FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For quarter ended June 30, 1998
Commission file number 0-24000
ERIE INDEMNITY COMPANY
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 25-0466020
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Erie Insurance Place, Erie, Pennsylvania 16530
(Address of principal executive offices) (Zip Code)
(814) 870-2000
Registrant's telephone number, including area code
Not applicable
Former name, former address and former fiscal year, if changed since last
report.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter periods
that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes X No
___
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practical date.
Class A Common Stock, no par value, with a stated value of
$.0292 per share-- 67,032,000 shares as of July 31,
1998.
Class B Common Stock, no par value, with a stated value of
$70.00 per share-- 3,070 shares as of July 31, 1998.
The common stock is the only class of stock the Registrant is presently
authorized to issue.
INDEX
ERIE INDEMNITY COMPANY
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Financial Position--June 30, 1998 and
December 31, 1997
Consolidated Statements of Operations--Three and six months ended
June 30, 1998 and 1997
Consolidated Statements of Comprehensive Income--Three and six months
ended June 30, 1998 and 1997
Consolidated Statements of Cash Flows--Six months ended June 30, 1998
and 1997
Notes to Consolidated Financial Statements--June 30, 1998
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
2
PART I. FINANCIAL INFORMATION
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
June 30, December 31,
ASSETS 1998 1997
--------------- ---------------
(Unaudited)
INVESTMENTS
Fixed Maturities Available-for-Sale at fair value
(amortized cost of $365,188,340 and
$333,135,959, respectively) $ 382,372,210 $ 349,972,703
Equity Securities (cost of $158,744,870 and
$144,123,112, respectively) 191,168,718 165,132,504
Real Estate Mortgage Loans 8,331,309 8,392,518
Other Invested Assets 17,067,857 7,932,571
--------------- ---------------
Total Investments $ 598,940,094 $ 531,430,296
Cash and Cash Equivalents 52,028,277 53,148,495
Equity in Erie Family Life
Insurance Company 37,671,530 34,687,640
Accrued Investment Income 6,576,617 6,128,725
Premiums Receivable from Policyholders 109,144,407 108,057,986
Prepaid Federal Income Tax 0 1,681,573
Deferred Policy Acquisition Costs 10,863,941 10,283,372
Receivables from Erie Insurance Exchange
and Affiliates 523,387,205 495,861,158
Note Receivable from Erie Family
Life Insurance Company 15,000,000 15,000,000
Property and Equipment 11,199,696 10,130,230
Other Assets 32,062,817 26,134,306
--------------- ---------------
Total Assets $ 1,396,874,584 $ 1,292,543,781
=============== ===============
See Notes to Consolidated Financial Statements.
3
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
June 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997
--------------- ---------------
(Unaudited)
LIABILITIES
Unpaid Losses and Loss Adjustment Expenses $ 433,284,343 $ 413,408,941
Unearned Premiums 228,898,506 219,210,522
Accounts Payable and Accrued Expenses 19,837,955 17,041,217
Accrued Commissions 83,601,392 81,150,931
Accrued Vacation and Sick Pay 5,400,531 5,322,327
Deferred Compensation 2,654,977 1,933,020
Deferred Income Taxes 12,194,878 7,101,371
Federal Income Tax Payable 1,069,800 0
Accrued Benefit Obligations 9,253,533 7,992,300
--------------- ---------------
Total Liabilities $ 796,195,915 $ 753,160,629
--------------- ---------------
SHAREHOLDERS' EQUITY
Capital Stock
Class A Common, stated value $.0292
per share; authorized 74,996,930 shares;
issued and outstanding 67,032,000 shares $ 1,955,100 $ 1,955,100
Class B Common, stated value $70.00
per share; authorized 3,070 shares;
issued and outstanding 3,070 shares 214,900 214,900
Additional Paid-In Capital 7,830,000 7,830,000
Accumulated Other Comprehensive Income
net of deferred taxes of $20,276,726 and
$15,626,105, respectively 37,661,441 29,024,573
Retained Earnings 553,017,228 500,358,579
--------------- ---------------
Total Shareholders' Equity $ 600,678,669 $ 539,383,152
--------------- ---------------
Total Liabilities and
Shareholders' Equity $ 1,396,874,584 $ 1,292,543,781
=============== ===============
See Notes to Consolidated Financial Statements.
