Edgar Filing: ERIE INDEMNITY CO

Erie 10-Q 03.31.2013

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PERSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

Commission file number 0-24000



	ERIE INDEMNITY COMPANY
	(Exact name of registrant as specified in its charter)



	PENNSYLVANIA		25-0466020
	(State or other jurisdiction of		(I.R.S. Employer
	incorporation or organization)		Identification No.)



	100 Erie Insurance Place, Erie, Pennsylvania		16530
	(Address of principal executive offices)		(Zip Code)



	(814) 870-2000
	(Registrant’s telephone number, including area code)



	Not applicable
	(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes X No ___

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes X No ___

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer X Accelerated Filer ___ Non-Accelerated Filer ___ Smaller Reporting Company ___

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes No X

The number of shares outstanding of the registrant’s Class A Common Stock as of the latest practicable date, with no par value and a stated value of $0.0292 per share, was 46,697,008 at April 19, 2013.

The number of shares outstanding of the registrant’s Class B Common Stock as of the latest practicable date, with no par value and a stated value of $70 per share, was 2,542 at April 19, 2013.

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PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Consolidated Statements of Operations – Three months ended March 31, 2013 and 2012

	Consolidated Statements of Comprehensive Income – Three months ended March 31, 2013 and 2012

	Consolidated Statements of Financial Position – March 31, 2013 and December 31, 2012

	Consolidated Statements of Cash Flows – Three months ended March 31, 2013 and 2012

	Notes to Consolidated Financial Statements – March 31, 2013

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.	Quantitative and Qualitative Disclosures About Market Risk

Item 4.	Controls and Procedures


PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings

Item 1A.	Risk Factors

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds

Item 6.	Exhibits


	SIGNATURES

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ERIE INDEMNITY COMPANY

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(dollars in millions, except per share data)



	Three months ended
	March 31,
	2013		2012
Revenues
Premiums earned	$	1,175	$	1,087
Net investment income	103		108
Net realized investment gains	249		296
Net impairment losses recognized in earnings	0		0
Equity in earnings of limited partnerships	36		21
Other income	8		8
Total revenues	1,571		1,520
Benefits and expenses
Insurance losses and loss expenses	842		716
Policy acquisition and underwriting expenses	293		270
Total benefits and expenses	1,135		986
Income from operations before income taxes and noncontrolling interest	436		534
Provision for income taxes	146		180
Net income	$	290	$	354

Less: Net income attributable to noncontrolling interest in consolidated entity – Exchange	253		318

Net income attributable to Indemnity	$	37	$	36


Earnings Per Share
Net income attributable to Indemnity per share
Class A common stock – basic	$	0.78	$	0.76
Class A common stock – diluted	$	0.69	$	0.67
Class B common stock – basic and diluted	$	117	$	114

Weighted average shares outstanding attributable to Indemnity – Basic
Class A common stock	46,774,968		47,749,799
Class B common stock	2,542		2,545

Weighted average shares outstanding attributable to Indemnity – Diluted
Class A common stock	52,960,165		53,930,044
Class B common stock	2,542		2,545

Dividends declared per share
Class A common stock	$	0.5925	$	0.5525
Class B common stock	$	88.8750	$	82.8750

See accompanying notes to Consolidated Financial Statements. See Note 12. "Indemnity Accumulated Other Comprehensive Income (Loss)," for amounts reclassified out of accumulated other comprehensive income (loss) into the Consolidated Statements of Operations. See Note 15. “Indemnity Supplemental Information,” for supplemental statements of operations information.

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ERIE INDEMNITY COMPANY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(in millions)



	Three months ended
	March 31,
	2013			2012
Net income	$	290		$	354

Other comprehensive (loss) income
Change in unrealized holding (losses) gains on available-for-sale securities, net of tax (benefit) of $(6) and tax expense of $41, respectively	(12		)	77
Reclassification adjustment for gross gains included in net income, net of tax expense of $5 and $2, respectively	(10		)	(5		)
Other comprehensive (loss) income	(22		)	72

Comprehensive income	$	268		$	426
Less: Comprehensive income attributable to noncontrolling interest in consolidated entity – Exchange	232			388
Total comprehensive income – Indemnity	$	36		$	38

See accompanying notes to Consolidated Financial Statements. See Note 12. "Indemnity Accumulated Other Comprehensive Loss," for supplemental statements of comprehensive income (loss) information.

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ERIE INDEMNITY COMPANY

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

(dollars in millions, except per share data)



	March 31, 2013			December 31, 2012
Assets	(Unaudited)
Investments – Indemnity
Available-for-sale securities, at fair value:
Fixed maturities (amortized cost of $406 and $437, respectively)	$	421		$	452
Equity securities (cost of $47 and $54, respectively)	49			55
Limited partnerships (cost of $142 and $151, respectively)	167			180
Other invested assets	1			1
Investments – Exchange
Available-for-sale securities, at fair value:
Fixed maturities (amortized cost of $7,242 and $7,016, respectively)	7,891			7,707
Equity securities (cost of $857 and $871, respectively)	943			945
Trading securities, at fair value (cost of $2,011 and $1,910, respectively)	2,662			2,417
Limited partnerships (cost of $880 and $913, respectively)	1,004			1,037
Other invested assets	20			20
Total investments	13,158			12,814

