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, 2017

Commission file number 0-24000



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



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



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



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



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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter 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, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]

(Do not check if a smaller reporting company)

Smaller reporting company [ ] Emerging growth company [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange

Act. [ ]

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 13, 2017.

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 13, 2017.

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PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Statements of Operations – Three and nine months ended September 30, 2017 and 2016

	Statements of Comprehensive Income – Three and nine months ended September 30, 2017 and 2016

	Statements of Financial Position – September 30, 2017 and December 31, 2016

	Statements of Cash Flows – Nine months ended September 30, 2017 and 2016

	Notes to Financial Statements – September 30, 2017

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,
	2017		2016			2017			2016
Operating revenue
Management fee revenue, net	$	435,214	$	411,139		$	1,268,591		$	1,195,262
Service agreement revenue	7,278		7,267			21,781			21,756
Total operating revenue	442,492		418,406			1,290,372			1,217,018

Operating expenses
Commissions	248,677		232,455			720,538			676,963
Salaries and employee benefits	60,499		53,265			181,013			161,579
All other operating expenses	52,480		50,431			158,407			142,797
Total operating expenses	361,656		336,151			1,059,958			981,339
Operating income	80,836		82,255			230,414			235,679

Investment income
Net investment income	5,970		5,331			18,184			14,884
Net realized investment gains	899		718			1,539			29
Net impairment losses recognized in earnings	0		0			(182		)	(345		)
Equity in earnings (losses) of limited partnerships	1,537		(1,723		)	1,899			(279		)
Total investment income	8,406		4,326			21,440			14,289
Interest expense, net	377		—			800			—
Income before income taxes	88,865		86,581			251,054			249,968
Income tax expense	30,322		29,205			86,108			85,388
Net income	$	58,543	$	57,376		$	164,946		$	164,580


Earnings Per Share
Net income per share
Class A common stock – basic	$	1.26	$	1.23		$	3.54		$	3.53
Class A common stock – diluted	$	1.12	$	1.09		$	3.15		$	3.14
Class B common stock – basic	$	189	$	185		$	531		$	530
Class B common stock – diluted	$	189	$	185		$	531		$	529

Weighted average shares outstanding – Basic
Class A common stock	46,188,949		46,188,980			46,186,109			46,188,971
Class B common stock	2,542		2,542			2,542			2,542

Weighted average shares outstanding – Diluted
Class A common stock	52,316,876		52,411,303			52,342,450			52,442,697
Class B common stock	2,542		2,542			2,542			2,542

Dividends declared per share
Class A common stock	$	0.7825	$	0.7300		$	2.3475		$	2.1900
Class B common stock	$	117.375	$	109.500		$	352.125		$	328.500

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,
	2017			2016		2017		2016
Net income	$	58,543		$	57,376	$	164,946	$	164,580

Other comprehensive income, net of tax
Change in unrealized holding (losses) gains on available-for-sale securities	(167		)	355		2,446		6,846

Comprehensive income	$	58,376		$	57,731	$	167,392	$	171,426

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ERIE INDEMNITY COMPANY

STATEMENTS OF FINANCIAL POSITION

(dollars in thousands, except per share data)



	September 30,			December 31,
	2017			2016
Assets	(Unaudited)
Current assets:
Cash and cash equivalents	$	184,628		$	189,072
Available-for-sale securities	65,318			56,138
Receivables from Erie Insurance Exchange and affiliates	428,500			378,540
Prepaid expenses and other current assets	35,797			30,169
Federal income taxes recoverable	0			5,260
Accrued investment income	6,435			6,337
Total current assets	720,678			665,516

Available-for-sale securities	683,948			657,153
Limited partnership investments	49,451			58,159
Fixed assets, net	75,370			69,142
Deferred income taxes, net	47,558			53,889
Note receivable from Erie Family Life Insurance Company	25,000			25,000
Other assets	29,424			20,096
Total assets	$	1,631,429		$	1,548,955

Liabilities and shareholders' equity
Current liabilities:
Commissions payable	$	236,056		$	210,559
Agent bonuses	93,448			114,772
Accounts payable and accrued liabilities	99,331			88,153
Dividends payable	36,441			36,441
Deferred executive compensation	12,794			19,675
Federal income taxes payable	5,331			0
Total current liabilities	483,401			469,600

Defined benefit pension plans	208,528			221,827
Employee benefit obligations	330			756
Deferred executive compensation	12,777			13,233
Long-term borrowings	49,734			24,766
Other long-term liabilities	1,509			1,863
Total liabilities	756,279			732,045

