As filed with the Securities and Exchange Commission on January 8, 2003.
Registration No. 333-99943
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 3
TO
FORM S-3
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Erie Indemnity Company
-------------------------------------------------
(Exact name of registrant as specified in charter)
Pennsylvania 25-0466020
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Erie Insurance Place
Erie, Pennsylvania 16530
814-870-2000
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(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Jan R. Van Gorder, Esquire
Senior Executive Vice President,
Secretary and General Counsel
Erie Indemnity Company
100 Erie Insurance Place
Erie, Pennsylvania 16530
814-870-2000
-------------------------------------------------------
(Name, address, including zip code, and telephone
number, including area code, of agent for service)
Copies to:
Frederick W. Dreher, Esquire Andrew S. Rowen, Esquire
Richard L. Cohen, Esquire John Evangelakos, Esquire
Duane Morris LLP Sullivan & Cromwell LLP
4200 One Liberty Place 125 Broad Street
Philadelphia, Pennsylvania 19103 New York, New York 10004
215-979-1234 212-558-4000
Approximate date of commencement of proposed sale to public: As soon as
practicable after this registration statement becomes effective.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [_]
If any of the securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act, other than securities offered only in connection with dividend
or interest reinvestment plans, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_] _________________
If this Form is a post-effective amendment filed pursuant to Rule
462(c) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. [_]
The registrant hereby amends this registration statement on such date
or dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
[LEFT SIDE OF PROSPECTUS COVER]
THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE
CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PRELIMINARY
PROSPECTUS IS NOT AN OFFER TO SELL NOR DOES IT SEEK AN OFFER TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION. DATED JANUARY ___, 2003.
[LOGO]
Shares
ERIE INDEMNITY COMPANY
Class A Common Stock
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Shares of Erie Indemnity Company Class A common stock, which are
non-voting, are being offered by the selling shareholder named in this
prospectus. Erie Indemnity Company will not receive any proceeds from the sale
of shares.
The Class A common stock is quoted on the NASDAQ Stock Market(SM) under the
symbol "ERIE". The last reported sale price of the Class A common stock on
January 6, 2003 was $36.38 per share.
SEE "RISK FACTORS" BEGINNING ON PAGE 11 TO READ ABOUT FACTORS YOU SHOULD
CONSIDER BEFORE BUYING SHARES OF THE CLASS A COMMON STOCK.
--------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY
BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
--------------
Per Share Total
--------- -----
Initial price to public .................................. $ $
Underwriting discount .................................... $ $
Proceeds, before expenses, to selling shareholder ........ $ $
To the extent the underwriters sell more than ____ shares of Class A common
stock, the underwriters have the option to purchase up to an additional ____
shares of Class A common stock from the selling shareholder at the public
offering price, less the underwriting discount.
--------------
The underwriters expect to deliver the shares against payment in New York,
New York on or about , 2003.
Goldman, Sachs & Co. Credit Suisse First Boston
Advest, Inc.
Cochran, Caronia Securities LLC
Legg Mason Wood Walker, Incorporated
--------------
Prospectus dated __________, 2003.
PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS THE INFORMATION CONTAINED IN THIS PROSPECTUS THAT WE
BELIEVE IS THE MOST IMPORTANT REGARDING US AND THIS OFFERING. HOWEVER, YOU
SHOULD READ THE ENTIRE PROSPECTUS CAREFULLY BEFORE INVESTING IN OUR CLASS A
COMMON STOCK. ALL FINANCIAL INFORMATION, OPERATING STATISTICS AND RATIOS IN THIS
PROSPECTUS ARE BASED ON GENERALLY ACCEPTED ACCOUNTING PRINCIPLES UNLESS
OTHERWISE NOTED. UNLESS THE CONTEXT INDICATES OTHERWISE, ALL REFERENCES IN THIS
PROSPECTUS TO "WE", "US", "OUR" OR THE "COMPANY" INCLUDE ERIE INDEMNITY COMPANY
AND ITS WHOLLY OWNED SUBSIDIARIES, ERIE INSURANCE COMPANY, ERIE INSURANCE
COMPANY OF NEW YORK AND ERIE INSURANCE PROPERTY & CASUALTY COMPANY. AS USED IN
THIS PROSPECTUS, THE "EXCHANGE" REFERS TO ERIE INSURANCE EXCHANGE, AND "ERIE
INSURANCE GROUP" REFERS TO THE COMPANY, THE EXCHANGE, ITS SUBSIDIARY, FLAGSHIP
CITY INSURANCE COMPANY, AND ITS AFFILIATE, ERIE FAMILY LIFE INSURANCE COMPANY.
OUR COMPANY
We operate predominantly as a provider of management services to Erie
Insurance Exchange (the "Exchange"). We also operate as a property and casualty
insurer through our subsidiaries. We have served since 1925 as the
attorney-in-fact for the policyholders of the Exchange. The Exchange is a
reciprocal insurance exchange, which is an unincorporated association of
individuals, partnerships and corporations that agree to insure one another.
Each applicant for insurance to a reciprocal insurance exchange signs a
subscriber's agreement, which contains an appointment of an attorney-in-fact. As
attorney-in-fact, the Company is required to perform certain services relating
to the sales, underwriting and issuance of policies on behalf of the Exchange.
The Exchange and its property and casualty subsidiary and our three
property and casualty subsidiaries (collectively, the "Property and Casualty
Group") write personal and commercial lines property and casualty coverages
exclusively through approximately 8,000 independent agents and pool their
underwriting results. The financial results of the Exchange are not consolidated
with ours.
For our services as attorney-in-fact, we charge the Exchange a management
fee calculated as a percentage, limited to 25%, of the direct written premiums
of the Property and Casualty Group. Management fees accounted for approximately
78% of our revenues for the nine months ended September 30, 2002. For the first
nine months of 2002, 70% of the direct premiums written by the Property and
Casualty Group were personal lines, while 30% were commercial lines. We also own
21.6% of the common stock of Erie Family Life Insurance Company, an affiliated
life insurance company, of which the Exchange owns 53.5% and public
shareholders, including certain of our directors, own 24.9%. At September 30,
2002, we had total assets of $2.2 billion, total liabilities of $1.2 billion and
shareholders' equity of $958 million. Our net income was $138.2 million for the
nine months ended September 30, 2002 and $122.3 million for the year ended
December 31, 2001.
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We believe we are the only publicly-traded attorney-in-fact for a
reciprocal insurance exchange in the country. Several other private property and
casualty companies, such as USAA and Farmers Insurance Group (owned by Zurich
Financial Services Group), are reciprocal insurance exchanges that operate with
separate management arrangements. Our earnings are largely generated by fees
based on premiums written directly by the underwriting pool of the Property and
Casualty Group, in which the Exchange has a 94.5% participation. We therefore
have a direct incentive to protect the financial condition of the Exchange. As a
result of the Exchange's 94.5% participation in the underwriting results of the
Property and Casualty Group, the underwriting risk of the Property and Casualty
Group's business is largely borne by the Exchange, which had $2.1 billion of
statutory surplus at September 30, 2002. The surplus of the Exchange was $4.8
billion at December 31, 1999 and has declined primarily from marketable security
investment declines and underwriting losses. Through the pool, our property and
casualty subsidiaries currently assume 5.5% of the Property and Casualty Group's
underwriting results, and therefore we also have a direct incentive to manage
the overall underwriting business as effectively as possible.
ERIE INSURANCE GROUP
ORGANIZATIONAL CHART
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| Shareholders |
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|
-------------------
| Erie Indemnity | Attorney-in-Fact -----------------------------
| Company |-----------for Policyholders------------| Erie Insurance Exchange* |
------------------- -----------------------------
| |
--------------------------------------------- ---------------------
| | | | |
| | | | |
100% 100% 21.6% 53.5% 100%
| | | | |
------------------ ------------------- ------------------------ --------------------
| | | Erie Insurance* | | | | |
| Erie Insurance*| | Property & | | Erie Family life | | Flagship City* |
| Company | | Casualty | | Insurance | | Insurance |
| | | Company | | Company | | Company |
------------------ ------------------- ------------------------ --------------------
|
|
100%
|
|
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| |
| Erie Insurance*|
| Company of |
| New York |
------------------
* Denotes a member of the Property and Casualty Group
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The Property and Casualty Group seeks to insure standard and preferred
risks in primarily private passenger automobile, homeowners and small commercial
lines, including workers' compensation policies. We believe the Property and
Casualty Group has differentiated its products from standard industry products
by providing additional coverages, which enhance agents' marketing efforts. The
Property and Casualty Group's agency force consists of over 1,700 independent
agencies comprised of approximately 8,000 agents in 11 Midwestern, Mid-Atlantic
and Southeastern states (Illinois, Indiana, Maryland, New York, North Carolina,
Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and Wisconsin) and the
District of Columbia. These independent agents play a significant role as
underwriters and are major contributors to the Property and Casualty Group's
success.
The Company has reported increasing net operating income for 14 consecutive
years. The increases in net operating income have been driven by the premium
growth of the Property and Casualty Group that resulted in a corresponding
increase in the amount of the management fee. The premium growth of the Property
and Casualty Group has resulted primarily from an expansion of its business into
new territories, the appointment of new agencies, high policy and agency
retention rates and, recently, increased premium rates.
. Since 1997, the Property and Casualty Group has entered Illinois and
Wisconsin and expects to begin operating in Minnesota in the third quarter
of 2004.
. In 2001, we continued the planned expansion of the Property and
Casualty Group's independent agency force by appointing 247 agencies. Since
1997, we have increased the overall number of agencies representing the
Property and Casualty Group by 60%.
. The Property and Casualty Group has a very stable base of
policyholders. The Property and Casualty Group's retention rate of 90.9% in
2001 compared favorably to an average of 82.6% for a core benchmark group
consisting largely of regional property and casualty insurers, according to
a 2001 Ward Group benchmark study.
. The Property and Casualty Group is achieving premium rate increases as
a result of the current favorable market conditions in both commercial and
personal property and casualty lines, which are generally referred to
within the industry as "hard market conditions". Hard market conditions are
characterized by increasing premium rates, more stringent underwriting
standards and a need for additional capital. The Property and Casualty
Group and the Company have benefited from these hard market conditions and
for the twelve months ended September 30, 2002 experienced average premium
per policy increases of 7.2% for personal automobile insurance policies,
17.6% for commercial lines policies and 9.5% across all lines. Management
believes increases in premium rates are likely to continue in 2002 and
-4-
2003. Generally, the Company's profit margins from management operations
have increased during periods of premium rate increases.
As a result of these growth initiatives and market conditions, the Property
and Casualty Group had over 3.4 million insurance policies in force as of
September 30, 2002, an 11.9% increase from September 30, 2001. Personal lines
policies in force grew by 11.8% during the twelve months ended September 30,
2002, while commercial lines policies increased 13.0% over the same period.
The Property and Casualty Group has incurred underwriting losses in recent
years, primarily as a result of reducing premium rates in 1998 and 1999 in
response to competitive conditions, due to increasing loss severity and due to
reinsurance losses, including losses from the terrorist attack on the World
Trade Center. Because we have a 5.5% participation in the underwriting results
of the Property and Casualty Group, 5.5% of its underwriting losses are
reflected in our results of operations. Our share of these underwriting losses,
which includes the reinsurance losses, were $3.5 million in 1999, $10.4 million
in 2000 and $20.5 million in 2001, respectively.
Each member of the Property and Casualty Group is rated A++ (Superior) by
A.M. Best Company, Inc. ("A.M. Best"), its highest financial strength rating,
which was held by only 2.8% of the property and casualty insurance groups rated
by A.M. Best as of July 11, 2002.
STRATEGY
The Erie Insurance Group's overall strategy includes providing attractive
property and casualty insurance products at competitive prices, coupled with
high-quality service. The Erie Insurance Group distributes these products
exclusively through independent insurance agents whose insurance and
underwriting expertise, local market knowledge and commitment to service have
been key drivers of Erie Insurance Group's growth. The Erie Insurance Group's
strategy includes:
. Growth by expansion of existing operations, rather than through
acquisition, including by (i) a careful agency selection process in which
the Property and Casualty Group seeks to be the primary property and
casualty underwriter for each agency, (ii) a thoughtful expansion into
favorable states and (iii) increased market penetration in existing
operating territories.
. Quality service to policyholders in claims handling, underwriting and
other service activities.
. Achieving underwriting profits for the Property and Casualty Group by
focusing on standard and preferred risks and by setting and adhering to
consistent underwriting standards.
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. A business model designed to provide the advantages of localized
marketing and claims servicing with the economies of scale derived from
centralized management and administration.
RECENT DEVELOPMENTS
At its meeting on December 10, 2002, our Board of Directors approved:
. the reduction of the management fee rate for 2003 from its previous
rate of 25% to 24%, which would have reduced the Company's net income by
$15.4 million and net income per share by $0.22 or 11.2% had such reduction
been effective for the nine months ended September 30, 2002;
. an increase in the regular quarterly dividend from $0.17 to $0.19 on
each share of Class A common stock and from $25.50 to $28.50 on each share
of Class B common stock; and
. the reduction of the service agreement rate, which relates to the
management and administration by us of the Exchange's voluntary assumed
reinsurance business from non-affiliated insurers, for 2003 from its
previous rate of 7% to 6%, which would have reduced the Company's net
income by $750,000 and net income per share by $0.01 or less than 1% had
such reduction been effective for the nine months ended September 30, 2002.
In determining whether to reduce the management fee rate and the service
agreement rate, the Company's board of directors considered the relative
financial position of the Exchange and the Company, including the surplus levels
and underwriting results of the Exchange and the management fee and earnings
growth prospects of the Company.
The Company recorded in the fourth quarter of 2002 a one-time charge to net
income of $3.9 million, or $.06 per share, to establish an estimated allowance
for returned management fees, rather than continuing to make adjustments upon
return. This charge recognizes the management fee anticipated to be returned to
the Exchange based on historical cancellation rates. The Company did not restate
prior period financial statements because the Company believes this adjustment
is not material to the trend of earnings for the Company nor any related
financial statement amount. Future changes in this allowance will be reflected
in the Company's statement of operations and are not expected to be material.
Cash flows will not be affected.
Members of the Property and Casualty Group increased their loss and loss
adjustment reserves by approximately $184 million in the fourth quarter of 2002.
Approximately $3.1 million to $6.2 million of these increases were for our
subsidiaries, which will result in after tax charges to us of approximately $.03
to $.06 in the fourth quarter. The increases in reserves were taken in response
to adverse loss experience in the group's automobile, homeowners
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and workers' compensation lines, which was primarily attributable to increased
loss severity from automobile bodily injury and catastrophic medical claims in
the workers' compensation lines.
The Company recognized realized capital losses during the fourth quarter of
2002 of approximately $8.4 million. These losses resulted from the sale of
certain securities and from charges for impairments based on the Company's
regular periodic review of equity, debt and limited partnership investments held
by the Company. The losses will reduce fourth quarter net income by
approximately $5.5 million or $.08 per share.
THE OFFERING
Class A common stock offered ............... 4,000,000 shares of our Class A
common stock, which is
non-voting, are being offered by
the Selling Shareholder named
below.
Class A common stock outstanding after
this offering .............................. 64,037,106 shares
Class B common stock outstanding after
this offering .............................. 2,900 shares
Class B common stock conversion ratio ...... One share of Class B common stock
may be converted into 2,400
shares of Class A common stock.
Class A common stock outstanding after
this offering assuming conversion .......... 70,997,106 shares
Dividend history ........................... We declared and paid cash
dividends of $0.17 per share of
Class A common stock for each of
the first three quarters of 2002
and $25.50 per share of Class B
common stock for each of the
first three quarters of 2002. We
declared a cash dividend of $0.19
per share of Class A common stock
for the fourth quarter of 2002
and $28.50 per share of Class B
common stock for the fourth
quarter of 2002.
We have paid regular quarterly
cash dividends since 1942. Our
board of
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directors considers the declaration of
cash dividends on a quarterly basis.
The payment of future dividends, if
any, will be at the discretion of our
board of directors and will depend upon
many factors, including:
. our earnings;
. our financial position;
. our capital requirements and those
of our subsidiaries; and
. our ability to receive dividends
from our subsidiaries, which is
subject to regulatory limitations.
There can be no assurance as to the
declaration of future dividends.
Use of proceeds ...................... We will not receive any of the proceeds
from this offering of our Class A
common stock. The Selling Shareholder
identified below will receive all the
net proceeds from the sale of these
shares.
NASDAQ Stock Market(SM) symbol ....... ERIE
The above information assumes that the option covering an additional
600,000 shares granted by the Selling Shareholder to the underwriters will not
be exercised.
The above information is based on the number of shares outstanding as of
January 1, 2003.
SELLING SHAREHOLDER
Black Interests Limited Partnership (the "Selling Shareholder") is offering
4.0 million shares of the Company's Class A common stock. The Selling
Shareholder has also granted the underwriters a 30-day option to purchase up to
an additional 600,000 shares of the Company's Class A common stock. Samuel P.
Black, III is the managing general partner of the Selling Shareholder and has
the right to vote the shares held by it. Mr. Black has been a director of the
Company since 1997 and succeeded his father, who served as a director during
various periods from 1930 to 1997. Mr. Black is also an officer and principal
shareholder of
-8-
an insurance agency that receives insurance commissions in the ordinary course
of business from the insurance companies we manage, in accordance with the
insurance companies' standard commission schedules and agents' contracts.
A majority of the proceeds of the shares being offered as described in this
prospectus will be used by the Selling Shareholder to pay estate taxes and other
estate-related expenses arising from the recent death of Mr. Black's mother and
to make a charitable bequest.
CORPORATE INFORMATION
We were incorporated in Pennsylvania in 1925. Our principal executive
offices are located at 100 Erie Insurance Place, Erie, Pennsylvania 16530, and
our telephone number is (814) 870-2000. Our website is located at
www.erieinsurance.com. The information on this website is not a part of this
prospectus.
-9-
SUMMARY HISTORICAL FINANCIAL INFORMATION
The summary consolidated financial data presented below as of or for the
years ended December 31, 1997 through 2001 is derived from our audited financial
statements. Our consolidated financial statements as of December 31, 2000 and
2001 and for each of the years in the three-year period ended December 31, 2001,
and our independent auditors' report thereon, are included elsewhere in this
prospectus and incorporated by reference herein. See "Where To Find More
Information/Incorporation by Reference". The summary consolidated financial data
presented below as of or for the nine-month periods ended September 30, 2001 and
2002 is derived from our unaudited consolidated financial statements included
elsewhere in this prospectus and incorporated by reference herein. See "Where To
Find More Information/Incorporation by Reference". Our results of operations for
the nine months ended September 30, 2002 are not necessarily indicative of our
results of operations that may be expected for the year ending December 31,
2002. In the opinion of our management, all adjustments, consisting only of
normal recurring accruals, considered necessary for a fair presentation have
been included. The financial data set forth below is only a summary and should
be read in conjunction with our consolidated financial statements and related
notes and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere herein.
Nine Months Ended
September 30, Year Ended December 31,
---------------------- ----------------------------------------------------------
(amounts in thousands, except per share data) 2002 2001 2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ---------- ---------- ----------
(unaudited)
STATEMENTS OF OPERATIONS DATA:
Operating revenue $ 730,029 $ 602,001 $ 799,861 $ 698,016 $ 646,040 $ 615,965 $ 581,979
Operating expense 556,871 466,566 635,756 549,672 501,061 470,155 450,037
Total other income and expenses 33,187 35,408 17,998 70,102 58,731 45,770 38,747
Equity in earnings of Erie Family Life
Insurance Company, net of tax 1,015 2,337 719 5,108 4,692 4,443 3,935
Federal income tax expense 69,171 56,835 60,561 71,161 65,296 61,472 56,043
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income $ 138,189 $ 116,345 $ 122,261 $ 152,393 $ 143,106 $ 134,551 $ 118,581
========== ========== ========== ========== ========== ========== ==========
PER SHARE DATA:
Net income per share $ 1.94 $ 1.63 $ 1.71 $ 2.12 $ 1.95 $ 1.81 $ 1.59
Book value per share 13.50 12.01 12.15 10.91 9.62 8.81 7.25
Weighted average shares outstanding 71,109 71,380 71,342 71,954 73,487 74,400 74,400
FINANCIAL POSITION:
Investments (1) $ 969,898 $ 884,599 $ 885,650 $ 853,146 $ 785,258 $ 709,417 $ 566,118
Receivables from the Exchange and affiliates 761,295 650,091 640,655 532,009 470,969 467,794 469,708
Total assets 2,194,690 1,897,077 1,935,566 1,680,599 1,518,794 1,454,062 1,292,544
Shareholders' equity 958,274 855,755 865,255 779,015 697,599 655,223 539,383
----------------
(1) Includes investment in Erie Family Life Insurance Company.
-10-
RISK FACTORS
YOU SHOULD CONSIDER CAREFULLY THE RISKS AND UNCERTAINTIES DESCRIBED BELOW AND
THE OTHER INFORMATION IN THIS PROSPECTUS, INCLUDING OUR CONSOLIDATED FINANCIAL
STATEMENTS AND RELATED NOTES, BEFORE DECIDING TO INVEST IN SHARES OF OUR CLASS A
COMMON STOCK. IF ANY OF THE FOLLOWING RISKS OR UNCERTAINTIES ACTUALLY OCCUR, OUR
BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS WOULD LIKELY SUFFER. IN THAT
EVENT, THE MARKET PRICE OF OUR CLASS A COMMON STOCK COULD DECLINE AND YOU COULD
LOSE ALL OR PART OF THE MONEY YOU PAID TO BUY OUR CLASS A COMMON STOCK.
RISKS RELATING TO OUR BUSINESS AND OUR RELATIONSHIPS WITH THIRD PARTIES
IF THE MANAGEMENT FEE RATE PAID TO US BY THE EXCHANGE IS FURTHER
REDUCED, IF THERE IS A SIGNIFICANT DECREASE IN THE AMOUNT OF PREMIUMS WRITTEN BY
THE EXCHANGE OR IF WE DO NOT CONTROL THE COSTS OF PROVIDING SERVICES TO THE
EXCHANGE, OUR REVENUES AND PROFITABILITY COULD BE MATERIALLY ADVERSELY AFFECTED.
We are dependent upon management fees paid to us by the Exchange, which
represent our principal source of revenue. Management fees from the Exchange
constituted 78% of our revenues for the first nine months of 2002, 78% of our
revenues for 2001, and 74% of our revenues during the three years ended December
31, 2001. The management fee rate we receive is determined by our board of
directors and may not exceed 25% of the direct written premiums of the Property
and Casualty Group. Since 1999, the management fee rate has been 25%. In 1998
and 1997, the management fee rate was 24.25% and 24%, respectively.
Our board of directors generally sets the management fee rate each
December for the following year. However, at their discretion, the rate can be
changed at any time. The factors our board of directors consider in setting the
management fee rate include our financial position in relation to the Exchange
and the long-term needs of the Exchange for capital and surplus to support its
continued growth and competitiveness. The Exchange's capital and surplus could
become impaired due to a number of factors, including those discussed under "--
Risks Relating to the Business of the Property and Casualty Group" and "-- Risks
Relating to the Property and Casualty Insurance Industry" below. In light of
factors including the strong growth of the Exchange's premium base and the
decline in the policyholders' surplus of the Exchange from $4.8 billion at
December 31, 1999 to $2.1 billion at September 30, 2002, the management fee rate
for 2003 was reduced to 24% at our board's December 2002 meeting.
If our board of directors were to determine that the management fee
rate should be further reduced, our revenues and profitability could be
materially adversely affected. For example, a 1% reduction in the management fee
rate during the nine months ended September 30, 2002 would have resulted in a
reduction in our net revenues of $23.8 million, or 12.6%, and a reduction in our
net income per share of $0.22, or 11.2%. A similar decrease of 1% during 2001
would have resulted in a reduction in our net revenues of $25.4 million, or
13.8%, and a reduction in our net income per share of $0.23, or 13.5%.
-11-
Our management fee revenue from the Exchange is calculated by
multiplying the management fee rate by the direct premiums written by the
Exchange and the direct premiums written by the other members of the Property
and Casualty Group, which are initially assumed by the Exchange. Accordingly,
any reduction in direct premiums written by the Property and Casualty Group
would have a proportional negative effect on our revenues and net income.
Pursuant to the attorney-in-fact agreements with the policyholders of
the Exchange, the Company is appointed to perform certain services, regardless
of the cost to the Company of providing those services. These services relate to
the sales, underwriting and issuance of policies on behalf of the Exchange. We
could lose money or be less profitable if our cost of providing those services
increases significantly.
OUR BOARD OF DIRECTORS FACES CERTAIN CONFLICTS OF INTEREST BECAUSE IT
MUST BALANCE FIDUCIARY OBLIGATIONS TO POLICYHOLDERS OF THE EXCHANGE AND TO OUR
SHAREHOLDERS; THUS OUR BOARD OF DIRECTORS MUST MAKE DECISIONS THAT ARE NOT
SOLELY IN THE INTERESTS OF OUR SHAREHOLDERS.
The Exchange has no board of directors or governing body of its own. In
our capacity as attorney-in-fact, we have a fiduciary duty to the policyholders
of the Exchange to protect their interests. Likewise, we have a fiduciary duty
to our shareholders. Certain conflicts of interest arise from these separate
fiduciary duties. Among these conflicts of interest are:
. Our board of directors sets the management fee rate paid by the
Exchange to us and decides the percentage participation rate of our
property and casualty subsidiaries in the pool.
. We make judgments about the allocation of shared costs between the
Exchange and the Company in accordance with intercompany agreements and
the attorney-in-fact agreements with the policyholders of the Exchange,
including costs relating to the eCommerce program.
. The Exchange may enter into other transactions and contractual
relationships with the Company and its subsidiaries.
As a consequence, our board of directors must make decisions or take
actions that are not solely in the interests of our shareholders. If, for
example, there should be a need to strengthen the surplus of the Exchange, our
board of directors may decide to reduce the management fee rate and/or that we
should make a capital contribution to the Exchange in the form of a surplus note
or some other form. Under such circumstances, we may be required to provide such
capital to the Exchange at a lower rate of return than would be available with
other investments or at no return at all. Payments of interest and repayment of
principal on a surplus note are subject to prior approval of the Pennsylvania
Department
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of Insurance, which may not approve such payments. We may also find it necessary
to fund additional surplus for the Exchange by issuing additional shares of our
capital stock, resulting in dilution of existing shareholders' interest. In
addition, state regulators could challenge the reasonableness of the
transactions between us and the Exchange.
WE ARE SUBJECT TO CREDIT RISK TO THE EXCHANGE BECAUSE OUR MANAGEMENT
FEES FROM THE EXCHANGE ARE NOT PAID IMMEDIATELY WHEN EARNED AND OUR INSURANCE
SUBSIDIARIES ARE SUBJECT TO CREDIT RISK TO THE EXCHANGE BECAUSE THE EXCHANGE
ASSUMES A HIGHER INSURANCE RISK UNDER AN INTERCOMPANY POOLING ARRANGEMENT THAN
IS PROPORTIONAL TO ITS DIRECT BUSINESS CONTRIBUTION TO THE POOL.
We recognize management fees due from the Exchange as income when the
premiums are written because at that time we have performed substantially all of
the services we are required to perform, including sales, underwriting and
policy issuance activities, but currently such fees are not paid to us by the
Exchange until it collects the premiums. As a result, we hold receivables for
management fees due us for premiums written but not yet collected by the
Exchange. In addition, we hold receivables from the Exchange for costs we pay on
their behalf and for reinsurance under the intercompany pooling arrangement. Our
total receivables from the Exchange, including the management fee, costs we pay
on behalf of the Exchange and reinsurance recoverables, totaled $759.6 million,
or 34.6% of our total assets at September 30, 2002, and $638.4 million, or 33.0%
of our total assets at December 31, 2001. The receivables represented 12.3% of
the Exchange's assets at September 30, 2002 and 9.1% at December 31, 2001.
The Exchange and two of our wholly owned subsidiaries, Erie Insurance
Company and Erie Insurance Company of New York, are parties to an intercompany
pooling arrangement. Under this pooling arrangement, our insurance subsidiaries
cede 100% of their property and casualty underwriting business to the Exchange,
which retrocedes 5% of the pooled business to Erie Insurance Company and 0.5% to
Erie Insurance Company of New York. In 2001, only approximately 81.4% of the
pooled direct property and casualty business was originally generated by the
Exchange and its subsidiary, while 94.5% of the pooled business is retroceded to
the Exchange under the intercompany pooling arrangement. Accordingly, the
Exchange assumes a higher insurance risk than is proportional to the insurance
business it contributes to the pool. In 2001, our subsidiaries wrote 18.6% of
the direct premiums, while assuming only 5.5% of the risk. This poses a credit
risk to our subsidiaries participating in the pool because they are still
responsible ultimately to the policyholders for policies they have written if
the Exchange is unable to meet its obligations.
OUR FINANCIAL CONDITION MAY SUFFER BECAUSE OF DECLINES IN THE VALUE OF
THE MARKETABLE SECURITIES THAT CONSTITUTE A SIGNIFICANT PORTION OF OUR ASSETS.
At September 30, 2002, we had investments in marketable securities of
approximately $828 million and investments in limited partnerships of
approximately $89 million. In
-13-
addition, we are obligated to invest up to an additional $116 million in limited
partnerships, including in partnerships for U.S. and foreign private equity real
estate and fixed income investments. All of our marketable security investments
are subject to market volatility. Our fixed income securities investments are
exposed to price risk and to risk from changes in interest rates as well as
credit risk related to the issuer. Generally, we do not hedge our exposure to
interest rate risk as we have the ability to hold fixed income securities to
maturity. Our marketable securities have exposure to price risk and the
volatility of the equity markets and general economic conditions. The stock
market decline in 2002 has reduced the value of our marketable securities by
$6.8 million during the first nine months of 2002 compared to $3.4 million
during the first nine months of 2001. To the extent that future market
volatility negatively impacts our investments, our results of operations will be
negatively impacted.
THE TWO INDIVIDUAL TRUSTEES OF OUR CONTROLLING SHAREHOLDERS, THE H.O.
HIRT TRUSTS, HAVE SIGNIFICANTLY DIFFERING VIEWS ON A NUMBER OF MATTERS RELATING
TO THE COMPANY; SUCH DISAGREEMENTS MAY HAVE AN ADVERSE EFFECT ON OUR BUSINESS
AND ON THE VALUE OF OUR CLASS A COMMON STOCK.
Two trusts established by our founder, H.O. Hirt (the "H.O. Hirt
Trusts"), own 80.7% of our Class B common stock, which is the only class of
stock that can vote for the election of directors and has the ability to
determine the outcome of all other matters that require shareholder approval,
except those matters pertaining only to the rights of the holders of our Class A
common stock. The corporate trustee of the H.O. Hirt Trusts is Bankers Trust
Company of New York ("Bankers Trust") and the two individual trustees of the
H.O. Hirt Trusts are F. William Hirt and Susan Hirt Hagen, who are brother and
sister and the children of H.O. Hirt. Any determination by the H.O. Hirt Trusts
requires a vote of two of the three trustees and, because the H.O. Hirt Trusts
control 80.7% of our Class B common stock, any such determination will be
controlling in a shareholder vote. Mrs. Hagen and Mr. Hirt disagree on a number
of matters relating to corporate governance, the appointment of a successor
corporate trustee and the financial condition of the Exchange.
Mrs. Hagen has recently raised concerns regarding a number of such
matters, including: the role of the H.O. Hirt Trusts as controlling shareholders
in the governance of the Company; the propriety of a corporate trustee of the
H.O. Hirt Trusts engaging in insurance brokerage activities; the restructuring
of our board of directors so that a majority of the directors are independent of
management; the restructuring of the committees of our board of directors to
provide a more meaningful role for directors who do not have ongoing business
relationships with us; the desirability of more liquidity and increased
institutional investor interest in the Company and the allocation of expenses
between the Exchange and us. Mrs. Hagen has also recently proposed five
amendments to the Company's Bylaws for consideration by the voting shareholders
at the Company's annual meeting of shareholders for 2003. These amendments
concern (i) revising the existing advance notice bylaw to
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provide that direct nomination by voting shareholders of candidates for director
are not due until after our Nominating Committee announces its proposed slate;
(ii) revising the advance notice bylaw to provide that other shareholder
proposals for annual meetings must be submitted not less than 60 nor more than
120 days prior to the first anniversary of the prior year's annual meeting;
(iii) fixing the size of our board of directors at 13 members; (iv) providing
that vacancies on our board of directors only may be filled by the voting
shareholders and (v) providing that the bylaw provisions containing the
foregoing may not be amended without a vote of the voting shareholders.
Mrs. Hagen on one occasion commenced litigation against us in
connection with corporate governance matters and has participated in litigation
involving the H.O. Hirt Trusts brought by each of the trustees of the H.O. Hirt
Trusts and by other beneficiaries of the H.O. Hirt Trusts. On two occasions in
the recent past, Mr. Hirt brought a suit, which was subsequently withdrawn
without prejudice, seeking the removal of Mrs. Hagen as an individual trustee.
In addition, Mrs. Hagen has sent the Company a notice requesting that the
Company's Nominating Committee consider a slate of director nominees proposed by
her for election at the 2003 annual meeting of shareholders. Mr. Hirt has sent
the Company a notice requesting that the Company's Nominating Committee consider
certain other persons as director nominees. The effect of these disagreements
and concerns and possible future disagreements between Mrs. Hagen and Mr. Hirt
on us and the value of our Class A common stock cannot be predicted.
MRS. HAGEN, WHO IS A MEMBER OF OUR BOARD OF DIRECTORS, A TRUSTEE AND A
BENEFICIARY OF THE H.O. HIRT TRUSTS AND A BENEFICIAL OWNER OF APPROXIMATELY
10.4% OF OUR CLASS A COMMON STOCK, IS OPPOSED TO OUR PARTICIPATION IN THIS
OFFERING BECAUSE SHE BELIEVES THERE MAY BE A BETTER ALTERNATIVE FOR US AND MAY
TAKE ADDITIONAL ACTIONS TO OPPOSE THIS OFFERING.
