UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2015
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-24000
ERIE INDEMNITY COMPANY | ||
(Exact name of registrant as specified in its charter)
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) | |||
(814) 870-2000 | ||
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Class A common stock, stated value $0.0292 per share, listed on the NASDAQ Stock Market, LLC | |||
(Title of each class) | (Name of each exchange on which registered) | ||
Securities registered pursuant to Section 12(g) of the Act: None
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 if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No X
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 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. [ ]
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
Aggregate market value of voting and non-voting common stock held by non-affiliates as of the last business day of the registrant’s most recently completed second fiscal quarter: $2.0 billion of Class A non-voting common stock as of June 30, 2015. There is no active market for the Class B voting common stock. The Class B common stock is closely held by few shareholders.
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:
46,189,068 shares of Class A common stock and 2,542 shares of Class B common stock outstanding on February 19, 2016.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Part III of this Form 10-K (Items 10, 11, 12, 13, and 14) are incorporated by reference to the information statement on Schedule 14(C) to be filed with the Securities and Exchange Commission no later than 120 days after December 31, 2015.
INDEX
PART | ITEM NUMBER AND CAPTION | PAGE | |
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PART I
ITEM 1. BUSINESS
General
Erie Indemnity Company ("Indemnity", "we", "us", "our") is a publicly held Pennsylvania business corporation that has since our incorporation in 1925 served as the attorney-in-fact for the subscribers (policyholders) at the Erie Insurance Exchange ("Exchange"). The Exchange, which also commenced business in 1925, is a Pennsylvania-domiciled, reciprocal insurer that writes property and casualty insurance. We function solely as the management company and all insurance operations are performed by the Exchange. We operate our business as one segment.
Our primary function as attorney-in-fact 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 individually by each subscriber (policyholder), which appoints us as their common attorney-in-fact to transact certain business on their behalf and to manage the affairs of the Exchange. Pursuant to the subscriber’s agreement and for our services as attorney-in-fact, we earn a management fee calculated as a percentage, not to exceed 25%, of the direct and assumed premiums written by the Exchange. The management fee rate is set annually by our Board of Directors.
Services
The services we provide to the Exchange are related to the sales, underwriting and issuance of policies. The sales related services we provide include agent compensation and certain sales and advertising support services. Agent compensation includes scheduled commissions to agents based upon premiums written as well as additional commissions and bonuses to agents, which are earned by achieving targeted measures. Agent compensation comprised approximately 67% of our 2015 expenses. The underwriting services we provide include underwriting and policy processing expenses and comprised approximately 11% of our 2015 expenses. We provide information technology services that support all functions that comprised approximately 10% of our 2015 expenses. The remaining services we provide include customer service and administrative costs.
Erie Insurance Exchange
Our primary purpose is to manage the affairs at the Exchange for the benefit of the policyholders. The Exchange is our sole customer and our earnings primarily come from management fees based on the direct and assumed premiums written by the Exchange. We have no direct competition in providing these services to the Exchange.
The Exchange generates revenue by insuring preferred and standard risks, with personal lines comprising 70% of the 2015 direct and assumed premiums written and commercial lines comprising the remaining 30%. The principal personal lines products are private passenger automobile and homeowners. The principal commercial lines products are commercial multi-peril, workers compensation and commercial automobile. Historically, due to policy renewal and sales patterns, the Exchange’s direct and assumed premiums written are greater in the second and third quarters than in the first and fourth quarters of the calendar year.
The Exchange is represented by independent agencies that serve as its sole distribution channel. In addition to their principal role as salespersons, the independent agents play a significant role as underwriting and service providers and are an integral part of the Exchange’s success.
Our results of operations are tied to the growth and financial condition of the Exchange. If any events occurred that impaired the Exchange’s ability to grow or sustain its financial condition, including but not limited to lower financial strength ratings, significant catastrophe losses, disruption in the independent agency relationships, or products offered not meeting customer demands, the Exchange could experience difficulty retaining its existing business and attracting new business. A decline in the business of the Exchange would likely result in a reduction of total premiums paid and a corresponding decrease in the amount of the management fees we receive. We also have an exposure to a concentration of credit risk related to the unsecured receivables due from the Exchange for its management fee. See Part II, Item 8. "Financial Statements and Supplementary Data - Note 14, Concentrations of Credit Risk, of Notes to Financial Statements" contained within this report. See the risk factors related to our dependency on the growth and financial condition of the Exchange in Item 1A. "Risk Factors" contained within this report.
Competition
Our primary function is to provide management services to the Exchange as set forth in the subscriber’s agreement executed by each policyholder of the Exchange. There are a limited number of companies that provide services under a reciprocal insurance
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exchange structure. We do not directly compete against other such companies, given we are appointed by the policyholders of the Exchange to provide these services.
The direct and assumed premiums written by the Exchange drive our management fee which is our primary source of revenue. The property and casualty insurance industry is highly competitive. Property and casualty insurers generally compete on the basis of customer service, price, consumer recognition, coverages offered, claims handling, financial stability and geographic coverage. Vigorous competition, particularly in the personal lines automobile and homeowners lines of business, is provided by large, well-capitalized national companies, some of which have broad distribution networks of employed or captive agents, by smaller regional insurers, and by large companies who market and sell personal lines products directly to consumers. In addition, because the insurance products of the Exchange are marketed exclusively through independent insurance agents, the Exchange faces competition within its appointed agencies based upon ease of doing business, product, price, and service relationships.
Market competition bears directly on the price charged for insurance products and services subject to regulatory limitations. Industry capital levels can also significantly affect prices charged for coverage. Growth is driven by a company’s ability to provide insurance services and competitive prices while maintaining target profit margins. Growth is a product of a company’s ability to retain existing customers and to attract new customers, as well as movement in the average premium per policy.
The Exchange’s strategic focus includes employing an underwriting philosophy and product mix targeted to produce an underwriting profit on a long-term basis through careful risk selection and rational pricing, and consistently providing superior service to policyholders and agents. The Exchange’s business model is designed to provide the advantages of localized marketing and claims servicing with the economies of scale and low cost of operations from centralized support services. The Exchange also carefully selects the independent agencies that represent it and seeks to be the lead insurer with its agents in order to enhance the agency relationship and the likelihood of receiving the most desirable underwriting opportunities from its agents.
See the risk factors related to our dependency on the growth and financial condition of the Exchange in Item 1A. "Risk Factors" contained within this report for further discussion on competition in the insurance industry.
Employees
We had over 4,800 full-time employees at December 31, 2015, of which approximately 2,200, or 46%, provide claims related services exclusively for the Exchange. The Exchange reimburses us monthly for the cost of these services.
Government Regulation
Most states have enacted legislation that regulates insurance holding company systems, defined as two or more affiliated persons, one or more of which is an insurer. The Exchange has the following wholly owned property and casualty subsidiaries: Erie Insurance Company, Erie Insurance Company of New York, Erie Insurance Property and Casualty Company and Flagship City Insurance Company, and a wholly owned life insurance company, Erie Family Life Insurance Company ("EFL"). Indemnity and the Exchange, and its wholly owned subsidiaries, meet the definition of an insurance holding company system.
Each insurance company in the holding company system is required to register with the insurance supervisory authority of its state of domicile and furnish information regarding the operations of companies within the holding company system that may materially affect the operations, management, or financial condition of the insurers within the system. Pursuant to these laws, the respective insurance departments may examine us, as the management company, and the Exchange and its wholly owned subsidiaries at any time, and may require disclosure and/or prior approval of certain transactions with the insurers and us, as an insurance holding company.
All transactions within a holding company system affecting the member insurers of the holding company system must be fair and reasonable and any charges or fees for services performed must be reasonable. Approval by the applicable insurance commissioner is required prior to the consummation of transactions affecting the members within a holding company system.
Website Access
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports are available free of charge on our website at www.erieinsurance.com as soon as reasonably practicable after such material is filed electronically with the Securities Exchange Commission. Additionally, copies of our annual report on Form 10-K are available free of charge, upon written request, by contacting Investor Relations, Erie Indemnity Company,
100 Erie Insurance Place, Erie, PA 16530, or calling (800) 458-0811.
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Our Code of Conduct and Code of Ethics for Senior Financial Officers are also available on our website and in printed form upon request, and our information statement on Schedule 14(C) is available free of charge on our website at www.erieinsurance.com.
ITEM 1A. RISK FACTORS
Our business involves various risks and uncertainties, including, but not limited to those discussed in this section. The risks and uncertainties described in the risk factors below, or any additional risk outside of those discussed below, could have a material adverse effect on our business, financial condition, operating results, cash flows, or liquidity if they were to develop into actual events. This information should be considered carefully together with the other information contained in this report and in other reports and materials we file periodically with the Securities and Exchange Commission.
If the management fee rate paid by the Exchange is reduced or if there is a significant decrease in the amount of direct and assumed premiums written by the Exchange, revenues and profitability could be materially adversely affected.
We are dependent upon management fees paid by the Exchange, which represent our principal source of revenue. Pursuant to the subscriber’s agreements with the policyholders at the Exchange, we may retain up to 25% of all direct and assumed premiums written by the Exchange. Therefore, management fee revenue from the Exchange is calculated by multiplying the management fee rate by the direct and assumed premiums written by the Exchange. Accordingly, any reduction in direct and assumed premiums written by the Exchange would have a negative effect on our revenues and net income.
The management fee rate is determined by our Board of Directors and may not exceed 25% of the direct and assumed premiums written by the Exchange. The Board of Directors sets the management fee rate each December for the following year. At their discretion, the rate can be changed at any time. The factors considered by the Board of Directors in setting the management fee rate include our financial position in relation to the Exchange and the long-term needs of the Exchange for capital and surplus to support its continued growth and competitiveness. If the Exchange’s surplus were significantly reduced, the management fee rate could be reduced and our revenues and profitability could be materially adversely affected.
If the costs of providing services to the Exchange are not controlled, our profitability could be materially adversely affected.
Pursuant to the subscriber’s agreements with the policyholders at the Exchange, we are appointed to perform certain services. These services relate to the sales, underwriting, and issuance of policies on behalf of the Exchange. We incur significant costs related to commissions, employees, and technology in order to provide these services.
Commissions to independent agents are the largest component of our cost of operations. Commissions include scheduled commissions to agents based upon premiums written as well as additional commissions and bonuses to agents, which are earned by achieving certain targeted measures. Changes to commission rates or bonus programs may result in increased future costs and lower profitability.
Employees are an essential part of the operating costs related to providing services for the Exchange. As a result, our profitability is affected by employee costs, including salaries, healthcare, pension, and other benefit costs. Recent regulatory developments, provider relationships, and economic factors that are beyond our control indicate that employee healthcare costs will continue to increase. Although we actively manage these cost increases, there can be no assurance that future cost increases will not occur and reduce our profitability.
Technological development is necessary to facilitate ease of doing business for the agents and policyholders of the Exchange and our employees. If we are unable to keep pace with advancements in technology, our ability to compete may be negatively affected and result in lower revenues and reduced profitability for us. In order to achieve a greater ease of doing business, additional costs may be incurred as we invest in new technology and systems, which may negatively impact profitability.
We are subject to credit risk from the Exchange because the management fees from the Exchange are not paid immediately when premiums are written.
We recognize management fees due from the Exchange as income when the premiums are written because at that time we have performed substantially all of the services we are required to perform, including sales, underwriting, and policy issuance activities. However, such fees are not paid to us by the Exchange until the Exchange collects the premiums from policyholders. As a result, we hold receivables for management fees on premiums that have been written and assumed but not yet collected.
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We also hold receivables from the Exchange for costs we pay on the Exchange’s behalf. The receivable from the Exchange totaled $348.1 million, or approximately 25% of our total assets at December 31, 2015.
Serving as the attorney-in-fact in the reciprocal insurance exchange structure results in the Exchange being our sole customer. We have an interest in the growth of the Exchange as our earnings are largely generated from management fees based on the direct and assumed premiums written by the Exchange. If the Exchange’s ability to grow or renew policies were adversely impacted, the premium revenue of the Exchange would be adversely affected which would reduce our management fee revenue. The circumstances or events that might impair the Exchange’s ability to grow include, but are not limited to, the items discussed below.
Unfavorable changes in economic conditions, including declining consumer confidence, inflation, high unemployment, and the threat of recession, among others, may lead the Exchange’s customers to modify coverage, not renew policies, or even cancel policies, which could adversely affect the premium revenue of the Exchange, and consequently our management fee.
The Exchange faces significant competition from other regional and national insurance companies. The property and casualty insurance industry is highly competitive on the basis of product, price and service. If the Exchange’s competitors offer property and casualty products with more coverage or offer lower rates, and the Exchange is unable to implement product improvements quickly enough to keep pace, its ability to grow and renew its business may be adversely impacted. Likewise, an inability to match or exceed the service provided by competitors, which is increasingly relying on digital delivery and enhanced distribution technology, may impede the Exchange's ability to maintain and/or grow its customer base. In addition, due to the Exchange’s focus on the automobile and homeowners insurance markets, it may be more sensitive to trends that could affect auto and home insurance coverages and rates over time, for example changing driving patterns or advancements in vehicle or home technology or safety features.
The Exchange markets and sells its insurance products through independent, non-exclusive insurance agencies. These agencies are not obligated to sell only the Exchange’s insurance products, and generally also sell products of the Exchange’s competitors. If agencies do not maintain their current levels of marketing efforts, bind the Exchange to unacceptable risks, place business with competing insurers, or the Exchange is unsuccessful in maintaining and/or increasing the number of agencies in its distribution system as well as its relationships with those agencies, the Exchange’s ability to grow and renew its business may be adversely impacted. Additionally, consumer preferences may cause the insurance industry as a whole to migrate to a delivery system other than independent agencies.
The Exchange maintains a brand recognized for customer service. The perceived performance, actions, conduct and behaviors of employees, independent insurance agency representatives, and third-party service partners may result in reputational harm to the Exchange’s brand. Specific incidents which may cause harm include but are not limited to disputes, long customer wait times, errors in processing a claim, failure to protect sensitive customer data, and inappropriate social media communications. If third-party service providers fail to perform as anticipated, the Exchange may experience operational difficulties, increased costs and reputational damage. If an extreme catastrophic event were to occur in a heavily concentrated area of policyholders, an extraordinarily high number of claims could have the potential to strain claims processing and affect the Exchange’s ability to satisfy its customers. Any reputational harm to the Exchange could have the potential to impair its ability to grow and renew its business.
