Erie Indemnity Company 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2005
OR
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o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number 0-24000
ERIE INDEMNITY COMPANY
(Exact name of registrant as specified in its charter)
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Pennsylvania
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25-0466020 |
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(State or other jurisdiction
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(I.R.S. Employer |
of incorporation or organization)
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Identification No.) |
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100 Erie Insurance Place, Erie, Pennsylvania
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16530 |
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(Address of principal executive offices)
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(Zip code) |
Registrants telephone number, including area code (814) 870-2000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, stated value $.0292 per share
Class B Common Stock, stated value $70 per share
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Act. Yes o No þ
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 period that the registrant was required to file such reports) and (2) has been subject
to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of Registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act
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Large accelerated filer þ
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Accelerated filer o
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Non-accelerated filer o |
Aggregate market value of voting stock of non-affiliates: There is no active market for the
Class B voting stock and no Class B voting stock has been sold in the last year upon which a price
could be established.
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the
Act).Yes o No þ
Indicate the number of shares outstanding of each of the Registrants classes of common stock, as
of the latest practicable date: 60,419,835 shares of Class A Common Stock and 2,833 shares of
Class B Common Stock outstanding on February 16, 2006.
DOCUMENTS INCORPORATED BY REFERENCE:
1. |
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Portions of the Registrants Annual Report to Shareholders for the fiscal year ended December
31, 2005 (the Annual Report) are incorporated by reference into Parts I, II and III of this Form 10-K
Report. |
2. |
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Portions of the Registrants Proxy Statement relating to the Annual Meeting of Shareholders
to be held April 18, 2006 are incorporated by reference into Parts I and III of this Form 10-K Report. |
INDEX
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PART ITEM NUMBER AND CAPTION |
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PAGE |
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3 |
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9 |
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14 |
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14 |
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14 |
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14 |
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15 |
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15 |
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15 |
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15 |
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15 |
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16 |
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16 |
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16 |
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17 |
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18 |
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18 |
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18 |
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19 |
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19 |
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27 |
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28 |
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88 |
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89 |
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90 |
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91 |
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92 |
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2
PART I
Item 1. Business
Erie Indemnity Company (Company), a Pennsylvania corporation, operates predominantly as the
management services company that provides sales, underwriting and policy issuance services to the
policyholders of Erie Insurance Exchange (Exchange). The Company has served as the
attorney-in-fact for the policyholders of the Exchange since 1925. The Company also operates as a
property/casualty insurer through its wholly-owned subsidiaries, Erie Insurance Company, Erie
Insurance Property and Casualty Company and Erie Insurance Company of New York. The Exchange and
its property/casualty insurance subsidiary, Flagship City Insurance Company, along with the
Companys three insurance subsidiaries (collectively, the Property and Casualty Group) write a
broad line of personal and commercial lines property and casualty coverages and pool their
underwriting results. The financial results of the Exchange are not consolidated with the
Companys.
For its services as attorney-in-fact, the Company charges the Exchange a management fee calculated
as a percentage, limited to 25%, of the direct written premiums of the Exchange and the direct
written premiums of the other members of the Property and Casualty Group, all of which are assumed
by the Exchange under the intercompany pooling arrangement. Management fees accounted for
approximately 72% of the Companys revenues in 2005 and approximately 74% in both 2004 and 2003.
Because the Companys earnings are largely generated from fees based on the direct written premium
of the Exchange and other members of the Property and Casualty Group, the Company has an interest
in the growth and financial condition of the Exchange. The Property and Casualty Group underwrites
a broad range of insurance. In 2005, personal lines comprised 70% of direct written premium
revenue of the Property and Casualty Group while commercial lines constituted the remaining 30%.
The core products in personal lines are private passenger automobile (49%) and homeowners (19%)
while the core commercial lines consist principally of multi-peril (11%), workers compensation
(9%) and automobile (8%). The Property and Casualty Group operates primarily in the Midwest,
mid-Atlantic and southeast regions of the United States exclusively through 7,800 independent
agents. While sales, underwriting and policy issuance services are centralized at the Companys
home office, the Property and Casualty Group maintains 23 field offices throughout the 11
contiguous states where the Property and Casualty Group does business to provide claims services
and marketing support for the independent agents. Historically, due to policy renewal and sales
patterns, the Property and Casualty Groups direct written premiums are greater in the second and
third quarters of the calendar year. While loss and loss adjustment expenses are not entirely
predictable, historically such costs have been greater during the third and fourth quarters,
influenced by the weather in the geographic regions, including the Midwest, mid-Atlantic and
southeast regions in which the Property and Casualty Group operates.
The Companys property/casualty insurance subsidiaries participate in the underwriting results of
the Exchange through the intercompany pooling arrangement. Under the arrangement, the Exchange
assumes 94.5% of the underwriting results of the Property and Casualty Group while the Companys
insurance subsidiaries assume 5.5%.
The Company also owns 21.6% of the common stock of Erie Family Life Insurance Company (EFL), an
affiliated life insurance company of which the Exchange owns 53.5%. Together with the Exchange,
the Company and its subsidiaries and affiliates operate collectively as the Erie Insurance Group.
3
Operating Segments
Financial information about these segments is set forth in and referenced to Note 20 of the Notes
to Consolidated Financial Statements included in the Annual Report. Further discussion of
financial results by operating segment is provided in and referenced to Managements Discussion
and Analysis also included in the 2005 Annual Report.
Competition
The markets in which the Property and Casualty Group operates are highly competitive. The Property
and Casualty Group ranked as the 15th largest automobile insurer in the United States
based on 2004 direct written premiums and as the 23rd largest property/casualty insurer
in the United States based on 2004 total lines net premium written according to A.M. Best Company,
Inc. Property and casualty insurers generally compete on the basis of customer service, price,
brand recognition, coverages offered, claim handling ability, financial stability and geographic
coverage. Vigorous competition is provided by large, well-capitalized national companies, some of
which have broad distribution networks of employed or captive agents, and by smaller regional
insurers. In addition, because the insurance products of the Property and Casualty Group are
marketed exclusively through independent insurance agents, the Property and Casualty Group, faces
competition within its appointed agencies based on ease of doing business, product, price and
service relationships.
Market competition bears directly on the price charged for insurance products and services subject
to regulatory limitations. Growth is driven by a companys ability to provide insurance services at
a price that is reasonable and acceptable to the customer. In addition, the marketplace is affected
by available capacity of the insurance industry. Industry surplus expands and contracts primarily
in conjunction with profit levels generated by the industry. Growth is a product of a companys
ability to retain existing customers and to attract new customers, as well as movement in the
average premium per policy charged by the Property and Casualty Group.
The Erie Insurance Group has followed several strategies that management believes will result in
long-term underwriting performance which exceeds those of the property/casualty industry in
general. First, the Erie Insurance Group employs an underwriting philosophy and product mix
targeted to produce a Property and Casualty Group underwriting profit on a long-term basis through
careful risk selection and rational pricing. The careful selection of risks allows for lower claims
frequency and loss severity, thereby enabling insurance to be offered at favorable prices. With the
recent introduction of insurance scoring into the underwriting and pricing processes, the Property
and Casualty Group has continued to refine its risk measurement and price segmentations skills.
Second, Erie Insurance Groups management focuses on consistently providing superior service to
policyholders and agents. Third, the Erie Insurance Groups business model is designed to provide
the advantages of localized marketing and claims servicing with the economies of scale from
centralized accounting, administrative, underwriting, investment, information management and other
support services.
Finally, the Company carefully selects the independent agencies that represent the Property and
Casualty Group. The Property and Casualty Group seeks to be the lead insurer with its agents in
order to enhance the agency relationship and the likelihood of receiving the most desirable
underwriting opportunities from its agents. The Company has ongoing, direct communications with the
agency force. Agents have access to a number of Company-sponsored venues designed to promote
sharing of ideas, concerns and suggestions with the senior management of the Property and Casualty
Group with the goal of improving communications and service. The Company continues to evaluate new
ways to support its agents efforts, from marketing programs to identifying potential customer
leads, to grow the business of the Property and Casualty Group. These efforts have resulted in
outstanding agency penetration and the ability to sustain long-term agency partnerships. The higher
agency penetration and long term relationships allow for greater efficiency in providing agency
support and training.
4
Employees
The Company employed over 4,600 persons at December 31, 2005, of which approximately 2,300 provide
claims specific services exclusively for the Property and Casualty Group and approximately 160
perform services exclusively for EFL. Both the Exchange and EFL reimburse the Company monthly for
the cost of these services.
Geographic areas
The Property and Casualty Group is represented by an agency force of 7,800 agents in 11 Midwest,
mid-Atlantic and southeast states including Illinois, Indiana, Maryland, New York, North Carolina,
Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and Wisconsin, and the District of Columbia.
See the table Management fee revenue by line by state for
the Company included in and referenced to the Managements Discussion and Analysis in the 2005 Annual Report.
Reserves for losses and loss adjustment expenses
The following table illustrates the change over time of the loss and loss adjustment expense
reserves established for the Companys property/casualty insurance subsidiaries at the end of the
last ten calendar years. Conditions and trends that have affected development of the liability in the past may not
necessarily occur in the future. Accordingly, it generally is not appropriate to extrapolate
future redundancies or deficiencies based on this data.
5
Property and Casualty Subsidiaries of Erie Indemnity Company
Reserves for Unpaid Losses and Loss Adjustment Expenses
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At December 31, |
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(amounts in millions) |
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1996 |
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1997 |
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1998 |
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1999 |
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2000 |
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2001 |
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2002 |
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2003 |
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2004 |
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2005 |
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Gross liability for
unpaid losses and
loss adjustment
expense (LAE) |
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$ |
386.4 |
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$ |
413.4 |
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$ |
426.2 |
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$ |
432.9 |
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$ |
477.9 |
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$ |
557.3 |
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$ |
717.0 |
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$ |
845.5 |
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$ |
943.0 |
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$ |
1,019.5 |
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Gross liability
re-estimated as of: |
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One year later |
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397.4 |
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410.8 |
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431.2 |
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477.0 |
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516.2 |
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622.6 |
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727.2 |
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832.2 |
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927.5 |
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Two years later |
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400.9 |
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411.5 |
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448.7 |
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487.2 |
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567.1 |
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635.1 |
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736.3 |
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843.3 |
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Three years later |
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400.4 |
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422.5 |
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453.3 |
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518.6 |
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567.2 |
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649.1 |
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755.5 |
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Four years later |
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404.6 |
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420.5 |
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471.9 |
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518.5 |
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588.7 |
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669.9 |
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Five years later |
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402.1 |
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435.6 |
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472.2 |
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541.1 |
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619.0 |
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Six years later |
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412.5 |
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438.3 |
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492.3 |
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568.9 |
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Seven years later |
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416.8 |
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456.2 |
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516.4 |
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Eight years later |
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433.7 |
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480.1 |
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Nine years later |
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457.5 |
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Cumulative
(deficiency)
redundancy |
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(71.1 |
) |
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(66.7 |
) |
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(90.2 |
) |
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(136.0 |
) |
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(141.1 |
) |
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(112.6 |
) |
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(38.5 |
) |
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2.2 |
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15.5 |
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Gross liability for
unpaid losses and
LAE |
|
$ |
386.4 |
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|
$ |
413.4 |
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|
$ |
426.2 |
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$ |
432.9 |
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$ |
477.9 |
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$ |
557.3 |
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$ |
717.0 |
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$ |
845.5 |
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$ |
943.0 |
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$ |
1,019.5 |
|
Reinsurance
recoverable on
unpaid losses |
|
|
301.5 |
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|
323.9 |
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334.8 |
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337.9 |
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375.6 |
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438.6 |
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577.9 |
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687.8 |
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765.6 |
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828.4 |
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Net liability for
unpaid losses and
LAE |
|
$ |
84.9 |
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|
$ |
89.5 |
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$ |
91.4 |
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$ |
95.0 |
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$ |
102.3 |
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$ |
118.7 |
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$ |
139.1 |
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$ |
157.7 |
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$ |
177.4 |
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$ |
191.1 |
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Net re-estimated
liability as of: |
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One year later |
|
$ |
87.3 |
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|
$ |
88.9 |
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$ |
92.5 |
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$ |
104.7 |
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$ |
109.8 |
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$ |
126.6 |
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$ |
140.9 |
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$ |
162.6 |
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$ |
181.2 |
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Two years later |
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|
88.1 |
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|
89.1 |
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|
96.2 |
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|
106.2 |
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|
116.0 |
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|
127.0 |
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144.6 |
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171.9 |
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Three years later |
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88.0 |
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|
91.5 |
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97.2 |
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|
110.6 |
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|
116.2 |
|
|
|
131.9 |
|
|
|
155.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Four years later |
|
|
88.9 |
|
|
|
91.0 |
|
|
|
101.2 |
|
|
|
110.8 |
|
|
|
120.9 |
|
|
|
143.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later |
|
|
88.3 |
|
|
|
94.3 |
|
|
|
101.3 |
|
|
|
115.3 |
|
|
|
132.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later |
|
|
90.6 |
|
|
|
94.9 |
|
|
|
105.6 |
|
|
|
124.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years later |
|
|
91.6 |
|
|
|
98.8 |
|
|
|
110.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years later |
|
|
95.3 |
|
|
|
103.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later |
|
|
100.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative
(deficiency)
redundancy |
|
|
(15.6 |
) |
|
|
(14.4 |
) |
|
|
(19.4 |
) |
|
|
(29.8 |
) |
|
|
(30.2 |
) |
|
|
(24.9 |
) |
|
|
(16.6 |
) |
|
|
(14.2 |
) |
|
|
(3.8 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The development of loss and loss adjustment expenses are presented on a gross basis (gross of
ceding transactions in the intercompany pool) and a net basis (the amount remaining as the
Companys exposure after ceding amounts through the intercompany pool and the Companys insurance
subsidiaries assuming their 5.5% of the pool, as well as transactions under the excess-of-loss
reinsurance agreement with the Exchange).
The Companys 5.5% share of the loss and loss reserves of the Property and Casualty Group are shown
in the net presentation and are more representative of the actual
development of the property/casualty insurance losses accruing to
the subsidiaries of the Company. The gross presentation is shown to be consistent with the balance
sheet presentation of reinsurance transactions which requires direct and ceded amounts to be
presented gross of one another, per FAS 113, Accounting and Reporting for Reinsurance of Short
Duration and Long Duration Contracts, i.e. the gross liability for unpaid losses and LAE of
$1,019.5 million agrees to the gross balance sheet amount, however, factoring in the gross
reinsurance recoverables of $828.4 million presented in the balance sheet results in the net obligation to
the Company of $191.1 million. The development on a gross basis is not necessarily indicative of the
Companys property/casualty insurance subsidiaries loss reserve development as the remaining
transactions (ceded) are not reflected in the amounts.
6
Reserves for Unpaid Losses and Loss Adjustment Expenses (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(amounts in millions) |
|
1996 |
|
|
1997 |
|
|
1998 |
|
|
1999 |
|
|
2000 |
|
|
2001 |
|
|
2002 |
|
|
2003 |
|
|
2004 |
|
|
2005 |
|
Cumulative amount of
gross liability paid
through: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later |
|
$ |
141.3 |
|
|
$ |
136.9 |
|
|
$ |
145.4 |
|
|
$ |
158.9 |
|
|
$ |
174.4 |
|
|
$ |
194.3 |
|
|
$ |
217.0 |
|
|
$ |
259.1 |
|
|
$ |
271.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Two years later |
|
|
212.2 |
|
|
|
211.5 |
|
|
|
228.2 |
|
|
|
244.9 |
|
|
|
270.9 |
|
|
|
302.1 |
|
|
|
351.0 |
|
|
|
410.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three years later |
|
|
250.0 |
|
|
|
256.8 |
|
|
|
274.9 |
|
|
|
297.6 |
|
|
|
326.1 |
|
|
|
372.5 |
|
|
|
434.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Four years later |
|
|
271.6 |
|
|
|
280.5 |
|
|
|
300.9 |
|
|
|
326.9 |
|
|
|
361.3 |
|
|
|
418.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later |
|
|
285.9 |
|
|
|
295.9 |
|
|
|
315.8 |
|
|
|
347.0 |
|
|
|
384.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later |
|
|
295.0 |
|
|
|
306.0 |
|
|
|
325.9 |
|
|
|
362.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years later |
|
|
302.3 |
|
|
|
313.1 |
|
|
|
336.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years later |
|
|
308.2 |
|
|
|
321.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later |
|
|
315.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative amount of
net liability paid
through: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later |
|
$ |
32.6 |
|
|
$ |
31.3 |
|
|
$ |
33.6 |
|
|
$ |
38.9 |
|
|
$ |
41.2 |
|
|
$ |
47.3 |
|
|
$ |
50.5 |
|
|
$ |
58.5 |
|
|
$ |
54.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Two years later |
|
|
48.7 |
|
|
|
48.3 |
|
|
|
52.4 |
|
|
|
59.2 |
|
|
|
64.9 |
|
|
|
72.9 |
|
|
|
80.9 |
|
|
|
86.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three years later |
|
|
57.8 |
|
|
|
59.2 |
|
|
|
63.9 |
|
|
|
73.5 |
|
|
|
78.5 |
|
|
|
91.0 |
|
|
|
95.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Four years later |
|
|
63.5 |
|
|
|
65.5 |
|
|
|
71.3 |
|
|
|
80.8 |
|
|
|
88.3 |
|
|
|
97.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later |
|
|
67.4 |
|
|
|
70.0 |
|
|
|
74.9 |
|
|
|
86.7 |
|
|
|
91.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later |
|
|
70.1 |
|
|
|
72.1 |
|
|
|
78.4 |
|
|
|
90.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years later |
|
|
70.2 |
|
|
|
74.5 |
|
|
|
81.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years later |
|
|
73.2 |
|
|
|
76.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later |
|
|
75.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Property and Casualty Group does not discount reserves except for workers compensation
reserves which are discounted on a nontabular basis. The workers compensation reserves are
discounted at a 2.5% interest rate as prescribed by the Insurance Department of the Commonwealth of
Pennsylvania. The discount is based upon the Property and Casualty Groups historical workers
compensation payout pattern. The Companys unpaid losses and loss adjustment expenses reserve was
reduced by $4.6 million and $4.1 million at December 31, 2005 and 2004, respectively, as a result
of this discounting.
The Companys share of the Property and Casualty Groups positive development on losses for prior
accident years was $3.2 million in 2005 which includes the effects of the Companys share of an
increase in the automobile catastrophe liability reserve of $2.6 million. The positive development
on losses of prior accident years in 2005 was experienced primarily in the commercial multi-peril
and the private passenger auto uninsured motorists lines of business. The increase in the automobile catastrophe
liability reserve was the result of higher cost expectations of future attendant care services as a
result of the settlement of class action litigation involving attendant care liabilities. See
Insurance Underwriting Operations and Financial Condition in the Managements Discussion and
Analysis contained in the 2005 Annual Report.
A reconciliation of claims reserves of the Companys property/casualty insurance subsidiaries can
be found at Note 12 of the Notes to Consolidated Financial Statements contained in the 2005
Annual Report. Additional discussion of reserve activity can be found in and is referenced to the
Financial Condition section of the Managements Discussion and Analysis in the 2005 Annual
Report.
7
Government Regulation
The Property and Casualty Group is subject to supervision and regulation in the states in which it
transacts business. The primary purpose of such supervision and regulation is the protection of
policyholders. The extent of such regulation varies, but generally derives from state statutes that
delegate regulatory, supervisory and administrative authority to state insurance departments.
Accordingly, the authority of the state insurance departments includes the establishment of
standards of solvency that must be met and maintained by insurers, the licensing to do business of
insurers and agents, the nature of the limitations on investments, the approval of premium rates
for property/casualty insurance, the provisions that insurers must make for current losses and
future liabilities, the deposit of securities for the benefit of policyholders, the approval of
policy forms, notice requirements for the cancellation of policies and the approval of certain
changes in control. In addition, many states have enacted variations of competitive rate-making
laws that allow insurers to set certain premium rates for certain classes of insurance without
having to obtain the prior approval of the state insurance department. State insurance departments
also conduct periodic examinations of the affairs of insurance companies and require the filing of
annual and other reports relating to the financial condition of insurance companies.
The Property and Casualty Group is also required to participate in various involuntary insurance
programs for automobile insurance, as well as other property/casualty lines, in states in which
such companies operate. These involuntary programs provide various insurance coverages to
individuals or other entities that otherwise are unable to purchase such coverage in the voluntary
market. These programs include joint underwriting associations, assigned risk plans, fair access to
insurance requirements (FAIR) plans, reinsurance facilities and windstorm plans. Legislation
establishing these programs generally provides for participation in proportion to voluntary
writings of related lines of business in that state. Generally, state law requires participation in
such programs as a condition to doing business in that state. The loss ratio on insurance written
under involuntary programs has traditionally been greater than the loss ratio on insurance in the
voluntary market. Involuntary programs generated underwriting losses for the Property and Casualty
Group of $12.5 million and $26.7 million in 2005 and 2004, compared to an underwriting profit of
$30.2 million in 2003. The Companys share of underwriting losses related to involuntary programs
was $.7 million and $1.5 million in 2005 and 2004, respectively.
Most states have enacted legislation that regulates insurance holding company systems. Each
insurance company in the holding company system is required to register with the insurance
supervisory authority of its state of domicile and furnish information regarding the operations of
companies within the holding company system that may materially affect the operations, management
or financial condition of the insurers within the system. Pursuant to these laws, the respective
insurance departments may examine the Company and the Property and Casualty Group at any time,
require disclosure of material transactions with the insurers and the Company as an insurance
holding company and require prior approval of certain transactions between the Company and the
Property and Casualty Group.
All transactions within the holding company system affecting the insurers the Company manages are
filed with the applicable insurance departments and must be fair and reasonable. Approval of the
applicable insurance commissioner is required prior to the consummation of transactions affecting
the control of an insurer. In some states, the acquisition of 10% or more of the outstanding common
stock of an insurer or its holding company is presumed to be a change in control.
Internet access
The Companys annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and all amendments to those reports are available free of charge on the Companys website at
www.erieinsurance.com as soon as reasonably practicable after such material is filed electronically
with the SEC. The Companys Code of Conduct is available on the Companys website and in printed
form upon request. Also copies of the Companys annual report will be made available, free of
charge, upon written request.
8
Item 1A. Risk Factors
The Companys business involves various risks and uncertainties, including, but not limited to
those discussed in this section. This information should be considered carefully together with the
other information contained in this report including the consolidated financial statements and the
related notes. If any of the following events described in the risk factors below actually occur,
the Companys business, financial condition and results of operations could be adversely affected.
Risk factors related to the Companys business and relationships with third parties
If the management fee rate paid by the Exchange is reduced, if there is a significant decrease in
the amount of premiums written by the Exchange, or if the costs of providing services to the
Exchange are not controlled, revenues and profitability could be materially adversely affected.
The Company is dependent upon management fees paid by the Exchange, which represent the Companys
principal source of revenue. The management fee rate is determined by the board of directors and
may not exceed 25% of the direct written premiums of the Property and Casualty Group. The board of
directors sets the management fee rate each December for the following year. However, at their
discretion, the rate can be changed at any time. The factors considered by the board in setting the
management fee rate include the Companys financial position in relation to the Exchange and the
long-term needs of the Exchange for capital and surplus to support its continued growth and
competitiveness. If the board of directors determines that the management fee rate should be
reduced, the Companys revenues and profitability could be materially adversely affected.
Management fee revenue from the Exchange is calculated by multiplying the management fee rate by
the direct premiums written by the Exchange and the direct premiums written by the other members of
the Property and Casualty Group, which are assumed by the Exchange under an intercompany pooling
arrangement. Accordingly, any reduction in direct premiums written by the Property and Casualty
Group would have a proportional negative effect on the Companys revenues and net income.
Pursuant to the attorney-in-fact agreements with the policyholders of the Exchange, the Company is
appointed to perform certain services, regardless of the cost to the Company of providing those
services. These services relate to the sales, underwriting and issuance of policies on behalf of
the Exchange. The Company would lose money or be less profitable if the cost of providing those
services increases significantly.
The Company is subject to credit risk from the Exchange because the management fees from the
Exchange are not paid immediately when earned. The Companys property/casualty insurance
subsidiaries are subject to credit risk from the Exchange because the Exchange assumes a higher
insurance risk under an intercompany pooling arrangement than is proportional to its direct
business contribution to the pool.
The Company recognizes management fees due from the Exchange as income when the premiums are
written because at that time the Company has performed substantially all of services it is required
to perform, including sales, underwriting and policy issuance activities. However, such fees are
not paid to the Company by the Exchange until the Exchange collects the premiums from
policyholders. As a result, the Company holds receivables for management fees earned and due the
Company.
The Company also holds receivables from the Exchange for costs the Company pays on the Exchanges
behalf and for reinsurance under the intercompany pooling arrangement. The Companys total
receivable
9
from the Exchange, including the management fee, reimbursable costs the Company paid on behalf of
the Exchange and total amounts recoverable from the intercompany pool, totaled $1.2 billion or
37.2% of the Companys total assets at December 31, 2005.
Two of the Companys wholly-owned property/casualty insurance subsidiaries, Erie Insurance Company
and Erie Insurance Company of New York are parties to the intercompany pooling arrangement with the
Exchange. Under this pooling arrangement, the Companys insurance subsidiaries cede 100% of their
property/casualty underwriting business to the Exchange, which retrocedes 5% of the pooled business
to Erie Insurance Company and .5% to Erie Insurance Company of New York. In 2005, approximately 83%
of the pooled direct property/casualty business was originally generated by the Exchange and its
subsidiary, while 94.5% of the pooled business is retroceded to the Exchange under the intercompany
pooling arrangement. Accordingly, the Exchange assumes a higher insurance risk than is
proportional to the insurance business it contributes to the pool. In 2005, the Companys
insurance subsidiaries wrote 17% of the direct premiums, while assuming only 5.5% of the risk.
This poses a credit risk to the Companys property/casualty subsidiaries participating in the pool
as they retain the responsibility to their direct policyholders if the Exchange is unable to meet
its reinsurance obligations.
The financial condition of the Company may suffer because of declines in the value of the
securities held in the Companys investment portfolio that constitute a significant portion of the
Companys assets.
The Companys fixed income securities investments, which totaled $972 million at December 31, 2005
and comprised 31% of total assets, are exposed to price risk and to risk from changes in interest
rates as well as credit risk related to the issuer. The Company does not hedge its exposure to
interest rate risk as the Company has the ability to hold fixed income securities to maturity. The
Companys investment strategy achieves a balanced maturity schedule in order to moderate investment
income in the event of interest rate declines in a year in which a large amount of securities could
be redeemed or mature.
At December 31, 2005, the Company had investments in marketable securities of approximately $266
million and investments in limited partnerships of approximately $153 million, or 8.6% and 5.0% of
total assets, respectively. In addition, the Company is obligated to invest up to an additional
$243 million in limited partnerships, including in partnerships for U.S. and foreign private
equity, real estate and fixed income investments. All of the Companys marketable security
investments are subject to market volatility. The Companys marketable securities have exposure to
price risk and the volatility of the equity markets and general economic conditions.
To the extent that future market volatility negatively impacts our investments, our financial
condition will be negatively impacted.
The Company reviews the investment portfolio on a continuous basis to evaluate positions that might
have incurred other-than-temporary declines in value. The primary factors considered in the
Companys review of investment valuation include the extent and duration to which fair value is
less than cost, historical operating performance and financial condition of the issuer, near term
prospects of the issuer and its industry, specific events that occurred affecting the issuer and
the Companys ability and intent to retain the investment for a period of time sufficient to allow
for a recovery in value. If the Companys policy for determining the recognition of impaired
positions were different, the Companys Consolidated Statements of Financial Position and
Statements of Operations could be significantly impacted. See also Note 3 of the Notes to
Consolidated Financial Statements contained in the 2005 Annual Report.
10
The threat of terrorism and other actions may adversely affect the Companys investment portfolio
and as a result the Companys net income and shareholders equity.
The threat of terrorism, both within the United States and abroad, and heightened security measures
in response to these types of threats, may cause significant volatility and declines in the debt
and equity markets in the United States and around the world. In addition, some of the assets in
the Companys investment portfolio may be adversely affected by declines in the equity markets and
economic activity caused by the continued threat of terrorism, ongoing military and other actions
and heightened security measures. The Company cannot predict whether and the extent to which
industry sectors in which the Company maintains investments may suffer losses as a result of
potential decreased commercial and economic activity.
The Company can offer no assurances that the threats of future terrorist-like events in the United
States and abroad will not have a material adverse effect on the Companys business, financial
condition or results of operations.
Risk factors relating to the business of the Property and Casualty Group
The Property and Casualty Group faces significant competition from other regional and national
insurance companies which may result in lower revenues.
The Property and Casualty Group competes with regional and national property/casualty insurers
including direct writers of insurance coverage. Many of these competitors are larger and many have
greater financial, technical and operating resources. In addition, there is competition within
each insurance agency that represents other carriers as well as the Property and Casualty Group.
As discussed previously, the property/casualty insurance industry is highly competitive on the
basis of product, price and service. If competitors offer property/casualty products with more
coverage and/or better service, or offer lower premiums, the Property and Casualty Groups ability
to grow and renew its business may be adversely impacted.
The internet has also emerged as a growing method of distribution, both from existing competitors
using their brand to write business and from new competitors. If the Property and Casualty Groups
method of distribution does not include advancements in technology that meet consumer preferences,
its ability to grow and renew its business may be adversely impacted.
If the Erie Insurance Group is unable to keep pace with the rapidly developing technological
advancements in the insurance industry or to replace its legacy policy administration systems, the
ability of the Property & Casualty Group to compete effectively could be impaired.
Technological development is necessary to reduce the cost of operating the Company and the Property
& Casualty Group and to facilitate agents and
policyholders ability to do business with the Property
& Casualty Group. If the Erie Insurance Group is unable to keep pace with advancements being made
in technology, its ability to compete with other insurance companies who have advanced
technological capabilities will be negatively affected. Further, if the Erie Insurance Group is
unable to update or replace its legacy policy administration systems as they become obsolete or as
emerging technology renders them competitively inefficient, the
Property and Casualty Groups competitive position would
be adversely affected.
Premium rates and reserves must be established for members of the Property and Casualty Group from
forecasts of the ultimate costs expected to arise from risks underwritten during the policy period.
The Companys underwriting profitability could be adversely affected to the extent such premium
rates or reserves are too low.
One of the distinguishing features of the property and casualty insurance industry in general is
that its products are priced before its costs are known, as premium rates are generally determined
before losses are reported. Accordingly, premium rates must be established from forecasts of the
ultimate costs expected to arise from risks underwritten during the policy period and may not prove
to be adequate. Further, property and casualty insurers establish reserves for losses and loss
adjustment expenses based upon estimates, and it is possible that the ultimate liability will
exceed these estimates because of the future development of known losses, the existence of losses
that have occurred but are currently unreported and larger than historical settlements on pending
and unreported claims. The process of estimating reserves is inherently judgmental and can be
influenced by factors that are subject to variation.
11
If pricing or reserves established by a member of the Property and Casualty Group are not
sufficient, the Companys underwriting profitability may be adversely impacted.
The financial performance of members of the Property and Casualty Group could be adversely affected
by severe weather conditions or other catastrophic losses, including terrorism.
The Property and Casualty Group conducts business in only 11 states and the District of Columbia,
primarily in the mid-Atlantic, midwestern and southeastern portions of the United States. A
substantial portion of this business is private passenger and commercial automobile, homeowners and
workers compensation insurance in Ohio, Maryland, Virginia and particularly, Pennsylvania. As a
result, a single catastrophe occurrence, destructive weather pattern, general economic trend,
terrorist attack, regulatory development or other condition disproportionately affecting one or
more of the states in which the Property and Casualty Group conducts substantial business could
adversely affect the results of operations of members of the Property and Casualty Group.
Common natural catastrophe events include hurricanes, earthquakes, tornadoes, hail storms and
severe winter weather. The frequency and severity of these catastrophes is inherently
unpredictable. The extent of losses from a catastrophe is a function of both the total amount of
insured exposures in the area affected by the event and the severity of the event.
Actual terrorist attacks could cause losses from insurance claims related to the property/casualty
insurance operations, as well as a decrease in the Companys shareholders equity, net income or
revenue. The Terrorism Risk Insurance Act of 2005 requires that some coverage for terrorist loss
be offered by primary commercial property insurers and provides Federal assistance for recovery of
claims through 2007. While the Property and Casualty Group is exposed to terrorism losses in
commercial lines and workers compensation, these lines are afforded a limited backstop above
insurer deductibles for foreign acts of terrorism under this federal program. The Property and
Casualty Group has no personal lines terrorist coverage in place. The Property and Casualty Group
could incur large net losses if future terrorism attacks occur.
The Property and Casualty Group maintains a property catastrophe reinsurance treaty that was
renewed effective January 1, 2006 that provides coverage of 95% of a loss up to $400 million in
excess of the Property and Casualty Groups loss retention of $300 million per occurrence. This
treaty excludes losses from acts of terrorism. Nevertheless, catastrophe reinsurance may prove
inadequate if a major catastrophic loss exceeds the reinsurance limit which could adversely effect
the Companys underwriting profitability. The Company is particularly exposed to an Atlantic
hurricane in its homeowners lines of insurance in the states of North Carolina, Virginia, Maryland
and Pennsylvania.
The Property and Casualty Group depends on independent insurance agents, which exposes the Property
and Casualty Group to risks not applicable to companies with dedicated agents.
The Property and Casualty Group markets and sells its insurance products through independent,
non-exclusive agencies. These agencies are not obligated to sell only the Property and Casualty
Groups insurance products, and generally they also sell competitors insurance products. As a
result, the Property and Casualty Groups business depends in part on the marketing and sales
efforts of these agencies. To the extent these agencies marketing efforts cannot be maintained at
their current levels of volume or they bind the Property and Casualty Group to unacceptable
insurance risks, fail to comply with established underwriting guidelines or otherwise improperly
market the Property and Casualty Groups products, the results of operations and business of the
Property and Casualty Group could be adversely affected.
To the extent that business migrates to a delivery system other than independent agencies because
of changing consumer preferences, the business of the Property and Casualty Group could be
adversely affected. Also, to the extent the agencies choose to place significant or all of their
business with
12
competing insurance companies, the results of operations and business of the Property and Casualty
Group could be adversely affected.
If there were a failure to maintain a commercially acceptable financial strength rating, the
Property and Casualty Groups competitive position in the insurance industry would be adversely
affected.
Financial strength ratings are an important factor in establishing the competitive position of
insurance companies and may be expected to have an effect on an insurance companys sales. Higher
ratings generally indicate greater financial stability and a stronger ability to meet ongoing
obligations to policyholders. Ratings are assigned by rating agencies to insurers based upon
factors that they believe are relevant to policyholders. Currently the Property and Casualty
Groups pooled A.M. Best rating is an A+ (superior). A significant future downgrade in this or
other ratings would reduce the competitive position of the Property and Casualty Group making it
more difficult to attract profitable business in the highly competitive property/casualty insurance
market.
Changes in applicable insurance laws, regulations or changes in the way regulators administer those
laws or regulations could adversely change the Property and Casualty Groups operating environment
and increase its exposure to loss or put it at a competitive disadvantage.
Property and casualty insurers are subject to extensive supervision in the states in which they do
business. This regulatory oversight includes, by way of example, matters relating to licensing and
examination, rate setting, market conduct, policy forms, limitations on the nature and amount of
certain investments, claims practices, mandated participation in involuntary markets and guaranty
funds, reserve adequacy, insurer solvency, transactions between affiliates, the amount of dividends
that may be paid and restrictions on underwriting standards. Such regulation and supervision are
primarily for the benefit and protection of policyholders and not for the benefit of shareholders.
For instance, members of the Property and Casualty Group are subject to involuntary participation
in specified markets in various states in which it operates, and the rate levels the Property and
Casualty Group is permitted to charge do not always correspond with the underlying costs associated
with the coverage issued. Although the federal government does not directly regulate the insurance
industry, federal initiatives, such as federal terrorism backstop legislation, from time to time,
also can impact the insurance industry.
The ability of the Company to attract, develop and retain talented employees, managers and
executives is critical to the Companys success.
The Companys success depends on its ability to attract, develop and retain talented employees,
including executives and other key management. The companys loss of certain key officers and
employees or the failure to attract and develop talented new executives and management could have
an adverse effect on the Companys business.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995: Certain
forward-looking statements contained herein involve risks and uncertainties. These statements
include certain discussions relating to management fee revenue, cost of management operations,
underwriting, premium and investment income volume, business strategies, profitability and business
relationships and the Companys other business activities during 2005 and beyond. In some cases,
you can identify forward-looking statements by terms such as may, will, should, could,
would, expect, plan, intend, anticipate, believe, estimate, project, predict,
potential and similar expressions. These forward-looking statements reflect the Companys current
views about future events, are based on assumptions and are subject to known and unknown risks and
uncertainties that may cause results to differ materially from those anticipated in those
statements. Many of the factors that will determine future events or achievements are beyond our
ability to control or predict.
13
Item 1B. Unresolved SEC Comments
None.
Item 2. Properties
The member companies of the Erie Insurance Group (the Company and its subsidiaries, the Exchange
and its subsidiary and EFL) share a corporate home office complex in Erie, Pennsylvania, which is
comprised of 496,160 square feet. The home office complex is owned by the Exchange. The Company is
charged rent expense for the related square footage it occupies.
The Company also operates 23 field offices, including the Erie branch office, in 11 states.
Eighteen of these offices provide both agency support and claims services and are referred to as
Branch Offices, while the remaining five provide only claims services and are considered Claims
Offices. The Company owns three of its field offices. Three other field offices are owned by the
Exchange and leased to the Company. The rent expense incurred by the Company for both the home
office complex and the field offices leased from the Exchange totaled $10.3 million in 2005.
One field office is owned by EFL and leased to the Company. The rent expense for the field office
leased from EFL was $.3 million in 2005.
The remaining 16 field offices are leased from various unaffiliated parties. In addition to these
field offices, the Company leases a warehouse facility from an unaffiliated party. During 2003, the
Company entered into a lease for a building in the vicinity of the home office complex. This
additional space is used to house certain home office employees. During 2005, the Company entered
into a lease for office space for its corporate financial personnel. Total lease payments to
external parties amounted to $2.8 million in 2005. Lease commitments for these properties expire
periodically through 2011.
The total operating expense, including rent expense, for all office space occupied by the Company
in 2005 was $20.1 million. This amount was reduced by allocations to the Property and Casualty
Group of $13.9 million for claims operations. The net amount after allocations is reflected in the
Companys cost of management operations.
Item 3. Legal Proceedings
Information concerning the legal proceedings of the Company is incorporated by reference to the
section Legal Proceedings in the Companys definitive Proxy Statement with respect to the
Companys Annual Meeting of Shareholders to be held on April 18, 2006 to be filed with the SEC
within 120 days of December 31, 2005 (the Proxy Statement).
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of 2005.
14
PART II
Item 5. Market for Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Reference is made to Market Price of and Dividends on Common Stock and Related Shareholder
Matters in the 2005 Annual Report, for information regarding the high and low sales prices for the
Companys stock and additional information regarding such stock of the Company.
Issuer Purchases of Equity Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Approximate |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dollar Value |
|
|
|
|
|
|
|
|
|
|
|
Total Number of |
|
|
of Shares that |
|
|
|
Total Number |
|
|
Average |
|
|
Shares Purchased |
|
|
May Yet Be |
|
|
|
of Shares |
|
|
Price Paid |
|
|
as Part of Publicly |
|
|
Purchased Under |
|
Period |
|
Purchased |
|
|
Per share |
|
|
Announced Plan |
|
|
the Plan |
|
October 1 31, 2005 |
|
|
367,552 |
|
|
$ |
52.68 |
|
|
|
365,178 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 1 30, 2005 |
|
|
331,482 |
|
|
|
52.73 |
|
|
|
331,482 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 1 31, 2005 |
|
|
288,696 |
|
|
|
52.97 |
|
|
|
288,696 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
987,730 |
|
|
$ |
52.78 |
|
|
|
985,356 |
|
|
$ |
97,000,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The month of October 2005 includes shares that vested under the stock compensation plan for the
Companys outside directors of 2,374. Included in this amount are the vesting of 2,216 of awards
previously granted and 158 dividend equivalent shares that vest as they are granted (as dividends
are declared by the Company).
Item 6. Selected Consolidated Financial Data
Reference is made to Selected Consolidated Financial Data in the 2005 Annual Report.
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
Reference is made to Managements Discussion and Analysis of Financial Condition and Results of
Operations in the 2005 Annual Report.
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
Reference is made to Managements Discussion and Analysis of Financial Condition and Results of
Operations in the 2005 Annual Report.
Item 8. Financial Statements and Supplementary Data
Reference is made to the Consolidated Financial Statements and the Quarterly Results of
Operations contained in the Notes to Consolidated Financial Statements in the 2005 Annual
Report.
15
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosures
None.
Item 9A. Controls and Procedures
Management is responsible for establishing and maintaining adequate internal control over financial
reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with
the participation of our management, including our Chief Executive Officer and Chief Financial
Officer, we conducted an evaluation of the effectiveness of our internal control over financial
reporting based on framework in Internal Control Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework
in Internal Control Integrated Framework, management concluded that our internal control over
financial reporting was effective as of December 31, 2005.
