Erie Indemnity Company — FY 2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020; comparisons are primarily with FY 2019. This is an annual filing, not a standalone fourth-quarter report.
Business context
Erie Indemnity is the attorney-in-fact for policyholders of Erie Insurance Exchange, its sole customer and principal source of revenue. It provides policy issuance and renewal services and administrative services. Its management fee is tied to the Exchange’s premiums written; the Board set the fee rate at the maximum 25% for 2020 and maintained it at 25% for 2021. The Exchange’s 2020 premiums were 71% personal lines and 29% commercial lines.
Key financial metrics
| Metric | FY 2020 | FY 2019 | Change |
|---|---|---|---|
| Total operating revenue | $2.536 billion | $2.477 billion | +2.4% |
| Operating income | $338.2 million | $357.3 million | -5.4% |
| Net income | $293.3 million | $316.8 million | -7.4% |
| Diluted Class A EPS | $5.61 | $6.06 | -7.4% |
| Total investment income | $32.9 million | $40.0 million | -17.8% |
| Operating cash flow | $342.6 million | $364.5 million | -6.0% |
Reported operating margin was approximately 13.3% of operating revenue, versus 14.4% in 2019; net margin was approximately 11.6%, versus 12.8%. These ratios include administrative-service reimbursements and matching costs reported gross, which have no net impact on operating income.
- Exchange direct and affiliated assumed premiums written grew 1.7% to $7.614 billion. Policies in force rose 2.1%; average premium per policy declined 0.4%, partly reflecting pandemic-related auto rate reductions.
- Policy issuance and renewal costs rose 3.3% to $1.589 billion, outpacing the 1.7% increase in related net management-fee revenue. Higher commissions, agent incentives and personnel costs contributed to lower service-line operating income, down 7.1% to $278.7 million.
- Administrative-services reimbursement revenue and matching expense were each $609.4 million. Net administrative-services operating income was $59.5 million, up 4.0%.
- Investment income declined as lower interest rates reduced net investment income and impairment losses increased. Net impairment losses recognized in earnings were $3.3 million, compared with $0.2 million in 2019.
- At year-end, assets were $2.117 billion and shareholders’ equity was $1.188 billion. Cash and cash equivalents were $161.2 million, down from $336.7 million. Investments totaled $1.106 billion, including $928.2 million of fixed maturities.
- Borrowings totaled approximately $95.9 million on the balance sheet. The $100 million revolving credit line had no borrowings; $99.1 million remained available after letters of credit. The company reported compliance with debt covenants.
Material changes and notable items
- COVID-19-related auto rate reductions announced by the Exchange were estimated at $200 million of premiums. About $90 million of premium reduction and $22 million of management-fee reduction affected 2020; remaining reductions were estimated to reduce 2021 premiums by $110 million and management-fee revenue by $28 million.
- Despite early-year business disruption, new-business premiums increased 10.8% in the second half of 2020 year over year. Full-year new-business premiums declined 1.2%, while renewal premiums rose 2.1%.
- Operating cash flow decreased, while investing cash outflow increased to $243.2 million, mainly as purchases of available-for-sale securities exceeded sales and maturities. Financing cash outflow increased to $274.9 million, including a $93.1 million special dividend paid in December. Total cash dividends paid were $272.9 million.
- The new headquarters building was completed in Q4 2020. Fixed assets, net, increased to $265.3 million. The term loan bears a fixed 4.35% rate and amortizes over 28 years.
- The Exchange and its property-and-casualty subsidiaries retained an A.M. Best A+ “Superior” rating with a stable outlook; statutory policyholders’ surplus increased to $10.7 billion from $9.5 billion.
- The Sullivan state-court lawsuit concerning policyholder service charges was dismissed with prejudice in December 2020. The related Beltz II federal action had been dismissed, and the Third Circuit affirmed the dismissal in 2018. The filing says the company’s litigation accruals are not expected to be material, while noting that some loss exposures cannot be estimated.
Outlook, risks and controls
Management expected the 2021 management-fee rate to remain at 25%, but did not provide broader earnings or revenue guidance. It cautioned that pandemic effects, economic conditions, changing driving patterns, competition and regulatory actions could affect Exchange premiums and Indemnity’s fees. Other key risks include dependence on the Exchange and independent agencies, catastrophe losses, investment-market and interest-rate risk, cyber and technology disruption, and the company’s concentration of unsecured affiliate receivables. Those receivables were $494.6 million, or 23.4% of total assets, at year-end.
Management expected its share of pension costs, after affiliate reimbursements, to increase to approximately $23.2 million in 2021 from $18.5 million in 2020, primarily due to a lower discount rate. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Proportional cost allocation was identified as a critical audit matter; the auditor reported testing related controls and allocation procedures.
Important facts for investors to verify
- Whether Exchange premium and policy growth can offset the 2021 run-off of pandemic-related auto rate reductions and any continuing economic or behavioral changes.
- Whether expense growth—especially commissions, agent incentives, technology and pension costs—continues to outpace management-fee revenue growth.
- Investment portfolio performance, credit impairments, interest-rate sensitivity and exposure to securities with LIBOR-linked terms.
- Liquidity and affiliate-receivable collectability, given the substantial concentration in the Exchange and affiliates.
- Any developments in pandemic-related litigation, other contingencies, and the agent-loan participation program, including the company’s guarantee exposure.