Serving as the attorney-in-fact in the reciprocal insurance exchange structure results in the Exchange being our sole customer. We have an interest in the financial condition of the Exchange as our earnings are largely generated from management fees based on the direct and assumed premiums written by the Exchange. If the Exchange were to fail to maintain acceptable financial strength ratings, its competitive position in the insurance industry would be adversely affected. If a rating downgrade led to customers not renewing or canceling policies, or impacted the Exchange’s ability to attract new customers, the premium revenue of the Exchange would be adversely affected which would reduce our management fee revenue. The circumstances or events that might impair the Exchange’s financial condition include, but are not limited to, the items discussed below.
Financial strength ratings are an important factor in establishing the competitive position of insurance companies such as the Exchange. Higher ratings generally indicate greater financial stability and a stronger ability to meet ongoing obligations to policyholders. The Exchange’s A.M. Best rating is currently A+ ("Superior"). Rating agencies periodically review insurers' ratings and change their rating criteria; therefore, the Exchange’s current rating may not be maintained in the future. A significant downgrade in this or other ratings would reduce the competitive position of the Exchange, making it more difficult to attract profitable business in the highly competitive property and casualty insurance market and potentially result in reduced sales of its products and lower premium revenue.
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The performance of the Exchange’s investment portfolio is subject to a variety of investment risks. The Exchange’s investment portfolio is comprised principally of fixed income securities, equity securities and limited partnerships. The fixed income portfolio is subject to a number of risks including, but not limited to, interest rate risk, investment credit risk, sector/concentration risk and liquidity risk. The Exchange’s common stock and preferred equity securities have exposure to price risk, the risk of potential loss in estimated fair value resulting from an adverse change in prices. Limited partnerships are significantly less liquid and generally involve higher degrees of price risk than publicly traded securities. Limited partnerships, like publicly traded securities, have exposure to market volatility; but unlike fixed income securities, cash flows and return expectations are less predictable. If any investments in the Exchange’s investment portfolio were to suffer a substantial decrease in value, the Exchange’s financial position could be materially adversely affected through increased unrealized losses or impairments. A significant decrease in the Exchange’s portfolio could also put it, or its subsidiaries, at risk of failing to satisfy regulatory or rating agency minimum capital requirements.
Property and casualty insurers are subject to extensive regulatory supervision in the states in which they do business. This regulatory oversight includes, by way of example, matters relating to licensing, examination, rate setting, market conduct, policy forms, limitations on the nature and amount of certain investments, claims practices, mandated participation in involuntary markets and guaranty funds, reserve adequacy, insurer solvency, restrictions on underwriting standards, accounting standards, and transactions between affiliates. Such regulation and supervision are primarily for the benefit and protection of policyholders. Changes in applicable insurance laws, regulations, or changes in the way regulators administer those laws or regulations could adversely change the Exchange’s operating environment and increase its exposure to loss or put it at a competitive disadvantage, which could result in reduced sales of its products and lower premium revenue.
As insurance industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. In some instances, these emerging issues may not become apparent for some time after the Exchange has issued the affected insurance policies. As a result, the full extent of liability under the Exchange’s insurance policies may not be known for many years after the policies are issued. These issues may adversely affect the Exchange’s business by either extending coverage beyond its underwriting intent or by increasing the number or size of claims.
The Exchange’s insurance operations are exposed to claims arising out of catastrophes. Common natural catastrophic events include hurricanes, earthquakes, tornadoes, hail storms, and severe winter weather. The frequency and severity of these catastrophes is inherently unpredictable. Changing climate conditions have added to the unpredictability, frequency and severity of natural disasters and have created additional uncertainty as to future trends and exposures. A single catastrophic occurrence or aggregation of multiple smaller occurrences could adversely affect the financial condition of the Exchange.
Terrorist attacks could also cause losses from insurance claims related to the property and casualty insurance operations. The Exchange could incur large net losses if terrorist attacks were to occur which could adversely affect its financial condition.
Our ability to attract, develop, and retain talented executives, key managers, and employees is critical to our success.
Our success is largely dependent upon our ability to attract and retain executives and other key management. The loss of the services and leadership of certain key officers and the failure to attract and develop talented new executives and managers could prevent us from successfully communicating, implementing, and executing business strategies, and therefore have a material adverse effect on our financial condition and results of operations.
Our success also depends on our ability to attract, develop, and retain a talented employee base. The inability to staff all functions of our business with employees possessing the appropriate technical expertise could have an adverse effect on our business performance. Staffing appropriately skilled employees for the handling of claims and servicing of customers, rendering of disciplined underwriting, and effective sales and marketing are critical to the core functions of our business. In addition, skilled employees in the actuarial, finance, and information technology areas are also essential to support our core functions.
If we are unable to ensure system availability, unable to secure sensitive information, or we make significant decisions based on inaccurate data, we may experience adverse financial consequences and/or may be unable to compete effectively. Our business depends on the uninterrupted operations of our facilities, systems, and business functions.
Our business is highly dependent upon the effective operations of our technology and information systems. We also conduct business functions and computer operations using the systems of third-party vendors, which may provide software, data storage, and other computer services to us. We rely upon our systems, and those of third-party vendors, to assist in key functions of core business operations including processing claims, applications, and premium payments, providing customer support, performing actuarial and financial analysis, and maintaining key data.
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We necessarily collect, use, and hold data concerning individuals, businesses, strategic plans, and intellectual property. Threats to data security, including unauthorized access, cyber-attacks, and other computer related penetrations, expose us to additional costs for protection or remediation to secure our data in accordance with customer expectations and statutory and regulatory requirements, including data privacy laws. Preventative actions we take, or our third-party vendors take, to reduce the risk of cyber incidents and protect our information may be insufficient to prevent physical and electronic break-ins or other security breaches to our computer system. Additionally, a breach of security that results in unauthorized access to our data could expose us to an operational disruption, data loss, litigation, fines and penalties, increased compliance costs, and reputational damages. While we maintain cyber liability insurance to mitigate the amount of financial loss, our insurance coverage may not be sufficient to protect against all loss.
We depend on a large amount of data to price policies appropriately, track exposures, perform financial analysis, and ultimately make business decisions. Should this data be inaccurate or insufficient, risk exposure may be underestimated and/or poor business decisions may be made. This may in turn lead to adverse operational or financial performance.
We have an established business continuity plan to ensure the continuation of core business operations in the event that normal business operations could not be performed due to a catastrophic event. While we continue to test and assess our business continuity plan to ensure it meets the needs of our core business operations and addresses multiple business interruption events, there is no assurance that core business operations could be performed upon the occurrence of such an event. Systems failures or outages could compromise our ability to perform our business functions in a timely manner, which could harm our ability to conduct business and hurt our relationships with our business partners and customers. Our business continuity is also dependent on third-party systems on which our information technology systems interface and rely. Our systems and those of our third-party vendors may become vulnerable to damage or disruption due to circumstances beyond our or their control, such as from catastrophic events, power anomalies or outages, natural disasters, network failures, and viruses. The failure of our information systems for any reason could result in a material adverse effect on our business, financial condition, or results of operations.
The performance of our investment portfolio is subject to a variety of investment risks, which may in turn have a material adverse effect on our results of operations or financial condition.
Our investment portfolio is comprised principally of fixed income securities and limited partnerships. At December 31, 2015, our investment portfolio consisted of approximately 85% fixed income securities, 13% limited partnerships, and 2% equity securities.
All of our marketable securities are subject to market volatility. To the extent that future market volatility negatively impacts our investments, our financial condition will be negatively impacted. We review the investment portfolio on a continuous basis to evaluate positions that might have incurred other-than-temporary declines in value. Inherent in management’s evaluation of a security are assumptions and estimates about the operations of the issuer and its future earnings potential. The primary factors considered in our review of investment valuation include the extent and duration to which fair value is less than cost, historical operating performance and financial condition of the issuer, short- and long-term prospects of the issuer and its industry, specific events that occurred affecting the issuer, including rating downgrades, and, depending on the type of security, our intent to sell or our ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value. As the process for determining impairments is highly subjective, changes in our assessments may have a material effect on our operating results and financial condition. See also Item 7A. "Quantitative and Qualitative Disclosures about Market Risk".
If the fixed income, equity, or limited partnership portfolios were to suffer a substantial decrease in value, our financial position could be materially adversely affected through increased unrealized losses or impairments.
Currently, 39% of the fixed income portfolio is invested in municipal securities. The performance of the fixed income portfolio is subject to a number of risks including, but not limited to:
• | Interest rate risk - the risk of adverse changes in the value of fixed income securities as a result of increases in market interest rates. A sustained low interest rate environment would pressure our net investment income. |
• | Investment credit risk - the risk that the value of certain investments may decrease due to the deterioration in financial condition of, or the liquidity available to, one or more issuers of those securities or, in the case of asset-backed securities, due to the deterioration of the loans or other assets that underlie the securities, which, in each case, also includes the risk of permanent loss. |
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• | Sector/Concentration risk - the risk that the portfolio may be too heavily concentrated in the securities of one or more issuers, sectors, or industries. Events or developments that have a negative impact on any particular industry, group of related industries, or geographic region may have a greater adverse effect on our investment portfolio to the extent that the portfolio is concentrated within those issuers, sectors, or industries. |
• | Liquidity risk - the risk that we will not be able to convert investment securities into cash on favorable terms and on a timely basis, or that we will not be able to sell them at all, when desired. Disruptions in the financial markets or a lack of buyers for the specific securities that we are trying to sell, could prevent us from liquidating securities or cause a reduction in prices to levels that are not acceptable to us. |
General economic conditions and other factors beyond our control can adversely affect the value of our equity investments and the realization of net investment income, or result in realized investment losses. In addition, downward economic trends also may have an adverse effect on our investment results by negatively impacting the business conditions and impairing credit for the issuers of securities held in their respective investment portfolios. This could reduce fair values of investments and generate significant unrealized losses or impairment charges which may adversely affect our financial results.
In addition to the fixed income securities, a portion of our portfolio is invested in limited partnerships. At December 31, 2015, we had investments in limited partnerships of $88.5 million, or 6% of total assets. In addition, we are obligated to invest up to an additional $19.1 million in limited partnerships, including private equity, mezzanine debt, and real estate partnership investments. Limited partnerships are significantly less liquid and generally involve higher degrees of price risk, the risk of potential loss in estimated fair value resulting from an adverse change in prices, than publicly traded securities. Limited partnerships, like publicly traded securities, have exposure to market volatility; but unlike fixed income securities, cash flows and return expectations are less predictable.
The primary basis for the valuation of limited partnership interests are financial statements prepared by the general partner. Because of the timing of the preparation and delivery of these financial statements, the use of the most recently available financial statements provided by the general partners result in a quarter delay in the inclusion of the limited partnership results in our Statements of Operations. Due to this delay, our financial statements at December 31, 2015 do not reflect market conditions experienced in the fourth quarter of 2015.
Our equity securities have exposure to price risk. We do not hedge our exposure to equity price risk inherent in our equity investments. Equity markets, sectors, industries, and individual securities may also be subject to some of the same risks that affect our fixed income portfolio, as discussed above.
Deteriorating capital and credit market conditions or a failure to accurately estimate capital needs may significantly affect our ability to meet liquidity needs and access capital.
Sufficient liquidity and capital levels are required to pay operating expenses, income taxes, and to provide the necessary resources to fund future growth opportunities, pay dividends on common stock, and repurchase common stock. Management estimates the appropriate level of capital necessary based upon current and projected results, which include a loading for potential risks. Failure to accurately estimate our capital needs may have a material adverse effect on our financial condition until additional sources of capital can be located. Further, a deteriorating financial condition may create a negative perception of us by third parties, including rating agencies, investors, agents, and customers which could impact our ability to access additional capital in the debt or equity markets.
Our primary sources of liquidity are management fees and cash flows generated from our investment portfolio. In the event our current sources do not satisfy our liquidity needs, we have the ability to access our $100 million bank revolving line of credit, from which there were no borrowings as of December 31, 2015, or sell assets in our investment portfolio. Volatility in the financial markets could limit our ability to sell certain of our fixed income securities or, to a greater extent, our significantly less liquid limited partnership investments, or cause such investments to sell at deep discounts.
In the event these traditional sources of liquidity are not available, we may have to seek additional financing. Our access to funds will depend upon a number of factors including current market conditions, the availability of credit, market liquidity, and credit ratings. In deteriorating market conditions, there can be no assurance that we will obtain additional financing, or, if available, that the cost of financing will not substantially increase and affect our overall profitability.
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We are subject to applicable insurance laws, tax statutes, and regulations, as well as claims and legal proceedings, which, if determined unfavorably, could have a material adverse effect on our business, results of operations, or financial condition.
We face a significant risk of litigation and regulatory investigations and actions in the ordinary course of operating our businesses including the risk of class action lawsuits. Our pending legal and regulatory actions include proceedings specific to us and others generally applicable to business practices in the industries in which we operate. In our operations, we are, have been, or may become subject to class actions and individual suits alleging, among other things, issues relating to sales or underwriting practices, payment of contingent or other sales commissions, product design, product disclosure, policy issuance and administration, additional premium charges for premiums paid on a periodic basis, charging excessive or impermissible fees on products, recommending unsuitable products to customers, and breaching alleged fiduciary or other duties, including our obligations to indemnify directors and officers in connection with certain legal matters. We are also subject to litigation arising out of our general business activities such as our contractual and employment relationships. Plaintiffs in class action and other lawsuits against us may seek very large or indeterminate amounts, including punitive and treble damages, which may remain unknown for substantial periods of time. We are also subject to various regulatory inquiries, such as information requests, subpoenas, and books and record examinations from state and federal regulators and authorities. Changes in the way regulators administer those laws, tax statutes, or regulations could adversely impact our business, results of operations, or financial condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Indemnity and the Exchange share a corporate home office complex in Erie, Pennsylvania, which comprises approximately 620,000 square feet. Additionally, we lease one office building and one warehouse facility from unaffiliated parties. We are charged rent for the related square footage we occupy.
Indemnity and the Exchange also operate 25 field offices in 12 states. Of these field offices, 16 provide both agency support and claims services and are referred to as branch offices, while seven provide only claims services and are referred to as claims offices, and two provide only agency support and are referred to as sales offices. We own three field offices and lease a portion of these buildings to the Exchange. The remaining field offices are leased from other parties as detailed below:
Number of | ||
Field office ownership: | field offices | |
Erie Indemnity Company | 3 | |
Erie Insurance Exchange | 3 | |
Erie Family Life Insurance Company | 1 | |
Unaffiliated parties (1) | 18 | |
25 | ||
(1) Lease commitments for these properties expire periodically through 2020. We
expect that most leases will be renewed or replaced upon expiration.