Managements annual report on internal control over financial reporting and the attestation report
of the Companys registered public accounting firm are included in Exhibit 13 under the headings
Report of Management on Internal Control Over Financial Reporting and Report of Independent
Registered Public Accounting Firm, respectively, and incorporated herein by reference.
Item 9B. Other Information
There was no information required to be reported in a report of Form 8-K during the fourth quarter
of 2005 that has not been reported.
16
PART III
Item 10. Directors and Executive Officers of the Registrant
The information with respect to directors, audit committee, and audit committee financial experts
of the Company and Section 16(a) beneficial ownership reporting compliance, is incorporated herein
by reference to the Companys definitive Proxy Statement relating to the Companys Annual Meeting
of Shareholders to be held on April 18, 2006 to be filed with the SEC within 120 days of December
31, 2005 in response to this item.
The Company has adopted a code of conduct that applies to all of its directors, officers (including
its chief executive officer, chief financial officer, chief accounting officer and any person
performing similar functions) and employees. The Company previously filed a copy of this Code of
Conduct as Exhibit 14 to the Registrants 2003 Form 10K Annual Report as filed with the SEC on
March 4, 2004. The Company has also made the Code of Conduct available on its website at
http://www.erieinsurance.com.
Certain information as to the executive officers of the Company is as follows:
|
|
|
|
|
|
|
|
|
Age |
|
Principal Occupation for Past |
|
|
as of |
|
Five Years and Positions with |
Name |
|
12/31/05 |
|
Erie Insurance Group |
|
President & Chief
Executive Officer |
|
|
|
|
|
|
|
|
|
|
|
|
|
Jeffrey A. Ludrof
|
|
|
46 |
|
|
President and Chief Executive
Officer of the Company, Erie
Family Life Insurance Company
(EFL), Erie Insurance Company,
Flagship City Insurance Company
(Flagship), Erie Insurance Company
of New York (Erie NY), and Erie
Insurance Property and Casualty
Company (Erie P&C) since May 8,
2002. Executive Vice
PresidentInsurance Operations of
the Company, Erie Insurance Co.,
Flagship, Erie P&C, and Erie NY
1999May 8, 2002; Senior Vice
President of the Company
19941999. |
|
|
|
|
|
|
|
Executive Vice Presidents |
|
|
|
|
|
|
|
|
|
|
|
|
|
Jan R. Van Gorder, Esq.
|
|
|
58 |
|
|
Senior Executive Vice President,
Secretary and General Counsel of
the Company, EFL and Erie
Insurance Co. since 1990, and of
Flagship and Erie P&C since 1992
and 1993, respectively, and of
Erie NY since 1994; Senior Vice
President, Secretary and General
Counsel of the Company, EFL and
Erie Insurance Co. for more than
five years prior thereto;
Director, Erie NY, Flagship
and Erie P&C. |
|
|
|
|
|
|
|
John J. Brinling, Jr.
|
|
|
58 |
|
|
Executive Vice President of Erie
Family Life Insurance Company
since December 1990. Division
Officer 1984Present; Director,
Erie NY. |
17
|
|
|
|
|
|
|
|
|
Age |
|
Principal Occupation for Past |
|
|
as of |
|
Five Years and Positions with |
Name |
|
12/31/05 |
|
Erie Insurance Group |
Philip A. Garcia
|
|
|
49 |
|
|
Executive Vice President and Chief
Financial Officer since 1997;
Senior Vice President and
Controller 19931997. Director,
the Erie NY, Flagship and Erie
P&C. |
|
|
|
|
|
|
|
Michael J. Krahe
|
|
|
52 |
|
|
Executive Vice PresidentHuman
Development and Leadership since
January 2003; Senior Vice
President 1999December 2002; Vice
President 19941999. Director,
the Erie NY, Flagship and Erie
P&C. |
|
|
|
|
|
|
|
Thomas B. Morgan
|
|
|
42 |
|
|
Executive Vice PresidentInsurance
Operations since January 2003;
Senior Vice President October
2000 December 2002; Assistant
Vice President and Branch Manager
1997October 2001; Director, Erie
NY, Erie P&C and Flagship. |
|
|
|
|
|
|
|
Senior
Vice President |
|
|
|
|
|
|
|
|
|
|
|
|
|
Douglas F. Ziegler
|
|
|
55 |
|
|
Senior Vice President, Treasurer
and Chief Investment Officer since
1993. Director, the Erie NY,
Flagship and Erie P&C. |
Item 11. Executive Compensation
The answer to this item is incorporated by reference to the Companys definitive Proxy Statement
relating to the Annual Meeting of Shareholders to be held on April 18, 2006, except for the
Performance Graph, which has not been incorporated herein by reference, to be filed with the SEC
within 120 days of December 31, 2005.
|
|
|
Item 12. |
|
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters |
The information with respect to security ownership of certain beneficial owners and management and
securities authorized for issuance under equity compensation plans, is incorporated by reference to
the Companys definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held
on April 18, 2006 to be filed with the SEC within 120 days of December 31, 2005.
As of February 17, 2006, there were approximately 1,052 beneficial shareholders of record of the
Companys Class A non-voting common stock and 20 beneficial shareholders of record of the Companys
Class B voting common stock.
Item 13. Certain Relationships and Related Transactions
The Companys earnings are largely generated from fees based on the direct written premium of the
Exchange in addition to the direct written premium of the other members of the Property and
Casualty Group. Also, the Companys property and casualty insurance subsidiaries participate in the
underwriting results of the Exchange via the pooling arrangement. As the Companys operations are
interrelated with the operations of the Exchange, the Companys results of operations are largely
dependent on the success of the Exchange. Reference is made to Note 15 of the Notes to
Consolidated Financial Statements in the 2005 Annual Report, for a further discussion of the
financial results of the Exchange.
18
Reference is also made to Note 13 of the Notes to Consolidated Financial Statements in the 2005
Annual Report, for a complete discussion of related party
transactions.
Information with respect to certain relationships with Company directors is incorporated by
reference to the Companys definitive Proxy Statement relating to the Annual Meeting of
Shareholders to be held on April 18, 2006 to be filed with the SEC within 120 days of December 31,
2005.
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated by reference to the Companys definitive
Proxy Statement relating to the Annual Meeting of Shareholders to be held on April 18, 2006, to be
filed with the SEC within 120 days of December 31, 2005.
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Financial statements, financial statement schedules and exhibits filed:
(1) Consolidated Financial Statements
|
|
|
|
|
|
|
Page* |
|
Erie Indemnity Company and Subsidiaries: |
|
|
|
|
|
Report of Independent Registered Public Accounting Firm on the
Consolidated Financial Statements |
|
|
56 |
|
|
Consolidated Statements of Operations for the three years ended
December 31, 2005, 2004 and 2003 |
|
|
57 |
|
|
Consolidated Statements of Financial Position as of December 31, 2005 and 2004 |
|
|
58 |
|
|
Consolidated Statements of Cash Flows for the three years ended
December 31, 2005, 2004 and 2003 |
|
|
59 |
|
|
Consolidated Statements of Shareholders Equity for the three years
Ended December 31, 2005, 2004 and 2003 |
|
|
60 |
|
|
Notes to Consolidated Financial Statements |
|
|
61 |
|
(2) Financial Statement Schedules
|
|
|
|
|
Erie Indemnity Company and Subsidiaries: |
|
|
|
|
|
Schedule I. Summary of Investments Other than Investments
in Related Parties |
|
|
21 |
|
|
Schedule IV. Reinsurance |
|
|
22 |
|
|
Schedule VI. Supplemental Information Concerning Property/Casualty
Insurance Operations |
|
|
23 |
|
All other schedules have been omitted since they are not required, not applicable or the
information is included in the financial statements or notes thereto.
* Refers to the respective page of Erie Indemnity Companys 2005 Annual Report to Shareholders. The
Consolidated Financial Statements and Notes to Consolidated Financial Statements and Auditors
Report thereon on pages 40 to 70 are incorporated by reference. With the exception of the portions
of such Annual Report specifically incorporated by reference in this Item and Items 1, 5, 6, 7, 7a,
8 and 13, such Annual Report shall not be deemed filed as part of this Form 10-K Report or
otherwise subject to the liabilities of Section 18 of the Securities Exchange Act of 1934.
(3)
Exhibits See Exhibit Index on page 25 hereof.
19
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
|
|
|
February 22, 2006
|
|
ERIE INDEMNITY COMPANY |
|
|
(Registrant) |
/s/ Jeffrey A. Ludrof
Jeffrey A. Ludrof, President and CEO (principal executive officer)
/s/ Jan R. Van Gorder
Jan R. Van Gorder, Executive Vice President, Secretary & General Counsel
/s/ Philip A. Garcia
Philip A. Garcia, Executive Vice President & CFO (principal financial officer)
/s/ Timothy G. NeCastro
Timothy G. NeCastro,
Senior Vice President & Controller (principal accounting officer)
Board of Directors
|
|
|
|
|
/s/ Kaj Ahlmann
|
|
|
|
/s/ Susan Hirt Hagen |
|
|
|
|
|
Kaj Ahlmann
|
|
|
|
Susan Hirt Hagen |
|
|
|
|
|
/s/ John T. Baily
|
|
|
|
/s/ C. Scott Hartz |
|
|
|
|
|
John T. Baily
|
|
|
|
C. Scott Hartz |
|
|
|
|
|
/s/ J. Ralph Borneman, Jr.
|
|
|
|
/s/ F. William Hirt |
|
|
|
|
|
J. Ralph Borneman, Jr.
|
|
|
|
F. William Hirt |
|
|
|
|
|
/s/ Wilson C. Cooney
|
|
|
|
/s/ Claude C. Lilly, III |
|
|
|
|
|
Wilson C. Cooney
|
|
|
|
Claude C. Lilly, III |
|
|
|
|
|
/s/ Patricia Garrison-Corbin
|
|
|
|
/s/ Jeffrey A. Ludrof |
|
|
|
|
|
Patricia Garrison-Corbin
|
|
|
|
Jeffrey A. Ludrof |
|
|
|
|
|
/s/ John R. Graham
|
|
|
|
/s/ Robert C. Wilburn |
|
|
|
|
|
John R. Graham
|
|
|
|
Robert C. Wilburn |
|
|
|
|
|
/s/ Jonathan Hagen |
|
|
|
|
|
|
|
|
|
Jonathan Hagen |
|
|
|
|
20
SCHEDULE I SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount at which |
|
|
|
|
|
|
|
|
|
|
|
Shown in the |
|
|
|
Cost or |
|
|
|
|
|
|
Consolidated |
|
|
|
Amortized |
|
|
Fair |
|
|
Statements of |
|
Type of Investment |
|
Cost |
|
|
Value |
|
|
Financial Position |
|
(In Thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasuries & government
agencies |
|
$ |
9,583 |
|
|
$ |
9,735 |
|
|
$ |
9,735 |
|
States & political subdivisions |
|
|
145,528 |
|
|
|
145,807 |
|
|
|
145,807 |
|
Special revenue |
|
|
195,059 |
|
|
|
195,745 |
|
|
|
195,745 |
|
Public utilities |
|
|
66,866 |
|
|
|
69,609 |
|
|
|
69,609 |
|
U.S. industrial & miscellaneous |
|
|
353,843 |
|
|
|
355,719 |
|
|
|
355,719 |
|
Mortgage-backed securities |
|
|
32,251 |
|
|
|
32,626 |
|
|
|
32,626 |
|
Asset-backed securities |
|
|
22,117 |
|
|
|
21,717 |
|
|
|
21,717 |
|
Foreign |
|
|
106,445 |
|
|
|
109,401 |
|
|
|
109,401 |
|
Redeemable preferred stock |
|
|
30,628 |
|
|
|
31,851 |
|
|
|
31,851 |
|
Equity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Common stock: |
|
|
|
|
|
|
|
|
|
|
|
|
Public utilities |
|
|
1,313 |
|
|
|
1,473 |
|
|
|
1,473 |
|
U.S. banks, trusts & insurance
companies |
|
|
10,783 |
|
|
|
12,025 |
|
|
|
12,025 |
|
U.S. industrial & miscellaneous |
|
|
53,713 |
|
|
|
60,782 |
|
|
|
60,782 |
|
Foreign |
|
|
18,950 |
|
|
|
21,281 |
|
|
|
21,281 |
|
Nonredeemable preferred stock: |
|
|
|
|
|
|
|
|
|
|
|
|
Public utilities |
|
|
26,266 |
|
|
|
26,103 |
|
|
|
26,103 |
|
U.S. banks, trusts & insurance
companies |
|
|
64,632 |
|
|
|
66,836 |
|
|
|
66,836 |
|
U.S. industrial & miscellaneous |
|
|
62,552 |
|
|
|
65,611 |
|
|
|
65,611 |
|
Foreign |
|
|
11,231 |
|
|
|
12,223 |
|
|
|
12,223 |
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
and equity securities |
|
$ |
1,211,760 |
|
|
$ |
1,238,544 |
|
|
$ |
1,238,544 |
|
|
|
|
|
|
|
|
|
|
|
Real estate mortgage loans |
|
|
4,885 |
|
|
|
4,885 |
|
|
|
4,885 |
|
Limited partnerships |
|
|
141,405 |
|
|
|
153,159 |
|
|
|
153,159 |
|
|
|
|
|
|
|
|
|
|
|
Total investments |
|
$ |
1,358,050 |
|
|
$ |
1,396,588 |
|
|
$ |
1,396,588 |
|
|
|
|
|
|
|
|
|
|
|
21
SCHEDULE IV REINSURANCE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage |
|
|
|
|
|
|
|
Ceded to |
|
|
Assumed |
|
|
|
|
|
|
of Amount |
|
|
|
|
|
|
|
Other |
|
|
From Other |
|
|
Net |
|
|
Assumed |
|
(In Thousands) |
|
Direct |
|
|
Companies |
|
|
Companies |
|
|
Amount |
|
|
to Net |
|
|
|
|
December 31, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums for the year |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Liability Insurance |
|
$ |
704,366 |
|
|
$ |
714,787 |
|
|
$ |
226,245 |
|
|
$ |
215,824 |
|
|
|
104.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums for the year |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Liability Insurance |
|
$ |
699,533 |
|
|
$ |
717,236 |
|
|
$ |
225,905 |
|
|
$ |
208,202 |
|
|
|
108.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums for the year |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Liability Insurance |
|
$ |
644,286 |
|
|
$ |
654,841 |
|
|
$ |
202,147 |
|
|
$ |
191,592 |
|
|
|
105.5 |
% |
|
|
|
22
SCHEDULE VI SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred |
|
|
|
|
|
|
|
|
|
|
|
|
|
Policy |
|
|
|
|
|
|
Discount, if |
|
|
|
|
|
|
Acquisition |
|
|
Reserves for |
|
|
any deducted |
|
|
Unearned |
|
|
|
Costs |
|
|
Unpaid Loss & LAE |
|
|
from reserves* |
|
|
Premiums |
|
(In Thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
@ 12/31/05 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated P&C Entities |
|
$ |
16,436 |
|
|
$ |
1,019,459 |
|
|
$ |
4,582 |
|
|
$ |
454,409 |
|
Unconsolidated P&C Entities |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Proportionate share of
registrant & subsidiaries |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
Total |
|
$ |
16,436 |
|
|
$ |
1,019,459 |
|
|
$ |
4,582 |
|
|
$ |
454,409 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
@ 12/31/04 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated P&C Entities |
|
$ |
17,112 |
|
|
$ |
943,034 |
|
|
$ |
4,094 |
|
|
$ |
472,553 |
|
Unconsolidated P&C Entities |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Proportionate share of
registrant & subsidiaries |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
Total |
|
$ |
17,112 |
|
|
$ |
943,034 |
|
|
$ |
4,094 |
|
|
$ |
472,553 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
@ 12/31/03 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated P&C Entities |
|
$ |
16,761 |
|
|
$ |
845,536 |
|
|
$ |
3,303 |
|
|
$ |
449,606 |
|
Unconsolidated P&C Entities |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Proportionate share of
registrant & subsidiaries |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
Total |
|
$ |
16,761 |
|
|
$ |
845,536 |
|
|
$ |
3,303 |
|
|
$ |
449,606 |
|
|
|
|
|
|
|
* |
|
Workers compensation case and incurred but not reported (IBNR) loss and loss adjustment reserves
were discounted at 2.5% for all years presented.
|
23
SCHEDULE VI SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS (CONTINUED)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and Loss |
|
|
Adjustment Expense |
|
|
Amortization |
|
|
|
|
|
|
|
|
|
|
|
|
Net |
|
|
Incurred |
|
|
Related to |
|
|
of Deferred |
|
|
Net |
|
|
|
|
|
|
Earned |
|
|
Investment |
|
|
(1) |
|
|
(2) |
|
|
Policy |
|
|
Loss & LAE |
|
|
Premiums |
|
|
|
Premiums |
|
|
Income |
|
|
Current Year |
|
|
Prior Years |
|
|
Acquisition Costs |
|
|
Paid |
|
|
Written |
|
(In Thousands) |
|
|
@ 12/31/05 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated P&C Entities |
|
$215,824 |
|
|
$ |
20,267 |
|
|
$ |
146,312 |
|
|
|
($5,927 |
) |
|
$ |
34,227 |
|
|
$ |
126,314 |
|
|
$ |
214,149 |
|
Unconsolidated P&C Entities |
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Proportionate share of
registrant & subsidiaries |
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
Total |
|
$215,824 |
|
|
$ |
20,267 |
|
|
$ |
146,312 |
|
|
|
($5,927 |
) |
|
$ |
34,227 |
|
|
$ |
126,314 |
|
|
$ |
214,149 |
|
|
|
|
|
@ 12/31/04 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated P&C Entities |
|
$208,202 |
|
|
$ |
22,470 |
|
|
$ |
153,563 |
|
|
|
($343 |
) |
|
$ |
34,341 |
|
|
$ |
133,466 |
|
|
$ |
216,398 |
|
Unconsolidated P&C Entities |
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Proportionate share of
registrant & subsidiaries |
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
Total |
|
$208,202 |
|
|
$ |
22,470 |
|
|
$ |
153,563 |
|
|
|
($343 |
) |
|
$ |
34,341 |
|
|
$ |
133,466 |
|
|
$ |
216,398 |
|
|
|
|
|
@ 12/31/03 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated P&C Entities |
|
$191,592 |
|
|
$ |
23,398 |
|
|
$ |
154,816 |
|
|
|
($1,832 |
) |
|
$ |
38,647 |
|
|
$ |
134,365 |
|
|
$ |
204,694 |
|
Unconsolidated P&C Entities |
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Proportionate share of
registrant & subsidiaries |
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
Total |
|
$191,592 |
|
|
$ |
23,398 |
|
|
$ |
154,816 |
|
|
|
($1,832 |
) |
|
$ |
38,647 |
|
|
$ |
134,365 |
|
|
$ |
204,694 |
|
|
|
|
24
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
|
|
|
|
|
|
|
|
|
Sequentially |
Exhibit |
|
|
|
Numbered |
Number |
|
Description of Exhibit |
|
Page |
3.5$
|
|
Amended and Restated By-laws of Registrant Section 2.07(a) effective
September 9, 2003 |
|
|
|
|
|
|
|
10.67@@@
|
|
Addendum to Aggregate Excess of Loss Reinsurance Contract effective
January 1, 2003 between Erie Insurance Exchange, by and through its
Attorney-in-Fact, Erie Indemnity Company and Erie Insurance Company
and its wholly-owned subsidiary Erie Insurance Company of New York |
|
|
|
|
|
|
|
10.68$$
|
|
Addendum to Aggregate Excess of Loss Reinsurance Contract effective
January 1, 2004 between Erie Insurance Exchange, by and through its
Attorney-in-Fact, Erie Indemnity Company and Erie Insurance Company
and its wholly-owned subsidiary Erie
Insurance Company of New York |
|
|
|
|
|
|
|
10.69$$
|
|
Addendum to Employment Agreement effective December 12, 2003 by
and between Erie Indemnity Company and John J. Brinling, Jr. |
|
|
|
|
|
|
|
10.70$$
|
|
Addendum to Employment Agreement effective December 12, 2003 by
and between Erie Indemnity Company and Thomas B. Morgan |
|
|
|
|
|
|
|
10.71$$
|
|
Addendum to Employment Agreement effective December 12, 2003 by
and between Erie Indemnity Company and Michael J. Krahe |
|
|
|
|
|
|
|
10.72$$
|
|
Addendum to Employment Agreement effective December 12, 2003 by
and between Erie Indemnity Company and Jeffrey A. Ludrof |
|
|
|
|
|
|
|
10.73$$
|
|
Addendum to Employment Agreement effective December 12, 2003 by
and between Erie Indemnity Company and Philip A. Garcia |
|
|
|
|
|
|
|
10.74$$
|
|
Addendum to Employment Agreement effective December 12, 2003 by
and between Erie Indemnity Company and Jan R. Van Gorder |
|
|
|
|
|
|
|
10.75$$
|
|
Addendum to Employment Agreement effective December 12, 2003 by
and between Erie Indemnity Company and Douglas F. Ziegler |
|
|
|
|
|
|
|
10.76$$
|
|
Insurance bonus agreement effective December 23, 2003 by and between
Erie Indemnity Company and Jeffrey A. Ludrof |
|
|
|
|
|
|
|
10.77$$
|
|
Insurance bonus agreement effective December 23, 2003 by and between
Erie Indemnity Company and Jeffrey A. Ludrof |
|
|
|
|
|
|
|
10.78$$
|
|
Insurance bonus agreement effective December 23, 2003 by and between
Erie Indemnity Company and John J. Brinling, Jr. |
|
|
|
|
|
|
|
10.79$$
|
|
Insurance bonus agreement effective December 23,
2003 by and between Erie Indemnity Company and Jan R. Van Gorder |
|
|
|
|
|
|
|
10.80$$
|
|
Insurance bonus agreement effective December 23, 2003 by and between
Erie Indemnity Company and Michael J. Krahe |
|
|
|
|
|
|
|
10.81$$
|
|
Insurance bonus agreement effective December 23, 2003 by and between
Erie Indemnity Company and Philip A. Garcia |
|
|
25
|
|
|
|
|
|
|
|
|
|
|
Sequentially |
Exhibit |
|
|
|
Numbered |
Number |
|
Description of Exhibit |
|
Page |
10.82$$
|
|
Insurance bonus agreement effective December 23, 2003 by and between
Erie Indemnity Company and Thomas B. Morgan |
|
|
|
|
|
|
|
|
|
|
|
10.83$$$
|
|
Annual Incentive Plan effective March 2, 2004 |
|
|
|
|
|
|
|
|
|
|
|
10.84$$$
|
|
Long-term Incentive Plan effective March 2, 2004 |
|
|
|
|
|
|
|
|
|
|
|
10.85
|
|
Termination of Aggregate Excess of Loss Reinsurance Contract effective December
31, 2005 between Erie Insurance Exchange, by and through its Attorney-In-Fact,
Erie Indemnity Company and Erie Insurance Company and its wholly-owned subsidiary
Erie Insurance Company of New York
|
|
|
27 |
|
|
|
|
|
|
|
|
13
|
|
2005 Annual Report to Shareholders Reference is made to the Annual Report
furnished to the Commission, herewith
|
|
|
28 |
|
|
|
|
|
|
|
|
14$$
|
|
Code of Conduct |
|
|
|
|
|
|
|
|
|
|
|
21
|
|
Subsidiaries of Registrant
|
|
|
88 |
|
|
|
|
|
|
|
|
23
|
|
Consent of Independent Registered Public Accounting Firm
|
|
|
89 |
|
|
|
|
|
|
|
|
31.1
|
|
Certification of Chief Executive Officer pursuant to
Section 302 of the SarbanesOxley Act of 2002
|
|
|
90 |
|
|
|
|
|
|
|
|
31.2
|
|
Certification of Chief Financial Officer pursuant to
Section 302 of the SarbanesOxley Act of 2002
|
|
|
91 |
|
|
|
|
|
|
|
|
32
|
|
Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the SarbanesOxley Act of 2002
|
|
|
92 |
|
|
|
|
@@@
|
|
Such exhibit is incorporated by reference to the like titled exhibit in the Registrants Form 10-Q quarterly report for the quarter ended March 31, 2003
that was filed with the Commission on April 24, 2003. |
|
|
|
$
|
|
Such exhibit is incorporated by reference to the like titled exhibit in the Registrants Form 10-Q quarterly report for the quarter ended September 30,
2003 that was filed with the Commission on October 29, 2003. |
|
|
|
$$
|
|
Such exhibit is incorporated by reference to the like titled exhibit in the Registrants Form 10-K annual report for the year ended December 31, 2003
that was filed with the Commission on March 4, 2004. |
|
|
|
$$$
|
|
Such exhibit is incorporated by reference to the like titled exhibit in the Registrants Form
10-K annual report for the year ended December 31, 2004 that was filed with the Commission on March
4, 2005. |
26
EX-10.85
Exhibit 10.85
Erie Insurance Company and Erie Insurance Company of New York
Erie, Pennsylvania
AGGREGATE EXCESS OF LOSS REINSURANCE
ADDENDUM NO. 5
TERMINATION ADDENDUM
Amendment to the REINSURANCE CONTRACT made the first day of January, 1998, between ERIE INSURANCE
EXCHANGE, by and through its Attorney-in-Fact, ERIE INDEMNITY COMPANY, of Erie, Pennsylvania,
(hereafter called the REINSURER), and ERIE INSURANCE COMPANY and its wholly owned subsidiary ERIE
INSURANCE COMPANY OF NEW YORK, both of Erie, Pennsylvania (herein referred to collectively (or
individually as the context requires) as the COMPANY)
It is understood and agreed that this Reinsurance Contract shall be terminated on December 31,
2005, in accordance with Article 18 Termination.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly
authorized representatives.
In Erie, Pennsylvania, this 8th day of November, 2005.
|
|
|
|
|
ATTEST:
|
|
ERIE INSURANCE COMPANY |
|
|
|
|
|
|
|
/s/ Margaret Porter
|
|
/s/ J.R. Van Gorder |
|
|
|
|
|
|
|
|
|
J. R. Van Gorder |
|
|
|
|
Sr. Exec. V.P., Secretary & General Counsel |
|
|
|
|
|
|
|
|
|
ERIE INSURANCE COMPANY |
|
|
ATTEST:
|
|
OF NEW YORK |
|
|
/s/ Margaret Porter
|
|
/s/ Philip A. Garcia |
|
|
|
|
|
|
|
|
|
Philip A. Garcia |
|
|
|
|
Executive Vice President & CFO |
|
|
|
|
|
|
|
|
|
ERIE INSURANCE EXCHANGE, by |
|
|
|
|
ERIE INDEMNITY COMPANY, |
|
|
ATTEST:
|
|
Attorney-in-Fact |
|
|
|
|
|
|
|
/s/ Margaret Porter
|
|
/s/ Michael S. Zavasky |
|
|
|
|
|
|
|
|
|
Michael S. Zavasky |
|
|
|
|
Senior Vice President |
|
|
27
EX-13
Exhibit 13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
|
|
|
(amounts in thousands, except per share data) |
|
|
|
|
2005 |
|
|
|
2004 |
|
|
|
2003 |
|
|
|
2002 |
|
|
|
2001 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating data |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenue |
|
|
$ |
1,124,950 |
|
|
|
$ |
1,123,144 |
|
|
|
$ |
1,048,788 |
|
|
|
$ |
920,723 |
|
|
|
$ |
764,938 |
|
Total operating expenses |
|
|
|
900,731 |
|
|
|
|
884,916 |
|
|
|
|
820,478 |
|
|
|
|
705,871 |
|
|
|
|
600,833 |
|
Total investment incomeunaffiliated |
|
|
|
115,237 |
|
|
|
|
88,119 |
|
|
|
|
66,743 |
|
|
|
|
40,549 |
|
|
|
|
17,998 |
|
Provision for income taxes |
|
|
|
111,733 |
|
|
|
|
105,140 |
|
|
|
|
102,237 |
|
|
|
|
84,886 |
|
|
|
|
60,561 |
|
Equity in earnings of Erie Family Life
Insurance, net of tax |
|
|
|
3,381 |
|
|
|
|
5,206 |
|
|
|
|
6,909 |
|
|
|
|
1,611 |
|
|
|
|
719 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
$ |
231,104 |
|
|
|
$ |
226,413 |
|
|
|
$ |
199,725 |
|
|
|
$ |
172,126 |
|
|
|
$ |
122,261 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per
share data |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share-diluted |
|
|
$ |
3.34 |
|
|
|
$ |
3.21 |
|
|
|
$ |
2.81 |
|
|
|
$ |
2.41 |
|
|
|
$ |
1.71 |
|
Book value per shareClass A common
and equivalent B shares |
|
|
|
18.81 |
|
|
|
|
18.14 |
|
|
|
|
16.40 |
|
|
|
|
13.91 |
|
|
|
|
12.15 |
|
Dividends declared per Class A share |
|
|
|
1.335 |
|
|
|
|
0.970 |
|
|
|
|
0.785 |
|
|
|
|
0.700 |
|
|
|
|
0.6275 |
|
Dividends declared per Class B share |
|
|
|
200.25 |
|
|
|
|
145.50 |
|
|
|
|
117.75 |
|
|
|
|
105.00 |
|
|
|
|
94.125 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial
position data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments (1) |
|
|
$ |
1,452,431 |
|
|
|
$ |
1,371,442 |
|
|
|
$ |
1,241,236 |
|
|
|
$ |
1,047,304 |
|
|
|
$ |
885,650 |
|
Recoverables from the
Exchange and affiliates |
|
|
|
1,176,419 |
|
|
|
|
1,144,625 |
|
|
|
|
1,024,146 |
|
|
|
|
844,049 |
|
|
|
|
655,655 |
|
Total assets |
|
|
|
3,101,261 |
|
|
|
|
2,982,804 |
|
|
|
|
2,756,329 |
|
|
|
|
2,359,545 |
|
|
|
|
1,985,568 |
|
Shareholders equity |
|
|
|
1,278,602 |
|
|
|
|
1,266,881 |
|
|
|
|
1,164,170 |
|
|
|
|
987,372 |
|
|
|
|
865,255 |
|
Cumulative number of shares
repurchased at December 31 |
|
|
|
6,438 |
|
|
|
|
4,548 |
|
|
|
|
3,403 |
|
|
|
|
3,403 |
|
|
|
|
3,196 |
|
|
|
|
(1) |
|
Includes investment in Erie Family Life Insurance Company. |
28
The following discussion and analysis should be read in conjunction with the audited financial
statements and related notes found on pages 4273 as they contain important information helpful in
evaluating the Companys operating results and financial condition. The discussions below also
focus heavily on the Companys three primary segments: management operations, insurance
underwriting operations and investment operations. The segment basis financial results presented
throughout Managements Discussion & Analysis herein are those which management uses internally to
monitor and evaluate results and are a supplemental presentation of the Companys Consolidated
Statements of Operations.
Erie Indemnity Company (Company) operates
predominantly as a provider of management services to
the Erie Insurance Exchange (Exchange). The Exchange is
a reciprocal insurance exchange, which is an
unincorporated association of individuals, partnerships
and corporations that agree to insure one another. Each
applicant for insurance to a reciprocal insurance
exchange signs a subscribers agreement
that contains an appointment of an attorney-in-fact.
The Company has served since 1925 as the
attorney-in-fact for the policyholders of the Exchange.
As attorney-in-fact, the Company is required to perform
certain services relating to the sales, underwriting
and issuance of policies on behalf of the Exchange. For
its services as attorney-in-fact, the Company charges a
management fee calculated as a percentage, not to
exceed 25%, of the direct and affiliated assumed
premiums written of the Exchange. Management fees
accounted for approximately 72% of the Companys total
revenues for 2005.
The Company also operates as a property/casualty
insurer through its three insurance subsidiaries. The
Exchange and its property/casualty subsidiary and the
Companys three property/casualty subsidiaries
(collectively, the Property and Casualty Group)
write personal and commercial lines property/casualty
coverages exclusively through independent agents. The
financial position or results of operations of the
Exchange are not consolidated with those of the
Company. During 2005, almost 70% of the direct
premiums written by the Property and Casualty Group
were personal lines, while 30% were commercial lines.
The Exchange is the Companys sole customer. The
members of the Property and Casualty Group pool their
underwriting results. Under the pooling agreement, the
Exchange assumes 94.5% of the pool. Accordingly, the
underwriting risk of the Property and Casualty Groups
business is largely borne by the Exchange, which had
$3.4 billion and $2.8 billion of statutory surplus at
December 31, 2005 and 2004, respectively. Through the
pool, the Companys property/casualty subsidiaries
currently assume 5.5% of the Property and Casualty
Groups underwriting results, and, therefore, the
Company also has direct incentive to manage the
insurance underwriting as effectively as possible.
The Property and Casualty Group seeks to insure
standard and preferred risks primarily in private
passenger automobile, homeowners and small
29
commercial lines, including workers compensation. The Property and Casualty Groups sole
distribution channel is its independent agency force, which consists of over 1,700 independent
agencies comprised of 7,800 licensed representatives in 11 midwestern, mid-Atlantic and southeastern
states (Illinois, Indiana, Maryland, NewYork, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia,
West Virginia and Wisconsin) and the District of Columbia. The Property and Casualty Group became
licensed in the state of Minnesota in December 2004, although it has not established a definitive
date to begin writing business in that state. In addition to their
principal role as salespersons,
the independent agents play a significant role as underwriters and service providers and are major
contributors to the Property and Casualty Groups success.
The company also owns 21.6% of the common stock of Erie Family Life Insurance (EFL), an affiliated
life insurance company, of which the Exchange owns 53.5% and public shareholders, including
certain of the Companys directors, own 24.9%. The company, together with the Property and Casualty
Group and EFL, collectively operate as the Erie Insurance Group.
For a complete discussion of all intercompany agreements, see the Transactions with Related
Parties section following the Liquidity and Capital Resources section herein.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
|
|
(dollars in
thousands) |
|
|
|
except
per share data |
|
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Income from management operations |
|
$ |
209,269 |
|
|
$ |
242,592 |
|
|
$ |
253,251 |
|
Underwriting income(loss) |
|
|
14,950 |
|
|
|
(4,364 |
) |
|
|
(24,941 |
) |
Net revenue from investment
operations |
|
|
118,873 |
|
|
|
93,717 |
|
|
|
74,172 |
|
|
Income before income taxes |
|
|
343,092 |
|
|
|
331,945 |
|
|
|
302,482 |
|
Provision for
income taxes |
|
|
111,988 |
|
|
|
105,532 |
|
|
|
102,757 |
|
|
Net income |
|
$ |
231,104 |
|
|
$ |
226,413 |
|
|
$ |
199,725 |
|
|
Net income
per share-diluted |
|
$ |
3.34 |
|
|
$ |
3.21 |
|
|
$ |
2.81 |
|
|
HIGHLIGHTS
|
|
Net income per sharediluted increased 4.0% in 2005
due to improvements in insurance
underwriting operations and investment operations. |
|
|
|
Gross margins from management operations decreased to 21.8% in 2005 from 25.1%
in 2004. |
|
|
The management fee rate was 23.75% for 2005 and 23.5% from January to June
2004 and 24.0% for the remainder of 2004 (effectively 23.74% in
2004). |
|
|
|
GAAP combined ratios of the insurance underwriting operations improved to 93.1
in 2005 from 102.1 in 2004. |
|
|
|
Increase of 26.8% in net revenues from investment
operations includes $10.1 million in adjustments to the market value
of limited partnership investments in 2005; these adjustments were
not included in income in 2004. |
|
|
|
The effective tax rate of 32.9% in 2005 was impacted by a $.7 million credit
related to prior years. A $ 3.1 million benefit was recorded to the 2004 tax provision
related to prior years which decreased the effective tax rate to 32.2% in 2004 from 34.7%
in 2003. |
|
|
|
The Company repurchased shares of its common stock totaling $ 99.0 million in
2005 at an average price of $52.36 per share. |
|
|
|
Return on average equity declined to 18.2 for 2005
compared to 18.6 for 2004. |
|
|
|
|
|
SEGMENT OVERVIEWS |
|
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Management operations |
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Management fee revenues decreased .5% in 2005 compared to 2004. The two
determining factors of management fee revenue are: 1) the management
fee rate charged by the Company, and 2) the direct written premiums of the Property and
Casualty Group. The effective management fee rate was 23.75% for 2005 and 23.74% for
2004. |
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In 2005, the direct written premiums of the Property and Casualty Group
decreased 1.0% compared to an 8.9% increase in 2004. The implementation of a personal
lines price segmentation model and the continued refinement of
rate classifications contributed to this decrease in premiums written, as
the average premiums per policy declined. While price segmentation allows the Property
and Casualty Group to provide a better correlation between the associated risk and
rates charged to policyholders, the short-term impact
of introducing such pricing can be disruptive to new policy growth. New policy direct
written premiums of the Property and Casualty Group decreased 7.5% in 2005. The recent
improvements in underwriting profitability afforded the Property and Casualty Group the
ability to implement rate reductions in
2005 to allow for more attractive prices to potential new policyholders and improve the
retention of existing policyholders. The impact of rate changes that were effective in
2005 resulted in a net decrease in written premiums of the Property and Casualty Group of
$9.9 million. Rate reductions are planned for 2006, which will continue to lower the
average premium per policy and slow premium growth of the Property
and Casualty Group. |
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The Property and Casualty Group continues to maintain its focus on underwriting
discipline |
30
and profitability as well as concentrating on
quality growth. With the recent improvements in
underwriting profitability, the Property and
Casualty Group is in a stronger financial
position to compete for profitable business. The
Property and Casualty Group was able to implement
moderate pricing actions during 2005, many of
which were rate decreases in its most significant
line of business, private passenger auto, in
Pennsylvania. The continued refinement and
increased utilization of segmented pricing in
2006 will enable the Company to offer competitive
rates to more customers, providing greater
flexibility in pricing policies with varying
degrees of risk. The Company plans to continue
its agent appointment efforts, generating an
anticipated increase of 125 new independent
agents in 2006.
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The cost of management operations increased
$27.3 million, or 3.8%, in 2005 compared to
2004. The increase in cost of management
operations in 2005 was the result of: |
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CommissionsTotal commission costs were up
1.6% to $539.5 million in 2005 compared to
2004. Agent bonuses increased $24.9 million, as
the bonus structure focuses on underwriting
profitability, which improved dramatically over
the measurement period used for the bonus
formula. Normal scheduled commissions were
$18.2 million lower in 2005 compared to 2004,
primarily due to reduced commercial commission
rates that became effective on premiums
collected beginning January 1, 2005, and the
1.0% decline in direct premiums written of the
Property and Casualty Group. New promotional
incentive programs that began in 2005, aimed at
stimulating premium growth, contributed $1.6
million in additional costs in 2005. |
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Total costs other than commissions rose $18.9
million to $212.0 million in 2005, mostly as a
result of increased personnel and underwriting
costs. Personnel costs, including external contract
labor, increased $13.4 million and insurance
scoring costs increased $3.6 million in 2005. |
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Personnel costsSalaries and wages and other
personnel costs of employees increased $10.2
million in 2005 driven by increased staffing
levels and normal pay rate increases. Contract
labor costs increased $3.2 million, primarily
related to information technology projects. |
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Insurance scoring costsIn the latter part of
2004, the use of insurance scores was
implemented in the underwriting process on new
business and was part of the Companys initiatives
to focus on underwriting profitability of the
Property and Casualty Group. In 2005, insurance
scores were obtained for all new and renewal
private passenger auto and homeowners business for
underwriting and rating purposes, which resulted
in increased costs of $3.6 million in 2005
compared to 2004. |
Insurance underwriting operations
Contributing to the improved insurance
underwriting operations, resulting in a 93.1 GAAP
combined ratio, were the following factors:
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Focused management efforts on improving
underwriting profitability by the Property
and Casualty Group in 2005 and 2004 |
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Below normalized level of catastrophe losses during 2005 |
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The Property and Casualty Group was not impacted by any of the major hurricanes of 2005,
including Hurricanes Katrina, Rita and Wilma |
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Lower level of charges related to the reversals
of recoveries under the intercompany aggregate
excess-of-loss reinsurance agreement between the
Companys property/casualty insurance subsidiaries
and the Exchange, which were $2.2 million in 2005,
compared to $7.7 million in 2004. |
Investment operations
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Net investment income increased 1.0% in 2005
compared to 2004. While certain funds were
reinvested in the market, a portion of the
available capital was used to repurchase Company
stock of $99.0 million during 2005, compared to
$54.1 million in 2004. Investment expense rose
due to fees being paid to external managers of
the common stock portfolio, which were hired in
the fourth quarter of 2004. Also, certain taxable
corporate debt securities were sold and replaced
with tax-exempt municipal bonds. |
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A one-time $10.1 million, or $.10 per
share-diluted, correction was made in 2005 to
record limited partnership market value
adjustments which increased equity in earnings of
limited partnerships. The limited partnership
market value adjustment was previously recorded as a component of
shareholders equity. The Company saw improved
performance on its limited partnership private equity
investments and the number of limited partnerships
included in the portfolio increased in 2005. |
The topics addressed in this overview are discussed in
more detail in the sections that follow.
