Erie Indemnity Company — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011. Financial statements are unaudited and stated in millions of dollars, except per-share data. Erie Indemnity manages the Erie Insurance Exchange and consolidates it as a variable interest entity. Consolidated results therefore include Exchange amounts attributable to policyholders; those amounts are not Indemnity shareholders’ earnings or assets available to them.
Key financial results
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Total consolidated revenue | $1,365 | $1,216 | +12.3% |
| Income before taxes and noncontrolling interest | $412 | $228 | +80.7% |
| Consolidated net income | $274 | $162 | +69.1% |
| Net income attributable to Indemnity | $44 | $47 | −6.4% |
| Indemnity diluted Class A EPS | $0.78 | $0.82 | −4.9% |
| Operating income attributable to Indemnity (non-GAAP) | $43 | $44 | −2.3% |
| Operating cash flow | $92 | $27 | +$65 |
Consolidated revenue growth reflected earned premiums of $1,030 million (+5.3%), net realized investment gains of $149 million (up from $125 million), and limited-partnership earnings of $72 million (up from $3 million). Net investment income was nearly flat at $105 million versus $104 million. Consolidated income growth substantially exceeded the change in Indemnity-attributable earnings: $230 million of Q1 2011 net income was attributable to the Exchange’s noncontrolling interest.
Indemnity management operations earned $48 million before tax, down from $53 million. Revenue grew 6.0% to $259 million, while costs rose 10.4% to $211 million. The gross margin was 18.6%, compared with 21.8%; management noted that the prior-year margin benefited from a $5 million favorable court ruling and would have been 19.8% excluding it. The management fee rate remained at its 25% maximum.
Property and casualty operations, now owned by the Exchange, reported underwriting income of $49 million versus a $41 million loss. Direct written premiums rose 6.3% to $1,008 million, and the combined ratio improved to 95.2% from 104.3% (below 100% generally indicates underwriting profitability). Losses and loss expenses fell 7.4%; catastrophe losses were $65 million versus $112 million, and favorable prior-year reserve development was $59 million versus $50 million. These underwriting results accrue to Exchange policyholders, not Indemnity shareholders.
Financial position, liquidity and capital
- At March 31, total consolidated assets were $14,553 million, liabilities $8,002 million, and total equity $6,551 million. Indemnity shareholders’ equity was $893 million, down from $912 million at year-end; Exchange noncontrolling interest was $5,658 million.
- Consolidated investments totaled $12,277 million, up from $11,815 million at December 31, 2010. Consolidated cash and equivalents fell to $211 million from $430 million. The filing reports $86 million of cash for Indemnity and $125 million for the Exchange; the Exchange’s assets and credit are not available to Indemnity shareholders.
- Operating cash flow was $92 million; investing activities used $254 million, largely reflecting investment purchases; financing activities used $57 million, including $36 million of treasury-stock purchases and $26 million of dividends. Consolidated cash decreased $219 million during the quarter.
- Indemnity and the Exchange had available credit lines of $100 million and $200 million, respectively, with no borrowings outstanding at quarter-end. Both were in covenant compliance. The filing identifies no other material debt balance.
- Quarterly dividends declared were $0.515 per Class A share and $77.25 per Class B share. Indemnity repurchased 529,024 Class A shares for approximately $36 million; $109.7 million remained under its $150 million authorization.
Material changes, outlook and risks
- Business structure: Indemnity sold its property-and-casualty subsidiaries to the Exchange on December 31, 2010. Consequently, their underwriting and investment results accrue to policyholders rather than Indemnity shareholders from 2011 onward, affecting comparisons of shareholder-attributable results.
- EFL sale: On March 31, 2011, Indemnity sold its 21.6% interest in Erie Family Life Insurance Company to the Exchange for $82 million. Final settlement was completed April 25 at the same price; estimated after-tax proceeds were $58 million. As a common-control transaction, no gain or loss was recorded. Future EFL results accrue entirely to Exchange policyholders.
- Management outlook: Management expected pricing actions to produce a net increase in 2011 direct written premiums, while noting that economic conditions, exposure reductions, and changes in business mix could affect average premiums. No specific earnings or EPS guidance was provided.
- Investment variability: Limited-partnership earnings are generally reported on a one-quarter lag; Q1 2011 results reflected partnership conditions in Q4 2010. Management cautioned that market volatility could affect investment income and gains and the ability to sell some securities without discounts. Limited partnerships are less liquid.
- Insurance and operating risks: Key exposures include catastrophe losses, uncertainty in loss reserves (particularly massive-injury claims), reinsurance availability and collectability, competition, regulation, economic conditions, and dependence on the Exchange and the management-fee relationship. Indemnity reported no obligation to support the Exchange, but a deterioration in Exchange strength or business could reduce management fees.
- Remaining limited-partnership investment commitments were $47 million for Indemnity and $429 million for the Exchange. Ordinary-course litigation was not expected by management to have a material effect. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Distinguish consolidated Group earnings and assets from amounts attributable or accessible to Indemnity shareholders; the Exchange accounts for most consolidated earnings and equity.
- Assess the continuing effects of the December 2010 P&C subsidiary sale and March 2011 EFL sale on Indemnity’s future earnings mix and comparisons.
- Review whether Q1’s investment-driven consolidated earnings—especially limited-partnership income reported on a lag and realized gains—are sustainable.
- Monitor Indemnity’s management-fee revenue, operating costs and margin, and the Exchange’s premium growth and financial strength.
- Evaluate reserve assumptions, catastrophe experience, liquidity needs, and the timing and funding of the $476 million combined limited-partnership commitments.