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ITEM 3. LEGAL PROCEEDINGS
State Court Lawsuit Against Erie Indemnity Company
Erie Indemnity Company (“Indemnity”) was named as a defendant in a complaint filed on August 1, 2012 by alleged subscribers of the Erie Insurance Exchange (the “Exchange”) in the Court of Common Pleas Civil Division of Fayette County, Pennsylvania captioned Erie Insurance Exchange, an unincorporated association, by Joseph S. Sullivan and Anita Sullivan, Patricia R. Beltz, and Jenna L. DeBord, trustees ad litem v. Erie Indemnity Co. (the “Sullivan” lawsuit).
As subsequently amended, the complaint alleges that, beginning on September 1, 1997, Indemnity retained “Service Charges” (installment fees) and “Added Service Charges” (late fees and policy reinstatement charges) on policies written by the Exchange and its insurance subsidiaries, which allegedly should have been paid to the Exchange, in the amount of approximately $308 million. In addition to their claim for monetary relief on behalf of the Exchange, the plaintiffs seek an accounting of all so-called intercompany transactions between Indemnity and the Exchange from 1996 to date. Plaintiffs allege that Indemnity breached its contractual, fiduciary, and equitable duties by retaining Service Charges and Added Service Charges that should have been retained by the Exchange. Plaintiffs bring these same claims under three separate derivative-type theories. First, plaintiffs purport to bring suit as members of the Exchange on behalf of the Exchange. Second, plaintiffs purport to bring suit as trustees ad litem on behalf of the Exchange. Third, plaintiffs purport to bring suit on behalf of the Exchange pursuant to Rule 1506 of the Pennsylvania Rules of Civil Procedure, which allows shareholders to bring suit derivatively on behalf of a corporation or similar entity.
Indemnity filed a motion in the state court in November 2012 seeking dismissal of the lawsuit. On December 19, 2013, the court granted Indemnity’s motion in part, holding that the Pennsylvania Insurance Holding Company Act “provides the [Pennsylvania Insurance] Department with special competence to address the subject matter of plaintiff’s claims” and referring “all issues” in the Sullivan lawsuit to the Pennsylvania Insurance Department (the “Department”) for “its views and any determination.” The court stayed all further proceedings and reserved decision on all other grounds for dismissal raised by Indemnity. Plaintiffs sought reconsideration of the court’s order, and on January 13, 2014, the court entered a revised order affirming its prior order and clarifying that the Department “shall decide any and all issues within its jurisdiction.” On January 30, 2014, Plaintiffs asked the court to certify its order to permit an immediate appeal to the Superior Court of Pennsylvania and to stay any proceedings in the Department pending completion of any appeal. On February 18, 2014, the court issued an order denying Plaintiffs’ motion. On March 20, 2014, Plaintiffs filed a petition for review with the Superior Court, which was denied by the Superior Court on May 5, 2014.
The Sullivan matter was assigned to an Administrative Judge within the Department for determination. The parties agreed that an evidentiary hearing was not required and they entered into a stipulated record and submitted briefing to the Department. Oral argument was held before the Administrative Judge on January 6, 2015. On April 29, 2015, the Department issued a declaratory opinion and order (1) finding that the transactions between Exchange and Indemnity in which Indemnity retained or received revenue from installment and other service charges from Exchange subscribers complied with applicable insurance laws and regulations and that Indemnity properly retained charges paid by Exchange policyholders for certain installment premium payment plans, dishonored payments, policy cancellations and policy reinstatements and (2) returning jurisdiction for the matter to the Fayette County Court of Common Pleas.
On May 26, 2015, Plaintiffs appealed the Department’s decision to the Pennsylvania Commonwealth Court. Oral argument was held before the Commonwealth Court en banc on December 9, 2015. On January 27, 2016, the Commonwealth Court issued an opinion vacating the Department’s ruling and directing the Department to return the case to the Court of Common Pleas, essentially holding that the primary jurisdiction referral of the trial court was improper at this time because the allegations of the complaint do not implicate the special competency of the Department. Indemnity is permitted to file a petition for allowance of appeal to the Pennsylvania Supreme Court seeking further review of the Commonwealth Court opinion. Such a filing currently would be due on February 26, 2016.
Indemnity believes that it continues to have meritorious legal and factual defenses to the Sullivan lawsuit and intends to vigorously defend against all allegations and requests for relief.
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Federal Court Lawsuit Against Directors
On February 6, 2013, a lawsuit was filed in the United States District Court for the Western District of Pennsylvania, captioned Erie Insurance Exchange, an unincorporated association, by members Patricia R. Beltz, Joseph S. Sullivan and Anita Sullivan, and Patricia R. Beltz, on behalf of herself and others similarly situate v. Richard L. Stover; J. Ralph Borneman, Jr; Terrence W. Cavanaugh; Jonathan Hirt Hagen; Susan Hirt Hagen; Thomas B. Hagen; C. Scott Hartz; Claude C. Lilly, III; Lucian L. Morrison; Thomas W. Palmer; Martin P. Sheffield; Elizabeth H. Vorsheck; and Robert C. Wilburn (the “Beltz” lawsuit), by alleged policyholders of the Exchange who are also the plaintiffs in the Sullivan lawsuit. The individuals named as defendants in the Beltz lawsuit were the then-current Directors of Indemnity.
As subsequently amended, the Beltz lawsuit asserts many of the same allegations and claims for monetary relief as in the Sullivan lawsuit. Plaintiffs purport to sue on behalf of all policyholders of the Exchange, or, alternatively, on behalf of the Exchange itself. Indemnity filed a motion to intervene as a Party Defendant in the Beltz lawsuit in July 2013, and the Directors filed a motion to dismiss the lawsuit in August 2013. On February 10, 2014, the court entered an order granting Indemnity’s motion to intervene and permitting Indemnity to join the Directors’ motion to dismiss; granting in part the Directors’ motion to dismiss; referring the matter to the Department to decide any and all issues within its jurisdiction; denying all other relief sought in the Directors’ motion as moot; and dismissing the case without prejudice. To avoid duplicative proceedings and expedite the Department’s review, the Parties stipulated that only the Sullivan action would proceed before the Department and any final and non-appealable determinations made by the Department in the Sullivan action will be applied to the Beltz action.
On March 7, 2014, Plaintiffs filed a notice of appeal to the United States Court of Appeals for the Third Circuit. Indemnity filed a motion to dismiss the appeal on March 26, 2014. On November 17, 2014, the Third Circuit deferred ruling on Indemnity’s motion to dismiss the appeal and instructed the parties to address that motion, as well as the merits of Plaintiffs’ appeal, in the parties’ briefing. Briefing was completed on April 2, 2015. In light of the Department’s April 29, 2015 decision in Sullivan, the Parties then jointly requested that the Beltz appeal be voluntarily dismissed as moot on June 5, 2015. The Third Circuit did not rule on the Parties’ request for dismissal and instead held oral argument as scheduled on June 8, 2015. On July 16, 2015, the Third Circuit issued an opinion and judgment dismissing the appeal. The Third Circuit found that it lacked appellate jurisdiction over the appeal, because the District Court’s February 10, 2014 order referring the matter to the Department was not a final, appealable order.
Indemnity believes that it has meritorious legal and factual defenses and intends to vigorously defend against all allegations and requests for relief in the Beltz lawsuit. The Directors have also advised Indemnity that they intend to vigorously defend against the claims in the Beltz lawsuit and have sought indemnification and advancement of expenses from the Company in connection with the Beltz lawsuit.
For additional information on contingencies, see Part II, Item 8. "Financial Statements and Supplementary Data - Note 15, Commitment and Contingencies, of Notes to Financial Statements".
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock Market Prices and Dividends
Our Class A, non-voting common stock trades on The NASDAQ Stock MarketSM LLC under the symbol "ERIE". No established trading market exists for the Class B voting common stock. American Stock Transfer & Trust Company serves as our transfer agent and registrar. As of February 19, 2016, there were approximately 715 beneficial shareholders of record for the Class A non-voting common stock and 9 beneficial shareholders of record for the Class B voting common stock.
Historically, we have 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 upon, among other things, our operating results, financial condition, cash requirements, and general business conditions at the time such payment is considered. The common stock high and low sales prices and cash dividends declared for each full quarter of the last two years were as follows:
2015 | 2014 | |||||||||||||||||||||||||||||||
Stock sales price | Cash dividend declared | Stock sales price | Cash dividend declared | |||||||||||||||||||||||||||||
Quarter ended | High | Low | Class A | Class B | High | Low | Class A | Class B | ||||||||||||||||||||||||
March 31 | $ | 93.01 | $ | 84.11 | $ | 0.681 | $ | 102.15 | $ | 74.57 | $ | 66.63 | $ | 0.635 | $ | 95.25 | ||||||||||||||||
June 30 | 87.15 | 80.02 | 0.681 | 102.15 | 76.71 | 68.72 | 0.635 | 95.25 | ||||||||||||||||||||||||
September 30 | 87.82 | 79.79 | 0.681 | 102.15 | 78.48 | 72.63 | 0.635 | 95.25 | ||||||||||||||||||||||||
December 31 | 100.56 | 81.37 | 0.730 | 109.50 | 93.35 | 75.72 | 0.681 | 102.15 | ||||||||||||||||||||||||
Total | $ | 2.773 | $ | 415.95 | $ | 2.586 | $ | 387.90 | ||||||||||||||||||||||||
Stock Performance
The following graph depicts the cumulative total shareholder return, assuming reinvestment of dividends, for the periods indicated for our Class A common stock compared to the Standard & Poor's 500 Stock Index and the Standard & Poor's Supercomposite Insurance Industry Group Index. The Standard & Poor's Supercomposite Insurance Industry Group Index is made up of 55 constituent members represented by property and casualty insurers, insurance brokers, and life insurers, and is a capitalization weighted index.
2010 | 2011 | 2012 | 2013 | 2014 | 2015 | |||||||||||||||||||
Erie Indemnity Company Class A common stock | $ | 100 | (1) | $ | 123 | $ | 116 | $ | 126 | $ | 160 | $ | 175 | |||||||||||
Standard & Poor's 500 Stock Index | 100 | (1) | 102 | 118 | 156 | 177 | 180 | |||||||||||||||||
Standard & Poor's Supercomposite Insurance Industry Group Index | 100 | (1) | 93 | 111 | 161 | 175 | 181 | |||||||||||||||||
(1) | Assumes $100 invested at the close of trading, on the last trading day preceding the first day of the fifth preceding fiscal year, in our Class A common stock, the Standard & Poor’s 500 Stock Index, and the Standard & Poor’s Supercomposite Insurance Industry Group Index. |
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Issuer Purchases of Equity Securities
We may purchase shares, from time-to-time, in the open market, through trading plans entered into with one or more brokerage firms pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934, or through privately negotiated transactions. The purchase of shares is dependent upon prevailing market conditions and alternate uses of capital, and at times and in a manner that is deemed appropriate.
Our Board of Directors authorized a stock repurchase program effective January 1, 1999, allowing the repurchase of our outstanding Class A nonvoting common stock. Various approvals for continuation of this program have since been authorized, with the most recent occurring in October 2011 for $150 million, which was authorized with no time limitation. There were no repurchases of our Class A common stock under this program during the quarter ending December 31, 2015. We had approximately $17.8 million of repurchase authority remaining under this program, based upon trade date, at both December 31, 2015 and February 19, 2016.
See Part II, Item 8. "Financial Statements and Supplementary Data – Note 11, Capital Stock, of Notes to Financial Statements" contained within this report for discussion of additional shares repurchased outside of this program.
ITEM 6. SELECTED FINANCIAL DATA
(in thousands, except per share data) | Years Ended December 31, | ||||||||||||||||||||
2015 | 2014 | 2013 | 2012 | 2011 | |||||||||||||||||
Operating Data: | |||||||||||||||||||||
Operating revenue | $ | 1,505,508 | $ | 1,407,119 | $ | 1,297,331 | $ | 1,188,430 | $ | 1,099,836 | |||||||||||
Operating expenses | 1,272,967 | 1,184,272 | 1,087,995 | 983,420 | 892,101 | ||||||||||||||||
Investment income | 33,708 | 28,417 | 37,278 | 36,204 | 46,999 | ||||||||||||||||
Income before income taxes | 266,249 | 251,264 | 246,614 | 241,214 | 254,734 | ||||||||||||||||
Net income | 174,678 | 167,505 | 162,611 | 160,145 | 169,503 | ||||||||||||||||
Per Share Data: | |||||||||||||||||||||
Net income per Class A share – diluted | $ | 3.33 | $ | 3.18 | $ | 3.08 | $ | 2.99 | $ | 3.08 | |||||||||||
Book value per share – Class A common and equivalent B shares | 14.72 | 13.45 | 13.96 | 12.11 | 14.48 | ||||||||||||||||
Dividends declared per Class A share | 2.773 | 2.586 | 2.4125 | 4.25 | 2.0975 | ||||||||||||||||
Dividends declared per Class B share | 415.95 | 387.90 | 361.875 | 637.50 | 314.625 | ||||||||||||||||
Financial Position Data: | |||||||||||||||||||||
Investments | $ | 688,476 | $ | 702,387 | $ | 721,728 | $ | 687,525 | $ | 808,500 | |||||||||||
Receivables from Erie Insurance Exchange and affiliates | 348,055 | 335,220 | 300,442 | 280,787 | 254,098 | ||||||||||||||||
Total assets | 1,407,296 | 1,319,198 | 1,213,042 | 1,160,153 | 1,237,277 | ||||||||||||||||
Total equity | 769,503 | 703,134 | 733,982 | 641,870 | 781,325 | ||||||||||||||||
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of financial condition and results of operations highlights significant factors influencing Erie Indemnity Company ("Indemnity", "we", "us", "our"). This discussion should be read in conjunction with the audited financial statements and related notes and all other items contained within this Annual Report on Form 10-K as these contain important information helpful in evaluating our financial condition and results of operations.
