UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PERSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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

Not applicable

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

Yes þ No o

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 þ No o

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes þ No o

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 þ		Accelerated Filer o		Non-Accelerated Filer o		Smaller Reporting Company o
				(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 o No þ

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 50,153,649 at October 22, 2010.

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 2,546 at October 22, 2010.

 

 

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)			3
Consolidated Statements of Operations—Three and nine months ended September 30, 2010 and 2009			3
Consolidated Statements of Financial Position—September 30, 2010 and December 31, 2009			4
Consolidated Statements of Comprehensive Income—Three and nine months ended September 30, 2010 and 2009			5
Consolidated Statements of Cash Flows—Nine months ended September 30, 2010 and 2009			6
Notes to Consolidated Financial Statements—September 30, 2010			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			42
Item 3. Quantitative and Qualitative Disclosures About Market Risk			68
Item 4. Controls and Procedures			69
PART II. OTHER INFORMATION
Item 1A. Risk Factors			70
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			70
Item 6. Exhibits			71
SIGNATURES			72
EX-10.1
EX-31.1
EX-31.2
EX-32
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ERIE INDEMNITY COMPANY

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(dollars in millions, except per share data)

		Three months ended								Nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
						(As adjusted								(As adjusted
						Note 2)								Note 2)
Revenues
Premiums earned		$	1,005			$	977			$	2,972			$	2,898
Net investment income			110				102				322				324
Net realized investment gains			205				251				117				304
Net impairment losses recognized in earnings			0				(16	)			(6	)			(99	)
Equity in earnings (losses) of limited partnerships			28				(37	)			58				(324	)
Other income			9				9				26				27
Total revenues			1,357				1,286				3,489				3,130
Benefits and expenses
Insurance losses and loss expenses			710				631				2,208				2,094
Policy acquisition and underwriting expenses			242				299				699				762
Total benefits and expenses			952				930				2,907				2,856
Income from operations before income taxes and noncontrolling interest			405				356				582				274
Provision for income taxes			130				104				176				2
Net income		$	275			$	252			$	406			$	272
Less: Net income attributable to noncontrolling interest in consolidated entity — Exchange			221				212				256				188
Net income attributable to Indemnity		$	54			$	40			$	150			$	84
Earnings Per Share
Net income attributable to Indemnity per share
Class A common stock — basic		$	1.05			$	0.77			$	2.92			$	1.62
Class A common stock — diluted		$	0.94			$	0.69			$	2.62			$	1.46
Class B common stock — basic and diluted		$	150.87			$	112.06			$	421.91			$	239.96
Weighted average shares outstanding attributable to Indemnity — Basic
Class A common stock			50,499,551				51,252,693				50,897,035				51,255,234
Class B common stock			2,546				2,546				2,546				2,549
Weighted average shares outstanding attributable to Indemnity— Diluted
Class A common stock			56,624,310				57,383,900				57,021,794				57,393,641
Class B common stock			2,546				2,546				2,546				2,549
Dividends declared per share
Class A common stock		$	0.48			$	0.45			$	1.44			$	1.35
Class B common stock		$	72.00			$	67.50			$	216.00			$	202.50

See accompanying notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(dollars in millions, except per share data)