Cash and cash equivalents (Exchange portion of $347 and $388, respectively)	388			400
Premiums receivable from policyholders – Exchange	1,113			1,062
Reinsurance recoverable – Exchange	169			168
Deferred income taxes – Indemnity	39			37
Deferred acquisition costs – Exchange	510			504
Other assets (Exchange portion of $299 and $339, respectively)	414			456
Total assets	$	15,791		$	15,441

Liabilities and shareholders’ equity
Liabilities
Indemnity liabilities
Other liabilities	$	506		$	515
Exchange liabilities
Losses and loss expense reserves	3,628			3,598
Life policy and deposit contract reserves	1,726			1,708
Unearned premiums	2,399			2,365
Deferred income taxes	410			365
Other liabilities	105			99
Total liabilities	8,774			8,650

Indemnity shareholders’ equity
Class A common stock, stated value $0.0292 per share; 74,996,930 shares authorized; 68,299,200 shares issued; 46,703,118 and 46,892,681 shares outstanding, respectively	2			2
Class B common stock, convertible at a rate of 2,400 Class A shares for one Class B share, stated value $70 per share; 3,070 shares authorized; 2,542 shares issued and outstanding	0			0
Additional paid-in-capital	16			16
Accumulated other comprehensive loss	(134		)	(133		)
Retained earnings	1,861			1,852
Total contributed capital and retained earnings	1,745			1,737
Treasury stock, at cost, 21,596,082 and 21,406,519 shares, respectively	(1,109		)	(1,095		)
Total Indemnity shareholders’ equity	636			642

Noncontrolling interest in consolidated entity – Exchange	6,381			6,149
Total equity	7,017			6,791
Total liabilities, shareholders’ equity and noncontrolling interest	$	15,791		$	15,441

See accompanying notes to Consolidated Financial Statements. See Note 15. “Indemnity Supplemental Information,” for supplemental consolidating statements of financial position information.

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ERIE INDEMNITY COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in millions)



	Three months ended
	March 31,
	2013			2012
Cash flows from operating activities
Premiums collected	$	1,159		$	1,081
Net investment income received	106			110
Limited partnership distributions	46			25
Service agreement fee received	7			7
Commissions and bonuses paid to agents	(197		)	(180		)
Losses paid	(666		)	(619		)
Loss expenses paid	(119		)	(119		)
Other underwriting and acquisition costs paid	(206		)	(181		)
Income taxes paid	(3		)	(52		)
Net cash provided by operating activities	127			72

Cash flows from investing activities
Purchase of investments:
Fixed maturities	(551		)	(418		)
Preferred stock	(9		)	(37		)
Common stock	(464		)	(258		)
Limited partnerships	(23		)	(23		)
Sales/maturities of investments:
Fixed maturity sales	122			163
Fixed maturity calls/maturities	265			217
Preferred stock	26			13
Common stock	453			247
Sale of and returns on limited partnerships	53			81
Net purchase of property and equipment	(6		)	(7		)
Net collections on agent loans	1			0
Net cash used in investing activities	(133		)	(22		)

Cash flows from financing activities
Annuity deposits and interest	24			25
Annuity surrenders and withdrawals	(18		)	(18		)
Universal life deposits and interest	5			5
Universal life surrenders	(2		)	(3		)
Purchase of treasury stock	(15		)	(18		)
Dividends paid to shareholders	0			(27		)
Net cash used in financing activities	(6		)	(36		)

Net (decrease) increase in cash and cash equivalents	(12		)	14
Cash and cash equivalents at beginning of period	400			185
Cash and cash equivalents at end of period	$	388		$	199

See accompanying notes to Consolidated Financial Statements. See Note 15. “Indemnity Supplemental Information,” for supplemental cash flow information.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1. Nature of Operations

Erie Indemnity Company (“Indemnity”) is a publicly held Pennsylvania business corporation that has been the managing attorney-in-fact for the subscribers (policyholders) at the Erie Insurance Exchange (“Exchange”) since 1925. The Exchange is a subscriber-owned, Pennsylvania-domiciled reciprocal insurer that writes property and casualty insurance.

Indemnity’s primary function is to perform certain services for the Exchange relating to the sales, underwriting and issuance of policies on behalf of the Exchange. This is done in accordance with a subscriber’s agreement (a limited power of attorney) executed by each subscriber (policyholder), which appoints Indemnity as their common attorney-in-fact to transact business on their behalf and to manage the affairs of the Exchange. Pursuant to the subscriber’s agreement and for its services as attorney-in-fact, Indemnity earns a management fee calculated as a percentage of the direct premiums written by the Exchange and the other members of the Property and Casualty Group (defined below), which are assumed by the Exchange under an intercompany pooling arrangement.

Indemnity has the power to direct the activities of the Exchange that most significantly impact the Exchange’s economic performance by acting as the common attorney-in-fact and decision maker for the subscribers (policyholders) at the Exchange.

The Exchange, together with its wholly owned subsidiaries, Erie Insurance Company (“EIC”), Erie Insurance Company of New York (“ENY”), Erie Insurance Property and Casualty Company (“EPC”), and Flagship City Insurance Company (“Flagship”), operate as a property and casualty insurer and are collectively referred to as the “Property and Casualty Group”. The Property and Casualty Group operates in 11 Midwestern, Mid-Atlantic and Southeastern states and the District of Columbia.

