RESULTS OF OPERATIONS
We earn management fee revenue from providing services relating to the sales, underwriting, and issuance of policies on behalf of the Exchange as a result of its attorney-in-fact relationship. A summary of the financial results of these operations is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
(dollars in thousands)
|
2017
|
2016
|
% Change
|
|
2017
|
2016
|
% Change
|
|
(Unaudited)
|
|
|
|
(Unaudited)
|
|
|
Management fee revenue, net
|
$
|
435,214
|
|
$
|
411,139
|
|
5.9
|
|
%
|
|
$
|
1,268,591
|
|
$
|
1,195,262
|
|
6.1
|
|
%
|
Service agreement revenue
|
7,278
|
|
7,267
|
|
0.2
|
|
|
|
21,781
|
|
21,756
|
|
0.1
|
|
|
Total operating revenue
|
442,492
|
|
418,406
|
|
5.8
|
|
|
|
1,290,372
|
|
1,217,018
|
|
6.0
|
|
|
Total operating expenses
|
361,656
|
|
336,151
|
|
7.6
|
|
|
|
1,059,958
|
|
981,339
|
|
8.0
|
|
|
Operating income
|
$
|
80,836
|
|
$
|
82,255
|
|
(1.7
|
)
|
%
|
|
$
|
230,414
|
|
$
|
235,679
|
|
(2.2
|
)
|
%
|
Gross margin
|
18.3
|
%
|
19.7
|
%
|
(1.4
|
)
|
pts.
|
|
17.9
|
%
|
19.4
|
%
|
(1.5
|
)
|
pts.
|
Management fee revenue
Management fee revenue is based upon all direct and assumed premiums written by the Exchange and the management fee rate, which is determined by our Board of Directors at least annually. The management fee rate was set at 25%, the maximum rate, for both
2017
and
2016
. Changes in the management fee rate can affect our revenue and net income significantly. Management fee revenue is calculated by multiplying the management fee rate by the direct and assumed premiums written by the Exchange. The following table presents the calculation of management fee revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
(dollars in thousands)
|
2017
|
2016
|
% Change
|
|
2017
|
2016
|
% Change
|
|
(Unaudited)
|
|
|
|
(Unaudited)
|
|
|
Direct and assumed premiums written by the Exchange
|
$
|
1,739,654
|
|
$
|
1,643,755
|
|
5.8
|
%
|
|
$
|
5,085,562
|
|
$
|
4,795,446
|
|
6.0
|
%
|
Management fee rate
|
25
|
%
|
25
|
%
|
|
|
|
25
|
%
|
25
|
%
|
|
|
Management fee revenue, gross
|
434,914
|
|
410,939
|
|
5.8
|
|
|
1,271,391
|
|
1,198,862
|
|
6.0
|
|
Change in allowance for management fee returned on cancelled policies
(1)
|
300
|
|
200
|
|
NM
|
|
|
(2,800
|
)
|
(3,600
|
)
|
NM
|
|
Management fee revenue, net of allowance
|
$
|
435,214
|
|
$
|
411,139
|
|
5.9
|
%
|
|
$
|
1,268,591
|
|
$
|
1,195,262
|
|
6.1
|
%
|
NM = not meaningful
|
|
(1)
|
Management fees are returned to the Exchange when policies are cancelled mid-term and unearned premiums are refunded. We record an estimated allowance for management fees returned on mid-term policy cancellations.
|
Direct and assumed premiums written by the Exchange
Direct and assumed premiums include premiums written directly by the Exchange and premiums assumed from its wholly owned property and casualty subsidiaries. Direct and assumed premiums written by the Exchange increased
5.8%
to
$1.7 billion
in the
third
quarter of
2017
compared to the
third
quarter of
2016
, driven by increases in both policies in force and average premium per policy. Year-over-year policies in force for all lines of business increased
3.4%
in the
third
quarter of
2017
as the result of continuing strong policyholder retention and an increase in new policies written, compared to
3.3%
in the
third
quarter of
2016
. The year-over-year average premium per policy for all lines of business increased
2.6%
at
September 30, 2017
, compared to
2.7%
at
September 30, 2016
.