The concerns that Mrs. Hagen has expressed to our board of directors
about this offering include:
. the amount of time and effort required of our officers to prepare a
registration statement relating to this offering and to assist in the
marketing of the shares offered hereby instead of fully concentrating
their efforts on business and financial issues confronting Erie
Insurance Group;
. the liability of our directors and the H.O. Hirt Trusts if the
registration statement, including this prospectus, were determined to
contain a material misstatement or a material omission and the
indemnification by us of the underwriters for certain potential
liabilities under federal securities laws related to this offering;
. the need for the Company to consider retention of a national
auditing firm;
-15-
. the impact of the offering on our ability to attract independent
director candidates during this offering because of the potential
liability associated therewith;
. doubts whether a public offering would unlock any long-term value
for our shareholders;
. concerns that increased public holdings of our Class A common stock
will attract institutional investors; and
. her opinion that a below-market purchase by us of the shares being
offered by the Selling Shareholder would be more advantageous to us.
Our board of directors considered Mrs. Hagen's concerns at meetings
held on August 16, 2002 and September 9, 2002. At each meeting, Mrs. Hagen was
the only member of our board of directors present to vote against proceeding
with this offering. We are unable to predict whether Mrs. Hagen or any other
trustee or any other beneficiary of the H.O. Hirt Trusts may take additional
actions to oppose this offering.
DECISIONS BY THE CORPORATE TRUSTEE OF THE H.O. HIRT TRUSTS OR A
SUCCESSOR TO EITHER OF THE INDIVIDUAL TRUSTEES COULD MATERIALLY ALTER OUR
MANAGEMENT, STRATEGIC DIRECTION, OPERATING PHILOSOPHY OR OTHER MATTERS MATERIAL
TO US.
Bankers Trust tendered its resignation as corporate trustee of the H.O.
Hirt Trusts on March 3, 1999, 36 days after it had been appointed. The selection
of a new corporate trustee of the H.O. Hirt Trusts to replace Bankers Trust is
pending before Orphan's Court in Erie County, Pennsylvania. We cannot predict or
estimate when a replacement corporate trustee will be chosen to replace Bankers
Trust or who it will be. Because any action of the H.O. Hirt Trusts requires a
vote of two of the three trustees and because Mrs. Hagen and Mr. Hirt have
significantly differing views, the vote of the corporate trustee has been, and
will likely continue to be, determinative of the actions of the H.O. Hirt
Trusts. There are a number of circumstances in which a successor to one of the
individual trustees would be appointed, including the death of an individual
trustee. If an individual trustee is to be appointed, under the terms of the
H.O. Hirt Trusts, the remaining individual trustee, the corporate trustee and
our board of directors may select a replacement individual trustee or, if no
successor is selected within 30 days, the remaining trustees and the Company
shall petition the Court of Common Pleas of Erie County, Pennsylvania to fill
said vacancy under the trust agreement. Mr. Hirt is 77 years old and Mrs. Hagen
is 67 years old. Decisions by the existing trustees or successor trustees,
including supporting a slate of directors put forth by Mrs. Hagen or another
shareholder, could materially alter our management, strategic direction,
operating philosophy or other matters material to us. It is impossible to
determine how these decisions may affect the value of the Company and therefore
our Class A common stock.
-16-
RISKS RELATING TO THE BUSINESS OF THE PROPERTY AND CASUALTY GROUP
THE PROPERTY AND CASUALTY GROUP CONDUCTS BUSINESS IN ONLY 11 STATES AND
THE DISTRICT OF COLUMBIA, WITH A CONCENTRATION OF BUSINESS IN OHIO, MARYLAND,
VIRGINIA AND, PARTICULARLY, PENNSYLVANIA. ANY SINGLE CATASTROPHE OCCURRENCE OR
OTHER CONDITION DISPROPORTIONATELY AFFECTING LOSSES IN THESE STATES COULD
ADVERSELY AFFECT THE RESULTS OF OPERATIONS OF MEMBERS OF THE PROPERTY AND
CASUALTY GROUP.
The Property and Casualty Group conducts business in only 11 states and
the District of Columbia, primarily in the Mid-Atlantic, Midwestern and
Southeastern portions of the United States. A substantial portion of this
business is private passenger and commercial automobile, homeowners and workers'
compensation insurance in Ohio, Maryland, Virginia and, particularly,
Pennsylvania. As a result, a single catastrophe occurrence, destructive weather
pattern, general economic trend, terrorist attack, regulatory development or
other condition disproportionately affecting one or more of the states in which
the Property and Casualty Group conducts substantial business could materially
adversely affect the results of operations of members of the Property and
Casualty Group. Common catastrophe events include hurricanes, earthquakes,
tornadoes, wind and hail storms, fires and explosions. Recent ice storms in
North Carolina and tornadoes and hail in Ohio and Pennsylvania during November
and December 2002 are examples of the type of event that can negatively impact
underwriting results. The Property and Casualty Group estimates the combined
exposure from the approximately 4,500 damage claims from these storms will
result in incurred losses of approximately $21 million to $24 million, our share
of which will be approximately $1.3 million or $.01 per share after taxes.
Effective January 1, 2003, the Property and Casualty Group entered into a
property catastrophe reinsurance treaty that provides coverage of 95% of a loss
up to $415 million in excess of the Property and Casualty Group's loss retention
of $115 million per occurrence.
THE OPERATING RESULTS OF THE EXCHANGE ARE SUBJECT TO GREATER
VARIABILITY BECAUSE THE PROPERTY AND CASUALTY GROUP GENERALLY DID NOT MAINTAIN
REINSURANCE COVERAGE AFTER 1993 THROUGH 2002.
The Property and Casualty Group did not purchase treaty reinsurance,
including catastrophe reinsurance, after 1993 through 2002, because management
concluded, during our periodic assessments of the Property and Casualty Group's
catastrophe exposure, that the benefits of such coverage were outweighed by the
costs of the coverage in light of the Exchange's substantial surplus and its
ratio of net premiums written to surplus. The Property and Casualty Group did
obtain property catastrophe treaty reinsurance to protect its 2003 accident year
underwriting results from catastrophes. The lower surplus levels of the
Exchange, along with increasing catastrophe risk exposure as a result of
accelerating policy growth, have resulted in management's decision to purchase
property catastrophe treaty reinsurance coverage. The Exchange's reported
surplus totaled $2.1 billion at September 30, 2002 compared to $4.8 billion at
December 31, 1999, a reduction of 56%.
-17-
We cannot determine whether the Exchange's profitability could have
been improved in years after 1993 through 2002 if the Exchange had purchased
treaty reinsurance because it is impossible to establish the terms on which the
Exchange might have obtained such reinsurance. If the recently purchased
property Catastrophe treaty reinsurance had been in effect during 2002, there
would have been no recoveries and the profitability of the Exchange would not
have been affected except by the cost of such reinsurance. The risk of not
maintaining reinsurance coverage in the event of a significant catastrophe or a
series of moderate catastrophes in the same year means that surplus levels could
be exposed to dramatic decline should such catastrophes occur. Reinsurance for
catastrophe exposure protects the balance sheet and income statement against
large and infrequent events and reduces the variability of earnings. A dramatic
decline in the surplus levels would result in pressure to reduce premium
writings, and thereby, curtail growth of our property and casualty subsidiaries.
Without the benefit of higher surplus levels, the ability of the Exchange to
write additional premium would be reduced and so would be the Company's
opportunity to grow.
Variability in the Exchange's financial results can affect our
financial results in several ways. The management fee rate charged to the
Exchange by us is set based in substantial part on a review of the relative
financial condition and operating results of the Exchange and us. Deterioration
in the financial condition and operating results of the Exchange could result in
a reduction in the management fee rate paid to us or could constrain the
capacity of the Exchange to write additional premium, which would reduce
management fees paid to us. In addition, if the Exchange's financial condition
worsened considerably we could be subject to greater credit risk related to our
large accounts receivable balance due from the Exchange.
THE BUSINESS AND RESULTS OF OPERATIONS OF THE PROPERTY AND CASUALTY
GROUP WILL BE ADVERSELY AFFECTED IF THE INDEPENDENT AGENTS THAT MARKET THE
PROPERTY AND CASUALTY GROUP'S PRODUCTS DO NOT MAINTAIN THEIR CURRENT LEVELS OF
PREMIUM WRITING, FAIL TO COMPLY WITH ESTABLISHED UNDERWRITING GUIDELINES OR
OTHERWISE IMPROPERLY MARKET OUR PRODUCTS.
The Property and Casualty Group markets its insurance products solely
through a network of over 1,700 independent insurance agencies. As a result, the
Property and Casualty Group is wholly dependent upon these agencies, each of
which has the authority to bind the Property and Casualty Group to insurance
contracts. To the extent that these agencies' marketing efforts cannot be
maintained at their current levels of volume and quality or they bind the
Property and Casualty Group to unacceptable insurance risks, fail to comply with
established underwriting guidelines or otherwise improperly market our products,
the results of operations and business of the Property and Casualty Group will
suffer.
THE BUSINESS OF THE PROPERTY AND CASUALTY GROUP MAY NOT CONTINUE TO
GROW AND MAY BE MATERIALLY ADVERSELY AFFECTED IF THE COMPANY CANNOT RETAIN
EXISTING, AND ATTRACT NEW, INDEPENDENT AGENCIES OR IF INSURANCE CONSUMERS
INCREASE USE OF OTHER INSURANCE DELIVERY SYSTEMS.
-18-
The continued growth of the business of members of the Property and Casualty
Group is partially dependent upon the Company's ability to retain existing, and
attract new, independent agencies for the Property and Casualty Group. The
following factors are among those that may cause the growth and retention in the
number of independent agencies of the Property and Casualty Group, and thereby
growth in revenue of its members, to be slower than it otherwise would have
been:
. There is significant competition to attract independent agencies;
. Our process to select a new independent agency is intensive and
typically requires from six to nine months;
. The Company has stringent criteria for new independent agencies and
requires adherence by independent agencies to consistent underwriting
standards; and
. The Company may be required to reduce agents' commissions, bonuses
and other incentives, thereby reducing our attractiveness to agencies.
The Property and Casualty Group sells insurance solely through its
network of independent agencies. The Property and Casualty Group's competitors
sell insurance through a variety of delivery methods, including independent
agencies, captive agencies, the Internet and direct sales. To the extent that
business migrates to a delivery system other than independent agencies because
of changing consumer preferences, the business of the Property and Casualty
Group will be adversely affected.
THE PROPERTY AND CASUALTY GROUP HAS INCURRED UNDERWRITING LOSSES IN
RECENT YEARS PRIMARILY AS A RESULT OF REDUCING PREMIUM RATES IN 1998 AND 1999 IN
RESPONSE TO COMPETITIVE CONDITIONS, DUE TO INCREASED LOSS SEVERITY AND DUE TO
REINSURANCE LOSSES, INCLUDING LOSSES FROM THE TERRORIST ATTACK ON THE WORLD
TRADE CENTER. TO THE EXTENT UNDERWRITING LOSSES CONTINUE, THE MANAGEMENT FEE
REVENUES WE RECEIVE MAY BE REDUCED, IN ADDITION TO THE CONTINUING ADVERSE EFFECT
ON OUR OPERATING RESULTS FROM OUR SUBSIDIARIES' 5.5% PARTICIPATION IN THE
UNDERWRITING RESULTS OF THE PROPERTY AND CASUALTY GROUP.
In 1997 and 1998, the property and casualty insurance market was marked
by "soft market" conditions, which is characterized by decreased revenues, less
stringent underwriting standards and an excess of surplus in the industry. These
conditions created severe price competition in commercial and personal lines of
insurance, including private passenger automobile, the Property and Casualty
Group's largest line of business. These competitive conditions resulted in
slower new policy growth and declines in policy retention rates for the Property
and Casualty Group. Management viewed these competitive effects as a serious
threat to the well-being of the Property and Casualty Group. In 1998, following
discussions with our board of directors, management decided to reduce premium
rates in 1998 and 1999 in order to retain the Property and Casualty Group's most
profitable
-19-
customers. The 1998 and 1999 premium rate reductions, coupled with a general
trend of increasing loss severity, negatively affected the Property and Casualty
Group's underwriting results, which increased from underwriting losses of $49.8
million in 1999 to $189.7 million in 2000 and $517.3 million in 2001. In 1999,
2000 and 2001, the Property and Casualty Group also incurred significant
underwriting losses from its non-affiliated assumed reinsurance business,
including $55 million in losses from wind storms in Western Europe in late
December 1999 and $150 million from the World Trade Center terrorist attack in
September 2001, assuming that attack is treated as one occurrence.
The Property and Casualty Group and the Company have responded to
underwriting losses in a number of ways, including adopting stricter
underwriting requirements; restricting policy coverages; increasing the emphasis
on reviewing existing policies and accounts to determine which risks continue to
meet underwriting guidelines and taking appropriate action regarding those
policies and accounts that do not; continuing the focus on claims strategies to
reduce claims severity, such as reducing claims fraud; raising premium rates on
its direct lines of insurance; reunderwriting all of its assumed reinsurance
treaties, resulting in the cancellation of a significant number of treaties and
the reduction in total aggregate limits for other treaties; significantly
raising reinsurance premium rates; and excluding terrorism coverage from all
reinsurance treaties entered into in 2002. However, there can be no assurance
that the measures taken or that may be taken by the Property and Casualty Group
and the Company will meet or exceed increases in loss costs or restore the
Property and Casualty Group's underwriting profitability.
To the extent underwriting losses continue, our operating results will
suffer from our subsidiaries' 5.5% participation in the pooling arrangement. In
addition, the Exchange's policyholders' surplus will be further adversely
affected. If the surplus of the Exchange were to decline significantly from its
current level, the Property and Casualty Group could find it more difficult to
retain its existing business and attract new business. A decline in the business
of the Property and Casualty Group would have an adverse effect on the amount of
the management fees we receive and the underwriting results of the Property and
Casualty Group in which we have a 5.5% participation. In addition, a decline in
the surplus of the Exchange from its current level would make it more likely
that the management fee rate received by us would be further reduced.
THE SURPLUS OF THE EXCHANGE HAS DECREASED FROM $4.8 BILLION AT DECEMBER
31, 1999 TO $2.1 BILLION AT SEPTEMBER 30, 2002. OF THIS DECREASE, APPROXIMATELY
$1.6 BILLION WAS BECAUSE OF DECLINES IN THE MARKET VALUE OF MARKETABLE
SECURITIES INVESTMENTS, INCLUDING THE SIGNIFICANT PORTFOLIO OF COMMON EQUITY
SECURITIES. TO THE EXTENT THESE DECLINES IN MARKET VALUE CONTINUE AND THE
EXCHANGE'S SURPLUS CONTINUES TO DECREASE, THE MANAGEMENT FEE RATE WE RECEIVE MAY
BE FURTHER REDUCED AND THE UNDERWRITING RESULTS OF OUR PROPERTY AND CASUALTY
SUBSIDIARIES MAY SUFFER.
-20-
In 1985, the Exchange increased its investments in common equity
securities as a core element of its investment strategy. At December 31, 1999,
when the Exchange's surplus was $4.8 billion, the Exchange's portfolio of
marketable securities investments included common equity securities that had
appreciated in value by $2.6 billion, to a market value of $3.8 billion.
However, as a result of the downturn in common equity markets since 1999, the
Exchange's portfolio of common equity securities has experienced a decline in
value of $1.8 billion and the value of the portfolio was $2.0 billion at
September 30, 2002. The common equity portfolio of the Exchange represents 32.8%
of its admitted assets at September 30, 2002 while the entire portfolio of
marketable securities investments represents 76.0% of its admitted assets at
that date.
All marketable securities held by the Exchange are subject to market
volatility. The Exchange's marketable securities have exposure to price risk and
the volatility of capital markets. The stock market decline in 2002 has reduced
the value of the Exchange's marketable securities by $1.3 billion during the
first nine months of 2002 compared to the decrease of $1.0 billion during the
first nine months of 2001.
To the extent that the Exchange incurs additional investment losses
resulting from declines in the value of its marketable securities, the
Exchange's policyholders' surplus will be further adversely affected. If the
surplus of the Exchange were to decline significantly from its current level,
the Property and Casualty Group could find it more difficult to retain its
existing business and attract new business. A decline in the business of the
Property and Casualty Group would have an adverse effect on the amount of the
management fees we receive and the underwriting results of the Property and
Casualty Group in which we have a 5.5% participation. In addition, a decline in
the surplus of the Exchange from its current level would make it more likely
that the management fee rate received by us would be further reduced.
ERIE INSURANCE GROUP'S RECENT EFFORTS TO DEVELOP TECHNOLOGY, INCLUDING
INTERNET CAPABILITIES, TO ENHANCE POLICY ADMINISTRATION AND TO IMPROVE
INTERACTION WITH AGENTS MAY BE MORE COSTLY THAN WE ANTICIPATE, MAY NOT BE
COMPLETED DUE TO COST OR TECHNOLOGY CONSIDERATIONS AND MAY INCREASE OUR EXPOSURE
TO BREACHES OF PRIVACY OR SECURITY.
Customers and agents expect rapid turnaround of quotes and endorsements
and efficient services. Failure to meet these service expectations could place
the Erie Insurance Group at a competitive disadvantage. To remain competitive,
the Erie Insurance Group has undertaken an initiative, called
"ERIEConnection(SM)", to utilize technology, including the Internet, to automate
certain functions to facilitate quoting, underwriting and the issuing of
policies and provide these services directly to its agents via the Internet.
Such an upgrading of technology requires a sizable financial investment.
Moreover, the effectiveness of certain areas of technology remain unproven. Erie
Insurance Group completed the first major component of the program during the
second quarter of 2002. Through September 30, 2002, the Erie Insurance Group has
spent $87 million on its current technology development
-21-
efforts. The timing, scope and level of spending for remaining deliverables
under the program are uncertain. Actual costs to complete the technology
initiatives may exceed anticipated costs and lead to a reduction in profits or
the termination of these technology initiatives. In addition, use of Internet
technology to connect directly with the Property and Casualty Group's agents
increases the risk of security breaches, which may cause short-term or long-term
disruptions to the Property and Casualty Group's business operations and could
lead to further and currently unanticipated technology costs to prevent and
mitigate the effects of such security breaches.
IF RATINGS FOR FINANCIAL STRENGTH ASSIGNED TO MEMBERS OF THE PROPERTY
AND CASUALTY GROUP BY INDUSTRY RATING ORGANIZATIONS WERE SIGNIFICANTLY
DOWNGRADED, THE PROPERTY AND CASUALTY GROUP'S COMPETITIVE POSITION IN THE
INSURANCE INDUSTRY WOULD BE ADVERSELY AFFECTED.
Ratings are a factor in establishing the competitive position of
insurance companies. Members of the Property and Casualty Group receive ratings
from A.M. Best and Standard & Poor's, which are industry-accepted measures of an
insurance company's financial strength and are specifically designed to provide
an independent opinion of an insurance company's financial health and ability to
meet ongoing obligations to policyholders. Members of the Property and Casualty
Group are also rated by Weiss Ratings, Inc., which is a consumer-oriented rating
company that issues ratings designed to provide an independent opinion of an
insurance company's financial strength. The ratings by Weiss Ratings, Inc. for
the Exchange and Erie Insurance Company were downgraded in July 2002. Ratings
are not recommendations to buy, sell or hold our common stock and are subject to
change. A description of the Company's recent ratings appears under "Business --
Financial Ratings" on page 78.
If the Exchange or any other member of the Property and Casualty Group
were to incur underwriting losses or reductions in surplus for an extended
period of time, the ratings of such entity may be downgraded. While management
of the Company believes that recent downgrades by Weiss Ratings, Inc. have not
impacted any member of the Property and Casualty Group, a significant future
downgrade in that or other ratings would reduce the competitive position of the
affected member by making it more difficult to attract profitable business in
the highly competitive property and casualty insurance market.
RISKS RELATING TO THE PROPERTY AND CASUALTY INSURANCE INDUSTRY
THE PROPERTY AND CASUALTY GROUP FACES SIGNIFICANT EXPOSURE TO
TERRORISM.
The tragic World Trade Center terrorist attack resulted in staggering
losses for the insurance industry and has caused uncertainty in the insurance
and reinsurance markets. The Property and Casualty Group incurred a loss of $150
million in this attack assuming it continues to be considered one occurrence,
and it estimates it would incur an additional loss
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of $50 to $75 million if the attack is considered two occurrences. The Company's
5.5% share of this incurred loss was $5.8 million. Accordingly, the industry has
been compelled to re-examine policy language and to address the potential for
future threats of terrorist events and losses. The Property and Casualty Group's
personal and commercial property and casualty insurance policies were not priced
to cover the risk of terrorist attacks and losses such as those suffered in the
World Trade Center terrorist attack. The Property and Casualty Group has
withdrawn from some coverages and exposures, including terrorism, where
permitted by state regulators. However, even in states where withdrawal has been
permitted, the Property and Casualty Group is still exposed to terrorism under
several lines, including personal lines and workers' compensation, and, in most
states, losses caused by an ensuing fire. On November 26, 2002, President Bush
signed the Terrorism Risk Insurance Act of 2002, establishing a program for
commercial property and casualty losses, including workers' compensation,
resulting from foreign acts of terrorism. The Terrorism Risk Insurance Act
requires commercial insurers to make terrorism coverage available immediately
and provides limited federal protection above individual company retention
levels, based upon a percentage of direct earned premium, and above aggregate
industry retention levels that range from $10 billion in the first year to $15
billion in the third year. The federal government will pay 90% of covered
terrorism losses that exceed retention levels. The Terrorism Risk Insurance Act
is scheduled to expire on December 31, 2005. Personal lines are not included
under the protection of the Terrorism Risk Insurance Act, and state regulators
have not approved exclusions for acts of terrorism on personal lines policies.
The Property and Casualty Group could incur large unexpected losses if future
terrorist attacks occur.
EVEN EXCLUDING TERRORISM EXPOSURE, THE PROPERTY AND CASUALTY GROUP
FACES THE THREAT OF SUBSTANTIAL CATASTROPHE LOSSES AND DID NOT MAINTAIN TREATY
REINSURANCE COVERAGE FOR CATASTROPHE LOSSES AFTER 1993 THROUGH 2002.
The Property and Casualty Group has experienced, and can be expected in
the future to experience, catastrophe losses that may have a material adverse
impact on our results of operations and financial condition. The Property and
Casualty Group did not maintain treaty reinsurance coverage to mitigate the
impact of catastrophe losses after 1993 through 2002; however, effective January
1, 2003, the Property and Casualty Group has obtained property catastrophe
reinsurance coverage. Catastrophes can be caused by various events, including
hurricanes, earthquakes, tornadoes, wind, hail, fires, explosions and man-made
disasters. The incidence and severity of catastrophes are inherently
unpredictable. The extent of losses from a catastrophe is a function of two
factors: the total amount of insured exposure in the area affected by the event
and the severity of the event. Most catastrophes are localized to small
geographic areas; however, events such as hurricanes, hail and ice storms have
the potential to produce significant damage in large, heavily populated areas.
-23-
For the Property and Casualty Group, areas of major potential hurricane
loss include major metropolitan centers in the eastern United States and areas
of major potential ice storm or hail loss include major metropolitan centers in
the Mid-Atlantic and Midwestern states. Although catastrophes can cause losses
in a variety of property and casualty lines, homeowners insurance has in the
past generated the vast majority of catastrophe-related claims. At December 31,
2001, 76% of the Property and Casualty Group's total homeowners insurance
exposure was comprised of risks in Mid-Atlantic states, which exposes the
Property and Casualty Group to significant risk of loss from catastrophes in
that region.
INCREASED LITIGATION AGAINST THE INDUSTRY, WILLINGNESS OF COURTS TO
EXPAND COVERED CAUSES OF LOSS, RISING JURY AWARDS, INCREASING MEDICAL COSTS AND
THE ESCALATION OF LOSS SEVERITY MAY CONTRIBUTE TO INCREASED COSTS AND TO THE
DETERIORATION OF RESERVE POSITIONS OF THE PROPERTY AND CASUALTY GROUP.
Loss severity for the Property and Casualty Group continues to
increase, principally driven by larger court judgments and increasing medical
costs in recent years. In addition, many legal actions and proceedings have been
brought on behalf of classes of complainants, which can increase the size of
judgments. The propensity of policyholders to litigate and the willingness of
courts to expand causes of loss and the size of awards may render loss reserves
inadequate for current and future losses. Loss reserves are liabilities
established by insurers and reinsurers to reflect the estimated cost of loss
payments and the related loss adjustment expenses that the insurer or reinsurer
will ultimately be required to pay in respect of insurance or reinsurance it has
written.
The Property and Casualty Group has exposure to mold claims for which
there has recently been a sharp increase in the industry generally. Sometimes
referred to as "sick building syndrome", tenants claiming to suffer illnesses
caused by mold may seek financial compensation from building owners. Businesses
also may claim loss-of-use business income interruption losses. Homeowners have
also been submitting claims based on mold that has occurred from water damage.
The Property and Casualty Group's exposure to date, including known and expected
claims, has been insignificant.
Members of the Property and Casualty Group increased their loss and
loss adjustment reserves by approximately $184 million in the fourth quarter of
2002 in response to adverse loss experience in the group's automobile,
homeowners and workers' compensation lines. To the extent that adverse trends
continue, including expansion by courts of covered causes of loss, rising jury
awards, increasing medical costs and the escalation of loss severity, the
Property and Casualty Group may need to further increase reserves and its
profitability may be adversely affected.
CHANGES IN APPLICABLE INSURANCE LAWS, REGULATIONS OR CHANGES IN THE WAY
REGULATORS ADMINISTER THOSE LAWS OR REGULATIONS COULD MATERIALLY ADVERSELY
CHANGE THE PROPERTY AND
-24-
CASUALTY GROUP'S OPERATING ENVIRONMENT AND INCREASE ITS EXPOSURE TO LOSS OR PUT
IT AT A COMPETITIVE DISADVANTAGE.
Property and casualty insurers are subject to extensive supervision in
the states in which they do business. This regulatory oversight includes, by way
of example, matters relating to licensing and examination, rate setting, market
conduct, policy forms, limitations on the nature and amount of certain
investments, claims practices, mandated participation in involuntary markets and
guaranty funds, reserve adequacy, insurer solvency, transactions between
affiliates, the amount of dividends that may be paid and restrictions on
underwriting standards. Such regulation and supervision are primarily for the
benefit and protection of policyholders and not for the benefit of shareholders.
For instance, members of the Property and Casualty Group are subject to
involuntary participation in specified markets in various states in which it
operates, and the rate levels the Property and Casualty Group is permitted to
charge do not always correspond with the underlying costs associated with the
coverage issued.
The National Association of Insurance Commissioners ("NAIC") and state
insurance regulators are re-examining existing laws and regulations,
specifically focusing on insurance company investments, issues relating to the
solvency of insurance companies, risk-based capital guidelines, interpretations
of existing laws and the development of new laws. Changes in state laws and
regulations, as well as changes in the way state regulators view related party
transactions in particular, could materially change the operating environment
for the Property and Casualty Group and significantly increase the amount of
loss to which the Property and Casualty Group is exposed after an insurance
policy has been issued.
The state insurance regulatory framework recently has come under
increased federal scrutiny. Congress is considering legislation that would
create an optional federal charter for insurers. Federal chartering has the
potential to create an uneven playing field for insurers. Federally chartered
companies could be subject to different regulatory requirements than state
chartered insurers in areas such as market conduct oversight, solvency
regulation, guaranty fund participation and premium tax burdens. If this occurs,
federally chartered insurers may obtain a competitive advantage over state
licensed carriers. Federal chartering also raises the specter of a matrix of
regulation and costly duplicative, or conflicting, federal and state
requirements. Specific federal regulatory developments include the potential
repeal of the McCarran-Ferguson Act. The repeal of the McCarran-Ferguson Act and
its partial exemption for the insurance industry from federal antitrust laws
would make it extremely difficult for insurers to compile and share loss data,
develop standard policy forms and manuals and predict future loss costs. The
ability of the industry, under the exemption permitted in the McCarran-Ferguson
Act, to collect loss cost data and build a credible database as a means of
predicting future loss costs is an extremely important part of cost-based
pricing. If the ability to collect this data were removed, then the
predictability of future loss costs, and hence, the reliability of pricing would
be greatly undermined.
-25-
IF CERTAIN STATE REGULATORS, LEGISLATORS AND SPECIAL INTEREST GROUPS
ARE SUCCESSFUL IN ATTEMPTS TO REDUCE, FREEZE OR SET RATES FOR INSURANCE
POLICIES, ESPECIALLY AUTOMOBILE POLICIES, AT LEVELS THAT DO NOT, IN OUR
MANAGEMENT'S VIEW, CORRESPOND WITH UNDERLYING COSTS, THE RESULTS OF OPERATIONS
OF THE PROPERTY AND CASUALTY GROUP WILL BE ADVERSELY AFFECTED.
From time to time, the automobile insurance industry in particular has been
under pressure from certain state regulators, legislators and special interest
groups to reduce, freeze or set rates at levels that do not, in our management's
view, correspond with underlying costs, including initiatives to roll back
automobile and other personal lines rates. For example, in recent years, certain
rate increase requests by the Property and Casualty Group for automobile
coverage that management believed were necessary were rejected in New York and
Maryland. This activity has adversely affected, and may in the future adversely
affect, the profitability of the Property and Casualty Group's automobile
insurance line of business in various states because increasing costs of
litigation and medical treatment, combined with rising automobile repair costs,
continue to increase the costs of providing automobile insurance coverage.
Adverse legislative and regulatory activity constraining the Property and
Casualty Group's ability to price automobile insurance coverage adequately may
occur in the future. The impact of the automobile insurance regulatory
environment on the results of operations of members of the Property and Casualty
Group in the future is not predictable.
THE PROPERTY AND CASUALTY GROUP IS SUBJECT TO ASSESSMENT, DEPENDING UPON
ITS MARKET SHARE OF A GIVEN LINE OF BUSINESS, TO ASSIST IN THE PAYMENT OF
UNPAID CLAIMS AND RELATED COSTS OF INSOLVENT INSURANCE COMPANIES; SUCH
ASSESSMENTS COULD SIGNIFICANTLY AFFECT THE FINANCIAL CONDITION OF ANY ASSESSED
MEMBER.
The Property and Casualty Group is obligated to pay assessments under the
guaranty fund laws of the various states in which they are licensed. These
assessments were $0.6 million for the year ended December 31, 1999, $0.8 million
for the year ended December 31, 2000 and $30.9 million for the year ended
December 31, 2001. Generally, under these laws, an insurer is subject to
assessment, depending upon its market share of a given line of business, to
assist in the payment of unpaid claims and related costs of insolvent insurance
companies. The number and magnitude of future insurance company failures in the
states in which the Property and Casualty Group does business cannot be
predicted, but resulting assessments levied on members of the Property and
Casualty Group could significantly affect the financial condition of members of
the Property and Casualty Group. The Property and Casualty Group believes that
it is likely to receive an assessment in the next year relating to the
insolvency of The Pennsylvania Hospital Insurance Company (PHICO), the amount of
which we cannot currently estimate.
PREMIUM RATES AND RESERVES MUST BE ESTABLISHED FOR MEMBERS OF THE PROPERTY
AND CASUALTY GROUP FROM FORECASTS OF THE ULTIMATE COSTS EXPECTED TO ARISE FROM
RISKS
-26-
UNDERWRITTEN DURING THE POLICY PERIOD; A MEMBER'S PROFITABILITY COULD BE
ADVERSELY AFFECTED TO THE EXTENT SUCH PREMIUM RATES OR RESERVES ARE TOO LOW.
One of the distinguishing features of the property and casualty insurance
industry in general is that its products are priced before its costs are known,
as premium rates are generally determined before losses are reported.
Accordingly, premium rates must be established from forecasts of the ultimate
costs expected to arise from risks underwritten during the policy period and may
not prove to be adequate. Further, property and casualty insurers establish
reserves for losses and loss adjustment expenses based upon estimates, and it is
possible that the ultimate liability will exceed these estimates because of the
future development of known losses, the existence of losses that have occurred
but are currently unreported and larger than historical settlements on pending
and unreported claims. The process of estimating reserves is inherently
judgmental and can be influenced by factors that are subject to variation. If
pricing or reserves established by a member of the Property and Casualty Group
are not sufficient, such member's profitability may be adversely impacted.
The Property and Casualty Group experienced adverse loss development
relating to losses from prior accident years of $107 million for calendar year
2000, or 5.6% of loss reserves at year-end 2000, and $117 million for calendar
year 2001, or 5.0% of loss reserves at year-end 2001. Adverse development of
losses from prior accident years results in higher calendar year loss ratios and
reduced calendar year underwriting results. To the extent prior year reserve
deficiencies are indicative of deteriorating underlying loss trends and are
material, the Property and Casualty Group's pricing of affected lines of
business would be increased to the extent permitted by state departments of
insurance.
SUBSTANTIAL PREMIUM RATE INCREASES ARE DRAWING NEW ENTRANTS AND NEW CAPITAL
TO THE REINSURANCE MARKETS, WHICH MAY INCREASE COMPETITION AMONG PROPERTY AND
CASUALTY INSURERS AND MAY CAUSE A REDUCTION IN OUR REVENUES.
Property and casualty market conditions in the wake of the World Trade
Center terrorist attack have been characterized by closer adherence to
underwriting standards, higher deductibles, reduced coverages and limits, more
restrictive terms and conditions and higher premium rates. As a result of these
changes in the industry, substantial new capital has entered the property and
casualty insurance market. A substantial portion of the new capital is dedicated
to building the capacity of new offshore reinsurers. This increased capital
could result in lower prices for reinsurance, which in turn would allow primary
insurers to offer more competitive prices or more favorable insurance terms and
conditions or increase capacity. Increased competition among insurers and
reinsurers could also allow the Property and Casualty Group's competitors to
relax their underwriting standards. If substantial premium rate increases were
to continue, additional new capital would likely be attracted, which would
further promote the effects of increased competition.