		September 30,				December 31,
		2010				2009
		(Unaudited)
Assets
Investments — Indemnity
Available-for-sale securities, at fair value:
Fixed maturities (amortized cost of $649 and $642, respectively)		$	695			$	664
Equity securities (cost of $40 and $35, respectively)			46				38
Trading securities, at fair value (cost of $22 and $36, respectively)			26				42
Limited partnerships (cost of $263 and $281, respectively)			234				235
Other invested assets			1				1
Investments — Exchange
Available-for-sale securities, at fair value:
Fixed maturities (amortized cost of $6,453 and $6,277, respectively)			7,019				6,517
Equity securities (cost of $467 and $425, respectively)			538				472
Trading securities, at fair value (cost of $1,689 and $1,556, respectively)			1,985				1,835
Limited partnerships (cost of $1,333 and $1,392, respectively)			1,148				1,116
Other invested assets			19				20
Total investments			11,711				10,940
Cash and cash equivalents (Exchange portion of $239 and $158, respectively)			312				234
Premiums receivable from policyholders (Exchange portion of $780 and $715, respectively)			993				906
Reinsurance recoverable (Exchange portion of $201 and $212, respectively)			204				215
Deferred income taxes (Exchange portion of $0 and $75, respectively)			11				116
Deferred acquisition costs (Exchange portion of $416 and $416, respectively)			473				467
Other assets (Exchange portion of $337 and $306, respectively)			454				409
Total assets		$	14,158			$	13,287
Liabilities and shareholders’ equity
Liabilities
Indemnity liabilities
Losses and loss expense reserves		$	743			$	752
Unearned premiums			355				325
Other liabilities			370				387
Exchange liabilities
Losses and loss expense reserves			2,870				2,846
Life policy and deposit contract reserves			1,600				1,540
Unearned premiums			1,803				1,656
Deferred income taxes			103				0
Other liabilities			88				56
Total liabilities			7,932				7,562
Indemnity’s shareholders’ equity
Class A common stock, stated value $0.0292 per share; authorized 74,996,930 shares; 68,289,600 issued; 50,252,872 and 51,203,473 shares outstanding, respectively			2				2
Class B common stock, convertible at a rate of 2,400 Class A shares for one Class B share, stated value $70 per share; 2,546 authorized, issued and outstanding, respectively			0				0
Additional paid-in-capital			8				8
Accumulated other comprehensive loss			(17	)			(43	)
Retained earnings, before cumulative effect adjustment			1,825				1,743
Cumulative effect of accounting changes, net of tax			0				6
Retained earnings, after cumulative effect adjustment			1,825				1,749
Total contributed capital and retained earnings			1,818				1,716
Treasury stock, at cost, 18,036,728 and 17,086,127 shares, respectively			(860	)			(814	)
Total Indemnity shareholders’ equity			958				902
Noncontrolling interest in consolidated entity — Exchange			5,268				4,823
Total equity			6,226				5,725
Total liabilities, shareholders’ equity and noncontrolling interest		$	14,158			$	13,287

See accompanying notes to Consolidated Financial Statements. See Note 14 for supplemental consolidating statements of financial position information.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in millions)

		Erie Insurance Group
		Three months ended								Nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
						(As adjusted								(As adjusted
						Note 2)								Note 2)
Accumulated other comprehensive loss:
Balance, beginning of period — Indemnity		$	(32	)		$	(101	)		$	(43	)		$	(136	)
Cumulative effect of accounting changes, net of tax*			—				—				—				(6	)
Adjusted balance, beginning of period			(32	)			(101	)			(43	)			(142	)
Gross unrealized holding gains on investments arising during period			25				47				44				101
Reclassification adjustment for gross (gains) losses included in net income			(2	)			3				(4	)			12
Unrealized gains on investments			23				50				40				113
Income tax expense related to unrealized gains			(8	)			(18	)			(14	)			(40	)
Change in other comprehensive income, net of tax — Indemnity			15				32				26				73
Balance, end of period — Indemnity		$	(17	)		$	(69	)		$	(17	)		$	(69	)
Change in other comprehensive income, net of tax — Indemnity		$	15			$	32			$	26			$	73
Change in other comprehensive income, net of tax — Exchange		$	118			$	198			$	189			$	491
Change in other comprehensive income, net of tax — Erie Insurance Group		$	133			$	230			$	215			$	564
Comprehensive income:
Net income — Erie Insurance Group		$	275			$	252			$	406			$	272
Change in other comprehensive income, net of tax — Erie Insurance Group			133				230				215				564
Total comprehensive income — Erie Insurance Group			408				482				621				836
Less: Noncontrolling interest in consolidated entity — Exchange			339				410				445				679
Total comprehensive income — Indemnity		$	69			$	72			$	176			$	157

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in millions)

