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.
<PAGE>
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
<PAGE>
PART I. FINANCIAL INFORMATION
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
<TABLE>
<CAPTION>
March 31, December 31,
ASSETS 1998 1997
-------------------- --------------------
(Unaudited)
<S> <C> <C>
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
==================== ====================
</TABLE>
(Continued)
See Notes to Consolidated Financial Statements.
3
<PAGE>
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
<TABLE>
<CAPTION>
March 31, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997
---------------------- ---------------------
(Unaudited)
<S> <C> <C>
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
====================== =====================
</TABLE>
See Notes to Consolidated Financial Statements.
4
<PAGE>
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1998 March 31, 1997
------------------ -------------------
MANAGEMENT OPERATIONS:
<S> <C> <C>
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
------------------ -------------------
</TABLE>
See Notes to Consolidated Financial Statements.
5
<PAGE>
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1998 March 31, 1997
------------------ -------------------
<S> <C> <C>
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
================== ===================
</TABLE>
See Notes to Consolidated Financial Statements.
6
<PAGE>
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1998 March 31, 1997
------------------ ------------------
<S> <C> <C>
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
================== =================
</TABLE>
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
<PAGE>
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
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
The following is a summary of available-for-sale securities:
Available-for-Sale Securities
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
(In Thousands) Cost Gains Losses Value
<S> <C> <C> <C> <C>
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
============= ============ ============= =============
</TABLE>
Available-for-Sale Securities
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
(In Thousands) Cost Gains Losses Value
<S> <C> <C> <C> <C>
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
============= ============ ============= =============
</TABLE>
9
<PAGE>
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:
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1998 March 31, 1997
------------------ ------------------
<S> <C> <C>
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)
================== ==================
</TABLE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
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
</LEGEND>
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<NAME> ERIE INDEMNITY COMPANY
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<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-END> MAR-31-1998 MAR-31-1997
<DEBT-HELD-FOR-SALE> 361,655 306,893
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<EQUITIES> 182,703 134,948
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<TOTAL-INVEST> 564,517 456,953
<CASH> 43,443 23,273
<RECOVER-REINSURE> 155 182
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