INDEX
Page Number | |
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995:
Statements contained herein that are not historical fact are forward-looking statements and, as such, are subject to risks and uncertainties that could cause actual events and results to differ, perhaps materially, from those discussed herein. Forward-looking statements relate to future trends, events or results and include, without limitation, statements and assumptions on which such statements are based that are related to our plans, strategies, objectives, expectations, intentions, and adequacy of resources. Examples of forward-looking statements are discussions relating to premium and investment income, expenses, operating results, and compliance with contractual and regulatory requirements. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Among the risks and uncertainties, in addition to those set forth in our filings with the Securities and Exchange Commission, that could cause actual results and future events to differ from those set forth or contemplated in the forward-looking statements include the following:
• | dependence upon our relationship with the Exchange and the management fee under the agreement with the subscribers at the Exchange; |
• | costs of providing services to the Exchange under the subscriber’s agreement; |
• | credit risk from the Exchange; |
• | dependence upon our relationship with the Exchange and the growth of the Exchange, including: |
◦ | general business and economic conditions; |
◦ | factors affecting insurance industry competition; |
◦ | dependence upon the independent agency system; and |
◦ | ability to maintain our reputation for customer service; |
• | dependence upon our relationship with the Exchange and the financial condition of the Exchange, including: |
◦ | the Exchange’s ability to maintain acceptable financial strength ratings; |
◦ | factors affecting the quality and liquidity of the Exchange’s investment portfolio; |
◦ | changes in government regulation of the insurance industry; |
◦ | emerging claims and coverage issues in the industry; and |
◦ | severe weather conditions or other catastrophic losses, including terrorism; |
• | ability to attract and retain talented management and employees; |
• | ability to maintain uninterrupted business operations; |
• | factors affecting the quality and liquidity of our investment portfolio; |
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• | our ability to meet liquidity needs and access capital; and |
• | outcome of pending and potential litigation. |
A forward-looking statement speaks only as of the date on which it is made and reflects our analysis only as of that date. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changes in assumptions, or otherwise.
RETROSPECTIVELY ADOPTED ACCOUNTING STANDARDS
In February 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-02, Consolidation, which changed the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. This guidance changed the conditions to be met in determining if a reporting entity has a variable interest in a legal entity. In accordance with the new accounting guidance, Indemnity is not deemed to have a variable interest in the Exchange as the fees paid for services provided to the Exchange no longer represent a variable interest. The compensation received from the attorney-in-fact fee arrangement with the subscribers is for services provided by Indemnity acting in its role as attorney-in-fact and is commensurate with the level of effort required to perform those services. Under the previously issued accounting guidance, Indemnity was deemed to have a variable interest and was the primary beneficiary of the Exchange and its financial position and operating results were consolidated with Indemnity. Following adoption of the new accounting guidance, the Exchange’s results are no longer required to be consolidated with Indemnity.
Indemnity adopted the new accounting standard on a retrospective basis effective with the annual reporting period ending December 31, 2015. The 2014 and 2013 financial information within this report has been conformed to the presentation in accordance with the amended guidance.
RECENT ACCOUNTING STANDARDS
See Part II, Item 8. "Financial Statements and Supplementary Data - Note 2, Significant Accounting Policies, of Notes to Financial Statements" contained within this report for a discussion of adopted and other recently issued accounting standards, none of which had or are expected to have a material impact on our future financial condition, results of operations or cash flows.
OPERATING OVERVIEW
Overview
We are a Pennsylvania business corporation that since 1925 has been the managing attorney-in-fact for the subscribers (policyholders) at the Erie Insurance Exchange ("Exchange"), a reciprocal insurer that writes property and casualty insurance. Our primary function is to perform certain services relating to the sales, underwriting and issuance of policies on behalf of the Exchange. We operate our business as one segment.
The Exchange is a reciprocal insurance exchange organized under Article X of Pennsylvania's Insurance Company Law of 1921 under which individuals, partnerships, and corporations are authorized to exchange reciprocal or inter-insurance contracts with each other, or with individuals, partnerships, and corporations of other states and countries, providing indemnity among themselves from any loss which may be insured against under any provision of the insurance laws except life insurance. Each applicant for insurance to the Exchange signs a subscriber’s agreement, which contains an appointment of Indemnity as their attorney-in-fact to transact the business of the Exchange on their behalf.
Pursuant to the subscriber’s agreement and for its services as attorney-in-fact, we earn a management fee calculated as a percentage of the direct and assumed premiums written by the Exchange.
Our earnings are primarily driven by the management fee revenue generated for the services we provide relating to certain sales, underwriting, and issuance of policies for the Exchange. Management fee revenue is based upon all direct and assumed premiums written by the Exchange and the management fee rate, which is not to exceed 25%. Our Board of Directors establishes the management fee rate at least annually, generally in December for the following year, and considers factors such as the relative financial strength of Indemnity and the Exchange and projected revenue streams. The management fee rate was set at 25% for 2015, 2014 and 2013. Our Board of Directors set the 2016 management fee rate again at 25%, its maximum level.
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The services we provide to the Exchange are related to the sales, underwriting and issuance of policies. The sales related services we provide include agent compensation and certain sales and advertising support services. Agent compensation includes scheduled commissions to agents based upon premiums written as well as additional commissions and bonuses to agents, which are earned by achieving targeted measures. Agent compensation comprised approximately 67% of our 2015 expenses. The underwriting services we provide include underwriting and policy processing expenses and comprised approximately 11% of our 2015 expenses. We provide information technology services that support all functions that comprised approximately 10% of our 2015 expenses. The remaining services we provide include customer service and administrative costs.
Our results of operations are tied to the growth and financial condition of the Exchange as the Exchange is our sole customer and our earnings are largely generated from management fees based on the direct and assumed premiums written by the Exchange. The Exchange generates revenue by insuring preferred and standard risks, with personal lines comprising 70% of the 2015 direct and assumed written premiums and commercial lines comprising the remaining 30%. The principal personal lines products are private passenger automobile and homeowners. The principal commercial lines products are commercial multi-peril, workers compensation and commercial automobile.
We generate investment income from our fixed maturity, equity security, and limited partnership investment portfolios. Our portfolio is managed with the objective of maximizing after-tax returns on a risk-adjusted basis. We actively evaluate the portfolios for impairments, and record impairment write-downs on investments in instances where the fair value of the investment is substantially below cost, and it is concluded that the decline in fair value is other-than-temporary, which includes consideration for intent to sell.
Financial Overview
Years ended December 31, | ||||||||||||||||||||
(dollars in thousands, except per share data) | 2015 | % Change | 2014 | % Change | 2013 | |||||||||||||||
Total operating revenue | $ | 1,505,508 | 7.0 | % | $ | 1,407,119 | 8.5 | % | $ | 1,297,331 | ||||||||||
Total operating expenses | 1,272,967 | 7.5 | 1,184,272 | 8.8 | 1,087,995 | |||||||||||||||
Net revenue from operations | 232,541 | 4.3 | 222,847 | 6.5 | 209,336 | |||||||||||||||
Total investment income | 33,708 | 18.6 | 28,417 | (23.8 | ) | 37,278 | ||||||||||||||
Income before income taxes | 266,249 | 6.0 | 251,264 | 1.9 | 246,614 | |||||||||||||||
Income tax expense | 91,571 | 9.3 | 83,759 | (0.3 | ) | 84,003 | ||||||||||||||
Net income | $ | 174,678 | 4.3 | % | $ | 167,505 | 3.0 | % | $ | 162,611 | ||||||||||
Net income per share - diluted | $ | 3.33 | 4.5 | % | $ | 3.18 | 3.5 | % | $ | 3.08 | ||||||||||
Total operating revenue increased 7.0% and 8.5% in 2015 and 2014, respectively, driven by the increase in management fee revenue. The two components of management fee revenue are the management fee rate we charge, and the direct and assumed premiums written by the Exchange. The management fee rate was 25% for both 2015 and 2014. The direct and assumed premiums written by the Exchange were $5.9 billion in 2015 and $5.5 billion in 2014.
Total operating expenses increased 7.5% and 8.8% in 2015 and 2014, respectively. The increase in operating expenses was driven primarily by increases in commissions and personnel costs.
Gross margin from operations decreased slightly to 15.4% in 2015 from 15.8% in 2014.
Total investment income increased 18.6% in 2015 primarily due to higher earnings from limited partnership investments.
Reconciliation of Operating Income to Net Income
We disclose operating income, a non-GAAP financial measure, to enhance our investors’ understanding of our performance. Our method of calculating this measure may differ from those used by other companies, and therefore comparability may be limited.
We define operating income as net income excluding realized capital gains and losses, impairment losses, and related federal income taxes.
We use operating income to evaluate the results of our operations. It reveals trends that may be obscured by the net effects of realized capital gains and losses including impairment losses. Realized capital gains and losses, including impairment losses,
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may vary significantly between periods and are generally driven by business decisions and economic developments such as capital market conditions which are not related to our ongoing operations. We are aware that the price to earnings multiple commonly used by investors as a forward-looking valuation technique uses operating income as the denominator. Operating income should not be considered as a substitute for net income prepared in accordance with U.S. generally accepted accounting principles ("GAAP") and does not reflect our overall profitability.
The following table reconciles operating income and net income for the years ended December 31:
(in thousands, except per share data) | ||||||||||||
2015 | 2014 | 2013 | ||||||||||
Operating income | $ | 175,371 | $ | 166,886 | $ | 162,248 | ||||||
Net realized (losses) gains and impairments on investments | (1,066 | ) | 952 | 557 | ||||||||
Income tax benefit (expense) | 373 | (333 | ) | (194 | ) | |||||||
Realized (losses) gains and impairments, net of income taxes | (693 | ) | 619 | 363 | ||||||||
Net income | $ | 174,678 | $ | 167,505 | $ | 162,611 | ||||||
Per Class A common share-diluted: | ||||||||||||
Operating income | $ | 3.34 | $ | 3.17 | $ | 3.07 | ||||||
Net realized (losses) gains and impairments on investments | (0.02 | ) | 0.02 | 0.01 | ||||||||
Income tax benefit (expense) | 0.01 | (0.01 | ) | 0.00 | ||||||||
Realized (losses) gains and impairments, net of income taxes | (0.01 | ) | 0.01 | 0.01 | ||||||||
Net income | $ | 3.33 | $ | 3.18 | $ | 3.08 | ||||||
General Conditions and Trends Affecting Our Business
Economic conditions
Unfavorable changes in economic conditions, including declining consumer confidence, inflation, high unemployment, and the threat of recession, among others, may lead the Exchange’s customers to modify coverage, not renew policies, or even cancel policies, which could adversely affect the premium revenue of the Exchange, and consequently our management fee. Further, unanticipated increased inflation costs including medical cost inflation, construction and auto repair cost inflation, and tort issues may impact the estimated loss reserves and future premium rates. If any of these items impacted the financial condition or continuing operations of the Exchange, it could have an impact on our financial results.
Financial market volatility
Our portfolio of fixed maturity, equity security, and limited partnership investments is subject to market volatility especially in periods of instability in the worldwide financial markets. Over time, net investment income could also be impacted by volatility and by the general level of interest rates, which impact reinvested cash flow from the portfolio and business operations. Depending upon market conditions, which are unpredictable and remain uncertain, considerable fluctuation could exist in the fair value of our investment portfolio and reported total investment income, which could have an adverse impact on our financial condition, results of operations, and cash flows.
CRITICAL ACCOUNTING ESTIMATES
The financial statements include amounts based upon estimates and assumptions that have a significant effect on reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period and related disclosures. We consider an accounting estimate to be critical if 1) it requires assumptions to be made that were uncertain at the time the estimate was made, and 2) different estimates that could have been used, or changes in the estimate that are likely to occur from period-to-period, could have a material impact on our Statements of Operations or Financial Position.
The following presents a discussion of those accounting policies surrounding estimates that we believe are the most critical to our reported amounts and require the most subjective and complex judgment. If actual events differ significantly from the underlying assumptions, there could be material adjustments to prior estimates that could potentially adversely affect our results of operations, financial condition, and cash flows. The estimates and the estimating methods used are reviewed continually, and any adjustments considered necessary are reflected in current earnings.
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Investment Valuation
Available-for-sale securities
We make estimates concerning the valuation of all investments. Valuation techniques are used to derive the fair value of the available-for-sale securities we hold. Fair value is the price that would be received to sell an asset in an orderly transaction between willing market participants at the measurement date.
Fair value measurements are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our view of market assumptions in the absence of observable market information. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.
For purposes of determining whether the market is active or inactive, the classification of a financial instrument is based upon the following definitions:
• | An active market is one in which transactions for the assets being valued occur with sufficient frequency and volume to provide reliable pricing information. |
• | An inactive (illiquid) market is one in which there are few and infrequent transactions, where the prices are not current, price quotations vary substantially, and/or there is little information publicly available for the asset being valued. |
We continually assess whether or not an active market exists for all of our investments and as of each reporting date re-evaluate the classification in the fair value hierarchy. All assets carried at fair value are classified and disclosed in one of the following three categories:
• | 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. |
Level 1 includes nonredeemable preferred stock and exchange traded funds, and reflects market data obtained from independent sources, such as prices obtained from an exchange or a nationally recognized pricing service for identical instruments in active markets.
Level 2 includes those financial instruments that are valued using industry-standard models that consider various inputs, such as the interest rate and credit spread for the underlying financial instruments. All significant inputs are observable, or derived from observable information in the marketplace, or are supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category primarily include corporate bonds, municipal bonds, structured securities, redeemable preferred stock and certain nonredeemable preferred stock.
Level 3 securities are valued based upon unobservable inputs, reflecting our estimates of value based upon assumptions used by market participants. Securities are assigned to Level 3 in cases where non-binding broker quotes are significant to the valuation and there is a lack of transparency as to whether these quotes are based upon information that is observable in the marketplace. Fair value estimates for securities valued using unobservable inputs require significant judgment due to the illiquid nature of the market for these securities and represent the best estimate of the fair value that would occur in an orderly transaction between willing market participants at the measurement date under current market conditions. Fair value for these securities are generally determined using comparable securities or non-binding broker quotes received from outside broker dealers based upon security type and market conditions. Remaining securities, where a price is not available, are valued using an estimate of fair value based upon indicative market prices that include significant unobservable inputs not based upon, nor corroborated by, market information, including the utilization of discounted cash flow analyses which have been risk-adjusted to take into account illiquidity and other market factors. This category primarily consists of collateralized debt obligations priced using non-binding broker quotes.
As of each reporting period, financial instruments recorded at fair value are classified based upon the lowest level of input that is significant to the fair value measurement. The presence of at least one unobservable input would result in classification as a Level 3 instrument. Our assessment of the significance of a particular input to the fair value measurement requires judgment,
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and considers factors specific to the asset, such as the relative impact on the fair value as a result of including a particular input and market conditions. We did not make any other significant judgments except as described above.
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 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 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 benchmark yields, reported trades, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and transaction volumes, and believe that the 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.
Other-than-temporary impairments
Investments are evaluated monthly for other-than-temporary impairment loss. Some factors considered in evaluating whether or not a decline in fair value is other-than-temporary include:
• | the extent and duration for which fair value is less than cost; |
• | historical operating performance and financial condition of the issuer; |
• | short- and long-term prospects of the issuer and its industry based upon analysts’ recommendations; |
• | specific events that occurred affecting the issuer, including rating downgrades; |
• | intent to sell or more likely than not we would be required to sell (debt securities); and |
• | ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value (equity securities). |
For available-for-sale equity securities, a charge is recorded in the Statements of Operations for positions that have experienced other-than-temporary impairments. For debt securities in which we do not expect full recovery of amortized cost, the security is deemed to be credit-impaired. Credit-related impairments and impairments on securities we intend to sell or more likely than not will be required to sell are recorded in the Statements of Operations. It is our intention to sell all debt securities with credit impairments.