Erie Family Life Insurance Company (“EFL”), a wholly owned subsidiary of the Exchange, operates as a life insurer that underwrites and sells individual and group life insurance policies and fixed annuities.

All property and casualty and life insurance operations are owned by the Exchange, and Indemnity functions solely as the management company.

The consolidated financial statements of Erie Indemnity Company reflect the results of Indemnity and its variable interest entity, the Exchange, which we refer to collectively as the “Erie Insurance Group” (“we,” “us,” “our”).

“Indemnity shareholder interest” refers to the interest in Erie Indemnity Company owned by the Class A and Class B shareholders. “Noncontrolling interest” refers to the interest in the Erie Insurance Exchange held for the subscribers (policyholders).

Note 2. Significant Accounting Policies

Basis of presentation

The accompanying consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of Indemnity together with its affiliate companies in which Indemnity holds a majority voting or economic interest.

Use of estimates

The preparation of financial statements in conformity with GAAP requires us 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.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of our financial position, results of operations and cash flows for the interim periods have been included. Operating results for the three month period ended March 31, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. The accompanying consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission on February 26, 2013.

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Principles of consolidation

We consolidate the Exchange as a variable interest entity for which Indemnity is the primary beneficiary. All intercompany accounts and transactions have been eliminated in consolidation. The required presentation of noncontrolling interests is reflected in the consolidated financial statements. Noncontrolling interests represent the ownership interests of the Exchange, all of which is held by parties other than Indemnity (i.e. the Exchange’s subscribers (policyholders)). Noncontrolling interests also include the Exchange subscribers’ ownership interest in EFL.

Presentation of assets and liabilities – While the assets of the Exchange are presented separately in the Consolidated Statements of Financial Position, the Exchange’s assets can only be used to satisfy the Exchange’s liabilities or for other unrestricted activities. Accounting Standards Codification (“ASC”) 810, Consolidation, does not require separate presentation of the Exchange’s assets; however, because the shareholders of Indemnity have no rights to the assets of the Exchange and, conversely, the Exchange has no rights to the assets of Indemnity, we have presented the invested assets of the Exchange separately on the Consolidated Statements of Financial Position along with the remaining consolidated assets reflecting the Exchange’s portion parenthetically. Liabilities are required under ASC 810, Consolidation, to be presented separately for the Exchange on the Consolidated Statements of Financial Position as the Exchange’s creditors do not have recourse to the general credit of Indemnity.

Rights of shareholders of Indemnity and subscribers (policyholders) of the Exchange – The shareholders of Indemnity, through the management fee, have a controlling financial interest in the Exchange; however, they have no other rights to or obligations arising from assets and liabilities of the Exchange. The shareholders of Indemnity own its equity but have no rights or interest in the Exchange’s (noncontrolling interest) income or equity. The noncontrolling interest equity represents the Exchange’s equity held for the interest of its subscribers (policyholders), who have no rights or interest in the Indemnity shareholder interest income or equity.

All intercompany assets, liabilities, revenues and expenses between Indemnity and the Exchange have been eliminated in the Consolidated Financial Statements.

Adopted accounting pronouncements

In February 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The amendments in this ASU require an entity to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the line items affected by the reclassification. For amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference to other related disclosures for additional information. ASU 2013-02 is effective prospectively for interim and annual periods beginning after December 15, 2012. We have elected to present amounts reclassified out of accumulated other comprehensive income by component and the respective line items of net income in the notes to our consolidated financial statements. See Note 12. "Indemnity's Accumulated Other Comprehensive Loss".

Pending accounting pronouncements

In February 2013, the FASB issued ASU 2013-04, Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date. The amendments in this ASU provide guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, except for obligations addressed within existing guidance in GAAP. ASU 2013-04 is effective for interim and annual periods beginning after December 15, 2013, with early adoption permitted. We do not expect the adoption of this new guidance to have a material impact on our consolidated financial statements.

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Note 3. Indemnity Earnings Per Share

Class A and Class B basic earnings per share and Class B diluted earnings per share are calculated under the two-class method. The two-class method allocates earnings to each class of stock based upon its dividend rights. Class B shares are convertible into Class A shares at a conversion ratio of 2,400 to 1.

Class A diluted earnings per share are calculated under the if-converted method, which reflects the conversion of Class B shares to Class A shares. Diluted earnings per share calculations include the effect of any potential common shares. Potential common shares include outstanding vested and not yet vested awards related to our outside directors’ stock compensation plan and any employee stock based awards.

In the first quarter of 2012, two shares of Class B common stock were converted into 4,800 shares of Class A common stock. See Note 11. “Indemnity Capital Stock”.

