimed-property matters, and related potential exposure; the filing provides no clear estimate for certain contingencies.
- Review the liquidity and funding implications of $418 in limited partnership commitments and the terms of the amended credit facilities.