Limited partnerships
The primary basis for the valuation of limited partnership interests is financial statements prepared by the general partner. Because of the timing of the preparation and delivery of these financial statements, the use of the most recently available financial statements provided by the general partners generally result in a quarter delay in the inclusion of the limited partnership results in our Statements of Operations. Due to this delay, these financial statements do not reflect the market conditions experienced in the fourth quarter of 2015.
The majority of our limited partnership holdings are considered investment companies where the general partners record assets at fair value. These limited partnerships are recorded using the equity method of accounting. We also own some real estate limited partnerships that do not meet the criteria of an investment company. These partnerships prepare audited financial statements on a cost basis. We have elected to report these limited partnerships under the fair value option, which is based on the net asset value (NAV) from our partner's capital statement reflecting the general partner's estimate of fair value for the
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fund's underlying assets. Fair value provides consistency in the evaluation and financial reporting for these limited partnerships and limited partnerships accounted for under the equity method.
We have three types of limited partnership investments: private equity, mezzanine debt, and real estate. Our private equity and mezzanine debt partnerships are diversified among numerous industries and geographies to minimize potential loss exposure. Nearly all of the underlying investments in our limited partnerships are valued using a source other than quoted prices in active markets. The fair value amounts for our private equity and mezzanine debt partnerships are based upon the financial statements prepared by the general partners, who use various methods to estimate fair value including the market approach, income approach, and the cost approach. The market approach uses prices and other pertinent information from market-generated transactions involving identical or comparable assets or liabilities. Such valuation techniques often use market multiples derived from a set of comparables. The income approach uses valuation techniques to convert future cash flows or earnings to a single discounted present value amount. The measurement is based upon the value indicated by current market expectations about those future amounts. The cost approach is derived from the amount that is currently required to replace the service capacity of an asset. If information becomes available that would impair the cost of investments owned by the partnerships, then the general partner would adjust the investments to the net realizable value.
The fair value of investments in real estate limited partnerships is determined by the general partner based upon independent appraisals and/or internal valuations. Real estate projects under development are generally valued at cost and impairment tested by the general partner. We minimize the risk of market decline by avoiding concentration in a particular geographic area and are diversified across residential, commercial, industrial, and retail real estate investments.
While we perform various procedures in review of the general partners’ valuations, we rely on the general partners’ financial statements as the best available information to record our share of the partnership unrealized gains and losses resulting from valuation changes. Due to the limited market for these investments, there is the greatest potential for variability. We survey each of the general partners quarterly about expected significant changes (plus or minus 10% compared to previous quarter) to valuations prior to the release of the fund’s quarterly and annual financial statements. Based upon that information from the general partner, we consider whether additional disclosure is warranted. We analyze limited partnerships measured at fair value based upon NAV to determine if the most recently available NAV reflects fair value at the balance sheet date, with an adjustment being made where appropriate (change of plus or minus 5% compared to most recent NAV.)
Retirement Benefit Plans for Employees
Our pension plans consist of a noncontributory defined benefit pension plan covering substantially all employees and an unfunded supplemental employee retirement plan ("SERP") for certain members of executive and senior management. Although we are the sponsor of these postretirement plans and record the funded status of these plans, the Exchange reimburses us for approximately 57% of the annual benefit expense of these plans, which represents pension benefits for our employees performing claims and life insurance functions.
Our pension obligation is developed from actuarial estimates. Several statistical and other factors, which attempt to anticipate future events, are used in calculating the expense and liability related to the plans. Key factors include assumptions about the discount rates and expected rates of return on plan assets. We review these assumptions annually and modify them considering historical experience, current market conditions, including changes in investment returns and interest rates and expected future trends.
Accumulated and projected benefit obligations are expressed as the present value of future cash payments. We discount those cash payments based upon a yield curve developed from corporate bond yield information with maturities that correspond to the payment of benefits. Lower discount rates increase present values and subsequent year pension expense, while higher discount rates decrease present values and subsequent year pension expense. The construction of the yield curve is based upon yields of corporate bonds rated Aa quality. Target yields are developed from bonds at various maturity points and a curve is fitted to those targets. Spot rates (zero coupon bond yields) are developed from the yield curve and used to discount benefit payment amounts associated with each future year. The present value of plan benefits is calculated by applying the spot/discount rates to projected benefit cash flows. A single discount rate is then developed to produce the same present value. The cash flows from the yield curve were matched against our projected benefit payments in the pension plan, which have a duration of about 19 years. This yield curve supported the selection of a 4.57% discount rate for the projected benefit obligation at December 31, 2015 and for the 2016 pension expense. The same methodology was used to develop the 4.17% and 5.11% discount rates used to determine the projected benefit obligation for 2014 and 2013, respectively, and the pension expense for 2015 and 2014, respectively. A 25 basis point decrease in the discount rate assumption, with other assumptions held constant, would increase pension cost in the following year by $3.5 million and would increase the pension benefit obligation by $33.0 million.
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Unrecognized actuarial gains and losses arise from several factors, including experience and assumption changes in the obligations and from the difference between expected returns and actual returns on plan assets. These unrecognized gains and losses are recorded in the pension plan obligation and accumulated other comprehensive income (loss) on the Statements of Financial Position. These amounts are systematically recognized to net periodic pension expense in future periods, with gains decreasing and losses increasing future pension expense. If actuarial net gains or losses exceed 5% of the greater of the projected benefit obligation and the market-related value of plan assets, the excess is recognized through the net periodic pension expense equally over the estimated service period of the employee group, which is currently 14 years.
The expected long-term rate of return for the pension plan represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. The expected long-term rate of return is less susceptible to annual revisions, as there are typically no significant changes in the asset mix. To determine the expected long-term rate of return assumption, we utilized models based upon rigorous historical analysis and forward-looking views of the financial markets based upon key factors such as historical returns for the asset class' applicable indices, the correlations of the asset classes under various market conditions and consensus views on future real economic growth and inflation. The expected future return for each asset class is then combined by considering correlations between asset classes and the volatilities of each asset class to produce a reasonable range of asset return results within which our expected long-term rate of return assumption falls. A change of 25 basis points in the expected long-term rate of return assumption, with other assumptions held constant, would have an estimated $1.4 million impact on net pension benefit cost in the following year, of which our share would be approximately $0.6 million.
We use a four year averaging method to determine the market-related value of plan assets, which is used to determine the expected return component of pension expense. Under this methodology, asset gains or losses that result from returns that differ from our long-term rate of return assumption are recognized in the market-related value of assets on a level basis over a four year period. The market-related asset experience during 2015 that related to the actual investment return being different from that assumed during the prior year was a loss of $37.0 million. Recognition of this loss will be deferred and recognized over a four year period, consistent with the market-related asset value methodology. Once factored into the market-related asset value, these experience gains and losses will be amortized over a period of 14 years, which is the remaining service period of the employee group.
Estimates of fair values of the pension plan assets are obtained primarily from our trustee and custodian of our pension plan. Our Level 1 category includes a money market fund that is a mutual fund for which the fair value is determined using an exchange traded price provided by the trustee and custodian. Our Level 2 category includes commingled pools. Estimates of fair values for securities held by our commingled pools are obtained primarily from the trustee and custodian. The methodologies used by the trustee and custodian that support a financial instrument Level 2 classification include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuers spreads, two-sided markets, benchmark securities, bids, offers, and reference data. There were no Level 3 investments in 2015 or 2014.
We expect our net pension benefit costs to decrease from $40.0 million in 2015 to $30.0 million in 2016. This decrease is primarily due to the higher discount rate and the mortality tables being updated with two additional years of mortality data, partially offset by less than expected asset returns in 2015. Our share of the net pension benefit costs after reimbursements will decrease from $17.8 million in 2015 to approximately $12.9 million in 2016.
The actuarial assumptions we used in determining our pension obligation may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates, or longer or shorter life spans of participants. While we believe that the assumptions used are appropriate, differences in actual experience or changes in assumptions may materially affect our financial position, results of operations, or cash flows. See Part II, Item 8. "Financial Statements and Supplementary Data - Note 8, Postretirement Benefits, of Notes to Financial Statements" contained within this report for additional details on the pension plans.
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RESULTS OF OPERATIONS
We earn management fee revenue from providing services relating to the sales, underwriting, and issuance of policies on behalf of the Exchange as a result of its attorney-in-fact relationship. A summary of the financial results of these operations is as follows:
Years ended December 31, | ||||||||||||||||||||
(dollars in thousands) | 2015 | % Change | 2014 | % Change | 2013 | |||||||||||||||
Management fee revenue, net | $ | 1,475,511 | 7.2 | % | $ | 1,376,190 | 8.7 | % | $ | 1,266,401 | ||||||||||
Service agreement revenue | 29,997 | (3.0 | ) | 30,929 | NM | 30,930 | ||||||||||||||
Total operating revenue | 1,505,508 | 7.0 | 1,407,119 | 8.5 | 1,297,331 | |||||||||||||||
Total operating expenses | 1,272,967 | 7.5 | 1,184,272 | 8.8 | 1,087,995 | |||||||||||||||
Net revenue from operations | $ | 232,541 | 4.3 | % | $ | 222,847 | 6.5 | % | $ | 209,336 | ||||||||||
Gross margin | 15.4 | % | (0.4 | ) | pts. | 15.8 | % | (0.3 | ) | pts. | 16.1 | % | ||||||||
NM = not meaningful
Management fee revenue
Management fee revenue is based upon all direct and assumed premiums written by the Exchange and the management fee rate, which is determined by our Board of Directors at least annually. Management fee revenue is calculated by multiplying the management fee rate by the direct and assumed premiums written by the Exchange. The following table presents the calculation of management fee revenue:
Years ended December 31, | ||||||||||||||||||
(dollars in thousands) | 2015 | % Change | 2014 | % Change | 2013 | |||||||||||||
Direct and assumed premiums written by the Exchange | $ | 5,914,045 | 7.3 | % | $ | 5,513,962 | 8.6 | % | $ | 5,076,003 | ||||||||
Management fee rate | 25 | % | 25 | % | 25 | % | ||||||||||||
Management fee revenue, gross | 1,478,511 | 7.3 | 1,378,490 | 8.6 | 1,269,001 | |||||||||||||
Change in allowance for management fee returned on cancelled policies(1) | (3,000 | ) | NM | (2,300 | ) | NM | (2,600 | ) | ||||||||||
Management fee revenue, net of allowance | $ | 1,475,511 | 7.2 | % | $ | 1,376,190 | 8.7 | % | $ | 1,266,401 | ||||||||
NM = not meaningful
(1) Management fees are returned to the Exchange when policies are cancelled mid-term and unearned premiums are refunded. We record an estimated allowance for management fees returned on mid-term policy cancellations.
Direct and assumed premiums written by the Exchange
Direct and assumed premiums include premiums written directly by the Exchange and premiums assumed from its wholly owned property and casualty subsidiaries. Direct and assumed premiums written by the Exchange increased 7.3% to $5.9 billion in 2015, from $5.5 billion in 2014, driven by an increase in policies in force and increases in average premium per policy. Year-over-year policies in force for all lines of business increased by 3.6% in 2015 as the result of continuing strong policyholder retention and an increase in new policies written, compared to 4.3% in 2014. The year-over-year average premium per policy for all lines of business increased 3.5% at December 31, 2015, compared to 4.2% at December 31, 2014.
Premiums generated from new business increased 3.9% to $722 million in 2015, compared to 5.8%, or $695 million, in 2014. Underlying the trend in new business premiums was a 2.3% increase in new business policies written in 2015, compared to 2.9% in 2014, while the year-over-year average premium per policy on new business increased 1.6% at December 31, 2015, compared to 2.9% at December 31, 2014.
Premiums generated from renewal business increased 7.7% to $5.2 billion in 2015, compared to 9.0%, or $4.8 billion, in 2014. Underlying the trend in renewal business premiums were increases in average premium per policy and steady policy retention ratios. The renewal business year-over-year average premium per policy increased 3.8% at December 31, 2015, compared to 4.3% at December 31, 2014.
The Exchange implemented rate increases in 2015, 2014, and 2013 in order to meet loss cost expectations. As the Exchange writes policies with annual terms only, rate actions take 12 months to be fully recognized in written premium and 24 months to
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be fully recognized in earned premiums. Since rate changes are realized at renewal, it takes 12 months to implement a rate change to all policyholders and another 12 months to earn the increased or decreased premiums in full. As a result, certain rate actions approved in 2014 were reflected in 2015, and recent rate actions in 2015 will be reflected in 2016. The Exchange continuously evaluates pricing and product offerings to meet consumer demands.
Personal lines – Total personal lines premiums written increased 6.5% to $4.2 billion in 2015, from $3.9 billion in 2014, driven by an increase of 3.7% in total personal lines policies in force and an increase of 2.7% in the total personal lines year-over-year average premium per policy.
Commercial lines – Total commercial lines premiums written increased 9.1%, to $1.8 billion in 2015, from $1.6 billion in 2014, driven by a 2.9% increase in total commercial lines policies in force and a 6.0% increase in the total commercial lines year-over-year average premium per policy.
Future trends-premium revenue - The Exchange plans to continue its efforts to grow premiums and improve its competitive position in the marketplace. Expanding the size of its agency force through a careful agency selection process and increased market penetration in our existing operating territories will contribute to future growth as existing and new agents build their books of business
Changes in premium levels attributable to the growth in policies in force directly affects the profitability of the Exchange and has a direct bearing on our management fee. The Exchange’s continued focus on underwriting discipline and the maturing of our pricing sophistication models has contributed to its growth in new policies in force, steady policy retention ratios, and increased average premium per policy. The continued growth of its policy base is dependent upon the Exchange’s ability to retain existing policyholders and attract new policyholders. A lack of new policy growth or the inability to retain existing customers could have an adverse effect on the Exchange’s premium level growth, and consequently our management fee.
Changes in premium levels attributable to rate changes also directly affect the profitability of the Exchange and have a direct bearing on our management fee. Pricing actions contemplated or taken by the Exchange are subject to various regulatory requirements of the states in which it operates. The pricing actions already implemented, or to be implemented, have an effect on the market competitiveness of the Exchange’s insurance products. Such pricing actions, and those of the Exchange’s competitors, could affect the ability of the Exchange’s agents to retain and attract new business. We expect the Exchange’s pricing actions to result in a net increase in direct written premium in 2016; however, exposure reductions and/or changes in mix of business as a result of economic conditions could impact the average premium written and assumed by the Exchange, as customers may reduce coverages.
