FORM 10-K/A
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(NO FEE REQUIRED)
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
For the transition period from to
Commission File Number 0-24000
ERIE INDEMNITY COMPANY
(Exact name of registrant as specified in its charter)
Pennsylvania 25-0466020
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
100 Erie Insurance Place, Erie, Pennsylvania 16530
(Address of principal executive offices) (Zip code)
Registrant's 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, no par value
Class B Common Stock, no par value
(Tile of class)
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 X No
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 Registrant's 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. [ ]
Aggregate market value of voting stock of nonaffiliates: 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 the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date: 67,007,500 Class A shares and
3,070 Class B shares of Common Stock outstanding on February 26, 1999.
DOCUMENTS INCORPORATED BY REFERENCE:
1. Portions of the Registrant's Annual Report to Shareholders for the fiscal
year ended December 31, 1998 (the "Annual Report") are incorporated by
reference into Parts I, II and IV of this Form 10-K Report.
2. Portions of the Registrant's proxy statement relating to the annual meeting
of shareholders to be held April 27, 1999 are incorporated by reference
into Part III of this Form 10-K Report.
1
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INDEX
PART ITEM NUMBER AND CAPTION PAGE
I Item 1. Business 3
I Item 2. Properties 13
I Item 3. Legal Proceedings 13
I Item 4. Submission of Matters to a
Vote of Security Holders 13
II Item 5. Market for Registrant's Common Equity
and Related Shareholder Matters 14
II Item 6. Selected Consolidated Financial Data 14
II Item 7. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 14
II Item 8. Financial Statements and Supplementary
Data 14
II Item 9. Changes In and Disagreements With
Accountants on Accounting and Financial
Disclosures 14
III Item 10. Directors and Executive Officers
of the Registrant 15
III Item 11. Executive Compensation 17
III Item 12. Security Ownership of Certain
Beneficial Owners and Management 17
III Item 13. Certain Relationships and Related
Transactions 17
IV Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K 19
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PART I
Item 1. Business
Erie Indemnity Company (the "Company") is a Pennsylvania business
corporation formed in 1925 to be the attorney-in-fact for Erie Insurance
Exchange (the "Exchange"), a Pennsylvania-domiciled reciprocal insurance
exchange. The Company's principal business activity consists of management of
the Exchange, and management fees received from the Exchange accounted for
approximately 75.3% of the Company's consolidated revenues in 1998. The Company
is also engaged in the property/casualty insurance business through its
wholly-owned subsidiaries, Erie Insurance Company (Erie Insurance Co.), Erie
Insurance Company of New York (Erie NY) and Erie Insurance Property & Casualty
Company (Erie P&C) and through its management of Flagship City Insurance Company
(Flagship), a subsidiary of the Exchange. In addition, the Company holds
investments in both affiliated and unaffiliated entities, including a 21.6%
common stock interest in Erie Family Life Insurance Company (EFL), an affiliated
life insurance company, 52.2% of whose capital stock is owned by the Exchange,
accounted for under the equity method of accounting. Together with the
Exchange, the Company and its subsidiaries and affiliates operate
collectively under the name "Erie Insurance Group". See the chart on the
following page which details the organization of the Erie Insurance Group.
As of December 31, 1998, the Company had 3,227 full-time
employees. Of that total, 1,588 full-time employees provide claims-specific
services exclusively for the Exchange and 89 full-time employees perform general
services exclusively for EFL. Both the Exchange and EFL reimburse the Company
monthly for these services. None of the Company's employees is covered by a
collective bargaining agreement. The Company believes that its relationship with
its employees is good.
Management Operations
The Exchange, which commenced operations in 1925, underwrites a
broad line of personal and commercial property and casualty insurance coverages,
including automobile, homeowners, commercial multi-peril and workers'
compensation. Erie Insurance Co. was organized in 1972 as a stock casualty
insurance company to supplement the lines of business written by the Exchange,
and was acquired by the Company from the Exchange as of December 31, 1991. Since
January 1, 1992, Erie Insurance Co. and the Exchange have participated in an
intercompany reinsurance pool whereby the parties share proportionately in the
results of the property/casualty insurance operations conducted by Erie
Insurance Co. and the Exchange. Effective January 1, 1995, Erie NY began
participating in this intercompany reinsurance pool whereby Erie Insurance Co.
maintained its 5% participation in the pool and Erie NY assumed a .5%
participation in the pool, thus reducing the Exchange's participation in the
pool from 95% to 94.5% at that date. Flagship was organized in 1992 as a stock
casualty insurance company to conduct the Exchange's residual automobile market
business. Erie P&C was organized in 1993 to conduct Erie Insurance Group's
business in West Virginia and to write workers' compensation insurance in
Pennsylvania. Erie NY was purchased in 1994 to conduct Erie Insurance Group's
business in New York State together with Erie Insurance Company. At December 31,
1998, the Erie Insurance Group conducted business in nine states and the
District of Columbia through approximately 1,200 agencies with approximately
5,400 agents.
3
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CORPORATE ORGANIZATION CHART AT DECEMBER 31, 1998
ERIE INDEMNITY COMPANY - Incorporated: April 17, 1925 (PA)
Total Capital Stock: 75,000,000 @ no par value (74,996,930 shares
Class A, 3,070,shares Class B)
Shares Outstanding: 67,032,000 (Class A), 3,070 (Class B)
ERIE INSURANCE EXCHANGE - Began Operation: April 20, 1925
(A reciprocal Insurance Exchange)
EI HOLDING CORP. - Incorporated: September 28, 1990 (DE)
Total Capital Stock: 100 @ $1.00 par value
Shares Outstanding: 100
EI SERVICE CORP. - Incorporated December 15, 1982 (PA)
Total Capital Stock: 100 @ $1.00 par value
Shares Outstanding: 100
ERIE INSURANCE COMPANY - Incorporated September 11, 1972 (PA)
Total Capital Stock: 23,500 @ $100 par value
Shares Outstanding: 23,500
ERIE INSURANCE COMPANY OF NEW YORK - Incorporated September 15, 1885 (NY)
Total Capital Stock: 23,500 @ $100 par value
Shares Outstanding: 23,500
ERIE INSURANCE PROPERTY & CASUALTY COMPANY - Incorporated January 19, 1993 (PA)
Total Capital Stock: 23,500 @ $100 par value
Shares Outstanding: 23,500
FLAGSHIP CITY INSURANCE COMPANY - Incorporated January 22, 1992 (PA)
Total Capital Stock: 23,500 @ $100 par value
Shares Outstanding: 23,500
ERIE FAMILY LIFE INSURANCE COMPANY - Incorporated May 23, 1967 (PA)
Total Capital Stock: 15,000,000 @ $.40 par value
Shares Outstanding: 9,450,000
The Erie Indemnity Company is the Attorney-in-Fact for the Erie Insurance
Exchange. EI Holding Corp., EI Service Corp., Erie Insurance Company and Erie
Insurance Property & Casualty Company are owned 100% by the Erie Indemnity
Company. The Erie Insurance Company of New York is 100% owned by the Erie
Insurance Company. The Flagship City Insurance Company is 100% owned by the Erie
Insurance Exchange. The Erie Indemnity Company owns 21.6% of the outstanding
stock of the Erie Family Life Insurance Company while the Erie Insurance
Exchange owns 52.2% of the outstanding stock of the Erie Family Life Insurance
Company.
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Property/Casualty Insurance Operations
One of the distinguishing features of the property/casualty
insurance industry is that its products generally are priced before its costs
are known, as premium rates usually are determined before losses are reported.
Changes in statutory and case law can dramatically affect the liabilities
associated with known risks after the insurance contract is in place. The number
of competitors and the similarity of products offered, as well as regulatory
constraints, limit the ability of property/casualty insurance companies to
increase prices in response to declines in profitability.
The profitability of the property/casualty insurance business is
generally subject to many factors, including rate competition, the severity and
frequency of claims, natural disasters, state regulation of premium rates,
defaults of reinsurers, interest rates, general business conditions, regulatory
measures and court decisions that define and may expand the extent of coverage
and the amount of compensation due for injuries and losses. Historically, the
overall financial performance of the property/casualty insurance industry has
tended to fluctuate in cyclical market patterns. A typical market cycle has been
composed of a period of heightened premium rate competition and depressed
underwriting performance, often referred to as a "soft market", followed by a
period of constricted industry capital and underwriting capacity, increasing
premium rates and underwriting performance, often referred to as a "hard
market". During a soft market, competitive conditions can result in premium
rates which are inadequate and therefore unprofitable and underwriting terms and
conditions which are not as favorable to a property/casualty insurer as during
hard markets.
The Exchange, Flagship, Erie Insurance Co., Erie P&C and Erie NY
all have current ratings of A++ (Superior) from A.M. Best with respect to their
financial strength and claims-paying ability. In evaluating an insurer's
financial and operating performance, A.M. Best reviews the insurer's
profitability, leverage and liquidity as well as the insurer's book of business,
the adequacy and soundness of its reinsurance, the quality and estimated market
value of its assets, the adequacy of its loss reserves and the experience and
competency of its management. Management believes that this A.M. Best rating of
A++ (Superior) is an important factor in marketing Erie Insurance Group's
property/casualty insurance to its agents and customers and that insurance
carriers with the higher ratings have some competitive advantage. A.M. Best's
classifications are A++ and A+ (Superior), A and A- (Excellent), B++ and B+
(Very Good), B and B- (Good), C++ and C+ (Fair), C and C- (Marginal), D (Below
Minimum Standards) and E and F (Liquidation). According to A.M. Best, a
"Superior" rating is assigned to those companies which, in A.M. Best's opinion,
have achieved superior overall performance when compared to the standards
established by A.M. Best and have a very strong ability to meet their
obligations to policyholders over a long period. A.M. Best's ratings are based
upon factors relevant to policyholders and are not directed towards the
protection of investors.
The property/casualty insurers managed by the Company are
licensed to do business in 15 states and in the District of Columbia, and at
December 31, 1998 operated in nine states and the District of Columbia. Erie
Insurance Group's business consists primarily of private passenger automobile,
homeowners, commercial multi-peril, workers compensation and commercial
automobile insurance business written in Pennsylvania, Ohio, Maryland and
Virginia.
5
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The Company, in managing the property/casualty insurers of the
Erie Insurance Group, has followed several strategies which the management of
the Company believes have resulted in underwriting results which are better than
those of the property and casualty industry in general. The principal strategies
employed by the Company in managing these insurers are:
o An underwriting philosophy and product mix designed to
produce an Erie Insurance Group-wide underwriting profit,
i.e., a combined ratio of less than 100%, through careful
risk selection and adequate pricing. The careful selection
of risks allows for lower claims frequency and loss
severity, thereby enabling insurance to be offered at
favorable prices.
o A focus on providing consistent, high quality service to
policyholders and agents in both underwriting and claims
handling.
o A business concept designed to provide the advantages of
localized marketing, underwriting and claims servicing
with the economies of scale from centralized accounting,
administrative, investment, data processing and other
support services.
o A careful agent selection process, in which Erie Insurance
Group seeks to be the lead underwriter with its agents in
order to enhance the agency relationship and the
likelihood of receiving the most desirable underwriting
opportunities from its agents.
Life Insurance Operations
EFL, which was organized in 1967 as a Pennsylvania-domiciled life
insurance company, has an A.M. Best rating of A+ (Superior). EFL is primarily
engaged in the business of underwriting and selling non-participating individual
and group life insurance policies, including universal life and individual and
group annuity products in eight states and the District of Columbia. At December
31, 1998, on a Generally Accepted Accounting Principles (GAAP) basis, EFL had
assets of $918 million and shareholders' equity of $183 million. At December 31,
1998, of EFL's total liabilities of $735 million, insurance and annuity reserves
accounted for $677 million and a note payable to the Company amounted to $15
million. Of EFL's investment portfolio of $775 million at December 31, 1998,
available-for-sale securities accounted for $741 million, real estate was $2
million, policy loans were $6 million, mortgage loans accounted for $10 million
and other invested assets were $16 million.
Financial Information About Industry Segments
Reference is made to Note 13 of the Notes to the Consolidated
Financial Statements included in the Annual Report, page 53 for information as
to revenues, net income and identifiable assets attributable to the three
business segments (management operations, property/casualty insurance operations
and life insurance operations) in which the Company is engaged.
Lines of Business
The Erie Insurance Group property/casualty insurers managed by
the Company write both personal and commercial lines of business. The commercial
lines consist primarily of commercial automobile, commercial multi-peril and
workers' compensation insurance. The personal lines consist primarily of
automobile and homeowners insurance. A description of these types of insurance
follows:
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Commercial
o Automobile -- policies that provide protection to
businesses against liability for bodily injury and
property damage arising from automobile accidents, and
provide protection against loss from damage to automobiles
owned by the insured business.
o Multi-peril -- policies that provide protection to
businesses against many perils, usually combining
liability and physical damage coverages.
o Workers' compensation -- policies purchased by employers
to provide benefits to employees for injuries sustained
during employment. The extent of coverage is established
by the workers' compensation laws of each state.
Personal
o Private passenger automobile -- policies that provide
protection against liability for bodily injury and
property damage arising from automobile accidents, and
provide protection against loss from damage to automobiles
owned by the insured.
o Homeowners -- policies that provide coverage for damage to
residences and their contents from a broad range of
perils, including fire, lightning, windstorm and theft.
These policies also cover liability of the insured arising
from injury to other persons or their property while on
the insured's property and under other specified
conditions.
See "Selected Market and Geographic Information" contained on page
36 of the Annual Report for the Company's 5.5% share of direct premiums written
by jurisdiction and line of business in addition to statutory loss and loss
adjustment expense ratios by line of business for the Company's wholly-owned
subsidiaries.
The property/casualty insurers managed by the Company are required
to participate in involuntary insurance programs for automobile insurance, as
well as other property and casualty lines, in states in which such companies
operate. 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 requires
all companies that write lines covered by these programs to provide coverage
(either directly or through reinsurance) for insureds who cannot obtain
insurance in the voluntary market. The legislation creating these programs
usually allocates a pro rata portion of risks attributable to such insureds to
each company on the basis of direct premiums written or the exposures insured.
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; however, the impact of these involuntary
programs on the property/casualty insurers managed by the Company has been
immaterial.
Combined Ratios
The following table sets forth for the periods indicated the
combined ratio of Erie Insurance Co. and Erie NY, prepared in accordance with
statutory accounting principles (SAP) prescribed or permitted by state insurance
authorities and the combined ratio of Erie Insurance Co. and Erie NY prepared in
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accordance with GAAP. The combined ratio is a traditional measure of
underwriting profitability. When the combined ratio is under 100%, underwriting
results are generally considered profitable. Conversely, when the combined ratio
is over 100% underwriting results are generally considered unprofitable. The
combined ratio does not reflect investment income, federal income taxes or other
non-operating income or expense. The operating income of Erie Insurance Co. and
Erie NY is dependent upon income from both underwriting operations and
investments.
<TABLE>
<CAPTION>
Year Ended
December 31,
1998 1997 1996
<S> <C> <C> <C>
GAAP combined ratio..................................... 99.5% 102.1% 111.4%
===== ====== ======
Statutory operating ratios:
Loss ratio............................................ 70.4 74.1 83.3
Expense ratio......................................... 28.0 26.6 26.4
Dividend ratio........................................ .6 0.9 1.0
---- ---- ----
Statutory combined ratio.............................. 99.0% 101.6% 110.7%
===== ====== ======
Industry statutory combined ratio(1).................... 105.0% 101.8% 105.8%
====== ====== ======
</TABLE>
- ---------------
(1) Source: A.M. Best
The Company's property/casualty insurance subisidiaries recorded
an underwriting gain of $567,275 in 1998 compared to underwriting losses of
$2,259,425 and $11,579,211 for the years 1997 and 1996, respectively. The 1998
insurance underwriting results improved as a result of loss cost
severity-management programs introduced by the Company combined with a generally
favorable claims environment and mild weather conditions. In 1997 mild winter
weather conditions and a lack of catastrophe losses in the Company's operating
territories positively affected insurance underwriting results. The 1996
underwriting results of the Company's wholly-owned subsidiaries, Erie Insurance
Company and Erie Insurance Company of New York, were impacted negatively by
severe winter weather in the first quarter of 1996 and catastrophe losses
experienced from Hurricane Fran in the eastern United States, particularly North
Carolina, and other storm-related catastrophe losses elsewhere in our operating
territories during the third quarter of 1996. Losses resulting from these
catastrophes were about $8.1 million in 1996 or about $.07 per share, after
federal income taxes. The majority of these losses were property losses on
homeowners and commercial property lines of business.
Reserves
Loss reserves are estimates of the amounts the insurer expects to
pay to claimants at a given point in time, based on facts and circumstances then
known. It can be expected that the ultimate claims liability will exceed or be
less than such estimates. Reserves are based on estimates of future trends and
claims severity, judicial theories of liability and other factors. Management
believes that the reserves currently established by the Company are adequate to
cover the eventual cost of the claims liability of the property and casualty
insurers managed by the Company. However, during the loss adjustment period,
additional facts regarding individual claims may become known, and consequently
it often becomes necessary to refine and adjust the estimates of liability. Loss
reserves are set at full expected cost except for loss reserves for workers'
compensation which have been discounted at 2.5%. Adjustments are reflected in
operating results in the year in which the changes in the estimates of liability
are made.
In establishing the liability for unpaid losses and loss
adjustment expenses related to asbestos-related illnesses and toxic waste
cleanup, management considers facts currently known and the current state of the
law and coverage litigation. Liabilities are recognized for known claims
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(including the cost of related litigation) when sufficient information has been
developed to indicate the involvement of a specific insurance policy, and
management can reasonably estimate its liability. In addition, liabilities have
been established to cover additional exposures on both known and unasserted
claims.
The establishment of appropriate reserves is an inherently
uncertain process, and there can be no assurance that the ultimate liability
will not exceed the loss and loss adjustment expense reserves of the property
and casualty insurers managed by the Company. An increase in these reserves
would have an adverse effect on the results of operations and financial
condition of the property/casualty insurers managed by the Company. As is the
case for virtually all property/casualty insurance companies, the Company has
found it necessary, in the past, to revise, in non-material amounts, estimated
future liabilities as reflected in the loss and loss adjustment expense reserves
of the property/casualty insurers managed by the Company, and further
adjustments could be required in the future.
On the basis of the Company's internal procedures, which analyze
the Company's experience with similar cases and historical trends such as
reserving patterns, loss payments, pending levels of unpaid claims and product
mix, as well as court decisions and economic conditions, management believes
adequate provision has been made for the loss and loss adjustment expense
reserves of the Company's property/casualty insurers managed by the Company.
Differences between reserves reported in the Company's financial
statements prepared on the basis of GAAP and financial statements prepared on
the basis of SAP are not significant.
The following table sets forth the development of reserves for
unpaid losses and loss adjustment expenses for the Company's property/casualty
subsidiaries on a GAAP basis for 1994, 1995, 1996, 1997 and 1998.
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996 1995 1994
-------- -------- -------- -------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C>
Reserve for unpaid
losses and loss
adjustment expense................... $426,165 $413,409 $386,425 $357,334 $344,824
========
Liability as of:
One year later....................... 412,189 395,308 351,684 327,283
-------
Two years later...................... 399,337 363,273 332,821
-------
Three years later.................... 374,050 351,721
-------
Four years later..................... 364,148
-------
Cumulative deficiency
(excess) ........................ ( 1,220) 12,912 16,716 19,324
======== ======== ======== ========
Cumulative amount of liability paid through:
One year later...................... $136,940 $142,425 $132,649 $134,044
======== ======== ======== ========
Two years later..................... $213,252 $200,171 $200,024
======== ======== ========
Three years later................... $236,758 $233,545
======== ========
Four years later.................... $253,512
========
</TABLE>
See Note 2 of the Notes to Consolidated Financial Statements
contained in the Annual Report page 43 for discussion of the development of such
reserves and activity contained in the unpaid loss and loss adjustment expense
reserves for the years ended December 31, 1998 and 1997.
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Safe Harbor Statement Under the Private Securities Litigation
Reform Act of 1995: Statements contained herein expressing the beliefs of
management 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 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, and technological difficulties and
advancements.
Reinsurance
Reference is made to Note 11 of the Notes to Consolidated
Financial Statements contained in the Annual Report pages 51 to 52 incorporated
herein by reference for a complete discussion of the reinsurance transactions
involving the Company and its affiliates.
Erie Insurance Group
Intercompany Reinsurance Chart
As of December 31, 1998
Source of Business:
The Erie Insurance Company, Erie Insurance Company of New York, Flagship City
Insurance Company and Erie Insurance Property & Casualty Company cede 100% of
their business to the Erie Insurance Exchange. This is considered the group's
Intercompany Reinsurance pool of business.
Allocation of Business:
The Erie Insurance Exchange then retrocedes 5% of the pool to the Erie Insurance
Company and .5% of the pool to the Erie Insurance Company of New York. The Erie
Insurance Exchange retains the remaining 94.5% of the pool.
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Competition
The property/casualty insurance industry is extremely competitive
on the basis of both price and service. There are numerous companies competing
for this business in the geographic areas where Erie Insurance Group operates,
many of which are substantially larger and have greater financial resources than
Erie Insurance Group. Competition may take the form of lower prices, broader
coverage, greater product flexibility or higher quality services. In addition,
because the insurance products of Erie Insurance Group are marketed exclusively
through independent insurance agencies, most of which represent more than one
company, Erie Insurance Group faces competition to retain qualified independent
agencies and competes for business in each agency.
Regulation
Government Regulation
The property/casualty insurers managed by the Company are subject
to supervision and regulation in the states in which they transact 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 which 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
which must be met and maintained by insurers, the licensing to do business of
insurers and agents, the nature of the limitations on investments, premium rates
for property/casualty insurance, the provisions which 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. 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 states in which the property/casualty insurers managed by the
Company operate have guaranty fund laws under which insurers doing business in
such states can be assessed on the basis of premiums written by the insurer in
that state in order to fund policyholder liabilities of insolvent insurance
companies. Under these laws in general, an insurer is subject to assessments,
depending upon its market share of a given line of business, to assist in the
payment of policyholder claims against insolvent insurers. The property/
casualty insurers managed by the Company have made accruals for their portion of
assessments related to such insolvencies based upon the most current information
furnished by the guaranty associations. Reflected in the Consolidated Statements
of Operations were $1,222,958 and $171,557 for these insolvencies for the years
ended December 31, 1998 and 1997, respectively.
Pennsylvania regulations limit the amount of dividends EFL can pay
its shareholders and limit the amount of dividends the Company's property/
casualty insurance subsidiaries can pay to the Company. The limitations are
fully described and reference is made herein to Note 12 of the Notes to
Consolidated Financial Statements contained in the Annual Report, page 52
incorporated by reference.
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Financial Regulation
The Company's property/casualty insurance subsidiaries are
required to file financial statements prepared using SAP with state regulatory
authorities. SAP differs from GAAP primarily in the recognition of revenue and
expense. The adjustments necessary to reconcile the Company's property/ casualty
insurance subsidiaries' net income and shareholders' equity determined by using
SAP to net income and shareholders' equity determined in accordance with GAAP
are as follows:
<TABLE>
<CAPTION>
Net Income
Year Ended
December 31,
---------------------------------------------
1998 1997
------------- --------------
(in thousands)
<S> <C> <C>
SAP amounts.................................. $ 14,663 $ 8,446
Adjustments:
Deferred policy acquisition
costs..................................... 580 742
Deferred income taxes...................... ( 1,855) 1,409
Federal alternative minimum
tax credit recoverable.................... 795 ( 1,815)
Salvage and subrogation.................... 12 94
Incurred premium adjustment................ ( 580) ( 742)
Bad debt write-offs -
prior period.............................. 0 ( 78)
Consolidating eliminations
and adjustments........................... ( 3) 0
------------ ------------
GAAP amounts................................. $ 13,612 $ 8,056
============ ============
</TABLE>
<TABLE>
<CAPTION>
Shareholders' Equity
As of December 31,
1998 1997 1996
------------ ------------ ------------
(in thousands)
<S> <C> <C> <C>
SAP amounts.................................. $ 74,348 $ 60,628 $ 53,154
Adjustments:
Deferred policy acquisition
costs..................................... 10,863 10,284 9,541
Deferred income taxes...................... 4,143 5,998 4,478
Salvage and subrogation.................... 2,970 2,957 2,863
Statutory reserves......................... 2,619 1,823 0
Incurred premium adjustment................ ( 10,863) ( 10,284) ( 9,541)
Unrealized gains net of
deferred taxes............................ 7,653 6,697 3,005
Amortization of goodwill................... 0 0 ( 619)
Federal alternative minimum
tax credit recoverable.................... ( 1,020) ( 1,815) 0
Off balance sheet items -
prior years............................... ( 3) 0 0
Consolidating eliminations
and adjustments........................... 3 8 50
------------ ------------ ------------
GAAP amounts................................. $ 90,713 $ 76,296 $ 62,931
============ ============ ============
</TABLE>
Pennsylvania imposes minimum risk-based capital requirements for
property/casualty insurance companies as developed by the NAIC. A full
description of these requirements is included in Management's Discussion and
Analysis of Financial Condition and Results of Operations under the heading
"Regulatory Risk-Based Capital" on page 29 of the Annual Report incorporated
herein by reference.
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Item 2. Properties
The Company and its subsidiaries, the Exchange and its
subsidiaries and EFL share a corporate home office complex in Erie,
Pennsylvania. The complex contains 548,799 square feet, and is owned by the
Exchange. At December 31, 1998, the Company also operated 20 field offices in
ten states. Of these offices, 16 provide both agency support and claims services
and are referred to as "Branch Offices", while the remaining four provide only
claims services and are considered "Claims Offices".
The Company owns three of its field offices. Four other offices
are owned by and leased from the Exchange. The rent for the home office and the
three field offices paid to the Exchange totaled $11,343,587 in 1998. One office
is owned by and leased from EFL at an annual rental in 1998 of $342,824. The
remaining twelve offices are leased from various unaffiliated parties at an
aggregate annual rental in 1998 of approximately $1,382,286. The Company is
reimbursed by its affiliates for a percentage of the rent for office space used
by its affiliates, which reimbursement was approximately 50% in 1998.
Item 3. Legal Proceedings
Reference is made to "Legal Proceedings" on pages 23 through 27
of the Company's proxy statement, incorporated herein by reference.
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 1998.
13
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters
Reference is made to "Market Price of and Dividends on the
Common Equity and Related Shareholder Matters" on page 55 of the Annual Report
for the year ended December 31, 1998, incorporated herein by reference, for
information regarding the high and low sales prices for the registrant's stock
and additional information regarding such stock of the Company.
As of February 26, 1999, there were approximately 1,308
beneficial shareholders of the Company's Class A non-voting common stock and 27
beneficial shareholders of the Company's Class B voting common stock.
Item 6. Selected Consolidated Financial Data
Reference is made to "Selected Consolidated Financial Data" on page
19 of the Annual Report for the year ended December 31, 1998, incorporated
herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Reference is made to "Management's Discussion and Analysis of
Financial Condition and Results of Operations" on pages 20 through 35 of the
Annual Report for the year ended December 31, 1998, incorporated herein by
reference.
Item 8. Financial Statements and Supplementary Data
Reference is made to the "Consolidated Financial Statements"
included on pages 38 through 41 and to the "Quarterly Results of Operations"
contained in the Notes to Consolidated Financial Statements on page 53 of
the Annual Report for the year ended December 31, 1998, incorporated herein by
reference.
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosures
None.
14
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
(a) The answer to this item, with respect to directors of the
Registrant, is incorporated by reference to pages 8 through 12 of the Company's
proxy statement relating to the annual meeting of shareholders to be held on
April 27, 1999.
(b) Certain information as to the executive officers of the Company
is as follows:
<TABLE>
<CAPTION>
Age Principal Occupation for Past
as of Five Years and Positions with
Name 12/31/98 Erie Insurance Group
<S> <C> <C>
President & Chief Executive Officer
Stephen A. Milne 50 President, Chief Executive Officer and a Director of the Company, EFL and Erie
Insurance Co. since February 12, 1996 and President and Chief Executive Officer of
Flagship, Erie P&C, and Erie NY since March 19, 1996; Executive Vice President -
Insurance Operations of the Company, Erie Insurance Co., Flagship, Erie P&C, and
Erie NY January 11, 1994 - February 12, 1996. Owner, Bennett-Damascus Insurance
Agency March 1991-December 31, 1993; Senior Vice President-Agency Division, the
Company, EFL, and Erie Insurance Co. 1988 - 1991; Director Flagship and Erie P&C
1996 - present; Director, Erie NY 1994 - present.
Executive Vice Presidents
Jan R. Van Gorder, Esq. 51 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 April 1994; Senior Vice President,
Secretary and General Counsel of the Company, EFL and Erie Insurance Co. for more
than five years prior thereto; Director, the Company, EFL, Erie Insurance Co., Erie
NY, Flagship and Erie P&C.
Philip A. Garcia 42 Executive Vice President and Chief Financial Officer since October 2, 1997; Senior
Vice President and Controller 1993 - 1997; Vice President 1988 - 1993. Director,
the Erie NY, Flagship and Erie P&C.
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
Age Principal Occupation for Past
as of Five Years and Positions with
Name 12/31/98 Erie Insurance Group
<S> <C> <C>
Senior Vice Presidents
John C. Bender 53 Senior Vice President since 1992; Vice President 1983 - 1992.
Eugene C. Connell 44 Senior Vice President since 1990; Vice President 1988 - 1990.
Dennis M. Geib 55 Senior Vice President since 1990; Vice President 1986 - 1990.
Elaine A. Lamm 60 Senior Vice President since 1990; Vice President 1988 - 1990.
George R. Lucore 48 Senior Vice President since March 1995; Regional Vice President 1993 - March 1995;
Assistant Vice President 1988 - 1993.
Jeffrey A. Ludrof 39 Senior Vice President since 1994; Regional Vice President 1993 - 1994; Assistant
Vice President 1989 - 1993.
David B. Miller 44 Senior Vice President since August 1996; Independent Insurance Agent 1991 - 1996;
Vice President 1989 - 1991.
Timothy G. NeCastro 38 Senior Vice President and Controller since November 10, 1997; Department Manager
Internal Audit November 1996 - 1997.
James R. Roehm 50 Senior Vice President since 1991; Vice President 1987 - 1991.
Michael S. Zavasky 46 Senior Vice President since April 1998; Vice President and Managing Director of
Reinsurance 1990 - April 1998; Vice President 1988 - 1990.
Douglas F. Ziegler 48 Senior Vice President, Treasurer and Chief Investment Officer since 1993; Vice
President and Managing Director of Treasury Administration 1988 - 1993.
Regional Vice Presidents
B. Crawford Banks 62 Regional Vice President since 1993; Vice President 1988 - 1993.
Douglas N. Fitzgerald 42 Regional Vice President since 1993; Vice President 1987 - 1993.
Terry L. Hamman 44 Regional Vice President since May 1995; Assistant Vice President 1993 - May 1995.
</TABLE>
16
<PAGE>
Item 11. Executive Compensation
The answer to this item is incorporated by reference to pages 13
through 20 of the Company's proxy statement dated April 1, 1999 relating to the
annual meeting of shareholders to be held on April 27, 1999, except for the
Performance Graph, which has not been incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The answer to this item is incorporated by reference to pages
5 through 8 of the Company's proxy dated April 1, 1999 relating to the annual
meeting of shareholders to be held on April 27, 1999.
Item 13. Certain Relationships and Related Transactions
Since the formation of the Company and the Exchange in 1925, the
Company, as the attorney-in-fact appointed by the policyholders of the Exchange,
has managed the property/casualty insurance operations of the Exchange. The
Company's operations are interrelated with the operations of the Exchange, and
the Company's results of operations are largely dependent on the success of the
Exchange.
The Company believes that its various transactions with the
Exchange and EFL, which are summarized herein, are fair and reasonable and have
been on terms no less favorable to the Company than the terms that approximate
those which could have been negotiated with an independent third party.
Pursuant to the Subscribers Agreement by which the Company
serves as attorney-in-fact for the Exchange, the Company's Board of Directors
establishes periodically an annual management fee for the Company's services as
attorney-in-fact which may not exceed 25% of the direct and affiliated assumed
written premiums of the Exchange. The Company's Board of Directors has the
ability to establish the percentage charged at its discretion within these
parameters. Such percentage was 23% from July 1, 1990 to June 30, 1991 and was
25% from July 1, 1991 through March 31, 1995. Such percentage was 24.5% from
April 1, 1995 through March 31, 1996. The Board elected to change such
percentage to 24% for the period April 1, 1996 through December 31, 1996 and to
maintain the 24% management fee rate for all of 1997. Beginning January 1, 1998
through December 31, 1998, the management fee charged the Exchange was increased
to 24.25%. The Board elected to change the management fee rate to 25% beginning
January 1, 1999 through December 31, 1999. The activities performed by the
Company as attorney-in-fact for the Exchange include insurance underwriting,
policy issuance, policy exchange and cancellation, processing of invoices for
premiums, the establishing and monitoring of loss reserves, oversight of
reinsurance transactions, payment of insurance commissions to insurance
agents, compliance with rules and regulations of supervisory authorities
and monitoring of legal affairs. The Company is obligated to conduct
these activities at its own expense, and realizes profits or losses depending
upon whether its costs of providing such services is less than the amount it
receives from the Exchange, in which case the Company has a profit from acting
as attorney-in-fact, or greater, in which case the Company has a loss from
such activities. The Exchange, however, bears the financial responsibility
for the payment of insurance losses, loss adjustment expenses, investment
expenses, legal expenses, assessments, damages, licenses, fees,
establishment of reserves and taxes. For the three years ended December 31,
1998, 1997 and 1996 the management fees were $489,147,394, $467,602,283 and
$442,904,376, respectively.
17
<PAGE>
A service arrangement fee of 7% is charged to the Exchange to
compensate the Company for its management of non-affiliated assumed reinsurance
business on behalf of the Exchange. Service agreement revenue from the
management of non-affiliated assumed reinsurance business was $6,715,026,
$5,015,192 and $5,069,140 in 1998, 1997 and 1996, respectively.
Effective September 1, 1997, the Company was reimbursed by the
Exchange a portion of the service charges collected from policyholders as
reimbursement for the costs incurred by the Company in providing extended
payment terms on policies written by the insurers managed by the Company.
Service charge revenue amounted to $7,163,895 in 1998 and $2,011,181 in 1997.
The Company's subsidiary, Erie Insurance Co., has participated
in a reinsurance pool with the Exchange since January 1, 1992 whereby Erie
Insurance Co. transfers, or "cedes" to the Exchange all of its direct premiums
written and the Exchange retrocedes to Erie Insurance Co. a 5% participation of
the pooled business, which also includes all of the property and casualty
insurance business of the Exchange. All premiums, losses, loss adjustment
expenses and other underwriting expenses are prorated among the parties on the
basis of their participation in the pool. The pooling agreement does not legally
discharge Erie Insurance Co. from its primary liability for the full amount of
the policies ceded. However, it makes the Exchange liable to Erie Insurance Co.
to the extent of the business ceded. The pooling agreement provides that it may
be amended or terminated at the end of any calendar year by agreement of the
parties. Effective January 1, 1995, the pooling agreement was amended to provide
that the Exchange's share of the pool be reduced from 95% to 94.5% and that Erie
Insurance Co. and Erie NY have a 5.5% share of the pool. Prior to January 1,
1992, all property/casualty insurance business of Erie Insurance Co. was
reinsured 100% with the Exchange under the terms of a quota share reinsurance
treaty. Erie P&C and Flagship, a subsidiary of the Exchange, reinsure 100% of
their property/casualty insurance business with the Exchange under the terms of
quota share reinsurance treaties with the Exchange.
The Company and the Exchange periodically purchase annuities
from EFL for use in connection with the structured settlement of insurance
claims. The Company's share of such purchases, through its subsidiaries, Erie
Insurance Co. and Erie NY, amounted to $983,574, $977,932 and $742,722 for the
years ended December 31, 1998, 1997 and 1996, respectively, and the reserves
held by EFL at December 31, 1998 for such annuities were approximately
$7,061,011. In addition, the Erie Insurance Group Retirement Plan for Employees
has, from time to time, purchased individual annuities from EFL for each retired
vested employee or beneficiary receiving benefits. Such purchases amounted to
$6,413,460, $1,992,060 and $4,894,042 for the years ended December 31, 1998,
1997 and 1996, respectively. The reserves held by EFL for all such annuities
were approximately $41,834,220 at December 31, 1998.
On December 29, 1995, EFL issued a surplus note to the Company
for $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 the prior approval of the
Pennsylvania Insurance Commissioner. Interest on the surplus note is scheduled
to be paid semi-annually. The note will be payable on demand on or after
December 31, 2005. Payment of principal and/or interest is subordinated to
payment of all other liabilities of EFL. During 1998 and 1997, EFL paid the
Company interest totaling $967,500 in each year.
Information with respect to certain relationships with Company
directors is incorporated by reference to page 22 of the Company's proxy dated
April 1, 1999 relating to the annual meeting of shareholders to be held on
April 27, 1999.
18
<PAGE>
PART IV
Item 14. 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:
Independent Auditors' Report on the
Consolidated Financial Statements............................. 37
Consolidated Statements of Operations
for the three years ended
December 31, 1998, 1997 and 1996.............................. 38
Consolidated Statements of Financial
Position as of December 31, 1998
and 1997 ................................................. 39
Consolidated Statements of Cash Flows
for the three years ended
December 31, 1998, 1997 and 1996.............................. 40
Consolidated Statements of Shareholders'
Equity for the three years ended
December 31, 1998, 1997 and 1996.............................. 41
Notes to Consolidated Financial Statements...................... 42
(2) Financial Statement Schedules
Page
Erie Indemnity Company and Subsidiaries:
Report of Independent Auditors on Schedules..................... 24
Schedule I. Summary of Investments - Other
than Investments in Related
Parties........................................... 25
Schedule IV. Reinsurance....................................... 26
Schedule VI. Supplemental Information
Concerning Property/Casualty
Insurance Operations.............................. 27
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 Company's 1998 Annual Report
to Shareholders. The Consolidated Financial Statements and Notes to Consolidated
Financial Statements and Auditors' Report thereon on pages 40 to 56 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
and 8, 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.