Critical accounting estimates
The Company makes estimates and assumptions that
have a significant effect on amounts and disclosures
reported in the financial statements. The most
significant estimates relate to valuation of
investments, reserves for property/casualty insurance
unpaid losses and loss adjustment expenses and
retirement benefits. While management believes its
estimates are appropriate, the ultimate amounts may
differ from the estimates provided. The estimates and
the estimating methods used are reviewed continually,
and any adjustments considered necessary are reflected
in current earnings.
31
Investment valuation
Management makes estimates concerning the
valuation of all investments. Except in rare cases
where quoted market prices are not available, the
Company values fixed maturities and equity securities
based on published market prices.
The primary basis for the valuation of limited
partnership interests are financial statements prepared
by the general partner. Because of the timing of the
preparation and delivery of these financial statements,
the use of the most recently available financial
statements provided by the general partners typically
results in not less than a quarter delay in the
inclusion of the limited partnership results in the
Companys Consolidated Statements of Operations. The
general partners use various methods to estimate fair
value of unlisted debt and equity investments, property
and other investments for which there is no published
market. These valuation techniques may vary broadly
depending on the asset class of the partnership. Due to
the nature of the investments, general partners must
make assumptions about the underlying companies or
assets as to future performance, financial condition,
liquidity, availability of capital, market conditions
and other factors to determine the estimated fair
value. The valuation procedures can include techniques
such as cash flow multiples, discounted cash flows or
the pricing used to value the entity or similar
entities in
recent financing transactions. The general partners
estimate and assumption of fair value of nonmarketable
securities may differ significantly from the values
that could have been derived had a ready market
existed. These values are not necessarily indicative of
the value that would be received in a current sale and
valuation differences could be significant. Upon receipt of the quarterly and annual financial
statements, management performs an in-depth analysis of the
valuations provided by the general partners.
Management surveys each
of the general partners about expected significant changes (plus or
minus 10% compared to previous quarter) to valuations prior to the
release of the funds quarterly and annual financial statements.
In the event of an expected significant change, the general partner
will notify the Company and the Company will evaluate the potential
change.
Investments are evaluated monthly for
other-than-temporary impairment loss. Some factors
considered in evaluating whether or not a decline in
fair value is other-than-temporary include:
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the extent and duration for which fair value is less than cost |
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historical operating performance and financial condition of the issuer |
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near-term prospects of the issuer and its industry based on analysts recommendations |
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specific events that occurred affecting the issuer, including rating downgrades |
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the Companys ability and intent to retain the investment for a period of time sufficient to
allow for a recovery in value. |
An investment deemed
impaired is written down to its
estimated net realizable value. Impairment
charges are included as a realized loss in the
Consolidated Statements of Operations.
Property/casualty insurance liabilities
Reserves for property/casualty insurance unpaid
losses and loss adjustment expenses reflect the
Companys best estimate of future amounts needed to pay
losses and related expenses with respect to insured
events. The process of establishing the liability for
property/casualty unpaid loss and loss adjustment
expense reserves is a complex process, requiring the
use of informed judgments and estimates. Reserve
estimates are based on managements assessment of known
facts and circumstances, review of historical
settlement patterns, estimates of trends in claims
frequency and severity, legal theories of liability and
other factors. Variables in the reserve estimation
process can be affected by both internal and external
events, such as changes in claims handling procedures,
economic inflation, legal trends and legislative
changes. Many of these items are not
directly quantifiable, particularly on a prospective
basis. There may be significant reporting lags between
the occurrence of the policy event and the time it is
actually reported to the insurer.
Management reviews reserve estimates on a quarterly
basis. Product line data is grouped according to
common characteristics. Multiple estimation methods
are employed for each product line and product
coverage combination analyzed at each evaluation date.
Most estimation methods assume that past patterns
discernible in the historical data will be repeated in
the future, absent a significant change in pertinent
variables. Significant changes, which are either known
or reasonably projected through analysis of internal
and external data, are quantified in the reserve
estimates each quarter. The estimation methods chosen
are those that are believed to produce the most
reliable indication at that particular evaluation date
for the losses being evaluated.
Using multiple estimation methods results in a
reasonable range of estimates for each product line
and product coverage combination. The nature of the
insurance product, number of risk factors,
pervasiveness of the risk factors across product
lines, and interaction of risk factors all influence
the size of the range of reasonable reserve estimates.
Whether the risk factor is sudden or evolutionary in
nature, and whether a risk factor is temporary or
permanent, also influences reserve estimates. The
final estimate recorded by management is a function of
detailed analysis of historical trends, which is
adjusted as new emerging data indicates.
The factors which may potentially cause the greatest
variation between current reserve estimates and the
actual future paid amounts are: unforeseen changes in
statutory or case law altering the amounts to be paid
on existing claim obligations; new medical procedures
and/or drugs, which result in costs significantly
different from the past; and claims patterns on
current business that differ significantly from
historical patterns.
32
The Company also performs analyses to evaluate the
adequacy of past reserves. Using subsequent
information, the Company performs retrospective reserve
analyses to test whether previously established
estimates for reserves were reasonable. See also the
Financial Condition section herein.
A relatively small percentage change in the estimate of
net loss reserves would have impacted the Companys
operating results. For example, a hypothetical 1%
increase in net loss reserves at December 31, 2005,
would have resulted in a pre-tax charge of
approximately $2.0 million. The Property and Casualty
Groups coverage that has the greatest potential for
variation is the pre-1986 automobile catastrophic
injury liability reserve. Automobile no-fault law in
Pennsylvania before 1986 provided for unlimited medical
benefits. The estimate of ultimate liabilities for
these claims is subject to significant judgment due to
variations in claimant health and mortality over time.
At December 31, 2005, the range of reasonable estimates
for reserves related to these claims, net of
reinsurance recoverables, for both personal and
commercial lines is from $188.5 million to $443.3
million for the Property and Casualty Group. The
reserve carried by the Property and Casualty Group,
which is managements best estimate of this liability
at this time, was $262.8 million at December 31, 2005,
which is net of $127.1 million of anticipated
reinsurance recoverables. The Companys
property/casualty subsidiaries share of the net
automobile catastrophic injury liability reserve is
$14.5 million at December 31, 2005.
Pension and postretirement health benefits
The Companys pension plan for employees is the
largest and only funded benefit plan of the Company.
The Company also provides postretirement medical and
pharmacy coverage for eligible retired employees and
eligible dependents. The Companys pension and other
postretirement benefit obligations are developed from
actuarial estimates in accordance with Financial
Accounting Standard (FAS) 87, Employers Accounting
for Pensions, and FAS 106, Employers Accounting for
Postretirement Benefits Other than Pensions. The
Company uses a consulting actuarial firm to develop
these estimates. As pension and other postretirement
obligations will ultimately be settled in future
periods, the determination of annual expense and
liabilities is subject to estimates and assumptions.
With the assistance of the consulting actuarial firm,
Company management reviews these assumptions annually
and modifies them based on historical experience and
expected future trends. Changes in the Companys
pension and other postretirement benefit obligations
may occur in the future due to variances in actual
results from the key assumptions made by Company
management. At December 31, 2005, the fair market value
of the pension assets totaled $220.5 million, which
continues to exceed the accumulated
benefit obligation of $164.1 million at that date.
Unrecognized actuarial gains and losses are being
recognized over a 16-year period, which represents
the expected remaining service life of the employee
group.
Because of the amount of sensitivity in reported
assets, operating results and financial position, the
most critical assumptions are the discount rate and the
expected long-term rate of return. For both the pension
and other postretirement health benefit plans, the
discount rate is estimated to reflect the prevailing
market rate of a portfolio of high-quality fixed-income
debt instruments that would provide the future cash
flows needed to pay the projected benefits included in
the benefit obligations as they become due. In
determining the discount rate, management engaged the
Companys consulting actuarial firm to complete a
bond-matching study in accordance with guidance
provided in FAS 87 and FAS 106 and Securities and
Exchange Commission Staff Accounting Bulletins. The
study developed a portfolio of non-callable bonds rated
AA- or better. The cash flows from the bonds were
matched against the Companys projected benefit
payments in the pension plan. This bond-matching study
supported the selection of a 5.75% discount rate for
the 2006 pension expense. The same discount rate was
selected for the postretirement health benefits. The
2005 expense was based on a discount rate assumption of
6.00%. A change of 25 basis points in the discount rate
assumption, with other assumptions held constant, would
have an estimated $2.1 million impact on net pension
and other postretirement benefit cost in 2006, before
consideration of reimbursement of affiliates.
The expected long-term rate of return for the pension
plan represents the average rate of return to be earned
on plan assets over the period the benefits included in
the benefit obligation are to be paid. The expected
long-term rate of return is less susceptible to annual
revisions as there are typically not significant
changes in the asset mix. The long-term rate-of-return
is based on historical long-term returns for asset
classes included in the pension plans target
allocation. A reasonably possible change of 25 basis
points in the expected long-term rate of return
assumption, with other assumptions held constant, would
have an estimated $.5 million impact on net pension
benefit cost, before consideration of reimbursement
from affiliates. Further information on the Companys
pension and postretirement benefit plans is provided on
page 58 in Note 8.
See Note 2 to the Consolidated Financial
Statements for a discussion of recently issued
accounting pronouncements.
33
Management
fee revenue by state and line of business
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For the year ended
December 31, 2005 (dollars in thousands) |
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Private |
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Commercial |
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Workers |
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Commercial |
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All other lines |
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State |
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Total |
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passenger auto |
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Homeowners |
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multi-peril |
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compensation |
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auto |
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of business |
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Pennsylvania |
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$ |
430,863 |
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$ |
235,183 |
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$ |
70,049 |
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$ |
39,691 |
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$ |
40,712 |
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$ |
30,895 |
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$ |
14,333 |
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Maryland |
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118,419 |
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56,182 |
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24,974 |
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9,682 |
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11,971 |
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10,436 |
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5,174 |
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Virginia |
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81,913 |
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30,748 |
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14,044 |
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11,394 |
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12,640 |
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8,509 |
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4,578 |
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Ohio |
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77,468 |
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35,530 |
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16,858 |
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13,740 |
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0 |
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6,912 |
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4,428 |
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North Carolina |
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56,447 |
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21,017 |
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13,558 |
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7,063 |
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4,531 |
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6,423 |
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3,855 |
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West Virginia |
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45,055 |
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25,621 |
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9,064 |
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4,784 |
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0 |
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3,824 |
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1,762 |
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Indiana |
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38,055 |
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17,597 |
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10,318 |
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3,684 |
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2,084 |
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2,325 |
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2,047 |
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New York |
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36,942 |
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16,588 |
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5,079 |
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6,396 |
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3,219 |
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4,162 |
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1,498 |
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Illinois |
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22,481 |
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7,836 |
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4,646 |
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|
3,340 |
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3,462 |
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1,972 |
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|
1,225 |
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Tennessee |
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18,365 |
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5,196 |
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|
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3,247 |
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|
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|
3,907 |
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2,665 |
|
|
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|
2,282 |
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|
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|
1,068 |
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Wisconsin |
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9,701 |
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4,503 |
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2,278 |
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1,158 |
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600 |
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|
517 |
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|
645 |
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District of Columbia |
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4,065 |
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|
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|
947 |
|
|
|
|
655 |
|
|
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|
888 |
|
|
|
|
1,061 |
|
|
|
|
159 |
|
|
|
|
355 |
|
|
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|
|
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Total |
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$ |
939,774 |
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|
|
$ |
456,948 |
|
|
|
$ |
174,770 |
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|
|
$ |
105,727 |
|
|
|
$ |
82,945 |
|
|
|
$ |
78,416 |
|
|
|
$ |
40,968 |
|
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This table is gross of an allowance for management fees returned on mid-term cancellations and
the intersegment elimination of management fee revenue.
Analysis of business segments
Management operations
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Years ended December 31 |
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(dollars in thousands) |
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2005 |
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2004 |
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2003 |
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Management fee revenue |
|
$ |
940,274 |
|
|
$ |
945,066 |
|
|
$ |
878,380 |
|
|
|
|
|
|
|
|
|
|
|
|
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Service agreement revenue |
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|
20,568 |
|
|
|
21,855 |
|
|
|
27,127 |
|
|
Total revenue from management operations |
|
|
960,842 |
|
|
|
966,921 |
|
|
|
905,507 |
|
|
|
|
|
|
|
|
|
|
|
|
|
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Cost of management operations |
|
|
751,573 |
|
|
|
724,329 |
|
|
|
652,256 |
|
|
Income from management operations |
|
$ |
209,269 |
|
|
$ |
242,592 |
|
|
$ |
253,251 |
|
|
Gross margins |
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|
21.8 |
% |
|
|
25.1 |
% |
|
|
28.0 |
% |
|
|
|
|
|
|
|
|
|
|
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Effective management fee rate |
|
|
23.75 |
% |
|
|
23.74 |
% |
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|
24 |
% |
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HIGHLIGHTS
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Effective management fee rate was 23.75% in 2005 and
23.74% in 2004 |
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Direct written premiums of the Property and Casualty Group decreased 1.0% in 2005 |
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Policies in force were 3,759,599 and 3,771,105 at December 2005 and
2004, respectively, a decrease of .3% |
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Year-over-year premium per policy was $1,052 in 2005 and $1,060 in
2004, a decrease of .7% |
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Premium rate decreases resulted in a $9.9 million decrease in
written premiums in 2005 |
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Cost of management operations increased 3.8% with commission costs increasing 1.6% and
costs other than commissions increasing 9.8% |
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Agent bonuses increased $24.9 million in 2005 while commercial commission costs
decreased $17.5 million |
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Personnel costs increased $13.4 million, including a $3.2 million increase in external
contract labor costs |
Management fee revenue
Management fees represented 71.6% of the
Companys total revenues for 2005 and 73.7% and 74.4% of
the Companys total revenues for 2004 and 2003, respectively. The management fee rate set by the
Companys Board of Directors and the volume of direct written premiums of the Property and Casualty
Group determine the level of management fees. Changes in the management fee rate affect the
Companys revenue and net income significantly. The management
fee rate was set at 23.75% in 2005.
In 2004, the management fee rate was
set at 23.5% for the first six months of the year and 24.0% for the last six months of the year,
effectively 23.74% for the year. In 2003, the rate was 24%. The Companys Board of Directors set
the management fee rate at 24.75% beginning January 1, 2006. If the management fee rate had been
24.75% in 2005, management fee revenue would have increased $39.6 million, or $.37 per
share-diluted.
Management fees are returned to the Exchange when policyholders cancel their insurance coverage
mid-term and unearned premiums are refunded to them. The
Company maintains an allowance for management fees
returned on mid-term policy cancellations that
recognizes the management fee anticipated to be
returned to the Exchange based on historical mid-term
cancellation experience. Due to changes in the
allowance, management fee revenues were increased by
$.5 million in 2005, compared to being reduced by $4.1
million and $3.0 million in 2004 and 2003,
respectively. The 2005 adjustment reflects a leveling
off of mid-term cancellations evidenced by policy
retention ratios of 88.6% at December 31, 2005,
compared to 88.4% at December 31, 2004. The reduction
in management fee revenues of $4.1 million in 2004
reflected higher cancellations, as anticipated with the
introduction of segmented pricing, evidenced by the
decrease in retention ratios from 90.2% at December 31,
2003, to 88.4% at December 31, 2004. The cash flows of
the Company are unaffected by the recording of the
allowances.
Management fee revenue derived from the direct written
premiums of the Property and Casualty Group, before
consideration of the allowance for mid-term
cancellations, was $939.8 million in 2005, compared to
$949.2 million in 2004. The direct written premiums of
the Property and Casualty Group were $4.0 billion in
2005 and 2004, reflecting a 1.0% decrease, compared to
growth of 8.9% in 2004 from $3.7 billion in 2003. The
decline in growth of direct written premiums of the
Property and Casualty Group in 2004 and the further
decrease in 2005 reflects the impact of the decline in
new policy growth and lower average premium per policy
partially as a result of rate decreases. In 2004, much
of the growth resulted from offsetting rate increases.
Premium production
The Property and Casualty Groups premiums
produced from new business declined as anticipated in
2005. New business premiums written in total were
$369.0 million in 2005, down 7.5% from $399.0 million
in 2004, and significantly lower than the $501.9
million produced in 2003. Policy retention ratios
stabilized to a 12-month moving average of 88.6% in
2005, up slightly from 88.4% in 2004, after decreasing
from 90.2% in 2003.
Personal linesPersonal lines new business premiums
written decreased 12.4% to $246.2 million in 2005
from $281.0 million in 2004 and $333.3 million in
2003. The Property and Casualty Groups largest
personal line of business is private passenger auto
for which new business premiums written decreased to
$149.1 million in 2005 from $177.8 million and $218.2
million in 2004 and 2003, respectively. The 12-month
moving average policy retention ratio for personal
lines was 89.1%, 88.8% and 90.5% in 2005, 2004 and
2003, respectively. The 12-month moving average
policy retention ratio for private passenger auto was
90.0% in 2005 and 2004, and 91.6% in 2003.
During 2003 and 2004, the Property and Casualty
Group implemented various initiatives to focus on
underwriting profitability to control exposure
growth and improve underwriting risk selection.
The Company also implemented significant rate
increases in all lines. In 2005, the Company
introduced the use of insurance scoring for
underwriting purposes for private passenger auto and
homeowners lines of business in all operating states,
except Maryland. The introduction of the pricing
segmentation model for personal lines, that included
insurance scoring, segments policyholders into
different rate classes based on the associated risks,
and was a significant change from the judgment-based
underwriting model previously used by the Company.
Segmenting policyholders into rate classes helps
insurers provide a better matching of prices and
related risks. The short-term impact of segmented
pricing is higher policy retention among
policyholders realizing either base rate decreases or
greater discounts, which reduces the premium base,
and lower policy retention among policyholders whose
rates rise under the new rate plan. The long-term
impact should result in a more desirable pool of
risks contributing to improvements in claims
severity. Introducing new variables into the pricing
plan should result in improvements in frequency of
claims. In the long run, the plan results in better
risk selection, lower loss costs and the ability to
offer lower prices to consumers and attract the most
favorable risks. Current personal lines market
conditions reflect price stabilization, or slightly
reducing rate levels. It is anticipated that the
Property and Casualty Groups 2006 pricing strategy
on introducing further refinements in personal lines
price segmenting will contribute to an improved
competitive position in the marketplace. Many
insurers in the property/casualty industry were
impacted by the major hurricanes in 2005, which in
turn will need to be considered in their
underwriting, pricing and capital allocation
decisions in 2006. These decisions may affect the
pricing environment for personal lines insurance in
2006 and beyond. The regions in which the Property
and Casualty Group operates were not impacted by the
major hurricanes of 2005.
Commercial linesThe commercial lines new business
premiums written rose 4.0% to $122.3 million in 2005
from $117.5 million in 2004, which had decreased
30.2% from $168.4 million in 2003. The 12-month
moving average policy retention ratio for commercial
lines was 85.2%, 85.1% and 87.3% in 2005, 2004 and
2003, respectively.
The Property and Casualty Groups largest commercial
lines of business, based upon written premiums, are
commercial auto and workers compensation. During
2005, the Property and Casualty Group implemented
initiatives to provide more competitive rates for
higher quality workers compensation risks. A more
formalized process of evaluating workers
compensation accounts should allow a better alignment
between rate and risk level similar to the pricing
segmentation efforts in the personal lines.
While premiums per policy have decreased, these
premiums are associated with more preferred risks.
35
Premium
rates and rate change impacts
The average premium per policy decreased .7% to $1,052 in
2005 from $1,060 in 2004, which had increased 8.1% in 2003. The
average premium per personal lines policy decreased 1.6% while
commercial lines average premiums increased .6% from 2004. In
2004, compared to 2003, the average premium per personal lines
policy increased 8.6% and commercial lines average premiums
increased 6.9%.
The recent improvement in underwriting results afforded the
Property and Casualty Group the ability to implement rate
reductions in 2005 to be more price competitive for potential
new policyholders and improve retention of existing
policyholders. Significant rate increases had been obtained in
2004 and 2003 to offset growing loss costs in certain lines. The
Property and Casualty Group writes one-year policies.
Consequently, rate actions take 12 months to be fully recognized
in written premium and 24 months to be recognized fully in
earned premiums. Since rate changes are realized at renewal, it
takes 12 months to implement a rate change to all policyholders
and another 12 months to earn the decreased or increased
premiums in full. As a result, certain rate increases approved
in 2004 were reflected in written premium in 2005 and some rate
actions in 2005 will be reflected in 2006. The effect of all
rate actions in 2005 resulted in a net decrease in written
premiums of $9.9 million. Rate increases accounted for $298.3
million and $208.4 million in additional written premium for the
Property and Casualty Group in 2004 and 2003. Management
continuously evaluates pricing actions and estimates that those
approved, filed and contemplated for filing during 2006 could
reduce direct written premiums by $96.7 million in 2006.
Personal linesThe private passenger auto average premium per
policy decreased 1.3% to $1,174 in 2005 from $1,190 in 2004,
which had increased 6.1% from 2003. The homeowners average
premium per policy decreased .5% to $543 in 2005 from $546 in
2004, compared to a 17.4% increase from $465 in 2003. The most
significant rate decreases effective in 2005 were in the
private passenger auto and homeowners lines of business in
Pennsylvania. The most significant rate decreases approved and
effective in 2006 are in the private passenger auto and
homeowners lines of business in Pennsylvania and Maryland.
In August 2004, the Property and Casualty Group
implemented insurance scoring for underwriting purposes for
its private passenger auto and homeowners lines of business
in most of its operating states in response to changing
competitive market conditions. Insurance scoring has also
been incorporated, along with other risk characteristics,
into a rating plan with multiple pricing tiers. Segmented
pricing provides the Property and Casualty Group greater
flexibility in pricing policies with varying degrees of risk,
which should result in more competitive rates being
offered
to customers with the most favorable loss characteristics.
The rating plan with multiple pricing tiers was implemented
in most states on new business in March 2005 and on renewal
business in April 2005.
The Property and Casualty Group has focused pricing
initiatives to focus on quality growth. During July 2005,
an 8% rate reduction on certain coverages for new private
passenger auto policyholders with no claims or violations
was effective in the majority of the states served by the
Property and Casualty Group. In Tennessee and Virginia,
this rate reduction for claim-free and violation-free
policyholders was 6%. Other initiatives include
discontinuing the surcharge placed on permitted drivers
and targeting more profitable risks through the
introduction of new rating variables into the pricing
segmentation model for both auto and homeowners. The
Property and Casualty Group is also evaluating
potential new personal lines product extensions and
enhancements that could be offered as well as new
coverages, such as identity recovery. Also, effective
January 1, 2006, additional discounts and interactions
will be introduced into the pricing plan for auto and
home, including number of cars and drivers in a household,
discounts for policyholders who buy life insurance and for
those who pay premiums up front.
Commercial linesThe commercial auto average premium per
policy decreased .3% to $2,781 in 2005 from $2,790 in 2004,
which had increased 4.2% from 2003. The workers compensation
average premium per policy increased 6.7% to $6,212 in 2005
from $5,820 in 2004, which had increased 12.8% in 2003. Rate
decreases approved and effective in 2006 related primarily to
these two lines of business in Pennsylvania, and for
commercial auto, Tennessee.
As mentioned previously, the Property and Casualty Group
has been implementing initiatives focused on workers
compensation to better align rate and risk levels, control
losses and implement rate changes. Rate changes became
effective in November 2005 in the state of Pennsylvania. Rate
changes for workers compensation in all other states except
Wisconsin are filed to be effective in the first half of 2006.
The Property and Casualty Group is evaluating the potential of
expanding its penetration of the small business market.
All linesIn 2005, the Company appointed 65 new agents,
compared to 33 new agent appointments in 2004. The Company
expects 125 new agent appointments in 2006. Expanding the size
of the agency force will contribute to future growth as new
agents build up their book of business with the Property and
Casualty Group.
36
Service agreement revenue
Service agreement revenue includes service charges the
Company collects from policyholders for providing extended
payment terms on policies written by the Property and Casualty
Group. These service charges are fixed dollar amounts per billed
installment. Such service charges amounted to $20.5 million,
$21.1 million and $19.9 million in 2005, 2004 and 2003,
respectively. The Property and Casualty Group is implementing
certain changes in the service charge amounts to be billed to
various installment arrangements. The outcome of such changes
will be dependent upon the mix of installment programs selected
by policyholders. See Factors That May Affect Future Results.
Prior to March 2005, service agreement revenue also included
service income received from the Exchange as compensation for
the management and administration of voluntary assumed
reinsurance from nonaffiliated insurers. The Company received a
service fee of 6.0% of nonaffiliated assumed reinsurance
premiums. These fees were minimal in 2005 and 2004 as the
Exchange exited the nonaffiliated assumed reinsurance business
effective December 31, 2003. Service fees totaled $7.2 million
on net voluntary nonaffiliated assumed reinsurance premiums in
2003.
Cost of management operations
The cost of management operations rose 3.8% to $751.6
million in 2005, from $724.3 million in 2004, and 11.1% in
2004, from $652.3 million in 2003. In 2005, commissions costs
rose 1.6% while costs other than commissions rose 9.8%.
Personnel costs increased 11.7% in 2005 as a result of staffing
levels and pay rate increases, as well as external labor costs
related to information technology projects. The use of insurance
scoring for the full year of 2005 and for all new and renewal
business resulted in $3.6 million in additional costs in 2005
compared to 2004. Commissions to independent agents, which are
the largest component of the cost of management operations,
include scheduled commissions earned by independent agents on
premiums written, accelerated commissions and agent bonuses.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
(dollars in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Scheduled and
accelerated
rate
commissions |
|
$ |
466,064 |
|
|
$ |
486,860 |
|
|
$ |
452,245 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agent
bonuses |
|
|
71,083 |
|
|
|
46,163 |
|
|
|
24,034 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Promotional
incentives |
|
|
1,792 |
|
|
|
175 |
|
|
|
361 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commission effect
from change in
allowance for
mid-term policy
cancellations |
|
|
600 |
|
|
|
( 2,000 |
) |
|
|
( 1,900 |
) |
|
Total
commissions |
|
$ |
539,539 |
|
|
$ |
531,198 |
|
|
$ |
474,740 |
|
|
Scheduled and accelerated rate commissions
Scheduled rate commissions were impacted by a 1.0% decrease
in the direct written premiums of the Property and Casualty
Group in 2005 and the reduction in certain commercial
commission rates. Commercial commission rate reductions
became effective January 1, 2005, for premiums collected
after December 31, 2004, and resulted in a $20.5 million
reduction in scheduled rate commissions in 2005.
Commission rates were reduced for certain new and
renewal commercial lines business effective January 1, 2005.
Thus all premiums collected after December 2004 were
commissioned at the new post-January 1, 2005 rates.
Commissions accrued at the end of 2004 were reduced by $5.2
million related to commissions to be paid in 2005 on
uncollected 2004 policy premium.
Accelerated rate commissions are offered to some
newly-recruited agents for their initial three years. Accelerated commissions were lower in 2005 as new agency
appointments were curtailed for the latter part of 2004, and
existing accelerated commission contracts expired. The
Company slowed agency appointments in conjunction with its
efforts to control exposure growth. Agent appointments
resumed in 2005, with 65 new agents added, and accelerated
commissions will begin to increase as new agent appointments
for 2006 increase.
Agent bonusesAgent bonuses are based on an individual
agencys property/casualty underwriting profitability over a
three-year period. There is also a growth component to the
bonus, paid only if the agency is profitable. The estimate for
the bonus is modeled on a monthly basis using the two prior
years actual underwriting data by agency combined with the
current year-to-date actual data. The increase in agent
bonuses in 2005 reflects the impact of improved underwriting
profitability of the Property and Casualty Group in 2005 and
2004. The bonus for 2003 was lower given the less favorable
underwriting results in 2003 and 2002.
Significant changes to the bonus formula were effective January 1, 2004, with the intent of
rewarding truly profitable agencies. The growth component was also added. These changes and
improved underwriting results in 2004 contributed to an increase in 2004 annual agent bonus expense
of $22.1 million as compared to 2003. Of the 2004 increase, approximately $5.0 million related to
one-time special transition rules for the new bonus.
Other costs of management operationsThe cost of management operations, excluding commission
costs, increased 9.8% in 2005 to $212.0 million, from $193.1 million in 2004, and 8.8% in 2004 from
$177.5 million in 2003. Personnel-related costs are the second largest component in cost of
management operations. The Companys personnel costs increased 11.7% to $128.7
million in 2005, from $115.3 million in 2004, and increased
12.1% in 2004, from $102.8
37
million in 2003. Contributing to the increase in 2005 was a
12.2% increase in salaries and wages. This increase includes
both base pay rate and staffing level increases as well as
higher costs of external contract labor. Costs incurred
related to external contract labor primarily related to
information technology projects which increased to $6.0
million in 2005 from $2.8 million in 2004.
Also contributing to the increase in the cost of
management operations were the cost of obtaining insurance
scores on new and renewal personal lines business of $4.0
million during 2005. The Company began using insurance scoring
in the latter half of 2004 on renewal personal lines business
only and had incurred $.4 million in 2004 for insurance scores.
Insurance underwriting operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
(dollars in thousands) |
2005 |
|
2004 |
|
2003 |
|
|
Premiums earned |
|
$ |
215,824 |
|
|
$ |
208,202 |
|
|
$ |
191,592 |
|
|
Losses and loss
adjustment
expenses
incurred |
|
|
140,386 |
|
|
|
153,220 |
|
|
|
152,984 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Policy acquisition
and other
underwriting
expenses |
|
|
60,488 |
|
|
|
59,346 |
|
|
|
63,549 |
|
|
Total losses and
expenses |
|
|
200,874 |
|
|
|
212,566 |
|
|
|
216,533 |
|
|
Underwriting
income (loss) |
|
$ |
14,950 |
|
|
$ |
(4,364 |
) |
|
$ |
(24,941 |
) |
|
The following table reconciles the underwriting results of the Property and Casualty Group on a
statutory accounting basis (SAP) to the underwriting results of the Company on a GAAP basis. The
two main components of insurance underwriting operations are the direct business written by the
Property and Casualty Group and the assumed reinsurance business. Because the Exchange exited the
assumed reinsurance business in 2003, the only assumed reinsurance included in 2004 and 2005 is
runoff activity. The detail of the Property and Casualty Group provides financial data for the
direct business and the reinsurance business separately.
Reconciliation of Property and Casualty Group underwriting results to company underwriting
results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
(dollars in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Property and Casualty Group insurance
underwriting operations (SAP basis) |
|
|
|
|
|
|
|
|
|
|
|
|
Direct underwriting results: |
|
|
|
|
|
|
|
|
|
|
|
|
Direct written premium |
|
$ |
3,956,942 |
|
|
$ |
3,997,330 |
|
|
$ |
3,672,419 |
|
|
Premium earned |
|
|
3,984,648 |
|
|
|
3,877,844 |
|
|
|
3,460,792 |
|
Loss and loss adjustment expenses incurred |
|
|
2,561,504 |
|
|
|
2,623,731 |
|
|
|
2,808,678 |
|
Policy acquisition and other underwriting expense |
|
|
1,100,772 |
|
|
|
1,105,028 |
|
|
|
1,023,177 |
|
|
Total losses and expense |
|
|
3,662,276 |
|
|
|
3,728,759 |
|
|
|
3,831,855 |
|
|
Direct underwriting income (loss) |
|
|
322,372 |
|
|
|
149,085 |
|
|
|
(371,063 |
) |
Nonaffiliated reinsurance underwriting resultsnet |
|
|
49,427 |
|
|
|
(24,538 |
) |
|
|
(32,588 |
) |
|
Net underwriting gain (loss) (SAP Basis) |
|
|
371,799 |
|
|
|
124,547 |
|
|
|
(403,651 |
) |
|
Erie Indemnity Company insurance
underwriting operations (SAP to GAAP basis) |
|
|
|
|
|
|
|
|
|
|
|
|
Percent of pool assumed by Company |
|
|
5.5 |
% |
|
|
5.5 |
% |
|
|
5.5 |
% |
|
|
Company preliminary underwriting income (loss): |
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
|
17,730 |
|
|
|
8,200 |
|
|
|
(20,408 |
) |
Nonaffiliated reinsurance |
|
|
2,719 |
|
|
|
(1,350 |
) |
|
|
(1,793 |
) |
|
Net underwriting gain (loss) (SAP basis) |
|
|
20,449 |
|
|
|
6,850 |
|
|
|
(22,201 |
) |
Excess-of-loss premiums ceded to the Exchange |
|
|
(3,262 |
) |
|
|
(3,628 |
) |
|
|
(2,530 |
) |
Excess-of-loss changes to recoveries under the agreement* |
|
|
(2,226 |
) |
|
|
(7,740 |
) |
|
|
6,461 |
|
SAP to GAAP adjustments |
|
|
(11 |
) |
|
|
154 |
|
|
|
(6,671 |
) |
|
Company underwriting income (loss) (GAAP basis) |
|
$ |
14,950 |
|
|
$ |
(4,364 |
) |
|
$ |
(24,941 |
) |
|
* |
|
The change in the recoverable under the excess-of-loss agreement is an offset to the prior
accident year loss development included in the loss and loss adjustment expenses reflected in the
table. |
38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
|
2005 |
|
2004 |
|
2003 |
|
Company GAAP combined ratio(1) |
|
|
93.1 |
|
|
|
102.1 |
(3) |
|
|
113.0 |
|
P&C Group statutory combined ratio |
|
|
90.5 |
|
|
|
95.6 |
|
|
|
109.5 |
|
P&C Group statutory combined ratio,
excluding catastrophes |
|
|
90.0 |
|
|
|
93.7 |
|
|
|
104.4 |
|
P&C Group adjusted statutory combined ratio(2) |
|
|
85.7 |
|
|
|
90.1 |
|
|
|
103.3 |
|
P&C Group adjusted statutory combined ratio,
excluding catastrophes |
|
|
85.2 |
|
|
|
88.2 |
|
|
|
98.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss ratio points from prior accident year reserve
development (redundancy) deficiencystatutory basis |
|
|
(1.9 |
) |
|
|
(1.5 |
) |
|
|
1.6 |
|
Loss ratio points from salvage and subrogation
recoveries collectedstatutory basis |
|
|
(1.5 |
) |
|
|
(1.5 |
) |
|
|
(1.5 |
) |
|
Total loss ratio points from prior accident years
statutory basis |
|
|
(3.4 |
) |
|
|
(3.0 |
) |
|
|
0.1 |
|
|
|
|
(1) |
|
The GAAP combined ratio represents the ratio of losses, loss adjustment,
acquisition and other underwriting expenses incurred to premiums earned. The GAAP combined ratios
of the Company are different than the results of the Property and Casualty Group due to certain
GAAP adjustments and the effects of the excess-of-loss reinsurance agreement between the Companys
property/casualty insurance subsidiaries and the Exchange. |
|
(2) |
|
The adjusted statutory combined ratio removes the profit component of the
management fee earned by the Company. |
|
(3) |
|
For 2004, the less favorable GAAP combined ratio, as compared to the
statutory combined ratio, was driven by $7.7 million of charges recorded by the Companys
property/casualty insurance subsidiaries under the intercompany excess-of-loss reinsurance
agreement, resulting in a variance of 3.7 GAAP combined ratio points. |
Direct
underwriting results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
(dollars in thousands) |
|
2005 |
|
2004 |
|
2003 |
|
SAP Basis |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and
Casualty
Group direct
underwriting
income (loss) |
|
$ |
322,372 |
|
|
$ |
149,085 |
|
|
$ |
(371,063 |
) |
Percent of pool
assumed by
Company |
|
|
5.5 |
% |
|
|
5.5 |
% |
|
|
5.5 |
% |
|
Company direct
underwriting
income (loss),
before
adjustments |
|
$ |
17,730 |
|
|
$ |
8,200 |
|
|
$ |
(20,408 |
) |
|
P&C Group
Direct business
only combined
ratio |
|
|
91.6 |
% |
|
|
95.4 |
% |
|
|
109.8 |
% |
|
HIGHLIGHTS
|
|
Low level of catastrophe losses contributed only .5
points to the combined ratio (1.9 points in 2004 and 5.2
points in 2003). Normalized catastrophes for the Property
and Casualty Group are 5.0 combined ratio points |
|
|
|
Favorable development of prior accident years improved
combined ratio by 1.5 points in 2005; however, an increase
to the pre-1986 automobile catastrophe injury liability reserves contributed 1.2 points
to the combined ratio, resulting in a net favorable
development of .3 combined ratio points |
|
|
|
Pre-1986 automobile catastrophe injury liability
reserves were increased in 2005, contributing 1.2
points to combined ratio, net of estimated reinsurance
recoverables |
The improvement in 2005 and 2004 underwriting results on direct
business were the result of initiatives implemented in 2004 to
help offset increased claim severity and control exposure
growth. Additionally, the Property and Casualty Group
experienced positive development on losses of prior accident
years on a direct basis of $11.0 million in 2005 and $71.6
million
39
in 2004, compared to adverse development on losses of prior
accident years of $4.2 million in 2003. While still favorable in
2005, the development of the direct business prior accident
years deteriorated as a result of an increase in the pre-1986
automobile catastrophe injury liability reserves. The Property
and Casualty Group increased these reserves by $47 million (net
of ceded recoveries) as a result of re-estimations on these
claims during the second half of 2005, which took into account
updated trends with respect to ongoing attendant care costs for
claimants. Catastrophe losses of the Property and Casualty Group
were $21.1 million, $73.3 million and $182.7 million in 2005,
2004 and 2003, respectively.
The 2003 underwriting losses on direct business resulted
primarily from continued increases in claims severity and
increased catastrophe losses. Claims severity rose in 2003 in
certain lines of business at rates much higher than general
inflation. While loss reserves continued to grow in 2004, this
growth was a reflection of increases in exposure, not
deterioration in prior year reserves.
Development of direct loss reserves
The Companys 5.5% share of the Property and Casualty
Groups positive development on losses for prior accident years
was $.6 million in 2005, which includes the effects of the
Companys share of the increase in the automobile catastrophe
liability reserve of $2.6 million. The Companys share of
positive development on losses for prior accident years was $3.9
million in 2004, compared to its share of adverse development on
losses for prior accident years of $0.2 million in 2003. The
positive development on losses of prior accident years in 2005
was experienced primarily in the commercial multi-peril and the
private passenger auto uninsured motorists lines of business. In
2004, certain unusual and significant claims emerged that
related to prior years and were factored into the trend analysis
for 2005. However, these trends did not continue into 2005,
which led to an improvement in prior accident year loss
reserves. The Company employed specialty claims units in
Pennsylvania to focus on uninsured motorists claims to improve
claims handling and control severity.
The positive development on losses of prior accident years in
2004 was experienced primarily in the homeowners and commercial
multi-peril lines of business. Generally, the Company
experienced improving loss development trends, which were
reflected in the new estimate of prior year reserves.
Contributing to the improving loss development on prior
accident year losses was the implementation of new claims
tools, such as new property loss estimation software, which has
helped in controlling property claims severity. Additionally,
property adjusters received extensive third-party training in
property
claims estimating in 2004. Property occurrences make up a
majority of the claims in the homeowners line of business and
approximately half of the commercial multi-peril claims.
Catastrophe losses
Catastrophes are an inherent risk of the property/
casualty insurance business and can have a material impact on
the Companys insurance underwriting results. In addressing
this risk, the Company employs what it believes are reasonable
underwriting standards and monitors its exposure by geographic
region. The Property and Casualty Group maintains property
catastrophe reinsurance coverage from unaffiliated insurers
(see page 39). The Companys property/ casualty insurance
subsidiaries all-lines excess-of-loss reinsurance
agreement with the Exchange was purchased to mitigate the
effect of catastrophe losses on the Companys financial
position. The excess-of-loss agreement was not renewed for the
2006 accident year due to the proposed pricing for the coverage
as well as the loss profile of the Property and Casualty Group.
The Property and Casualty Group maintains sufficient property
catastrophe coverage from unaffiliated reinsurers and no longer
participates in the assumed reinsurance business, which lowers
the variability of the underwriting results of the Property and
Casualty Group.
There was no impact on the Property and Casualty Groups
underwriting results from Hurricanes Katrina, Rita or Wilma
during 2005. During 2005, 2004 and 2003, the Companys share of
catastrophe losses, as defined by the Property and Casualty
Group, amounted to $1.2 million, $4.0 million and $10.0
million, respectively. The 2004 catastrophe losses were largely
driven by Hurricane Ivan, which affected the states of North
Carolina, Virginia, West Virginia and Pennsylvania. The 2003
Property and Casualty Group catastrophe losses were primarily
due to Hurricane Isabel, which affected the states of North
Carolina, Maryland, Virginia, Pennsylvania and the District of
Columbia. For the Company, these 2003 catastrophe losses were
offset with recoveries recorded under the intercompany
excess-of-loss reinsurance agreement. Catastrophe losses in
2005 contributed .5 points to the Companys GAAP combined
ratio, compared to 1.9 points in 2004 and 5.2 points in 2003.