		Nine months ended
		September 30,
		2010				2009
						(As adjusted
						Note 2)
Cash flows from operating activities
Premiums collected		$	3,068			$	3,025
Net investment income received			325				306
Limited partnership distributions			88				57
Service agreement fee received			26				26
Commissions and bonuses paid to agents			(414	)			(420	)
Losses paid			(1,808	)			(1,701	)
Loss expenses paid			(321	)			(306	)
Other underwriting and acquisition costs paid			(394	)			(435	)
Income taxes (paid) recovered			(105	)			161
Net cash provided by operating activities			465				713
Cash flows from investing activities
Purchase of investments:
Fixed maturities			(1,415	)			(1,339	)
Preferred stock			(146	)			(132	)
Common stock			(787	)			(1,129	)
Limited partnerships			(105	)			(133	)
Sales/maturities of investments:
Fixed maturity sales			486				386
Fixed maturity calls/maturities			794				531
Preferred stock			117				146
Common stock			740				1,082
Net policy loans			0				1
Sale of and returns on limited partnerships			40				8
Purchase of property and equipment			(27	)			(10	)
Net collections (distributions) on agent loans			2				(2	)
Net cash used in investing activities			(301	)			(591	)
Cash flows from financing activities
Annuity and supplementary contract deposits and interest			87				134
Annuity and supplementary contract surrenders and withdrawals			(59	)			(107	)
Universal life deposits and interest			30				27
Universal life surrenders			(26	)			(27	)
Purchase of treasury stock			(44	)			(1	)
Dividends paid to shareholders			(74	)			(70	)
Decrease in collateral from securities lending			0				(119	)
Redemption of securities lending collateral			0				119
Net cash used in financing activities			(86	)			(44	)
Net increase in cash and cash equivalents			78				78
Cash and cash equivalents at beginning of period			234				277
Cash and cash equivalents at end of period		$	312			$	355

See accompanying notes to Consolidated Financial Statements. See Note 14 for supplemental cash flow information.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1. Nature of Operations

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

Indemnity’s primary function is to perform certain services for the Exchange relating to sales, underwriting and issuance of policies on behalf of the Exchange. This is done in accordance with a subscriber’s agreement (a limited power of attorney) executed by each subscriber (policyholder), appointing Indemnity as their common attorney-in-fact to transact business on their behalf and to manage the affairs of the Exchange. Indemnity earns a management fee from the Exchange for these services, which is paid from the premiums collected from subscribers (policyholders).

Indemnity also operates as a property and casualty insurer through its wholly-owned subsidiaries, Erie Insurance Company (“EIC”), Erie Insurance Company of New York (“ENY”) and the Erie Insurance Property and Casualty Company (“EPC”).

The “Property and Casualty Group” refers to the Exchange and its wholly-owned subsidiary, Flagship City Insurance Company (“Flagship”) and Indemnity’s wholly-owned subsidiaries. The Property and Casualty Group operates in 11 Midwestern, Mid-Atlantic and Southeastern states and the District of Columbia and primarily writes personal auto insurance, which comprised 48% of its 2009 direct premiums.

Erie Family Life Insurance Company (“EFL”) is an affiliated life insurance company that underwrites and sells nonparticipating individual and group life insurance policies and fixed annuities. Indemnity and Exchange own 21.6% and 78.4% of EFL, respectively.

“Indemnity shareholder interest” refers to the interest in Erie Indemnity Company owned by the Class A and Class B shareholders. In addition to referring to Erie Insurance Exchange, the term “Exchange” sometimes refers to the noncontrolling interest held for the benefit of the subscribers (policyholders) and includes its interests in Flagship and EFL.

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

Note 2. Significant Accounting Policies

Basis of presentation and principles of consolidation

The accompanying consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of Indemnity together with its affiliate companies in which Indemnity holds a majority voting or economic interest. In addition, we consolidate the Exchange as a variable interest entity for which Indemnity is the primary beneficiary. All intercompany accounts and transactions have been eliminated in consolidation. The required presentation of noncontrolling interests is reflected in the consolidated financial statements. Noncontrolling interests represent the ownership interests of the Exchange, all of which is held by parties other than Indemnity (i.e. the Exchange’s subscribers (policyholders)). Noncontrolling interests also include the Exchange subscribers’ 78.4% ownership interest in EFL. See the discussion “Retrospective adoption of new accounting principle” that follows for additional consolidation information.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. For further information, refer to the consolidated financial statements and footnotes for the year ended December 31, 2009 included in our Form 8-K as filed with the Securities and Exchange Commission on May 6, 2010.

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

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

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

Retrospective adoption of new accounting principle

On June 12, 2009, the Financial Accounting Standards Board (FASB) updated ASC 810, Consolidation, which amended the existing guidance for determining whether an enterprise is the primary beneficiary of a variable interest entity (“VIE”). As of January 1, 2010, Indemnity adopted the new accounting principle on a retrospective basis since inception.