19
<PAGE>
(3) Exhibits
Exhibit
Number Description of Exhibit
3.1* Articles of Incorporation of Registrant
3.2** Amended and Restated By-laws of Registrant
3.3 Amended and Restated By-laws of Registrant dated
March 9, 1999
4A* Form of Registrant's Class A Common
Stock certificate
4B* Form of Registrant's Class B Common
Stock certificate
10.1*** Retirement Plan for Employees of Erie
Insurance Group, effective as of
December 31, 1989
10.2*** Restatement of Supplemental Retirement
Plan for Certain Members of the Erie
Insurance Group Retirement Plan for
Employees, effective as of January 1,
1990
10.3*** Deferred Compensation Plan of
Registrant
10.4*** Retirement Plan for Outside Directors
of Registrant, effective as of
January 1, 1991
10.5*** Employee Savings Plan of Erie Insurance
Group, effective as of April 1, 1992
10.6*** Amendment to Employee Savings Plan of
Erie Insurance Group
10.7*** Supplemental 401(k) Plan of Erie Insurance
Group effective as of January 1, 1994
10.8*** Service Agreement dated January 1, 1989
between Registrant and Erie Insurance
Company
10.9*** Service Agreement dated June 21, 1993
between Registrant and Erie Insurance
Property & Casualty Company
10.10*** Service Agreement dated June 21, 1993
between Registrant and Flagship City
Insurance Company
10.11*** Reinsurance Pooling Agreement dated
January 1, 1992 between Erie Insurance
Company and Erie Insurance Exchange
10.12*** Form of Subscriber's Agreement whereby
policyholders of Erie Insurance Exchange
appoint Registrant as their
Attorney-in-Fact
20
<PAGE>
Exhibit
Number Description of Exhibit
10.13* Stock Redemption Plan of Registrant dated
December 14, 1989
10.14* Stock Purchase Agreement dated December 20,
1991, between Registrant and Erie Insurance
Exchange relating to the capital stock of
Erie Insurance Company
10.15** Property Catastrophe Excess of Loss
Reinsurance Agreement dated January 1,
1994 between Erie Insurance Exchange
and Erie Insurance Co.
10.16**** Stock Redemption Plan of Registrant as
restated December 12, 1995
10.17**** Property Catastrophe Excess of Loss
Reinsurance Agreement dated January 1, 1995
between Erie Insurance Exchange and Erie
Insurance Company of New York
10.18**** Service Agreement dated January 1, 1995
between Registrant and Erie Insurance
Company of New York
10.19***** Consulting Agreement for Investing Services
dated January 2, 1996 between Erie Indemnity
Company and John M. Petersen
10.20***** Agreement dated April 29, 1994 between Erie
Indemnity Company and Thomas M. Sider
10.21****** Aggregate Excess of Loss Reinsurance Agreement effective
January 1, 1997 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
10.22# 1997 Annual Incentive Plan of Erie Indemnity
Company
10.23# Erie Indemnity Company Long-Term Incentive Plan
10.24# Employment Agreement dated December 16, 1997 by
and between Erie Indemnity Company and Stephen A.
Milne
10.25# Employment Agreement dated December 16, 1997 by
and between Erie Indemnity Company and Jan R. Van
Gorder
10.26# Employment Agreement dated December 16, 1997 by
and between Erie Indemnity Company and Philip A.
Garcia
10.27# Employment Agreement dated December 16, 1997 by and between
Erie Indemnity Company and John J.
Brinling, Jr.
21
<PAGE>
Exhibit
Number Description of Exhibit
11 Statement re computation of per share
earnings
13 1998 Annual Report to Security Holders.
Reference is made to the Annual Report
furnished to the Commission, herewith.
21 Subsidiaries of Registrant
27 Financial Data Schedule
99.1 Report of the Special Committee to the Board of Directors
* Such exhibit is incorporated by reference to the like numbered
exhibit in Registrant's Form 10 Registration Statement Number 0-24000
filed with the Securities and Exchange Commission on May 2, 1994.
** Such exhibit is incorporated by reference to the like numbered
exhibit in Registrant's Form 10/A Registration Statement Number
0-24000 filed with the Securities and Exchange Commission on August
3, 1994.
*** Such exhibit is incorporated by reference to the like titled but
renumbered exhibit in Registrant's Form 10 Registration Statement
Number 0-24000 filed with the Securities and Exchange Commission on
May 2, 1994.
**** Such exhibit is incorporated by reference to the like titled exhibit
in the Registrant's Form 10-K annual report for the year ended
December 31, 1995 that was filed with the Commission on March 25,
1996.
***** Such exhibit is incorporated by reference to the like titled exhibit
in the Registrant's Form 10-K/A amended annual report for the year
ended December 31, 1995 that was filed with the Commission on April
25, 1996.
****** Such exhibit is incorporated by reference to the like titled exhibit
in the Registrant's Form 10-K annual report for the year ended
December 31, 1996 that was filed with the Commission on March 21,
1997.
# Such exhibit is incorporated by reference to the like titled
exhibit in the Registrant's Form 10-K annual report for the year
ended December 31, 1997 that was filed with the Commission on March
25, 1998.
(b) Reports on Form 8-K:
During the quarter ended December 31, 1998, Registrant did not file any
reports on Form 8-K.
22
<PAGE>
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.
Date: March 9, 1999 ERIE INDEMNITY COMPANY
(Registrant)
Principal Officers
/s/ Stephen A. Milne
Stephen A. Milne, President and CEO
/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
/s/ Timothy G. NeCastro
Timothy G. NeCastro, Senior Vice President & Controller
Board of Directors
/s/ Peter B. Bartlett Edmund J. Mehl
Peter B. Bartlett
/s/ Samuel P. Black, III /s/ Stephen A. Milne
Samuel P. Black, III Stephen A. Milne
/s/ J. Ralph Borneman /s/ John M. Petersen
J. Ralph Borneman John M. Petersen
/s/ Patricia A. Goldman /s/ Jan R. Van Gorder
Patricia A. Goldman Jan R. Van Gorder
Susan Hirt Hagen /s/ Harry H. Weil
Harry H. Weil
/s/ F. William Hirt
F. William Hirt
23
<PAGE>
INDEPENDENT AUDITORS' REPORT
To The Board of Directors and Shareholders
Erie Indemnity Company
We have audited the consolidated statements of financial position of Erie
Indemnity Company and subsidiaries (Company) as of December 31, 1998 and 1997
and the related consolidated statements of operations, shareholders' equity and
cash flows for each of the three years in the period ended December 31, 1998, as
contained in the 1998 annual report, incorporated by reference in the annual
report on Form 10-K for the year ended December 31, 1998. In connection with our
audits of the financial statements, we also have audited the financial statement
schedules, as listed in the accompanying index. These financial statements and
financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 that 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, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles. Also in our opinion, the related 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/ Brown Schwab Bergquist & Co.
Erie, Pennsylvania
February 16, 1999
24
<PAGE>
SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES
<TABLE>
<CAPTION>
DECEMBER 31, 1998
Cost or Amount at which
Amortized Fair Shown in the
Type of Investment Cost Value Balance Sheet
- -------------------------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Available-for-Sale Securities
Common Stocks
U.S. Industrial and
Miscellaneous $ 57,436 $ 87,051 $ 87,051
Foreign Industrial and
Miscellaneous 3,186 3,179 3,179
Non-Redeemable Preferred Stocks
U.S. Banks, Trusts and
Insurance Companies 42,807 45,338 45,338
U.S. Industrial and
Miscellaneous 59,858 60,463 60,463
Foreign Industrial and
Miscellaneous 6,690 6,773 6,773
Fixed Maturities
U.S. Treasuries & Government
Agencies 13,018 13,707 13,707
Foreign Governments 1,990 1,809 1,809
Obligations of State and
Political Subdivisions 48,307 51,599 51,599
Special Revenues 132,025 139,236 139,236
Public Utilities 13,116 13,416 13,416
U.S. Industrial and
Miscellaneous 195,296 203,695 203,695
Foreign Industrial and
Miscellaneous 5,159 5,238 5,238
Redeemable Preferred Stocks 12,191 12,653 12,653
-----------------------------------------------------
Total Available-for-Sale
Securities $ 591,079 $ 644,157 $ 644,157
-----------------------------------------------------
Real Estate Mortgage Loans $ 8,287 $ 8,287 $ 8,287
Other Invested Assets 17,493 17,494 $ 17,494
-----------------------------------------------------
Total Investments $ 616,859 $ 669,938 $ 669,938
-----------------------------------------------------
</TABLE>
25
<PAGE>
SCHEDULE IV - REINSURANCE
<TABLE>
<CAPTION>
Percentage
Ceded to Assumed of amount
Other from Other Net Assumed
Direct Companies Companies Amount to Net
<S> <C> <C> <C> <C> <C>
December 31,1998
Premiums for the year
Property and Liability Insurance $338,162,409 $343,051,100 $117,828,137 $112,939,446 104.3%
--------------------------------------------------------------------------------------------------
December 31,1997
Premiums for the year
Property and Liability Insurance $334,771,551 $340,165,100 $112,743,217 $107,349,668 105.0%
--------------------------------------------------------------------------------------------------
December 31,1996
Premiums for the year
Property and Liability Insurance $321,735,580 $324,617,961 $104,392,140 $101,509,759 102.8%
--------------------------------------------------------------------------------------------------
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE VI - SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
Deferred
Policy Reserves for Discount, if
Acquisition Unpaid Loss & LAE any deducted Unearned
Costs Expenses from reserves * Premiums
(In Thousands)
<S> <C> <C> <C> <C>
@ 12/31/98
Consolidated P&C Entities $ 10,863 $426,165 $ 1,562 $229,057
Unconsolidated P&C Entities 0 0 0 0
Proportionate share of
registrant & subsidiaries 0 0 0 0
---------------------------------------------------------------------------------
Total $ 10,863 $426,165 $ 1,562 $229,057
---------------------------------------------------------------------------------
@ 12/31/97
Consolidated P&C Entities $ 10,283 $413,409 $ 0 $219,211
Unconsolidated P&C Entities 0 0 0 0
Proportionate share of
registrant & subsidiaries 0 0 0 0
---------------------------------------------------------------------------------
Total $ 10,283 $413,409 $ 0 $219,211
---------------------------------------------------------------------------------
@ 12/31/96
Consolidated P&C Entities $ 9,541 $386,425 $ 0 $216,938
Unconsolidated P&C Entities 0 0 0 0
Proportionate share of
registrant & subsidiaries 0 0 0 0
---------------------------------------------------------------------------------
Total $ 9,541 $386,425 $ 0 $216,938
---------------------------------------------------------------------------------
* Worker's compensation incurred but not reported (IBNR) loss and loss adjustment expenses were discounted at 2.5% in 1998.
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE VI - SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS (CONTINUED)
Loss and Loss Adjustment Expenses
Net Incurred Related to
Earned Investment (1) (2)
Premiums Income Current Year Prior Years
(In Thousands)
<S> <C> <C> <C> <C>
@ 12/31/98
Consolidated P&C Entities $112,939 $ 16,887 $ 80,637 $ (746)
Unconsolidated P&C Entities 0 0 0 0
Proportionate share of
registrant & subsidiaries 0 0 0 0
---------------------------------------------------------------------------------
Total $112,939 $ 16,887 $ 80,637 $ (746)
---------------------------------------------------------------------------------
@ 12/31/97
Consolidated P&C Entities $107,350 $ 13,569 $ 77,345 $ 2,625
Unconsolidated P&C Entities 0 0 0 0
Proportionate share of
registrant & subsidiaries 0 0 0 0
---------------------------------------------------------------------------------
Total $107,350 $ 13,569 $ 77,345 $ 2,625
---------------------------------------------------------------------------------
@ 12/31/96
Consolidated P&C Entities $101,510 $ 11,032 $ 85,311 $ (240)
Unconsolidated P&C Entities 0 0 0 0
Proportionate share of
registrant & subsidiaries 0 0 0 0
---------------------------------------------------------------------------------
Total $101,510 $ 11,032 $ 85,311 $ (240)
---------------------------------------------------------------------------------
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE VI - SUPPLEMETAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS (CONTINUED)
Amortization
of Deferred Net
Policy Loss & LAE Premiums
Acquisition Costs Paid Written
(In Thousands)
<S> <C> <C> <C>
@ 12/31/98
Consolidated P&C Entities $ 21,357 $ 77,933 $115,094
Unconsolidated P&C Entities 0 0 0
Proportionate share of
registrant & subsidiaries 0 0 0
------------------------------------------------------
Total $ 21,357 $ 77,933 $115,094
------------------------------------------------------
@ 12/31/97
Consolidated P&C Entities $ 20,103 $ 75,343 $110,282
Unconsolidated P&C Entities 0 0 0
Proportionate share of
registrant & subsidiaries 0 0 0
------------------------------------------------------
Total $ 20,103 $ 75,343 $110,282
------------------------------------------------------
@ 12/31/96
Consolidated P&C Entities $ 18,909 $ 79,208 $105,020
Unconsolidated P&C Entities 0 0 0
Proportionate share of
registrant & subsidiaries 0 0 0
------------------------------------------------------
Total $ 18,909 $ 79,208 $105,020
------------------------------------------------------
</TABLE>
29
<PAGE>
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
Sequentially
Exhibit Numbered
Number Description of Exhibit Page
3.1* Articles of Incorporation of Registrant
3.2** Amended and Restated By-laws of Registrant
3.3 Amended and Restated By-laws of Registrant dated 33-50
March 9, 1999
4A* Form of Registrant's Class A Common
Stock certificate
4B* Form of Registrant's Class B Common
Stock certificate
10.1*** Retirement Plan for Employees of Erie
Insurance Group, effective as of
December 31, 1989
10.2*** Restatement of Supplemental Retirement
Plan for Certain Members of the Erie
Insurance Group Retirement Plan for
Employees, effective as of January 1,
1990
10.3*** Deferred Compensation Plan of
Registrant
10.4*** Retirement Plan for Outside Directors
of Registrant, effective as of
January 1, 1991
10.5*** Employee Savings Plan of Erie Insurance
Group, effective as of April 1, 1992
10.6*** Amendment to Employee Savings Plan of
Erie Insurance Group
10.7*** Supplemental 401(k) Plan of Erie Insurance
Group effective as of Janaury 1, 1994
10.8*** Service Agreement dated January 1, 1989
between Registrant and Erie Insurance
Company
10.9*** Service Agreement dated June 21, 1993
between Registrant and Erie Insurance
Property & Casualty Company
10.10*** Service Agreement dated June 21, 1993
between Registrant and Flagship City
Insurance Company
10.11*** Reinsurance Pooling Agreement dated
January 1, 1992 between Erie Insurance
Company and Erie Insurance Exchange
30
<PAGE>
Sequentially
Exhibit Numbered
Number Description of Exhibit Page
10.12*** Form of Subscriber's Agreement whereby
policyholders of Erie Insurance Exchange
appoint Registrant as their
Attorney-in-Fact
10.13* Stock Redemption Plan of Registrant dated
December 14, 1989
10.14* Stock Purchase Agreement dated December 20,
1991, between Registrant and Erie Insurance
Exchange relating to the capital stock of
Erie Insurance Company
10.15** Property Catastrophe Excess of Loss
Reinsurance Agreement dated January 1,
1994 between Erie Insurance Exchange
and Erie Insurance Co.
10.16**** Stock Redemption Plan of Registrant
restated as of December 12, 1995
10.17**** Property Catastrophe Excess of Loss
Reinsurance Agreement dated January 1, 1995
between Erie Insurance Exchange and Erie
Insurance Company of New York
10.18**** Service Agreement dated January 1, 1995
between Registrant and Erie Insurance
Company of New York
10.19***** Consulting Agreement for Investing Services
dated January 2, 1996 between Erie Indemnity
Company and John M. Petersen
10.20***** Agreement dated April 29, 1994 between Erie
Indemnity Company and Thomas M. Sider
10.21****** Aggregate Excess of Loss Reinsurance Agreement effective
January 1, 1997 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
10.22# 1997 Annual Incentive Plan of Erie Indemnity
Company
10.23# Erie Indemnity Company Long-Term Incentive Plan
10.24# Employment Agreement dated December 16, 1997 by
and between Erie Indemnity Company and Stephen A.
Milne
10.25# Employment Agreement dated December 16, 1997 by
and between Erie Indemnity Company and Jan R. Van
Gorder
31
<PAGE>
Sequentially
Exhibit Numbered
Number Description of Exhibit Page
10.26# Employment Agreement dated December 16, 1997 by
and between Erie Indemnity Company and Philip A.
Garcia
10.27# Employment Agreement dated December 16, 1997 by
and between Erie Indemnity Company and John J.
Brinling, Jr.
11 Statement re computation of per share
earnings 51
13 1998 Annual Report to Security Holders.
Reference is made to the Annual Report
furnished to the Commission, herewith. 52-104
21 Subsidiaries of Registrant 105
27 Financial Data Schedule 106
99.1 Report of the Special Committee to the Board 107-144
of Directors
* Such exhibit is incorporated by reference to the like numbered
exhibit in Registrant's Form 10 Registration Statement Number 0-24000
filed with the Securities and Exchange Commission on May 2, 1994.
** Such exhibit is incorporated by reference to the like numbered
exhibit in Registrant's Form 10/A Registration Statement Number
0-24000 filed with the Securities and Exchange Commission on August
3, 1994.
*** Such exhibit is incorporated by reference to the like titled but
renumbered exhibit in Registrant's Form 10 Registration Statement
Number 0-24000 filed with the Securities and Exchange Commission on
May 2, 1994.
**** Such exhibit is incorporated by reference to the like titled exhibit
in the Registrant's Form 10-K annual report for the year ended
December 31, 1995 that was filed with the Commission on March 25,
1996.
***** Such exhibit is incorporated by reference to the like titled exhibit
in the Registrant's Form 10-K/A amended annual report for the year
ended December 31, 1995 that was filed with the Commission on April
25, 1996.
****** Such exhibit is incorporated by reference to the like titled exhibit
in the Registrant's Form 10-K annual report for the year ended
December 31, 1996 that was filed with the Commission on March 21,
1997.
# Such exhibit is incorporated by reference to the like titled exhibit
in the Registrant's Form 10-K annual report for the year ended
December 31, 1997 that was filed with the Commission on March 25,
1998.
32
AMENDMENT AND RESTATEMENT OF
BYLAWS
-- of --
ERIE INDEMNITY COMPANY
March 9, 1999
ARTICLE I
Offices
Section 1.01. Principal Office. The principal office of Erie
Indemnity Company, a Pennsylvania business corporation, shall be
located in the City of Erie, Pennsylvania.
ARTICLE II
Meetings of Shareholders
Section 2.01. Annual Meeting. The Annual Meeting of Shareholders shall
be held each year, at a day and time fixed by the Board of Directors. At the
Annual Meeting, the Shareholders then entitled to vote shall elect Directors and
shall transact such other business as may properly be brought before the
meeting. In elections for Directors, voting need not be by ballot, except upon
demand made by a Shareholder entitled to vote at the election and before the
voting begins.
Section 2.02. Special Meetings.
(a) Call of Special Meetings. Special meetings of the
Shareholders may be called at any time by:
(1) the Chairman of the Board,
(2) the Chief Executive Officer,
(3) the Board of Directors,
(4) the Chairman of the Executive Committee, or
(5) Shareholders entitled to cast at least twenty
percent (20%) of the votes that all Shareholders are
entitled to cast at the particular meeting.
(b) Fixing of Time for Meeting. At any time, upon written request of
any person who has called a special meeting, it shall be the duty of the
33
<PAGE>
Secretary to fix the day and time of the meeting, which shall be held not more
than 60 days after the receipt of the request. If the Secretary neglects or
refuses to fix the day and time of the meeting, the person or persons calling
the meeting may do so.
Section 2.03. Place of Meeting. The place of meeting for any Annual or
Special Meeting of Shareholders of the corporation shall be at the principal
office of the corporation, unless another place is designated by the Board of
Directors in the notice of the meeting.
Section 2.04. Notice of Meeting.
(a) General Rule. Written notice of every meeting of the Shareholders
stating the place, day and time of the meeting shall be given by, or at the
direction of, the Secretary to each Shareholder of record entitled to vote at
the meeting at least:
(1) ten days prior to the day named for a meeting called to
consider a fundamental transaction under 15 Pa.C.S. Chapter 19; or
(2) five days prior to the day named for the meeting in any
other case.
If the Secretary neglects or refuses to give notice of a meeting, the person or
persons calling the meeting may do so. In the case of a Special Meeting of
Shareholders, the notice shall specify the general nature of the business to be
transacted.
(b) Manner of Giving Notice. Whenever written notice is required to be
given to any Shareholder, it may be given either personally or by sending a copy
thereof by first class or express mail, postage prepaid, or by telegram (with
messenger service specified), telex or TWX (with answerback received) or courier
service, charges, prepaid, or by telecopier, to the address (or to the telex,
TWX, telecopier or telephone number) of the Shareholder appearing on the books
of the corporation. If the notice is sent by mail, telegraph or courier service,
it shall be deemed to have been given to the person entitled thereto when
deposited in the United States mail or with a telegraph office or courier
service for delivery to that person or, in the case of telex or TWX, when
dispatched or, in the case of telecopier, when received.
(c) Adjourned Shareholder Meetings. When a meeting of Shareholders is
adjourned, it shall not be necessary to give any notice of the adjourned meeting
or of the business to be transacted at an adjourned meeting, other than by
announcement at the meeting at which the adjournment is taken, unless the Board
fixes a new record date for the adjourned meeting.
(d) Notice of Action by Shareholders on Bylaws. In the case of a
meeting of Shareholders that has as one of its purposes action on the bylaws,
written notice shall be given to each Shareholder that the purpose, or one of
the purposes, of the meeting is to consider the adoption, amendment or repeal of
the bylaws. There shall be included in, or enclosed with, the notice a copy of
the proposed amendment or a summary of the changes to be effected thereby.
34
<PAGE>
Section 2.05. Quorum.
(a) General Rule. A meeting of Shareholders of the corporation duly
called shall not be organized for the transaction of business unless a quorum is
present. The presence, in person or by proxy, of Shareholders entitled to cast
at least a majority of the votes that all Shareholders are entitled to cast on a
particular matter to be acted upon at the meeting shall constitute a quorum for
the purposes of consideration and action on the matter. Shares of the
corporation owned, directly or indirectly, by it and controlled, directly or
indirectly, by the Board of Directors of this corporation, as such, shall not be
counted in determining the total number of outstanding shares for quorum
purposes at any given time.
(b) Withdrawal of a Quorum. The Shareholders present at a duly
organized meeting can continue to do business until adjournment, notwithstanding
the withdrawal of enough Shareholders to leave less than a quorum.
(c) Adjournment for Lack of Quorum. If a meeting cannot be organized
because a quorum has not attended, those present may, except as provided in the
Business Corporation Law, adjourn the meeting to such time and place as they may
determine.
(d) Adjournments Generally. Any meeting at which Directors are to be
elected shall be adjourned only from day to day, or for such longer periods not
exceeding 15 days each as the Shareholders present and entitled to vote shall
direct, until the Directors have been elected. Any other regular or special
meeting may be adjourned for such period as the Shareholders present and
entitled to vote shall direct.
Section 2.06. Informal Action by Shareholders. Any action required or
permitted to be taken at a meeting of the Shareholders or of a class of
Shareholders may be taken without a meeting if, prior or subsequent to the
action, a consent or consents thereto by all of the Shareholders who would be
entitled to vote at a meeting for such purpose shall be filed in writing with
the Secretary of the corporation.
Section 2.07. Waiver of Notice. Whenever any written notice is required
to be given to any Shareholder, a waiver thereof in writing signed by the
Shareholder entitled to such notice, whether before or after the time stated
therein, shall be deemed equivalent to the giving of the notice. Attendance of a
person at any meeting shall constitute a waiver of notice of the meeting except
where a person attends a meeting for the express purpose of objecting, at the
beginning of the meeting, to the transaction of any business because the meeting
was not lawfully called or convened.
Section 2.08. Voting and Other Action by Proxy.
(a) General Rule.
(1) Every Shareholder entitled to vote at a meeting of
35
<PAGE>
Shareholders or to express consent or dissent to corporate action in
writing without a meeting may authorize another person to act for the
Shareholder by proxy.
(2) The presence of, or vote or other action at a meeting of
Shareholders, or the expression of consent or dissent to corporate
action in writing, by a proxy of a Shareholder shall constitute the
presence of, or vote or action by, or written consent or dissent of the
Shareholder.
(3) Where two or more proxies of a Shareholder are present,
the corporation shall, unless otherwise expressly provided in the
proxy, accept as the vote of all shares represented thereby the vote
cast by a majority of them and, if a majority of the proxies cannot
agree whether the shares represented shall be voted or upon the manner
of voting the shares, the voting of the shares shall be divided equally
among those persons.
(b) Minimum Requirements. Every proxy shall be executed in writing by
the Shareholder or by the duly authorized attorney-in-fact of the Shareholder
and filed with the Secretary of the corporation. A proxy, unless coupled with an
interest, shall be revocable at will, notwithstanding any other agreement or any
provision in the proxy to the contrary, but the revocation of a proxy shall not
be effective until written notice thereof has been given to the Secretary of the
corporation. An unrevoked proxy shall not be valid after three years from the
date of its execution unless a longer time is expressly provided therein. A
proxy shall not be revoked by the death or incapacity of the maker unless,
before the vote is counted or the authority is exercised written notice of the
death or incapacity is given to the Secretary of the corporation.
(c) Expenses. Unless otherwise restricted in the articles, the
corporation shall pay the reasonable expenses of solicitation of votes, proxies
or consents of Shareholders by or on behalf of the Board of Directors or its
nominees for election to the Board, including solicitation by professional proxy
solicitors and otherwise.
Section 2.09. Voting by Fiduciaries and Pledgees. Shares of the
corporation standing in the name of a trustee or other fiduciary and shares held
by an assignee for the benefit of creditors or by a receiver may be voted by the
trustee, fiduciary, assignee or receiver. A shareholder whose shares are pledged
shall be entitled to vote the shares until the shares have been transferred into
the name of the pledgee, or a nominee of the pledgee, but nothing in this
section shall affect the validity of a proxy given to a pledgee or nominee.
Section 2.10. Voting by Joint Holders of Shares.
(a) General Rule. Where shares of the corporation are held
jointly or as tenants in common by two or more persons, as fiduciaries or
otherwise:
(1) if only one or more of such persons is present in person
or by proxy, all of the shares standing in the names of such persons
36
<PAGE>
shall be deemed to be represented for the purpose of determining a
quorum and the corporation shall accept as the vote of all the shares
the vote cast by a joint owner or a majority of them; and
(2) if the persons are equally divided upon whether the shares
held by them shall be voted or upon the manner of voting the shares,
the voting of the shares shall be divided equally among the persons
without prejudice to the rights of the joint owners or the beneficial
owners thereof among themselves.
(b) Exception. If there has been filed with the Secretary of the
corporation a copy, certified by an attorney-at-law to be correct, of the
relevant portions of the agreement under which the shares are held or the
instrument by which the trust or estate was created or the order of court
appointing them or of an order of court directing the voting of the shares, the
persons specified as having such voting power in the document latest in date of
operative effect so filed, and only those persons, shall be entitled to vote the
shares but only in accordance therewith.
Section 2.11. Voting by Corporations.
(a) Voting by Corporate Shareholders. Any corporation that is a
Shareholder of this corporation may vote by any of its officers or agents, or by
proxy appointed by any officer or agent, unless some other person, by resolution
of the Board of Directors of the other corporation or a provision of its
articles or bylaws, a copy of which resolution or provision certified to be
correct by one of its officers has been filed with the Secretary of this
corporation, is appointed its general or special proxy in which case that person
shall be entitled to vote the shares.
(b) Controlled Shares. Shares of this corporation owned, directly or
indirectly, by it and controlled, directly or indirectly, by the Board of
Directors of this corporation, as such, shall not be voted at any meeting and
shall not be counted in determining the total number of outstanding shares for
voting purposes at any given time.
Section 2.12. Determination of Shareholders of Record.
(a) Fixing Record Date. The Board of Directors may fix a time prior to
the date of any meeting of Shareholders as a record date for the determination
of the Shareholders entitled to notice, or to vote at, the meeting, which time,
except in the case of an adjourned meeting, shall be not more than 90 days prior
to the date of the meeting of Shareholders. Only Shareholders of record on the
date fixed shall be so entitled notwithstanding any transfer of shares on the
books of the corporation after any record date fixed as provided in this
subsection. The Board of Directors may similarly fix a record date for the
determination of Shareholders of record for any other purpose. When a
determination of Shareholders of record has been made as provided in this
section for purposes of a meeting, the determination shall apply to any
adjournment thereof unless the Board fixes a new record date for the adjourned
meeting.
37
<PAGE>
(b) Determination When a Record Date is not Fixed. If a record date is
not fixed:
(1) The record date for determining Shareholders entitled to
notice of or to vote at a meeting of Shareholders shall be at the close
of business on the day next preceding the day on which notice is given
or, if notice is waived, at the close of business on the day
immediately preceding the day on which the meeting is held.
(2) The record date for determining Shareholders entitled to
express consent or dissent to corporate action in writing without a
meeting, when prior action by the Board of Directors is not necessary,
shall be the close of business on the day on which the first written
consent or dissent is filed with the Secretary of the corporation.
(3) The record date for determining Shareholders for any other
purpose shall be at the close of business on the day on which the Board
of Directors adopts the resolution relating thereto.
Section 2.13. Voting Lists.
(a) General Rule. The officer or agent having charge of the transfer
books for shares of the corporation shall make a complete list of the
Shareholders entitled to vote at any meeting of Shareholders, arranged in
alphabetical order, with the address of and the number of shares held by each.
The list shall be produced and kept open at the time and place of the meeting
and shall be subject to the inspection of any Shareholder during the whole time
of the meeting for the purposes thereof.
(b) Effect of List. Failure to comply with the requirements of this
section shall not affect the validity of any action taken at a meeting prior to
a demand at the meeting by any Shareholder entitled to vote thereat to examine
the list. The original share register or transfer book, or a duplicate thereof
kept in this Commonwealth, shall be prima facie evidence as to who are the
Shareholders entitled to examine the list or share register or transfer book or
to vote at any meeting of Shareholders.
Section 2.14. Judges of Election.
(a) Appointment. In advance of any meeting of Shareholders of the
corporation, the Board of Directors may appoint Judges of Election, who need not
be Shareholders, to act at the meeting or any adjournment thereof. If Judges of
Election are not so appointed, the presiding officer of the meeting may, and on
the request of any Shareholder shall, appoint Judges of Election at the meeting.
The number of Judges shall be one or three. A person who is a candidate for
office to be filled at the meeting shall not act as a Judge.
(b) Vacancies. In case any person appointed as a Judge fails to appear
or fails or refuses to act, the vacancy may be filled by appointment made by the
Board of Directors in advance of the convening of the meeting or at the meeting
by the presiding officer thereof.
(c) Duties. The Judges of Election shall determine the number of shares
outstanding and the voting power of each, the shares represented at the meeting,
38
<PAGE>
the existence of a quorum, the authenticity, validity and effect of proxies,
receive votes or ballots, hear and determine all challenges and questions in any
way arising in connection with the right to vote, count and tabulate all votes,
determine the result and do such acts as may be proper to conduct the election
or vote with fairness to all Shareholders. The Judges of Election shall perform
their duties impartially, in good faith, to the best of their ability and as
expeditiously as is practical. If there are three Judges of Election, the
decision, act or certificate of a majority shall be effective in all respects as
the decision, act or certificate of all.
(d) Report. On request of the presiding officer of the meeting, or of
any Shareholder, the Judges shall make a report in writing of any challenge or
question or matter determined by them, and execute a certificate of any fact
found by them. Any report or certificate made by them shall be prima facie
evidence of the facts stated therein.
ARTICLE III
Directors
Section 3.01. General Powers. All powers vested by law in the
corporation shall be exercised by or under the authority of, and the business
and affairs of the corporation shall be managed under the direction of,
the Board of Directors.
Section 3.02. Number, Tenure and Qualifications. The Board of Directors
shall consist of not less than seven (7), nor more than sixteen (16), Directors
(the exact number to be fixed from time to time by resolution of the Board), the
majority of whom shall be citizens and residents of the United States, each of
whom shall be at least eighteen (18) years of age, elected at the Annual Meeting
of Shareholders, to serve until the ensuing Annual Meeting and until a successor
is elected and qualified or until his or her earlier death, resignation or
removal. Not less than one-third of the Directors shall be persons who are not
officers or employees of the corporation or of any entity controlling,
controlled by, or under common control with the corporation and who are not
beneficial owners of a controlling interest in the voting securities of the
corporation. "Control," "controlling," "controlled by" and "under common control
with" as used herein, shall be given those meanings prescribed by Section 1201
of Pennsylvania Act 178 of 1992 (40 P.S. ss.991.1401). No person who is seventy
(70) years of age or older shall be elected a Director unless already a Director
in office and qualifying under one or more of the following exceptions if such
person is: (a) seventy-five (75) years of age or older on the date of the 1990
Annual Meeting; or (b) under seventy-five (75) years of age on the date of the
1990 Annual Meeting, provided however, that such person cannot continue to serve
beyond the end of the term in which becoming seventy-five (75) years of age; or
(c) seventy (70) years of age or older and serving as a Trustee of the H. O.
Hirt Trust, so long as the Trust holds the majority Class B, or equivalent,
voting shares of the corporation; or (d) seventy (70) years of age or older and
serving, or previously served, in at least one of the two highest full-time
executive positions of the corporation for a period of at least one (1) year.
39
<PAGE>
Section 3.03. Meetings. The Annual Meeting of the Board of Directors
shall be held immediately after the Annual Meeting of Shareholders for the
purpose of organization and the election of officers, and notice thereof shall
be given in the same manner as hereinbefore provided in the case of the Annual
Meeting of Shareholders. The Board of Directors shall provide, by resolution,
for the holding of at least four (4) regular meetings including the annual
meeting on specified days or dates without notice. Special meetings of the Board
of Directors may be called by or at the request of the Chairman of the Board or
by the President, or by at least three (3) Directors. Written notice of every
special meeting of Directors stating the place, day and time of the meeting
shall be given not less than five (5) days before the meeting, either personally
or by first class or express mail or by telegraph, telex or TWX (with answerback
received) or courier services, charges prepaid, or by telecopier. If the notice
is sent by mail, telegraph or courier service, it shall be deemed to have been
given to the person entitled thereto when deposited in the United States mail or
with a telegraph office or courier service for delivery to that person or, in
the case of telex or TWX, when dispatched or, in the case of telecopier, when
received.
Section 3.04. Waiver of Notice. Whenever any written notice is required
to be given to any Director, a waiver thereof in writing signed by the Director
entitled to the notice, whether before or after the time stated therein, shall
be deemed equivalent to the giving of the notice. Attendance of a person at any
meeting shall constitute a waiver of notice of the meeting except where a person
attends a meeting for the express purpose of objecting, at the beginning of the
meeting, to the transaction of any business because the meeting was not lawfully
called or convened.
Section 3.05. Quorum. A majority of the Directors in office of the
corporation shall be necessary to constitute a quorum for the transaction of
business; provided, however, that a quorum shall consist of at least five (5)
Directors if the Board consists of only seven (7) Directors. At least one
Director who is not an officer of employee of the corporation or of any entity
controlling, controlled by or under common control with the corporation and who
is not a beneficial owner of a controlling interest in the voting securities of
the corporation must be present for a quorum of Directors. The acts of a
majority of the directors present and voting at a meeting at which a quorum is
present shall be the acts of the Board of Directors.
Section 3.06. Limiting Liability of Directors.
A. A Director of the corporation shall stand in a fiduciary relation to the
corporation and shall perform his duties as a Director, including his duties as
a member of any committee of the Board of Directors upon which he may serve, in
good faith, in a manner he reasonably believes to be in the best interest of the
corporation, and with such care, including reasonable inquiry, skill and
diligence, as a person of ordinary prudence would use under similar
circumstances. In performing his duties, a Director shall be entitled to rely in
40
<PAGE>
good faith on information, opinions, reports or statements, including financial
statements and other financial data, in each case prepared or presented by any
of the following:
(1) One or more officers or employees of the corporation whom
the Director reasonably believes to be reliable and
competent in the matters present, or
(2) Counsel, public accountants or other persons as to matters
which the Director reasonably believes to be within the
professional or expert competence of such persons, or
(3) A committee of the Board of Directors upon which he does not
serve, duly designated in accordance with law, as to matters
within its designated authority, which committee the Director
reasonably believes to merit confidence.
A Director shall not be considered to be acting in good faith if he has
knowledge concerning the matter in question that would cause his reliance to be
unwarranted.
B. In discharging the duties of their respective positions, the Board of
Directors, committees of the Board of Directors and individual Directors, may,
in considering the best interest of the corporation, consider the effects of any
action upon employees, upon suppliers and customers of the corporation and upon
communities in which offices or other establishments of the corporation are
located, and all other pertinent factors. The consideration of these factors
shall not constitute a violation of subsection A of this section.
C. Absent breach of fiduciary duty, lack of good faith or self-dealing, any
action taken as a Director or any failure to take any action as a Director shall
be presumed to be in the best interests of the corporation.
D. Section 1715 of 15 Pa.C.S. shall not be applicable to the corporation.
(Added 4/27/91.)
