Erie Indemnity Company — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Amounts below are in millions of dollars unless stated otherwise. Erie Indemnity acts as attorney-in-fact and management company for the Erie Insurance Exchange; the Exchange is its sole customer and conducts the insurance operations.
Financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Operating revenue | $418.4 | $396.6 | $1,217.0 | $1,149.1 |
| Net revenue from operations | $82.3 | $68.3 | $235.7 | $190.7 |
| Total investment income | $4.3 | $7.2 | $14.3 | $29.5 |
| Net income | $57.4 | $49.6 | $164.6 | $144.5 |
| Diluted Class A EPS | $1.09 | $0.94 | $3.14 | $2.75 |
| Gross margin from operations | 19.7% | 17.2% | 19.4% | 16.6% |
- Management fee revenue was $411.1 million in Q3 and $1,195.3 million year to date, up 5.6% and 6.1%, respectively. The fee rate remained at 25%; Exchange premiums written grew 5.5% in Q3 and 6.1% year to date.
- Operating expenses rose 2.4% in both periods. Higher agent commissions were partly offset by lower non-commission expenses, including personnel costs.
- Investment income fell 40.1% in Q3 and 51.5% year to date, chiefly reflecting sharply lower limited-partnership earnings. Net investment income itself increased 22.7% in Q3 and 11.7% year to date.
- Operating cash flow was $155.6 million for the nine months, versus $131.0 million in 2015. Investing activities used $96.6 million; dividends used $102.0 million. Cash declined $43.1 million to $139.8 million.
Balance sheet, debt and liquidity
- At September 30, total assets were $1,485.0 million, total liabilities $646.1 million, and shareholders’ equity $838.9 million. Cash and cash equivalents were $139.8 million; available-for-sale securities totaled $704.4 million.
- Current assets were $627.8 million and current liabilities $453.3 million. Receivables from the Exchange and affiliates were $400.0 million, up from $348.1 million at year-end, creating a significant related-party credit concentration.
- No bank-line borrowings were outstanding. The $100 million revolving facility had $99 million available after letters of credit; it expires November 2020. The company reported covenant compliance. Bonds with fair value of $109.4 million were pledged as collateral.
- The company held a $25 million surplus note receivable from Erie Family Life; principal and interest payments require Pennsylvania Insurance Commissioner approval.
Changes, outlook and risks
- Net revenue from operations increased 20.5% in Q3 and 23.6% year to date as revenue growth exceeded expense growth. Exchange premiums benefited from growth in policies and average premium per policy; policy retention was 89.8% at September 30.
- Limited-partnership results are reported generally on a one-quarter lag. A real-estate partnership sold its remaining assets in October; management expects an approximately $7.5 million gain to be recorded in Q4 2016.
- No specific earnings guidance was provided. Management said operating cash needs are expected to be met from operations and it believes liquidity is sufficient, including if market volatility persists. Available sources also include cash, the credit facility, and investment assets; securities-market volatility could constrain sales or require discounts.
- Key risks include dependence on the Exchange’s premium growth, financial strength and ability to retain business; the unsecured receivable concentration; investment valuation and liquidity; catastrophe and economic risks affecting the Exchange; and litigation.
- Two related lawsuits concern the company’s retention of policy installment, late and reinstatement charges. Plaintiffs allege approximately $308 million in charges should have gone to the Exchange and seek monetary and other relief. The company disputes the claims; motions to dismiss were pending at quarter-end. Management states litigation accruals are not expected to be material, but notes outcomes could differ.
- A contingent liability of $21.4 million exists if Erie Family Life does not honor certain pension annuity contracts. Limited-partnership investment commitments were $18.6 million. The company reported no material change in risk factors and no material off-balance-sheet obligations other than these investment commitments.
- The Exchange’s financial-strength rating was A+ “Superior,” with a stable outlook as affirmed in June 2016. Following adoption of revised consolidation guidance, the Exchange is no longer consolidated; the change did not affect Indemnity’s net income or equity.
Important facts for investors to verify
- Whether Exchange premium growth and the 25% management-fee rate continue to support revenue and operating margins.
- How limited-partnership returns develop, including recognition of the expected Q4 gain and the effect of the reporting lag.
- Updates and potential financial exposure in the service-charge lawsuits, including whether any loss becomes probable and estimable.
- Collectability and timing of the $400.0 million related-party receivable, and ongoing liquidity, investment-market and pension exposures.