Edgar Filing: ERIE INDEMNITY CO

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016

Commission file number 0-24000



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



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



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



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



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

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

Yes X No ___

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes X No ___

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

Yes X No ___

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

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

(Do not check if a smaller reporting company)

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

Yes No X

The number of shares outstanding of the registrant’s Class A Common Stock as of the latest practicable date, with no par value and a stated value of $0.0292 per share, was 46,189,068 at October 14, 2016.

The number of shares outstanding of the registrant’s Class B Common Stock as of the latest practicable date, with no par value and a stated value of $70 per share, was 2,542 at October 14, 2016.

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PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Statements of Operations – Three and nine months ended September 30, 2016 and 2015

	Statements of Comprehensive Income – Three and nine months ended September 30, 2016 and 2015

	Statements of Financial Position – September 30, 2016 and December 31, 2015

	Statements of Cash Flows – Nine months ended September 30, 2016 and 2015

	Notes to Financial Statements – September 30, 2016

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

Item 3.	Quantitative and Qualitative Disclosures About Market Risk

Item 4.	Controls and Procedures


PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings

Item 1A.	Risk Factors

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

Item 6.	Exhibits


	SIGNATURES

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PART I. FINANCIAL INFORMATION


ITEM 1.	FINANCIAL STATEMENTS

ERIE INDEMNITY COMPANY

STATEMENTS OF OPERATIONS (UNAUDITED)

(dollars in thousands, except per share data)



	Three months ended						Nine months ended
	September 30,						September 30,
	2016			2015			2016			2015
Operating revenue
Management fee revenue, net	$	411,139		$	389,168		$	1,195,262		$	1,126,626
Service agreement revenue	7,267			7,469			21,756			22,502
Total operating revenue	418,406			396,637			1,217,018			1,149,128

Operating expenses
Commissions	232,455			223,741			676,963			641,189
Salaries and employee benefits	53,265			58,342			161,579			170,715
All other operating expenses	50,431			46,265			142,797			146,522
Total operating expenses	336,151			328,348			981,339			958,426
Net revenue from operations	82,255			68,289			235,679			190,702

Investment income
Net investment income	5,331			4,346			14,884			13,322
Net realized investment gains (losses)	718			(483		)	29			(125		)
Net impairment losses recognized in earnings	0			(480		)	(345		)	(635		)
Equity in (losses) earnings of limited partnerships	(1,723		)	3,837			(279		)	16,902
Total investment income	4,326			7,220			14,289			29,464
Income before income taxes	86,581			75,509			249,968			220,166
Income tax expense	29,205			25,947			85,388			75,621
Net income	$	57,376		$	49,562		$	164,580		$	144,545


Earnings Per Share
Net income per share
Class A common stock – basic	$	1.23		$	1.06		$	3.53		$	3.10
Class A common stock – diluted	$	1.09		$	0.94		$	3.14		$	2.75
Class B common stock – basic	$	185		$	160		$	530		$	466
Class B common stock – diluted	$	185		$	159		$	529		$	465

Weighted average shares outstanding – Basic
Class A common stock	46,188,980			46,189,068			46,188,971			46,189,068
Class B common stock	2,542			2,542			2,542			2,542

Weighted average shares outstanding – Diluted
Class A common stock	52,411,303			52,602,083			52,442,697			52,599,783
Class B common stock	2,542			2,542			2,542			2,542

Dividends declared per share
Class A common stock	$	0.730		$	0.681		$	2.190		$	2.043
Class B common stock	$	109.500		$	102.150		$	328.500		$	306.450

See accompanying notes to Financial Statements. See Note 10, "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 (UNAUDITED)

(in thousands)



	Three months ended					Nine months ended
	September 30,					September 30,
	2016		2015			2016		2015
Net income	$	57,376	$	49,562		$	164,580	$	144,545

Other comprehensive income (loss), net of tax
Change in unrealized holding gains (losses) on available-for-sale securities	355		(521		)	6,846		(3,004		)

Comprehensive income	$	57,731	$	49,041		$	171,426	$	141,541

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ERIE INDEMNITY COMPANY

STATEMENTS OF FINANCIAL POSITION

(dollars in thousands, except per share data)