4
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended
June 30 June 30
------------------------------------- -------------------------------------
MANAGEMENT OPERATIONS: 1998 1997 1998 1997
Management Fee Revenue $ 130,184,972 $ 123,993,772 $ 247,508,627 $ 237,248,101
Service Agreement Revenue 2,942,924 1,056,494 5,942,245 2,328,285
Other Operating Revenue 373,829 452,258 747,790 1,061,232
----------------- ------------------ ------------------ -----------------
Total Revenues from Management Operations 133,501,725 125,502,524 254,198,662 240,637,618
Cost of Management Operations 94,437,016 90,139,706 181,373,102 173,520,742
----------------- ------------------ ------------------ -----------------
Net Revenues From
Management Operations $ 39,064,709 $ 35,362,818 $ 72,825,560 $ 67,116,876
----------------- ------------------ ------------------ -----------------
INSURANCE UNDERWRITING OPERATIONS:
Premiums Earned $ 28,146,565 $ 26,888,265 $ 55,607,627 $ 52,738,839
Losses and Loss Adjustment Expenses Incurred 20,453,563 20,327,478 38,950,953 39,225,257
Policy Acquisition and Other Underwriting
Expenses 7,999,725 7,343,702 15,535,916 14,344,410
----------------- ------------------ ------------------ -----------------
Total Losses and Expenses 28,453,288 27,671,180 54,486,869 53,569,667
----------------- ------------------ ------------------ -----------------
Underwriting (Loss) Gain $ (306,723) $ (782,915) $ 1,120,758 $ (830,828)
----------------- ------------------ ------------------ -----------------
INVESTMENT OPERATIONS:
Equity in Earnings of Erie Family
Life Insurance Company $ 1,203,568 $ 997,955 $ 2,609,044 $ 1,949,799
Interest and Dividends 9,160,614 7,780,537 18,075,277 15,327,797
Realized Gain on Investments 3,189,588 1,359,760 4,186,366 2,497,084
----------------- ------------------ ------------------ -----------------
Revenue from Investment Operations 13,553,770 10,138,252 24,870,687 19,774,680
----------------- ------------------ ------------------ -----------------
Income Before Income Taxes 52,311,756 44,718,155 98,817,005 86,060,728
Provision for Income Taxes 16,841,275 14,274,386 31,647,465 27,406,165
----------------- ------------------ ------------------ -----------------
Net Income $ 35,470,481 $ 30,443,769 $ 67,169,540 $ 58,654,563
================= ================== ================== =================
Net Income per Share $ 0.48 $ 0.41 $ 0.90 $ 0.79
================= ================== ================== =================
Dividends Declared per Share:
Class A non-voting Common $ 0.1075 $ 0.095 $ 0.215 $ 0.19
----------------- ------------------ ------------------ -----------------
Class B Common $ 16.125 $ 14.25 $ 32.25 $ 28.50
----------------- ------------------ ------------------ -----------------
5
See Notes to Consolidated Financial Statements.
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended Six Months Ended
June 30 June 30
------------------------------------- -------------------------------------
1998 1997 1998 1997
Net Income $ 35,470,481 $ 30,443,769 $ 67,169,540 $ 58,654,563
----------------- ------------------ ------------------ -----------------
Unrealized Gains (Losses) on Securities:
Unrealized Holding Gains (Losses) Arising
During Period 2,719,010 18,280,623 17,473,855 10,025,742
Less: Reclassification Adjustment for
Gains Included in Net Income 3,189,589 1,359,759 4,186,366 2,497,084
----------------- ------------------ ------------------ -----------------
Net Unrealized Holding (Losses) Gains
Arising During Period $ (470,579) $ 16,920,864 $ 13,287,489 $ 7,528,658
Income Tax (Expense) Benefit Related to
Unrealized Gains or Losses 164,703 (5,922,302) (4,650,621) (2,635,030)
----------------- ------------------ ------------------ -----------------
Other Comprehensive Income (Loss), Net of Tax $ (305,876) $ 10,998,562 $ 8,636,868 $ 4,893,628
----------------- ------------------ ------------------ -----------------
Comprehensive Income $ 35,164,605 $ 41,442,331 $ 75,806,408 $ 63,548,191
================= ================== ================== =================
6
See Notes to Consolidated Financial Statements.