A reconciliation of the numerators and denominators used in the basic and diluted per-share computations is presented as follows for each class of Indemnity common stock:



	Indemnity Shareholder Interest
(dollars in millions, except per share data)	Three months ended March 31,
	2013					2012
	Allocated net income (numerator)		Weighted shares (denominator)	Per-share amount		Allocated net income (numerator)		Weighted shares (denominator)	Per- share amount
Class A – Basic EPS:
Income available to Class A stockholders	$	36	46,774,968	$	0.78	$	36	47,749,799	$	0.76
Dilutive effect of stock-based awards	0		84,397	—		0		72,245	—
Assumed conversion of Class B shares	1		6,100,800	—		0		6,108,000	—
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares	$	37	52,960,165	$	0.69	$	36	53,930,044	$	0.67
Class B – Basic and diluted EPS:
Income available to Class B stockholders	$	0	2,542	$	117	$	0	2,545	$	114

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Note 4. Variable Interest Entity

Erie Insurance Exchange

The Exchange is a reciprocal insurance exchange domiciled in Pennsylvania, for which Indemnity serves as attorney-in-fact. Indemnity holds a variable interest in the Exchange due to the absence of decision-making capabilities by the equity owners (subscribers/policyholders) of the Exchange and due to the significance of the management fee the Exchange pays to Indemnity as its decision maker. As a result, Indemnity is deemed to have a controlling financial interest in the Exchange and is considered to be its primary beneficiary.

Consolidation of the Exchange’s financial results is required given the significance of the management fee to the Exchange and because Indemnity has the power to direct the activities of the Exchange that most significantly impact the Exchange’s economic performance. The Exchange’s anticipated economic performance is the product of its underwriting results combined with its investment results. The fees paid to Indemnity under the subscriber’s agreement impact the anticipated economic performance attributable to the Exchange’s results. Indemnity earns a management fee from the Exchange for the services it provides as attorney-in-fact. Indemnity’s management fee revenues are based on all premiums written or assumed by the Exchange. Indemnity’s Board of Directors determines the management fee rate to be paid by the Exchange to Indemnity. This rate cannot exceed 25% of the direct and assumed written premiums of the Exchange, as defined by the subscriber’s agreement signed by each policyholder. Management fee revenues and management fee expenses are eliminated upon consolidation.

The shareholders of Indemnity have no rights to the assets of the Exchange and no obligations arising from the liabilities of the Exchange. Indemnity has no obligation related to any underwriting and/or investment losses experienced by the Exchange. Indemnity would, however, be adversely impacted if the Exchange incurred significant underwriting and/or investment losses. If the surplus of the Exchange were to decline significantly from its current level, its financial strength ratings could be reduced and, as a consequence, the Exchange could find it more difficult to retain its existing business and attract new business. A decline in the business of the Exchange would have an adverse effect on the amount of the management fees Indemnity receives. In addition, a decline in the surplus of the Exchange from its current level may impact the management fee rate received by Indemnity. Indemnity also has an exposure to a concentration of credit risk related to the unsecured receivables due from the Exchange for its management fee. If any of these events occurred, Indemnity’s financial position, financial performance and/or cash flows could be adversely impacted.

All property and casualty and life insurance operations are owned by the Exchange, and Indemnity functions solely as the management company.

Indemnity has not provided financial or other support to the Exchange for any the reporting periods presented. At March 31, 2013, there are no explicit or implicit arrangements that would require Indemnity to provide future financial support to the Exchange. Indemnity is not liable if the Exchange was to be in violation of its debt covenants or was unable to meet its obligation for unfunded commitments to limited partnerships.

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Note 5. Segment Information

Our reportable segments include management operations, property and casualty insurance operations, life insurance operations and investment operations. Accounting policies for segments are the same as those described in the summary of significant accounting policies. See Item 8. “Financial Statements and Supplementary Data, Note 2. Significant Accounting Policies,” in our Annual Report on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission on February 26, 2013. Assets are not allocated to the segments, but rather, are reviewed in total for purposes of decision-making. No single customer or agent provides 10% or more of revenues.

Management operations

Our management operations segment consists of Indemnity serving as attorney-in-fact for the Exchange. Indemnity operates in this capacity solely for the Exchange. We evaluate profitability of our management operations segment principally on the gross margin from management operations. Indemnity earns a management fee from the Exchange for providing sales, underwriting and policy issuance services. Management fee revenue, which is eliminated upon consolidation, is calculated as a percentage not to exceed 25% of all the direct premiums written by the Exchange and the other members of the Property and Casualty Group, which are assumed by the Exchange under an intercompany pooling arrangement. The Property and Casualty Group issues policies with annual terms only. Management fees are recorded upon policy issuance or renewal, as substantially all of the services required to be performed by Indemnity have been satisfied at that time. Certain activities are performed and related costs are incurred by us subsequent to policy issuance in connection with the services provided to the Exchange; however, these activities are inconsequential and perfunctory. Although these management fee revenues and expenses are eliminated upon consolidation, the amount of the fee directly impacts the allocation of our consolidated net income between the noncontrolling interest, which bears the management fee expense and represents the interests of the Exchange subscribers (policyholders), and Indemnity’s interest, which earns the management fee revenue and represents the Indemnity shareholder interest in net income.

Property and casualty insurance operations

Our property and casualty insurance operations segment includes personal and commercial lines. Personal lines consist primarily of personal auto and homeowners and are marketed to individuals. Commercial lines consist primarily of commercial multi-peril, commercial auto and workers compensation and are marketed to small- and medium-sized businesses. Our property and casualty policies are sold by independent agents. Our property and casualty insurance underwriting operations are conducted through the Exchange and its subsidiaries and include assumed voluntary reinsurance from nonaffiliated domestic and foreign sources, assumed involuntary and ceded reinsurance business. The Exchange exited the assumed voluntary reinsurance business effective December 31, 2003, and therefore unaffiliated reinsurance includes only run-off activity of the previously assumed voluntary reinsurance business. We evaluate profitability of the property and casualty insurance operations principally based upon net underwriting results represented by the combined ratio.