-27-
RISKS RELATING TO OUR CLASS A COMMON STOCK
THE PRICE OF OUR CLASS A COMMON STOCK MAY BE ADVERSELY AFFECTED BY ITS LOW
TRADING VOLUME.
The trading market for our Class A common stock is marked by limited
liquidity. Reported average daily trading volume in our Class A common stock for
the period January 1, 2002 through October 31, 2002 was approximately 32,000
shares. Of our 63.7 million shares of Class A common stock outstanding at
September 30, 2002, approximately 29 million shares are available for public
sale, with the remainder held by a small number of significant shareholders.
Since 1999, we have had a stock repurchase program that authorized us to
repurchase up to $120 million of our outstanding Class A common stock through
December 31, 2002. Approximately $101.9 million of Class A common stock has been
repurchased under the program to date. We believe the repurchase program had the
effect of stabilizing the price of our Class A common stock notwithstanding that
the variability of the price of our Class A common stock had been declining
every year in the three years prior to our stock repurchase program. The
program, however, has been suspended in connection with this offering of Class A
common stock, and as a result, there may be an adverse effect on the market
price of our Class A common stock.
THE MARKET PRICE OF OUR CLASS A COMMON STOCK MAY BE ADVERSELY AFFECTED BY
FUTURE SALES OF A SUBSTANTIAL NUMBER OF SHARES OF OUR CLASS A COMMON STOCK BY
OUR EXISTING SHAREHOLDERS IN THE PUBLIC MARKET, OR THE AVAILABILITY OF SUCH
SHARES FOR SALE.
In connection with this offering, the Company, certain of its directors and
officers, the Selling Shareholder and certain other shareholders have indicated
that they will enter into lock-up agreements under which they will generally
agree not to dispose of or hedge any of their shares or securities convertible
into or exchangeable for shares of common stock of the Company during the 90-day
period from the date of this prospectus without prior written approval of the
underwriters. Certain of our existing shareholders, however, have not indicated
that they will agree to enter into lock-up agreements, including Susan Hirt
Hagen, who is a member of our board of directors and a trustee and a beneficiary
of the H.O. Hirt Trusts and Thomas B. Hagen, who is Mrs. Hagen's husband. Also,
Laurel A. Hirt has indicated that she will not agree to enter into a lock-up
agreement. Ms. Hirt is a daughter of F. William Hirt, the chairman of our board
of directors. Mr. Hirt is also a trustee and a beneficiary of the H.O. Hirt
Trusts. Although we have not received any indication that Mr. and Mrs. Hagen or
Laurel Hirt are planning to sell shares of Class A common stock during the
90-day period from the date of this prospectus, Mr. and Mrs. Hagen and Laurel
Hirt, if they do not execute lock-up agreements, may have available for sale up
to 31.76% of the outstanding shares of Class A common stock, assuming no further
conversion of Class B shares into Class A shares. Sales, or the availability for
sale, by these shareholders following the consummation of this offering of a
substantial number of shares of our Class A common
-28-
stock that are not subject to lock-up agreements may have an adverse effect on
the market price of our Class A common stock.
HOLDERS OF CLASS A COMMON STOCK HAVE LIMITED VOTING RIGHTS, AND TWO
SHAREHOLDERS OF OUR CLASS B COMMON STOCK, THE H.O. HIRT TRUSTS, HAVE THE ABILITY
TO DETERMINE THE OUTCOME OF ALL MATTERS SUBMITTED FOR SHAREHOLDER APPROVAL,
EXCEPT THOSE MATTERS PERTAINING ONLY TO THE RIGHTS OF THE HOLDERS OF CLASS A
COMMON STOCK.
Our Class A common stock cannot vote for the election of directors and
generally can only vote on matters pertaining to the rights of holders of Class
A common stock. Generally, voting control of the Company is vested in the 2,900
outstanding shares of Class B common stock. The H.O. Hirt Trusts together own
2,340 shares, or 80.7%, of the outstanding Class B common stock and can
therefore together elect the entire board of directors and determine the outcome
of all matters submitted for approval of our shareholders, except those matters
pertaining only to the rights of the holders of Class A common stock.
THE VALUE OF OUR CLASS A COMMON STOCK MAY BE ADVERSELY AFFECTED BECAUSE THE
ABILITY OF OUR PRINCIPAL SHAREHOLDERS TO VOTE IN FAVOR OF A TRANSACTION THAT
WOULD RESULT IN A CHANGE OF CONTROL IS LIMITED.
The vote of the H.O. Hirt Trusts will determine the outcome of any matter
submitted for shareholder approval, except those matters pertaining only to the
rights of the holders of Class A common stock. The trust agreement governing the
H.O. Hirt Trusts provide that at least two of the three trustees, including the
corporate trustee, would be required to vote in favor of a transaction under
which we would be acquired and such action, by the terms of the trust
agreements, would be permitted only if required to maintain the health of the
Exchange. This may prevent anyone from acquiring us in a transaction that
shareholders, other than the H.O. Hirt Trusts, may consider to be in their best
interests and may consequently have a negative effect on the price of our Class
A common stock.
-29-
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus and the documents incorporated by reference into this
prospectus contain "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. These statements include certain discussions relating to underwriting,
premium and investment income volume, business strategies, profitability and
business relationships and our other business activities during 2002 and beyond.
In some cases, you can identify forward-looking statements by terms such as
"may", "will", "should", "could", "would", "expect", "plan", "intend",
"anticipate", "believe", "estimate", "project", "predict", "potential" and
similar expressions. These forward-looking statements reflect our current views
about future events, are based on assumptions and are subject to known and
unknown risks and uncertainties that may cause results to differ materially from
those anticipated in those statements. Many of the factors that will determine
future events or achievements are beyond our ability to control or predict. Such
factors may include those described under "Risk Factors" beginning on page 11.
The forward-looking statements contained in this prospectus reflect our
views and assumptions only as of the date of this prospectus. Except as required
by law, we assume no responsibility for updating any forward-looking statements.
You should read this prospectus and the documents that we reference in this
prospectus and have filed as exhibits to the registration statement of which
this prospectus is a part, completely and with the understanding that our actual
future results may be materially different from what we expect.
We qualify all of our forward-looking statements by these cautionary
statements.
-30-
PRICE RANGE OF OUR CLASS A COMMON STOCK AND DIVIDEND HISTORY
Prices for our Class A common stock are quoted on the NASDAQ Stock
Market(SM) under the symbol "ERIE". The following table presents for the periods
indicated the high and low closing prices for our Class A common stock as
reported by the NASDAQ Stock Market(SM) and the cash dividends declared.
Price Range Cash Dividends
-------------------------
2000: High Low Declared
------- ------- --------
First Quarter .................. $ 32.44 $ 26.50 $ 0.1350
Second Quarter ................. 32.50 27.50 0.1350
Third Quarter .................. 32.00 29.19 0.1350
Fourth Quarter ................. 30.00 24.00 0.1525
Price Range Cash Dividends
-------------------------
2001: High Low Declared
------- ------- --------
First Quarter .................. $ 30.00 $ 26.50 $ 0.1525
Second Quarter ................. 36.12 27.54 0.1525
Third Quarter .................. 39.55 32.70 0.1525
Fourth Quarter ................. 40.63 36.91 0.1700
Price Range Cash Dividends
-------------------------
2002: High Low Declared
------- ------- --------
First Quarter .................. $ 40.82 $ 37.65 $ 0.1700
Second Quarter ................. 45.49 40.44 0.1700
Third Quarter .................. 44.50 37.45 0.1700
Fourth Quarter ................. 42.39 35.90 0.1900
Price Range Cash Dividends
-------------------------
2003: High Low Declared
------- ------- --------
First Quarter
(through January 6) ....... $ 36.58 $ 36.38 --
The last reported sale price of our Class A common stock on January 6, 2003
was $36.38. As of September 30, 2002, there were 1,061 holders of record of our
Class A common stock.
We have paid regular quarterly cash dividends since 1942. Our board of
directors considers the declaration of cash dividends on a quarterly basis. The
payment of future dividends, if any, will be at the discretion of our board of
directors and will depend upon many factors, including:
. our earnings;
. our financial position;
-31-
. our capital requirements and those of our subsidiaries; and
. our ability to receive dividends from our subsidiaries, which is
subject to regulatory limitations.
Therefore, there can be no assurance as to the declaration of future dividends.
Although a potential source of cash for the payment of dividends to our
shareholders is dividends from our insurance subsidiaries, our insurance
subsidiaries have never paid us a dividend. Our insurance subsidiaries are
subject to state laws that restrict their ability to pay dividends.
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 2002.
We will not receive any proceeds from the sale of the shares of Class A common
stock being offered hereby.
(amounts in thousands) September 30, 2002
------------------
Long-term debt ................................................................. ---
Shareholders' equity:
Class A common stock, stated value .......................................... $ 1,957
$0.0292 per share; authorized 74,996,930 shares;
issued 67,080,000 shares and outstanding 63,677,106 shares
Class B common stock, stated value .......................................... 213
$70 per share; authorized 3,070 shares;
issued and outstanding 3,050 shares
Additional paid-in capital .................................................. 7,830
Accumulated other comprehensive income ...................................... 31,266
Retained earnings ........................................................... 1,018,868
------------
Contributed capital and retained earnings .......................... $ 1,060,134
Treasury stock, at cost (3,402,894 shares) ..................................... (101,860)
------------
Total capitalization ................................................ $ 958,274
============
-32-
SELECTED HISTORICAL FINANCIAL INFORMATION OF THE COMPANY
The selected consolidated financial data presented below as of or for the
years ended December 31, 1997 through 2001 is derived from our audited financial
statements. Our consolidated financial statements as of December 31, 2000 and
2001 and for each of the years in the three-year period ended December 31, 2001,
and our independent auditors' report thereon, are included elsewhere in this
prospectus and incorporated by reference herein. See "Where To Find More
Information/Incorporation by Reference". The selected consolidated financial
data presented below as of or for the nine-month periods ended September 30,
2001 and 2002 are derived from our unaudited consolidated financial statements
included elsewhere in this prospectus and incorporated by reference herein. See
"Where To Find More Information/Incorporation by Reference". Our results of
operations for the nine months ended September 30, 2002 are not necessarily
indicative of our results of operations that may be expected for the year ending
December 31, 2002. In the opinion of our management, all adjustments, consisting
only of normal recurring accruals, considered necessary for a fair presentation
have been included. The financial data set forth below is only a summary and
should be read in conjunction with our consolidated financial statements and
related notes and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included elsewhere herein.
Nine Months Ended
September 30, Year Ended December 31,
----------------------- -----------------------------------------------------------
(amounts in thousands, except per share data) 2002 2001 2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ---------- ---------- ----------
(unaudited)
STATEMENTS OF OPERATIONS DATA:
Operating revenue $ 730,029 $ 602,001 $ 799,861 $ 698,016 $ 646,040 $ 615,965 $ 581,979
Operating expense 556,871 466,566 635,756 549,672 501,061 470,155 450,037
Total other income and expenses 33,187 35,408 17,998 70,102 58,731 45,770 38,747
Equity in earnings of Erie Family Life
Insurance Company, net of tax 1,015 2,337 719 5,108 4,692 4,443 3,935
Federal income tax expense 69,171 56,835 60,561 71,161 65,296 61,472 56,043
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income $ 138,189 $ 116,345 $ 122,261 $ 152,393 $ 143,106 $ 134,551 $ 118,581
========== ========== ========== ========== ========== ========== ==========
PER SHARE DATA:
Net income per share $ 1.94 $ 1.63 $ 1.71 $ 2.12 $ 1.95 $ 1.81 $ 1.59
Dividends declared per Class A share 0.51 0.4575 0.6275 0.5575 0.4950 0.4425 0.3925
Dividends declared per Class B share 76.50 68.625 94.125 83.625 74.250 66.375 58.875
Book value per share 13.50 12.01 12.15 10.91 9.62 8.81 7.25
Weighted average shares outstanding 71,109 71,380 71,342 71,954 73,487 74,400 74,400
FINANCIAL POSITION:
Investments (1) $ 969,898 $ 884,599 $ 885,650 $ 853,146 $ 785,258 $ 709,417 $ 566,118
Receivables from the Exchange and affiliates 761,295 650,091 640,655 532,009 470,969 467,794 469,708
Total assets 2,194,690 1,897,077 1,935,566 1,680,599 1,518,794 1,454,062 1,292,544
Shareholders' equity 958,274 855,755 865,255 779,015 697,599 655,223 539,383
Cumulative shares repurchased
at December 31/September 30 3,403 3,170 3,196 2,976 1,900 0 0
-------------------
(1) Includes investment in Erie Family Life Insurance Company.
-33-
SELECTED HISTORICAL FINANCIAL INFORMATION OF THE EXCHANGE
(STATUTORY ACCOUNTING PRINCIPLES)
The selected financial data of the Exchange presented below as of and for
the years ended December 31, 1997 through 2001 is derived from financial
statements prepared in accordance with statutory accounting principles ("SAP")
that were audited by our independent auditors. The selected financial data below
as of and for the nine months ended September 30, 2001 and 2002 are derived from
the Exchange's unaudited financial statements prepared in accordance with SAP.
In the opinion of management, all adjustments consisting only of normal
recurring accruals, considered necessary for a fair presentation have been
included. The financial data set forth below is only a summary. More information
about the Exchange, including the reasons why the Company believes the financial
data set forth below is meaningful to a reader of this prospectus, can be found
in "Erie Insurance Exchange". The Annual Statements filed by the Exchange with
the Insurance Department of the Commonwealth of Pennsylvania are available for
inspection without charge at the Department's offices at Strawberry Square,
Harrisburg, Pennsylvania. The financial statements of the Exchange included in
these annual statements are prepared in accordance with SAP required by the NAIC
Accounting Practices and Procedures Manual, as modified to include prescribed or
permitted practices of the Commonwealth of Pennsylvania. See "Erie Insurance
Exchange -- General" on page 94 for a discussion of significant differences
between SAP and generally accepted accounting principles ("GAAP"). The Exchange
does not, nor is it required to, prepare financial statements in accordance with
GAAP.
Nine Months Ended
September 30, Year Ended December 31,
------------------------ ---------------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- ----------- ----------- -----------
(unaudited)
OPERATING DATA:
Premiums earned $ 2,140,526 $ 1,792,450 $ 2,422,600 $ 2,161,034 $ 2,039,791 $ 1,971,525 $ 1,877,270
Loss and loss adjustment expenses 1,727,052 1,568,896 2,150,749 1,714,487 1,509,895 1,372,705 1,375,643
Insurance underwriting and other expenses 718,881 551,623 766,304 624,622 576,031 568,149 520,648
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net underwriting (loss) income $ (305,407) $ (328,069) $ (494,453) $ (178,075) $ (46,135) $ 30,671 $ (19,021)
Investment income (loss), net 48,237 (32,489) (421,754) 347,582 428,874 378,845 365,393
Federal income tax expense (benefit) (68,925) (43,230) (300,257) 42,433 102,339 102,917 86,627
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net income (loss) $ (188,245) $ (317,328) $ (615,950) $ 127,074 $ 280,400 $ 306,599 $ 259,745
=========== =========== =========== =========== =========== =========== ===========
FINANCIAL POSITION:
Cash and invested assets $ 5,238,660 $ 5,563,420 $ 5,990,511 $ 6,357,658 $ 6,860,008 $ 5,604,496 $ 4,670,320
Total assets 6,190,240 6,317,728 6,998,794 6,969,746 7,415,176 6,174,590 5,204,856
Claims and unearned premium reserves 3,663,000 3,084,067 3,200,836 2,654,300 2,463,806 2,388,958 2,328,230
Total liabilities 4,042,623 3,418,368 3,953,243 2,847,861 2,660,713 2,582,998 2,490,465
Policyholders' surplus (1)(2) 2,147,617 2,899,360 3,045,551 4,121,885 4,754,462 3,591,592 2,714,391
------------------
(1) Periods beginning after January 1, 2001 are computed taking into
consideration changes in SAP required by the NAIC Accounting Practices and
Procedures Manual. An adjustment made on January 1, 2001 as a result of
such changes decreased policyholders' surplus by $523.8 million.
(2) Under a practice prescribed by the Commonwealth of Pennsylvania, unearned
premium reserves are reduced (and policyholders' surplus increased) by the
amount of the management fee ultimately payable by the Exchange to us
correlating to premiums not yet earned at the respective financial
statement date. At December 31, 2001, this amount was $240.9 million.
-34-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL
CONDITION AND RESULTS OF OPERATIONS IN CONJUNCTION WITH THE "SELECTED HISTORICAL
FINANCIAL INFORMATION OF THE COMPANY" AND THE CONSOLIDATED FINANCIAL STATEMENTS,
AND THE RELATED NOTES, INCLUDED ELSEWHERE IN THIS PROSPECTUS AND INCORPORATED BY
REFERENCE HEREIN. IN ADDITION TO THIS INFORMATION, THE TABLE ENTITLED
"MANAGEMENT EVALUATION OF OPERATING RESULTS" ON THE NEXT PAGE DIRECTLY REFLECTS
MEASUREMENTS USED BY MANAGEMENT IN EVALUATING OPERATING RESULTS. THIS TABLE,
WHICH MANAGEMENT USES INTERNALLY TO MONITOR AND EVALUATE RESULTS, IS AN
ALTERNATIVE PRESENTATION OF THE COMPANY'S CONSOLIDATED STATEMENTS OF OPERATIONS.
YOU SHOULD REFER TO THIS TABLE IN CONJUNCTION WITH READING THOSE PORTIONS OF THE
FOLLOWING DISCUSSIONS RELATING TO OPERATING RESULTS AND MEASUREMENTS.
GENERAL
We operate predominantly as a provider of management services to Erie
Insurance Exchange (the "Exchange") and also as an underwriter of insurance
through our subsidiaries. We have served since 1925 as the attorney-in-fact, or
management company, for the policyholders of the Exchange. The Exchange and its
property and casualty subsidiary and our three property and casualty
subsidiaries (collectively, the "Property and Casualty Group") write personal
and commercial lines property and casualty coverages exclusively through
approximately 8,000 independent agents and pool their underwriting results. The
financial results of the Exchange are not consolidated with ours. For our
services as attorney-in-fact in providing sales, underwriting and policy
issuance services to the Exchange, we charge the Exchange a management fee
calculated as a percentage, limited to 25%, of the direct written premiums of
the Property and Casualty Group.
Under the pooling arrangement, all property and casualty insurance business
of the five property and casualty insurance companies that comprise the Property
and Casualty Group is pooled within the Exchange as the pooling entity. Our
insurance subsidiaries, Erie Insurance Company and Erie Insurance Company of New
York, share in the underwriting results of the pool through retrocession. Erie
Insurance Company has a 5.0% participation, Erie Insurance Company of New York
has a 0.5% participation and the Exchange has a 94.5% participation in the
pooled underwriting results. These participation percentages are determined by
our board of directors. We also own 21.6% of the common stock of Erie Family
Life Insurance Company, an affiliated life insurance company, of which the
Exchange owns 53.5% and public shareholders, including its officers and
directors, own 24.9%.
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ERIE INDEMNITY COMPANY
MANAGEMENT EVALUATION OF OPERATING RESULTS
Nine Months Ended
September 30, Year Ended December 31,
----------------------- -------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999
--------- --------- --------- --------- ---------
(unaudited)
MANAGEMENT OPERATIONS:
Management fee revenue $ 593,895 $ 480,805 $ 634,966 $ 551,646 $ 513,375
Service agreement revenue 16,310 20,339 27,247 22,662 15,441
Cost of management operations (421,097) (349,796) (477,645) (415,562) (380,298)
--------- --------- --------- --------- ---------
Income from management operations $ 189,108 $ 151,348 $ 184,568 $ 158,746 $ 148,518
--------- --------- --------- --------- ---------
INSURANCE UNDERWRITING OPERATIONS:
Premiums earned $ 119,824 $ 100,857 $ 137,648 $ 123,708 $ 117,224
Losses and loss adjustment expenses incurred (98,431) (88,074) (117,201) (99,564) (87,719)
Policy acquisition and other underwriting expenses (37,343) (28,696) (40,910) (34,546) (33,044)
--------- --------- --------- --------- ---------
Underwriting loss ($15,950) ($15,913) ($20,463) ($10,402) ($3,539)
--------- --------- --------- --------- ---------
INVESTMENT OPERATIONS:
Net investment income $ 40,705 $ 36,855 $ 49,884 $ 48,401 $ 43,344
Net realized (losses) gains on investments (8,628) (2,726) (31,879) 16,968 14,746
Equity in earnings of EFL 1,091 2,513 773 5,492 5,045
Equity in earnings (losses) of limited partnerships 1,110 1,279 (7) 4,733 641
--------- --------- --------- --------- ---------
Net revenue from investment operations $ 34,278 $ 37,921 $ 18,771 $ 75,594 $ 63,776
--------- --------- --------- --------- ---------
Income before income taxes 207,436 173,356 182,876 223,938 208,755
Provision for income taxes (69,247) (57,011) (60,615) (71,545) (65,649)
--------- --------- --------- --------- ---------
Net income $ 138,189 $ 116,345 $ 122,261 $ 152,393 $ 143,106
========= ========= ========= ========= =========
Operating income (1) $ 143,797 $ 118,117 $ 142,983 $ 141,364 $ 133,521
========= ========= ========= ========= =========
PER SHARE DATA:
Net income $ 1.94 $ 1.63 $ 1.71 $ 2.12 $ 1.95
--------------------
(1) Operating income excludes net realized gain (loss) on investments and
related federal income taxes.
CRITICAL ACCOUNTING ESTIMATES
We make estimates and assumptions that can have a significant effect on
amounts and disclosures we report in our financial statements. The most
significant estimates relate to our reserves for property and casualty insurance
unpaid losses and loss adjustment expenses, valuation of investments and
guaranty fund liability accruals. While management believes its estimates are
appropriate, the ultimate amounts may differ from the estimates provided. The
methods for making these estimates are continually reviewed, and any adjustments
considered necessary are reflected in current earnings.
With respect to reserves for property and casualty unpaid losses and loss
adjustment expenses, significant components of estimates include a variety of
factors such as medical inflation trends, regulatory and judicial rulings, legal
settlements, property replacements and repair cost trends, and losses for
assumed reinsurance activities. In recent years, certain of
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these component costs such as medical inflation trends and legal settlements
have experienced significant volatility and resulted in incurred amounts higher
than our original estimates. We have factored these changes in trends into our
loss estimates. However, due to the nature of these liabilities, actual results
could ultimately vary significantly from the amounts recorded. If the ultimate
liability for unpaid losses and loss adjustment expenses were 10% more than the
recorded amount at December 31, 2001, the effect would be a reduction in the
Company's pre-tax income of approximately $12 million or $0.17 per share.
We make estimates concerning the valuation of our investments and the
recognition of other than temporary declines in value of these investments. When
the decline in value of an individual investment is considered by management to
be other than temporary, the investment is written down to its estimated net
realizable value and reflected as a realized loss in the statement of
operations. All investments are individually monitored for other than temporary
declines in value. Management makes judgments about when there are other than
temporary declines in its investments. Generally, if an individual security has
depreciated in value by more than 20% of original cost, and has been in such
unrealized loss position for more than six months, we assume there has been an
other than temporary decline in value. In addition, the Company may write-down
other securities in an unrealized loss position depending on the existence of
certain other factors. These other factors we consider include: the significance
of the fair value below cost, whether there has been a deterioration in
financial condition of the issuer, whether there have been specific events
adversely affecting an investment, debt security downgrades and specific
industry or geographic events. If we had determined there was an other than
temporary decline in value in 2001 for 10% of our investments with unrealized
losses, then the Company would have recorded an additional realized loss of
$480,000 in our 2001 statement of operations. Our evaluation of the need for
write-downs due to other than temporary declines in value is also applied to our
investment in limited partnerships and mortgage loans.
Our investments in fixed maturity and marketable equity securities are
presented at estimated fair value, which generally represents quoted market
prices. Our investments in limited partnerships are recorded using the equity
method, which approximates the Company's proportionate share of the
partnership's reported net equity. Because of their illiquidity relative to our
other investments, there is increased risk in valuation of limited partnerships.
The recorded value of limited partnerships includes the valuation of investments
held by these partnerships, which include U.S. and foreign private equity, real
estate and fixed income investments. These valuations are determined by the
general partner. We consider the reasonableness of these valuations based on
various information including: audited and unaudited financial statements from
these partnerships, and other information provided by the general partner. The
carrying value of limited partnership investments totaled $81.6 million at
December 31, 2001.
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Estimates are also made by the Company's insurance subsidiaries of
liabilities for guaranty fund and other assessments. Our insurance subsidiaries
are sometimes required to pay assessments to states in which the subsidiaries
are licensed because of insurance company insolvencies. The liability for the
assessments is recorded when the insolvency event has occurred and can be
reasonably estimated. We commonly become aware of insolvencies that will affect
us prior to obtaining specific assessment amounts from state guaranty
associations to estimate our share of the liability. It is often a long process
before state guaranty associations know of the ultimate amount of assessment
needed to cover the insolvency. We initiate communication with the state
insurance departments and guaranty associations when we learn of an insolvency.
Although the insurance departments and guaranty associations may not be able to
provide specifics on the ultimate assessment amounts, they will sometimes
provide us with information from which we develop an estimated range of the
future assessment. We generally record a liability at the mid-point of the
range. In these cases, the mid-point of the range we develop represents our best
estimate of the ultimate loss to be incurred due to the assessment. We adjust
our estimated liability as the guaranty association provides us with more up to
date assessment amounts. For example in 2001, the insolvency of Reliance
Insurance Company was significant. Although we had not received definitive
notices of assessment amounts as of December 31, 2001 from the guaranty funds,
we recorded an estimated liability of $2.0 million at December 31, 2001. This
liability was recorded based on the mid-point of the range of estimated
assessment amounts. Additional future information may result in adjustments to
our estimated liability.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2001
FINANCIAL OVERVIEW
Our consolidated net income for the nine months ended September 30, 2002
increased 18.8% to $138.2 million, from $116.3 million during the same period in
2001. Income from management operations grew as a result of a 23.5% increase in
direct written premiums of the Property and Casualty Group. Results of our
insurance underwriting operations were about the same in the first nine months
of 2002 compared to the same period in 2001 as a result of wind storm-related
catastrophe losses and increased technology spending related to the eCommerce
initiative in 2002 and World Trade Center losses in 2001. In addition, charges
of $17.7 million and $5.7 million were taken for impaired investments
contributing to net realized losses on investments in the first nine months of
2002 and 2001, respectively. The board of directors voted to reduce the
management fee rate from 25% to 24% for 2003 at its December 10, 2002 meeting.
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For the nine months ended September 30, 2002, operating income (net income
excluding net realized (losses) gains and related federal income taxes)
increased 21.7% to $143.8 million, from $118.1 million reported for the same
period in 2001.
We have benefited during this period, and expect to continue to benefit,
from premium increases by the Property and Casualty Group that have resulted
from pricing actions approved by regulators through September 30, 2002. These
premiums accounted for $48.4 million in increased premiums from the Property and
Casualty Group for the nine months ended September 30, 2002. These increases
were primarily related to private passenger automobile, workers' compensation
and homeowners lines of business premium rate increases realized in the states
of Pennsylvania, Maryland and Ohio. The remaining anticipated premium rate
increases to be recognized in future periods are in the private passenger
automobile, commercial multiple peril and homeowners lines of business in the
states of Pennsylvania, Ohio and West Virginia.
ANALYSIS OF MANAGEMENT OPERATIONS
Our management fee revenue increased 23.5% to $593.9 million for the nine
months ended September 30, 2002, from $480.8 million for the same period in
2001.
The direct written premium of the Property and Casualty Group upon which
our management fee revenue is calculated grew 23.5% to $2,375.6 million during
the first nine months of 2002, from $1,923.2 million for the same period in
2001. Increases in average premium per policy, improvements in new policy growth
and continuing favorable policy retention rates were all contributing factors in
the growth of direct written premium.
The average premium per policy increased 9.5% to $877 for the rolling
twelve months ended September 30, 2002, from $801 for the same period ended
September 30, 2001. In private passenger automobile, which accounted for 53.1%
of the direct written premiums of the Property and Casualty Group and over 1.5
million policies in force, the average premium per policy increased 7.2% to
$1,023 for the rolling twelve months ended September 30, 2002, from $954 during
the same period ended September 30, 2001.
Continued growth in the number of new policies also drove the gains
experienced in the Property and Casualty Group's direct written premium.
Personal lines new business premium grew 45.3% for the first nine months of 2002
to $270.6 million, from $186.2 million, while commercial lines new premium grew
56.8% to $164.6 million, from $104.9 million, during the same period in 2001.
Policies in force increased at an annualized rate of 11.9% to 3,411,953 at
September 30, 2002, from 3,048,808 at September 30, 2001.
Policy retention remained strong at 91.1% and 90.9% for the periods ended
September 30, 2002 and 2001, respectively, for all lines of business combined.
-39-
Changes in the management fee rate can affect our revenue and net income
significantly. If our board of directors had reduced the management fee rate 1%
(from 25% to 24%) for the nine-month periods ended September 30, 2002 and 2001,
the decrease would have resulted in a reduction of our management fee revenue of
$23.8 million and $19.2 million, respectively. The net income per share impact
would have been a reduction of $0.22 and $0.18 for the nine-month periods ended
September 30, 2002 and 2001, respectively. The board of directors voted to
reduce the management fee rate from 25% to 24% for 2003 at its December 10, 2002
meeting.
Service agreement revenue decreased by 19.8% to $16.3 million for the nine
months ended September 30, 2002, from $20.3 million for the same period in 2001.
Service agreement revenue includes service charges the Company collects from
policyholders for providing extended payment plans on policies written by the
Property and Casualty Group. During the third quarter of 2002, the Company
determined service charges were incorrectly being recognized in full as billing
installments were created at the time of policy issuance instead of at the time
the billings were rendered. The Company recorded a one-time adjustment reducing
service charge income by $7.4 million. The effect on 2002 net income per share
after taxes and other adjustments was $.06 per share. The Company did not
restate prior period financial statements because the Company believes this
adjustment is not material to the trend of earnings for the Company nor any
related financial statement amount.
Service agreement revenue also includes service income received from the
Exchange as compensation for the management and administration of voluntary
assumed reinsurance from non-affiliated insurers. These fees totaled $9.6
million and $8.3 million for the nine months ended September 30, 2002 and 2001
on net voluntary assumed reinsurance premiums of $137.1 million and $118.7
million, respectively. During the 2002 reinsurance renewal season, the Exchange
obtained significant price increases on treaties it renewed. In addition, the
Exchange reduced its aggregate exposure in non-affiliated assumed voluntary
reinsurance by non-renewing unprofitable business, generally excluding terrorism
coverage and restricting its exposure on certain types of risks. These factors
impact the level of service income received from the Exchange since this fee is
based on a percentage of non-affiliated assumed reinsurance premiums.
The cost of management operations increased 20.4% for the first nine months
of 2002 to $421.1 million, from $349.8 million during the same period in 2001.
Commissions to independent agents are the largest component of the cost of
management operations, and include scheduled commissions earned by independent
agents on premiums written, as well as promotional incentives for agents and
agent contingency awards. Commission costs totaled $302.6 million for the first
nine months of 2002, a 23.9% increase over the $244.1 million reported in the
same period of 2001. Growth in commission costs was slightly greater than the
growth in direct premium written in the first nine months of 2002, primarily
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due to increased accelerated commissions as well as an accrual for a promotional
incentive contest for agents that will run through 2002.
Accelerated commissions are offered to newly recruited agents in addition
to normal commission schedules. For the nine months ended September 30, 2002,
additional charges for accelerated commission costs totaled $6.8 million,
compared to $5.0 million for the same period one year ago due to an increase in
the number of agents. For the nine months ended September 30, 2002, the accrual
recorded for a sales incentive contest was $1.8 million. There was no similar
sales contest in 2001.
The cost of management operations, excluding commission costs, increased
12.2% for the nine months ended September 30, 2002 to $118.5 million, from
$105.6 million for the same period in 2001. These costs include amounts related
to information technology hardware and infrastructure from the eCommerce
initiative launched in September 2001. For the first nine months of 2002, these
costs totaled $2.5 million, compared to $0.5 million in the same period in 2001.
Personnel costs also increased as employment grew by 8.4%, driven by strong
policy sales growth. In addition, temporary labor costs were incurred to assist
with a company-wide rollout of personal computers. As a result, salaries, wages,
benefits and payroll taxes for the first nine months of 2002 increased 10.2% to
$68.8 million, from $62.5 million for the same period in 2001.
Our gross margin from management operations (net revenue divided by total
revenue) increased to 31.0% in the first nine months of 2002, compared to the
gross margin of 30.2% reported in the same period of 2001.
ANALYSIS OF INSURANCE UNDERWRITING OPERATIONS
The underwriting loss from the insurance underwriting operations of Erie
Insurance Company and Erie Insurance Company of New York, which together assume
a 5.5% share of the direct and non-affiliate assumed underwriting results of the
Property and Casualty Group under the intercompany pooling arrangement, was
$16.0 million during the first nine months of 2002 compared to an underwriting
loss of $15.9 million during the same period in 2001. Losses of $4.4 million
resulting from spring storm-related catastrophes were partly responsible for the
underwriting loss in 2002. The per share impact, after federal income taxes, was
about $0.04 per share for the first nine months of 2002. The underwriting
results for the first nine months of 2002 also reflect increased underwriting
expenses related to the eCommerce technology program and assigned risk buyout
program costs. In addition, our share of catastrophe losses was $5.4 million for
the nine months ended September 30, 2002, compared to $1.5 million for the same
period in 2001.