40
Reinsurance underwriting results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
(dollars in thousands) |
|
2005 |
|
2004 |
|
2003 |
|
SAP Basis |
|
|
|
|
|
|
|
|
|
|
|
|
Company insurance
underwriting
operations: |
|
|
|
|
|
|
|
|
|
|
|
|
Nonaffiliated
reinsurance |
|
$ |
2,719 |
|
|
$ |
(1,350 |
) |
|
$ |
(1,793 |
) |
|
Affiliated
reinsurance |
|
|
|
|
|
|
|
|
|
|
|
|
Premiums
ceded to
Exchange |
|
|
(3,262 |
) |
|
|
(3,628 |
) |
|
|
(2,530 |
) |
Change to
recoveries
under the excess-of-loss
agreement |
|
|
(2,226 |
) |
|
|
(7,740 |
) |
|
|
6,461 |
|
|
Affiliated
reinsurance |
|
$ |
(5,488 |
) |
|
$ |
(11,368 |
) |
|
$ |
3,931 |
|
|
HIGHLIGHTS
|
|
Assumed loss reserves related to September 11, 2001,
were reduced by $42 million of which the Companys share
was $2.3 million. Reversal of previously recorded
recoveries under the intercompany excess-of-loss
reinsurance agreement resulted in no material financial
impact |
|
|
|
Termination of the intercompany excess-of-loss
reinsurance agreement effective December 31, 2005, for
the 2006 accident year |
The Companys property/casualty insurance subsidiaries
nonaffiliated reinsurance business includes its share of the
Property and Casualty Groups
voluntary and involuntary assumed reinsurance
business and ceded reinsurance business. The
Exchange exited the voluntary assumed reinsurance
business as of December 31, 2003, to allow the
Property and Casualty Group to focus on its core
business and lessen its underwriting exposure. In
2005 and 2004, only runoff activity of the assumed
reinsurance business remains. The effects of the
excess-of-loss reinsurance agreement between the
Companys property/casualty insurance subsidiaries
and the Exchange is also reflected in the reinsurance
business when looking at the Companys results
on a segment basis. The excess-of-loss reinsurance
agreement is not subject to the intercompany pooling
agreement.
Assumed loss reserves related to September 11th
During 2005, the Property and Casualty Groups
estimate of assumed loss and loss adjustment
expenses related to the September 11, 2001, event
was reduced by $42 million. While the Companys
share of this reduction was $2.3 million (see Financial
Condition for further discussion), this reserve change
triggered a $2.2 million reduction in recoveries due
to the Company under the aggregate excess-of-loss
reinsurance agreement for the 2001 accident year. The
net effect of this World Trade Center reserve activity to
the Company was a $.1 million reduction in expense in
2005.
Aggregate excess-of-loss reinsurance agreement
(Charges) Recoveries by accident year are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
Calendar |
|
Accident year |
|
(charges) |
year |
|
2004 |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
1999 |
|
recoveries |
|
2005 |
|
$ |
0 |
|
|
$ |
0 |
|
|
$ |
0 |
|
|
$ |
(1,881 |
) |
|
$ |
41 |
|
|
$ |
(386 |
) |
|
$ |
(2,226 |
) |
2004 |
|
|
|
|
|
|
(6,012 |
) |
|
|
(33 |
) |
|
|
(1,637 |
) |
|
|
(488 |
) |
|
|
430 |
|
|
|
(7,740 |
) |
2003(1) |
|
|
|
|
|
|
6,012 |
|
|
|
(1,969 |
) |
|
|
2,645 |
|
|
|
(57 |
) |
|
|
(170 |
) |
|
|
6,461 |
|
2002 |
|
|
|
|
|
|
|
|
|
|
2,002 |
|
|
|
2,176 |
|
|
|
2,213 |
|
|
|
2,424 |
|
|
|
8,815 |
|
2001 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,506 |
|
|
|
0 |
|
|
|
735 |
|
|
|
7,241 |
|
2000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
(1) |
|
During calendar year 2003, the $6.0 million in recoveries from the 2003 accident
year included the recoveries of losses incurred from Hurricane Isabel. |
41
The charges and recoveries under the excess-of-loss
reinsurance agreement are recorded to the Companys loss and
loss adjustment expenses on the Consolidated Statements of
Operations. Included in the 2005 net changes to recoveries
under the excess-of-loss agreement of $2.2 million are charges
for unexpired accident years of $1.5 million plus charges of
$.7 million related to the commutations of the 1999 and 2000
accident years. In accordance with the agreement, commutation
of an accident year occurs five years after the accident year
expires. The unpaid loss recoverable related to the 1999
accident year of $3.4 million was settled in March 2005. The
present value of the estimated losses from the 1999 accident
year, or $3.0 million, was settled with the Exchange and cash
was paid by the Companys property/casualty insurance
subsidiaries resulting in a charge to the Company of $.4
million.
The $2.0 million unpaid loss recoverable related to the 2000
accident year was settled in December 2005. The present value
of these estimated losses from the 2000 accident year, or $1.7
million, was settled with the Exchange by the Companys
property/casualty insurance subsidiaries resulting in a charge
to the Company of $.3 million. Cash payment of the present
value of these losses will occur in the first quarter of 2006.
The purpose of the excess-of-loss agreement was to reduce the
variability of earnings and thereby reduce the adverse effects
on the results of operations of EIC and EINY in a given year if
the frequency or severity of claims were substantially higher
than historical averages. The Property and Casualty Group did
not renew the excess-of-loss agreement for the 2006 accident
year. While the excess-of-loss agreement was not renewed for
2006, the unexpired accident years of 2001 through 2005 will be
settled and losses will be commuted as the 60-month periods
expire. The Company has the option of purchasing the coverage
for future accident year periods.
Policy acquisition and other underwriting expenses
Policy acquisition and other underwriting expenses of the
Property and Casualty Group include the management fee to the
Company of $939.8 million, $949.2 million and $881.4 million in
2005, 2004 and 2003, respectively. The amount presented on the
Companys Statements of Operations as management fee revenue
reflects the elimination of intercompany management fee revenue
between the Erie Insurance Company, the Erie Insurance Company
of New York and the Company, and the allowance for mid-term
policy cancellations.
Investment operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
(dollars in thousands) |
|
2005 |
|
2004 |
|
2003 |
|
Net investment
income |
|
$ |
61,555 |
|
|
$ |
60,988 |
|
|
$ |
58,298 |
|
|
Net realized
gains on
investments |
|
|
15,620 |
|
|
|
18,476 |
|
|
|
10,445 |
|
|
Equity in earnings
of EFL |
|
|
3,636 |
|
|
|
5,598 |
|
|
|
7,429 |
|
|
Equity in earnings
(losses) of limited
partnerships |
|
|
38,062 |
|
|
|
8,655 |
|
|
|
( 2,000 |
) |
|
|
Net revenue from
investment
operations |
|
$ |
118,873 |
|
|
$ |
93,717 |
|
|
$ |
74,172 |
|
|
HIGHLIGHTS
|
|
Equity on earnings of limited partnerships increased
dramatically to $38.1 million in 2005, from $8.7 million in
2004 |
|
|
|
Earnings of limited partnerships reflects a correction in
accounting for the market value adjustment which increased
earnings by $10.1 million in 2005 |
|
|
|
Funds used to repurchase Company stock amounted to
$99.0 million in 2005 compared to $54.1 million in 2004 |
Net investment income increased 1.0% in 2005 and 4.6% in 2004.
Included in net investment income are primarily interest and
dividends on the Companys fixed maturity and equity security
portfolios. Net investment income in 2005 remained at a
comparable level to 2004 as the Company continued to repurchase
shares of its common stock under its three-year stock repurchase
program, which diverted some available funds away from the
investment market. The stock repurchase program runs from 2004
through 2006. Increases in investments in taxable bonds
contributed to the growth in net investment income in 2004 and
2003. However, declines in overall market yields caused a lower
growth rate in 2004 investment income compared to 2003.
Net revenue from investment operations increased in 2004
compared to 2003 largely due to the increase in realized gains
on investments attributable to the sale of common stock
securities in conjunction with the conversion to the use of
external equity managers.
Limited partnership earnings pertain to investments in U.S. and
foreign private equity, real estate and mezzanine debt
partnerships. Private equity and mezzanine debt limited
partnerships generated earnings of $20.3 million and $4.3
million in 2005 and 2004, respectively, compared to
losses of $5.3 million in 2003. Real estate limited partnerships
reflected
42
earnings of $7.7 million, $4.4 million and $3.3 million in 2005,
2004 and 2003, respectively. Impairment charges on limited
partnerships were $1.2 million and $5.0 million in 2004 and
2003, respectively. The components of equity in earnings of
limited partnerships, including the valuation adjustments to
record limited partnerships at fair value, for the years ended
December 31 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands) |
|
2005 |
|
2004 |
|
2003 |
|
|
|
|
Private equity |
|
$ |
16,732 |
|
|
$ |
2,324 |
|
$ |
(3,983 |
) |
Real estate |
|
|
7,657 |
|
|
|
4,350 |
|
|
3,349 |
|
Mezzanine debt |
|
|
3,530 |
|
|
|
1,981 |
|
|
(1,366 |
) |
Valuation adjustments |
|
|
10,143 |
|
|
|
0 |
|
|
0 |
|
|
|
|
|
Total equity in
earnings of limited
partnerships |
|
$ |
38,062 |
|
|
$ |
8,655 |
|
$ |
(2,000 |
) |
|
|
|
|
Valuation adjustments are recorded to reflect the fair value
of limited partnerships. These adjustments are recorded as a
component of equity in earnings of limited partnerships in the
Consolidated Statements of Operations. The limited partnership
market value adjustment was previously recorded as a component
of shareholders equity.
The Companys performance of its fixed maturities and equity
securities, compared to selected market indices, is presented
below.
Pre-tax annualized returns
|
|
|
|
|
|
|
Two years ended December 31, 2005 |
|
Fixed maturitiescorporate |
|
|
3.83 |
% |
Fixed maturitiesmunicipal |
|
|
2.90 |
|
Preferred stock |
|
|
5.04 |
|
Common stock(1) |
|
|
6.58 |
|
Other indices: |
|
|
|
|
Lehman Brothers
U.S. Aggregate |
|
|
3.38 |
% |
S&P500 Composite Index |
|
|
7.85 |
|
|
(1) Return is net of fees to external managers. |
Financial condition
Investments
The Companys 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 Companys investment strategy also provides
for liquidity to meet the short- and long-term commitments of
the Company. At December 31, 2005 and 2004, the Companys
investment portfolio of investment-grade bonds, common stock,
investment-
grade preferred stock and cash and cash equivalents represents
40.3% and 39.4%, respectively, of total assets. These
investments provide the liquidity the Company requires to meet
the demands on its funds.
Distribution of investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Carrying value at December 31 |
(dollars in thousands) |
|
2005 |
|
% |
|
2004 |
|
% |
|
Fixed maturities |
|
$ |
972,210 |
|
|
|
70 |
|
|
$ |
974,512 |
|
|
|
74 |
|
|
Equity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stock |
|
|
170,774 |
|
|
|
12 |
|
|
|
143,851 |
|
|
|
11 |
|
Common stock |
|
|
95,560 |
|
|
|
6 |
|
|
|
58,843 |
|
|
|
4 |
|
|
Limited
partnerships |
|
|
153,159 |
|
|
|
11 |
|
|
|
130,464 |
|
|
|
10 |
|
|
Real estate
mortgage loans |
|
|
4,885 |
|
|
|
1 |
|
|
|
5,044 |
|
|
|
1 |
|
|
Total investments |
|
$ |
1,396,588 |
|
|
|
100 |
% |
|
$ |
1,312,714 |
|
|
|
100 |
% |
|
The Company continually reviews the investment portfolio to
evaluate positions that might incur other-than-temporary
declines in value. For all investment holdings, general economic
conditions and/or conditions specifically affecting the
underlying issuer or its industry, including downgrades by the
major rating agencies, are considered in evaluating impairment
in value. In addition to specific factors, other factors
considered in the Companys review of investment valuation are
the length of time the market value is below cost and the amount
the market value is below cost.
There is a presumption of impairment for common equity
securities and equity limited partnerships when the decline is,
in managements opinion, significant and of an extended
duration. The Company considers market conditions, industry
characteristics and the fundamental operating results of the
issuer to determine if sufficient objective evidence exists to
refute the presumption of impairment. When the presumption of
impairment is confirmed, the Company will recognize an
impairment charge to operations. Common stock impairments are
included in realized losses in the Consolidated Statements of
Operations.
For fixed maturity and preferred stock investments, the Company
individually analyzes all positions with emphasis on those that
have, in managements opinion, declined significantly below
cost. The Company considers market conditions, industry
characteristics and the fundamental operating results of the
issuer to determine if the decline is due to changes in interest
rates, changes relating to a decline in credit quality, or other
issues affecting the investment. A charge is recorded in the
Consolidated Statements of Operations for positions that have
experienced other-than-temporary impairments due to credit
quality or other factors, or for which it is not the intent of
the Company to hold the position until recovery has occurred.
43
Fixed maturities
Under its investment strategy, the Company maintains a
fixed maturities portfolio that is of high quality and well
diversified within each market sector. This investment strategy
also achieves a balanced maturity schedule in order to moderate
investment income in the event of interest rate declines in a
year in which a large amount of securities could be redeemed or
mature. The fixed maturities portfolio is managed with the goal of achieving reasonable
returns while limiting exposure to risk.
The Companys fixed maturity investments include 96.1% of
high-quality, marketable bonds and redeemable preferred stock,
all of which were rated at investment-grade levels (above
Ba1/BB+) at December 31, 2005. Included in this investment-grade
category are $435.1 million, or 44.8%, of the highest quality
bonds and redeemable preferred stock rated Aaa/AAA or Aa/AA or
bonds issued by the United States government. Generally, the
fixed maturities in the Companys portfolio are rated by
external rating agencies. If not externally rated, they are
rated by the Company on a basis consistent with that used by the
rating agencies. Management classifies all fixed maturities as
available-for-sale securities, allowing the Company to meet its
liquidity needs and provide greater flexibility for its
investment managers to appropriately respond to changes in
market conditions or strategic direction.
Securities classified as available-for-sale are carried at
market value with unrealized gains and losses net of deferred
taxes included in shareholders equity. At December 31, 2005,
the net unrealized gain on fixed maturities, net of deferred
taxes, amounted to $6.4 million, compared to $22.9 million at
December 31, 2004.
|
|
|
* |
|
As rated by Standard & Poors or Moodys Investors Service, Inc. |
Equity securities
The Companys equity securities consist of common stock and nonredeemable preferred stock.
Investment characteristics of common stock and nonredeemable
preferred stock differ substantially from one another. The
Companys nonredeemable preferred stock portfolio provides a
source of highly predictable current income that is competitive
with investment-grade bonds. Nonredeemable preferred stocks
generally provide for fixed rates of return that, while not
guaranteed, resemble fixed income securities and are paid before
common stock dividends. Common stock provides capital
appreciation potential within the portfolio. Common stock investments inherently
provide no assurance of producing income because
dividends are not guaranteed.
(1) Common stock (2) Nonredeemable preferred stock
The Companys equity securities are carried on the
Consolidated Statements of Financial Position at market value.
At December 31, 2005, the net unrealized gain on equity
securities, net of deferred taxes, amounted to $11.0 million,
compared to $17.4 million at December 31, 2004.
Limited partnership investments
The Companys limited partnership investments include U.S.
and foreign private equity, real estate and mezzanine debt
investments. During 2005, limited partnership investments
increased $22.7 million to $153.2 million. Mezzanine debt and
real estate limited partnerships, which comprise 57.9% of the
total limited partnerships, produce a more predictable earnings
stream while private equity limited partnerships, which comprise 42.1% of the
total limited partnerships, tend to provide a less predictable
earnings stream but the potential for greater long-term returns.
Liabilities
Property/casualty loss reserves
Loss reserves are established to account for the estimated
ultimate costs of loss and loss adjustment expenses for claims
that have been reported but not yet settled and claims that
have been incurred but not reported.
44
Loss and loss adjustment expense reserves are
presented on the Companys Statements of Financial
Position on a gross of reinsurance basis for EIC,
EINY and EIPC. The property/casualty insurance
subsidiaries of the Company wrote about 17% of the
direct property/casualty premiums of the Property
and Casualty Group in 2005. Under the terms of
the Property and Casualty Groups quota share and
intercompany pooling arrangement, a significant
portion of these reserve liabilities are recoverable.
Recoverable amounts are reflected as an asset on
the Companys Statements of Financial Position. The
direct and assumed loss and loss adjustment expense
reserves by major line of business and the related
amount recoverable under the intercompany pooling
arrangement and excess-of-loss reinsurance agreement
are presented below:
|
|
|
|
|
|
|
|
|
|
|
As of December 31 |
|
(dollars in thousands) |
|
2005 |
|
|
2004 |
|
|
Gross reserve liability |
|
|
|
|
|
|
|
|
Personal: |
|
|
|
|
|
|
|
|
Private passenger auto |
|
$ |
413,118 |
|
|
$ |
400,609 |
|
Catastrophic injury |
|
|
123,875 |
|
|
|
86,239 |
|
Homeowners |
|
|
23,995 |
|
|
|
22,798 |
|
Other personal |
|
|
6,978 |
|
|
|
6,322 |
|
Commercial: |
|
|
|
|
|
|
|
|
Workers compensation |
|
|
231,858 |
|
|
|
216,808 |
|
Commercial auto |
|
|
83,688 |
|
|
|
78,646 |
|
Commercial multi-peril |
|
|
65,891 |
|
|
|
63,118 |
|
Catastrophic injury |
|
|
468 |
|
|
|
454 |
|
Other commercial |
|
|
15,894 |
|
|
|
15,288 |
|
Reinsurance |
|
|
53,694 |
|
|
|
52,752 |
|
|
Gross reserves |
|
|
1,019,459 |
|
|
|
943,034 |
|
Reinsurance
recoverables* |
|
|
828,447 |
|
|
|
765,914 |
|
|
Net reserve liability |
|
$ |
191,012 |
|
|
$ |
177,120 |
|
|
* Includes $827.1 million in 2005 and $765.0 million in
2004 due from the Exchange.
As discussed previously, loss and loss adjustment
expense reserves are developed using multiple
estimation methods that result in a range of estimates
for each product coverage combination. The estimate
recorded is a function of detailed analysis of historical
trends and management expectations of future events
and trends. The product coverage that has the greatest
potential for variation is the pre-1986 automobile
catastrophic injury liability reserve. The range of
reasonable estimates for the pre-1986 automobile
catastrophic injury liability reserve, net of reinsurance
recoverables, for both personal and commercial lines is
from $188.5 million to $443.3 million for the Property
and Casualty Group. The reserve carried by the
Property and Casualty Group, which is managements
best estimate of this liability at this time, was $262.8
million at December 31, 2005, which is net of $127.1
million of anticipated reinsurance recoverables. The
reserve carried by the Property and Casualty Group
at December 31, 2004, was $200.0 million, which
was net of $95.8 million of anticipated reinsurance
recoverables. The majority of the increase during 2005
was the result of higher cost expectations of future
attendant care services as a result of the settlement of
class action litigation involving attendant care liabilities.
The Companys property/casualty subsidiaries share of
the net automobile catastrophic injury liability reserve
is $14.5 million at December 31, 2005.
The potential variability in these reserves can be
primarily attributed to automobile no-fault claims
incurred prior to 1986. The automobile no-fault law
in Pennsylvania at that time provided for unlimited
medical benefits. There are currently 392 claimants
requiring lifetime medical care of which 77 involve
catastrophic injuries. The estimation of ultimate
liabilities for these claims is subject to significant
judgment due to variations in claimant health over
time.
It is anticipated that these automobile no-fault claims
will require payments over approximately the next
40 years. The impact of medical cost inflation in
future years is a significant variable in estimating this
liability over 40 years. A 100-basis point change in
the medical cost inflation assumption would result
in a change in net liability for the Company of $2.6
million. Claimants future life expectancy is another
significant variable. The life expectancy assumption
underlying the estimate reflects experience to date.
Actual experience, different than that assumed, could
have a significant impact on the reserve estimate. The
Companys share of the automobile catastrophic injury
claim payments made was $.6 million and $.4 million
during 2005 and 2004, respectively.
During the third quarter of 2005, the Property and
Casualty Group re-evaluated its estimate of assumed
loss and loss adjustment expense reserves estimated
for the September 11, 2001, event. Based on that
assessment, the Property and Casualty Group reduced
its World Trade Center reserves by $42 million as of
September 2005. The original $150 million estimated
total loss and loss adjustment expense estimate was
based on uncertainties, including cedant reserve
estimates, the potential of retrocessional spirals,
undeveloped claims and the uncertainty of legal
actions. As a result of this reserve re-estimate, the
Property and Casualty Groups total loss and loss
adjustment expense estimate for the World Trade
Center claims are estimated at $107 million. As of
the third quarter 2005, four years subsequent to the
date of the event, most of the reported claims have
been property losses which are short-tailed and have
developed since 2001 providing more known data.
Only one claim was identified as being exposed to
a retrocessional spiral, which results when there are
multiple levels of reinsurers, and has the potential
to increase the Companys obligation. Factoring in
this loss experience, and a thorough review of all
contracts, supported the reduction in the World
Trade Center reserve. The most critical factor in the
estimation of these losses is whether the destruction
of the World Trade Center Towers will be considered
a single event or two separate events. The Company
believes the current reserves should be sufficient to
absorb the potential development that may occur
45
should the destruction of the World Trade Center
Towers be considered two separate events. At
December 2005, the Property and Casualty Groups
estimated total loss exposure includes $29 million
related to the coverage disputes with respect to the
number of events.
Impact of inflation
Property/casualty insurance premiums are established
before losses and loss adjustment expenses, and the
extent to which inflation may impact such expenses are
known. Consequently, in establishing premium rates,
the Company attempts to anticipate the potential
impact of inflation.
Quantitative and qualitative disclosures about market risk
The Company is exposed to potential loss from various
market risks, including changes in interest rates, equity
prices, foreign currency exchange rate risk and credit
risk.
Interest rate risk
The Companys exposure to interest rates is
concentrated in the fixed maturities portfolio. The fixed
maturities portfolio comprises 69.6% of invested assets
at December 31, 2005 and 2004. The Company does
not hedge its exposure to interest rate risk since it has
the capacity and intention to hold the fixed maturity
positions until maturity. The Company calculates the
duration and convexity of the fixed maturities portfolio
each month to measure the price sensitivity of the
portfolio to interest rate changes. Duration measures
the relative sensitivity of the fair value of an investment
to changes in interest rates. Convexity measures the
rate of change of duration with respect to changes in
interest rates. These factors are analyzed monthly to
ensure that both the duration and convexity remain in
the targeted ranges established by management.
Principal cash flows and related weighted-average
interest rates by expected maturity dates for financial
instruments sensitive to interest rates are as follows:
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2005 |
|
|
Principal |
|
Weighted average |
(dollars in thousands) |
|
cash flows |
|
interest rate |
|
Fixed maturities, including note from EFL: |
|
|
|
|
|
|
2006 |
|
$ |
83,351 |
|
|
|
5.2 |
% |
2007 |
|
|
61,664 |
|
|
|
5.2 |
|
2008 |
|
|
96,083 |
|
|
|
4.9 |
|
2009 |
|
|
96,015 |
|
|
|
4.8 |
|
2010 |
|
|
81,885 |
|
|
|
4.8 |
|
Thereafter |
|
|
554,173 |
|
|
|
5.8 |
|
|
Total |
|
$ |
973,171 |
|
|
|
|
|
|
Market value |
|
$ |
997,210 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2004 |
|
|
Principal |
|
Weighted average |
(dollars in thousands) |
|
cash flows |
|
interest rate |
|
Fixed
maturities, including notes from EFL: |
|
|
|
|
|
|
2005 |
|
$ |
59,294 |
|
|
|
5.9 |
% |
2006 |
|
|
76,236 |
|
|
|
4.5 |
|
2007 |
|
|
79,242 |
|
|
|
4.6 |
|
2008 |
|
|
100,742 |
|
|
|
4.7 |
|
2009 |
|
|
100,834 |
|
|
|
4.9 |
|
Thereafter |
|
|
557,643 |
|
|
|
5.9 |
|
|
Total |
|
$ |
973,991 |
|
|
|
|
|
|
Market value |
|
$ |
1,014,512 |
|
|
|
|
|
|
Actual cash flows may differ from those stated as a
result of calls, prepayments or defaults. The Company
received payment from EFL during December 2005 for
a $15 million surplus note, due for repayment, resulting
in only the remaining $25 million surplus note with EFL
included in the principal cash flows as of December 31,
2005.
A sensitivity analysis is used to measure the potential
loss in future earnings, fair values or cash flows of
market-sensitive instruments resulting from one or
more selected hypothetical changes in interest rates
and other market rates or prices over a selected
period. In the Companys sensitivity analysis model, a
hypothetical change in market rates is selected that
is expected to reflect reasonably possible changes
in those rates. The following pro forma information
is presented assuming a 100-basis point increase in
interest rates at December 31 of each year and reflects
the estimated effect on the fair value of the Companys
fixed maturity investment portfolio. The Company used
the modified duration of its fixed maturity investment
portfolio to model the pro forma effect of a change in
interest rates at December 31, 2005 and 2004.
Fixed
maturities interest-rate sensitivity analysis
100-basis point rise in interest rates
|
|
|
|
|
|
|
|
|
|
|
As of December 31 |
|
(dollars in thousands) |
|
2005 |
|
|
2004 |
|
|
Current market value |
|
$ |
997,210 |
|
|
$ |
1,014,512 |
|
Change in market value (1) |
|
|
( 35,325 |
) |
|
|
(37,251 |
) |
|
Pro forma market value |
|
$ |
961,885 |
|
|
$ |
977,261 |
|
|
Modified duration (2) |
|
|
3.9 |
|
|
|
4.2 |
|
|
|
|
|
(1) |
|
The change in market value is calculated by taking the
negative of the product obtained by multiplying (i)
modified duration by (ii) change in interest rates by (iii)
market value of the portfolio. |
|
(2) |
|
Modified duration is a measure of a portfolios sensitivity
to changes in interest rates. It is interpreted as the
approximate percentage change in the market value of
a portfolio for a certain basis point change in interest
rates. |
46
Equity price risk
The Companys portfolio of marketable equity
securities, which is carried on the Consolidated
Statements of Financial Position at estimated fair value,
has exposure to price risk, the risk of potential loss in
estimated fair value resulting from an adverse change
in prices. The Company does not hedge its exposure
to equity price risk inherent in its equity investments.
The Companys objective is to earn competitive
relative returns by investing in a diverse portfolio of
high-quality, liquid securities. Portfolio holdings are
diversified across industries and among exchange
traded small- to large-cap stocks. The Company
measures risk by comparing the performance of the
marketable equity portfolio to benchmark returns such
as the S&P 500.
The Companys portfolio of limited partnership
investments has exposure to market risks, primarily
relating to the financial performance of the various
entities in which they invested. The limited partnership
portfolio comprises 11% of total invested assets
at December 31, 2005. These investments consist
primarily of equity and mezzanine investments in small,
medium and large companies and in real estate. The
Company achieves diversification within the limited
partnership portfolio by investing in 88 partnerships
that have 1,501 distinct investments. The Company
reviews at least quarterly the limited partnership
investments by sector, geography and vintage year.
These limited partnership investments are diversified
to avoid concentration in a particular industry or
geographic area. The Company performs extensive
research prior to investment in these partnerships.
Foreign currency risk
The Company has foreign currency risk in the limited
partnership and common equity portfolio. The
limited partnership portfolio includes approximately
$21.6 million of partnerships that are denominated
in Euros, $2.6 million denominated in Japanese yen
and $4.0 million denominated in British pounds
sterling (pounds). The Company also is exposed
to foreign currency risk through commitments to
Euro-, yen- and pound-denominated partnerships of
approximately $25.4 million, $14.1 million and $1.2
million, respectively. The foreign currency risk in the
partnerships and the commitments due, denominated
in Euros, yens and pounds, are partially offsetting. This
risk is not hedged, although the Euro, yen and pound
rates are monitored daily and the Company may
decide to hedge all or some of the partnership-related
foreign currency risk at some time in the future. The
Company has additional foreign currency exposure
through common stock investments of $13.6 million in
seven different currencies which are not hedged.
Credit risk
The Companys objective is to earn competitive returns
by investing in a diversified portfolio of securities.
The Companys portfolios of fixed maturity securities,
nonredeemable preferred stock, mortgage loans and,
to a lesser extent, short-term investments are subject
to credit risk. This risk is defined as the potential loss
in market value resulting from adverse changes in the
borrowers ability to repay the debt. The Company
manages this risk by performing upfront underwriting
analysis and ongoing reviews of credit quality by
position and for the fixed maturity portfolio in total.
The Company does not hedge the credit risk inherent
in its fixed maturity investments.
The Company is also exposed to a concentration
of credit risk with the Exchange. See the section,
Transactions and Agreements with Related Parties,
for further discussion of this risk.
Liquidity and capital resources
Liquidity
Liquidity is a measure of an entitys ability to secure
enough cash to meet its contractual obligations and
operating needs. The Companys major sources of
funds from operations are the net cash flow generated
from management operations, the net cash flow from
Erie Insurance Companys and Erie Insurance Company
of New Yorks 5.5% participation in the underwriting
results of the reinsurance pool with the Exchange, and
investment income from affiliated and nonaffiliated
investments.
The Company generates sufficient net positive cash
flow from its operations to fund its commitments
and build its investment portfolio, thereby increasing
future investment returns. The Company maintains a
high degree of liquidity in its investment portfolio in
the form of readily marketable fixed maturities, equity
securities and short-term investments. Net cash flows
provided by operating activities for the years ended
December 31, 2005, 2004 and 2003, were $301.1
million, $257.7 million and $246.6 million, respectively.
With respect to the management fee, funds are
received generally from the Exchange on a premiums-collected
basis. The Company has a receivable
from the Exchange and affiliates related to the
management fee receivable from premiums written,
but not yet collected, as well as the management
fee receivable on premiums collected in the current
month. The Company pays nearly all general and
administrative expenses on behalf of the Exchange and
other affiliated companies. The Exchange generally
reimburses the Company for these expenses on a paid
basis each month.
47
Management fee and other cash settlements due at
December 31 from the Exchange were $194.8 million
and $207.2 million in 2005 and 2004, respectively.
A receivable from EFL for cash settlements totaled
$3.9 million at December 31, 2005, compared to
$4.3 million at December 31, 2004. The receivable
due from the Exchange for reinsurance recoverable
from unpaid loss and loss adjustment expenses
and unearned premium balances ceded to the
intercompany reinsurance pool rose 6.7% to $952.7
million from $893.1 million at December 31, 2005
and 2004, respectively. This increase is the result
of corresponding increases in direct loss reserves,
loss adjustment expense reserves of the Companys
property/casualty insurance subsidiaries that are ceded
to the Exchange under the intercompany pooling
agreement. Total receivables from the Exchange
represented 12.7% of the Exchanges assets at
December 31, 2005, and 13.3% at December 31, 2004.
Cash flows provided by operating activities were
positively impacted in 2005 by the reduction in certain
commercial commission rates, which became effective
January 1, 2005. Commissions paid during 2005
decreased $9.2 million compared to 2004. Salaries
and wages paid during the year increased due to a
2.9% increase in staffing levels, as well as for external
contract labor costs. Pension funding and employee
benefits paid decreased as there was no contribution
made to the employee pension plan in 2005 compared
to a $7.7 million contribution in 2004. The Company
has generally contributed the maximum deductible
amount to its pension plan for employees under
IRS Code Section 404(a)(1). In 2005, the maximum
contribution was zero, therefore no contribution could
be made by the Company to the plan. The Company
expects to make a $7.5 million contribution to its
pension plan in 2006. Payments for agent bonuses
increased in 2005 as a result of changes in the agent
bonus program. The Companys expected agent bonus
payout in 2006 related to the period ended in 2005 is
$70.2 million.
Cash used in investing activities in 2005 reflects an
increase in limited partnership activity. The number
of limited partnership investments grew to 88
partnerships at December 2005 from 72 at December
2004. During 2004, sales of equity securities were
higher as the Company liquidated certain of its
internally managed equity securities to allow external
managers to manage the portfolio. This process was
completed during 2005. Overall, cash used in investing
activities is lower than 2004, as some available funds
were used to repurchase shares of the Companys
outstanding common stock during the year.
Proceeds from the sales, calls and maturities of fixed
maturity positions totaled $348.0 million, $263.4
million and $359.0 million in 2005, 2004 and 2003,
respectively. The higher sales transactions of fixed
maturities in 2005 was related to some repositioning of the investment portfolio from taxable corporate debt securities to tax-exempt municipal bonds.
Dividends paid to shareholders totaled $81.9 million,
$55.1 million and $49.0 million in 2005, 2004 and
2003, respectively. As part of its capital management
activities in 2004, the Company increased its Class A
shareholder quarterly dividend for 2005 by 51% to
$.325 per share from $.215 per share. The Class B
shareholder quarterly dividend was increased from
$32.25 to $48.75, also a 51% increase. This change in
dividends increased the Companys 2005 payout by
$26.8 million from the prior dividend level. This action
was approved by the Companys Board of Directors in
December 2004 considering, among other factors, the
Companys strong financial results, capital levels and
return on capital targets. Based on the share market
price at the time of the decision, the new dividend
results in a dividend yield of about 2.5%. There are no
regulatory restrictions on the payment of dividends to
the Companys shareholders, although there are state
law restrictions on the payment of dividends from the
Companys subsidiaries to the Company. The Company
increased the 2006 dividends by 10.8%.
The Company also continues to use its capital to
repurchase outstanding shares under its current three-year, $250
million repurchase plan. The plan allows the Company
to repurchase up to $250 million of its Class A common
stock from January 1, 2004, through December 31,
2006. In 2005, 1.9 million shares were repurchased at
a total cost of $99.0 million. The Company intends to
be active in repurchasing shares in 2006; however, the
Company is unable to estimate the number of shares
that will be repurchased during a specified period.
Approximately $97.0 million of outstanding repurchase
authority remains under the plan at December 31, 2005.
On
February 21, 2006, the Companys Board of Directors
approved a continuation of the current stock repurchase program
allowing the Company to repurchase an additional
$250 million of its Class A common stock through
December 31, 2009.
Contractual obligations
Cash outflows are variable because the fluctuations in
settlement dates for claims payments vary and cannot
be predicted with absolute certainty. While volatility in
claims payments could be significant for the Property
and Casualty Group, the effect on the Company of this
volatility is mitigated by the intercompany reinsurance
pooling arrangement. The exposure for large loss
payments is also mitigated by the Companys excess-of-loss reinsurance agreement with the Exchange. The
cash flow requirements for claims have not historically
been significant to the Companys liquidity. Based
on a historical 15-year average, about 50% of losses
and loss adjustment expenses included in the reserve
are paid out in the subsequent 12-month period
and approximately 89% is paid out within a five-year
period. Losses that are paid out after that five-year
period are comprised of such long-tail lines as workers
compensation and auto bodily injury. Such payments
are reduced by recoveries under the intercompany
reinsurance pooling agreement.
48
The Company has certain obligations and commitments to make future payments under various
contracts. As of December 31, 2005, the aggregate obligations were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments due by period |
|
|
|
|
|
|
Less than |
|
1-3 |
|
3-5 |
|
|
(dollars in thousands) |
|
Total |
|
1 year |
|
years |
|
years |
|
Thereafter |
|
Fixed obligations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Limited partnership commitments |
|
$ |
243,186 |
|
|
$ |
42,947 |
|
|
$ |
74,385 |
|
|
$ |
112,582 |
|
|
$ |
13,272 |
|
Other commitments |
|
|
40,532 |
|
|
|
18,001 |
|
|
|
19,556 |
|
|
|
2,537 |
|
|
|
438 |
|
Operating leasesvehicles |
|
|
17,353 |
|
|
|
5,313 |
|
|
|
9,118 |
|
|
|
2,922 |
|
|
|
0 |
|
Operating leasesreal estate |
|
|
10,203 |
|
|
|
3,287 |
|
|
|
4,907 |
|
|
|
2,009 |
|
|
|
0 |
|
Operating leasescomputer |
|
|
6,011 |
|
|
|
3,145 |
|
|
|
2,866 |
|
|
|
0 |
|
|
|
0 |
|
Financing arrangements |
|
|
860 |
|
|
|
385 |
|
|
|
475 |
|
|
|
0 |
|
|
|
0 |
|
|
Fixed contractual obligations |
|
|
318,145 |
|
|
|
73,078 |
|
|
|
111,307 |
|
|
|
120,050 |
|
|
|
13,710 |
|
Gross loss and loss expense reserves |
|
|
1,019,459 |
|
|
|
509,730 |
|
|
|
299,721 |
|
|
|
99,907 |
|
|
|
110,101 |
|
|
Gross contractual obligations |
|
$ |
1,337,604 |
|
|
$ |
582,808 |
|
|
$ |
411,028 |
|
|
$ |
219,957 |
|
|
$ |
123,811 |
|
|
Gross contractual obligations net of estimated reinsurance recoverables and reimbursements from
affiliates are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments due by period |
|
|
|
|
|
|
Less than |
|
1-3 |
|
3-5 |
|
|
(dollars in thousands) |
|
Total |
|
1 year |
|
years |
|
years |
|
Thereafter |
|
Gross contractual obligations |
|
$ |
1,337,604 |
|
|
$ |
582,808 |
|
|
$ |
411,028 |
|
|
$ |
219,957 |
|
|
$ |
123,811 |
|
Estimated reinsurance recoverables |
|
|
827,917 |
|
|
|
413,959 |
|
|
|
243,408 |
|
|
|
81,136 |
|
|
|
89,414 |
|
Estimated reimbursements from
affiliates |
|
|
54,983 |
|
|
|
21,973 |
|
|
|
27,105 |
|
|
|
5,565 |
|
|
|
340 |
|
|
Net contractual obligations |
|
$ |
454,704 |
|
|
$ |
146,876 |
|
|
$ |
140,515 |
|
|
$ |
133,256 |
|
|
$ |
34,057 |
|
|
The limited partnership commitments included in
the table above will be funded as required for capital
contributions at any time prior to the agreement
expiration date. The commitment amounts are presented
using the expiration date as the factor by which to age
when the amounts are due. At December 31, 2005,
the total commitment to fund limited partnerships that
invest in private equity securities is $86.5 million, real
estate activities $108.7 million and mezzanine debt of
$48.0 million. The Company expects to have sufficient
cash flows from operations and from positive cash flows
generated from existing limited partnership investments
to meet these partnership commitments.
The other commitments include various agreements
for service, including such things as computer software,
telephones, and maintenance. The Company has
operating leases for 16 of its 23 field offices that are
operated in the states in which the Property and
Casualty Group does business and three operating
leases for warehousing facilities and remote office
locations. One of the branch locations is leased from
EFL. The computer operating leases are for computer
equipment and were entered into in conjunction with
the Companys recent technology initiatives. The
total of these obligations, including the financing
arrangement, is $75.0 million, of which $55.0 million
will be reimbursed to the Company from its affiliates.
Not included in the table above are the obligations for
the Companys unfunded benefit plans, including the
Supplemental Employee Retirement Plan (SERP) for its
executive and senior management and the directors
retirement plan. The recorded accumulated benefit
obligations for these plans at December 31, 2005, is
$17.2 million. The Company expects to have sufficient
cash flows from operations to meet the future benefit
payments as they become due. See also Footnote 8 in
the notes to the Consolidated Financial Statements.
Off-balance sheet arrangements
Off-balance sheet arrangements include those with
unconsolidated entities that may have a material
current or future effect on the financial condition
or results of operations of the Company, including
material variable interests in unconsolidated entities
that conduct certain activities. There are no off-balance
sheet obligations related to the variable interest the
Company has in the Exchange. Any liabilities between
the Exchange and the Company are recorded in the
Consolidated Statements of Financial Position of the
Company. The Company has no other material off-balance
sheet obligations or guarantees.
Financial
ratings
The property/casualty insurers of the Company are rated
by rating agencies that provide insurance consumers
with meaningful information on the financial strength
of insurance entities. Higher ratings generally indicate
financial stability and a strong ability to pay claims. The
ratings are generally based upon factors relevant to
policyholders and are not directed toward return to
investors. The insurers of the Erie Insurance Group are
currently rated by A.M. Best Company as follows:
|
|
|
|
|
Erie Insurance Exchange |
|
|
A+ |
|
Erie Insurance Company |
|
|
A+ |
|
Erie Insurance Property and Casualty Company |
|
|
A+ |
|
49
|
|
|
|
|
Erie Insurance Company of New York |
|
|
A+ |
|
Flagship City Insurance |
|
|
A+ |
|
Erie Family Life Insurance |
|
|
A |
|
According to A.M. Best, a Superior rating (A+) is
assigned to those companies that, in A.M. Bests
opinion, have achieved superior overall performance
when compared to the standards established by A.M.
Best and have a superior ability to meet their obligations
to policyholders over the long term. The A (Excellent)
rating of EFL continues to affirm its strong financial
position, indicating that EFL has an excellent ability to
meet its ongoing obligations to policyholders. By virtue
of its affiliation with the Property and Casualty Group,
EFL is typically rated one financial strength rating lower
than the property/casualty companies by A.M. Best
Company. The insurers of the Erie Insurance Group are
also rated by Standard & Poors, but this rating is based
solely on public information. Standard & Poors rates
these insurers Api, strong. Financial strength ratings
continue to be an important factor in evaluating the
competitive position of insurance companies.
Regulatory risk-based capital
The standard set by the National Association of Insurance
Commissioners (NAIC) 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, 2005, the
companies comprising the Property and Casualty Group
all had RBC levels substantially in excess of levels that
would require regulatory action.