	September 30,			December 31,
	2016			2015
Assets	(Unaudited)
Current assets:
Cash and cash equivalents	$	139,813		$	182,889
Available-for-sale securities	52,108			62,067
Receivables from Erie Insurance Exchange and affiliates	399,975			348,055
Prepaid expenses and other current assets	29,593			24,697
Federal income taxes recoverable	0			11,947
Accrued investment income	6,261			5,491
Total current assets	627,750			635,146

Available-for-sale securities	652,267			537,874
Limited partnership investments	65,949			88,535
Fixed assets, net	58,311			59,087
Deferred income taxes, net	36,161			40,686
Note receivable from Erie Family Life Insurance Company	25,000			25,000
Other assets	19,577			20,968
Total assets	$	1,485,015		$	1,407,296

Liabilities and shareholders' equity
Current liabilities:
Commissions payable	$	218,267		$	195,542
Agent bonuses	84,805			106,752
Accounts payable and accrued liabilities	94,504			88,532
Dividends payable	33,996			33,996
Deferred executive compensation	16,873			20,877
Federal income taxes payable	4,813			0
Total current liabilities	453,258			445,699

Defined benefit pension plans	178,257			172,700
Employee benefit obligations	751			1,234
Deferred executive compensation	12,057			16,580
Other long-term liabilities	1,763			1,580
Total liabilities	646,086			637,793

Shareholders’ equity
Class A common stock, stated value $0.0292 per share; 74,996,930 shares authorized; 68,299,200 shares issued; 46,189,068 shares outstanding	1,992			1,992
Class B common stock, convertible at a rate of 2,400 Class A shares for one Class B share, stated value $70 per share; 3,070 shares authorized; 2,542 shares issued and outstanding	178			178
Additional paid-in-capital	16,300			16,311
Accumulated other comprehensive loss	(90,018		)	(96,864		)
Retained earnings	2,056,567			1,993,976
Total contributed capital and retained earnings	1,985,019			1,915,593
Treasury stock, at cost; 22,110,132 shares held	(1,155,571		)	(1,155,108		)
Deferred compensation	9,481			9,018
Total shareholders’ equity	838,929			769,503
Total liabilities and shareholders’ equity	$	1,485,015		$	1,407,296

See accompanying notes to Financial Statements.

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ERIE INDEMNITY COMPANY

STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)



	Nine months ended
	September 30,
	2016			2015
Cash flows from operating activities
Management fee received	$	1,155,234		$	1,094,122
Service agreement fee received	21,756			22,501
Net investment income received	19,643			18,972
Limited partnership distributions	7,222			12,077
Decrease in reimbursements collected from affiliates	(11,893		)	(16,716		)
Commissions paid to agents	(565,490		)	(539,227		)
Agents bonuses paid	(110,503		)	(93,495		)
Salaries and wages paid	(119,991		)	(115,126		)
Pension contribution and employee benefits paid	(37,341		)	(34,125		)
General operating expenses paid	(133,729		)	(143,955		)
Income taxes paid	(69,357		)	(74,033		)
Net cash provided by operating activities	155,551			130,995

Cash flows from investing activities
Purchase of investments:
Available-for-sale securities	(269,237		)	(173,330		)
Limited partnerships	(449		)	(693		)
Proceeds from investments:
Available-for-sale securities	164,266			153,265
Trading securities	5,171			—
Limited partnerships	12,404			21,777
Net purchase of fixed assets	(10,415		)	(7,176		)
Net collections on agent loans	1,622			696
Net cash used in investing activities	(96,638		)	(5,461		)

Cash flows from financing activities
Dividends paid to shareholders	(101,989		)	(95,143		)
Net cash used in financing activities	(101,989		)	(95,143		)

Net (decrease) increase in cash and cash equivalents	(43,076		)	30,391
Cash and cash equivalents, beginning of period	182,889			91,747
Cash and cash equivalents, end of period	$	139,813		$	122,138

See accompanying notes to Financial Statements.

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NOTES TO FINANCIAL STATEMENTS (UNAUDITED)

Note 1. Nature of Operations

Erie Indemnity Company ("Indemnity", "we", "us", "our") is a publicly held Pennsylvania business corporation that has since its 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.

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 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.

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. The underwriting services we provide include underwriting and policy processing. The remaining services we provide include customer service and administrative support. We also provide information technology services that support all the functions listed above.