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	16,470			16,300
Accumulated other comprehensive loss	(118,935		)	(121,381		)
Retained earnings	2,121,535			2,065,911
Total contributed capital and retained earnings	2,021,240			1,963,000
Treasury stock, at cost; 22,110,132 shares held	(1,155,396		)	(1,155,846		)
Deferred compensation	9,306			9,756
Total shareholders’ equity	875,150			816,910
Total liabilities and shareholders’ equity	$	1,631,429		$	1,548,955

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,
	2017			2016
Cash flows from operating activities
Management fee received	$	1,225,966		$	1,155,234
Service agreement fee received	21,781			21,756
Net investment income received	23,593			19,643
Limited partnership distributions	2,993			7,222
Decrease in reimbursements collected from affiliates	(7,335		)	(11,893		)
Commissions paid to agents	(597,700		)	(565,490		)
Agents bonuses paid	(118,862		)	(110,503		)
Salaries and wages paid	(128,071		)	(119,991		)
Pension contribution and employee benefits paid	(62,837		)	(37,341		)
General operating expenses paid	(167,985		)	(133,729		)
Income taxes paid	(70,504		)	(69,357		)
Interest paid	(705		)	—
Net cash provided by operating activities	120,334			155,551

Cash flows from investing activities
Purchase of investments:
Available-for-sale securities	(292,702		)	(269,237		)
Limited partnerships	(330		)	(449		)
Proceeds from investments:
Available-for-sale securities sales	120,418			67,415
Available-for-sale securities maturities/calls	146,434			96,851
Trading securities	—			5,171
Limited partnerships	7,986			12,404
Net purchase of fixed assets	(18,036		)	(10,415		)
Net (distributions) collections on agent loans	(4,185		)	1,622
Net cash used in investing activities	(40,415		)	(96,638		)

Cash flows from financing activities
Dividends paid to shareholders	(109,324		)	(101,989		)
Net proceeds from long-term borrowings	24,961			—
Net cash used in financing activities	(84,363		)	(101,989		)

Net decrease in cash and cash equivalents	(4,444		)	(43,076		)
Cash and cash equivalents, beginning of period	189,072			182,889
Cash and cash equivalents, end of period	$	184,628		$	139,813

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. 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 and arranges for the provision of all claims handling services, investment management services, and certain other common overhead and service department functions and serves as the common pay agent. The amounts Indemnity incurs in this capacity are reimbursed to Indemnity from the Exchange at cost.

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, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. For further information, refer to the financial statements and footnotes included in our Form 10-K for the year ended December 31, 2016 as filed with the Securities and Exchange Commission on February 23, 2017.

Use of estimates

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

Recently issued accounting standards

In March 2017, the FASB issued ASU 2017-07, "Compensation-Retirement Benefits", which requires the service cost component of net benefit costs to be reported with other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit costs are required to be presented separately from the service cost component and outside of income from operations. This amendment also allows only the service cost component to be eligible for capitalization when applicable. The guidance is effective for interim and annual periods beginning after December 15, 2017. While the presentation of the costs within the Statements of Operations will change, we do not expect a material impact on our financial statements or related disclosures.

In March 2017, the FASB issued ASU 2017-08, "Receivables-Nonrefundable Fees and Other Costs", which shortens the amortization period for certain purchased callable debt securities held at a premium from maturity date to the earliest call date. ASU 2017-08 is effective for interim and annual reporting periods beginning after December 31, 2018. The guidance should be applied using a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. 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 have evaluated the impact of this guidance on our invested assets. Our investments are not measured at amortized cost, which are the investments that require the use of a new expected loss model. Our available-for-sale debt securities will continue to be monitored for credit losses which would be reflected as an allowance for credit losses rather than a reduction of the carrying value of the asset. The other material financial assets subject to this guidance include our receivables from Erie Insurance Exchange and affiliates. Given the financial strength of the Exchange, demonstrated by its strong surplus position and industry ratings, it is unlikely these receivables would have significant, if any, credit loss exposure. We do not expect a material impact on our financial statements or related disclosures as a result of this guidance.

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. Leases are required to be recognized and measured at the beginning of the earliest period presented using a modified retrospective approach. Early adoption is permitted. We expect to adopt ASU 2016-02 as of January 1, 2019 using the modified retrospective method. Under existing guidance, we recognize lease expense as a component of operating expenses in the Statements of Operations. We are in the process of evaluating our existing lease contracts to determine the impact to our financial statements and disclosures.

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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. As of September 30, 2017, we do not own any equity security investments, therefore the adoption of this guidance would have no impact to our financial statements. We will continue to monitor our investment portfolio as we may enter into investments in equity securities; however, at this time we do not expect that recognizing the change in fair value of future equity investments through net income instead of accumulated other comprehensive income would be material.