Transactions and agreements with related parties
Board oversight
The Companys Board of Directors (Board) has broad
oversight responsibility over intercompany relationships
within Erie Insurance Group. As a consequence, the Board
must make decisions or take actions that are not solely in
the interest of the Companys shareholders, but balance
these interests in these separate fiduciary duties such as:
|
|
the Companys Board sets the management fee
rate paid by the Exchange to the Company, |
|
|
|
the Companys Board of Directors determines the
participation percentages of the intercompany
pooling agreement, and |
|
|
|
the Companys Board approves the annual
shareholders dividend, and |
|
|
the Companys Board ratifies other significant
intercompany activity, for example any new cost-sharing
agreements. |
If the Board determines that the Exchanges surplus
requires strengthening, it could decide to reduce the
management fee rate, change the Companys property/
casualty insurance subsidiaries intercompany pooling
participation percentages or reduce the shareholder
dividends level in any given year. The Board could also
decide, under such circumstances, that the Company
should provide capital to the Exchange, although there
is no legal obligation to do so. The Board, however,
recognizes that the long-term financial strength of the
Exchange enures to the benefit of the Company.
The Board of the Company is also the Board for EFL.
Intercompany agreements
Pooling: Members of the Property and Casualty Group
participate in an intercompany reinsurance pooling
agreement. Under the pooling agreement, all insurance
business of the Property and Casualty Group is pooled
in the Exchange. The Erie Insurance Company and
Erie Insurance Company of New York share in the
underwriting results of the reinsurance pool through
retrocession. Since 1995, the Board of Directors has
set the allocation of the pooled underwriting results at
5.0% participation for Erie Insurance Company, 0.5%
participation for Erie Insurance Company of New York
and 94.5% participation for the Exchange.
Excess-of-loss
reinsurance: From 1997 through
December 2005, the Companys property/casualty
insurance subsidiaries had in effect an all-lines aggregate
excess-of-loss reinsurance agreement with the Exchange
which was excluded from the intercompany pooling
agreement. The excess-of-loss reinsurance agreement
limited the amount of sustained ultimate net losses
in any applicable accident year for the Erie Insurance
Company and Erie Insurance Company of New York.
Company management set the terms for this excess-of-loss
reinsurance agreement, obtaining third party quotes
in setting the premium, determining the loss level at
which the excess agreement becomes effective and the
portion of ultimate net loss to be retained by each of
the companies. The Property and Casualty Group did
not renew this coverage for the 2006 accident year.
Technology development: The Erie Insurance Group
undertook a program of information technology
initiatives to develop eCommerce capabilities which
began in 2001. In connection with this program,
the Company and the Property and Casualty Group
entered into a Cost-Sharing Agreement for Information
Technology Development (Agreement). The
Agreement describes how member companies of the
Erie Insurance Group share certain costs to be incurred
for the development and maintenance of new Internet-enabled
property/casualty agency interface, policy
administration and customer relationship management
systems. Costs are shared under the Agreement in
the same proportion as the underwriting results of
the Property and Casualty Group are shared. The
Agreement confers ownership of the certain systems
being developed under the Agreement to the Exchange
50
and grants the Companys property/casualty insurance subsidiaries a perpetual right to use the system.
The financial terms and conditions of the Companys eventual use
of the system have not, as yet, been determined, and could have an
impact on the Companys future earnings.
Leased property: The Exchange leases certain office
facilities to the Company on a year-to-year basis. Rents
are determined considering returns on invested capital
and building operating and overhead costs. Rental
costs of shared facilities are allocated based on square
footage occupied.
Intercompany cost allocation
Company management makes judgments affecting
the financial condition of the Erie Insurance Group
companies, including the allocation of shared costs
between the companies. Management must determine
that allocations are consistently made in accordance
with intercompany agreements, the attorney-in-fact
agreements with the policyholders of the Exchange
and applicable insurance laws and regulations.
While allocation of costs under these various agreements
requires management judgment and interpretation,
such allocations are performed using a consistent
methodology, which in managements opinion, adheres
to the terms and intentions of the underlying agreements.
Intercompany receivables
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands) |
|
|
|
Percentage |
|
|
|
|
|
Percentage |
|
|
|
|
|
|
of total |
|
|
|
|
|
of total |
|
|
|
|
|
|
Company |
|
|
|
|
|
Company |
|
|
2005 |
|
assets |
|
2004 |
|
assets |
|
Reinsurance
recoverable
from and
ceded
unearned
premiums
to the
Exchange |
|
$ |
952,705 |
|
|
|
30.7 |
% |
|
$ |
893,137 |
|
|
|
29.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
receivables
from the
Exchange
and affiliates
(management
fees, costs &
reimbursements) |
|
|
198,714 |
|
|
|
6.4 |
|
|
|
211,488 |
|
|
|
7.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes
receivable
from EFL |
|
|
25,000 |
|
|
|
.8 |
|
|
|
40,000 |
|
|
|
1.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
intercompany
receivables |
|
$ |
1,176,419 |
|
|
|
37.9 |
% |
|
$ |
1,144,625 |
|
|
|
38.3 |
% |
|
The Company has significant receivables from the
Exchange that result in a concentration of credit
risk. These receivables include unpaid losses and
unearned premiums ceded to the Exchange under
the intercompany pooling agreement and from
management services performed by the Company for
the Exchange. Credit risks related to the receivables
from the Exchange are evaluated periodically by
Company management. Reinsurance contracts do not
relieve the Company from its primary obligations to
policyholders if the Exchange were unable to satisfy
its obligation. The Company collects its reinsurance
recoverable amount generally within 30 days of actual
settlement of losses.
The Company also has a receivable from the Exchange
for management fees and costs paid by the Company
on behalf of the Exchange. The Company also pays
certain costs for, and is reimbursed by, EFL. Since the
Companys inception, it has collected these amounts
due from the Exchange and EFL in a timely manner
(generally within 120 days).
The Company has a surplus note for $25 million with
EFL that is payable on demand on or after December
31, 2018. A second surplus note for $15 million was
repaid by EFL to the Company on December 30, 2005.
EFL paid interest to the Company on the surplus notes
totaling $2.7 million in both 2005 and 2004 and $1.6
million during 2003. No other interest is charged or
received on these intercompany balances due to the
timely settlement terms and nature of the items.
Factors that may affect future results
Financial condition of the Exchange
The Company has a direct interest in the financial
condition of the Exchange because management fee
revenues are based on the direct written premiums
of the Exchange and the other members of the
Property and Casualty Group. Additionally, the
Company participates in the underwriting results of
the Exchange through the pooling arrangement in
which the Companys insurance subsidiaries have 5.5%
participation. A concentration of credit risk exists
related to the unsecured receivables due from the
Exchange for certain fees, costs and reimbursements.
To the extent that the Exchange incurs underwriting
losses or investment losses resulting from declines in
the value of its marketable securities, the Exchanges
policyholders surplus would be adversely affected.
If the surplus of the Exchange were to decline
significantly from its current level, the Property and
Casualty Group could find it more difficult to retain
its existing business and attract new business. A
decline in the business of the Property and Casualty
Group would have an adverse effect on the amount
of the management fees the Company receives and
the underwriting results of the Property and Casualty
Group in which the Company has 5.5% participation.
In addition, a decline in the surplus of the Exchange
from its current level would make it more likely that the
management fee rate would be reduced.
Insurance premium rate actions
The changes in premiums written attributable to rate
changes of the Property and Casualty Group directly
affects underwriting profitability of the Property and
Casualty Group, the Exchange and the Company.
In 2005, the industry trend has been for insurers to
maintain or reduce rate levels. Rate reductions have
been implemented and additional reductions are being
sought by the Property and Casualty Group in 2006
to recognize improved underwriting results and to be
more price competitive. Pricing actions contemplated
51
or taken by the Property and Casualty Group are
subject to various regulatory requirements of the
states in which these insurers operate. The pricing
actions already implemented, or to be implemented
through 2006, will also have an effect on the market
competitiveness of the Property and Casualty Groups
insurance products. Such pricing actions, and those of
competitors, could affect the ability of the Companys
agents to sell and/or renew business. Management
estimates that pricing actions approved, contemplated
or filing and awaiting approval through 2005, could
reduce premium for the Property and Casualty Group
by $96.7 million in 2006.
The Property and Casualty Group continues refining its
pricing segmentation model for private passenger auto
and homeowners lines of business. The new rating plan
includes significantly more pricing segments than the
former plan, providing the Company greater flexibility
in pricing for policyholders with varying degrees of risk.
Insurance scoring is among the most significant risk
factors the Company has recently incorporated into
the rating plan. Refining pricing segmentation should
enable the Company to provide more competitive
rates to policyholders with varying risk characteristics,
as risks can be more accurately priced over time.
The continued introduction of new pricing variables
could impact retention of existing policyholders and
could affect the Property and Casualty Groups ability
to attract new policyholders.
Policy growth
Premium levels attributable to growth in policies in
force of the Property and Casualty Group directly
affects the profitability of management operations
of the Company. The recent focus on underwriting
discipline and implementation of the new rate
classification plan through the pricing segmentation
model have resulted in a reduction in new policy sales
and policy retention ratios, as expected. The continued
growth of the policy base of the Property and Casualty
Group is dependent upon its ability to retain existing
and attract new policyholders. A lack of new policy
growth or the inability to retain existing customers
could have an adverse effect on the growth of
premium levels for the Property and Casualty Group.
Premium service charges
Effective for policies renewing on or after January
1, 2006, paid in installments, the service charge
assessed policyholders will increase from $3 to $5
per installment. Also effective for policies renewing
on or after January 1, 2006, paid using the direct
debit payment method, the service charges will be
eliminated. The financial impact this will have on the
Company cannot be determined since the payment
plan policyholders will choose cannot be predicted.
However, if the number and mix of policyholders
currently using the installment plans and the direct
debit program were to remain the same, premium
service charges would increase approximately $7.5
million in 2006, and $13 million on an annual basis
once fully realized in subsequent years.
Catastrophe losses
The Property and Casualty Group conducts business in
11 states and the District of Columbia, primarily in the
mid-Atlantic, midwestern and southeastern portions of
the United States. A substantial portion of the business
is private passenger and commercial automobile,
homeowners and workers compensation insurance in
Ohio, Maryland, Virginia and, particularly, Pennsylvania.
As a result, a single catastrophe occurrence or
destructive weather pattern could materially adversely
affect the results of operations and surplus position
of the members of the Property and Casualty Group.
Common catastrophe events include severe winter
storms, hurricanes, earthquakes, tornadoes, wind and
hail storms. In its homeowners line of insurance, the
Property and Casualty Group is particularly exposed to
an Atlantic hurricane, which might strike the states of
North Carolina, Maryland, Virginia and Pennsylvania.
The Property and Casualty Group maintains a property
catastrophe reinsurance treaty to mitigate the future
potential catastrophe loss exposure. The property
catastrophe reinsurance coverage in 2005 provided coverage of
up to 95% of a loss of $400 million in excess of the
Property and Casualty Groups loss retention of $200
million per occurrence. This agreement was renewed
for 2006 under the terms of coverage of up to 95%
of a loss of $400 million in excess of the Property and
Casualty Groups loss retention of $300 million per
occurrence.
Incurred But Not Reported (IBNR) losses
The Property and Casualty Group is exposed to new
claims on previously closed files and to larger than
historical settlements on pending and unreported
claims. The Company is exposed to increased losses
by virtue of its 5.5% participation in the intercompany
reinsurance pooling agreement with the Exchange.
The Company exercises professional diligence to
establish reserves at the end of each period that
are fully reflective of the ultimate value of all claims
incurred. However, these reserves are, by their nature,
only estimates and cannot be established with absolute
certainty.
The product coverage that has the greatest potential
for variation is the pre-1986 automobile catastrophic
injury liability reserve, as automobile no-fault law
in Pennsylvania at that time provided for unlimited
medical benefits. The estimation of ultimate liabilities
for these claims is subject to significant judgment due
to variations in claimant health and mortality over time.
Actual experience, different than that assumed, could
have a significant impact on the reserve estimates.
Information technology development
A comprehensive program of eCommerce initiatives
being undertaken by the Erie Insurance Group
began in 2001. Early in the program, substantial
advancements in the organizations internal
infrastructure were put in place, providing the enabling
foundation for implementing advanced technology,
including operating environments and Web-based
applications.
52
ERIEConnection®, the central policy administration and
agent interface application under development in the
eCommerce program, has not progressed as originally
expected. Development costs have substantially
exceeded estimates made in 2002. Target delivery
dates established in 2002 have generally not been
met. While functional as a personal lines rating and
policy administration system, the agency interface
component of ERIEConnection® has generally not met
the Companys or agents expectations for ease of
use. The Company has postponed further deployment
of the system until such usability issues are resolved.
Estimates of the costs for alternative approaches to
improve the agency interface for ease of use needed
to facilitate future deployment and the timetable for
deployment continue to be analyzed and developed. Through
December 31, 2005, the total costs incurred for the development
of the
ERIEConnection®
application amounted to approximately $100 million. This amount
includes approximately $10 million related to the development of an alternative agent interface
approach which has been abandoned.
During 2005, all independent agencies were migrated
to a common, Windows XP-based agency interface
platform called DSpro®. Previously, many agencies
interfaced with the Company utilizing a DOS-based
platform that was commercially unsupportable, while
some were on the Windows XP platform. While this
more stable Windows XP platform does not interface
to ERIEConnection®, this migration mitigated the risk
of business interruption posed by the DOS system and
gives the Company the time necessary to thoroughly
research and plan for its future interface development
and rollout strategy using ERIEConnection®. In the
first quarter 2006, the Company is implementing
broadband connectivity with most agencies through
DSpro®.
Since the substantial majority of the costs for
program development are borne by the Exchange,
the Companys operating results are not expected
to be materially impacted in the near term by
ERIEConnection®
development decisions. However, the financial terms and conditions of
the Companys eventual use of the
ERIEConnection®
system have not, as yet, been determined, and could have an impact on
the Companys future earnings. In addition, the
Property and Casualty Groups ability to attract new
policyholders, which bears significantly on the Companys
management fee revenue, is directly influenced by
the Companys independent agent decisions to place
business with the Property and Casualty Group. To the
extent that technological capabilities of alternative
carriers represented by the Companys agents are
greater than those of the Property and Casualty
Group, the Property and Casualty Groups sales could
be adversely affected, thereby reducing the Companys
management fee.
It is also possible that the development of the
ERIEConnection® system could be abandoned, which
would require a charge to the Companys earnings of
$2.0 million.
Terrorism
The Terrorism Risk Insurance Act of 2002, which
established a federal program for commercial/property
casualty losses resulting from foreign acts of terrorism,
originally scheduled to expire on December 31, 2005,
was extended through December 31, 2007. The Act
continues to require commercial insurers to make
terrorism coverage available for commercial property/
casualty losses, including workers compensation.
Commercial auto, burglary/theft, surety, professional
liability and farmowners multiple-peril are no longer
included in the program. Industry deductible levels
were increased and an event trigger was added
providing that in the case of a certified act of
terrorism occurring after March 31, 2006, no federal
compensation shall be paid by the Secretary of
Treasury unless aggregate industry losses exceed $50
million for the rest of 2006 and $100 million in 2007.
The federal government will pay 90% of covered
terrorism losses above insurer retention levels in 2006
and 85% of covered terrorism losses in 2007.
The Erie Insurance Group is continuing to take the
steps necessary to comply with the Act by providing
notices to commercial policyholders disclosing the
premium, if any, attributable to coverage for acts of
terrorism, as defined in the Act, and disclosing federal
participation in payment of terrorism losses. Terrorism
coverage is not excluded under the majority of the
Property and Casualty Group commercial property/
casualty policies. Other than workers compensation,
which incur charges consistent with state law,
premium charges for terrorism coverage are currently
applied only for a small number of new and renewal
commercial policies where deemed appropriate
based upon individual risk factors and characteristics.
Appropriate disclosure notices are provided in
accordance with the Act.
Personal lines are not included under the protection
of the Act and state regulators have not approved
exclusions for acts of terrorism on personal lines
policies. The Property and Casualty Group is exposed
to terrorism losses for personal lines. While the
Property and Casualty Group is exposed to terrorism
losses in commercial lines and workers compensation,
these lines are afforded a limited backstop above
insurer deductibles for foreign acts of terrorism under
the federal program. The Property and Casualty Group
has no personal lines terrorist coverage in place. The
Property and Casualty Group could incur large losses if
future terrorism attacks occur.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995: Certain
forward-looking statements contained herein involve risks and uncertainties. These statements include certain
discussions relating to management fee revenue, cost of management operations, underwriting,
premium and investment income volume, business strategies, profitability and business relationships
and the Companys other business activities during 2005 and beyond. In some cases, you can identify
forward-looking statements by terms such as may, will, should, could, would, expect,
plan, intend, anticipate, believe, estimate, project, predict, potential and
similar expressions. These forward-looking statements reflect the Companys current views about future
events, are based on assumptions and are subject to known and unknown risks and uncertainties that
may cause results to differ materially from those anticipated in those statements. Many of the
factors that will determine future events or achievements are beyond our ability to control or predict.
53
The direct written premiums of the Property and Casualty Group have a direct impact on the
Companys management fee revenue and, consequently, the Companys management operations. Below is a
summary of direct written premiums of the Property and Casualty Group by state and line of
business.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
|
2005 |
|
2004 |
|
2003 |
|
Premiums written as a percent of total by state: |
|
|
|
|
|
|
|
|
|
|
|
|
Pennsylvania |
|
|
45.9 |
% |
|
|
46.3 |
% |
|
|
46.6 |
% |
Maryland |
|
|
12.6 |
|
|
|
12.4 |
|
|
|
12.0 |
|
Virginia |
|
|
8.7 |
|
|
|
8.3 |
|
|
|
8.2 |
|
Ohio |
|
|
8.2 |
|
|
|
8.6 |
|
|
|
8.8 |
|
North Carolina |
|
|
6.0 |
|
|
|
5.8 |
|
|
|
5.9 |
|
West Virginia |
|
|
4.8 |
|
|
|
4.8 |
|
|
|
4.7 |
|
Indiana |
|
|
4.1 |
|
|
|
4.3 |
|
|
|
4.4 |
|
New York |
|
|
3.9 |
|
|
|
3.8 |
|
|
|
3.8 |
|
Illinois |
|
|
2.4 |
|
|
|
2.5 |
|
|
|
2.5 |
|
Tennessee |
|
|
2.0 |
|
|
|
1.9 |
|
|
|
1.9 |
|
Wisconsin |
|
|
1.0 |
|
|
|
0.9 |
|
|
|
0.8 |
|
District of Columbia |
|
|
0.4 |
|
|
|
0.4 |
|
|
|
0.4 |
|
|
Total direct premiums written |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
Premiums written by line of business: |
|
|
|
|
|
|
|
|
|
|
|
|
Personal |
|
|
|
|
|
|
|
|
|
|
|
|
Automobile |
|
|
48.6 |
% |
|
|
49.7 |
% |
|
|
51.1 |
% |
Homeowners |
|
|
18.6 |
|
|
|
18.4 |
|
|
|
16.8 |
|
Other |
|
|
2.5 |
|
|
|
2.4 |
|
|
|
2.3 |
|
|
Total personal |
|
|
69.7 |
% |
|
|
70.5 |
% |
|
|
70.2 |
% |
Commercial |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial multi-peril |
|
|
11.3 |
% |
|
|
10.9 |
% |
|
|
10.9 |
% |
Workers compensation |
|
|
8.8 |
|
|
|
8.6 |
|
|
|
8.8 |
|
Automobile |
|
|
8.3 |
|
|
|
8.2 |
|
|
|
8.4 |
|
Other |
|
|
1.9 |
|
|
|
1.8 |
|
|
|
1.7 |
|
|
Total commercial |
|
|
30.3 |
% |
|
|
29.5 |
% |
|
|
29.8 |
% |
|
The growth rate of policies in force and policy retention trends can impact the Companys
management and insurance operating segments. Below is a summary of each by line of business for the
Property and Casualty Group business.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
(amounts in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Policies in force: |
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines |
|
|
3,281 |
|
|
|
3,297 |
|
|
|
3,273 |
|
Commercial lines |
|
|
479 |
|
|
|
474 |
|
|
|
470 |
|
|
Total policies in force |
|
|
3,760 |
|
|
|
3,771 |
|
|
|
3,743 |
|
|
Policy retention percentages: |
|
|
|
|
|
|
|
|
|
|
|
|
Personal policy retention percentages |
|
|
89.1 |
% |
|
|
88.8 |
% |
|
|
90.5 |
% |
Commercial policy retention percentages |
|
|
85.2 |
|
|
|
85.1 |
|
|
|
87.3 |
|
Total policy retention percentages |
|
|
88.6 |
|
|
|
88.4 |
|
|
|
90.2 |
|
|
54
Management is responsible for establishing and maintaining adequate internal control over
financial reporting of Erie Indemnity Company, as such term is defined in Exchange Act Rules
13a-15(f). Under the supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of
Erie Indemnity Companys internal control over financial reporting based on the framework in
Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on our evaluation under the framework in Internal ControlIntegrated
Framework, management has concluded that Erie Indemnity Companys internal control over financial
reporting was effective as of December 31, 2005.
Managements assessment of the effectiveness of Erie Indemnity Companys internal control over
financial reporting as of December 31, 2005, has been audited by Ernst & Young LLP, an independent
registered public accounting firm, as stated in their report which is included herein.
|
|
|
|
|
|
|
|
|
|
Jeffrey A. Ludrof
|
|
Philip A. Garcia
|
|
Timothy G. NeCastro |
President and
|
|
Executive Vice President and
|
|
Senior Vice President and |
Chief Executive Officer
|
|
Chief Financial Officer
|
|
Controller |
February 16, 2006
|
|
February 16, 2006
|
|
February 16, 2006 |
To the Board of Directors and Shareholders
Erie Indemnity Company
Erie, Pennsylvania
We have audited managements assessment, included
in the accompanying Report of Management on
Internal Control Over Financial Reporting, that Erie
Indemnity Company maintained effective internal control
over financial reporting as of December 31, 2005, based on
criteria established in Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations
of the Treadway Commission (the COSO criteria). Erie
Indemnity Companys management is responsible for
maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control
over financial reporting. Our responsibility is to express an
opinion on managements assessment and an opinion on the
effectiveness of the companys internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of
the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained
in all material respects. Our audit included obtaining an
understanding of internal control over financial reporting,
evaluating managements assessment, testing and evaluating
the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary
in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance
with generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations
of management and directors of the company; and (3)
provide reasonable assurance regarding prevention or timely
55
detection of unauthorized acquisition, use, or disposition of
the companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may
deteriorate.
In our opinion, managements assessment that Erie
Indemnity Company maintained effective internal control
over financial reporting as of December 31, 2005, is fairly
stated, in all material respects, based on the COSO criteria.
Also, in our opinion, Erie Indemnity Company maintained,
in all material respects, effective internal control over financial
reporting as of December 31, 2005, based on the COSO
criteria.
We also have audited, in accordance with the standards of
the Public Company Accounting Oversight Board (United
States), the consolidated statements of financial position
of Erie Indemnity Company as of December 31, 2005 and
2004, and the related consolidated statements of operations,
shareholders equity, and cash flows for each of the three years
in the period ended December 31, 2005, of Erie Indemnity
Company and our report dated February 16, 2006, (except
Note 11, as to which the date is February 21, 2006) expressed
an unqualified opinion thereon.
Cleveland, Ohio
February 16, 2006
To the Board of Directors and Shareholders
Erie Indemnity Company
Erie, Pennsylvania
We have audited the accompanying consolidated statements of financial position of Erie
Indemnity Company and subsidiaries as of December 31, 2005 and 2004, and the related consolidated
statements of operations, shareholders equity and cash flows for each of the three years in the
period ended December 31, 2005. These consolidated financial statements are the responsibility of
the Companys management. Our responsibility is to express an opinion on these financial statements
based on our audits.
We conducted our audits in accordance with standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Erie Indemnity Company and subsidiaries as of December
31, 2005 and 2004, and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting
principles.
We also have audited, in accordance with the Standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of Erie Indemnity Companys internal control over
financial reporting as of December 31, 2005, based on criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 16, 2006, expressed an unqualified opinion thereon.
Cleveland, Ohio
February 16, 2006,
except for Note 11, as to which the date is
February 21, 2006,
56
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
(dollars in thousands, except per share data) |
|
2005 |
|
2004 |
|
2003 |
|
Operating revenue |
|
|
|
|
|
|
|
|
|
|
|
|
Management fee revenue, net |
|
$ |
888,558 |
|
|
$ |
893,087 |
|
|
$ |
830,069 |
|
Premiums earned |
|
|
215,824 |
|
|
|
208,202 |
|
|
|
191,592 |
|
Service agreement revenue |
|
|
20,568 |
|
|
|
21,855 |
|
|
|
27,127 |
|
|
Total operating revenue |
|
|
1,124,950 |
|
|
|
1,123,144 |
|
|
|
1,048,788 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses |
|
|
|
|
|
|
|
|
|
|
|
|
Cost of management operations |
|
|
710,237 |
|
|
|
684,491 |
|
|
|
616,382 |
|
Losses and loss adjustment expenses incurred |
|
|
140,385 |
|
|
|
153,220 |
|
|
|
152,984 |
|
Policy acquisition and other underwriting expenses |
|
|
50,109 |
|
|
|
47,205 |
|
|
|
51,112 |
|
|
Total operating expenses |
|
|
900,731 |
|
|
|
884,916 |
|
|
|
820,478 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment incomeunaffiliated |
|
|
|
|
|
|
|
|
|
|
|
|
Investment income, net of expenses |
|
|
61,555 |
|
|
|
60,988 |
|
|
|
58,298 |
|
Net realized gains on investments |
|
|
15,620 |
|
|
|
18,476 |
|
|
|
10,445 |
|
Equity in earnings (losses) of limited partnerships |
|
|
38,062 |
|
|
|
8,655 |
|
|
|
(2,000 |
) |
|
Total investment incomeunaffiliated |
|
|
115,237 |
|
|
|
88,119 |
|
|
|
66,743 |
|
|
Income before income taxes and equity in
earnings of Erie Family Life Insurance |
|
|
339,456 |
|
|
|
326,347 |
|
|
|
295,053 |
|
Provision for income taxes |
|
|
(111,733 |
) |
|
|
(105,140 |
) |
|
|
(102,237 |
) |
Equity in earnings of Erie Family Life
Insurance, net of tax |
|
|
3,381 |
|
|
|
5,206 |
|
|
|
6,909 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
231,104 |
|
|
$ |
226,413 |
|
|
$ |
199,725 |
|
|
Net income per sharebasic |
|
|
|
|
|
|
|
|
|
|
|
|
Class A common stock |
|
$ |
3.69 |
|
|
$ |
3.54 |
|
|
$ |
3.09 |
|
|
Class B common stock |
|
$ |
558.34 |
|
|
$ |
539.88 |
|
|
$ |
474.19 |
|
|
Net income per sharediluted |
|
$ |
3.34 |
|
|
$ |
3.21 |
|
|
$ |
2.81 |
|
|
Weighted
average shares outstanding |
|
|
|
|
|
|
|
|
|
|
|
|
Basic : |
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A common stock |
|
|
62,392,860 |
|
|
|
63,508,873 |
|
|
|
64,075,506 |
|
|
Class B common stock |
|
|
2,843 |
|
|
|
2,877 |
|
|
|
2,884 |
|
|
Diluted shares |
|
|
69,293,649 |
|
|
|
70,492,292 |
|
|
|
71,094,167 |
|
|
See accompanying notes to Consolidated Financial Statements.
57
(dollars
in thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
As of December 31
|
|
|
2005 |
|
2004 |
|
Assets |
|
|
|
|
Investments |
|
|
|
|
|
|
|
|
Fixed
maturities at fair
value (amortized cost of
$962,320 and $939,280, respectively) |
|
$ |
972,210 |
|
|
$ |
974,512 |
|
Equity securities
at fair value (cost of $249,440 and $175,860, respectively) |
|
|
266,334 |
|
|
|
202,694 |
|
Limited
partnerships (cost of $141,405 and $116,097, respectively) |
|
|
153,159 |
|
|
|
130,464 |
|
Real estate
mortgage loans |
|
|
4,885 |
|
|
|
5,044 |
|
|
Total investments |
|
|
1,396,588 |
|
|
|
1,312,714 |
|
Cash and cash
equivalents |
|
|
31,666 |
|
|
|
50,061 |
|
Accrued investment
income |
|
|
13,131 |
|
|
|
12,480 |
|
Premiums receivable from policyholders |
|
|
267,632 |
|
|
|
275,721 |
|
Federal income
taxes recoverable |
|
|
15,170 |
|
|
|
3,331 |
|
Reinsurance recoverable from Erie Insurance Exchange on unpaid losses |
|
|
827,126 |
|
|
|
764,950 |
|
Ceded unearned premiums to Erie Insurance Exchange |
|
|
125,579 |
|
|
|
128,187 |
|
Notes receivable from Erie Family Life Insurance |
|
|
25,000 |
|
|
|
40,000 |
|
Other receivables from Erie Insurance Exchange and affiliates |
|
|
198,714 |
|
|
|
211,488 |
|
Reinsurance recoverable from non-affiliates |
|
|
1,321 |
|
|
|
964 |
|
Deferred policy
acquisition costs |
|
|
16,436 |
|
|
|
17,112 |
|
Equity in Erie Family Life Insurance |
|
|
55,843 |
|
|
|
58,728 |
|
Securities lending
collateral |
|
|
30,831 |
|
|
|
0 |
|
Prepaid pension
costs |
|
|
38,720 |
|
|
|
50,860 |
|
Other assets |
|
|
57,504 |
|
|
|
56,208 |
|
|
Total assets |
|
$ |
3,101,261 |
|
|
$ |
2,982,804 |
|
|
Liabilities and shareholders equity |
|
|
|
|
|
|
|
|
|
Liabilities |
|
|
|
|
|
|
|
|
Unpaid losses and loss adjustment expenses |
|
$ |
1,019,459 |
|
|
$ |
943,034 |
|
Unearned premiums |
|
|
454,409 |
|
|
|
472,553 |
|
Commissions payable and accrued |
|
|
200,459 |
|
|
|
179,284 |
|
Securities lending
collateral |
|
|
30,831 |
|
|
|
0 |
|
Accounts payable and accrued expenses |
|
|
34,885 |
|
|
|
33,016 |
|
Deferred executive
compensation |
|
|
24,447 |
|
|
|
19,069 |
|
Deferred income
taxes |
|
|
6,538 |
|
|
|
24,122 |
|
Dividends payable |
|
|
22,172 |
|
|
|
20,612 |
|
Employee benefit
obligations |
|
|
29,459 |
|
|
|
24,233 |
|
|
Total liabilities |
|
|
1,822,659 |
|
|
|
1,715,923 |
|
|
Shareholders
equity |
|
|
|
|
|
|
|
|
Capital stock: |
|
|
|
|
|
|
|
|
Class A common,
stated value $.0292 per share; authorized
74,996,930 shares; 67,600,800 and 67,540,800 shares issued,
respectively; 61,162,682 and 62,992,841 shares outstanding, respectively |
|
|
1,972 |
|
|
|
1,970 |
|
Class B common, convertible at a rate of 2,400 Class A shares for
one Class B share; stated value $70 per share; 2,833 and 2,858 shares
authorized, issued and outstanding, respectively |
|
|
198 |
|
|
|
200 |
|
Additional paid-in
capital |
|
|
7,830 |
|
|
|
7,830 |
|
Accumulated other comprehensive income |
|
|
21,681 |
|
|
|
58,611 |
|
Retained earnings |
|
|
1,501,798 |
|
|
|
1,354,181 |
|
|
Total contributed capital and retained earnings |
|
|
1,533,479 |
|
|
|
1,422,792 |
|
|
Treasury stock, at cost, 6,438,118 and 4,547,959 shares
respectively |
|
|
(254,877 |
) |
|
|
(155,911 |
) |
|
Total
shareholders
equity |
|
|
1,278,602 |
|
|
|
1,266,881 |
|
|
Total liabilities and shareholders equity |
|
$ |
3,101,261 |
|
|
$ |
2,982,804 |
|
|
See accompanying notes to Consolidated Financial Statements.
58
(dollars
in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31
|
|
|
2005 |
|
2004 |
|
2003 |
|
Cash flows from operating activities |
|
|
|
|
|
|
|
|
|
|
|
|
Management fee received |
|
$ |
891,965 |
|
|
$ |
882,893 |
|
|
$ |
813,963 |
|
Service agreement fee received |
|
|
20,334 |
|
|
|
21,789 |
|
|
|
26,427 |
|
Premiums collected |
|
|
214,592 |
|
|
|
189,904 |
|
|
|
193,443 |
|
Settlement of commutation received from Exchange |
|
|
3,031 |
|
|
|
0 |
|
|
|
0 |
|
Net investment income received |
|
|
66,274 |
|
|
|
64,268 |
|
|
|
62,370 |
|
Limited
partnership distributions |
|
|
71,718 |
|
|
|
37,165 |
|
|
|
21,266 |
|
Dividends received from Erie Family Life Insurance |
|
|
1,799 |
|
|
|
1,799 |
|
|
|
1,717 |
|
Salaries and wages paid |
|
|
(95,408 |
) |
|
|
(83,263 |
) |
|
|
(78,586 |
) |
Pension funding and employee benefits paid |
|
|
(10,184 |
) |
|
|
(21,250 |
) |
|
|
(30,624 |
) |
Commissions paid to agents |
|
|
(471,492 |
) |
|
|
(480,685 |
) |
|
|
(438,699 |
) |
Agents bonuses paid |
|
|
(46,883 |
) |
|
|
(24,163 |
) |
|
|
(18,436 |
) |
General operating expenses paid |
|
|
(85,333 |
) |
|
|
(80,211 |
) |
|
|
(70,971 |
) |
Losses and loss adjustment expenses paid |
|
|
(126,314 |
) |
|
|
(133,466 |
) |
|
|
(134,365 |
) |
Other underwriting and acquisition costs paid |
|
|
(8,269 |
) |
|
|
(8,908 |
) |
|
|
(11,196 |
) |
Income taxes paid |
|
|
(124,749 |
) |
|
|
(108,127 |
) |
|
|
(89,692 |
) |
|
Net cash provided by operating activities |
|
|
301,081 |
|
|
|
257,745 |
|
|
|
246,617 |
|
|
Cash flows from investing activities |
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of investments: |
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
|
(372,979 |
) |
|
|
(363,232 |
) |
|
|
(503,859 |
) |
Equity securities |
|
|
(155,141 |
) |
|
|
(135,386 |
) |
|
|
(32,860 |
) |
Limited partnerships |
|
|
(75,279 |
) |
|
|
(41,352 |
) |
|
|
(36,659 |
) |
Sales/maturities of investments: |
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity sales |
|
|
232,617 |
|
|
|
140,745 |
|
|
|
207,008 |
|
Fixed maturity calls/maturities |
|
|
115,422 |
|
|
|
122,661 |
|
|
|
152,001 |
|
Equity securities |
|
|
95,676 |
|
|
|
124,008 |
|
|
|
52,043 |
|
Return on limited partnerships |
|
|
6,164 |
|
|
|
2,396 |
|
|
|
1,848 |
|
Purchase of property and equipment |
|
|
(2,003 |
) |
|
|
(2,689 |
) |
|
|
(2,658 |
) |
Net collections on agent loans |
|
|
1,942 |
|
|
|
2,023 |
|
|
|
1,057 |
|
|
Net cash used in investing activities |
|
|
(153,581 |
) |
|
|
(150,826 |
) |
|
|
(162,079 |
) |
|
Cash flows from financing activities |
|
|
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in collateral from securities lending |
|
|
30,831 |
|
|
|
(34,879 |
) |
|
|
(9,037 |
) |
Redemption of securities lending collateral |
|
|
(30,831 |
) |
|
|
34,879 |
|
|
|
9,037 |
|
Dividends paid to shareholders |
|
|
(81,929 |
) |
|
|
(55,120 |
) |
|
|
(49,021 |
) |
Payment of note from Erie Family Life Insurance |
|
|
15,000 |
|
|
|
0 |
|
|
|
0 |
|
Issuance of note to Erie Family Life Insurance |
|
|
0 |
|
|
|
0 |
|
|
|
(25,000 |
) |
Purchase of treasury stock |
|
|
(98,966 |
) |
|
|
(54,051 |
) |
|
|
0 |
|
|
Net cash used in financing activities |
|
|
(165,895 |
) |
|
|
(109,171 |
) |
|
|
(74,021 |
) |
|
Net (decrease) increase in cash and cash equivalents |
|
|
(18,395 |
) |
|
|
(2,252 |
) |
|
|
10,517 |
|
Cash and cash equivalents at beginning of year |
|
|
50,061 |
|
|
|
52,313 |
|
|
|
41,796 |
|
|
Cash and cash equivalents at end of year |
|
$ |
31,666 |
|
|
$ |
50,061 |
|
|
$ |
52,313 |
|
|
See accompanying notes to Consolidated Financial Statements.
59
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands, except per share data) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
|
|
|
|
|
|
|
|
other |
|
|
Class A |
|
|
Class B |
|
|
|
|
|
|
|
|
|
shareholders |
|
|
Comprehensive |
|
|
Retained |
|
|
comprehensive |
|
|
common |
|
|
common |
|
|
Additional |
|
|
Treasury |
|
|
|
equity |
|
|
income |
|
|
earnings |
|
|
income |
|
|
stock |
|
|
stock |
|
|
paid-in capital |
|
|
stock |
|
|
Balance, January
1, 2003 |
|
$ |
987,372 |
|
|
|
|
|
|
$ |
1,040,547 |
|
|
$ |
38,685 |
|
|
$ |
1,967 |
|
|
$ |
203 |
|
|
$ |
7,830 |
|
|
$ |
(101,860 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
199,725 |
|
|
$ |
199,725 |
|
|
|
199,725 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
appreciation of
investments,
net of tax |
|
|
27,732 |
|
|
|
27,732 |
|
|
|
|
|
|
|
27,732 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minimum pension
liability
adjustment,
net of tax |
|
|
(15 |
) |
|
|
(15 |
) |
|
|
|
|
|
|
(15 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income |
|
|
|
|
|
$ |
227,442 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of Class B shares
to Class A shares |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
(2 |
) |
|
|
|
|
|
|
|
|
Dividends declared: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A $.785 per
share |
|
|
(50,304 |
) |
|
|
|
|
|
|
(50,304 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class B $117.75 per
share |
|
|
(340 |
) |
|
|
|
|
|
|
(340 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December
31, 2003 |
|
|
1,164,170 |
|
|
|
|
|
|
|
1,189,628 |
|
|
|
66,402 |
|
|
|
1,969 |
|
|
|
201 |
|
|
|
7,830 |
|
|
|
(101,860 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
226,413 |
|
|
$ |
226,413 |
|
|
|
226,413 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
depreciation of
investments,
net of tax |
|
|
(7,793 |
) |
|
|
(7,793 |
) |
|
|
|
|
|
|
(7,793 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minimum pension
liability
adjustment,
net of tax |
|
|
2 |
|
|
|
2 |
|
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income |
|
|
|
|
|
$ |
218,622 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of
treasury stock |
|
|
(54,051 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(54,051 |
) |
Conversion of Class
B shares
to Class A shares |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
Dividends declared: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A $.97 per
share |
|
|
(61,442 |
) |
|
|
|
|
|
|
(61,442 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class B $145.50 per
share |
|
|
(418 |
) |
|
|
|
|
|
|
(418 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December
31, 2004 |
|
|
1,266,881 |
|
|
|
|
|
|
|
1,354,181 |
|
|
|
58,611 |
|
|
|
1,970 |
|
|
|
200 |
|
|
|
7,830 |
|
|
|
(155,911 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
231,104 |
|
|
$ |
231,104 |
|
|
|
231,104 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
depreciation of
investments, net
of tax |
|
|
(36,933 |
) |
|
|
(36,933 |
) |
|
|
|
|
|
|
(36,933 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minimum pension
liability
adjustment,
net of tax |
|
|
3 |
|
|
|
3 |
|
|
|
|
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income |
|
|
|
|
|
$ |
194,174 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of
treasury stock |
|
|
(98,966 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(98,966 |
) |
Conversion of Class
B shares
to Class A shares |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
(2 |
) |
|
|
|
|
|
|
|
|
Dividends declared: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A $1.335 per
share |
|
|
(82,918 |
) |
|
|
|
|
|
|
(82,918 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class B $200.25 per
share |
|
|
(569 |
) |
|
|
|
|
|
|
(569 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December
31, 2005 |
|
$ |
1,278,602 |
|
|
|
|
|
|
$ |
1,501,798 |
|
|
$ |
21,681 |
|
|
$ |
1,972 |
|
|
$ |
198 |
|
|
$ |
7,830 |
|
|
$ |
(254,877 |
) |
See accompanying notes to Consolidated Financial Statements.
60
Note 1.