-41-
Our insurance subsidiaries' share of the Property and Casualty Group's
direct business generated net underwriting losses was $16.4 million and $8.7
million for the nine months ended September 30, 2002 and 2001, respectively. The
increase in the underwriting loss of $7.7 million was primarily attributable to
two factors: (i) increased incurred underwriting losses of $5.4 million
resulting from catastrophes in our underwriting territories and increased loss
severity and (ii) increased underwriting expenses related to the eCommerce
technology initiatives, which amounted to $3.0 million, and to the assigned risk
buyout program costs, which amounted to $0.8 million. The firming of automobile
insurance pricing in 2001 by the industry in response to deteriorating loss cost
trends allowed the Property and Casualty Group to begin raising automobile
insurance prices in order to improve underwriting profitability. The Property
and Casualty Group only writes one-year policies; therefore, rate increases take
24 months to be reflected fully in earned premium because it takes 12 months to
implement the rate increase as to all policyholders and 12 months thereafter to
earn fully the increased premiums.
In late 2001, we took measures to improve the underwriting results from our
non-affiliated voluntary assumed reinsurance book of business. The effect of
these measures was to lower the Property and Casualty Group's exposure to loss
by excluding terrorism coverage on certain contracts, not renewing unprofitable
contracts and, at the same time, raising pricing substantially. Pricing in the
reinsurance marketplace has firmed considerably since the World Trade Center
terrorist attack and we have obtained significant price increases in our 2002
contract renewals.
Our insurance subsidiaries' share of the Property and Casualty Group's
unaffiliated voluntary net assumed reinsurance business generated net
underwriting income of $0.5 million and a net underwriting loss of $7.2 million
in the first nine months of 2002 and 2001, respectively. The 2001 losses include
the Company's 5.5% share of the Property and Casualty Group's estimated incurred
losses from the terrorist attack on the World Trade Center. These losses, net of
recoveries under the excess of loss agreement with the Exchange, totaled $5.8
million. There was no additional reserve development in 2002 relating to our
insurance subsidiaries' 5.5% share of the Property and Casualty Group's
estimated incurred reinsurance loss of $150 million from the World Trade Center
terrorist attack. Through September 30, 2002, loss payments made by the Property
and Casualty Group related to the terrorist attack have totaled $35.6 million
with an additional $114.4 million established as reserves for case and incurred
but not reported claims. Incurred but not reported claims are claims for
indemnity against losses that have been incurred by an insurer or reinsurer that
have not yet been reported to the insurer or reinsurer and include future
developments on losses that have been reported to the insurer or reinsurer.
A dispute concerning whether the World Trade Center terrorist attack should
be considered one or two insurable events is currently being litigated. The
Property and Casualty Group's $150 million estimated incurred loss, which was
recorded in the third
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quarter of 2001, assumes that the World Trade Center terrorist attack will
continue to be considered one event. If the attack is considered as two events,
the total potential exposure for the Property and Casualty Group would increase
between $50 million and $75 million. The effect on us, as a result, would be an
additional loss of between $2.7 million and $4.1 million out of this amount.
Taking into consideration the excess of loss reinsurance agreement, the net
impact of such potential additional losses would be minimal to our results of
operations or financial condition.
An all-lines aggregate excess of loss reinsurance agreement with the
Exchange limits the ultimate net losses of Erie Insurance Company and Erie
Insurance Company of New York. Under the reinsurance agreement, once Erie
Insurance Company and Erie Insurance Company of New York sustain ultimate net
losses and allocated loss expenses in an accident year that exceed an amount
equal to 72.5% of Erie Insurance Company's and Erie Insurance Company of New
York's net premiums earned, the Exchange will be liable for 95% of the amount of
such excess up to, but not exceeding, an amount equal to 95% of 15% of Erie
Insurance Company's and Erie Insurance Company of New York's net premium earned.
Erie Insurance Company and Erie Insurance Company of New York retain the
remaining 5% of such layer as well as ultimate net losses and allocated loss
expenses in excess of 87.5% of Erie Insurance Company's and Erie Insurance
Company of New York's net premiums earned. Erie Insurance Company and Erie
Insurance Company of New York pay a premium to the Exchange equal to 1.01% of
their net premium earned, subject to a minimum premium of $800,000 for each
annual period. Net premiums means gross premiums net of reinsurance premiums.
The premium paid to the Exchange for the agreement totaled $1.4 million for each
of the nine-month periods ended September 30, 2002 and 2001. Recoveries during
the first nine months of 2002 amounted to $2.0 million, compared to recoveries
of $3.1 million for the same period one year ago. No cash payments have been
made between the companies in 2002 for recoveries under this agreement since the
recoveries are recorded based on reserved but not yet paid losses.
During 2001, we and the Property and Casualty Group entered into a
cost-sharing agreement for information technology development. This agreement
describes how member companies of the Property and Casualty Group will share the
costs to be incurred for the development of new customer relationship management
and Internet-enabled property and casualty policy administration systems. This
agreement provides that the application development costs and the related
enabling technology costs, such as technical infrastructure and architectural
tools, will be shared among the property and casualty insurance companies in a
manner consistent with the sharing of insurance transactions under the existing
intercompany pooling arrangement. These technology costs are included in the
Property and Casualty Group's policy acquisition and other underwriting
expenses. Our share of eCommerce initiative expenses covered under the cost
sharing agreement amounted to $3.0 million and $0.6 million for the nine-month
periods ended September 30, 2002 and 2001,
-43-
respectively. These shared costs will continue to be incurred in future periods
as the program proceeds.
As part of the eCommerce initiative, a significant portion of Erie
Insurance Group's information technology staff have been deployed to work on the
eCommerce program. As such, certain personnel costs are currently being
allocated to the Property and Casualty Group as part of the eCommerce project.
However, once the eCommerce program is completed, some of these personnel costs
will again be included in our cost of management operations. Approximately 60
full time equivalent staff, or 15% of the Erie Insurance Group information
technology staff, are currently deployed to work on the eCommerce program. We
expect the cost of operations to increase by as much as $8.0 million per year
when the staff is reassigned to non-eCommerce tasks.
The Property and Casualty Group experienced an increase in costs associated
with assigned risk buyout programs during the first nine months of 2002. Under a
buyout program, one insurer pays another insurer to assume the first insurer's
obligations to participate in a state-mandated involuntary coverage program,
such as an assigned risk plan, for those who are unable to obtain automobile
insurance in the voluntary market because of underwriting considerations. Our
share of these costs in the first nine months of 2002 were $0.8 million,
compared to $0.2 million for the same period in 2001. The buyout programs
consist of Limited Assignment Distribution ("LAD") agreements, which cover
personal automobile risks, and Commercial Limited Assignment Distribution
("CLAD") agreements, which cover commercial automobile risks. The Property and
Casualty Group has a CLAD program in Pennsylvania and both LAD and CLAD programs
in New York, Illinois, Virginia, West Virginia and Tennessee. These programs
provide that a servicing carrier perform all administrative functions relative
to the assigned risk policies, including collecting premiums and making payments
for losses and loss adjustment expenses. The Property and Casualty Group makes
payments to the servicing carrier, which includes an administrative fee, as well
as a fee for rate inadequacy costs above the collected premium.
The increase in LAD/CLAD expense is almost exclusively attributable to the
buy-out program in the State of New York, which had costs of $0.8 million,
compared to $0.2 million during the first nine months of 2002 and 2001,
respectively. The rise in costs in New York State is the result of significant
increases in both the population of assigned risk policies and the deteriorating
rate adequacy of the New York State residual market. A residual market consists
of consumers who are unable to purchase insurance in the voluntary market due to
a variety of factors. In addition, the Property and Casualty Group's market
share in the state has increased, resulting in additional assigned risk policies
being allocated to the Property and Casualty Group.
The combined ratio computed under GAAP for our property and casualty
insurance underwriting operations was 113.3% and 115.8% for the nine months
ended September 30, 2002 and 2001, respectively. The GAAP combined ratio
represents the ratio of loss, loss
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adjustment, acquisition and other underwriting expenses and dividends incurred
to premiums earned. The 2002 ratio was affected by 2.5 combined ratio points
related to eCommerce expenses and by 4.5 combined ratio points related to
catastrophe losses and increased loss severity in the first nine months of 2002.
The GAAP combined ratio for our property/casualty operations, excluding
eCommerce costs and catastrophe losses, was 106.3% for the nine months ended
September 30, 2002.
ANALYSIS OF INVESTMENT OPERATIONS
Our net revenue from investment operations is comprised of four major
elements, (1) equity in earnings (losses) of Erie Family Life Insurance Company;
(2) equity in the earnings (losses) of limited partnerships; (3) net realized
capital gains (losses) and (4) net investment income that is comprised of
interest, dividend and rental income from our invested assets less investment
expenses incurred.
Our net revenue from investment operations for the first nine months of
2002 declined 9.6% to $34.3 million, from $37.9 million in the same period of
2001. As a result of impairment charges taken in the first nine months of 2002,
we realized net losses on investments of $8.6 million, compared to losses of
$2.7 million in the same period of 2001. The impairment charges were for fixed
maturity, non-redeemable preferred stock and common stock, which totaled $17.7
million. Net realized losses included charges related to the WorldCom Group
securities totaling $5.7 million.
For the nine months ended September 30, 2002, our net investment income
increased 10.4% to $40.7 million, compared to $36.9 million for the same period
one year ago. Increases in investments in taxable bonds contributed to the
growth in net investment income for the first nine months of 2002. The following
table compares the performance of our equities portfolio to selected indices:
ERIE INDEMNITY COMPANY
PORTFOLIO PERFORMANCE
Two Years Ended
September 30, 2002
(Pre-Tax Annualized Returns)
----------------------------
ERIE INDEMNITY COMPANY:
Fixed Maturities - Corporate 8.43%
Fixed Maturities - Municipal 7.40 (1)
Preferred Stock 9.42 (1)
Common Stock (27.90)
OTHER INDICES:
Lehman Brothers Global Aggregate Bond Index - Unhedged 8.67%
S&P 500 Composite Index (23.57)
--------------
(1) Returns on municipal fixed maturities and preferred stocks have
tax-equivalent yields of 10.47% and 11.27%, respectively.
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Our equity in earnings of limited partnerships totaled $1.1 million and
$1.3 million for the nine months ended September 30, 2002 and 2001,
respectively. Private equity and fixed income limited partnerships realized
losses of $2.6 million for the nine months ended September 30, 2002, compared to
losses of $39,000 for the same period in 2001. Our earnings from real estate
limited partnerships were $3.7 million for the nine months ended September 30,
2002, compared to earnings of $1.3 million for the same period in 2001. Our
September 30, 2002 earnings included impairment charges totaling almost $1.4
million in private equity limited partnerships where we considered declines in
value to be other than temporary.
Our share of the earnings of Erie Family Life Insurance Company totaled
$1.1 million during the first nine months of September 30, 2002, down from the
$2.5 million recorded for the same period in 2001. The decrease in the level of
earnings from our investment in Erie Family Life Insurance Company is related to
impairment charges recorded on investments by Erie Family Life Insurance Company
totaling $17.2 million, which resulted in net realized losses for Erie Family
Life Insurance Company. Our investment in Erie Family Life Insurance Company is
accounted for under the equity method of accounting.
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
FINANCIAL OVERVIEW
Our consolidated net income in 2001 was $122.3 million, a decrease of 19.8%
from net income of $152.4 million in 2000, which in turn represented an increase
of 6.5% from net income of $143.1 million in 1999. Gains made in our management
operations, including a 15.1% increase in management fee revenue in 2001 over
2000 and a 7.5% increase in 2000 over 1999, were outpaced by losses experienced
in our insurance underwriting operations and reduced levels of income from
investment operations in 2001. In 2000, gains in our management and investment
operations outpaced losses experienced in our insurance underwriting operations.
Our 2001 underwriting loss resulted from increased losses in the direct business
of our property and casualty subsidiaries, primarily in private passenger and
commercial automobile and workers' compensation insurance, as well as assumed
reinsurance losses, some of which relate to the World Trade Center terrorist
attack. We recognized $31.9 million in net realized losses from investments in
2001 on the sale of securities and related charges for other than temporary
impairments of equity securities and limited partnerships. There were no similar
impairments in 2000 or 1999. Our 2000 underwriting loss stemmed from increased
losses in private passenger automobile and several commercial lines of business.
Revenue from our investment operations increased 18.5% in 2000 from 1999 as our
cash flows were reinvested for higher returns and our equity earnings in limited
partnerships grew substantially over 1999.
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Our operating income (net income excluding realized gains/losses and
related federal income taxes) increased by 1.1% in 2001, to $143.0 million from
$141.4 million in 2000, and 5.9% in 2000 from $133.5 million in 1999. Operating
income in 2001 reflected a third quarter after-tax charge of $3.8 million, or
$0.06 per share, from the World Trade Center terrorist attack and a fourth
quarter after-tax charge of $6.9 million, or almost $0.10 a share, for severance
charges related to the retirement of our chief executive officer. Our operating
income in 2000 reflected adverse developments on assumed reinsurance losses from
the catastrophic wind storms that devastated Europe in December 1999, which
resulted in a loss of $1.4 million, or $0.01 per share, after federal income
taxes.
ANALYSIS OF MANAGEMENT OPERATIONS
Our income from management operations rose 16.3% to $184.6 million in 2001
from $158.7 million in 2000 and 6.9% in 2000 from $148.5 million in 1999. Gross
margins from management operations were 27.9% in 2001 compared to gross margins
of 27.6% in 2000 and 28.1% in 1999.
Our management fee revenue rose $83.3 million, or 15.1%, to $635.0 million
in 2001 from $551.6 million in 2000 and $38.3 million, or 7.5%, in 2000 from
$513.4 million in 1999. The direct and affiliated assumed premiums of the
Exchange grew 15.1% in 2001 to $2,539.9 million from $2,206.6 million in 2000
and grew by 7.5% in 2000 from $2,053.5 million in 1999. Increases in average
premium per policy, improvements in new policy growth and favorable policy
retention rates were all contributing factors in the growth. Firming pricing in
2001 for commercial and personal insurance allowed the Property and Casualty
Group to price its products more favorably while maintaining their competitive
advantage in the marketplace. The year-to-year growth rate of direct written
premium in the fourth quarter was 18.9%, up from 14.8% growth in the third
quarter, 14.0% growth in the second quarter and 12.8% growth in the first
quarter of 2001.
The Property and Casualty Group's average premium per policy increased 6.1%
to $817 in 2001 from $770 in 2000, and 0.9% in 2000 from $763 in 1999. For
private passenger automobile (which accounted for 54.6% of the direct written
premiums of the Property and Casualty Group during 2001 with over 1.4 million
policies in force), the average premium per policy increased 3.1% to $967 in
2001 from $938 in 2000, and decreased 1.6% in 2000 from $954 in 1999.
Continued improvement in new policy growth also drove the gains experienced
in the Property and Casualty Group's direct written premiums. Policies in force
increased 8.5% to 3.1 million in 2001 from 2.9 million in 2000, and 6.5% in
2000, from 2.7 million in 1999. Policy retention of the Property and Casualty
Group remained strong at 90.9%, 91.0% and 90.5% during 2001, 2000 and 1999,
respectively, for all lines of business combined.
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Changes in the management fee rate can affect our revenue and net income
significantly. If our board of directors had decreased the management fee rate
1% (from 25% to 24%) for 2001, 2000 and 1999, the decrease would have resulted
in a reduction of our management fee revenues of $25.4 million, $22.1 million
and $20.5 million, respectively, and a per share reduction in net income of
$0.23, $0.20 and $0.18, respectively. At our December 2001 board of directors
meeting, the board voted to maintain the management fee rate at 25% for 2002.
Our service agreement revenue grew 20.2% to $27.2 million in 2001 from
$22.7 million in 2000, and 46.8% in 2000 from $15.4 million in 1999. Service
agreement revenue earned for the management and administration of the Exchange's
voluntary assumed reinsurance from non-affiliated insurers, totaled $11.3
million, $10.1 million and $8.2 million on net voluntary assumed reinsurance
premiums of $160.7 million, $145.0 million and $116.6 million for 2001, 2000 and
1999, respectively.
Service charges we collect from policyholders who pay premiums in
installments on policies written by the Property and Casualty Group amounted to
$16.0 million, $12.5 million and $7.3 million in 2001, 2000 and 1999,
respectively. The 2001 and 2000 growth was positively affected by service charge
increases from $2 to $3 per installment for policies renewing in most states
beginning in the second quarter of 2000.
The cost of management operations rose 14.9% to $477.6 million in 2001,
from $415.6 million in 2000, and 9.3% in 2000 from $380.3 million in 1999.
Commissions to independent agents, which are the largest component of the cost
of management operations, include scheduled commissions earned by independent
agents on premiums written, as well as promotional incentives for agents and
agent contingency awards. Agent contingency awards are based upon a three-year
average of the underwriting profitability of the direct business written and
serviced within the Property and Casualty Group by the independent agent. The
estimate for the agent contingency awards is modeled on a monthly basis using
the two prior years' actual underwriting data by agency combined with the
current year to date actual data. The Company uses projected underwriting data
for the remainder of the current year in order to model the 36-month
underwriting results by agency. Commission costs rose 14.3% to $323.1 million in
2001, from $282.7 million in 2000, and 7.5% in 2000 from $263.1 million in 1999.
Commission costs grew at a slower rate relative to the growth in direct premiums
written in 2001 as a result of lower accruals for agent contingency awards
compared to 2000. The provision for agent contingency awards totaled $15.7
million, $18.3 million and $19.9 million in 2001, 2000 and 1999, respectively.
Commission costs, excluding agent contingency awards, increased 16.2% in 2001
compared to 2000, and 9.0% in 2000 compared to 1999, which is in line with the
increase in direct written premiums.
Cost of our management operations, excluding commission costs, increased
16.4% in 2001 to $154.6 million, from $132.8 million in 2000, and increased
13.3% in 2000 from $117.2 million in 1999, due primarily to increases in
personnel costs. Our personnel costs totaled
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$94.4 million, $79.3 million and $69.5 million in 2001, 2000 and 1999,
respectively. A portion of the 2001 increase in personnel costs resulted from
recognition of the severance obligation related to the retirement of our
president and chief executive officer on January 18, 2002. We recorded a
severance charge in the fourth quarter 2001 of $10.7 million. Personnel costs,
excluding the severance charge, rose 5.5% in 2001 due to increases in employee
pay rates and staffing levels. Increases in 2000 over 1999 were attributable to
pay rate increases and the introduction of an incentive compensation program for
branch sales employees.
During 2001, we also incurred information technology infrastructure
expenditures related to the eCommerce program that were not subject to the
cost-sharing agreement for information technology. These eCommerce program costs
were included in the cost of management operations and totaled $1.6 million in
2001.
ANALYSIS OF INSURANCE UNDERWRITING OPERATIONS
We recorded underwriting losses of $20.5 million, $10.4 million and $3.5
million in 2001, 2000 and 1999, respectively. The underwriting results in 2001
reflect higher losses experienced in private passenger automobile, and
commercial automobile and workers' compensation lines of business, as well as
losses from assumed reinsurance.
Premiums earned increased 11.3% to $137.6 million in 2001, from $123.7
million in 2000, and 5.5% in 2000 from $117.2 million in 1999. The average
premium per policy of the Property and Casualty Group was $817, $770 and $763 in
2001, 2000 and 1999, respectively. Losses and loss adjustment expenses incurred
increased 17.7%, to $117.2 million in 2001 from $99.6 million in 2000, and 13.5%
in 2000 from $87.7 million in 1999.
Our property and casualty insurance subsidiaries' share of the Property and
Casualty Group's direct business generated net underwriting losses of $16.4
million, $6.1 million and $0.5 million in 2001, 2000 and 1999, respectively. In
2001, the Property and Casualty Group continued to experience a decrease in loss
frequency, although loss severity continued to rise. The higher loss costs in
2001 also include adverse development of prior accident year losses amounting to
$5.9 million, net of reinsurance recoveries. In 1998 and 1999, the Property and
Casualty Group lowered prices in the private passenger automobile lines of
insurance in response to extremely competitive market conditions and improving
loss trends in automobile insurance. The firming of automobile pricing in 2001
by the industry in response to deteriorating loss cost trends allowed the
Property and Casualty Group to begin raising automobile insurance prices in
order to improve underwriting profitability. Because all policies issued by the
Property and Casualty Group are for a one-year term, it will take 24 months
before the full impact of 2001 rate increases are recognized in earned premiums
of Erie Insurance Group.
Our insurance subsidiaries' unaffiliated voluntary assumed reinsurance
business generated net underwriting losses of $4.1 million, $4.3 million and
$3.0 million in 2001, 2000
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and 1999, respectively. Our 5.5% share of the Property and Casualty Group's
estimated incurred reinsurance losses of $150 million from the World Trade
Center terrorist attack contributed to the increased loss in 2001. Our share of
these losses totaled $8.3 million in 2001.
During 2001, our property and casualty insurance subsidiaries, Erie
Insurance Company and Erie Insurance Company of New York, recorded $7.2 million
in reinsurance recoveries under the excess of loss reinsurance agreement with
the Exchange. Of the total recoveries in 2001, $6.5 million related to accident
year 2001, including the losses related to the World Trade Center terrorist
attack, with the balance pertaining to the 1999 accident year. The total
recoverable reduced our loss and loss adjustment expenses in 2001. No cash
payments were made between the companies in 2001 for these recoveries since the
recoveries were recorded based on reserved but yet unpaid losses. No such
recoveries were recognized in calendar years 2000 or 1999.
Under the cost sharing agreement for information technology development,
our policy acquisition and other underwriting expenses include our property and
casualty insurance subsidiaries' share of costs related to the eCommerce
initiative totaling $1.3 million for 2001. No such costs were incurred in 2000
or 1999.
The 2001 combined ratio for our property and casualty insurance
underwriting operations calculated under GAAP was 114.9%, compared to 108.4% in
2000 and 103.0% in 1999. During 2001, 2000 and 1999, the Company's share of
catastrophe losses from direct business amounted to $1.6 million, $2.1 million
and $4.4 million, respectively. The GAAP combined ratio for 2001, 2000 and 1999,
excluding catastrophe losses on direct business, was 113.7, 106.7 and 99.3,
respectively.
During 2001, we received notification of the insolvency of the Reliance
Insurance Group. As a result, the Property and Casualty Group companies recorded
an estimated assessment of $36.8 million, before consideration of potential
premium tax recoveries of $5.9 million. Our share of this assessment was $1.7
million and was recorded in the policy acquisition and other underwriting
expenses during the fourth quarter of 2001. This estimate was based upon
preliminary data relating to this insolvency and is subject to change as more
information becomes available.
ANALYSIS OF INVESTMENT OPERATIONS
Our net revenue from investment operations in 2001 decreased by 75.2% to
$18.8 million, compared to $75.6 million in 2000, compared to an increase of
18.5% in 2000 from $63.8 million in 1999. In 2001, the equity markets declined
and recovery was further slowed by the World Trade Center terrorist attack. As a
result, we experienced declines in value in our investment portfolios over the
past year. Net realized losses totaled $31.9 million in 2001 compared to
realized gains of $17.0 million in 2000 and $14.7 million in 1999. We recognized
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realized losses in 2001 as a result of the sale of securities and charges for
other than temporary impairments of preferred stock and limited partnerships.
The sale of investments in a loss position in 2001 was part of a proactive
year-end tax selling strategy. Included in the 2001 realized loss was $4.5
million related to sales of securities of Enron Corporation and its related
legal entities. The period of time that various securities held by the Company
had been continuously in an unrealized loss position varied. The table below
lists the quarter in which any equity securities sold during the fourth quarter
of 2001 were first in an unrealized loss position of any amount:
ERIE INDEMNITY COMPANY
QUARTER WHEN EQUITY ISSUES SOLD IN THE FOURTH QUARTER OF 2001
WERE FIRST IN UNREALIZED LOSS POSITION
Number
Quarter of Issues
------------------ ---------
Third Quarter 2001 12
Second Quarter 2001 15
First Quarter 2001 16
Fourth Quarter 2000 12
Third Quarter 2000 5
Second Quarter 2000 2
First Quarter 2000 6
Fourth Quarter 1999 3
Third Quarter 1999 3
Second Quarter 1999 1
First Quarter 1999 --
Fourth Quarter 1998 1
Third Quarter 1998 1
Impairment charges of investments with declines in value considered by
management to be other than temporary totaled $12.1 million in 2001, including
charges of $5.7 million in the third quarter of 2001 and $6.4 million in the
fourth quarter of 2001. Additionally, $1.3 million of impairment charges were
incurred in the fourth quarter of 2000. There were no such impairment charges
recorded in 1999. See "Business -- Investments" beginning on page 79 for a
description of the Company's impairment policy for equity securities.
Net investment income rose 3.1% to $49.9 million in 2001 and 11.7% to
$48.4 million in 2000 from $43.3 million in 1999. The growth in investment
income for 2001, 2000 and 1999 was offset by cash outflows we used to repurchase
$93.4 million of our Class A common stock through December 31, 2001.
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Our equity in losses of limited partnerships were $7,000 in 2001,
compared to earnings of $4.7 million and $0.6 million in 2000 and 1999,
respectively. Private equity and fixed income limited partnerships investments
we held realized losses of $1.4 million in 2001 compared to earnings of $2.8
million in 2000 and losses of $0.3 million in 1999. Earnings on our real estate
limited partnerships were $1.4 million in 2001, compared to $1.9 million in 2000
and $0.9 million in 1999.
Our share of the earnings of Erie Family Life Insurance Company totaled
$0.8 million in 2001, down from $5.5 million in 2000 and $5.0 million in 1999.
The decrease in level of earnings from our investment in Erie Family Life
Insurance Company is related to Erie Family Life Insurance Company's sales of
investments in 2001 resulting in net realized losses on that company's statement
of operations.
FINANCIAL CONDITION
SEPTEMBER 30, 2002 AND 2001
At September 30, 2002 and 2001, our investment portfolio of
investment-grade bonds, common stock, preferred stock and cash and cash
equivalents totaled $889 million and $792 million, respectively, representing
40.6% and 41.7% of our total assets.
At September 30, 2002 and 2001, the carrying value of our fixed
maturity investments represented 70.0% and 65.1%, respectively, of our total
invested assets. Our fixed maturity investments consisted of 97.6% and 96.1% of
high-quality marketable bonds and redeemable preferred stock, all of which were
rated at investment-grade levels (above Ba/BB), at September 30, 2002 and 2001,
respectively. Included in this investment-grade category at September 30, 2002
were $244 million, or 37.8%, and at September 30, 2001 were $224 million, or
41.3%, respectively, of the highest quality bonds and redeemable preferred stock
rated Aaa/AAA or Aa/AA or bonds issued by the United States government.
At September 30, 2002, the net unrealized gain on fixed maturities, net
of deferred taxes, amounted to $16.8 million, compared to $13.5 million at
September 30, 2001.
At September 30, 2002 and 2001, equity securities held by the Company
included net unrealized gains of $10.5 million and $2.6 million, respectively,
net of deferred taxes.
At September 30, 2002, our limited partnership investments increased to
$89.0 million from $77.5 million at September 30, 2001. Fixed income and real
estate limited partnerships comprised 42.1% and 31.8% of the total limited
partnerships at September 30, 2002 and 2001, respectively, while private equity
limited partnerships comprised 57.9% and 68.2%, respectively.
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DECEMBER 31, 2001, 2000 AND 1999
At December 31, 2001, 2000 and 1999, our investment portfolio of
investment-grade bonds, common stock, preferred stock and cash and cash
equivalents totaled $824.6 million, $758.4 million and $714.5 million
respectively, representing 42.6%, 46.1% and 47.1%, respectively, of our total
assets.
At December 31, 2001, 2000 and 1999, the carrying value of our fixed
maturity investments represented 66.6%, 65.6% and 64.9% of our total invested
assets, respectively.
Our fixed maturity investments consisted 96.9%, 96.9% and 97.9% of
high-quality, marketable bonds and redeemable preferred stock, all of which were
rated at investment-grade levels (above Ba/BB), at December 31, 2001, 2000 and
1999, respectively. Included in this investment-grade category at December 31,
2001 were $230.2 million, or 41.1%, at December 31, 2000, $220.8 million or
41.5%, and at December 31, 1999, $225.7 million or 46.5%, of the highest quality
bonds and redeemable preferred stock rated Aaa/AAA or Aa/AA or bonds issued by
the United States government.
At December 31, 2001, the net unrealized gain on fixed maturities, net
of deferred taxes, amounted to $10.7 million, compared to $4.8 million at
December 31, 2000 and a net realized loss of $2.5 million at December 31, 1999.
At December 31, 2001, 2000 and 1999, equity securities held by the
Company included net unrealized gains of $22.1 million, $12.7 million and $28.5
million, respectively, net of deferred taxes.
During 2001, limited partnership investments increased to $81.6 million
from $68.2 million at December 31, 2000 and $39.1 million at December 31, 1999.
Fixed income and real estate limited partnerships, which comprised 34.5%, 28.6%
and 49.9% of the total limited partnerships at December 31, 2001, 2000 and 1999,
respectively, produced a predictable earnings stream while private equity
limited partnerships, which comprised 65.5%, 71.4% and 50.1% of the total
limited partnerships, tend to provide a less predictable earnings stream but the
potential for greater long-term returns.
COVERED LOSSES AND LOSS RESERVES
Loss reserves are set at full expected cost, except for loss reserves
for workers' compensation that were discounted at 2.5% in 2001 and 2000.
Inflation is implicitly provided for in the reserving function through analysis
of costs, trends and reviews of historical reserving results.
The Property and Casualty Group is exposed to new claims on files
previously closed (e.g., covered losses not detected during original claim
settlement) and to larger than historical settlements (due to changes in law,
precedent or underlying inflation) on pending
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and unreported claims. We are exposed to increased losses by virtue of our 5.5%
participation in the intercompany reinsurance pooling arrangement with the
Exchange.
Adverse development of losses from prior accident years results in
higher calendar year loss ratios and reduced calendar year underwriting results.
To the extent prior year reserve deficiencies are indicative of deteriorating
underlying loss trends and are material, the Property and Casualty Group's
pricing of affected lines of business would be increased to the extent permitted
by state departments of insurance. Management also reviews trends in loss
developments in order to determine if adjustments, such as reserve
strengthening, are appropriate. Any adjustments considered necessary are
reflected in current results of operations.
The Property and Casualty Group's $150 million loss estimate
anticipates that the World Trade Center terrorist attack is considered one
event. If the attack comes to be considered two events, the total potential
exposure for the Property and Casualty Group would increase between $50 million
and $75 million. The effect on the Company, as a result, would be additional
losses between $2.7 million and $4.1 million. Taking into consideration the
excess of loss reinsurance agreement, the net impact of such potential
additional losses to us would be minimal.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to the impact of interest rate changes, changes
in market values of investments and to credit risk.
In the normal course of business, the Company employs established
policies and procedures to manage its exposure to changes in interest rates,
fluctuations in the value of the fair market value of its debt and equity
securities and credit risk. The Company seeks to mitigate these risks by various
actions described below.
INTEREST RATE RISK
The Company's exposure to market risk for a change in interest rates is
concentrated in the investment portfolio. The Company monitors this exposure
through periodic reviews of asset and liability positions. Estimates of cash
flows and the impact of interest rate fluctuations relating to the investment
portfolio are monitored regularly. Generally, the Company does not hedge its
exposure to interest rate risk because it has the capacity to, and does, hold
fixed maturity investments to maturity.
Principal cash flows and related weighted-average interest rates by
expected maturity dates for financial instruments sensitive to interest rates
are as follows:
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ERIE INDEMNITY COMPANY
PRINCIPAL CASH FLOWS/WEIGHTED AVERAGE INTEREST RATES
(amounts in thousands) As of December 31, 2001
-----------------------------------------------
Weighted-average
Principal cash flows interest rate
-------------------- ----------------
FIXED MATURITIES:
2002 $ 37,245 6.5%
2003 35,245 6.5
2004 37,978 7.0
2005 49,515 6.3
2006 55,340 6.5
Thereafter $330,872 7.5
--------
Total $546,195
========
Market Value $574,874
========
FIXED MATURITIES AND SHORT-TERM BONDS:
2002 $ 54,677 6.5%
2003 55,203 6.6
2004 49,720 6.7
2005 47,852 7.0
2006 59,775 6.5
Thereafter $289,077 7.2
--------
Total $556,304
========
Market Value $561,502
========
The following pro forma information is presented assuming a 100 basis
point increase in interest rates at December 31 of each year, and reflects the
estimated effect on the fair value of the Company's fixed maturity investment
portfolio. The Company used the modified duration of its fixed maturity
investment portfolio to model the pro forma effect of a change in interest rates
at December 31, 2001 and 2000.
ERIE INDEMNITY COMPANY
FIXED MATURITY INTEREST RATE SENSITIVITY ANALYSIS
(amounts in thousands) As of December 31,
-------------------------------------
2001 2000
------- ------
Market value 574,874 561,502
Change in market value (1) (24,145) (22,460)
Pro forma market value 550,729 539,042
Modified duration (2) 4.2 4.0
----------------
(1) The change in market value is calculated by taking the negative of the
product obtained by multiplying (i) modified duration by (ii) change in
interest rates by (iii) market value of the portfolio.
(2) Modified duration is a measure of a portfolio's sensitivity to changes
in interest rates. It is interpreted as the approximate percentage
change in the market value of a portfolio for a certain basis point
change in interest rates.
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EQUITY PRICE RISK
The Company's portfolio of marketable equity securities, which is
carried on the Consolidated Statements of Financial Position at estimated fair
value, has exposure to price risk, the risk of potential loss in estimated fair
value resulting from an adverse change in prices. The Company's objective is to
earn competitive relative returns by investing in a diverse portfolio of
high-quality, liquid securities.
Portfolio characteristics are analyzed regularly, and market risk is
actively managed through a variety of techniques. Portfolio holdings are
diversified across industries; concentrations in any one company or industry are
limited by parameters established by management and the Company's board of
directors. The Company's marketable equity security portfolio is well
diversified among primarily actively traded mid- to large-cap stocks. The value
of the Company's marketable equity portfolio generally moves with the broad
market indices such as the S&P 500. If market prices were to decrease by 10%,
the fair value of the Company's marketable equity securities would have had a
corresponding decrease of approximately $19 million at December 31, 2001
compared to approximately $20 million at December 31, 2000.