Management fee rate
The management fee rate was set at 25%, the maximum rate, for 2015, 2014 and 2013. The management fee rate for 2016 was set at 25% by our Board of Directors. Changes in the management fee rate can affect our revenue and net income significantly. See also, the “Transactions/Agreements with Related Parties” section within this report.
Change in allowance for management fee returned on cancelled policies
Management fees are returned to the Exchange when policyholders cancel their insurance coverage mid-term and unearned premiums are refunded to them. We maintain an allowance for management fees returned on mid-year policy cancellations that recognizes the management fee anticipated to be returned to the Exchange based on historical mid-term cancellation experience. Our cash flows are unaffected by the recording of this allowance.
Service agreement revenue
Service agreement revenue includes service charges we collect from policyholders for providing extended payment terms on policies written and assumed by the Exchange and late payment and policy reinstatement fees. The service charges are fixed dollar amounts per billed installment. Service agreement revenue totaled $30.0 million in 2015 and $30.9 million in 2014 and 2013. The consistency in the service agreement revenue compared to the growth in policies in force reflects the continued shift in policies to the monthly direct debit payment plan, which does not incur service charges, and the no-fee single payment plan, which offers a premium discount. The shift to these plans is driven by the consumers’ desire to avoid paying service charges and to take advantage of the discount in pricing offered for paid-in-full policies.
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Cost of management operations
Years ended December 31, | ||||||||||||||||||
(dollars in thousands) | 2015 | % Change | 2014 | % Change | 2013 | |||||||||||||
Commissions: | ||||||||||||||||||
Total commissions | $ | 847,880 | 8.3 | % | $ | 783,017 | 10.3 | % | $ | 710,058 | ||||||||
Non-commission expense: | ||||||||||||||||||
Underwriting and policy processing | $ | 134,837 | 6.4 | $ | 126,779 | 5.8 | $ | 119,777 | ||||||||||
Information technology | 123,362 | 1.9 | 121,094 | 12.5 | 107,605 | |||||||||||||
Sales and advertising | 64,403 | 6.7 | 60,334 | 2.1 | 59,079 | |||||||||||||
Customer service | 29,325 | 10.6 | 26,522 | 18.4 | 22,397 | |||||||||||||
Administrative and other | 73,160 | 10.0 | 66,526 | (3.7 | ) | 69,079 | ||||||||||||
Total non-commission expense | 425,087 | 5.9 | 401,255 | 6.2 | 377,937 | |||||||||||||
Total cost of management operations | $ | 1,272,967 | 7.5 | % | $ | 1,184,272 | 8.8 | % | $ | 1,087,995 | ||||||||
Commissions – Commissions increased $64.9 million in 2015 compared to 2014, and increased $73.0 million in 2014 compared to 2013, primarily as a result of the 7.3% and 8.6% respective increases in direct and assumed premiums written by the Exchange, while approximately one-quarter of the respective increases for the years ended December 31, 2015 and 2014 was due to higher agent incentive costs primarily related to profitable growth.
Non-commission expense – Non-commission expense increased $23.8 million in 2015 compared to 2014. Underwriting and policy processing costs increased $8.0 million due to increased personnel and postage costs. Information technology costs increased $2.3 million primarily due to hardware and software costs. Sales and advertising costs increased $4.1 million primarily due to personnel costs. Customer service costs increased $2.8 million due to an increase in personnel costs and credit card processing fees. Administrative and other costs increased $6.6 million due to personnel costs and professional fees. Personnel costs in all expense categories were impacted by increased pension and medical costs, and increased estimates for incentive plan compensation costs related to underwriting performance.
In 2014, compared to 2013, non-commission expense increased $23.3 million. Underwriting and policy processing costs increased $7.0 million due to the increased cost of underwriting reports, postage, and printing costs related to increased volume. Information technology costs increased $13.5 million, which included $6.1 million of professional fees, $3.9 million of personnel costs, and $3.5 million of hardware and software costs. Customer service costs increased $4.1 million due to an increase of $2.1 million in credit card processing fees and $2.0 million in personnel costs. All other operating costs decreased $1.3 million.
Gross margin
The gross margin in 2015 was 15.4%, compared to 15.8% in 2014 and 16.1% in 2013.
Total Investment Income
A summary of the results of our investment operations is as follows for the years ended December 31:
(dollars in thousands) | 2015 | % Change | 2014 | % Change | 2013 | |||||||||||||
Net investment income | $ | 17,791 | 7.6 | % | $ | 16,536 | 10.0 | % | $ | 15,027 | ||||||||
Net realized investment gains | 492 | (53.4 | ) | 1,057 | 11.8 | 945 | ||||||||||||
Net impairment losses recognized in earnings | (1,558 | ) | NM | (105 | ) | NM | (388 | ) | ||||||||||
Equity in earnings of limited partnerships | 16,983 | 55.4 | 10,929 | (49.6 | ) | 21,694 | ||||||||||||
Total investment income | $ | 33,708 | 18.6 | % | $ | 28,417 | (23.8 | )% | $ | 37,278 | ||||||||
NM = not meaningful
Net investment income
Net investment income primarily includes interest and dividends on our fixed maturity and equity security portfolios.
Net investment income increased by $1.3 million in 2015, compared to 2014, and increased by $1.5 million in 2014, compared to 2013. The increases in net investment income in both 2015 and 2014 were primarily attributable to income from fixed maturity investments, reflecting higher invested balances and higher investment yields.
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Net realized investment gains
A breakdown of our net realized investment gains (losses) is as follows for the years ended December 31:
(in thousands) | 2015 | 2014 | 2013 | |||||||||
Securities sold: | ||||||||||||
Fixed maturities | $ | (193 | ) | $ | 120 | $ | 847 | |||||
Equity securities | 685 | 937 | 98 | |||||||||
Total net realized gains (1) | $ | 492 | $ | 1,057 | $ | 945 | ||||||
(1) | See Part II, Item 8. "Financial Statements and Supplementary Data – Note 5, Investments, of Notes to Financial Statements" contained within this report for additional disclosures regarding net realized investment gains (losses). |
Net realized investment gains and losses include gains and losses resulting from the sales of our fixed maturity or equity securities.
Net realized gains were $0.5 million in 2015, compared to gains of $1.1 million in 2014 and $0.9 million in 2013. Net realized gains in 2015 were due to gains from sales of nonredeemable preferred stock, which were partially offset by losses from sales of fixed maturities. Net realized gains were primarily attributable to gains from sales of equity securities in 2014, and gains from sales of fixed maturity securities in 2013.
Net impairment losses recognized in earnings
Net impairment losses recognized in earnings were $1.6 million in 2015, compared to $0.1 million in 2014, and $0.4 million in 2013. Net impairment losses recognized in earnings in 2015 were primarily due to several securities in an unrealized loss position where we determined the loss was other-than-temporary based on credit factors. Impairment losses were also recognized in 2015 on securities in an unrealized loss position that we intended to sell prior to an expected recovery to our cost basis.
Equity in earnings of limited partnerships
The components of equity in earnings of limited partnerships are as follows for the years ended December 31:
(in thousands) | 2015 | 2014 | 2013 | |||||||||
Private equity | $ | 12,169 | $ | 4,060 | $ | 6,377 | ||||||
Mezzanine debt | 1,788 | 1,882 | 2,761 | |||||||||
Real estate | 3,026 | 4,987 | 12,556 | |||||||||
Total equity in earnings of limited partnerships | $ | 16,983 | $ | 10,929 | $ | 21,694 | ||||||
Limited partnership earnings pertain to investments in U.S. and foreign private equity, mezzanine debt, and real estate partnerships. Valuation adjustments are recorded to reflect the changes in fair value of the underlying investments held by the limited partnerships. These adjustments are recorded as a component of equity in earnings of limited partnerships in the Statements of Operations.
Limited partnership earnings tend to be cyclical based upon market conditions, the age of the partnership, and the nature of the investments. Generally, limited partnership earnings are recorded on a quarter lag from financial statements we receive from our general partners. As a consequence, earnings from limited partnerships reported at December 31, 2015 reflect investment valuation changes resulting from the financial markets and the economy for the twelve month period ending September 30, 2015.
Equity in earnings of limited partnerships increased by $6.1 million in 2015, compared to 2014, and decreased by
$10.8 million in 2014, compared to 2013. The increase in earnings in 2015 was due to higher earnings from private equity investments that were partially offset by lower earnings from real estate investments. The decrease in earnings in 2014 was the result of lower earnings from each investment sector.
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Financial Condition of Erie Insurance Exchange
Serving in the capacity of attorney-in-fact for the Exchange, we are dependent on the growth and financial condition of the Exchange, who is our sole customer. The strength of the Exchange and its wholly owned subsidiaries is rated annually by A.M. Best Company. Higher ratings of insurance companies generally indicate financial stability and a strong ability to pay claims. The ratings are generally based upon factors relevant to policyholders and are not directed toward return to investors. The Exchange and each of its property and casualty subsidiaries are rated A+ “Superior”. The outlook for the financial strength rating is stable. According to A.M. Best, this second highest financial strength rating category is assigned to those companies that, in A.M. Best’s opinion, have achieved superior overall performance when compared to the standards established by A.M. Best and have a superior ability to meet obligations to policyholders over the long term. Only 11.0% of insurance groups are rated A+ or higher, and the Exchange is included in that group.
The financial statements of the Exchange are prepared in accordance with statutory accounting principles prescribed by the Commonwealth of Pennsylvania. Financial statements prepared under statutory accounting principles focus on the solvency of the insurer and generally provide a more conservative approach than under GAAP. Statutory direct written premiums of the Exchange and its wholly owned property and casualty subsidiaries grew 7.3% to $5.9 billion in 2015 from $5.5 billion in 2014. These premiums, along with investment income, are the major sources of cash that support the operations of the Exchange. Policyholders’ surplus, determined under statutory accounting principles was $7.1 billion and $6.8 billion at December 31, 2015 and 2014, respectively. The Exchange and its wholly owned property and casualty subsidiaries' year-over-year policy retention ratio continues to be high at 89.9% at December 31, 2015 and 90.3% at December 31, 2014.
FINANCIAL CONDITION
Investments
Our investment portfolio is managed with the objective of maximizing after-tax returns on a risk-adjusted basis.
Distribution of investments
Carrying value at December 31, | ||||||||||||||
(dollars in thousands) | 2015 | % to total | 2014 | % to total | ||||||||||
Fixed maturities | $ | 587,209 | 85 | % | $ | 564,540 | 80 | % | ||||||
Equity securities: | ||||||||||||||
Preferred stock | 0 | 0 | 12,541 | 2 | ||||||||||
Common stock | 12,732 | 2 | 12,689 | 2 | ||||||||||
Limited partnerships: | ||||||||||||||
Private equity | 48,397 | 7 | 51,379 | 7 | ||||||||||
Mezzanine debt | 12,701 | 2 | 13,978 | 2 | ||||||||||
Real estate | 27,437 | 4 | 47,260 | 7 | ||||||||||
Real estate mortgage loans | 333 | 0 | 490 | 0 | ||||||||||
Total investments | $ | 688,809 | 100 | % | $ | 702,877 | 100 | % | ||||||
We continually review our investment portfolio to evaluate positions that might incur other-than-temporary declines in value. We record impairment write-downs on investments in instances where the fair value of the investment is substantially below cost, and we conclude that the decline in fair value is other-than-temporary, which includes consideration for intent to sell.
For all investment holdings, general economic conditions and/or conditions specifically affecting the underlying issuer or its industry, including downgrades by the major rating agencies, are considered in evaluating impairment in value. In addition to specific factors, other factors considered in our review of investment valuation are the length of time the fair value is below cost and the amount the fair value is below cost.
We individually analyze all positions with emphasis on those that have, in our opinion, declined significantly below cost. In compliance with impairment guidance for debt securities, we perform further analysis to determine if a credit-related impairment has occurred. Some of the factors considered in determining whether a debt security is credit impaired include potential for the default of interest and/or principal, level of subordination, collateral of the issue, compliance with financial covenants, credit ratings and industry conditions. We have the intent to sell all credit-impaired debt securities; therefore, the entire amount of the impairment charges are included in earnings and no impairments are recorded in other comprehensive income. For available-for-sale equity securities, a charge is recorded in the Statements of Operations for positions that have experienced other-than-temporary impairments. (See the "Total Investment Income" section herein for further information.)
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We believe our investment valuation philosophy and accounting practices result in appropriate and timely measurement of value and recognition of impairment.
Fixed maturities
Under our investment strategy, we maintain a fixed maturity portfolio that is of high quality and well diversified within each market sector. This investment strategy also achieves a balanced maturity schedule. Our fixed maturity portfolio is managed with the goal of achieving reasonable returns while limiting exposure to risk. Our municipal bond portfolio accounts for
$231.8 million, or 39%, of the total fixed maturity portfolio at December 31, 2015. The overall credit rating of the municipal portfolio without consideration of the underlying insurance is AA+.
Fixed maturities classified as available-for-sale are carried at fair value with unrealized gains and losses, net of deferred taxes, included in shareholders’ equity. Net unrealized gains on fixed maturities, net of deferred taxes, amounted to $3.4 million at December 31, 2015, compared to $6.2 million at December 31, 2014.
The following table presents a breakdown of the fair value of our fixed maturity portfolio by sector and rating as of December 31, 2015: (1)
(in thousands) | Non-investment | Fair | ||||||||||||||||||||||
Industry Sector | AAA | AA | A | BBB | grade | value | ||||||||||||||||||
Indemnity | ||||||||||||||||||||||||
Basic materials | $ | 0 | $ | 0 | $ | 1,965 | $ | 3,016 | $ | 2,901 | $ | 7,882 | ||||||||||||
Communications | 0 | 0 | 2,008 | 18,584 | 12,473 | 33,065 | ||||||||||||||||||
Consumer | 0 | 0 | 7,126 | 22,638 | 36,139 | 65,903 | ||||||||||||||||||
Diversified | 0 | 0 | 0 | 0 | 235 | 235 | ||||||||||||||||||
Energy | 0 | 0 | 3,565 | 7,739 | 3,657 | 14,961 | ||||||||||||||||||
Financial | 0 | 2,102 | 27,599 | 46,801 | 12,297 | 88,799 | ||||||||||||||||||
Government-municipal | 112,329 | 102,046 | 16,430 | 1,042 | 0 | 231,847 | ||||||||||||||||||
Industrial | 0 | 0 | 617 | 5,130 | 10,785 | 16,532 | ||||||||||||||||||
Structured securities (2) | 32,366 | 35,961 | 18,021 | 16,191 | 2,490 | 105,029 | ||||||||||||||||||
Technology | 0 | 0 | 2,305 | 2,298 | 5,863 | 10,466 | ||||||||||||||||||
Utilities | 0 | 0 | 8,169 | 3,002 | 1,319 | 12,490 | ||||||||||||||||||
Total | $ | 144,695 | $ | 140,109 | $ | 87,805 | $ | 126,441 | $ | 88,159 | $ | 587,209 | ||||||||||||
(1) Ratings are supplied by S&P, Moody’s, and Fitch. The table is based upon the lowest rating for each security.