Nature of business
Erie Indemnity Company (Company), formed in 1925,
is the attorney-in-fact for the subscribers of Erie
Insurance Exchange (Exchange), a reciprocal insurance
exchange. The Company performs certain services for the
Exchange relating to the sales, underwriting and
issuance of policies on behalf of the Exchange and
earns a management fee for these services. The Exchange
is a Pennsylvania-domiciled property/ casualty insurer
rated A+ (Superior) by A.M. Best. The Exchange is the
23rd largest property/casualty insurer in the United
States based on 2004 net premiums written for all lines
of business. The Exchange and its wholly-owned
subsidiary, Flagship City Insurance Company (Flagship)
and the Companys wholly-owned subsidiaries, Erie
Insurance Company (EIC), Erie Insurance Company of New
York (EINY) and the Erie Insurance Property and
Casualty Company (EIPC), comprise the Property and
Casualty Group. The Property and Casualty Group is a
regional insurance group operating in 11 midwestern,
mid-Atlantic, and southeastern states and the District
of Columbia. The Property and Casualty Group primarily
writes personal auto insurance, which comprises 48.5%
of its direct premiums. The Company also owns 21.6% of
the common stock of the Erie Family Life Insurance
Company (EFL), an affiliated life insurance company.
The Company, together with the Property and Casualty
Group and EFL, operate collectively as the Erie
Insurance Group (the Group).
Note 2.
Recent accounting pronouncements
In November 2005, the Financial Accounting
Standards Board (FASB) issued Staff Position (FSP) FAS
115-1 and FAS 124-1, The Meaning of
Other-Than-Temporary Impairment and its Application to
Certain Investments. This FSP nullifies the
requirements of measurement and recognition in
paragraphs 1018 of Emerging Issues Task Force (EITF)
Issue 03-1, of the same name, carries forward the
disclosure requirements included in Issue 03-1 and
references existing other-than-temporary impairment
guidance. This final FSP is effective for fiscal years
beginning after December 15, 2005. The Company had
previously adopted the disclosure requirements of EITF
03-1, which were unchanged by this final FSP.
Management does not anticipate a change in policy that
would significantly impact the Companys financial
condition or results of operations.
The Accounting Standards Executive Committee issued
Statement of Position (SOP) 05-1, Accounting by
Insurance Enterprises for Deferred Acquisition Costs
in Connection With Modifications or Exchanges of
Insurance Contracts, in September 2005, which is
effective for fiscal years beginning after December
15,
2006, with earlier adoption encouraged. The SOP
provides guidance on accounting for deferred
acquisition costs on internal replacements of insurance
contracts that are modifications to product features
that occur by the exchange of a contract for a new
contract. Insurance contracts issued by the Property
and Casualty Group include nonintegrated contract
features as defined in the SOP, or those that provide
coverage that is underwritten and priced only for that
incremental insurance coverage and do not result in
reunderwriting or repricing of other components of the
contract. Nonintegrated contract features do not change
the existing base contract and do not require further
evaluation under the SOP. This SOP has no impact on the
Companys financial condition or results of operations.
In December 2004, the FASB issued Statement of
Financial Accounting Standards (FAS) No. 123(R),
Share-Based Payment, an amendment of FASB Statements
No. 123 and 95. FAS 123(R) addresses the accounting
for transactions in which an enterprise exchanges its
valuable equity instruments for employee services. It
also addresses transactions in which an enterprise
incurs liabilities that are based on the fair value of
the enterprises equity instruments or that may be
settled by the issuance of those equity instruments in
exchange for employee services. The cost of employee
services received in exchange for equity instruments
would be measured based on the grant-date fair value of
those instruments. That cost would be recognized as
compensation expense over the requisite service period
(often the vesting period). For employees that become
eligible to retire during an explicit service period,
compensation cost would be recognized over the period
through the date that the employee first becomes
eligible to retire and is no longer required to provide
service to earn the award. If vesting of share-based
payments accelerates upon an employees retirement,
this should be accrued at the date of retirement.
Alternatively, an award may continue to vest after
retirement, even though the employee no longer is
providing services to the employer. FAS 123(R) is
effective for periods beginning after June 15, 2005.
The implementation of FAS 123(R) will have minimal
impact on the Companys financial position, results of
operations or cash flows, as the Company does not
settle the cost of employee services through the
issuance of equity instruments.
Note 3.
Significant accounting policies
Basis of presentation
The accompanying consolidated financial statements
have been prepared in conformity with U.S. generally
accepted accounting principles (GAAP) that differ from
statutory accounting practices prescribed or permitted
for insurance companies by regulatory authorities. See
also Note 17.
61
Principles of consolidation
The consolidated financial statements include the
accounts of the Company and its wholly-owned
subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation. The
21.6% equity ownership of EFL is not consolidated but
accounted for under the equity method of accounting.
Reclassifications
Certain amounts reported in prior years have
been reclassified to conform to the current years
financial statement presentation.
Use of estimates
The preparation of financial statements in
conformity with U.S. generally accepted accounting
principles requires management to make estimates and
assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from
those estimates.
Investments and cash equivalents
Fixed maturities consist of bonds, notes and
redeemable preferred stock. Fixed maturities are
classified as available for sale and are reported at
fair value, with unrealized investment gains and
losses, net of income taxes, charged or credited
directly to shareholders equity in accumulated other
comprehensive income. Market value of fixed maturities
are determined based upon quoted market prices or
dealer quotes. If quoted market prices or dealer quotes
are not available, valuation is based on discounted
expected cash flows using market rates commensurate
with the credit quality and maturity of the investment.
Also included in fixed maturities are mortgage-backed
securities, which are amortized using the constant
effective yield method based on anticipated prepayments
and the estimated economic life of the securities. If
actual prepayments differ significantly from anticipated prepayments, the
effective yield is recalculated to reflect actual
payments to date and anticipated future payments. The
net investment in the security is adjusted to the
amount that would have existed had the new effective
yield been applied since the acquisition of the
security, with the corresponding adjustment included as
part of investment income.
Equity securities, which include common and
nonredeemable preferred stocks, are classified as
available for sale and carried at fair value based on
quoted market prices. Changes in fair values of equity
securities, net of income tax, are charged or credited
directly to shareholders equity in accumulated other
comprehensive income.
Limited partnerships include U.S. and foreign private
equity, real estate and mezzanine debt investments.
The private equity limited partnerships invest
primarily in small- to medium-sized companies. Limited
partnerships are recorded using the equity method,
which is the Companys share of the reported value of
the partnership.
Realized gains and losses on sales of investments are
recognized in income based upon specific identification
of the investments sold on the trade date. Interest and
dividend income is recorded as earned. The amortized
cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to lowest yield.
Such amortization is included in investment income.
All investments are evaluated monthly for other-than-temporary impairment loss. Some factors
considered in evaluating whether or not a decline in fair value is other-than-temporary include:
|
|
the extent and duration to which fair value is less than cost; |
|
|
|
historical operating performance
and financial condition of the issuer; |
|
|
|
near term prospects of the issuer and its industry based
on analysts recommendations; |
|
|
|
specific events that occurred affecting the issuer, including a
ratings downgrade; and |
|
|
|
the Companys ability and intent to hold the investment for a period of
time sufficient to allow for a recovery in value. |
An investment that is deemed impaired is written down
to its estimated net realizable value.
Impairment charges are included as
realized losses in the Consolidated Statements of
Operations.
Securities lending program
The Company engages in securities lending
activities from which it generates investment income
from the lending of certain of its investments to other
institutions for short periods of time. The Company
receives marketable securities as collateral equal to
at least 102% of the market value of the loaned
securities. The Company maintains full ownership rights
to the securities loaned and, accordingly, the loaned securities remain classified as investments of
the Company.
The Company shares a portion of the
interest charged on lent securities with the third
party custodian and the borrowing institution. In
accordance with FAS 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of
Liabilities, the Company recognizes the receipt of the
collateral held by the third party custodian and the
obligation to return the collateral on its Consolidated
Statements of Financial Position.
62
Deferred policy acquisition costs
Amounts which vary with, and are primarily related
to, the production of new and renewal insurance
policies, primarily commissions, are deferred and
amortized pro rata over the policy periods in which the
related premiums are earned. Deferred acquisition costs
are reviewed to determine if they are recoverable from
future income, and if not, are charged to expense.
Future investment income attributable to related
premiums is taken into account in measuring the
recoverability of the carrying value of this asset.
Amortization expense, included in policy acquisition
and other underwriting expenses, was $34.2 million,
$34.3 million and $38.6 million in 2005, 2004 and 2003,
respectively.
Insurance liabilities
The liability for losses and loss adjustment
expenses represent estimated provisions for both
reported and unreported claims and related expenses.
The reserves are adjusted regularly based on
experience. Reserve estimates are based on
managements assessment of known facts and
circumstances, review of historical settlement
patterns, estimates of trends in claims severity,
frequency, legal theories of liability and other
factors. Multiple estimation methods are employed for
each product line, which results in a range of
reasonable estimates for each product line. Loss
reserves are set at full expected cost except for
workers compensation loss reserves, which have been
discounted using an interest rate of 2.5%. Unpaid
losses and loss adjustment expenses in the
Consolidated Statements of Financial Position were
reduced by $4.6 million and $4.1 million at December
31, 2005 and 2004, respectively, due to discounting.
The reserves for losses and loss adjustment expenses
are reported net of receivables for salvage and
subrogation of $6.7 million at both December 31, 2005
and 2004.
The reserve for losses and loss adjustment expenses is
necessarily based on estimates and, while management
believes the amount is appropriate, the ultimate
liability may be more or less than the amounts provided. The methods for making such estimates and for
establishing the resulting liability are continually
reviewed. The effects of changes in such estimated
reserves are included in the results of operations in
the period in which the estimates are changed. Changes
in the estimated reserves recorded as of period end may
be material to the result of operations and financial
condition in future periods.
Reinsurance
Premiums earned and losses and loss adjustment
expenses incurred are presented net of reinsurance
activities in the Consolidated Statements of
Operations. Reinsurance premiums are recognized as
revenue on a pro-rata basis over the policy term. Gross
losses and expenses incurred are reduced for amounts
expected to be recovered under reinsurance agreements.
Estimated reinsurance recoverables and receivables for
ceded unearned premiums are recorded as assets with
liabilities recorded for related unpaid losses and
expenses and unearned premiums in the Consolidated
Statements of Financial Position. See the discussion of
the intercompany reinsurance pooling arrangement in
Note 13.
Recognition of management fee revenue
In exchange for providing sales, underwriting, and
policy issuance services, the Company earns management
fees from the Exchange. The management fee revenue is
calculated as a percentage of the direct written
premium of the Property and Casualty Group. The
Exchange issues policies with annual terms only.
Management fees are recorded as revenue upon policy
issuance or renewal, as substantially all of the
services required to be performed by the Company have
been satisfied at that time. Certain activities are
performed and related costs are incurred by the Company
subsequent to policy issuance in connection with the
services provided to the Exchange; however, these
activities are deemed to be inconsequential and
perfunctory.
Although the Company is not required to do so under the
subscribers agreement with the Exchange, it forgives
the management fee charged the Exchange when mid-term
policy cancellations occur. The Company estimates
mid-term policy cancellations and records a related
allowance which is adjusted quarterly. The effect of
recording changes in this estimated allowance increased
the Companys management fee revenue by $.5 million for
the year ended December 31, 2005. Management fee
revenue was reduced by $4.1 million and $3.0 million
for the years ended December 31, 2004 and 2003,
respectively, due to changes in the allowance.
Recognition of premium revenues and losses
Property and liability premiums are recognized
as revenue on a pro-rata basis over the policy term.
Unearned premiums represent the unexpired portion of
premiums written. Losses and loss adjustment expenses
are recorded as incurred. Premiums earned and losses
and loss adjustment expenses incurred are reflected
net of amounts ceded to the Exchange on the
Consolidated Statements of Operations. See also Note
16.
63
Recognition of service agreement revenue
Included in service agreement revenue are service
charges the Company collects from policyholders for
providing multiple payment plans on policies written by
the Property and Casualty Group. Service charges, which
are flat dollar charges for each installment billed
beyond the first installment, are recognized as revenue
when each additional billing is rendered to the
policyholder.
Prior to March 2005, service agreement revenue also
included service income received from the Exchange as
compensation for the management of voluntary assumed
reinsurance from nonaffiliated insurers. The service
fee revenue, calculated as 6% of nonaffiliated assumed
reinsurance premiums written, was recognized in the
period in which the related premium was earned since
the Companys services extended to that same period.
The Exchange exited the assumed reinsurance business
effective December 31, 2003. The service agreement
remained in effect while existing contracts expired
throughout 2004 and was terminated effective March 31,
2005.
Agent bonus estimates
Agent bonuses are based on an individual agencys
property/casualty underwriting profitability and also
include a component for growth in agency current and
prior two year property/casualty premiums, if the
agencies are profitable. The estimate for agent
bonuses, which are based on the performance over 36
months, is modeled on a monthly basis using actual
underwriting data by agency for the two prior years
combined with the current year-to-date actual data and
projected underwriting data for the remainder of the
current year. At December 31 of each year, the Company
uses actual data available and records an accrual
based on expected payment amount. The estimated
incurred agent bonus at December 31, 2005, is $71.1
million. The 2004 and 2003 agent bonus amounts
incurred were $46.2 million and $24.0 million,
respectively. These costs are included in the cost of
management operations in the Consolidated Statements
of Operations.
Income taxes
Provisions for income taxes include deferred taxes
resulting from changes in cumulative temporary
differences between the tax basis and financial
statement basis of assets and liabilities. Deferred tax
assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of enactment.
In the fourth quarter of 2003, the Company recorded an
adjustment to deferred income taxes to recognize future
tax obligations which will arise when earnings from the
Companys equity investment in
EFL are distributed. The deferred tax provision was
computed assuming undistributed earnings of EFL in
excess of the Companys basis would be distributed in
the form of dividends. The one-time non-cash charge of
$3.2 million to record these deferred taxes reduced
net income per share-diluted by $.05 in 2003.
Stock-based compensation
The Company has a long-term incentive plan (LTIP)
from which restricted stock awards are issued to
executive management that are settled in Company
stock. The Company does not issue stock, but instead
purchases stock in the open market to settle these
obligations. The Company currently applies the FAS
123, Accounting for Stock-Based Compensation, fair
value method of accounting for stock-based employee
awards. Under this method, compensation cost is
measured at the grant date based on the fair value of
the award and recognized ratably over the three-year
performance period. The fair value of the restricted
stock is measured at the market price of a share of
the Companys Class A common stock on the grant date.
The effects of changes in the stock price are
recognized as compensation expense over the
performance period. The LTIP does not include an
acceleration of vesting clause. Therefore, if an
employee retired prior to the close of the plans
three-year performance period, vesting would cease at
the end of the year in which they retire.
Note 4.
Earnings per share
Basic earnings per share is calculated under the
two-class method which allocates earnings to each class
of stock based on its dividend rights. Weighted average
shares used in the Class A basic earnings per share
calculation were 62.4 million in 2005, 63.5 million in
2004 and 64.1 million in 2003. Class B shares used in
the basic earnings per share calculation were 2,843
shares, 2,877 shares and 2,884 shares in 2005, 2004 and
2003, respectively. Class B shares are convertible into
Class A at a conversion ratio of 2,400 to 1. The
computation of diluted earnings per share reflects the effect of potentially dilutive outstanding employee
stock-based awards under the long-term incentive plan.
See also Note 9. The total weighted average number of
Class A equivalent shares outstanding (including
conversion of Class B shares) was 69.3 million, 70.5
million and 71.1 million during 2005, 2004 and 2003,
respectively.
64
The following table reconciles the numerators and denominators of the basic and diluted per-share
computations for each of the years ended December 31. (See Note 9 for a description of the
restricted stock awards not yet vested.)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 |
(net income amounts in thousands) |
|
2005 |
|
2004 |
|
2003 |
|
Basic: |
|
|
|
|
|
|
|
|
|
|
|
|
Allocated net incomeClass A |
|
$ |
229,517 |
|
|
$ |
224,861 |
|
|
$ |
198,357 |
|
Class A shares of common stock |
|
|
62,392,860 |
|
|
|
63,508,873 |
|
|
|
64,075,506 |
|
|
Class A earnings per sharebasic |
|
$ |
3.69 |
|
|
$ |
3.54 |
|
|
$ |
3.09 |
|
|
Allocated net incomeClass B |
|
$ |
1,587 |
|
|
$ |
1,552 |
|
|
$ |
1,368 |
|
Class B shares of common stock |
|
|
2,843 |
|
|
|
2,877 |
|
|
|
2,884 |
|
|
Class B earnings per sharebasic |
|
$ |
558.34 |
|
|
$ |
539.88 |
|
|
$ |
474.19 |
|
|
Diluted: |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
231,104 |
|
|
$ |
226,413 |
|
|
$ |
199,725 |
|
Class A shares of common stock |
|
|
62,392,860 |
|
|
|
63,508,873 |
|
|
|
64,075,506 |
|
Assumed conversion of class B common stock and
restricted stock awards |
|
|
6,900,789 |
|
|
|
6,983,419 |
|
|
|
7,018,661 |
|
|
Class A shares of common and equivalent shares |
|
|
69,293,649 |
|
|
|
70,492,292 |
|
|
|
71,094,167 |
|
|
Earnings per sharediluted |
|
$ |
3.34 |
|
|
$ |
3.21 |
|
|
$ |
2.81 |
|
|
Note 5.
Investments
The following tables summarize the cost and market value of available-for-sale securities at
December 31, 2005 and 2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Gross |
|
Gross |
|
|
|
|
Amortized |
|
unrealized |
|
unrealized |
|
Estimated |
December 31, 2005 |
|
cost |
|
gains |
|
losses |
|
fair value |
|
Fixed maturities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. treasuries and government agencies |
|
$ |
9,583 |
|
|
$ |
204 |
|
|
$ |
52 |
|
|
$ |
9,735 |
|
States and political subdivisions |
|
|
145,528 |
|
|
|
1,383 |
|
|
|
1,104 |
|
|
|
145,807 |
|
Special revenue |
|
|
195,059 |
|
|
|
1,816 |
|
|
|
1,130 |
|
|
|
195,745 |
|
Public utilities |
|
|
66,866 |
|
|
|
3,077 |
|
|
|
334 |
|
|
|
69,609 |
|
U. S. industrial and miscellaneous |
|
|
353,843 |
|
|
|
5,889 |
|
|
|
4,013 |
|
|
|
355,719 |
|
Mortgage-backed securities |
|
|
32,251 |
|
|
|
788 |
|
|
|
413 |
|
|
|
32,626 |
|
Asset-backed securities |
|
|
22,117 |
|
|
|
43 |
|
|
|
443 |
|
|
|
21,717 |
|
Foreign |
|
|
106,445 |
|
|
|
3,772 |
|
|
|
816 |
|
|
|
109,401 |
|
|
Total bonds |
|
|
931,692 |
|
|
|
16,972 |
|
|
|
8,305 |
|
|
|
940,359 |
|
Redeemable preferred stock |
|
|
30,628 |
|
|
|
1,340 |
|
|
|
117 |
|
|
|
31,851 |
|
|
Total fixed maturities |
|
|
962,320 |
|
|
|
18,312 |
|
|
|
8,422 |
|
|
|
972,210 |
|
|
Equity securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Public utilities |
|
|
1,313 |
|
|
|
160 |
|
|
|
0 |
|
|
|
1,473 |
|
U. S. banks, trusts and insurance companies |
|
|
10,783 |
|
|
|
1,528 |
|
|
|
286 |
|
|
|
12,025 |
|
U. S. industrial and miscellaneous |
|
|
53,713 |
|
|
|
8,668 |
|
|
|
1,599 |
|
|
|
60,782 |
|
Foreign |
|
|
18,950 |
|
|
|
2,712 |
|
|
|
381 |
|
|
|
21,281 |
|
Nonredeemable preferred stock: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Public utilities |
|
|
26,266 |
|
|
|
285 |
|
|
|
448 |
|
|
|
26,103 |
|
U. S. banks, trusts and insurance companies |
|
|
64,632 |
|
|
|
2,432 |
|
|
|
228 |
|
|
|
66,836 |
|
U. S. industrial and miscellaneous |
|
|
62,552 |
|
|
|
3,523 |
|
|
|
464 |
|
|
|
65,611 |
|
Foreign |
|
|
11,231 |
|
|
|
1,033 |
|
|
|
41 |
|
|
|
12,223 |
|
|
Total equity securities |
|
$ |
249,440 |
|
|
$ |
20,341 |
|
|
$ |
3,447 |
|
|
$ |
266,334 |
|
|
65
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Gross |
|
Gross |
|
|
|
|
Amortized |
|
unrealized |
|
unrealized |
|
Estimated |
December 31, 2004 |
|
cost |
|
gains |
|
losses |
|
fair value |
|
Fixed maturities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. treasuries and government agencies |
|
$ |
11,850 |
|
|
$ |
412 |
|
|
$ |
69 |
|
|
$ |
12,193 |
|
States and political subdivisions |
|
|
80,508 |
|
|
|
2,515 |
|
|
|
164 |
|
|
|
82,859 |
|
Special revenue |
|
|
125,083 |
|
|
|
3,407 |
|
|
|
137 |
|
|
|
128,353 |
|
Public utilities |
|
|
66,927 |
|
|
|
4,708 |
|
|
|
52 |
|
|
|
71,583 |
|
U. S. industrial and miscellaneous |
|
|
429,793 |
|
|
|
14,953 |
|
|
|
1,669 |
|
|
|
443,077 |
|
Mortgage-backed securities |
|
|
48,504 |
|
|
|
772 |
|
|
|
390 |
|
|
|
48,886 |
|
Asset-backed securities |
|
|
21,596 |
|
|
|
76 |
|
|
|
286 |
|
|
|
21,386 |
|
Foreign |
|
|
125,590 |
|
|
|
9,628 |
|
|
|
312 |
|
|
|
134,906 |
|
|
Total bonds |
|
|
909,851 |
|
|
|
36,471 |
|
|
|
3,079 |
|
|
|
943,243 |
|
Redeemable preferred stock |
|
|
29,429 |
|
|
|
1,949 |
|
|
|
109 |
|
|
|
31,269 |
|
|
Total fixed maturities |
|
|
939,280 |
|
|
|
38,420 |
|
|
|
3,188 |
|
|
|
974,512 |
|
|
Equity securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Public utilities |
|
|
992 |
|
|
|
11 |
|
|
|
0 |
|
|
|
1,003 |
|
U. S. banks, trusts and insurance companies |
|
|
6,197 |
|
|
|
2,334 |
|
|
|
50 |
|
|
|
8,481 |
|
U. S. industrial and miscellaneous |
|
|
34,120 |
|
|
|
13,136 |
|
|
|
171 |
|
|
|
47,085 |
|
Foreign |
|
|
2,245 |
|
|
|
57 |
|
|
|
28 |
|
|
|
2,274 |
|
Nonredeemable preferred stock: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Public utilities |
|
|
21,373 |
|
|
|
1,939 |
|
|
|
59 |
|
|
|
23,253 |
|
U. S. banks, trusts and insurance companies |
|
|
43,605 |
|
|
|
3,401 |
|
|
|
2 |
|
|
|
47,004 |
|
U. S. industrial and miscellaneous |
|
|
55,096 |
|
|
|
4,667 |
|
|
|
88 |
|
|
|
59,675 |
|
Foreign |
|
|
12,232 |
|
|
|
1,730 |
|
|
|
43 |
|
|
|
13,919 |
|
|
Total equity securities |
|
$ |
175,860 |
|
|
$ |
27,275 |
|
|
$ |
441 |
|
|
$ |
202,694 |
|
|
The amortized cost and estimated fair value of fixed
maturities at December 31, 2005, by remaining
contractual term to maturity, are shown below.
Mortgage-backed securities are allocated based on
their stated maturity dates. Actual cash flows may
differ from those presented as a result of calls,
prepayments or defaults.
|
|
|
|
|
|
|
|
|
|
|
Amortized |
|
Estimated |
(in thousands) |
|
cost |
|
fair value |
|
Due in one year or less |
|
$ |
88,040 |
|
|
$ |
87,857 |
|
Due after one year through
five years |
|
|
334,109 |
|
|
|
333,063 |
|
Due after
five years through ten years |
|
|
351,622 |
|
|
|
359,076 |
|
Due after ten years |
|
|
188,549 |
|
|
|
192,214 |
|
|
Total fixed maturities |
|
$ |
962,320 |
|
|
$ |
972,210 |
|
|
66
Fixed maturities and equity securities in a gross unrealized loss position are as follows.
Data is provided by length of time securities were in a gross unrealized loss position:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 months |
|
12 months or longer |
|
Total |
|
|
|
|
Fair |
|
Unrealized |
|
Fair |
|
Unrealized |
|
Fair |
|
Unrealized |
|
Number of |
(in thousands) |
|
value |
|
losses |
|
value |
|
losses |
|
value |
|
losses |
|
holdings |
|
December 31, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasuries and
government agencies |
|
$ |
5,615 |
|
|
$ |
40 |
|
|
$ |
257 |
|
|
$ |
12 |
|
|
$ |
5,872 |
|
|
$ |
52 |
|
|
|
7 |
|
States and political
subdivisions |
|
|
88,553 |
|
|
|
907 |
|
|
|
5,035 |
|
|
|
197 |
|
|
|
93,588 |
|
|
|
1,104 |
|
|
|
40 |
|
Special revenue |
|
|
108,565 |
|
|
|
992 |
|
|
|
6,284 |
|
|
|
138 |
|
|
|
114,849 |
|
|
|
1,130 |
|
|
|
52 |
|
Public utilities |
|
|
20,215 |
|
|
|
220 |
|
|
|
2,877 |
|
|
|
114 |
|
|
|
23,092 |
|
|
|
334 |
|
|
|
13 |
|
U.S. industrial &
miscellaneous |
|
|
106,403 |
|
|
|
1,766 |
|
|
|
68,585 |
|
|
|
2,247 |
|
|
|
174,988 |
|
|
|
4,013 |
|
|
|
100 |
|
Mortgage-backed securities |
|
|
6,889 |
|
|
|
92 |
|
|
|
12,194 |
|
|
|
321 |
|
|
|
19,083 |
|
|
|
413 |
|
|
|
15 |
|
Asset-backed securities |
|
|
2,903 |
|
|
|
97 |
|
|
|
12,420 |
|
|
|
346 |
|
|
|
15,323 |
|
|
|
443 |
|
|
|
7 |
|
Foreign |
|
|
21,103 |
|
|
|
398 |
|
|
|
13,973 |
|
|
|
418 |
|
|
|
35,076 |
|
|
|
816 |
|
|
|
17 |
|
|
Total bonds |
|
|
360,246 |
|
|
|
4,512 |
|
|
|
121,625 |
|
|
|
3,793 |
|
|
|
481,871 |
|
|
|
8,305 |
|
|
|
251 |
|
Redeemable preferred
stock |
|
|
5,018 |
|
|
|
117 |
|
|
|
0 |
|
|
|
0 |
|
|
|
5,018 |
|
|
|
117 |
|
|
|
1 |
|
|
Total fixed maturities |
|
|
365,264 |
|
|
|
4,629 |
|
|
|
121,625 |
|
|
|
3,793 |
|
|
|
486,889 |
|
|
|
8,422 |
|
|
|
252 |
|
|
Equity securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock |
|
|
20,858 |
|
|
|
2,095 |
|
|
|
2,280 |
|
|
|
171 |
|
|
|
23,138 |
|
|
|
2,266 |
|
|
|
84 |
|
Nonredeemable preferred
stock |
|
|
35,567 |
|
|
|
764 |
|
|
|
8,022 |
|
|
|
417 |
|
|
|
43,589 |
|
|
|
1,181 |
|
|
|
19 |
|
|
Total equity securities |
|
|
56,425 |
|
|
|
2,859 |
|
|
|
10,302 |
|
|
|
588 |
|
|
|
66,727 |
|
|
|
3,447 |
|
|
|
103 |
|
|
Total fixed maturities and
equity securities |
|
$ |
421,689 |
|
|
$ |
7,488 |
|
|
$ |
131,927 |
|
|
$ |
4,381 |
|
|
$ |
553,616 |
|
|
$ |
11,869 |
|
|
|
355 |
|
|
67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 months |
|
12 months or longer |
|
Total |
|
|
|
Fair |
|
Unrealized |
|
Fair |
|
Unrealized |
|
Fair |
|
Unrealized |
|
Number of |
(in thousands) |
|
value |
|
losses |
|
value |
|
losses |
|
value |
|
losses |
|
holdings |
|
December 31, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasuries and
government agencies |
|
$ |
1,014 |
|
|
$ |
12 |
|
|
$ |
1,934 |
|
|
$ |
57 |
|
|
$ |
2,948 |
|
|
$ |
69 |
|
|
|
3 |
|
States and political
subdivisions |
|
|
15,798 |
|
|
|
131 |
|
|
|
1,467 |
|
|
|
33 |
|
|
|
17,265 |
|
|
|
164 |
|
|
|
8 |
|
Special revenue |
|
|
19,098 |
|
|
|
137 |
|
|
|
0 |
|
|
|
0 |
|
|
|
19,098 |
|
|
|
137 |
|
|
|
7 |
|
Public utilities |
|
|
11,828 |
|
|
|
52 |
|
|
|
0 |
|
|
|
0 |
|
|
|
11,828 |
|
|
|
52 |
|
|
|
5 |
|
U.S. industrial &
miscellaneous |
|
|
133,339 |
|
|
|
1,396 |
|
|
|
11,737 |
|
|
|
273 |
|
|
|
145,076 |
|
|
|
1,669 |
|
|
|
69 |
|
Mortgage-backed securities |
|
|
13,879 |
|
|
|
200 |
|
|
|
7,021 |
|
|
|
190 |
|
|
|
20,900 |
|
|
|
390 |
|
|
|
13 |
|
Asset-backed securities |
|
|
17,700 |
|
|
|
277 |
|
|
|
918 |
|
|
|
8 |
|
|
|
18,618 |
|
|
|
285 |
|
|
|
7 |
|
Foreign |
|
|
26,156 |
|
|
|
215 |
|
|
|
1,865 |
|
|
|
98 |
|
|
|
28,021 |
|
|
|
313 |
|
|
|
13 |
|
|
Total bonds |
|
|
238,812 |
|
|
|
2,420 |
|
|
|
24,942 |
|
|
|
659 |
|
|
|
263,754 |
|
|
|
3,079 |
|
|
|
125 |
|
Redeemable preferred
stock |
|
|
3,052 |
|
|
|
109 |
|
|
|
0 |
|
|
|
0 |
|
|
|
3,052 |
|
|
|
109 |
|
|
|
1 |
|
|
Total fixed maturities |
|
|
241,864 |
|
|
|
2,529 |
|
|
|
24,942 |
|
|
|
659 |
|
|
|
266,806 |
|
|
|
3,188 |
|
|
|
126 |
|
|
Equity securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock |
|
|
12,985 |
|
|
|
249 |
|
|
|
0 |
|
|
|
0 |
|
|
|
12,985 |
|
|
|
249 |
|
|
|
66 |
|
Nonredeemable preferred
stock |
|
|
17,628 |
|
|
|
149 |
|
|
|
1,352 |
|
|
|
43 |
|
|
|
18,980 |
|
|
|
192 |
|
|
|
10 |
|
|
Total equity securities |
|
|
30,613 |
|
|
|
398 |
|
|
|
1,352 |
|
|
|
43 |
|
|
|
31,965 |
|
|
|
441 |
|
|
|
76 |
|
|
Total fixed maturities and
equity securities |
|
$ |
272,477 |
|
|
$ |
2,927 |
|
|
$ |
26,294 |
|
|
$ |
702 |
|
|
$ |
298,771 |
|
|
$ |
3,629 |
|
|
|
202 |
|
|
The fixed maturity investments with continuous
unrealized losses for less than 12 months were
primarily due to the impact of higher market interest
rates rather than a decline in credit quality of the
specific issuers. Of the fixed maturities that are
below amortized cost for less than 12 months,
securities that were investment-grade had a fair value
of $357.7 million at December 31, 2005. These fixed
maturities had unrealized losses as of December 31,
2005, of $4.3 million.
The remaining fair value of fixed maturities below
amortized cost for less than 12 months of $7.6 million
at December 31, 2005, were non-investment grade
securities and had unrealized losses of $.4 million.
Comprising this amount are three issuers, all of which
were downgraded to non-investment grade credits in
2005. These three issuers are in the automotive and
auto financing industries. The Company is monitoring
the financial condition of these three issuers. An
impairment charge of $.3 million was recorded for one
of these securities to write it down to its estimated
market value in 2005. It is possible that these
securities may be further impaired resulting in
realized losses in future periods.
There are $121.6 million in investment-grade fixed
maturity securities at fair value that at December 31,
2005, had been below amortized cost for 12 months or
longer. These fixed maturities had unrealized losses as
of December 31, 2005, of $3.8 million. All of these
securities were investment grade at December 31, 2005.
These unrealized losses are due to higher market
interest rates and greater spread requirements in the
market in general and are not related to the credit
quality of specific issuers.
68
Investment income net of expenses was generated
from the following portfolios for the years ended
December 31 as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Fixed maturities |
|
$ |
50,222 |
|
|
$ |
49,601 |
|
|
$ |
46,366 |
|
Equity securities |
|
|
10,847 |
|
|
|
10,440 |
|
|
|
10,598 |
|
Cash equivalents
and other |
|
|
2,113 |
|
|
|
2,003 |
|
|
|
2,040 |
|
|
Total investment
income |
|
|
63,182 |
|
|
|
62,044 |
|
|
|
59,004 |
|
Less: investment
expenses |
|
|
1,627 |
|
|
|
1,056 |
|
|
|
706 |
|
|
Investment income,
net of expenses |
|
$ |
61,555 |
|
|
$ |
60,988 |
|
|
$ |
58,298 |
|
|
Following are the components of net realized gains on
investments as reported in the Consolidated Statements
of Operations. Included in 2005 gross realized losses
are impairment charges of $2.9 million and $1.6 million
related to fixed maturities and equity securities,
respectively. The fixed maturity impairment charges
related to bonds in the automotive industry. The equity
securities that were impaired were in the consumer
products, automotive and technology sectors. There were
no impairment charges in 2004. Included in the 2003
gross realized losses are impairment charges of $2.3
million and $3.7 million related to fixed maturities
and equity securities, respectively. The impairment
charges related to bonds
in the financial and retail sectors and
charges related to equity securities were in the energy
sector.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Fixed maturities |
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized gains |
|
$ |
7,231 |
|
|
$ |
6,855 |
|
|
$ |
15,589 |
|
Gross realized losses |
|
|
(6,097 |
) |
|
|
(524 |
) |
|
|
(3,952 |
) |
|
Net realized
gains |
|
|
1,134 |
|
|
|
6,331 |
|
|
|
11,637 |
|
|
Equity securities |
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized gains |
|
|
19,517 |
|
|
|
14,175 |
|
|
|
4,602 |
|
Gross realized losses |
|
|
(5,031 |
) |
|
|
(2,030 |
) |
|
|
(5,794 |
) |
|
Net realized
gains (losses) |
|
|
14,486 |
|
|
|
12,145 |
|
|
|
(1,192 |
) |
|
Net realized gains
on investments |
|
$ |
15,620 |
|
|
$ |
18,476 |
|
|
$ |
10,445 |
|
|
Change in difference between fair value and cost of
investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Fixed maturities |
|
$ |
(25,342 |
) |
|
$ |
(9,480 |
) |
|
$ |
12,520 |
|
Equity securities |
|
|
(9,940 |
) |
|
|
(10,231 |
) |
|
|
18,580 |
|
|
|
|
|
(35,282 |
) |
|
|
(19,711 |
) |
|
|
31,100 |
|
Deferred taxes on
unrealized (losses)
gains of fixed
maturities and
equity securities |
|
|
12,349 |
|
|
|
6,899 |
|
|
|
(10,885 |
) |
|
Change in net
unrealized (losses)
gains |
|
$ |
(22,933 |
) |
|
$ |
(12,812 |
) |
|
$ |
20,215 |
|
|
Limited partnerships are recorded using the equity
method. The components of equity in earnings (losses)
of limited partnerships as reported in the Consolidated
Statements of Operations for the years ended December
31 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Private equity |
|
$ |
16,732 |
|
|
$ |
2,324 |
|
|
$ |
(3,983 |
) |
Real estate |
|
|
7,657 |
|
|
|
4,350 |
|
|
|
3,349 |
|
Mezzanine debt |
|
|
3,530 |
|
|
|
1,981 |
|
|
|
(1,366 |
) |
Valuation adjustments |
|
|
10,143 |
|
|
|
0 |
|
|
|
0 |
|
|
Total equity in
earnings (losses)
of limited
partnerships |
|
$ |
38,062 |
|
|
$ |
8,655 |
|
|
$ |
(2,000 |
) |
|
During 2005, the Company made a correction to its
treatment of unrealized gains and losses on limited
partnerships. This correction resulted in an increase
to second quarter 2005 pre-tax income of $14.2 million,
or an increase to net income per share-diluted of $.13
to record changes in the fair value of limited
partnerships to equity in earnings or losses of limited
partnerships in the Consolidated Statement of
Operations. The Company had previously reflected
unrealized gains and losses on limited partnerships in
shareholders equity in accumulated other comprehensive
income. Included in the pre-tax adjustment was $9.4
million of unrealized gains related to 2004 and prior
years, or $.09 per share-diluted. While there was an
earnings impact related to this adjustment, there was no impact
on the Companys shareholders equity.
Impairment charges in which the decline in value of
limited partnerships is considered
other-than-temporary by management are included in the
related category in the table above. Included in the
private equity partnership net earnings or losses are
impairment charges of $1.2 million and $5.0 million
for 2004 and 2003, respectively. Included in the 2003
mezzanine debt partnership losses is an impairment
charge of $2.5 million from partnerships concentrated
in the facility resources, textile and food and
beverage industries.
69
See also Note 19 for investment commitments related to
partnerships.
The Company participates in a program whereby
marketable securities from its investment portfolio are
lent to independent brokers or dealers based on, among
other things, their creditworthiness in exchange for
collateral initially equal to at least 102% of the
value of the securities on loan and is thereafter
maintained at a minimum of 100% of the market value of
the securities loaned. The market value of the
securities on loan to each borrower is monitored daily
by the third party custodian and the borrower is
required to deliver additional collateral if the market
value of the collateral falls below 100% of the market
value of the securities on loan.
The Company had loaned securities included as part of
its invested assets with a market value of $30.0
million at December 31, 2005. The Company had no loaned
securities at December 31, 2004. The Company has
incurred no losses on the securities lending program
since the programs inception.
Cash equivalents are principally comprised of
investments in bank money market funds and
approximate fair value.
|
|
|
|
|
Note 6. |
|
|
|
|
|
Comprehensive income |
|
|
|
|
|
The components of changes to comprehensive income
follow for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Unrealized holding
(losses) gains on
securities arising
during period |
|
$ |
(41,199 |
) |
|
$ |
6,487 |
|
|
$ |
53,110 |
|
Less: gains included
in net income |
|
|
(15,620 |
) |
|
|
(18,476 |
) |
|
|
(10,445 |
) |
|
Net unrealized
holding (losses)
gains arising
during period |
|
|
(56,819 |
) |
|
|
(11,989 |
) |
|
|
42,665 |
|
Income tax benefit
(liability) related to
unrealized gains
or losses |
|
|
19,886 |
|
|
|
4,196 |
|
|
|
(14,933 |
) |
|
Net (depreciation)
appreciation
of investments |
|
|
(36,933 |
) |
|
|
(7,793 |
) |
|
|
27,732 |
|
|
Minimum pension
liability adjustment
(See Note 8) |
|
|
4 |
|
|
|
3 |
|
|
|
(23 |
) |
Income tax (liability)
benefit related to
pension adjustment |
|
|
(1 |
) |
|
|
(1 |
) |
|
|
8 |
|
|
Net minimum pension
liability adjustment |
|
|
3 |
|
|
|
2 |
|
|
|
(15 |
) |
|
Change in other
comprehensive
income, net of tax |
|
$ |
(36,930 |
) |
|
$ |
(7,791 |
) |
|
$ |
(27,717 |
) |
|
The components of accumulated other comprehensive
income, net of tax, as of December 31 are as follows:
|
|
|
|
|
|
|
|
|
(in thousands) |
|
2005 |
|
2004 |
|
Accumulated net |
|
|
|
|
|
|
|
|
appreciation of investments
|
|
$ |
21,720 |
|
|
$ |
58,653 |
|
Accumulated minimum |
|
|
|
|
|
|
|
|
pension liability adjustment
|
|
|
(39 |
) |
|
|
(42 |
) |
|
Accumulated other |
|
|
|
|
|
|
|
|
comprehensive income
|
|
$ |
21,681 |
|
|
$ |
58,611 |
|
|
|
|
|
|
|
Note 7. |
|
|
|
|
|
Equity in Erie Family Life Insurance |
|
|
|
|
|
The Company owns 21.6% of EFLs common shares
outstanding, which is accounted for using the equity
method of accounting. EFL is a Pennsylvania-domiciled
life insurance company operating in 10 states and the
District of Columbia. EFLs undistributed earnings
accounted for under the equity method and included in
the Companys retained earnings as of December 31, 2005
and 2004, are $51.6 million and $49.9 million,
respectively.
The following represents condensed financial
information for EFL on a U.S. GAAP basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Revenues |
|
$ |
148,876 |
|
|
$ |
149,833 |
|
|
$ |
149,973 |
|
Benefits and
expenses |
|
|
124,561 |
|
|
|
104,541 |
|
|
|
102,668 |
|
Income before
income taxes |
|
|
24,315 |
|
|
|
45,292 |
|
|
|
47,305 |
|
Net income |
|
|
16,539 |
|
|
|
29,632 |
|
|
|
32,487 |
|
Comprehensive
(loss) income |
|
|
(7,242 |
) |
|
|
24,281 |
|
|
|
46,313 |
|
Dividends paid to
shareholders |
|
|
8,316 |
|
|
|
8,222 |
|
|
|
7,938 |
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31 |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
Investments |
|
$ |
1,498,099 |
|
|
$ |
1,466,579 |
|
Total assets |
|
|
1,776,360 |
|
|
|
1,661,440 |
|
Liabilities |
|
|
1,520,390 |
|
|
|
1,389,912 |
|
Accumulated other
comprehensive income |
|
|
15,471 |
|
|
|
39,252 |
|
Total shareholders equity |
|
|
255,970 |
|
|
|
271,528 |
|
|
The Companys share of EFLs unrealized appreciation
of investments, net of tax, reflected in EFLs
shareholders equity, is $3.3 million and $8.5 million
at December 31, 2005 and 2004, respectively. Dividends
paid to the Company totaled $1.8 million for the years
ended December 31, 2005 and 2004, and $1.7 million for
the year ended December 31, 2003.
70
The liabilities for the plans described in this
note are presented in total for all employees of the
Group, before allocations to related entities. The
gross liability for the pension and postretirement
benefit plans is presented in the Consolidated
Statements of Financial Position as employee benefit
obligations with amounts expected to be recovered from
the Companys affiliates included in other assets. The
remaining liabilities not separately presented in this
note are presented in the Consolidated Statements of
Financial Position as accounts payable and accrued
expenses.
The Companys pension plans consist of: 1) a
noncontributory defined benefit pension plan covering
substantially all employees of the Company, 2) an
unfunded supplemental employee retirement plan (SERP)
for its executive and senior management and 3) an
unfunded pension plan for certain of its outside
directors. The pension plans provide benefits to
covered individuals satisfying certain age and service
requirements. The defined benefit pension plan and SERP
provide benefits through a final average earnings
formula and a percent of average monthly compensation
formula, respectively. The benefit provided under the
pension plan for outside directors
equals the annual retainer fee at the date of
retirement. The outside directors plan has been frozen
since 1997.
The Company also provides postretirement
health benefits in the form of medical and pharmacy
health plans for eligible retired employees and
eligible dependents. To be eligible for benefits, an
employee must be at least 60 years old when separating
from service and have 15 years of continuous full-time
service. The benefits are provided from retirement date
to age 65. Actuarially determined costs are recognized
over the period the employee provides service to the
Company.
The Company pays the obligations when due for
those benefit plans that are unfunded.
The following tables summarize the funded status,
obligations and amounts recognized in the Consolidated
Statements of Financial Position for the Companys
plans. The Company uses a December 31 measurement date
for its pension and postretirement health benefit
plans. The projected benefit obligation is presented
below for the pension plans and the accumulated
benefit obligation is presented for the postretirement
health benefit plan.
The accumulated benefit obligation of the Companys
pension plans was $181.3 million and $150.4 million at
December 31, 2005 and 2004, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement |
|
|
|
Pension plans |
|
|
health benefit plan |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
Change in benefit obligation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefit obligation at January 1 |
|
$ |
241,641 |
|
|
$ |
212,713 |
|
|
$ |
12,628 |
|
|
$ |
11,367 |
|
Service cost |
|
|
14,564 |
|
|
|
13,236 |
|
|
|
1,259 |
|
|
|
968 |
|
Interest cost |
|
|
14,576 |
|
|
|
12,949 |
|
|
|
968 |
|
|
|
708 |
|
Amendments |
|
|
221 |
|
|
|
296 |
|
|
|
(290 |
) |
|
|
(730 |
) |
Actuarial loss |
|
|
15,603 |
|
|
|
3,512 |
|
|
|
6,108 |
|
|
|
566 |
|
Benefits paid |
|
|
(1,628 |
) |
|
|
(1,065 |
) |
|
|
(638 |
) |
|
|
(251 |
) |
|
Benefit obligation at December 31 |
|
$ |
284,977 |
|
|
$ |
241,641 |
|
|
$ |
20,035 |
|
|
$ |
12,628 |
|
|
Change in plan assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of plan assets at January 1 |
|
$ |
203,071 |
|
|
$ |
181,714 |
|
|
$ |
|
|
|
$ |
|
|
Actual return on plan assets |
|
|
18,996 |
|
|
|
14,673 |
|
|
|
|
|
|
|
|
|
Employer contributions |
|
|
70 |
|
|
|
7,749 |
|
|
|
|
|
|
|
|
|
Benefits paid |
|
|
(1,628 |
) |
|
|
(1,065 |
) |
|
|
|
|
|
|
|
|
|
Fair value of plan assets at December 31 |
|
$ |
220,509 |
|
|
$ |
203,071 |
|
|
$ |
|
|
|
$ |
|
|
|
Reconciliation of funded status |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funded status at December 31 |
|
$ |
(64,468 |
) |
|
$ |
(38,570 |
) |
|
$ |
(20,035 |
) |
|
$ |
(12,628 |
) |
Unrecognized net actuarial loss |
|
|
82,699 |
|
|
|
72,305 |
|
|
|
9,055 |
|
|
|
3,273 |
|
Unrecognized prior service cost |
|
|
3,463 |
|
|
|
3,942 |
|
|
|
(1,253 |
) |
|
|
(1,071 |
) |
|
Net amount recognized |
|
$ |
21,694 |
|
|
$ |
37,677 |
|
|
$ |
(12,233 |
) |
|
$ |
(10,426 |
) |
|
Amounts recognized in the Consolidated
Statements of Financial Position consist of |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid benefit cost (defined benefit plan) |
|
$ |
38,720 |
|
|
$ |
50,860 |
|
|
$ |
|
|
|
$ |
|
|
Accrued benefit liability |
|
|
(17,226 |
) |
|
|
(13,807 |
) |
|
|
(12,233 |
) |
|
|
(10,426 |
) |
Intangible asset |
|
|
140 |
|
|
|
560 |
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income |
|
|
60 |
|
|
|
64 |
|
|
|
|
|
|
|
|
|
|
Net amount recognized |
|
$ |
21,694 |
|
|
$ |
37,677 |
|
|
$ |
(12,233 |
) |
|
$ |
(10,426 |
) |
|
Accrued benefit liability |
|
|
17,226 |
|
|
|
13,807 |
|
|
|
12,233 |
|
|
|
10,426 |
|
Reimbursements from affiliates included in other assets |
|
|
(7,845 |
) |
|
|
(6,309 |
) |
|
|
(6,576 |
) |
|
|
(5,424 |
) |
|
Net accrued benefit liability |
|
$ |
9,381 |
|
|
$ |
7,498 |
|
|
$ |
5,657 |
|
|
$ |
5,002 |
|
|
71
The 2005 actuarial loss in the pension plan was due
to a change in the discount rate assumption used to
estimate the benefit obligation from 6.00% in 2004 to
5.75% in 2005. The postretirement health benefit
plans actuarial loss was principally due to changes
in the mortality and discount rate assumptions,
offset by actual plan experience that was better than
the experience used to estimate 2005 expense.
Previously, a single health care plan was offered for
all employees. Effective January 1, 2005, two
alternative health plan options were offered to
employees which required increased employee
cost-sharing. This plan change resulted in a decrease
in the per-capita medical costs under the
postretirement health benefit plan.
For pension plans
with an accumulated benefit obligation in excess of
plan assets (SERP and the plan for outside directors),
the aggregate projected benefit obligation and the
aggregate accumulated benefit obligation were $30.4
million and $17.2 million, respectively, at
December 31, 2005, and $26.5 million and $13.8
million, respectively, at December 31, 2004. As these
plans are unfunded, consequently, there are no plan
assets.
The accrued benefit liability of $17.2 million
and $13.8 million at December 31, 2005 and 2004,
respectively, relates principally to the SERP plan.
The intangible asset relates entirely to the SERP
plan.
The Companys funding policy regarding the employee
pension plan is to contribute amounts sufficient to
meet ERISA funding requirements plus such additional
amounts as may be determined to be appropriate, subject
to IRS funding limits. In 2005, the Companys
contribution to the pension plan was limited by IRS
funding limits. The Company expects to contribute
approximately $7.5 million to the employee pension plan
in 2006. The following table summarizes the components
of net benefit expense recognized in the Consolidated
Statements of Operations for the years ended December
31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement |
|
|
|
Pension plans |
|
|
health benefit plan |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Net periodic benefit cost |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service cost |
|
$ |
14,564 |
|
|
$ |
13,236 |
|
|
$ |
10,045 |
|
|
$ |
1,259 |
|
|
$ |
968 |
|
|
$ |
715 |
|
Interest cost |
|
|
14,576 |
|
|
|
12,949 |
|
|
|
11,096 |
|
|
|
968 |
|
|
|
708 |
|
|
|
595 |
|
Expected return on
plan assets |
|
|
(17,382 |
) |
|
|
(16,996 |
) |
|
|
(16,553 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of prior
service cost |
|
|
700 |
|
|
|
901 |
|
|
|
885 |
|
|
|
(108 |
) |
|
|
(53 |
) |
|
|
(50 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recognized net actuarial
loss |
|
|
3,595 |
|
|
|
3,205 |
|
|
|
811 |
|
|
|
326 |
|
|
|
154 |
|
|
|
54 |
|
Amortization of
unrecognized initial
net asset |
|
|
0 |
|
|
|
0 |
|
|
|
(234 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic benefit cost |
|
$ |
16,053 |
|
|
$ |
13,295 |
|
|
$ |
6,050 |
|
|
$ |
2,445 |
|
|
$ |
1,777 |
|
|
$ |
1,314 |
|
|
A portion of the net periodic benefit cost for the
pension plans and the postretirement health benefit
plan is borne by the Exchange and EFL. The Company was
reimbursed approximately 51% from the Exchange and EFL
during 2005 and approximately 50% in both 2004 and
2003.
Assumptions and health care cost trend rate
sensitivity
|
|
|
|
|
|
|
|
|
|
|
2005 |
|
|
2004 |
|
|
Assumptions used to determine benefit obligations |
Employee pension plan: |
|
|
|
|
|
|
|
|
Discount rate |
|
|
5.75 |
% |
|
|
6.00 |
% |
Expected return on plan assets |
|
|
8.25 |
|
|
|
8.25 |
|
Rate of compensation increase |
|
|
4.75 |
* |
|
|
5.00 |
|
SERP: |
|
|
|
|
|
|
|
|
Discount rate |
|
|
5.75 |
% |
|
|
6.00 |
% |
Rate of compensation increase |
|
|
6.00-7.25 |
|
|
|
6.00-7.25 |
|
Postretirement health benefit plan: |
|
|
|
|
|
|
|
|
Discount rate |
|
|
5.75 |
% |
|
|
6.00 |
% |
|
|
|
* |
|
Rate of compensation increase is age-graded. An
equivalent single compensation increase rate of 4.75%
would produce similar results. |
|
|
|
|
|
|
|
|
|
|
|
2005 |
|
|
2004 |
|
|
Assumptions used to determine net periodic benefit
cost |
Employee pension plan: |
|
|
|
|
|
|
|
|
Discount rate |
|
|
6.00 |
% |
|
|
6.00 |
% |
Expected return on plan assets |
|
|
8.25 |
|
|
|
8.25 |
|
Rate of compensation increase |
|
|
4.75 |
* |
|
|
5.00 |
|
SERP: |
|
|
|
|
|
|
|
|
Discount rate |
|
|
6.00 |
% |
|
|
6.00 |
% |
Rate of compensation increase |
|
|
6.00-7.25 |
|
|
|
6.00-7.25 |
|
Postretirement health benefit plan: |
|
|
|
|
|
|
|
|
Discount rate |
|
|
6.00 |
% |
|
|
6.00 |
% |
|
|
|
|
|
|
|
|
|
|
|
2005 |
|
|
2004 |
|
|
Assumed health care cost trend rates |
Health care cost trend rate
assumed for next year |
|
|
10.0 |
% |
|
|
9.0 |
% |
Rate to which the cost trend
rate is assumed to decline
(the ultimate trend rate) |
|
|
5.0 |
% |
|
|
5.0 |
% |
Year that the rate reaches
the ultimate trend rate |
|
|
2011 |
|
|
|
2009 |
|
72
The discount rate used to determine net periodic
pension and postretirement benefit costs for 2006 will
be 5.75% compared to 6.00% used for 2005. The rate
was modeled by management in a bond-matching
study that compared projected pension plan benefit
flows to the cash flows from a comparable portfolio of
fixed maturity instruments which yielded approximately
5.75%. The employee pension plans expected long-term
rate of return on assets is based on historical
long-term returns for the asset classes included in
the employee pension plans target asset allocation.
In 2005, the Companys consulting pension actuarial
firm completed an experience study which supported
the use of an age-graded scale for the rate of
compensation increase, which correlates a participants
age to their rate of compensation increase.
The December 31, 2005, accumulated postretirement
health benefit obligation was based on a 9.0% increase
in the cost of covered health care benefits during 2005.
Assumed health care cost trend rates have a significant
effect on the amounts reported for the health care
plans. A 100-basis point change in assumed health care
cost trend rates would have the following effects:
|
|
|
|
|
|
|
|
|
|
|
100-basis |
|
100-basis |
|
|
|
point |
|
point |
(in thousands) |
|
increase |
|
decrease |
|
|
Effect on total of
service and interest
cost |
|
$ |
387 |
|
$ |
(322 |
) |
|
|
|
|
|
|
|
|
|
|
Effect on postretirement
health benefit obligation |
|
|
2,970 |
|
|
(2,520 |
) |
|
The following benefit payments, which reflect expected
future service, as appropriate, are expected to be
paid:
|
|
|
|
|
|
|
|
|
|
|
Pension |
|
|
Postretirement |
|
(in thousands) |
|
benefits |
|
|
health benefits |
|
|
2006 |
|
$ |
2,425 |
|
|
$ |
410 |
|
2007 |
|
|
3,164 |
|
|
|
482 |
|
2008 |
|
|
4,087 |
|
|
|
542 |
|
2009 |
|
|
5,039 |
|
|
|
759 |
|
2010 |
|
|
6,216 |
|
|
|
1,001 |
|
Years 2011-2015 |
|
|
53,062 |
|
|
|
7,662 |
|
Pension plan assets
The SERP and pension plan for outside directors
are unfunded. The employee pension plan is a funded
plan with asset allocation by asset category as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Plan assets at December 31 |
|
Asset category |
|
|
|
|
|
2005 |
|
|
|
|
|
|
2004 |
|
|
Equity securities |
|
|
|
|
|
|
62.5 |
% |
|
|
|
|
|
|
58.9 |
% |
Debt securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due beyond
one year |
|
|
35.9 |
% |
|
|
|
|
|
|
34.3 |
% |
|
|
|
|
Due within
one year |
|
|
.8 |
% |
|
|
36.7 |
% |
|
|
6.2 |
% |
|
|
40.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
|
|
|
|
.8 |
% |
|
|
|
|
|
|
.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
|
|
|
|
100.0 |
% |
|
|
|
|
|
|
100.0 |
% |
|
Equity securities included 60,000 shares of Company
Class A common stock, with market values of $3.2
million (1.5% of total plan assets), at both December
31, 2005 and 2004. Dividends paid on these shares were
less than $.1 million for 2005 and 2004.
Also included
in equity securities are 69,750 shares of EFL common
stock at December 31, 2005 and 2004, with market values
of $1.9 million (.9% of total plan assets) and $2.2
million (1.0% of total plan assets), respectively.
Dividends paid on these shares were less than $.1
million for 2005 and 2004.
The employee pension plans investment strategy is
based on an understanding that:
|
|
equity investments are expected to outperform debt investments over the long term; |
|
|
|
the potential volatility of short-term returns from equities is acceptable in exchange for
the larger expected long-term returns; |
|
|
|
a portfolio structured across investment styles and markets (both domestic and foreign)
reduces volatility. |
As a result, the employee pension plans asset
allocation will include a broadly diversified
allocation among equity, debt and other investments.
The target percentage range for asset categories is:
|
|
|
|
|
|
|
2005 |
|
|
|
target |
|
Asset category |
|
allocation |
|
|
Equity securities |
|
|
40% 65 |
% |
Debt securities |
|
|
35% 60 |
% |
Other |
|
|
0% 5 |
% |
|
Employee savings plan
The
Company has a qualified 401(k) savings plan for
its employees. Eligible participants are permitted to
make contributions to the plan up to the Internal
Revenue Service limit. The Company match is 100% of the
participant contributions up to 3% of compensation and
50% of participant contributions over 3% and up to 5%
of compensation. All full-time and regular part-time
employees are eligible to participate in the plan. The
Companys matching contributions to the plan were $7.7
million, $7.2 million and $6.6 million in 2005, 2004,
and 2003, respectively, before reimbursements from
affiliates. The Companys matching contributions after
reimbursements from affiliates were $3.2 million, $2.9
million, and $2.6 million in 2005, 2004, and 2003,
respectively. Employees are only permitted to invest
employer-matching contributions in the Class A common
stock of the Company. The plan acquires shares in the
open market necessary to meet the obligations of the
plan. Plan participants held .1 million Company Class A
shares at December 31, 2005, 2004 and 2003.
73
Health and dental benefits
The Company has self-funded health care plans for
all of its employees and eligible dependents. Estimated
unpaid claims incurred are accrued as a liability at
December 31, 2005 and 2004. Operations were charged
$30.9 million, $32.1 million and $28.3 million in 2005,
2004 and 2003, respectively, for the cost of health and
dental care provided under these plans before
reimbursements from affiliates. Beginning January 1,
2005, the Company offered new health plan alternatives
which increased employee cost-sharing. The charges
after reimbursement from affiliates were $14.1 million
in 2005 and 2004, and $12.5 million in 2003.
|
|
|
|
|
Note 9. |
|
|
|
|
|
Incentive plans and deferred compensation |
|
|
|
|
|
The Company has separate annual and long-term
incentive plans for executive and senior management
and regional vice presidents of the Company. The
Company also makes available several deferred
compensation plans for executive and senior
management and certain outside directors.
Annual incentive plan
The annual incentive plan is a bonus plan that
annually pays cash bonuses to executive, senior and
regional vice presidents of the Company.
Pre-2004 PlanPrior to 2004, incentives under the
annual incentive plan were based on growth in written
premiums and the underwriting results of the Property
and Casualty Group compared to a peer group of
property/casualty companies that wrote predominately
personal lines insurance and were rated A++ by A.M.
Best.
Post-2004
Plans Beginning in 2004, the incentives
under the plan are based on the achievement of certain
predetermined performance targets. These targets are
established by the Executive Compensation and
Development Committee of the Board and can include
various financial measures. The 2005 incentives were
based on the adjusted operating ratio and the growth in
direct written premiums of the Property and Casualty
Group.
The cost of the plan is charged to operations as the
compensation is earned over the performance period of
one year. The amount charged to expense for the annual
incentive plan bonus before reimbursement from
affiliates was $4.1 million, $4.4 million and $1.8
million for 2005, 2004 and 2003, respectively. After
reimbursements from affiliates, the Companys expense
was $2.8 million, $2.9 million and $1.2 million for
2005, 2004 and 2003, respectively.
Long-term incentive plan
The long-term incentive plan (LTIP) of the
Company is a restricted stock award plan designed to
reward executive, senior and regional vice presidents
who can have a significant impact on the performance
of the Company with long-term compensation that is
settled in Company stock.
Pre-2004
Plan Prior to 2004, awards were determined
based on the achievement of predetermined Company
financial performance goals compared to the actual
growth in retained earnings of the Company.
Post-2004
Plans Beginning in 2004, the award is based on
the level of achievement of objective measures of
performance over a three-year period as compared to a peer
group of property/casualty companies that write
predominately personal lines insurance. The 2005 award was
based on the adjusted combined ratio and the growth in
direct written premiums and total return on invested assets
of the adjusted property/casualty operations of the Erie
Insurance Group compared to a peer group of companies.
Because the award is based on a comparison to results of a
peer group over a three-year period, the estimated award is
based on estimates of results for the remaining performance
period. This estimate is subject to variability if the
results of the Company or peer group are substantially
different than those results projected by
the Company.
The Company cannot issue new stock or stock from
treasury to settle the compensation award obligations
under the LTIP, but instead must purchase Company stock
on the open market. The restricted stock awards are
granted at the beginning of a three-year performance
period. The maximum number of shares which may be
earned under the post-2004 LTIP plan by any single
participant during any one calendar year is limited to .25 million shares. The aggregate number of Class A
common stock that may be issued pursuant to awards
granted under the LTIP is 1.0 million shares. A
liability is recorded and compensation expense is
recognized ratably over the performance period. For
performance periods beginning before 2004, the stock
awards vest ratably over a three-year vesting period
subsequent to the three-year performance period. For
performance periods beginning in 2004, stock awards are
considered vested at the end of the performance period.
At December 31, 2005, 2004 and 2003, the unvested
outstanding restricted shares under the LTIP totaled
73,471 shares, 75,399 shares and 68,176 shares,
respectively, with average grant prices of $52.65,
$46.83 and $39.47, respectively. The change in market
value of stock from the date of award under the LTIP
and the balance sheet date is charged or
credited to operations. The compensation cost charged
to operations for these restricted stock awards after
corporate federal income tax, was $3.9 million,
74
$2.1 million, and $1.6 million for the years ending
December 31, 2005, 2004 and 2003, respectively, after
reimbursements from affiliates.
The following table shows the number of shares
awarded and not yet vested at December 31, 2005.
There were no forfeitures in any of the performance
periods presented.
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
Number |
|
Long-term |
|
average |
|
|
of |
|
incentive plan |
|
grant price |
|
|
shares |
|
|
2001-2003
|
|
|
|
|
|
|
|
|
Performance period |
|
|
|
|
|
|
|
|
Awarded |
|
$ |
39.47 |
|
|
|
33,859 |
|
Shares vested |
|
|
|
|
|
|
23,284 |
|
|
|
|
|
|
|
|
|
Shares not yet vested |
|
|
|
|
|
|
10,575 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2002-2004
|
|
|
|
|
|
|
|
|
Performance period |
|
|
|
|
|
|
|
|
Awarded |
|
$ |
46.84 |
|
|
|
40,517 |
|
Shares vested |
|
|
|
|
|
|
15,230 |
|
|
|
|
|
|
|
|
|
Shares not yet vested |
|
|
|
|
|
|
25,287 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2003-2005
|
|
|
|
|
|
|
|
|
Performance period |
|
|
|
|
|
|
|
|
Awarded |
|
$ |
51.15 |
|
|
|
39,870 |
|
Shares vested |
|
|
|
|
|
|
2,261 |
|
|
|
|
|
|
|
|
|
Shares not yet vested |
|
|
|
|
|
|
37,609 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted shares not yet vested at
December 31, 2005 |
|
|
|
|
|
|
73,471 |
|
|
Deferred compensation plans
The deferred compensation plans are arrangements
for executive and senior vice presidents of the Company
whereby the participants can elect to defer a portion
of their compensation until separation from services to
the Company. Those participating in the plans select
hypothetical investment funds for their deferrals and
are credited with the hypothetical returns generated.
The deferred compensation plan for directors allows
them to defer director and meeting fees. Directors
participating in the plan select hypothetical
investment funds for their deferrals and are credited
with the hypothetical returns generated. The Company
does not match any deferrals to the director plan.
The awards, payments, deferrals and liabilities under
the deferred compensation, annual and long-term
incentive plans for officers and directors, were as
follows for the years ended December 31. The gross
liabilities are presented separately in the
Consolidated Statements of Financial Position, while
reimbursements from affiliates are included in other
assets.
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Plan awards, employer match
and hypothetical earnings |
|
|
|
|
|
|
|
|
|
|
|
|
Long-term incentive
plan awards |
|
$ |
5,814 |
|
|
$ |
3,039 |
|
|
$ |
2,036 |
|
Annual incentive
plan awards |
|
|
4,145 |
|
|
|
4,394 |
|
|
|
1,703 |
|
Deferred compensation
plan, employer match
and hypothetical
earnings |
|
|
1,188 |
|
|
|
1,718 |
|
|
|
1,154 |
|
|
Total plan awards
and earnings |
|
$ |
11,147 |
|
|
$ |
9,151 |
|
|
$ |
4,893 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total plan awards paid |
|
$ |
6,088 |
|
|
$ |
3,108 |
|
|
$ |
4,572 |
|
|
Compensation deferred
under the plans |
|
$ |
496 |
|
|
$ |
551 |
|
|
$ |
842 |
|
|
Distributions from the
deferred compensation
plans |
|
$ |
(177 |
) |
|
$ |
(458 |
) |
|
$ |
(309 |
) |
|
Gross incentive
plan and deferred
compensation
liabilities |
|
$ |
24,447 |
|
|
$ |
19,069 |
|
|
$ |
12,933 |
|
|
Reimbursements
from affiliates |
|
|
3,958 |
|
|
|
3,091 |
|
|
|
1,722 |
|
|
Net incentive
plan and deferred
compensation
liabilities |
|
$ |
20,489 |
|
|
$ |
15,978 |
|
|
$ |
11,211 |
|
|
Stock compensation plan for outside directors
The Company has a stock compensation plan for its
outside directors. The purpose of this plan is to
further align the interests of directors with
shareholders by providing for a portion of annual
compensation for the directors services in shares of
the Companys Class A common stock. Each director vests
in the grant 25% every three months over the course of
a year. Dividends paid by the Company are reinvested
into each directors account with additional shares of
the Companys Class A common stock. The Company accounts
for grants under the stock compensation plan for
outside directors under the fair value method as
defined in FAS 123, Accounting for Stock-Based
Compensation. The annual charge related to this plan,
net of reimbursement, totaled $.3 million for each of
the years 2005, 2004 and 2003. The implementation of
FAS 123(R), Share Based Compensation, will have
minimal impact on the Companys financial position or
results of operations.
75
|
Note 10. |
|
Income taxes |
|
The
provision for income taxes consists of the
following for the years ended December 31: |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Federal income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
Currently due |
|
$ |
112,655 |
|
|
$ |
104,274 |
|
|
$ |
101,288 |
|
Deferred |
|
|
(922 |
) |
|
|
866 |
|
|
|
949 |
|
|
Total |
|
$ |
111,733 |
|
|
$ |
105,140 |
|
|
$ |
102,237 |
|
|
A reconciliation of the provision for income taxes
with amounts determined by applying the statutory
federal income tax rates to pretax income is as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Income tax at
statutory rates |
|
$ |
118,810 |
|
|
$ |
114,222 |
|
|
$ |
103,269 |
|
Tax-exempt interest |
|
|
(4,013 |
) |
|
|
(2,726 |
) |
|
|
(2,601 |
) |
Dividends received
deduction |
|
|
(2,727 |
) |
|
|
(2,636 |
) |
|
|
(3,010 |
) |
Other |
|
|
(337 |
) |
|
|
(3,720 |
) |
|
|
4,579 |
|
|
Provision for
income taxes |
|
$ |
111,733 |
|
|
$ |
105,140 |
|
|
$ |
102,237 |
|
|
Temporary differences and carryforwards, which give
rise to deferred tax assets and liabilities, are as
follows for the years ended December 31:
|
|
|
|
|
|
|
|
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
Deferred tax assets |
|
|
|
|
|
|
|
|
Loss reserve discount |
|
$ |
5,630 |
|
|
$ |
5,504 |
|
Unearned premiums |
|
|
7,490 |
|
|
|
7,607 |
|
Net allowance for service fees
and premium cancellations |
|
|
2,923 |
|
|
|
2,872 |
|
Other employee benefits |
|
|
8,277 |
|
|
|
6,525 |
|
Alternative minimum tax
carryforwards |
|
|
0 |
|
|
|
1,761 |
|
Write-downs of
impaired securities |
|
|
1,393 |
|
|
|
1,592 |
|
Limited partnerships |
|
|
4,027 |
|
|
|
3,847 |
|
Other |
|
|
1,659 |
|
|
|
1,481 |
|
|
Total deferred tax assets |
|
$ |
31,399 |
|
|
$ |
31,189 |
|
|
Deferred tax liabilities |
|
|
|
|
|
|
|
|
Deferred policy
acquisition costs |
|
$ |
5,752 |
|
|
$ |
5,989 |
|
Unrealized gains
on investments |
|
|
9,354 |
|
|
|
26,432 |
|
Pension and other benefits |
|
|
10,164 |
|
|
|
15,467 |
|
Equity interest in EFL |
|
|
3,619 |
|
|
|
3,490 |
|
Limited partnerships |
|
|
3,550 |
|
|
|
0 |
|
Depreciation |
|
|
2,241 |
|
|
|
976 |
|
Other |
|
|
3,257 |
|
|
|
2,957 |
|
|
Total deferred tax liabilities |
|
|
37,937 |
|
|
|
55,311 |
|
|
Net deferred income
tax liability |
|
$ |
6,538 |
|
|
$ |
24,122 |
|
|
The Company, as a corporate attorney-in-fact for a
reciprocal insurer, is not subject to state corporate
taxes, as the Property and Casualty Group pays gross
premium taxes. In 2004, the Company underwent an audit
by the Internal Revenue Service (IRS) for the years
2002 and 2001. The Company recorded a reduction in
income tax expense of $3.1 million as a result of
related audit adjustments, the most significant of
which was an additional deduction related to the
pension plan that had a favorable impact on the
Companys tax position. The adjustment was recorded as
part of the current tax position and had a $.04
benefit to net income per sharediluted in the fourth
quarter of 2004.
|
|
|
Note 11. |
|
|
|
Capital stock |
|
|
|
|
Class A and B shares |
|
|
Holders of Class B shares may, at their option,
convert their shares into Class A shares at the rate of
2,400 Class A shares for each Class B share. During the
year 2005, a total of 25 Class B shares were converted to
60,000 Class A shares. In 2004, 20 Class B shares were
converted to 48,000 Class A shares. There is no provision
for conversion of Class A shares to Class B shares and
Class B shares surrendered for conversion cannot be
reissued. Each share of Class A common stock
outstanding at the time of the declaration of any dividend
upon shares of Class B common stock shall be entitled to a
dividend payable at the same time, at the same record date,
and in an amount at least equal to 2/3 of 1.0% of any
dividend declared on each share of Class B common stock.
The Company may declare and pay a dividend in respect to
Class A common stock without any requirement that any
dividend be declared and paid in respect to Class B common
stock. Sole voting power is vested in Class B common stock
except insofar as any applicable law shall permit Class A
common stock to vote as a class in regards to any changes
in the rights,
preferences and privileges attaching to Class A common
stock.
In 2004, the Company increased both its Class A and
Class B quarterly dividends by 51%. The annualized
dividends increased the Companys payout for 2005 by
approximately $27 million. The increase in quarterly
shareholder dividends beginning in January 2006 was
10.8% for both Class A and Class B shareholders.
Stock repurchase plan
The current stock repurchase program allows the
Company to repurchase up to $250 million of its
outstanding Class A common stock from January 1, 2004,
through December 31, 2006. Treasury shares are recorded
in the Consolidated Statements of Financial Position at
cost. Shares repurchased during 2005 totaled 1.9
million at a total cost of $99.0 million. Cumulative
shares repurchased under the currently authorized
repurchase plan through 2005 totaled 3.0 million at a
total cost of $153.0 million, or $50.41 per share.
On
February 21, 2006, the Board of Directors approved a
continuation of the current stock repurchase program
allowing an additional $250 million of Company Class A
Common stock to be repurchased through December 31, 2009.
76
Note
12.
Unpaid losses and loss adjustment expenses
The following table provides a reconciliation
of beginning and ending loss and loss adjustment
expense liability balances for the Companys
wholly-owned property/casualty insurance
subsidiaries:
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
2005 |
|
2004 |
|
2003 |
|
Total unpaid losses
and loss adjustment
expenses at
January 1, gross |
|
$ |
943,034 |
|
|
$ |
845,536 |
|
|
$ |
717,015 |
|
Less reinsurance
recoverables |
|
|
765,563 |
|
|
|
687,819 |
|
|
|
577,917 |
|
|
Net balance at
January 1 |
|
|
177,471 |
|
|
|
157,717 |
|
|
|
139,098 |
|
|
Incurred related to: |
|
|
|
|
|
|
|
|
|
|
|
|
Current accident year |
|
|
146,312 |
|
|
|
153,563 |
|
|
|
154,816 |
|
Prior accident years |
|
|
(5,927 |
) |
|
|
(343 |
) |
|
|
(1,832 |
) |
|
Total incurred |
|
|
140,385 |
|
|
|
153,220 |
|
|
|
152,984 |
|
|
Paid related to: |
|
|
|
|
|
|
|
|
|
|
|
|
Current accident year |
|
|
72,352 |
|
|
|
75,371 |
|
|
|
83,043 |
|
Prior accident years |
|
|
53,962 |
|
|
|
58,095 |
|
|
|
51,322 |
|
|
Total paid |
|
|
126,314 |
|
|
|
133,466 |
|
|
|
134,365 |
|
|
Net balance at
December 31 |
|
|
191,542 |
|
|
|
177,471 |
|
|
|
157,717 |
|
Plus reinsurance
recoverables |
|
|
827,917 |
|
|
|
765,563 |
|
|
|
687,819 |
|
|
Total unpaid losses
and loss adjustment
expenses at
December 31,
gross |
|
$ |
1,019,459 |
|
|
$ |
943,034 |
|
|
$ |
845,536 |
|
|
The 2005 net incurred losses and loss adjustment
expenses of $5.9 million related to prior accident
years are the result of positive development of
personal auto and commercial multi-peril attributable
to an improvement in actual claims severity compared to
historical trends.
Note
13.
Related party transactions
Management fee
A management fee is charged to the Exchange for
services provided by the Company under subscribers
agreements with policyholders of the Exchange. The fee
is a percentage of direct written premium of the
Property and Casualty Group. This percentage rate is
adjusted periodically by the Companys Board of
Directors but cannot exceed 25%. The management rate
charged the Exchange was 23.75% in 2005. In 2004, the
management fee rate charged the Exchange was 23.5% in
the first half of 2004 and 24% during the second half
of 2004. The management fee rate was 24% during 2003.
The Board of Directors elected to set the fee at 24.75%
beginning January 1, 2006.
There is no provision for termination of the Companys
appointment as attorney-in-fact and the appointment is
not affected by a policyholders disability or
incapacity.
Service agreement revenue
Service agreement revenue previously included
service income received from the Exchange as
compensation for the management of voluntary assumed
reinsurance from nonaffiliated insurers. Service
agreement fee revenue amounted to $.8 million and $7.2
million in 2004 and 2003, respectively.
Intercompany reinsurance pooling agreement
EIC, EIPC, Flagship and EINY have an intercompany
reinsurance pooling agreement with the Exchange,
whereby these companies cede all of their direct
property/casualty insurance to the Exchange, except for
the annual premium under the all-lines aggregate
excess-of-loss reinsurance agreement discussed below.
EIC and EINY then assume 5% and 0.5%, respectively, of
the total of the Exchanges insurance business
(including the business assumed from EIC and EINY). The
participation percentages are determined by the Board
of Directors. Intercompany accounts are settled by
payment within 30 days after the end of each quarterly
accounting period. The purpose of the pooling agreement
is to spread the risks of the members of the Property
and Casualty Group by the different lines of business
they underwrite and geographic regions in which each
operates. This agreement may be terminated by any party
as of the end of any calendar year by providing not
less than 90 days advance written notice.
Aggregate excess-of-loss reinsurance agreement
Through 2005, EIC and EINY had in effect an
all-lines aggregate excess-of-loss reinsurance
agreement with the Exchange. The purpose of the
excess-of-loss reinsurance agreement was to reduce the
variability of earnings and thereby reduce the adverse
effects on the results of operations of EIC and EINY
in a given year if the frequency or severity of claims
were substantially higher than historical averages.
The excess-of-loss reinsurance agreement was not
renewed for the 2006 accident year due to the proposed pricing for
the coverage as well as the loss profile of the Property and Casualty
Group. The Property and Casualty Group maintains sufficient property
catastrophe coverage from unaffiliated reinsurers and no longer
participates in the assumed reinsurance business.
This excess-of-loss reinsurance agreement limited EICs
and EINYs retained share of ultimate net losses in any
applicable accident year. The excess-of-loss agreement
provided that once EIC and EINY sustained ultimate net
losses, excluding losses from terrorism, nuclear,
biological and chemical events, in any applicable
accident year that exceeded an amount equal to 72.5% of
EICs and EINYs net premium earned in that period, the
Exchange would be liable for 95% of the amount of such
excess, up to but not exceeding, an amount equal to 95%
of 15% of EIC and EINYs net premium
77
earned. Losses equal to 5% of the net ultimate net loss
in excess of the retention under the contract were
retained net by EIC and EINY. The contract permitted
loss recoverables only when claims were paid. The
contract also required that any unpaid loss
recoverables be commuted 60 months after an annual
period expired. This reinsurance treaty was excluded
from the intercompany pooling agreement. The annual
premium was subject to a minimum premium of $3.0 million in 2005. The annual premium paid to the Exchange for
the agreement totaled $3.3 million, $3.6 million and
$2.5 million in 2005, 2004 and 2003, respectively.
Included in the 2005 net charges of $2.2 million are
charges under the agreement of $1.5 million plus net
charges of $.7 million related to the commutations of
the 1999 and 2000 accident year. The unpaid loss
recoverable related to the 1999 accident year of $3.4
million was settled in March 2005. The present value of
the estimated losses from the 1999 accident year, or
$3.0 million, was settled with the Exchange and cash
payment made by the Companys property/ casualty
insurance subsidiaries resulting in a charge to the
Company of $.4 million. The $2.0 million unpaid loss
recoverable related to the 2000 accident year was
settled in December 2005. The present value of these
estimated losses from the 2000 accident year, or $1.7
million, was settled with the Exchange by the Companys
property/casualty insurance subsidiaries resulting in a
charge to the Company of $.3 million. The cash will be
paid for settlement of the 2000 accident year in the
first quarter of 2006.
|
|
|
|
|
|
|
|
|
|
|
|
Accident year |
(in thousands) |
|
1999 |
|
2000 |
|
Loss recoverables |
|
$ |
3,419 |
|
|
$ |
2,038 |
|
Settlement of loss
recoverables at
present value |
|
|
(3,033 |
) |
|
|
(1,710 |
) |
|
Net charge related
to commutation |
|
$ |
386 |
|
|
$ |
328 |
|
|
Total charges of $7.7 million were recorded under the
excess-of-loss reinsurance agreement during 2004, of
which $6.0 million related to the reversal of
previously recorded recoverables for the 2003 accident
year. Recoveries recorded during 2003 totaled $6.5
million.
While the excess-of-loss agreement was not
renewed for 2006, the remaining open accident years
under the agreement, 2001 through 2005, will be settled
and losses will be commuted as the 60 months expire.
eCommerce program and related information
technology infrastructure
The Erie Insurance Group undertook a series of
initiatives to develop its capabilities to transact
business electronically, which began in 2001. In
connection with this program, referred to as eCommerce,
the Company and the Property and Casualty Group entered
into a Cost Sharing Agreement for Information
Technology Development (Agreement). The Agreement
describes how member companies of the Erie Insurance
Group will share the costs to be incurred for the
development
and maintenance of new Internet-enabled property/
casualty agency interface, policy administration
and customer relationship management systems
(ERIEConnection® system).
The
Agreement provides that the development cost of the
application systems and the directly related enabling
technology costs, such as required infrastructure and
architectural tools, will be shared among the Property
and Casualty Group in a manner consistent with the
sharing of insurance transactions under the existing
intercompany pooling agreement. Certain other costs of
the eCommerce program are related to information
technology hardware, networks and upgrades to
technology platforms and are not included under the
Agreement. These costs are included in the cost of
management operations in the Consolidated Statements
of Operations. The amounts incurred by the
property/casualty subsidiaries of the Company have not
been material.
Expense allocations
The claims handling services of the Exchange are
performed by personnel who are entirely dedicated to
and paid for by the Exchange from its own policyholder
revenues. The Exchanges claims function and its
management and administration are exclusively the
responsibility of the Exchange and not a part of the
service the Company provides under the subscribers
agreement. Likewise, personnel who perform activities
within the life insurance operations of EFL are paid
for by EFL from its own policyholder revenues. However,
the Company is the legal entity that employs personnel
on behalf of the Exchange and EFL and functions as a
common paymaster for all employees. Common overhead
expenses included in the expenses paid for by the
Company are allocated based on appropriate utilization
statistics (employee count, square footage, vehicle
count, project hours, etc.) specifically measured to
accomplish proportional allocations. Executive
compensation is allocated based on each executives
primary responsibilities (management services,
property/casualty claims operations, EFL operations and
investment operations). Management believes the methods
used to allocate common overhead expenses among the
affiliated entities are reasonable.
Payments on behalf of related entities
The Company makes certain payments for the account
of the Groups related entities. The Company, in making
these payments, is acting as the common paymaster. Cash
transfers are settled monthly.