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended Six Months Ended
June 30, 1998 June 30, 1997
--------------------- ---------------------
CASH FLOW FROM OPERATING ACTIVITIES
Net income $ 67,169,540 $ 58,654,563
Adjustment to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation and amortization 992,036 910,963
Deferred income tax expense 974,895 207,211
Realized gain on investments (4,186,366) (2,497,084)
Amortization of bond discount (88,703) (60,032)
Undistributed earnings of Erie Family Life (1,995,874) (1,397,946)
Deferred compensation 721,957 169,337
(Increase) decrease in accrued investment income (447,892) 14,877
Increase in receivables (28,562,521) (45,797,322)
Policy acquisition costs deferred (11,085,056) (10,516,726)
Amortization of deferred policy acquisition costs 10,504,487 9,846,851
Increase in prepaid expenses and
other assets (5,740,002) (5,345,268)
Increase in accounts payable and
accrued expenses 4,142,361 1,816,505
Increase in accrued commissions 2,450,461 5,846,848
Increase in income taxes payable 2,751,373 2,006,025
Increase in loss reserves 19,875,401 19,106,504
Increase in unearned premiums 9,687,984 7,212,711
------------------ -----------------
Net cash provided by operating
activities $ 67,164,081 $ 40,178,017
CASH FLOW FROM INVESTING ACTIVITIES
Purchase of investments:
Fixed maturities (52,491,656) (26,360,043)
Equity securities (35,906,487) (40,312,355)
Mortgage loans 0 (1,086,241)
Other invested assets (9,768,461) (757,605)
Sales/maturities of investments:
Fixed maturities 21,264,251 18,325,584
Equity securities 24,734,685 22,808,428
Mortgage loans 61,335 65,725
Other invested assets 632,882 227,069
Purchase of property and equipment (346,947) (39,558)
Purchase of computer software (1,714,556) (670,343)
Loans to Agents (983,013) (744,905)
Collections on Agent loans 744,557 564,467
------------------ -----------------
Net cash used in investing activities $ (53,773,410) $ (27,979,777)
CASH FLOW FROM FINANCING ACTIVITIES
Dividends paid to shareholders $ (14,510,889) $ (12,823,576)
------------------ -----------------
Net cash used in financing activities $ (14,510,889) $ (12,823,576)
------------------ -----------------
Net (decrease) in cash and cash equivalents (1,120,218) (625,336)
Cash and cash equivalents at beginning of period 53,148,495 18,719,624
------------------ -----------------
Cash and cash equivalents at end of period $ 52,028,277 $ 18,094,288
================== =================
Supplemental disclosures of cash flow information:
Cash paid during the six months ended June 30, 1998 and 1997 for income taxes
was $28,221,547 and $25,638,127 respectively.
See Notes to Consolidated Financial Statements.
7
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements, which include the
accounts of the Erie Indemnity Company and its' wholly owned subsidiaries Erie
Insurance Company, Erie Insurance Company of New York and Erie Insurance
Property & Casualty Company, have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the
six-month period ended June 30, 1998 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1998. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Form 10-K for the year ended December 31,
1997.
NOTE B -- RECLASSIFICATIONS
Certain amounts as previously reported in the 1997 financial statements have
been reclassified to conform to the current year's presentation.
NOTE C -- EARNINGS PER SHARE
Earnings per share is based on the weighted average number of Class A shares
outstanding (67,032,000 as retroactively stated in 1997), giving effect to the
conversion of the weighted average number of Class B shares outstanding (3,070
in 1998 and 1997) at a rate of 2,400 Class A shares for one Class B share as set
out in the Articles of Incorporation. Equivalent shares outstanding total
74,400,000.
NOTE D -- INVESTMENTS
Management considers all fixed maturities and marketable equity securities
available-for-sale. Marketable equity securities consist primarily of common and
nonredeemable preferred stocks while fixed maturities consist of bonds and
notes. Available-for-sale securities are stated at fair value, with the
unrealized gains and losses, net of tax, reported as a separate component of
shareholders' equity. Management determines the appropriate classification of
fixed maturities at the time of purchase and reevaluates such designation as of
each statement of financial position date.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
The following is a summary of available-for-sale securities:
Available-for-Sale Securities
Gross Gross
Amortized Unrealized Unrealized Fair
(In Thousands) Cost Gains Losses Value
June 30, 1998
U.S. Treasuries & Agencies $ 13,019 $ 493 $ 3 $ 13,509
States & Political Subdivisions 41,662 2,837 4 44,495
Special Revenue 120,710 6,985 1 127,694
Public Utilities 10,369 166 0 10,535
Industrial & Miscellaneous 173,773 7,468 489 180,752
Foreign Governments 1,990 0 355 1,635
Foreign Industrial & Miscellaneous 3,665 87 0 3,752
------------- ------------ ------------- -------------