By virtue of its legal structure as a reciprocal insurer, the Exchange does not have the ability to enter into contractual relationships and therefore Indemnity serves as the attorney-in-fact on behalf of the Exchange for all claims handling services and certain other common overhead and service department functions in accordance with the subscriber’s agreement. The amounts Indemnity incurs on behalf of the Exchange in this capacity are reimbursed to Indemnity from the Exchange at cost. See Note 11, "Related Party" contained within this report.

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 reduced financial strength ratings, disruption in the independent agency relationships, significant catastrophe losses, or products not meeting customer demands, the Exchange could find it more difficult to retain its existing business and attract new business. A decline in the business of the Exchange almost certainly would have as a consequence a decline in the total premiums paid and a correspondingly adverse effect on 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 Note 12, "Concentrations of Credit Risk" contained within this report.

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Note 2. Significant Accounting Policies

Basis of presentation

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. For further information, refer to the financial statements and footnotes included in our Form 10-K for the year ended December 31, 2015 as filed with the Securities and Exchange Commission on February 25, 2016.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Certain prior period amounts have been reclassified on the statements of financial position to conform to the current period presentation. These reclassifications had no effect on the previously reported results of operations.

Recently issued accounting standards

In February 2015, the Financial Accounting Standards Board ("FASB") updated Accounting Standards Codification ("ASC") 810 "Consolidation", which amended the existing guidance for determining if a reporting entity has a variable interest in a legal entity. We adopted the new accounting principle on a retrospective basis as of December 31, 2015. 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 be 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. There was no cumulative effect to Indemnity's shareholders’ equity or net income from no longer consolidating the Exchange's results with ours.

In August 2016, the FASB issued Accounting Standards Update ("ASU") 2016-15, "Statement of Cash Flows", which provides guidance on how certain cash receipts and cash payments are presented and classified to reduce diversity in practice. ASU 2016-15 is effective for interim and annual reporting periods beginning after December 31, 2017. Early adoption is permitted, including adoption in an interim period. We do not expect the adoption of this guidance to have a material impact on our financial statements.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses", which requires financial assets measured at amortized cost to be presented at the net amount expected to be collected through the use of a new forward-looking expected loss model and credit losses relating to available-for-sale debt securities to be recognized through an allowance for credit losses. ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019. Early adoption for interim and annual periods beginning after December 15, 2018 is permitted. We are currently evaluating the potential impact of this guidance on our financial statements.

In February 2016, the FASB issued ASU 2016-02, "Leases", which requires lessees to recognize assets and liabilities arising from operating leases on the statement of financial position and to disclose key information about leasing arrangements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. Early adoption is permitted. We are currently evaluating the potential impact of this guidance on our financial statements.

In January 2016, the FASB issued ASU 2016-01, "Financial Instruments-Overall". ASU 2016-01 revises the accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. ASU 2016-01 is effective for interim and annual reporting periods beginning after December 15, 2017. We are currently evaluating the potential impact of this guidance on our financial statements.

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In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers". ASU 2014-09 requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance is effective for fiscal years beginning after December 15, 2017 including interim periods within that reporting period. We do not expect the adoption of this guidance to have a material impact on our financial statements.

Note 3. Earnings Per Share

Class A and Class B basic earnings per share and Class B diluted earnings per share are calculated under the two-class method. The two-class method allocates earnings to each class of stock based upon its dividend rights. Class B shares are convertible into Class A shares at a conversion ratio of 2,400 to 1. See Note 9, "Capital Stock".

Class A diluted earnings per share are calculated under the if-converted method, which reflects the conversion of Class B shares to Class A shares. Diluted earnings per share calculations include the dilutive effect of assumed issuance of stock-based awards under compensation plans that have the option to be paid in stock using the treasury stock method.