E. A Director of the corporation shall not be personally liable for monetary
damages as such for any action taken, or any failure to take any action, unless:
(1) The Director has breached or failed to perform his duties of
his office under subsections A through C of this section, and
(2) The breach or failure to perform constitutes self-dealing, willful
misconduct or recklessness.
F. The provisions of subsection E of this section shall not apply to:
(1) The responsibility or liability of a Director pursuant to any
criminal statute, or
(2) The liability of a Director for the payment of taxes pursuant
to local, state or federal law.
41
<PAGE>
Section 3.07. Executive Committee.
(a) General Rule. There shall be an Executive Committee which, except
as provided in subsection (b), shall have and exercise all power and authority
of the Board of Directors between meetings of the Board. The Executive Committee
shall consist of not fewer than three (3) regular members including the Chief
Executive Officer of the corporation who shall be Chairman of the Executive
Committee, unless another member shall be designated by resolution of the Board.
All of the regular members shall be designated by resolution of the Board. Not
less than one-third of the committee must be Directors who are not officers or
employees of the corporation or of any entity controlling, controlled by, or
under common control with the corporation and who are not beneficial owners of a
controlling interest in the voting securities of the corporation. The Executive
Committee shall meet at any time and place designated and at least six hours
oral or written notice given by or on behalf of the Chairman of the Executive
Committee, and shall report promptly to the entire Board of Directors the
substance of any action taken by the Executive Committee, which action may be
changed by the Board without prejudice to intervening rights.
(b) Limitation on Authority. The Executive Committee shall not have any
power or authority as to the following:
(1) The submission to Shareholders of any action requiring
approval of Shareholders under the Business Corporation Law.
(2) The creation or filling of vacancies in the Board of
Directors.
(3) The adoption, amendment or repeal of these bylaws.
(4) The amendment or repeal of any resolution of the Board
that by its terms is amendable or repealable only by the Board.
(5) Action on matters committed by a resolution of the
Board of Directors to another committee of the Board.
Section 3.08. Audit Committee and Audit.
(a) Appointment. The Board of Directors shall appoint annually an Audit
Committee which shall consist of not less than three (3) Directors who are not
officers or employees of the corporation or of any entity controlling,
controlled by, or under common control with the corporation and who are not
beneficial owners of a controlling interest in the voting securities of the
corporation. The Audit Committee shall determine the nature and extent of the
audit of the records and of the verification and certification of the accounts
of the corporation, and not later than at the last meeting of the Board in a
calendar year, shall recommend to the Board the engagement and compensation of
an independent Certified Public Accountant or firm of such accountants to audit
the said records and certify the said accounts for the ensuing calendar year. In
making said audit, verification and certification, said accountant or firm shall
be under the direction of the Audit Committee and shall be responsible to and
shall report to the Board of Directors and not to the officers of the
corporation. The Chief Executive Officer and the President, if not also the
Chief Executive Officer, shall be non-voting, ex-officio members of the Audit
Committee.
42
<PAGE>
(b) Audit. The Audit Committee shall present the audit in full to the
Board of Directors at a meeting of the Board which shall be held at least two
weeks prior to the next Annual Meeting of Shareholders. The audit of the
corporation need not be mailed to Shareholders, but it shall be available for
inspection by any Shareholders at the office of the corporation during usual
business hours and at the Annual Meeting.
Section 3.09. Nominating Committee. The Board of Directors shall
appoint annually a Nominating Committee which shall consist of not less than
three (3) Directors who are not officers or employees of the corporation or of
any entity controlling, controlled by, or under common control with the
corporation and who are not beneficial owners of a controlling interest in the
voting securities of the corporation. The Nominating Committee shall, prior to
the annual meeting, determine and nominate candidates for the office of Director
of the corporation to be elected by the shareholders to serve terms as
established by the bylaws and until their successors are appointed.
Section 3.10. Executive Compensation Committee. The Board of Directors
shall appoint annually an Executive Compensation committee which shall consist
of not less than three (3) Directors who are not officers or employees of the
corporation or of any entity controlling, controlled by, or under common control
with the corporation and who are not beneficial owners of a controlling interest
in the voting securities of the corporation. The Executive Compensation
Committee shall be responsible for evaluating the performance of the principal
officers of the corporation and recommending to the Board of Directors the
selection and compensation of the principal officers. The Executive Compensation
Committee shall also be responsible for the drafting of reports, disclosures,
evaluations and other documents relating to executive compensation for filing
with State and Federal regulatory authorities.
Section 3.11. Alternate Committee Members. The Board of Directors may
designate one or more Directors as alternate members of any committee who may
replace any absent or disqualified member at any meeting of the committee or for
the purpose of any written action by the committee. In the absence or
disqualification of a member and alternate member or members of a committee, the
member or members thereof present at any meeting and not disqualified from
voting, whether or not constituting a quorum, may unanimously appoint another
Director to act at the meeting in the place of the absent or disqualified
member.
Section 3.12. Other Committees. The Board of Directors may designate
from time to time any other committees as the Board may deem necessary and
appropriate. The Board may set the number of members of any such committee and
43
<PAGE>
may appoint such members. Not less than one-third of any committee created
hereunder must be Directors who are not officers or employees of the corporation
or of any entity controlling, controlled by, or under common control with the
corporation and who are not beneficial owners of a controlling interest in the
voting securities of the corporation.
Section 3.13. Informal Action by Directors. Any action required or
permitted to be taken at a meeting of the Directors may be taken without a
meeting if, prior or subsequent to the action, a consent or consents thereto by
all of the Directors in office is filed with the Secretary of the corporation.
Any action without a meeting of the Board shall be limited to those situations
where time is of the essence and not in lieu of a regularly scheduled meeting.
Section 3.14. Vacancies. Vacancies in the Board of Directors, including
vacancies resulting from an increase in the number of Directors, may be filled
by a majority vote of the remaining members of the Board though less than a
quorum, or by a sole remaining Director, and each person so selected shall be a
director to serve for the balance of the unexpired term, and until a successor
has been selected and qualified or until his or her earlier death, resignation
or removal.
Section 3.15. Removal of Directors.
(a) Removal by the Shareholders. The entire Board of Directors, or any
class of the Board, or any individual Director may be removed from office
without assigning any cause by the vote of Shareholders, or of the holders of a
class or series of shares, entitled to elect Directors, or the class of
Directors. In case the Board or a class of the Board or any one or more
Directors are so removed, new Directors may be elected at the same meeting. The
Board of Directors may be removed at any time with or without cause by the
unanimous vote or consent of Shareholders entitled to vote thereon.
(b) Removal by the Board. The Board of Directors may declare vacant the
office of a Director who has been judicially declared of unsound mind or who has
been convicted of an offense punishable by imprisonment for a term of more than
one year or if, within 60 days after notice of his or her selection, the
Director does not accept the office either in writing or by attending a meeting
of the Board of Directors.
Section 3.16. Compensation. The Board of Directors has the
responsibility and authority to determine the compensation of directors and
officers elected by the Board of Directors in connection with their service to
the corporation and a Director may be a salaried officer of the corporation, who
shall not receive any additional compensation as a Director. The acceptance of
gifts of significant value from persons associated with the corporation may
impair the ability of the Board of Directors to establish appropriate levels of
compensation and incentives for directors and officers elected by the Board of
Directors that the Board considers appropriate. For these reasons, a director or
an officer elected by the Board of Directors may not accept, or arrange for any
member of his or her immediate family to receive, gifts or gratuities of other
than nominal or insignificant value from any of the following persons or members
of their immediate families: a director or officer elected by the Board of
Directors, an employee of the corporation, or any person elected by the Board of
Directors who is known to be a beneficial owner of more than 5 percent of the
outstanding capital stock of any class of the corporation. If a gift or gratuity
of more than nominal or insignificant value is received from any such persons,
the gift or gratuity must be returned and the Board of Directors notified. Gifts
or gratuities from any person to any member of the immediate family of such
person are not prohibited by this bylaw.
ARTICLE IV
Officers
Section 4.01. Number. The officers of the corporation shall be a
Chairman of the Board, a President, a Secretary, a Treasurer, and as many
44
<PAGE>
Executive Vice Presidents, and Senior Vice Presidents as from time to time may
be determined by the Board of Directors. The President, Secretary and Treasurer
may not be the same person. The Treasurer must be a natural person. There shall
also be as many Vice Presidents and Assistant Officers as from time to time may
be determined by the Chief Executive Officer. Other officers, including the
office of Vice Chairman of the Board, as from time to time may be determined may
be added by resolution of the Board of Directors.
Section 4.02. Election, Appointment and Term of Office. The Board of
Directors shall elect annually at their first meeting following the Annual
Meeting of Shareholders, the following officers to serve until the next Annual
Meeting of Directors and until their successors are duly elected and qualified
or until their earlier death, resignation or removal:
(1) the three highest paid officers of the corporation,
(2) the Chairman of the Board and the President if they
are not among the three highest paid officers, and
(3) such other officers as the Board of Directors from
time to time may designate by resolution.
All officers not required to be elected by the Board or not designated by the
Board to be elected by the Board shall be appointed by the Chief Executive
Officer to serve at his or her pleasure.
Section 4.03. Standard of Care. An officer of the corporation shall
perform his or her duties as an officer in good faith, in a manner he or she
reasonably believes to be in the best interests of the corporation and with such
care, including reasonable inquiry, skill and diligence, as a person of ordinary
prudence would use under similar circumstances. A person who so performs his or
her duties shall not be liable by reason of having been an officer of this
corporation.
Section 4.04. Duties and Responsibilities. Officers of the corporation
shall have the duties and responsibilities assigned to them in their respective
position descriptions approved by the Chief Executive Officer in addition to the
following duties and responsibilities of the various offices:
(a) Chairman of the Board. The Chairman of the Board shall be the
Chief Executive Officer of the corporation unless otherwise provided by
resolution of the Board of Directors and shall have general supervision of the
business, affairs and property of the corporation and over its several
officers. The Chairman of the Board shall preside at all meetings of the
Shareholders and of the Board of Directors, and shall perform such other
duties as from time to time may be assigned by the Board of Directors. The
Chairman of the Board shall be ex-officio member of all committees, if any, but
shall have no vote on the Audit Committee and the Executive Compensation
Committee.
45
<PAGE>
(b) President. The President, in the absence of the Chairman of the
Board, or a Vice Chairman of the Board, if any, shall preside at all meetings of
the Shareholders and the Board of Directors. The President shall have and
exercise all the powers and authority of the Chairman of the Board when the
Chairman and a Vice Chairman, if any, are absent or unable to act during a
vacancy in the office of the Chairman of the Board. The President shall also
have such other duties and responsibilities as from time to time may be assigned
by the Chief Executive Officer or the Board of Directors.
(c) Secretary. The Secretary, or an Assistant Secretary, shall be
present at all meetings of the Board of Directors and of the Shareholders, and
the Secretary shall keep a record of all proceedings of the Board and its
committees and the Shareholders. The Secretary shall notify the Shareholders and
members of the Board of all regular and special meetings, have charge of the
corporate seal and of the books and records of the corporation pertaining to
actions of the Board or the Shareholders, and shall have such other duties and
authority as prescribed by the Pennsylvania Business Corporation Law and any
other applicable law. The Secretary shall also perform such duties as are
customary and incident to the office of the Secretary and shall have such other
duties as from time to time may be assigned by the Chief Executive Officer or
the Board of Directors.
(d) Treasurer. The Treasurer shall have the care and custody of all
funds and securities of the corporation, depositing the same in the name of the
corporation with such bank or banks as the Board of Directors may select. The
Treasurer shall also perform such duties as are customary and incident to the
office of Treasurer and shall have such other duties as from time to time may be
assigned by the Chief Executive Officer or the Board of Directors.
(e) Executive Vice Presidents. An Executive Vice President shall, in
the absence of the President, perform all the duties of the President. If there
is more than one Executive Vice President, the Chief Executive Officer may
designate one of them to be senior. Executive Vice Presidents shall also have
such other duties and responsibilities as from time to time may be assigned by
the Chief Executive Officer or the Board of Directors.
(f) Senior Vice Presidents, Vice Presidents, Assistant Vice Presidents
and Other Officers. Senior Vice Presidents, Vice Presidents and Assistant Vice
Presidents and other officers shall perform such duties as from time to time may
be assigned by the Chief Executive Officer. The duties and responsibilities of
the Vice Chairman of the Board shall be assigned by resolution of the Board of
Directors.
Section 4.05. Compensation. The compensation of officers elected by the
Board of Directors shall be fixed by the Board of Directors subject to change
from time to time as the Board may determine; and the compensation of officers,
assistant officers, and agents appointed by the Chief Executive Officer shall be
fixed by the Chief Executive Officer subject to change from time to time as the
Chief Executive Officer shall determine.
46
<PAGE>
ARTICLE V
Share Certificates and Their Transfer
Section 5.01. Share Certificates.
(a) Form. Certificates for shares of the corporation shall be in such
form as approved by the Board of Directors, and shall state that the corporation
is incorporated under the laws of Pennsylvania, the name of the person to whom
issued, and the number and class of shares and the designation of the series (if
any) that the certificate represents. The share register or transfer books and
blank share certificates shall be kept by the Secretary or by any transfer agent
or registrar designated by the Board of Directors for that purpose.
(b) Issuance. The share certificates of the corporation shall be
numbered, dated, and registered in the share register on transfer books of the
corporation as they are issued. They shall be signed by the Chairman of the
Board or the President and by the Secretary or the Treasurer, and shall bear the
corporate seal, which may be a facsimile, engraved or printed; but where such
certificate is signed by a transfer agent or a registrar the signature of any
corporate officer upon such certificate may be a facsimile, engraved or printed.
In case any officer who has signed, or whose facsimile signature has been placed
upon, any share certificate shall have ceased to be such officer because of
death, resignation or otherwise, before the certificate is issued, it may be
issued with the same effect as if the officer had not ceased to be such at the
date of its issue. The provisions of this Section 5.01 shall be subject to any
inconsistent or contrary agreement at the time between the corporation and any
transfer agent or registrar.
Section 5.02. Transfer of Shares. Transfer of shares of the corporation
shall be made on the books of the corporation by the registered holder thereof
or by his attorney thereunto authorized by a power of attorney, duly executed
and filed with the Secretary of the corporation and upon surrender for
cancellation of the certificate or certificates for such shares. No transfer
shall be made inconsistent with the provisions of the Uniform Commercial Code,
13 Pa.C.S. ss.ss.8101 et. seq., and its amendments and supplements.
Section 5.03. Record Holder of Shares. The corporation shall be
entitled to treat the person in whose name any share or shares of the
corporation stand on the books of the corporation as the absolute owner thereof,
and shall not be bound to recognize any equitable or other claim to, or interest
in, such share or shares on the part of any other person.
Section 5.04. Lost, Destroyed or Mutilated Certificates. The holder of
any shares of the corporation shall immediately notify the corporation of any
loss, destruction or mutilation of the certificate therefore, and the Secretary
may, in his discretion, cause a new certificate or certificates to be issued to
such holder, in case of mutilation of the certificate, upon the surrender of the
mutilated certificate or, in case of loss or destruction of the certificate,
upon satisfactory proof of such loss or destruction and, if the Secretary shall
so determine, the deposit of a bond in such form and in such sum, and with such
surety or sureties, as he may direct.
47
<PAGE>
ARTICLE VI
Corporate Actions
Section 6.01. Voting Securities of Other Corporations. Securities held
by the corporation in any other corporation shall be voted in person or by proxy
by the Chief Executive Officer or any other person duly authorized by the Chief
Executive Officer.
ARTICLE VII
Indemnification of Directors, Officers & Employees
Section 7.01. (The provisions of this Section were adopted by the
Shareholders on April 28, 1987.)
The Company shall indemnify any Director, officer or employee, who was or is a
party to, or is threatened to be made a party to or who is called as a witness
in connection with any threatened, pending, or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative, including
an action by or in the right of the corporation by reason of the fact that he is
or was a Director, officer or employee of the corporation, or is or was serving
at the request of the corporation as a Director, officer or employee of another
corporation, partnership, joint venture, trust or other enterprise, against
expenses, including attorneys' fees, judgments, fines and amounts paid in
settlement actually and reasonably incurred by him in connection with such
action, suit or proceeding unless the act or failure to act giving rise to the
claim for indemnification is determined by a court to have constituted willful
misconduct or recklessness.
The indemnification and advancement of expenses provided by, or granted pursuant
to, this Article VII shall not be deemed exclusive of any other rights to which
those seeking indemnification or advancement of expenses may be entitled under
any bylaw, agreement, contract, vote of Shareholders, vote of disinterested
Directors or pursuant to the direction, howsoever embodied, of any court of
competent jurisdiction or otherwise, both as to action in his official capacity
and as to action on another capacity while holding such office. It is the policy
of the corporation that indemnification of, and advancement of expenses to,
Directors, officers and employees of the corporation shall be made to the
fullest extent permitted by law. To this end, the provisions of this Article VII
shall be deemed to have been amended for the benefit of Directors, officers and
employees of the corporation effective immediately upon any modification of the
Business Corporation Law of the Commonwealth of Pennsylvania (the "BCL") or the
Directors' Liability Act of the Commonwealth of Pennsylvania (the "DLA") which
expands or enlarges the power or obligation of corporations organized under the
BCL or subject to the DLA to indemnify, or advance expenses to, Directors,
officers and employees of the corporation.
48
<PAGE>
The corporation shall pay expenses incurred by an officer, Director or other
employee, in defending a civil or criminal action, suit or proceeding in advance
of the final disposition of such action, suit or proceeding upon receipt of an
undertaking by or on behalf of such person to repay such amount if it shall
ultimately be determined that he is not entitled to be indemnified by the
corporation.
The indemnification and advancement of expenses provided by, or granted pursuant
to, this Article VII shall, unless otherwise provided when authorized or
ratified, continue as to a person who has ceased to be a Director, officer or
employee and shall inure to the benefit of the heirs, executors and
administrators of such person.
The corporation shall have the authority to create a fund of any nature, which
may, but need not be, under the control of a trustee, or otherwise secure or
insure in any manner, its indemnification obligations, whether arising under
these Bylaws or otherwise. This authority shall include, without limitation, the
authority to (i) deposit funds in trust or in escrow, (ii) establish any form of
self-insurance, (iii) secure its indemnity obligation by grant of a security
interest, mortgage or other lien on the assets of the corporation, or (iv)
establish a letter of credit, guaranty or surety arrangement for the benefit of
such persons in connection with the anticipated indemnification or advancement
of expenses contemplated by this Article VII. The provision of this Article VII
shall not be deemed to preclude the indemnification of, or advancement of
expenses to, any person who is not specified in Section 7.01 of this Article
VII, but whom the corporation has the power or obligation to indemnify, or to
advance expenses for, under the provisions of the BCL or the DLA or otherwise.
The authority granted by this section shall be exercised by the Board of
Directors of the corporation.
Section 7.02. Proceedings Initiated by Indemnified Persons.
Notwithstanding any other provision of this Article VII, the corporation shall
not indemnify any person under this Article VII for any liability incurred in an
action, suit or proceeding initiated (which shall not be deemed to include
counterclaims or affirmative defenses) or participated in as an intervenor or
amicus curiae by the person seeking indemnification unless such initiation of or
participation in the action, suit or proceeding is authorized, either before or
after its commencement, by the affirmative vote of a majority of the Directors
in office. This section does not apply to successfully prosecuting or defending
the rights of any person to indemnification granted by or pursuant to this
Article VII.
ARTICLE VIII
Amendments
Section 8.01. Amendments. These bylaws may be altered, amended or
repealed and new bylaws adopted, either (i) by vote of the Shareholders at any
duly organized annual or special meeting of Shareholders, or (ii) with respect
to those matters that are not by statute committed expressly to the Shareholders
and regardless of whether the Shareholders have previously adopted or approved
the bylaw being amended or repealed, by vote of a majority of the Board of
Directors of the corporation in office at any regular or special meeting of
Directors. Any change in these bylaws shall take effect when adopted unless
otherwise provided in the resolution affecting the change.
49
<PAGE>
I hereby certify that the foregoing Bylaws were adopted at the 46th Annual
Meeting of Shareholders of the ERIE INDEMNITY COMPANY held on the 27th day of
April 1971, and were amended at the following meetings: the 52nd Annual Meeting
of Shareholders, April 26, 1977; the Special Shareholders Meeting, August 21,
1979; the 233rd Board of Directors Meeting, November 13, 1979; the 242nd Board
of Directors Meeting, March 4, 1981; and 248th Board of Directors Meeting,
August 24, 1982; the 62nd Annual Meeting of Shareholders, April 28, 1987; the
280th Board of Directors Meeting, April 24, 1990; by unanimous consent
resolution adopted by the Board of Directors on April 27, 1991; the 288th Board
of Directors Meeting, December 19, 1991; the 297th Board of Directors Meeting,
September 27, 1993; and the 299th Board of Directors Meeting, March 1, 1994; the
313th Board of Directors Meeting, September 17, 1996; 320th Board of Directors
Meeting, March 11, 1998, and the 325th Board of Directors Meeting, March 9,
1999.
/s/ J. R. Van Gorder
J. R. Van Gorder, Secretary
50
<TABLE>
<CAPTION>
EXHIBIT 11. - STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Class A common shares outstanding
(stated value $.0292) $ 67,032,000 $ 67,032,000 $ 67,032,000
Class B common shares outstanding
(stated value $70) 3,070 3,070 3,070
Conversion of Class B shares to shares
(One share of Class B for 2,400 shares of Class A) 7,368,000 7,368,000 7,368,000
------------ ------------ ------------
Total 74,400,000 74,400,000 74,400,000
============ ============ ============
Net income $134,551,494 $118,581,190 $105,132,359
============ ============ ============
Per-share amount $1.81 $1.59 $1.41
===== ===== =====
</TABLE>
Note: At the Annual Meeting of the Company's shareholders held on May 1, 1996,
the number of authorized shares of the Company's Class A Common Stock was
increased pursuant to a vote of the shareholders and a three-for-one stock split
was effected.
At the December 16, 1998 regular meeting of the board of directors of the Erie
Indemnity Company, the board approved a stock repurchase plan beginning
January 1, 1999, under which the Company may repurchase as much as $70 million
of its outstanding Class A common stock through December 31, 2001. The Company
may purchase the shares from time to time in the open market or by privately
negotiated transactions, depending on prevailing market conditions and
alternative uses of the Company's capital.
51
INCORPORATED BY REFERENCE, PAGE 19 OF THE COMPANY'S 1998 ANNUAL REPORT TO
SHAREHOLDERS
Selected Consolidated Financial Data
<TABLE>
<CAPTION>
Years ended December 31
1998 1997 1996 1995 1994
(dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
OPERATING DATA:
Net revenue from management operations $ 145,243 $ 134,201 $ 127,320 $ 111,276 $ 96,328
Underwriting gain (loss) 567 (2,259) (11,579) (3,738) (8,250)
Total revenue from investment operations 50,547 42,978 36,307 30,473 16,939
Income before income taxes 196,357 174,920 152,048 138,011 105,017
Provision for income taxes 61,806 56,339 46,916 44,460 33,288
Net Income $ 134,551 $ 118,581 $ 105,132 $ 93,551 $ 71,729
PER SHARE:
Net income per share $1.81 $1.59 $1.41 $1.26 $0.96
Dividends declared per Class A share (2) $0.4425 $0.3925 $0.345 $0.28 $0.225
Dividends declared per Class B share $66.375 $58.875 $51.75 $41.75 $33.75
FINANCIAL POSITION:
Investments (1) $ 709,417 $ 620,162 $ 484,784 $ 360,555 $255,449
Receivables from Exchange and affiliates 489,914 495,861 478,304 451,778 433,109
Total assets 1,453,432 1,293,440 1,150,639 1,022,432 869,531
Shareholders' equity 655,223 539,383 435,759 354,064 260,934
Book value per share (2) $8.81 $7.25 $5.86 $4.76 $3.51
<FN>
(1) Includes investment in Erie Family Life Insurance Company.
(2) All per share data has been adjusted to reflect the three-for-one stock split of Class A Common Stock effective May 2, 1996.
</FN>
</TABLE>
52
<PAGE>
INCORPORATED BY REFERENCE, PAGE 36 OF THE COMPANY'S 1998 ANNUAL REPORT TO
SHAREHOLDERS
Selected Market & Geographic Information
The Company's 5.5 percent share of direct premiums written by the Erie Insurance
Exchange and affiliated insurers, under the intercompany reinsurance pooling
agreement, through its subsidiaries, Erie Insurance Company and Erie Insurance
Company of New York for each of the three years ended December 31, were as
follows:
<TABLE>
<CAPTION>
Years Ended December 31
1998 1997 1996
(in thousands)
<S> <C> <C> <C>
Premiums Written:
District of Columbia $ 242 $ 240 $ 210
Indiana 4,203 3,959 3,708
Maryland 13,025 12,905 12,278
New York 1,503 860 493
North Carolina 3,629 2,852 2,164
Ohio 8,381 7,937 7,674
Pennsylvania 64,473 63,488 60,159
Tennessee 1,311 1,113 914
Virginia 8,975 8,898 8,907
West Virginia 5,199 4,907 4,486
Total Premiums Written $ 110,941 $ 107,159 $ 100,993
Reinsurance Assumed Premiums - Unaffiliated 5,762 4,452 5,135
Reinsurance Ceded Premiums - Unaffiliated (1,608) (1,329) (1,108)
Net Premiums Written $ 115,095 $ 110,282 $ 105,020
</TABLE>
The following table sets forth the premiums written and loss and loss adjustment
expense ratios by line of insurance for the Company's insurance subsidiaries
prepared in accordance with statutory accounting practices prescribed or
permitted by state insurance authorities, for the periods indicated.
<TABLE>
<CAPTION>
Years Ended December 31
1998 1997 1996
(in thousands)
<S> <C> <C> <C>
Premiums Written:
Commercial:
Automobile $ 7,611 $ 7,516 $ 7,156
Workers' Compensation 7,124 7,541 8,906
Commercial multi-peril 8,187 7,186 6,586
Other 2,227 2,414 2,303
Total Commercial $ 25,149 $ 24,657 $ 24,951
Personal:
Automobile $ 68,954 $ 67,701 $ 62,933
Homeowners 15,841 13,851 12,201
Other 997 950 908
Total Personal $ 85,792 $ 82,502 $ 76,042
Total Premiums Written $ 110,941 $ 107,159 $ 100,993
Statutory Loss and Loss Adjustment Expense Ratios:
Commercial:
Automobile 65.6% 77.0% 83.9%
Workers' Compensation 56.0 52.1 36.8
Commercial multi-peril 68.4 65.6 82.2
Other 25.2 15.5 36.8
Commercial Loss Ratios 59.8% 59.7% 61.6%
Personal:
Automobile 72.3% 81.0% 87.1%
Homeowners 67.3 65.3 114.8
Other 54.2 48.2 64.6
Personal Loss Ratios 71.2% 78.0% 91.2%
Total Loss Ratios (Excluding Unaffiliated Rein 68.6% 73.7% 83.7%
</TABLE>
53
<PAGE>
INCORPORATED BY REFERENCE, PAGES 20 AND 21 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
Management's Discussion and
Analysis of Financial Condition and
Results of Operations
The following discussion and analysis should be read in conjunction with the
audited financial statements and related notes found on pages 37 to 53 as they
contain important information helpful in evaluating the Company's operating
results and financial condition. (Note: A glossary of certain terms used in this
discussion can be found on page 35, herein. Defined terms are italicized the
first time they appear in the text.)
Overview
Erie Indemnity Company (the Company) is a Pennsylvania business corporation
formed in 1925 to be the attorney-in-fact for Erie Insurance Exchange (the
Exchange), a Pennsylvania-domiciled reciprocal insurance exchange. The Company's
principal business activity consists of management of the affairs of the
Exchange. Management fees received from the Exchange account for the majority of
the Company's consolidated revenues. The Company also is engaged in the
property/casualty insurance business through its wholly-owned subsidiaries, Erie
Insurance Company, Erie Insurance Property & Casualty Company, and Erie
Insurance Company of New York and through its management of Flagship City
Insurance Company (Flagship), a subsidiary of the Exchange. The Company also has
investments in both affiliated and unaffiliated entities, including a 21.63
percent common stock interest in Erie Family Life Insurance Company (EFL), an
affiliated life insurance company. Together with the Exchange, the Company and
its subsidiaries and affiliates operate collectively under the name Erie
Insurance Group.
In its role as attorney-in-fact for the Policyholders of the Exchange, the
Company may charge a management fee up to 25.0 percent of the affiliated assumed
and direct premiums written by the Exchange. The Company=s Board of Directors
has the authority to change the management fee at its discretion. The management
fee is compensation for: (a) acting as attorney-in-fact for the Exchange, (b)
managing the business and affairs of the Exchange, and (c) paying certain
general administrative expenses, including sales commissions, salaries, Employee
benefits, taxes, rent, depreciation, data processing expenses and other general
and administrative expenses not incurred in the adjustment of losses or the
management of investments. All premiums collected, less the management fee paid
to the Company, are retained by the Exchange for the purpose of paying losses,
loss adjustment expenses, investment expenses and other miscellaneous expenses
including taxes, licenses and fees. The Company pays certain loss adjustment and
investment expenses on behalf of the Exchange and is reimbursed fully for these
expenses by the Exchange. The management fee rate charged the Exchange was set
at the following rates:
January 1, 1995 to March 31, 1995 25.00 percent
April 1, 1995 to March 31, 1996 24.50 percent
April 1, 1996 to December 31, 1997 24.00 percent
January 1, 1998 to December 31, 1998 24.25 percent
The management fee rate was set by the Board at 25.0 percent for the period
January 1, 1999 through December 31, 1999. In determining the management fee
rate, the Company=s Board of Directors reviews the relative financial positions
of the Erie Insurance Exchange and the Company and considers the long-term needs
of the Exchange to ensure its continued growth, competitiveness, and superior
financial strength, which ultimately benefits the Company.
The Company's wholly-owned subsidiary, Erie Insurance Company, participates in
an intercompany pooling arrangement with the Exchange. This pooling arrangement
provides for Erie Insurance Company to share proportionately in the results of
all property/casualty insurance operations of the Exchange and the Company=s
subsidiaries. Since the inception of this pooling arrangement on January 1,
1992, Erie Insurance Company's proportionate share of the reinsurance pool has
been 5.0 percent.
54
<PAGE>
INCORPORATED BY REFERENCE, PAGES 21 AND 22 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
On January 1, 1995, the Exchange began retroceding to the Erie Insurance Company
of New York, a wholly-owned subsidiary of Erie Insurance Company, as part of the
existing intercompany pooling arrangement, 0.5 percent of its total direct and
assumed writings. Erie Insurance Company maintained its 5.0 percent
participation in the pool which, when combined with the 0.5 percent
participation of the Erie Insurance Company of New York, results in a 5.5
percent participation level for the Company owned affiliates since 1995.
The results of the Company's insurance operations are affected by the conditions
that affect all property/casualty insurance companies, such as increased
competition, catastrophic events, changes in the regulatory and legislative
environments, and changes in general economic and investment conditions.
Result of Operations
Overview
Consolidated net income in 1998 was a record $134,551,494, or $1.81 per share,
which exceeded the 1997 net income of $118,581,190, or $1.59 per share, by 13.5
percent. The 1998 results, when compared with the 1997 results, improved in all
operating segments. Management operations improved in 1998 as the Exchange
continued to experience written premium growth rates that exceeded industry
growth rates. Insurance underwriting operations results improved as a result of
loss cost severity-management programs introduced by the Company combined with a
generally favorable claims environment and mild weather conditions. Revenues
from investment operations improved as the Company's excess cash flows were
reinvested. The 1997 net income exceeded the 1996 net income of $105,132,359, or
$1.41 per share, by 12.8 percent. The 1997 results, when compared with 1996's
results, improved in all operating segments. In the two prior years, the
underwriting results of the Company's property/casualty insurance subsidiaries
were affected negatively by severe winter weather in the first quarter of 1996
and losses related to Hurricane Fran in the third quarter of 1996.
Analysis of Management Operations
Net revenues from management operations rose 8.2 percent to $145,243,209 in 1998
from $134,200,893 in 1997 and 5.4 percent from $127,319,678 in 1996. Gross
margins from management operations improved to 28.8 percent in 1998 compared to
gross margins of 28.2 percent in 1997 and 28.3 percent in 1996.
Total revenues from management operations rose $28,574,661 for the year ended
December 31, 1998, an increase of 6.0 percent. Management fee revenue derived
from the direct premiums of the Exchange rose $21,545,111, or 4.6 percent, for
the year ended December 31, 1998. The direct premiums of the Exchange grew 3.5
percent in 1998. The rate of growth in management fee revenue was greater than
the rate of growth in direct premium of the Exchange because the management fee
rate charged the Exchange in 1998 was 24.25 percent compared to 24.0 percent in
1997.
Several factors influenced the rate of growth in premiums written by the
Exchange. First, the Exchange's involuntary automobile premiums have decreased
over the last year as a result of fewer assignments from the Pennsylvania
Assigned Risk Plan. Involuntary automobile business is written on substandard
risks and historically has produced underwriting results much worse than the
preferred risks voluntarily written by the Exchange. Second, the Exchange's
overall premium growth was negatively influenced by rate reductions in
Pennsylvania workers' compensation insurance driven by legislative reforms and
competitive pressures in workers' compensation insurance in general. When the
effect of workers' compensation and involuntary automobile insurance premium
decrease is excluded, the direct premiums of the Exchange increased 4.7 percent
for the twelve months ended December 31, 1998 when compared to the same period
in 1997. Finally, severe rate pressures in the personal lines automobile market,
which the Company believes will continue into 1999, affected the growth in
premium. The Company has decreased private passenger automobile rates in several
jurisdictions effective in 1999. The effect of these rating actions will reduce
1999 written premium by about $60 million which will adversely affect the growth
in the management fee revenue of the Company in 1999.
Total revenues from management operations for the year ended December 31, 1997
grew $26,799,865 or 6.0 percent. The growth in direct premiums was 6.1 percent
in 1997. The Exchange's overall premium growth was negatively influenced by rate
reductions in Pennsylvania workers' compensation insurance driven by
Pennsylvania legislative reforms. Total direct written premiums, excluding
workers' compensation, increased 8.2 percent in 1997.
55
<PAGE>
INCORPORATED BY REFERENCE, PAGES 22 AND 23 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Service agreement revenue grew 97.5 percent to $13,878,922 in 1998 from
$7,026,373 in 1997. Beginning September 1, 1997 the Company is being reimbursed
by the Exchange for a portion of service charges collected by the
property/casualty insurers of the Group from Policyholders to compensate for the
costs incurred by the Company in providing extended payment terms on policies
written by them. Service charges amounted to $7,163,895 and $2,011,181 in 1998
and 1997, respectively. Also included in service agreement revenue is service
income received from the Exchange as compensation for the management and
administration of voluntary assumed reinsurance from non-affiliated insurers.
The Company receives a 7.0 percent service fee on the premiums from this
business. These fees totaled $6,715,027, $5,015,192, and $5,069,140 for 1998,
1997, and 1996, respectively.
The cost of management operations rose $17,532,345 or 5.1 percent for the year
ended December 31, 1998. The largest component of the cost of management
operations, Agent commission expense, rose 6.2 percent to $244,895,269 in 1998
from $230,659,805 in 1997 and 10.0 percent in 1997 from $209,756,209 in 1996.
Commissions on direct business rose 6.2 percent to $234,287,822 in 1998 from
$220,662,335 in 1997 and rose 8.5 percent in 1997 from $203,367,469 in 1996.
Promotional incentive and Agent contingency bonus costs increased 6.1 percent to
$10,607,447 in 1998 from $9,997,470 in 1997 and increased 56.5 percent in 1997
from $6,388,740 in 1996. The increases in 1998 and 1997 were due to the improved
underwriting profitability of the insurance operations of the Group, which
resulted in higher Agent profitability bonuses.
The cost of management operations, excluding commission costs, increased 3.0
percent in 1998 to $114,428,137 from $111,131,256 in 1997. The Company's
personnel costs, net of reimbursement from affiliates, totaled $67,467,067,
$66,410,377, and $68,949,232 in 1998, 1997 and 1996, respectively. Personnel
costs are the second largest cost component in the cost of management operations
after commissions. Personnel costs increased 1.6 percent in 1998 compared to a
decrease of 3.7 percent in 1997. As attorney-in-fact for the Exchange, the
Company pays almost all expenses of the Group and allocates those costs to the
respective Company responsible for them in accordance with intercompany
agreements. Increased reimbursements in 1998 to the Company for personnel costs
of the loss adjustment function were the result of an increased ratio of loss
adjustment personnel to total personnel. The increased ratio resulted in a
larger share of staff department overhead being allocated to the loss adjustment
function resulting in higher reimbursements to the Company. The 1997 decline is
the result of increased expense reimbursements from the Exchange and a decrease
in pension costs.
