-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UFdT6F5YAwhvOaQntqnTgoz7hs/a9Y4pUxYbhpzBaSnANtYHGOjFCXD7YDGWV1y1 Ud6Twb+CMC2RjRhp8bv1fQ== 0000922621-98-000003.txt : 19980515 0000922621-98-000003.hdr.sgml : 19980515 ACCESSION NUMBER: 0000922621-98-000003 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980514 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ERIE INDEMNITY CO CENTRAL INDEX KEY: 0000922621 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 250466020 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-24000 FILM NUMBER: 98619307 BUSINESS ADDRESS: STREET 1: 100 ERIE INSURANCE PL CITY: ERIE STATE: PA ZIP: 16530 BUSINESS PHONE: 8148702000 MAIL ADDRESS: STREET 1: 100 ERIE INSURANCE PLACE CITY: ERIE STATE: PA ZIP: 16530 10-Q 1 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For quarter ended March 31, 1998 Commission file number 0-24000 ERIE INDEMNITY COMPANY (Exact name of registrant as specified in its charter) PENNSYLVANIA 25-0466020 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 Erie Insurance Place, Erie, Pennsylvania 16530 (Address of principal executive offices) (Zip Code) (814) 870-2000 Registrant's telephone number, including area code Not applicable Former name, former address and former fiscal year, if changed since last report. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Class A Common Stock, no par value, with a stated value of $.0292 per share-- 67,032,000 shares as of April 30, 1998. Class B Common Stock, no par value, with a stated value of $70.00 per share-- 3,070 shares as of April 30, 1998. The common stock is the only class of stock the Registrant is presently authorized to issue. INDEX ERIE INDEMNITY COMPANY PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Consolidated Statements of Financial Position--March 31, 1998 and December 31, 1997 Consolidated Statements of Operations--Three months ended March 31, 1998 and 1997 Consolidated Statements of Comprehensive Income--Three months ended March 31, 1998 and 1997 Consolidated Statements of Cash Flows--Three months ended March 31, 1998 and 1997 Notes to Consolidated Financial Statements--March 31, 1998 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations PART II. OTHER INFORMATION Item 1. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders Item 6. Exhibits and Reports on Form 8-K SIGNATURES 2 PART I. FINANCIAL INFORMATION ERIE INDEMNITY COMPANY CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
March 31, December 31, ASSETS 1998 1997 -------------------- -------------------- (Unaudited) INVESTMENTS Fixed Maturities Available-for-Sale at fair value (amortized cost of $345,245,557 and $333,135,959, respectively) $ 361,654,967 $ 349,972,703 Equity Securities (cost of $148,261,095 and $144,123,112, respectively) 182,702,684 165,132,504 Real Estate Mortgage Loans 8,360,731 8,392,518 Other Invested Assets 11,798,327 7,932,571 -------------------- -------------------- Total Investments $ 564,516,709 $ 531,430,296 Cash and Cash Equivalents 43,442,807 53,148,495 Equity in Erie Family Life Insurance Company 36,274,524 34,687,640 Accrued Interest and Dividends 7,336,652 6,128,725 Premiums Receivable from Policyholders 107,555,183 108,057,986 Prepaid Federal Income Tax 0 1,681,573 Deferred Policy Acquisition Costs 10,338,222 10,283,372 Receivables from Erie Insurance Exchange and Affiliates 523,666,248 495,861,158 Note Receivable from Erie Family Life Insurance Company 15,000,000 15,000,000 Property and Equipment 10,577,127 10,130,230 Other Assets 28,114,003 26,134,306 -------------------- -------------------- Total Assets $ 1,346,821,475 $ 1,292,543,781 ==================== ====================
(Continued) See Notes to Consolidated Financial Statements. 3 ERIE INDEMNITY COMPANY CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
March 31, December 31, LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997 ---------------------- --------------------- (Unaudited) LIABILITIES Losses and Loss Adjustment Expenses $ 420,367,208 $ 413,408,941 Unearned Premiums 217,849,436 219,210,522 Accounts Payable 5,044,988 5,745,581 Accrued Commissions 78,033,439 81,150,931 Accrued Payroll and Payroll Taxes 4,401,097 4,040,192 Accrued Vacation and Sick Pay 5,617,827 5,322,327 Deferred Compensation 2,468,527 1,933,020 Deferred Income Taxes 12,008,242 7,101,371 Dividends Payable 7,255,444 7,255,444 Federal Income Tax Payable 13,040,158 0 Benefit Plans Liability 7,965,600 7,992,300 ---------------------- --------------------- Total Liabilities $ 774,051,966 $ 753,160,629 ---------------------- --------------------- SHAREHOLDERS' EQUITY Capital Stock Class A Common, stated value $.0292 per share; authorized 74,996,930 shares; issued and outstanding 67,032,000 shares 1,955,100 1,955,100 Class B Common, stated value $70.00 per share; authorized 3,070 shares; issued and outstanding 3,070 shares 214,900 214,900 Additional Paid-In Capital 7,830,000 7,830,000 Accumulated Other Comprehensive Income (net of deferred taxes) 37,967,317 29,024,573 Retained Earnings 524,802,192 500,358,579 ---------------------- --------------------- Total Shareholders' Equity $ 572,769,509 $ 539,383,152 ---------------------- --------------------- Total Liabilities and Shareholders' Equity $ 1,346,821,475 $ 1,292,543,781 ====================== =====================