Premiums generated from new business increased
14.2%
to
$222 million
in the
third
quarter of
2017
, compared to an increase of
3.9%
to
$194 million
in the
third
quarter of
2016
. Underlying the trend in new business premiums was a
9.2%
increase in new business policies written in the
third
quarter of
2017
, compared to a
1.1%
increase in the
third
quarter of
2016
, while the year-over-year average premium per policy on new business increased
4.6%
at
September 30, 2017
, compared to
1.9%
at
September 30, 2016
. Premiums generated from renewal business increased
4.7%
to
$1.5 billion
in the
third
quarter of
2017
, compared to an increase of
5.7%
to
$1.4 billion
in the
third
quarter of
2016
. Underlying the trend in renewal business premiums was an increase in year-over-year average premium per policy of
2.4%
at
September 30, 2017
, compared to
2.8%
at
September 30, 2016
, and steady policy retention ratios.
Personal lines
– Total personal lines premiums written increased
6.5%
to
$1.3 billion
in the
third
quarter of
2017
, from
$1.2 billion
in the
third
quarter of
2016
, driven by an increase of
3.5%
in total personal lines policies in force and an increase of
3.2%
in the total personal lines year-over-year average premium per policy.
Commercial lines
– Total commercial lines premiums written increased
4.0%
to
$457 million
in the
third
quarter of
2017
, from
$440 million
in the
third
quarter of
2016
, driven by a
2.7%
increase in total commercial lines policies in force and a
1.6%
increase in the total commercial lines year-over-year average premium per policy.
Future trends-premium revenue
– The Exchange plans to continue its efforts to grow premiums and improve its competitive position in the marketplace. Expanding the size of its agency force through a careful agency selection process and increased market penetration in our existing operating territories will contribute to future growth as existing and new agents build their books of business.
Changes in premium levels attributable to the growth in policies in force and rate changes directly affect the profitability of the Exchange and have a direct bearing on our management fee. Our continued focus on underwriting discipline and the maturing of pricing sophistication models has contributed to the Exchange's growth in new policies in force, steady policy retention ratios, and increased average premium per policy.
Service agreement revenue
Service agreement revenue includes service charges we collect from policyholders for providing extended payment terms on policies written and assumed by the Exchange, and late payment and policy reinstatement fees. The service charges are fixed dollar amounts per billed installment. Service agreement revenue totaled
$7.3 million
in both the
third
quarter of
2017
and
2016
, and
$21.8 million
for both the
nine months
ended
September 30, 2017
and
2016
. While policies in force continue to grow, service agreement revenue remains flat. This reflects the continued shift in policies to the monthly direct debit payment plan, which does not incur service charges, and the no-fee single payment plan, which offers a premium discount for certain payment methods. The shift to these plans is driven by the consumers’ desire to avoid paying service charges and to take advantage of the discount in pricing offered for paid-in-full policies.
Cost of operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
(in thousands)
|
2017
|
2016
|
% Change
|
|
2017
|
2016
|
% Change
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
Commissions:
|
|
|
|
|
|
|
|
Total commissions
|
$
|
248,677
|
|
$
|
232,455
|
|
7.0
|
%
|
|
$
|
720,538
|
|
$
|
676,963
|
|
6.4
|
%
|
Non-commission expense:
|
|
|
|
|
|
|
|
Underwriting and policy processing
|
$
|
36,060
|
|
$
|
33,946
|
|
6.2
|
%
|
|
$
|
108,115
|
|
$
|
102,108
|
|
5.9
|
%
|
Information technology
|
32,688
|
|
31,114
|
|
5.1
|
|
|
102,850
|
|
87,714
|
|
17.3
|
|
Sales and advertising
|
15,722
|
|
14,869
|
|
5.7
|
|
|
46,375
|
|
46,872
|
|
(1.1
|
)
|
Customer service
|
7,083
|
|
5,381
|
|
31.6
|
|
|
20,661
|
|
18,689
|
|
10.5
|
|
Administrative and other
|
21,426
|
|
18,386
|
|
16.5
|
|
|
61,419
|
|
48,993
|
|
25.4
|
|
Total non-commission expense
|
112,979
|
|
103,696
|
|
9.0
|
|
|
339,420
|
|
304,376
|
|
11.5
|
|
Total cost of operations
|
$
|
361,656
|
|
$
|
336,151
|
|
7.6
|
%
|
|
$
|
1,059,958
|
|
$
|
981,339
|
|
8.0
|
%
|
Commissions
– Commissions increased
$16.2 million
in the
third
quarter of
2017
and
$43.6 million
for the
nine months
ended
September 30, 2017
, compared to the same respective periods in
2016
. The increases were primarily driven by the
5.8%
and
6.0%
increases in direct and assumed premiums written by the Exchange for the
third
quarter and
nine months
ended
September 30, 2017
, respectively. The remaining portion of the increases were due to higher agent incentive costs related to profitable growth, compared to the same respective periods in
2016
. The estimated agent incentive payout at
September 30, 2017
is based on actual underwriting results for the two prior years and current year-to-date actual results and forecasted results for the remainder of
2017
. Therefore, fluctuations in the current quarter underwriting results can impact the estimated incentive payout on a quarter-to-quarter basis.
Non-commission expense
– Non-commission expense increased
$9.3 million
in the
third
quarter of
2017
compared to the same period in
2016
. Underwriting and policy processing costs increased
$2.1 million
primarily due to increased personnel costs and underwriting report costs. Information technology costs increased
$1.6 million
primarily due to increased personnel costs and hardware and software costs, somewhat offset by lower professional fees. Customer service costs increased
$1.7 million
primarily due to increased credit card processing fees. Administrative and other expenses increased
$3.0 million
driven by increased personnel costs.
Non-commission expense increased
$35.0 million
for the
nine months
ended
September 30, 2017
compared to the same period in
2016
. Underwriting and policy processing costs increased
$6.0 million
primarily due to increased personnel costs and underwriting report costs. Information technology costs increased
$15.1 million
primarily due to increased professional fees, personnel costs and hardware and software costs. Customer service costs increased
$2.0 million
primarily due to increased personnel costs and credit card processing fees. Administrative and other expenses increased
$12.4 million
primarily driven by increased personnel costs, including higher incentive plan costs and pension expenses. The incentive plan cost increase was driven by the long-term incentive plan due to the increase in the company stock price during the first
nine months
of
2017
. Additionally, the employee incentive plan program was expanded to additional employee groups beginning in 2017.
Gross margin
The gross margin in the
third
quarter of
2017
was
18.3%
compared to
19.7%
in the
third
quarter of
2016
, and was
17.9%
for the
nine months
ended
September 30, 2017
, compared to
19.4%
for the
nine months
ended
September 30, 2016
.
Total investment income
A summary of the results of our investment operations is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
2017
|
|
2016
|
|
% Change
|
|
2017
|
|
2016
|
|
% Change
|
|
|
(Unaudited)
|
|
|
|
|
(Unaudited)
|
|
|
|
Net investment income
|
|
$
|
5,970
|
|
|
$
|
5,331
|
|
|
12.0
|
%
|
|
$
|
18,184
|
|
|
$
|
14,884
|
|
|
22.2
|
%
|
Net realized investment gains
|
|
899
|
|
|
718
|
|
|
25.4
|
|
|
1,539
|
|
|
29
|
|
|
NM
|
|
Net impairment losses recognized in earnings
|
|
0
|
|
|
0
|
|
|
0.0
|
|
|
(182
|
)
|
|
(345
|
)
|
|
47.3
|
|
Equity in earnings (losses) of limited partnerships
|
|
1,537
|
|
|
(1,723
|
)
|
|
NM
|
|
|
1,899
|
|
|
(279
|
)
|
|
NM
|
|
Total investment income
|
|
$
|
8,406
|
|
|
$
|
4,326
|
|
|
94.3
|
%
|
|
$
|
21,440
|
|
|
$
|
14,289
|
|
|
50.0
|
%
|
NM = not meaningful
Net investment income
Net investment income primarily includes interest and dividends on our fixed maturity and equity security portfolios, net of investment expenses.
Net investment income increased by
$0.6 million
in the third quarter of 2017, compared to the third quarter of 2016, and increased by
$3.3 million
for the nine months ended September 30, 2017, compared to the nine months ended September 30, 2016. The increase in net investment income in both periods was primarily due to an increase in the invested balances and yields of fixed maturity securities.
Net realized investments gains (losses)
A breakdown of our net realized investment gains (losses) is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Securities sold:
|
|
(Unaudited)
|
|
(Unaudited)
|
Fixed maturities
|
|
$
|
899
|
|
|
$
|
576
|
|
|
$
|
1,592
|
|
|
$
|
(644
|
)
|
Equity securities
|
|
0
|
|
|
0
|
|
|
(145
|
)
|
|
(34
|
)
|
Common stock trading securities
|
|
0
|
|
|
121
|
|
|
0
|
|
|
707
|
|
Common stock increases in fair value
(1)
|
|
0
|
|
|
21
|
|
|
0
|
|
|
0
|
|
Miscellaneous
|
|
0
|
|
|
0
|
|
|
92
|
|
|
0
|
|
Net realized investment gains
(2)
|
|
$
|
899
|
|
|
$
|
718
|
|
|
$
|
1,539
|
|
|
$
|
29
|
|
|
|
(1)
|
The fair value of our common stocks is determined based upon exchange traded prices provided by a nationally recognized pricing service.
|
|
|
(2)
|
See Part I, Item 1. "Financial Statements - Note 5, Investments, of Notes to Financial Statements" contained within this report for additional disclosures regarding net realized investment gains.
|
Net realized investment gains and losses include gains and losses resulting from the sales of our fixed maturity or equity securities, as well as changes in fair value of common stocks designated as trading securities.
Net realized gains of $0.9 million during the third quarter of 2017 reflected gains from sales of fixed maturity securities, while net realized gains of $0.7 million during the third quarter 2016 resulted from gains on sales of fixed maturity securities and common stock. Net realized gains of $1.5 million for the nine months ended September 30, 2017 primarily reflected gains from sales of fixed maturity securities, partially offset by losses from sales of equity securities, while net realized gains for the nine months ended September 30, 2016 primarily reflected gains from the sale of common stock, partially offset by losses from sales of fixed maturity securities.
Net impairment losses recognized in earnings
There were no impairment losses in the third quarter of 2017 or 2016. Net impairment losses were $0.2 million and $0.3 million for the nine months ended September 30, 2017 and 2016, respectively. Impairments were primarily related to securities in an unrealized loss position where we determined the loss was other-than-temporary based on credit factors. In 2017, impairments also included securities in an unrealized loss position that we intended to sell prior to expected recovery of our amortized cost basis.
Equity in earnings (losses) of limited partnerships
The components of equity in earnings of limited partnerships are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
|
(Unaudited)
|
|
(Unaudited)
|
Private equity
|
|
$
|
594
|
|
|
$
|
(443
|
)
|
|
$
|
822
|
|
|
$
|
(2,240
|
)
|
Mezzanine debt
|
|
387
|
|
|
(120
|
)
|
|
274
|
|
|
(26
|
)
|
Real estate
|
|
556
|
|
|
(1,160
|
)
|
|
803
|
|
|
1,987
|
|
Total equity in earnings (losses) of limited partnerships
|
|
$
|
1,537
|
|
|
$
|
(1,723
|
)
|
|
$
|
1,899
|
|
|
$
|
(279
|
)
|
Limited partnership earnings pertain to investments in U.S. and foreign private equity, mezzanine debt, and real estate partnerships. Valuation adjustments are recorded to reflect the changes in fair value of the underlying investments held by the limited partnerships. These adjustments are recorded as a component of equity in earnings of limited partnerships in the Statements of Operations.
Limited partnership earnings tend to be cyclical based upon market conditions, the age of the partnership, and the nature of the investments. Generally, limited partnership earnings are recorded on a quarter lag from financial statements we receive from our general partners. As a consequence, earnings from limited partnerships reported at
September 30, 2017
reflect investment valuation changes resulting from the financial markets and the economy in the fourth quarter of 2016 and the first two quarters of 2017.
Equity in earnings of limited partnerships increased by $3.3 million in the third quarter of 2017, compared to the third quarter of 2016, and increased by $2.2 million for the nine months ended September 30, 2017, compared to the nine months ended September 30, 2016. The increase in earnings during both periods was primarily due to higher earnings across all sectors, except for real estate for the nine months ended September 30, 2017, which decreased compared to the nine months ended September 30, 2016.
Financial condition of Erie Insurance Exchange
Serving in the capacity of attorney-in-fact for the Exchange, we are dependent on the growth and financial condition of the Exchange, who is our sole customer. The strength of the Exchange and its wholly owned subsidiaries is rated annually by A.M. Best Company. Higher ratings of insurance companies generally indicate financial stability and a strong ability to pay claims. The ratings are generally based upon factors relevant to policyholders and are not directed toward return to investors. The Exchange and each of its property and casualty subsidiaries are rated A+ "Superior". On July 12, 2017, the outlook for the financial strength rating was affirmed as stable.
According to A.M. Best, this second highest financial strength rating category is assigned to those companies that, in A.M. Best’s opinion, have achieved superior overall performance when compared to the standards established by A.M. Best and have a superior ability to meet obligations to policyholders over the long term. As of
December 31, 2016
, only approximately
11%
of insurance groups are rated A+ or higher, and the Exchange is included in that group.
The financial statements of the Exchange are prepared in accordance with statutory accounting principles prescribed by the Commonwealth of Pennsylvania. Financial statements prepared under statutory accounting principles focus on the solvency of
the insurer and generally provide a more conservative approach than under GAAP. Statutory direct written premiums of the Exchange and its wholly owned property and casualty subsidiaries grew
6.0%
to
$5.1 billion
for the
nine months
ended
September 30, 2017
from
$4.8 billion
for the
nine months
ended
September 30, 2016
. These premiums, along with investment income, are the major sources of cash that support the operations of the Exchange. Policyholders’ surplus, determined under statutory accounting principles, was
$8.4 billion
at
September 30, 2017
,
$7.7 billion
at
December 31, 2016
, and
$7.6 billion
at
September 30, 2016
. The Exchange and its wholly owned property and casualty subsidiaries' year-over-year policy retention ratio continues to be high at
89.6%
at
September 30, 2017
, and
89.8%
at
December 31, 2016
and
September 30, 2016
.
FINANCIAL CONDITION
Investments
Our investment portfolio is managed with the objective of maximizing after-tax returns on a risk-adjusted basis.
Distribution of investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Carrying value at
|
|
|
|
Carrying value at
|
|
|
(dollars in thousands)
|
|
September 30, 2017
|
|
% to total
|
|
December 31, 2016
|
|
% to total
|
|
|
(Unaudited)
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
749,266
|
|
|
94
|
%
|
|
$
|
707,341
|
|
|
90
|
%
|
Common stock
|
|
0
|
|
|
0
|
|
|
5,950
|
|
|
1
|
|
Limited partnerships:
|
|
|
|
|
|
|
|
|
Private equity
|
|
33,478
|
|
|
4
|
|
|
35,228
|
|
|
5
|
|
Mezzanine debt
|
|
4,797
|
|
|
1
|
|
|
6,010
|
|
|
1
|
|
Real estate
|
|
11,176
|
|
|
1
|
|
|
16,921
|
|
|
3
|
|
Real estate mortgage loans
(1)
|
|
156
|
|
|
0
|
|
|
213
|
|
|
0
|
|
Total investments
|
|
$
|
798,873
|
|
|
100
|
%
|
|
$
|
771,663
|
|
|
100
|
%
|
(1)
Real estate mortgage loans are included with Other assets in the Statements of Financial Position.
We continually review our investment portfolio to evaluate positions that might incur other-than-temporary declines in value. We record impairment write-downs on investments in instances where the fair value of the investment is substantially below cost, and we conclude that the decline in fair value is other-than-temporary, which includes consideration for intent to sell. For all investment holdings, general economic conditions and/or conditions specifically affecting the underlying issuer or its industry, including downgrades by the major rating agencies, are considered in evaluating impairment in value. In addition to specific factors, other factors considered in our review of investment valuation are the length of time the fair value is below cost and the amount the fair value is below cost.
We individually analyze all positions with emphasis on those that have, in management’s opinion, declined significantly below cost. In compliance with impairment guidance for debt securities, we perform further analysis to determine if a credit-related impairment has occurred. Some of the factors considered in determining whether a debt security is credit impaired include potential for the default of interest and/or principal, level of subordination, collateral of the issue, compliance with financial covenants, credit ratings and industry conditions. We have the intent to sell all credit-impaired debt securities; therefore, the entire amount of the impairment charges is included in earnings and no impairments are recorded in other comprehensive income. For available-for-sale equity securities, a charge is recorded in the Statements of Operations for positions that have experienced other-than-temporary impairments. (See the "Results of Operations" section contained within this report for further information.) Management believes its investment valuation philosophy and accounting practices result in appropriate and timely measurement of value and recognition of impairment.
Fixed maturities
Under our investment strategy, we maintain a fixed maturity portfolio that is of high quality and well diversified within each market sector. This investment strategy also achieves a balanced maturity schedule. Our fixed maturity portfolio is managed with the goal of achieving reasonable returns while limiting exposure to risk. Our municipal bond portfolio accounts for
$262.0 million
, or
35%
, of the total fixed maturity portfolio at
September 30, 2017
. The overall credit rating of the municipal portfolio without consideration of the underlying insurance is AA+.
Fixed maturities classified as available-for-sale are carried at fair value with unrealized gains and losses, net of deferred taxes, included in shareholders’ equity. Net unrealized gains on fixed maturities, net of deferred taxes, amounted to $5.5 million at
September 30, 2017
, compared to $3.2 million at
December 31, 2016
.
The following table presents a breakdown of the fair value of our fixed maturity portfolio by sector and rating:
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2017
|
(in thousands)
|
|
(Unaudited)
|
Industry Sector
|
|
AAA
|
|
AA
|
|
A
|
|
BBB
|
|
Non- investment
grade
|
|
Fair
value
|
Basic materials
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
15,558
|
|
|
$
|
15,558
|
|
Communications
|
|
0
|
|
|
0
|
|
|
4,018
|
|
|
7,683
|
|
|
24,777
|
|
|
36,478
|
|
Consumer
|
|
0
|
|
|
1,064
|
|
|
4,651
|
|
|
33,576
|
|
|
48,210
|
|
|
87,501
|
|
Diversified
|
|
0
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
347
|
|
|
347
|
|
Energy
|
|
0
|
|
|
1,006
|
|
|
3,002
|
|
|
12,035
|
|
|
17,221
|
|
|
33,264
|
|
Financial
|
|
0
|
|
|
3,996
|
|
|
24,981
|
|
|
57,283
|
|
|
17,968
|
|
|
104,228
|
|
Government-municipal
|
|
105,004
|
|
|
148,164
|
|
|
8,798
|
|
|
0
|
|
|
0
|
|
|
261,966
|
|
Industrial
|
|
0
|
|
|
0
|
|
|
7,035
|
|
|
3,388
|
|
|
22,671
|
|
|
33,094
|
|
Structured securities
(2)
|
|
70,879
|
|
|
32,202
|
|
|
12,073
|
|
|
5,415
|
|
|
8,018
|
|
|
128,587
|
|
Technology
|
|
0
|
|
|
3,987
|
|
|
0
|
|
|
6,056
|
|
|
14,814
|
|
|
24,857
|
|
U.S. treasury
|
|
0
|
|
|
11,834
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
11,834
|
|
Utilities
|
|
0
|
|
|
0
|
|
|
3,995
|
|
|
4,997
|
|
|
2,560
|
|
|
11,552
|
|
Total
|
|
$
|
175,883
|
|
|
$
|
202,253
|
|
|
$
|
68,553
|
|
|
$
|
130,433
|
|
|
$
|
172,144
|
|
|
$
|
749,266
|
|
|
|
(1)
|
Ratings are supplied by S&P, Moody’s, and Fitch. The table is based upon the lowest rating for each security.
|
|
|
(2)
|
Structured securities include residential mortgage-backed securities, commercial mortgage-backed securities, collateralized debt obligations, and asset-backed securities.
|
Common stock
At December 31, 2016, equity securities carried at a fair value of $5.9 million classified as available-for-sale included certain exchange traded funds with underlying holdings of fixed maturity securities. These securities met the criteria of a common stock under U.S. GAAP, and were included on the Statements of Financial Position as available-for-sale equity securities. Changes in unrealized gains and losses on these securities were reflected in other comprehensive income. The net unrealized loss on these securities, net of deferred taxes, was $0.1 million at
December 31, 2016
. There were no holdings in these securities as of September 30, 2017.
Limited partnerships
At September 30, 2017, investments in limited partnerships decreased from the investment levels at
December 31, 2016
. Changes in partnership values are a function of contributions and distributions, adjusted for market value changes in the underlying investments. The decrease in limited partnership investments was primarily due to net distributions received from the partnerships. We have made no new limited partnership commitments since 2006, and the balance of limited partnership investments is expected to decline over time as additional distributions are received. The results from our limited partnerships are based upon financial statements received from our general partners, which are generally received on a quarter lag. As a result, the market values and earnings recorded during
2017
reflect the partnership activity experienced in the fourth quarter of 2016 and the first two quarters of 2017.
LIQUIDITY AND CAPITAL RESOURCES
Sources and Uses of Cash
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet the short- and long-term cash requirements of its business operations and growth needs. Our liquidity requirements have been met primarily by funds generated from management fee revenue and income from investments. Cash provided from these sources is used primarily to fund the costs of our operations including commissions, salaries and wages, pension plans, share repurchases, dividends to shareholders, and the purchase and development of information technology. We expect that our operating cash needs will be met by funds generated from operations.
Volatility in the financial markets presents challenges to us as we do occasionally access our investment portfolio as a source of cash. Some of our fixed income investments, despite being publicly traded, are illiquid. Volatility in these markets could limit our ability to sell certain of our fixed income securities or cause such securities to sell at deep discounts. Additionally, our limited partnership investments are significantly less liquid. We believe we have sufficient liquidity to meet our needs from sources other than the liquidation of securities.
Cash flow activities
The following table provides condensed cash flow information for the
nine months
ended
September 30
:
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2017
|
|
2016
|
|
|
(Unaudited)
|
Net cash provided by operating activities
|
|
$
|
120,334
|
|
|
$
|
155,551
|
|
Net cash used in investing activities
|
|
(40,415
|
)
|
|
(96,638
|
)
|
Net cash used in financing activities
|
|
(84,363
|
)
|
|
(101,989
|
)
|
Net decrease in cash and cash equivalents
|
|
$
|
(4,444
|
)
|
|
$
|
(43,076
|
)
|
Net cash provided by operating activities was
$120.3 million
in the first
nine months
of
2017
, compared to
$155.6 million
in the first
nine months
of
2016
. Decreased cash provided by operating activities for the first
nine months
of
2017
was primarily due to higher commissions and bonuses paid to agents, general operating expenses paid and pension contributions, compared to the first
nine months
of
2016
. Cash paid for agent commissions and bonuses increased
$40.6 million
to
$716.6 million
in the first
nine months
of
2017
due to higher scheduled commissions driven by premium growth and higher bonus award payments resulting from profitable underwriting results. Cash paid for general operating expenses increased
$34.3 million
to
$168.0 million
in the first
nine months
of
2017
driven by higher information technology-related professional fees and hardware and software costs. We contributed
$19.0 million
to our pension plan in the first quarter of
2017
and an additional
$20.0 million
in the third quarter of
2017
, compared to
$17.4 million
in the first quarter of
2016
. Our funding policy is generally to contribute an amount equal to the greater of the target normal cost for the plan year or the amount necessary to fund the plan to 100% plus interest to the date the contribution is made. We are reimbursed approximately
58%
of the net periodic benefit cost of the pension plans from the Exchange, which represents pension benefits for our employees performing claims and life insurance functions and their share of service department costs. Somewhat offsetting the decrease in cash provided in first
nine months
of
2017
was an increase in management fee revenue received, reflecting the increase in direct and assumed premiums written by the Exchange, compared to the first
nine months
of
2016
. At
September 30, 2017
, we recorded a net deferred tax asset of
$47.6 million
. There was no deferred tax valuation allowance recorded at
September 30, 2017
.
Net cash used in investing activities totaled
$40.4 million
in the first
nine months
of
2017
, compared to
$96.6 million
in the first
nine months
of
2016
. The decrease in cash used for the first
nine months
of
2017
, compared to the first
nine months
of
2016
, was driven by more cash being generated from the sales, maturities and calls of available-for-sale securities. Also impacting our future investing activities are limited partnership commitments, which totaled
$16.4 million
at
September 30, 2017
, and will be funded as required by the partnerships’ agreements. Of this amount, the total remaining commitment to fund limited partnerships that invest in private equity securities was
$6.6 million
, mezzanine debt securities was
$8.2 million
and real estate activities was
$1.6 million
. Additionally, we have committed to incur future costs related to the construction of the building that will serve as part of our principal headquarters, which is not expected to exceed $100 million and is being funded by the senior secured draw term loan credit facility of the same amount.
Net cash used in financing activities totaled
$84.4 million
in the first
nine months
of
2017
, compared to
$102.0 million
in the first
nine months
of
2016
. The decrease was due to the scheduled draw on the senior secured draw term loan credit facility of $25 million on June 1, 2017, offset by an increase in cash paid for dividends to shareholders. We increased both our Class A and Class B shareholder regular quarterly dividends by
7.2%
for
2017
, compared to
2016
. There are no regulatory restrictions on the payment of dividends to our shareholders. Future financing activities will include the cash draws required under the
senior secured draw term loan credit facility, which will increase the cash provided by financing activities by another $25 million in 2017 and $25 million in 2018, while principal payments will not commence until 2019.
No shares of our Class A nonvoting common stock were repurchased in the first
nine months
of
2017
and
2016
in conjunction with our stock repurchase program. In
October 2011
, our Board of Directors approved a continuation of the current stock repurchase program for a total of
$150 million
with no time limitation. This repurchase authority includes, and is not in addition to, any unspent amounts remaining under the prior authorization. We had approximately
$17.8 million
of repurchase authority remaining under this program at
September 30, 2017
, based upon trade date.
In the first
nine months
of
2017
, we purchased shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program for certain stock-based incentive plans. In January 2017, we purchased 3,785 shares for $0.4 million, or $111.55 per share, for our equity compensation plan, for which the shares were delivered to plan participants in January 2017. In February, May and August 2017, we purchased 2,662, 2,604 and 2,194 shares, respectively, to fund the rabbi trust for the outside director deferred compensation plan. The shares purchased in February for $0.3 million, or $118.69 per share, were transferred to the rabbi trust in March 2017. The shares purchased in May for $0.3 million, or $118.43 per share, were transferred to the rabbi trust in May 2017. The shares purchased in August for $0.3 million, or $128.42 per share, were transferred to the rabbi trust in August 2017. In June 2017, we purchased 46,884 shares for $5.7 million, or $122.40 per share, for the vesting of stock-based awards under the long-term incentive plan, which were delivered to plan participants in June 2017.
In the first
nine months
of
2016
, we purchased shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program for certain stock-based incentive plans. In May and August 2016, we purchased 2,041 and 2,713 shares, respectively, to fund the rabbi trust for the outside director deferred compensation plan. The shares purchased in May for $0.2 million, or $94.73 per share, were transferred to the rabbi trust in May 2016. The shares purchased in August for $0.3 million, or $99.28 per share, were transferred to the rabbi trust in August 2016. In May and June 2016, we purchased 7,661 shares for $0.8 million, or $98.20 per share, for the vesting of stock-based awards under the long-term incentive plan, which were delivered to plan participants in June 2016.
Capital Outlook
We regularly prepare forecasts evaluating the current and future cash requirements for both normal and extreme risk events. Should an extreme risk event result in a cash requirement exceeding normal cash flows, we have the ability to meet our future funding requirements through various alternatives available to us.
Outside of our normal operating and investing cash activities, future funding requirements could be met through:
1) cash and cash equivalents, which total approximately
$184.6 million
at
September 30, 2017
, 2) a
$100 million
bank revolving line of credit, and 3) liquidation of unpledged assets held in our investment portfolio, including investment grade bonds, which totaled approximately
$357.9 million
at
September 30, 2017
. Volatility in the financial markets could impair our ability to sell certain fixed income securities or cause such securities to sell at deep discounts. Additionally, we have the ability to curtail or modify discretionary cash outlays such as those related to shareholder dividends and share repurchase activities.
As of
September 30, 2017
, we have access to a
$100 million
bank revolving line of credit with a
$25 million
letter of credit sublimit that expires on
November 3, 2020
. As of
September 30, 2017
, a total of
$99.1 million
remains available under the facility due to
$0.9 million
outstanding letters of credit, which reduce the availability for letters of credit to
$24.1 million
. We had
no
borrowings outstanding on our line of credit as of
September 30, 2017
. Bonds with a fair value of
$109.5 million
were pledged as collateral on the line at
September 30, 2017
. These securities have no trading restrictions and are reported as available-for-sale securities in the Statements of Financial Position. The bank requires compliance with certain covenants, which include leverage ratios and debt restrictions. We were in compliance with our bank covenants at
September 30, 2017
.
Contractual Obligations
On July 10, 2017, we agreed to the guaranteed maximum price terms of an agreement with our construction manager for the construction of the office building that will serve as part of our principal headquarters. The total cost of the project will not exceed $100 million, which amount is subject to change based on agreed-upon changes to the scope of work. The expected date for substantial completion of the project is January 2020.
Balance Sheet Arrangements
Off-balance sheet arrangements include those with unconsolidated entities that may have a material current or future effect on our financial condition or results of operations, including material variable interests in unconsolidated entities that conduct certain activities. We have no material off-balance sheet obligations or guarantees, other than the unused portion of the senior secured draw term loan credit facility and limited partnership investment commitments.
Surplus Note
We hold a surplus note for $25 million from EFL that is payable on demand on or after
December 31, 2018
; however, no principal or interest payments may be made without prior approval by the Pennsylvania Insurance Commissioner. Interest payments are scheduled to be paid semi-annually. For each of the
nine months
ended
September 30, 2017
and
2016
, we recognized interest income on the note of $1.3 million.
TRANSACTIONS/AGREEMENTS WITH RELATED PARTIES
Leased Property
On April 28, 2017, after securing approval from the Pennsylvania Insurance Department, a new home office lease was executed between the Exchange and Indemnity, which was retroactive to January 1, 2017, when the prior lease expired. Under the new lease, rent is based on rental rates of like property in Erie, Pennsylvania and all operating expenses including utilities, cleaning, repairs, real estate taxes, property insurance and leasehold improvements will be the responsibility of the tenant (Indemnity). Under the previous lease, rents were determined considering returns on invested capital and included building operating and overhead costs. Rent costs and related operating expenses of shared facilities are allocated between Indemnity, Exchange and EFL based upon usage or square footage occupied.
CRITICAL ACCOUNTING ESTIMATES
We make estimates and assumptions that have a significant effect on the amounts and disclosures reported in the financial statements. The most significant estimates relate to investment valuation and retirement benefit plans for employees. While management believes its estimates are appropriate, the ultimate amounts may differ from estimates provided. Our most critical accounting estimates are described in Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" for the year ended
December 31, 2016
of our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on
February 23, 2017
. See Part I, Item 1. "Financial Statements - Note 4, Fair Value, of Notes to Financial Statements" contained within this report for additional information on our valuation of investments.