<TABLE>
<CAPTION>
Management Fee Revenue
By State and Line of Business
For the Year Ended December 31, 1998
(Dollars in thousands)
Private Workers' Commercial Commercial All Other Lines Total
State Passenger Auto Homeowners Compensation Auto Multi Peril of Business by State
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
District of Columbia $ 300 $ 154 $ 329 $ 37 $ 186 $ 60 $ 1,066
Indiana 10,706 3,265 1,348 1,082 1,549 582 18,532
Maryland 34,709 9,119 3,317 4,526 3,529 2,229 57,429
New York 3,698 874 452 584 819 198 6,625
North Carolina 5,886 2,479 2,076 2,509 2,269 782 16,001
Ohio 23,434 6,547 --- 2,438 3,439 1,094 36,952
Pennsylvania 186,860 38,602 18,434 15,743 17,923 6,703 284,265
Tennessee 2,268 736 795 792 952 239 5,782
Virginia 20,347 5,142 4,658 3,951 3,794 1,680 39,572
West Virginia 15,818 2,927 --- 1,893 1,636 649 22,923
- ------------------------------------------------------------------------------------------------------------------------------------
Total by line of business $304,026 $ 69,845 $ 31,409 $ 33,555 $ 36,096 $ 14,216 $489,147
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
56
<PAGE>
INCORPORATED BY REFERENCE, PAGES 24 AND 25 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Analysis of Insurance Underwriting Operations
The Company recorded an underwriting gain of $567,275 in 1998 compared to
underwriting losses of $2,259,425 and $11,579,211 for the years 1997 and 1996,
respectively. The 1998 insurance underwriting results improved as a result of
loss cost severity-management programs introduced by the Company combined with a
generally favorable claims environment and mild weather conditions. In 1997 mild
winter weather conditions and a lack of catastrophe losses in the Company's
operating territories positively affected insurance underwriting results. The
1996 underwriting results were impacted negatively by severe winter weather in
the first quarter of 1996 and catastrophe losses experienced from Hurricane Fran
in the eastern United States, particularly North Carolina, and other
storm-related catastrophe losses elsewhere in our operating territories during
the third quarter of 1996. Losses resulting from these catastrophes were about
$8.1 million in 1996, or about $.07 per share, after federal income taxes.
Catastrophes are an inherent risk of the property/casualty insurance business.
Catastrophes can have a material impact on the Company=s insurance underwriting
operating results. However, the Company's insurance subsidiaries have in effect
a reinsurance agreement with the Exchange that would mitigate the effect of
catastrophe losses on the Company's operating results and financial position.
Catastrophic losses, as classified by the Company's property/casualty insurance
subsidiaries, were $3,739,284 and $701,414 in 1998 and 1997, respectively.
Losses, loss adjustment expenses and underwriting expenses incurred increased
$2,763,078, or 2.5 percent, for the year ended December 31, 1998 compared to a
decrease of $3,479,877, or 3.1 percent, for the year ended December 31, 1997.
Generally favorable claims experience resulted in a slight decrease of $89,437
for loss and loss adjustment expenses incurred in 1998. In 1997, losses and loss
adjustment expenses incurred fell 6.0 percent to $79,970,102 due to the lack of
catastrophe losses and milder weather conditions in 1997 compared to 1996. 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 based necessarily on estimates and, while
management believes the amounts reserved are adequate, the ultimate liabilities
may be in excess of, or less than, amounts provided.
Included in the other underwriting expenses are assessments made by state
insurance guaranty associations. These assessments are mandated by statute and
are used by the various state insurance guaranty associations to guarantee the
property/casualty policies of companies that have become insolvent. These
mandatory assessments totaled $1,222,958 and $171,557 in 1998 and 1997,
respectively. The 1998 increased expense resulted from assessments from state
guaranty associations which were prompted by several large insurer insolvencies
in the states where the Group conducts business.
The 1998 combined ratio for the Company's property/casualty operations
calculated under Generally Accepted Accounting Principles (GAAP) was 99.5
compared to a ratio of 102.1 in 1997 and 111.4 in 1996. The GAAP combined ratio
for 1998, 1997 and 1996, excluding catastrophe losses, as classified by the
Company, was 96.2, 101.5, and 103.4, respectively.
Analysis of Investment Operations
Total revenue from investment operations was $50,546,973 in 1998, compared to
$42,978,156 in 1997 and $36,307,324 in 1996, increases of 17.6 percent and 18.4
percent, respectively. Net investment income rose $5,674,117, or 17.2 percent,
for the year ended December 31, 1998 and $7,028,902, or 27.1 percent, for the
year ended December 31, 1997. These increases were consistent with the growth in
the Company's cash, cash equivalents and investments, which increased 23.8
percent, 23.1 percent and 21.9 percent in 1998, 1997 and 1996, respectively.
The Company's earnings from its 21.63 percent ownership of Erie Family Life
Insurance Company (EFL) totaled $4,777,089 in 1998, up from $4,230,909 in 1997
and $3,820,957 in 1996. This investment is accounted for under the equity method
of accounting. Consequently, the Company's investment earnings in 1998, 1997 and
1996 were a direct result of its share of EFL's net income of $22,085,479,
$19,560,368, and $17,666,250, respectively. The 12.9 percent increase in EFL's
net income in 1998 was the result of an 8.7 percent increase in policy revenues
as well as a 23.9 percent decrease in death claims. The increase in EFL's net
income in 1997 was due to increased policy revenues (up 13.1 percent in 1997
compared to 1996) and to increased investment income of 8.6 percent.
57
<PAGE>
INCORPORATED BY REFERENCE, PAGE 25 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
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
December 31, 1998 and 1997, the Company's investment portfolio of
investment-grade bonds, common stock and preferred stock, all of which are
readily marketable, represent 44.3 percent and 40.0 percent, respectively, of
total assets. These investments provide the liquidity the Company requires to
meet the demands on its funds.
Distribution of Invested Assets
Carrying Value at December 31,
(Dollars in thousands)
<TABLE>
<CAPTION>
1998 % 1997 %
<S> <C> <C> <C> <C>
Fixed maturities $441,353 66 $349,973 66
Equity securities:
Common stock 90,230 13 80,170 15
Preferred stock 112,574 17 84,963 16
Real estate mortgage loans 8,287 1 8,392 2
Other invested assets 17,494 3 7,932 1
Total invested assets $669,938 100% $531,430 100%
</TABLE>
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. Certain of the
Company's corporate and municipal bond investments 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. 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.
Fixed Maturities
The Company's investment strategy includes maintaining a fixed maturities
portfolio that is of very high quality and well diversified within each market
sector. The fixed maturities portfolio is managed conservatively with the goal
of achieving reasonable returns while limiting exposure to risk. At December 31,
1998, the carrying value of fixed maturity investments represented 66.0 percent
of total invested assets.
The Company invests in both taxable and tax-exempt securities as part of its
strategy to maximize after-tax income. This strategy considers, among other
factors, the impact of the alternative minimum tax.
58
<PAGE>
INCORPORATED BY REFERENCE, PAGE 26 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Diversification of Fixed Maturities
at December 31, 1998
<TABLE>
<CAPTION>
(Dollars in thousands) Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
U. S. government & agencies $ 13,018 $ 689 $ 0 $ 13,707
States & political subdivisions 48,307 3,293 0 51,600
Special revenue 132,025 7,215 5 139,235
Public utilities 13,116 300 0 13,416
U. S. industrial & miscellaneous 195,296 9,028 629 203,695
Foreign governments 1,990 0 181 1,809
Foreign industrial &
miscellaneous 5,159 165 86 5,238
Total bonds 408,911 20,690 901 428,700
Redeemable preferred stock 12,191 577 115 12,653
Total fixed maturities $ 421,102 $ 21,267 $ 1,016 $ 441,353
</TABLE>
The Company's fixed maturity investments consist of high-quality, marketable
bonds all of which were rated at investment-grade levels (Ba/BB or better) at
December 31, 1998. Included in this investment-grade category are $244.9
million, or 55.5 percent, of the highest quality bonds rated Aaa/AAA or Aa/AA or
bonds issued by the United States government. Generally, the fixed maturities in
the Company's portfolio are rated by external rating agencies; if such bonds are
not rated externally, 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 restructure the Company's investments in response
to changes in market conditions or strategic direction. Securities classified as
available-for-sale are carried at market value with unrealized gains and losses
included in shareholders' equity. At December 31, 1998 and 1997, unrealized
gains on fixed maturities amounted to $13,164,000 and $10,944,000, respectively,
net of deferred taxes.
59
<PAGE>
INCORPORATED BY REFERENCE, PAGES 26 AND 27 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
The Company attempts to achieve a balanced maturity schedule in order to
stabilize investment income in the event of a reduction in interest rates in a
year in which a large amount of securities could mature.
Equity Securities
Diversification of Equity Securities
at December 31, 1998
<TABLE>
<CAPTION>
(Dollars in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
Common stock:
U.S. banks, trusts and
insurance companies $ 3,522 $ 197 $ 231 $ 3,488
U.S. industrial and
miscellaneous 53,914 37,158 7,509 83,563
Foreign industrial and
miscellaneous 3,186 271 278 3,179
Preferred stock:
U.S. banks, trusts and
insurance companies 42,807 2,561 30 45,338
U.S. industrial and
miscellaneous 59,858 2,024 1,419 60,463
Foreign industrial and
miscellaneous 6,690 228 145 6,773
Total equity securities $ 169,977 $ 42,439 $ 9,612 $202,804
</TABLE>
Equity securities are carried on the Consolidated Statements of Financial
Position at market value. At December 31, 1998 and 1997, equity securities held
by the Company include net unrealized gains of $21,338,000 and $13,656,000,
respectively, net of deferred taxes. Investment characteristics of common and
preferred stocks differ substantially from one another. The Company's preferred
stock portfolio provides a source of highly predictable current income that is
competitive with investment-grade bonds. The preferred stocks are of very high
quality and marketable. Common stock provides capital appreciation potential
within the portfolio. Common stock investments inherently provide no assurance
of producing income because dividends are not guaranteed. Preferred stocks
generally provide for fixed rates of return which, while not guaranteed,
resemble fixed income securities. As with all investments, the continuing value
of common stock is subject to change based on the underlying value of the
issuer. Common stocks also are subject to valuation fluctuations driven by
investment market conditions. The current appreciation in the value of the
Company=s equity security investments is subject to these risks. Management
addresses these risks by providing for investment strategies which tend to
balance investment holdings along the lines of type of investment, maturity
dates, industry and geographic concentrations and income-producing
characteristics.
Investment in EFL
The Company owns 21.63 percent of the outstanding common stock of EFL, a member
company of the Erie Insurance Group. EFL markets various life insurance
products, principally non-participating individual and group life policies,
including universal life and individual and group annuity products, in nine
jurisdictions. The Company's investment in EFL is accounted for under the equity
method of accounting; consequently, the Company's carrying value of $39,478,746
represents 21.63 percent of the shareholders' equity of EFL at December 31,
1998.
60
<PAGE>
INCORPORATED BY REFERENCE, PAGES 28 AND 29 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Liquidity and Capital Resources
Liquidity is a measure of an entity'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, the net cash flow from Erie Insurance Company's and Erie Insurance
Company of New York's 5.5 percent participation in the underwriting results of
the reinsurance pool with the Exchange, and investment income from affiliated
and non-affiliated investments.
The Company generates sufficient net positive cash flow from its operations to
fund its commitments and to build its investment portfolio, thereby increasing
future investment returns. The Company maintains a high degree of liquidity in
its investment portfolio in the form of readily marketable fixed maturities,
equity securities, and short-term investments. The Company purchased investments
totaling $235,568,211 in 1998 compared with purchases of $146,394,800 in 1997.
The Company's Consolidated Statements of Cash Flows indicate that net cash flows
provided from operating activities in 1998, 1997 and 1996 were $150,498,495,
$118,905,654, and $103,362,034, respectively. Net cash used in investing
activities totaled $121,045,167, $58,829,631, and $119,001,849 in 1998, 1997 and
1996, respectively. In 1998, the Company purchased computer software totaling
$3.9 million to enhance product development capabilities as well as to provide
support to our agency force.
The Company incurs substantially 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 when calculating the
management fee due for the month. Since management fees traditionally have not
been paid to the Company by the Exchange until the premiums from Policyholders
are collected, the change in the premium receivable balance is used in
determining the actual monthly amount transferred.
Management fee and expense reimbursements due at December 31 from the Exchange
were $106,986,856 and $111,577,074 in 1998 and 1997, respectively. A receivable
from Erie Family Life Insurance Company for expense reimbursements totaled
$1,625,408 at December 31, 1998 compared to $1,153,057 at December 31, 1997. The
Company also has a receivable due from the Exchange for reinsurance recoverable
from losses and unearned premium balances ceded to the pool. Such amounts
totaled $381,301,722 and $383,131,027, respectively, in 1998 and 1997.
On December 16, 1998, the Board of Directors approved a stock repurchase plan
beginning January 1, 1999, under which the Company may repurchase as much as $70
million of its outstanding Class A common stock through December 31, 2001. The
Company may purchase the shares from time to time in the open market or by
privately negotiated transactions, depending on prevailing market conditions and
alternative uses of the Company's capital.
In 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 20.0 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 20.0 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 33.0 percent of total share holdings of
such shareholder. At the Board of Directors meeting 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. There were no shares of stock redeemed under this
Plan during 1998 or 1997.
Dividends declared to shareholders totaled $29,865,438, $26,490,811, and
$23,284,957 in 1998, 1997, and 1996, respectively. There are no regulatory
restrictions on the payment of dividends to the Company's shareholders, although
there are state law restrictions on the payment of dividends from the Company=s
subsidiaries to the Company. Dividends from subsidiaries are not material to the
Company's cash flows.
61
<PAGE>
INCORPORATED BY REFERENCE, PAGE 29 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Temporary differences between the financial statement carrying amounts and tax
basis of assets and liabilities that give rise to deferred tax assets and
liabilities resulted in net deferred tax liabilities at December 31, 1998 and
1997 of $17,121,777 and $7,101,371, respectively. The primary reason for the
increase in the deferred tax liability is due to an increase in unrealized gains
from available-for-sale securities in 1998 and 1997. The deferred tax liability
generated from these unrealized gains amounted to $18,590,000 as of 1998 and
$13,246,000 as of 1997, an increase of $5,344,000. Management believes it is
likely that the Company will have sufficient taxable income in future years to
realize the benefits of the deferred tax assets.
Financial Ratings
The following table summarizes the current A. M. Best Company ratings for the
insurers managed by the Company:
Erie Insurance Exchange A++
Erie Insurance Company A++
Erie Insurance Property & Casualty Company A++
Erie Insurance Company of New York A++
Flagship City Insurance Company A++
Erie Family Life Insurance Company A+
According to A. M. Best, a superior rating (A++ or A+) is assigned to those
companies which, in A. M. Best=s opinion, have achieved superior overall
performance when compared to the standards established by A. M. Best and have a
very strong ability to meet their obligations to policyholders over the long
term. Financial strength ratings have become increasingly important to the
insurers managed by the Company and to the industry in marketing insurance
products.
Regulatory Risk-Based Capital
The 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, 1998, the
Company's property/casualty insurance subsidiaries' RBC levels are all
substantially in excess of levels that would require regulatory action.
Reinsurance
Effective January 1, 1994, the property/casualty insurers managed by the Company
have discontinued all ceded reinsurance treaties, other than with affiliated
insurers, due to the strong surplus position of the insurers managed by the
Company, the cost of reinsurance, and the low ratio of the premium writings of
the insurers managed by the Company to their surplus. The Company does not
believe this discontinuance of reinsurance treaties will have a material adverse
effect, over the long term, on the results of operations of the insurance
companies managed by the Company. However, the absence of such treaties could
have an adverse effect on the results of operations of the insurance companies
managed by the Company in a given year, if the frequency or severity of claims
were substantially higher than historical averages because of an unusual event
during a short-term period. Although the Company experienced significant winter
storm losses in 1996, the Company would not have recognized any recoveries from
these discontinued treaties had they been in effect during that year. The
insurers managed by the Company continue to maintain facultative reinsurance on
certain individual property/casualty risks.
62
<PAGE>
INCORPORATED BY REFERENCE, PAGES 29 AND 30 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Effective January 1, 1997, Erie Insurance Company and Erie Insurance Company of
New York placed in effect an all lines aggregate excess of loss reinsurance
agreement with the Exchange that supersedes the prior catastrophe excess of loss
reinsurance agreement between the parties. Under the new agreement, Erie
Insurance Company and Erie Insurance Company of New York reinsure their net
retained share of the intercompany reinsurance pool such that once Erie
Insurance Company and Erie Insurance Company of New York have sustained ultimate
net losses that exceed an amount equal to 72.5 percent of Erie Insurance Company
and Erie Insurance Company of New York's net premiums earned, the Exchange will
be liable for 95.0 percent of the amount of such excess up to, but not
exceeding, an amount equal to 95.0 percent of 15.0 percent of Erie Insurance
Company's and Erie Insurance Company of New York's net premiums earned. Erie
Insurance Company and Erie Insurance Company of New York retain losses equal to
5.0 percent of the ultimate net loss in excess of the retention under the
contract. The annual premium for this reinsurance treaty is 1.01 percent of the
net premiums earned by Erie Insurance Company and Erie Insurance Company of New
York during the term of this agreement subject to a minimum premium of $800,000.
The annual premium for this agreement with the Exchange was $1,158,245 in 1998
compared to $1,102,868 in 1997, a 5.0 percent increase. There were no loss
recoveries by Erie Insurance Company or Erie Insurance Company of New York under
this agreement for 1998 or 1997. This reinsurance treaty is excluded from the
intercompany reinsurance pooling agreement and replaces the earlier reinsurance
agreement between the Company and Erie Insurance Company and Erie Insurance
Company of New York, which is described below.
During 1996, Erie Insurance Company and Erie Insurance Company of New York had
in effect a Property Catastrophe Excess of Loss Reinsurance Treaty with the
Exchange. The coverage included in the treaty for Erie Insurance Company was
$25,000,000 in excess of $10,000,000 and was excluded from the aforementioned
pooling arrangement. The coverage included in the treaty for Erie Insurance
Company of New York was $2,250,000 in excess of $250,000 and also was excluded
from the aforementioned pooling arrangement. The annual premium for these
agreements to the Exchange was $424,170 in 1996.
Effects of Inflation
Inflationary considerations can impact the Company's activities in several ways.
Inflationary expectations can impact the market value of the Company's portfolio
of securities, particularly fixed maturities and preferred stock. At December
31, 1998, the Company's investments totaled $669,938,120. Of this amount,
$553,927,529 was invested in interest rate sensitive bonds and preferred stock.
At December 31, 1998 the market value exceeded the book value of the Company's
interest rate sensitive bonds and preferred stock by $23,471,207.
Inflation also can affect the loss costs of property/casualty insurers and, as a
consequence, insurance rates. Insurance premiums are established before loss 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.
Property/Casualty Loss Reserves
General
The reserve liabilities for property/casualty losses and loss adjustment
expenses (LAE) represent estimates of the ultimate net cost of all unpaid losses
and loss adjustment expenses incurred through December 31, 1998 and 1997. The
reserves are determined using adjusters' individual case estimates and
statistical projections. These projections are employed in four specific areas:
(1) to calculate incurred but not reported (IBNR) reserves, (2) to test the
adequacy of case basis estimates of loss reserves, (3) to calculate allocated
LAE reserves and (4) to calculate unallocated LAE reserves. These projections
are reviewed continually and adjusted as necessary, as experience develops and
new information becomes known. Such adjustments are reflected in current
operations.
The IBNR reserve is based on the historical relationship of the emergence of
reported claims to earned premiums. The calculation includes components for
changes in claim costs resulting from trends in claims frequency and severity.
Allocated LAE reserves are based on long-term historical relationships of
incurred loss adjustment expenses to incurred losses. Unallocated LAE reserves
are based on the historical relationships of paid unallocated expenses to paid
losses.
63
<PAGE>
INCORPORATED BY REFERENCE, PAGE 31 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Environmental-Related Claims
The Company's property/casualty subsidiaries had 38 reported open claims
concerning environmental-related liabilities at December 31, 1998 and 36 and 31
such claims at December 31, 1997 and 1996, respectively. The Company's
property/casualty subsidiaries' share of direct losses paid related to
environmental-related claims was $5,049, $1,621, and $5,308 related to years
ended December 31, 1998, 1997 and 1996, respectively. The Company's
property/casualty subsidiaries' share of unpaid direct losses related to
environmental claims amounted to $86,466, $40,583, and $42,194 for the years
ended December 31, 1998, 1997 and 1996, respectively.
In establishing the liability for unpaid losses and loss adjustment expenses
related to environmental claims, management considers facts currently known and
the current state of the law and coverage litigation. Establishing reserves for
these types of claims is subject to uncertainties that are generally greater
than those represented by other types of claims. Factors contributing to those
uncertainties include a lack of historical data, long reporting delays,
uncertainty as to the number and identity of insureds with potential exposure,
unresolved legal issues regarding policy coverage, and the extent and timing of
any such contractual liability. Courts have reached different and sometimes
inconsistent conclusions as to when the loss occurred and what policies provide
coverage, what claims are covered, whether there is an insured obligation to
defend, how policy limits are determined, how policy exclusions are applied and
interpreted, and whether cleanup costs represent insured property damage.
Further, even if and when the courts rule definitively on the various legal
issues, many cases will still present complicated factual questions affecting
coverage that will need to be resolved.
The insurers managed by the Company have incurred few environmental claims and,
as a result, have made few indemnity payments to date. Because these payments
have not been significant in the aggregate and have varied in amount from claim
to claim, management cannot determine whether past claims experience will be
representative of future claims experience. The Company's property/casualty
subsidiaries have established reserves for these exposures in amounts, which
they believe to be adequate, based on information currently known by them.
Management does not believe that these claims will have a material impact on the
Company's liquidity, results of operations, cash flows, or financial condition.
Factors That May Affect Future Results
Management Operations
Management Fee Rate. The management fee paid to the Company as attorney-in-fact
for the Exchange is subject to approval by the Company's Board of Directors. The
rate may be changed periodically by the Board at their discretion but may not
exceed 25.0 percent. The Board considers several factors in determining the
management fee rate, including the relative financial position of the Exchange
and the Company and the long-term capital needs of the Exchange in order to
foster growth, competitiveness, and maintain its superior financial strength.
Because the management fee revenue from the Exchange provides the majority of
the Company's revenue, the income of the Company is dependent upon the ability
of the Exchange to offer competitive insurance products in the marketplace.
Competition. Intense price competition in private passenger automobile
insurance, the Group's largest line of business, has affected the premium growth
rate of the insurers managed by the Company and, as a consequence, the growth in
the Company's management revenue. Favorable underwriting trends for personal
automobile writers, along with strong investment returns, have created an
environment of significant decreases in personal automobile rate levels.
Additionally, direct response writers, with their low-cost operating models, are
positioning themselves to take advantage of these trends. These writers are
segmenting the personal automobile marketplace and offering significantly lower
premium rates to drivers with favorable risk characteristics. The Group is
responding by decreasing its private passenger automobile rates in several
jurisdictions effective in 1999. The effect of these competitive rate actions
will reduce 1999 written premiums by about $60 million, which will adversely
affect the growth in management fee revenue of the Company in 1999. To maintain
the competitive position of the insurers managed by the Company in the private
passenger automobile insurance marketplace, additional rate actions that reduce
written premiums are possible in 1999 or 2000.
64
<PAGE>
INCORPORATED BY REFERENCE, PAGE 32 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Insurance Operations
Underwriting Exposure. The insurers managed by the Company, including its
wholly-owned subsidiaries, are subject to the risk of losses due to catastrophic
events. In addressing this risk, the Company employs what it believes are
conservative underwriting standards and monitors its exposures by geographic
region. The Company also evaluates other means available to insurers to
effectively manage risk. Catastrophic events are a perpetual factor that could
impact future results of the industry as a whole as well as the Company. The
current aggregate excess of loss reinsurance agreement between the Company's
property/casualty insurance subsidiaries and the Exchange substantially lessens
the effect of catastrophe losses on the Company.
Geographic Expansion. The Exchange, the Erie Insurance Company and EFL are
licensed in the State of Illinois effective January 1, 1999. The companies began
operating and marketing all lines of business in Illinois at that time. The
expansion into a new operating territory offers the opportunity for growth in
property/casualty premiums of the Exchange upon which management fee revenue of
the Company is based. Over the last five years, geographic expansion has made a
significant contribution to the property/casualty premium growth rate of The
ERIE. The Company anticipates that the Illinois market eventually will
contribute to the growth and profitability of The ERIE.
Investment Operations
The Company's portfolio of fixed maturities and equity securities is subject to
the ongoing risks associated with fluctuations in interest rates and stock
market conditions in general. Current investment results may not be indicative
of performance in future periods.
Regulatory
Pennsylvania Commercial Deregulation. Pennsylvania enacted legislation providing
for the deregulation of rates and forms for certain commercial insureds.
Effective February 19, 1999, insurers are no longer required to file for
approval, rates and forms with the Pennsylvania Insurance Department for larger
commercial risks [defined as commercial entities generating an aggregate annual
premium of $25,000 or more (exclusive of workers' compensation) or which have
twenty-five employees and an insurance manager, consultant or buyer]. Risks that
are smaller than large commercial risks are now to be rated under a flex band (+
or - 10%) from the filed rates. The law allows greater flexibility in the rating
of commercial risks and a faster response to changing market conditions than
under the prior system. The new law could impact all insurance companies
operating in Pennsylvania, either negatively or positively, depending on the
market and the aggressiveness of the insurer in retaining and/or writing new
commercial risks in Pennsylvania. The Company believes, generally, that
commercial deregulation will result in lower rather than higher premium rate
levels.
65
<PAGE>
INCORPORATED BY REFERENCE, PAGES 32 AND 33 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Financial Services Reform. Federal action begun in 1997 could culminate in
significant changes in the way insurance companies, banks and securities firms
are regulated in the future. The elimination of some regulatory barriers to
banks entering the insurance market, and the interjection of Federal
governmental agencies into the traditionally state-regulated insurance industry
could dramatically change the ground rules under which insurance products are
marketed. Further action and advancing technology will likely influence the way
the property/casualty and life insurance industries distribute, price and
service their products.
Urban Insurance Issues. Federal regulators have heightened their scrutiny of the
property/casualty insurance industry, particularly its underwriting and
marketing practices relative to homeowners insurance. Assertions have been made
and complaints filed against various insurers for an alleged practice called
"redlining," a term used to describe an insurer=s illegal and unfair
discrimination against minority communities, which are typically located in
economically depressed inner cities. Much of the action at the Federal level has
been initiated by the Department of Housing and Urban Development, with
enforcement by the United States Department of Justice. A number of complaints
have culminated in consent decrees under which insurers have agreed to pay
substantial sums of money.
Auto-Choice Reform Act. Currently pending before Congress, the Auto Choice
Reform Act is one of the more recent attempts at insurance regulation by the
Federal government. The bill offers consumers a choice between traditional auto
insurance (i.e., a tort liability system) or coverage at a reduced premium under
a personal protection policy which allows insureds to recover economic damages
from their insurer, but requires them to relinquish their right to sue or be
sued for noneconomic damages. States could Aopt out@ of such a system by passing
legislation to do so. Federal legislation that mandates auto premium rate
reductions would adversely affect the management fee revenue of the Company and
could affect its insurance underwriting profitability.
Year 2000 Readiness Disclosure
Erie Indemnity Company and the property/casualty insurance companies it manages
are dependent on electronic processing and information systems to conduct
business. Like all companies with such dependencies, the Company is continually
faced with significant decisions and technology challenges. Among these
challenges is the so-called "Year 2000 Issue," the inability of many computer
systems to recognize dates beginning with the year 2000 and beyond. The Year
2000 Issue presents a profound risk management issue which is perhaps more
pervasive than any previous issue faced by businesses of all types. To
effectively manage the risks associated with the Year 2000 Issue, management has
taken measures over the past six years designed to reduce the Company's
potential for business interruption. References to the Company in the
description below, including cost information, pertain to the Company and the
property/casualty insurance companies under its management.
The effect of the Year 2000 Issue cannot be measured exactly with certainty; any
forecasts about the effect of the Year 2000 Issue and remediation projections
are necessarily forward-looking statements and are subject to the risks and
uncertainties noted on page 34.
Company's State of Readiness
Exposure to systems failure is a risk faced by the Company every day. Unlike
these other risks, the date change to the Year 2000 is predictable. Efforts to
mitigate The ERIE's exposure through effective identification, remediation and
contingency planning are organized and being conducted on all major business
processes to minimize the risks.
66
<PAGE>
INCORPORATED BY REFERENCE, PAGES 33 AND 34 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
To assure that the Company effectively addresses this risk at all levels of the
organization, management has in place a structure that provides oversight of
Year 2000 risk management activities, which are being conducted within the major
business units of the Company. Oversight by Executive and Senior Management is
being facilitated through a dedicated project office. This office, (the Y2K
Office) is working in consultation with each business unit to assure consistency
and adequacy of risk management activities and to collect companywide project
status and cost information.
Within each business unit, each key business process is being evaluated to
assure that underlying systems and components exposed to potential Year 2000
failure are appropriately identified and addressed. Underlying system components
include internal operating systems (hardware and software), infrastructure
elements including non-information technology components and systems,
communications systems and devices, internally developed mainframe applications,
personal computer hardware and software, external parties and providers and
peripheral devices.
Each of these underlying components supporting key business processes was
identified and mission critical business processes were prioritized during 1998.
Priority was assigned based on the relative importance of the component to the
business process and based on the importance of the business process relative to
other business processes.
Efforts to remediate non-compliant internal components (principally mainframe
applications) began in the mid-1990's as a routine part of systems development
and maintenance. The Company's mainframe applications are believed to be 100
percent remediated. Management estimates that internal systems component testing
will be completed during the first quarter, or early in the second quarter, of
1999.
Test plans for substantially all other key business process components
identified during 1998 were developed during the first quarter of 1999. Where
individual testing of these other key components is beneficial, testing is being
conducted during the first quarter or early in the second quarter of 1999.
To supplement component testing and to provide a greater degree of assurance
that our business functions will be uninterrupted, full systems Year 2000
simulation testing is planned for March, April and May of 1999. Full systems
testing will entail simultaneous testing of underlying components necessary to
the support of key business processes. Testing environments that closely
approximate our operating environments for mainframe and LAN-based PC
applications are being developed and are expected to be fully functional before
the end of the first quarter of 1999. Each key business process (inclusive of
underlying components and the operating environments) will be scheduled during
the first quarter of 1999 as well. This effort incorporates key third parties
with which we are coordinating our testing efforts.
As testing progresses, each business unit is consulting with the Y2K Office to
develop contingency plans to address the possibility of component or business
process failures. The extent of contingency planning will be responsive to the
risk of failure and the relative importance of the component or business
process. Contingency planning is addressing both business continuity and system
recovery.
During the first quarter of 1999, the Company engaged an international
professional services consulting firm to perform a Y2K project methodology
evaluation. Their recommendations concerning certain aspects of our project
methodology and remediation, testing, and planning efforts have been
incorporated into our Y2K program.
67
<PAGE>
INCORPORATED BY REFERENCE, PAGE 34 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Cost to Address Year 2000 Issues
Prior to 1998, the Company did not establish a specific budget to address the
Year 2000 Issue. By including Year 2000 changes in the scope of each system
development and maintenance project, the Year 2000 Issue became an extension of
all system projects. It is estimated that through December 31, 1998 costs
incurred for specific Y2K activities including programming, testing, integrated
test planning, and administrative efforts approximate $1 million. This estimate
includes the cost of our internal efforts based on rates for personnel engaged
in these activities. Future costs will be incurred as testing and contingency
planning continues during 1999.
Management believes that the cost of testing and administrative support will
approximate $1.2 million during 1999 based on the project plans for these
activities. This estimate includes the cost of personnel involved in testing
($575,000) and the cost to complete the technical test environment ($500,000).
The cost of consulting resources engaged during the first quarter will
approximate $100,000. Any costs that may be incurred to replace non-compliant
software and hardware during 1999 are not expected to be significant.
In addition to these costs, the Company will incur internal personnel costs for
the development and testing of contingency plans during 1999. Such costs are not
yet determinable but are not believed to be material to the financial position
or results of operations of the Company.
Risk of the Company's Year 2000 Issues
The proper functioning of the Company's computer systems and applications is
critical to the continued operations of the Company. By addressing the Year 2000
Issue over several years in the ordinary course of business, the costs and
uncertainty associated with it have been reduced significantly. Management
believes that all critical business process systems and applications will be
Year 2000 compliant sufficiently in advance of January 1, 2000 and, therefore,
will not adversely affect the operations of the Company.
It is possible that certain key external parties will certify their systems as
year 2000 compliant when in fact they are not. The inability of the Company to
respond to uncontrollable circumstances is always a concern. For example, if
numerous key third parties are unable to support the operations of the Company,
operations could be adversely affected. The Company, as part of overall risk
management, will be preparing contingency plans during 1999 in response to the
possibility of key third party failure. Management does not anticipate these
scenarios as having a greater than remote possibility of occurrence.
Company's Contingency Plans if a Vendor or the Company fail to Address Year 2000
Issues
This risk described above will be addressed through contingency planning. The
level of contingency planning will be commensurate with the relative importance
of the external party to the operations of the Company and the relative risk
that the party will be unable to operate satisfactorily in 2000. Such
contingency plans are being developed and will be finalized during the first
nine months of 1999.
The statements containing the beliefs of management about the Company's state of
readiness for Year 2000 Issues are necessarily forward-looking statements that
involve risks and uncertainties. These risks and uncertainties include but are
not limited to: human or mechanical errors in correcting Year 2000 Issues;
incorrect or improper (intentional or otherwise) representations by third
parties as to their compliance or remediation efforts; the failure of third
parties to follow through on their remediation efforts; and the inability to
identify and/or locate processing chips that are subject to Year 2000 problems.
"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 "Analysis of Management Operations", "Analysis of
Insurance Underwriting Operations", "Financial Condition", "Reinsurance",
"Environmental-Related Claims" and "Factors That May Affect Future Results"
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 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, and technological
difficulties and advancements.
68
<PAGE>
INCORPORATED BY REFERENCE, PAGE 35 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Glossary of Selected Insurance Terms
! Assume:
To receive from an insurer or a reinsurer all or part of the insurance
or reinsurance written by an insurance or reinsurance entity.
! Attorney-in-fact:
Legal entity (Erie Indemnity Company, a corporate attorney-in-fact)
which is legally appointed by another (subscribers of the Exchange) to
transact business on its behalf.
! Cede:
To transfer to an insurer or a reinsurer all or part of the insurance
or reinsurance written by an insurance or reinsurance entity.
! Direct premiums written:
Premiums on policies written by an insurer, excluding premiums for
reinsurance assumed or ceded by an insurer.
! GAAP combined ratio:
Ratio of acquisition and underwriting expenses, losses and loss
adjustment expenses incurred to premiums earned.
! Gross margins from management operations:
Net revenues from management operations divided by total revenues from
management operations.
! Incurred but not reported reserves:
Estimated liabilities established by an insurer to reflect the losses
estimated to have occurred but which are not yet known by the insurer.
! Losses:
An occurrence that is the basis for submission of a claim. Losses may
be covered, limited or excluded from coverage, depending on the terms
of the policy. "Loss" also refers to the amount of the insurer's
liability arising out of the occurrence.
69
<PAGE>
INCORPORATED BY REFERENCE, PAGE 35 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
! Loss adjustment expenses (LAE):
The expenses of settling claims, including legal and other fees and
expenses, and the portion of general expenses allocated to claim
settlement costs.
! Loss reserves:
Estimated liabilities established by an insurer to reflect the
estimated cost of claims payments and the related expenses that
ultimately will be incurred in respect of insurance it has written.
! NAIC:
The National Association of Insurance Commissioners, an association of
the top regulatory officials of all 50 states and the District of
Columbia organized to promote consistency of regulatory practices and
statutory accounting practices throughout the United States.
! Property/Casualty insurance:
Casualty insurance indemnifies an insured against legal liability
imposed for losses caused by injuries to third persons (i.e. not the
policyholder). It includes, but is not limited to, employers'
liability, workers' compensation, public liability, automobile
liability and personal liability. Property insurance indemnifies a
person with an insurable interest in tangible property for his property
loss, damage or loss of use.
! Reciprocal insurance exchange:
An unincorporated group of persons known as subscribers who, under a
common name, exchange insurance contracts with each other for the
purpose of providing indemnity among themselves from losses through a
common attorney-in-fact. Each subscriber gives a power of attorney
under which the attorney-in-fact represents each subscriber in
exchanging insurance contracts with the other subscribers.
! Reinsurance:
An instrument under which an insurer cedes to another insurer all or a
portion of the risk insured and conveys/pays to that other insurer a
portion of the premium received from the insured. Reinsurance makes the
assuming reinsurer liable to the extent of the coverage ceded. However,
in the event the reinsurer is unable to pay the assumed portion of the
loss, the ceding insurer would be responsible for the entire loss.
70
<PAGE>
INCORPORATED BY REFERENCE, PAGE 55 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
Market Price of and Dividends on the Common Equity and Related Shareholder
Matters
Common Stock Prices:
The Class A non-voting common stock of the Company trades on The NASDAQ Stock
MarketK under the symbol "ERIE." The following sets forth the range of high and
low trading prices by quarter as reported by The NASDAQ Stock Market.
Class A Trading Price
<TABLE>
<CAPTION>
1998 1997
Low High Low High
<S> <C> <C> <C> <C>
First Quarter 26 1/2 32 3/4 26 35
Second Quarter 28 1/4 34 26 1/2 39 1/4
Third Quarter 25 1/2 32 15/16 30 1/2 40
Fourth Quarter 20 1/2 31 1/4 28 1/8 34 1/2
</TABLE>
No established trading market exists for the Class B voting common stock.
On February 18, 1997, The Executive Committee of the Board of Directors approved
an enhancement to the Company's 401(K) plan for Employees which permits
participants to invest a portion of the Company's contributions to the Plan in
shares of Erie Indemnity Class A common stock. The Plan's Trustee was authorized
to buy Erie Indemnity Company Class A common stock on behalf of 401(K) plan
participants beginning May 8, 1997.
At the December 16, 1998 regular meeting of the Board of Directors of the Erie
Indemnity Company, the Board approved a stock repurchase plan beginning January
1, 1999, under which the Company may repurchase as much as $70 million of its
outstanding Class A common stock through December 31, 2001. 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 Company's capital.