This guidance changed the methodology for assessing whether an enterprise is the primary beneficiary of a VIE by requiring a qualitative analysis to determine if an enterprise’s variable interest gives it a controlling financial interest. The qualitative analysis looks at the power to direct activities of the VIE that most significantly impact economic performance and the right to receive benefits (or obligation to absorb losses) from the VIE that could potentially be significant.

In accordance with the new accounting guidance, Indemnity is deemed to be the primary beneficiary of the Exchange given the significance of the management fee to the Exchange and Indemnity’s power to direct the Exchange’s significant activities. Under the previously issued accounting guidance, Indemnity was not deemed the primary beneficiary of the Exchange and its financial position and operating results were not consolidated with Indemnity’s. Following adoption of the new accounting guidance, as primary beneficiary of the Exchange, Erie Indemnity Company has consolidated Indemnity and the Exchange’s financial position and operating results.

Furthermore, upon consolidation of the Exchange, 100% of the ownership of EFL resides within the consolidated entity and consequently EFL’s financial results are also consolidated. The financial statements and notes to the financial statements presented herein have all been adjusted to reflect the retrospective adoption of the new accounting principle.

There was no cumulative effect to Indemnity’s shareholders’ equity from consolidation of the Exchange and EFL. The noncontrolling interest in total equity represents the amount of the Exchange’s subscribers’ (policyholders’) equity.

Recent Accounting Updates

In January 2010, the FASB issued Accounting Standards Update (ASU) 2010-06, Improving Disclosures about Fair Value Measurements. This guidance updated the disclosures for FASB ASC 820, Fair Value Measurements and Disclosures. The additional disclosures include the amounts and reasons for significant transfers between the levels in the fair value hierarchy, the expansion of fair market disclosures by each class of assets, disclosure of the policy for recognition of level transfers, and disclosure of the valuation techniques used for all Level 2 and Level 3 assets. These disclosures are effective for periods beginning after December 15, 2009 and have been included in Note 6. An additional disclosure requirement to present purchases, sales, issuances, and settlements of Level 3 activity on a gross basis becomes effective with periods beginning after December 15, 2010.

Note 3. Earnings Per Share

Basic earnings per share is calculated under the two-class method, which allocates earnings to each class of stock based on its dividend rights. Class B shares are convertible into Class A shares at a conversion ratio of 2,400 to 1. Class A diluted earnings per share is calculated under the if-converted method which reflects the conversion of Class B shares and the effect of potentially dilutive outstanding employee stock-based awards and awards not yet vested related to the outside directors’ stock compensation plan.

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

		Indemnity Earnings Per Share Calculation
(dollars in millions,		Three months ended September 30,
except share data)		2010												2009
		Allocated				Weighted				Per-				Allocated				Weighted				Per-
		net income				shares				share				net income				shares				share
		(numerator)				(denominator)				amount				(numerator)				(denominator)				amount
Class A — Basic EPS:
Income available to Class A stockholders		$	54				50,499,551			$	1.05			$	40				51,252,693			$	0.77
Dilutive effect of stock awards			0				14,359				—				0				20,807				—
Assumed conversion of Class B shares			0				6,110,400				—				0				6,110,400				—
Class A — Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares		$	54				56,624,310			$	0.94			$	40				57,383,900			$	0.69
Class B — Basic and diluted EPS:
Income available to Class B stockholders		$	0				2,546			$	150.87			$	0				2,546			$	112.06
		Indemnity Earnings Per Share Calculation
(dollars in millions,		Nine months ended September 30,
except share data)			2010											2009
		Allocated				Weighted				Per-				Allocated				Weighted				Per-
		net income				shares				share				net income				Shares				share
		(numerator)				(denominator)				amount				(numerator)				(denominator)				amount
Class A — Basic EPS:
Income available to Class A stockholders		$	149				50,897,035			$	2.92			$	83				51,255,234			$	1.62
Dilutive effect of stock awards			0				14,359				—				0				20,807				—
Assumed conversion of Class B shares			1				6,110,400				—				1				6,117,600				—
Class A — Diluted EPS:
Income available to Class A stockholders on Class A equivalent shares		$	150				57,021,794			$	2.62			$	84				57,393,641			$	1.46
Class B — Basic and diluted EPS:
Income available to Class B stockholders		$	1				2,546			$	421.91			$	1				2,549			$	239.96

Included in the diluted earnings per share calculations for the third quarters of 2010 and 2009, respectively, were 7,959 and 9,607 shares of awards not yet vested related to our outside directors’ stock compensation plan, and 6,400 and 11,200 shares of other stock-based awards not yet vested.