The Company's portfolio of limited partnership investments has exposure
to market risks, primarily relating to the viability of the various entities in
which they invested. These investments consist primarily of equity investments
in small and medium sized companies, and in real estate. These investments
involve risk related to changes in the equity and real estate markets. The
market value of these limited partnership investments equaled 10% of total
invested assets. We actively manage these risks in a variety of ways. These
limited partnership investments are diversified to avoid concentration in a
particular industry. We perform extensive research, including consideration of
the identity of other potential investors, prior to investment in these
partnerships.
CREDIT RISK
The Company's objective is to earn competitive returns by investing in
a diversified portfolio of securities. The Company's portfolios of fixed
maturity securities, mortgage loans and, to a lesser extent, short-term
investments are subject to credit risk. This risk is defined as the potential
loss in market value resulting from adverse changes in the borrower's ability to
repay the debt. The Company manages this risk by performing up front
underwriting analysis and through regular reviews by the Company's investment
staff. The fixed maturity investments are also maintained between minimum and
maximum percentages of invested assets.
The Company's results of operations are directly related to the
financial strength of the Exchange. Credit risks related to the receivables from
the Exchange are evaluated monthly. Since the Company's inception, it has
collected its other receivables from the Exchange in a
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timely manner (generally within 120 days). Other receivables include amounts due
for the management fee and costs paid by the Company on behalf of the Exchange.
Other receivables from the Exchange equaled 8.7% and 7.7% of total Company
assets as of September 30, 2002 and December 31, 2001, respectively. An
additional receivable from the Exchange as relates to reinsurance recoverable,
amounted to $570.1 million and $491.1 million at September 30, 2002 and December
31, 2001, respectively, or 26.0% and 25.4% of assets, respectively. This
receivable relates primarily to unpaid losses ceded to the Exchange as part of
the pooling agreement between the Exchange and the Company's property and
casualty subsidiaries. The Company collects its reinsurance recoverable
receivable generally within 30 days of actual settlement of losses. Reinsurance
contracts do not relieve the Company from its primary obligations to
policyholders. A contingent liability exists with respect to reinsurance
receivables from the Exchange in the event the Exchange would be unable to meet
its obligations under its reinsurance agreement with the Exchange. The aggregate
of these receivables from the Exchange at September 30, 2002 and December 31,
2001 equaled $761.3 million and $640.7 million, respectively, or 34.7% and
33.1%, respectively, of the Company's total assets. Because of the Company's
attorney-in-fact agreements with the subscribers to the Exchange and its pooling
agreement with the Exchange, the Company's existence and performance is
dependent on the existence and financial stability of the Exchange.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measure of an entity's ability to secure enough cash to
meet its contractual obligations and operating needs as they arise. Our major
sources of funds from operations are the net cash flow generated from management
operations, the net cash flow from our property and casualty insurance
subsidiaries' 5.5% participation in the underwriting results of the Property and
Casualty Group and investment income from affiliated and nonaffiliated
investments.
We generate sufficient net positive cash flow from our operations to
fund our commitments and build our investment portfolio, thereby increasing
future investment returns. We maintain a high degree of liquidity in our
investment portfolio in the form of readily marketable fixed maturities, equity
securities and short-term investments. Net cash flows provided by operating
activities in 2001, 2000 and 1999, were $148.6 million, $130.6 million and
$137.0 million, respectively.
Management fee and other cash settlements due at December 31 from the
Exchange were $147.3 million, $118.0 million and $104.3 million in 2001, 2000
and 1999, respectively. A receivable from Erie Family Life Insurance Company for
cash settlements totaled $2.3 million at December 31, 2001, compared to $2.0
million at December 31, 2000 and $1.5 million at December 31, 1999. We also have
a receivable due from the Exchange for reinsurance recoverable from losses and
unearned premium balances ceded to the intercompany reinsurance pool.
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The reinsurance recoverable from the Exchange rose 19.2% to $491.1
million at December 31, 2001 from the $412.0 million at December 31, 2000 and
12.8% from $365.2 million at December 31, 1999. These increases are the result
of corresponding increases in direct loss reserves, loss adjustment expense
reserves and unearned premium reserves of the Company's property and casualty
insurance subsidiaries that are ceded to the Exchange under the intercompany
pooling arrangement. The increase in direct loss reserves, loss adjustment
expense reserves and unearned premium reserves ceded to the Exchange is a result
of a corresponding increase in direct premium written by the Company's property
and casualty insurance subsidiaries. The increase in direct written premium of
the subsidiaries of the Company that is ceded to the Exchange was 18.3% and
11.4% for the years ended December 31, 2001 and 2000, respectively. Total
receivables from the Exchange represented 12.3% of the Exchange's assets at
September 30, 2002, 9.1% at December 31, 2001, 7.6% at December 31, 2000 and
6.3% at December 31, 1999.
We established a stock repurchase program in 1999 pursuant to which we
may repurchase as much as $120 million of our Class A common stock through
December 31, 2002. In 2001, 220,000 shares were repurchased at a total cost of
$7.7 million. During the first nine months of 2002, 207,000 shares were
repurchased at a total cost of $8.5 million. From its inception through
September 30, 2002, 3,402,894 shares have been repurchased at a total cost of
$101.9 million. We suspended the stock repurchase program in connection with
this offering of Class A common stock because we did not believe it was
appropriate to buy Class A common stock in the market while a registered
offering was pending and considering the repurchase program was expiring at the
end of 2002.
Dividends declared to shareholders totaled $40.4 million, $36.2 million
and $32.8 million in 2001, 2000 and 1999, respectively. There are no regulatory
restrictions on the payment of dividends to our shareholders, although there are
state law restrictions on the payment of dividends from our insurance
subsidiaries to us.
Temporary differences between the financial statement carrying amounts
and tax bases of assets and liabilities that give rise to deferred tax assets
and liabilities resulted in net deferred tax liabilities at December 31, 2001,
2000 and 1999 of $12.9 million, $7.2 million and $11.8 million, respectively.
The primary reason for the increase in the deferred tax liability in 2001 is an
increase in unrealized gains from available-for-sale securities and limited
partnerships in 2001 of $18.0 million resulting in an increase in deferred tax
liability of $6.3 million. Management believes it is likely that we will have
sufficient taxable income in future years to realize the benefits of the gross
deferred tax assets.
-58-
BUSINESS
We operate predominantly as a provider of sales, underwriting and policy
issuance services to the Exchange. We also operate as a property and casualty
insurer through our subsidiaries. We have served since 1925 as the
attorney-in-fact for the policyholders of the Exchange. The Property and
Casualty Group writes personal and commercial lines property and casualty
coverages exclusively through approximately 8,000 independent agents and pool
their underwriting results. The financial results of the Exchange are not
consolidated with ours.
For our services as attorney-in-fact, we charge the Exchange a management
fee calculated as a percentage, limited to 25%, of the direct written premiums
of the Exchange in addition to the direct written premiums of the other members
of the Property and Casualty Group, all of which are initially assumed by the
Exchange under the pooling agreement. Management fees accounted for
approximately 78% of our revenues for the nine months ended September 30, 2002.
For the first nine months of 2002, 70% of direct premiums written by the
Property and Casualty Group were personal lines, while 30% were commercial
lines. We also own 21.6% of the common stock of Erie Family Life Insurance
Company, an affiliated life insurance company, of which the Exchange owns 53.5%
and public shareholders, including our directors, own 24.9%. At September 30,
2002, we had total assets of $2.2 billion and shareholders' equity of $958
million. Our net income was $138.2 million for the nine months ended September
30, 2002 and $122.3 million for the year ended December 31, 2001.
We believe we are the only publicly-traded attorney-in-fact for a
reciprocal insurance exchange in the country. Several other private property and
casualty companies, such as USAA and Farmers Insurance Group (owned by Zurich
Financial Services Group), also operate as reciprocals with separate management
arrangements. Our earnings are largely generated from fees based on the direct
written premium of the Exchange in addition to the direct written premiums of
the other members of the Property and Casualty Group. As such, we have an
interest in the growth and financial condition of the Exchange.
In addition to our interest in the growth in premium of the Exchange, our
property and casualty insurance subsidiaries also participate in the
underwriting results of the Exchange. Our property and casualty insurance
subsidiaries share in the underwriting results of the Exchange via a pooling
arrangement under which the Exchange has a 94.5% participation in the
underwriting results of the Property and Casualty Group and our insurance
subsidiaries, the Erie Insurance Company and the Erie Insurance Company of New
York, have a 5.5% participation. As such, we have an interest in the
underwriting profitability of the business written as well as the volume of
premium written. The Property and Casualty Group wrote approximately $3.0
billion in premium during the twelve months ended September 30, 2002. Of the net
underwriting risk for this $3.0 billion, $2.8 billion in premium, or 94.5%, is
borne by the Exchange. The remaining $165 million, or 5.5%, of the net
-59-
underwriting risk is borne by our property and casualty insurance subsidiaries
via the pooling arrangement with the Exchange.
ERIE INSURANCE GROUP
ORGANIZATIONAL CHART
------------------
| Shareholders |
------------------
|
-------------------
| Erie Indemnity | Attorney-in-Fact -----------------------------
| Company |-----------for Policyholders------------| Erie Insurance Exchange* |
------------------- -----------------------------
| |
--------------------------------------------- ---------------------
| | | | |
| | | | |
100% 100% 21.6% 53.5% 100%
| | | | |
------------------ ------------------- ------------------------ --------------------
| | | Erie Insurance* | | | | |
| Erie Insurance*| | Property & | | Erie Family life | | Flagship City* |
| Company | | Casualty | | Insurance | | Insurance |
| | | Company | | Company | | Company |
------------------ ------------------- ------------------------ --------------------
|
|
100%
|
|
------------------
| |
| Erie Insurance*|
| Company of |
| New York |
------------------
* Denotes a member of the Property and Casualty Group
The Property and Casualty Group seeks to insure standard and preferred
risks in primarily private passenger automobile, homeowners and small commercial
lines, including workers' compensation policies. We believe the Property and
Casualty Group has differentiated its products from standard industry products
by providing additional coverages, which enhance agents' marketing efforts. The
Property and Casualty Group is represented by an agency force consisting of over
1,700 independent agencies comprised of approximately 8,000 agents in 11
Midwestern, Mid-Atlantic and Southeastern states (Illinois, Indiana, Maryland,
New York, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia
and Wisconsin) and the District of Columbia. These independent agents play a
significant role as underwriters and are major contributors to our success.
-60-
We have reported increasing net operating income for 14 consecutive years.
Our growth has primarily been driven by an expansion of the Property and
Casualty Group's business into new territories, the appointment of new agencies,
high policy and agency retention rates and, recently, increased premium rates.
. Since 1997, the Property and Casualty Group has entered Illinois and
Wisconsin and expects to begin operating in Minnesota in the third quarter
of 2004.
. In 2001, we continued the planned expansion of the Property and
Casualty Group's independent agency force by appointing 247 agencies. Since
1997, we have increased the overall number of agencies representing the
Property and Casualty Group by 60%.
. The Property and Casualty Group has a very stable base of
policyholders. The Property and Casualty Group's retention rate (the
percentage of existing policyholders who renew their policies) of 90.9% in
2001 compared favorably to an average of 82.6% for a core benchmark group
consisting largely of regional property and casualty carriers, according to
a 2001 Ward Group benchmark study.
. The Property and Casualty Group is achieving premium rate increases as
a result of the current favorable market conditions in both commercial and
personal property and casualty lines, which are generally referred to
within the industry as "hard market conditions". Hard market conditions are
characterized by increasing premium rates, more stringent underwriting
standards and a need for additional capital in the industry. The Property
and Casualty Group and the Company have benefited from these hard market
conditions and for the twelve months ended September 30, 2002 experienced
average premium per policy increases of 7.2% for personal automobile
insurance policies, 17.6% for commercial lines policies and 9.5% across all
lines. Management believes increases in premium rates are likely to
continue in 2002 and 2003 because of the industry's need to improve
underwriting results and to achieve adequate operating returns in light of
the reduced investment yields resulting from low interest rates and poor
returns in the equity markets. Premium rates approved by regulators that
will be realized in the fourth quarter of 2002 and in 2003 totaled $46.9
million and $96.6 million, respectively. These premium increases were
primarily related to private passenger automobile, homeowners and
commercial multiple peril lines of business in the states of Pennsylvania,
Ohio and West Virginia. Generally, the Company's profit margins from
management operations have increased during periods of premium rate
increases.
As a result of these growth initiatives and market conditions, the Property
and Casualty Group had over 3.4 million insurance policies in force as of
September 30, 2002, an 11.9% increase from September 30, 2001. Personal lines
policies in force grew by 11.8%
-61-
during the twelve months ended September 30, 2002, while commercial lines
policies increased 13.0% over the same period.
The Erie Insurance Group built its reputation in the industry and among
insurance consumers, agents and others on its commitment to be "Above all in
sERvIcE(SM)". Customer satisfaction surveys independently conducted by a
nationally recognized research firm have ranked the Property and Casualty Group:
. No. 2 for homeowners insurance in 2002 and No. 1 for homeowners
insurance in 2001;
. No. 3 for private passenger automobile insurance in 2002 and No. 2 for
private passenger automobile insurance in 2001 and 2000; and
. No. 1 for automobile collision repair in 2002, the first year this
survey was conducted.
Each member of the Property and Casualty Group is rated A++ (Superior) by
A.M. Best, its highest financial strength rating, which was held by only 2.8% of
the property and casualty insurance groups rated by A.M. Best as of July 11,
2002.
OUR COMPETITIVE ADVANTAGES
We believe that our competitive advantages come from:
. COMMITTED, LOYAL AND PRODUCTIVE INDEPENDENT AGENCY FORCE. We seek to
develop long-term business relationships with high-quality independent
agencies. Prior to allowing an agency to represent the Property and
Casualty Group, we undertake a rigorous selection process that seeks agency
principals who meet our high standards and operate their agencies in line
with Erie Insurance Group's business philosophy. We believe the independent
agency force has been loyal and that the Property and Casualty Group is the
preferred carrier for most of the independent agencies that represent it.
Average annual written premium volume per agency is approximately $1.7
million for these agencies.
. FOCUS ON QUALITY SERVICE. Service to the policyholder and agent has
been a tradition of the Erie Insurance Group since its founding more than
77 years ago. Erie Insurance Group has consistently been recognized as a
provider of quality service. Customer satisfaction surveys independently
conducted by a nationally recognized research firm ranked the Property and
Casualty Group No. 2 for homeowners insurance in 2002 and No. 1 in 2001,
No. 3 for private passenger automobile insurance in 2002 and No. 2 in 2001
and 2000 and No. 1 for automobile collision repair in 2002, the first year
that survey was conducted. The claims force is comprised
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predominantly of personnel trained in Erie Insurance Group's service-oriented
claims settlement philosophy.
. COMPETITIVE PRODUCTS AND PRICING. A key to attracting a highly
effective sales force of independent agents and enhancing the Property and
Casualty Group's ability to attract customers is a portfolio of
competitively priced products. These products include many additional
coverages that we believe differentiate the Property and Casualty Group's
products in the marketplace.
. COST-EFFICIENT OPERATION. Expense management is one of Erie Insurance
Group's founding traditions and is an important part of its culture. We
believe the Erie Insurance Group's operations are cost-efficient. In
addition, Erie Insurance Group's organizational structure is relatively
flat and combines the advantages of centralized common services with field
marketing and claims services. Average agency annual written premium volume
of $1.7 million allows us to keep agency training, marketing and support
costs low. The Property and Casualty Group's five-year statutory average
loss adjustment and underwriting expense ratio for the period from 1997 to
2001 is 37.2%, which compares favorably to A.M. Best's property and
casualty industry composite average of 40.3%. The loss adjustment expense
ratio is the ratio of loss adjustment expenses (the expenses incurred in
settling a claim) incurred, including estimates thereof for claims incurred
but not reported, to net premiums earned, and an underwriting expense ratio
is the ratio of underwriting expenses incurred to net premiums earned. The
Property and Casualty Group's underwriting expense ratio includes the
management fee paid to us of 25% of direct premiums written, which was
reduced to 24% for 2003. The actual cost of management operations is less
than the management fee, which results in a profit for our shareholders. If
the actual cost of management operations were used to compute the
underwriting expense ratio, consistent with industry-reported results, the
loss adjustment and underwriting expense ratio would be 30.7%, which
compares even more favorably to industry averages. In a 2001 benchmarking
study completed by Ward Group, productivity of the Company and the Property
and Casualty Group, as measured by the ratio of full time equivalent
employees to gross premiums written (total insurance premiums written
during a given period), is over 40% better than the core benchmark group.
. UNIQUE CORPORATE STRUCTURE. The Erie Insurance Group's operating
structure allows for:
-- A LONG-TERM MANAGEMENT APPROACH TO BUSINESS. Erie Insurance Group
aims to nurture its relationships with policyholders, agents and
employees to create long-term value. Each of our principal
executive officers has been with Erie Insurance Group for over 20
years and is committed to this long-term view of the business.
-63-
-- LOWER EARNINGS VOLATILITY. Since the bulk of the insurance
risk of the Property and Casualty Group remains with the
Exchange, we do not experience the same earnings
volatility as competing property and casualty insurance
carriers.
-- A LONG-TERM INVESTMENT HORIZON. Since most of the capital
and reserves necessary to support the Property and
Casualty Group's insurance underwriting business are held
by the Exchange, which is not a publicly-owned entity, a
long-term total return strategy is used in investing the
Exchange's assets. Though recent equity market results
have had a significant negative effect on the value of the
Exchange's investment portfolio, the Exchange's investment
strategy of investing in equity securities has created
substantial surplus capacity over an extended period of
time. From January 1, 1995 to September 30, 2002, the
Exchange's equity investments generated a pre-tax compound
annual return of 10.8% compared to a pre-tax compound
annual return of 9.5% for the Standard & Poor's 500 Index.
STRATEGY
The Erie Insurance Group's overall strategy includes providing
attractive property and casualty insurance products at competitive prices,
coupled with high-quality service. The Erie Insurance Group distributes these
products exclusively through independent insurance agents whose insurance and
underwriting expertise, local market knowledge and commitment to service have
been key drivers of Erie Insurance Group's growth. The Erie Insurance Group's
strategy includes:
. Growth by expansion of existing operations, rather than through
acquisition, including by (i) a careful agency selection process in
which the Property and Casualty Group seeks to be the primary property
and casualty underwriter for each agency, (ii) a thoughtful expansion
into favorable states and (iii) increased market penetration in
existing operating territories.
. Quality service to policyholders in claims handling, underwriting
and other service activities.
. Achieving underwriting profits for the Property and Casualty Group
by focusing on standard and preferred risks and by setting and adhering
to consistent underwriting standards.
. A business model designed to provide the advantages of localized
marketing and claims servicing with the economies of scale derived from
centralized management and administration.
-64-
OUR OPERATING SEGMENTS
Our financial results are segmented into management operations,
insurance underwriting operations and investment operations. As attorney-in-fact
for the subscribers to the Exchange, we provide sales, underwriting and policy
issuance services on behalf of the Exchange and take no underwriting risk. This
segment is the largest contributor to our earnings, providing pre-tax income of
$189.1 million for the nine months ended September 30, 2002 and $184.6 million
for 2001. In the property and casualty insurance underwriting operations, we
take underwriting risk through our insurance subsidiaries. This segment had a
pre-tax loss of $16.0 million for the nine months ended September 30, 2002 and
$20.5 million for 2001. Investment operations includes investment income and
realized gains and losses generated by assets of our management and insurance
underwriting operations. This segment had pre-tax income of $33.2 million for
the nine months ended September 30, 2002 and $18.0 million for 2001.
The following table summarizes the revenue we receive and the costs we
incur in connection with these three segments:
-65-
ERIE INDEMNITY COMPANY
OPERATING SEGMENT SUMMARY
(amounts in thousands)
Nine Months Year
Income Ended Ended
Segment Statement Item Description September 30, 2002 December 31, 2001
----------- --------------------- ---------------------------------- ------------------- -----------------
(unaudited)
MANAGEMENT Management fee revenue Direct premium written by the $ 593,895 $ 634,966
OPERATIONS Property and Casualty Group x
management fee rate (25% for 2002
and 24% for 2003)
+
Service agreement revenue Reinsurance premiums assumed from 16,310 27,247
non-affiliates x service agreement
rate (7% for 2002 and 6% for 2003)
and per installment charge for
premiums billed on an installment
basis (currently $3) (421,097) (477,645)
-
Cost of management Cost of sales, including
operations commissions, underwriting, policy
issuance and administration __________ ________
=
Segment income before
income taxes $ 189,108 $ 184,568
---------- ---------
INSURANCE Premiums earned 5.5% of the Property and Casualty $ 119,824 $ 137,648
UNDERWRITING Group earned premiums
OPERATIONS (1) -
Losses and loss 5.5% of the Property and Casualty (98,431) (117,201)
adjustment expense Group losses and loss adjustment
- expense
Policy acquisition and 5.5% of the Property and Casualty (37,343) (40,910)
other underwriting expense Group policy acquisition and other
underwriting expense __________ _________
=
Segment (loss) before
income taxes $ (15,950) $ (20,463)
---------- ---------
INVESTMENT Net investment revenue Investment income and realized $ 24,882 $ 927
OPERATIONS from management gains (losses) generated by assets
operations (2) retained in management operations
+
Net investment revenue Investment income and realized 8,305 17,071
from insurance gains (losses) generated by assets
underwriting of our property and casualty __________ _________
operations (3) subsidiaries
=
Segment income before
income taxes $ 33,187 $ 17,998
---------- ---------
TOTAL Total income before
income taxes $ 206,345 $ 182,103
========== =========
---------------
(1) Includes the effect of the all-lines aggregate excess of loss agreement
currently in place with the Exchange.
(2) Includes realized capital losses of $3.4 million for the nine months ended
September 30, 2002 and $30.7 million for 2001.
(3) Includes realized capital losses of $5.2 million for the nine months ended
September 30, 2002 and $1.1 million for 2001.
-66-
OUR MANAGEMENT OPERATIONS
We recognize management fees due from the Exchange as income when the
premiums are written because at that time we have performed substantially all of
the services we are required to perform, including sales, underwriting and
policy issuance activities, but currently such fees are not paid to us by the
Exchange until it collects the premiums. Management fees received from the
Exchange accounted for 78% of our revenues for the nine months ended September
30, 2002 and 78% of our revenues in 2001. The management fee rate charged to the
Exchange is set by and may be changed at the discretion of our board of
directors. The fee has been at its maximum permitted level of 25% since 1999 and
was 24.25% in 1998 and 24% in 1997. Our board of directors generally sets the
management fee rate each December for the following year. At our December 10,
2002 board of directors meeting, the board voted to reduce the management fee
for 2003 to 24%.
Since 1995, we have received a service agreement fee from the Exchange,
at the rate of 7% of voluntary assumed written premium as compensation for the
management and administration of its voluntary assumed reinsurance business from
non-affiliated insurers. Reinsurance is an arrangement in which an assuming
company indemnifies an insurer or reinsurer (a "ceding company") against all or
a portion of the insurance or reinsurance risks underwritten by the ceding
company under one or more policies. At our December 10, 2002 board of directors
meeting, the board voted to reduce the service agreement rate for 2003 to 6%.
Service agreement revenue is earned when reinsurance premiums are earned because
the services we are required to perform are completed over the terms of the
related treaties. We also collect service charges from policyholders who pay
their premiums in installments on policies written by the Property and Casualty
Group. The service agreement rate and service charge amount are periodically
evaluated and are subject to change.
ERIE INDEMNITY COMPANY
MANAGEMENT OPERATIONS FINANCIAL RESULTS
Nine Months Ended
September 30 Year Ended December 31,
--------------------- ----------------------------------------------------------
(amounts in thousands, except percentages) 2002 2001 2001 2000 1999 1998 1997
--------- ---------- ---------- ---------- ---------- ---------- ----------
(unaudited)
Direct premium written by Property and
Casualty Group $2,375,579 $1,923,219 $2,539,863 $2,206,583 $2,053,501 $2,017,103 $1,948,343
MANAGEMENT FEE RATE 25.00% 25.00% 25.00% 25.00% 25.00% 24.25% 24.00%
Management fee revenue $ 593,895 $ 480,805 $ 634,966 $ 551,646 $ 513,375 $ 489,147 $ 467,603
Service agreement revenue 16,310 20,339 27,247 22,662 15,441 13,879 7,026
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total revenue from management operations $ 610,205 $ 501,144 $ 662,213 $ 574,308 $ 528,816 $ 503,026 $ 474,629
Cost of management operations 421,097 349,796 477,645 415,562 380,298 357,783 340,428
Net investment revenue from management
operations (1) 24,882 20,474 927 51,721 41,966 28,883 25,179
Income before income taxes ---------- ---------- ---------- ---------- ---------- ---------- ----------
$ 213,990 $ 171,822 $ 185,495 $ 210,467 $ 190,484 $ 174,126 $ 159,380
========== ========== ========== ========== ========== ========== ==========
-------------
(1) Includes realized (losses) gains of: $ (3,467) $ (4,099) $ (30,735) $ 16,469 $ 14,408 $ 6,363 $ 5,551
-67-
The direct written premiums of the Property and Casualty Group have a
direct impact on the Company's management fee revenue and, consequently, the
Company's management operations. The following table sets forth our management
fee revenue by state and by line of business for the year ended December 31,
2001:
ERIE INDEMNITY COMPANY
MANAGEMENT FEE REVENUE BY STATE AND LINE OF BUSINESS FOR 2001
All
(amounts in thousands) other
Private Commercial Commercial Workers' Lines of
State Passenger Auto Homeowners Multi Peril Compensation Business Total
---------------------- --------- ---------- ---------- ----------- ------------ -------- ---------
Pennsylvania $193,280 $ 23,004 $ 50,042 $27,319 $ 26,801 $ 7,806 $328,252
Maryland 40,521 6,869 12,689 6,383 6,311 2,671 75,444
Ohio 29,094 4,312 9,619 7,123 0 1,697 51,845
Virginia 22,413 5,404 7,695 6,254 6,993 1,958 50,717
North Carolina 11,948 4,718 6,171 5,255 3,993 1,384 33,469
West Virginia 18,070 2,644 4,115 2,757 0 838 28,424
Indiana 13,309 1,721 5,742 2,846 2,041 845 26,504
New York 10,319 1,887 2,654 3,010 1,645 494 20,009
Tennessee 3,712 1,378 1,450 1,830 1,278 386 10,034
Illinois 3,075 645 1,048 1,667 1,010 223 7,668
District of Columbia 548 108 247 510 595 117 2,125
Wisconsin 191 52 68 63 78 23 475
-------- -------- -------- ------- ---------- -------- --------
Total $346,480 $ 52,742 $101,540 $65,017 $ 50,745 $ 18,442 $634,966
======== ======== ======== ======= ========== ======== ========
The following table sets forth our management fee revenue by line of
business and percentage growth for each of the five years ended December 31,
2001:
ERIE INDEMNITY COMPANY
MANAGEMENT FEE REVENUE BY LINE OF BUSINESS 2001 - 1997
(amounts in thousands, except percentages)
All other
Private Commercial Commercial Workers' Lines of Percent
Year Passenger Auto Homeowners Multi Peril Compensation Business Total Increase
---- --------- ---------- ---------- ----------- ------------ -------- --------- --------
2001 $346,480 $52,742 $101,540 $65,017 $50,745 $18,442 $634,966 15.1%
2000 313,703 43,318 88,743 50,401 39,914 15,567 551,646 7.5
1999 305,346 37,663 80,377 42,646 33,363 13,980 513,375 5.0
1998 304,026 33,555 69,845 36,096 31,409 14,216 489,147 4.6
1997 295,424 32,796 60,443 31,384 32,906 14,649 467,602 5.6
-68-
The following table sets forth the Property and Casualty Group's
percentage of management fees by state for each of the five years ended December
31, 2001.
ERIE INDEMNITY COMPANY
PERCENTAGE OF MANAGEMENT FEES BY STATE 2001-1997
State 2001 2000 1999 1998 1997
------------------------------- -------- -------- -------- -------- --------
Pennsylvania 51.7% 53.9% 55.6% 58.1% 59.3%
Maryland 11.9 11.9 11.9 11.7 12.0
Ohio 8.2 8.0 7.9 7.6 7.4
Virginia 8.0 8.0 8.1 8.1 8.3
North Carolina 5.3 4.6 4.1 3.3 2.7
West Virginia 4.4 4.6 4.6 4.6 4.6
Indiana 4.2 4.0 3.9 3.8 3.7
New York 3.1 2.7 2.2 1.4 0.8
Tennessee 1.6 1.4 1.3 1.2 1.0
Illinois 1.2 0.6 0.2 0.0 0.0
District of Columbia 0.3 0.3 0.2 0.2 0.2
Wisconsin 0.1 0.0 0.0 0.0 0.0
------ ------ ------ ------ ------
Total direct premiums written 100.0% 100.0% 100.0% 100.0% 100.0%
====== ====== ====== ====== ======
The cost of management operations includes all independent agent
commission expenses as well as personnel and benefit costs, underwriting and
policy issuance costs and other administrative expenses of the Company.
The largest component of the cost of management operations is the cost
of our independent agent commissions and other incentives to our independent
agents. Included in commission costs is the cost of scheduled commissions earned
on premiums written, agency contingency awards based on the three-year average
underwriting profitability of the business written with us, accelerated
commissions earned by start-up agencies and promotional incentives to agents.
Personnel and benefit costs related to the sales, underwriting and
issuance of policies and the administrative staff of the Company are the second
largest cost of management operations. Expenses other than personnel and benefit
costs related to the underwriting and issuance of new business vary with the
number of new policies. Underwriting reports, printing, postage and other cost
of materials necessary for the underwriting and issuance of policies are
included in the cost of management operations.
Additional costs are incurred for general administrative expenses of
the Company including the cost of office facilities, travel, telephone and
communication costs, the cost of data processing and information technology and
other miscellaneous expenses. Beginning in 2001, Erie Insurance Group initiated
the eCommerce program and committed to new information technology infrastructure
expenditures as part of the program. Our share of these eCommerce infrastructure
expenditures are included in the cost of management
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operations. Non-infrastructure costs of the eCommerce program which are subject
to the technology cost-sharing agreement are included in the insurance
underwriting segment.
We also earn investment income in this business segment on the cash
flow from management operations, which is invested in our investment portfolio.
We also report our share of earnings from our 21.6% investment in Erie Family
Life Insurance Company as part of the investment income of our management
operations segment.
INSURANCE UNDERWRITING OPERATIONS
Our insurance underwriting operations consist of our three property and
casualty insurance subsidiaries that participate in an intercompany pooling
arrangement with the Exchange. The pool also includes reinsurance assumed by the
Exchange from non-affiliated entities. The table below presents a financial
summary of results of the property and casualty insurance operations of the
Property and Casualty Group.
ERIE INDEMNITY COMPANY
INSURANCE UNDERWRITING OPERATIONS FINANCIAL RESULTS
Nine Months Ended
September 30, Year Ended December 31,
------------------- -------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- -------- -------- --------
(unaudited)
Premiums earned $119,824 $100,857 $137,648 $123,708 $117,224 $112,939 $107,350
Net investment revenue from insurance
underwriting operations (1) 8,305 14,934 17,071 18,381 16,765 16,887 13,569
-------- -------- -------- -------- -------- -------- --------
Total revenues $128,129 $115,791 $154,719 $142,089 $133,989 $129,826 $120,919
Losses and loss adjustment expenses 98,431 88,074 117,201 99,564 87,719 79,881 79,970
Policy acquisition and underwriting expenses 37,343 28,696 40,910 34,546 33,044 32,491 29,639
-------- -------- -------- -------- -------- -------- --------
Total losses and expenses $135,774 $116,770 $158,111 $134,110 $120,763 $112,372 $109,609
-------- -------- -------- -------- -------- -------- --------
(Loss) income before income taxes $ (7,645) $ (979) $ (3,392) $ 7,979 $ 13,226 $ 17,454 $ 11,310
======== ======== ========= ======== ======== ======== ========
-----------
(1) Includes realized (losses) gains of: $ (5,160) $ 1,374 $ (1,144) $ 499 $ 337 $ 800 $ 264
Under the pooling arrangement, all property and casualty insurance
business of the five property and casualty insurance companies that comprise the
Property and Casualty Group is pooled within the Exchange as the pooling entity.
Our insurance subsidiaries, Erie Insurance Company and Erie Insurance Company of
New York, share in the underwriting results of the pool through retrocession.
Erie Insurance Company has a 5.0% participation, Erie Insurance Company of New
York has a 0.5% participation and the Exchange has a 94.5% participation in the
pooled underwriting results. These participation percentages are determined by
our board of directors. Pooling participation percentages have not changed since
1995.
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PROPERTY AND CASUALTY GROUP
POOLING ARRANGEMENT
CEDED FROM RETROCEDED TO
-----------------------------
| | -----------------
| Erie Insurance Exchange |--------- | |
| | | | | --------------------
----------------------------- | | | | |
| | | 94.5% | Erie Insurance |
----------------------------- | | |--------------| Exchange |
| | | | | --------------------
| Flagship City |--------- | |
| Insurance Company | | | |
| | | | |
----------------------------- | | |
| | | --------------------
----------------------------- | | | | |
| | | 100% | Property and | 5.0% | Erie Insurance |
| Erie Insurance Company |------------------| Casualty |--------------| Company |
| | | | Group Pool | | |
----------------------------- | | | | |
| | | --------------------
----------------------------- | | |
| | | | |
| Erie Insurance Company | | | |
| of New York |--------| | | --------------------
| | | | | | |
----------------------------- | | | | |
| | | 0.5% | Erie Insurance |
----------------------------- | | |--------------| Company |
| | | | | | of New York |
| Erie Insurance Property | | | | | |
| & Casualty Company |--------| | | --------------------
| | | |
----------------------------- -----------------
Erie Insurance Company and Erie Insurance Company of New York have an
all-lines aggregate excess of loss reinsurance agreement with the Exchange that
limits the amount of their annual net losses. Excess of loss reinsurance is
reinsurance that indemnifies the reinsured against all or a specified portion of
losses on underlying insurance policies in excess of a specified amount. Under
the reinsurance agreement, once Erie Insurance Company and Erie Insurance
Company of New York sustain ultimate net losses and allocated loss expenses in
an accident year that exceed an amount equal to 72.5% of Erie Insurance
Company's and Erie Insurance Company of New York's net premiums earned, the
Exchange will be liable for 95% of the amount of such excess up to, but not
exceeding, an amount equal to 95% of 15% of Erie Insurance Company's and Erie
Insurance Company of New York's net premium earned. Erie Insurance Company and
Erie Insurance Company of New York retain the remaining 5% of such layer as well
as ultimate net losses and allocated loss expenses in excess of 87.5% of Erie
Insurance Company's and Erie Insurance Company of New York's net premiums
earned.