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 1998 and 1997 are as follows:
Dividends Declared
Class A Share Class B Share
1998:
First Quarter $ .1075 $ 16.125
Second Quarter .1075 16.125
Third Quarter .1075 16.125
Fourth Quarter .1200 18.000
$ .4425 $ 66.375
1997:
First Quarter $ .0950 $ 14.250
Second Quarter .0950 14.250
Third Quarter .0950 14.250
Fourth Quarter .1075 16.125
$ .3925 $ 58.875
71
<PAGE>
INCORPORATED BY REFERENCE, PAGE 55 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
As of February 26, 1999 there were approximately 1,308 shareholders of record of
the Company's Class A non-voting common stock and 27 shareholders of record of
the Company's Class B voting common stock.
Of the 67,007,500 shares of the Company's Class A common stock outstanding as of
February 26, 1999, approximately 24,617,867 shares are freely transferable
without restriction or further registration under the Securities Act of 1933
(the Act), as amended unless purchased by affiliates of the Company as that term
is defined in Rule 144 under the Act. The 42,389,633 remaining outstanding
shares of Class A common stock (the Restricted Shares) are held by the Company's
directors, executive officers and their affiliates and are restricted securities
which are eligible to be sold publicly pursuant to an effective registration
statement under the Act or in accordance with an applicable exemption,
including, after September 28, 1994, Rule 144, from the registration
requirements under the Act. The Company is unable to estimate the amount of
Restricted Shares that may be sold under Rule 144 since this amount will depend
in part on the price for the Class A common stock, the personal circumstances of
the sellers and other factors. Sales of a substantial number of Restricted
Shares in the public market, or the availability of such shares, could adversely
affect the price of the Class A common stock.
In general, under Rule 144 as currently in effect, a person (or persons whose
shares are aggregated for purposes of Rule 144) who beneficially has owned
Restricted Shares for at least two years, including affiliates of the Company,
is entitled to sell within any three-month period a number of shares that does
not exceed the greater of: (1) one percent of the number of shares of Class A
common stock then outstanding, or (2) the average weekly trading volume of the
Class A common stock in The NASDAQ Stock MarketK during the four calendar weeks
preceding the date on which notice of sale is filed with the SEC. Sales under
Rule 144 are also subject to certain manner of sale provisions, notice
requirements and the availability of current public information about the
Company. However, a person (or persons whose shares are aggregated for purposes
of Rule 144) who is deemed not to have been an affiliate of the Company at any
time during the 90 days preceding a sale, and who beneficially has owned the
Restricted Shares for at least three years at the time of sale, would be
entitled to sell such shares under Rule 144(k) without regard to the aforesaid
limitations.
The Company serves as its own transfer agent and registrar.
72
<PAGE>
Index to Graphs included in the
Management's Discussion and Analysis
Graph #1 ERIE INSURANCE GROUP
Organizational Structure/Major Business Units
Pooling
Property/Casualty Insurance Participation
Erie Insurance Exchange 94.5%
Erie Insurance Company*** 5.0%
Erie Insurance Company of New York** 0.5%
Erie Insurance Property & Casualty Company*** 0.0%
Flagship City Insurance Company* 0.0%
*Wholly-owned by Erie Insurance Exchange
**Wholly-owned by Erie Insurance Company
***Wholly-owned by Erie Indemnity Company
Management Operations
Erie Indemnity Company is the Attorney-in-Fact for the Erie
Insurance Exchange (A Reciprocal Insurance Exchange)
Life Insurance Operations
Erie Family Life Insurance Company
52.2% ownership by Erie Insurance Exchange
21.6% ownership by Erie Indemnity Company
Graph #2 NET INCOME
(In millions of dollars)
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Net Income for Year Ended December 31 $105.1 $118.6 $134.6
</TABLE>
Graph #3 NET REVENUES FROM MANAGEMENT
OPERATIONS AND GROSS MARGINS
(In millions of Dollars, except ratios)
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Net Revenues from Management Operations $127.3 $134.2 $145.2
Gross Margin from Management Operations 28.3% 28.2% 28.8%
</TABLE>
Graph #4 PREMIUMS EARNED AND GAAP
COMBINED RATIO EXCLUDING CATASTROPHES
(In millions of Dollars, except ratios)
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Premiums Earned for Year Ended December 31 $101.5 $107.3 $112.9
GAAP Combined Ratio Excluding Catastrophes 103.4 101.5 96.2
</TABLE>
73
<PAGE>
Index to Graphs included in the
Management's Discussion and Analysis
(Continued)
Graph #5 REVENUE FROM INVESTMENT OPERATIONS
(In millions of dollars)
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Realized Gain on Loss on Investments $ 6.6 $ 5.8 $ 7.2
Equity in Earnings of EFL $ 3.8 $ 4.2 $ 4.8
Net Investment Income $25.9 $32.9 $38.6
</TABLE>
Graph #6 DIVERSIFICATION OF FIXED MATURITIES
at December 31, 1998 - Carrying Value
U.S. Industrial & Misc. 46%
Special Revenue 31%
Political Subdivisions 12%
U.S. Gov'ts. 3%
Public Utilities 3%
Redeemable Preferred Stock 3%
Foreign Gov'ts, Industrial & Misc. 2%
Graph #7 QUALITY* OF FIXED MATURITIES
at December 31, 1998 - Carrying Value
Aaa/AAA 40%
A 23%
Aa/AA 16%
Baa/BBB 19%
Ba/BB 2%
* As rated by Standard & Poor's or Moody's Investor's Service, Inc.
Graph #8 TERM TO MATURITY OF FIXED MATURITIES
Subsequent to 2009 41%
2000-2004 30%
2005-2009 21%
1999 8%
Graph #9 DIVERSIFICATION OF EQUITY SECURITIES
At December 31, 1998 - Carrying Value
(1) U.S. Industrial & Misc. 41%
(2) U.S. Industrial & Misc. 30%
(2) Banks & Insurance 22%
(2) Foreign Industrial & Misc. 3%
(1) Foreign Industrial & Misc. 2%
(1) Banks & Insurance 2%
(1) Common Stocks
(2) Preferred Stocks
74
<PAGE>
INCORPORATED BY REFERENCE, PAGE 37 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
INDEPENDENT AUDITORS' REPORT
ON THE CONSOLIDATED FINANCIAL STATEMENTS
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, 1998 and 1997, and
the related consolidated statements of operations, shareholders' equity, and
cash flows for each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles.
/s/ Brown, Schwab, Bergquist & Co.
Erie, Pennsylvania
February 16, 1999
75
<PAGE>
INCORPORATED BY REFERENCE, PAGE 39 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
As of December 31, 1998 and 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
-------------- --------------
<S> <C> <C>
Investments:
Fixed maturities, at fair value
(amortized cost of $421,101,561
and $333,135,959, respectively) $ 441,353,427 $ 349,972,703
Equity securities, at fair value
(cost of $169,976,774 and $144,123,112,
respectively) 202,804,068 165,132,504
Real estate mortgage loans 8,287,129 8,392,518
Other invested assets 17,493,496 7,932,571
-------------- --------------
Total investments $ 669,938,120 $ 531,430,296
Cash and cash equivalents 53,580,043 53,148,495
Accrued investment income 7,252,439 6,128,725
Note receivable from Erie Family Life
Insurance Company 15,000,000 15,000,000
Premiums receivable from policyholders 114,695,231 108,057,986
Prepaid federal income taxes 2,508,908 1,681,573
Reinsurance recoverable from Erie Insurance
Exchange 381,301,722 383,131,027
Other receivables from Erie Insurance
Exchange and affiliates 108,612,264 112,730,131
Reinsurance recoverable non-affiliates 938,894 241,664
Deferred policy acquisition costs 10,863,107 10,283,372
Property and equipment 12,388,650 10,130,230
Equity in Erie Family Life Insurance Company 39,478,746 34,687,640
Other assets 36,873,922 25,892,642
-------------- --------------
Total assets $1,453,432,046 $1,292,543,781
============== ==============
</TABLE>
76
<PAGE>
INCORPORATED BY REFERENCE, PAGE 39 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997
-------------- --------------
<S> <C> <C>
LIABILITIES
Unpaid losses and loss adjustment expenses $ 426,164,578 $ 413,408,941
Unearned premiums 229,056,597 219,210,522
Accrued commissions 85,005,699 81,150,931
Accounts payable and accrued expenses 20,252,904 17,041,120
Deferred income taxes 17,121,777 7,101,371
Dividends payable 8,099,100 7,255,444
Employee benefit obligations 12,508,130 7,992,300
-------------- --------------
Total liabilities $ 798,208,785 $ 753,160,629
-------------- --------------
SHAREHOLDERS' EQUITY
Capital stock
Class A common, stated value $.0292 per
share; authorized 74,996,930 shares;
67,032,000 shares issued and outstanding $ 1,955,100 $ 1,955,100
Class B common, stated value $70 per
share; authorized 3,070 shares;
3,070 shares issued and outstanding 214,900 214,900
Additional paid-in capital 7,830,000 7,830,000
Accumulated other comprehensive income 40,178,626 29,024,573
Retained earnings 605,044,635 500,358,579
------------- --------------
Total shareholders' equity $ 655,223,261 $ 539,383,152
-------------- --------------
Total liabilities and
shareholders' equity $1,453,432,046 $1,292,543,781
============== ==============
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
77
<PAGE>
INCORPORATED BY REFERENCE, PAGE 38 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
-------------------- ------------------ ------------------
<S> <C> <C> <C>
MANAGEMENT OPERATIONS:
Management fee revenue $ 489,147,394 $ 467,602,283 $ 442,904,376
Service agreement revenue 13,878,922 7,026,373 5,069,140
Other operating revenue 1,540,299 1,363,298 1,218,573
-------------------- ------------------ ------------------
Total revenue from
management operations $ 504,566,615 $ 475,991,954 $ 449,192,089
Cost of management operations 359,323,406 341,791,061 321,872,411
-------------------- ------------------ ------------------
Net revenue from
management operations $ 145,243,209 $ 134,200,893 $ 127,319,678
-------------------- ------------------ ------------------
INSURANCE UNDERWRITING OPERATIONS:
Premiums earned $ 112,939,446 $ 107,349,668 $ 101,509,759
-------------------- ------------------ ------------------
Losses and loss adjustment
expenses incurred $ 79,880,665 $ 79,970,102 $ 85,070,861
Policy acquisition and
other underwriting expenses 32,491,506 29,638,991 28,018,109
-------------------- ------------------ ------------------
Total losses and
expenses $ 112,372,171 $ 109,609,093 $ 113,088,970
-------------------- ------------------ ------------------
Underwriting gain (loss) $ 567,275 ($ 2,259,425) ($ 11,579,211)
-------------------- ------------------ ------------------
INVESTMENT OPERATIONS:
Equity in earnings of Erie
Family Life Insurance Company $ 4,777,089 $ 4,230,909 $ 3,820,957
Net investment income 38,606,178 32,932,061 25,903,159
Net realized gain on
investments 7,163,706 5,815,186 6,583,208
-------------------- ------------------ ------------------
Total revenue from
investment operations $ 50,546,973 $ 42,978,156 $ 36,307,324
-------------------- ------------------ ------------------
Income before income
taxes $ 196,357,457 $ 174,919,624 $ 152,047,791
Provision for income taxes 61,805,963 56,338,434 46,915,432
-------------------- ------------------ ------------------
NET INCOME $ 134,551,494 $ 118,581,190 $ 105,132,359
==================== ================== ==================
Net income per share $ 1.81 $ 1.59 $ 1.41
==================== ================== ==================
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
78
<PAGE>
INCORPORATED BY REFERENCE, PAGE 41 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Total
Shareholders' Comprehensive Retained
Equity Income Earnings
<S> <C> <C> <C>
Balance, January 1, 1996 $ 354,064,241 $ 326,420,798
Comprehensive income
Net income 105,132,359 105,132,359 105,132,359
Other comprehensive loss,
net of tax:
Unrealized holding gains
arising during year 4,126,133 4,126,133
Less: reclassification
adjustment for gains
included in net income ( 4,279,085) ( 4,279,085)
-------------------
Other comprehensive loss,
net of tax ( 152,952)
-------------------
Comprehensive income $ 104,979,407
===================
Dividends:
Class A $.345 per share ( 23,126,084) ( 23,126,084)
Class B $51.75 per share ( 158,873) ( 158,873)
------------------- --------------------
Balance, December 31, 1996 $ 435,758,691 $ 408,268,200
------------------- --------------------
Balance, January 1, 1997
Comprehensive income
Net income 118,581,190 118,581,190 118,581,190
Other comprehensive income,
net of tax:
Unrealized holding gains
arising during year 15,313,953 15,313,953
Less: reclassification
adjustment for gains
included in net income ( 3,779,871) ( 3,779,871)
-------------------
Other comprehensive income,
net of tax 11,534,082
-------------------
Comprehensive income $ 130,115,272
===================
Dividends:
Class A $.3925 per share ( 26,310,064) ( 26,310,064)
Class B $58.875 per share ( 180,747) ( 180,747)
------------------- --------------------
Balance, December 31, 1997 $ 539,383,152 $ 500,358,579
------------------- --------------------
Balance, January 1, 1998
Comprehensive income
Net income 134,551,494 134,551,494 134,551,494
Other comprehensive income,
net of tax:
Unrealized holding gains
arising during year 15,810,462 15,810,462
Less: reclassification
adjustment for gains
included in net income ( 4,656,409) ( 4,656,409)
-------------------
Other comprehensive income,
net of tax 11,154,053
-------------------
Comprehensive income $ 145,705,547
===================
Dividends:
Class A $.4425 per share ( 29,661,666) ( 29,661,666)
Class B $66.375 per share ( 203,772) ( 203,772)
------------------- --------------------
Balance, December 31, 1998 $ 655,223,261 $ 605,044,635
=================== ====================
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
79
<PAGE>
INCORPORATED BY REFERENCE, PAGE 41 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Accumulated
Other
Comprehensive Class A Class B Additional
Income Common Common Paid-in Capital
<S> <C> <C> <C> <C>
Balance, January 1, 1996 $ 17,643,443 $ 1,955,100 $ 214,900 $ 7,830,000
Comprehensive income
Net income
Other comprehensive loss,
net of tax:
Unrealized holding gains
arising during year
Less: reclassification
adjustment for gains
included in net income
Other comprehensive loss, ( 152,952)
net of tax
Comprehensive income
Dividends:
Class A $.345 per share
Class B $51.75 per share
Balance, December 31, 1996 $ 17,490,491 $ 1,955,100 $ 214,900 $ 7,830,000
------------------- -------------------- -------------------- ----------------------
Balance, January 1, 1997
Comprehensive income
Net income
Other comprehensive income,
net of tax:
Unrealized holding gains
arising during year
Less: reclassification
adjustment for gains
included in net income
Other comprehensive income, 11,534,082
net of tax
Comprehensive income
Dividends:
Class A $.3925 per share
Class B $58.875 per share
Balance, December 31, 1997 $ 29,024,573 $ 1,955,100 $ 214,900 $ 7,830,000
------------------- -------------------- -------------------- ----------------------
Balance, January 1, 1998
Comprehensive income
Net income
Other comprehensive income,
net of tax:
Unrealized holding gains
arising during year
Less: reclassification
adjustment for gains
included in net income
Other comprehensive income, 11,154,053
net of tax
Comprehensive income
Dividends:
Class A $.4425 per share
Class B $66.375 per share
Balance, December 31, 1998 $ 40,178,626 $ 1,955,100 $ 214,900 $ 7,830,000
=================== ==================== ==================== ======================
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
80
<PAGE>
INCORPORATED BY REFERENCE, PAGE 40 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
-------------- -------------- ---------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 134,551,494 $ 118,581,190 $ 105,132,359
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and amortization 2,000,816 1,888,660 1,428,376
Deferred income tax expense 4,677,456 440,871 1,255,163
Amortization of deferred policy
acquisition costs 21,356,677 20,102,986 18,909,001
Realized gain on investments ( 7,163,706) ( 5,815,186) ( 6,583,208)
Net amortization of bond discount ( 88,636) ( 158,240) ( 19,640)
Undistributed earnings of
Erie Family Life ( 3,550,749) ( 3,127,202) ( 2,799,190)
Deferred compensation 1,081,594 345,450 ( 151,646)
Increase in accrued investment
income ( 1,123,714) ( 558,686) ( 589,879)
Increase in receivables ( 1,387,303) ( 21,845,530) ( 30,842,709)
Policy acquisition costs deferred ( 21,936,412) ( 20,845,360) ( 19,438,265)
Increase in prepaid expenses
and other assets ( 10,194,185) ( 4,503,392) ( 3,655,923)
Increase (decrease) in accounts
payable and accrued expenses 6,646,018 ( 2,864,021) ( 2,200,926)
Increase in accrued commissions 3,854,768 5,632,338 2,820,729
(Decrease) increase in income
taxes payable ( 827,335) 2,375,401 ( 3,124,595)
Increase in loss reserves 12,755,637 26,983,922 29,090,892
Increase in unearned premiums 9,846,075 2,272,453 14,131,495
----------------- ---------------- ----------------
Net cash provided by
operating activities $ 150,498,495 $ 118,905,654 $ 103,362,034
----------------- ----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments:
Fixed maturities ($ 132,217,320) ($ 69,647,276) ($ 129,218,290)
Equity securities ( 90,404,633) ( 73,953,554) ( 71,925,472)
Mortgage loans ( 159,612) ( 1,222,747) ( 2,933,110)
Other invested assets ( 12,786,646) ( 1,571,223) ( 3,114,141)
Sales/maturities of investments:
Fixed maturities 45,147,935 37,995,727 58,677,994
Equity securities 70,847,725 51,482,876 32,959,337
Mortgage loans 265,257 124,108 68,519
Other invested assets 3,308,459 648,453 1,422,557
Purchase of property and equipment ( 394,493) ( 558,824) ( 2,129,961)
Purchase of computer software ( 3,864,743) ( 1,618,530) ( 898,016)
Loans to agents ( 2,431,326) ( 1,729,022) ( 3,086,074)
Collections on agent loans 1,644,230 1,220,381 1,174,808
---------------- ---------------- ----------------
Net cash used in
investing activities ($ 121,045,167) ($ 58,829,631) ($ 119,001,849)
---------------- ---------------- ----------------
CASH FLOW FROM FINANCING ACTIVITY
Dividends paid to shareholders ($ 29,021,780) ($ 25,647,152) ($ 22,497,544)
---------------- ---------------- ----------------
Net cash used in
financing activity ($ 29,021,780) ($ 25,647,152) ($ 22,497,544)
---------------- ---------------- ----------------
Net increase (decrease) in cash and
cash equivalents 431,548 34,428,871 ( 38,137,359)
Cash and cash equivalents at beginning
of year 53,148,495 18,719,624 56,856,983
---------------- ---------------- ----------------
Cash and cash equivalents at end of year $ 53,580,043 $ 53,148,495 $ 18,719,624
================ ================= =================
Supplemental disclosures of cash flow information:
Cash paid during the year ended December 31, 1998, 1997 and 1996 for income
taxes was $57,928,552, $55,166,001 and $48,784,864 respectively.
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
81
<PAGE>
INCORPORATED BY REFERENCE, PAGE 42 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All amounts are in thousands of dollars except per share data
NOTE 1. NATURE OF BUSINESS
Erie Indemnity Company (Company) is the attorney-in-fact for
the Erie Insurance Exchange (Exchange), a reciprocal
insurance exchange. The Company earns a management fee for
administrative and underwriting services provided to the
Exchange and its affiliates. The Exchange is a
property/casualty insurer rated A++, Superior, by
A. M. Best. See also Note 9.
The Company's property/casualty insurance subsidiaries
share proportionately in the results of all property/casualty
insurance underwriting operations of the Exchange. The
Exchange, Erie Insurance Company (EIC), a wholly-owned
subsidiary of the Company and the Erie Insurance Company of New
York (EINY), a wholly-owned subsidiary of the EIC, are part of
an intercompany pooling agreement. Under this agreement, EIC
and EINY cede 100% of their property/casualty insurance
business, including property/casualty insurance operations
assets and liabilities, to the Exchange. The Exchange
retrocedes to EIC and EINY a specified percentage (5% for EIC
and .5% for EINY during 1998, 1997 and 1996) of all pooled
property/casualty insurance business, including insurance
operations assets and liabilities. Insurance ceded by EIC and
EINY to the Exchange does not relieve EIC and EINY from their
primary liability as the original insurers. See also Note 11.
The property and casualty insurers operate in nine states and
the District of Columbia. Business consists, to a large
extent, of private passenger and commercial automobile,
homeowners and workers' compensation insurance in
Pennsylvania, Ohio, West Virginia, Maryland and Virginia.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The accompanying consolidated financial statements have been
prepared in conformity with generally accepted accounting
principles that differ from statutory accounting practices
prescribed or permitted for insurance companies by regulatory
authorities.
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.
Reclassifications
Certain amounts reported in the 1997 and 1996 financial
statements have been reclassified to conform to the current
year's financial statement presentation.
82
<PAGE>
INCORPORATED BY REFERENCE, PAGE 42 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Use of estimates
The preparation of financial statements in conformity with
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
Fixed maturities determined by management not to be
held-to-maturity and marketable equity securities are
classified as available-for-sale. 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
comprehensive income and shareholders' equity.
There are no securities classified as "trading" or
"held-to-maturity".
Realized gains and losses on sales of investments, including
losses from declines in value of specific securities determined
by management to be other-than-temporary, are recognized in
income on the specific identification method.
Interest and dividend income is recorded as earned.
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 Statements of Operations in net realized gain
on investments.
Other invested assets (primarily investments in real estate
limited partnerships) are recorded under the equity method of
accounting.
Fair values of available-for-sale securities are based on
quoted market prices, where available, or dealer quotations.
The carrying value of short-term investments approximates fair
value because of the short-term maturity of these instruments.
The carrying value of receivables and liabilities arising in
the ordinary course of business approximates their fair values.
Cash equivalents
Cash equivalents include, primarily, investments in bank money
market funds. The carrying amounts reported in the Statements
of Financial Position approximate fair value due to the
short-term maturity of these investments.
83
<PAGE>
INCORPORATED BY REFERENCE, PAGES 42 AND 43 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Recognition of premium revenues and losses
Property and liability premiums are generally recognized as
revenue on a pro rata basis over the policy term. Unearned
premiums are established for the unexpired portion of premiums
written. Losses and loss adjustment expenses are recorded as
incurred. Premiums earned and losses and loss expenses incurred
are reflected in the Statements of Operations net of amounts
ceded to the Exchange. See also Note 11.
Deferred policy acquisition costs
Commissions and other costs of acquiring insurance that vary
with and are primarily related to the production of new and
renewal business are deferred and amortized over the terms of
the policies or reinsurance treaties to which they relate. The
amount of costs to be deferred would be reduced to the extent
future policy premiums and anticipated investment income would
not exceed related losses, expenses and Policyholder dividends.
Amortization equaled $21,357, $20,103 and $18,909 in 1998, 1997
and 1996, respectively.
Insurance liabilities
Losses refer to amounts paid or expected to be paid for events
which have occurred. The cost of investigating, resolving and
processing these claims are referred to as loss adjustment
expenses. A liability is established for the total unpaid cost
of losses and loss adjustment expenses, which covers events
occurring in current and prior years.
The liability for losses and loss adjustment expenses includes
an amount determined from loss reports and individual cases and
an amount, based on past experience, for losses incurred but
not reported. Inflation is provided for in the reserving
function through analysis of costs, trends and reviews of
historical reserving results. Such liabilities are necessarily
based on estimates and, while management believes the amount is
appropriate, the ultimate liability may differ from the amounts
provided. The methods for making such estimates and for
establishing the resulting liability are continually reviewed,
and any adjustments are reflected in earnings current. Loss
reserves are set at full expected cost except for loss reserves
for workers' compensation which have been discounted at 2.5%.
The effect of discounting workers' compensation loss reserves
on profit and loss for 1998 was $1,562, a reduction loss and
loss adjustment expenses. The reserves for losses and loss
adjustment expenses is reported net of receivables for salvage
and subrogation of $2,970 and $2,957 at December 31, 1998 and
1997, respectively.
Environmental-related claims
In establishing the liability for unpaid losses and loss
adjustment expenses related to environmental claims, management
considers facts currently known and the current state of the
law and coverage litigation. Liabilities are recognized for
known claims (including the cost of related litigation) when
sufficient information has been developed to indicate the
84
<PAGE>
INCORPORATED BY REFERENCE, PAGE 43 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
involvement of a specific insurance policy, and management can
reasonably estimate its liability. In addition, liabilities
have been established to cover additional exposures on both
known and unasserted claims. Estimates of the liabilities are
reviewed and updated continually.
Liability for guaranty fund and other assessments
The Company may be required, under the solvency or guaranty
laws of the various states in which it is licensed, to pay
assessments up to prescribed limits to fund Policyholder losses
or liabilities of insolvent insurance companies. Certain states
permit these assessments, or a portion thereof, to be recovered
as an offset to future premium taxes. Assessments are
recognized when they are imposed or information indicates it is
probable one will be imposed, or an event obligating the
Company has occurred and the amount is reasonably estimated.
When the assessment is subject to credit against future premium
taxes and judged to be recoverable, it may be capitalized and
amortized on a basis consistent with the credits to be realized
under applicable state law. The Company's estimated liability
for guaranty fund and other assessments at December 31, 1998
and 1997 totaled $1,189 and $489, respectively.
Reinsurance
The Statements of Operations are reflected net of reinsurance
activities. Gross losses and expenses incurred are reduced for
amounts expected to be recovered under reinsurance agreements.
Reinsurance transactions are recorded "gross" on the Statements
of Financial Position. 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.
Income taxes
Provisions for income taxes include deferred taxes resulting
from changes in cumulative temporary differences between the
tax bases and financial statement bases of assets and
liabilities. Deferred taxes are provided on a liability method
whereby deferred tax assets are recognized for deductible
temporary differences and deferred tax liabilities are
recognized for taxable temporary differences. Deferred tax
assets and liabilities are adjusted for the effects of changes
in tax laws and rates on the date of enactment.
Property and equipment
Property and equipment are stated at cost. Improvements and
replacements are capitalized, while expenditures for
maintenance and repairs are charged to expense as incurred.
Depreciation of property and equipment is computed using
straight line and accelerated methods over the estimated useful
lives of the assets. The costs and accumulated depreciation and
amortization of property sold or retired are removed from the
accounts and gains or losses, if any, are reflected in earnings
for the year.
85
<PAGE>
INCORPORATED BY REFERENCE, PAGES 43 AND 44 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In March of 1998, the American Institute of Certified Public
Accountants issued Statement of Position (SOP) 98-1,
"Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." This SOP provided guidance on
accounting for the costs of computer software developed or
obtained for internal use. The Company adopted this SOP in the
first quarter of 1998. Software development costs totaling
$3,639 in 1998 were capitalized. These costs will be amortized
on a straight line basis over the expected life of the product
once the software is ready for its intended use.
Property and equipment as of December 31 is summarized as
follows:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Land $ 737 $ 737
Buildings 5,858 5,857
Leasehold improvements 251 242
Computer software 12,497 8,632
Computer equipment 3,030 2,645
Transportation equipment 450 450
----------- -----------
$ 22,823 $ 18,563
Less accumulated depreciation 10,434 8,433
----------- -----------
$ 12,389 $ 10,130
=========== ===========
</TABLE>
Earnings per share
Earnings per share is based on the weighted average number of
Class A shares outstanding, giving effect to the conversion of
the weighted average number of Class B shares outstanding at a
rate of 2,400 Class A shares for one Class B share. The total
weighted average number of Class A equivalent shares
outstanding (including conversion of Class B shares) is
74,400,000.
Comprehensive income
The Company adopted the provisions of the Statement of
Financial Accounting Standards (FAS) No. 130, "Reporting
Comprehensive Income," in 1998. Comprehensive income is defined
as any change in equity from transactions and other events
originating from nonowner sources. The Company began displaying
comprehensive income in the first quarter of 1998 and has
displayed accumulated comprehensive income in the Statements of
Shareholders' Equity at December 31, 1998.
86
<PAGE>
INCORPORATED BY REFERENCE, PAGE 44 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. INVESTMENTS
The following tables summarize the cost and market value of
available-for-sale securities at December 31, 1998 and 1997
based on current year classifications.
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
December 31, 1998
Fixed Maturities:
U.S. treasuries &
government agencies $ 13,018 $ 689 $ 0 $ 13,707
States & political
subdivisions 48,307 3,293 0 51,600
Special revenue 132,025 7,215 5 139,235
Public utilities 13,116 300 0 13,416
U. S. industrial &
miscellaneous 195,296 9,028 629 203,695
Foreign industrial &
miscellaneous 5,159 165 86 5,238
Foreign governments-
agency 1,990 0 181 1,809
------------- --------------- -------------- -------------
Total bonds 408,911 20,690 901 428,700
Redeemable preferred
stock 12,191 577 115 12,653
------------- --------------- -------------- -------------
Total fixed
maturities $ 421,102 $ 21,267 $ 1,016 $ 441,353
------------- --------------- -------------- -------------
Equity Securities:
Common stock:
U. S. banks, trusts &
insurance companies $ 3,522 $ 197 $ 231 $ 3,488
U. S. industrial &
miscellaneous 53,914 37,158 7,509 83,563
Foreign industrial &
miscellaneous 3,186 271 278 3,179
Non-redeemable
preferred stock:
U. S. banks, trusts &
insurance companies 42,807 2,561 30 45,338
U. S. industrial &
miscellaneous 59,858 2,024 1,419 60,463
Foreign industrial &
miscellaneous 6,690 228 145 6,773
------------- --------------- -------------- -------------
Total equity
securities $ 169,977 $ 42,439 $ 9,612 $ 202,804
------------- --------------- -------------- -------------
Total available-
for-sale
securities $ 591,079 $ 63,706 $ 10,628 $ 644,157
============= =============== ============== =============
</TABLE>
87
<PAGE>
INCORPORATED BY REFERENCE, PAGE 45 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. INVESTMENTS (CONTINUED)
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
December 31, 1997
Fixed Maturities:
U. S. treasuries &
government agencies $ 12,771 $ 432 $ 3 $ 13,200
Foreign governments-
agency 1,989 0 418 1,571
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 industrial &
miscellaneous 2,556 61 0 2,617
------------- --------------- -------------- -------------
Total fixed
maturities $ 333,136 $ 17,660 $ 823 $ 349,973
------------- --------------- -------------- -------------
Equity Securities:
Common stock:
U. S. banks, trusts &
insurance companies $ 3,138 $ 3,379 $ 0 $ 6,517
U. S. industrial &
miscellaneous 58,415 19,650 6,874 71,191
Foreign industrial &
miscellaneous 3,209 53 800 2,462
Non-redeemable
preferred stock:
Public utilities 2,619 27 0 2,646
U. S. banks, trusts &
insurance companies 46,901 3,347 0 50,248
U. S. industrial &
miscellaneous 25,909 2,006 1 27,914
Foreign industrial &
miscellaneous 3,932 223 0 4,155
------------- --------------- -------------- -------------
Total equity
securities $ 144,123 $ 28,685 $ 7,675 $ 165,133
------------- --------------- -------------- -------------
Total available-
for-sale
securities $ 477,259 $ 46,345 $ 8,498 $ 515,106
============= =============== ============== =============
</TABLE>
88
<PAGE>
INCORPORATED BY REFERENCE, PAGE 45 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of fixed maturities at
December 31, 1998, by remaining contractual term to maturity, are
shown below.
<TABLE>
<CAPTION>
Amortized Estimated
Cost Fair Value
<S> <C> <C>
Due in one year or less $ 34,272 $ 34,288
Due after one year through five years 131,820 134,131
Due after five years through ten years 85,657 90,449
Due after ten years 169,353 182,485
------------- --------------
$ 421,102 $ 441,353
============= ==============
</TABLE>
Changes in unrealized gains consist of the following for the years
ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ---------- ----------
<S> <C> <C> <C>
Equity securities $ 11,818 $ 5,462 $ 5,830
Fixed maturities 3,415 7,754 ( 2,955)
Other 32 63 ( 69)
Equity in unrealized gains
(losses) of Erie Family Life
Insurance Company 1,232 2,880 ( 1,994)
Deferred federal income taxes ( 5,343) ( 4,625) ( 965)
------------ ---------- ----------
Increase (decrease) in unrealized
gains $ 11,154 $ 11,534 ($ 153)
============ ========== ==========
</TABLE>
Net investment income consists of the following for the years
ended December 31:
<TABLE>
1998 1997 1996
------------- -------------- -------------
<S> <C> <C> <C>
Fixed maturities $ 25,562 $ 21,929 $ 18,071
Equity securities 8,227 7,059 6,897
Other 5,256 4,237 1,201
------------- -------------- -------------
Total investment income 39,045 33,225 26,169
Investment expense 439 293 266
------------- -------------- -------------
Net investment income $ 38,606 $ 32,932 $ 25,903
============= ============== =============
</TABLE>
89
<PAGE>
INCORPORATED BY REFERENCE, PAGE 46 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. INVESTMENTS (CONTINUED)
Realized gains and losses on investments reflected in operations
are summarized below for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Realized gains:
Fixed maturities $ 809 $ 252 $ 1,015
Equity securities 9,663 6,613 5,969
Other invested assets 688 0 299
----------- ----------- -----------
Total gains $ 11,160 $ 6,865 $ 7,283
----------- ----------- -----------
Realized losses:
Fixed maturities $ 1 $ 19 $ 198
Equity securities 3,397 1,031 378
Other invested assets 598 0 124
----------- ----------- -----------
Total losses $ 3,996 $ 1,050 $ 700
----------- ----------- -----------
Net realized gain on
on investments $ 7,164 $ 5,815 $ 6,583
=========== =========== ===========
</TABLE>
NOTE 4. EQUITY IN ERIE FAMILY LIFE INSURANCE COMPANY
The following represents condensed financial information for Erie
Family Life Insurance Company (EFL):
<TABLE>
<CAPTION>
1998 1997 1996
-------------- ------------- -------------
<S> <C> <C> <C>
Investments $ 774,882 $ 703,033 $ 653,917
Total assets 917,606 832,534 740,651
Liabilities 735,075 672,155 608,020
Shareholders'
equity 182,531 160,379 132,631
Revenues 96,210 91,037 82,720
Net income 22,085 19,560 17,666
Dividends paid to
shareholders 5,528 5,009 4,615
</TABLE>
The Company's share of EFL's net unrealized gains or losses on
securities is reflected in shareholders' equity ($5,656, $4,425
and $1,545 at December 31, 1998, 1997 and 1996, respectively.) The
1998, 1997 and 1996 changes in this net unrealized gain on
securities were $1,232, $2,880 and ($1,994), respectively.
Deferred federal income taxes have not been provided on the
Company's equity in undistributed earnings of EFL. It is
management's current intent to reinvest undistributed earnings
indefinitely and not liquidate its investment in EFL. The
estimated deferred tax liability unrecognized at December 31,
1998, 1997 and 1996 is $2,737, $2,401 and $1,981, respectively.
90
<PAGE>
INCORPORATED BY REFERENCE, PAGES 46 AND 47 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. BENEFIT PLANS
The following benefit plan information is presented in accordance
with FAS 132, "Employers' Disclosures about Pensions and Other
Post-retirement Benefits." FAS132 addresses only disclosure
requirements of pensions and other post-retirement benefits, not
measurement or recognition issues.
Pension plan for Employees
The Company has a non-contributory defined benefit pension plan
covering substantially all Employees of the Company.
Information about this plan follows for the years ended
December 31:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Net periodic benefit cost:
Service cost $ 5,119 $ 4,451
Interest cost 6,214 5,550
Expected return on plan assets ( 9,419) ( 8,060)
Amortization of prior service cost 448 447
Recognized actuarial gain ( 1,252) ( 979)
Amortization of unrecognized
initial net obligation ( 234) ( 234)
-------------- --------------
Net periodic benefit
cost $ 876 $ 1,175
============== ==============
Fair Value of Plan Assets:
Fair value of plan assets at January 1 $ 117,644 $ 98,761
Actual return on plan assets 12,330 12,796
Employer contributions 6,491 6,290
Benefits paid ( 3,088) ( 203)
-------------- --------------
Fair value of plan assets at December 31 $ 133,377 $ 117,644
============== ==============
Benefit obligation:
Benefit obligation at January 1 $ 83,575 $ 72,016
Service cost 5,119 4,451
Interest cost 6,214 5,550
Actuarial gain 8,461 1,761
Benefits paid ( 3,088) ( 203)
-------------- --------------
Benefit obligation at December 31 $ 100,281 $ 83,575
============== ==============
Funded status:
Funded status at December 31 $ 33,096 $ 34,069
Unrecognized net actuarial gain ( 23,073) ( 29,875)
Unrecognized prior service cost 2,929 3,376
Unrecognized initial net obligation ( 1,168) ( 1,402)
-------------- --------------
Net asset recognized on Statements of
Financial Condition $ 11,784 $ 6,168
============== ==============
</TABLE>
91
<PAGE>
INCORPORATED BY REFERENCE, PAGE 47 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. BENEFIT PLANS (CONTINUED)
The plan assets include cash, treasury bonds, corporate bonds,
common and preferred stocks and mortgages.
Assumptions used in accounting for the pension plan were as
follows:
<TABLE>
<CAPTION>
1998 1997
------ ------
<S> <C> <C>
Weighted average discount rate used to
measure projected benefit obligation 6.75% 7.25%
Weighted average rate of compensation
increase used to measure projected
benefit obligation 5.00% 5.00%
Weighted average expected long-term
rate of return on plan assets 8.25% 8.25%
</TABLE>
The Company's funding policy is to contribute amounts
sufficient to meet minimum ERISA funding requirements plus such
additional amounts as may be determined to be appropriate.
The pension plan purchases individual annuities periodically
from EFL to settle retiree benefit payments. Such purchases
equaled $6,413, $1,992 and $4,894 in 1998, 1997 and 1996,
respectively. These are non-participating annuity contracts
under which EFL has unconditionally contracted to provide
specified benefits to beneficiaries in return for a fixed
premium from the plan. However, the plan remains the primary
obligor to the beneficiaries and a contingent liability exists
in the event EFL could not honor the annuity contracts. The
benefit obligation has been reduced for these annuities
purchased for retirees.