Note 4. Variable Interest Entity

Exchange

The Exchange is a reciprocal insurance exchange domiciled in Pennsylvania, for which Indemnity serves as attorney-in-fact. Indemnity holds a variable interest in the Exchange because of the absence of decision-making capabilities by the equity owners (i.e. subscribers (policyholders)) of the Exchange and because of the significance of the management fees the Exchange pays to Indemnity as the decision maker. The new accounting guidance, which we adopted on January 1, 2010, requires entities to perform a qualitative analysis to determine the primary beneficiary of variable interest entities. As a result of adopting the new guidance, Indemnity is deemed to have a controlling financial interest in the Exchange and is considered the primary beneficiary. The Exchange’s results have been consolidated with those of Indemnity. We have retrospectively applied the new accounting guidance and have consolidated the Exchange for all periods presented in this report for comparability purposes. See Note 2.

Consolidation of the Exchange is required given the significance of the management fee to the Exchange and because Indemnity has the power to direct the activities of the Exchange that most significantly impact the Exchange’s economic performance. Indemnity earns management fee revenues from the Exchange for services provided as attorney-in-fact for the Exchange. Indemnity’s management fee revenues are based on the direct written premiums of the Exchange and the other members of the Property and Casualty Group. Indemnity’s Board of Directors determines the management fee rate paid by the Exchange to Indemnity. This rate cannot exceed 25% of the direct and affiliated assumed written premiums of the Exchange, as defined by the subscriber agreement signed by each policyholder. The management fee revenues and management fee expenses are eliminated in consolidation.

Indemnity participates in the underwriting results of the Exchange through the pooling arrangement in which its insurance subsidiaries have a 5.5% participation. If the Exchange were to default, Indemnity’s insurance subsidiaries would be liable for the policies that they wrote directly. Indemnity’s property and casualty insurance subsidiaries wrote approximately 16% of the 2009 direct written premiums of the Property and Casualty Group. Indemnity’s Board of Directors determines the continuation and participation percentage of Indemnity’s property and casualty subsidiaries in the reinsurance pooling arrangement.

Indemnity has no obligation related to any underwriting and/or investment losses experienced by the Exchange. Indemnity would however be adversely impacted if the Exchange incurred significant underwriting and/or investment losses. If the surplus of the Exchange were to decline significantly from its current level, its financial strength ratings could be reduced and as a consequence the Exchange could find it more difficult to retain its existing business and attract new business. A decline in the business of the Exchange would have an adverse effect on the amount of the management fees Indemnity receives and the underwriting results of the Property and Casualty Group in which Indemnity has a 5.5% participation. In addition, a decline in the surplus of the Exchange from its current level may impact the management fee rate received by Indemnity. Indemnity also has an exposure to a concentration of credit risk related to the unsecured receivables due from the Exchange for its management fee, reinsurance recoverables from unpaid losses and loss expenses and unearned premium balances ceded under the pooling arrangement and cost reimbursements.

Indemnity has not provided financial or other support to the Exchange for the reporting periods presented. At September 30, 2010, there are no explicit or implicit arrangements that would require Indemnity to provide future financial support to the Exchange. Indemnity is not liable if the Exchange was to be in violation of its debt covenants or was unable to meet its obligation for unfunded commitments to limited partnerships.

Note 5. Segment Information

As a result of the changes in our reporting entity at January 1, 2010 (see Note 2), our reportable segments have increased from three to four. Our reportable segments include management operations, property and casualty insurance operations, life insurance operations and investment operations. The segment information presented below includes reclassification of all comparative prior period segment information. Accounting policies for segments are the same as those described in the summary of significant accounting policies. For further information, refer to the consolidated financial statements and footnotes for the year ended December 31, 2009 included in our Form 8-K as filed with the Securities and Exchange Commission on May 6, 2010. Assets are not allocated to the segments but rather are reviewed in total for purposes of decision-making. No single customer or agent provides 10% or more of revenues.

Our management operations segment reflects the results of serving as attorney-in-fact for the Exchange. Indemnity operates in this capacity solely for the Exchange. We evaluate profitability of our management operations segment principally on the gross margin from management operations.