Total Fixed Maturities $ 365,188 $ 18,036 $ 852 $ 382,372
------------- ------------ ------------- -------------
Common Stock $ 66,570 $ 31,863 $ 7,113 $ 91,320
Preferred Stock 92,175 7,753 79 99,849
------------- ------------ ------------- -------------
Total Equity Securities $ 158,745 $ 39,616 $ 7,192 $ 191,169
------------- ------------ ------------- -------------
$ 523,933 $ 57,652 $ 8,044 $ 573,541
============= ============ ============= =============
Available-for-Sale Securities
Gross Gross
Amortized Unrealized Unrealized Fair
(In Thousands) Cost Gains Losses Value
December 31, 1997
U.S. Treasuries & Agencies $ 12,771 $ 432 $ 3 $ 13,200
States & Political Subdivisions 41,931 2,840 0 44,771
Special Revenue 116,052 7,850 1 123,901
Public Utilities 7,171 160 0 7,331
U.S. Industrial & Miscellaneous 150,666 6,317 401 156,582
Foreign Governments 1,989 0 418 1,571
Foreign Industrial & Miscellaneous 2,556 61 0 2,617
------------- ------------ ------------- -------------
Total Fixed Maturities $ 333,136 $ 17,660 $ 823 $ 349,973
------------- ------------ ------------- -------------
Common Stock $ 64,762 $ 23,082 $ 7,674 $ 80,170
Preferred Stock 79,361 5,603 1 84,963
------------- ------------ ------------- -------------
Total Equity Securities $ 144,123 $ 28,685 $ 7,675 $ 165,133
------------- ------------ ------------- -------------
$ 477,259 $ 46,345 $ 8,498 $ 515,106
============= ============ ============= =============
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
Mortgage loans on real estate are recorded at unpaid balances, adjusted for
amortization of premium or discount. A valuation allowance is provided for
impairment in net realizable value based on periodic valuations. The change in
the allowance is reflected on the income statement in realized gain (loss) on
investments.
NOTE E -- SUMMARIZED INCOME STATEMENT INFORMATION OF AFFILIATE
The Company has a 21.6% investment in Erie Family Life Insurance Company (EFL)
and accounts for this investment using the equity method. The following
represents summarized income statement information for EFL:
Six Months Ended Six Months Ended
June 30, 1998 June 30, 1997
------------------ ------------------
Revenues $ 47,691,941 $ 43,588,649
Benefits and expenses 29,057,962 30,005,294
------------------ ------------------
Income before income taxes 18,633,979 13,583,355
Income taxes 6,571,824 4,569,028
------------------ ------------------
Net income $ 12,062,155 $ 9,014,327
================== ==================
Dividends paid to shareholders $ 2,835,000 $ 2,457,004
================== ==================
Net unrealized appreciation (depreciation) on
investment securities at June 30, net of
deferred taxes $ 25,004,334 $ 7,489,012
================== ==================
10
NOTE F -- NOTE RECEIVABLE FROM AFFILIATE
On December 29, 1995, EFL issued a surplus note to the Company in return for
cash of $15 million. The note bears an annual interest rate of 6.45% and all
payments of interest and principal of the note may be repaid only out of
unassigned surplus of EFL and are subject to prior approval of the Pennsylvania
Insurance Commissioner. Interest on the surplus note is scheduled to be paid
semi-annually. The note will be payable on demand on or after December 31, 2005.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
financial statements and related notes found on pages 3 through 10, since they
contain important information that is helpful in evaluating the Company's
operating results and financial condition.
OPERATING RESULTS
Financial Overview
Consolidated net income increased by 16.5% for the second quarter of 1998 to
$35,470,481, or $.48 per share, from $30,443,769 or $.41 per share, for the
second quarter of 1997. The increase in net income was driven by improved
results in all three of the Company's operating segments. The gains generated by
management and investment operations were supplemented by improved underwriting
results when compared to the second quarter of 1997.
For the six months ended June 30, 1998, net income rose 14.5% to $67,169,540 or
$.90 per share, from $58,654,563 or $.79 per share reported for the same period
in 1997. Management operations improved as growth in management fee revenue
outpaced the cost of management operations. Insurance underwriting operations
improved considerably in the first six months of 1998 as a result of mild
weather conditions experienced in the Company's operating territories. Revenue
from investment operations grew by 25.8% as the Company's cash flow was
invested.
RESULTS OF OPERATIONS
Analysis of Management Operations
Management fee revenue derived from the management operations of the Company,
which serves as attorney-in-fact for the Erie Insurance Exchange (the Exchange),
increased 5.0% to $130,184,972 for the three months ended June 30, 1998 from
$123,993,772 for the three months ended June 30, 1997. Management fee revenue
increased 4.3% to $247,508,627 in the first six months of 1998 compared to
$237,248,101 for the same period in 1997.
