Business context and reporting period
Erie Indemnity Company’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2015, compared with the corresponding 2014 periods. The consolidated statements include both Indemnity, which manages the Erie Insurance Exchange and earns a fee based on premiums written, and the Exchange’s insurance operations. Exchange assets and earnings largely belong to its policyholders, shown as noncontrolling interest; consolidated results should not be read as Indemnity shareholder results alone. Amounts below are in millions unless stated otherwise.
Financial results and position
| Metric | Three months ended June 30, 2015 | Three months ended June 30, 2014 | Six months ended June 30, 2015 | Six months ended June 30, 2014 |
|---|---|---|---|---|
| Premiums earned | $1,434 | $1,319 | $2,836 | $2,607 |
| Total revenues | $1,632 | $1,598 | $3,237 | $3,109 |
| Net income, consolidated | $197 | $103 | $333 | $212 |
| Net income attributable to Indemnity | $56 | $49 | $95 | $95 |
| Indemnity diluted Class A EPS | $1.07 | $0.94 | $1.81 | $1.82 |
| Operating cash flow | Not presented quarterly | $311 | $245 |
- Underwriting: Property and Casualty Group earned premiums increased 8.7% in Q2 and 8.8% year to date. Its combined ratio improved to 96.8% from 114.0% for Q2, and to 99.8% from 111.1% year to date; below 100% generally indicates an underwriting profit.
- Investment results: Consolidated net investment income was $127 in Q2 (2014: $111) and $240 for six months (2014: $220). Net realized investment results were a $7 loss in Q2 versus a $133 gain, and a $49 gain year to date versus $189. Limited partnership earnings rose to $72 in Q2 from $27 and to $100 year to date from $77.
- Margins and expenses: Indemnity management operations gross margin declined to 17.4% from 18.2% in Q2 and 16.3% from 18.0% year to date, primarily due to higher estimated agent incentives. Management-operation costs grew faster than management fee revenue year to date.
- Cash and liquidity: Cash and equivalents were $421 at June 30, 2015, down from $514 at year-end. Six-month operating cash flow was $311; investing used $350 and financing used $54. Management said expected operating cash needs should be met from operations and that liquidity was sufficient for needs through 2015, including under continued market volatility.
- Debt and capital: No borrowings were outstanding under either the Indemnity $100 revolving facility or the Exchange $300 facility; $98 and $299, respectively, remained available, subject to letters of credit and facility terms. The filing reports no material funded debt balance. Indemnity shareholders’ equity was $732; Exchange noncontrolling interest was $7,430. Consolidated assets were $18,069 and liabilities $9,907.
- Dividends: Six-month dividends paid were $63, versus $59. 2015 quarterly dividends per share were raised 7.2% versus 2014; declared year-to-date dividends were $1.362 per Class A share and $204.30 per Class B share.
Material changes versus the prior comparable period
- Consolidated net income increased substantially, while Indemnity-attributable income was up in Q2 but unchanged at $95 for the first half. Much of the consolidated improvement reflected better P&C underwriting and changes in investment results, with a greater share of consolidated earnings attributable to the Exchange.
- Lower catastrophe losses and more favorable prior-year reserve development drove the underwriting improvement. Q2 catastrophe losses were $52 versus $244; first-half catastrophe losses were $137 versus $337. Favorable prior-year development was $42 in Q2 and $63 year to date, compared with $9 and $22, respectively, in 2014.
- Investment gains were markedly lower than in 2014, especially in Q2: Exchange realized results included decreases in trading common-stock fair value, producing a $7 Q2 loss versus a $133 gain. Limited partnership earnings and net investment income partly offset this effect.
- Operating cash flow increased, but cash declined as investment purchases and shareholder dividends exceeded cash generated after other cash flows.
- At June 30, consolidated investments were $14,881 versus $14,669 at year-end; gross P&C loss reserves were $3,963 versus $3,853, and unearned premiums were $3,007 versus $2,834.
Outlook, commentary, risks and unusual items
- Management intends to pursue premium growth through agency expansion and increased market penetration while maintaining underwriting discipline. No quantitative earnings or premium guidance was provided; management cautioned that first-half results are not necessarily indicative of full-year results.
- Growth reflected a 4.1% increase in policies in force and a 3.9% increase in average premium per policy. Overall policy retention was 90.1%, versus 90.6% a year earlier. Management identified agency-system dependence, competition, economic conditions, inflation in medical, construction and auto repair costs, catastrophe exposure, reserve estimation, reinsurance collectability, investment-market volatility and liquidity as key risks.
- Property and casualty reserves are estimates subject to uncertainty. Massive-injury lifetime medical reserves were $245 net of anticipated reinsurance recoverables, down from $274 at year-end; workers’ compensation reserves are discounted at 2.5%. Actual claims, inflation, legal changes and settlement patterns may differ from assumptions.
- Limited partnership results are generally reported on a one-quarter lag, so reported year-to-date earnings reflect partnership activity through the first quarter of 2015, not the second quarter. The group had $550 of remaining investment commitments at June 30, including $527 for the Exchange and $23 for Indemnity.
- The FASB’s new consolidation guidance, effective for periods beginning after December 15, 2015, could result in Indemnity no longer consolidating the Exchange; the company was evaluating the impact. This could materially change reported consolidated presentation without necessarily changing underlying Indemnity shareholder economics.
- Legal matters include the Sullivan policyholder suit alleging approximately $308 of service charges should have gone to the Exchange. The Pennsylvania Insurance Department ruled in April 2015 that the charges complied with applicable insurance laws; plaintiffs appealed. A related federal appeal was dismissed on jurisdictional grounds in July 2015, while the underlying matter remained subject to further proceedings. Separately, a West Virginia court ruled that insurers have an implied duty to investigate insureds’ deaths for unclaimed-property purposes; EFL sought rehearing. An ongoing multistate unclaimed-property audit may result in additional claims, payments or fines, but the potential loss could not be estimated.
- Indemnity reported effective disclosure controls and no material change in internal control over financial reporting. The company reported no material change in market-risk exposures from its prior annual report.
Important facts for investors to verify
- Whether the underwriting improvement persists after unusually lower catastrophe losses and favorable reserve development, and how current accident-year loss trends evolve.
- How much reported earnings depend on volatile trading-security marks and lagged limited partnership valuations, versus recurring management-fee and investment income.
- Whether management-operation costs, agent incentives and technology expenses continue to pressure Indemnity gross margin.
- The outcome and financial exposure of the service-charge litigation, West Virginia unclaimed-property matter and ongoing multistate audit.
- The effect of adopting the revised consolidation standard on financial statements, segment reporting and comparability.
- Liquidity and capital needs relative to the $550 of limited partnership commitments, insurance reserves and potential market-value declines; Exchange assets and credit facilities are not available to Indemnity shareholders.