The accumulated benefit obligation was $59,537 and $50,290,
respectively, as of December 31, 1998 and 1997.
Pension plans for officers and outside directors
The Company has an unfunded supplemental pension plan for its
officers and an unfunded pension plan for its outside
directors. The pension plan for outside directors froze
accruals effective April 30, 1997. The benefits for all active
participants were settled effective July 31, 1997 through
participants' elections to transfer the lump sum values of
these benefits to a deferred compensation plan for outside
directors. The effect of curtailments on the Company was not
significant. Information about the plans follow for the years
ended December 31:
<TABLE>
<CAPTION>
1998 1997
------------- --------------
<S> <C> <C>
Net periodic benefit cost:
Service cost $ 363 $ 225
Interest cost 628 404
Amortization of prior service cost 528 216
Recognized actuarial loss 364 388
------------- --------------
Net periodic benefit cost $ 1,883 $ 1,233
============= ==============
</TABLE>
92
<PAGE>
INCORPORATED BY REFERENCE, PAGES 47 AND 48 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. BENEFIT PLANS (CONTINUED)
<TABLE>
<CAPTION>
1998 1997
------------ -------------
<S> <C> <C>
Benefit obligation:
Benefit obligation at January 1 $ 5,049 $ 3,915
Service cost 363 225
Interest cost 628 401
Amendments 3,138 109
Actuarial loss 993 1,693
Benefits paid ( 70) ( 1,294)
------------ -------------
Benefit obligation at December 31 $ 10,101 $ 5,049
============ =============
Funded status:
Funded status at December 31 $ 10,101 $ 5,049
Unrecognized net actuarial gain ( 3,423) ( 2,455)
Unrecognized prior service cost ( 3,299) ( 689)
------------ -------------
Net liability recognized on Statements
of Financial Condition $ 3,379 $ 1,905
============ =============
Amounts recognized in the Statements of
Financial Condition consist of:
Accrued benefit liability $ 6,678 $ 2,690
Intangible asset ( 3,299) ( 785)
------------ -------------
Net amount recognized $ 3,379 $ 1,905
============ =============
</TABLE>
The weighted average discount rate used for purposes of
determining the projected benefit obligation of the officers'
supplemental pension plan was 6.75% and 7.25% in 1998 and 1997,
respectively. The weighted average rate of compensation
increase used to measure the projected benefit obligation of
the officers' supplemental pension plan was 5.0% in 1998 and
1997.
An intangible asset has been recorded to reflect the transition
of the additional liability of the Company.
The accumulated benefit obligation was $6,678 and $2,690,
respectively, as of December 31, 1998 and 1997.
Post-retirement benefits other than pensions
The Company provides post-retirement medical coverage for
eligible retired Employees and eligible dependents. The Company
pays the obligation when due. Actuarially determined costs are
recognized over the period the Employee provides service to the
Company. Information about this plan follows for the years
ended December 31:
<TABLE>
<CAPTION>
1998 1997
---------- -----------
<S> <C> <C>
Net periodic benefit cost:
Service cost $ 333 $ 288
Interest cost 319 290
Amortization of prior service cost ( 37) ( 37)
Recognized actuarial gain ( 40) ( 30)
---------- -----------
Net periodic benefit cost $ 575 $ 511
========== ===========
</TABLE>
93
<PAGE>
INCORPORATED BY REFERENCE, PAGE 48 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. BENEFIT PLANS (CONTINUED)
<TABLE>
<CAPTION>
1998 1997
------------ -------------
<S> <C> <C>
Change in benefit obligation:
Benefit obligation at January 1 $ 4,071 $ 4,475
Service cost 333 288
Interest cost 319 290
Amendments 0 ( 513)
Actuarial loss (gain) 423 ( 358)
Benefits paid ( 112) ( 111)
------------ -------------
Benefit obligation at December 31 $ 5,034 $ 4,071
============ =============
Funded status:
Funded status at December 31 $ 5,034 $ 4,071
Unrecognized net actuarial loss 356 755
Unrecognized initial net obligation 440 476
------------ -------------
Net amount recognized $ 5,830 $ 5,302
============ =============
</TABLE>
The cash payments for such benefits were $112, $176 and
$213 in 1998, 1997 and 1996, respectively.
The weighted average discount rate used to measure the
accumulated post-retirement benefit obligation was 6.75% and
7.25% in 1998 and 1997, respectively. The December 31, 1998
accumulated benefit obligation was based on a 9.0% increase in
the cost of covered health care benefits during 1998. The
expected health care cost trend rate assumption for 1999 is
8.5%. This rate is assumed to decrease gradually to 5% per year
in 2006 and to remain at that level thereafter.
<TABLE>
<CAPTION>
1998 1997
------------ -------------
<S> <C> <C>
Effect on total of service and interest
cost components:
1% Increase $ 113 $ 100
1% Decrease ( 94) ( 83)
Effect on post-retirement benefit
obligation:
1% Increase $ 766 $ 640
1% Decrease ( 647) ( 541)
</TABLE>
Employee savings plan
The Company has an Employee Savings Plan for its Employees.
Eligible participants are permitted to make contributions of 1%
to 8% of compensation to the plan on a pre-tax salary reduction
basis in accordance with provisions of Section 401(k) of the
Internal Revenue Code. The Company matches one-half of the
participant contributions up to 6% of compensation. All
full-time Employees are eligible to participate in the plan.
The Company's matching contributions to the plan in 1998, 1997
and 1996 were $3,069, $2,892 and $2,688, respectively.
Effective May 1997, Employees were permitted to invest a
portion of employer contributions in the Class A common stock
of the Company. The plan will acquire shares necessary to meet
the obligations of the plan in the open market.
94
<PAGE>
INCORPORATED BY REFERENCE, PAGE 49 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. BENEFIT PLANS (CONTINUED)
Deferred compensation and incentive plans
The Company has deferred compensation and incentive plans for
certain eligible Employees of the Company and its affiliates.
Compensation deferred under these plans and charged to
operations amounted to $2,817, $1,347 and $259 during 1998,
1997 and 1996, respectively.
Health and dental benefits
The Company has self-funded health and dental care plans for
all of its Employees and eligible dependents. Estimated unpaid
claims incurred are accrued as a liability at December 31, 1998
and 1997. Operations were charged $13,057, $12,646 and $9,899
in 1998, 1997 and 1996, respectively, for the cost of health
and dental care provided under these plans.
The above mentioned benefit plan expenses are presented gross,
prior to reimbursement from the Exchange and EFL. See also Note 9.
NOTE 6. INCOME TAXES
The provision for income taxes consists of the following for the
years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
-------------- ------------- -------------
<S> <C> <C> <C>
Federal
Current $ 57,129 $ 55,897 $ 45,660
Deferred 4,677 441 1,255
-------------- ------------- -------------
$ 61,806 $ 56,338 $ 46,915
============== ============= =============
</TABLE>
A reconciliation of the provision for income taxes with amounts
determined by applying the statutory federal income tax rates to
pre-tax income is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------ -------------
<S> <C> <C> <C>
Income tax at
statutory rates $ 68,725 $ 61,222 $ 53,217
Deduct:
Undistributed earnings
of affiliate ( 1,242) ( 1,095) ( 980)
Tax-exempt interest ( 3,192) ( 3,009) ( 3,338)
Dividends received
deduction ( 1,782) ( 1,628) ( 1,483)
Other ( 703) 848 ( 501)
-------------- ------------- -------------
Provision for income taxes $ 61,806 $ 56,338 $ 46,915
============== ============= =============
</TABLE>
95
<PAGE>
INCORPORATED BY REFERENCE, PAGE 49 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. INCOME TAXES (CONTINUED)
Temporary differences and carryforwards which give rise to
deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
December 31,
1998 1997
----------- -----------
<S> <C> <C>
Deferred tax assets:
Loss reserve discount $ 3,497 $ 4,012
Unearned premiums 3,884 3,733
Alternative minimum tax paid 1,108 2,305
Employee benefit plan obligations 2,526 1,943
Other 275 95
----------- -----------
Total deferred tax assets $ 11,290 $ 12,088
=========== ===========
Deferred tax liabilities:
Deferred policy acquisition costs $ 3,802 $ 3,599
Unrealized gains 18,590 13,246
Pension and other benefits 3,469 1,472
Capitalized salaries and benefits 589 0
Accrual of discount 988 792
Property and equipment 547 80
Other 427 0
----------- -----------
Total deferred tax liabilities $ 28,412 $ 19,189
----------- -----------
Net deferred tax liability $ 17,122 $ 7,101
=========== ===========
</TABLE>
A reconciliation of the provision for income taxes with
comprehensive income reported on the Statements of Shareholders'
Equity is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------------- ----------------- ----------------
<S> <C> <C> <C>
Unrealized gains (losses) on
securities:
Unrealized holding gains arising
during year $ 24,324 $ 23,560 $ 6,348
Less: reclassification
adjustment for gains included
in net income 7,164 5,815 6,583
----------------- ----------------- ----------------
Net unrealized holding gains
(losses) arising during
year $ 17,160 $ 17,745 ($ 235)
----------------- ----------------- ----------------
Income tax (expense) benefit
related to unrealized gains
(losses) ($ 6,006) ($ 6,211) $ 82
----------------- ----------------- ----------------
Other comprehensive income
(loss), net of tax $ 11,154 $ 11,534 ($ 153)
================= ================= ================
</TABLE>
Erie Indemnity Company, as a corporate attorney-in-fact for a
reciprocal insurer, is not subject to state corporate taxes.
96
<PAGE>
INCORPORATED BY REFERENCE, PAGE 50 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7. 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. 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% of any
dividend declared on each share of Class B common stock. The
Company may declare and pay a dividend in respect of Class A
common stock without any requirement that any dividend be
declared and paid in respect of 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.
Redemption provisions
The Erie Indemnity Company Stock Redemption Plan entitles heirs
of 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 as determined in the Board's sole discretion after
consideration of certain factors at time of redemption. The
redemption amount is limited 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% 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% of the
Company's retained earnings determined as of the close of the
prior year. In addition, the plan limits the repurchase from
any single shareholder's estate to 33% of total shareholdings
of such shareholder. On March 11, 1997, the Board of Directors
approved an increase in the redemption amount of $16,655 to
$41,005. On April 28, 1998, the Board approved an increase in
the redemption amount of $17,792 to $58,797. There were no
shares of stock redeemed during 1998, 1997 or 1996.
Stock repurchase plan
At the December 16, 1998 regular meeting of the Board of
Directors of the Erie Indemnity Company, the board approved a
stock repurchase plan beginning January 1, 1999, under which
the Company may repurchase as much as $70 million of its
outstanding Class A common stock through December 31, 2001. 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 Company's capital.
97
<PAGE>
INCORPORATED BY REFERENCE, PAGE 50 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of beginning and
ending liability balances for 1998, 1997 and 1996 for the
Company's wholly-owned property/casualty subsidiaries.
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------- ------------
<S> <C> <C> <C>
Total unpaid losses and loss
adjustment expenses at
January 1, gross $ 413,409 $ 386,425 $ 357,334
Less reinsurance recoverables 323,910 301,553 278,325
------------ ------------- ------------
Net balance at January 1 89,499 84,872 79,009
Incurred related to:
Current year 80,627 77,345 85,311
Prior years ( 746) 2,625 ( 240)
------------ ------------- ------------
Total incurred 79,881 79,970 85,071
------------ ------------- ------------
Paid related to:
Current year 46,645 42,792 49,901
Prior years 31,278 32,551 29,307
------------ ------------- ------------
Total paid 77,923 75,343 79,208
------------ ------------- ------------
Net balance at December 31 91,457 89,499 84,872
Plus reinsurance recoverables 334,708 323,910 301,553
------------ ------------- ------------
Total unpaid losses and loss
adjustment expenses at
December 31, gross $ 426,165 $ 413,409 $ 386,425
============ ============= ============
</TABLE>
NOTE 9. RELATED PARTY TRANSACTIONS
Management fee
A management fee is charged to the Exchange for administrative
and underwriting services. The fee is recorded as revenue and
computed monthly as a percentage of Exchange direct and
affiliated assumed premiums written. The percentage rate is
adjusted periodically within specified limits by the Company's
Board of Directors. The management fee was charged to the
Exchange at the following rates:
April 1, 1995 to March 31, 1996 24.5%
April 1, 1996 to December 31, 1997 24%
January 1, 1998 to December 31, 1998 24.25%
Beginning January 1, 1999 through December 31, 1999, the
management fee rate charged the Exchange was set at 25%. The
Company's Board of Directors may change the management fee rate
at its discretion, but it may not exceed 25%.
98
<PAGE>
INCORPORATED BY REFERENCE, PAGE 51 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9. RELATED PARTY TRANSACTIONS (CONTINUED)
Service agreement revenue
A service arrangement fee is charged to the Exchange to
compensate the Company for its management of non-affiliated
assumed reinsurance business on behalf of the Exchange. The
Company receives a fee of 7% of voluntary reinsurance premiums
assumed from non-affiliated insurers and is responsible for
accounting and operating expenses in connection with the
administration of this business.
Effective September 1, 1997 the Company was reimbursed by the
Exchange a portion of the service charges collected from
Policyholders as reimbursement for the costs incurred by the
Company in providing extended payment terms on policies written
by the insurers managed by the Company. Service charge revenue
amounted to $7,164 in 1998 and $2,011 in 1997.
Expense reimbursements
The Company pays for and is reimbursed by the Exchange for
expenses incurred in connection with adjustment of claims and
by EFL for administrative expenses. Reimbursements are made to
the Company from these affiliates monthly. The amounts of such
expense reimbursements were as follows for the years ended
December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Erie Insurance Exchange $ 123,577 $ 109,076 $ 95,820
EFL 13,346 13,038 10,095
------------- ------------- -------------
$ 136,923 $ 122,114 $ 105,915
============= ============= =============
</TABLE>
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 $11,344, $11,288 and $10,949 in 1998, 1997 and
1996, respectively. The Company has a lease commitment in
excess of one year with EFL for a branch office. Rentals paid
to EFL under this lease totaled $343 in 1998 and $423 in 1997
and 1996.
Note receivable from EFL
EFL issued a surplus note to the Company for $15,000. The note
bears an annual interest rate of 6.45% and all payments of
interest and principal of the note may be repaid only out of
unassigned surplus of EFL and are subject to prior approval of
the Pennsylvania Insurance Commissioner. Interest on the
surplus note is scheduled to be paid semi-annually. The note
will be payable on demand on or after December 31, 2005. During
1998 and 1997, EFL paid interest to the Company totaling $968
each year.
Structured settlements with EFL
The Company and Exchange periodically purchase annuities from
EFL in connection with the structured settlements of claims.
The Company's pro-rata share (5.5%) of such annuities purchased
equaled $984, $978 and $743 in 1998, 1997 and 1996,
respectively.
99
<PAGE>
INCORPORATED BY REFERENCE, PAGE 51 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. RECEIVABLES FROM ERIE INSURANCE EXCHANGE AND CONCENTRATIONS OF CREDIT
RISK
Financial instruments which potentially expose the Company to
concentrations of credit risk include unsecured receivables
from the Exchange. A significant amount of the Company's
revenue and a receivable are from the Exchange and affiliates.
Management fee and expense reimbursements due from the Exchange
were $106,987 and $111,577 in 1998 and 1997, respectively. A
receivable from EFL for expense reimbursements totaled $1,625
at December 31, 1998 compared to $1,153 at December 31, 1997.
The Company also has a receivable due from the Exchange for
reinsurance recoverable from losses and unearned premium
balances ceded to the pool. Such amounts totaled $381,302 and
$383,131, respectively, in 1998 and 1997.
Premiums receivable from Policyholders at December 31, 1998 and
1997 equaled $114,695 and $108,058, respectively. A significant
amount of these receivables are ceded to the Exchange as part
of the intercompany pooling arrangement.
The property/casualty insurance business relates primarily to
private passenger and commercial automobile, homeowners,
commercial multi peril and workers' compensation insurance in
ten jurisdictions. Premiums from insureds in Pennsylvania,
Maryland, West Virginia, Virginia and Ohio account for a
significant percentage of the business.
NOTE 11. REINSURANCE
EIC and EINY have a pooling arrangement with the Exchange,
whereby EIC and EINY cede all of their direct property/casualty
insurance to the Exchange, except for 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 Exchange's insurance business (including the
business assumed from EIC and EINY). The companies settle
accounts between them by payment of such amounts within 30 days
after the end of each quarterly accounting period. Amounts not
settled within 30 days will accrue interest until such payments
are made.
Effective January 1, 1997, EIC and EINY placed in effect an all
lines aggregate excess of loss reinsurance agreement with the
Exchange. Under this agreement, EIC and EINY reinsure their net
retained share of the intercompany reinsurance pool such that
once EIC and EINY have sustained ultimate net losses that
exceed an amount equal to 72.5% of EIC and EINY's net premiums
earned, the Exchange will 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 EINY's net premium earned. Losses equal to 5% of
the net ultimate net loss in excess of the retention under the
contract are retained net by EIC and EINY. The annual premium
for this reinsurance treaty is 1.01% of the net premiums earned
by EIC and EINY during the term of this agreement subject to a
minimum premium of $800. This reinsurance treaty is excluded
from the intercompany pooling agreement. The annual premium
paid to the Exchange for the agreement totaled $1,158 in 1998
and $1,103 for 1997. There were no loss recoveries by EIC or
EINY under the agreement for 1998 or 1997.
100
<PAGE>
INCORPORATED BY REFERENCE, PAGE 52 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11. REINSURANCE (CONTINUED)
To the extent the Exchange assumes reinsurance business from
affiliated and non-affiliated sources, the Company participates
because of its pooling arrangement with the Exchange.
Similarly, the Company also participates in the business ceded
from the Exchange. Reinsurance premiums, commissions, expense
reimbursements and reserves related to reinsurance business are
accounted for on bases consistent with those used in accounting
for the original policies issued and the terms of the
reinsurance contracts. Premiums ceded to the Exchange have been
reported as a reduction of premium income. The Company's
property and liability reinsurance assumed from foreign
insurance companies is accounted for using the periodic method,
whereby premiums are recognized as revenue over the policy
term, and claims, including an estimate of claims incurred but
not reported, are recognized as they occur. The amount of
reinsurance business assumed from foreign insurance companies
is not significant.
Reinsurance contracts do not relieve the Company from its
primary obligations to Policyholders. A contingent liability
exists with respect to reinsurance receivables in the event
reinsurers are unable to meet their obligations under the
reinsurance agreements.
The following summarizes insurance and reinsurance activities
for the Company:
<TABLE>
<CAPTION>
1998 1997 1996
-------------- -------------- ---------------
<S> <C> <C> <C>
Premiums Earned:
Direct $ 338,162 $ 334,772 $ 321,736
Assumed - non-affiliates 4,889 5,393 2,882
Ceded to Erie Insurance
Exchange ( 343,051) ( 340,165) ( 324,618)
Assumed from Erie Insurance
Exchange 112,939 107,350 101,510
-------------- -------------- ---------------
Net $ 112,939 $ 107,350 $ 101,510
============== ============== ===============
Losses and Loss Adjustment
Expenses Incurred:
Direct $ 269,710 $ 265,678 $ 261,097
Assumed - non-affiliates 3,912 5,896 2,511
Ceded to Erie Insurance
Exchange ( 273,622) ( 271,574) ( 263,608)
Assumed from Erie Insurance
Exchange 79,881 79,970 85,071
-------------- -------------- ---------------
Net $ 79,881 $ 79,970 $ 85,071
============== ============== ===============
</TABLE>
101
<PAGE>
INCORPORATED BY REFERENCE, PAGE 52 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12. STATUTORY INFORMATION
The Company's insurance subsidiaries are required to file
statutory financial statements with state insurance regulatory
authorities. Accounting principles used to prepare statutory
financial statements differ from financial statements prepared on
the basis of generally accepted accounting principles.
Consolidated balances including amounts reported by the
consolidated and unconsolidated insurance subsidiaries on the
statutory basis would be as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Shareholders' equity
at December 31, $ 638,859 $ 523,715 $ 414,674
Net income for the
year ended
December 31, 135,603 118,970 104,007
</TABLE>
The amount of dividends the Company's Pennsylvania-domiciled
property/casualty subsidiaries, EIC and Erie Insurance Property &
Casualty Company, can pay without the prior approval of the
Pennsylvania Insurance Commissioner is limited by Pennsylvania
regulation to not more than the greater of: (a) ten percent 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 Company's 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) ten percent of its statutory surplus
as reported on its last annual statement, or (b) one hundred
percent of its adjusted net investment income during such period.
At December 31, 1998, the maximum dividend the Company could
receive from its property/casualty insurance subsidiaries was
$14,624. No dividends were paid to the Company from its
property/casualty insurance subsidiaries in 1998 or 1997.
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 percent 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 insurer's own securities.
Accordingly, the Company's share of the maximum dividend payout
which may be made in 1999 without prior Pennsylvania Commissioner
approval is $2,982. Dividends to the Company totaled $1,226 in
1998 and $1,104 in 1997.
102
<PAGE>
INCORPORATED BY REFERENCE, PAGE 53 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13. SEGMENT INFORMATION
The Company's principal operations consist of serving as
attorney-in-fact for the Exchange which constitutes its management
operations. The Company's property/casualty insurance operations
arise by virtue of a pooling arrangement between its subsidiaries
and the Exchange. The Company also has a 21.63% equity interest in
EFL which comprises its life insurance operations segment.
Summarized financial information for these operations is presented
below. Income amounts include each industry segment's share of
investment income and realized gain or loss on investments which
are reported in the investment operations segment on the
Statements of Operations.
<TABLE>
<CAPTION>
1998 1997 1996
---------------- --------------- --------------
<S> <C> <C> <C>
Revenue:
Management operations $ 533,449 $ 501,148 $ 470,538
Property/casualty
insurance operations 129,827 120,918 112,541
Life insurance operations 4,777 4,231 3,821
---------------- --------------- --------------
Total revenue $ 668,053 $ 626,297 $ 586,900
================ =============== ==============
Income before income taxes:
Management operations $ 174,126 $ 159,380 $ 148,774
Property/casualty
insurance operations 17,454 11,309 ( 547)
Life insurance operations 4,777 4,231 3,821
---------------- --------------- --------------
Total income before income
taxes $ 196,357 $ 174,920 $ 152,048
================ =============== ==============
Net income:
Management operations $ 116,411 $ 106,513 $ 99,045
Property/casualty
insurance operations 13,612 8,056 2,338
Life insurance operations 4,528 4,012 3,749
---------------- --------------- --------------
Net income $ 134,551 $ 118,581 $ 105,132
================ =============== ==============
Assets:
Management operations $ 666,781 $ 550,748 $ 456,598
Property/casualty
insurance operations 747,172 707,108 665,355
Life insurance operations 39,479 34,688 28,686
---------------- --------------- --------------
Total assets $ 1,453,432 $ 1,292,544 $ 1,150,639
================ =============== ==============
</TABLE>
103
<PAGE>
INCORPORATED BY REFERENCE, PAGE 53 OF THE COMPANY'S ANNUAL REPORT
TO SHAREHOLDERS
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
<S> <C> <C> <C> <C>
1998
Net revenue from
management
operations $ 33,761 $ 39,065 $ 40,047 $ 32,370
Underwriting gain
(loss) 1,428 ( 307) ( 97) ( 457)
Total revenue from
investment
operations 11,317 13,554 11,847 13,829
Net income $ 31,699 $ 35,470 $ 35,697 $ 31,685
======== ======== ======== ========
Net income per share $ 0.43 $ 0.47 $ 0.48 $ 0.43
======== ======== ======== ========
Comprehensive income $ 40,641 $ 35,165 $ 23,990 $ 45,910
======== ======== ======== ========
1997
Net revenue from
management
operations $ 31,754 $ 35,363 $ 36,541 $ 30,543
Underwriting loss ( 48) ( 783) ( 299) ( 1,129)
Total revenue from
investment
operations 9,636 10,138 11,750 11,454
Net income $ 28,211 $ 30,444 $ 32,128 $ 27,798
======== ======== ======== ========
Net income per share $ 0.38 $ 0.41 $ 0.43 $ 0.37
======== ======== ======== ========
Comprehensive income $ 22,106 $ 41,442 $ 41,208 $ 25,359
======== ======== ======== ========
</TABLE>
104
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
105
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE DECEMBER
31, 1998 FORM 10-K AND RESTATED SUMMARY INFORMATION FOR THE YEARS ENDED DECEMBER
31,1997 AND 1996 FOR THE ERIE INDEMNITY COMPANY AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FORM 10-K
</LEGEND>
<CIK> 0000922621
<NAME> ERIE INDEMNITY COMPANY
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<PERIOD-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<DEBT-HELD-FOR-SALE> 441,353 349,973 310,176
<DEBT-CARRYING-VALUE> 0 0 0
<DEBT-MARKET-VALUE> 0 0 0
<EQUITIES> 202,804 165,133 131,618
<MORTGAGE> 8,287 8,393 7,294
<REAL-ESTATE> 0 0 0
<TOTAL-INVEST> 669,938 531,430 456,098
<CASH> 53,581 53,148 18,720
<RECOVER-REINSURE> 939 242 164
<DEFERRED-ACQUISITION> 10,863 10,283 9,541
<TOTAL-ASSETS> 1,453,432 1,292,544 1,150,639
<POLICY-LOSSES> 426,165 413,408 386,425
<UNEARNED-PREMIUMS> 229,057 219,211 216,938
<POLICY-OTHER> 0 0 0
<POLICY-HOLDER-FUNDS> 0 0 0
<NOTES-PAYABLE> 0 0 0
0 0 0
0 0 0
<COMMON> 2,170 2,170 2,170
<OTHER-SE> 653,053 537,213 433,589
<TOTAL-LIABILITY-AND-EQUITY> 1,453,432 1,292,544 1,150,639
112,939 107,350 101,510
<INVESTMENT-INCOME> 39,083 37,163<F1> 29,724<F1>
<INVESTMENT-GAINS> 7,164 5,815 6,583
<OTHER-INCOME> 0 0 0
<BENEFITS> 79,881 79,970 85,071
<UNDERWRITING-AMORTIZATION> 32,492 29,639 28,098
<UNDERWRITING-OTHER> 0 0 0
<INCOME-PRETAX> 196,357 174,920 152,048
<INCOME-TAX> 61,806 56,338 46,915
<INCOME-CONTINUING> 0 0 0
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 134,551 118,581 105,132
<EPS-PRIMARY> 1.81 1.59 1.41
<EPS-DILUTED> 1.81 1.59 1.41
<RESERVE-OPEN> 413,409 386,425 357,334
<PROVISION-CURRENT> 80,637 77,345 85,311
<PROVISION-PRIOR> (746) 2,625 (240)
<PAYMENTS-CURRENT> 46,645 42,792 49,901
<PAYMENTS-PRIOR> 31,278 32,551 29,307
<RESERVE-CLOSE> 426,165 413,409 386,425
<CUMULATIVE-DEFICIENCY> (1,220) 8,883 132,649
<FN>
<F1> Investment income has been restated to reflect the statement of investment expenses.
</FN>
</TABLE>
ERIE INDEMNITY COMPANY
Report
of
The Special Committee
to
The Board of Directors
March 9, 1999
107
<PAGE>
EXHIBITS
Number Description
1 April 1, 1998 Proxy Statement
2 H. O. Hirt Trust
3 Excerpt of September 27, 1993 Board of Directors' Minutes
4 Thomas B. Hagen's Termination Agreement
5A August 13, 1996 Letter from Susan Hagen to Seth Schofield, with
cover memo
5B September 4, 1996 Letter from F. William Hirt to Seth Schofield
5C September 5, 1996 Letter from Seth Schofield to Susan Hirt Hagen
5D September 30, 1996 Letter from Susan Hirt Hagen to Seth Schofield
5E October 24, 1996 Letter from Seth Schofield to Susan Hirt Hagen
5F November 25, 1996 Letter from Susan Hirt Hagen to Seth Schofield
5G December 13, 1996 Letter from F. William Hirt to Susan Hirt Hagen
5H January 9, 1997 Letter from Susan Hagen to F. W. Hirt
5I April 26, 1994 Letter from James Moffat, Mellon Bank, to Susan
Hagen and F. William Hirt
6 Excerpt of July 21, 1994 Board of Directors' Minutes
7 February 5, 1996 letter from William H. Clark, Esq., to James M.
Glockley
8 Excerpt of February 12, 1996 Board of Directors' Minutes
9 F. William Hirt's and Audrey Hirt's answer to the second set of
interrogatories in Orphans' Court litigation
108
<PAGE>
10 October 16, 1998 letters from Susan Hagen to Messrs. Milne,
Petersen, Schofield and Van Gorder
11 October 22, 1998 letter from Seth Schofield to F. William Hirt
12 Excerpt of October 27, 1998 Board of Directors' Minutes
13 Excerpt of December 16, 1998 Board of Directors' Minutes
14 Corporate Personnel Manual, "Conflict of Interest and Outside
Employment"
15 Conflict of Interest Questionnaire
16 Schiff, Hardin & Waite's August 15, 1989 Memorandum to F. William
Hirt and Thomas Hagen Re: Estate Planning Recommendations
17 December 18, 1998 Letter from F. William Hirt to Bruce A. Baird
18 February 19, 1992 and March 20, 1992 letters re: stock transfers
19 F. William Hirt's handwritten lists re: Erie stock gifts, 1994-98
20 Typed lists re: Hirt gifts, 1994-98
21 Schiff, Hardin & Waite's September 5, 1996 letter to Doug
Ziegler, with attached August 29, 1996 Memorandum Re: Legal
Consequences of Mr. Hirt giving Erie stock to All Employees
22 October 27, 1998 and November 23, 1998 statements of F. W. Hirt
23 August 1998 letters from Messrs. Kochel and Hubbard
24 List of gifts by Doug Ziegler
25A Excerpt of May 26, 1994 Board of Directors' Minutes
25B Excerpt of April 25, 1995 Board of Directors' Minutes (draft)
109
<PAGE>
25C Excerpt of December 13, 1994 Board of Directors' Minutes
25D Excerpt of September 21, 1995 Board of Directors' Minutes
25E Excerpt of March 19, 1998 Board of Directors' Minutes
25F Excerpt of December 16, 1997 Board of Directors' Minutes
25G Excerpt of December 16, 1998 Board of Directors' Minutes
26A Excerpt of December 16, 1993 Board of Directors' Minutes
26B Excerpt of June 22, 1995 Board of Directors' Minutes
26C Excerpt of March 26, 1996 Board of Directors' Minutes
26D Excerpt of May 1, 1996 Board of Directors' Minutes
26E May 7, 1996 Letter from Jan Van Gorder
26F Excerpt of June 17, 1996 Board of Directors' Minutes
26G Excerpt of September 29, 1994 Board of Directors' Minutes
26H Excerpt of March 2, 1995 Board of Directors' Minutes
27 Erie in-house counsel's and Duane Morris & Heckscher's opinions re:
indemnification of Mr. Sider
28 Messrs. Milne's and Van Gorder's 1997 employment agreements
29 Opinion Letter re: Special Committee's Independence
30 March 11, 1997 Board Minutes
31 November 4, 1998 Letter from Stephen J. Harmelin
110
<PAGE>
32 November 24, 1998 Letter from Stephen J. Harmelin
33 Table of Stock Holdings and Dividend Payments, 1997-98
34 Team Dispatch Sales Analysis
35 February 18, 1999 Letter from Timothy Mehl
36 Body-Borneman & Associates, Inc. contract
37 Black & Associates, Inc. contract
38 Black & Associates, Inc.'s Premiums Received from Dispatch Printing
and Edmund J. Mehl
39 Erie's Investments with Brown Brothers Harriman
40A Brown Brothers Harriman Revenue from Erie
40B Letter re: Brown Brothers Harriman total assets under management
41A December 18, 1997 Brown Brothers Harriman memorandum
41B October 14, 1998 Brown Brothers Harriman memorandum
41C October 20, 1998 Brown Brothers Harriman memorandum
41D January 19, 1999 Letter from Peter Bartlett, with attachments
42 February 11, 1999 Letter from Jan Van Gorder
111
<PAGE>
March 9, 1999
The Board of Directors
Erie Indemnity Company
100 Erie Insurance Place
Erie, PA
To the Board:
The following is the Report of the Special Committee (the
"Committee") of the Board of Directors (the "Board") of the Erie Indemnity
Company ("Erie") regarding its investigation of whether gifts of Class A common
stock of Erie made by F. William Hirt ("Mr. Hirt") and his wife (the "gifts") to
directors John M. Petersen ("Mr. Petersen"), Stephen A. Milne ("Mr. Milne"), and
Jan R. Van Gorder ("Mr. Van Gorder") and former director Seth E. Schofield
("Mr. Schofield") have resulted in violations of any applicable law, Erie policy
or principle of corporate governance.
I. Description of the Report
This Report will begin with an Executive Summary that
summarizes our investigation and its findings. Second, we will set forth the
chronology of events and describe the scope of the investigation. Third, we
will discuss relevant legal authorities. Fourth, we will describe the evidence
with respect to Mr. Hirt's intent in giving the gifts and the recipients' intent
in receiving them. Finally, we will set forth our conclusions and our
recommendation for an addition to the corporate bylaws with respect to the
acceptance of gifts by officers and directors from other directors and Erie
employees and shareholders. Exhibits referred to in this Report are attached
hereto in a separate volume.
II. Executive Summary
The Board established the Committee on October 27, 1998 to
investigate allegations that gifts of Erie stock made by Mr. Hirt to certain
other directors constituted violations of law, Erie policy or principles of
corporate governance. During the following four months, the Committee and its
independent counsel, Covington & Burling ("C&B"), conducted an extensive
investigation which was substantially completed by the last week of February
1999.
Having concluded the investigation, the Committee makes the
following findings, which are only summarized here and which should be read in
the context of the entire Report:
First, the Committee concluded, with the advice of its
counsel, that its members were disinterested and capable of objective judgment
under Pennsylvania law with respect to the propriety of the gifts. Allegations
to the contrary were made by director Susan Hirt Hagen ("Mrs. Hagen"), which the
Committee carefully investigated and considered.
Second, the Committee considered possible violations of state
and federal criminal laws and concluded that these laws had not been violated.
Such violations require improper intent, and the evidence demonstrated
overwhelmingly that Mr. Hirt gave the gifts out of generosity and not with the
intent to influence anyone.
Third, the Committee considered any possible breach of
fiduciary duty under Pennsylvania law, and concluded that no such breach had
occurred. Again, there was an absence of evidence of improper intent by either
Mr. Hirt or the gift recipients.
Fourth, the Committee considered possible violations of Erie's
conflict of interest policy or any other principle of corporate governance.
After considering both Erie's policy and comparable private and public policies,
the Committee concluded that Erie's policy does not apply to the gifts and that
the evidence failed to demonstrate any intent to violate the policy or any other
principle of corporate governance.
112
<PAGE>
Fifth, the Committee found no evidence either that Mr. Hirt
intended to influence directors with respect to any issues before the Board, or
that the directors who accepted Mr. Hirt's gifts believed that the gifts were
intended to or did influence them with respect to matters affecting Erie. The
evidence overwhelmingly establishes Mr. Hirt's and the gift recipients'
integrity and good faith. The evidence is that they believed their actions were
in the best interests of Erie and its shareholders.
Last, the Committee considered the benefits of adopting any
new policies relating to gifts. Because of the Board's responsibility to govern
compensation for Board members and officers elected by the Board, the Committee
has recommended an additional corporate bylaw that will, in the future, prohibit
Board members and officers elected by the Board from accepting significant gifts
of cash or securities from directors, employees or large shareholders, except
from those who are family members.
III. Chronology of Events
A. Erie Stock Ownership and Values
Erie was founded in 1925 by H. O. Hirt and a partner, and the
descendants of H. O. Hirt own over 75 percent of the Erie voting stock. Other
significant holders of voting stock include the family of director Samuel P.
Black III ("Mr. Black") and Mr. Petersen, who is also a director. Exhibit 1.
Samuel Black, Jr. was an early Erie employee and a director for over 70 years.
Mr. Black, his son, succeeded him in 1997. Mr. Petersen is a former CFO and CEO
of Erie who still manages many of its investments as a consultant.
The Hirt family voting stock was placed by H. O. Hirt by the
time of his retirement in 1976 into two companion trusts for the benefit of his
son, Mr. Hirt, and his daughter, Mrs. Hagen. The beneficiaries do not
themselves control the voting of any of the stock in the trusts. Instead all
the stock is voted as directed by a majority of the three trustees: Mr. Hirt,
Mrs. Hagen and a corporate trustee that until recently has been Mellon Bank and
is now Bankers Trust. Exhibit 2.
Until 1995, there were fewer than 500 shareholders of
non-voting stock. In 1995 Erie surpassed 500 shareholders and became a reporting
company under the federal securities laws. It is traded on the NASDAQ. The
market capitalization of Erie and value of the holdings of long-time
shareholders have increased dramatically since the 1980s. The nonvoting stock
has split as follows:
1987 10 for one
1989 200 for one
1993 four for one
1996 three for one
The stock has recently traded in the range of $30 per share.
Substantial credit for this large increase in value is given by all to Mr.
Petersen, who has overseen the management of Erie's investments throughout the
period.
The value of the Hirt family's stock has correspondingly
increased. Compared to a value of several million dollars before the 1987 stock
split, the Hirt family holdings are today worth well in excess of a billion
dollars, divided approximately evenly between Mr. Hirt's family and Mrs. Hagen's
family.