(2) Structured securities include residential mortgage-backed securities. commercial mortgage-backed securities, collateralized debt obligations, and asset-backed securities.
Equity securities
Our equity securities consist of common stock and nonredeemable preferred stock. Investment characteristics of common stock and nonredeemable preferred stock differ from one another. Our nonredeemable preferred stock portfolio provides a source of current income that is competitive with investment-grade bonds.
The following table presents an analysis of the fair value of our preferred and common stock securities by sector at December 31:
(in thousands) | 2015 | 2014 | ||||||||||||||
Industry sector | Preferred stock | Common stock | Preferred stock | Common stock | ||||||||||||
Communications | $ | 0 | $ | 0 | $ | 1,251 | $ | 0 | ||||||||
Financial | 0 | 0 | 6,964 | 0 | ||||||||||||
Funds (1) | 0 | 12,732 | 0 | 12,689 | ||||||||||||
Utilities | 0 | 0 | 4,326 | 0 | ||||||||||||
Total | $ | 0 | $ | 12,732 | $ | 12,541 | $ | 12,689 | ||||||||
(1) Includes certain exchange traded funds with underlying holdings of fixed maturity securities. These securities meet the criteria of a common stock under U.S. GAAP, and are included on the balance sheet as available-for-sale equity securities.
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Equity securities classified as available-for-sale include preferred and certain common stock securities, and are carried at fair value on the Statements of Financial Position with all changes in unrealized gains and losses reflected in other comprehensive income. The net unrealized loss on equity securities classified as available-for-sale, net of deferred taxes, was $0.1 million at December 31, 2015, compared to a net unrealized gain of $0.6 million at December 31, 2014.
During 2015, we sold our preferred stock portfolio to fund purchases of additional fixed maturity investments.
Limited partnerships
In 2015, investments in limited partnerships decreased from the investment levels at December 31, 2014. Changes in partnership values are a function of contributions and distributions, adjusted for market value changes in the underlying investments. The decrease in limited partnership investments was due to net distributions received from the partnerships which were partially offset by increases in underlying asset values. We have made no new limited partnership commitments since 2006, and the balance of limited partnership investments is expected to decline over time as additional distributions are received. The results from our limited partnerships are based upon financial statements received from our general partners, which are generally received on a quarter lag. As a result, the market values and earnings recorded at December 31, 2015 reflect the partnership activity experienced during the twelve month period ending September 30, 2015.
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Shareholders’ Equity
Postretirement benefit plans
The funded status of our postretirement benefit plans is recognized in the Statements of Financial Position, with a corresponding adjustment to accumulated other comprehensive income, net of tax. At December 31, 2015, shareholders’ equity amounts related to these postretirement plans increased by $25.1 million, net of tax, of which $9.4 million represents amortization of the prior service cost and net actuarial loss and $15.7 million represents the current period actuarial gain. The 2015 actuarial gain was primarily due to the change in the discount rate assumption used to measure the future benefit obligations to 4.57% in 2015, from 4.17% in 2014. At December 31, 2014, shareholders’ equity amounts related to these postretirement plans decreased by $59.4 million, net of tax, of which $4.4 million represents amortization of the prior service cost and net actuarial loss and $63.8 million represents the current period actuarial loss. The 2014 actuarial loss was primarily due to the change in the discount rate assumption used to measure the future benefit obligations to 4.17% in 2014, from 5.11% in 2013. Although we are the sponsor of these postretirement plans and record the funded status of these plans, the Exchange reimburses us for approximately 57% of the annual benefit expense of these plans, which represents pension benefits for our employees performing claims and life insurance functions.
LIQUIDITY AND CAPITAL RESOURCES
Sources and Uses of Cash
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet the short- and long-term cash requirements of its business operations and growth needs. Our liquidity requirements have been met primarily by funds generated from management fee revenue and income from investments. Cash provided from these sources is used primarily to fund the costs of our management operations including commissions, salaries and wages, pension plans, share repurchases, dividends to shareholders, and the purchase and development of information technology. We expect that our operating cash needs will be met by funds generated from operations.
Volatility in the financial markets presents challenges to us as we do occasionally access our investment portfolio as a source of cash. Some of our fixed income investments, despite being publicly traded, are illiquid. Volatility in these markets could impair our ability to sell certain of our fixed income securities or cause such securities to sell at deep discounts. Additionally, our limited partnership investments are significantly less liquid. We believe we have sufficient liquidity to meet our needs from other sources even if market volatility persists throughout 2016.
Cash flow activities
The following table provides condensed cash flow information for the years ended December 31:
(in thousands) | 2015 | 2014 | 2013 | |||||||||
Net cash provided by operating activities | $ | 217,378 | $ | 186,013 | $ | 218,008 | ||||||
Net cash provided by (used in) investing activities | 622 | (5,097 | ) | (65,232 | ) | |||||||
Net cash used in financing activities | (126,858 | ) | (138,218 | ) | (115,339 | ) | ||||||
Net increase in cash | $ | 91,142 | $ | 42,698 | $ | 37,437 | ||||||
Net cash provided by operating activities increased to $217.4 million in 2015, compared to $186.0 million in 2014, and $218.0 million in 2013. Increased cash from operating activities in 2015 was primarily due to increases in management fee revenue received and reimbursements collected from affiliates, combined with a decrease in pension and employee benefits paid. Somewhat offsetting this increase in cash provided were increases in commissions and bonuses paid to agents, and general operating expenses and income taxes paid, compared to 2014. Management fee revenues were higher reflecting the increase in direct and assumed premiums written by the Exchange. Cash paid for agent commissions and bonuses increased to $822.5 million in 2015, compared to $748.6 million in 2014, as a result of an increase in cash paid for scheduled commissions due to premium growth and bonus awards due to profitable underwriting results. We contributed $17.0 million to our pension plan in 2015, compared to $23.1 million in 2014. Additionally, we made a contribution to our pension plan for $17.4 million in January 2016. Our funding policy is generally to contribute an amount equal to the greater of the target normal cost for the plan year or the amount necessary to fund the plan to 100% plus interest to the date the contribution is made. We are reimbursed approximately 57% of the net periodic benefit cost of the pension plans from the Exchange, which represents pension benefits for our employees performing claims and life insurance functions. In 2014, decreased cash from operating activities, compared to 2013, was primarily due to increases in commissions and bonuses paid to agents and general operating expenses, combined with decreases in reimbursements collected from affiliates and limited partnership distributions. Somewhat offsetting this decrease in cash provided was an increase in management fee revenue received, compared to 2013.
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At December 31, 2015, we recorded a net deferred tax asset of $40.7 million. There was no deferred tax valuation allowance recorded at December 31, 2015.
Net cash provided by investing activities totaled $0.6 million in 2015 compared to cash used of $5.1 million in 2014 and $65.2 million in 2013. While cash generated from the sale of available-for-sale securities was lower in 2015, compared to 2014, decreases in purchases of available-for-sale securities and fixed assets contributed to net cash being generated for the year. Also impacting our future investing activities are limited partnership commitments, which totaled $19.1 million at December 31, 2015, and will be funded as required by the partnerships’ agreements. Of this amount, the total remaining commitment to fund limited partnerships that invest in private equity securities was $7.3 million, mezzanine debt securities was $8.2 million, and real estate activities was $3.6 million. Changes in our 2014 investing activities primarily included increased cash generated from the sale of available-for-sale securities somewhat offset by an increase in purchases of fixed assets and available-for-sale securities, compared to 2013.
Net cash used in financing activities totaled $126.9 million in 2015, $138.2 million in 2014, and $115.3 million in 2013. While cash was paid in dividends to shareholders, there were no share repurchases under our program in 2015. The increase in cash used in financing activities for 2014, compared to 2013, was driven by an increase in the cash outlay for dividends paid to shareholders, somewhat offset by a decrease in the cash outlay for share repurchases. Dividends paid to shareholders totaled $126.9 million, $118.5 million, and $83.6 million in 2015, 2014 and 2013, respectively. We increased both our Class A and Class B shareholder regular quarterly dividends for 2015 and 2014. Dividends have been approved at a 7.2% increase for 2016.
No shares of our Class A nonvoting common stock were repurchased in 2015 in conjunction with our stock repurchase program. In 2014, shares repurchased under this program totaled 276,390 at a total cost of $19.5 million, compared to 441,024 shares at a total cost of $31.9 million in 2013, based upon settlement date. In October 2011, our Board of Directors approved a continuation of the current stock repurchase program for a total of $150 million with no time limitation. This repurchase authority includes, and is not in addition to, any unspent amounts remaining under the prior authorization. We had approximately $17.8 million of repurchase authority remaining under this program at December 31, 2015, based upon trade date.
In 2015, we purchased 111,535 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $10.4 million for the vesting of stock-based awards in conjunction with our long-term incentive plan, for stock-based awards for executive management and an outside director, and for the rabbi trust outside director deferred compensation plan. These shares were delivered in 2015. In 2014, we purchased 64,398 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $4.9 million for the vesting of stock-based awards for executive management and an outside director, and for awards under our long-term incentive plan. These shares were delivered in 2014. In 2013, we purchased 3,477 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $0.3 million to settle payments due to a retired executive under our long-term incentive plan. These shares were delivered in 2013.
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Capital Outlook
We regularly prepare forecasts evaluating the current and future cash requirements for both normal and extreme risk events. Should an extreme risk event result in a cash requirement exceeding normal cash flows, we have the ability to meet our future funding requirements through various alternatives available to us.
Outside of our normal operating and investing cash activities, future funding requirements could be met through:
1) cash and cash equivalents, which total approximately $182.9 million at December 31, 2015, 2) a $100 million bank revolving line of credit, and 3) liquidation of assets held in our investment portfolio, including common stock and investment grade bonds which totaled approximately $402.8 million at December 31, 2015. Volatility in the financial markets could impair our ability to sell certain of its fixed income securities or cause such securities to sell at deep discounts. Additionally, we have the ability to curtail or modify discretionary cash outlays such as those related to shareholder dividends and share repurchase activities.
As of December 31, 2015, we have access to a $100 million bank revolving line of credit with a $25 million letter of credit sublimit that expires on November 3, 2020. As of December 31, 2015, a total of $98.2 million remains available under the facility due to $1.8 million outstanding letters of credit, which reduce the availability for letters of credit to $23.2 million. We had no borrowings outstanding on our line of credit as of December 31, 2015. Bonds with a fair value of $109.0 million were pledged as collateral on the line at December 31, 2015. These securities have no trading restrictions and are reported as available-for-sale securities in the Statements of Financial Position. The bank requires compliance with certain covenants, which include leverage ratios. We were in compliance with our bank covenants at December 31, 2015.
Contractual Obligations
We have certain obligations and commitments to make future payments under various contracts. As of December 31, 2015, the aggregate obligations were as follows:
(in thousands) | Payments due by period | |||||||||||||||||||
Total | 2016 | 2017-2018 | 2019-2020 | 2021 and thereafter | ||||||||||||||||
Limited partnership commitments(1) | $ | 19,108 | $ | 19,108 | $ | 0 | $ | 0 | $ | 0 | ||||||||||
Pension contribution(2) | 17,357 | 17,357 | 0 | 0 | 0 | |||||||||||||||
Other commitments(3) | 52,353 | 28,333 | 21,306 | 2,714 | 0 | |||||||||||||||
Operating leases – vehicles | 17,243 | 5,163 | 8,983 | 3,097 | 0 | |||||||||||||||
Operating leases – real estate(4) | 7,710 | 2,607 | 3,488 | 1,463 | 152 | |||||||||||||||
Operating leases – computer equipment | 2,307 | 1,587 | 720 | 0 | 0 | |||||||||||||||
Gross contractual obligations | 116,078 | 74,155 | 34,497 | 7,274 | 152 | |||||||||||||||
Estimated reimbursements from affiliates | 50,712 | 22,163 | 23,202 | 5,244 | 103 | |||||||||||||||
Net contractual obligations | $ | 65,366 | $ | 51,992 | $ | 11,295 | $ | 2,030 | $ | 49 | ||||||||||
(1) | Limited partnership commitments will be funded as required for capital contributions at any time prior to the agreement expiration date. The commitment amounts are presented using the expiration date as the factor by which to age when the amounts are due. At December 31, 2015, our total commitment to fund limited partnerships that invest in private equity securities was $7.3 million, mezzanine debt was $8.2 million, and real estate activities was $3.6 million. |
(2) | The pension contribution for 2016 was estimated in accordance with the Pension Protection Act of 2006. Contributions anticipated in future years depend upon certain factors that cannot be reasonably predicted. Any contributions required in future years will be an amount equal to the greater of the target normal cost for the plan year or the amount necessary to fund the plan to 100% plus interest to the date the contribution is made. The obligations for our unfunded benefit plans, including the Supplemental Employee Retirement Plan (SERP) for our executive and senior management, are not included in gross contractual obligations. The recorded accumulated benefit obligation for this plan at December 31, 2015 is $10.5 million. We expect to have sufficient cash flows from operations to meet the future benefit payments as these become due. |
(3) | Other commitments include various agreements for services, including such things as computer software, telephones, copiers, and maintenance. |
(4) | Operating leases – real estate are for 18 of our 25 field offices and two operating leases are for office space and a warehouse facility. |
Balance Sheet Arrangements
Off-balance sheet arrangements include those with unconsolidated entities that may have a material current or future effect on our financial condition or results of operations, including material variable interests in unconsolidated entities that conduct certain activities. We have no material off-balance sheet obligations or guarantees, other than limited partnership investment commitments. See the preceding Contractual Obligations section for further discussion of limited partnership investment commitments.
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Enterprise Risk Management
The role of our Enterprise Risk Management ("ERM") function is to ensure that all significant risks are clearly identified, understood, proactively managed and consistently monitored to achieve strategic objectives for all stakeholders. Our ERM program views risk holistically across our entire group of companies. It ensures implementation of risk responses to mitigate potential impacts. See Item 1A "Risk Factors" contained in this report for a list of risk factors.