The Property and Casualty Group sells personal and commercial lines
policies through independent agencies. Commercial lines policies are marketed to
small- and
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medium-sized businesses. Premium revenues from our property and casualty
insurance underwriting operations accounted for approximately 16% of our
revenues in the nine months ended September 30, 2002 and 17% of our revenues in
2001.
The Property and Casualty Group has exposure to reinsurance that the
Exchange assumes from unaffiliated insurers, placed principally through
unaffiliated brokers. The Exchange engages in this assumed reinsurance business,
which represented net premiums written of $131.3 million for the nine months
ended September 30, 2002 and $158.1 million for the year ended December 31,
2001, in each case net of retrocessions, in order to geographically diversify
the overall insurance risk to the Property and Casualty Group. The assumed
business, which is included in the pooling arrangement, consists predominately
of property lines excess of loss treaties. In 2002, management tightened
underwriting standards, limited coverages, excluded terrorism coverage and,
consistent with market conditions, increased rates for this business. Treaties
are generally renewed annually and management evaluates each treaty for
profitability and continuing desirability of the customer relationship during
the renewal process.
We also earn investment income in this business segment on the cash
flow from property and casualty insurance underwriting operations, which is
invested in our investment portfolio.
The following table sets forth certain data for the Property and
Casualty Group compared to industry composites for the five years ended December
31, 2001.
PROPERTY AND CASUALTY GROUP
FIVE-YEAR COMPARISON VS. INDUSTRY COMPOSITE
Net Premiums Operating Expense Policyholder
Written Growth Loss Ratio Ratio (2) Dividend Ratio Combined Ratio
------------------- ------------ ----------------- ---------------- ------------------
Erie Industry (1) Erie Industry (1) Erie Industry (1) Erie Industry (1) Erie Industry (1)
---- ------------ ---- ------------ ---- ------------ ---- -------- ---- --------
2001 14.8% 9.1% 78.1% 75.4% 39.7% 39.7% 0.6% 0.8% 118.4% 115.9%
2000 8.3 5.7 69.8 68.5 36.8 40.4 0.8 1.5 107.4 110.3
1999 2.6 2.0 65.5 65.4 36.1 41.1 0.4 1.3 102.0 107.8
1998 4.4 1.6 59.2 63.4 38.2 40.7 0.6 1.9 98.0 106.0
1997 5.6 3.0 65.1 60.6 34.6 39.4 0.9 1.8 100.6 101.9
5-year 7.2% 4.2% 68.0% 66.9% 37.2% 40.3% 0.7% 1.4% 105.9% 108.6%
compound
annual
growth
rate or
average
---------------
(1) A.M. Best's Aggregates and Averages, 2002 Edition.
(2) Includes loss adjustment and underwriting expenses.
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DISTRIBUTION
The Property and Casualty Group's insurance products are marketed
primarily in the Midwest, Mid-Atlantic and Southeast regions through over 1,700
insurance agencies that are comprised of approximately 8,000 agents. The
Property and Casualty Group is licensed to do business in 16 states and in the
District of Columbia and, at September 30, 2002, operated in 11 states
(Illinois, Indiana, Maryland, New York, North Carolina, Ohio, Pennsylvania,
Tennessee, Virginia, West Virginia and Wisconsin) and the District of Columbia.
The Property and Casualty Group maintains branch offices throughout these
states. The Property and Casualty Group expects to begin operating in Minnesota
in the third quarter of 2004.
PROPERTY AND CASUALTY GROUP
STATES OF OPERATION
Year Began
State Writing % of Total
----- ------- ----------
Pennsylvania 1925 52%
Maryland 1953 12
Ohio 1968 8 [GRAPHIC OMITTED - Map of
eastern half of United
Virginia 1955 8 States highlighting active
states of operation, the
North Carolina 1991 5 home office, branch offices
and field offices.]
West Virginia 1963 4
Indiana 1978 4
New York 1995 3
Tennessee 1987 2
Illinois 1999 1
District of Columbia 1953 Less than 1%
Wisconsin 2001 Less than 1%
In 2001, we continued our ongoing expansion of the independent agency
force by appointing 247 agencies. Since 1997, we have increased the overall
number of agencies representing the Property and Casualty Group by 60%.
Partially due to growth in the number of agents, the Property and Casualty Group
has achieved rapid growth in premiums. As of September 30, 2002, the Property
and Casualty Group had over 3.4 million insurance policies in force, an 11.9%
increase from September 30, 2001. Personal lines policies in force grew by 11.8%
during the twelve months ended September 30, 2002, while commercial lines
increased 13.0% over the same period.
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PROPERTY AND CASUALTY GROUP
12-MONTH ROLLING AVERAGE POLICY GROWTH RATES BY LINE OF BUSINESS
Twelve Months Ended
--------------------------------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30, June 30, March 31,
2002 2002 2002 2001 2001 2001 2001
-------- -------- --------- -------- -------- -------- ---------
PERSONAL LINES:
Private passenger auto 10.4% 9.4% 8.3% 7.1% 6.3% 5.9% 5.3%
Homeowners 13.1 11.4 10.1 9.0 8.4 8.1 7.7
All other personal lines 14.4 13.4 12.2 11.5 11.4 10.9 10.7
Total personal lines 11.8 10.5 9.3 8.2 7.5 7.1 6.6
COMMERCIAL LINES:
Commercial auto 11.8 11.6 10.7 9.7 8.8 7.9 7.0
Commercial multi-peril 14.4 13.9 12.5 11.6 11.1 10.8 10.6
Workers' compensation 12.5 11.9 10.8 10.3 9.6 9.5 8.7
All other commercial
lines 11.5 11.7 10.7 9.9 9.0 8.9 8.0
Total commercial lines 13.0 12.6 11.5 10.7 9.9 9.5 8.9
Total 11.9 10.8 9.6 8.5 7.8 7.4 6.9
In addition, the Property and Casualty Group experiences above average
retention rates. Based upon an annual best practices benchmark study conducted
by the Ward Group, an independent financial services consulting company, the
Property and Casualty Group's policy retention rate of 90.9% is among the
highest of all the property and casualty companies benchmarked by the Ward
Group.
PROPERTY AND CASUALTY GROUP
12-MONTH ROLLING AVERAGE POLICY RETENTION RATES BY LINE OF BUSINESS
Twelve Months Ended
--------------------------------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30, June 30, March 31,
2002 2002 2002 2001 2001 2001 2001
-------- -------- --------- -------- -------- -------- ---------
Private passenger
automobile 92.50% 92.35% 92.26% 92.24% 92.22% 92.25% 92.24%
Commercial automobile 90.79 91.12 90.86 90.53 90.16 90.35 90.29
Homeowners 90.54 90.35 90.24 90.24 90.38 90.63 90.66
Commercial multi-peril 88.69 88.95 88.77 88.03 88.18 88.36 88.58
Workers' compensation 89.51 89.46 89.34 88.43 88.53 88.76 89.06
All other lines 88.15 88.30 88.11 88.15 88.16 88.18 88.03
Total 91.12 91.02 90.91 90.85 90.89 91.01 91.03
Careful selection of independent agencies to represent the Property and
Casualty Group is a key strategy of our Company. The Property and Casualty Group
strives to be the primary writing company with the agents. In order to enhance
agency relationships and the likelihood of receiving the most desirable
underwriting opportunities, we have ongoing, direct communications with the
agency force. We believe the independent agency force has been loyal and that
the Property and Casualty Group is the preferred carrier for most of these
independent agencies. Average agency annual written premium volume is $1.7
million for
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all of these agencies. Agents have access to a number of Company-sponsored
venues designed to promote sharing of ideas, concerns and suggestions with the
senior management of Erie Insurance Group with the goal of improving
communications and service. These efforts have resulted in outstanding agency
penetration and the ability to sustain long-term agency partnerships.
Agents receive commissions for premiums written, as well as promotional
incentives and contingency awards. Agent contingency awards are based upon a
three-year average of the underwriting profitability of the direct business
written and serviced within the Erie Insurance Group by the independent agent.
Commission costs rose 14.3% to $323.1 million in 2001 from $282.7 million in
2000 and 7.3% in 2000 from $263.1 million in 1999. Commission costs grew at a
slower rate relative to the growth in direct premiums written in 2001 as a
result of lower accruals for agent contingency awards compared to 2000. The
provision for agent contingency awards totaled $15.7 million, $18.3 million and
$19.9 million in 2001, 2000 and 1999, respectively. Commission costs, excluding
agent contingency awards, increased 16.2% in 2001, in line with the increase in
direct written premiums.
PRODUCTS
The Property and Casualty Group underwrites a broad range of insurance for
risks. In 2001, personal lines comprised 72.6% of direct and affiliated assumed
premium revenue while commercial lines constituted the remaining 27.4%. The core
products in the personal lines are private passenger automobile (75.2%) and
homeowners (22.0%) while the core commercial lines consist principally of
multi-peril (37.0%), automobile (30.3%) and workers' compensation (29.2%).
The insurance policies of the Property and Casualty Group contain many
features not offered as standard coverages by many of our competitors. These
"extras" are a major selling feature for agents. Some examples of these features
include:
. full replacement cost coverage with no loss cap on the percentage of
insured value in the Property and Casualty Group's full-cost replacement
homeowners policy;
. waiver of collision deductible in an automobile claim involving two
insureds of the Property and Casualty Group;
. coverage for transportation expense that begins immediately after a
collision;
. coverage for locksmith services for keys locked in cars;
. coverage for cost of replacing a deployed airbag;
. coverage for losses due to theft, loss or other unauthorized use of a
credit card; and
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. coverage for theft, misplacement or loss of jewelry.
The growth rate of policies in force and policy retention trends impact the
Company's management and property and casualty operating segments.
PROPERTY AND CASUALTY GROUP
POLICIES IN FORCE AND 12-MONTH ROLLING AVERAGE POLICY RETENTION RATE BY LINE OF
BUSINESS
At September 30, At December 31,
--------------------------------- ---------------------------------------------
(amounts in thousands, except percentages) 2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- -------- -------- --------
POLICIES IN FORCE:
Personal lines 2,985 2,671 2,724 2,517 2,368 2,255 2,174
Commercial lines 426 377 386 349 322 304 291
Total policies in force 3,411 3,048 3,110 2,866 2,690 2,559 2,465
POLICY RETENTION PERCENTAGES:
Personal policy retention percentages 91.5% 91.4% 91.3% 91.5% 91.0% 90.4% 90.9%
Commercial policy retention percentages 88.1 87.5 87.7 87.3 86.5 85.6 85.6
Total policy retention percentages 91.1 90.9 90.9 91.0 90.5 89.4 89.7
UNDERWRITING
Our Commercial Underwriting Division (Commercial Property and Commercial
Automobile Underwriting and Risk Management) and our Personal Lines Underwriting
Division (Personal Property and Personal Automobile Underwriting) perform
underwriting and processing functions, provide advice, instruction and guidance
to the agency force regarding underwriting philosophy and assist other divisions
in developing quality products at competitive prices to promote growth and
profitability.
We strive toward underwriting profitability by: (1) assessing and selecting
quality standard and preferred risks; (2) by adhering to underwriting and
re-underwriting guidelines; (3) by providing loss control services with "in
house" loss control specialists and (4) by offering risk management services
such as hazard identification loss control program development, risk management
training programs and the establishment of safety committees. The Company
evaluates and selects those policies believed to be good quality risks. The
Company "reunderwrites" by reviewing existing policies and accounts to determine
which risks continue to meet underwriting qualifications and taking appropriate
action regarding these policies or accounts. Loss control services are offered
to policyholders via the Company's dedicated team of loss control personnel.
Risk management services offered to policyholders include hazard identification
and analysis, loss control program development, and establishment of safety
committees and risk management training programs.
To assure maintenance of acceptable underwriting results, we conduct an
annual review of agencies to identify those that do not meet our underwriting
performance
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expectations. Agencies failing to meet our profitability criteria are subject to
a detailed review. This review focuses on the factors affecting the property and
casualty underwriting results for the agency. The review process includes an
evaluation of the underwriting and reunderwriting practices of the agency,
completeness and accuracy of applications submitted, staffing levels and
adequacy of training of agency staff and adherence by the agency to the business
practice, underwriting and service standards of Erie Insurance Group. The review
team and the agency jointly develop an action plan to improve agency processes
and procedures designed to improve the underwriting profitability of the agency.
We then monitor the agency's progress and underwriting performance and may take
additional measures, including reducing commissions, and/or terminating the
agency if underwriting profitability continues to be unacceptable.
CLAIMS
The Property and Casualty Group realizes that an insurance policy is also a
promise of service. The Property and Casualty Group uses its own trained
adjusters wherever possible, to assure that claims are settled quickly and
fairly by personnel who know the coverages in the Property and Casualty Group's
policies and understand the Erie Insurance Group's service philosophy.
The Property and Casualty Group claims services include:
. Prompt response standards, generally the same day, for contact with
an insured after a loss is reported;
. A toll-free number for claims call center where Erie Insurance Group
trained personnel handle reporting of losses after normal business hours
and on weekends and holidays;
. An automobile glass repair and replacement program for automobile
claims designed to simplify and speed the claims process and permit the
insured to decide who should do the repair or replacement; and
. A direct repair program for automobile claims that allows insureds to
select their own body shop and use one of numerous participating body shops
that bill the Property and Casualty Group directly for the repair costs
less any deductible.
These and other claims services the Property and Casualty Group offers have
resulted in a reputation for fast, fair and courteous claim services and the
service awards received from independent consumer organizations.
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TECHNOLOGY
In 2001, Erie Insurance Group began a comprehensive program of eCommerce
initiatives in support of the Erie Insurance Group's agency force and back
office policy underwriting, issuance and administration. The eCommerce program
is intended to improve service and efficiency, as well as result in increased
sales. The first major component of the eCommerce program (network and desktop
hardware deployment) was completed during the second quarter of 2002. Also, the
Erie Insurance Group completed the release of the new web interface to a limited
number of agents and employees in July 2002. In August 2002, the eCommerce
program took advantage of a significant business opportunity to work with a
well-known provider of information technology services and solutions to develop
the Erie Insurance Group's eCommerce system called ERIEConnection(SM). The Erie
Insurance Group is now working with that service provider, who is the chief
integrator and manager of the eCommerce program and provides software
applications that meet the Company's needs. Management of Erie Insurance Group
believes this approach will allow the eCommerce program to meet its established
budget goals. The Company estimates its share of eCommerce costs in 2003 will
amount to approximately $.09 to $.12 per share after income taxes.
FINANCIAL RATINGS
Insurance companies are rated by rating agencies to provide insurance
consumers and investors with meaningful information on the rated companies.
Higher ratings generally indicate financial stability and a stronger ability to
pay claims. The ratings are generally based upon factors relevant to
policyholders and are not directed toward return to investors.
Each member of the Property and Casualty Group currently has an A++
("superior") rating from A.M. Best. A++ is the highest rating that A.M. Best
gives to insurance companies, and represents a superior ability to meet ongoing
obligations to policyholders. Each member of the Property and Casualty Group
also has a rating of AApi ("very strong") from Standard & Poor's. A rating of AA
means that the insurer has very strong financial security characteristics,
differing only slightly from those with the highest rating, AAA. The subscript
"pi" means the rating was based on publicly available information of the
Exchange. The Exchange's rating from Weiss Ratings, Inc. was downgraded from A
("excellent," the highest Weiss rating) to B- (lower end of the "good" rating)
in July 2002, while Erie Insurance Company's rating was downgraded from B+
(higher end of "good" rating) to B ("good"). At that time, our other insurance
subsidiaries maintained their B ratings from Weiss Ratings, Inc. A Weiss rating
of B means that the rated company has the financial strength to deal with a
variety of adverse economic conditions, but should be reassessed in the event of
a severe economic downturn.
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INVESTMENTS
Our investment strategy takes a long-term perspective emphasizing
investment quality, diversification and investment returns providing liquidity
for our short and long-term commitments. Investments are managed on a total
return approach that focuses on both current income and capital appreciation. At
September 30, 2002, our investment portfolio increased to $923 million,
representing 42.0% of total assets. For the nine months ended September 30,
2002, net investment income was $40.7 million. Net investment income totaled
$49.9 million in 2001, compared to $48.4 million in 2000, and $43.3 million in
1999.
ERIE INDEMNITY COMPANY
TOTAL INVESTMENTS AT MARKET VALUE
At September 30, At December 31,
------------------- ----------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- -------- -------- --------
(unaudited)
INVESTMENTS:
Fixed maturities $646,172 $545,700 $559,873 $531,546 $485,522 $441,353 $349,973
Equity securities
Preferred stock 146,955 132,682 130,007 109,081 99,584 112,574 84,963
Common stock 34,964 76,984 63,791 95,365 115,799 90,230 80,170
Limited partnerships 88,952 77,546 81,596 68,242 39,116 17,494 7,932
Real estate mortgage loans 5,601 5,731 5,700 6,581 8,230 8,287 8,392
-------- -------- -------- -------- -------- -------- --------
Total Investments $922,644 $838,643 $840,967 $810,815 $748,251 $669,938 $531,430
======== ======== ======== ======== ======== ======== ========
----------------------
ERIE INDEMNITY COMPANY
TOTAL INVESTMENTS AT COST
At September 30, At December 31,
------------------- ----------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- -------- -------- --------
(unaudited)
INVESTMENTS:
Fixed maturities $620,274 $524,929 $543,423 $524,172 $489,394 $421,102 $333,136
Equity securities
Preferred stock 143,732 131,875 127,725 110,555 106,625 109,355 79,361
Common stock 22,040 73,793 32,002 74,413 64,870 60,622 64,762
Limited partnerships 93,197 76,725 79,668 60,661 37,402 17,494 7,932
Real estate mortgage loans 5,601 5,731 5,700 6,581 8,230 8,287 8,392
-------- -------- -------- -------- -------- -------- --------
Total Investments $884,844 $813,053 $788,518 $776,382 $706,521 $616,860 $493,583
======== ======== ======== ======== ======== ======== ========
----------------------
Management considers all fixed maturities and marketable equity securities
available-for-sale. These securities are stated at fair value, with the
unrealized gains and losses, net of deferred tax, reported as a separate
component of accumulated other comprehensive income in shareholders' equity.
When a decline in the value of investments is considered to be other than
temporary by management, the investments are written down in the Consolidated
Statements of Operations to their realizable value.
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For common equity securities (including equity limited partnerships) where
the decline in market value is more than 20% below cost for a period exceeding
six months, there is a presumption of impairment. Management considers market
conditions, industry characteristics and the fundamental operating results of
the issuer before deciding to sell the investment at a loss or to recognize an
impairment charge to operations. For common equity securities that have declined
more than 20% below cost for a period exceeding twelve months, the position is
either sold or recognized as impaired and a charge to operations is recognized
as realized losses through the Consolidated Statements of Operations. If a
security's market value is at least 80% of cost, there is a presumption that the
security's decline is temporary regardless if the decline in value is material
either individually or in the aggregate unless there are conditions specifically
affecting the underlying issuer or its industry that would lead us to believe
the security's decline is other than temporary.
Prior to the fourth quarter of 2001, the Company's impairment policy for
common equity securities, which was based on existing GAAP guidance, was based
primarily on judgments by management as to whether declines in value were other
than temporary. The policy considered such factors as the underlying financial
condition of the issuer, the short- and long-range prospects of the issuer and
other risk factors such as corporate actions and events affecting the issuer. If
the Company had used the criteria established for common equity securities in
the amended impairment policy it adopted in the fourth quarter of 2001 in
earlier periods, approximately $1.8 million (pre-tax) in realized capital losses
recognized in the fourth quarter of 2001 would have been recognized over various
earlier periods.
For fixed maturity investments, our management analyzes all positions
individually whose market value have declined below cost for a period exceeding
six months. Management considers market conditions, industry characteristics and
the fundamental operating results of the issuer to determine if the decline is
due to changes in interest rates, changes relating to a decline in credit
quality, or other issues specifically affecting the investment. Positions that
have incurred market price decline of over 20% for a period greater than six
months where the creditworthiness of the issuer indicates a decline that is
other than temporary are either sold or recognized as impaired and reflected as
a charge to the Company's operations.
If the Company's policy for determining the recognition of impaired
positions were different, the Company's Consolidated Statements of Financial
Position and results of operations could be significantly impacted. Management
believes its investment valuation philosophy and accounting practices result in
appropriate and timely measurement of value and recognition of impairment.
Our investments include a 21.6% common stock interest in Erie Family Life
Insurance Company of $47.3 million at September 30, 2002, which is accounted for
under the equity method of accounting. Dividends paid to us for the nine months
ended September 30, 2002 and 2001 totaled over $1.2 million and $1.1 million,
respectively. Related to this investment,
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we are also due $15 million in principal in the form of a surplus note. The note
bears an annual interest rate of 6.45% and all payments of interest and
principal on the note may be repaid only out of unassigned surplus of Erie
Family Life Insurance Company and are subject to prior approval by the
Pennsylvania Insurance Commissioner. Interest of the surplus note is scheduled
to be paid semi-annually. The note will be payable on demand on or after
December 31, 2005.
FIXED INCOME SECURITIES
At September 30, 2002, the carrying value of fixed income securities
accounted for 70.0% of total invested assets. The Company's investment strategy
achieves a balanced maturity schedule in order to moderate the effect on
investment income in the event of interest rate declines in a year in which a
large amount of securities are scheduled to be redeemed or mature.
ERIE INDEMNITY COMPANY
FIXED MATURITY SECURITIES AT MARKET VALUE
At September 30, At December 31,
--------------------- ----------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- --------- --------- --------- --------- --------- ---------
(unaudited)
FIXED MATURITIES:
U.S. treasuries and government agencies $ 8,926 $ 11,844 $ 11,713 $ 11,612 $ 11,051 $ 13,707 $ 13,200
State and political subdivisions 55,442 40,801 44,121 51,959 53,118 51,600 44,771
Special revenue 101,574 114,393 113,418 114,566 122,096 139,235 123,901
Public utilities 43,356 28,340 26,270 23,564 20,318 13,416 7,331
U.S. industrial and miscellaneous 376,382 303,143 319,308 266,061 227,176 203,695 156,582
Foreign 46,556 28,579 27,476 29,914 20,743 7,047 4,188
-------- --------- --------- --------- --------- --------- ---------
Total bonds $632,236 $ 527,100 $ 542,306 $ 497,676 $ 454,502 $ 428,700 $ 349,973
Redeemable preferred stock 13,936 18,600 17,567 33,870 31,020 12,653 --
-------- --------- --------- --------- --------- --------- ---------
Total fixed maturities $646,172 $ 545,700 $ 559,873 $ 531,546 $ 485,522 $ 441,353 $ 349,973
======== ========= ========= ========= ========= ========= =========
ERIE INDEMNITY COMPANY
FIXED MATURITY SECURITIES AT AMORTIZED COST
At September 30, At December 31,
--------------------- ----------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- --------- --------- --------- --------- --------- ---------
(unaudited)
FIXED MATURITIES:
U.S. treasuries and government agencies $ 8,281 $ 11,211 $ 11,211 $ 11,216 $ 11,029 $ 13,018 $ 12,771
State and political subdivisions 52,071 38,511 42,392 50,337 52,064 48,307 41,931
Special revenue 96,068 110,046 110,267 110,855 120,170 132,025 116,052
Public utilities 42,820 27,286 25,150 23,221 20,909 13,116 7,171
U.S. industrial and miscellaneous 360,806 292,729 311,757 267,231 232,458 195,296 150,666
Foreign 47,177 27,584 26,634 30,082 21,593 7,149 4,545
-------- --------- --------- --------- --------- --------- ---------
Total bonds $607,223 $ 507,367 $ 527,411 $ 492,942 $ 458,223 $ 408,911 $ 333,136
Redeemable preferred stock 13,051 17,562 16,012 31,230 31,171 12,191 --
-------- --------- --------- --------- --------- --------- ---------
Total fixed maturities $620,274 $ 524,929 $ 543,423 $ 524,172 $ 489,394 $ 421,102 $ 333,136
======== ========= ========= ========= ========= ========= =========
At September 30, 2002, the Company's fixed maturity investments consist of
97.6% of high-quality, marketable bonds and redeemable preferred stock, all of
which were rated at investment-grade levels (above Ba/BB). Included in this
investment-grade category are $244.3 million or 37.8% of the highest quality
bonds and redeemable preferred stock rated Aaa/AAA or Aa/AA or bonds issued by
the United States government. Generally, the fixed maturities in the Company's
portfolio are rated by external agencies. Management classifies all fixed
maturities as available-for-sale securities, allowing the Company to meet its
liquidity needs and provide greater flexibility for its investment managers to
appropriately respond to changes in market conditions or strategic direction.
ERIE INDEMNITY COMPANY
FIXED MATURITY SECURITIES BY CREDIT QUALITY
(amounts in thousands, except percentages) At September 30, 2002
------------------------------
Moody's Equivalent Estimated Fair
Description Amortized Cost Market Value % of Carry
---------------------------- -------------- ------------ ----------
Aaa/Aa/A $ 381,509 $ 408,320 63.2%
Baa 223,267 222,525 34.4
Ba/BB 3,929 3,837 0.6
B 5,750 6,775 1.1
In or near default 5,820 4,715 0.7
--------- --------- -----
Total $ 620,275 $ 646,172 100.0%
========= ========= =====
ERIE INDEMNITY COMPANY
FIXED MATURITY SECURITIES TERM TO MATURITY
(amounts in thousands, except percentages) At September 30, 2002
------------------------------
Estimated Fair
Term to Maturity Amortized Cost Market Value % of Carry
--------------------------------- -------------- ------------ ----------
Due in less than one year $ 30,328 $ 30,608 4.7%
Due in 1-5 years 174,835 182,964 28.3
Due in 5-10 years 241,915 251,941 39.0
Due after 10 years 173,197 180,659 28.0
--------- --------- -----
Total $ 620,275 $ 646,172 100.0%
========= ========= =====
Equity Securities
Equity securities (common stock and non-redeemable preferred stock) are
carried on the Consolidated Statements of Financial Position at market value.
The Company's non-redeemable preferred stock portfolio provides a source of
highly predictable current income that is competitive with investment-grade
bonds. Non-redeemable preferred stocks generally provide for fixed rates of
return that, while not guaranteed, resemble fixed income securities and are paid
before common stock dividends. Common stock provides capital appreciation
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potential within the portfolio. Common stock investments inherently provide no
assurance of producing income because dividends are not guaranteed.
ERIE INDEMNITY COMPANY
EQUITY SECURITIES AT MARKET VALUE
At September 30, At December 31,
------------------- ----------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- -------- -------- --------
(unaudited)
COMMON STOCK:
U.S. industrials and miscellaneous $ 32,168 $ 68,846 $ 59,709 $ 86,605 $103,132 $ 83,563 $ 71,191
U.S. banks, trusts and insurance 2,146 4,445 4,082 3,798 7,156 3,488 6,517
Foreign 650 3,693 -- 4,962 5,511 3,179 2,462
NONREDEEMABLE PREFERRED STOCK:
U.S. industrial and miscellaneous 90,032 90,792 91,647 61,134 56,662 60,463 27,914
U.S. banks, trusts and insurance 23,181 16,396 15,565 22,125 36,694 45,338 50,248
Foreign 21,829 25,494 20,416 25,822 6,228 6,773 4,155
Public utilities 11,913 -- 2,379 -- -- -- 2,646
-------- -------- -------- -------- -------- -------- --------
Total $181,919 $209,666 $193,798 $204,446 $215,383 $202,804 $165,133
======== ======== ======== ======== ======== ======== ========
ERIE INDEMNITY COMPANY
EQUITY SECURITIES AT COST
At September 30, At December 31,
------------------- ----------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- -------- -------- --------
(unaudited)
COMMON STOCK:
U.S. industrials and miscellaneous $ 19,777 $ 65,206 $ 28,718 $ 63,662 $ 56,035 $ 53,914 $ 58,415
U.S. banks, trusts and insurance 1,846 3,651 3,284 3,651 3,887 3,522 3,138
Foreign 417 4,936 -- 7,100 4,948 3,186 3,209
NONREDEEMABLE PREFERRED STOCK:
U.S. industrial and miscellaneous 89,166 91,593 91,185 62,266 61,109 59,858 25,909
U.S. banks, trusts and insurance 22,189 15,684 14,685 22,094 38,708 42,807 46,901
Foreign 20,475 24,598 19,485 26,195 6,808 6,690 3,932
Public utilities 11,902 -- 2,370 -- -- -- 2,619
-------- -------- -------- -------- -------- -------- --------
Total $165,772 $205,668 $159,727 $184,968 $171,495 $169,977 $144,123
======== ======== ======== ======== ======== ======== ========
LIMITED PARTNERSHIPS
The Company's limited partnership investments include U.S. and foreign
private equity, real estate and fixed income investments. During the first nine
months of 2002, limited partnership investments increased $7.4 million to $89.0
million. Fixed income and real estate limited partnerships, which comprise 42.1%
of the total limited partnerships, produce a predictable earnings stream while
private equity partnerships, which comprise 57.9% of the total limited
partnerships, tend to provide a less predictable earnings stream but the
potential for greater long-term returns.
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At September 30, 2002, the Company had contractual commitments to invest up
to $116 million related to these limited partnership investments. The Company is
required to fund these commitments as required by the partnership agreements
through September 2007. These represented commitments by the Company to these
limited partnerships to fund investments of up to $80 million in private equity
securities, $20 million in real estate activities and $16 million in fixed
income securities. The Company expects to have sufficient cash flows from
operations to meet these limited partnership commitments.
DERIVATIVES
During 2001, we entered into several foreign currency forward contracts
that are by definition derivatives. The purpose of these contracts is to
partially hedge future capital calls related to our limited partnership
commitments. However, under accounting rules, these contracts are not considered
hedges. The forward contracts have no cash requirements at the inception of the
arrangement. At September 30, 2002, there were no contracts outstanding. For the
quarter ended September 30, 2002, changes in value totaling $85,000 were
recognized currently in earnings as realized gains in the Consolidated
Statements of Operations. Gains on these contracts totaled $214,000 for the nine
months ended September 30, 2002 and $50,000 in 2001.
SECURITIES LENDING PROGRAM
The Company participates in a securities lending program whereby certain
securities from its portfolio are loaned to other institutions for short periods
of time through a lending agent. A fee is paid to us by the borrower.
Collateral, comprised of cash and government securities, is maintained by the
lending agent. The Company has an indemnification agreement with the lending
agent in the event a borrower becomes insolvent or fails to return securities.
The Company had loaned securities with a market value of $37.4 million and $38.5
million secured by collateral of $39.1 million and $39.6 million at September
30, 2002 and 2001, respectively. The loaned securities are maintained on the
Consolidated Statements of Financial Position as a part of invested assets. We
have incurred no losses on the loan program since its inception.
RESERVES FOR OUR PROPERTY AND CASUALTY SUBSIDIARIES
Loss reserves are established to account for the estimated ultimate costs
of loss and loss adjustment expenses for claims that have been reported but not
yet settled and claims that have been incurred but not yet reported. The
estimated loss reserve for reported claims is based primarily upon a
case-by-case evaluation of the type of risk involved and knowledge of the
circumstances surrounding each claim and the insurance policy provisions
relating to the type of loss. Estimates of reserves for unreported claims and
loss settlement expenses are determined on the basis of historical information
by line of business as adjusted to current conditions. Inflation is implicitly
provided for in the reserving function through analysis of
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historical loss development patterns that reflect the impact of inflation as
well as other factors such as changes in claims handling practices, changes in
laws and changes in allowable expenses among other things.
The Property and Casualty Group establishes loss and loss expense reserves
for the Property and Casualty Group and for all states as a whole for various
lines of business groupings. Bulk and incurred but not reported reserves are
allocated to each company, state, and line of business. The Property and
Casualty Group reviews the insurance laws of all states in which it operates,
not just domiciliary states, to ensure that carried loss and loss adjustment
expense reserves meet requirements. The statutory annual statements filed by the
companies comprising the Property and Casualty Group contain actuarial opinions
as to reserve adequacy as required by the states in which the Property and
Casualty Group does business.
The loss and loss adjustment expense reserves are computed in accordance
with accepted loss reserving standards and principles for the purpose of making
a reasonable provision for all unpaid loss and loss expense obligations under
the terms of the Property and Casualty Group's policies and agreements. However,
the process of estimating the liability for unpaid losses and loss adjustment
expenses is inherently judgmental and can be influenced by factors subject to
variation. Possible sources of variation include claim frequency and severity,
changing rates of inflation as well as changes in other economic conditions,
judicial trends and legislative changes. It is unlikely that future losses and
loss adjustment expenses will develop exactly as projected. The Property and
Casualty Group continually refines reserves as experience develops and new
information becomes known. The Property and Casualty Group reflects adjustments
to reserves in the results of operations in the periods in which the estimates
are changed. With the exception of reserves relating to certain workers'
compensation cases, which have been discounted at 2.5% since 1998, loss reserves
are not discounted.
The Property and Casualty Group continuously reevaluates reserve estimates
and retrospectively reviews past reserve estimates. The Property and Casualty
Group modifies our selections when we observe current development diverging from
our selected development pattern. The Property and Casualty Group also performs
various reasonability checks. Historical variation between actual and estimated
development has not been material in relation to policyholder surplus as of the
year ended December 31, 2001.
The following table sets forth the development of our property and casualty
subsidiaries' reserves for unpaid losses and loss adjustment expense from 1992
through 2001, the period that our property and casualty subsidiaries have
assumed underwriting activity under the intercompany pool.
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PROPERTY AND CASUALTY SUBSIDIARIES OF ERIE INDEMNITY COMPANY
RESERVES FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Year Ended December 31,
------------------------------------------------------------------------------------------
(amounts in millions) 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992
------- ------- ------- ------ ------ ------ ------ ------ ------ -----
Net liability for unpaid losses
and loss adjustment $ 118.7 $ 102.3 $ 95.0 $ 91.4 $ 89.5 $ 84.9 $ 79.0 $ 68.9 $ 65.4 $ 61.0
expense ("LAE") -------
NET LIABILITY RE-ESTIMATED AS OF:
One year later 110.4 103.0 91.3 88.9 87.2 78.4 65.7 61.8 59.0
-----
Two years later 103.9 93.2 85.3 86.6 79.4 65.3 58.5 55.2
-----
Three years later 94.1 87.6 83.4 80.2 68.6 60.1 53.4
----
Four years later 87.5 84.4 78.2 69.4 65.7 56.1
----
Five years later 84.5 78.9 68.2 67.3 60.9
----
Six years later 79.8 68.8 68.8 62.9
----
Seven years later 69.7 68.2 64.3
----
Eight years later 69.3 63.8
----
Nine years later 64.8
----
Cumulative (deficiency)
redundancy (8.1) (8.9) (2.7) 2.0 0.4 (0.8) (0.8) (3.9) (3.8)
======== ======== ======= ======= ======= ======= ======= ======= =======
Net liability for unpaid
losses and LAE $ 118.7 $ 102.3 $ 95.0 $ 91.4 $ 89.5 $ 84.9 $ 79.0 $ 68.9 $ 65.4 $ 61.0
Reinsurance recoverable on
unpaid losses 438.6 375.6 337.9 334.8 323.9 301.5 278.3 275.9 288.5 293.0
------- -------- -------- ------- ------- ------- ------- ------- ------- -------
Gross liability for unpaid
losses and LAE $ 557.3 $ 477.9 $ 432.9 $ 426.2 $ 413.4 $ 386.4 $ 357.3 $ 344.8 $ 353.9 $ 354.0
======= ======== ======== ======= ======= ======= ======= ======= ======= =======
GROSS RE-ESTIMATED LIABILITY AS OF:
One year later $ 500.4 $ 463.2 $ 414.3 $ 410.6 $ 394.2 $ 351.0 $ 327.3 $ 323.2 $ 408.4
--------
Two years later 464.9 429.0 398.4 398.2 362.3 332.7 322.8 312.6
--------
Three years later 426.9 406.0 388.0 373.0 351.6 332.7 313.2
-------
Four years later 402.4 391.3 367.7 364.0 358.2 325.9
-------
Five years later 389.3 370.8 361.8 371.8 349.2
-------
Six years later 368.6 365.0 370.3 364.1
-------
Seven years later 363.0 374.9 362.1
-------
Eight years later 373.4 367.9
-------
Nine years later 365.4
-------
Cumulative (deficiency)
redundancy (22.5) (32.0) (0.7) 11.0 (2.9) (11.3) (18.2) (19.5) (11.4)
======== ======== ======= ======= ======= ======= ======= ======= =======
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PROPERTY AND CASUALTY SUBSIDIARIES OF ERIE INDEMNITY COMPANY
RESERVES FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
(CONTINUED)
CUMULATIVE AMOUNT OF
NET LIABILITY PAID THROUGH:
One year later $ 41.2 $ 38.9 $ 33.6 $ 31.3 $ 32.6 $ 29.3 $ 22.1 $ 24.2 $ 22.0
------
Two years later 59.2 52.4 48.3 48.7 44.7 36.2 34.9 34.2
----
Three years later 63.9 59.2 57.8 53.9 44.7 42.2 39.3
----
Four years later 65.5 63.5 59.4 49.8 46.5 43.3
----
Five years later 67.4 62.5 53.2 49.1 45.6
----
Six years later 64.8 55.0 51.3 47.1
----
Seven years later 56.5 52.6 48.5
----
Eight years later 53.7 49.4
----
Nine years later 50.2
----
CUMULATIVE AMOUNT OF
GROSS LIABILITY PAID THROUGH:
One year later $174.4 $158.9 $145.4 $136.9 $141.3 $131.9 $134.0 $140.6 $130.3
------
Two years later 244.9 228.2 211.5 212.2 199.2 199.9 214.7 205.6
-----
Three years later 274.9 256.8 250.0 235.7 233.4 247.2 244.7
-----
Four years later 280.5 271.6 256.0 253.4 264.4 262.0
-----
Five years later 285.9 267.7 265.0 275.3 270.9
-----
Six years later 276.1 272.3 282.8 277.1
-----
Seven years later 277.6 288.1 281.3
-----
Eight years later 292.5 284.9
-----
Nine years later 288.7
-----
Additional information with respect to the reserve activity of our property and
casualty subsidiaries may be found at Notes to Consolidated Financial Statements
-- Note 2 -- Significant Accounting Policies beginning on page F-12.
The top line shows the estimated liability that was recorded at the end of
each of the indicated years for all current and prior year unpaid losses and
loss expenses. The upper portion of the table shows re-estimations of the
original recorded reserve as of the end of each successive year. The estimate is
increased or decreased as payments are made and more information becomes known
about the development of remaining unpaid claims. The lower portion of the table
shows the cumulative amount paid in succeeding years for losses incurred prior
to the Statement of Financial Position date. The cumulative deficiency or
redundancy represents the aggregate amount by which original estimates of
reserves as of that year-end have changed in subsequent years. An excess in
reserves means that reserves established in prior years exceeded actual losses
and loss adjustment expenses or were reevaluated at less than the originally
reserved amount. A deficiency in reserves means that
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the reserves established in prior years were less than actual losses and loss
adjustment expenses or were reevaluated at more than the originally reserved
amount.
The Property and Casualty Group does not discount reserves except for
workers' compensation reserves on a non-tabular basis. The workers' compensation
reserves are discounted at a risk-adjusted 2.5% interest rate as permitted by
the Insurance Department of the Commonwealth of Pennsylvania. The discount is
based upon the Property and Casualty Group's historical workers' compensation
payout pattern. Our reserve liability, as a result of this discounting, was
reduced by $2.4 million, $1.5 million, $1.4 million and $1.6 million at December
31, 2001, 2000, 1999 and 1998, respectively. Reserves were not discounted before
1998.
The 2001 unpaid losses and loss adjustment expenses reserve of $557.3
million includes the Property and Casualty Group's share of estimated incurred
losses from the unaffiliated reinsurance business stemming from the September
11th attack on the World Trade Center. Incurred losses are the total losses
sustained by an insurer or reinsurer under its policies or contracts, whether
paid or unpaid, and include a provision for incurred but not reported losses.
The portion of World Trade Center losses recorded by our property and casualty
subsidiaries after giving effect to recoveries from the excess of loss agreement
with the Exchange was $5.8 million, or $0.06 per share, after taxes. The
Property and Casualty Group is exposed to both direct and reinsurance losses
arising from possible future terrorist actions.
Adverse development on loss reserves established for the year ended
December 31, 2000 was the result of an increase in loss costs experienced by the
Property and Casualty Group's direct business related to its automobile
liability and workers' compensation lines of business. The development for the
personal and commercial automobile liability lines of business has been above
expected due to changes in claims handling procedures, which makes the
extrapolation of future development from historical patterns very difficult.
Development has also been above expected on uninsured motorist bodily injury and
underinsured motorist bodily injury coverages due to precedents set by
unfavorable court decisions and an evolving arbitration system. The increase in
claims development costs for the workers' compensation line of business has been
above expected largely because of the reevaluation of known claims in which the
claimants suffered catastrophic injuries. Adverse development on loss reserves
established for the year ended December 31, 1999 was the result of an increase
in loss severity experienced by the Property and Casualty Group on its direct
business and additional losses on its voluntary assumed reinsurance business
related to the late December 1999 European wind storms.
Adjustments to reserves for adverse loss development from prior accident
years are recorded when known to management. Adverse loss development has been
incurred on prior accident years during the first nine months of 2002. This
adverse loss development was factored into management's decision to increase
loss and loss adjustment reserves for
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members of the Property and Casualty Group by approximately $184 million in the
fourth quarter of 2002.
REINSURANCE OF THE PROPERTY AND CASUALTY GROUP
After 1993 through 2002, the Property and Casualty Group did not purchase
treaty reinsurance, including catastrophe reinsurance, because management
concluded, during its periodic assessment of the Property and Casualty Group's
catastrophe exposure, that the benefits of such coverage were outweighed by the
costs of such coverage in light of the Exchange's substantial surplus and its
ratio of net premiums written to surplus. Effective January 1, 2003, the
Property and Casualty Group entered into a property catastrophe reinsurance
treaty that provides coverage of 95% of a loss up to $415 million in excess
of the Property and Casualty Group's loss retention of $115 million per
occurrence. Treaty reinsurance is an agreement between a ceding company and a
reinsurer reinsuring a specified type or category of risk defined in the
agreement. Under a typical reinsurance treaty, the ceding company is obligated
to offer and the reinsurer is obligated to accept a specified portion of all
such type or category of risk originally insured or reinsured by the ceding
company. Because the Exchange has a 94.5% participation in the Property and
Casualty Group's underwriting results and provides reinsurance for the 5.5%
participation in the underwriting results of our subsidiaries, the Exchange's
financial condition could be adversely affected by insurance losses to a greater
extent than if reinsurance coverage were maintained. If the recently purchased
property catastrophe treaty reinsurance had been in effect during 2002, there
would have been no recoveries and the profitability of the Exchange would not
have been affected except by the cost of such reinsurance. Effective January 1,
2003, the Property and Casualty Group has obtained a property risk excess of
loss reinsurance treaty on commercial property risks that covers commercial
risks that exceed our current risk retention guidelines of $5.0 million per
risk.
BUSINESS VOLATILITY
The Company's management fee is earned when premiums are written as
substantially all of the services performed by the Company, including sales,
underwriting and policy issuance are completed. Historically, due to policy
renewal and sales patterns, management fees earned are greater in the second and
third quarters of the calendar year. While loss and loss adjustment expenses are
not entirely predictable, historically such costs have been greater during the
third and fourth quarters, influenced by the weather in the geographic regions
where the Property and Casualty Group operates.
The profitability of the property and casualty insurance business can be
influenced by many external factors some of which include rate competition, the
severity and frequency of claims, terrorist actions, natural disasters, state
regulation of premium rates, other competitive factors, defaults of reinsurers,
investment market conditions, general business
-89-
conditions, court decisions that define and may expand the extent of coverage
and the amount of compensation due for injuries and losses.
COMPETITION
The Property and Casualty Group is ranked by the A.M. Best Company as the
25th largest property and casualty insurance group in the United States based
upon the 2001 net premium written. Among the Property and Casualty Group's major
national competitors are State Farm Group (ranked #1), Allstate Insurance Group
(ranked #2), Zurich / Farmers Group (ranked #3), Travelers/Citigroup Companies
(ranked #6) and Nationwide Group (ranked #7). Among the regional insurance
companies, the Property and Casualty Group's major competitors are Cincinnati
Insurance Companies (ranked #28) and American Family Insurance Group (ranked
#19).
The property and casualty markets in which the Property and Casualty Group
operates are highly competitive. Property and casualty insurers generally
compete on the basis of customer service, price, brand recognition, coverages
offered, claim handling ability, financial stability and geographic coverage. In
addition, because the insurance products of the Property and Casualty Group are
marketed exclusively through independent insurance agents, these agents have the
opportunity to represent more than one company. The Property and Casualty Group,
thus, potentially faces competition within its appointed agencies based on
product, price and service relationships.
Market competition bears directly on the price charged for insurance
products and services, subject to the regulatory limitations. Growth is driven
by a company's ability to provide insurance services at a price that is
reasonable and acceptable to the customer. In addition, the marketplace is
affected by available capacity of the insurance industry. Industry surplus
expands and contracts primarily in conjunction with profit levels generated by
the industry. Growth is the product of a company's ability to retain existing
customers and to attract new customers as well as movement in the average
premium per policy charged by the Property and Casualty Group. Firming pricing
in 2001 and the first nine months of 2002 and a return to "hard market"
conditions, particularly for commercial and personal insurance, have allowed the
Property and Casualty Group to raise premium rates or maintain current premium
rates to gain competitive advantage in the insurance marketplace.
The Erie Insurance Group follows several strategies that our management
believes will result in underwriting performance that exceeds those of the
property and casualty industry in general. First, we employ an underwriting
philosophy and product mix targeted to produce a Property and Casualty
Group-wide underwriting profit, i.e., a combined ratio of less than 100% on a
long-term basis, through careful risk selection and rational pricing. The
careful selection of risks allows for lower claims frequency and loss severity,
thereby enabling insurance to be offered at favorable prices.
-90-
Second, Erie Insurance Group's management focuses on consistently providing
superior service to policyholders and agents is reflected in its policy
retention and new policy growth rates. Policy retention remained excellent at
91.1%, 90.9%, 91.0% and 90.5% for the twelve months ended September 30, 2002 and
the years ended December 31, 2001, 2000 and 1999, respectively, for all lines of
business combined. Continued improvement in new policy growth drove the gains
experienced in the Property and Casualty Group's direct written premium.
Policies in force increased at an annualized rate of 11.9% to 3.4 million at
September 30, 2002, 8.5% to 3.1 million in 2001 from 2.9 million in 2000 and
6.5% in 2000 from 2.7 million in 1999.
Third, Erie Insurance Group's business model is designed to provide the
advantages of localized marketing and claims servicing with the economies of
scale from centralized accounting, administrative, underwriting, investment,
information management and other support services.
Finally, the Company carefully selects the independent agencies that
represent the Property and Casualty Group and the Property and Casualty Group
seeks to be the lead insurer with agents in order to enhance the agency
relationship and the likelihood of receiving the most desirable underwriting
opportunities from agents. The Company has ongoing, direct communications with
the agency force. Agents have access to a number of Company-sponsored venues
designed to promote sharing of ideas, concerns and suggestions with the senior
management of the Property and Casualty Group with the goal of improving
communications and service. These efforts have resulted in outstanding agency
penetration and the ability to sustain long-term agency partnerships.
GOVERNMENT REGULATION
The Property and Casualty Group are subject to supervision and regulation
in the states in which they transact business. The primary purpose of such
supervision and regulation is the protection of policyholders. The extent of
such regulation varies, but generally derives from state statutes that delegate
regulatory, supervisory and administrative authority to state insurance
departments. Accordingly, the authority of the state insurance departments
includes the establishment of standards of solvency that must be met and
maintained by insurers, the licensing to do business of insurers and agents, the
nature of the limitations on investments, the approval of premium rates for
property and casualty insurance, the provisions that insurers must make for
current losses and future liabilities, the deposit of securities for the benefit
of policyholders, the approval of policy forms, notice requirements for the
cancellation of policies and the approval of certain changes in control. In
addition, many states have enacted variations of competitive rate-making laws
that allow insurers to set certain premium rates for certain classes of
insurance without having to obtain the prior approval of the state insurance
department. State insurance departments also conduct periodic examinations of
the affairs of insurance companies and require the filing of annual and other
reports relating to the financial condition of insurance companies.
-91-
The Property and Casualty Group may be required, under the solvency or
guaranty laws of the various states in which they are licensed, to pay
assessments to fund policyholder losses or liabilities of insolvent insurance
companies. Depending on state law, insurers can be assessed an amount that is
generally equal to between 1% and 2% of premiums written for the relevant lines
of insurance in that state each year to pay the claims of an insolvent insurer.
Certain states permit these assessments, or a portion thereof, to be recorded as
an offset to future premium taxes. The members of the Property and Casualty
Group has made accruals for their portion of assessments related to such
insolvencies to the extent they can be estimated, based upon the most current
information furnished by the guaranty associations.
The Property and Casualty Group are also required to participate in various
involuntary insurance programs for automobile insurance, as well as other
property and casualty lines, in states in which such companies operate. These
involuntary programs provide various insurance coverages to individuals or other
entities that otherwise are unable to purchase such coverage in the voluntary
market. These programs include joint underwriting associations, assigned risk
plans, fair access to insurance requirements ("FAIR") plans, reinsurance
facilities and windstorm plans. Legislation establishing these programs
generally provides for participation in proportion to voluntary premium writings
of related lines of business in that state. Generally, state law requires
participation in such programs as a condition to doing business in that state.
The loss ratio on insurance written under involuntary programs has traditionally
been greater than the loss ratio on insurance in the voluntary market; however,
the impact of these involuntary programs on the Property and Casualty Group has
been immaterial.
Most states have enacted legislation that regulates insurance holding
company systems. Each insurance company in the holding company system is
required to register with the insurance supervisory authority of its state of
domicile and furnish information regarding the operations of companies within
the holding company system that may materially affect the operations, management
or financial condition of the insurers within the system. Pursuant to these
laws, the respective insurance departments may examine us and the Property and
Casualty Group at any time, require disclosure of material transactions with the
insurers and us as an insurance holding company and require prior approval of
certain transactions between us and the Property and Casualty Group.
All transactions within the holding company system affecting the insurers
we manage are filed with the applicable insurance departments and must be fair
and reasonable. Approval of the applicable insurance commissioner is required
prior to the consummation of transactions affecting the control of an insurer.
In some states, the acquisition of 10% or more of the outstanding common stock
of an insurer or its holding company is presumed to be a change in control.
As a public company, we are subject to the corporate governance standards
set forth in the recently enacted Sarbanes-Oxley Act of 2002 and other recent
changes to the federal
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securities laws, as well as any rules or regulations that may be promulgated by
the Securities and Exchange Commission or the Nasdaq Stock Market(SM).
Compliance with these standards, rules and regulations, as well as with
accelerated filing requirements that have recently been enacted, impose
additional administrative costs and burdens on us.
FINANCIAL REGULATION
Our property and casualty insurance subsidiaries are required to file
financial statements prepared in accordance with SAP. The adjustments necessary
to reconcile the net income and shareholders' equity of our property and
casualty insurance subsidiaries' prepared in accordance with SAP to net income
and shareholders' equity prepared in accordance with GAAP are as follows:
ERIE INDEMNITY COMPANY SUBSIDIARIES
GAAP RECONCILIATION OF NET INCOME
Nine Months Ended
September 30, Year Ended December 31,
-------- -------- --------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
-------- -------- -------- -------- -------- -------- --------
(unaudited)
SAP net income (loss) ......................... $ (7,306) $ (2,225) $ (4,929) $ 5,091 $ 9,546 $ 14,663 $ 8,446
ADJUSTMENTS:
Deferred policy acquisition costs ............ 4,617 3,431 3,816 1,798 542 580 742
Deferred income taxes ........................ 1,734 17 1,392 32 226 (1,855) 1,409
Federal alternative minimum tax credit
recoverable ................................ 0 0 0 188 0 795 (1,815)
Salvage and subrogation ...................... 0 0 312 221 158 12 94
Incurred premium adjustment .................. (3,251) (1,931) (1,816) (798) (542) (580) (742)
Other ........................................ (114) 130 83 10 (59) (3) (78)
-------- -------- -------- -------- -------- -------- --------
GAAP net income (loss) ........................ $ (4,320) $ (578) $ (1,142) $ 6,542 $ 9,871 $ 13,612 $ 8,056
======== ======== ======== ======== ======== ======== ========
ERIE INDEMNITY COMPANY SUBSIDIARIES
GAAP RECONCILIATION OF SHAREHOLDERS' EQUITY
At September 30, At December 31,
--------------------- -----------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
--------- --------- ---------- --------- --------- --------- ---------
(unaudited)
SAP shareholders' equity .................... $ 85,543 $ 95,018 $ 92,128 $ 89,637 $ 81,709 $ 74,348 $ 60,628
ADJUSTMENTS:
Deferred policy acquisition costs .......... 21,635 16,633 17,018 13,202 11,405 10,863 10,284
Difference between GAAP and SAP deferred
income taxes ............................. (1,190) (2,024) (354) 3,569 3,350 4,143 5,998
Federal alternative maximum tax credit
recoverable .............................. 0 0 0 0 0 (1,020) (1,815)
Salvage and subrogation .................... 3,661 3,349 3,661 3,349 3,128 2,970 2,957
Statutory reserves ......................... 0 0 0 865 2,656 2,619 1,823
Incurred premium adjustment ................ (17,269) (14,133) (14,018) (12,202) (11,405) (10,863) (10,284)
Unrealized gains net of deferred taxes ..... 9,557 6,666 4,722 2,331 38 7,653 6,697
Other ...................................... 230 159 223 7 (3) 0 8
--------- --------- --------- --------- --------- --------- ---------
GAAP shareholders' equity ................... $ 102,167 $ 105,668 $ 103,380 $ 100,758 $ 90,878 $ 90,713 $ 76,296
========= ========= ========= ========= ========= ========= =========
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Effective January 1, 2001, the NAIC adopted the Codification of Statutory
Accounting Principles (Codification) as the NAIC-supported basis of accounting.
Codification resulted in changes to the SAP-based financial statements of our
property and casualty insurance subsidiaries, the most significant of which was
the recording of statutory deferred taxes for certain of the property and
casualty insurance subsidiaries. The total cumulative adjustment increased the
statutory surplus of our property and casualty insurance subsidiaries by $4.4
million as of January 1, 2001.
The NAIC has adopted risk-based capital ("RBC") standards that require
insurance companies to calculate and report statutory capital and surplus needs
based on a formula measuring underwriting, investment and other business risks
inherent in an individual company's operations. These RBC standards have not
affected the operation of our property and casualty insurance subsidiaries and
affiliates because each of them has statutory capital and surplus in excess of
RBC requirements.
ERIE INSURANCE EXCHANGE
GENERAL
Erie Insurance Exchange was organized in Pennsylvania in 1925 by H.O. Hirt
and Oliver G. Crawford as a reciprocal insurance exchange. A reciprocal
insurance exchange is an unincorporated association that consists of
individuals, corporations or entities who, as subscribers, exchange contracts of
insurance (policies) and share insurance risks among themselves, and whose
affairs are managed by an attorney-in-fact appointed at the time of application
for insurance. The subscribers pay premiums for insurance coverage that are
intended to be sufficient to cover all of the costs of operating the reciprocal
insurance exchange, including the payments of losses covered by the insurance
policies issued by the reciprocal insurance exchange and the payment of the
management fees of the attorney-in-fact, and generate a profit that is retained
by the reciprocal insurance exchange as surplus. The purpose of the surplus is
to increase the financial strength of the reciprocal insurance exchange so that
it has greater capacity to pay the insurance losses incurred by its subscribers.
The subscriber's agreement between each policyholder and the Exchange,
which is executed by each applicant when applying for insurance coverage from
the Exchange, permits us to retain up to 25% of the direct written premiums of
the Exchange in addition to the direct written premiums of the other members of
the Property and Casualty Group, all of which are assumed by the Exchange under
a pooling agreement. The management fee rate is generally set by our board of
directors each December for the following year. In consideration for this
payment, the Company performs certain services for the Exchange relating to the
sales, underwriting and issuance of policies on behalf of the Exchange. Each
subscriber's agreement provides that the remainder of the premium must be used
by the Exchange for losses, loss adjustment expenses, investment expenses,
damages, legal
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expenses, court costs, taxes, assessments, licenses, fees, any other
governmental fines and charges, establishment of reserves and surplus and
reinsurance and may be used for dividends and other purposes to the advantage of
the policyholders of the Exchange. The provisions in the subscriber's agreements
executed by the policyholders regarding the Company's appointment as
attorney-in-fact are the sole agreements governing the services performed by the
Company for the Exchange. There is no provision for termination of the Company's
appointment as attorney-in-fact and it is not affected by an insured's
disability or incapacity. Under the insurance holding company statute in effect
in Pennsylvania, all transactions between members of an insurance holding
company system, including the attorney-in-fact portions of the subscriber's
agreement, are subject to various filing and approval requirements. The Exchange
has not received any notices of disapproval from the Pennsylvania Insurance
Department.
Flagship City Insurance Company is a Pennsylvania-based, wholly owned
subsidiary of Erie Insurance Exchange that writes Pennsylvania assigned risk
automobile and workers' compensation business.
The principal entity in the Erie Insurance Group, the Exchange, wrote $2.0
billion in direct premiums in 2001 and is the 26th largest writer of property
and casualty insurance in the United States as measured by direct premiums
according to A.M. Best. Premiums written in Pennsylvania accounted for 59% of
the Exchange's direct written premiums in 2001.
Under an agreement among the Exchange, Erie Insurance Company and Erie
Insurance Company of New York governing the pooling arrangement, all property
and casualty business, including relevant liabilities, premiums and reserves, is
ceded to the Exchange. The pooling arrangement expressly does not include
investment results and other non-underwriting operations and income tax
obligations of the parties. The Exchange acts on behalf of Erie Insurance
Company and Erie Insurance Company of New York to fulfill all obligations under
ceded insurance policies and to adjust and pay all related claims and
underwriting expenses. This pooling arrangement provides for Erie Insurance
Company and Erie Insurance Company of New York to share proportionately
thereafter through retrocession of liabilities, premiums and reserves in the
results of the Property and Casualty Group, except for the provisions of the
excess of loss reinsurance agreement discussed below. Erie Insurance Company's
and Erie Insurance Company of New York's proportionate share of the reinsurance
pool is 5.0% and 0.5% percent, respectively, which percentages may only be
changed by each party executing a written amendment. Erie Insurance Property &
Casualty Company and Flagship City Insurance Company, the other members of the
Property and Casualty Group, have entered into quota share reinsurance
agreements with the Exchange, whereby all property and casualty business of
those entities, including relevant liabilities, premiums and reserves, is ceded
to the Exchange. Accordingly, all of this business becomes subject to the pool.
The pooling agreement and the two quota share
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reinsurance agreements each may be terminated by any party to the respective
agreement as of the end of any calendar year by providing not less than 90 days'
advance written notice.
The Pennsylvania Insurance Holding Companies Act requires that all
transactions within a holding company system to which an insurer is a party must
be fair and reasonable and any charges or fees for services performed must be
reasonable. Any management agreement, service agreement, cost sharing
arrangement and reinsurance agreements must be filed with the Pennsylvania
Insurance Department and are subject to Department review. The agreement
governing the pooling arrangement and the quota share reinsurance agreements
were accordingly filed with the Pennsylvania Insurance Department. The
Pennsylvania Insurance Department has never provided any notification of
disapproval to any member of the Property and Casualty Group or the Company.
The Exchange has A.M. Best's highest rating of A++ (superior). On a
statutory basis, the Exchange had total assets of $6.2 billion, total
liabilities of $4.0 billion and policyholders' surplus of $2.1 billion, as of
September 30, 2002. The Exchange owns a 53.5% stake in Erie Family Life
Insurance Company, an affiliated life insurance and annuity provider.
The selected financial data of the Exchange presented below as of and for
the years ended December 31, 1997 through 2001 are derived from annual
statements prepared in accordance with SAP that were audited by our independent
auditors. The financial statements of the Exchange included in these annual
statements are prepared in accordance with SAP required by the NAIC Accounting
Practices and Procedures Manual, as modified to include prescribed or permitted
practices of the Commonwealth of Pennsylvania. The Exchange does not, nor is it
required to, prepare financial statements in accordance with GAAP. Financial
statements prepared under SAP provide a more conservative approach than under
GAAP. Under SAP, the principal focus is on the solvency of the insurer in order
to protect the interests of the policyholders. The material differences between
SAP and GAAP as they relate to the Exchange include the following:
. SAP provides a more conservative approach to the valuation of invested
assets than GAAP.
. SAP recognizes expenses when incurred and does not allow for the
establishment of deferred policy acquisition cost assets that is required
by GAAP.
. GAAP requires the establishment of an asset for the estimated salvage
and subrogation that will be recovered in the future. Under SAP, a company
may establish this recoverable but is not required to do so. The Exchange
does not establish salvage and subrogation recoveries.
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. SAP deferred tax calculations follow GAAP with certain modifications
for the realization criteria of deferred tax assets and the recording of
the impact of changes in its deferred tax balances.
The Company believes the condensed statutory financial statements of the
Exchange, particularly its surplus and premium levels, are relevant to investors
and other readers of this prospectus, and that the Exchange's financial
information is meaningful even if it is presented using SAP because:
. The Exchange is the sole entity for which the Company contractually
provides services in its role as attorney-in-fact for the policyholders.
These revenues constituted 78% of the Company's total revenues in 2001.
. The management fee rate level is reviewed and established annually by
the board of directors of the Company. A major criterion for setting the
management fee rate level is the financial strength and well being of the
Exchange as determined by a review of the information presented in the
statutory financial statements of the Exchange.
. The Company has significant accounts receivable from the Exchange, and
three of the Company's subsidiaries have reinsurance agreements with the
Exchange.
The selected financial data below as of and for the nine months ended
September 30, 2001 and 2002 is derived from the Exchange's unaudited financial
statements prepared in accordance with SAP. In the opinion of management, all
adjustments, consisting only of normal recurring accruals, considered necessary
for a fair presentation have been included. The financial data set forth below
is only a summary.
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ERIE INSURANCE EXCHANGE
SELECTED FINANCIAL INFORMATION
(STATUTORY ACCOUNTING BASIS)
Nine Months Ended
September 30, Year Ended December 31,
----------- ----------- --------------------------------------------------------------
(amounts in thousands) 2002 2001 2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- ----------- ----------- -----------
(unaudited)
INCOME STATEMENT INFORMATION:
Net premiums earned $ 2,140,526 $ 1,792,450 $ 2,422,600 $ 2,161,034 $ 2,039,791 $ 1,971,525 $ 1,877,270
Loss and loss adjustment expenses 1,727,052 1,568,896 2,150,749 1,714,487 1,509,895 1,372,705 1,375,643
Insurance underwriting and other expenses 718,881 551,623 766,304 624,622 576,031 568,149 520,648
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net underwriting (loss) income $ (305,407) $ (328,069) $ (494,453) $ (178,075) $ (46,135) $ 30,671 $ (19,021)
Investment income (loss), net 48,237 (32,489) (421,754) 347,582 428,874 378,845 365,393
Federal income tax expense (benefit) (68,925) (43,230) (300,257) 42,433 102,339 102,917 86,627
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net income (loss) $ (188,245) $ (317,328) $ (615,950) $ 127,074 $ 280,400 $ 306,599 $ 259,745
=========== =========== =========== =========== =========== =========== ===========
BALANCE SHEET INFORMATION:
Cash and invested assets $ 5,238,660 $ 5,563,420 $ 5,990,511 $ 6,357,658 $ 6,860,008 $ 5,604,496 $ 4,670,320
Total assets 6,190,240 6,317,728 6,998,794 6,969,746 7,415,176 6,174,590 5,204,856
Claims and unearned premium reserves 3,663,000 3,084,067 3,200,836 2,654,300 2,463,806 2,388,958 2,328,230
Total liabilities 4,042,623 3,418,368 3,953,243 2,847,861 2,660,713 2,582,998 2,490,465
Policyholders' surplus (1)(2) 2,147,617 2,899,360 3,045,551 4,121,885 4,754,462 3,591,592 2,714,391
-------------------
(1) Periods beginning after January 1, 2001 are computed taking into
consideration changes in SAP required by the NAIC Accounting Practices and
Procedures Manual. An adjustment made on January 1, 2001 as a result of
such changes decreased policyholders' surplus by $523.8 million.
(2) Under a practice prescribed by the Commonwealth of Pennsylvania, unearned
premium reserves are reduced (and policyholders' surplus increased) by the
amount of the management fee ultimately payable by the Exchange to us
correlating to premiums not yet earned at the respective financial
statement date. At December 31, 2001, this amount was $240.9 million.
PERFORMANCE OF THE EXCHANGE
OVERVIEW OF FINANCIAL RESULTS (STATUTORY ACCOUNTING BASIS)
The Exchange has a 94.5% participation in the underwriting results of the
Property and Casualty Group.
In 1997 and 1998, soft market conditions in the property and casualty
insurance industry characterized by decreased revenues, less stringent
underwriting standards and an excess of surplus in the industry, created severe
price competition in commercial and personal lines of insurance, including
private passenger automobile, the Property and Casualty Group's largest line of
business. Lower pricing on private passenger automobile insurance was driven by
changing driver demographics, safer cars, tougher drunk driving laws and other
factors that reduced automobile insurance loss costs. Emerging forms of
distribution, including direct response writers who spent a considerable amount
of money on advertising in order to build brand awareness, intensified
competition. Competitors targeted the Property and Casualty Group's private
passenger automobile policyholders by offering them lower insurance rates.
Management believed the loss of these customers would have
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adversely affected the Property and Casualty Group since its policyholder base
would have included a greater percentage of drivers with higher loss costs.
Higher average premium rates would then be required to be charged to these less
profitable policyholders, which would have exacerbated the competitive rate
problem. These competitive conditions resulted in slower new policy growth and
declines in policy retention rates for the Property and Casualty Group.
Management viewed these competitive effects as a serious threat to the
well-being of the Property and Casualty Group.
Following discussions with our board of directors in 1998, management
decided to reduce premium rates in 1998 and 1999 to remain price competitive in
order to retain the Property and Casualty Group's most profitable customers.
Management discussed with our board that one effect of these pricing actions
would be to reduce underwriting profitability, with a consequent reduction in
surplus. All policies issued by the Property and Casualty Group are for a
one-year term. Therefore, it takes one year for a rate change to be effective
and another year to be recognized fully in the underwriting results of the
Property and Casualty Group. As a result, the 1998 and 1999 premium rate
reductions negatively affected the Property and Casualty Group's underwriting
results in 2000 and 2001. The lower, more competitive private passenger
automobile premium rates have been an important factor in stronger new policy
growth and a return to traditional retention rates for the Property and Casualty
Group in 2002.