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



(dollars in thousands, except per share data)	Three months ended September 30,
	2016					2015
	Allocated net income (numerator)		Weighted shares (denominator)	Per-share amount		Allocated net income (numerator)		Weighted shares (denominator)	Per-share amount
Class A – Basic EPS:
Income available to Class A stockholders	$	56,906	46,188,980	$	1.23	$	49,156	46,189,068	$	1.06
Dilutive effect of stock-based awards	0		121,523	—		0		312,215	—
Assumed conversion of Class B shares	470		6,100,800	—		406		6,100,800	—
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares	$	57,376	52,411,303	$	1.09	$	49,562	52,602,083	$	0.94
Class B – Basic EPS:
Income available to Class B stockholders	$	470	2,542	$	185	$	406	2,542	$	160
Class B – Diluted EPS:
Income available to Class B stockholders	$	469	2,542	$	185	$	405	2,542	$	159



(dollars in thousands, except per share data)	Nine months ended September 30,
	2016					2015
	Allocated net income (numerator)		Weighted shares (denominator)	Per-share amount		Allocated net income (numerator)		Weighted shares (denominator)	Per-share amount
Class A – Basic EPS:
Income available to Class A stockholders	$	163,233	46,188,971	$	3.53	$	143,361	46,189,068	$	3.10
Dilutive effect of stock-based awards	0		152,926	—		0		309,915	—
Assumed conversion of Class B shares	1,347		6,100,800	—		1,184		6,100,800	—
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares	$	164,580	52,442,697	$	3.14	$	144,545	52,599,783	$	2.75
Class B – Basic EPS:
Income available to Class B stockholders	$	1,347	2,542	$	530	$	1,184	2,542	$	466
Class B – Diluted EPS:
Income available to Class B stockholders	$	1,346	2,542	$	529	$	1,181	2,542	$	465

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Note 4. Fair Value

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

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


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


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


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

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

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

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

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

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

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The following tables present our fair value measurements on a recurring basis by asset class and level of input:



	At September 30, 2016
	Fair value measurements using:
(in thousands)	Total		Quoted prices in active markets for identical assets Level 1		Observable inputs Level 2		Unobservable inputs Level 3
Available-for-sale securities:
U.S. government & agencies	$	2,048	$	0	$	2,048	$	0
States & political subdivisions	246,259		0		246,259		0
Corporate debt securities	320,268		0		310,079		10,189
Residential mortgage-backed securities	17,145		0		17,145		0
Commercial mortgage-backed securities	40,985		0		40,985		0
Collateralized debt obligations	66,647		0		61,526		5,121
Other debt securities	2,003		0		2,003		0
Total fixed maturities	695,355		0		680,045		15,310
Common stock	9,020		9,020		0		0
Total available-for-sale securities	704,375		9,020		680,045		15,310
Other investments ⁽¹⁾	3,964		—		—		—
Total	$	708,339	$	9,020	$	680,045	$	15,310



	At December 31, 2015
	Fair value measurements using:
(in thousands)	Total		Quoted prices in active markets for identical assets Level 1		Observable inputs Level 2		Unobservable inputs Level 3
Available-for-sale securities:
States & political subdivisions	$	231,847	$	0	$	231,847	$	0
Corporate debt securities	250,333		0		250,264		69
Residential mortgage-backed securities	13,513		0		13,513		0
Commercial mortgage-backed securities	37,571		0		37,571		0
Collateralized debt obligations	51,745		0		43,168		8,577
Other debt securities	2,200		0		2,200		0
Total fixed maturities	587,209		0		578,563		8,646
Common stock	12,732		12,732		0		0
Total available-for-sale securities	599,941		12,732		578,563		8,646
Other investments ⁽¹⁾	4,526		—		—		—
Total	$	604,467	$	12,732	$	578,563	$	8,646

(1) Other investments measured at fair value represent real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option using the net asset value practical expedient. These amounts are not required to be categorized in the fair value hierarchy. The investments can never be redeemed with the funds. Instead, distributions are received when liquidation of the underlying assets of the funds occur. It is estimated that the underlying assets will generally be liquidated between 5 and 10 years from the inception of the funds. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner. Fair value is based on our proportionate share of the NAV based on the most recent partners' capital statements received from the general partners, which is generally one quarter prior to our balance sheet date. These values are then analyzed to determine if the NAV represents fair value at our balance sheet date, with adjustment being made where appropriate. We consider observable market data and perform a review validating the appropriateness of the NAV at each balance sheet date. It is likely that all of the investments will be redeemed at a future date for an amount different than the NAV of our ownership interest in partners' capital as of September 30, 2016 and December 31, 2015. During the nine months ended September 30, 2016, no contributions were made and distributions totaling $0.7 million were received from these investments. During the year ended December 31, 2015, no contributions were made and distributions totaling $3.5 million were received from these investments. The amount of unfunded commitments related to the investments was $0.3 million as of September 30, 2016, and $0.6 million as of December 31, 2015.