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 with early application permitted beginning in the first interim period in 2017. We expect to adopt the ASU 2014-09 as of January 1, 2018 under the modified retrospective method where the cumulative effect is recognized at the date of initial application. Our evaluation is ongoing and not complete. We performed an analysis in accordance with the steps identified in the new guidance around the recognition, measurement, and presentation of management fee revenue. We determined that service fee revenue is not within the scope of the new guidance. We have preliminarily concluded that adoption of this guidance will not have a material impact on our management fee revenue recognition pattern or our financial statements. We are also reviewing agreements related to the amounts we receive as reimbursements from the Exchange and its subsidiaries, such as claims-related expenses, investment and other overhead expenses. While the expenses are reimbursed to us at actual cost, we are evaluating if there is a performance obligation that would require allocation of revenue under this guidance. Additionally, we are evaluating the impact of the new disclosure requirements.

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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:



	Three months ended September 30,
	2017					2016
(dollars in thousands, except per share data)	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	$	58,064	46,188,949	$	1.26	$	56,906	46,188,980	$	1.23
Dilutive effect of stock-based awards	0		27,127	—		0		121,523	—
Assumed conversion of Class B shares	479		6,100,800	—		470		6,100,800	—
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares	$	58,543	52,316,876	$	1.12	$	57,376	52,411,303	$	1.09
Class B – Basic EPS:
Income available to Class B stockholders	$	479	2,542	$	189	$	470	2,542	$	185
Class B – Diluted EPS:
Income available to Class B stockholders	$	479	2,542	$	189	$	469	2,542	$	185



	Nine months ended September 30,
	2017					2016
(dollars in thousands, except per share data)	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	$	163,596	46,186,109	$	3.54	$	163,233	46,188,971	$	3.53
Dilutive effect of stock-based awards	0		55,541	—		0		152,926	—
Assumed conversion of Class B shares	1,350		6,100,800	—		1,347		6,100,800	—
Class A – Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares	$	164,946	52,342,450	$	3.15	$	164,580	52,442,697	$	3.14
Class B – Basic EPS:
Income available to Class B stockholders	$	1,350	2,542	$	531	$	1,347	2,542	$	530
Class B – Diluted EPS:
Income available to Class B stockholders	$	1,350	2,542	$	531	$	1,346	2,542	$	529

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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 virtually all of our prices are obtained from third party sources, we also perform an internal pricing review on outliers, which include securities with price changes inconsistent with 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.

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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, 2017
	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. treasury	$	11,834	$	0	$	11,834	$	0
States & political subdivisions	261,966		0		261,966		0
Foreign government securities	507		0		507		0
Corporate debt securities	346,372		0		338,457		7,915
Residential mortgage-backed securities	25,719		0		25,719		0
Commercial mortgage-backed securities	34,331		0		34,331		0
Collateralized debt obligations	62,381		0		62,381		0
Other debt securities	6,156		0		6,156		0
Total fixed maturities	749,266		0		741,351		7,915
Total available-for-sale securities	749,266		0		741,351		7,915
Other investments ⁽¹⁾	4,338		—		—		—
Total	$	753,604	$	0	$	741,351	$	7,915



	At December 31, 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. treasury	$	5,031	$	0	$	5,031	$	0
Government sponsored entities	2,026		0		2,026		0
States & political subdivisions	253,132		0		253,132		0
Corporate debt securities	322,948		0		313,596		9,352
Residential mortgage-backed securities	16,102		0		16,102		0
Commercial mortgage-backed securities	36,849		0		36,849		0
Collateralized debt obligations	69,253		0		69,253		0
Other debt securities	2,000		0		2,000		0
Total fixed maturities	707,341		0		697,989		9,352
Common stock	5,950		5,950		0		0
Total available-for-sale securities	713,291		5,950		697,989		9,352
Other investments ⁽¹⁾	4,412		—		—		—
Total	$	717,703	$	5,950	$	697,989	$	9,352

(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, 2017 and December 31, 2016. During the nine months ended September 30, 2017, no contributions were made and distributions totaling $0.3 million were received from these investments. During the year ended December 31, 2016, no contributions were made and distributions totaling $0.9 million were received from these investments. There were no unfunded commitments related to the investments as of September 30, 2017, and $0.3 million as of December 31, 2016.

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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 and nine months ended September 30, 2017 and 2016, respectively.