Life insurance operations

Our life insurance operations segment includes traditional and universal life insurance products and fixed annuities marketed to individuals using the same independent agency force utilized by our property and casualty insurance operations. We evaluate profitability of the life insurance segment principally based upon segment net income, including investments, which for segment purposes are reflected in the investment operations segment. At the same time, we recognize that investment-related income is integral to the evaluation of the life insurance segment because of the long duration of life products. For the first quarters of 2013 and 2012, investment activities on life insurance related assets generated revenues of $26 million and $24 million, respectively, resulting in EFL reporting income before income taxes of $11 million and $9 million, respectively, before intercompany eliminations.

Investment operations

The investment operations segment performance is evaluated based upon appreciation of assets, rate of return and overall return. Investment related income for the life operations is included in the investment segment results.

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The following tables summarize the components of the Consolidated Statements of Operations by reportable business segment:



	Erie Insurance Group
(in millions)	Three months ended March 31, 2013
	Management operations		Property and casualty insurance operations		Life insurance operations			Investment operations		Eliminations			Consolidated
Premiums earned/life policy revenue			$	1,156	$	19				$	0		$	1,175
Net investment income								$	106	(3		)	103
Net realized investment gains								249					249
Net impairment losses recognized in earnings								0					0
Equity in earnings of limited partnerships								36					36
Management fee revenue	$	296								(296		)	—
Service agreement and other revenue	7				1								8
Total revenues	303		1,156		20			391		(299		)	1,571
Cost of management operations	254									(254		)	—
Insurance losses and loss expenses			817		26					(1		)	842
Policy acquisition and underwriting expenses			328		9					(44		)	293
Total benefits and expenses	254		1,145		35			—		(299		)	1,135
Income (loss) before income taxes	49		11		(15		)	391		—			436
Provision for income taxes	17		4		(5		)	130		—			146
Net income (loss)	$	32	$	7	$	(10	)	$	261	—			$	290



	Erie Insurance Group
(in millions)	Three months ended March 31, 2012
	Management operations		Property and casualty insurance operations		Life insurance operations			Investment operations		Eliminations			Consolidated
Premiums earned/life policy revenue			$	1,069	$	18				$	0		$	1,087
Net investment income								$	111	(3		)	108
Net realized investment gains								296					296
Net impairment losses recognized in earnings								0					0
Equity in earnings of limited partnerships								21					21
Management fee revenue	$	269								(269		)	—
Service agreement and other revenue	7				1								8
Total revenues	276		1,069		19			428		(272		)	1,520
Cost of management operations	230									(230		)	—
Insurance losses and loss expenses			692		25					(1		)	716
Policy acquisition and underwriting expense			302		9					(41		)	270
Total benefits and expenses	230		994		34			—		(272		)	986
Income (loss) before income taxes	46		75		(15		)	428		—			534
Provision for income taxes	16		26		(5		)	143		—			180
Net income (loss)	$	30	$	49	$	(10	)	$	285	$	—		$	354

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Note 6. Fair Value

Our available-for-sale and trading securities are recorded at fair value, which is the price that would be received to sell the asset in an orderly transaction between willing market participants as of the measurement date.

Valuation techniques used to derive the fair value of our available-for-sale and trading securities are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources. Unobservable inputs reflect our own assumptions regarding fair market value for these securities. Although the majority of our prices are obtained from third party sources, we also perform an internal pricing review for securities with low trading volumes in the current market conditions. Financial instruments are categorized based upon the following characteristics or inputs to the valuation techniques:


•	Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.


•	Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.


•	Level 3 – Unobservable inputs for the asset or liability.

Estimates of fair values for our investment portfolio are obtained primarily from a nationally recognized pricing service. Our Level 1 category includes those securities valued using an exchange traded price provided by the pricing service. The methodologies used by the pricing service that support a Level 2 classification of a financial instrument include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Pricing service valuations for Level 3 securities are based upon proprietary models and are used when observable inputs are not available or in illiquid markets.

In limited circumstances we adjust the price received from the pricing service when, in our judgment, a better reflection of fair value is available based upon corroborating information and our knowledge and monitoring of market conditions such as a disparity in price of comparable securities and/or non-binding broker quotes. In other circumstances, certain securities are internally priced because prices are not provided by the pricing service.

We perform continuous reviews of the prices obtained from the pricing service. This includes evaluating the methodology and inputs used by the pricing service to ensure that we determine the proper classification level of the financial instrument. Price variances, including large periodic changes, are investigated and corroborated by market data. We have reviewed the pricing methodologies of our pricing service as well as other observable inputs, such as data, and transaction volumes and believe that their prices adequately consider market activity in determining fair value. Our review process continues to evolve based upon accounting guidance and requirements.

When a price from the pricing service is not available, values are determined by obtaining non-binding broker quotes and/or market comparables. When available, we obtain multiple quotes for the same security. The ultimate value for these securities is determined based upon our best estimate of fair value using corroborating market information. Our evaluation includes the consideration of benchmark yields, reported trades, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data.

For certain structured securities in an illiquid market, there may be no prices available from a pricing service and no comparable market quotes available. In these situations, we value the security using an internally-developed, risk-adjusted discounted cash flow model.