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Level 3 Assets – Quarterly Change:





(in thousands)	Beginning balance at June 30, 2016		Included in earnings ⁽¹⁾		Included in other comprehensive income		Purchases		Sales			Transfers in and (out) of Level 3			Ending balance at September 30, 2016
Available-for-sale securities:
Corporate debt securities	$	8,851	$	22	$	38	$	3,217	$	(318	)	$	(1,621	)	$	10,189
Commercial mortgage-backed securities	1,003		0		0		0		0			(1,003		)	0
Collateralized debt obligations	1,200		0		7		3,000		0			914			5,121
Total fixed maturities	11,054		22		45		6,217		(318		)	(1,710		)	15,310
Total available-for-sale securities	11,054		22		45		6,217		(318		)	(1,710		)	15,310
Total Level 3 assets	$	11,054	$	22	$	45	$	6,217	$	(318	)	$	(1,710	)	$	15,310


(1)	These amounts are reported in the Statement of Operations as net investment income and net realized investment gains (losses) for the three months ended September 30, 2016 on Level 3 securities.

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

There were no transfers between Level 1 and Level 2 for the three months ended September 30, 2016. Level 2 to Level 3 transfers totaled $4.6 million for 11 fixed maturity holdings due to the use of unobservable market data to determine the fair value at September 30, 2016. Level 3 to Level 2 transfers totaled $6.3 million for 18 fixed maturity holdings due to the use of observable market data to determine the fair value at September 30, 2016.

Level 3 Assets – Year-to-Date Change:




(in thousands)	Beginning balance at December 31, 2015		Included in earnings ⁽¹⁾		Included in other comprehensive income			Purchases		Sales			Transfers in and (out) of Level 3			Ending balance at September 30, 2016
Available-for-sale securities:
Corporate debt securities	$	69	$	67	$	119		$	11,887	$	(924	)	$	(1,029	)	$	10,189
Commercial mortgage-backed securities	0		0		3			1,000		0			(1,003		)	0
Collateralized debt obligations	8,577		4		(5		)	7,722		(54		)	(11,123		)	5,121
Total fixed maturities	8,646		71		117			20,609		(978		)	(13,155		)	15,310
Total available-for-sale securities	8,646		71		117			20,609		(978		)	(13,155		)	15,310
Total Level 3 assets	$	8,646	$	71	$	117		$	20,609	$	(978	)	$	(13,155	)	$	15,310


(1)	These amounts are reported in the Statement of Operations as net investment income and net realized investment gains (losses) for the nine months ended September 30, 2016 on Level 3 securities.

There were no transfers between Level 1 and Level 2 for the nine months ended September 30, 2016. Level 2 to Level 3 transfers totaled $7.6 million for 27 fixed maturity holdings due to the use of unobservable market data to determine the fair value at September 30, 2016. Level 3 to Level 2 transfers totaled $20.8 million for 40 fixed maturity holdings due to the use of observable market data to determine the fair value at September 30, 2016.

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Level 3 Assets – Quarterly Change:





(in thousands)	Beginning balance at June 30, 2015		Included in earnings ⁽¹⁾			Included in other comprehensive income			Purchases		Sales		Transfers in and (out) of Level 3		Ending balance at September 30, 2015
Available-for-sale securities:
Corporate debt securities	$	0	$	(1	)	$	(58	)	$	0	$	0	$	124	$	65
Collateralized debt obligations	660		1			(3		)	4,546		0		0		5,204
Total fixed maturities	660		0			(61		)	4,546		0		124		5,269
Total available-for-sale securities	660		0			(61		)	4,546		0		124		5,269
Total Level 3 assets	$	660	$	0		$	(61	)	$	4,546	$	0	$	124	$	5,269


(1)	These amounts are reported in the Statement of Operations as net investment income for the three months ended September 30, 2015 on Level 3 securities.

There were no transfers between Level 1 and Level 2 or from Level 3 to Level 2 for the three months ended September 30, 2015. Level 2 to Level 3 transfers totaled $0.1 million for one fixed maturity holding due to the use of unobservable market data to determine the fair value at September 30, 2015.

