Erie Indemnity Company — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; filed July 26, 2018. Erie Indemnity is the attorney-in-fact and management company for Erie Insurance Exchange and its insurance subsidiaries. It does not conduct the Exchange’s insurance operations; its revenue and earnings depend principally on fees tied to the Exchange’s written premiums.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total operating revenue | $621.5 million | $448.6 million | $1,193.6 million | $847.9 million |
| Operating income | $95.3 million | $83.4 million | $172.9 million | $150.4 million |
| Income before taxes | $101.0 million | $89.2 million | $184.2 million | $162.2 million |
| Net income | $79.7 million | $58.5 million | $145.5 million | $106.4 million |
| Class A diluted EPS | $1.52 | $1.12 | $2.78 | $2.03 |
| Operating cash flow | Not separately reported | Not separately reported | $41.6 million | $39.5 million |
- Q2 operating income rose 14.2% and net income rose 36.2%; for the first half, operating income rose 15.0% and net income rose 36.7%.
- Exchange direct and assumed premiums written grew 6.5% in Q2 and 6.7% in the first half. Net management fee revenue for policy issuance and renewal services increased 3.0% and 3.3%, respectively. Additional management fee revenue allocated to administrative services was $13.3 million in Q2 and $26.4 million year to date.
- Administrative services reimbursement revenue and matching expense were $146.5 million in Q2 and $292.5 million year to date; this gross presentation increased reported revenue and expenses without changing operating income.
- Policy issuance and renewal service operating income declined 1.7% in Q2 and 2.6% year to date, as related costs grew faster than revenue. The filing reports no consolidated profit-margin measure; reported revenue comparisons are affected by the accounting presentation change.
- Investment income totaled $6.2 million in Q2 and $12.4 million year to date, down 3.8% and 5.1%. Net investment income increased, but realized losses, impairments and limited-partnership losses reduced total investment income.
Financial position and liquidity
- At June 30, 2018, cash and cash equivalents were $198.4 million, total assets $1.65 billion, shareholders’ equity $880.2 million, and total liabilities $772.1 million.
- Long-term borrowings were $98.8 million, with $0.9 million current; the $100 million term facility was fully drawn. It carries a fixed 4.35% rate, with scheduled principal amortization beginning in 2019. The company had no borrowings under its separate revolving credit line and reported $99.1 million of availability, net of letters of credit.
- First-half cash flow: $41.6 million provided by operations, $5.7 million used in investing and $53.2 million used in financing. Cash fell $17.3 million to $198.4 million. Financing outflows included $78.2 million in shareholder dividends.
- The company made $80 million in accelerated pension contributions during the first half. Its defined-benefit pension liability was $145.7 million at June 30, down from $207.5 million at year-end.
Material changes, outlook and risks
- Accounting change: ASC 606 was adopted January 1, 2018, using the modified retrospective method. It split management-fee revenue between policy issuance/renewal services and administrative services, and moved administrative reimbursements and related expenses to gross presentation. Adoption established a $50.6 million contract liability at June 30 and reduced opening retained earnings by $38.3 million, net of tax. Prior-year figures were not restated, so reported revenue growth is not directly comparable.
- The lower 21% federal corporate tax rate, effective January 1, 2018, reduced tax expense and materially contributed to net-income growth. Management noted tax estimates could change as further guidance becomes available.
- Management expects operating cash needs to be met from operations and considers available liquidity sufficient. It identifies cash, the revolving line, and unpledged investments as funding sources. The Exchange plans continued premium growth through agency expansion and greater market penetration; the filing provides no specific financial guidance.
- Key risks include dependence on the Exchange as sole customer, its premium growth and financial strength, catastrophe and other insurance losses, agent relationships, operating costs, investment-market volatility and liquidity, technology or cybersecurity disruptions, and litigation. Exchange and property-casualty subsidiaries were rated A+ by A.M. Best with a stable outlook; policyholders’ surplus was $8.8 billion at June 30.
- Receivables from the Exchange and affiliates were $445.2 million, a significant concentration of unsecured credit exposure. The company also had $13.9 million of limited-partnership investment commitments and an $18.3 million contingent exposure relating to pension annuity contracts issued by Erie Family Life.
- Litigation includes the Sullivan matter concerning service charges and the Ritz lawsuit alleging excessive management fees; motions to dismiss in Ritz remained pending. A separate related Beltz II case was dismissed, and the Third Circuit affirmed the dismissal in May 2018. Management says it intends to vigorously defend the pending matters and does not expect accrued legal exposures to be material, while noting outcomes cannot be assured.
Important facts for investors to verify
- Reconcile reported revenue growth with ASC 606’s allocation of fees and gross administrative-service reimbursements; compare underlying management-fee growth and Exchange premium trends.
- Monitor Exchange-related receivables and the Exchange’s financial strength, premium growth, retention and surplus, given the company’s single-customer concentration.
- Review the pending Sullivan and Ritz litigation, including possible financial exposure and developments in the motions to dismiss.
- Assess the pension plan’s funded position and future contributions, alongside the $100 million term loan’s amortization and construction-related commitments.
- Track investment impairments and unrealized losses, particularly given market sensitivity, Level 3 valuations and the quarter-lagged reporting of limited partnerships.