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The following table represents our consolidated fair value measurements on a recurring basis by asset class and level of input at March 31, 2013:



	Erie Insurance Group
	March 31, 2013
	Fair value measurements using:
(in millions)	Total		Quoted prices in active markets for identical assets Level 1		Observable inputs Level 2		Unobservable inputs Level 3
Indemnity
Available-for-sale securities:
States & political subdivisions	$	176	$	0	$	176	$	0
Corporate debt securities	243		0		242		1
Collateralized debt obligations	2		0		0		2
Total fixed maturities	421		0		418		3
Nonredeemable preferred stock	23		2		21		0
Common stock	26		26		0		0
Total available-for-sale securities	470		28		439		3
Other investments ⁽¹⁾	20		0		0		20
Total – Indemnity	$	490	$	28	$	439	$	23
Exchange
Available-for-sale securities:
U.S. government & agencies	$	185	$	0	$	185	$	0
States & political subdivisions	1,299		0		1,299		0
Foreign government securities	29		0		29		0
Corporate debt securities	5,974		0		5,916		58
Residential mortgage-backed securities	234		0		234		0
Commercial mortgage-backed securities	56		0		51		5
Collateralized debt obligations	46		0		32		14
Other debt securities	68		0		68		0
Total fixed maturities	7,891		0		7,814		77
Nonredeemable preferred stock	631		236		383		12
Common stock	312		312		0		0
Total available-for-sale securities	8,834		548		8,197		89
Trading securities:
Common stock	2,662		2,655		0		7
Total trading securities	2,662		2,655		0		7
Other investments ⁽¹⁾	112		0		0		112
Total – Exchange	$	11,608	$	3,203	$	8,197	$	208
Total – Erie Insurance Group	$	12,098	$	3,231	$	8,636	$	231

(1) Other investments measured at fair value represent four real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option. These investments can never be redeemed with the funds. Instead, distributions are received when liquidation of the underlying assets of the funds occur. It is estimated that the underlying assets will generally be liquidated between 5 and 10 years from the inception of the funds. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner. Fair value is based on our proportionate share of the NAV based on the most recent partners' capital statements received from the general partners, which is generally one quarter prior to our balance sheet date. These values are then analyzed to determine if they represent the NAV at our balance sheet date, with adjustment being made where appropriate. We consider observable market data and perform a review validating the appropriateness of the NAV at each balance sheet date. It is likely that all of the investments will be redeemed at a future date for an amount different than the NAV of our ownership interest in partners' capital as of March 31, 2013. During the quarter ended March 31, 2013, Indemnity made no contributions and received no distributions, and the Exchange made no contributions and received distributions totaling $0.8 million for these investments. As of March 31, 2013, the amount of unfunded commitments related to the investments was $1.5 million for Indemnity and $4.5 million for the Exchange.

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Level 3 Assets – Quarterly Change:



	Erie Insurance Group
(in millions)	Beginning balance at December 31, 2012		Included in earnings ⁽¹⁾			Included in other comprehensive income		Purchases		Sales			Transfers in and (out) of Level 3 ⁽²⁾		Ending balance at March 31, 2013
Indemnity
Available-for-sale securities:
Corporate debt securities	$	1	$	0		$	0	$	0	$	0		$	0	$	1
Collateralized debt obligations	3		0			0		0		(1		)	0		2
Total fixed maturities	4		0			0		0		(1		)	0		3
Total available-for-sale securities	4		0			0		0		(1		)	0		3
Other investments	19		1			0		0		0			0		20
Total Level 3 assets – Indemnity	$	23	$	1		$	0	$	0	$	(1	)	$	0	$	23
Exchange
Available-for-sale securities:
Corporate debt securities	$	43	$	0		$	1	$	0	$	(1	)	$	15	$	58
Commercial mortgage-backed securities	0		0			0		0		0			5		5
Collateralized debt obligations	16		1			1		0		(5		)	1		14
Total fixed maturities	59		1			2		0		(6		)	21		77
Nonredeemable preferred stock	0		0			3		4		0			5		12
Total available-for-sale securities	59		1			5		4		(6		)	26		89
Trading securities:
Common stock	15		(3		)	0		0		(5		)	0		7
Total trading securities	15		(3		)	0		0		(5		)	0		7
Other investments	109		4			0		0		(1		)	0		112
Total Level 3 assets – Exchange	$	183	$	2		$	5	$	4	$	(12	)	$	26	$	208
Total Level 3 assets – Erie Insurance Group	$	206	$	3		$	5	$	4	$	(13	)	$	26	$	231


(1)	These amounts are reported in the Consolidated Statement of Operations. There is $2 million of losses included in net realized investment gains (losses) and $5 million of earnings included in equity in earnings of limited partnerships for the three months ended March 31, 2013 on Level 3 securities.


(2)	Transfers in and out of Level 3 are attributable to changes in the availability of market observable information for individual securities within the respective categories. Transfers in and out of levels are recognized at the start of the period.

We review the fair value hierarchy classifications each reporting period. Transfers between hierarchy levels may occur due to changes in the available market observable inputs. Transfers in and out of level classifications are reported as having occurred at the beginning of the quarter in which the transfers occurred.