Level 3 Assets – Year-to-Date Change:




(in thousands)	Beginning balance at December 31, 2014		Included in earnings ⁽¹⁾			Included in other comprehensive income			Purchases		Sales		Transfers in and (out) of Level 3		Ending balance at September 30, 2015
Available-for-sale securities:
Corporate debt securities	$	0	$	(1	)	$	(58	)	$	110	$	0	$	14	$	65
Collateralized debt obligations	0		1			(3		)	5,206		0		0		5,204
Total fixed maturities	0		0			(61		)	5,316		0		14		5,269
Total available-for-sale securities	0		0			(61		)	5,316		0		14		5,269
Total Level 3 assets	$	0	$	0		$	(61	)	$	5,316	$	0	$	14	$	5,269


(1)	These amounts are reported in the Statement of Operations as net investment income for the nine months ended September 30, 2015 on Level 3 securities.

There were no transfers between Level 1 and Level 2 for the nine months ended September 30, 2015. Level 2 to Level 3 transfers totaled $0.1 million for one fixed maturity holding due to the use of unobservable market data to determine the fair value at September 30, 2016. Level 3 to Level 2 transfers totaled $0.1 million for one fixed maturity holding due to the use of observable market data to determine the fair value at September 30, 2015.

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Quantitative and Qualitative Disclosures about Unobservable Inputs

When a non-binding broker quote was the only input available, the security was classified within Level 3. Use of non-binding brokers quotes totaled $15.3 million at September 30, 2016. The unobservable inputs are not reasonably available to us.

The following table presents our fair value measurements on a recurring basis by pricing source:



(in thousands)	At September 30, 2016
	Total		Level 1		Level 2		Level 3
Fixed maturities:
Priced via pricing services	$	689,205	$	0	$	679,955	$	9,250
Priced via market comparables/broker quotes	6,150		0		90		6,060
Total fixed maturities	695,355		0		680,045		15,310
Common stock:
Priced via pricing services	9,020		9,020		0		0
Total common stock	9,020		9,020		0		0
Other investments:
Priced via unobservable inputs ⁽¹⁾	3,964		—		—		—
Total other investments	3,964		—		—		—
Total	$	708,339	$	9,020	$	680,045	$	15,310

(1)

Other investments measured at fair value represent real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option using the net asset value practical expedient. These amounts are not required to be categorized in the fair value hierarchy. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner.

There were no assets measured at fair value on a nonrecurring basis during the nine months ended September 30, 2016.

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Note 5. Investments

Available-for-sale securities

The following table summarizes the cost and fair value of our available-for-sale securities:



	At September 30, 2016
(in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair value
Available-for-sale securities:
U.S. government & agencies	$	2,008	$	40	$	0	$	2,048
States & political subdivisions	234,111		12,207		59		246,259
Corporate debt securities	317,745		3,351		828		320,268
Residential mortgage-backed securities	17,246		65		166		17,145
Commercial mortgage-backed securities	41,565		213		793		40,985
Collateralized debt obligations	66,448		263		64		66,647
Other debt securities	2,000		3		0		2,003
Total fixed maturities	681,123		16,142		1,910		695,355
Common stock	8,949		71		0		9,020
Total available-for-sale securities	$	690,072	$	16,213	$	1,910	$	704,375



	At December 31, 2015
(in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair value
Available-for-sale securities:
States & political subdivisions	$	221,093	$	10,761	$	7	$	231,847
Corporate debt securities	254,464		281		4,412		250,333
Residential mortgage-backed securities	13,639		4		130		13,513
Commercial mortgage-backed securities	38,630		30		1,089		37,571
Collateralized debt obligations	51,905		61		221		51,745
Other debt securities	2,241		0		41		2,200
Total fixed maturities	581,972		11,137		5,900		587,209
Common stock	12,865		0		133		12,732
Total available-for-sale securities	$	594,837	$	11,137	$	6,033	$	599,941

The amortized cost and estimated fair value of fixed maturities at September 30, 2016 are shown below by remaining contractual term to maturity. Mortgage-backed securities are allocated based upon their stated maturity dates. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



	At September 30, 2016
(in thousands)	Amortized		Estimated
	cost		fair value
Due in one year or less	$	51,666	$	51,821
Due after one year through five years	314,652		319,198
Due after five years through ten years	195,967		203,310
Due after ten years	118,838		121,026
Total fixed maturities	$	681,123	$	695,355

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Available-for-sale securities in a gross unrealized loss position are as follows. Data is provided by length of time for securities in a gross unrealized loss position.