See Notes to Consolidated Financial Statements. 4 ERIE INDEMNITY COMPANY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Three Months Ended March 31, 1998 March 31, 1997 ------------------ ------------------- MANAGEMENT OPERATIONS: Management Fee Revenue $ 117,323,655 $ 113,254,329 Service Agreement Revenue 2,999,321 1,271,791 Other Operating Revenue 373,961 608,974 ------------------ ------------------- Total Revenues from Management Operations 120,696,937 115,135,094 Cost of Management Operations 86,936,086 83,381,036 ------------------ ------------------- Net Revenues From Management Operations 33,760,851 31,754,058 ------------------ ------------------- INSURANCE UNDERWRITING OPERATIONS: Premiums Earned 27,461,062 25,850,574 Losses and Loss Adjustment Expenses Incurred 18,497,390 18,897,779 Policy Acquisition and Other Underwriting Expenses 7,536,191 7,000,708 ------------------ ------------------- Total Losses and Expenses 26,033,581 25,898,487 ------------------ ------------------- Underwriting Gain (Loss) 1,427,481 (47,913) ------------------ ------------------- INVESTMENT OPERATIONS: Equity in Earnings of Erie Family Life Insurance Company 1,405,476 951,844 Interest and Dividends 8,914,663 7,547,260 Realized Gain on Investments 996,778 1,137,325 ------------------ ------------------- Revenue from Investment Operations 11,316,917 9,636,429 ------------------ ------------------- Income Before Income Taxes 46,505,249 41,342,574 Provision for Income Taxes 14,806,190 13,131,779 ------------------ ------------------- Net Income $ 31,699,059 $ 28,210,795 ================== =================== Net Income per Share $ 0.43 $ 0.38 ================== =================== Dividends Declared per Share: Class A non-voting Common $ 0.1075 $ 0.095 ------------------ ------------------- Class B Common $ 16.125 $ 14.25 ------------------ -------------------
See Notes to Consolidated Financial Statements. 5 ERIE INDEMNITY COMPANY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended Three Months Ended March 31, 1998 March 31, 1997 ------------------ ------------------- Net Income $ 31,699,059 $ 28,210,795 ------------------ ------------------- Unrealized Gains (Losses) on Securities: Unrealized Holding Gains (Losses) Arising During Period 14,754,846 (8,254,881) Less: Reclassification Adjustment for Gains Included in Net Income (996,778) (1,137,325) ------------------ ------------------- Net Unrealized Holding Gains (Losses) Arising During Period $ 13,758,068 $ (9,392,206) Income Tax (Expense) Benefit Related to Unrealized Gains or Losses (4,815,324) 3,287,272 ------------------ ------------------- Other Comprehensive Income (Loss), Net of Tax $ 8,942,744 $ (6,104,934) ------------------ ------------------- Comprehensive Income $ 40,641,803 $ 22,105,861 ================== ===================
See Notes to Consolidated Financial Statements. 6 ERIE INDEMNITY COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended Three Months Ended March 31, 1998 March 31, 1997 ------------------ ------------------ CASH FLOW FROM OPERATING ACTIVITIES Net income $ 31,699,059 $ 28,210,795 Adjustment to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 478,676 454,484 Deferred income tax expense 355,086 217,787 Realized gain on investments (996,778) (1,137,325) Amortization of bond discount (48,741) (13,198) Undistributed earnings of Erie Family Life (1,098,891) (675,917) Deferred compensation 535,507 51,617 Increase in accrued investment income (1,207,927) (1,010,462) Increase in receivables (27,215,535) (31,659,297) Policy acquisition costs deferred (5,264,786) (5,026,335) Amortization of deferred policy acquisition costs 5,209,936 4,873,385 Increase in prepaid expenses and other assets (1,952,609) (8,173,349) (Decrease) increase in accounts payable and accrued expenses (69,452) 2,582,800 (Decrease) increase in accrued commissions (3,117,492) 93,768 Increase in income taxes payable 14,721,731 12,937,072 Increase in loss reserves 6,958,267 16,874,746 Decrease in unearned premiums (1,361,086) (1,436,353) ------------------ ----------------- Net cash provided by operating activities $ 17,624,965 $ 17,164,218 CASH FLOW FROM INVESTING ACTIVITIES Purchase of investments: Fixed maturities (18,971,576) (9,999,340) Equity securities (12,634,645) (12,939,623) Mortgage loans 0 (747,801) Other invested assets (4,121,398) (93,995) Sales/maturities of investments: Fixed maturities 7,020,218 7,960,502 Equity securities 9,383,875 10,031,953 Mortgage loans 31,850 34,072 Other invested assets 255,883 0 Purchase of property and