Indemnity earns management fees from the Exchange for providing sales, underwriting and policy issuance services. The management fee revenue, which is eliminated in consolidation, is calculated as a percentage of the direct written premium of the Property and Casualty Group. The Exchange issues policies with annual terms only. Management fees are recorded upon policy issuance or renewal, as substantially all of the services required to be performed by Indemnity have been satisfied at that time. Certain activities are performed and related costs are incurred

by Indemnity subsequent to policy issuance in connection with the services provided to the Exchange; however, these activities are inconsequential and perfunctory. Although these management fee revenues and expenses are eliminated in consolidation, the amount of the fee directly impacts allocations of our consolidated net income between noncontrolling interest, which bears the management fee expense and represents the interests of the Exchange subscribers, and Indemnity’s interests, which earns the management fee revenue and represents Indemnity shareholder interest in net income.

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

Our life insurance operations segment includes traditional and universal life insurance products and fixed annuities marketed to individuals using the same independent agency force utilized by our property and casualty operations. We evaluate profitability of the life insurance operations segment principally based on segment net income, including investments, which for segment purposes are reflected in the investment operations segment. At the same time, we recognize that investment-related income is integral to the evaluation of the life insurance segment because of the long duration of life products. For the third quarter 2010 and 2009, investment activities on life insurance-related assets generated revenues of $27 million and $19 million, respectively, resulting in EFL reporting income before income taxes of $16 million and $8 million, respectively, before intercompany eliminations. For the nine months ended September 30, 2010 and 2009, investment activities on life insurance and related assets generated revenues of $79 million and $45 million, respectively, resulting in EFL reporting income before taxes of $37 million and $8 million, respectively, before intercompany eliminations. See Note 15 for EFL supplemental information.

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

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

		Erie Insurance Group
		For the three months ended September 30, 2010
						Property
						and
						casualty				Life
		Management				insurance				insurance				Investment
(in millions)		operations				operations				operations				operations				Eliminations				Consolidated
Premiums earned/life policy revenue						$	990			$	16							$	(1	)		$	1,005
Net investment income														$	113				(3	)			110
Net realized investment gains															205								205
Net impairment losses recognized in earnings															0								0
Equity in earnings of limited partnerships															28								28
Management fee revenue		$	266																(266	)			—
Service agreement and other revenue			9								0												9
Total revenues			275				990				16				346				(270	)			1,357
Cost of management operations			217																(217	)			—
Insurance losses and loss expenses							690												(1	)			689
Benefits and other changes in policy reserves											21												21
Policy acquisition and underwriting expense							288				6								(52	)			242
Total benefits and expenses			217				978				27				—				(270	)			952
Income (loss) before income taxes			58				12				(11	)			346				—				405
Provision (benefit) for income taxes			22				4				(4	)			108				—				130
Net income (loss)		$	36			$	8			$	(7	)		$	238			$	—			$	275

		Erie Insurance Group
		For the three months ended September 30, 2009
						Property and
		Management				casualty insurance				Life insurance				Investment
(in millions)		operations				operations				operations				operations(1)				Eliminations				Consolidated
Premiums earned/life policy revenue						$	964			$	14							$	(1	)		$	977
Net investment income														$	105				(3	)			102
Net realized investment gains															251								251
Net impairment losses recognized in earnings															(16	)							(16	)
Equity in losses of limited partnerships															(37	)							(37	)
Management fee revenue		$	253																(253	)			—
Service agreement and other revenue			9								0												9
Total revenues			262				964				14				303				(257	)			1,286
Cost of management operations			214																(214	)			—
Insurance losses and loss expenses							613												(1	)			612
Benefits and other changes in policy reserves											19												19
Policy acquisition and underwriting expense							335				6								(42	)			299
Total benefits and expenses			214				948				25				—				(257	)			930
Income (loss) before income taxes			48				16				(11	)			303				—				356
Provision (benefit) for income taxes			24				6				(4	)			78				—				104
Net income (loss)		$	24			$	10			$	(7	)		$	225			$	—			$	252
		Erie Insurance Group
		For the nine months ended September 30, 2010
						Property
						and
						casualty				Life
		Management				insurance				insurance				Investment
(in millions)		operations				operations				operations				operations				Eliminations				Consolidated
Premiums earned/life policy revenue						$	2,926			$	48							$	(2	)		$	2,972
Net investment income														$	330				(8	)			322
Net realized investment gains															117								117
Net impairment losses recognized in earnings															(6	)							(6	)
Equity in earnings of limited partnerships															58								58
Management fee revenue		$	773																(773	)			—
Service agreement and other revenue			26								0												26
Total revenues			799				2,926				48				499				(783	)			3,489
Cost of management operations			626																(626	)			—
Insurance losses and loss expenses							2,145												(4	)			2,141
Benefits and other changes in policy reserves											67												67
Policy acquisition and underwriting expense							829				23								(153	)			699
Total benefits and expenses			626				2,974				90				—				(783	)			2,907
Income (loss) before income taxes			173				(48	)			(42	)			499				—				582
Provision (benefit) for income taxes			61				(17	)			(15	)			147				—				176
Net income (loss)		$	112			$	(31	)		$	(27	)		$	352			$	—			$	406