The direct and affiliated assumed premiums of the Exchange grew by 3.9% for the
second quarter of 1998 versus the same period in 1997. The personal lines auto
market continues to be extremely competitive and rate pressures have increased
in many of the Exchange's operating territories. The Exchange's overall premium
growth was influenced negatively by a rate reduction included in Pennsylvania
workers compensation legislative reforms. The Exchange's involuntary automobile
premiums have also decreased over the last year as a result of fewer assignments
from the Pennsylvania assigned risk plan. Involuntary automobile business is
written on substandard risks and historically has produced underwriting results
worse than the preferred risks voluntarily written by the Erie Insurance Group.
When the effect of workers compensation and involuntary automobile insurance are
excluded, the direct and affiliated assumed premiums of the Exchange grew 4.9%
for the first six months of 1998 when compared to the same period in 1997.
On July 31, 1998 the Erie Insurance Group filed to lower its private passenger
auto insurance rates in Pennsylvania beginning January 1, 1999. The overall
effect will be a $53.2 million reduction in premium in 1999. This reduction is
the result of the favorable loss experience in Pennsylvania and is subject to
the approval by the Pennsylvania Insurance Department. This rate decrease will
reduce the Company's net revenue from management operations by about $7.5
million in 1999, assuming a management fee rate of 24.25% in 1999.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
The rate of growth in the management fee revenue was greater than the growth in
direct and affiliated assumed premium of the Exchange because the management fee
rate charged the Exchange in the second quarter of 1998 was 24.25% compared to a
rate of 24% charged in the second quarter of 1997. The Company's Board of
Directors has the authority to change the management fee rate at its discretion,
but cannot exceed a rate of 25%.
Service agreement revenue totaled $2,942,924 and $1,056,494 for the quarter
ended June 30, 1998 and 1997, respectively. Beginning September 1, 1997 the
Company was reimbursed by the Exchange for a portion of service charges
collected by the property/casualty insurers of the Group from Policyholders as
reimbursement for the costs incurred by the Company in providing extended
payment terms on policies written by them. These reimbursements totaled
$1,508,081 for the three months ended June 30, 1998.
The cost of management operations rose 4.8% for the second quarter of 1998 to
$94,437,016 from $90,139,706 during the second quarter of 1997.
Commissions are the largest component of the cost of management operations. The
Company is responsible for the payment of commissions to the independent Agents
who sell insurance products for the Company's subsidiaries and the Exchange, and
its subsidiary, Flagship City Insurance Company. The Agents receive commissions
based on fixed percentage fee schedules with different commission rates by
product line of insurance. Also included in commission expense are the costs of
promotional incentives for Agents and Agent contingency awards. Agent
contingency awards are based upon the underwriting profitability of the
insurance written and serviced by the Agent within the Erie Insurance Group of
companies.
Commission costs totaled $65,015,264 for the second quarter of 1998, a 6.5%
increase over the $61,068,198 reported in the second quarter of 1997. Commission
costs grew at a rate faster than the rate of growth in direct and affiliated
assumed written premiums of the Exchange due to increased provisions for agent
contingency awards resulting from improved underwriting. The growth in premiums
written on a quarterly and year-to-date basis were 3.9% and 3.2%, respectively.
The cost of management operations excluding commission costs, grew 1.2% for the
three months ended June 30, 1998 to $29,421,752 from $29,071,509 recorded in the
second quarter of 1997 as productivity improvements and modest growth in
operating costs continued.
Personnel costs, including salaries, employee benefits, and payroll taxes, are
the second largest component in cost of operations, after commissions. The
Company's personnel costs totaled $17,406,012 for the three month period ended
June 30, 1998, compared to $17,660,039 for the same period in 1997, a decrease
of 1.4%.
Net revenues from the Company's management operations rose 10.5% to $39,064,709
for the three months ended June 30, 1998 from $35,362,818 for the same period in
1997. For the six months ended June 30, 1998 net revenue from management
operations totaled $72,825,560, an increase of 8.5% when compared to the first
six months of 1997.
Analysis of Insurance Underwriting Operations
The insurance underwriting operations of the Company's wholly-owned
subsidiaries, Erie Insurance Company and Erie Insurance Company of New York,
which share proportionally in the property/ casualty underwriting results of the
Erie Insurance Group, improved during the second quarter of 1998 versus the same
period in 1997. In the second quarter of 1998, premiums earned for the Company's
property/casualty insurance subsidiaries grew 4.7% to $28,146,565 compared to
$26,888,265 for the same period in 1997. Losses, loss adjustment expenses and
other underwriting expenses incurred increased at a slower rate than premiums
earned, up 2.8% for the second quarter of 1998 amounting to $28,453,288 compared
to $27,671,180 for the prior years second quarter. Catastrophe losses, as
classified by the
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Company were $2,262,739 in the second quarter of 1998 compared to $279,907 in
the second quarter of 1997. Despite the increase in catastrophe losses, the
underwriting loss reported in the second quarter of 1998 amounted to $306,723
compared to a loss of $782,915 experienced in the second quarter of 1997. Second
quarter 1997 underwriting profitability was reduced by the return of first
quarters' recoveries under the aggregate excess of loss reinsurance agreement
with the Exchange, which amounted to $1,262,112. There were no recoveries, or
return of recoveries, in the second quarter of 1998 under this reinsurance
agreement.
