Business context and reporting period
Erie Indemnity Company’s Form 10-K covers the fiscal year ended December 31, 2011. Indemnity manages the policy sales, underwriting and issuance functions for the policyholder-owned Erie Insurance Exchange and earns a fee based on premiums written. The consolidated statements include both Indemnity and the Exchange; the Exchange’s results are presented largely as noncontrolling interest, not as earnings belonging to Indemnity shareholders.
Following the sale of Indemnity’s property-and-casualty subsidiaries to the Exchange on December 31, 2010, and its 21.6% interest in Erie Family Life Insurance Company (EFL) to the Exchange on March 31, 2011, Indemnity functions as the management company. These changes make comparisons with prior years less like-for-like.
Financial results and position
| Metric | 2011 | 2010 |
|---|---|---|
| Consolidated revenue | $4.824 billion | $4.890 billion |
| Consolidated net income | $268 million | $660 million |
| Net income attributable to Indemnity | $169 million | $162 million |
| Diluted Class A EPS attributable to Indemnity | $3.08 | $2.85 |
| Indemnity operating income, non-GAAP | $167 million | $163 million |
| Operating cash flow, consolidated | $360 million | $721 million |
- Indemnity management fee revenue rose 5.7% to $1.067 billion, supported by 5.9% growth in Property and Casualty Group direct written premiums to $4.271 billion. The management fee remained at the 25% maximum, including for 2012.
- Management operations income increased to $208 million from $202 million; gross margin was 18.9%, down from 19.4%. Costs grew 6.1%, faster than management fee revenue.
- Property and casualty net premiums earned increased 5.7% to $4.149 billion. Underwriting loss widened to $378 million from $3 million; the combined ratio rose to 109.1% from 100.1%, indicating an underwriting loss.
- Catastrophe losses were $773 million, up from $288 million, adding 18.6 percentage points to the 2011 loss ratio. Favorable prior-year reserve development of $272 million partly offset current-year losses.
- Net investment income was $433 million, unchanged. Net realized investment results shifted to a $4 million loss from $313 million in gains; limited partnership earnings rose to $149 million from $128 million. Partnership results are reported on a lag and do not reflect fourth-quarter 2011 market conditions.
- At year-end, consolidated assets were $14.348 billion, liabilities $8.055 billion, and total equity $6.293 billion. Indemnity shareholder equity was $781 million, down from $912 million; book value per share was $14.48 versus $16.24.
- Consolidated cash and cash equivalents were $185 million, including $11 million held by Indemnity and $174 million by the Exchange. The company reported no borrowings on Indemnity’s $100 million revolving facility or the Exchange’s $300 million facility. These entities’ assets and credit facilities are separate and are not freely available to one another.
- There is no clear consolidated debt balance stated in the provided filing text; it reports no revolver borrowings at year-end. Consolidated operating, investing and financing cash flows were $360 million, negative $375 million and negative $230 million, respectively.
- Indemnity declared $2.0975 per Class A share in dividends for 2011, up from $1.955, and repurchased 2.2 million shares for $155 million under its repurchase program.
Material changes versus prior period
- Consolidated net income fell sharply, chiefly reflecting the Exchange’s higher catastrophe-related underwriting losses and much lower investment gains than in 2010. Indemnity-attributable net income nevertheless rose 4.3%, and diluted EPS increased 8.1%; buybacks also reduced weighted-average shares.
- The 2011 property-and-casualty combined ratio moved above 100%, from 100.1% to 109.1%, as losses and loss expenses rose 19.0%, substantially faster than earned premiums.
- Cash from operations fell by about half, primarily because of increased catastrophe-related claim payments and higher agent commissions.
- The portfolio’s reported results include a changed allocation of insurance and investment earnings after the 2010 subsidiary sale and the 2011 EFL sale. Investors should not interpret consolidated totals as Indemnity shareholder results.
Outlook, risks and unusual items
- Management expected pricing actions to produce a net increase in direct written premiums in 2012 and planned further growth through its independent-agent network. Economic exposure reductions, coverage changes and shifts in business mix could temper premium growth. The 2012 management fee rate was set at 25%.
- Catastrophe reinsurance was renewed for 2012, with additional coverage layers, but the treaties exclude terrorism losses and may not cover losses above stated limits. Reinsurance does not remove the insurers’ obligations to policyholders.
- Key risks include severe weather and geographic concentration, rate competition and regulatory limits, inflation in medical and repair costs, uncertain loss reserves, investment-market and interest-rate volatility, illiquid limited partnerships, and the Exchange’s dependence on Indemnity’s services.
- Indemnity had $254 million of receivables from the Exchange and affiliates, approximately 20.5% of Indemnity assets, creating counterparty concentration risk. The Exchange had $384 million of remaining limited-partnership commitments; Indemnity had $40 million.
- Property-and-casualty loss reserves were $3.499 billion gross and $3.348 billion net of reinsurance. The filing highlights sensitivity of long-tail massive-injury reserves to medical-cost inflation; a 100-basis-point increase in that assumption would increase combined auto and workers-compensation massive-injury reserves by $81 million.
- Legal matters arise in the ordinary course. Management said accrued amounts and potential excess exposure were not expected to be material, while noting losses on some proceedings could not be reasonably estimated.
- The 2010 results included a $22 million Exchange goodwill impairment and an $18 million Indemnity deferred-tax charge related to the EFL sale. The 2011 annual filing also reports quarterly volatility: second- and third-quarter consolidated losses were followed by fourth-quarter net income of $281 million, of which $26 million was attributable to Indemnity.
- AM Best ratings were A+ for the Property and Casualty Group and A for EFL, all with stable outlooks. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Separate Indemnity shareholder earnings and cash flows from the Exchange’s policyholder-owned results, and account for the subsidiary and EFL ownership transfers when comparing periods.
- Review catastrophe loss experience, rate adequacy, the 109.1% combined ratio, and whether the announced 2012 pricing actions offset loss-cost trends.
- Assess reserve-estimate sensitivity and the sustainability of favorable prior-year development, especially for long-tail and massive-injury claims.
- Check the liquidity and valuation of limited partnerships, their reporting lag, and the remaining investment commitments; assess investment results excluding unusually large prior-year realized gains.
- Confirm the management fee rate, Exchange receivable collectability, available credit facilities and restrictions on access to Exchange assets and capital.