Business context and reporting period
Erie Indemnity Company filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2012. Indemnity manages the policyholder-owned Erie Insurance Exchange and earns a fee based on premiums written. Consolidated results include the Exchange, but its assets and earnings belong to policyholders and are presented as noncontrolling interest; they are not available to Indemnity shareholders.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Premiums earned | $1,109 million | $1,047 million | $2,196 million | $2,077 million |
| Total revenue | $1,160 million | $1,245 million | $2,680 million | $2,610 million |
| Consolidated net income (loss) | $(38) million | $(107) million | $316 million | $167 million |
| Net income attributable to Indemnity | $43 million | $52 million | $79 million | $96 million |
| Diluted Class A EPS attributable to Indemnity | $0.80 | $0.94 | $1.47 | $1.72 |
| Operating income attributable to Indemnity, diluted Class A EPS | $0.82 | $0.87 | $1.45 | $1.64 |
- Q2 consolidated results included a $107 million net realized investment loss, versus a $39 million gain a year earlier, primarily from valuation losses on the Exchange’s common-stock portfolio. For the first half, net realized investment gains were $189 million, versus $188 million.
- Net investment income was $113 million in Q2 and $221 million for the first half, compared with $113 million and $218 million, respectively. Equity in limited-partnership earnings fell to $58 million for the first half from $110 million; reported partnership results generally lag market activity by one quarter.
- Property and Casualty Group earned premiums increased 6.0% in Q2 and 5.7% for the first half. Its combined ratio improved to 114.6% from 140.2% in Q2 and to 103.9% from 117.9% for the first half; both remained above 100%, indicating underwriting losses.
- Indemnity management-fee revenue rose 8.3% to $308 million in Q2 and 7.7% to $577 million for the first half. Management-operation gross margin declined to 18.6% from 21.6% in Q2 and to 17.8% from 20.2% for the first half, as costs grew faster than revenue.
- Six-month operating cash flow was $191 million, compared with $200 million; investing cash outflow was $57 million, versus $397 million; financing cash outflow was $79 million, versus $124 million. Cash and cash equivalents ended June at $240 million, up from $185 million at year-end.
- At June 30, total investments were $12.530 billion, total assets $15.042 billion, and total liabilities $8.445 billion. Exchange loss reserves were $3.613 billion, up from $3.499 billion at year-end; unearned premiums were $2.331 billion, up from $2.178 billion.
- There were no borrowings on Indemnity’s $100 million revolving credit facility or the Exchange’s separate $300 million facility. Both entities reported covenant compliance. Indemnity had $766 million of equity; Exchange noncontrolling interest was $5.831 billion. Indemnity has no rights to Exchange assets or credit facilities.
Changes, outlook, and risks
- Q2 consolidated revenue fell year over year despite premium growth, principally reflecting the swing in realized investment results. Consolidated net loss improved from the prior-year quarter, while income attributable to Indemnity declined.
- Lower catastrophe losses supported the improvement in P&C underwriting results: Q2 catastrophe losses were $204 million versus $537 million, and first-half losses were $229 million versus $602 million. Prior-year reserve development was less favorable: Q2 had $5 million of favorable development versus $60 million; first-half favorable development was $24 million versus $119 million.
- Management expected pricing actions to increase direct written premiums in 2012, while noting that coverage reductions or business-mix changes could constrain average premiums. It also expected non-commission management expenses to grow faster than revenue for the rest of 2012.
- Management cited economic uncertainty, competition, dependence on independent agents and the Exchange relationship, severe weather and catastrophe exposure, reserve-estimation uncertainty, reinsurance collectability, investment-market volatility, and liquidity risks. The Exchange’s financial strength and business levels can affect Indemnity’s management-fee income.
- Limited-partnership funding commitments totaled up to $400 million: $39 million for Indemnity and $361 million for the Exchange. Ordinary-course litigation was not expected to have a material effect, though some claims could not yet be reasonably estimated. No material risk-factor changes or reportable subsequent events were identified.
- A $6 million reimbursement from the North Carolina Reinsurance Facility reduced Indemnity commission expense in 2012 for prior-period surcharges; management noted prior-period amounts had been recorded incorrectly. Adoption of updated insurance acquisition-cost guidance reduced costs capitalized but did not affect Indemnity shareholder interest or EPS.
Important facts for investors to verify
- Separate Indemnity shareholder earnings from consolidated results that include the Exchange; the Exchange’s assets and earnings are policyholder interests.
- Assess the volatility of trading common-stock valuations and limited-partnership earnings, including the one-quarter reporting lag.
- Track catastrophe claims, reserve development—especially massive-injury claims—and whether the combined ratio falls below 100%.
- Monitor management-operation expense growth and the stated expectation that non-commission costs will outpace revenue during the rest of 2012.
- Review the timing and funding of the $400 million partnership commitments and liquidity under market stress; the two revolving facilities are separate and currently undrawn.