The GAAP combined ratio for the Company's property/casualty insurance operations
improved to 98.0% for the six months ended June 30, 998 compared to a ratio of
101.6% for the same period in 1997. The GAAP combined ratio is the ratio of
loss, loss adjustment, acquisition, and other underwriting expenses incurred to
premiums earned.
Analysis of Investment Operations
Revenue from investment operations for the second quarter of 1998 increased by
33.7% to $13,553,770 from $10,138,252 in the second quarter of 1997. These
results include a 17.7% increase in interest and dividends combined with a 20.6%
increase in income from Erie Family Life Insurance Company (EFL). Realized gains
on investments were $3,189,588 in the second quarter of 1998 and $1,359,760 in
the second quarter of 1997. Revenue from investment operations for the six
months ended June 30, 1998 increased 25.8% to $24,870,687 from $19,774,680 for
the same period in 1997.
The Company owns a 21.6% investment in an affiliated life insurer, Erie Family
Life Insurance Company. This investment is accounted for under the equity method
of accounting. Consequently, the Company's investment earnings were a direct
result of EFL's net income increasing to $12,062,155 from $9,014,327 for the six
months ended June 30, 1998 and 1997, respectively. The earnings recognized from
the investment in EFL increased to $2,609,044 for the six months ended June 30,
1998 from $1,949,799 for the same period in 1997.
FINANCIAL CONDITION
Investments
The Company's investment strategy takes a long-term perspective emphasizing
investment quality, diversification and superior investment returns. Investments
are managed on a total return approach that focuses on current income and
capital appreciation. The Company's investment strategy also provides for
liquidity to meet the short and long-term commitments of the Company. At June
30, 1998, the Company's investment portfolio of investment-grade bonds, common
stock and preferred stock, all of which are readily marketable, and cash and
short-term investments, totaled $626 million, or 44.8%, of total assets. These
resources provide the liquidity the Company requires to meet demands on its
funds.
The total investments of the Company consist of investments in fixed maturities,
common stock, preferred stock, real estate mortgage loans and other invested
assets. At June 30, 1998, 95.8% of total investments were invested in fixed
maturities and equity securities. Mortgage loans and other invested assets
represented only 4.2% of total investments at that date. Mortgage loans and real
estate investments have the potential for higher returns, but also carry more
risk, including less liquidity and greater uncertainty in the rate of return.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
The Company's investments are subject to certain risks, including interest rate
and reinvestment risk. Fixed maturity and preferred stock security values
generally fluctuate inversely with movements in interest rates. The Company's
corporate and municipal bond investments may contain call and sinking fund
features which may result in early redemptions. Declines in interest rates could
cause early redemptions or prepayments which could require the Company to
reinvest at lower rates.
At June 30, 1998, the Company's five largest investments in corporate debt
securities totaled $26.5 million, none of which individually exceeded $6.7
million. These investments had a market value of $27.7 million.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measure of the Company's ability to secure enough cash to meet
its contractual obligations and operating needs. Operating cash flows are
generated from management operations as the attorney-in-fact for the Exchange,
the net cash flow from the Erie Insurance Company's 5% and the Erie Insurance
Company of New York's .5% participation in the underwriting results of the
reinsurance pool with the Exchange, and the Company's investment income from
affiliated and non-affiliated investments. With respect to the management fee
cash flow, funds are generally received from the Exchange on a premiums
collected basis, as the Company pays commissions on premiums collected rather
than written premiums. The Company generates sufficient net positive cash flow
from its operations to fund its commitments and to build its investment
portfolio, thereby increasing future investment returns. The Company also
maintains a high degree of liquidity in its investment portfolio in the form of
readily marketable fixed maturities, common stocks and short-term investments.
Net cash flows provided by operating activities for the six months ended June
30, 1998 and 1997, were $67,164,081 and $40,178,017 respectively.
Dividends declared and paid to shareholders in the three months ended June 30,
1998 and 1997, totaled $7,255,444 and $6,411,788, respectively. There are state
law restrictions on the payment of dividends from the insurance subsidiaries to
the Company. No dividends were paid to the Company from its property/casualty
insurance subsidiaries during the first six months of 1998.