113
<PAGE>
B. Erie Management
The management of Erie has also remained in the Hirt family
until recently. H. O. Hirt was chairman of the Board and Chief Executive
Officer until his retirement in 1976. Mr. Hirt, who had worked at Erie in a
variety of senior executive positions since the early 1950s, succeeded his
father as CEO and chairman of the Board and held these positions until 1990,
when he retired and was succeeded in both positions by his sister's husband,
Thomas B. Hagen ("Mr. Hagen"), who had also worked at Erie for some 40 years.
In 1993, the Board consisted of Mr. Hirt, Mr. Hagen,
Mrs. Hagen, Samuel P. Black, Jr., J. Ralph Borneman ("Mr.Borneman"), Tim
Hubbard, Steve Jones, Irvin Kochel, Jeff Leininger, Edmund J. Mehl ("Mr. Mehl"),
Mr. Schofield, Mr. Petersen, and Mr. Van Gorder, Erie's general counsel. H. O.
Hirt had asked most of these directors to join the Board, while Mr. Hagen had
asked Messrs. Schofield, Borneman and Van Gorder. In September 1993, in
compliance with an amendment to the Pennsylvania Insurance Company Law of 1921,
the Board amended its bylaws and formed a nominating committee, with
Mr. Schofield as its chairman. Mr. Schofield, who joined the Board in 1991, the
same year he became CEO of US Airways, was the first prominent outsider to join
the Board, whose members otherwise had ties to Erie or the Hirt family.
C. The Beginning of Conflict
By 1993 Erie employees and agents became concerned about an
inappropriate relationship between Mr. Hagen and an Erie senior officer.
Employees began complaining directly to the retired Mr. Hirt that the
relationship was disrupting business decisions and causing the resignations of
valuable employees. One of these was Mr. Milne, a well-regarded senior employee
who left to become an insurance agent because of conflicts with both Mr. Hagen
and the senior officer. The relationship was raised as a problem at a large
meeting of the Erie agents advisory council. Finally, Mr. Hirt apprised Board
members of what he knew of the situation and, at the September 27, 1993 Board
meeting, directors Hirt, Petersen, Van Gorder, Black, Borneman, Hubbard, Jones,
Leininger, Kochel, Mehl, and Schofield voted to terminate the employment of Mr.
Hagen and the senior officer. Exhibit 3. Mr. Hagen's termination agreement gave
him the right to remain as a director during 1994. Exhibit 4. Mr. Petersen
became CEO and Mr. Hirt returned as chairman of the Board. Since this time there
have been a number of Board votes on which the Hagens have not voted with the
majority of the directors. Further, Mr. and Mrs. Hagen have made efforts to
reconstitute the Board to obtain directors favorable to them, and Mr.
Hirt and other directors have opposed these efforts. Exhibits 5A through 5I,
Exhibit 7.
The first complaints were about Messrs. Hubbard and Jones, who
agreed not to seek renomination in 1994. Mellon Bank also agreed that Mr.
Leininger, a Mellon Bank officer, would not seek renomination.
The nominating committee considered suggestions from Mr. Hirt,
the Hagens, Mellon Bank and others to replace the departing directors and
proposed (1) Patricia A. Goldman ("Ms. Goldman"), who had extensive public
relations, regulatory and federal government background and contacts, experience
on a board of a significant family-owned corporation, a vacation home near Erie,
and fulfilled the Board's goal to have another woman as a director; (2) Peter B.
Bartlett ("Mr. Bartlett"), who would be Erie's first director associated with
the New York investment community; and (3) Harry H. Weil ("Mr. Weil"), who had
extensive corporate legal experience. On July 21, 1994, the Board approved a
slate of proposed directors, including these three, over the Hagens' dissent.
Exhibit 6.
At the end of 1995, Mr. Petersen retired as CEO, though he
remained as a director and remained in charge of Erie's domestic equity
portfolio. A search committee recommended Mr. Milne, who had returned to Erie
after Mr. Hagen's departure. Through legal counsel, the Hagens unsuccessfully
sought to condition their acceptance of Mr. Milne on the resignation of Mr. Van
Gorder and a restructuring of the Board to ensure a number of directors who
would "reflect the views" of the Hagens. Exhibit 7. The Board elected Mr. Milne
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CEO and President on February 12, 1996. Exhibit 8. Other Board votes evidencing
disagreement between the Hagens and other directors are set forth in Section V,
B.2., infra.
In 1997, Samuel P. Black, Jr. retired and the nominating
committee selected Mr. Black to fill his father's seat. In 1998, the Board did
not renominate Mr. Hagen or Irvin Kochel who was of retirement age. These two
directors have not been replaced.
D. The Allegations
On April 1, 1998, Mrs. Hagen filed an action in the Court of
Common Pleas of Erie County, Orphans' Court Division, seeking to remove Mellon
Bank as the corporate trustee ("the Mellon Bank case"). As part of that action,
Mr. Hirt and his wife stated in answer to an interrogatory that "as part of
annual gifting programs established pursuant to a comprehensive multi-year
family estate plan designed by and within the advice of tax specialists," they
had given 75 gifts of Class A Erie common stock since 1993 to past and present
Erie directors and officers and members of their families. Exhibit 9. The Hirts
identified, by year, the various recipients and the amount of Erie stock given.
Specifically, over a period of four or five years, Mr. Milne's family received
13 gifts of stock, Mr. Van Gorder's family received 8 gifts of stock, Mr.
Schofield's family received 10 gifts of stock, and Mr. Petersen's family
received 8 gifts of stock. A complete list of the gifts to current and former
Erie directors, officers, employees and agents and their values appears in
Section V, B.1., infra.
Each director disclosed the transfers of stock on the SEC
Forms 4 and 5 filed annually. None of the directors or Mr. Hirt disclosed the
gifts on his annual Erie conflicts questionnaire. Nor did any other Erie
employee who received gifts.
On October 16, 1998, Mrs. Hagen wrote to each of Messrs.
Milne, Van Gorder, Schofield, and Petersen, stating that "The acceptance of
these 'gifts' violates the Company's clear policy against acceptance of gifts,"
specifically section 720 of Erie's Corporate Personnel Manual, "Conflict of
Interest and Outside Employment." Exhibit 10. Mrs. Hagen further stated to each,
"I, therefore, demand your immediate resignation from the Board of Directors in
order to protect the best interests of the stockholders." On October 22, 1998,
Mr. Schofield resigned from the Board. His letter of resignation denied any
violation of law or Erie policy, further stating "I believe even more strongly
that I have done nothing inappropriate during my service as a director and my
resignation is not in any way related to the allegations contained in Mrs.
Hagen's October 16, 1998 letter to me, which I believe are unfounded and
baseless." Exhibit 11.
On October 27, 1998, the Board held a special meeting,
attended by all directors, to "consider and act upon the taking of any action
deemed necessary or appropriate by the Board" in response to Mrs. Hagen's
letters. The Board voted, with Messrs. Milne, Petersen, Hirt and Van Gorder
abstaining, and Mrs. Hagen dissenting, to appoint Messrs. Bartlett, Black,
Borneman, Mehl and Weil and Ms. Goldman to the Committee. Exhibit 12. At the
December 16, 1998 meeting the Board passed with no dissent a resolution setting
forth the Committee's responsibilities. Exhibit 13.
E. The Investigation
The investigation was conducted under the supervision of the
Committee and on its behalf by C&B. The Committee and its individual members had
meetings and telephone conferences with C&B throughout the investigation
including three meetings with C&B on February 8, 17 and 26, 1999 after the bulk
of the investigation was complete to discuss the facts and law, to determine the
need for additional work, and to reach conclusions.
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The investigation focused principally on the following issues
arising out of Mrs. Hagen's allegations about the Hirt gifts:
o The disinterestedness and objectivity of the Committee members,
o Whether the giving or receipt of the gifts was unlawful under any
applicable criminal law,
o Whether the giving or receipt of the gifts was unlawful under any
other applicable law,
o Whether the giving or receipt of the gifts violated any Erie policy or
principle of corporate governance, and
o The evidence of the intent of the giver and recipients of the gifts.
The investigation was carried out principally through
interviews of relevant personnel conducted by C&B with follow-up questions and
additional interviews determined by the Committee. In addition C&B obtained
numerous relevant documents, Board materials, correspondence, and legal
materials from Erie files, court files, and from counsel for Erie, for Mr. Hirt,
for Messrs. Milne, Van Gorder and Petersen, and for Mrs. Hagen.1
1. Interviews
C&B conducted interviews involving the following individuals:
1. Thomas Abendroth, partner, Schiff, Hardin & Waite
2. Roy Adams, partner, Kirkland & Ellis
3. Peter B. Bartlett, director
4. Samuel P. Black III, director
5. J. Ralph Borneman, director
6. Samuel Braver, shareholder, Buchanan Ingersoll, counsel to
Mr. Hirt
7. John Brinling, president, Erie Family Life Insurance Co.
8. Dan Burt, Retired Supervisor, Erie corporate fleet
9. Mark Christ, supervisor, Erie claims audit department
10. Sherrie-Jo Christ, Erie data quality analyst
11. Shawn Cummings, Erie district sales manager
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1 The Committee is aware of pending litigation brought by Mrs. Hagen in which
additional documents or testimony relevant to this matter may be produced. The
Committee will review any such materials for their effect on this Report and its
conclusions.
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12. Linda Etter, Erie stock transfer clerk
13. Christopher Farrell, shareholder, Buchanan Ingersoll, counsel to
Mr. Hirt
14. Edward Finley, Kirkland & Ellis
15. Carl Godleski, Erie agent
16. Patricia A. Goldman, Erie director
17. Susan Hirt Hagen, Erie director
18. Thomas B. Hagen, former director and former Erie CEO
19. Stephen J. Harmelin, Dilworth Paxson LLP, counsel to the Hagens
20. F. William Hirt, chairman of the board
21. Audrey Hirt, wife of Mr. Hirt
22. Laurel Hirt, Erie securities analyst and daughter of Mr. Hirt
23. Jim Lloyd, former General Counsel, US Airways
24. Lawrence McMichael, Dilworth Paxson LLP, counsel to the Hagens
25. Edmund J. Mehl, Erie director
26. Stephen A. Milne, Erie CEO
27. William F. Newlin, shareholder, Buchanan, Ingersoll, counsel to
Mr. Hirt
28. John M. Petersen, director
29. Roger Richards, Richards & Associates, P.C., counsel to the
Hagens
30. Seth E. Schofield, former director
31. Thomas Sider, former Erie chief financial officer
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32. Keith Smith, former Senior Vice Chairman, Mellon Bank
33. Jan R. Van Gorder, Erie general counsel
34. Harry H. Weil, director
35. Douglas F. Ziegler, Erie chief investment officer
2. Documents Reviewed
C&B requested documents from Erie, from many of those interviewed, and
from attorneys for various interested parties. Important sources of documents
are listed below.
a. Depositions in Trust of Henry Orth Hirt, Settlor, Nos. 100-1998,
101-1998, Court of Common Pleas of Erie County Pennsylvania,
Orphan's Court Division
(1) Peter B. Bartlett
(2) J. Ralph Borneman
(3) Linda Etter
(4) Susan Hirt Hagen
(5) Thomas B. Hagen (hearing testimony)
(6) F. William Hirt
(7) Laurel Hirt
(8) Seth E. Schofield
(9) Jan R. Van Gorder
(10) Harry H. Weil
(11) Douglas Ziegler
b. All filings in Trust of Henry Orth Hirt, Settlor, Nos. 100-1998,
101-1998, Court of Common Pleas of Erie County, Pennsylvania,
Orphans' Court Division
c. Documents Received from Erie
(1) Board of Directors and Committee Minutes, 1990-1998
(2) Bylaws and Articles of Incorporation
(3) Annual Report
(4) Corporate Personnel Manual, "Conflict of Interest and
Outside Employment," and Employee Handbook
(5) Conflict of Interest Questionnaires completed by all
current and former directors, 1995-1998
(6) Background material re: conflicts policy
(7) Background material and correspondence re: proposed
demutualization legislation
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(8) Background material re: indemnification of Thomas Sider
(9) Correspondence re: Thomas Hagen's eligibility to serve
on nominating committee
(10) SEC Form 4s and 5s completed by all current and former
directors, 1995-1998
(11) April 1, 1998 Proxy Statement
(12) Background material for April 1998 proxy statement
disclosures
(13) Chart re: Erie's investments with Brown Brothers
Harriman
(14) Team Dispatch Sales Analysis
(15) News articles
(16) Thomas B. Hagen's October 11, 1993 agreement with Erie
(17) Messrs. Van Gorder's and Milne's 1997 employment
agreements
(18) Chart re: Hagen Interests in Erie
(19) Undated letter from Laurel Hirt to her father
(20) Letter re: 1997 and 1998 fees paid to Reed Smith Shaw &
McClay
(21) List of persons to whom Doug Ziegler has given Erie
stock
(22) March 3, 1999 facsimile from Dennis Geib
(23) March 4, 1999 letter from Philip Garcia
(24) March 5, 1999 facsimile from Jan Van Gorder
d. Special Committee's Counsel's Communications with Represented
Parties
(1) Mrs. Hagen's Counsel
(a) December 14, 1998 letter from Bruce A. Baird
(b) January 5, 1999 letter from Bruce A. Baird
(c) January 14, 1999 letter from Bruce A. Baird
(d) February 1, 1999 letter from Bruce A. Baird
(2) Mr. Hirt's Counsel
(a) January 21, 1999 letter from Bruce A. Baird
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(3) Counsel for Messrs. Milne, Petersen and Van Gorder
(a) January 21, 1999 letter from Bruce A. Baird
(4) Counsel for Erie
(a) January 21, 1999 letter from Bruce A. Baird
e. Documents Received from Persons Interviewed
(1) Various curriculum vitae
(2) Correspondence between and among Susan Hirt Hagen,
F. William Hirt and Seth E. Schofield, 1996-1997
(3) April 26, 1994 letter from James Moffat, Mellon Bank, to
Susan Hagen and F. William Hirt
(4) February 5, 1996 letter from William Clark to James
Glockley
(5) June 6, 1997 letter from Stephen F. Harmelin to James
M. Glockley
(6) October 16, 1998 letters from Susan Hagen to Messrs.
Milne, Petersen, Schofield and Van Gorder
(7) October 22, 1998 letter from Seth Schofield to F.
William Hirt
(8) October 23, 1998 letter from David H. Pittinsky to
Stephen J. Harmelin
(9) October 27, 1998 letter from Fred Dreher to F. William
Hirt
(10) October 27, 1998 letter from Stephen J. Harmelin to
David H. Pittinsky
(11) March 2, 1999 letter from Reed Smith Shaw & McClay
f. Documents Received from F. William Hirt
(1) August 15, 1989 memorandum re: Estate Planning
Recommendations
(2) February 19, 1992 and two March 20, 1992 letters re:
stock transfers
(3) June 11, 1994 letter from Jonathan Hagen to James Moffat
(4) September 5, 1996 letter to Doug Ziegler, with attached
August 19, 1996 memorandum re: Legal consequences of
Mr. Hirt giving Erie stock to the employees
(5) Mr. and Mrs. Hirt's gift tax returns, 1992-97
(6) August 5, 1998 letter from Thomas H. Hubbard
(7) August 6, 1998 letter from Irvin H. Kochel
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(8) Statement of F. W. Hirt, October 27, 1998
(9) Statement of F. W. Hirt, November 23, 1998
(10) H. O. Hirt trusts, including prior versions and
counsel's analysis
(11) F. William Hirt's handwritten lists re: Erie stock
gifts, 1994-98
(12) Doug Ziegler's typed lists re: Hirt gifts, 1994-98
(13) Production of documents in Orphans' Court litigation
g. Documents Received from Brown Brothers Harriman
(1) Memoranda and letters re: Peter B. Bartlett's exclusion
from fees received from Erie
(2) Letter re: Erie's fees as percentage of firm revenues
(3) March 3, 1999 letter re: total assets under management
h. Documents Received from Samuel Black & Associates, Inc.
(1) Agency Agreement
(2) Summary Sheets re: Black family ownership of Erie stock
(3) Premiums received from Dispatch Printing and Edmund
Mehl, 1996-98
i. Documents Received from Body-Borneman & Associates, Inc.
(1) Agency Agreement
j. Mrs. Hagen's Counsel
(1) November 4, 1998 letter from Stephen J. Harmelin
(2) November 24, 1998 letter from Stephen J. Harmelin
(3) December 21, 1998 letter from Stephen J. Harmelin
(4) January 4, 1999 letter from Stephen J. Harmelin
(5) January 28, 1999 letter from Stephen J. Harmelin
(6) February 10, 1999 letter from Stephen J. Harmelin
(7) February 17, 1999 letter from Stephen J. Harmelin
(8) February 19, 1999 letter from Pierce E. Buller
k. F. William Hirt's Counsel
(1) February 5, 1999 memorandum from Samuel W. Braver
(2) February 9, 1999 letter from Christopher F. Farrell
(3) February 18, 1999 letter from Christopher F. Farrell
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l. Counsel for Messrs. Milne, Petersen and Van Gorder
(1) February 1, 1999 letter from David H. Pittinsky
m. Counsel for Erie
(1) February 17, 1999 letter from John Soroko
IV. Relevant Legal Authorities
In this section we will set forth the legal authorities under
which providing something of value to a corporate officer or director could
under some circumstances be unlawful or which provide guidance in determining
whether a violation has occurred.2 We will also discuss the relevant Erie
policy and those of other entities.
A. Criminal Bribery and Gratuity Law
1. Pennsylvania
Under Pennsylvania law, it is a misdemeanor of the second
degree, known as commercial bribery, for an employee or fiduciary to accept,
without the consent of his employer or principal, a benefit from "another person
upon agreement or understanding that such benefit will influence his conduct in
relation to the affairs of his employer or principal," or to confer such a
benefit.18 Pa. Cons. Stat. Ann. ss. 4108(a) (West 1983). As with the commercial
bribery laws of many states, the agreement or understanding "requires a
subjective intent on the part of the briber to confer a benefit in return for
some illicit gain" such as influencing conduct, but does not require
"mutual assent on the parts of both the briber and the bribee to form an
agreement." United States v. Traitz, 871 F.2d 368, 385 (3d Cir. 1989)
(bribery of public official); United States v. Johns, 742 F. Supp. 196, 220
(E.D. Pa. 1990); see also People v. Tran, 80 NY2d 170, 177-78 (N.Y. 1992)
(interpreting "agreement or understanding" under New York statute prohibiting
bribery of public official); People v. Schepis, 614 N.Y.S. 2d 719, 721 (N.Y.
App. Div. 1994) (interpreting "agreement or understanding" under New York
statute prohibiting bribery of a labor official).
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2 This section has been reviewed for accuracy by C&B. In
particular, Paul Duke, an active member of the Pennsylvania bar and former
general counsel of the Penn Central Railroad, has reviewed this section with
regard to Pennsylvania law.
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The influence or conduct need not be adverse to the
corporation; rather, the direction of influence is as the payor wishes, either
favorable or unfavorable to the employer or principal. See United States v.
Parise, 159 F.3d 790, 799 (3d Cir. 1998); Commonwealth v. Bellis, 399 A.2d 397,
400 (Pa. 1979). There is also no specific intent requirement. United States v.
Parise, 159 F.3d at 803 ("statute does not require that the parties knew that
their agreement was wrong or illegal").
2. Federal
a. Bribery
Federal bribery requires that a thing of value be given or
promised to a public official or witness in order to influence a particular act,
or be received in return for a particular act. 18 U.S.C. ss. 201(b)(1)-(2)
(1997). See United States v. Sun-Diamond Growers, 138 F.3d 961, 966 (D.C. Cir.
1998); United States v. Niederberger, 580 F.2d 63, 68 (3d Cir. 1978); Randall E.
Ravitz and Nicholas Sanservino, Federal Criminal Conflict of Interest, 35 Am.
Crim. L. Rev. 709, 711 (1998). The statute hence does not apply here, but we
analyze it for analogous language in the cases concerning intent. As with
commercial bribery, there must be evidence that the payor intends to receive
some benefit in return for the payments, United States v. Muldoon, 931 F.2d 282,
287 (4th Cir. 1991), or of knowing acceptance of payment in return for violation
of duty. United States v. Strand, 574 F.2d 993, 996 (9th Cir. 1978).
b. Illegal Gratuities
For a federal gratuity conviction under another subsection of
the same statute, the giver must intend either to reward some past official act,
or to enhance the likelihood of some future act. 18 U.S.C. ss. 201(c) (1997);
see United States v. Sun-Diamond, 138 F.3d at 966. It is not unlawful to give
gifts with the purpose of gaining "generalized sympathy" or "inducing warm
feelings" from an official. Id. at 967; see United States v. Brewster, 506 F.2d
62, 81-82 (D.C. Cir. 1974).
While it has been held that there is no requirement of corrupt
intent, United States v. Standefer, 610 F.2d 1076 (3d Cir. 1979) (en banc),
aff'd on other grounds, 447 U.S. 10 (1980) (gifts motivated solely by
recipient's official position may be illegal gratuities), the Supreme Court has
granted certiorari on this issue in United States v. Sun-Diamond, 119 S. Ct.
402 (1998).
c. Criminal Unauthorized Compensation
Federal officials may also be charged with acceptance of
unauthorized compensation. 18 U.S.C.ss.203 (1997). Under this statute there is
no requirement to show an intent to be influenced. Ravitz, supra, at 724.
d. The Friendship Defense
It is a defense to liability under any of these statutes if a
gift is given and accepted in friendship rather than as compensation or because
of official position. For example, in United States v. Standefer, 610 F.2d at
1080, a corporate officer contended that the gifts (from corporate funds) to an
IRS agent who was conducting an audit of the corporation arose from friendship,
and had no relationship to official duties. The court rejected this argument,
finding that there was no prior or subsequent gift-giving between the two,
corporate records did not show that the defendant "was as generous with
corporate funds in giving gifts to any non-business related friends," and the
defendant had no relationship with the agent other than in their official
capacities. Id.; see also United States v. Gaines, Nos. 92-5446, 92-5501, 1993
WL 220206 (4th Cir. June 1993); United States v. Roberto, 801 F.Supp. 946 (D.
Conn. 1992) (contacts did not include normal incidents of friendship such as
visits, correspondence, and phone calls).
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On the other hand, when the giver and recipient have a real
friendship, when the giver did not mention the official relationship when the
gift was given, and when the giver could point to prior acts of generosity
toward other employees, there is no violation. See NLRB v. Dickinson Press,
Inc.,153 F.3d 282 (6th Cir. 1998); Roper v. Dynamique Concepts Inc., 447 S.E.2d
218 (S.C.
1994).
B. Civil Liability for Breach of Fiduciary Duty
Directors and officers are fiduciaries of a corporation, 15
Pa. Cons. Stat. Ann. ss. 1712(a) (West 1995), and thus owe a duty of undivided
loyalty to the corporation. CST, Inc. v. Mark, 520 A.2d 469, 471 (Pa. Super.
Ct. 1987). Directors generally cannot personally profit through the use of
corporate assets, so corporate transactions in which directors have personal or
financial interests should be approved by disinterested directors. See Seaboard
Indus, Inc. v. Monaco, 276 A.2d 305, 308-09 (Pa. 1971); Bailey v. Jacobs, 189 A.
320, 324 (Pa. 1937); Corporate Director's Guidebook 12-13 (ABA 1994).
Commercial bribery represents a clear violation of the duty of
loyalty. United States v. Parise, 159 F.3d at 800-01. Under agency principles,
an employer may recover commercial bribes from its employee. Sierra Rutile Ltd.
v. Katz, No. 90 Civ. 4913, 1996 WL 556963, at * 4 (S.D.N.Y. Oct. 1, 1996). A
corporation does not have to show intent to harm the corporation or loss to the
corporation, only the fact and amount of the bribe; disgorgement of the amount
of the bribe is the appropriate remedy. See United States v. Shaw, 725 F. Supp.
896, 899-900 (S.D. Miss. 1989); County of Cook v. Lynch, 560 F. Supp. 136, 141
(N.D. Ill. 1982); Fidelity Management & Research Co. v. Ostrander, 1 Mass. L.
Rptr. 397 (1993), 1993 WL 818684, at * 4 (Mass. Super. Ct. Dec. 9, 1993).
Keystone Guard v. Beaman, 107 A. 835 (Pa. 1919), demonstrates
the importance of intent in such cases. In this early case a director accepted
$5,000 of the corporation's funds not to stand for re-election. He received
payment from those seeking to give control of the corporation to a third party
that would fraudulently misappropriate assets. The director was "influenced by
a selfish cupidity and, by incautiously concurring in certain steps of others,
he assisted in the consummation of the conspiracy." Id. at 836. The court held
that "gifts, gratuities or bribes given to a director to influence his official
action must be accounted for by him and surrendered to the company." Id. at 837
(emphasis added).
C. Federal Tax Law
Tax cases addressing the distinction between taxable
compensation and nontaxable gifts also provide helpful guidance in
distinguishing between the two. Evidence of the giver's intent is the key to
determining whether a tax is owed. See Heyen v. United States, 731 F. Supp.
1488 (D. Kan. 1990). In Arnold v. Bingler, 254 F. Supp. 156 (W.D. Pa. 1966),
for example, the issue was "whether the transferor of stock had the requisite
intent of 'detached and disinterested generosity' or was motivated by a business
purpose in making the transfer." Id. at 156, citing Commissioner of the
Internal Revenue v. Duberstein, 363 U.S. 278, 285 (1960). The court held that
the transfers of stock to two men who handled scientific research at the company
were valid gifts, not ordinary income, stating
It seems quite natural that the founder of such a business,
thrown into association with men concerned in the same field
of endeavor, would take an interest in their advancement
sufficient to motivate the desire to benefit them by a gift of
stock in the company, especially when he had no sons or
sons-in-law interested in succeeding him in the business.
Id. at 157.
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As the court noted in Neville v. Brodrick, 235 F.2d 263
(10th Cir. 1956), "[w]hether an amount received by an employee either in cash or
stock constitutes compensation for services or a gift depends upon the intention
of the parties, principally that of the payor or the party issuing or causing
the issuance of the stock." Id. at 265-66. Further, "[u]pon the conventional
transfer of stock, there is an element of economic benefit to the recipient
thereof. But if the motivating purpose of the transaction is that of a gift,
such economic benefit is incidental and not compensatory. . . . And if the
transfer is intended as a gift, it is a gift nonetheless because inspired by a
feeling of gratitude for past or anticipated future services." Id. at 266.
In Neville, the court determined that stock given to an
executive vice president ("EVP"), his wife and his son from the company's major
shareholders were non-taxable gifts. The court highlighted the following points:
1. The EVP was very good friends with a major shareholder who had
"unlimited confidence" in the EVP;
2. The major shareholder was of "advanced age" and had two daughters but no
sons;
3. The EVP had not requested compensation beyond his salary and bonus;
4. The EVP knew nothing of the plan to issue stock until told; and
5. All involved consistently referred to the transfers as gifts.
Id. at 266-67. If, on the other hand, a major shareholder who has no record of
making gifts to employees except as compensation transfers stock to an employee
with whom he has no personal relationship, a court may question the claim that
the transfer was intended as a gift. Adair v. Comm'r of Internal Revenue, 50
T.C.M. (CCH) 620 (1985).
A final point relevant here is that "long and faithful service
may create the atmosphere of goodwill and kindliness toward the recipient which
tends to support a finding that a gift rather than additional compensation was
intended." Brimm v. Comm'r of Internal Revenue, 27 T.C.M. (CCH) 1148 (1968).
D. Conflict of Interest Policies
1. The Erie Policy
The Erie Conflict of Interest Policy contains two provisions
relevant to this case. Exhibit 14. The core policy is straightforward:
Employees should not permit personal interests to conflict, or
appear to conflict with the performance of their duties on
behalf of the Erie. A conflict of interest exists when an
employee's personal or non-Erie business-related activities
adversely affect the Erie's interests or permit that employee
or a third-party to obtain improper gain or advantage,
adversely affecting the Erie's interests.
The intent of the policy is to ensure that neither its
employees nor third parties take advantage of Erie by putting other interests
ahead of Erie. The policy also specifically makes reference to the accepting of
gifts or other benefits:
Employees should not solicit or accept any benefits that might
influence or appear to influence their independence of
judgment or affect their decisions or actions concerning Erie
business. Likewise, employees should not offer to give any
benefits to other persons that might influence or appear to
influence such other persons' conduct in relation to any
transaction involving the Erie. Gifts of cash should never be
given or accepted, regardless of the amount involved.
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Additionally, gifts, gratuities, favors, discounts, or unusual
or expensive entertainment should not be offered, given or
accepted beyond those usual and customary nominal courtesies
associated with lawful and accepted business practices.
The benefits which should not be accepted are those that might
influence or appear to influence decisions concerning Erie business. Thus, the
gifts forbidden by the last two sentences should be read, consistent with the
general policy quoted above, as gifts from third parties because it is such
gifts that might be seen as efforts to influence decisions. We do not read this
provision as forbidding gifts among employees made out of friendship.
This interpretation is confirmed by the conflict of interest
questionnaire, Exhibit 15, required to be filled out each year by all directors
and many Erie employees, which asks
Have you or any member of your immediate family accepted
gifts, gratuities, favors, discounts, benefits, or unusual or
expensive entertainment, beyond those usual and customary
nominal courtesies associated with lawful and accepted
business practices, that might be regarded as placing you
under an obligation to a third party dealing or desiring to
deal with The ERIE?
We believe Erie's policy read as a whole forbids other than
nominal gifts from third parties dealing or desiring to deal with Erie, and
forbids other gifts only if they appear intended to influence judgment. Mr. Hirt
cannot be construed to be a third party with respect to Erie. His active roles
as trustee, an important shareholder, and chairman of the Board make him an
integral part of Erie.
This policy has been in place for ten years. Though we
discovered no corporate documents bearing on its interpretation, its draftsman,
Mr. Van Gorder, interprets the policy as we do. The Erie employees we
interviewed typically either believed that the policy did not apply to
Mr. Hirt's gifts or believed that if a particular gift was motivated by
friendship, the policy would not apply.
2. Other Corporate Policies
We have surveyed conflict and gift policies at other large
corporations. Most have a general conflict rule similar to Erie's policy. Gifts
from third parties are widely forbidden, but the policies either do not address
gifts among employees or make it clear that only gifts to supervisors from those
supervised are forbidden, lest the evaluation process be affected.
For example, the recently adopted Columbia/HCA policy
specifically addresses the limits of its gift prohibition: For
clarity purposes, please note that these limitations govern
activities with those outside of Columbia/HCA. This section
does not pertain to actions between the organization and its
colleagues nor actions among Columbia/HCA colleagues
themselves.
The policy has a different rule for gifts between colleagues
While we wish to avoid any strict rules, no one should ever
feel compelled to give a gift to anyone, and any gifts offered
or received should be appropriate to the circumstances. A
lavish gift to anyone in a supervisory role would clearly
violate organization policy.
Columbia/HCA Healthcare Corporation, www.columbia-hca.com/ethics/fulcode.html.
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Another policy specifically addresses commercial bribes:
Company policy prohibits commercial bribes, kickbacks and
other similar payoffs and benefits paid to any suppliers or
customers. Employees and agents are also prohibited from
receiving, directly or indirectly, anything of a significant
value (other than salary, wages or other ordinary compensation
from the Company) in connection with a transaction entered
into by the Company.
This same company makes clear in its conflicts policy that it is gifts from
those dealing with the company that are forbidden:
Accepts money, gifts of other than nominal value, excessive
hospitality, loans or other special treatment from any
supplier, customer or competitor of the Company (loans from
lending institutions at prevailing interest rates are
excluded);
Halliburton at www.halliburton.com/corp/cobc/ethical.html. Accord
Ingersoll-Rand at www.ingersoll-rand.com/general/coc4.htm.
Another clear policy on the gift issue is that of Lockheed
Martin Corporation:
Lockheed Martin employees are not permitted to accept funds in
any form or amount, or any gift that has a retail or exchange
value of $20 or more from individuals, companies, or
representatives of companies having or seeking business
relationships with Lockheed Martin. If you have any questions
about the propriety of a gift, gratuity, or item of value,
contact your Ethics Officer or the Corporate Office of Ethics
and Business Conduct for guidance.
Lockheed Martin at www.lmco.com/exeth/html/sel.1/ethset.html. Accord Barbara
Abrams, How to Start a Compliance Program, 1057 PLI/Corp 591 (PLI 1998); Nortel
at www. nortel.com/cool/ethics/decision7.html.
We have found no other corporate conflict or gift policy or
principle of corporate governance that would bar Mr. Hirt's gifts if they were
made out of friendship rather than to influence corporate decisions.
3. Federal Employee Policies
We also examined federal employee gift policies. These
policies are very explicit and entirely consistent with our interpretation of
Erie's policy outlined above.
As to gifts between employees, the only prohibition is against
gifts to a supervisor from one who is supervised:
(1) Employees cannot make a gift to an
official superior.
(2) An employee cannot accept a gift
from another employee who receives
less pay unless the two are not in a
subordinate-official superior
relationship and there is a personal
relationship between the two that
would justify the gift.
(3) "Official superior" means any other
employee, other than the President
and the Vice President, including
but not limited to an immediate
supervisor, whose official
responsibilities include directing
or evaluating the performance of the
employee's official duties or those
of any other official superior of
the employee. . . . [A]n employee is
considered to be the subordinate of
any of his official superiors.
5 C.F.R. ss.ss. 2635.302-304.
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Gifts from outside sources are more broadly prohibited:
(1) Employees cannot solicit or accept
gifts (1) from prohibited sources or
(2) given because of the employee's
official position.
(2) "Prohibited sources" includes any
person who is seeking official
action by the employee's agency,
does business or seeks to do
business with the agencies, conducts
activities regulated by the
employee's agency, or has interests
that may be substantially affected
by the performance or nonperformance
of the employee's official duties.
(3) A gift is solicited or accepted
because of the employee's official
position if it is from a person
other than an employee and would not
have been solicited, offered or
given had the employee not held the
status, authority or duties
associated with his Federal
position.
5 C.F.R. ss.ss. 2635.202, 203. These federal policies would not bar Mr. Hirt's
gifts if they were made out of friendship rather than to influence corporate
decisions.
E. Disclosure Requirements
1. Securities and Exchange Commission
No disclosure of the gifts was required in any periodic report
or other filing under the applicable federal securities laws, except that the
shares received by directors and officers were required to be, and appear to
have been, reflected in Forms 4 and 5 and in the stock ownership section of the
Erie proxy statements.
2. Pennsylvania Insurance Law
Although the Erie Indemnity Company is involved in the
insurance business as attorney in fact for the Erie Insurance Exchange and as
manager of the Erie group of insurance companies, it is incorporated as a
Pennsylvania domestic business corporation. It is not incorporated under the
provisions of the Pennsylvania statutes governing insurance companies which
require the disclosure of transfers of stock in certain instances.
V. Evidence of Intent
Under the foregoing survey of law and policy, questions could
be raised about the propriety of Mr. Hirt's gifts only if his intent in giving
the gifts to the directors or theirs in accepting the gifts was to influence
their decisions as directors. Mrs. Hagen and her counsel allege that this is the
case. They point out that the gifts began at about the same time as Mr. Hagen's
termination as CEO. They also point to a series of Board votes in which all or
almost all of the directors voted one way and the Hagens voted the other way
during the years when the gifts were being given. They believe that those to
whom the gifts were given controlled others on the Board. They believe that
buying influence is the only reason Mr. Hirt would give gifts to four directors
who all had substantial assets. The Committee has asked for any evidence
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supporting these assertions, and has received none beyond the circumstantial
points made above. Mrs. Hagen and her counsel contend that the only conclusion
possible is that Mr. Hirt intended with his gifts to influence votes of the
Board. Our conclusion, however, is that there is no credible evidence of such an
intent, and overwhelming evidence that Mr. Hirt's intent in giving the gifts was
disinterested generosity.
A. Interviews
1. Mr. Hirt's Tax Lawyers
The lawyers from whom Mr. Hirt has sought tax advice have
substantial recollections of Mr. Hirt's intent in making the gifts that are
supported by documents.
When the value of their assets dramatically increased with the
value of Erie's stock in the late 1980s, both the Hirts and the Hagens asked the
law firm of Schiff Hardin & Waite ("Schiff Hardin") to review their holdings and
offer advice. In August 1989, Schiff Hardin prepared a lengthy memorandum
addressed both to Mr. Hirt and Mr. Hagen entitled "Estate Planning
Recommendations." Exhibit 16. Aside from requesting a joint memorandum, the
Hirts and Hagens did not consult or collaborate with each other on estate
planning issues. Schiff Hardin met with each of the Hirt and Hagen families
separately and recommended which of the techniques described in the memorandum
best suited each family's needs and goals.
The Hirts followed many of Schiff Hardin's recommendations.
They gifted large amounts of Erie nonvoting stock to immediate family members
and charities, formed a family partnership and established trusts to fulfill
their desires to provide a secure financial future for their children and
grandchildren and to benefit the community as well as to minimize taxation.
Schiff Hardin recommended that the Hirts make gifts of Erie stock, rather than
another asset, because the Hirts need their cash to pay taxes, their assets
primarily consist of Erie stock, and gifts of those assets that are most likely
to appreciate secure the greatest benefit to any estate. Despite the size and
number of these transfers of the Hirts' wealth, the Hirts' estate continued to
escalate in value as Erie's stock similarly became worth more and more.
On a continuing basis, Mr. Hirt consulted with Schiff Hardin
to receive their advice on his estate planning. Schiff Hardin suggested to Mr.
Hirt that he consider giving "annual exclusion gifts" of Erie stock to a wider
group of recipients, such as extended family members and current or former Erie
employees, directors or shareholders. Simply put, an exclusion gift is a
transfer during one's lifetime of less than $10,000 to any person in any one
year that is presumed to be a gift and thus excluded from all federal and state
taxes. The Hirts followed this advice.