Level 3 Assets – Quarterly Change:



(in thousands)	Beginning balance at June 30, 2017		Included in earnings⁽¹⁾		Included in other comprehensive income			Purchases		Sales			Transfers into Level 3⁽²⁾		Transfers out of Level 3⁽²⁾			Ending balance at September 30, 2017
Available-for-sale securities:
Corporate debt securities	$	9,295	$	24	$	(60	)	$	539	$	(1,240	)	$	2,633	$	(3,276	)	$	7,915
Total fixed maturities	9,295		24		(60		)	539		(1,240		)	2,633		(3,276		)	7,915
Total available-for-sale securities	9,295		24		(60		)	539		(1,240		)	2,633		(3,276		)	7,915
Total Level 3 assets	$	9,295	$	24	$	(60	)	$	539	$	(1,240	)	$	2,633	$	(3,276	)	$	7,915

Level 3 Assets – Year-to-Date Change:



(in thousands)	Beginning balance at December 31, 2016		Included in earnings⁽¹⁾		Included in other comprehensive income			Purchases		Sales			Transfers into Level 3⁽²⁾		Transfers out of Level 3⁽²⁾			Ending balance at September 30, 2017
Available-for-sale securities:
Corporate debt securities	$	9,352	$	3	$	(108	)	$	4,520	$	(4,372	)	$	8,444	$	(9,924	)	$	7,915
Total fixed maturities	9,352		3		(108		)	4,520		(4,372		)	8,444		(9,924		)	7,915
Total available-for-sale securities	9,352		3		(108		)	4,520		(4,372		)	8,444		(9,924		)	7,915
Total Level 3 assets	$	9,352	$	3	$	(108	)	$	4,520	$	(4,372	)	$	8,444	$	(9,924	)	$	7,915

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 into Level 3⁽²⁾		Transfers out of Level 3⁽²⁾			Ending balance at September 30, 2016
Available-for-sale securities:
Corporate debt securities	$	8,851	$	22	$	38	$	3,217	$	(318	)	$	2,514	$	(4,135	)	$	10,189
Commercial mortgage-backed securities	1,003		0		0		0		0			0		(1,003		)	0
Collateralized debt obligations	1,200		0		7		3,000		0			2,114		(1,200		)	5,121
Total fixed maturities	11,054		22		45		6,217		(318		)	4,628		(6,338		)	15,310
Total available-for-sale securities	11,054		22		45		6,217		(318		)	4,628		(6,338		)	15,310
Total Level 3 assets	$	11,054	$	22	$	45	$	6,217	$	(318	)	$	4,628	$	(6,338	)	$	15,310

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 into Level 3⁽²⁾		Transfers out of Level 3⁽²⁾			Ending balance at September 30, 2016
Available-for-sale securities:
Corporate debt securities	$	69	$	67	$	119		$	11,887	$	(924	)	$	5,470	$	(6,499	)	$	10,189
Commercial mortgage-backed securities	0		0		3			1,000		0			0		(1,003		)	0
Collateralized debt obligations	8,577		4		(5		)	7,722		(54		)	2,114		(13,237		)	5,121
Total fixed maturities	8,646		71		117			20,609		(978		)	7,584		(20,739		)	15,310
Total available-for-sale securities	8,646		71		117			20,609		(978		)	7,584		(20,739		)	15,310
Total Level 3 assets	$	8,646	$	71	$	117		$	20,609	$	(978	)	$	7,584	$	(20,739	)	$	15,310


(1)	These amounts are reported in the Statements of Operations as net investment income and net realized investment gains (losses) for the each of the periods presented above.


(2)	Transfers into and/or (out) of Level 3 are primarily attributable to the availability of market observable information and the re-evaluation of the observability of pricing inputs.

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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 broker quotes totaled $7.9 million at September 30, 2017. 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, 2017
	Total		Level 1		Level 2		Level 3
Fixed maturities:
Priced via pricing services	$	749,266	$	0	$	741,351	$	7,915
Total fixed maturities	749,266		0		741,351		7,915
Other investments:
Priced via unobservable inputs ⁽¹⁾	4,338		—		—		—
Total other investments	4,338		—		—		—
Total	$	753,604	$	0	$	741,351	$	7,915

(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 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, 2017.