Temporary differences between the financial statement carrying amounts and tax
bases of assets and liabilities that give rise to deferred tax assets and
liabilities resulted in net deferred tax liabilities at June 30, 1998 of
$12,194,878 and at December 31, 1997 of $7,101,371.
The National Association of Insurance Commissioners (NAIC) standard for
measuring the solvency of insurance companies, referred to as Risk Based Capital
(RBC), is a method of measuring the minimum amount of capital appropriate for an
insurance company to support its overall business operations in consideration of
its size and risk profile. The RBC formula is used by state insurance regulators
as an early warning tool to identify, for the purpose of initiating regulatory
action, insurance companies that potentially are inadequately capitalized. In
addition, the formula defines minimum capital standards that will supplement the
current system of low fixed minimum capital and surplus requirements on a
state-by-state basis. At December 31, 1997, the Company' property/casualty
insurance subsidiaries' financial statements prepared under Statutory Accounting
Practices are all substantially in excess of levels that would require
regulatory action.
At June 30, 1998 and December 31, 1997, the Company's receivables from its
affiliates totaled $523,387,205 and $495,861,158, respectively. These
receivables, primarily due from the Exchange, as a result of the management fee,
expense reimbursements and the intercompany reinsurance pool, potentially expose
the Company to concentrations of credit risk.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
ACCOUNTING PRONOUNCEMENTS
FAS 130
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 130 (FAS 130) "Reporting Comprehensive
Income". FAS 130 is effective for fiscal years beginning after December 31, 1997
and requires reporting of comprehensive income in a full set of general purpose
financial statements. The purpose of reporting comprehensive income is to report
a measure of all changes in equity of the Company that result from recognized
transactions and other economic events of the period. The two components of
comprehensive income reported by the Company are net income from operations and
unrealized gain or loss from investments, net of tax. Included in the report are
statements of comprehensive income for the three and six months ended June 30,
1998 and 1997.
SOP 98-1 - Software Costs
During the first quarter of 1998, the Company adopted AICPA Statement of
Position (SOP) 98-1 "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use". In accordance with SOP 98-1 the Company began
capitalizing internal use software costs. The adoption of this statement
resulted in an immaterial impact on 1998 net income.
"Safe Harbor" Statement Under the Private Securities Litigation Reform Act of
1995: Statements contained herein expressing the beliefs of management such as
those contained in the "Results of Operations - Analysis of Insurance
Underwriting Operations", "Financial Condition - Investments", and the
"Liquidity and Capital Resources" sections hereof, and the other statements
which are not historical facts contained in this report are forward looking
statements that involve risks and uncertainties. These risks and uncertainties
include but are not limited to: legislative, judicial and regulatory changes,
the impact of competitive products and pricing, product development, geographic
spread of risk, weather and weather-related events, other types of catastrophic
events, securities markets fluctuations, and technological difficulties and
advancements.
15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The H.O. Hirt Trusts collectively own 2,340 shares of the Company's Class B
Common Stock. The Company's Class B Common Stock has the exclusive right to vote
in the election of directors of the Company. Since such shares represent 76.22%
of the outstanding shares of the Company's Class B Common Stock, the vote of the
H.O. Hirt Trusts is sufficient to determine the outcome of any election of
directors. The trustees of the H.O. Hirt Trusts are F. William Hirt, Chairman of
the Board of the Company, a director of the Company, a beneficial owner of more
than 10% of the Company's outstanding Class A Common Stock and a beneficiary of
one of the two H.O. Hirt Trusts; his sister, Susan Hirt Hagen, a director of the
Company, a beneficial owner of more than 10% of the Company's outstanding Class
A Common Stock and a beneficiary of the other H.O. Hirt Trust, and Mellon Bank,
N.A. ("Mellon"). Under the provisions of the H.O. Hirt Trusts, the shares of the
Company's Class B Common Stock held by the H.O. Hirt Trusts are to be voted as
directed by a majority of the three trustees.
Under the Pennsylvania Insurance Company Law and the Company's By-laws, the
candidates for the election as directors of the Company are to be nominated by a
committee consisting solely of persons who are not officers or employees of the
Company or of any entity controlling, controlled by or under common control with
the Company and who are not beneficial owners of a controlling interest in the
voting securities of the Company. On March 11, 1998, the Nominating Committee of
the Company's Board of Directors nominated 12 persons as candidates for election
as directors of the Company at the Company's April 28, 1998 annual meeting of
shareholders. The 12 persons nominated did not include Thomas B. Hagen, the
husband of Susan Hirt Hagen, as a candidate for election as a director of the
Company at such annual meeting. Thomas B. Hagen had served as a director of the
Company since 1979.
