NOTES TO FINANCIAL STATEMENTS
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.
Our primary function as attorney-in-fact is to perform policy issuance and renewal services on behalf of the subscribers at the Exchange. We also act as attorney-in-fact on behalf of the Exchange with respect to all claims handling and investment management services, as well as the service provider for all claims handling, life insurance, and investment management services for its insurance subsidiaries, collectively referred to as "administrative services". Acting as attorney-in-fact in these
two
capacities 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 for acting as attorney-in-fact in these
two
capacities, we earn a management fee calculated as a percentage of the direct and assumed premiums written by the Exchange.
The policy issuance and renewal services we provide to the Exchange are related to the sales, underwriting and issuance of policies. The sales related services we provide include agent compensation and certain sales and advertising support services. Agent compensation includes scheduled commissions to agents based upon premiums written as well as additional commissions and bonuses to agents, which are earned by achieving targeted measures. Agent compensation comprised approximately
67%
of our
2018
policy issuance and renewal expenses. The underwriting services we provide include underwriting and policy processing and comprised approximately
10%
of our
2018
policy issuance and renewal expenses. The remaining services we provide include customer service and administrative support. We also provide information technology services that support all the functions listed above that comprised approximately
10%
of our
2018
policy issuance and renewal expenses. Included in these expenses are allocations of costs for departments that support these policy issuance and renewal functions.
By virtue of its legal structure as a reciprocal insurer, the Exchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. Claims handling services include costs incurred in the claims process, including the adjustment, investigation, defense, recording and payment functions. Life insurance management services include costs incurred in the management and processing of life insurance business. Investment management services are related to investment trading activity, accounting and all other functions attributable to the investment of funds. Included in these expenses are allocations of costs for departments that support these administrative functions. The amounts incurred for these services are reimbursed to Indemnity at cost in accordance with the subscriber's agreement and the service agreements. State insurance regulations require that intercompany service agreements and any material amendments be approved in advance by the state insurance department.
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 and cost reimbursements. See Note 15, "Concentrations of Credit Risk".
Note 2. Significant Accounting Policies
Basis of presentation
The accompanying financial statements have been prepared in conformity with U.S. generally accepted accounting principles ("GAAP").
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 adopted accounting standards
We adopted Accounting Standards Codification 606,
"Revenue from Contracts with Customers"
("ASC 606") on January 1, 2018, using the modified retrospective method applied to all contracts. We recognized the cumulative effect of initially adopting ASC 606 as an adjustment to the opening balance of retained earnings at January 1, 2018. The comparative information for periods preceding January 1, 2018 has not been restated and continues to be reported under the accounting standards in effect for those periods.
Under ASC 606, we determined that we have
two
performance obligations under the subscriber’s agreement. The first performance obligation is providing policy issuance and renewal services. The second performance obligation is acting as the attorney-in-fact on behalf of the Exchange, as well as the service provider for its insurance subsidiaries, with respect to all administrative services. Therefore, upon adoption of ASC 606 beginning January 1, 2018, the management fee earned per the subscriber’s agreement, currently
25%
of all direct and assumed premiums written by the Exchange, is allocated between the
two
performance obligations. Prior to the adoption of ASC 606, the entire management fee was allocated to the policy issuance and renewal services. Additionally, the expenses we incur and related reimbursements we receive related to the administrative services are presented gross in our Statement of Operations effective January 1, 2018. There was no significant impact to service agreement revenue upon adoption of ASC 606.
Revenue allocated to the policy issuance and renewal services continues to be recognized at the time of policy issuance or renewal because it is at the time of policy issuance or renewal when the economic benefits of the service Indemnity provides (i.e. the substantially completed policy issuance or renewal service) and the control of the promised asset (i.e. the executed insurance policy) transfers to the customer. A significant portion of the management fee is currently allocated to this performance obligation and therefore, the related revenue recognition pattern for the vast majority of our revenues remains unchanged.
The revenue allocated to the second performance obligation is recognized over several years in correlation with the costs incurred because the economic benefit of the services provided (i.e. management of the administrative services) transfers to the customer over a period of time. The amounts incurred for these services are reimbursed to Indemnity at cost in accordance with the subscriber's agreement and the service agreements. On January 1, 2018, we established a contract liability of
$48.5 million
representing the portion of revenue not yet earned related to the administrative services to be provided in subsequent years. We recorded a related deferred tax asset of
$10.2 million
and a cumulative effect adjustment that reduced retained earnings by
$38.3 million
. The adoption of ASC 606 changed the presentation of our Statement of Cash Flows, but had no net impact to our cash flows.
The cumulative effect of the changes made to our Statement of Financial Position at January 1, 2018 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Balance at December 31, 2017
|
Adjustments due to ASC 606
|
Balance at January 1, 2018
|
Statement of Financial Position:
|
|
|
|
|
Assets
|
|
|
|
|
Deferred tax asset
|
|
$
|
19,390
|
|
$
|
10,188
|
|
$
|
29,578
|
|
Liabilities
|
|
|
|
|
Contract liability
|
|
—
|
|
48,514
|
|
48,514
|
|
Equity
|
|
|
|
|
Retained earnings
|
|
2,140,853
|
|
(38,326
|
)
|
2,102,527
|
|
The impact of adoption on our Statement of Financial Position at
December 31, 2018
was as follows:
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|
|
|
|
|
|
|
|
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(in thousands)
|
|
As Reported
|
Balances without ASC 606
|
Impact of Change
Higher/(Lower)
|
|
|
|
Statement of Financial Position:
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|
|
|
|
Assets
|
|
|
|
|
Deferred tax asset
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|
$
|
24,101
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|
$
|
13,238
|
|
$
|
10,863
|
|
Liabilities
|
|
|
|
|
Contract liability
|
|
51,727
|
|
—
|
|
51,727
|
|
Equity
|
|
|
|
|
Retained earnings
|
|
2,231,417
|
|
2,272,281
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(40,864
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)
|
The impact of adoption on our Statement of Operations for the year ended
December 31, 2018
was as follows:
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(in thousands)
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|
As Reported
|
Balances without ASC 606
|
Impact of Change
Higher/(Lower)
|
|
|
|
Statement of Operations:
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|
|
|
|
Management fee revenue allocated to policy issuance and renewal services, gross
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|
$
|
1,721,309
|
|
$
|
1,778,212
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|
$
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(56,903
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)
|
Less: change in allowance for management fee returned on cancelled policies
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|
(1,742
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)
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(1,800
|
)
|
58
|
|
Management fee revenue allocated to policy issuance and renewal services, net
|
|
$
|
1,719,567
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|
$
|
1,776,412
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|
$
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(56,845
|
)
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|
|
|
|
|
|
|
|
|
|
Management fee revenue allocated to administrative services, gross
|
|
$
|
53,694
|
|
$
|
—
|
|
$
|
53,694
|
|
Less: change in allowance for management fee returned on cancelled policies
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|
(62
|
)
|
—
|
|
(62
|
)
|
Management fee revenue allocated to administrative services, net
|
|
53,632
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|
—
|
|
53,632
|
|
Administrative services reimbursement revenue
|
|
580,336
|
|
—
|
|
580,336
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|
Total revenue allocated to administrative services
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$
|
633,968
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|
$
|
—
|
|
$
|
633,968
|
|
|
|
|
|
|
|
|
|
|
|
Administrative services expenses
|
|
$
|
580,336
|
|
$
|
—
|
|
$
|
580,336
|
|
In February 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2018-02,
"Income Statement-Reporting Comprehensive Income-Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income"
, which permits entities to reclassify from accumulated other comprehensive income to retained earnings tax effects stranded in accumulated other comprehensive income as a result of tax reform. ASU 2018-02 is effective for all entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted for reporting periods for which financial statements have not yet been issued or made available for issuance. We elected to early adopt this guidance effective December 31, 2017 using a portfolio method, which resulted in a decrease of
$26.4 million
in accumulated other comprehensive income and a corresponding increase in retained earnings.
In January 2016, the FASB issued ASU 2016-01,
"Financial Instruments-Overall"
. ASU 2016-01 revises the accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. ASU 2016-01 is effective for interim and annual reporting periods beginning after December 15, 2017. We adopted this guidance on a prospective basis effective January 1, 2018. The adoption of this guidance resulted in reclassifying unrealized losses, net of tax, on equity securities from accumulated other comprehensive loss to retained earnings, which reduced retained earnings by
$0.1 million
at January 1, 2018. As of January 1,
2018, equity securities are presented separately in our Statement of Financial Position. Our disclosures were prepared in accordance with this guidance.
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 on a retrospective basis. This amendment also allows only the service cost component to be eligible for capitalization, when applicable, prospectively after the effective date. ASU 2017-07 is effective for interim and annual periods beginning after December 15, 2017. We adopted this guidance effective January 1, 2018 and have included the other components of net benefit costs in "Other income (expense)" in the Statements of Operations and conformed the prior-period presentation. The adoption of this guidance did not have a material impact on the presentation of our financial statements or related disclosures.
In August 2018, the FASB issued ASU 2018-14,
"Compensation-Retirement Benefits-Defined Benefit Plans-General"
, which modifies the disclosure requirements for employers that sponsor defined benefit pension or other post retirement plans. ASU 2018-14 is effective for fiscal years ending after December 15, 2020 and should be applied on a retrospective basis to all periods presented. Early adoption is permitted. We implemented this guidance as of December 31, 2018, and presented our disclosures in accordance with the new requirements. The adoption of this guidance did not have a material impact on our disclosures.
In August 2018, the FASB issued ASU 2018-13,
"Fair Value Measurement"
, which is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. This guidance both modifies and adds new disclosure requirements primarily related to Level 3 fair value measurements. We implemented this guidance as of December 31, 2018, and presented our disclosures in accordance with the new requirements. The adoption of this guidance did not have a material impact on our disclosures.
Recently issued accounting standards
In August 2018, the FASB issued ASU 2018-15,
"Intangibles-Goodwill and Other Internal-Use Software"
, which align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. The amendments under ASU 2018-15 may be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. Early adoption is permitted. We are currently evaluating the impact of ASU 2018-15 on our financial statements and disclosures.
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, and therefore do not 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. Other financial assets subject to this guidance include our receivables from the Exchange and its subsidiaries and agent loans. 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. Accordingly, 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 Statements of Financial Position and to disclose key information about leasing arrangements. Under existing guidance, we recognize our operating lease expense in the Statements of Operations. The new lease guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. In July 2018, the FASB issued ASU 2018-11,
"Leases-Targeted Improvements"
, which permits entities to apply the existing lease guidance in comparative periods and recognize any cumulative effect adjustment in the year of adoption. We will apply this optional transition method upon adoption of ASU 2016-02. Leases for which an asset and related liability are recognized include agreements for real estate, computer equipment, vehicles, and copiers. While we will recognize lease assets and liabilities on our Statement of Financial Position at adoption date, there will not be a material cumulative effect adjustment. New disclosures are required with the adoption of this guidance. There will not be a material impact to our results of operations or cash flows in 2019.
Cash and cash equivalents
–
Cash, money market accounts and other short-term, highly liquid investments with a maturity of
three months
or less at the date of purchase, are considered cash and cash equivalents.
Investments
Available-for-sale securities
– Fixed maturity, preferred stock, and common stock securities, prior to the adoption of ASU 2016-01 on January 1, 2018, are classified as available-for-sale and reported at fair value. Common stock securities classified as available-for-sale represent certain exchange traded funds with underlying holdings of fixed maturity securities. Unrealized holding gains and losses, net of related tax effects, on available-for-sale securities are recorded directly to shareholders' equity as accumulated other comprehensive income (loss). As discussed in the recently adopted accounting standards, we prospectively adopted ASU 2016-01 as of January 1, 2018. Subsequently, changes in the fair value of equity securities formerly classified as available-for-sale, which include preferred and common stock securities, are recognized in earnings rather than in other comprehensive income (loss). Additionally, equity securities are presented separately in the Statement of Financial Position.
Available-for-sale securities with a remaining maturity of
12 months
or less are reported as current assets on the Statements of Financial Position. Realized gains and losses on sales of available-for-sale securities are recognized in income based upon the specific identification method. Interest and dividend income are recognized as earned and recorded to net investment income.
Available-for-sale securities are evaluated monthly for other-than-temporary impairment loss. For fixed maturity securities that have experienced a decline in fair value and that we intend to sell, or for which it is more likely than not we will be required to sell the security before recovery of its amortized cost, an other-than-temporary impairment is deemed to have occurred, and is recognized in earnings. Fixed maturity securities that have experienced a decline in fair value and that we do not intend to sell, and that we will not be required to sell before recovery, are evaluated to determine if the decline in fair value is other-than-temporary.
Some factors considered in this evaluation include:
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|
•
|
the extent and duration to which fair value is less than cost;
|
|
|
•
|
historical operating performance and financial condition of the issuer;
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•
|
short and long-term prospects of the issuer and its industry based upon analysts' recommendations;
|
|
|
•
|
specific events that occurred affecting the issuer, including a ratings downgrade;
|
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|
•
|
near term liquidity position of the issuer; and
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•
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compliance with financial covenants.
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If a decline is deemed to be other-than-temporary, an assessment is made to determine the amount of the total impairment related to a credit loss and that related to all other factors. Consideration is given to all available information relevant to the collectability of the security in this determination. If the entire amortized cost basis of the security will not be recovered, a credit loss exists. Currently, we have the intent to sell all of our securities that have been determined to have a credit-related impairment. As a result, the entire amount of any impairment is recognized in earnings. If we had securities with credit impairments that we did not intend to sell, the non-credit portion of the impairment would be recorded in other comprehensive income.
Limited partnerships
– Limited partnerships include U.S. and foreign private equity, mezzanine debt, and real estate investments. The majority of our limited partnership holdings are considered investment companies and are recorded using the equity method of accounting. For these limited partnerships the general partners record assets at fair value, including any other-than-temporary impairments of these individual investments. Our ownership interest in partnerships accounted for under the equity method is generally less than
10%
, and does not provide us the ability to significantly influence the operations of the partnerships. However, we believe the equity method most appropriately reflects the value of our economic interest in these investments. We also own one real estate limited partnership that does not meet the criteria of an investment company. This partnership prepares audited financial statements on a cost basis. We have elected to report this limited partnership under the fair value option, which is based on the net asset value (NAV) from our partner's capital statement reflecting the general partner's estimate of fair value for the fund's underlying assets. Fair value provides consistency in the evaluation and financial reporting for this limited partnership and limited partnerships accounted for under the equity method. Limited partnerships reported under the fair value option are disclosed in Note 5, "Fair Value" as other limited partnership investments.
Because of the timing of the preparation and delivery of financial statements for limited partnership investments, the use of the most recently available financial statements provided by the general partners results in a quarter delay in the inclusion of the limited partnership results in our Statements of Operations. Due to this delay, these financial statements do not yet reflect the market conditions experienced in the fourth quarter of
2018
for all partnerships other than the real estate limited partnership that is reported under the fair value option.
Nearly all of the underlying investments in our limited partnerships are valued using a source other than quoted prices in active markets. The fair value amounts for our private equity and mezzanine debt partnerships are based upon the financial statements of the general partners, who use multiple methods to estimate fair value including the market approach, income approach or the cost approach. The market approach uses prices and other pertinent information from market-generated transactions involving identical or comparable assets or liabilities. Such valuation techniques often use market multiples derived from a set of comparables. The income approach uses valuation techniques to convert future cash flows or earnings to a single discounted present value amount. The measurement is based upon the value indicated by current market expectations on those future amounts. The cost approach is derived from the amount that is currently required to replace the service capacity of an asset. If information becomes available that would impair the cost of investments owned by the partnerships, then the general partner would adjust to the net realizable value. For real estate limited partnerships, the general partners record these at fair value based upon an independent appraisal or internal estimates of fair value.
While we perform various procedures in review of the general partners' valuations, we rely on the general partners' financial statements as the best available information to record our share of the partnership unrealized gains and losses resulting from valuation changes. Due to the limited market for these investments, there is a greater potential for market price variability.
Unrealized gains and losses for these investments are reflected in equity in (losses) earnings of limited partnerships in our Statements of Operations in accordance with the equity method of accounting or the fair value option, as applicable. Cash contributions made to and distributions received from the partnerships are recorded in the period in which the transaction occurs.
Deferred taxes
Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and the reported amounts in the financial statements, using the statutory tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date under the law. The need for valuation allowances on deferred tax assets are estimated based upon our assessment of the realizability of such amounts.
Fixed assets
Fixed assets are stated at cost less accumulated depreciation and amortization. Fixed assets are primarily comprised of software, which includes internally used capitalized software and development costs, as well as equipment, buildings and building improvements, and leasehold improvements. Assets in use are depreciated using the straight-line method over the estimated useful life except for leasehold improvements, which are depreciated over the shorter of their economic useful life or the lease term. Software is depreciated over periods ranging from
3
-
7 years
, equipment is depreciated over
3
-
10 years
, and buildings and building improvements are depreciated over
20
-
45 years
. We review long-lived assets for impairment whenever events or changes indicate that the carrying value may not be recoverable. Under these circumstances, if the fair value were less than the carrying amount of the asset, we would recognize a loss for the difference. We capitalize applicable interest charges incurred during the construction period of significant long-term building projects as part of the historical cost of the asset.
Other assets
Other assets include agent loans and other long-term assets. Agent loans are carried at unpaid principal balance with interest recorded in investment income as earned. It is our policy to charge the loans that are in default directly to expense. We do not record an allowance for credit losses on these loans, as the majority of the loans are senior secured and historically have had insignificant default amounts.
Agent bonus estimates
Agent bonuses are based upon an individual agency's property and casualty underwriting profitability and also include a component for growth in agency property and casualty premiums if the agency's underwriting profitability targets for the book of business are met. The estimate for agent bonuses, which are based upon the performance over
36 months
, is modeled on a monthly basis using actual underwriting results for the
two
prior years and current year-to-date actual results and forecasted results for the remainder of the year.
At December 31 of each year, we use actual data available and record an accrual based upon the expected payment amount. These costs are included in "Cost of operations - policy issuance and renewal services" in the Statements of Operations.
Recognition of management fee revenue
We earn management fees from the Exchange under the subscriber’s agreement for services provided. Pursuant to the subscriber’s agreement, we may retain up to
25%
of all direct and assumed premiums written by the Exchange. The
management fee rate is set at least annually by our Board of Directors. The management fee revenue is calculated by multiplying the management fee rate by the direct and assumed premiums written by the Exchange. Upon adoption of ASC 606 beginning January 1, 2018, we determined we have
two
performance obligations under the subscriber’s agreement. The first performance obligation is to provide policy issuance and renewal services. The second performance obligation is acting as the attorney-in-fact with respect to the administrative services. Beginning January 1, 2018, our management fee revenue is allocated to these
two
performance obligations. Prior to the adoption of ASC 606, the entire management fee was allocated to the policy issuance and renewal services.
Management fee revenue allocated to the policy issuance and renewal services is recognized at the time of policy issuance or renewal, because it is at the time of policy issuance or renewal when the economic benefit of the service we provide (the substantially completed policy issuance or renewal service) and the control of the promised asset (the executed insurance policy) transfers to the customer.
Management fee revenue allocated to the second performance obligation relates to us acting as the attorney-in-fact on behalf of the Exchange, as well as the service provider for its insurance subsidiaries, with respect to the administrative services and is recognized over a
four
-year period representing the time over which the economic benefit of the services provided (i.e. management of the administrative services) transfers to the customer.
Administrative services
By virtue of its legal structure as a reciprocal insurer, the Exchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services in accordance with the subscriber's agreement. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. Claims handling services include costs incurred in the claims process, including the adjustment, investigation, defense, recording and payment functions. Life insurance management services include costs incurred in the management and processing of life insurance business. Investment management services are related to investment trading activity, accounting and all other functions attributable to the investment of funds. Included in these expenses are allocations of costs for departments that support these administrative functions. Common overhead expenses and certain service department costs incurred by us on behalf of the Exchange and its insurance subsidiaries are reimbursed by the proper entity based upon appropriate utilization statistics (employee count, square footage, vehicle count, project hours, etc.) specifically measured to accomplish proportional allocations, which we believe are reasonable. Prior to the adoption of ASC 606, we recorded the reimbursements we receive for the administrative services expenses as receivables from the Exchange and its subsidiaries with a corresponding reduction to our expenses. Total cash settlements for the Exchange and its subsidiaries were
$522.3 million
and
$496.1 million
in
2017
and
2016
, respectively. Upon adoption of ASC 606 on January 1, 2018, the expenses we incur and related reimbursements we receive for administrative services are presented gross in our Statement of Operations. Reimbursements are settled on a monthly basis. The amounts incurred for these services are reimbursed to Indemnity at cost in accordance with the subscriber's agreement and the service agreements. State insurance regulations require that intercompany service agreements and any material amendments be approved in advance by the state insurance department.
Recognition of service agreement revenue
Service agreement revenue consists of service charges we collect from policyholders for providing multiple payment plans on policies written by the Exchange. Service charges, which are flat dollar charges for each installment billed beyond the first installment, are recognized as revenue when bills are rendered to the policyholder.
Service agreement revenue also includes late payment and policy reinstatement fees, which are also recognized as revenue when bills are rendered to the policyholder.
Reclassifications
Certain amounts previously reported in the 2017 and 2016 financial statements have been reclassified for comparative purposes to conform to the current period’s presentation. One of the reclassifications resulted from new accounting guidance and only affected the Statements of Operations. Most notably, "Commissions", "Salaries and employee benefits", and "All other operating expenses" have been combined within "Cost of operations - policy issuance and renewal services" in the Statements of Operations (see Note 3, "Revenue"). This reclassification had no effect on previously reported net income.
Note 3. Revenue
The
majority of our revenue is derived from the subscriber’s agreement between us and the subscribers (policyholders) at the Exchange. Pursuant to the subscriber’s agreement, we earn a management fee calculated as a percentage, not to exceed
25%
, of all direct and assumed written premiums of the Exchange. We account for management fee revenue earned under the subscriber’s agreement in accordance with ASC 606, which we adopted on January 1, 2018, using the modified retrospective method. See Note 2, "Significant Accounting Policies" for further discussion of the adoption, including the impact on our financial statements.
We allocate a portion of our management fee revenue, currently
25%
of the direct and assumed written premiums of the Exchange, between the
two
performance obligations we have under the subscriber’s agreement. The first performance obligation is to provide policy issuance and renewal services to the subscribers (policyholders) at the Exchange, and the second is to act as attorney-in-fact on behalf of the Exchange, as well as the service provider for its insurance subsidiaries, with respect to all administrative services. The transaction price, including management fee revenue and administrative service reimbursement revenue, is allocated based on the estimated standalone selling prices developed using industry information and other available information for similar services.
The first performance obligation is to provide policy issuance and renewal services that result in executed insurance policies between the Exchange or one of its insurance subsidiaries and the subscriber (policyholder). Our customer, the subscriber (policyholder), receives economic benefits when substantially all the policy issuance or renewal services are complete and an insurance policy is issued or renewed by the Exchange or one of its insurance subsidiaries. It is at the time of policy issuance or renewal that the allocated portion of revenue is recognized.
The Exchange, by virtue of its legal structure as a reciprocal insurer, does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services in accordance with the subscriber's agreement. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. Collectively, these services represent a second performance obligation under the subscriber’s agreement and the service agreements. The revenue allocated to this performance obligation is recognized over time as these services are provided. The portion of revenue not yet earned is recorded as a contract liability in the Statement of Financial Position. We recorded a contract liability of
$48.5 million
at January 1, 2018, upon adoption of ASC 606. The gross management fee revenue recognized as earned for these services for the year ended
December 31, 2018
was
$53.7 million
. Beginning with the adoption of ASC 606 on January 1, 2018, the administrative services expenses we incur and the related reimbursements we receive are recorded gross in the Statement of Operations.
Indemnity records a receivable from the Exchange for management fee revenue when the premium is written or assumed by the Exchange. Indemnity collects the management fee from the Exchange when the Exchange collects the premiums from the subscribers (policyholders). As the Exchange issues policies with annual terms only, cash collections generally occur within one year.
A constraining estimate exists around the management fee received as consideration related to the potential for management fee to be returned if a policy were to be cancelled mid-term. Management fees are returned to the Exchange when policyholders cancel their insurance coverage mid-term and unearned premiums are refunded to them. We maintain an estimated allowance to reduce the management fee to its estimated net realizable value to account for the potential of mid-term policy cancellations based on historical cancellation rates. This estimated allowance has been allocated between the
two
performance obligations consistent with the revenue allocation proportions.
The following table disaggregates revenue by our
two
performance obligations for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
Management fee revenue - policy issuance and renewal services, net
|
|
$
|
1,719,567
|
|
|
$
|
1,662,625
|
|
|
$
|
1,567,431
|
|
|
|
|
|
|
|
|
Management fee revenue - administrative services, net
|
|
53,632
|
|
|
—
|
|
|
—
|
|
Administrative services reimbursement revenue
|
|
580,336
|
|
|
—
|
|
|
—
|
|
Total administrative services
|
|
$
|
633,968
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Note 4. 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 12, "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. See Note 10, "Incentive and Deferred Compensation Plans".
At
December 31, 2017
, we recorded a one-time net non-cash tax expense of
$10.1 million
as a result of the enactment of the Tax Cuts and Jobs Act ("TCJA") on
December 22, 2017
. See Note 11, "Income Taxes". This resulted in a reduction in Class A basic earnings per share of
$0.22
and diluted earnings per share of
$0.19
, and a reduction in Class B basic earnings per share of
$33
and diluted earnings per share of
$32
.
A reconciliation of the numerators and denominators used in the basic and diluted per-share computations is presented as follows for each class of common stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands, except per share data)
|
|
|
|
|
|
|
|
For the years ended December 31,
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
|
|
Allocated net income (numerator)
|
|
Weighted shares (denominator)
|
|
Per- share amount
|
|
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
|
|
$
|
285,864
|
|
|
46,188,637
|
|
|
$
|
6.19
|
|
|
$
|
195,386
|
|
|
46,186,831
|
|
|
$
|
4.23
|
|
|
$
|
208,644
|
|
|
46,188,952
|
|
|
$
|
4.52
|
|
Dilutive effect of stock-based awards
|
|
0
|
|
|
25,776
|
|
|
—
|
|
|
0
|
|
|
49,832
|
|
|
—
|
|
|
0
|
|
|
145,551
|
|
|
—
|
|
Assumed conversion of Class B shares
|
|
2,360
|
|
|
6,100,800
|
|
|
—
|
|
|
1,613
|
|
|
6,100,800
|
|
|
—
|
|
|
1,722
|
|
|
6,100,800
|
|
|
—
|
|
Class A – Diluted EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available to Class A stockholders on Class A equivalent shares
|
|
$
|
288,224
|
|
|
52,315,213
|
|
|
$
|
5.51
|
|
|
$
|
196,999
|
|
|
52,337,463
|
|
|
$
|
3.76
|
|
|
$
|
210,366
|
|
|
52,435,303
|
|
|
$
|
4.01
|
|
Class B – Basic EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available to Class B stockholders
|
|
$
|
2,360
|
|
|
2,542
|
|
|
$
|
928
|
|
|
$
|
1,613
|
|
|
2,542
|
|
|
$
|
635
|
|
|
$
|
1,722
|
|
|
2,542
|
|
|
$
|
678
|
|
Class B – Diluted EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available to Class B stockholders
|
|
$
|
2,359
|
|
|
2,542
|
|
|
$
|
928
|
|
|
$
|
1,613
|
|
|
2,542
|
|
|
$
|
634
|
|
|
$
|
1,721
|
|
|
2,542
|
|
|
$
|
677
|
|
Note 5. Fair Value
Our available-for-sale debt securities and equity 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 debt securities and equity 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 market data, and transaction volumes and believe that the prices adequately consider market activity in determining fair value.
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.
The following tables present our fair value measurements on a recurring basis by asset class and level of input:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2018
|
|
|
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
(1)
|
|
$
|
208,412
|
|
|
$
|
0
|
|
|
$
|
208,412
|
|
|
$
|
0
|
|
States & political subdivisions
(1)
|
|
159,023
|
|
|
0
|
|
|
159,023
|
|
|
0
|
|
Corporate debt securities
|
|
249,947
|
|
|
0
|
|
|
237,370
|
|
|
12,577
|
|
Residential mortgage-backed securities
|
|
4,609
|
|
|
0
|
|
|
4,609
|
|
|
0
|
|
Commercial mortgage-backed securities
|
|
46,515
|
|
|
0
|
|
|
46,515
|
|
|
0
|
|
Collateralized debt obligations
|
|
64,239
|
|
|
0
|
|
|
64,239
|
|
|
0
|
|
Other debt securities
|
|
15,778
|
|
|
0
|
|
|
15,778
|
|
|
0
|
|
Total available-for-sale securities
|
|
748,523
|
|
|
0
|
|
|
735,946
|
|
|
12,577
|
|
Equity securities
|
|
|
|
|
|
|
|
|
Nonredeemable preferred stock - financial services sector
|
|
11,853
|
|
|
1,809
|
|
|
10,044
|
|
|
0
|
|
Total equity securities
|
|
11,853
|
|
|
1,809
|
|
|
10,044
|
|
|
0
|
|
Other limited partnership investments
(2)
|
|
3,206
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total
|
|
$
|
763,582
|
|
|
$
|
1,809
|
|
|
$
|
745,990
|
|
|
$
|
12,577
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 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
|
|
$
|
11,734
|
|
|
$
|
0
|
|
|
$
|
11,734
|
|
|
$
|
0
|
|
States & political subdivisions
|
|
259,264
|
|
|
0
|
|
|
259,264
|
|
|
0
|
|
Foreign government securities
|
|
503
|
|
|
0
|
|
|
503
|
|
|
0
|
|
Corporate debt securities
|
|
346,523
|
|
|
0
|
|
|
338,644
|
|
|
7,879
|
|
Residential mortgage-backed securities
|
|
25,571
|
|
|
0
|
|
|
25,571
|
|
|
0
|
|
Commercial mortgage-backed securities
|
|
32,804
|
|
|
0
|
|
|
32,804
|
|
|
0
|
|
Collateralized debt obligations
|
|
58,034
|
|
|
0
|
|
|
55,834
|
|
|
2,200
|
|
Other debt securities
|
|
11,528
|
|
|
0
|
|
|
11,528
|
|
|
0
|
|
Total fixed maturities
|
|
745,961
|
|
|
0
|
|
|
735,882
|
|
|
10,079
|
|
Nonredeemable preferred stock - financial services sector
|
|
11,659
|
|
|
2,015
|
|
|
9,644
|
|
|
0
|
|
Nonredeemable preferred stock - utilities sector
|
|
1,093
|
|
|
0
|
|
|
1,093
|
|
|
0
|
|
Total available-for-sale securities
|
|
758,713
|
|
|
2,015
|
|
|
746,619
|
|
|
10,079
|
|
Other limited partnership investments
(2)
|
|
4,816
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total
|
|
$
|
763,529
|
|
|
$
|
2,015
|
|
|
$
|
746,619
|
|
|
$
|
10,079
|
|
|
|
(1)
|
In the fourth quarter of 2018, we began selling off our municipal bonds as part of a portfolio rebalancing. We intend to sell the remaining municipal bonds in the first half of 2019. We have currently invested proceeds from these sales in short-term U.S. Treasuries.
|
|
|
(2)
|
The limited partnership investment measured at fair value represents one real estate fund included on the balance sheet as a limited partnership investment 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 investment can never be redeemed with the fund. Instead, distributions are received when liquidation of the underlying assets of the fund occurs. The fair value of this investment 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 partner, 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. During the years ended
December 31, 2018
and 2017,
no
contributions were made and distributions totaling
$1.2 million
and
$0.5 million
, respectively, were received from this investment. There were
no
unfunded commitments related to the investment as of
December 31, 2018
and 2017. In 2018, the one remaining real estate fund was in the process of liquidating the underlying assets. Liquidation of the fund was completed in January 2019.
|
We review the fair value hierarchy classifications each reporting period. Transfers between hierarchy levels may occur due to changes in available market observable inputs.
Level 3 Assets – Year-to-Date Change:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Beginning balance at December 31, 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 December 31, 2018
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate debt securities
|
|
$
|
7,879
|
|
|
$
|
6
|
|
|
$
|
(312
|
)
|
|
$
|
5,550
|
|
|
$
|
(2,854
|
)
|
|
$
|
18,232
|
|
|
$
|
(15,924
|
)
|
|
$
|
12,577
|
|
Collateralized debt obligations
|
|
2,200
|
|
|
0
|
|
|
10
|
|
|
905
|
|
|
0
|
|
|
0
|
|
|
(3,115
|
)
|
|
0
|
|
Total Level 3 available-for-sale securities
|
|
$
|
10,079
|
|
|
$
|
6
|
|
|
$
|
(302
|
)
|
|
$
|
6,455
|
|
|
$
|
(2,854
|
)
|
|
$
|
18,232
|
|
|
$
|
(19,039
|
)
|
|
$
|
12,577
|
|
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 December 31, 2017
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate debt securities
|
|
$
|
9,352
|
|
|
$
|
(85
|
)
|
|
$
|
(41
|
)
|
|
$
|
4,954
|
|
|
$
|
(5,411
|
)
|
|
$
|
11,196
|
|
|
$
|
(12,086
|
)
|
|
$
|
7,879
|
|
Collateralized debt obligations
|
|
0
|
|
|
0
|
|
|
0
|
|
|
2,200
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
2,200
|
|
Total Level 3 available-for-sale securities
|
|
$
|
9,352
|
|
|
$
|
(85
|
)
|
|
$
|
(41
|
)
|
|
$
|
7,154
|
|
|
$
|
(5,411
|
)
|
|
$
|
11,196
|
|
|
$
|
(12,086
|
)
|
|
$
|
10,079
|
|
|
|
(1)
|
These amounts are reported in the Statements of Operations as net investment income and net realized investment gains (losses) for 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.
|
The change in unrealized gains or losses included in other comprehensive income related to Level 3 securities held at the reporting date is as follows for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
Available-for-sale securities:
|
|
|
|
|
|
|
Corporate debt securities
|
|
$
|
(554
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
Net unrealized losses on Level 3 securities held at reporting date
|
|
$
|
(554
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
Quantitative and Qualitative Disclosures about Unobservable Inputs
When a non-binding broker quote was the only input available, the security was classified as Level 3. The quantitative detail of the unobservable inputs is neither provided nor reasonably available to us.
The following table presents our fair value measurements on a recurring basis by pricing source:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
At December 31, 2018
|
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
(1)
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
Priced via pricing services
|
|
$
|
748,480
|
|
|
$
|
0
|
|
|
$
|
735,946
|
|
|
$
|
12,534
|
|
Priced via market comparables/broker quotes
|
|
43
|
|
|
0
|
|
|
0
|
|
|
43
|
|
Total available-for-sale securities
|
|
748,523
|
|
|
0
|
|
|
735,946
|
|
|
12,577
|
|
Equity securities priced via pricing services
|
|
11,853
|
|
|
1,809
|
|
|
10,044
|
|
|
0
|
|
Other limited partnership investments priced via unobservable inputs
(2)
|
|
3,206
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total
|
|
$
|
763,582
|
|
|
$
|
1,809
|
|
|
$
|
745,990
|
|
|
$
|
12,577
|
|
|
|
(1)
|
Securities classified as Level 3 were priced using non-binding broker quotes.
|
|
|
(2)
|
Represents one real estate fund included on the Statements of Financial Position as limited partnership investments that is reported under the fair value option using the NAV practical expedient. These amounts are not required to be categorized in the fair value hierarchy.
|
Financial instruments disclosed, but not carried at fair value
The following table presents the carrying values and fair value measurements, which are categorized as Level 3 in the fair value hierarchy, of financial instruments disclosed, but not carried at fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2018
|
|
At December 31, 2017
|
(in thousands)
|
|
Carrying Value
|
|
Fair Value
|
|
Carrying Value
|
|
Fair Value
|
Agent loans
(1)
|
|
$
|
58,006
|
|
|
$
|
54,110
|
|
|
$
|
21,849
|
|
|
$
|
21,849
|
|
Long-term borrowings
|
|
99,730
|
|
|
94,057
|
|
|
74,728
|
|
|
72,424
|
|
|
|
(1)
|
The fair value of agent loans approximates carrying value at December 31, 2017.
|
Note 6. Investments
Available-for-sale securities
The following tables summarize the cost and fair value of our available-for-sale securities. See also Note 5, "Fair Value" for additional fair value disclosures.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2018
|
(in thousands)
|
|
Amortized cost
|
|
Gross unrealized gains
|
|
Gross unrealized losses
|
|
Estimated fair value
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
U.S. Treasury
(1)
|
|
$
|
208,610
|
|
|
$
|
18
|
|
|
$
|
216
|
|
|
$
|
208,412
|
|
States & political subdivisions
(1)
|
|
157,003
|
|
|
2,020
|
|
|
0
|
|
|
159,023
|
|
Corporate debt securities
|
|
259,362
|
|
|
139
|
|
|
9,554
|
|
|
249,947
|
|
Residential mortgage-backed securities
|
|
4,603
|
|
|
38
|
|
|
32
|
|
|
4,609
|
|
Commercial mortgage-backed securities
|
|
47,022
|
|
|
80
|
|
|
587
|
|
|
46,515
|
|
Collateralized debt obligations
|
|
65,039
|
|
|
30
|
|
|
830
|
|
|
64,239
|
|
Other debt securities
|
|
15,756
|
|
|
33
|
|
|
11
|
|
|
15,778
|
|
Total available-for-sale securities
|
|
$
|
757,395
|
|
|
$
|
2,358
|
|
|
$
|
11,230
|
|
|
$
|
748,523
|
|
|
|
(1)
|
In the fourth quarter of 2018, we began selling off our municipal bonds as part of a portfolio rebalancing. We intend to sell the remaining municipal bonds in the first half of 2019. We have currently invested proceeds from these sales in short-term U.S. Treasuries.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2017
|
(in thousands)
|
|
Amortized cost
|
|
Gross unrealized gains
|
|
Gross unrealized losses
|
|
Estimated fair value
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
U.S. Treasury
|
|
$
|
11,873
|
|
|
$
|
0
|
|
|
$
|
139
|
|
|
$
|
11,734
|
|
States & political subdivisions
|
|
254,533
|
|
|
5,351
|
|
|
620
|
|
|
259,264
|
|
Foreign government securities
|
|
501
|
|
|
2
|
|
|
0
|
|
|
503
|
|
Corporate debt securities
|
|
346,759
|
|
|
1,688
|
|
|
1,924
|
|
|
346,523
|
|
Residential mortgage-backed securities
|
|
25,324
|
|
|
371
|
|
|
124
|
|
|
25,571
|
|
Commercial mortgage-backed securities
|
|
33,475
|
|
|
26
|
|
|
697
|
|
|
32,804
|
|
Collateralized debt obligations
|
|
57,838
|
|
|
237
|
|
|
41
|
|
|
58,034
|
|
Other debt securities
|
|
11,496
|
|
|
32
|
|
|
0
|
|
|
11,528
|
|
Total fixed maturities
|
|
741,799
|
|
|
7,707
|
|
|
3,545
|
|
|
745,961
|
|
Nonredeemable preferred stock - financial services sector
|
|
11,719
|
|
|
15
|
|
|
75
|
|
|
11,659
|
|
Nonredeemable preferred stock - utilities sector
|
|
1,118
|
|
|
0
|
|
|
25
|
|
|
1,093
|
|
Total available-for-sale securities
|
|
$
|
754,636
|
|
|
$
|
7,722
|
|
|
$
|
3,645
|
|
|
$
|
758,713
|
|
The amortized cost and estimated fair value of available-for-sale securities at
December 31, 2018
, are shown below by remaining contractual term to maturity. Mortgage-backed securities are allocated based upon 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 December 31, 2018
|
(in thousands)
|
|
Amortized
|
|
Estimated
|
|
|
cost
|
|
fair value
|
Due in one year or less
|
|
$
|
263,957
|
|
|
$
|
263,837
|
|
Due after one year through five years
|
|
163,276
|
|
|
160,504
|
|
Due after five years through ten years
|
|
217,659
|
|
|
212,692
|
|
Due after ten years
|
|
112,503
|
|
|
111,490
|
|
Total available-for-sale securities
(1)
|
|
$
|
757,395
|
|
|
$
|
748,523
|
|
(1) The contractual maturities of our municipal bond portfolio are included in the table. However, given our intent to sell this portfolio, municipal bond securities are classified as current assets in our Statements of Financial Position at December 31, 2018.
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 December 31, 2018
|
(dollars in thousands)
|
|
Less than 12 months
|
|
12 months or longer
|
|
Total
|
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
No. of
|
|
|
value
|
|
losses
|
|
value
|
|
losses
|
|
value
|
|
losses
|
|
holdings
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury
|
|
$
|
129,474
|
|
|
$
|
19
|
|
|
$
|
11,656
|
|
|
$
|
197
|
|
|
$
|
141,130
|
|
|
$
|
216
|
|
|
7
|
|
Corporate debt securities
|
|
157,300
|
|
|
6,866
|
|
|
86,586
|
|
|
2,688
|
|
|
243,886
|
|
|
9,554
|
|
|
635
|
|
Residential mortgage-backed securities
|
|
777
|
|
|
6
|
|
|
1,618
|
|
|
26
|
|
|
2,395
|
|
|
32
|
|
|
3
|
|
Commercial mortgage-backed securities
|
|
17,624
|
|
|
175
|
|
|
16,997
|
|
|
412
|
|
|
34,621
|
|
|
587
|
|
|
30
|
|
Collateralized debt obligations
|
|
55,246
|
|
|
826
|
|
|
1,248
|
|
|
4
|
|
|
56,494
|
|
|
830
|
|
|
39
|
|
Other debt securities
|
|
8,213
|
|
|
11
|
|
|
0
|
|
|
0
|
|
|
8,213
|
|
|
11
|
|
|
7
|
|
Total available-for-sale securities
|
|
$
|
368,634
|
|
|
$
|
7,903
|
|
|
$
|
118,105
|
|
|
$
|
3,327
|
|
|
$
|
486,739
|
|
|
$
|
11,230
|
|
|
721
|
|
Quality breakdown of available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment grade
|
|
$
|
242,821
|
|
|
$
|
1,295
|
|
|
$
|
98,118
|
|
|
$
|
1,641
|
|
|
$
|
340,939
|
|
|
$
|
2,936
|
|
|
147
|
|
Non-investment grade
|
|
125,813
|
|
|
6,608
|
|
|
19,987
|
|
|
1,686
|
|
|
145,800
|
|
|
8,294
|
|
|
574
|
|
Total available-for-sale securities
|
|
$
|
368,634
|
|
|
$
|
7,903
|
|
|
$
|
118,105
|
|
|
$
|
3,327
|
|
|
$
|
486,739
|
|
|
$
|
11,230
|
|
|
721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2017
|
(dollars in thousands)
|
|
Less than 12 months
|
|
12 months or longer
|
|
Total
|
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
No. of
|
|
|
value
|
|
losses
|
|
value
|
|
losses
|
|
value
|
|
losses
|
|
holdings
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury
|
|
$
|
10,237
|
|
|
$
|
110
|
|
|
$
|
1,497
|
|
|
$
|
29
|
|
|
$
|
11,734
|
|
|
$
|
139
|
|
|
4
|
|
States & political subdivisions
|
|
52,553
|
|
|
288
|
|
|
14,361
|
|
|
332
|
|
|
66,914
|
|
|
620
|
|
|
33
|
|
Corporate debt securities
|
|
171,154
|
|
|
1,585
|
|
|
31,113
|
|
|
339
|
|
|
202,267
|
|
|
1,924
|
|
|
331
|
|
Residential mortgage-backed securities
|
|
4,156
|
|
|
29
|
|
|
7,064
|
|
|
95
|
|
|
11,220
|
|
|
124
|
|
|
11
|
|
Commercial mortgage-backed securities
|
|
10,836
|
|
|
85
|
|
|
11,984
|
|
|
612
|
|
|
22,820
|
|
|
697
|
|
|
19
|
|
Collateralized debt obligations
|
|
21,598
|
|
|
41
|
|
|
0
|
|
|
0
|
|
|
21,598
|
|
|
41
|
|
|
12
|
|
Other debt securities
|
|
1,499
|
|
|
0
|
|
|
0
|
|
|
0
|
|
|
1,499
|
|
|
0
|
|
|
1
|
|
Total fixed maturities
|
|
272,033
|
|
|
2,138
|
|
|
66,019
|
|
|
1,407
|
|
|
338,052
|
|
|
3,545
|
|
|
411
|
|
Nonredeemable preferred stock - financial services sector
|
|
9,644
|
|
|
75
|
|
|
0
|
|
|
0
|
|
|
9,644
|
|
|
75
|
|
|
5
|
|
Nonredeemable preferred stock - utilities sector
|
|
1,093
|
|
|
25
|
|
|
0
|
|
|
0
|
|
|
1,093
|
|
|
25
|
|
|
1
|
|
Total available-for-sale securities
|
|
$
|
282,770
|
|
|
$
|
2,238
|
|
|
$
|
66,019
|
|
|
$
|
1,407
|
|
|
$
|
348,789
|
|
|
$
|
3,645
|
|
|
417
|
|
Quality breakdown of fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment grade
|
|
$
|
214,586
|
|
|
$
|
1,064
|
|
|
$
|
62,193
|
|
|
$
|
985
|
|
|
$
|
276,779
|
|
|
$
|
2,049
|
|
|
158
|
|
Non-investment grade
|
|
57,447
|
|
|
1,074
|
|
|
3,826
|
|
|
422
|
|
|
61,273
|
|
|
1,496
|
|
|
253
|
|
Total fixed maturities
|
|
$
|
272,033
|
|
|
$
|
2,138
|
|
|
$
|
66,019
|
|
|
$
|
1,407
|
|
|
$
|
338,052
|
|
|
$
|
3,545
|
|
|
411
|
|
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, which are recognized in earnings.
Net investment income
Investment income, net of expenses, was generated from the following portfolios for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
Fixed maturities
(1)
|
|
$
|
24,978
|
|
|
$
|
23,587
|
|
|
$
|
20,175
|
|
Equity securities
|
|
628
|
|
|
82
|
|
|
171
|
|
Cash equivalents and other
|
|
5,628
|
|
|
2,486
|
|
|
1,391
|
|
Total investment income
|
|
31,234
|
|
|
26,155
|
|
|
21,737
|
|
Less: investment expenses
|
|
1,025
|
|
|
1,516
|
|
|
1,179
|
|
Investment income, net of expenses
|
|
$
|
30,209
|
|
|
$
|
24,639
|
|
|
$
|
20,558
|
|
|
|
(1)
|
Includes interest earned on note receivable from Erie Family Life Insurance Company ("EFL") of
$1.6 million
in 2018 and $
1.7 million
in 2017 and 2016.
|
Realized investment (losses) gains
Realized (losses) gains on investments were as follows for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
Available-for-sale securities:
|
|
|
|
|
|
|
Gross realized gains
|
|
$
|
1,892
|
|
|
$
|
2,996
|
|
|
$
|
2,112
|
|
Gross realized losses
|
|
(3,189
|
)
|
|
(1,756
|
)
|
|
(2,147
|
)
|
Net realized (losses) gains on available-for-sale securities
|
|
(1,297
|
)
|
|
1,240
|
|
|
(35
|
)
|
Equity securities
|
|
(819
|
)
|
|
—
|
|
|
—
|
|
Common stock trading securities
|
|
—
|
|
|
0
|
|
|
707
|
|
Other
|
|
106
|
|
|
94
|
|
|
0
|
|
Net realized investment (losses) gains
|
|
$
|
(2,010
|
)
|
|
$
|
1,334
|
|
|
$
|
672
|
|
The portion of net unrealized losses recognized during the reporting period related to equity securities held at the reporting date is calculated as follows for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
Equity securities:
(1)
|
|
|
|
|
|
|
Net losses recognized during the period
|
|
$
|
(819
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
Less: net losses recognized on securities sold
|
|
(86
|
)
|
|
—
|
|
|
—
|
|
Net unrealized losses recognized on securities held at reporting date
|
|
$
|
(733
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
(1)
|
With the adoption of ASU 2016-01 effective January 1, 2018, changes in unrealized gains and losses on equity securities are included in net realized investment gains (losses) in the Statement of Operations. The adoption of this guidance resulted in a reclassification of net unrealized losses of
$0.1 million
from accumulated other comprehensive loss to retained earnings at January 1, 2018.
|
Other-than-temporary impairments on available-for-sale securities recognized in earnings were
$1.6 million
,
$0.2 million
and
$0.4 million
for the years ended December 31, 2018, 2017 and 2016, respectively. We have the intent to sell all credit-impaired available-for-sale debt securities; therefore, the entire amount of the impairment charges were included in earnings and
no
non-credit impairments were recognized in other comprehensive income. See also Note 2, "Significant Accounting Policies".
Limited partnerships
The majority of our limited partnership holdings are considered investment companies where the general partners record assets at fair value. These limited partnerships are recorded using the equity method of accounting and are generally reported on a one-quarter lag; therefore, our year-to-date limited partnership results through
December 31, 2018
are comprised of partnership financial results for the fourth quarter of
2017
and the first, second and third quarters of
2018
. Given the lag in reporting, our limited partnership results do not reflect the market conditions of the fourth quarter of
2018
. We also own one real estate limited partnership that does not meet the criteria of an investment company. This partnership prepares audited financial statements on a cost basis. We have elected to report this limited partnership under the fair value option, which is based on the NAV from our partner's capital statement reflecting the general partner's estimate of fair value for the fund's underlying assets. Fair value provides consistency in the evaluation and financial reporting for this limited partnership and limited partnerships accounted for under the equity method. Cash contributions made to and distributions received from the partnerships are recorded in the period in which the transaction occurs.
Equity in (losses) earnings of limited partnerships by method of accounting were as follows for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
Equity in (losses) earnings of limited partnerships - equity method
|
|
$
|
(448
|
)
|
|
$
|
1,925
|
|
|
$
|
6,273
|
|
Change in fair value of limited partnerships - fair value option
|
|
(374
|
)
|
|
876
|
|
|
752
|
|
Equity in (losses) earnings of limited partnerships
|
|
$
|
(822
|
)
|
|
$
|
2,801
|
|
|
$
|
7,025
|
|
The following table summarizes limited partnership investments by sector at December 31:
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
Private equity
|
|
$
|
28,271
|
|
|
$
|
31,663
|
|
Mezzanine debt
|
|
1,152
|
|
|
3,516
|
|
Real estate
|
|
2,192
|
|
|
5,127
|
|
Real estate - fair value option
|
|
3,206
|
|
|
4,816
|
|
Total limited partnership investments
|
|
$
|
34,821
|
|
|
$
|
45,122
|
|
See also Note 16, "Commitments and Contingencies", for investment commitments related to limited partnerships.
Note 7. Fixed Assets
The following table summarizes our fixed assets by category at December 31:
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
Land, buildings, and building improvements
|
|
$
|
—
|
|
|
$
|
7,627
|
|
Leasehold improvements
|
|
617
|
|
|
1,375
|
|
Software
|
|
163,735
|
|
|
129,553
|
|
Equipment
|
|
15,075
|
|
|
13,858
|
|
Projects in progress
|
|
10,392
|
|
|
21,898
|
|
Construction in progress
|
|
66,088
|
|
|
26,312
|
|
Total fixed assets, gross
|
|
255,907
|
|
|
200,623
|
|
Less: Accumulated depreciation and amortization
|
|
(125,075
|
)
|
|
(117,474
|
)
|
Fixed assets, net
|
|
$
|
130,832
|
|
|
$
|
83,149
|
|
On
December 31, 2018
, we sold the field offices we owned to the Exchange at the current independent appraised value in order to align the ownership interest of these facilities with the functions being performed at these locations, which are claims-related activities. We recognized a gain on the sale of
$3.4 million
, which is included in "Other income (expense)" in the Statements of Operations. See Note 14, "Related Party".
Software increased primarily related to an investment in platform technology, as well as internally developed software projects in progress that were completed and placed in production related to providing new quote and application processing capabilities for commercial lines and new web-based system functionality for personal lines.
Projects in progress include certain computer software and software developments costs for internal use that are not yet subject to amortization.
In 2016, we announced the construction of a new office building that will serve as part of our principal headquarters. The costs associated with this project are included in construction in progress. Capitalized interest included in construction in progress was
$2.1 million
at
December 31, 2018
and
$0.6 million
at
December 31, 2017
, respectively. The building is expected to be completed in
2020
and is financed using a senior secured draw term loan credit facility. See Note 8, "Borrowing Arrangements".
For the years ended
December 31, 2018
,
2017
and
2016
, depreciation and amortization of fixed assets totaled
$13.4 million
,
$14.8 million
and
$15.1 million
, respectively, and is included in "Cost of operations - policy issuance and renewal services" in the Statements of Operations.
Note 8. Borrowing Arrangements
Bank Line of Credit
As of
December 31, 2018
, we have access to a
$100 million
bank revolving line of credit with a
$25 million
letter of credit sublimit that expires on
October 30, 2023
. As of
December 31, 2018
, a total of
$99.1 million
remains available under the facility due to
$0.9 million
outstanding letters of credit, which reduces the availability for letters of credit to
$24.1 million
. We had
no
borrowings outstanding on our line of credit as of
December 31, 2018
. Bonds with a fair value of
$108.7 million
were pledged as collateral on the line at
December 31, 2018
. The securities pledged as collateral have no trading restrictions and are reported as available-for-sale securities in the Statements of Financial Position as of
December 31, 2018
. The banks require compliance with certain covenants, which include leverage ratios and debt restrictions, for our line of credit. We are in compliance with all covenants at
December 31, 2018
.
Term Loan Credit Facility
In 2016, we entered into a credit agreement for a
$100 million
senior secured draw term loan credit facility ("Credit Facility") for the acquisition of real property and construction of an office building that will serve as part of our principal headquarters. Under the agreement,
$25 million
was drawn on December 1, 2016, June 1, 2017, December 1, 2017, and June 1, 2018, for a total drawn amount of
$100 million
. During the draw period from December 1, 2016 through December 31, 2018, we made monthly interest payments under the Credit Facility. At expiration of the draw period, the Credit Facility converted to a fully-amortized term loan with monthly payments of principal and interest over a period of
28 years
, commencing on January 1, 2019. Borrowings under the Credit Facility will bear interest at a fixed rate of
4.35%
. In addition, we were required to pay a quarterly commitment fee of
0.08%
on the unused portion of the Credit Facility during the draw period. Bonds with a fair value of
$114.3 million
were pledged as collateral for the facility and are reported as available-for-sale securities in the Statements of Financial Position as of
December 31, 2018
. The bank requires compliance with certain covenants, which include leverage ratios, debt restrictions and minimum net worth, for our Credit Facility. We are in compliance with all covenants at
December 31, 2018
.
Amounts drawn from the Credit Facility are reported at carrying value on our Statements of Financial Position, net of unamortized loan origination and commitment fees. See Note 5, "Fair Value" for the estimated fair value of these borrowings.
Annual principal payments
The scheduled maturity of the
$100 million
Credit Facility began on January 1, 2019. The following table sets forth future principal payments:
|
|
|
|
|
(in thousands)
|
|
|
Year
|
|
Principal payments
|
2019
|
$
|
1,870
|
|
2020
|
|
1,953
|
|
2021
|
|
2,040
|
|
2022
|
|
2,130
|
|
2023
|
|
2,225
|
|
Thereafter
|
|
89,782
|
|
Note 9. Postretirement Benefits
Pension plans
Our pension plans consist of a noncontributory defined benefit pension plan covering substantially all employees and an unfunded supplemental employee retirement plan ("SERP") for certain members of executive and senior management. The pension plans provide benefits to covered individuals satisfying certain age and service requirements. The defined benefit pension plan and SERP each provide benefits through a final average earnings formula.
Although we are the sponsor of these postretirement plans and record the funded status of these plans, the Exchange and its subsidiaries reimburse us for approximately
59%
of the annual benefit expense of these plans, which represents pension benefits for employees performing administrative services and their allocated share of costs for employees in departments that support the administrative functions. For our funded pension plan, amounts are settled in cash for the portion of pension costs allocated to the Exchange and its subsidiaries. For our unfunded plans, we pay the obligations when due and amounts are settled in cash between entities when there is a payout.
Cost of pension plans
Pension plan cost includes the following components:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
|
Service cost for benefits earned
|
|
$
|
38,052
|
|
|
$
|
31,106
|
|
|
$
|
28,201
|
|
|
Interest cost on benefit obligation
|
|
35,382
|
|
|
34,275
|
|
|
33,125
|
|
|
Expected return on plan assets
|
|
(51,260
|
)
|
|
(41,267
|
)
|
|
(39,520
|
)
|
|
Prior service cost amortization
|
|
1,353
|
|
|
871
|
|
|
696
|
|
|
Net actuarial loss amortization
|
|
12,809
|
|
|
9,301
|
|
|
8,111
|
|
|
Settlement cost
(1)
|
|
—
|
|
|
302
|
|
|
—
|
|
|
Pension plan cost
(2)
|
|
$
|
36,336
|
|
|
$
|
34,588
|
|
|
$
|
30,613
|
|
|
|
|
(1)
|
The final SERP benefit for
two
former executives was settled with lump sum payments in 2017.
|
|
|
(2)
|
Pension plan costs represent the total cost before reimbursements to Indemnity from the Exchange and its subsidiaries.
|
Actuarial assumptions
The following table describes the assumptions at December 31 used to measure the year-end obligations and the net periodic benefit costs for the subsequent year:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
|
2015
|
|
Employee pension plan:
|
|
|
|
|
|
|
|
|
|
Discount rate
|
|
4.47
|
%
|
|
3.73
|
%
|
|
4.24
|
%
|
|
4.57
|
%
|
|
Expected return on assets
|
|
6.75
|
|
|
6.75
|
|
|
7.00
|
|
|
7.00
|
|
|
Compensation increases
(1)
|
|
3.32
|
|
|
3.32
|
|
|
3.32
|
|
|
3.32
|
|
|
SERP:
|
|
|
|
|
|
|
|
|
|
|
Discount rate – pre-retirement/post-retirement
|
|
4.47/3.97
|
|
|
3.73/3.23
|
|
|
4.24/3.74
|
|
|
4.57/4.07
|
|
|
Rate of compensation increase
|
|
5.00
|
|
|
5.00
|
|
|
5.00
|
|
|
5.00
|
|
|
|
|
(1)
|
The rate of compensation increase for the employee plan is age-graded. An equivalent single compensation increase rate of
3.32%
in
2018
,
2017
and
2016
would produce similar results.
|
The economic assumptions that have the most impact on the postretirement benefits expense are the discount rate and the long-term rate of return on plan assets. The discount rate assumption used to determine the benefit obligation for all periods presented was based upon a yield curve developed from corporate bond yield information.
The pension plan's expected long-term rate of return represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. To determine the expected long-term rate of return assumption, we utilized models based upon rigorous historical analysis and forward-looking views of the financial markets based upon key factors such as historical returns for the asset class' applicable indices, the correlations of the asset classes under various market conditions and consensus views on future real economic growth and inflation. The expected future return for each asset class is then combined by considering correlations between asset classes and the volatilities of each asset class to produce a reasonable range of asset return results within which our expected long-term rate of return assumption falls.
Funding policy/funded status
In
2018
, we made accelerated pension contributions totaling
$80 million
. Following our
2018
contributions, we would not expect to make a subsequent contribution until the sum of the target normal costs for plan years beginning on and after
December 31, 2017
exceeds
$80 million
, or earlier if a contribution is necessary to fund the plan to
100%
. At that time, our funding policy will again generally be to contribute an amount equal or greater of the target normal cost for the plan year, or the amount necessary to fund the plan to
100%
. Additional contributions may be necessary or desirable due to future plan changes, our particular business or investment strategy, or pending law changes. In 2017, in addition to our planned contribution of
$19.0 million
, we made additional unplanned contributions of
$39.9 million
. The following table sets forth the funded status of the pension plans and the amounts recognized in the Statements of Financial Position at December 31:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
2018
|
|
2017
|
|
Funded status at end of year
|
|
$
|
(118,596
|
)
|
|
$
|
(207,766
|
)
|
|
|
|
|
|
|
|
Pension liabilities – due within one year
(1)
|
|
$
|
(1,730
|
)
|
|
$
|
(236
|
)
|
|
Pension liabilities – due after one year
|
|
(116,866
|
)
|
|
(207,530
|
)
|
|
Net amount recognized
|
|
$
|
(118,596
|
)
|
|
$
|
(207,766
|
)
|
|
(1) The current portion of pension liabilities is included in accounts payable and accrued liabilities in the Statements of Financial Position.
Benefit obligations
Benefit obligations are described in the following tables. Accumulated and projected benefit obligations represent the obligations of a pension plan for past service as of the measurement date. The accumulated benefit obligation is the present value of pension benefits earned as of the measurement date based on employee service and compensation prior to that date. It differs from the projected benefit obligation in that the accumulated benefit obligation includes no assumptions to reflect expected future compensation. The following table sets forth a reconciliation of beginning and ending balances of the projected benefit obligation, as well as the accumulated benefit obligation at December 31:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
2018
|
|
2017
|
|
Projected benefit obligation, beginning of year
|
|
$
|
951,666
|
|
|
$
|
816,659
|
|
|
Service cost for benefits earned
|
|
38,052
|
|
|
31,106
|
|
|
Interest cost on benefit obligation
|
|
35,382
|
|
|
34,275
|
|
|
Plan amendments
|
|
3,007
|
|
|
5,050
|
|
|
Actuarial (gain) loss
|
|
(123,910
|
)
|
|
82,940
|
|
|
Benefits paid
|
|
(18,032
|
)
|
|
(16,184
|
)
|
|
Settlement cost
|
|
—
|
|
|
(2,180
|
)
|
|
Projected benefit obligation, end of year
|
|
$
|
886,165
|
|
|
$
|
951,666
|
|
|
|
|
|
|
|
|
Accumulated benefit obligation, end of year
|
|
$
|
727,340
|
|
|
$
|
767,527
|
|
|
Projected benefit obligations decreased
$65.5 million
at
December 31, 2018
compared to
December 31, 2017
due primarily to actuarial gains resulting from the increase in the discount rate used to measure the future benefit obligations. The discount rate increased to
4.47%
in 2018 from
3.73%
in 2017.
The following table describes plans with assets less than projected benefit obligation at December 31:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Projected Benefit Obligation in Excess of Plan Assets
|
|
|
|
2018
|
|
2017
|
|
Projected benefit obligation
|
|
$
|
886,165
|
|
|
$
|
951,666
|
|
|
Plan assets
|
|
767,569
|
|
|
743,900
|
|
|
At December 31, 2018 and 2017, both the defined benefit plan and the SERP had projected benefit obligations in excess of plan assets.
The following table describes plans with assets less than accumulated benefit obligation at December 31:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Accumulated Benefit Obligation in Excess of Plan Assets
|
|
|
|
2018
|
|
2017
|
|
Accumulated benefit obligation
|
|
$
|
18,908
|
|
|
$
|
767,527
|
|
|
Plan assets
|
|
—
|
|
|
743,900
|
|
|
At
December 31, 2018
, the SERP had an accumulated benefit obligation in excess of plan assets. At December 31, 2017, both the defined benefit plan and the SERP had accumulated benefit obligations in excess of plan assets.
Pension assets
The following table sets forth a reconciliation of beginning and ending balances of the fair value of plan assets at December 31:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
2018
|
|
2017
|
|
Fair value of plan assets, beginning of year
|
|
$
|
743,900
|
|
|
$
|
592,544
|
|
|
Actual (loss) gain on plan assets
|
|
(38,360
|
)
|
|
108,618
|
|
|
Employer contributions
|
|
80,061
|
|
|
61,102
|
|
|
Benefits paid
|
|
(18,032
|
)
|
|
(16,184
|
)
|
|
Settlements
(1)
|
|
—
|
|
|
(2,180
|
)
|
|
Fair value of plan assets, end of year
|
|
$
|
767,569
|
|
|
$
|
743,900
|
|
|
|
|
(1)
|
The final SERP benefit for
two
former executives was settled with lump sum payments in
2017
.
|
Accumulated other comprehensive income
Net actuarial loss and prior service cost included in accumulated other comprehensive income that were not yet recognized as components of net benefit costs were as follows:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
2018
|
|
2017
|
|
Net actuarial loss
|
|
$
|
144,165
|
|
|
$
|
191,264
|
|
|
Prior service cost
|
|
11,855
|
|
|
10,201
|
|
|
Net amount not yet recognized
|
|
$
|
156,020
|
|
|
$
|
201,465
|
|
|
Other comprehensive income
Amounts recognized in other comprehensive income for pension plans were as follows:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
2018
|
|
2017
|
|
Net actuarial (gain) loss arising during the year
|
|
$
|
(34,290
|
)
|
|
$
|
15,588
|
|
|
Amortization of net actuarial loss
|
|
(12,809
|
)
|
|
(9,301
|
)
|
|
Amortization of prior service cost
|
|
(1,353
|
)
|
|
(871
|
)
|
|
Amendments
(1)
|
|
3,007
|
|
|
5,050
|
|
|
Impact due to settlement
(2)
|
|
—
|
|
|
(302
|
)
|
|
Total recognized in other comprehensive income
|
|
$
|
(45,445
|
)
|
|
$
|
10,164
|
|
|
|
|
(1)
|
In 2018, there were
five
new SERP participants. In
2017
, amendments include an enactment to the surviving spouse's death benefits, which increased the pension plan obligation by
$3.6 million
and the SERP obligation by
$0.3 million
, additionally there were
two
new SERP participants in
2017
, which contributed
$1.2 million
.
|
|
|
(2)
|
The final SERP benefit for
two
former executives was settled with lump sum payments in
2017
.
|
Asset allocation
The employee pension plan utilizes a return seeking and a liability asset matching allocation strategy. It is based upon the understanding that 1) equity investments are expected to outperform debt investments over the long-term, 2) the potential volatility of short-term returns from equities is acceptable in exchange for the larger expected long-term returns, and 3) a portfolio structured across investment styles and markets (both domestic and foreign) reduces volatility. As a result, the employee pension plan's investment portfolio utilizes a broadly diversified asset allocation across domestic and foreign equity and debt markets. The investment portfolio is composed of commingled pools that are dedicated exclusively to the management of employee benefit plan assets.
The target and actual asset allocations for the portfolio are as follows for the years ended December 31:
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Target asset
allocation
(1)
|
|
Target asset
allocation
|
|
Actual asset
allocation
|
|
Actual asset
allocation
|
|
Asset allocation:
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
U.S. equity securities
|
|
25
|
%
|
(2)
|
35
|
%
|
|
24
|
%
|
|
39
|
%
|
|
Non-U.S. equity securities
|
|
16
|
|
(3)
|
20
|
|
|
14
|
|
|
19
|
|
|
Total equity securities
|
|
41
|
|
|
55
|
|
|
38
|
|
|
58
|
|
|
Debt securities
|
|
58
|
|
(4)
|
44
|
|
|
61
|
|
|
41
|
|
|
Other
|
|
1
|
|
(5)
|
1
|
|
|
1
|
|
|
1
|
|
|
Total
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
|
|
(1)
|
Changes to the target asset allocation in 2018 were made to reduce investment risk by shifting portfolio assets from equity securities to debt securities.
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|
(2)
|
U.S. equity securities
–
21%
seek to achieve excess returns relative to the Russell 2000 Index. The remaining
79%
of the allocation to U.S. equity securities are comprised of equity index funds that track the S&P 500.
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|
|
(3)
|
Non-U.S. equity securities
–
11%
are allocated to international small cap investments, while another
20%
are allocated to international emerging market investments. The remaining
69%
of the Non-U.S. equity securities are allocated to investments seeking to achieve excess returns relative to an international market index.
|
|
|
(4)
|
Debt securities
–
32%
are allocated to long U.S. Treasury Strips,
62%
are allocated to U.S. corporate bonds with an emphasis on long duration bonds rated A or better, while the remaining
6%
are allocated to floating rate high income leverage loans.
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|
(5)
|
Institutional money market fund.
|
The following tables represent the fair value measurements for the pension plan assets by major category and level of input:
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|
At December 31, 2018
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|
|
Fair value measurements of plan assets using:
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|
(in thousands)
|
|
Total
|
|
Quoted prices in
active markets for
identical assets
Level 1
|
|
Significant
observable
inputs
Level 2
|
|
Significant
unobservable
inputs
Level 3
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
U.S. equity securities
|
|
$
|
182,495
|
|
|
$
|
0
|
|
|
$
|
182,495
|
|
|
$
|
0
|
|
|
Non-U.S. equity securities
|
|
110,942
|
|
|
0
|
|
|
110,942
|
|
|
0
|
|
|
Total equity securities
|
|
293,437
|
|
|
0
|
|
|
293,437
|
|
|
0
|
|
|
Debt securities
|
|
464,613
|
|
|
0
|
|
|
464,613
|
|
|
0
|
|
|
Other
|
|
9,519
|
|
|
9,519
|
|
|
0
|
|
|
0
|
|
|
Total
|
|
$
|
767,569
|
|
|
$
|
9,519
|
|
|
$
|
758,050
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
At December 31, 2017
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|
|
Fair value measurements of plan assets using:
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|
(in thousands)
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|
Total
|
|
Quoted prices in
active markets for
identical assets
Level 1
|
|
Significant
observable
inputs
Level 2
|
|
Significant
unobservable
inputs
Level 3
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
U.S. equity securities
|
|
$
|
288,861
|
|
|
$
|
0
|
|
|
$
|
288,861
|
|
|
$
|
0
|
|
|
Non-U.S. equity securities
|
|
145,238
|
|
|
0
|
|
|
145,238
|
|
|
0
|
|
|
Total equity securities
|
|
434,099
|
|
|
0
|
|
|
434,099
|
|
|
0
|
|
|
Debt securities
|
|
303,331
|
|
|
0
|
|
|
303,331
|
|
|
0
|
|
|
Other
|
|
6,470
|
|
|
6,470
|
|
|
0
|
|
|
0
|
|
|
Total
|
|
$
|
743,900
|
|
|
$
|
6,470
|
|
|
$
|
737,430
|
|
|
$
|
0
|
|
|
Estimates of fair values of the pension plan assets are obtained primarily from the trustee and custodian of our pension plan. Our Level 1 category includes a money market fund that is a mutual fund for which the fair value is determined using an exchange traded price provided by the trustee and custodian. Our Level 2 category includes commingled pools. Estimates of fair values for securities held by our commingled pools are obtained primarily from the trustee and custodian. The methodologies used by the trustee and custodian that support a financial instrument Level 2 classification include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuers spreads, two-sided markets, benchmark securities, bids, offers, and reference data.
Estimated future benefit payments
The following table sets forth amounts of benefits expected to be paid over the next
10
years from our pension plans as of December 31:
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|
(in thousands)
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|
Year ending
December 31,
|
|
Expected future
benefit payments
|
2019
|
$
|
22,039
|
|
2020
|
|
23,244
|
|
2021
|
|
25,946
|
|
2022
|
|
29,319
|
|
2023
|
|
32,631
|
|
2024 - 2028
|
|
213,490
|
|
Employee savings plan
All full-time and regular part-time employees are eligible to participate in a traditional qualified 401(k) or a Roth 401(k) savings plan. We match
100%
of the participant contributions up to
3%
of compensation and
50%
of participant contributions over
3%
and up to
5%
of compensation. Matching contributions paid to the plan were
$13.9 million
in
2018
,
$12.8 million
in
2017
, and
$12.1 million
in
2016
. In 2018, we made an additional discretionary employer contribution of
$5.4 million
, as a way of sharing the tax savings realized from the lower corporate income tax rate that became effective January 1, 2018 with our employees. The Exchange and its subsidiaries reimbursed us for approximately
61%
of the matching and discretionary contributions. Employees are permitted to invest the employer-matching contributions in our Class A common stock. Employees, other than executive and senior officers, may sell the shares at any time without restriction, provided they are in compliance with applicable insider trading laws; sales by executive and senior officers are subject to additional pre-clearance restrictions imposed by our insider trading policies. The plan acquires shares in the open market necessary to meet the obligations of the plan. Plan participants held
0.2 million
shares of our Class A common stock at
December 31, 2018
and
2017
.
Note 10. Incentive and Deferred Compensation Plans
We have
two
incentive plans and
two
deferred compensation plans for our executives, senior vice presidents and other selected officers, and
two
deferred compensation plans for our outside directors.
Annual incentive plan
Our annual incentive plan ("AIP") is a bonus plan that pays cash to our executives, senior vice presidents and other selected officers annually. Participants can elect to defer up to
100%
of the award under either the deferred compensation plan or the incentive compensation deferral plan, which began in 2017. The awards are based on attainment of corporate and individual performance measures, which can include various financial measures. The plan includes a funding qualifier which considers our financial results, based on operating income, before a payout can be made to plan participants. If the funding qualifier is met, plan participants are eligible to receive the incentive based upon specific performance measures. The measures are established at the beginning of each year by the Executive Compensation and Development Committee of our Board of Directors ("ECDC"), with ultimate approval by the full Board of Directors. The performance measures primarily included the growth in direct written premium and statutory combined ratio of the Exchange and its property and casualty subsidiaries for all periods presented.
Long-term incentive plan
Our long-term incentive plan ("LTIP") is a performance based incentive plan designed to reward executives, senior vice presidents and other selected officers who can have a significant impact on our long-term performance and to further align the interests of such employees with those of our shareholders. The LTIP permits grants of performance shares or units, or phantom shares to be satisfied with shares of our Class A common stock or cash payment as determined by the ECDC. Participants can elect to defer up to
100%
of the award under the incentive compensation deferral plan, which began in 2017. The ECDC determines the form of the award to be granted at the beginning of each performance period, which is generally a
three
-year period. The number of shares of the Company's common stock authorized for grant under the LTIP is
1.5 million
shares, with no one person able to receive more than
250,000
shares or the equivalent of
$5 million
during any one performance period. We repurchase our Class A common stock on the open market to settle stock awards under the plan. We do not issue new shares of common stock to settle stock awards. LTIP awards are considered vested at the end of each applicable performance period.
The LTIP provides the recipient the right to earn performance shares or units, or phantom stock based on the level of achievement of performance goals as defined by us. Performance measures and a peer group of property and casualty companies to be used for comparison are determined by the ECDC. The performance measures for all periods presented were the reported growth in direct written premium and statutory combined ratio of the Exchange and its property and casualty subsidiaries and return on invested assets over a
three
-year performance period as compared to the results of the peer group over the same period. Because the award is based upon a comparison to results of a peer group over a
three
-year period, the award accrual is based upon estimates of probable results for the remaining performance period. This estimate is subject to variability if our results or the results of the peer group are substantially different than the results we project.
The fair value of LTIP awards is measured at each reporting date at the current share price of our Class A common stock. A liability is recorded and compensation expense is recognized ratably over the performance period.
At
December 31, 2018
, the plan awards for the
2016-2018
performance period, which will be granted as a cash award, were fully vested. Distributions will be made in
2019
once peer group financial information becomes available. The estimated plan award based upon the peer group information as of
September 30, 2018
is
$7.4 million
. At
December 31, 2017
, the awards paid in cash for the
2015-2017
performance period were fully vested and resulted in an
$8.3 million
payment to participants in
June 2018
. At
December 31, 2016
, the awards for the
2014-2016
performance period were fully vested. Participants had the option of receiving either cash or stock for the
2014-2016
awards. The cash award of
$4.7 million
was paid in
June 2017
and the stock award of
46,884
shares with an average share price of
$126.21
and a market value of
$5.9 million
was delivered to plan participants in
June 2017
. The ECDC has determined that the plan awards for the 2017-2019 and 2018-2020 performance periods will be paid in cash.
The Exchange and its subsidiaries reimburse us for compensation costs of employees performing administrative services. Earned compensation costs are allocated to these entities and reimbursed to us in cash once the payout is made. The total compensation cost charged to operations related to these LTIP awards was
$6.3 million
in
2018
,
$10.3 million
in
2017
, and
$8.2 million
in
2016
. The related tax benefits recognized in income were
$1.3 million
in
2018
,
$3.6 million
in
2017
, and
$2.9 million
in
2016
. The Exchange and its subsidiaries reimburse us for approximately
47%
of the annual compensation cost of these plans. At
December 31, 2018
, there was
$5.7 million
of total unrecognized compensation cost for non-vested LTIP awards related to open performance periods. Unrecognized compensation is expected to be recognized over a period of
two
years.
Deferred compensation plan
Our deferred compensation plan allows executives, senior vice presidents and other selected officers to elect to defer receipt of a portion of their compensation and AIP cash awards until a later date. Employer 401(k) matching contributions that are in excess of the annual contribution or compensation limits are also credited to the participant accounts for those who elected to defer receipt of some portion of their base salary. Participants select hypothetical investment funds for their deferrals which are credited with the hypothetical returns generated.
Incentive compensation deferral plan
Effective January 1, 2017, our Board of Directors approved an unfunded, non-qualified incentive compensation deferral plan for participants of the AIP and LTIP. Participants can elect to defer up to
100%
of their annual AIP award and/or up to
100%
of their LTIP award for each performance period. Deferred awards will be credited to a deferred stock account as credits denominated in Class A shares of the Company stock until retirement or other separation from service from the Company. Participants are
100%
vested at date of deferral. The shares are held in a rabbi trust, which was established to hold the shares earned under both the incentive compensation deferral plan and the deferred stock compensation plan for outside directors. The rabbi trust is classified and accounted for as equity in a manner consistent with the accounting for treasury stock. Dividends received on the shares in the rabbi trust are used to purchase additional shares. Vested share credits will be paid to participants from the rabbi trust upon separation from service in approximate equal annual installments of Class A shares for a period of
three
years. In
2018
, the rabbi trust purchased
12,005
shares of our common stock in the open market at an average price of
$119.28
for
$1.4 million
to satisfy the liability for the
2017
AIP awards deferred under the incentive compensation deferral plan. The total compensation charged to operations related to these deferred AIP awards was
$0.7 million
in
2018
and
$1.4 million
in
2017
. The Exchange and its subsidiaries reimbursed us for approximately
42%
of the annual compensation cost of this plan.
Deferred compensation plans for outside directors
We have a deferred compensation plan for our outside directors that allows participants to defer receipt of a portion of their annual compensation until a later date. Participants select hypothetical investment funds for their deferrals which are credited with the hypothetical returns generated.
We also have a deferred stock compensation plan for our outside directors to further align the interests of directors with those of our shareholders that provides for a portion of the directors' annual compensation in shares of our Class A common stock.
Each director vests in the grant 25% every three months over the course of a year.
Dividends paid by us are credited to each director's account which vest immediately. We do not issue new shares of common stock to directors. Our practice is to repurchase shares of our Class A common stock in the open market to satisfy these awards, which are held in the rabbi trust.
The rabbi trust purchased
9,285
shares of our common stock on the open market at an average price of
$122.19
for
$1.1 million
in
2018
,
9,663
shares at an average price of
$121.85
for
$1.2 million
in
2017
, and
7,432
shares at an average price of
$99.23
for
$0.7 million
in
2016
to satisfy the liability of the stock compensation plan for outside directors. The shares are distributed to the outside director from the rabbi trust upon ending board service. The total compensation charged to operations related to these awards totaled
$0.8 million
,
$0.9 million
and
$0.5 million
in
2018
,
2017
and
2016
, respectively.
The following summarizes our deferred executive and outside directors' compensation liability for
December 31
:
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|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
Annual incentive plan awards
|
|
$
|
4,751
|
|
|
$
|
6,118
|
|
|
$
|
6,460
|
|
Long-term incentive plan awards
|
|
6,331
|
|
|
10,931
|
|
|
11,321
|
|
Employer match and hypothetical earnings on deferred compensation
|
|
1,484
|
|
|
2,664
|
|
|
1,164
|
|
Total plan awards and earnings
|
|
12,566
|
|
|
19,713
|
|
|
18,945
|
|
Total plan awards paid
|
|
(14,482
|
)
|
|
(20,621
|
)
|
|
(20,418
|
)
|
Compensation deferred
|
|
1,928
|
|
|
680
|
|
|
1,214
|
|
Distributions from the deferred compensation plans
|
|
(1,321
|
)
|
|
(853
|
)
|
|
(435
|
)
|
Forfeitures
(1)
|
|
0
|
|
|
(593
|
)
|
|
(3,117
|
)
|
Funding of rabbi trust for deferred stock compensation plan for outside directors
|
|
(1,165
|
)
|
|
(1,177
|
)
|
|
(738
|
)
|
Funding of rabbi trust for incentive compensation deferral plan
|
|
(1,401
|
)
|
|
—
|
|
|
—
|
|
Incentive plan and deferred compensation liabilities at end of period
|
|
$
|
26,182
|
|
|
$
|
30,057
|
|
|
$
|
32,908
|
|
(1) Forfeitures are the result of plan participants who separated from service with the Company.
Equity compensation plan
We also have an equity compensation plan ("ECP") which is designed to reward key employees, as determined by the ECDC or the chief executive officer, who can have a significant impact on our long-term performance and to further align the interests of such employees with those of our shareholders. The ECP permits grants of restricted shares, restricted share units and other share based awards, to be satisfied with shares of our Class A common stock or cash. The ECDC determines the form of the award to be granted at the beginning of each performance period. The number of shares of the Company's Class A common stock authorized for grant under the ECP is
100,000
shares, with no one person able to receive more than
5,000
shares in a calendar year. We do not issue new shares of common stock to satisfy plan awards. Share awards are settled through the repurchase of our Class A common stock on the open market.
Restricted share awards may be entitled to receive dividends payable during the performance period, or, if subject to performance goals, to receive dividend equivalents payable upon vesting. Dividend equivalents may provide for the crediting of interest or hypothetical reinvestment experience payable after expiration of the performance period.
Vesting conditions are determined at the time the award is granted and may include continuation of employment for a specific period, satisfaction of performance goals and the defined performance period, and the satisfaction of any other terms and conditions as determined to be appropriate. The plan is to remain in effect until December 31, 2022, unless earlier amended or terminated by our Board of Directors. Awards will be satisfied with shares of our Class A common stock. In
2018
,
5,830
Class A shares with an average share price of
$115.45
and a market value of
$0.7 million
were delivered to plan participants to satisfy the
2015
plan year and remainder of
2014
plan year awards. In
2017
,
3,785
Class A shares with an average share price of
$109.41
and a market value of
$0.4 million
were delivered to plan participants to satisfy a portion of the
2014
plan year award. The total compensation charged to operations related to these ECP awards was
$0.4 million
in
2018
,
$0.2 million
in
2017
, and
$0.8 million
in
2016
. The Exchange and its subsidiaries reimburse us for earned compensation costs of employees performing administrative services, which can fluctuate each year based on the plan participants. The Exchange and its subsidiaries reimbursed us for approximately
68%
and
38%
of the awards paid in
2018
and
2017
, respectively. Unearned compensation expense of
$0.3 million
is expected to be recognized over a period of
three
years.
Note 11. Income Taxes
The provision for income taxes consists of the following for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
Current income tax expense
|
|
$
|
84,454
|
|
|
$
|
81,689
|
|
|
$
|
109,727
|
|
Deferred income tax (benefit) expense
|
|
(1,358
|
)
|
|
26,912
|
|
|
(2
|
)
|
Other income tax expense
|
|
—
|
|
|
10,095
|
|
|
—
|
|
Income tax expense
|
|
$
|
83,096
|
|
|
$
|
118,696
|
|
|
$
|
109,725
|
|
Other income tax expense for 2017 was impacted by the re-measurement of our deferred tax assets and liabilities due to the enactment of the Tax Cuts and Jobs Act ("TCJA") on December 22, 2017, which reduced the corporate tax rate from
35%
to
21%
effective January 1, 2018. The current and deferred income tax (benefit) expense for 2018 is measured at the statutory rate of
21%
and
35%
for 2017 and 2016.
A reconciliation of the provision for income taxes, with amounts determined by applying the statutory federal income tax rate to pre-tax income, is as follows for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
Income tax at statutory rate
|
|
$
|
77,977
|
|
|
$
|
110,493
|
|
|
$
|
112,032
|
|
Change in tax rate
(1)
|
|
—
|
|
|
10,095
|
|
|
—
|
|
Tax-exempt interest
|
|
(1,305
|
)
|
|
(2,278
|
)
|
|
(2,270
|
)
|
Unrecognized tax benefits
|
|
3,088
|
|
|
—
|
|
|
—
|
|
Other, net
|
|
3,336
|
|
|
386
|
|
|
(37
|
)
|
Income tax expense
|
|
$
|
83,096
|
|
|
$
|
118,696
|
|
|
$
|
109,725
|
|
|
|
(1)
|
The change in tax rate represents the tax effect of the re-measurement of deferred tax assets and liabilities due to the enactment of the TCJA.
|
The statutory rate for the year ended December 31, 2018 is
21%
and
35%
for the years ended December 31, 2017 and 2016.
At December 31, 2017, we recorded provisional amounts for certain enactment-date effects of the TCJA based on information available at that time. The Securities and Exchange Commission issued rules that allowed for a measurement period of one year after the enactment date of the TCJA to finalize the recording of the related tax impact. We completed our analysis for the effects of the TCJA and there were no material changes made in 2018 to the provisional amounts and no material impact on the effective tax rate.
Temporary differences and carry-forwards, which give rise to deferred tax assets and liabilities, are as follows for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
2018
|
|
2017
|
Deferred tax assets:
|
|
|
|
|
Other employee benefits
|
|
$
|
12,237
|
|
|
$
|
14,092
|
|
Pension and other postretirement benefits
|
|
20,124
|
|
|
22,758
|
|
Allowance for management fee returned on cancelled policies
|
|
3,292
|
|
|
3,024
|
|
Deferred revenue
|
|
3,524
|
|
|
0
|
|
Unrealized losses on investments
|
|
2,030
|
|
|
0
|
|
Other
|
|
1,246
|
|
|
812
|
|
Total deferred tax assets
|
|
42,453
|
|
|
40,686
|
|
Deferred tax liabilities:
|
|
|
|
|
Depreciation
|
|
13,015
|
|
|
10,204
|
|
Prepaid expenses
|
|
1,376
|
|
|
5,568
|
|
Commissions
|
|
1,270
|
|
|
0
|
|
Limited partnerships
|
|
2,534
|
|
|
4,509
|
|
Unrealized gains on investments
|
|
0
|
|
|
856
|
|
Other
|
|
157
|
|
|
159
|
|
Total deferred tax liabilities
|
|
18,352
|
|
|
21,296
|
|
Net deferred tax asset
|
|
$
|
24,101
|
|
|
$
|
19,390
|
|
If we determine that any of our deferred tax assets will not result in future tax benefits, a valuation allowance must be established for the portion of the assets that are not expected to be realized. We had
no
valuation allowance recorded at
December 31, 2018
or
December 31, 2017
.
A reconciliation of unrecognized tax benefits for the years ended December 31 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
Balance at the beginning of the year
|
|
$
|
0
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Additions for current year tax positions
|
|
7,719
|
|
|
—
|
|
|
—
|
|
Reductions for current year tax positions
|
|
(4,631
|
)
|
|
—
|
|
|
—
|
|
Additions for prior year tax positions
|
|
—
|
|
|
2,337
|
|
|
—
|
|
Reductions for prior year tax positions
|
|
—
|
|
|
(2,337
|
)
|
|
—
|
|
Balance at the end of the year
|
|
$
|
3,088
|
|
|
$
|
0
|
|
|
$
|
—
|
|
Included in the balance at December 31, 2018 was
$3.1 million
of tax expense related to uncertain tax positions for which the ultimate deductibility is certain, but for which there is uncertainty around the timing of deductibility. The amounts recorded in 2018 resulted from the difference in measuring the tax liability at the previous tax rate and the current enacted tax rate. This increased our effective tax rate by
0.8%
in 2018. In 2017, we had an uncertain tax position of
$2.3 million
, for which a current liability was recorded. As a related temporary tax difference was also recognized, there was no impact to our results of operations or financial position. It is not expected that there will be a significant change in the unrecognized tax benefits in the next 12 months. Interest expense related to uncertain tax positions is recognized in income tax expense. Interest expense was
$0.8 million
and
$0.1 million
in
2018
and
2017
, respectively. There was no interest expense related to uncertain tax positions in
2016
.
Tax years ending
December 31, 2017
,
2016
and
2015
remain open to IRS examination. We are not currently under IRS audit, nor have we been notified of an upcoming IRS audit.
We are the attorney-in-fact for the subscribers (policyholders) at the Exchange, a reciprocal insurance exchange. In that capacity, we provide all services and facilities necessary to conduct the Exchange's insurance business. Indemnity and the Exchange together constitute a single insurance business. Consequently, we are not subject to state corporate income or franchise taxes in states where the Exchange conducts its business and the states collect premium tax in lieu of corporate income or franchise tax, as a result of the Exchange's remittance of premium taxes in those states.
Note 12. Capital Stock
Class A and B common stock
We have
two
classes of common stock: Class A which has a dividend preference and Class B which has voting power and a conversion right. Each share of Class A common stock outstanding at the time of the declaration of any dividend upon shares of Class B common stock shall be entitled to a dividend payable at the same time, at the same record date, and in an amount at least equal to 2/3 of 1.0% of any dividend declared on each share of Class B common stock. We may declare and pay a dividend in respect to Class A common stock without any requirement that any dividend be declared and paid in respect to Class B common stock. Sole shareholder voting power is vested in Class B common stock except insofar as any applicable law shall permit Class A common shareholders to vote as a class in regards to any changes in the rights, preferences, and privileges attaching to Class A common stock. Holders of Class B shares may, at their option, convert their shares into Class A shares at the rate of
2,400
Class A shares per Class B share. There were
no
shares of Class B common stock converted into Class A common stock in
2018
,
2017
or
2016
.
Stock repurchases
Our Board of Directors authorized a stock repurchase program effective January 1, 1999 allowing the repurchase of our outstanding Class A nonvoting common stock. Treasury shares are recorded in the Statements of Financial Position at total cost based upon trade date. There were
no
shares repurchased under this program during
2018
,
2017
or
2016
. In
2011
, our Board of Directors approved a continuation of the current stock repurchase program for a total of
$150 million
, with no time limitation. We had approximately
$17.8 million
of repurchase authority remaining under this program at
December 31, 2018
, based upon trade date.
In
2018
, we purchased
27,120
shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of
$3.2 million
. Of this amount, we purchased
5,830
shares for
$0.7 million
, or
$117.39
per share, for stock-based awards in conjunction with our equity compensation plan. We purchased
9,285
shares for
$1.1 million
, or
$122.19
per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The remaining
12,005
shares were purchased at a total cost of
$1.4 million
, or
$119.28
per share, to fund the rabbi trust for the incentive compensation deferral plan. These shares were delivered in 2018.
In
2017
, we purchased
60,332
shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of
$7.3 million
. Of this amount, we purchased
3,785
shares for
$0.4 million
, or
$111.55
per share, for stock-based awards in conjunction with our equity compensation plan. We purchased
9,663
shares for
$1.2 million
, or
$121.85
per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The remaining
46,884
shares were purchased at a total cost of
$5.7 million
, or
$122.40
per share, for the vesting of stock-based awards in conjunction with our long-term incentive plan. These shares were delivered in 2017.
In
2016
, we purchased
15,093
shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of
$1.5 million
. Of this amount, we purchased
7,432
shares for
$0.7 million
, or
$99.23
per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The remaining
7,661
shares were purchased at a total cost of
$0.8 million
, or
$98.20
per share, for the vesting of stock-based awards in conjunction with our long-term incentive plan. These shares were delivered in
2016
.
Note 13. Accumulated Other Comprehensive Income (Loss)
Changes in accumulated other comprehensive income ("AOCI") (loss) by component, including amounts reclassified to other comprehensive income ("OCI") (loss) and the related line item in the Statements of Operations where net income is presented, are as follows for the year ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
|
|
Before Tax
|
Income Tax
(1)
|
Net
|
|
Before Tax
|
Income Tax
(1)
|
Net
|
|
Before Tax
|
Income Tax
(1)
|
Net
|
Investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
AOCI, beginning of year
|
|
$
|
3,410
|
|
$
|
716
|
|
$
|
2,694
|
|
|
$
|
3,954
|
|
$
|
1,384
|
|
$
|
2,570
|
|
|
$
|
3,888
|
|
$
|
1,361
|
|
$
|
2,527
|
|
OCI (loss) before reclassifications - pre TCJA
(1)
|
|
—
|
|
—
|
|
—
|
|
|
(648
|
)
|
(227
|
)
|
(421
|
)
|
|
(385
|
)
|
(135
|
)
|
(250
|
)
|
OCI before reclassifications - post TCJA
(1)
|
|
(15,372
|
)
|
(3,228
|
)
|
(12,144
|
)
|
|
1,162
|
|
243
|
|
919
|
|
|
—
|
|
—
|
|
—
|
|
Realized investment losses (gains)
|
|
1,297
|
|
272
|
|
1,025
|
|
|
(1,240
|
)
|
(434
|
)
|
(806
|
)
|
|
35
|
|
12
|
|
23
|
|
Impairment losses
|
|
1,581
|
|
332
|
|
1,249
|
|
|
182
|
|
64
|
|
118
|
|
|
416
|
|
146
|
|
270
|
|
Cumulative effect of adopting ASU 2016-01
(2)
|
|
(85
|
)
|
(18
|
)
|
(67
|
)
|
|
—
|
|
—
|
|
—
|
|
|
—
|
|
—
|
|
—
|
|
OCI (loss)
|
|
(12,579
|
)
|
(2,642
|
)
|
(9,937
|
)
|
|
(544
|
)
|
(354
|
)
|
(190
|
)
|
|
66
|
|
23
|
|
43
|
|
Reclassification adjustment
(3)
|
|
—
|
|
—
|
|
—
|
|
|
—
|
|
(314
|
)
|
314
|
|
|
—
|
|
—
|
|
—
|
|
AOCI, end of year
|
|
$
|
(9,169
|
)
|
$
|
(1,926
|
)
|
$
|
(7,243
|
)
|
|
$
|
3,410
|
|
$
|
716
|
|
$
|
2,694
|
|
|
$
|
3,954
|
|
$
|
1,384
|
|
$
|
2,570
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension and other postretirement plans:
|
|
|
|
|
|
|
|
|
AOCI (loss), beginning of year
|
|
$
|
(200,954
|
)
|
$
|
(42,201
|
)
|
$
|
(158,753
|
)
|
|
$
|
(190,695
|
)
|
$
|
(66,744
|
)
|
$
|
(123,951
|
)
|
|
$
|
(152,910
|
)
|
$
|
(53,519
|
)
|
$
|
(99,391
|
)
|
OCI (loss) before reclassifications
|
|
31,401
|
|
6,594
|
|
24,807
|
|
|
(20,314
|
)
|
(7,111
|
)
|
(13,203
|
)
|
|
(46,244
|
)
|
(16,185
|
)
|
(30,059
|
)
|
Amortization of prior service costs
(4)
|
|
1,353
|
|
284
|
|
1,069
|
|
|
871
|
|
306
|
|
565
|
|
|
695
|
|
243
|
|
452
|
|
Amortization of net actuarial loss
(4)
|
|
12,451
|
|
2,615
|
|
9,836
|
|
|
8,882
|
|
3,109
|
|
5,773
|
|
|
7,764
|
|
2,717
|
|
5,047
|
|
Settlement loss
(4)
|
|
—
|
|
—
|
|
—
|
|
|
302
|
|
106
|
|
196
|
|
|
—
|
|
—
|
|
—
|
|
Impact of change in tax rate
(5)
|
|
—
|
|
—
|
|
—
|
|
|
—
|
|
1,436
|
|
(1,436
|
)
|
|
—
|
|
—
|
|
—
|
|
OCI (loss)
|
|
45,205
|
|
9,493
|
|
35,712
|
|
|
(10,259
|
)
|
(2,154
|
)
|
(8,105
|
)
|
|
(37,785
|
)
|
(13,225
|
)
|
(24,560
|
)
|
Reclassification adjustment
(3)
|
|
—
|
|
—
|
|
—
|
|
|
—
|
|
26,697
|
|
(26,697
|
)
|
|
—
|
|
—
|
|
—
|
|
AOCI (loss), end of year
|
|
$
|
(155,749
|
)
|
$
|
(32,708
|
)
|
$
|
(123,041
|
)
|
|
$
|
(200,954
|
)
|
$
|
(42,201
|
)
|
$
|
(158,753
|
)
|
|
$
|
(190,695
|
)
|
$
|
(66,744
|
)
|
$
|
(123,951
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
AOCI (loss), beginning of year
|
|
$
|
(197,544
|
)
|
$
|
(41,485
|
)
|
$
|
(156,059
|
)
|
|
$
|
(186,741
|
)
|
$
|
(65,360
|
)
|
$
|
(121,381
|
)
|
|
$
|
(149,022
|
)
|
$
|
(52,158
|
)
|
$
|
(96,864
|
)
|
Investment securities
|
|
(12,579
|
)
|
(2,642
|
)
|
(9,937
|
)
|
|
(544
|
)
|
(354
|
)
|
(190
|
)
|
|
66
|
|
23
|
|
43
|
|
Pension and other postretirement plans
|
|
45,205
|
|
9,493
|
|
35,712
|
|
|
(10,259
|
)
|
(2,154
|
)
|
(8,105
|
)
|
|
(37,785
|
)
|
(13,225
|
)
|
(24,560
|
)
|
OCI (loss)
|
|
32,626
|
|
6,851
|
|
25,775
|
|
|
(10,803
|
)
|
(2,508
|
)
|
(8,295
|
)
|
|
(37,719
|
)
|
(13,202
|
)
|
(24,517
|
)
|
Reclassification adjustment
(3)
|
|
—
|
|
—
|
|
—
|
|
|
—
|
|
26,383
|
|
(26,383
|
)
|
|
—
|
|
—
|
|
—
|
|
AOCI (loss), end of year
|
|
$
|
(164,918
|
)
|
$
|
(34,634
|
)
|
$
|
(130,284
|
)
|
|
$
|
(197,544
|
)
|
$
|
(41,485
|
)
|
$
|
(156,059
|
)
|
|
$
|
(186,741
|
)
|
$
|
(65,360
|
)
|
$
|
(121,381
|
)
|
|
|
(1)
|
Deferred taxes related to unrealized gains and losses for the period from December 23, 2017 through December 31, 2018 were recognized at the
21%
corporate rate following enactment of the TCJA. Prior to enactment, they were recognized at the
35%
corporate rate.
|
|
|
(2)
|
A reclassification of unrealized losses of equity securities from AOCI to retained earnings was required at January 1, 2018 due to the implementation of ASU 2016-01. See Note 2, "Significant Accounting Policies".
|
|
|
(3)
|
A one-time adjustment was made in the fourth quarter of 2017 to reclassify stranded tax effects of the components of AOCI resulting from enactment of TCJA from AOCI to retained earnings, resulting in the ending AOCI balances now reflected at the
21%
corporate rate, which represents the rate in which the amounts are expected to be settled. See Note 2, "Significant Accounting Policies".
|
|
|
(4)
|
These components of accumulated other comprehensive income (loss) are included in the computation of net periodic pension cost. See Note 9, "Postretirement Benefits", for additional information.
|
|
|
(5)
|
Deferred taxes related to the December 31, 2017 portion of the pension and other postretirement component recognized in AOCI of
$10.3 million
were recognized at the
21%
corporate rate following the enactment of the TCJA.
|
Note 14. Related Party
Management fee
A management fee is charged to the Exchange for services we provide under the subscriber's agreement with subscribers at the Exchange. The fee is a percentage of direct and assumed premiums written by the Exchange. This percentage rate is determined at least annually by our Board of Directors but cannot exceed
25%
. The effective management fee rate charged the Exchange was
25%
in
2018
,
2017
and
2016
. The Board of Directors elected to maintain the fee at
25%
beginning January 1, 2019.
There is no provision in the subscriber's agreement for termination of our appointment as attorney-in-fact by the subscribers at the Exchange and the appointment is not affected by a policyholder's disability or incapacity.
Insurance holding company system
Most states have enacted legislation that regulates insurance holding company systems, defined as
two
or more affiliated persons,
one
or more of which is an insurer. The Exchange has the following wholly owned property and casualty subsidiaries: Erie Insurance Company, Erie Insurance Company of New York, Erie Insurance Property and Casualty Company and Flagship City Insurance Company, and a wholly owned life insurance company, Erie Family Life Insurance Company. Indemnity and the Exchange, and its wholly owned subsidiaries, meet the definition of an insurance holding company system.
All transactions within a holding company system affecting the member insurers of the holding company system must be fair and reasonable and any charges or fees for services performed must be reasonable. Approval by the applicable insurance commissioner is required prior to the consummation of transactions affecting the members within a holding company system.
Office leases
We lease certain office space from the Exchange including the home office. 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 are the responsibility of the tenant (Indemnity). This lease agreement expires December 31, 2021. 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 its subsidiaries based upon usage or square footage occupied. Rent expenses under the new lease totaled
$6.2 million
in
2018
and
$6.3 million
in
2017
. Rent expense totaled
$14.3 million
in
2016
, under the prior lease agreement, which included all operating expenses. Operating expenses totaled
$14.5 million
in
2018
and
$13.1 million
in
2017
. The Exchange and its subsidiaries reimburse us for space used to perform administrative services. Reimbursements related to the use of this space totaled
$4.7 million
in
2018
,
$4.6 million
in
2017
and
$4.9 million
in
2016
. We also had a lease commitment with EFL for a field office until December 31, 2018. Annual rentals paid to EFL under this lease totaled
$0.4 million
in
2018
,
2017
and
2016
.
We previously owned
three
field offices for which rental costs of shared facilities were allocated based upon usage or square footage occupied. On December 31, 2018, we sold the
three
field offices to the Exchange. See Note 7, "Fixed Assets".
Notes receivable from EFL
We previously held a
$25 million
surplus note that was issued to us by EFL in 2003 and was payable on demand on or after December 31, 2018. On December 14, 2018, EFL, with the appropriate approval from the Pennsylvania Insurance Commissioner, satisfied its obligation and repaid the surplus note. The note bore an annual interest rate of
6.7%
and EFL paid interest to us of
$1.6 million
in
2018
, and
$1.7 million
in both
2017
and
2016
.
Note 15. Concentrations of Credit Risk
Financial instruments could potentially expose us to concentrations of credit risk, including unsecured receivables from the Exchange. A large majority of our revenue and receivables are from the Exchange and its subsidiaries. See also Note 1, "Nature of Operations". Management fee amounts and other reimbursements due from the Exchange and its subsidiaries were
$449.9 million
and
$418.3 million
at
December 31, 2018
and
2017
, respectively.
Note 16. Commitments and Contingencies
We have contractual commitments to invest up to
$12.2 million
related to our limited partnership investments at
December 31, 2018
. These commitments are split between private equity securities of
$4.4 million
, mezzanine debt securities of
$7.5 million
, and real estate activities of
$0.3 million
. These commitments will be funded as required by the limited partnership agreements.
We are involved in litigation arising in the ordinary course of conducting business. In accordance with current accounting standards for loss contingencies and based upon information currently known to us, we establish reserves for litigation when it is probable that a loss associated with a claim or proceeding has been incurred and the amount of the loss or range of loss can be reasonably estimated. When no amount within the range of loss is a better estimate than any other amount, we accrue the minimum amount of the estimable loss. To the extent that such litigation against us may have an exposure to a loss in excess of the amount we have accrued, we believe that such excess would not be material to our financial condition, results of operations, or cash flows. Legal fees are expensed as incurred. We believe that our accruals for legal proceedings are appropriate and, individually and in the aggregate, are not expected to be material to our financial condition, operations, or cash flows.
We review all litigation on an ongoing basis when making accrual and disclosure decisions. For certain legal proceedings, we cannot reasonably estimate losses or a range of loss, if any, particularly for proceedings that are in their early stages of development or where the plaintiffs seek indeterminate damages. Various factors, including, but not limited to, the outcome of potentially lengthy discovery and the resolution of important factual questions, may need to be determined before probability can be established or before a loss or range of loss can be reasonably estimated. If the loss contingency in question is not both probable and reasonably estimable, we do not establish an accrual and the matter will continue to be monitored for any developments that would make the loss contingency both probable and reasonably estimable. In the event that a legal proceeding results in a substantial judgment against, or settlement by, us, there can be no assurance that any resulting liability or financial commitment would not have a material adverse effect on our financial condition, results of operations, or cash flows.
Note 17.
Supplementary Data on Cash Flows
A reconciliation of net income to net cash provided by operating activities as presented in the Statements of Cash Flows is as follows for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2018
|
|
2017
|
|
2016
|
|
|
|
|
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
Net income
|
|
$
|
288,224
|
|
|
$
|
196,999
|
|
|
$
|
210,366
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
Depreciation and amortization
|
|
13,368
|
|
|
14,831
|
|
|
15,095
|
|
Deferred income tax (benefit) expense
|
|
(1,358
|
)
|
|
26,912
|
|
|
(2
|
)
|
Other income tax expense
(1)
|
|
—
|
|
|
10,095
|
|
|
—
|
|
Realized losses (gains) and impairments on investments
|
|
3,591
|
|
|
(1,152
|
)
|
|
(256
|
)
|
Equity in losses (earnings) of limited partnerships
|
|
822
|
|
|
(2,801
|
)
|
|
(7,025
|
)
|
(Gain) loss on disposal of fixed assets
|
|
(3,047
|
)
|
|
98
|
|
|
59
|
|
Net amortization of bond premium
|
|
5,601
|
|
|
7,038
|
|
|
7,436
|
|
Decrease in deferred compensation
|
|
(3,886
|
)
|
|
(2,681
|
)
|
|
(4,561
|
)
|
Limited partnership distributions
|
|
7,173
|
|
|
5,128
|
|
|
17,837
|
|
Increase in receivables from affiliates
|
|
(30,804
|
)
|
|
(39,788
|
)
|
|
(30,485
|
)
|
Decrease (increase) in accrued investment income
|
|
1,590
|
|
|
(516
|
)
|
|
(846
|
)
|
Decrease (increase) in federal income taxes recoverable
|
|
21,738
|
|
|
(24,640
|
)
|
|
6,687
|
|
(Increase) decrease in prepaid pension
|
|
(47,335
|
)
|
|
(27,265
|
)
|
|
10,524
|
|
Increase in prepaid expenses and other assets
|
|
(727
|
)
|
|
(7,636
|
)
|
|
(4,674
|
)
|
Increase in accounts payable and accrued expenses
|
|
11,039
|
|
|
17,183
|
|
|
11,144
|
|
Increase in commissions payable
|
|
13,449
|
|
|
17,565
|
|
|
15,017
|
|
(Decrease) increase in accrued agent bonuses
|
|
(19,066
|
)
|
|
7,756
|
|
|
8,020
|
|
Increase in contract liability
|
|
3,213
|
|
|
—
|
|
|
—
|
|
Net cash provided by operating activities
|
|
$
|
263,585
|
|
|
$
|
197,126
|
|
|
$
|
254,336
|
|
|
|
(1)
|
Other income tax expense for 2017 was impacted by the re-measurement of our deferred tax assets and liabilities due to the enactment of the TCJA on December 22, 2017, which reduced the corporate tax rate from
35%
to
21%
effective January 1, 2018.
|
Note 18. Quarterly Results of Operations (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2018
|
(in thousands, except per share data)
|
|
First
quarter
|
|
Second
quarter
|
|
Third
quarter
|
|
Fourth
quarter
|
|
Year
|
Operating revenue
(1)
|
|
$
|
572,160
|
|
|
$
|
621,458
|
|
|
$
|
612,126
|
|
|
$
|
576,468
|
|
|
$
|
2,382,212
|
|
Operating expenses
(1)
|
|
494,593
|
|
|
526,135
|
|
|
515,431
|
|
|
501,710
|
|
|
2,037,869
|
|
Investment income
|
|
6,163
|
|
|
6,207
|
|
|
8,431
|
|
|
4,995
|
|
|
25,796
|
|
Interest expense and other (income), net
(2)
|
|
509
|
|
|
544
|
|
|
655
|
|
|
(2,889
|
)
|
|
(1,181
|
)
|
Income before income taxes
|
|
83,221
|
|
|
100,986
|
|
|
104,471
|
|
|
82,642
|
|
|
371,320
|
|
Net income
|
|
$
|
65,758
|
|
|
$
|
79,706
|
|
|
$
|
80,446
|
|
|
$
|
62,314
|
|
|
$
|
288,224
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share
(3)
|
|
|
|
|
|
|
|
|
|
|
Net income per share
|
|
|
|
|
|
|
|
|
|
|
Class A common stock – basic
|
|
$
|
1.41
|
|
|
$
|
1.71
|
|
|
$
|
1.73
|
|
|
$
|
1.34
|
|
|
$
|
6.19
|
|
Class A common stock – diluted
|
|
$
|
1.26
|
|
|
$
|
1.52
|
|
|
$
|
1.54
|
|
|
$
|
1.19
|
|
|
$
|
5.51
|
|
Class B common stock – basic and diluted
|
|
$
|
212
|
|
|
$
|
257
|
|
|
$
|
259
|
|
|
$
|
201
|
|
|
$
|
928
|
|
|
|
(1)
|
In accordance with ASC 606, "Revenue from Contracts with Customers", effective January 1, 2018, we allocate our management fee between the
two
performance obligations we have in the subscriber's agreement, policy issuance and renewal services and administrative services. We also present expenses we incur and the related reimbursements we receive for administrative services gross in our Statement of Operations. See Note 2, "Significant Accounting Policies".
|
|
|
(2)
|
The decrease in interest expense and other (income), net in the fourth quarter is driven by the
$3.4 million
gain recognized on the sale of the field offices we owned to Exchange. See Note 7, "Fixed Assets".
|
|
|
(3)
|
The cumulative sum of quarterly basic and diluted net income per share amounts may not equal total basic and diluted net income per share for the year due to differences in weighted average shares and equivalent shares outstanding for each of the periods presented.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2017
|
(in thousands, except per share data)
|
|
First
quarter
|
|
Second
quarter
|
|
Third
quarter
|
|
Fourth
quarter
|
|
Year
|
Operating revenue
|
|
$
|
399,316
|
|
|
$
|
448,564
|
|
|
$
|
442,492
|
|
|
$
|
401,402
|
|
|
$
|
1,691,774
|
|
Operating expenses
(1)
|
|
332,376
|
|
|
365,116
|
|
|
361,253
|
|
|
342,777
|
|
|
1,401,522
|
|
Investment income
(1)
|
|
6,589
|
|
|
6,451
|
|
|
8,418
|
|
|
7,134
|
|
|
28,592
|
|
Interest expense and other, net
(1)
|
|
575
|
|
|
664
|
|
|
792
|
|
|
1,118
|
|
|
3,149
|
|
Income before income taxes
|
|
72,954
|
|
|
89,235
|
|
|
88,865
|
|
|
64,641
|
|
|
315,695
|
|
Net income
|
|
$
|
47,876
|
|
|
$
|
58,527
|
|
|
$
|
58,543
|
|
|
$
|
32,053
|
|
|
$
|
196,999
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share
(2)
|
|
|
|
|
|
|
|
|
|
|
Net income per share
|
|
|
|
|
|
|
|
|
|
|
Class A common stock – basic
|
|
$
|
1.03
|
|
|
$
|
1.26
|
|
|
$
|
1.26
|
|
|
$
|
0.69
|
|
|
$
|
4.23
|
|
Class A common stock – diluted
(3)
|
|
$
|
0.91
|
|
|
$
|
1.12
|
|
|
$
|
1.12
|
|
|
$
|
0.61
|
|
|
$
|
3.76
|
|
Class B common stock – basic
|
|
$
|
154
|
|
|
$
|
189
|
|
|
$
|
189
|
|
|
$
|
103
|
|
|
$
|
635
|
|
Class B common stock – diluted
|
|
$
|
154
|
|
|
$
|
188
|
|
|
$
|
189
|
|
|
$
|
103
|
|
|
$
|
634
|
|
|
|
(1)
|
Amounts presented have been reclassified from previously reported amounts as a result of the adoption of ASU 2017-07, "Compensation-Retirement Benefits". See Note 2, "Significant Accounting Policies".
|
|
|
(2)
|
The cumulative sum of quarterly basic and diluted net income per share amounts may not equal total basic and diluted net income per share for the year due to differences in weighted average shares and equivalent shares outstanding for each of the periods presented.
|
|
|
(3)
|
Class A diluted earnings per share was reduced by
$0.19
for the fourth quarter and total year as a result of increased income tax expense from enactment of the TCJA of
$10.1 million
. See Note 4, "Earnings Per Share" and Note 11, "Income Taxes".
|
Note 19.
Subsequent Events
No items were identified in this period subsequent to the financial statement date that required adjustment or additional disclosure.