		Erie Insurance Group
		For the nine months ended September 30, 2009
						Property
						and
						casualty				Life
		Management				insurance				insurance				Investment
(in millions)		operations				operations				operations				operations(1)				Eliminations				Consolidated
Premiums earned/life policy revenue						$	2,852			$	48							$	(2	)		$	2,898
Net investment income														$	332				(8	)			324
Net realized investment gains															304								304
Net impairment losses recognized in earnings															(99	)							(99	)
Equity in losses of limited partnerships															(324	)							(324	)
Management fee revenue		$	742																(742	)			—
Service agreement and other revenue			26								1												27
Total revenues			768				2,852				49				213				(752	)			3,130
Cost of management operations			615																(615	)			—
Insurance losses and loss expenses							2,033												(4	)			2,029
Benefits and other changes in policy reserves											65												65
Policy acquisition and underwriting expense							874				21								(133	)			762
Total benefits and expenses			615				2,907				86				—				(752	)			2,856
Income (loss) before income taxes			153				(55	)			(37	)			213				—				274
Provision (benefit) for income taxes			54				(19	)			(13	)			(20	)			—				2
Net income (loss)		$	99			$	(36	)		$	(24	)		$	233			$	—			$	272

See the “Results of the Erie Insurance Group’s operations by interest” table in the Management’s Discussion and Analysis for the composition of income attributable to Indemnity and income attributable to the noncontrolling interest (Exchange).

Note 6. Fair Value

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

Valuation techniques used to derive the fair value of our available-for-sale and trading securities are based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources.

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

		Level 1		Quoted prices for identical instruments in active markets not subject to adjustments or discounts.
		Level 2		Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
		Level 3		Instruments whose significant value drivers are unobservable and reflect management’s estimate of fair value based on assumptions used by market participants in an orderly transaction as of the valuation date.

The following table represents the fair value measurements on a recurring basis for our consolidated available-for-sale and trading securities by asset class and level of input at September 30, 2010:

		Erie Insurance Group
		September 30, 2010
		Fair value measurements using:
						Quoted prices in								Significant
						active markets for				Significant				unobservable
						identical assets				observable inputs				inputs
(in millions)		Total				Level 1				Level 2				Level 3
Indemnity
Available for sale securities:
Fixed maturities
U.S. treasuries and government agencies		$	6			$	4			$	2			$	0
U.S. government sponsored enterprises			13				0				13				0
Municipal securities			263				0				263				0
U.S. corporate debt — non-financial			180				0				180				0
U.S. corporate debt — financial			149				0				147				2
Foreign corporate debt — non-financial			29				0				29				0
Foreign corporate debt — financial			25				0				25				0
Structured securities:
Asset-backed securities — auto loans			2				0				2				0
Collateralized debt obligations			10				0				3				7
Commercial mortgage-backed			4				0				4				0
Residential mortgage-backed:
Government sponsored enterprises			11				0				11				0
Non-government sponsored enterprises			3				0				3				0
Total fixed maturities — Indemnity		$	695			$	4			$	682			$	9
Equity securities
U.S. nonredeemable preferred securities:
Financial		$	27			$	7			$	18			$	2
Non-financial			14				6				8				0
Foreign nonredeemable preferred securities:
Financial			4				0				4				0
Non-financial			1				0				1				0
Total equity securities — Indemnity		$	46			$	13			$	31			$	2
Total available-for-sale securities — Indemnity		$	741			$	17			$	713			$	11
Trading securities:
Common stock		$	26			$	26			$	0			$	0
Total trading securities		$	26			$	26			$	0			$	0
Total Indemnity		$	767			$	43			$	713			$	11