On April 2, 1998, Susan Hirt Hagen, a director of the Company, filed petitions
in the Orphan's Court Division of the Court of Common Pleas of Erie County,
Pennsylvania (the "Court") seeking the removal of Mellon as a co-trustee of the
H.O. Hirt Trust with respect to Susan Hirt Hagen and as a co-trustee of the H.O.
Hirt Trust with respect to F. William Hirt. Among the relief requested by Susan
Hirt Hagen in the petitions was the grant of a preliminary injunction against
Mellon from voting the Class B Common Stock held by the H.O. Hirt Trusts for the
purpose of the election of directors at the Company's April 28, 1998 annual
meeting of shareholders. Because of the potential substantial harm to the
Company if the preliminary injunction were granted, the Company filed a petition
to intervene in the preliminary injunction proceedings which the Court granted
on April 20, 1998. Following a hearing on April 20, 1998, the Court issued an
opinion on April 21, 1998 and an order denying Susan Hirt Hagen's request for a
preliminary injunction. On April 28, 1998, the Company's 1998 annual meeting of
shareholders was held as scheduled and each of the candidates for election as a
director of the Company named in the Company's April 1, 1998 proxy statement was
elected as a director of the Company.
On June 3, 1998, the Company, because of its substantial interest in the outcome
of any matter involving a change in Mellon's status as a co-trustee of the H.O.
Hirt Trusts, petitioned the Court to intervene in the trial of the issues
remaining under Susan Hirt Hagen's petitions to remove Mellon as a co-trustee.
On June 24, 1998, the court denied the Company's petition, and, on July 13,
1998, the Company appealed the Court's denial to the Superior Court of
Pennsylvania which appeal remains pending. On August 5, 1998, Susan Hirt Hagen,
a director of the Company, filed a motion with the Superior Court of
Pennsylvania to quash the Company's appeal. The Company's response to this
motion is to be filed not later than August 9, 1998.
During June and July 1998, substantial discovery took place involving Susan Hirt
Hagen's petitions to remove Mellon as co-trustee. In the ten days preceding the
scheduled trial date of July 30, 1998, discussions took place between counsel
for Mellon and Susan Hirt Hagen concerning a possible basis for settlement of
the pending litigation. These discussions involved the circumstances under which
Mellon might resign as co-trustee of the H.O. Hirt Trusts and the establishment
of procedures pursuant to which a successor trustee would be appointed by the
Court or by agreement of Susan Hirt Hagen and F. William Hirt. After a hearing
conducted on July 30, 1998, the Court by letter advised counsel for all parties
that the Court would not approve the settlement proposal that had been presented
during the July 30, 1998 hearing, and that Mellon was to advise the Court on or
before August 21, 1998 whether a revised settlement proposal
16
Item 1. Legal Proceedings (Continued)
would be submitted or whether the petitions to remove Mellon as co-trustee
should be scheduled for trial by the Court for some later unspecified date.
On August 4, 1998, the Company filed a further petition with the Court seeking
the right to intervene in the proceedings insofar as the proceedings would
entail the possible approval of any settlement of the petitions to remove Mellon
as co-trustee or the appointment of a successor trustee to Mellon.
Item 6. Exhibits and Reports on Form 8-K
The Company did not file any reports on Form 8-K during the three months ended
June 30, 1998.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Erie Indemnity Company
(Registrant)
Date: August 6, 1998 /s/ Stephen A. Milne
President & CEO
/s/ Philip A. Garcia,
Executive Vice President & CFO
17
7
0000922621
ERIE INDEMNITY COMPANY
1,000
3-MOS 3-MOS
DEC-31-1998 DEC-31-1997
JUN-30-1998 JUN-30-1997
382,372 317,743
0 0
0 0
191,169 159,056
8,731 8,314
0 0
598,940 492,644
52,028 18,094
192 191
10,864 10,211
1,396,875 1,238,250
433,284 405,532
228,899 224,151
0 0
0 0
0 0
0 0
0 0
2,170 2,170
590,679 476,483
1,396,875 1,238,250
55,607 52,739
20,684 17,278
4,186 2,497
0 0
0 0
15,536 14,344
38,950 39,225
98,817 86,060
31,647 27,406
0 0
0 0
0 0
0 0
67,170 58,654
.90 .79
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
THE INFORMATION REPORTED FOR THE SIX MONTHS ENDED JUNE 30,1998 REPRESENTS
AMOUNTS THAT HAVE BEEN RECLASSIFIED TO CONFORM TO THE CURRENT YEAR'S
PRESENTATION.