Records reflect that as early as 1989, Mr. Hirt gave three
shares of Erie stock to Doug Ziegler, an Erie employee Mr. Hirt had known for
years and who had helped Mr. Hirt with a variety of estate planning matters, and
two shares to his wife, Diane Ziegler, for a total value of $15,000. Exhibit
17. In the spring of 1992, after Mr. Hirt's retirement, each of Mr. Milne and
Carl Godleski, then Erie agents, as well as Mr. Schofield received Erie stock
from the Hirts. Exhibit 18. Mr. Milne and Mr. Godleski were well known,
long-time friends of Mr. Hirt. Mr. Schofield had been asked to be a director
the year before by Mr. Hagen.
Beginning in 1994 and each year thereafter until 1997, the
Hirts gave Christmas gifts of Erie stock to certain directors who were Erie
officers as well as other Erie employees, former employees, and numerous
friends. Exhibits 19 and 20. According to the Hirts' answer to an interrogatory
filed in Erie County, Orphans' Court Division, "as part of annual gifting
programs established pursuant to a comprehensive multi-year family estate plan
designed by and within the advice of tax specialists," they had given 75 gifts
of nonvoting Erie stock since 1993 to the families of past and present Erie
directors and officers. The Hirts identified, by year, the various recipients
and the amount of Erie stock given. Specifically, the Hirts stated that between
1993 and the present the Milne family received 13 gifts of stock, the Van Gorder
family received 8 gifts of stock, the Schofield family received 10 gifts of
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stock, and the Petersen family received 8 gifts of stock. Exhibit 9. A complete
list of gifts to present and former Erie directors and employees is set forth in
Section V, B.1, infra.
By 1995, the Hirts had given substantial amounts of Erie stock
to their family members, charities, and friends both associated and not
associated with Erie. Nonetheless, Mr. Hirt's wealth continued to increase. He
told Schiff Hardin that he expected to leave the remainder of his estate to
charity. However, when Schiff Hardin analyzed Mr. Hirt's finances, his counsel
as well as Mr. Hirt believed that his estate had become too large to leave to
charity.
Mr. Hirt next asked Schiff Hardin whether a gift of $10,000 in
Erie stock to each of Erie's employees or a large stock gift to Erie directly,
which would in turn give $10,000 in Erie stock to each employee, would more
effectively reduce the tax consequences to his estate. Mr. Hirt advised Schiff
Hardin that he wished for the gifts to be anonymous, if that could be done
without adverse tax consequences, because he wanted to enrich the employees'
lives without any personal attribution. Discussions regarding Mr. Hirt's
intentions culminated in a 1996 letter from Schiff Hardin, in which Schiff
Hardin concluded that while even such a large number of sizable transfers of
stock would probably be construed as gifts, the transfers might incur increased
scrutiny from federal tax authorities. Exhibit 21. After much deliberation, Mr.
Hirt elected not to make gifts to every Erie employee because of the tax risk
involved for the recipients as well as for him.
2. Mr. Hirt
Mr. Hirt has stated that his gifts of stock to Erie officers
and directors were solely motivated by the escalation in the Hirts' wealth and
their desire to share a small portion of this wealth with the people who have
worked hard on Erie's behalf and whom Mr. Hirt has come to admire and respect.
Exhibit 22. Mr. Hirt stated that he was not motivated by a desire to have any
officer or director act in opposition to the Hagens and in fact believes that it
would be an insult to suggest that any of the particular recipients would vote
for anything other than what they believe to be in the best interest of Erie and
its shareholders. Mr. Hirt did not even consider whether the gifts should be
disclosed under Erie's conflict policy because he knew that H.O. Hirt had made
gifts of Erie stock. Exhibit 23.
3. Board Member Gift Recipients
a. Mr. Hirt's Intent
Directors who received gifts of Erie stock from Mr. Hirt
recalled Mr. Hirt stating that his intention in making the gifts was to share
his unanticipated financial fortune and none recall a word spoken about Board
issues in connection with these gifts:
(1) Mr. Milne: Mr. Hirt stated that he made the gifts because he has
been blessed, almost to the point of being embarrassed, by his
wealth.
(2) Mr. Petersen: Mr. Hirt told Mr.Petersen that he had so much
money and simply wanted to share it rather than see it go to the
government. Mr. Hirt said nothing about giving the stock with
any intent to influence Mr. Petersen.
(3) Mr. Schofield: At an earlier time, Mr. Hirt had asked Mr. Schofield if
then-CEO Mr. Hagen had arranged for Mr. Schofield to acquire any Erie
stock. When Mr. Schofield told Mr. Hirt that Mr. Hagen had not,
Mr. Hirt had said that he would do so. Mr. Schofield also knew that at
one point. Pennsylvania law required directors of insurance companies
to own stock. Mr. Hirt never in any way suggested that the gifts were
to influence Mr. Schofield to vote Board issues in a particular way.
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(4) Mr. Van Gorder: Mr. Hirt told Mr. Van Gorder that he was embarrassed
by his wealth, that he had too much money to give away in his lifetime,
that he had already taken care of his family, and that he was
determine to give the remainder of his estate to charity so that there
would be no estate tax due upon his death. Mr. Van Gorder told
Mr. Hirt that he would probably give the stock away. Mr. Hirt stated
that Mr. Van Gorder should do whatever he chose with the stock.
Mr. Hirt never stated that the gifts of stock were to ensure
Mr. Van Gorder's loyalty against anyone or anything remotely along
those lines. Such a statement would be completely against Mr. Hirt's
character.
b. Gift Recipients' Intent
The Directors also believed that the gifts did not violate
Erie's conflict of interest policy.
(1) Mr. Milne: He looked very carefully at Erie's conflict of interest
forms, reading them with particular care to see if they applied to the
gifts. He concluded that the questions pertained only to gifts from
third parties. Rather than pose a conflict, Mr. Milne see Mr. Hirt's
gifts as being in the best interest of the company in motivating
its employees. Thus, Mr. Hirt's gifts are of benefit to large
shareholders, such as the Hagens.
(2) Mr. Petersen: It "never crossed [his] mind" that the stock he received
from Mr. Hirt might be a potential violation of company policy. Erie's
policy applies to vendors, customers and brokers from whom Mr. Petersen
never even accepted lunch. Moreover, none of Mr. Hirt's gifts were
designed to influence or had the effect of influencing him or anyone
else. Mr. Petersen noted that he owns well over two million Erie
shares and thus "can't be influenced by a few hundred" from Mr. Hirt.
Mr. Petersen added that he had twice received $2,000 in cash from H.O.
Hirt and had given some Erie stock to Ms. Etter, his secretary while he
was chief financial officer, and that he did not see any of these gifts
as violating the Erie policy.
(3) Mr. Schofield: The Erie conflict of interest policy does not pertain
to Mr. Hirt's gifts because it has the "standard" language that
Mr. Schofield has seen at so many companies and that concerns third
parties. In this regard, Mr. Schofield noted that he had fired the
director of purchasing at US Airways because he had accepted gifts from
vendors. Even if Mr. Hirt could be considered a third party under the
policy, the gifts had no capacity or intent to influence Mr. Schofield,
who did not even think about the reasons for the gifts, and whose net
worth, in excess of $10 million, was too high for him to be influenced
by the gifts.
(4) Mr. Van Gorder: In completing his Erie conflict of interest
questionnaires, Mr. Van Gorder never even contemplated that the
form addressed Mr. Hirt's gifts of stock. The questions pertain to
whether an employee or director has received anything of value from a
third party and whether the employee or director has steered any
business to the third party. Mr. Van Gorder noted that Mr. Hagen, when
CEO, had given him the opportunity to buy Erie stock at a time when the
stock was otherwise unavailable, a very valuable gift at the time.
4. Other Gift Recipients
a. Mr. Hirt's Intent
Other gift recipients who are not directors but are present or
former Erie employees have recollections similar to those of the gift recipients
about Mr. Hirt's motives and their own intent.
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(1) Mr. Ziegler: Mr. Hirt explained to Mr. Ziegler that he has been very
fortunate and could never spend all the money he has amassed. Mr. Hirt
said that he would rather give the money to charities and friends
than have any of it go to the IRS upon his death.
(2) Mr. Brinling: Mr. Hirt said that he had taken good care of his
family and various charities and had decided that because
Erie had been so good to them that they wanted to share their
wealth with their friends. In no way did Mr. Hirt suggest that
he expected Mr. Brinling to do anything for Mr. Hirt because of the
gifts.
(3) Mr. Burt: Mr. Hirt said that Mr. Burt should not do anything in return
for the gift. Mr. Hirt explained that he had so much money that he did
not know what to do with it and so was giving it away. Mr. Hirt
explained that he could give up to $10,000 to one individual without
paying a gift tax. He told Mr. Burt that he would like to make larger
gifts to his friends but that he would then face a 50 percent tax rate.
(4) Mr. Sider: Mr. Hirt told him that he could keep, sell or gift the
stock, whatever he chose.
(5) The Christs: Mr. Hirt told them that the gift of stock was simply
because of their friendship. He did not say anything about estate
planning or any motivation on his part, and the Christs saw the gift of
stock simply as reflective of the Hirts' generosity.
(6) The Cummings: Mr. Hirt told them that the $10,000 in Erie stock to
each of them was purely a gift and that he wanted nothing in return
because he has everything he needs. Mr. Hirt also said that the stock
was the Cummings' to do with as they pleased.
(7) Mr. Godleski: Mr. Godleski said that Mr. Hirt told him that a Chicago
law firm had given him estate planning advice. Mr. Hirt stated that
his wealth had grown so much that he could not even spend the dividend
income on his Erie holdings.
b. Gift Recipients' Intent
These other gift recipients also did not think about the
conflicts policy, in part because the motive they saw for the gifts was so
obviously generosity. Mr. Ziegler and Mr. Sider have also given Erie stock to
their subordinates.
(1) Mr. Ziegler: He never considered that Mr. Hirt's gifts of stock might
violate company policy or that Mr. Hirt was trying to buy anyone's
loyalty. Mr. Ziegler believes that all of the Erie officers
that received gifts work long hours and are extremely devoted to Erie
so their loyalty is not in question. Mr. Ziegler has also given Erie
stock to his subordinates in an effort to emulate Mr. Hirt's
generosity, and does not believe that his own gifts violate any
policies. Exhibit 24.
(2) Mr. Brinling: He never thought that Erie's conflicts policy might
apply to Mr. Hirt's gifts. He reads the conflicts form each year and
interpreted it to cover gifts that could influence decisions that he
might make on behalf of Erie. Mr. Hirt's gifts could not influence him
because they could not affect his behavior or his opinion of Mr. Hirt.
(3) Mr. Burt: He would not have thought that these gifts would violate
Erie's policy because they arose from his long-term friendship with
Mr. Hirt.
(4) Mr. Sider: It never crossed Mr. Sider's mind that the gifts might
violate Erie policy. He had 150,000 shares of Erie stock at the time
and does not see how less than 400 could influence him. Mr. Sider
twice gave 100 shares of Erie stock to his secretary.
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(5) Ms. Etter: She is a non-exempt employee so she has not paid any
attention to the corporate personnel manual. She never thought
accepting the gifts from Mr. Hirt was in any way improper.
(6) The Christs: They never thought of any conflict that the gifts of
stock might pose, because of their friendship with the
Hirts and because they do not believe that they occupy positions
of influence or power with respect to decisions to be made on behalf
of Erie.
(7) Mr. Cummings: He did not think that there was anything wrong with his
receiving the gifts, but believes he asked Laurel Hirt whether the
gifts posed a conflict and she said that they did not. Mr. Cummings
stated that he cannot see Mr. Hirt trying to influence anyone
through his gifts; Mr. Hirt is simply "overly generous."
(8) Mr. Godleski: Mr. Hirt told Mr. Godleski not even to say thank you
or send a note, that he expected nothing in return. There was
absolutely no suggestion of an intent to influence.
5. Family Members
Mrs. Hirt and Laurel Hirt agree that Mr. Hirt expressed great
friendship and admiration for all four of the directors who received gifts.
Mrs. Hagen and Laurel Hirt, however, cannot understand how Mr. Hirt could have
given them such gifts without an ulterior motive.
a. Laurel Hirt: Ms. Hirt, Mr. and Mrs. Hirt's daughter, is a securities
analyst at Erie, and stated that her father is a generous man.
Ms. Hirt knew of the 1992 gifts to Messrs. Milne, Schofield and
Godleski. She does not know if they or the subsequent gifts were part
of her father's estate plan but believes this mischaracterizes them.
Mr. Hirt speaks highly of Mr. Milne and is "unusually" loyal to him.
Mr. Hirt believes Mr. Van Gorder is a "sharp attorney." Mr. Petersen
is like family and has done a tremendous job managing Erie's portfolio.
Mr. Hirt speaks highly of Mr. Schofield, a man he considers to be of
the highest integrity. The other recipients are also long-time
business acquaintances of her father's.
b. Audrey Hirt: Mrs. Hirt stated that shortly before the 1994 gifts were
made, Mr. Hirt told her that Schiff Hardin had discussed the Hirts'
option of making gifts of Erie stock of less than $10,000 per person.
These gifts, Mr. Hirt told her, would not be taxable either to the
Hirts or the recipients. Mrs. Hirt annually composed her own list of
the persons to whom she wished to give, Mr. Hirt did the same, and
Mr. Hirt merged the lists into one to give to Mr. Ziegler. With
respect to the recipients of Mr. Hirt's gifts, including the four
directors, Mrs. Hirt stated that Mr. Hirt had fond feelings for each
and had known most for many years. Mr. Hirt never said that he was
making these gifts to influence anyone or to try and encourage someone
to act in a particular manner.
c. Mrs. Hagen: Mrs. Hagen does not see any connection between the
millions of dollars of gifts of stock Mr. Hirt also gave to friends,
charities and other Erie employees who are not officers and the
gifts to the four directors. Her counsel stated that no matter
how many times someone does something right, he may still do something
wrong on another occasion. Mrs. Hagen's counsel explained that all the
directors were aware of the "business disagreements" between Mr. Hirt
and Mrs. Hagen, that Mr. Hirt made large gifts to certain
directors, and Mrs. Hagen lost all the votes.
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B. Documents
We reviewed estate planning documents, records of Board
conflicts, and records of the gifts themselves. The circumstantial evidence
provided by the documents strengthens the case for generosity as Mr. Hirt's
motive.
1. The Gifts
Set out below is a complete record of the relevant Hirt gifts.
<TABLE>
<CAPTION>
Amount 3
Recepient's Name 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Directors
Stephen A. Milne $ 0 $ 0 $ 0 $ 9,600 $ 0 $ 0 $ 19,988 $ 19,952 $ 20,622.50 $ 19,755.62
Joy Milne 0 0 0 0 0 0 19,600 19,952 20,622.50 19,755.62
Lucas Milne 0 0 0 0 0 0 19,600 19,952 20,622.50 19,765.25
Holly Milne 0 0 0 0 0 19,998 19,600 19,952 20,622.50 19,765.25
John Petersen 0 0 0 0 0 19,988 22,326 0 0 0
Gertrude Petersen 0 0 0 0 0 19,988 22,326 0 0 0
Marissa Rickloff 0 0 0 0 0 0 0 22,050 20,355 0
Matthew Rickloff 0 0 0 0 0 0 0 22,050 20,355 0
Seth Schofield 0 0 0 9,600 0 0 19,988 22,326 22,050 20,355
Diane Scholfield 0 0 0 0 0 0 19,988 22,326 22,050 20,355
Jan Van Gorder 0 0 0 0 0 9,994 11,163 11,025 10,177.50 0
Linda Van Gorder 0 0 0 0 0 9,994 11,163 11,025 10,177.50 0
<FN>
- --------------------
3 The amounts stated are those provided on Mr. Hirt's original lists, Exhibit
19, that were given to Doug Ziegler to assist with the transfers. All were
intended to be annual exclusion gifts, i.e. under $10,000 per donor and the
amounts stated may reflect fluctuations in the stock price between the
dates on which the Hirts first composed the lists and the dates on which
the stock was actually transferred.
4 In 1995, Mr. Milne received his gift in January and the rest of his family
received their gifts in July. In 1996, 1997 and 1998, Mr. Milne and his
family received their gifts in January. All other recipients received their
gifts at Christmas time of the year listed.
</FN>
</TABLE>
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<TABLE>
<CAPTION>
Amount 3
Recepient's Name 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Erie Employees
John Brinling 5 $ 0 $ 0 $ 0 $ 0 $ 0 $ 9,994 $ 11,163 $ 11,025 $ 10,177.50 $ 0
Elaine Brinling 0 0 0 0 0 9,994 11,163 11,025 10,177.50 0
Doug Ziegler 9,000 0 0 0 0 9,994 11,163 11,025 20,355 0
Diane Ziegler 6,000 0 0 0 0 9,994 11,163 11,025 20,355 0
Alexander Ziegler 0 0 0 0 0 0 0 0 20,355 0
Tom Sider 0 0 0 0 0 0 0 22,050 0 0
Mark Christ 0 0 0 0 0 9,994 11,163 11,025 10,177.50 0
Sherrie-Jo Christ 0 0 0 0 0 9,994 11,163 11,025 10,177.50 0
Shawn Cummings 0 0 0 0 0 0 0 11,025 10,177.50 0
Jennifer Cummings 0 0 0 0 0 0 0 11,025 10,177.50 0
Linda Etter 0 0 0 0 0 0 0 22,050 20,355 0
<FN>
- ------------------
5 President, Erie Family Life Company
</FN>
</TABLE>
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<TABLE>
<CAPTION>
Amount 3
Recepient's Name 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Former Employees
Peter Cipriani 6 $ 0 $ 0 $ 0 $ 0 $ 0 $ 9,994 $ 11,163 $ 11,025 $ 20,355 $ 0
Antonette Cipriani 0 0 0 0 0 9,994 11,163 11,025 20,355 0
James Nuber 7 0 0 0 0 0 0 0 11,025 10,177.50 0
Katherine Nuber 0 0 0 0 0 0 0 11,025 10,177.50 0
Frank Yarian 8 0 0 0 0 0 19,988 0 0 0 0
Agnes Yarian 0 0 0 0 0 19,988 0 0 0 0
Dan Burt 9 0 0 0 0 0 0 0 11,025 10,177.50 0
Frances Burt 0 0 0 0 0 0 0 11,025 10,177.50 0
<FN>
- -----------------
6 Former Senior Vice President, automobile underwriting
7 Non-officer employee
8 Former Director
9 Former Supervisor, automobile fleet
</FN>
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Amount 3
Recepient's Name 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Agents
Raymond Sitter 10 $ 0 $ 0 $ 0 $ 0 $ 0 $ 9,994 $ 11,163 $ 0 $ 20,355 $ 0
Jo Ellen Sitter 0 0 0 0 0 9,994 11,163 0 20,355 0
Robert Rutkowski 11 0 0 0 0 0 9,994 11,163 11,025 20,355 0
Olivia Rutkowski 0 0 0 0 0 9,994 11,163 11,025 20,355 0
Carl Godleski 12 0 0 0 0 9,600 9,994 0 11,025 10,177.50 0
Nancy Godleski 0 0 0 0 9,600 9,994 0 11,025 10,177.50 0
<FN>
10 Former agent, Mrs. Hirt's brother
11 Former agent
12 Agent
</FN>
</TABLE>
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2. The Board Votes
An examination of all Board minutes since 1990 reveals voting
to be typically unanimous until Mr. Hagen's termination in September 1993. Since
then, there have been a number of issues on which the Hagens have taken a
different position from the rest of the Board. On some of these issues, said by
the Hagens to be examples of Mr. Hirt's influence, the Board outvoted the
Hagens. The first of these votes, in May 1994, was well after Mr. Hirt's 1992
gifts and before any of his 1994 gifts. On other issues, unremarked by the
Hagens, the Board deferred to them.
a. The "Influenced" Votes
The following votes are said by the Hagens to have been
influenced by Mr. Hirt's gifts. Exhibits 25A-G. We find no evidence in the Board
minutes or in our investigation to believe that those in the majority voted for
any reason other than the merits of the issues.
(1) The May 26, 1994 vote in favor of a $5 million payout limit per
shareholder from the Redemption Fund.
Mr. Hirt initiated discussion of this item at an executive
committee meeting, which adopted the limit and the Board later ratified the
executive committee's action. Previously, the fund comprised a set percentage of
retained earnings. With the change, the death of a major shareholder would not
have as large a financial impact on Erie. Major shareholders Hirt, Petersen and
Black, as well as the other directors supported the change. The Hagens
dissented, on the ground that the Board's concerns about the fund arose from
erroneous data. Exhibit 25A.
(2) The April 25, 1995 vote in favor of indemnifying Mr. Sider,
Erie's chief financial officer, in an insider trading lawsuit.
The law firm of Duane Morris & Heckscher seconded Erie's
in-house counsel's view that Mr. Sider was entitled as a matter of law to be
indemnified and that the Board did not need officially to approve the
indemnification. Exhibit 27. The Hagens dissented, on the ground that in their
view Mr. Sider should not be indemnified in a "personal" lawsuit. Exhibit 25B.
(3) The December 13, 1994 and September 21, 1995 votes in favor of
increasing Mr. Sider's pay.
Prior to the December 1994 meeting, the Board's executive
compensation committee received extensive background material from Erie as well
as reports on executive compensation issues from two objective outside
consultants. Messrs. Van Gorder and Petersen did not participate in the votes,
and Mr. Milne was not yet a director. The Hagens dissented on both votes, on the
ground that they did not think a raise was in order for someone who should be
terminated, and Ms. Goldman dissented on the first vote. Exhibits 25C and 25D.
(4) The December 13, 1994 vote in favor of granting Mr. Petersen a
large retroactive pay increase.
The executive compensation committee received extensive
background material from Erie as well as reports on compensation from two
objective outside consultants. Managers responsible for investing portfolios
the size of Erie's typically made many times Mr. Petersen's salary. Messrs.
Petersen and Van Gorder did not participate in the vote, and Mr. Milne was not
yet a director. The Hagens and Mr. Weil dissented. Exhibit 25C.
(5) The December 13, 1994 and September 21, 1995 votes in favor of
increasing Mr. Milne's compensation package.
Prior to the December 1994 meeting, the Board's executive
compensation committee received extensive background material from Erie as well
as reports on executive compensation issues from two objective outside
consultants. Messrs. Petersen and Van Gorder did not participate in the votes,
and Mr. Milne was not yet a director. The Hagens dissented on the ground that
the raise exceeded the Erie employees' two or three percent raise to such an
extent as to be against the Erie culture. Exhibits 25C and 25D.
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(6) The April 25, 1995 and December 16, 1997 votes in favor of entering
into and continuing employment contracts with certain senior officers.
Before the April 1995 meeting, the executive compensation
committee received information and suggestions from various directors and the
committee reported to the Board on the topic. The December 1997 vote was to
extend Messrs. Milne's and Van Gorder's contracts, which were set to expire in
November 1998. Mr. Milne, who was not a director at the time of the first vote,
and Mr. Van Gorder did not participate in either vote. The Hagens dissented, on
the ground that that they viewed these contracts as giving the executives
"golden parachutes" that were not necessary. Exhibits 25B, 25F and 28.
(7) The March 19, 1998 vote for a slate of directors that did not include
Mr. Hagen.
The nominating committee received advice from Duane Morris &
Heckscher before making its unanimous decision and issued a report. The Board
stated its belief that Mr. Hagen was a disruptive influence. The Hagens
dissented. It is notable that the Hagens do not assert that influence played a
role in the 1993 vote terminating Mr. Hagen as CEO. Exhibit 25E.
(8) The December 16, 1998 vote to implement a stock repurchase plan.
Mr. Ziegler presented the Board with information, provided by
outside investment advisers, that stock repurchases are a common and
well-regarded course of action when the stock price is low enough to make it an
attractive investment. Mrs. Hagen, joined by Mr. Weil and Ms. Goldman,
dissented because management had provided little background before the meeting
and the plan as voted on was somewhat different than originally proposed.
Exhibit 25G.
b. Other Disputed Issues
An examination of other disputed Board issues reveals that the
Board often deferred to the Hagens on such issues.
(1) Delaware Holding Company
The majority of the Board favored establishing a Delaware
holding company; the Hagens did not. Tax advantages for Erie would accompany
the change. CEO Petersen reviewed this issue at the December 16, 1993 meeting.
Exhibit 26A. The Board discussed this issue at its June 22, 1995 meeting.
Exhibit 26B. In a February 5, 1996 letter from William Clark, Esq. to James
Glockley, Mellon Bank, Mr. Clark proposed that further action on this issue be
deferred. Exhibit 7. At the March 26, 1996 Board meeting, Mr. Van Gorder
reported on the previous day's meeting with attorneys for each of Mr. Hirt,
Mrs. Hagen and Mellon Bank about this issue. Exhibit 26C. On June 17, 1996,
the Board voted unanimously to table the issue. Exhibit 26F.
(2) Secondary Stock Offering
Messrs. Van Gorder, Petersen and Milne, as well as Messrs.
Hirt and Schofield, have favored considering a secondary stock offering.
Exhibit 25D. This would increase the number of shareholders and therefore
create a broader market for the stock. The Hagens have opposed this proposal and
the matter has been tabled.
(3) Demutualization Legislation
The majority of the Board, including Mr. Hirt, shared Mr. Van
Gorder's position that if a proposed state bill allowing the demutualization of
insurance companies were to be passed, it should contain a similar proposal for
reciprocal insurance companies like Erie. The Hagens viewed Mr. Van Gorder's
actions as an effort to change control of Erie, and hired a personal lobbyist to
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oppose the legislative change. In the February 5, 1996 letter to which we have
previously referred, Mr. Clark proposed that further action on the bill be
deferred until, among other things, Messrs. Van Gorder and Sider were replaced.
At the March 26, 1996 Board meeting, Mrs. Hagen questioned the need for the
legislation and asked that her counsel be contacted about the matter. Exhibit
26C. At the May 1, 1996 Board meeting, Mr. Milne asked the Board to table its
support for the legislation. Exhibit 26D. On May 7, 1996, Mr. Van Gorder wrote
to the Insurance Federation of Pennsylvania, stating that Erie would prefer that
the bill not be enacted. Exhibit 26E.
(4) Erie's Management Fee
Another issue has been the management fee issue, which is the
percentage of earned premiums paid by the Erie Insurance Exchange to its
"attorney-in-fact," Erie. Other things being equal, the higher the percentage
of premiums paid, the higher Erie's earnings. The Hagens favor keeping the rate
at or near the maximum 25 percent allowed by law. At the September 29, 1994
Board meeting, then CEO Petersen stated that he would prefer to see the rate
reduced below its then level of 25 percent because Erie's earnings that year
were already so strong. Exhibit 26G. The Board deferred consideration of the
issue. On March 2, 1995, Mr. and Mrs. Hagen dissented from an otherwise
unanimous vote in favor of reducing the attorney-in-fact compensation to 24.5
percent. Exhibit 26H. All subsequent votes have been unanimous.
c. Conclusions
Our examination of the above Board votes, and other non-
unanimous votes not raised by the Hagens, reveals no evidence of influence. As
participants in those votes, we believe the issues were resolved on the merits,
and that appropriate deference, but no more than that, was given to the views of
both the Hagens and Mr. Hirt.
C. Mr. Hirt's Intent
The individuals we interviewed, from many backgrounds and
perspectives, overwhelmingly portrayed Mr. Hirt as a generous man embarrassed by
his wealth, too modest to live opulently himself, and eager to give a large part
of his money to family and charity and a relatively small part to people who
were special to him for various reasons. Neither our interviews nor the
documents we reviewed provide any support for the thesis that Mr. Hirt was
trying to influence Board votes.
Mrs. Hagen points to two circumstantial facts that she
suggests mandate a contrary conclusion: the gifts started at the time Mr. Hagen
was terminated and Mr. and Mrs. Hagen were outvoted on a number of subsequent
Board votes. First, the gifts started earlier and became large only a year
later, at Christmas 1994. When Mr. Hirt gave his 1992 gifts to Messrs. Milne
and Schofield, Mr. Hagen was CEO, there was no conflict on the Board, and
Mr. Milne was not even an Erie employee. Mr. Milne also received gifts in 1994
and 1995, by which time he was an Erie employee, but not yet a member of the
Board. The much more salient fact about the timing of the gifts was the great
increase in Mr. Hirt's wealth caused by the increase at this same time in the
value of Erie stock and the advice he sought from Schiff Hardin about how to
diminish that wealth without adverse tax consequences. In 1994 he began taking
their advice to broaden his giving and made many more gifts to directors and
nondirectors alike.
Second, if Mr. Hirt wished to secure votes on Board issues,
logically he would have given gifts to more directors. He certainly had no
financial constraints. What separated those to whom he gifted from those to
whom he did not was that for various reasons he felt a special kinship with
these four. Mr. Petersen and Mr. Van Gorder were long-time close colleagues to
whom Mr. Hirt felt close. Mr. Milne was a protege in whose career Mr. Hirt had
taken a special interest, and Mr. Schofield was someone of whom Mr. Hirt quickly
grew especially fond for personality reasons. Mrs. Hagen believes that the gift
recipients were dominant directors who led others, but this is not the personal
experience of the members of this Committee and is not borne out by our
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examination of Board votes highlighted by Mrs. Hagen. To take only one example,
half of the disputed votes said by the Hagens to have been tainted by Mr. Hirt's
influence related to senior management compensation on which some or all of
Messrs. Petersen, Milne and Van Gorder did not vote. If these votes were
important to Mr. Hirt, he influenced the wrong directors.
Third, Mr. Hirt's gifts of stock to other Erie employees are
strong support for the conclusion that his motive was generosity. These gifts,
given at the same time as the gifts to directors, and in similar amounts, could
have no motive but friendship and generosity. The authorities we have discussed
above highlight the existence of a record of generous actions as important
circumstantial evidence of intent.
D. The Gift Recipients' Intent
1. Mr. Schofield
Mr. Schofield had long experience on corporate boards. He
believes many corporations have a practice of giving directors stock or matching
stock or the opportunity to buy stock at an attractive price. Mr. Hirt gave him
his first gift only after asking him whether Mr. Hagen, then chairman and CEO,
had already done so. This was at a time when there were no Board disputes and
no conflict between Mr. Hirt and the Hagens. After that, according to the two
men themselves and numerous other witnesses, Mr. Schofield and Mr. Hirt became
good friends. They seemed to relate to each other particularly well and
Mr. Hirt often expressed his respect and admiration for Mr. Schofield.
Mr. Schofield also informed us that his net worth is in excess of $10 million
and that Mr. Hirt's gifts had no capacity to influence him.
2. Mr. Petersen
Mr. Petersen is a long-time dedicated associate credited by
Mr. Hirt and others with a large part of Erie's success. Laurel Hirt told us
that giving a gift to Mr. Petersen was like giving to a member of the family.
Because of his control over Erie's investments, Mr. Petersen
is particularly wary of acting in any way that could cause his decisions to be
influenced and is known for this within Erie. He is constantly importuned by New
York investment banks eager to entertain him and obtain Erie's business. He has
made a point of accepting nothing, even lunch, from those with whom he was
considering doing business.
Mr. Petersen is such a large Erie stockholder that he can be
presumed to want what is best for Erie, making him unlikely to be influenced in
a way adverse to corporate interests. ALI Principles ss. 1.34, Comment b; In
re The Walt Disney Co. Deriv. Litig., No. 15452, 1998 WL 731587, at * 6 (Del.
Ch. 1998). Moreover his net worth is near $100 million, making the gifts very
small in comparison. Indeed, Mr. Petersen resisted Mr. Hirt's gifts, saying
that they only made his own estate planning harder, and finally persuaded
Mr. Hirt to give to Mr. Petersen's grandchildren instead.
Mr. Petersen has made gifts of Erie stock himself to his
secretary, and received at least one substantial cash gift from H. O. Hirt. He
therefore never imagined that a gift from Mr. Hirt could be considered improper.
3. Mr. Milne
Mr. Milne did look at Erie's conflicts policy to satisfy
himself that Mr. Hirt's gift was proper, and concluded that the policy only
applied to third parties. He never considered that Mr. Hirt might try to buy his
support because the 1992 gift was made when Mr. Milne was still an agent in
Maryland, and the 1994 and 1995 gifts were made before he became a member of the
Board.
Moreover, Mr. Hirt and Mr. Milne first worked together 25
years ago and their close, almost father-son, relationship is remarked on by
all. Conversely, Mr. Milne long disliked Mr. Hagen and originally left Erie
because of that conflict. If there is anyone on the Board that Mr. Hirt does
not need to try to influence with respect to the Hagens, it is Mr. Milne.
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4. Mr. Van Gorder
Mr. Van Gorder, who joined the company in 1981, is another
long-time associate of Mr. Hirt as well as Mr. Hagen. Based on his
conversations with Mr. Hirt and the work they had done together, Mr. Van Gorder
believed Mr. Hirt's reason for giving him the gifts was purely friendship.
Moreover, as the draftsman of Erie's conflicts policy it never occurred to him
that it might apply to a gift from Mr. Hirt made out of friendship.
In addition, as with Mr. Milne, Mr. Hirt has no need to buy
Mr. Van Gorder's support. Since the 1993 termination of Mr. Hagen, the Hagens
have sought to have Mr. Van Gorder fired and removed from the Board.
Mr. Van Gorder is certainly not otherwise sympathetic to the Hagens' point of
view on the compensation and senior officer tenure issues that Mrs. Hagen points
to as the key votes showing Mr. Hirt's influence. Moreover, those whose
compensation is being considered, like Messrs. Van Gorder and Milne, cannot take
part in Board consideration of these matters. Finally, Mr. Van Gorder, too, has
substantial Erie stock and substantial resources. He has given Erie stock to
charities each year in amounts exceeding the amount of Erie stock given to him
by Mr. Hirt.
VI. Conclusions and Recommendations
A. Conclusions
After reviewing the law and facts set forth above, the
Committee reaches the following conclusions with respect to Mr. Hirt's gifts:
1. With the advice of counsel, the Committee concludes that it is
disinterested and capable of objective judgment under
Pennsylvania law with respect to the conclusions reached in
this report. Counsel's letter to the Committee on that issue
is attached as Exhibit 29.
2. No violation of criminal law has occurred.
3. No director has breached his fiduciary duty.
4. No Erie policy or principle of corporate governance has been
violated.
5. Mr. Hirt's intent in giving the gifts was generosity toward
particular friends. We find no evidence that influencing
directors on any Board issue or vote was any part of his
intent.
6. The intent of the directors who received gifts was entirely to
accept a gift they believed to be appropriate. We find no
evidence that their votes on any issue were affected by the
gifts.
7. We find no evidence to cast doubt on the integrity or good
faith of the directors who accepted gifts. The evidence is
that at all times they believed their actions were in the best
interests of Erie and its shareholders.
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B. Recommendations
We believe that the current discord on the Board is
destructive. Actions that are entirely innocent may appear otherwise in such an
atmosphere. Moreover, we believe that the Board should maintain control over
compensation for directors and senior management. There is potential for very
large stockholders to affect that compensation in a company like Erie. We
therefore recommend that the following bylaw be adopted by the Board
The Board of Directors has the responsibility and authority to
determine the compensation of directors and officers elected by
the Board of Directors in connection with their service to the
corporation. The acceptance of gifts of significant value from
persons associated with the corporation may impair the ability of
the Board of Directors to establish appropriate levels of
compensation and incentives for directors and officers elected by
the Board of Directors that the Board considers appropriate. For
these reasons, a director or an officer elected by the Board of
Directors may not accept, or arrange for any member of his or her
immediate family to receive, gifts or gratuities of other than
nominal or insignificant value from any of the following persons
or members of their immediate families: a director or officer
elected by the Board of Directors, an employee of the
corporation, or any person elected by the Board of Directors who
is known to be a beneficial owner of more than 5 percent of the
outstanding capital stock of any class of the corporation. If a
gift or gratuity of more than nominal or insignificant value is
received from any such persons, the gift or gratuity must be
returned and the Board of Directors notified. Gifts or gratuities
from any person to any member of the immediate family of such
person are not prohibited by this bylaw.
Respectfully submitted,
Harry H. Weil, Chairman
Peter B. Bartlett
Samuel P. Black, III
J. Ralph Borneman
Patricia A. Goldman
Edmund J. Mehl
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TABLE OF CONTENTS
I. Description of the Report...............................................1
II. Executive Summary.......................................................2
III. Chronology of Events....................................................4
A. Erie Stock Ownership and Values......................................4
B. Erie Management......................................................5
C. The Beginning of Conflict............................................6
D. The Allegations......................................................8
E. The Investigation...................................................10
1. Interviews..........................................................11
2. Documents Reviewed..................................................13
IV. Relevant Legal Authorities.............................................18
A. Criminal Bribery and Gratuity Law...................................19
1. Pennsylvania........................................................19
2. Federal.............................................................20
B. Civil Liability for Breach of Fiduciary Duty........................22
C. Federal Tax Law.....................................................24
D. Conflict of Interest Policies.......................................26
1. The Erie Policy.....................................................26
2. Other Corporate Policies............................................27
3. Federal Employee Policies...........................................29
E. Disclosure Requirements.............................................31
1. Securities and Exchange Commission..................................31
2. Pennsylvania Insurance Law..........................................31
V. Evidence of Intent.....................................................31
A. Interviews..........................................................32
1. Mr. Hirt's Tax Lawyers..............................................32
2. Mr. Hirt............................................................35
3. Board Member Gift Recipients........................................36
4. Other Gift Recipients...............................................38
5. Family Members......................................................41
B. Documents...........................................................42
1. The Gifts...........................................................42
2. The Board Votes.....................................................47
C. Mr. Hirt's Intent...................................................53
D. The Gift Recipients' Intent.........................................55
1. Mr. Schofield.......................................................55
2. Mr. Petersen........................................................55
3. Mr. Milne...........................................................56
4. Mr. Van Gorder......................................................57
VI. Conclusions and Recommendations........................................58
144