	At September 30, 2016
(dollars in thousands)	Less than 12 months				12 months or longer				Total
	Fair value		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses		No. of holdings
Available-for-sale securities:
States & political subdivisions	$	14,735	$	59	$	0	$	0	$	14,735	$	59	7
Corporate debt securities	71,837		407		14,876		421		86,713		828		152
Residential mortgage-backed securities	7,225		27		2,816		139		10,041		166		11
Commercial mortgage-backed securities	18,373		107		8,426		686		26,799		793		25
Collateralized debt obligations	11,092		31		8,727		33		19,819		64		10
Total fixed maturities	123,262		631		34,845		1,279		158,107		1,910		205
Total available-for-sale securities	$	123,262	$	631	$	34,845	$	1,279	$	158,107	$	1,910	205
Quality breakdown of fixed maturities:
Investment grade	$	100,205	$	296	$	27,442	$	688	$	127,647	$	984	79
Non-investment grade	23,057		335		7,403		591		30,460		926		126
Total fixed maturities	$	123,262	$	631	$	34,845	$	1,279	$	158,107	$	1,910	205



	At December 31, 2015
(dollars in thousands)	Less than 12 months				12 months or longer				Total
	Fair value		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses		No. of holdings
Available-for-sale securities:
States & political subdivisions	$	5,867	$	7	$	0	$	0	$	5,867	$	7	3
Corporate debt securities	172,831		2,447		19,086		1,965		191,917		4,412		349
Residential mortgage-backed securities	9,827		84		936		46		10,763		130		9
Commercial mortgage-backed securities	13,081		68		19,081		1,021		32,162		1,089		24
Collateralized debt obligations	27,981		103		9,174		118		37,155		221		19
Other debt securities	1,960		40		241		1		2,201		41		2
Total fixed maturities	231,547		2,749		48,518		3,151		280,065		5,900		406
Common stock	12,732		133		0		0		12,732		133		1
Total available-for-sale securities	$	244,279	$	2,882	$	48,518	$	3,151	$	292,797	$	6,033	407
Quality breakdown of fixed maturities:
Investment grade	$	174,723	$	1,296	$	38,369	$	1,256	$	213,092	$	2,552	105
Non-investment grade	56,824		1,453		10,149		1,895		66,973		3,348		301
Total fixed maturities	$	231,547	$	2,749	$	48,518	$	3,151	$	280,065	$	5,900	406

The above securities have been evaluated and determined to be temporary impairments for which we expect to recover our entire principal plus interest. The primary components of this analysis include a general review of market conditions and financial performance of the issuer along with the extent and duration at which fair value is less than cost. Any securities that we intend to sell or will more likely than not be required to sell before recovery are included in other-than-temporary impairments with the impairment charges recognized in earnings.

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Net investment income

Interest and dividend income are recognized as earned and recorded to net investment income. Investment income, net of expenses, was generated from the following portfolios:



(in thousands)	Three months ended September 30,				Nine months ended September 30,
	2016		2015		2016		2015
Fixed maturities	$	5,245	$	4,010	$	14,629	$	12,239
Equity securities	50		218		132		718
Cash equivalents and other	366		287		1,011		862
Total investment income	5,661		4,515		15,772		13,819
Less: investment expenses	330		169		888		497
Net investment income	$	5,331	$	4,346	$	14,884	$	13,322

Realized investment gains (losses)

Realized gains and losses on sales of securities are recognized in income based upon the specific identification method. Realized gains (losses) on investments were as follows:



(in thousands)	Three months ended September 30,						Nine months ended September 30,
	2016			2015			2016			2015
Available-for-sale securities:
Fixed maturities:
Gross realized gains	$	603		$	120		$	1,175		$	491
Gross realized losses	(27		)	(661		)	(1,819		)	(1,036		)
Net realized gains (losses)	576			(541		)	(644		)	(545		)
Equity securities:
Gross realized gains	0			57			0			419
Gross realized losses	0			0			(34		)	0
Net realized gains (losses)	0			57			(34		)	419
Trading securities:
Common stock:
Gross realized gains	121			0			707			0
Gross realized losses	0			0			0			0
Increases in fair value⁽¹⁾	21			0			0			0
Net realized gains	142			0			707			0
Miscellaneous: