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 affiliated 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 2019 policy issuance and renewal expenses. The underwriting services we provide include underwriting and policy processing and comprised approximately 10% of our 2019 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 11% of our 2019 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 16, "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 ("ASC") 842, "Leases" on January 1, 2019 using the optional transition method, which permits entities to apply the new guidance prospectively with certain practical expedients available. We elected the package of practical expedients which among other things allowed us to carry forward the historical lease classifications. We did not elect the hindsight practical expedient in determining the lease term for existing leases. The adoption of the new standard resulted in the recognition of operating lease assets of $32.7 million and operating lease liabilities of $32.1 million on the Statement of Financial Position at January 1, 2019. The adoption of this standard did not have a material impact on our Statement of Operations and had no impact on our net cash flows.
We adopted ASC 606, "Revenue from Contracts with Customers" on January 1, 2018, using the modified retrospective method applied to all contracts. 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. Upon adoption of ASC 606, the management fee earned per the subscriber’s agreement, currently 25% of all direct and affiliated 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.
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.
In 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. 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.
Recently issued accounting standards
In August 2018, the FASB issued ASU 2018-15, "Intangibles-Goodwill and Other Internal-Use Software", which aligns 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 interim and annual reporting periods beginning after December 15, 2019. The amendments under ASU 2018-15 may be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption and early adoption is permitted. We adopted this guidance on a prospective basis on January 1, 2020 and there was no material impact on our financial statements or 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 related to available-for-sale debt securities to be recognized through an allowance for credit losses. New disclosures are also required upon adoption of this guidance. ASU 2016-13 is effective for interim and annual reporting
periods beginning after December 15, 2019. Our financial assets subject to this guidance include our receivable from Erie Insurance Exchange, agent loans, and investments. We do not expect a significant credit loss exposure for our receivable from Erie Insurance Exchange given the financial strength of the Exchange and the lack of any historical credit loss. As the majority of our agent loans are senior secured and have experienced only insignificant default amounts, we have historically not recorded an allowance for credit losses related to our agent loans. Upon adoption of this guidance on January 1, 2020, we established allowances for both the receivable from Erie Insurance Exchange and agent loans and recognized an immaterial cumulative effect adjustment. 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 securities will continue to be monitored for credit losses, which will be limited to the amount by which the fair value is below amortized cost and reflected as an allowance for credit losses rather than a reduction of the carrying value of the asset.
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 debt securities and redeemable preferred stock are classified as available-for-sale and reported at fair value with unrealized investment gains and losses, net of income taxes, recognized in other comprehensive income (loss). Available-for-sale securities with a remaining maturity of 12 months or less and any security that we intend to sell as of the reporting date are classified as current assets.
Available-for-sale securities are evaluated monthly for other-than-temporary impairment loss. For securities that have experienced a decline in fair value below amortized cost 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 recognized in earnings. 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 the extent and duration to which fair value is less than cost, historical operating performance and financial condition of the issuer, 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, near term liquidity position of the issuer and compliance with financial covenants.
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. When the entire amortized cost basis of the security will not be recovered, a credit loss exists. For securities with credit impairments that we did not intend to sell, the credit portion of the loss would be recorded through net income and the non-credit portion of the impairment would be recorded in other comprehensive income. 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.
Equity securities – Non-redeemable preferred and common stocks are classified as equity securities and reported at fair value with changes in fair value recognized in net realized investment gains (losses). Prior to January 1, 2018, equity securities were classified as available-for-sale and changes in fair value were recognized in other comprehensive income. Securities that we intend to sell as of the reporting date are classified as current assets.
Realized gains and losses and investment income – Realized gains and losses on sales of available-for-sale and equity securities are recognized in income based upon the specific identification method and reported as net realized investment gains (losses). Interest income is recognized as earned and includes amortization of premium and accretion of discount. Income is recognized based on the constant effective yield method, which includes periodically updated prepayment assumptions obtained from third party data sources on our prepaying securities. The effective yield for prepaying securities is recalculated on a retrospective basis. Dividend income is recognized at the ex-dividend date. Both interest and dividend income are reported as net investment income.
Limited partnership investments – Limited partnership investments primarily include U.S. and foreign private equity investments and are recorded using the equity method of accounting. The partnerships record assets on their balance sheet at 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 availability of financial statements provided by the general partner, our share of limited partnership results is generally recorded on a quarter lag within equity in earnings (losses) of limited partnerships. Cash contributions made to and distributions received from the partnerships are recorded in the period in which the transaction
occurs. We have made no new limited partnership commitments since 2006, and the balance of limited partnership investments is expected to continue to decrease over time as additional distributions are received.
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, operating lease assets and other long-term prepaid 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.
The determination of whether an arrangement is a lease and the related lease classification is made at inception of a contract. Our leases are classified as operating leases. Effective January 1, 2019, operating lease assets and liabilities are recorded at inception based on the present value of the future minimum lease payments over the lease term at commencement date. When an implicit rate for the lease is not available, we use our incremental borrowing rate based on the information available at commencement date to determine the present value of future payments. Lease terms include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Most of our lease contracts contain lease and non-lease components. Non-lease components are expensed as incurred. Operating lease assets are included in other assets, and the current and noncurrent portions of the operating lease liabilities are included in accounts payable and accrued expenses and other long-term liabilities, respectively.
Agent bonus estimates
Our more significant agent bonus plan is based upon an individual agency's property and casualty underwriting profitability and also includes 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 this agent bonus plan is based upon the performance over 36 months, and 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. Our second agent bonus plan is based on an agency's one-year underwriting profitability and uses a similar model but considers actual and forecasted results for a calendar year only. 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.
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 affiliated 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 affiliated 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 in 2017. 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.
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 affiliated assumed written premiums of the Exchange. We account for management fee revenue in accordance with ASC 606, which we adopted in 2018. See Note 2, "Significant Accounting Policies".
We allocate a portion of our management fee revenue, currently 25% of the direct and affiliated 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. We update the transaction price allocation annually based upon the most recent information available. There was no material change to the allocation in 2019.
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 Statements of Financial Position. The administrative services expenses we incur and the related reimbursements we receive are recorded gross in the Statements of Operations.
Indemnity records a receivable from the Exchange for management fee revenue when the premium is written or assumed from affiliates 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.
The amount of management fee revenue we receive can vary due to the potential of mid-term cancellations. 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:
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(in thousands)
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2019
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2018
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2017
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Management fee revenue - policy issuance and renewal services, net
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$
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1,810,457
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$
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1,719,567
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$
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1,662,625
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Management fee revenue - administrative services, net
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57,204
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53,632
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—
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Administrative services reimbursement revenue
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582,010
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580,336
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—
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Total administrative services
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$
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639,214
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$
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633,968
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$
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—
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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 13, "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 11, "Incentive and Deferred Compensation Plans".
In 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"). See Note 12, "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 $32.
A reconciliation of the numerators and denominators used in the basic and diluted per-share computations is presented as follows for each class of common stock:
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(dollars in thousands, except per share data)
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For the years ended December 31,
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2019
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2018
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2017
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Allocated net income (numerator)
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Weighted shares (denominator)
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Per- share amount
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Allocated net income (numerator)
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Weighted shares (denominator)
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Per- share amount
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Allocated net income (numerator)
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Weighted shares (denominator)
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Per- share amount
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Class A – Basic EPS:
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Income available to Class A stockholders
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$
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314,227
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46,188,836
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$
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6.80
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$
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285,864
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46,188,637
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$
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6.19
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$
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195,386
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46,186,831
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$
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4.23
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Dilutive effect of stock-based awards
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0
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30,224
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—
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0
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25,776
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—
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0
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49,832
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—
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Assumed conversion of Class B shares
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2,594
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6,100,800
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—
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2,360
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6,100,800
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—
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1,613
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6,100,800
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—
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Class A – Diluted EPS:
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Income available to Class A stockholders on Class A equivalent shares
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$
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316,821
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52,319,860
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$
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6.06
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$
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288,224
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52,315,213
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$
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5.51
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$
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196,999
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52,337,463
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$
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3.76
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Class B – Basic EPS:
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Income available to Class B stockholders
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$
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2,594
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2,542
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$
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1,020
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$
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2,360
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2,542
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$
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928
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$
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1,613
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2,542
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$
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635
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Class B – Diluted EPS:
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Income available to Class B stockholders
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$
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2,593
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2,542
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$
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1,020
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$
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2,359
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2,542
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$
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928
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$
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1,613
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2,542
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$
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634
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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. Financial instruments are categorized based upon the following characteristics or inputs to the valuation techniques:
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•
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Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.
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•
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Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
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•
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Level 3 – Unobservable inputs for the asset or liability.
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Estimates of fair values for our investment portfolio are obtained primarily from a nationally recognized pricing service. Our Level 1 securities are valued using an exchange traded price provided by the pricing service. Pricing service valuations for Level 2 securities 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.
Although virtually all of our prices are obtained from third party sources, we also perform internal pricing reviews, including evaluating the methodology and inputs used to ensure that we determine the proper classification level of the financial instrument and reviewing securities with price changes that vary significantly from current market conditions or independent third party price sources. Price variances are investigated and corroborated by market data and transaction volumes. We have reviewed the pricing methodologies of our pricing service as well as other observable inputs and believe that the prices adequately consider market activity in determining fair value.
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.
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 as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
|
|
Fair value measurements using:
|
(in thousands)
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
Corporate debt securities (1)
|
|
$
|
454,880
|
|
|
$
|
2,683
|
|
|
$
|
443,873
|
|
|
$
|
8,324
|
|
Residential mortgage-backed securities (1)
|
|
125,343
|
|
|
0
|
|
|
125,343
|
|
|
0
|
|
Commercial mortgage-backed securities (1)
|
|
67,541
|
|
|
0
|
|
|
64,220
|
|
|
3,321
|
|
Collateralized debt obligations (1)
|
|
77,856
|
|
|
0
|
|
|
77,856
|
|
|
0
|
|
Other debt securities
|
|
5,081
|
|
|
0
|
|
|
5,081
|
|
|
0
|
|
Total available-for-sale securities
|
|
730,701
|
|
|
2,683
|
|
|
716,373
|
|
|
11,645
|
|
Equity securities - nonredeemable preferred and common stock (1)
|
|
|
|
|
|
|
|
|
Financial services sector
|
|
53,513
|
|
|
14,927
|
|
|
38,586
|
|
|
0
|
|
Utilities sector
|
|
6,818
|
|
|
3,190
|
|
|
3,628
|
|
|
0
|
|
Communications sector
|
|
3,433
|
|
|
3,433
|
|
|
0
|
|
|
0
|
|
Energy sector
|
|
1,881
|
|
|
0
|
|
|
1,881
|
|
|
0
|
|
Other sectors
|
|
1,488
|
|
|
0
|
|
|
1,488
|
|
|
0
|
|
Total equity securities
|
|
67,133
|
|
|
21,550
|
|
|
45,583
|
|
|
0
|
|
Total
|
|
$
|
797,834
|
|
|
$
|
24,233
|
|
|
$
|
761,956
|
|
|
$
|
11,645
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2018
|
|
|
Fair value measurements using:
|
(in thousands)
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
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
|
|
|
|
(1)
|
In 2018, we began selling off our municipal bonds as part of a portfolio rebalancing and invested proceeds in short-term U.S. Treasuries. In 2019, proceeds from sales and maturities of the remaining municipal bond portfolio and short-term U.S. Treasuries were reinvested in corporate debt, structured securities and preferred stock.
|
|
|
(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 (NAV) practical expedient, which is not required to be categorized in the fair value hierarchy. The fair value of this investment is based on our proportionate share of the NAV from the most recent partners' capital statements received from the general partner, which is generally one quarter prior to our balance sheet date. We consider observable market data and perform a review validating the appropriateness of the NAV at each balance sheet date. Liquidation of this fund was completed in January 2019.
|
The following table presents our fair value measurements on a recurring basis by pricing source as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
(in thousands)
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
Pricing services
|
|
$
|
730,551
|
|
|
$
|
2,683
|
|
|
$
|
716,373
|
|
|
$
|
11,495
|
|
Internal modeling
|
|
150
|
|
|
0
|
|
|
0
|
|
|
150
|
|
Total available-for-sale securities
|
|
730,701
|
|
|
2,683
|
|
|
716,373
|
|
|
11,645
|
|
Equity securities priced using pricing services
|
|
67,133
|
|
|
21,550
|
|
|
45,583
|
|
|
0
|
|
Total
|
|
$
|
797,834
|
|
|
$
|
24,233
|
|
|
$
|
761,956
|
|
|
$
|
11,645
|
|
Quantitative and Qualitative Disclosures about Unobservable Inputs
The following table presents quantitative information about the significant unobservable inputs utilized in the fair value measurements of Level 3 assets. Level 3 securities where cost is the best estimate of fair value totaled $0.2 million at December 31, 2019 and are excluded from the table below. When a non-binding broker quote was the only input available, the security was classified within Level 3. The quantitative detail of the unobservable inputs is neither provided nor reasonably available to us and therefore has not been included in the table below. These investments totaled $1.3 million at December 31, 2019 and $12.6 million at December 31, 2018. The weighted average is calculated based on estimated fair value.
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
(dollars in thousands)
|
|
Fair
value
|
Valuation techniques
|
Unobservable input
|
Range
(basis points)
|
Weighted
average
(basis points)
|
Impact of increase in input on estimated fair value
|
|
|
|
|
|
|
|
|
Corporate debt securities - bank loans
|
|
$
|
8,048
|
|
Syndicated loan model
|
Market residual yield (1)
|
-489 - +566
|
+76
|
Decrease
|
Commercial mortgage-backed securities
|
|
2,143
|
|
Relative value pricing model
|
Credit spread (2)
|
+49 - +53
|
+51
|
Decrease
|
|
|
(1)
|
Values for bank loans classified as Level 3 are determined by our pricing vendor based on model yield curves adjusted for observable inputs. The market residual yield represents a net adjustment to the model yield curve for unobservable input factors.
|
|
|
(2)
|
Values for commercial mortgage-backed securities classified as Level 3 include adjustments to the base spread over the appropriate U.S. Treasury yield assuming no prepayments until penalty provisions have expired.
|
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, 2018
|
|
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, 2019
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate debt securities
|
|
$
|
12,577
|
|
|
$
|
10
|
|
|
$
|
146
|
|
|
$
|
2,020
|
|
|
$
|
(7,415
|
)
|
|
$
|
11,542
|
|
|
$
|
(10,556
|
)
|
|
$
|
8,324
|
|
Residential mortgage-backed securities
|
|
0
|
|
|
4
|
|
|
15
|
|
|
921
|
|
|
(32
|
)
|
|
0
|
|
|
(908
|
)
|
|
0
|
|
Commercial mortgage-backed securities
|
|
0
|
|
|
(9
|
)
|
|
(21
|
)
|
|
478
|
|
|
(1,068
|
)
|
|
7,281
|
|
|
(3,340
|
)
|
|
3,321
|
|
Collateralized debt obligations
|
|
0
|
|
|
0
|
|
|
1
|
|
|
2,300
|
|
|
0
|
|
|
0
|
|
|
(2,301
|
)
|
|
0
|
|
Total Level 3 available-for-sale securities
|
|
$
|
12,577
|
|
|
$
|
5
|
|
|
$
|
141
|
|
|
$
|
5,719
|
|
|
$
|
(8,515
|
)
|
|
$
|
18,823
|
|
|
$
|
(17,105
|
)
|
|
$
|
11,645
|
|
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
|
|
|
|
(1)
|
These amounts are reported 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 (loss) related to Level 3 securities held at the reporting date is as follows for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2019
|
|
2018
|
|
2017
|
Available-for-sale securities:
|
|
|
|
|
|
|
Corporate debt securities
|
|
$
|
38
|
|
|
$
|
(554
|
)
|
|
$
|
—
|
|
Commercial mortgage-backed securities
|
|
30
|
|
|
—
|
|
|
—
|
|
Net unrealized gains (losses) on Level 3 securities held at reporting date
|
|
$
|
68
|
|
|
$
|
(554
|
)
|
|
$
|
—
|
|
Financial instruments not carried at fair value
The following table presents the carrying values and fair values of financial instruments categorized as Level 3 in the fair value hierarchy that are recorded at carrying value as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
|
December 31, 2018
|
(in thousands)
|
|
Carrying Value
|
|
Fair Value
|
|
Carrying Value
|
|
Fair Value
|
Agent loans
|
|
$
|
67,696
|
|
|
$
|
71,602
|
|
|
$
|
58,006
|
|
|
$
|
54,110
|
|
Long-term borrowings
|
|
98,080
|
|
|
101,888
|
|
|
99,730
|
|
|
94,057
|
|
Note 6. Investments
Available-for-sale securities
See Note 5, "Fair Value" for additional fair value disclosures. The following tables summarize the cost and fair value of our available-for-sale securities as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
(in thousands)
|
|
Amortized cost
|
|
Gross unrealized gains
|
|
Gross unrealized losses
|
|
Estimated fair value
|
Corporate debt securities (1)
|
|
$
|
450,295
|
|
|
$
|
6,289
|
|
|
$
|
1,704
|
|
|
$
|
454,880
|
|
Residential mortgage-backed securities (1)
|
|
124,337
|
|
|
1,056
|
|
|
50
|
|
|
125,343
|
|
Commercial mortgage-backed securities (1)
|
|
67,210
|
|
|
479
|
|
|
148
|
|
|
67,541
|
|
Collateralized debt obligations (1)
|
|
78,059
|
|
|
44
|
|
|
247
|
|
|
77,856
|
|
Other debt securities
|
|
5,049
|
|
|
71
|
|
|
39
|
|
|
5,081
|
|
Total available-for-sale securities
|
|
$
|
724,950
|
|
|
$
|
7,939
|
|
|
$
|
2,188
|
|
|
$
|
730,701
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2018
|
(in thousands)
|
|
Amortized cost
|
|
Gross unrealized gains
|
|
Gross unrealized losses
|
|
Estimated fair value
|
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 2018, we began selling off our municipal bonds as part of a portfolio rebalancing and invested proceeds in short-term U.S. Treasuries. In 2019, proceeds from sales and maturities of the remaining municipal bond portfolio and short-term U.S. Treasuries were reinvested in corporate debt, structured securities and preferred stock.
|
The amortized cost and estimated fair value of available-for-sale securities at December 31, 2019, are shown below by remaining contractual term to maturity. 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.
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
|
|
Amortized
|
|
Estimated
|
(in thousands)
|
|
cost
|
|
fair value
|
Due in one year or less
|
|
$
|
32,613
|
|
|
$
|
32,655
|
|
Due after one year through five years
|
|
336,377
|
|
|
339,033
|
|
Due after five years through ten years
|
|
120,716
|
|
|
122,068
|
|
Due after ten years
|
|
235,244
|
|
|
236,945
|
|
Total available-for-sale securities
|
|
$
|
724,950
|
|
|
$
|
730,701
|
|
The below securities have been evaluated and determined to be temporary impairments for which we expect to recover our entire principal plus interest. The following tables present available-for-sale securities based on length of time in a gross unrealized loss position as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
|
|
Less than 12 months
|
|
12 months or longer
|
|
Total
|
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
No. of
|
(dollars in thousands)
|
|
value
|
|
losses
|
|
value
|
|
losses
|
|
value
|
|
losses
|
|
holdings
|
Corporate debt securities
|
|
$
|
25,804
|
|
|
$
|
342
|
|
|
$
|
15,699
|
|
|
$
|
1,362
|
|
|
$
|
41,503
|
|
|
$
|
1,704
|
|
|
158
|
|
Residential mortgage-backed securities
|
|
16,712
|
|
|
50
|
|
|
0
|
|
|
0
|
|
|
16,712
|
|
|
50
|
|
|
7
|
|
Commercial mortgage-backed securities
|
|
21,981
|
|
|
147
|
|
|
372
|
|
|
1
|
|
|
22,353
|
|
|
148
|
|
|
30
|
|
Collateralized debt obligations
|
|
20,889
|
|
|
33
|
|
|
41,010
|
|
|
214
|
|
|
61,899
|
|
|
247
|
|
|
49
|
|
Other debt securities
|
|
2,350
|
|
|
39
|
|
|
0
|
|
|
0
|
|
|
2,350
|
|
|
39
|
|
|
2
|
|
Total available-for-sale securities
|
|
$
|
87,736
|
|
|
$
|
611
|
|
|
$
|
57,081
|
|
|
$
|
1,577
|
|
|
$
|
144,817
|
|
|
$
|
2,188
|
|
|
246
|
|
Quality breakdown of available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment grade
|
|
$
|
76,315
|
|
|
$
|
287
|
|
|
$
|
46,390
|
|
|
$
|
218
|
|
|
$
|
122,705
|
|
|
$
|
505
|
|
|
100
|
|
Non-investment grade
|
|
11,421
|
|
|
324
|
|
|
10,691
|
|
|
1,359
|
|
|
22,112
|
|
|
1,683
|
|
|
146
|
|
Total available-for-sale securities
|
|
$
|
87,736
|
|
|
$
|
611
|
|
|
$
|
57,081
|
|
|
$
|
1,577
|
|
|
$
|
144,817
|
|
|
$
|
2,188
|
|
|
246
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2018
|
|
|
Less than 12 months
|
|
12 months or longer
|
|
Total
|
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
No. of
|
(dollars in thousands)
|
|
value
|
|
losses
|
|
value
|
|
losses
|
|
value
|
|
losses
|
|
holdings
|
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
|
|
Net investment income
Investment income, net of expenses, was generated from the following portfolios for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2019
|
|
2018
|
|
2017
|
Available-for-sale securities (1)
|
|
$
|
22,496
|
|
|
$
|
24,978
|
|
|
$
|
23,669
|
|
Equity securities
|
|
1,418
|
|
|
628
|
|
|
—
|
|
Cash equivalents and other
|
|
10,546
|
|
|
5,628
|
|
|
2,486
|
|
Total investment income
|
|
34,460
|
|
|
31,234
|
|
|
26,155
|
|
Less: investment expenses
|
|
1,061
|
|
|
1,025
|
|
|
1,516
|
|
Investment income, net of expenses
|
|
$
|
33,399
|
|
|
$
|
30,209
|
|
|
$
|
24,639
|
|
|
|
(1)
|
Includes interest earned on note receivable from EFL of $1.6 million in 2018 and $1.7 million in 2017. The note was repaid in full in 2018.
|
Realized investment gains (losses)
Realized gains (losses) on investments were as follows for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2019
|
|
2018
|
|
2017
|
Available-for-sale securities:
|
|
|
|
|
|
|
Gross realized gains
|
|
$
|
6,258
|
|
|
$
|
1,892
|
|
|
$
|
2,996
|
|
Gross realized losses
|
|
(1,639
|
)
|
|
(3,189
|
)
|
|
(1,756
|
)
|
Net realized gains (losses) on available-for-sale securities
|
|
4,619
|
|
|
(1,297
|
)
|
|
1,240
|
|
Equity securities
|
|
1,484
|
|
|
(819
|
)
|
|
—
|
|
Miscellaneous
|
|
0
|
|
|
106
|
|
|
94
|
|
Net realized investment gains (losses)
|
|
$
|
6,103
|
|
|
$
|
(2,010
|
)
|
|
$
|
1,334
|
|
The portion of net unrealized gains and 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)
|
|
2019
|
|
2018
|
|
2017
|
Equity securities: (1)
|
|
|
|
|
|
|
Net gains (losses) recognized during the period
|
|
$
|
1,484
|
|
|
$
|
(819
|
)
|
|
$
|
—
|
|
Less: net gains (losses) recognized on securities sold
|
|
360
|
|
|
(86
|
)
|
|
—
|
|
Net unrealized gains (losses) recognized on securities held at reporting date
|
|
$
|
1,124
|
|
|
$
|
(733
|
)
|
|
$
|
—
|
|
|
|
(1)
|
Effective January 1, 2018, changes in unrealized gains and losses on equity securities are included in net realized investment gains (losses).
|
Other-than-temporary impairments on available-for-sale securities recognized in earnings were $0.2 million, $1.6 million and $0.2 million for the years ended December 31, 2019, 2018 and 2017, respectively. We have the intent to sell all credit-impaired available-for-sale securities; therefore, the entire amount of the impairment charges were included in earnings and no impairments were recognized in other comprehensive income (loss). See also Note 2, "Significant Accounting Policies".
Note 7. Fixed Assets
The following table summarizes our fixed assets by category at December 31:
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2019
|
|
2018
|
Land, buildings, and building improvements
|
|
$
|
5,068
|
|
|
$
|
—
|
|
Leasehold improvements
|
|
1,313
|
|
|
617
|
|
Software
|
|
191,709
|
|
|
163,735
|
|
Equipment
|
|
14,546
|
|
|
15,075
|
|
Furniture, fixtures, and equipment
|
|
1,934
|
|
|
—
|
|
Projects in progress
|
|
22,992
|
|
|
10,392
|
|
Construction in progress
|
|
122,801
|
|
|
66,088
|
|
Total fixed assets, gross
|
|
360,363
|
|
|
255,907
|
|
Less: Accumulated depreciation and amortization
|
|
(138,984
|
)
|
|
(125,075
|
)
|
Fixed assets, net
|
|
$
|
221,379
|
|
|
$
|
130,832
|
|
In 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)". See Note 15, "Related Party". The increase in land, buildings, and building improvements in 2019 resulted from the purchase of additional office space from a third party.
Software increased primarily related to mainframe software licenses and investments in data technology, as well as internally developed software projects completed and placed in production related to providing personal lines new product processing capabilities.
Projects in progress include certain computer software and software developments costs for internal use that are not yet subject to amortization.
Construction in progress includes a new office building that will serve as part of our principal headquarters. Capitalized interest included in construction in progress was $3.4 million and $2.1 million at December 31, 2019 and 2018, respectively. The building is expected to be completed in 2020 and is financed using a senior secured draw term loan credit facility. See Note 9, "Borrowing Arrangements".
Depreciation and amortization of fixed assets totaled $16.8 million, $13.4 million and $14.8 million for the years ended December 31, 2019, 2018 and 2017, respectively, and is included in cost of operations - policy issuance and renewal services.
Note 8. Leases
The following table summarizes our lease assets and liabilities at December 31:
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2019
|
|
2018
|
Operating lease assets
|
|
$
|
22,401
|
|
|
$
|
—
|
|
|
|
|
|
|
Operating lease liabilities - current
|
|
$
|
11,289
|
|
|
$
|
—
|
|
Operating lease liabilities - long-term
|
|
10,665
|
|
|
—
|
|
Total operating lease liabilities
|
|
$
|
21,954
|
|
|
$
|
—
|
|
We currently have leases for real estate, technology equipment, copiers, and vehicles. Our largest operating lease asset at December 31, 2019 of $11.7 million is for home office space leased from the Exchange. Under this lease, rent is based on rental rates of like property and all operating expenses are the responsibility of the tenant (Indemnity). The lease agreement expires December 31, 2021. See Note 15, "Related Party".
Operating lease costs for the year ended 2019 totaled $14.0 million. Of this amount, the Exchange and its subsidiaries reimbursed us $6.0 million for the year ended 2019, which represents the allocated share of lease costs supporting administrative services activities.
Note 9. Borrowing Arrangements
Bank Line of Credit
As of December 31, 2019, 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, 2019, 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, 2019. Investments with a fair value of $110.1 million were pledged as collateral on the line at December 31, 2019. The securities pledged as collateral have no trading restrictions and are reported as available-for-sale securities and cash and cash equivalents as of December 31, 2019. 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, 2019.
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 to serve as part of our principal headquarters. On January 1, 2019, the Credit Facility converted to a fully-amortized term loan with monthly payments of principal and interest at a fixed rate of 4.35% over a period of 28 years. Investments with a fair value of $112.4 million were pledged as collateral for the facility and are reported as available-for-sale securities and cash and cash equivalents as of December 31, 2019. 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, 2019.
The remaining unpaid balance from the Credit Facility is reported at carrying value, net of unamortized loan origination and commitment fees as long-term borrowings. See Note 5, "Fair Value" for the estimated fair value of these borrowings.
Annual principal payments
The following table sets forth future principal payments:
|
|
|
|
|
(in thousands)
|
|
|
Year
|
|
Principal payments
|
2020
|
$
|
1,979
|
|
2021
|
|
2,019
|
|
2022
|
|
2,109
|
|
2023
|
|
2,226
|
|
2024
|
|
2,302
|
|
Thereafter
|
|
87,445
|
|
Note 10. 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)
|
|
|
|
|
|
2019
|
|
2018
|
|
2017
|
|
Service cost for benefits earned
|
|
$
|
33,854
|
|
|
$
|
38,052
|
|
|
$
|
31,106
|
|
|
Interest cost on benefit obligation
|
|
39,306
|
|
|
35,382
|
|
|
34,275
|
|
|
Expected return on plan assets
|
|
(47,484
|
)
|
|
(51,260
|
)
|
|
(41,267
|
)
|
|
Prior service cost amortization
|
|
1,394
|
|
|
1,353
|
|
|
871
|
|
|
Net actuarial loss amortization
|
|
5,113
|
|
|
12,809
|
|
|
9,301
|
|
|
Settlement cost (1)
|
|
—
|
|
|
—
|
|
|
302
|
|
|
Pension plan cost (2)
|
|
$
|
32,183
|
|
|
$
|
36,336
|
|
|
$
|
34,588
|
|
|
|
|
(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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
2017
|
|
2016
|
|
Employee pension plan:
|
|
|
|
|
|
|
|
|
|
Discount rate
|
|
3.59
|
%
|
|
4.47
|
%
|
|
3.73
|
%
|
|
4.24
|
%
|
|
Expected return on assets
|
|
6.00
|
|
|
6.75
|
|
|
6.75
|
|
|
7.00
|
|
|
Compensation increases (1)
|
|
3.21
|
|
|
3.32
|
|
|
3.32
|
|
|
3.32
|
|
|
SERP:
|
|
|
|
|
|
|
|
|
|
|
Discount rate – pre-retirement/post-retirement
|
|
3.59/3.09
|
|
|
4.47/3.97
|
|
|
3.73/3.23
|
|
|
4.24/3.74
|
|
|
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 3.21% in 2019 and 3.32% in 2018 and 2017 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 to the 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. 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)
|
|
|
|
|
|
2019
|
|
2018
|
|
Funded status at end of year
|
|
$
|
(146,842
|
)
|
|
$
|
(118,596
|
)
|
|
|
|
|
|
|
|
Pension liabilities – due within one year (1)
|
|
$
|
(1,183
|
)
|
|
$
|
(1,730
|
)
|
|
Pension liabilities – due after one year
|
|
(145,659
|
)
|
|
(116,866
|
)
|
|
Net amount recognized
|
|
$
|
(146,842
|
)
|
|
$
|
(118,596
|
)
|
|
(1) The current portion of pension liabilities is included in accounts payable and accrued liabilities.
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)
|
|
|
|
|
|
2019
|
|
2018
|
|
Projected benefit obligation, beginning of year
|
|
$
|
886,165
|
|
|
$
|
951,666
|
|
|
Service cost for benefits earned
|
|
33,854
|
|
|
38,052
|
|
|
Interest cost on benefit obligation
|
|
39,306
|
|
|
35,382
|
|
|
Plan amendments
|
|
452
|
|
|
3,007
|
|
|
Actuarial loss (gain)
|
|
138,144
|
|
|
(123,910
|
)
|
|
Benefits paid
|
|
(43,454
|
)
|
|
(18,032
|
)
|
|
Projected benefit obligation, end of year
|
|
$
|
1,054,467
|
|
|
$
|
886,165
|
|
|
|
|
|
|
|
|
Accumulated benefit obligation, end of year
|
|
$
|
858,209
|
|
|
$
|
727,340
|
|
|
Projected benefit obligations increased $168.3 million at December 31, 2019 compared to December 31, 2018 due primarily to actuarial losses resulting from the lower discount rate discount rate used to measure the future benefit obligations. The discount rate decreased to 3.59% in 2019 from 4.47% in 2018. The increase in benefits paid of $25.4 million in 2019 compared to 2018 was primarily due to a pension plan amendment offering a one-time lump sum payment to former vested employees.
Both the defined benefit plan and the SERP had projected benefit obligations in excess of plan assets at December 31:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Projected Benefit Obligation in Excess of Plan Assets
|
|
|
|
2019
|
|
2018
|
|
Projected benefit obligation
|
|
$
|
1,054,467
|
|
|
$
|
886,165
|
|
|
Plan assets
|
|
907,625
|
|
|
767,569
|
|
|
The SERP had accumulated benefit obligations in excess of plan assets at December 31:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Accumulated Benefit Obligation in Excess of Plan Assets
|
|
|
|
2019
|
|
2018
|
|
Accumulated benefit obligation
|
|
$
|
23,411
|
|
|
$
|
18,908
|
|
|
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)
|
|
|
|
|
|
2019
|
|
2018
|
|
Fair value of plan assets, beginning of year
|
|
$
|
767,569
|
|
|
$
|
743,900
|
|
|
Actual gain (loss) on plan assets
|
|
182,002
|
|
|
(38,360
|
)
|
|
Employer contributions
|
|
1,508
|
|
|
80,061
|
|
|
Benefits paid
|
|
(43,454
|
)
|
|
(18,032
|
)
|
|
Fair value of plan assets, end of year
|
|
$
|
907,625
|
|
|
$
|
767,569
|
|
|
Accumulated other comprehensive loss
Net actuarial loss and prior service cost included in accumulated other comprehensive loss that were not yet recognized as components of net benefit costs were as follows:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
2019
|
|
2018
|
|
Net actuarial loss
|
|
$
|
142,678
|
|
|
$
|
144,165
|
|
|
Prior service cost
|
|
10,913
|
|
|
11,855
|
|
|
Net amount not yet recognized
|
|
$
|
153,591
|
|
|
$
|
156,020
|
|
|
Other comprehensive income
Amounts recognized in other comprehensive income for pension plans were as follows:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
|
|
|
2019
|
|
2018
|
|
Net actuarial loss (gain) arising during the year
|
|
$
|
3,626
|
|
|
$
|
(34,290
|
)
|
|
Amortization of net actuarial loss
|
|
(5,113
|
)
|
|
(12,809
|
)
|
|
Amortization of prior service cost
|
|
(1,394
|
)
|
|
(1,353
|
)
|
|
Amendments (1)
|
|
452
|
|
|
3,007
|
|
|
Total recognized in other comprehensive income
|
|
$
|
(2,429
|
)
|
|
$
|
(45,445
|
)
|
|
|
|
(1)
|
In 2019, there was one new SERP participant. In 2018, there were five new SERP participants.
|
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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Target asset
allocation
|
|
Target asset
allocation
|
|
Actual asset
allocation
|
|
Actual asset
allocation
|
|
Asset allocation:
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
U.S. equity securities
|
|
27
|
%
|
(1)
|
25
|
%
|
|
28
|
%
|
|
24
|
%
|
|
Non-U.S. equity securities
|
|
18
|
|
(2)
|
16
|
|
|
18
|
|
|
14
|
|
|
Total equity securities
|
|
45
|
|
|
41
|
|
|
46
|
|
|
38
|
|
|
Debt securities
|
|
54
|
|
(3)
|
58
|
|
|
53
|
|
|
61
|
|
|
Other
|
|
1
|
|
(4)
|
1
|
|
|
1
|
|
|
1
|
|
|
Total
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
|
|
(1)
|
U.S. equity securities – 22% seek to achieve excess returns relative to the Russell 2000 Index. The remaining 78% of the allocation to U.S. equity securities are comprised of equity index funds that track the S&P 500.
|
|
|
(2)
|
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.
|
|
|
(3)
|
Debt securities – 33% are allocated to long U.S. Treasury Strips, 67% are allocated to U.S. corporate bonds with an emphasis on long duration bonds rated A or better.
|
|
|
(4)
|
Institutional money market fund.
|
The following tables present fair value measurements for the pension plan assets by major category and level of input as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
|
|
|
Fair value measurements of plan assets using:
|
|
(in thousands)
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
U.S. equity securities
|
|
$
|
248,585
|
|
|
$
|
0
|
|
|
$
|
248,585
|
|
|
$
|
0
|
|
|
Non-U.S. equity securities
|
|
165,752
|
|
|
0
|
|
|
165,752
|
|
|
0
|
|
|
Total equity securities
|
|
414,337
|
|
|
0
|
|
|
414,337
|
|
|
0
|
|
|
Debt securities
|
|
482,497
|
|
|
0
|
|
|
482,497
|
|
|
0
|
|
|
Other
|
|
10,791
|
|
|
10,791
|
|
|
0
|
|
|
0
|
|
|
Total
|
|
$
|
907,625
|
|
|
$
|
10,791
|
|
|
$
|
896,834
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2018
|
|
|
|
Fair value measurements of plan assets using:
|
|
(in thousands)
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
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
|
|
|
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 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. Trustee and custodian valuation methodologies for Level 2 securities 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:
|
|
|
|
|
(in thousands)
|
|
|
Year ending
December 31,
|
|
Expected future
benefit payments
|
2020
|
$
|
23,788
|
|
2021
|
|
25,903
|
|
2022
|
|
29,031
|
|
2023
|
|
32,497
|
|
2024
|
|
35,722
|
|
2025 - 2029
|
|
229,518
|
|
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 $14.9 million in 2019, $13.9 million in 2018, and $12.8 million in 2017. 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 59% 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, 2019 and 2018.