Our ERM process is founded on a governance framework that includes oversight at multiple levels of our organization, including our Board of Directors and executive management. Accountability to identify, manage, and mitigate risk is embedded within all functions and areas of our business. We have defined risk tolerances to monitor and manage significant risks within acceptable levels. In addition to identifying, evaluating, prioritizing, monitoring, and mitigating significant risks, our ERM process includes extreme event analyses and scenario testing. Given our defined tolerance for risk, risk model output is used to quantify the potential variability of future performance and the sufficiency of capital and liquidity levels.
TRANSACTIONS/AGREEMENTS WITH RELATED PARTIES
Board Oversight
Our Board of Directors has a broad oversight responsibility over our intercompany relationships with the Exchange. As a consequence, our Board of Directors may be required to make decisions or take actions that may not be solely in the interest of our shareholders, such as setting the management fee rate paid by the Exchange to us and ratifying any other significant intercompany activity.
Subscriber’s Agreement
We serve as attorney-in-fact for the policyholders at the Exchange, a reciprocal insurance exchange. Each applicant for insurance to a reciprocal insurance exchange signs a subscriber’s agreement that contains an appointment of an attorney-in-fact. Through the designation of attorney-in-fact, we are required to provide certain sales, underwriting, and policy issuance services to the policyholders of the Exchange, as discussed previously. Pursuant to the subscriber’s agreement, we earn a management fee for these services calculated as a percentage of the direct and assumed premiums written by the Exchange.
Insurance holding company system
Most states have enacted legislation that regulates insurance holding company systems, defined as two or more affiliated persons, one or more of which is an insurer. The Exchange has the following wholly owned property and casualty subsidiaries: Erie Insurance Company, Erie Insurance Company of New York, Erie Insurance Property and Casualty Company and Flagship City Insurance Company, and a wholly owned life insurance company, Erie Family Life Insurance Company ("EFL"). Indemnity and the Exchange, and its wholly owned subsidiaries, meet the definition of an insurance holding company system.
Intercompany Agreements
Service agreements
We make certain payments on behalf of the Exchange and EFL. These amounts are reimbursed to us on a cost basis in accordance with service agreements between us and the Exchange’s wholly owned subsidiaries. These reimbursements are settled on a monthly basis.
Leased property
We lease certain office space from the Exchange including the home office and three field office facilities. We also have a lease commitment with EFL for a field office. Rents are determined considering returns on invested capital and building operating and overhead costs. Rental costs of shared facilities are allocated based upon usage or square footage occupied.
Cost Allocation
The allocation of costs affects the financial condition of us and the Exchange and its wholly owned subsidiaries. Management’s role is to determine that allocations are consistently made in accordance with the subscriber’s agreements with the policyholders at the Exchange, intercompany service agreements, and applicable insurance laws and regulations. Allocation of costs under these various agreements requires judgment and interpretation, and such allocations are performed using a consistent methodology, which is intended to adhere to the terms and intentions of the underlying agreements.
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Intercompany Receivables
(dollars in thousands) | 2015 | Percent of total assets | 2014 | Percent of total assets | ||||||||||
Receivables from the Exchange and other affiliates (management fees, costs and reimbursements) | $ | 348,055 | 24.7 | % | $ | 335,220 | 25.4 | % | ||||||
Note receivable from EFL | 25,000 | 1.8 | 25,000 | 1.9 | ||||||||||
Total intercompany receivables | $ | 373,055 | 26.5 | % | $ | 360,220 | 27.3 | % | ||||||
We have significant receivables from the Exchange that result in a concentration of credit risk. These receivables include management fees due for services performed by us for the Exchange under the subscriber’s agreement, and certain costs we pay on behalf of the Exchange and EFL. We periodically evaluate credit risks related to the receivables from the Exchange. The receivable from the Exchange for management fees and costs we pay on behalf of the Exchange and EFL is settled monthly.
Surplus Note
We hold a surplus note for $25 million from EFL that is payable on demand on or after December 31, 2018; however, no principal or interest payments may be made without prior approval by the Pennsylvania Insurance Commissioner. Interest payments are scheduled to be paid semi-annually. We recognized interest income on the note of $1.7 million in 2015, 2014 and 2013.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Market risk is the risk of loss arising from adverse changes in interest rates, credit spreads, equity prices, or foreign exchange rates, as well as other relevant market rate or price changes. The volatility and liquidity in the markets in which the underlying assets are traded directly influence market risk. The following is a discussion of our primary risk exposures, including interest rate risk, investment credit risk, concentration risk, liquidity risk, and equity price risk, and how those exposures are currently managed as of December 31, 2015.
Interest Rate Risk
We invest primarily in fixed maturity investments, which comprised 85% of our invested assets at December 31, 2015. The value of the fixed maturity portfolio is subject to interest rate risk. As market interest rates decrease, the value of the portfolio increases with the opposite holding true in rising interest rate environments. We do not hedge our exposure to interest rate risk. A common measure of the interest sensitivity of fixed maturity assets is effective duration, a calculation that utilizes maturity, coupon rate, yield, and call terms to calculate an expected change in fair value given a change in interest rates. The longer the duration, the more sensitive the asset is to market interest rate fluctuations. Duration is analyzed quarterly to ensure that it remains in the targeted range we established.
A sensitivity analysis is used to measure the potential loss in future earnings, fair values, or cash flows of market-sensitive instruments resulting from one or more selected hypothetical changes in interest rates and other market rates or prices over a selected period. In our sensitivity analysis model, a hypothetical change in market rates is selected that is expected to reflect reasonably possible changes in those rates. The following pro forma information is presented assuming a 100-basis point increase in interest rates at December 31 of each year and reflects the estimated effect on the fair value of our fixed maturity portfolio. We used the effective duration of our fixed maturity portfolio to model the pro forma effect of a change in interest rates at December 31, 2015 and 2014.
Fixed maturities interest-rate sensitivity analysis
(dollars in thousands) | At December 31, | |||||||
2015 | 2014 | |||||||
Fair value of fixed maturity portfolio | $ | 587,209 | $ | 564,540 | ||||
Fair value assuming 100-basis point rise in interest rates | $ | 571,167 | $ | 552,230 | ||||
Effective duration (as a percentage) | 2.5 | 2.6 | ||||||
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At December 31, 2015, we began reporting effective duration instead of a previously utilized modified duration calculation to measure the interest rate risk of our fixed maturity portfolio. We believe effective duration more appropriately reflects the economic impact of features such as call provisions contained in certain securities in our fixed maturity portfolio.
While the fixed maturity portfolio is sensitive to interest rates, the future principal cash flows that will be received by contractual maturity date are presented below at December 31, 2015 and 2014. Actual cash flows may differ from those stated as a result of calls, prepayments, or defaults.
Contractual repayments of principal by maturity date
(in thousands) | ||||
Fixed maturities: | December 31, 2015 | |||
2016 | $ | 61,608 | ||
2017 | 76,526 | |||
2018 | 92,108 | |||
2019 | 37,921 | |||
2020 | 53,169 | |||
Thereafter | 237,824 | |||
Total(1) | $ | 559,156 | ||
Fair value | $ | 587,209 | ||
(1) This amount excludes Indemnity’s $25 million surplus note due from EFL.
(in thousands) | ||||
Fixed maturities: | December 31, 2014 | |||
2015 | $ | 62,563 | ||
2016 | 110,845 | |||
2017 | 62,239 | |||
2018 | 28,617 | |||
2019 | 32,721 | |||
Thereafter | 233,100 | |||
Total(1) | $ | 530,085 | ||
Fair value | $ | 564,540 | ||
(1) This amount excludes Indemnity’s $25 million surplus note due from EFL.
Investment Credit Risk
Our objective is to earn competitive returns by investing in a diversified portfolio of securities. Our portfolios of fixed maturity securities, nonredeemable preferred stock, mortgage loans and, to a lesser extent, short-term investments are subject to credit risk. This risk is defined as the potential loss in fair value resulting from adverse changes in the borrower’s ability to repay the debt. We manage this risk by performing upfront underwriting analysis and ongoing reviews of credit quality by position and for the fixed maturity portfolio in total. We do not hedge the credit risk inherent in our fixed maturity investments.
Generally, the fixed maturities in our portfolio are rated by external rating agencies. If not externally rated, we rate them internally on a basis consistent with that used by the rating agencies. We classify all fixed maturities as available-for-sale securities, allowing us to meet our liquidity needs and provide greater flexibility to appropriately respond to changes in market conditions.
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The following table shows our fixed maturity investments by rating as of December 31, 2015: (1)
(dollars in thousands) | Amortized cost | Fair value | Percent of total | ||||||||
AAA, AA, A | $ | 363,088 | $ | 372,609 | 63 | % | |||||
BBB | 127,489 | 126,441 | 22 | ||||||||
Total investment grade | 490,577 | 499,050 | 85 | ||||||||
BB | 35,145 | 34,765 | 6 | ||||||||
B | 43,350 | 42,311 | 7 | ||||||||
CCC, CC, C, and below | 12,900 | 11,083 | 2 | ||||||||
Total non-investment grade | 91,395 | 88,159 | 15 | ||||||||
Total | $ | 581,972 | $ | 587,209 | 100 | % | |||||
(1) Ratings are supplied by S&P, Moody’s, and Fitch. The table is based upon the lowest rating for each security.
Approximately 18% of the fixed income portfolio is invested in structured products. This includes residential mortgage-backed securities, commercial mortgage-backed securities, collateralized debt obligations, and asset-backed securities. The overall credit rating of the structured product portfolio is AA-.
Our municipal bond portfolio accounts for $231.8 million, or 39% of the total fixed maturity portfolio. The overall credit rating of our municipal portfolio is AA+.
Our limited partnership investment portfolio is exposed to credit risk, as well as price risk. Price risk is defined as the potential loss in estimated fair value resulting from an adverse change in prices. Our investments are directly affected by the impact of changes in these risk factors on the underlying investments held by our fund managers, which could vary significantly from fund to fund. We manage these risks by performing up-front due diligence on our fund managers, ongoing monitoring, and through the construction of a diversified portfolio.
We are also exposed to a concentration of credit risk with the Exchange. See the section, "Transactions/Agreements with Related Parties, Intercompany Receivables" for further discussion of this risk.
Concentration Risk
While our portfolio is well diversified within each market sector, there is an inherent risk of concentration in a particular industry or sector. We continually monitor our level of exposure to individual issuers as well as our allocation to each industry and market sector against internally established policies. See the "Financial Condition" section of Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" contained within this report for details of investment holdings by sector.
Liquidity Risk
Periods of volatility in the financial markets can create conditions where fixed maturity investments, despite being publicly traded, can become illiquid. However, we actively manage the maturity profile of our fixed maturity portfolio such that scheduled repayments of principal occur on a regular basis. Additionally, there is no ready market for limited partnerships, which increases the risk that these investments may not be converted to cash on favorable terms and on a timely basis.
Equity Price Risk
Common stocks designated as available-for-sale securities represent investments in certain exchange traded funds with underlying holdings of fixed maturity securities. While the performance of the exchange traded funds closely tracks that of the underlying fixed maturity securities, these investments are reported as common stock based on U.S. GAAP requirements. The average effective duration of these investments as reported by the funds was 4.7 at December 31, 2015, compared to 6.3 at December 31, 2014.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Erie Indemnity Company
We have audited the accompanying statements of financial position of Erie Indemnity Company as of December 31, 2015 and 2014, and the related statements of operations, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2015. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether 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 financial statements referred to above present fairly, in all material respects, the financial position of Erie Indemnity Company at December 31, 2015 and 2014, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Erie Indemnity Company's internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 25, 2016 expressed an unqualified opinion thereon.
/s/ Ernst & Young
Philadelphia, PA
February 25, 2016
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ERIE INDEMNITY COMPANY
STATEMENTS OF OPERATIONS
Years ended December 31, 2015, 2014 and 2013
(dollars in thousands, except per share data)
2015 | 2014 | 2013 | ||||||||||
Operating revenue | ||||||||||||
Management fee revenue, net | $ | 1,475,511 | $ | 1,376,190 | $ | 1,266,401 | ||||||
Service agreement revenue | 29,997 | 30,929 | 30,930 | |||||||||
Total operating revenue | 1,505,508 | 1,407,119 | 1,297,331 | |||||||||
Operating expenses | ||||||||||||
Commissions | 847,880 | 783,017 | 710,058 | |||||||||
Salaries and employee benefits | 226,713 | 206,690 | 207,559 | |||||||||
All other operating expenses | 198,374 | 194,565 | 170,378 | |||||||||
Total operating expenses | 1,272,967 | 1,184,272 | 1,087,995 | |||||||||
Net revenue from operations | 232,541 | 222,847 | 209,336 | |||||||||
Investment income | ||||||||||||
Net investment income | 17,791 | 16,536 | 15,027 | |||||||||
Net realized investment gains | 492 | 1,057 | 945 | |||||||||
Net impairment losses recognized in earnings | (1,558 | ) | (105 | ) | (388 | ) | ||||||
Equity in earnings of limited partnerships | 16,983 | 10,929 | 21,694 | |||||||||
Total investment income | 33,708 | 28,417 | 37,278 | |||||||||
Income before income taxes | 266,249 | 251,264 | 246,614 | |||||||||
Income tax expense | 91,571 | 83,759 | 84,003 | |||||||||
Net income | $ | 174,678 | $ | 167,505 | $ | 162,611 | ||||||
Earnings Per Share | ||||||||||||
Net income per share | ||||||||||||
Class A common stock – basic | $ | 3.75 | $ | 3.59 | $ | 3.46 | ||||||
Class A common stock – diluted | $ | 3.33 | $ | 3.18 | $ | 3.08 | ||||||
Class B common stock – basic | $ | 563 | $ | 539 | $ | 520 | ||||||
Class B common stock – diluted | $ | 562 | $ | 538 | $ | 519 | ||||||
Weighted average shares outstanding – Basic | ||||||||||||
Class A common stock | 46,186,671 | 46,247,876 | 46,660,651 | |||||||||
Class B common stock | 2,542 | 2,542 | 2,542 | |||||||||
Weighted average shares outstanding – Diluted | ||||||||||||
Class A common stock | 52,498,811 | 52,616,234 | 52,855,757 | |||||||||
Class B common stock | 2,542 | 2,542 | 2,542 | |||||||||
See accompanying notes to Financial Statements. See Note 12, "Accumulated Other Comprehensive Income (Loss)", for amounts reclassified out of accumulated other comprehensive income (loss) into the Statements of Operations.
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ERIE INDEMNITY COMPANY
STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31, 2015, 2014 and 2013
(in thousands)
2015 | 2014 | 2013 | ||||||||||
Net income | $ | 174,678 | $ | 167,505 | $ | 162,611 | ||||||
Other comprehensive (loss) income, net of tax | ||||||||||||
Change in unrealized holding (losses) gains on available-for-sale securities | (4,280 | ) | 823 | |||||||||