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Note 5. Investments

Available-for-sale securities

The following tables summarize the cost and fair value of our available-for-sale securities:



	At September 30, 2017
(in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair value
Available-for-sale securities:
U.S. treasury	$	11,878	$	0	$	44	$	11,834
States & political subdivisions	254,835		7,809		678		261,966
Foreign government securities	501		6		0		507
Corporate debt securities	345,003		2,201		832		346,372
Residential mortgage-backed securities	25,388		404		73		25,719
Commercial mortgage-backed securities	34,892		73		634		34,331
Collateralized debt obligations	62,193		207		19		62,381
Other debt securities	6,119		37		0		6,156
Total fixed maturities	740,809		10,737		2,280		749,266
Total available-for-sale securities	$	740,809	$	10,737	$	2,280	$	749,266



	At December 31, 2016
(in thousands)	Amortized cost		Gross unrealized gains		Gross unrealized losses		Estimated fair value
Available-for-sale securities:
U.S. treasury	$	5,093	$	0	$	62	$	5,031
Government sponsored entities	2,004		22		0		2,026
States & political subdivisions	249,312		6,113		2,293		253,132
Corporate debt securities	321,041		3,293		1,386		322,948
Residential mortgage-backed securities	16,232		61		191		16,102
Commercial mortgage-backed securities	37,723		59		933		36,849
Collateralized debt obligations	68,998		351		96		69,253
Other debt securities	2,000		0		0		2,000
Total fixed maturities	702,403		9,899		4,961		707,341
Common stock	6,152		0		202		5,950
Total available-for-sale securities	$	708,555	$	9,899	$	5,163	$	713,291

The amortized cost and estimated fair value of fixed maturities at September 30, 2017 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, 2017
(in thousands)	Amortized		Estimated
	cost		fair value
Due in one year or less	$	65,085	$	65,208
Due after one year through five years	332,904		337,986
Due after five years through ten years	239,042		242,425
Due after ten years	103,778		103,647
Total fixed maturities	$	740,809	$	749,266

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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, 2017
(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:
U.S. treasury	$	11,835	$	44	$	0	$	0	$	11,835	$	44	4
States & political subdivisions	49,278		449		7,280		229		56,558		678		26
Corporate debt securities	108,828		619		19,951		213		128,779		832		255
Residential mortgage-backed securities	5,553		19		5,771		54		11,324		73		10
Commercial mortgage-backed securities	12,793		106		11,019		528		23,812		634		21
Collateralized debt obligations	16,426		19		0		0		16,426		19		8
Total fixed maturities	204,713		1,256		44,021		1,024		248,734		2,280		324
Total available-for-sale securities	$	204,713	$	1,256	$	44,021	$	1,024	$	248,734	$	2,280	324
Quality breakdown of fixed maturities:
Investment grade	$	152,341	$	745	$	42,020	$	533	$	194,361	$	1,278	113
Non-investment grade	52,372		511		2,001		491		54,373		1,002		211
Total fixed maturities	$	204,713	$	1,256	$	44,021	$	1,024	$	248,734	$	2,280	324



	At December 31, 2016
(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:
U.S. treasury	$	5,031	$	62	$	0	$	0	$	5,031	$	62	1
States & political subdivisions	84,611		2,293		0		0		84,611		2,293		40
Corporate debt securities	112,453		987		8,692		399		121,145		1,386		155
Residential mortgage-backed securities	7,451		60		4,974		131		12,425		191		13
Commercial mortgage-backed securities	26,509		437		4,319		496		30,828		933		28
Collateralized debt obligations	27,470		75		4,208		21		31,678		96		15
Total fixed maturities	263,525		3,914		22,193		1,047		285,718		4,961		252
Common stock	5,950		202		0		0		5,950		202		1
Total available-for-sale securities	$	269,475	$	4,116	$	22,193	$	1,047	$	291,668	$	5,163	253
Quality breakdown of fixed maturities:
Investment grade	$	239,041	$	3,605	$	16,061	$	399	$	255,102	$	4,004	136
Non-investment grade	24,484		309		6,132		648		30,616		957		116
Total fixed maturities	$	263,525	$	3,914	$	22,193	$	1,047	$	285,718	$	4,961	252

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,
	2017		2016		2017		2016
Fixed maturities	$	4,234	$	5,245	$	16,358	$	14,629
Equity securities	0		50		49		132
Cash equivalents and other	1,936		366		2,852		1,011
Total investment income	6,170		5,661		19,259		15,772
Less: investment expenses	200		330		1,075		888
Net investment income	$	5,970	$	5,331	$	18,184	$	14,884

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,
	2017			2016			2017			2016
Available-for-sale securities:
Fixed maturities:
Gross realized gains	$	1,621		$	603		$	2,708		$	1,175
Gross realized losses	(722		)	(27		)	(1,116		)	(1,819		)
Net realized gains (losses)	899			576			1,592			(644		)
Equity securities:
Gross realized losses	0			0			(145		)	(34		)
Net realized losses	0			0			(145		)	(34		)
Trading securities:
Common stock:
Gross realized gains	0			121			0			707
Increases in fair value⁽¹⁾	0			21			0			0
Net realized gains	0