equipment (102,038) 0 Purchase of computer software (823,534) (432,230) Loans to Agents (472,824) (294,374) Collections on Agent loans 358,982 281,449 ------------------ ----------------- Net cash used in investing activities $ (20,075,207) $(6,199,387) CASH FLOW FROM FINANCING ACTIVITIES Dividends paid to shareholders $ (7,255,446) $ (6,411,788) ------------------ ----------------- Net cash used in financing activities $ (7,255,446) $ (6,411,788) ------------------ ----------------- Net decrease (increase) in cash and cash equivalents (9,705,688) 4,553,043 Cash and cash equivalents at beginning of period 53,148,495 18,719,624 ------------------ ----------------- Cash and cash equivalents at end of period $ 43,442,807 $ 23,272,667 ================== =================
Supplemental disclosures of cash flow information: Cash paid during the three months ended March 31, 1998 and 1997 for income taxes was $35,481 and $23,028, respectively. See Notes to Consolidated Financial Statements. 7 ERIE INDEMNITY COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE A -- BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 1998 are not necessarily indicative of the results that may be expected for the year ending December 31, 1998. For further information, refer to the financial statements and footnotes thereto included in the Company's Form 10-K for the year ended December 31, 1997. NOTE B -- RECLASSIFICATIONS Certain amounts as perviously reported in the 1997 financial statements have been reclassified to conform to the current year's presentation. NOTE C -- EARNINGS PER SHARE Earnings per share is based on the weighted average number of Class A shares outstanding (67,032,000 as retroactively stated in 1997), giving effect to the conversion of the weighted average number of Class B shares outstanding (3,070 in 1998 and 1997) at a rate of 2,400 Class A shares for one Class B share as set out in the Articles of Incorporation. Equivalent shares outstanding total 74,400,000. NOTE D -- INVESTMENTS Management considers all fixed maturities and marketable equity securities available-for-sale. Marketable equity securities consist primarily of common and nonredeemable preferred stocks while fixed maturities consist of bonds and notes. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. Management determines the appropriate classification of fixed maturities at the time of purchase and reevaluates such designation as of each statement of financial position date. 8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued) The following is a summary of available-for-sale securities: Available-for-Sale Securities
Gross Gross Amortized Unrealized Unrealized Fair (In Thousands) Cost Gains Losses Value March 31, 1998 U.S. Treasuries & Agencies $ 12,771 $ 438 $ 6 $ 13,203 States & Political Subdivisions 43,446 2,865 5 46,306 Special Revenue 115,243 7,404 1 122,646 Public Utilities 9,166 159 0 9,325 Industrial & Miscellaneous 159,066 6,094 352 164,808 Foreign Governments 1,990 0 212 1,778 Foreign Industrial & Miscellaneous 3,564 41 16 3,589 ------------- ------------ ------------- ------------- Total Fixed Maturities $ 345,246 $ 17,001 $ 592 $ 361,655 ------------- ------------ ------------- ------------- Common Stock $ 65,183 $ 33,373 $ 5,423 $ 93,133 Preferred Stock 83,078 6,515 23 89,570 ------------- ------------ ------------- ------------- Total Equity Securities $ 148,261 $ 39,888 $ 5,446 $ 182,703 ------------- ------------ ------------- ------------- $ 493,507 $ 56,889 $ 6,038 $ 544,358 ============= ============ ============= =============
Available-for-Sale Securities
Gross Gross Amortized Unrealized Unrealized Fair (In Thousands) Cost Gains Losses Value December 31, 1997 U.S. Treasuries & Agencies $ 12,771 $ 432 $ 3 $ 13,200 States & Political Subdivisions 41,931 2,840 0 44,771 Special Revenue 116,052 7,850 1 123,901 Public Utilities 7,171 160 0 7,331 U.S. Industrial & Miscellaneous 150,666 6,317 401 156,582 Foreign Governments 1,989 0 418 1,571 Foreign Industrial & Miscellaneous 2,556 61 0 2,617 ------------- ------------ ------------- ------------- Total Fixed Maturities $ 333,136 $ 17,660 $ 823 $ 349,973 ------------- ------------ ------------- ------------- Common Stock $ 64,762 $ 23,082 $ 7,674 $ 80,170 Preferred Stock 79,361 5,603 1 84,963 ------------- ------------ ------------- ------------- Total Equity Securities $ 144,123 $ 28,685 $ 7,675 $ 165,133 ------------- ------------ ------------- ------------- $ 477,259 $ 46,345 $ 8,498 $ 515,106 ============= ============ ============= =============
9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued) Deferred income taxes increased by $4,551,782 at March 31, 1998 and decreased by $2,117,000 at December 31, 1997 related to the change in unrealized gains (losses) on available-for-sale securities. Mortgage loans on real estate are recorded at unpaid balances, adjusted for amortization of premium or discount. A valuation allowance is provided for impairment in net realizable value based on periodic valuations. The change in the allowance is reflected on the income statement in realized gain (loss) on investments. NOTE E -- SUMMARIZED INCOME STATEMENT INFORMATION OF AFFILIATE The Company has a 21.6% investment in Erie Family Life Insurance Company (EFL) and accounts for this investment using the equity method. The following represents summarized income statement information for EFL:
Three Months Ended Three Months Ended March 31, 1998 March 31, 1997 ------------------ ------------------ Revenues $ 23,771,476 $ 21,631,389 Benefits and expenses 13,755,036 15,045,371 ------------------ ------------------ Income before income taxes 10,016,440 6,586,018 Income taxes 3,518,631 2,184,954 ------------------ ------------------ Net income $ 6,497,809 $ 4,401,064 ================== ================== Dividends paid to shareholders $ 1,275,750 $ 1,181,252 ================== ================== Net unrealized appreciation (depreciation) on investment securities at March 31, net of deferred taxes $ 22,692,021 $ (3,004,822) ================== ==================
NOTE F -- NOTE RECEIVABLE FROM EFL On December 29, 1995, EFL issued a surplus note to the Company in return for cash of $15 million. The note bears an annual interest rate of 6.45% and all payments of interest and principal of the note may be repaid only out of unassigned surplus of EFL and are subject to prior approval of the Pennsylvania Insurance Commissioner. Interest on the surplus note is schedule to be paid semi-annually. The note will be payable on demand on or after December 31, 2005. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the financial statements and related notes found on pages 3 through 10, since they contain important information that is helpful in evaluating the Company's operating results and financial condition. OPERATING RESULTS Financial Overview Consolidated net income increased by 12.4% for the first quarter of 1998 to $31,699,059, or $.43 per share, from $28,210,795 or $.38 per share, for the first quarter of 1997. The increase in net income was driven by improved results in all three of the Company's operating segments. Management operations improved as management fee revenue outpaced the cost of management operations. Revenue from investment operations grew as the Company's increased cash flow was invested. Insurance underwriting operations recorded a gain, in part, as a result of mild weather conditions experienced in the Company's operating territories. RESULTS OF OPERATIONS Analysis of Management Operations For the first quarter 1998 management fee revenue derived from the management operations of the Company, which serves as attorney-in-fact for the Erie Insurance Exchange (the Exchange), increased 3.6% to $117,323,655 in the three months ended March 31, 1998 from $113,254,329 for the first quarter 1997. The rate of growth in the management fee revenue was greater than the growth in direct and affiliated assumed premium of the Exchange as a result of the management fee rate increasing in the first quarter of 1998 to 24.25% compared to a rate of 24% charged in the first quarter of 1997. The Company's Board of Directors has the authority to change the management fee rate at its discretion, but cannot exceed a rate of 25%. The direct and affiliated assumed premiums of the Exchange grew by 2.5% for the first quarter of 1998 versus the same period in 1997. The Exchange's overall premium growth was influenced negatively by a rate reduction included in Pennsylvania workers compensation legislative reforms. In addition, the Exchange's involuntary automobile premiums have decreased this year as a result of fewer assignments from the Pennsylvania assigned risk plan. Involuntary automobile business is written on substandard risks and historically has produced underwriting results worse than the preferred risks voluntarily written by the Erie Insurance Group. When the effect of workers compensation and involuntary automobile insurance are excluded, the direct and affiliated assumed premiums of the Exchange grew 4.2% for the first three months of 1998 when compared to the same period in 1997. Service agreement revenue totaled $2,999,321 and $1,271,791 for the quarter ended March 31, 1998 and 1997, respectively. Beginning September 1, 1997 the Company was reimbursed by the Exchange for a portion of service charges collected by the property/casualty insurers of the Group from Policyholders as reimbursement for the costs incurred by the Company in providing extended payment terms on policies written by them. These reimbursements totaled $1,508,081 for the three months ended March 31, 1998. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) The Company is responsible for the payment of commissions to the independent Agents who sell insurance products for the Company's subsidiaries and the Exchange, and its subsidiary, Flagship City Insurance Company. The Agents receive commissions based on fixed percentage fee schedules with different commission rates by product line of insurance. Also included in commission expense are the costs of promotional incentives for Agents and Agent contingency awards. Agent contingency awards are based upon the underwriting profitability of the insurance written and serviced by the Agent within the Erie Insurance Group of companies. Commissions are the largest component of the cost of management operations. The Company's commission costs increased 4.7% to $58,042,379 for the first quarter of 1998, compared to $55,458,798 in the first quarter of 1997. Commission costs grew faster than the rate of growth in direct and affiliated assumed written premiums of the Exchange due to increased provisions for agent contingency awards resulting from improved underwriting results in the first quarter of 1998. The growth in premiums written on a year-to-date basis was 2.5%. The cost of management operations rose 4.3% for the first quarter of 1998 to $86,936,086 from $83,381,036 during the first quarter of 1997. The cost of management operations excluding commission costs, grew 3.5% for the three months ended March 31, 1998 to $28,893,707 from $27,922,237 recorded in the first quarter of 1997 as productivity improvements and modest growth in operating costs continued. Personnel costs, including salaries, employee benefits, and payroll taxes, are the second largest component in cost of operations, after commissions. The Company's personnel costs, net of those reimbursed by affiliated companies, totaled $17,551,152 for the three month period ended March 31, 1998, compared to $16,967,942 for the same period in 1997, an increase of 3.4%. Net revenues from the Company's management operations rose 6.3% to $33,760,851 for the three months ended March 31, 1998 compared to $31,754,058 for the same period in 1997. The gross margin from management operations (net revenue divided by total revenue), of 28.0% in the first quarter of 1998, was slightly improved from the gross margin of 27.6% reported in the first quarter of 1997. Analysis of Insurance Underwriting Operations The insurance underwriting operations of the Company's wholly-owned subsidiaries, Erie Insurance Company and Erie Insurance Company of New York, which share proportionally in the property/ casualty underwriting results of the Erie Insurance Group, improved during the first quarter of 1998 versus the same period in 1997. In the first quarter of 1998, premiums earned for the Company's property/casualty insurance subsidiaries grew 6.2% to $27,461,062 compared to $25,850,574 for the same period in 1997. The mild weather conditions experienced in the Company's operating territories and claims and underwriting initiatives recently begun resulted in a decrease in the loss and loss adjustment expenses incurred of 2.1% to $18,497,390 in the first quarter of 1998 compared to $18,897,779 for the same period in 1997. The result of the growth in premiums earned combined with a decrease in loss and loss adjustment expenses generated an underwriting gain of $1,427,481 for the first quarter of 1998 compared to an underwriting loss of $47,913 for the first quarter of 1997. First quarter 1997 underwriting results were positively affected by $1,262,112 in Company recoveries under the aggregate excess of loss reinsurance agreement that went into effect on January 1, 1997. There were no recoveries in the first quarter of 1998 under this reinsurance agreement. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) The GAAP combined ratio for the Company's property/casualty insurance operations improved to 94.8% for the three months ended March 31, 998 compared to a ratio of 100.2% for the same period in 1997. The GAAP combined ratio is the ratio of loss, loss adjustment, acquisition, and other underwriting expenses incurred to premiums earned. Catastrophes are an inherent risk of the property/casualty insurance business, which can have a material impact on year-to-year fluctuations in the Company's property/casualty insurance underwriting operating results. No weather-related catastrophes, that were material to the financial position of the Company, occurred in the first three months of 1998. The Company continually reviews its methods for estimating its liability for losses and loss adjustment expenses, which includes an estimate for losses incurred but not reported. Such liabilities are necessarily based on estimates and, while management believes the amount is adequate, the ultimate liability may be in excess of or less than amounts provided. Analysis of Investment Operations Revenue from investment operations for the first quarter of 1998 increased by 17.4% to $11,316,917 from $9,636,429 posted in the first quarter of 1997. These results were fueled by an 18.1% increase in interest and dividends combined with a 47.7% increase in income from Erie Family Life Insurance Company (EFL). Non-recurring realized gains on investments were $996,778 in the first quarter of 1998 and $1,137,325 in the first quarter of 1997. The Company owns a 21.6% investment in an affiliated life insurer, Erie Family Life Insurance Company. This investment is accounted for under the equity method of accounting. Consequently, the Company's investment earnings were a direct result of EFL's net income increasing to $6,497,809 from $4,401,064 for the three months ended March 31, 1998 and 1997, respectively. The earnings recognized from the investment in EFL increased to $1,405,476 for the three months ended March 31, 1998 from $951,844 for the same period in 1997. FINANCIAL CONDITION Investments The Company's investment strategy takes a long-term perspective emphasizing investment quality, diversification and superior investment returns. Investments are managed on a total return approach that focuses on current income and capital appreciation. The Company's investment strategy also provides for liquidity to meet the short- and long-term commitments of the Company. At March 31, 1998, the Company's investment portfolio of investment-grade bonds, common stock and preferred stock, all of which are readily marketable, and cash and short-term investments, totaled $588 million, or 44%, of total assets. These resources provide the liquidity the Company requires to meet demands on its funds. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) The total investments of the Company consist of investments in fixed maturities, common stock, preferred stock, real estate mortgage loans and other invested assets. At March 31, 1998, 96.4% of total investments were invested in fixed maturities and equity securities. Mortgage loans and other invested assets represented only 3.6% of total investments at that date. Mortgage loans and real estate investments have the potential for higher returns, but also carry more risk, including less liquidity and greater uncertainty in the rate of return. Consequently, these investments have been kept to a minimum by the Company. The Company's investments are subject to certain risks, including interest rate and reinvestment risk. Fixed maturity and preferred stock security values generally fluctuate inversely with movements in interest rates. The Company's corporate and municipal bond investments may contain call and sinking fund features which may result in early redemptions. Declines in interest rates could cause early redemptions or prepayments which could require the Company to reinvest at lower rates. At March 31, 1998, the Company's five largest investments in corporate debt securities totaled $24.7 million, none of which individually exceeded $6.5 million. These investments had a market value of $25.8 million. LIQUIDITY AND CAPITAL RESOURCES Liquidity is a measure of the Company's ability to secure enough cash to meet its contractual obligations and operating needs. The Company's major sources of funds from operations are the net cash flow generated from management operations as the attorney-in-fact for the Exchange, the net cash flow from the Erie Insurance Company's 5% and the Erie Insurance Company of New York's .5% participation in the underwriting results of the reinsurance pool with the Exchange, and the Company's investment income from affiliated and non-affiliated investments. With respect to the management fee cash flow, funds are generally released from the Exchange to the Company on a premiums collected basis, as the Company incurs commission expense on premiums collected rather than written premiums. The Company generates sufficient net positive cash flow from its operations which is used to fund its commitments and to build its investment portfolio, thereby increasing future investment returns. The Company also maintains a high degree of liquidity in its investment portfolio in the form of readily marketable fixed maturities, common stocks and short-term investments. The Company's consolidated statements of cash flows indicate that net cash flows provided by operating activities for the three months ended March 31, 1998 and 1997, were $17,659,948 and $17,164,218 respectively. Those statements also classify the other sources and uses of cash by investing activities and financing activities. Dividends declared and paid to shareholders in the three months ended March 31, 1998 and 1997, totaled $7,255,444 and $6,411,788, respectively. There are state law restrictions on the payment of dividends from the insurance subsidiaries to the Company. No dividends were paid to the Company from its property/casualty insurance subsidiaries during the first three months of 1998. Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to deferred tax assets and liabilities resulted in net deferred tax liabilities at March 31, 1998 of $12,008,242 and at December 31, 1997 of $7,101,371. 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) The National Association of Insurance Commissioners (NAIC) standard for measuring the solvency of insurance companies, referred to as Risk Based Capital (RBC), is a method of measuring the minimum amount of capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. At December 31, 1997, the Company' property/casualty insurance subsidiaries' financial statements prepared under Statutory Accounting Practices are all substantially in excess of levels that would require regulatory action. At March 31, 1998 and December 31, 1997, the Company's receivables from its affiliates totaled $523,666,248 and $495,861,158, respectively. These receivables, primarily due from the Exchange, as a result of the management fee, expense reimbursements and the intercompany reinsurance pool, potentially expose the Company to concentrations of credit risk. STOCK REDEMPTION PLAN On December 14, 1989, the shareholders adopted the Erie Indemnity Company Stock Redemption Plan (the Plan). The Plan entitles estates of qualified shareholders to cause the Company to redeem shares of stock of the Company at a price equal to the fair market value of the stock at time of redemption. On December 12, 1995, the Board of Directors amended and restated the Plan. The restatement limits the redemption amount to an aggregation of: (1) an initial amount of $10 million as of December 31, 1995 and (2) beginning in 1996 and annually thereafter, an additional annual amount as determined by the Board in its sole discretion, not to exceed 20 percent of the Company's net income from management operations during the prior fiscal year. This aggregate amount is reduced by redemption amounts paid. However, at no time shall the aggregate redemption limitation exceed 20 percent of the Company's retained earnings determined as of the close of the prior year. In addition, the restated plan limits the repurchase from any single shareholder's estate to 33 percent of total share holdings of such shareholder. At the Board of Directors meeting on February 29, 1996, the Board approved an increase in the redemption amount of $14,350,186 to $24,350,186. On March 11, 1997, the Board approved an increase in the redemption amount of $16,655,226 to $41,005,412. On April 28, 1998, the Board approved an increase in the redemption amount of $17,791,624 to $58,797,036. ACCOUNTING PRONOUNCEMENTS FAS 130 In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 130 (FAS 130) "Reporting Comprehensive Income". FAS 130 is effective for fiscal years beginning after December 31, 1997 and requires reporting of comprehensive income in a full set of general purpose financial statements. The purpose of reporting comprehensive income is to report a measure of all changes in equity of the Company that result from recognized transactions and other economic events of the period. The two components of comprehensive income reported by the Company are net income from operations and unrealized gain or loss from investments, net of tax. Included in the report are statements of comprehensive income for the three months ended March 31, 1998 and 1997. 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) SOP 98-1 - Software Costs During the first quarter of 1998, the Company adopted AICPA Statement of Position (SOP) 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". In accordance with SOP 98-1 the Company began capitalizing internal use software costs. A change in accounting estimate was recognized to reflect the adoption of this statement, resulting in immaterial impact on net income for the first quarter of 1998. "Safe Harbor" Statement Under the Private Securities Litigation Reform Act of 1995: Statements contained herein expressing the beliefs of management such as those contained in the "Results of Operations - Analysis of Insurance Underwriting Operations", "Financial Condition - Investments", and the "Liquidity and Capital Resources" sections hereof, and the other statements which are not historical facts contained in this report are forward looking statements that involve risks and uncertainties. These risks and uncertainties include but are not limited to: legislative, judicial and regulatory changes, the impact of competitive products and pricing, product development, geographic spread of risk, weather and weather-related events, other types of catastrophic events, securities markets fluctuations, and technological difficulties and advancements. PART II. OTHER INFORMATION Item 1. Legal Proceedings The H.O. Hirt Trusts collectively own 2,340 shares of the Company's Class B Common Stock, which has the exclusive right to vote in the election of directors of the Company. Since such shares represent 76.22% of the outstanding shares of the Company's Class B Common Stock, the vote of the H.O. Hirt Trusts is sufficient to determine the outcome of any election of directors. The trustees of the H.O. Hirt Trusts are F. William Hirt, Chairman of the Board of the Company, a director of the Company, a beneficial owner of more than 10% of the Company's outstanding Class A Common Stock and a beneficiary of one of the two H.O. Hirt Trusts; his sister, Susan Hirt Hagen, a director of the Company, a beneficial owner of more than 10% of the Company's outstanding Class A Common Stock and a beneficiary of the other H.O. Hirt Trust and Mellon Bank, N.A. Under the provisions of the H.O. Hirt Trusts, the shares of the Company's Class B Common Stock held by the H.O. Hirt Trusts are to be voted as directed by a majority of the three trustees. Under the Pennsylvania Insurance Company Law and the Company's By-laws, the candidates for the election as directors of the Company are to be nominated by a committee consisting solely of persons who are not officers or employees of the Company or of any entity controlling, controlled by or under common control with the Company and who are not beneficial owners of a controlling interest in the voting securities of the Company. On March 11, 1998, the Nominating Committee of the Company's Board of Directors nominated 12 persons as candidates for election as directors of the Company at the Company's April 28, 1998 annual meeting of shareholders. The 12 persons nominated did not include Thomas B. Hagen, the husband of Susan Hirt Hagen, as a candidate for election as a director of the Company at such annual meeting. Thomas B. Hagen had served as a director of the Company since 1979. On April 2, 1998, Susan Hirt Hagen filed petitions in the Orphan's Court Division of the Court of Common Pleas of Erie County, Pennsylvania (the "Court") seeking the removal of Mellon Bank, N.A. as a co-trustee of the H.O. Hirt Trust with respect to Susan Hirt Hagen and as a co-trustee of the H.O. Hirt Trust with respect to F. William Hirt. Among the relief requested by Susan Hirt Hagen in the petitions was the grant of a preliminary injunction against Mellon Bank, N.A. from voting the Class B Common Stock held by the H.O. Hirt Trusts for the purpose of the election of directors at the Company's April 28, 1998 annual meeting of shareholders. Because of the potential substantial harm to the Company if the preliminary injunction were granted, the Company filed a petition to intervene in the preliminary injunction proceedings which was granted by the Court on April 20, 1998. Following a hearing on April 20, 1998, the Court issued an opinion on April 21, 1998 and an order denying Susan Hirt Hagen's request for a preliminary injunction. On April 28, 1998, the Company's 1998 annual meeting of shareholders was held as scheduled and each of the candidates for election as a director of the Company named in the Company's April 1, 1998 proxy statement was elected as a director of the Company. The petitions filed by Susan Hirt Hagen to remove Mellon Bank, N.A. as trustee of the H.O. Hirt Trusts remains pending. Item 4. Submission of Matters to a Vote of Security Holders The Company's Annual Meeting of Shareholders was held April 28, 1998. a. The following directors were elected at the Annual Meeting of Shareholders for a one-year term and until a successor is elected and qualified: Peter B. Bartlett Edmund J. Mehl Samuel P. Black, III Stephen A. Milne J. Ralph Borneman, Jr. John M. Petersen Patricia A. Goldman Seth E. Schofield Susan H. Hagen Jan R. Van Gorder F. William Hirt Harry H. Weil b. The following other matter was voted upon at the meeting and the following number of affirmative votes were cast with respect to such matter: The proposal to ratify the selection of Brown, Schwab, Bergquist & Co. as independent public accountants to perform the annual audit of the Company's financial statements for the year ending December 31, 1998. This proposal received 3,057 affirmative votes with no negative votes or abstentions. Item 6. Exhibits and Reports on Form 8-K The Company did not file any reports on Form 8-K during the three months ended March 31, 1998. 16 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Erie Indemnity Company (Registrant) Date: May 4, 1998 /s/ Stephen A. Milne President & CEO /s/ Philip A. Garcia Executive Vice President & CFO 17 EX-27 2 FDS
7 THIS FDS CONTAINS INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF THE ERIE INDEMNITY COMPANY FOR THE QUARTER ENDED MARCH 31, 1998 AND IS QUALIFIED IN REFERENCE TO THE COMPANY'S FORM 10-Q 0000922621 ERIE INDEMNITY COMPANY 1,000 3-MOS 3-MOS DEC-31-1998 DEC-31-1997 MAR-31-1998 MAR-31-1997 361,655 306,893 0 0 0 0 182,703 134,948 8,360 8,007 0 0 564,517 456,953 43,443 23,273 155 182 10,338 9,694 1,346,821 1,191,465 420,367 403,300 217,849 215,502 0 0 0 0 0 0 0 0 0 0 2,170 2,170 570,600 449,283 1,346,821 1,191,465 27,461 25,851 10,320 8,580 997 1,137 0 0 0 0 7,536 7,001 18,497 18,898 46,505 41,343 14,806 13,132 0 0 0 0 0 0 0 0 31,699 28,211 .43 .38 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
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