For Indemnity, there were no Level 1 to Level 2 transfers for the three months ended March 31, 2013. Level 2 to Level 1 transfers totaled $1 million, due to trading activity levels related to one preferred stock holding, and there were no transfers between Levels 2 and 3.

For the Exchange, Level 1 to Level 2 transfers totaled $6 million and Level 2 to Level 1 transfers totaled $51 million due to trading activity levels related to one preferred stock holding and five preferred stock holdings, respectively, for the three months ended March 31, 2013. Level 2 to Level 3 transfers totaled $39 million related to seven fixed maturity holdings and one preferred stock holding. Level 3 to Level 2 transfers totaled $13 million for one fixed maturity holding. These transfers in and out of Level 3 were primarily the result of using non-binding and binding broker quotes, respectively, to determine the fair value at March 31, 2013.

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Quantitative and Qualitative Disclosures about Unobservable Inputs



	Erie Insurance Group
	March 31, 2013
(dollars in millions)	Fair value		No. of holdings	Valuation techniques	Unobservable input	Range	Weighted average
Indemnity
Corporate debt securities	$	1	1	Market approach	Non-binding broker quote	114.84
Collateralized debt obligations	2		2	Income approach	Projected maturity date	Sep 2014
					Repayment at maturity	42 - 100%	81.7%
					Discount rate	7.5 - 15.0%	9.9%
					Projected LIBOR rate	0.29%
Total Level 3 assets – Indemnity	$	3	3

Exchange
Corporate debt securities	58		11	Market approach	Non-binding broker quote	101.5 - 115.50	108.62
					Comparable transaction EBITDA multiples	6.7 - 17.1x	8.0x
					Comparable security yield	6.00%
Commercial mortgage-backed securities	5		1	Market approach	Non-binding broker quote	102.63
Collateralized debt obligations	11		4	Income approach	Projected maturity date	Sep 2014 - Oct 2035
					Repayment at maturity	42 - 100%	88.1%
					Discount rate	7.0 - 15.0%	8.9%
					Projected LIBOR rate	0.29%

	3		3	Market approach	Non-binding broker quote	15 - 64	51.6
Nonredeemable preferred stock	12		2	Market approach	Non-binding broker quote	104.00
					Comparable transaction EBITDA multiples	6.7 - 17.1x	8.0x
Common stock	7		3	Market approach	Comparable transaction EBITDA multiples	6.7 - 17.1x	8.0x
					Discount for lack of marketability	5 - 30%	30%
Total Level 3 assets – Exchange	$	96	24
Total Level 3 assets – Erie Insurance Group	$	99	27

Securities valued using unobservable inputs shown above totaled $99 million at March 31, 2013. Other investments representing certain limited partnerships recorded at fair value of $132 million are also included in Level 3 within our consolidated fair value measurements. These values are based upon net asset value (NAV) information provided by the general partner. In total, Level 3 assets represent less than 1.9% of the assets measured at fair value on a recurring basis for the Erie Insurance Group.

Collateralized-debt-obligation securities – The unobservable inputs used in the fair value measurement of certain collateralized-debt-obligation securities are the repayment at maturity of underlying collateral available to pay note holders, the projected maturity of the underlying security, an expectation that the London Inter-Bank Offer Rates (“LIBOR”) do not change until maturity and a discount rate appropriate for the security. Significant changes in any of those inputs in isolation would result in a significantly higher or lower fair value measurement. Generally, a change in the assumption used for the performance of the underlying collateral is accompanied by an opposite change in the maturity and a directionally opposite change in the discount rate used to value the security. LIBOR assumptions are independent of collateral performance.

Corporate debt securities, Commercial mortgage-backed securities and Nonredeemable preferred stock – When a non-binding broker quote was the only input available, it was considered unobservable.

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Corporate debt securities – The unobservable input used in the fair value measurement of certain corporate debt securities is the likelihood of repayment by the underlying entity when there is no market for trading these securities. When available, we obtain non-binding broker quotes to value such securities.

Common stock investments, Nonredeemable preferred stock and Corporate debt securities – The unobservable inputs used in the fair value measurement of direct private equity common stock investments, certain corporate debt securities and certain nonredeemable preferred securities are comparable private transaction earnings before interest, taxes, depreciation and amortization (“EBITDA”) multiples, the average EBITDA multiple for comparable publicly traded companies and the amount of discount applied to the price due to the illiquidity of the securities being valued. Significant changes in any of those inputs in isolation could result in a significantly higher or lower fair value measurement.

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The following table represents our consolidated fair value measurements on a recurring basis by asset class and level of input at December 31, 2012:



	Erie Insurance Group
	December 31, 2012
	Fair value measurements using:
(in millions)	Total		Quoted prices in active markets for identical assets Level 1		Observable inputs Level 2		Unobservable inputs Level 3
Indemnity
Available-for-sale securities:
States & political subdivisions	$	185	$	0	$	185	$	0
Corporate debt securities	261		0		260		1
Commercial mortgage-backed securities	3		0		3		0
Collateralized debt obligations	3		0		0		3
Total fixed maturities	452		0		448		4
Nonredeemable preferred stock	29		4		25		0
Common stock	26		26		0		0
Total available-for-sale securities	507		30		473		4
Other investments ⁽¹⁾	19		0		0		19
Total – Indemnity	$	526	$	30	$	473	$	23
Exchange
Available-for-sale securities:
U.S. government & agencies	$	191	$	0	$	191	$	0
States & political subdivisions	1,321		0		1,321		0
Foreign government securities	16		0		16		0
Corporate debt securities	5,777		0		5,734		43
Residential mortgage-backed securities	231		0		231		0
Commercial mortgage-backed securities	67		0		67		0
Collateralized debt obligations	49		0		33		16
Other debt securities	55		0		55		0
Total fixed maturities	7,707		0		7,648		59
Nonredeemable preferred stock	631		199		432		0
Common stock	314		314		0		0
Total available-for-sale securities	8,652		513		8,080		59
Trading securities:
Common stock	2,417		2,402		0		15
Total trading securities	2,417		2,402		0		15
Other investments ⁽¹⁾	109		0		0		109
Total – Exchange	$	11,178	$	2,915	$	8,080	$	183
Total – Erie Insurance Group	$	11,704	$	2,945	$	8,553	$	206

(1) Other investments measured at fair value represent four real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option. These investments can never be redeemed with the funds. Instead, distributions are received when liquidation of the underlying assets of the funds occur. It is estimated that the underlying assets will generally be liquidated between 5 and 10 years from the inception of the funds. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner. Fair value is based on our proportionate share of the NAV based on the most recent partners' capital statements received from the general partners, which is generally one quarter prior to our balance sheet date. These values are then analyzed to determine if they represent the NAV at our balance sheet date, with adjustment being made where appropriate. We consider observable market data and perform a review validating the appropriateness of the NAV at each balance sheet date. It is likely that all of the investments will be redeemed at a future date for an amount different than the NAV of our ownership interest in partners' capital as of December 31, 2012. During the year ended December 31, 2012, Indemnity made contributions totaling $0.2 million and received distributions totaling $0.3 million, and the Exchange made contributions totaling $0.7 million and received distributions totaling $4.7 million for these investments. As of December 31, 2012, the amount of unfunded commitments related to the investments was $1.5 million for Indemnity and $4.5 million for the Exchange.

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Level 3 Assets – Quarterly Change:



	Erie Insurance Group
(in millions)	Beginning balance at December 31, 2011		Included in earnings ⁽¹⁾		Included in other comprehensive income		Purchases		Sales			Transfers in and (out) of Level 3 ⁽²⁾		Ending balance at March 31, 2012
Indemnity
Available-for-sale securities:
Corporate debt securities	$	0	$	0	$	0	$	0	$	0		$	1	$	1
Collateralized debt obligations	4		0		0		0		0			0		4
Total fixed maturities	4		0		0		0		0			1		5
Total available-for-sale securities	4		0		0		0		0			1		5
Other investments ⁽³⁾	17		0		0		0		0			0		17
Total Level 3 assets – Indemnity	$	21	$	0	$	0	$	0	$	0		$	1	$	22
Exchange
Available-for-sale securities:
States & political subdivisions	$	4	$	0	$	1	$	0	$	0		$	0	$	5
Corporate debt securities	12		0		0		0		0			14		26
Collateralized debt obligations	29		0		0		0		(4		)	2		27
Other debt securities	5		0		0		0		0			0		5
Total fixed maturities	50		0		1		0		(4		)	16		63
Nonredeemable preferred stock	5		0		1		0		0			0		6
Total available-for-sale securities	55		0		2		0		(4		)	16		69
Trading securities:
Common stock	12		2		0		0		0			0		14
Total trading securities	12		2		0		0		0			0		14
Other investments ⁽³⁾	102		1		0		1		(1		)	0		103
Total Level 3 assets – Exchange	$	169	$	3	$	2	$	1	$	(5	)	$	16	$	186
Total Level 3 assets – Erie Insurance Group	$	190	$	3	$	2	$	1	$	(5	)	$	17	$	208


(1)	These amounts are reported in the Consolidated Statement of Operations. There is $2 million of earnings included in net realized investment gains (losses) and $1 million of earnings included in equity in earnings of limited partnerships for the three months ended March 31, 2012 on Level 3 securities.


(2)	Transfers in and out of Level 3 are attributable to changes in the availability of market observable information for individual securities within the respective categories. Transfers in and out of levels are recognized at the start of the period.


(3)	The other investments reported as Level 3 assets represent four real estate funds which were previously presented with our limited partnerships reported under the equity method of accounting and therefore were not included in our fair value measurements table. This table has been adjusted to reflect the appropriate fair value of these assets during the first quarter of 2012.

For Indemnity, there were no transfers between Levels 1 and 2 for the three months ended March 31, 2012. Level 2 to Level 3 transfers totaled $1 million related to one fixed maturity holding, primarily as the result of using non-binding broker quotes to determine the fair value at March 31, 2012, and there were no Level 3 to Level 2 transfers.

For the Exchange, there were no transfers between Levels 1 and 2 for the three months ended March 31, 2012. Level 2 to Level 3 transfers totaled $16 million related to five fixed maturity holdings, primarily as the result of using non-binding broker quotes to determine the fair value at March 31, 2012, and there were no Level 3 to Level 2 transfers.

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The following table sets forth our consolidated fair value measurements on a recurring basis by pricing source at March 31, 2013:

Erie Insurance Group

(in millions)

March 31, 2013

Total

Level 1

Level 2

Level 3

Indemnity

Fixed maturities:

Priced via pricing services

404