Erie Indemnity Company — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013; the filing also reports unaudited fourth-quarter results. The consolidated statements include Erie Indemnity Company (Indemnity) and the Erie Insurance Exchange (Exchange), whose insurance results and equity largely belong to Exchange subscribers, not Indemnity shareholders. Indemnity primarily earns a management fee for services to the Exchange.
Financial results and key metrics
| Metric | 2013 | 2012 | Change / context |
|---|---|---|---|
| Consolidated revenue | $6.271 billion | $5.512 billion | Up 13.8% |
| Consolidated net income | $1.048 billion | $619 million | Up 69.3%; includes Exchange results |
| Net income attributable to Indemnity | $163 million | $160 million | Up 1.9% |
| Indemnity diluted Class A EPS | $3.08 | $2.99 | Up 3.0% |
| Operating income attributable to Indemnity, non-GAAP | $162 million | $157 million | Excludes realized investment gains/losses, impairments and related taxes |
| Net cash from operating activities | $903 million | $577 million | Up $326 million |
| Total assets / total equity | $16.676 billion / $7.550 billion | $15.441 billion / $6.791 billion | At year-end; Indemnity shareholder equity was $734 million |
| Property and casualty combined ratio | 98.6% | 105.6% | Improved 7.0 percentage points; below 100% indicates underwriting profit |
- Property and casualty direct written premiums rose 9.6% to $5.076 billion; policies in force increased 4.8% and average premium per policy rose 4.5%. Net premiums earned increased 9.0% to $4.820 billion.
- Property and casualty underwriting income was $68 million, versus a $246 million loss in 2012. Catastrophe losses declined to $162 million from $489 million; prior-year reserve development was only $19 million favorable, compared with $115 million favorable in 2012.
- Indemnity management fee revenue increased 9.4% to $1.266 billion, with the fee rate held at its 25% maximum. Management operations income rose to $209 million from $205 million, while gross margin declined to 16.1% from 17.3%, reflecting costs growing faster than revenue.
- Investment results were a major contributor to consolidated improvement: the Exchange recorded $770 million of realized investment gains, versus $413 million in 2012. Consolidated net investment income declined to $422 million from $438 million. The Exchange also recorded $13 million of investment impairment losses.
- Consolidated cash increased $52 million to $452 million. Investing activities used $759 million and financing activities used $92 million. Indemnity’s separate operating cash flow was $218 million.
- At year-end, Indemnity had $49 million cash and the Exchange $403 million. Each had an undrawn revolving credit facility: $100 million for Indemnity and $300 million for the Exchange, subject to outstanding letters of credit. The entities’ assets and credit facilities are not available to one another.
- Total liabilities were $9.126 billion, including $3.747 billion of gross property and casualty loss reserves and $1.758 billion of life policy and deposit reserves. The filing does not present a clear consolidated borrowings balance; it reports no revolver borrowings at year-end.
Material changes and fourth-quarter results
- Full-year consolidated revenue increased from $5.512 billion to $6.271 billion, and consolidated net income rose from $619 million to $1.048 billion. This growth was primarily driven by higher realized investment gains and improved property and casualty underwriting.
- Indemnity shareholder earnings rose much less: net income attributable to Indemnity increased from $160 million to $163 million. The Exchange’s share of consolidated net income increased to $885 million from $459 million.
- Fourth-quarter consolidated revenue was $1.697 billion versus $1.372 billion in Q4 2012; consolidated net income was $314 million versus $119 million. Q4 net income attributable to Indemnity was $36 million versus $30 million; diluted Class A EPS was $0.67 versus $0.56.
- Consolidated total equity increased to $7.550 billion, while Indemnity shareholder equity increased to $734 million from $642 million. Indemnity’s 2013 declared Class A dividends totaled $2.4125 per share, down from $4.25 in 2012, which included a $2.00 special dividend.
Outlook, risks and unusual items
- Management expected pricing actions to produce a net increase in direct written premiums in 2014, while warning that coverage reductions, business mix and economic conditions could affect average premiums. The company planned to enter Kentucky by the first quarter of 2015 or earlier. The 2014 management fee rate remained 25%.
- Key risks include claims inflation and uncertain reserve estimates, severe weather and catastrophe exposure, competition and agent-channel dependence, investment-market and interest-rate volatility, liquidity constraints in limited partnerships, cybersecurity and system outages, regulatory limits on rates and insurer dividends, and reliance on the Exchange for most of Indemnity’s revenue and receivables.
- Property and casualty gross loss reserves were $3.747 billion at year-end. Massive-injury medical claims are particularly judgment-sensitive; a 100-basis-point increase in the medical-cost inflation assumption was estimated to increase combined auto and workers’ compensation massive-injury reserves by $57 million.
- Limited partnership investments are generally reported with a one-quarter lag, so most reported year-end results do not reflect fourth-quarter 2013 market conditions. Indemnity and the Exchange had additional limited-partnership funding commitments of $29 million and $409 million, respectively.
- Two related lawsuits allege Indemnity improperly retained approximately $308 million of policy service and added service charges. Courts referred issues within the Pennsylvania Insurance Department’s jurisdiction to the Department and stayed or dismissed court proceedings without prejudice; Indemnity disputes the allegations. The filing says the potential loss cannot currently be reasonably estimated for certain matters.
- An ongoing unclaimed-property audit and related inquiries may result in additional death-claim payments, escheatment and possible fines; the company could not estimate a loss range. The West Virginia Treasurer’s suit against EFL was dismissed with prejudice in December 2013, and the Treasurer appealed in January 2014.
- AM Best ratings were A+ for the property and casualty insurers and A for EFL, all with stable outlooks. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- How much of consolidated earnings growth reflects recurring underwriting and fee income versus volatile realized investment gains?
- Whether the improvement in the combined ratio persists as catastrophe losses, pricing and claims severity change, and as favorable prior-year reserve releases remain limited.
- The adequacy and sensitivity of long-tail and massive-injury reserves, including medical inflation assumptions and reinsurance recoverability.
- The outcome and potential financial exposure of the service-charge litigation and unclaimed-property matters.
- Indemnity’s dependence on the Exchange, including the $296 million of management-fee and cost receivables reported due from the Exchange and the separate financial resources of each entity.
- Investment concentration, unrealized-value volatility, limited-partnership liquidity and unfunded commitments, alongside the company’s capacity to meet claims, dividends and operating needs.