The amounts of these cash settlements for Company
payments made for the account of related entities
were as follows for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Erie Insurance
Exchange |
|
$ |
265,359 |
|
|
$ |
237,842 |
|
|
$ |
217,794 |
|
Erie Family
Life Insurance |
|
|
35,556 |
|
|
|
28,925 |
|
|
|
26,081 |
|
|
Total cash
settlements |
|
$ |
300,915 |
|
|
$ |
266,767 |
|
|
$ |
243,875 |
|
|
78
Office leases
The Company occupies certain office facilities
owned by the Exchange and EFL. The Company leases
office space on a year-to-year basis from the Exchange.
Rent expenses under these leases totaled $10.3 million,
$11.4 million and $11.8 million in 2005, 2004 and 2003,
respectively. The Company has a lease commitment until
2008 with EFL for a branch office. Rentals paid to EFL
under this lease totaled $.3 million in each of the
years 2005, 2004 and 2003, respectively.
Notes receivable from EFL
The Company is due $25 million from EFL in the
form of a surplus note that was issued in 2003. The
note may be repaid only out of unassigned surplus of
EFL. Both principal and interest payments are subject
to prior approval by the Pennsylvania Insurance
Commissioner. The note bears an annual interest rate of
6.70% and will be payable on demand on or after
December 31, 2018, with interest scheduled to be paid
semi-annually. EFL paid interest to the Company
totaling $1.7 million in 2005 and 2004 and $.6 million
in 2003.
On December 30, 2005, EFL repaid its $15 million
surplus note that was payable to the Company on
December 31, 2005. Prior approval was received from
the Pennsylvania Insurance Commissioner authorizing
repayment of the surplus note. EFL paid interest on
this note to the Company totaling $1.0 million in each
of the years 2005, 2004 and 2003, respectively.
Note 14.
Receivables from Erie Insurance Exchange
and concentrations of credit risk
Financial instruments could potentially expose the
Company to concentrations of credit risk, including
unsecured receivables from the Exchange. A large
majority of the Companys revenue and receivables are
from the Exchange and affiliates. See also Note 15.
The
Company has a receivable due from the Exchange for
reinsurance recoverable from unpaid losses and loss
adjustment expenses and unearned premium balances ceded
under the intercompany pooling arrangement totaling
$952.7 million and $893.1 million at December 31, 2005
and 2004, respectively. Management fee and expense
allocation amounts due from the Exchange were $194.8
million and $207.2 million at December 31, 2005 and
2004, respectively. The receivable from EFL for expense
allocations totaled $3.9 million at December 31, 2005,
compared to $4.3 million at December 31, 2004.
Premiums due from policyholders of the Companys
wholly-owned property/casualty insurance subsidiaries
equaled $267.6 million and $275.7 million at December
31, 2005 and 2004, respectively. A significant amount
of these receivables are ceded to the Exchange as part
of the intercompany pooling agreement and are included
in reinsurance recoverables on the Consolidated
Statements of Financial Position. See also Note 16.
Note 15.
Variable interest entity
The Exchange is a variable interest entity because
of the absence of decision-making capabilities by the
equity owners (subscribers) of the Exchange. The
Company holds a variable interest in the Exchange,
however, the Company does not qualify as the primary
beneficiary under Financial Accounting Standards
Interpretation 46, Consolidation of Variable Interest
Entities. The Company has a significant interest in
the financial condition of the Exchange because
management fee revenues, which accounted for 71.6% of
the Companys 2005 total revenues, are based on the
direct written premiums of the Exchange and the other
members of the Property and Casualty Group.
Additionally, the Company participates in the
underwriting results of the Exchange through the
pooling arrangement in which the Companys insurance
subsidiaries have a 5.5% participation. Finally, a
concentration of credit risk exists related to the
unsecured receivables due from the Exchange for certain
fees, costs and reimbursements.
The financial statements of the Exchange are prepared
in accordance with Statutory Accounting Principles
(SAP) required by the National Association of Insurance
Commissioners (NAIC) Accounting Practices and
Procedures Manual, as modified to include prescribed or
permitted practices of the Commonwealth of
Pennsylvania. The Exchange does not, nor is it required
to, prepare financial statements in accordance with
Generally Accepted Accounting Principles (GAAP).
Financial statements prepared under SAP generally
provide a more conservative approach than under GAAP.
Under SAP, the principle focus is on the solvency of
the insurer in order to protect the interests of the
policyholders. Some significant differences between SAP
and GAAP include the following:
* |
|
Fixed maturities and short-term investments are
valued at amortized cost or the lower of
amortized cost or market under SAP. The SAP
valuations are dependent upon the ERIE
designation prescribed to the investment by the
NAIC. GAAP requires these securities be valued at
fair value; |
|
* |
|
SAP recognizes expenses when incurred and does
not allow for the establishment of deferred
policy acquisition cost assets; |
|
* |
|
Statutory deferred tax calculations limit the
amount of deferred tax assets that can be recorded
and deferred taxes are direct charges or credits
to surplus; |
|
* |
|
GAAP requires the establishment of an asset for
the estimated salvage and subrogation that will be
recovered in the future. Under SAP, a company may
establish this recoverable, but is not required to
do so. The Exchange does not establish estimated
salvage and subrogation recoveries; |
|
* |
|
As prescribed by the Insurance Department of
the Commonwealth of Pennsylvania, the Exchange
records in its statutory basis financial
statements, |
79
|
|
unearned subscriber fees (fees to attorney-in-fact)
as deductions from unearned premium reserve and
charges current operations on a pro-rata basis over
the periods covered by the policies. |
The selected financial data below is derived from the
Exchanges financial statements prepared in accordance
with SAP. In the opinion of management, all
adjustments consisting only of normal recurring
accruals, considered necessary for a fair
presentation, have been included. The condensed
financial data set forth below represents the
Exchanges share of underwriting results after
accounting for intercompany pool transactions.
Selected financial data of the Exchange
Condensed statutory statements of operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Premiums earned |
|
$ |
3,762,260 |
|
|
$ |
3,672,486 |
|
|
$ |
3,372,308 |
|
Losses and loss
adjustment
expenses |
|
|
2,371,660 |
|
|
|
2,502,313 |
|
|
|
2,772,940 |
|
Insurance
underwriting
and other
expenses* |
|
|
996,357 |
|
|
|
1,013,846 |
|
|
|
955,377 |
|
Dividends to
policyholders |
|
|
25,004 |
|
|
|
14,692 |
|
|
|
16,788 |
|
Other expense |
|
|
12,778 |
|
|
|
13,305 |
|
|
|
11,189 |
|
|
Total underwriting
operations
expenses |
|
|
3,405,799 |
|
|
|
3,544,156 |
|
|
|
3,756,294 |
|
|
Net underwriting
gain (loss) |
|
|
356,461 |
|
|
|
128,330 |
|
|
|
( 383,986 |
) |
|
Net investment
income |
|
|
370,977 |
|
|
|
282,388 |
|
|
|
232,677 |
|
Net realized
gains |
|
|
438,487 |
|
|
|
162,905 |
|
|
|
734,848 |
|
|
Total investment
income |
|
|
809,464 |
|
|
|
445,293 |
|
|
|
967,525 |
|
|
Net income
before federal
income tax |
|
|
1,165,925 |
|
|
|
573,623 |
|
|
|
583,539 |
|
Federal income
tax expense |
|
|
379,563 |
|
|
|
180,824 |
|
|
|
142,106 |
|
|
Net income |
|
$ |
786,362 |
|
|
$ |
392,799 |
|
|
$ |
441,433 |
|
|
|
|
|
* |
|
Includes management fees and service fees paid or
accrued to the Company |
Condensed statutory statements of financial position
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31 |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
Assets |
|
|
|
|
|
|
|
|
Fixed maturities |
|
$ |
4,534,116 |
|
|
$ |
4,399,458 |
|
Equity securities: |
|
|
|
|
|
|
|
|
Common stock |
|
|
1,736,538 |
|
|
|
1,508,664 |
|
Preferred stock |
|
|
648,301 |
|
|
|
550,090 |
|
Limited partnerships |
|
|
599,745 |
|
|
|
567,089 |
|
Real estate
mortgage loans |
|
|
10,533 |
|
|
|
10,859 |
|
Real estate |
|
|
35,277 |
|
|
|
36,305 |
|
Cash and cash
equivalents |
|
|
299,160 |
|
|
|
125,933 |
|
Surplus note from EFL |
|
|
20,000 |
|
|
|
0 |
|
Other assets |
|
|
33,945 |
|
|
|
1,049 |
|
|
Total invested assets |
|
|
7,917,615 |
|
|
|
7,199,447 |
|
Premiums receivable |
|
|
981,844 |
|
|
|
1,002,818 |
|
Federal income taxes
recoverable |
|
|
76,217 |
|
|
|
0 |
|
Deferred income taxes |
|
|
17,518 |
|
|
|
0 |
|
Other assets |
|
|
77,069 |
|
|
|
67,497 |
|
|
Total assets |
|
$ |
9,070,263 |
|
|
$ |
8,269,762 |
|
|
Liabilities |
|
|
|
|
|
|
|
|
Loss and LAE reserves |
|
$ |
3,549,128 |
|
|
$ |
3,436,246 |
|
Unearned premium
reserves |
|
|
1,509,636 |
|
|
|
1,536,890 |
|
Accrued liabilities |
|
|
629,749 |
|
|
|
400,375 |
|
Deferred income taxes |
|
|
0 |
|
|
|
92,193 |
|
|
Total liabilities |
|
|
5,688,513 |
|
|
|
5,465,704 |
|
|
Total policyholders
surplus |
|
|
3,381,750 |
|
|
|
2,804,058 |
|
|
Total liabilities and
policyholders surplus |
|
$ |
9,070,263 |
|
|
$ |
8,269,762 |
|
|
The Exchanges Policyholders surplus increased
20.6% during 2005, primarily as a result of improved
underwriting results and increased net investment
income.
80
Common equity securities represent a significant
portion of the Exchanges investment portfolio and
surplus and are exposed to price risk, volatility of
the capital markets and general economic conditions.
Common stock investments made up approximately 51%
and 54% of the Exchanges statutory surplus at
December 31, 2005 and 2004, respectively. The common
stock portfolio has been diversified and all of the
portfolio is now managed by external equity managers.
The Exchange had realized and unrealized capital gains
on its common stock portfolio of $105.2 million and $60
million for the years ended December 31, 2005 and 2004,
respectively. Net proceeds from the sale of common
stock investments were $969.9 million in 2005, which
included $447.5 million in realized capital gains
compared to proceeds of $381.4 million in 2004, which
included $137.4 million in realized capital gains.
The
weighted average current price to 12-months earnings
ratio of the Exchanges common stock portfolio was
21.08 and 20.85 at December 31, 2005 and 2004,
respectively. The Standard & Poors composite price to
trailing 12-months earnings ratio
was 17.39 at December 31, 2005, and 20.24 at December
31, 2004.
If the surplus of the Exchange were to decline
significantly from its current level, the Property and
Casualty Group could find it more difficult to retain
its existing business and attract new business. A
decline in the business of the Property and Casualty
Group would have an adverse effect on the amount of the
management fees the Company receives and the
underwriting results of the Property and Casualty Group
in which the Company has a 5.5% participation. In
addition, a decline in the surplus of the Exchange from
its current level would make it more likely that the
management fee rate received by the Company would be
reduced.
Condensed statutory statements of cash flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Cash flows from
operating activities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums
collected net
of reinsurance |
|
$ |
3,754,392 |
|
|
$ |
3,748,540 |
|
|
$ |
3,473,030 |
|
Net investment
income received |
|
|
385,153 |
|
|
|
293,517 |
|
|
|
236,656 |
|
Miscellaneous
expense |
|
|
(12,778 |
) |
|
|
(13,305 |
) |
|
|
(11,188 |
) |
Losses paid |
|
|
(1,929,867 |
) |
|
|
(1,993,342 |
) |
|
|
(2,029,696 |
) |
Management
fee and
expenses paid |
|
|
(1,336,369 |
) |
|
|
(1,325,798 |
) |
|
|
(1,237,829 |
) |
Dividends to
policyholders |
|
|
(22,652 |
) |
|
|
(16,409 |
) |
|
|
(13,892 |
) |
Income taxes (paid)
recovered |
|
|
(477,469 |
) |
|
|
(313,840 |
) |
|
|
171,881 |
|
|
Net cash
provided by
operating
activities |
|
|
360,410 |
|
|
|
379,363 |
|
|
|
588,962 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from
investing activities |
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from
investment
sales and
maturities |
|
|
3,316,424 |
|
|
|
2,032,622 |
|
|
|
4,370,411 |
|
Purchases of
investments |
|
|
(3,748,296 |
) |
|
|
(2,797,488 |
) |
|
|
(4,501,440 |
) |
|
Net cash used
in investing
activities |
|
|
(431,872 |
) |
|
|
(764,866 |
) |
|
|
(131,029 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from
financing activities |
|
|
|
|
|
|
|
|
|
|
|
|
Payments on
borrowings |
|
|
0 |
|
|
|
(55 |
) |
|
|
(53 |
) |
Other cash
provided
(applied) |
|
|
244,689 |
|
|
|
(101,480 |
) |
|
|
(341,711 |
) |
|
Net cash
provided
by (used in)
financing
activities |
|
|
244,689 |
|
|
|
(101,535 |
) |
|
|
(341,764 |
) |
|
Net increase
(decrease) in
cash and cash
equivalents |
|
|
173,227 |
|
|
|
(487,038 |
) |
|
|
116,169 |
|
Cash and cash
equivalents at
beginning of year |
|
|
125,933 |
|
|
|
612,971 |
|
|
|
496,802 |
|
|
Cash and cash
equivalents at
end of year |
|
$ |
299,160 |
|
|
$ |
125,933 |
|
|
$ |
612,971 |
|
|
81
Note 16.
Reinsurance
Reinsurance contracts do not relieve the Property
and Casualty Group from its primary obligations to
policyholders. A contingent liability exists with
respect to reinsurance recoverables in the event
reinsurers are unable to meet their obligations under
the reinsurance agreements.
During 2003, the Property and Casualty Group replaced
coverage previously provided by individual facultative
contracts with reinsurance treaties. One of the
agreements was a property risk excess-of-loss
reinsurance treaty on commercial property risks that
provided coverage of 100% of a loss of $20 million in
excess of the Property and Casualty Groups loss
retention of $5 million per risk. There was a limit of
$40 million per any one loss occurrence. This agreement
was terminated as of December 31, 2003. Since January
1, 2004, the Property and Casualty Group has acquired
facultative reinsurance on all risks in excess of $25
million in property limits.
The Company maintains an umbrella excess-of-loss
reinsurance treaty covering commercial and personal
catastrophe liability risks. In 2005, this treaty
provided coverage of 60% of a specified loss amount in
excess of the loss retention of $1 million per
occurrence. The specified maximum loss amount for the
commercial and personal catastrophe liability was $9
million and $4 million, respectively. This treaty was
renewed, effective January 1, 2006, at coverage of 90%,
all other limits remaining the same. The specified
maximum loss amounts remained the same for commercial
and personal catastrophe liabilities.
The Property and Casualty Group maintains a property
catastrophe treaty to mitigate future potential
catastrophe loss exposure. During 2005, this
reinsurance treaty provided coverage of up to 95% of a
loss of $400 million in excess of the Property and
Casualty Groups loss retention of $200 million per
occurrence. This agreement was renewed for 2006 to
provide coverage of up to 95% of a loss of $400 million
in excess of the Property and Casualty Groups loss
retention of $300 million per occurrence.
The Property and Casualty Group exited the assumed
reinsurance business effective December 31, 2003.
While certain expenses will continue to be incurred
until all related claims are settled, only nominal
premiums were generated in 2004 and 2005. Loss
reserves for unaffiliated assumed reinsurance of the
Property and Casualty Group was $177 million at
December 31, 2005.
The following tables summarize insurance and
reinsurance activities of the Companys property/
casualty insurance subsidiaries. See also Note 13 for
a discussion of the intercompany reinsurance pooling
agreement with the Exchange.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Premiums earned |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
704,366 |
|
|
$ |
699,533 |
|
|
$ |
644,286 |
|
|
Assumed from
nonaffiliates and intercompany pool |
|
|
226,245 |
|
|
|
225,905 |
|
|
|
202,147 |
|
|
Ceded to Erie
Insurance Exchange |
|
|
( 714,787 |
) |
|
|
( 717,236 |
) |
|
|
( 654,841 |
) |
|
Assumed from Erie
Insurance Exchange |
|
|
215,824 |
|
|
|
208,202 |
|
|
|
191,592 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and
loss adjustment
expenses incurred |
|
Direct |
|
$ |
499,262 |
|
|
$ |
510,260 |
|
|
$ |
512,740 |
|
|
Assumed from
nonaffiliates and intercompany pool |
|
|
152,534 |
|
|
|
169,870 |
|
|
|
175,360 |
|
|
Ceded to Erie
Insurance Exchange |
|
|
( 511,411 |
) |
|
|
( 526,910 |
) |
|
|
( 535,116 |
) |
|
Assumed from Erie
Insurance Exchange |
|
|
140,385 |
|
|
|
153,220 |
|
|
|
152,984 |
|
|
Note 17.
Statutory information
Accounting principles used to prepare statutory
financial statements differ from those used to prepare
financial statements under U.S. GAAP. The statutory
financial statements of EIPC and EIC are prepared in
accordance with accounting practices prescribed and
permitted by the Pennsylvania Insurance Department.
EINY prepares its statutory financial statements in
accordance with accounting practices prescribed and
permitted by the New York Insurance Department.
Prescribed SAP include state laws, regulations and
general administration rules, as well as a variety of
publications from the NAIC.
Consolidated shareholders equity, including amounts
reported by the Companys property/casualty insurance
subsidiaries on the statutory basis, was $1.3 billion
at both December 31, 2005 and 2004. Consolidated net
income, including amounts reported by the Companys
property/casualty insurance subsidiaries on a
statutory basis, was $233.4 million, $228.6 million
and $200.0 million for 2005, 2004 and 2003,
respectively.
The minimum statutory capital and surplus requirements
under Pennsylvania and New York law for the Companys
stock property/casualty subsidiaries amounts to $10.0
million. The Companys subsidiaries total statutory
capital and surplus significantly exceed these minimum
requirements, totaling, $184.4 million at December 31,
2005. The Companys subsidiaries risk-based capital
levels significantly exceed the minimum requirements.
82
Cash and securities with carrying values of $3.6
million were deposited by the Companys
property/casualty insurance subsidiaries with
regulatory authorities under statutory requirements as
of December 31, 2005 and 2004.
The amount of dividends the Companys
Pennsylvania-domiciled property/casualty subsidiaries,
EIC and EIPC, can pay without the prior approval of the
Pennsylvania Insurance Commissioner is limited by
Pennsylvania regulation to not more than the greater
of: (a) 10% of its statutory surplus as reported on its
last annual statement, or (b) the net income as
reported on its last annual statement. The amount of
dividends that the Erie Insurance Companys New
York-domiciled property/casualty subsidiary, EINY, can
pay without the prior approval of the New York
Superintendent of Insurance is limited to the lesser
of: (a) 10% of its statutory surplus as reported on its
last annual statement, or (b) 100% of its adjusted net
investment income during such period. At December 31,
2005, the maximum dividend the Company could receive
from its property/casualty insurance subsidiaries was
$25.2 million. No dividends were paid to the Company
from its property/casualty insurance subsidiaries in
2005, 2004 or 2003.
The amount of dividends EFL, a Pennsylvania-domiciled
life insurer, can pay to its shareholders without the
prior approval of the Pennsylvania Insurance
Commissioner is limited by statute to the greater of:
(a) 10% of its statutory surplus as regards
policyholders as shown on its last annual statement on
file with the commissioner, or (b) the net income as
reported for the period covered by such annual
statement, but shall not include pro-rata distribution
of any class of the insurers own securities.
Accordingly, the Companys share of the maximum
dividend payout which may be made in 2006 without prior
Pennsylvania Commissioner approval is $4.0 million.
Dividends declared to the Company totaled $1.8 million
in 2005.
Note 18.
Supplementary data on cash flows
A reconciliation of net income to net cash
provided by operating activities as presented in the
Consolidated Statements of Cash Flows is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Cash flows from
operating activities |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
231,104 |
|
|
$ |
226,413 |
|
|
$ |
199,725 |
|
|
Adjustments to reconcile
net income to net cash
provided by operating
activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and
amortization |
|
|
36,855 |
|
|
|
37,317 |
|
|
|
41,816 |
|
|
Deferred income tax
(benefit) expense |
|
|
(922 |
) |
|
|
866 |
|
|
|
949 |
|
|
Realized gain
on investments |
|
|
(15,620 |
) |
|
|
(18,476 |
) |
|
|
(10,445 |
) |
|
Equity in (earnings)
losses from limited
partnerships |
|
|
(38,062 |
) |
|
|
(8,655 |
) |
|
|
2,000 |
|
|
Net amortization
of bond premium |
|
|
2,742 |
|
|
|
1,664 |
|
|
|
1,124 |
|
|
Undistributed
earnings of Erie
Family Life
Insurance |
|
|
(1,837 |
) |
|
|
(3,800 |
) |
|
|
(5,712 |
) |
|
Deferred
compensation |
|
|
4,631 |
|
|
|
2,987 |
|
|
|
1,392 |
|
|
Limited
partnership distributions |
|
|
71,718 |
|
|
|
37,165 |
|
|
|
21,266 |
|
|
Increase in
receivables from
the Exchange and
reinsurance
recoverable |
|
|
(39,062 |
) |
|
|
(129,726 |
) |
|
|
(182,598 |
) |
|
Increase in prepaid
expenses and
other assets |
|
|
(37,201 |
) |
|
|
(38,984 |
) |
|
|
(34,017 |
) |
|
Increase in accounts
payable and
accrued expenses |
|
|
28,454 |
|
|
|
30,530 |
|
|
|
26,081 |
|
|
Increase in loss
reserves |
|
|
76,425 |
|
|
|
97,498 |
|
|
|
128,521 |
|
|
(Decrease) increase in
unearned premiums |
|
|
(18,144 |
) |
|
|
22,946 |
|
|
|
56,515 |
|
|
Net cash provided by
operating activities |
|
$ |
301,081 |
|
|
$ |
257,745 |
|
|
$ |
246,617 |
|
|
83
Note 19.
Commitments
The Company has contractual commitments to
invest up to $243.2 million related to its limited
partnership investments at December 31, 2005. These
commitments will be funded as required by the
partnerships agreements which principally expire in
2010. At December 31, 2005, the total remaining
commitment to fund limited partnerships that invest
in private equity securities is $86.5 million, real
estate activities is $108.7 million and mezzanine
debt securities is $48.0 million. The Company expects
to have sufficient cash flows from operations to meet
these partnership commitments.
The Company is involved in litigation arising in
the ordinary course of business. In the opinion of
management, the effects, if any, of such
litigation are not expected to be material to the
Companys consolidated financial condition, cash
flows or operations.
Note 20.
Segment information
The Company operates its business as three
reportable segmentsmanagement operations, insurance
underwriting operations and investment operations.
Accounting policies for segments are the same as those
described in the summary of significant accounting
policies, with the exception of the management fee
revenues received from the property/casualty insurance
subsidiaries. These revenues are not eliminated in the
segment detail below, as management bases its decisions
on the segment presentation. See also Note 3. Assets
are not allocated to the segments but rather are
reviewed in total by management for purposes of
decision-making. No single customer or agent provides
10% or more of revenues for the Property and Casualty
Group.
The Companys principal operations consist of serving
as attorney-in-fact for the Exchange, which constitute
its management operations. The Company operates in this
capacity solely for the Exchange. The Companys
insurance underwriting operations arise through direct
business of its property/casualty insurance
subsidiaries and by virtue of the pooling agreement
between its subsidiaries and the Exchange, which
includes assumed reinsurance from nonaffiliated
domestic and foreign sources. The Exchange exited the
assumed reinsurance business effective December 31,
2003, and therefore reinsurance-nonaffiliates includes
only run-off activity of the assumed reinsurance
business in 2004 and 2005. Insurance provided in the
insurance underwriting operations consists of personal
and commercial lines and is sold by independent agents.
Personal lines are marketed to individuals and
commercial lines are marketed to small- and
medium-sized businesses. The performance of the
personal lines and commercial lines is evaluated based
upon the underwriting results as determined under SAP
for the total pooled business of the Property and
Casualty Group.
Company management evaluates profitability of its
management operations segment principally on the gross
margin from management operations, while profitability
of the insurance underwriting operations segment is
evaluated principally based on the combined ratio.
Investment operations performance is evaluated by
Company management based on appreciation of assets,
rate of return and overall return.
84
Summarized financial information for these operations
is presented below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Management operations |
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenue |
|
|
|
|
|
|
|
|
|
|
|
|
Management
fee revenue |
|
$ |
940,274 |
|
|
$ |
945,066 |
|
|
$ |
878,380 |
|
Service agreement
revenue |
|
|
20,568 |
|
|
|
21,855 |
|
|
|
27,127 |
|
|
Total operating
revenue |
|
|
960,842 |
|
|
|
966,921 |
|
|
|
905,507 |
|
Cost of management
operations |
|
|
751,573 |
|
|
|
724,329 |
|
|
|
652,256 |
|
|
Income before
income taxes |
|
$ |
209,269 |
|
|
$ |
242,592 |
|
|
$ |
253,251 |
|
|
Net income from
management
operations |
|
$ |
140,388 |
|
|
$ |
164,436 |
|
|
$ |
165,495 |
|
|
Insurance underwriting
operations |
|
|
|
|
Operating revenue |
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned: |
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines |
|
$ |
153,859 |
|
|
$ |
148,935 |
|
|
$ |
132,093 |
|
Commercial lines |
|
|
65,605 |
|
|
|
62,647 |
|
|
|
56,248 |
|
Reinsurancenonaffiliates |
|
|
(378 |
) |
|
|
250 |
|
|
|
5,781 |
|
Reinsuranceaffiliate |
|
|
(3,262 |
) |
|
|
(3,630 |
) |
|
|
(2,530 |
) |
|
Total premiums
earned |
|
|
215,824 |
|
|
|
208,202 |
|
|
|
191,592 |
|
|
Operating expenses |
|
|
|
|
|
|
|
|
|
|
|
|
Losses and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines |
|
|
144,953 |
|
|
|
143,458 |
|
|
|
147,927 |
|
Commercial lines |
|
|
56,732 |
|
|
|
59,726 |
|
|
|
67,413 |
|
Reinsurancenonaffiliates |
|
|
(3,037 |
) |
|
|
1,642 |
|
|
|
7,654 |
|
Reinsuranceaffiliate |
|
|
2,226 |
|
|
|
7,740 |
|
|
|
(6,461 |
) |
|
Total losses and
expenses |
|
|
200,874 |
|
|
|
212,566 |
|
|
|
216,533 |
|
|
Income (loss) before
income taxes |
|
$ |
14,950 |
|
|
$ |
(4,364 |
) |
|
$ |
(24,941 |
) |
|
Net income (loss)
from insurance
underwriting
operations |
|
$ |
10,029 |
|
|
$ |
(2,958 |
) |
|
$ |
(16,296 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31 |
|
(in thousands) |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
Investment operations |
|
|
|
|
|
|
|
|
|
|
|
|
Investment income,
net of expenses |
|
$ |
61,555 |
|
|
$ |
60,988 |
|
|
$ |
58,298 |
|
Net realized
gains on
investments |
|
|
15,620 |
|
|
|
18,476 |
|
|
|
10,445 |
|
Equity in earnings
(losses) of limited
partnerships |
|
|
38,062 |
|
|
|
8,655 |
|
|
|
( 2,000 |
) |
|
Income before
income taxes and
before equity in
earnings of EFL |
|
$ |
115,237 |
|
|
$ |
88,119 |
|
|
$ |
66,743 |
|
|
Net income from
investment
operations |
|
$ |
77,306 |
|
|
$ |
59,729 |
|
|
$ |
43,617 |
|
|
Equity in earnings
of EFL, net of tax |
|
$ |
3,381 |
|
|
$ |
5,206 |
|
|
$ |
6,909 |
|
|
Reconciliation of
reportable segment
revenues
and operating expenses
to the Consolidated
Statements of
Operations |
Segment revenues |
|
$ |
1,176,666 |
|
|
$ |
1,175,123 |
|
|
$ |
1,097,099 |
|
Elimination of
intersegment
management
fee revenues |
|
|
( 51,716 |
) |
|
|
( 51,979 |
) |
|
|
( 48,311 |
) |
|
Total operating
revenue |
|
$ |
1,124,950 |
|
|
$ |
1,123,144 |
|
|
$ |
1,048,788 |
|
|
Segment operating
expenses |
|
$ |
952,447 |
|
|
$ |
936,895 |
|
|
$ |
868,789 |
|
Elimination of
intersegment
management
fee expenses |
|
|
( 51,716 |
) |
|
|
( 51,979 |
) |
|
|
( 48,311 |
) |
|
Total operating
expenses |
|
$ |
900,731 |
|
|
$ |
884,916 |
|
|
$ |
820,478 |
|
|
The intersegment revenues and expenses that are
eliminated in the Consolidated Statements of
Operations relate to the Companys property/casualty
insurance subsidiaries 5.5% share of the management
fees paid to the Company.
85
Note 21.
Quarterly results of operations (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First |
|
|
Second |
|
|
Third |
|
|
Fourth |
|
(in thousands, except per share data) |
|
quarter |
|
|
quarter |
|
|
quarter |
|
|
quarter |
|
|
2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenue |
|
$ |
276,171 |
|
|
$ |
299,915 |
|
|
$ |
287,551 |
|
|
$ |
261,313 |
|
Operating expenses |
|
|
( 212,461 |
) |
|
|
( 233,373 |
) |
|
|
( 233,688 |
) |
|
|
( 221,209 |
) |
Investment incomeunaffiliated |
|
|
22,076 |
|
|
|
45,775 |
|
|
|
24,552 |
|
|
|
22,834 |
|
|
Income before income taxes
and equity in earnings of EFL |
|
$ |
85,786 |
|
|
$ |
112,317 |
|
|
$ |
78,415 |
|
|
$ |
62,938 |
|
|
Net income |
|
$ |
57,771 |
|
|
$ |
76,168 |
|
|
$ |
53,005 |
|
|
$ |
44,160 |
|
|
Net income per share:(*) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class Abasic |
|
$ |
.91 |
|
|
$ |
1.21 |
|
|
$ |
.84 |
|
|
$ |
.72 |
|
Class Bbasic |
|
|
138.84 |
|
|
|
183.89 |
|
|
|
128.01 |
|
|
|
107.45 |
|
Diluted |
|
|
.83 |
|
|
|
1.10 |
|
|
|
.76 |
|
|
|
.66 |
|
Comprehensive income |
|
|
37,455 |
|
|
|
73,969 |
|
|
|
42,250 |
|
|
|
40,500 |
|
|
2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenue |
|
$ |
265,911 |
|
|
$ |
298,326 |
|
|
$ |
291,083 |
|
|
$ |
267,824 |
|
Operating expenses |
|
|
( 211,176 |
) |
|
|
( 234,556 |
) |
|
|
( 224,414 |
) |
|
|
( 214,770 |
) |
Investment incomeunaffiliated |
|
|
17,957 |
|
|
|
20,100 |
|
|
|
19,499 |
|
|
|
30,563 |
|
|
Income before income taxes
and equity in earnings of EFL |
|
$ |
72,692 |
|
|
$ |
83,870 |
|
|
$ |
86,168 |
|
|
$ |
83,617 |
|
|
Net income |
|
$ |
49,572 |
|
|
$ |
56,955 |
|
|
$ |
58,566 |
|
|
$ |
61,320 |
|
|
Net income per share:(*) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class Abasic |
|
$ |
.77 |
|
|
$ |
.89 |
|
|
$ |
.92 |
|
|
$ |
.96 |
|
Class Bbasic |
|
|
117.87 |
|
|
|
135.81 |
|
|
|
139.84 |
|
|
|
146.36 |
|
Diluted |
|
|
.70 |
|
|
|
.81 |
|
|
|
.83 |
|
|
|
.87 |
|
Comprehensive income |
|
|
62,630 |
|
|
|
23,878 |
|
|
|
73,689 |
|
|
|
58,425 |
|
|
|
|
|
(*) |
|
The cumulative sum of quarterly basic and diluted net income per share amounts may not
equal total basic and diluted net income per share for the year due to differences in weighted
average shares and equivalent shares outstanding for each of the periods presented. |
2005
Includes a $14.2 million second quarter correction to record unrealized gains and losses on limited
partnerships to equity in earnings or losses of limited partnerships in the Consolidated Statements
of Operations. This correction increased net income per share-diluted by $.13, of which $.09 per
share-diluted related to 2004 and prior years.
2004
Includes a $5.2 million fourth quarter adjustment to recognize reduced commercial commission rates
to be paid in 2005 on premiums yet to be collected at December 31, 2004.
Reflects a fourth quarter adjustment of $3.1 million to record a tax benefit as a result of an IRS
audit of 2002 and 2001.
86
Common stock prices
The Class A non-voting common stock of the Company
trades on the NASDAQ Stock Market under the symbol
ERIE. The following sets forth the range of closing
high and low trading prices by quarter as reported by
the NASDAQ Stock Market.
Class A trading price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 |
|
|
2004 |
|
|
|
Low |
|
|
High |
|
|
Low |
|
|
High |
|
|
First quarter |
|
$ |
51.33 |
|
|
$ |
54.39 |
|
|
$ |
41.75 |
|
|
$ |
48.26 |
|
Second quarter |
|
|
50.15 |
|
|
|
54.83 |
|
|
|
43.92 |
|
|
|
49.29 |
|
Third quarter |
|
|
52.14 |
|
|
|
54.66 |
|
|
|
45.32 |
|
|
|
51.29 |
|
Fourth quarter |
|
|
51.79 |
|
|
|
53.34 |
|
|
|
47.79 |
|
|
|
53.00 |
|
|
No established trading market exists for the Class B
voting common stock.
The Companys 401(k) plan for employees permits
participants to invest a portion of the Companys
contributions to the plan in shares of Erie Indemnity
Class A common stock. The plans trustee is authorized
to buy Erie Indemnity Company Class A common stock on
behalf of 401(k) plan participants. Plan participants
held 126,451 and 112,698 Company Class A shares at
December 31, 2005 and 2004, respectively.
The Company has a stock repurchase plan that was
authorized at the end of 2003, allowing the Company to
repurchase up to $250 million of its outstanding Class
A common stock through December 31, 2006. The Company
may purchase the shares from time to time in the open
market or through privately negotiated transactions,
depending on prevailing market conditions and
alternative uses of the Companys capital. Shares
repurchased during 2005 totaled 1,890,159 at a total
cost of $99.0 million. Cumulative shares repurchased
under the plan since
inception was 3,035,224 at a total cost of $153.0
million.
On
February 21, 2006, the Companys Board of Directors
reauthorized a $250 million stock repurchase program. The
reauthorized stock repurchase program is effective once the available
funds from the current repurchase program are expended, and continues
through December 31, 2009.
Common stock dividends
The Company historically has declared and paid
cash dividends on a quarterly basis at the discretion
of the Board of Directors. The payment and amount of
future dividends on the common stock will be determined
by the Board of Directors and will depend on, among
other things, earnings, financial condition and cash
requirements of the Company at the time such payment is
considered, and on the ability of the Company to
receive dividends from its subsidiaries, the amount of
which is subject to regulatory limitations. Dividends
declared for each class of stock during 2005 and 2004
are as follows:
Dividends declared:
|
|
|
|
|
|
|
|
|
|
|
Class A |
|
|
Class B |
|
2005 |
|
share |
|
|
share |
|
|
First quarter |
|
$ |
.325 |
|
|
$ |
48.75 |
|
Second quarter |
|
|
.325 |
|
|
|
48.75 |
|
Third quarter |
|
|
.325 |
|
|
|
48.75 |
|
Fourth quarter |
|
|
.360 |
|
|
|
54.00 |
|
|
Total |
|
$ |
1.335 |
|
|
$ |
200.25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A |
|
|
Class B |
|
2004 |
|
share |
|
|
share |
|
|
First quarter |
|
$ |
.215 |
|
|
$ |
32.25 |
|
Second quarter |
|
|
.215 |
|
|
|
32.25 |
|
Third quarter |
|
|
.215 |
|
|
|
32.25 |
|
Fourth quarter |
|
|
.325 |
|
|
|
48.75 |
|
|
Total |
|
$ |
.970 |
|
|
$ |
145.50 |
|
|
American Stock Transfer & Trust Company serves as
the Companys transfer agent and registrar.
87
EX-21
Exhibit 21
SUBSIDIARIES OF REGISTRANT
Registrant owns 100% of the outstanding stock of the following companies:
|
|
|
|
Name |
|
State of Formation |
|
Erie Insurance Property
& Casualty Company |
|
Pennsylvania |
|
|
Erie Insurance Company |
|
Pennsylvania |
|
|
EI Holding Corp. |
|
Delaware |
|
|
EI Service Corp. |
|
Pennsylvania |
|
|
Erie Insurance Company of New York -
Wholly owned by Erie Insurance Company |
|
New York |
|
88
EX-23
Exhibit
23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in this Annual Report (Form 10-K) of Erie
Indemnity Company of our report dated February 16, 2006 (except
Note 11, as to which the date is February 21, 2006), included in the 2005 Annual Report to
Shareholders of Erie Indemnity Company.
Our audit also included the 2005 and 2004 financial statement schedules of Erie Indemnity
Company listed in Item 15(a). These schedules are the
responsibility of the Erie Indemnity Companys
management. Our responsibility is to express an opinion based on our audits. In our opinion
the consolidated financial statement schedules when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects the information
set forth therein.
/s/
Ernst & Young, LLP
February 21, 2006
Cleveland, Ohio
89
EX-31.1
Exhibit
31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Jeffrey A. Ludrof, certify that:
1. |
|
I have reviewed this annual report on Form 10-K of Erie Indemnity Company for the
year ended December 31, 2005; |
2. |
|
Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report; |
3. |
|
Based on my knowledge, the financial statements, and other financial information
included in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and for, the
periods presented in this report; |
4. |
|
The registrants other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in
Exchange Act 13a-15(f) and 15d-15(f)) for the registrant and have: |
|
a. |
|
Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this report is being prepared; |
|
|
b. |
|
Designed such internal control over financial reporting or caused
such internal control over financial reporting to be designated under our
supervision, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles; |
|
|
c. |
|
Evaluated the effectiveness of the registrants disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the
period covered by this report based on such evaluation; and |
|
|
d. |
|
Disclosed in this report any change in the registrants internal
control over financial reporting that occurred during the registrants most
recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the registrants internal control over financial reporting;
and |
5. |
|
The registrants other certifying officer and I have disclosed, based on our most
recent evaluation of internal control over financial reporting, to the registrants
auditors and the audit committee of registrants board of directors: |
|
a. |
|
All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting, which are reasonably
likely to adversely affect the registrants ability to record, process,
summarize and report financial information; and |
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b. |
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Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal control over
financial reporting. |
Date: February 22, 2006
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/s/ Jeffrey A. Ludrof |
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Jeffrey A. Ludrof, President & CEO |
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90
EX-31.2
Exhibit
31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Philip A. Garcia, certify that:
1. |
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I have reviewed this annual report on Form 10-K of Erie Indemnity Company for the
year ended December 31, 2005; |
2. |
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Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report; |
3. |
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Based on my knowledge, the financial statements, and other financial information
included in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and for, the
periods presented in this report; |
4. |
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The registrants other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in
Exchange Act 13a-15(f) and 15d-15(f)) for the registrant and have: |
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a. |
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Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this report is being prepared; |
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b. |
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Designed such internal control over financial reporting or caused
such internal control over financial reporting to be designated under our
supervision, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles; |
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c. |
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Evaluated the effectiveness of the registrants disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the
period covered by this report based on such evaluation; and |
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d. |
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Disclosed in this report any change in the registrants internal
control over financial reporting that occurred during the registrants most
recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the registrants internal control over financial reporting;
and |
5. |
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The registrants other certifying officer and I have disclosed, based on our most
recent evaluation of internal control over financial reporting, to the registrants
auditors and the audit committee of registrants board of directors: |
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a. |
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All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting, which are reasonably
likely to adversely affect the registrants ability to record, process,
summarize and report financial information; and |
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b. |
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Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal control over
financial reporting. |
Date: February 22, 2006
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/s/ Philip A. Garcia |
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Philip A. Garcia, Executive Vice President & CFO |
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91
EX-32
Exhibit
32
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
We, Jeffrey A. Ludrof, Chief Executive Officer of the Erie Indemnity Company (Company), and
Philip A. Garcia, Chief Financial Officer of the Company, certify, pursuant to § 906 of the
Sarbanes-Oxley Act of 2002, 18 U.S.C. § 1350, that:
|
(1) |
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The Annual Report on Form 10-K of the Company for the annual period December 31, 2005
(the Report) fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78m); and |
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(2) |
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The information contained in the Report fairly presents, in all material respects,
the financial condition and results of operations of the Company. |
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/s/ Jeffrey A. Ludrof |
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President & Chief Executive Officer |
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/s/ Philip A. Garcia |
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Executive VP & Chief Financial Officer |
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February 22, 2006
A signed original of this written statement required by Section 906, or other document
authenticating, acknowledging, or otherwise adopting the signature that appears in typed form
within the electronic version of this written statement required by Section 906, has been
provided to Erie Indemnity Company and will be retained by Erie Indemnity Company and furnished
to the Securities and Exchange Commission or its staff upon request.
92