The Company and the Property and Casualty Group have responded to
underwriting losses in their direct business in light of changing competitive
positions in a number of ways, including:
. adopting stricter underwriting requirements;
. restricting policy coverages;
. increasing the emphasis on reviewing existing policies and accounts to
determine which risks continue to meet underwriting guidelines and taking
appropriate action regarding those policies and accounts that do not;
. continuing the focus on claims strategies to reduce claims severity,
such as reducing claims fraud; and
. raising premium rates on its direct lines of insurance.
The Property and Casualty Group began raising premium rates on its direct
lines of insurance in 2001, and has continued to file and receive approval for
significant premium rate increases for 2002 and 2003. Through October 1, 2002,
the calendar year impact of premium rate increases approved by regulators, filed
and unapproved by regulators and anticipated filings not yet filed amounted to
$122 million for 2002 and $145 million for 2003. In most instances, a
combination of these measures has been employed to address
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underwriting losses in a particular line of business or line of business within
a particular state.
Since it takes one year for rate changes to become effective and another
year to be recognized fully in the underwriting results of the Property and
Casualty Group, management believes increased pricing, together with these other
measures, will help to reduce the Property and Casualty Group's underwriting
losses for future accident years, excluding catastrophe losses, as long as
increases in loss costs do not exceed the effect of the measures taken. The
Property and Casualty Group continually monitors its accident year loss costs
and takes actions designed to lower or offset its loss costs.
In 1999, 2000, and 2001, the Property and Casualty Group also incurred
significant underwriting losses from its non-affiliated assumed reinsurance
business. In late December 1999, significant assumed reinsurance losses were
incurred from severe wind storms in Western Europe, which also affected incurred
losses in 2000 as a result of adverse loss reserve development related to these
storms. In 2001, the Property and Casualty Group incurred a $150 million loss
from assumed reinsurance related to the World Trade Center terrorist attack.
Other significant losses were incurred in 2000 and 2001 by the Property and
Casualty Group from non-affiliated assumed reinsurance.
The Property and Casualty Group has also taken action to respond to
underwriting losses in its non-affiliated assumed reinsurance business. In 2002,
the Property and Casualty Group reunderwrote all of its assumed reinsurance
treaties. A significant number of treaties were cancelled, and total aggregate
limits on the treaties written were reduced significantly. Reinsurance premium
rates also were increased significantly, rising 40% to 50%. Finally, terrorism
coverage was specifically excluded from all reinsurance treaties entered into in
2002. Management believes these measures will significantly improve the 2002
accident year results for the non-affiliated assumed reinsurance business of the
Property and Casualty Group.
In 1985, the Exchange increased its investments in common equities as a
core element of its investment strategy. Prior to the more recent decline in the
equity markets, the Exchange's common equities portfolio had grown at December
31, 1999 to a market value of $3.8 billion including unrealized appreciation of
$2.6 billion. However, as a result of the recent downturn in the equity markets,
the common equities portfolio of the Exchange has experienced a decline in
value. From its inception in 1985 through September 30, 2002, the common
equities portfolio of the Exchange has produced returns, inclusive of realized
and unrealized gains (net of losses) and dividend income, of $1.4 billion.
At September 30, 2002, the Exchange had investments in marketable
securities of approximately $4.7 billion, which included investments in
unaffiliated common equity securities of approximately $2.0 billion with a cost
basis of $1.4 billion. Investments in marketable securities and marketable
common equity securities comprised 76.0% and 32.8%,
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respectively, of the Exchange's admitted assets at September 30, 2002.
Management believes the Exchange's concentration of investment in marketable
common equity securities is greater than that of most of its competitors. All of
the Exchange's marketable security investments are subject to market volatility.
The Exchange's marketable securities have exposure to price risk and the
volatility of the capital markets and general economic conditions. The stock
market decline in 2002 has reduced the value of the Exchange's marketable
securities by $1.3 billion during the first nine months of 2002, compared to
$1.0 billion during the first nine months of 2001.
Management believes that the Exchange's focus on investments in common
equities has produced a higher rate of return since 1985 than the Exchange would
have realized if its investment portfolio had included a lesser amount of common
equities.
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2001 (STATUTORY
ACCOUNTING BASIS)
The Exchange recorded a net loss of $188.2 million in the first nine months
of 2002, compared to a net loss of $317.3 million for the same period in 2001.
Premiums earned increased 19.4% for the nine months ended September 30, 2002, to
$2.1 billion from $1.8 billion for the same period in 2001. The strong premium
growth was outpaced by greater loss and underwriting expenses in 2002. The
Exchange also recognized $118.3 million in net realized losses from investments
in 2002 on the sale of securities and related charges for impairments in
investment values.
The underwriting loss recorded by the Exchange totaled $305.4 million in
the first nine months of 2002, compared to a loss of $328.1 million for the same
period in 2001. Catastrophe losses were partly responsible for the increased
losses and totaled $93.3 million for the nine months ended September 30, 2002,
compared to $25.3 million for the same period in 2001. Increased loss severity
was also a factor in the underwriting loss. Losses resulting from spring wind
and hail storm related events and categorized as catastrophes by the Property
and Casualty Group totaled $79.6 million in 2002. Increased underwriting
expenses also contributed to the increased underwriting loss in the first nine
months of 2002 when compared to 2001. Included in the underwriting expenses are
the Exchange's share of eCommerce initiative expenses covered under the
technology cost sharing agreement that totaled $51.6 million for the nine months
ended September 30, 2002 compared to $10.3 million for the same period in 2001.
Net investment income totaled $48.2 million for the nine months ended
September 30, 2002 compared to losses of $32.5 million for the same period in
2001. Investment income from interest, dividends and rent increased 9.7% to
$166.6 million for the first nine months of 2002 from $151.9 million for the
same period in 2001. Realized losses on investments totaled $118.3 million in
the first nine months of 2002, compared to $184.4 million in 2001. Impairment
charges of investments with declines in value considered by management to be
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other than temporary totaled $132.0 million for the nine months ended September
30, 2002, including $17.8 million related to securities of WorldCom Group.
Impairment charges on investments totaled $215.9 million for the nine months
ended September 30, 2001.
Unrealized capital losses, net of deferred taxes, totaled $749.3 million
and $822.3 million for the nine months ended September 30, 2002 and 2001,
respectively. In the first nine months of 2002, the Exchange's policyholders'
surplus declined by $897.9 million. Policyholders' surplus totaled $2.1 billion
at September 30, 2002.
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 (STATUTORY ACCOUNTING BASIS)
The Exchange recorded a net loss of $616.0 million in 2001, compared to net
income of $127.1 million in 2000 and $280.4 million in 1999. Premiums earned
increased 12.1% in 2001, to $2.4 billion from $2.2 billion in 2000, and 5.9% in
2000 from $2.0 billion in 1999. While the premium growth was strong, the
Exchange incurred greater losses and loss adjustment expenses in 2001. The
Exchange also recognized $622.1 million in net realized losses from investments
in 2001 on the sale of securities and related charges for impairments in
investment values.
The underwriting loss during 2001 was $494.5 million, compared to losses of
$178.1 million recorded in 2000 and $46.1 million recorded in 1999. The 2001
underwriting loss largely resulted from significant premium rate reductions
implemented in 1998 and 1999 in response to the intensely competitive conditions
in the private passenger automobile lines of business and higher claims severity
in private passenger and commercial automobile and workers' compensation
insurance, as well as losses from assumed reinsurance, some of which relate to
the September 11th terrorist attack on the World Trade Center. The Exchange's
estimated incurred losses from the World Trade Center terrorist attack assumes
that the attack is considered one event. The Exchange's potential exposure would
increase between approximately $47 million and $71 million if the attack is
considered two events. The 2000 underwriting results were negatively impacted by
the adverse loss development experienced in the Exchange's reinsurance
operations, specifically adverse loss development during calendar year 2000 from
end of December 1999 European wind storms.
Net investment losses totaled $421.8 million in 2001 compared to net
investment income of $347.6 million in 2000 and $428.9 million in 1999.
Investment income from interest, dividends and rent declined 7.8% to $200.4
million in 2001 from $217.3 in 2000 and increased 3.4% in 2000 from $210.2
million in 1999. Investment income dropped in 2001, due to reduced earnings from
limited partnership investments and interest rate declines on the Exchange's
bond portfolio. Realized losses on investments totaled $622.1 million in 2001,
compared to realized gains of $130.2 million in 2000 and $218.7 million in 1999.
The Exchange recognized realized losses in 2001 as a result of the sale of
securities and charges for other than temporary impairments of common and
preferred stock and limited partnership investments. The sale on investments in
a loss position in 2001 was part of a
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proactive year-end tax selling strategy. Net realized losses from the sales of
securities totaled $583.1 million, of which the Exchange recovered $197.6
million in federal income taxes paid in 1998, 1999 and 2000. Of this total
realized loss, $21.0 million related to sales of securities of Enron Corporation
and its related legal entities. Impairment charges of investments with declines
in value considered by management to be other than temporary totaled $256.9
million in 2001 and $7.6 million in 2000. There were no such charges recorded in
1999.
Effective January 1, 2001, the Exchange adopted changes in SAP required by
the NAIC Accounting Practices and Procedures Manual, with deviations for
practices prescribed or permitted by state insurance commissioners. Adoption of
these new accounting standards resulted in changes to the Exchange's
statutory-basis financial statements. The cumulative effect of adoption reduced
statutory surplus by $523.8 million at January 1, 2001. The most significant
portion of the surplus adjustment was the establishment of a liability for
deferred taxes, which reduced surplus by $538.8 million at that date, the
majority of which resulted from deferred taxes on unrealized capital gains on
the common stock investments of the Exchange.
Underwriting losses combined with net realized capital losses and the
cumulative effect of adopting codified statutory accounting principles resulted
in a reduction to policyholders' surplus of $1.1 billion. Policyholders' surplus
totaled $3.0 billion at December 31, 2001.
ERIE FAMILY LIFE INSURANCE COMPANY
Erie Family Life Insurance Company markets individual and group life
insurance policies, including universal life, annuity and disability income
products. Many of the Company's and the Exchange's agents are also agents of
Erie Family Life Insurance Company and can sell a broader portfolio of Erie
Insurance Group products to their customers. Erie Family Life Insurance Company
is owned 21.6% by us, 53.5% by the Exchange and the remaining 24.9% by public
shareholders, who are predominantly directors, agents and employees of the
Company. Erie Family Life Insurance Company trades on the OTC Bulletin Board
under the symbol "ERIF".
As of September 30, 2002, Erie Family Life Insurance Company had GAAP
assets of $1,266.9 million and shareholders' equity of $216.5 million. For the
nine months ended September 30, 2002, Erie Family Life Insurance Company had net
operating income, excluding realized losses, of $13.0 million.
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MANAGEMENT
DIRECTORS
Our board of directors currently consists of 12 members, each of whom is
elected annually to serve for a term of one year and until the election of the
director's successor. In July 2002, we increased the number of board seats to
13, and there is currently one vacancy on the board. Certain information as to
our directors is as follows:
Name Age Director Since
--------------------------- ----- --------------------
Samuel P. Black, III 60 1997
J. Ralph Borneman, Jr. 64 1992
Patricia A. Garrison-Corbin 55 2000
Susan Hirt Hagen 67 1980
F. William Hirt 77 1965
Samuel P. Katz 53 2000
Claude C. Lilly, III 56 2000
Jeffrey A. Ludrof 43 2002
Henry N. Nassau 48 2000
John M. Petersen 74 1979
Jan R. Van Gorder 55 1990
Robert C. Wilburn 59 1999
Samuel P. Black, III is President, Treasurer and Secretary of Samuel P.
Black & Associates, Inc., an insurance agency with which he has been associated
since 1973. Mr. Black is also the managing general partner and a limited partner
of Black Interests Limited Partnership, the selling shareholder.
J. Ralph Borneman, Jr. has been President and Chief Executive Officer of
Body-Borneman Associates, Inc., an insurance agency, and President of
Body-Borneman, Ltd. and Body-Borneman, Inc., insurance agencies, since 1967. Mr.
Borneman is also a director of National Penn Bancshares.
Patricia A. Garrison-Corbin is a founder, and has been President and Chief
Executive Officer since 1986, of P.G. Corbin & Company, Inc., a firm that
provides financial advisory and investment management services for
municipalities. She is also a director of P.G. Corbin Asset Management, Inc.
Susan Hirt Hagen was Managing Partner of Hagen, Herr & Peppin, group
relations consultants, from 1990 until it discontinued operations in 1999. Since
1999, Mrs. Hagen has focused more of her time and efforts fulfilling her
responsibilities as a co-trustee of the H.O.
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Hirt Trusts, a position she has held since 1967, and as a director of the
Company and its subsidiaries. Mrs. Hagen also engages in private investment,
community leadership and philanthropic activities.
F. William Hirt has been Chairman of the Board of the Company since 1993.
Mr. Hirt is a co-trustee of the H.O. Hirt Trusts.
Samuel P. Katz has been Chief Executive Officer of Greater Philadelphia
First, a business leadership civic organization, since July 2000. He is also a
founder, and has been President since 1997, of EnterSport Capital Advisors,
Inc., a private investment and consulting firm and Managing Partner of
Wynnefield Capital Advisors, Inc., a fund manager of a private equity venture
fund since 1997.
Claude C. Lilly, III has been Dean, Belk College of Business
Administration, University of North Carolina, Charlotte, since 1998, and James
H. Harris Chair of Risk Management and Insurance, Belk College of Business
Administration, University of North Carolina, Charlotte, since 1997.
Jeffrey A. Ludrof has been President and Chief Executive Officer of the
Company since May 2002. Mr. Ludrof was Executive Vice President-Insurance
Operations of the Company from 1999 to May 2002, and was a Senior Vice President
of the Company from 1994 to 1999.
Henry N. Nassau has been Managing Director, General Counsel and Secretary
of Internet Capital Group, Inc., an internet holding company, since 1999. He was
a partner of Dechert for 12 years prior thereto and Chairman of the Business
Department of that law firm for his last 18 months at the firm. Mr. Nassau is a
director of various companies associated with Internet Capital Group, Inc.,
various companies associated with Albert Abela Corporation and of Bliley
Technologies, Inc.
John M. Petersen, who retired from the Company in 1995 and currently serves
as an equity investment consultant to the Company, was President of the Company
from 1990 to 1995, Chief Executive Officer of the Company from 1993 to 1995 and
Treasurer and Chief Financial Officer of the Company from 1992 to 1995. Mr.
Petersen is a director of Spectrum Control.
Jan R. Van Gorder has been Senior Executive Vice President, Secretary and
General Counsel of the Company since 1990. Mr. Van Gorder served as Acting
President and Chief Executive Officer from January 2002 to May 2002.
Robert C. Wilburn has been President and Chief Executive Officer of the
Gettysburg National Battlefield Museum Foundation since 2000, and Distinguished
Service Professor, Carnegie Mellon University, since 1999. Mr. Wilburn was
President and Chief Executive Officer of the Colonial Williamsburg Foundation
from 1992 to 1999.
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Information regarding the compensation and benefits of the Company's
directors and executive and division officers is included in the proxy
statements relating to the Company's annual meetings of shareholders that are
incorporated herein by reference.
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EXECUTIVE OFFICERS
The following table sets forth certain information regarding executive
officers of companies that comprise Erie Insurance Group, each of whom has
served with us for more than 20 years.
Name Age Positions
------------------------- ----- ----------------------------------------------
Jeffrey A. Ludrof 43 President and Chief Executive Officer since
May 2002
Jan R. Van Gorder 55 Senior Executive Vice President, Secretary and
General Counsel since 1990
Philip A. Garcia 46 Executive Vice President and Chief Financial
Officer since 1997
John J. Brinling, Jr. 55 Executive Vice President, Erie Family Life
Insurance Company, since 1990
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
J. Ralph Borneman, Jr. and Samuel P. Black, III, two of our directors, are
also officers and principal shareholders of insurance agencies that receive
insurance commissions in the ordinary course of business from the insurance
companies we manage in accordance with the insurance companies' standard
commission schedules and agents' contracts. During 2001, the Borneman agencies
were paid $3,761,503 and the Black agencies were paid $517,923 in commissions
for insurance business placed with the insurance companies we managed. In 1999,
2000 and 2001, Mr. Borneman, in his capacity as an insurance agent, received a
commission of $4,500 in connection with a workers' compensation insurance policy
covering our employees that he placed with Fireman's Fund Insurance Company,
based on competitive bids. The policy was placed with another insurance carrier
as of January 1, 2002, and Mr. Borneman will not receive any commission from the
placement of this policy.
John M. Petersen, a director and a former President and Chief Executive
Officer who retired on December 31, 1995 and who served as Chief Investment
Officer for Erie Insurance Group companies for many years, is a party to a
consulting arrangement with us. Under the consulting arrangement, which is
terminable on 30 days notice by either party, Mr. Petersen provides investment
services with respect to the common stock investments of us, our pension trust,
the Exchange and Erie Family Life Insurance Company. As compensation for his
services, Mr. Petersen receives a fee of 0.15 of 1%, on an annualized basis, of
the fair market value of the common equities portfolios he manages. We also pay
for all necessary and reasonable expenses incurred by Mr. Petersen in rendering
the services he provides. The payments to Mr. Petersen in 2001 for services he
rendered to the Exchange, us, our pension trust and Erie Family Life Insurance
Company were $4,584,610, $177,956, $135,723 and $93,632, respectively, or a
total of $4,991,921.
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PRINCIPAL SHAREHOLDERS
The following table sets forth as of December 31, 2002, the amount and
percentage of our outstanding Class A common stock and Class B common stock
beneficially owned by (i) each person who is known by us to own beneficially
more than 5% of our Class A common stock or Class B common stock, (ii) each
director of the Company, (iii) each of our five highest-paid executive officers
in 2001 and (iv) all of our officers and directors as a group.
At December 31, 2002
-------------------------------------------------------------------------------------
Shares of Class A Percent of Shares of Percent of
Name of Individual Common Stock Outstanding Class B Common Outstanding
or Identity of Group Beneficially Class A Stock Beneficially Class B Common
-------------------- Owned (12)(13) Common Stock (14) Owned (12)(13) Stock (14)
-------------- ----------------- -------------- ----------
5% HOLDERS:
SELLING SHAREHOLDER:
Black Interests Limited Partnership (1) 8,726,250 13.63% 390 13.45%
Erie, Pennsylvania
OTHER SHAREHOLDERS:
Samuel P. Black, III (1)(2) 8,880,286 13.87% 410 14.14%
Erie, Pennsylvania
Hagen Family Limited Partnership (3)(4) 10,092,900 15.76% 1 ---
Erie, Pennsylvania
H.O. Hirt Trusts (5) --- --- 2,340 80.69%
Erie, Pennsylvania
Susan Hirt Hagen (3)(4)(5) 6,659,086 10.40% 2,352 81.10%
Erie, Pennsylvania
Hirt Family Limited Partnership (6)(7) 11,830,000 18.47% --- ---
Erie, Pennsylvania
F. William Hirt (5)(6)(7) 12,718,546 19.86% 2,360 81.38%
Erie, Pennsylvania
DIRECTORS (8):
J. Ralph Borneman, Jr. 50,286 --- --- ---
Patricia A. Garrison-Corbin 386 --- --- ---
Samuel P. Katz 786 --- --- ---
Claude C. Lilly, III 786 --- --- ---
Jeffrey A. Ludrof 2,326 --- --- ---
Henry N. Nassau 886 --- --- ---
John M. Petersen (9) 2,260,323 3.53% 1 ---
Jan R. Van Gorder 122,167 --- 1 ---
Robert C. Wilburn 2,286 --- --- ---
EXECUTIVE OFFICERS (10):
Philip A. Garcia 90,835 --- --- ---
John J. Brinling, Jr. 15,075 --- --- ---
All Directors and Executive Officers
as a group (15 persons) (11) 40,915,755 63.89% 2,788 96.14%
-------------
(1) Mr. Black is the managing general partner and a limited partner of Black
Interests Limited Partnership. Mr. Black has the right to vote the
shares held by Black Interests Limited Partnership. If all of the 390
shares of Class B common stock beneficially owned by the Black Interests
Limited Partnership were converted into Class A common stock, the
maximum number of shares of Class A common stock that the Black
Interests Limited Partnership could be deemed to own would be 9,662,250
shares of Class A common stock, or 14.87% of the then outstanding shares
of Class A common stock.
(2) Mr. Black owns 130,036 shares of Class A common stock directly and
24,000 shares of Class A common stock indirectly through Samuel P. Black
& Associates, of which Mr. Black is President and for which Mr. Black
has the right to vote the shares. Mr. Black also owns 20 shares of Class
B common stock directly. If all of these 20 shares of Class B common
stock were converted into Class A common stock, the maximum number of
shares of Class A common stock that Mr. Black could be deemed to own
would be 202,036
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shares of Class A common stock, or less than 1% of the then outstanding
shares of Class A common stock. The beneficial ownership of Class A common
stock and Class B common stock includes the 8,726,250 shares of Class A
common stock and 390 shares of Class B common stock owned by the Black
Interests Limited Partnership discussed in footnote 1. The maximum number
of shares of Class A common stock that could be deemed beneficially owned
by Mr. Black and Black Interests Limited Partnership, including upon
conversion of Class B common stock, would be 9,864,286 shares of Class A
common stock or 15.17% of the then outstanding shares of Class A common
stock.
(3) Mrs. Hagen and her husband, Thomas B. Hagen, are limited partners of the
Hagen Family Limited Partnership and Mr. Hagen is the general partner. If
the share of Class B common stock beneficially owned by the Hagen Family
Limited Partnership were converted into Class A common stock, the maximum
number of shares of Class A common stock that the Hagen Family Limited
Partnership could be deemed to own beneficially would be 10,095,300 shares
of Class A common stock, or 15.76% of the then outstanding shares of Class
A common stock.
(4) Mrs. Hagen owns 586 shares of Class A common stock directly and 6,658,500
shares of Class A common stock indirectly through a personal trust of which
Mrs. Hagen is the sole trustee. Mrs. Hagen owns 12 shares of Class B common
stock directly. If all 12 of these shares of Class B common stock Mrs.
Hagen could be deemed to own beneficially were converted into Class A
common stock, the maximum number of shares of Class A common stock that
Mrs. Hagen could be deemed to own beneficially would be 6,687,886 shares of
Class A common stock, or 10.44% of the then outstanding shares of Class A
common stock. Thomas B. Hagen, Mrs. Hagen's husband, disclaims beneficial
ownership of the shares of Class A common stock and Class B common stock
owned by Mrs. Hagen. Mrs. Hagen disclaims beneficial ownership of the Class
A common stock and Class B common stock owned by Mr. Hagen. Mrs. Hagen also
disclaims beneficial ownership of the 10,092,900 shares of Class A common
stock and one share of Class B common stock owned by the Hagen Family
Limited Partnership discussed in footnote 3. However, the beneficial
ownership for Mrs. Hagen includes the 2,340 shares of Class B common stock
owned by the H.O. Hirt Trusts discussed in footnote 5. The maximum number
of shares of Class A common stock that could be deemed beneficially owned
by Mrs. Hagen, Mr. Hagen and the Hagen Family Limited Partnership,
including upon conversion of Class B common stock, would be 22,411,486
shares of Class A common stock or 32.16% of the then outstanding shares of
Class A common stock.
(5) There are two H.O. Hirt Trusts, one for the benefit of Mr. Hirt and one for
the benefit of Mrs. Hagen. Each of the H.O. Hirt Trusts is the record owner
of 1,170 shares of Class B common stock, or 40.34% of the outstanding
shares of Class B common stock. The trustees of the H.O. Hirt Trusts as of
the date of this prospectus are Mr. Hirt, Mrs. Hagen and Bankers Trust
Company. Mr. Hirt and Mrs. Hagen, who are brother and sister, are each the
beneficial owner of 1,170 shares of Class B common stock held by the H.O.
Hirt Trust of which each is the beneficiary and, as Co-Trustees, along with
Bankers Trust Company, have shared voting power over the 2,340 shares of
Class B common stock held by the H.O. Hirt Trusts. If all 2,340 shares of
Class B common stock the H.O. Hirt Trusts own were converted into Class A
common stock, the maximum number of shares of Class A common stock that the
H.O. Hirt Trusts could own would be 5,616,000 shares of Class A common
stock or 8.06% of the then outstanding shares of Class A common stock.
(6) Mr. Hirt is the general and a limited partner of the Hirt Family Limited
Partnership.
(7) Mr. Hirt owns 888,546 shares of Class A common stock directly. Mr. Hirt
also owns 20 shares of Class B common stock directly. If all of these 20
shares of Class B common stock were converted into Class A common stock,
the maximum number of shares of Class A common stock that Mr. Hirt could be
deemed to own beneficially would be 936,546 shares of Class A common stock,
or 1.46% of the then outstanding shares of Class A common stock. The
beneficial ownership of Class A common stock and Class B common stock
includes the 11,830,000 shares of Class A common stock owned by the Hirt
Family Limited Partnership discussed in footnote 6 and the 2,340 shares of
Class B common stock owned by the H.O Hirt Trusts discussed in footnote 5.
The maximum number of shares of Class A common stock that could be deemed
beneficially owned by Mr. Hirt, the Hirt Family Limited Partnership and the
H.O. Hirt Trusts, including upon conversion of Class B common stock, would
be 18,382,546 shares of Class A common stock or 26.37% of the then
outstanding shares of Class A common stock.
(8) Excludes directors listed under "5% Holders".
(9) Mr. Petersen disclaims beneficial ownership of 120,000 shares of Class A
common stock owned by his wife, Gertrude E. Petersen, which have been
included in the total listed herein. The total also includes 200,000 shares
held in the Petersen Family Limited Partnership of which Mr. Petersen is
the general partner.
(10) Excludes executive officers listed under "Directors".
(11) If all of the 2,788 shares of Class B common stock beneficially owned by
the directors and executive officers were converted into Class A common
stock, the maximum number of shares of Class A common stock that the
directors and executive officers could be deemed to own would be 47,606,955
shares of Class A common stock, or 67.31% of the then outstanding shares of
Class A common stock.
(12) Information furnished by the named persons.
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(13) Under the rules of the SEC, a person is deemed to be the beneficial owner
of securities if the person has, or shares, "voting power" (which includes
the power to vote, or to direct the voting of, such securities) or
"investment power" (which includes the power to dispose, or to direct the
disposition, of such securities). Under these rules, more than one person
may be deemed to be the beneficial owner of the same securities. Securities
beneficially owned also include securities owned jointly, in whole or in
part, or individually by the person's spouse, minor children or other
relatives who share the same home. The information set forth in the above
table includes all shares of Class A common stock over which the named
individuals, individually or together, share voting power or investment
power, adjusted, however to eliminate the reporting of shares more than
once in order not to overstate the aggregate beneficial ownership of such
persons and to reflect shares as to which the named individuals disclaim
beneficial ownership. The table does not reflect shares of Class A common
stock issuable upon conversion of shares of Class B common stock, each of
which is currently convertible into 2,400 shares of Class A common stock.
(14) Less than 1% unless otherwise indicated.
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THE H.O. HIRT TRUSTS
The H.O. Hirt Trusts own 80.7% of our Class B common stock, which is the
only class of stock that can vote for the election of directors and most other
matters. The trustees of the H.O. Hirt Trusts are Bankers Trust and F. William
Hirt and Susan Hirt Hagen, who are brother and sister. Any determination by the
H.O. Hirt Trusts requires a vote of two of the three trustees and, because the
H.O. Hirt Trusts control 80.7% of our Class B voting stock, any such
determination will control the outcome of any matter submitted for shareholder
approval, except those matters pertaining only to the rights of the holders of
Class A common stock.
PURPOSE OF THE H.O. HIRT TRUSTS
The purpose of the H.O. Hirt Trusts, as set forth in paragraph 4.03(B) of
the H.O. Hirt Trust Agreement, is as follows:
"The Settlor [H.O. Hirt] hereby declares that the purpose of this Trust is
to create and preserve unified ownership and control of ERIE INDEMNITY
COMPANY as a means of preserving the existence of ERIE INSURANCE EXCHANGE
and ERIE INDEMNITY COMPANY as viable entities capable of furnishing
insurance to subscribers at the Exchange and employment to loyal employees
of the Exchange and the Company. The Settlor further declares that in his
experience in the insurance business over half a century, including the
Great Depression of the 1930's, World War II, the Korean and Viet Nam wars
and several recessions, he has never lost sight of the fact that ERIE
INSURANCE EXCHANGE, as a reciprocal insurer, was organized and exists
primarily for the benefit of its subscribers or policyholders and that
therefore the interests of the people who put their trust in the Exchange
for the protection of their personal and business affairs must come first.
However, when the Exchange is healthy, its managing attorney-in-fact ERIE
INDEMNITY COMPANY, will necessarily be prosperous and healthy, to the
benefit of the stockholders of the latter. The Settlor therefore urges that
the Trustees [currently Bankers Trust, F. William Hirt and Susan Hirt
Hagen] familiarize themselves with the nature of reciprocal insurers in
general and the ERIE INSURANCE EXCHANGE in particular; that in the
discharge of their trust duties they concentrate, in cooperation with the
Board of Directors of ERIE INDEMNITY COMPANY and the individual whom the
Board designates from time to time as "Manager" of the Exchange and
Company, to keep ERIE INSURANCE EXCHANGE in the best of health; and that
only when the task proves impossible shall they consider what then appears
to them to be a logical change to prevent deterioration and possible
disaster to the interests of all concerned."
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CERTAIN RECENT LITIGATION INVOLVING THE H.O. HIRT TRUSTS OR THE INDIVIDUAL
TRUSTEES OF THE H.O. HIRT TRUSTS AND THE COMPANY
LEGAL PROCEEDINGS RELATING TO THE APPOINTMENT OF A SUCCESSOR CORPORATE
TRUSTEE TO BANKERS TRUST
On March 3, 1999, Bankers Trust filed a petition with the Orphans' Court
Division of the Court of Common Pleas of Erie County, Pennsylvania (the
"Court"), requesting that the Court accept its resignation as corporate trustee
of the H.O. Hirt Trusts. Two successor corporate trustee candidates, one
supported by Mr. Hirt and one supported by Mrs. Hagen, have presented testimony
to the Court in this matter. Subsequent to that testimony, Laurel Hirt, Mr.
Hirt's daughter and a contingent beneficiary of the H.O. Hirt Trusts, filed a
petition requesting that the Court also consider a third successor corporate
trustee candidate not supported by Mr. Hirt. Mr. Hirt has made a filing
objecting to Ms. Hirt's petition that is pending. Mrs. Hagen has not stated a
position on Ms. Hirt's petition.
In a related matter, Mr. Hirt and Mrs. Hagen were subject to a February 23,
2000 order issued by the Court to finalize certain matters relating to a
so-called "funding plan" for the payment of the fees and costs of the successor
corporate co-trustee and to make application to the Internal Revenue Service for
a private letter ruling on the tax treatment of the finalized "funding plan". On
June 13, 2002, the Court granted a petition filed by the trustees of the H.O.
Hirt Trusts that permits the H.O. Hirt Trusts, under certain circumstances, to
sell shares owned by the H.O. Hirt Trusts in order to fund the fees and expenses
of the corporate trustee. Ms. Hirt has filed a notice of appeal with respect to
this decision.
PETITION FOR DECLARATORY JUDGMENT FILED BY BANKERS TRUST
On May 6, 1999, Bankers Trust, in its capacity as corporate trustee of the
H.O. Hirt Trusts, filed a petition with the Court seeking a determination
whether Section 1405(c)(4) of the Pennsylvania Insurance Holding Companies Act
provides the exclusive means by which persons may be nominated and elected to
the Company's board of directors or whether shareholders independently have the
power to nominate and elect to the board of directors persons other than those
nominated by the nominating committee of the board of directors. Mrs. Hagen
supported the petition, which was opposed by the Company and Mr. Hirt. On July
15, 1999, the Court dismissed the petition for lack of ripeness.
LITIGATION REGARDING NOMINATIONS OF CANDIDATES FOR ELECTION AS DIRECTORS BY
THE HOLDERS OF CLASS B COMMON STOCK
On March 9, 2000, Mrs. Hagen commenced litigation in the Court in which she
sought relief in the form of an order that (i) the nominating committee of the
Company's board of directors does not have the exclusive right to nominate
candidates for election as directors of the Company by shareholders, (ii) any
holder of Class B common stock may nominate
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directly candidates for election as directors of the Company by shareholders and
vote on those nominees and (iii) Mrs. Hagen has the right to submit nominees to
a vote of Class B shareholders at annual meetings. On April 5, 2001, a
Stipulation among Mrs. Hagen, Bankers Trust and the Company was filed with the
Court whereby these three parties agreed to accept as a final adjudication of
this matter an April 24, 2000 ruling by the Court granting a preliminary
injunction, as requested by Mrs. Hagen, allowing the nomination by holders of
Class B common stock directly of candidates for director in addition to those
nominated by the nominating committee. The Stipulation is not binding on any
other parties other than the signatories to the Stipulation.
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SELLING SHAREHOLDER
Black Interests Limited Partnership (the "Selling Shareholder") is offering
4.0 million shares of the Company's Class A common stock. The Selling
Shareholder has also granted the underwriters a 30-day option to purchase up to
an additional 600,000 shares of the Company's Class A common stock. Samuel P.
Black, III is the managing general partner of the partnership and has the right
to vote the shares held by it. Mr. Black has been a director of our Company
since 1997 and succeeded his father who served as a director during various
periods from 1930 to 1997. Mr. Black is also an officer and principal
shareholder of an insurance agency that receives insurance commissions in the
ordinary course of business from the insurance companies we manage in accordance
with the insurance companies' standard commission schedules and agents'
contracts.
A majority of the proceeds of the shares being offered as described in this
prospectus will be used by the Selling Shareholder to pay estate taxes and other
estate-related expenses arising from the recent death of the mother of Mr. Black
and to make a charitable bequest. The following table lists the shares of Class
A common stock and percentage of outstanding Class A common stock beneficially
owned by the Selling Shareholder both before and after this offering.
Percent of Percent of
Shares of Class A Outstanding Shares of Class A Outstanding
Common Stock Class A Common Stock Class A
Name of Beneficially Owned Common Stock Shares to Beneficially Owned Common Stock
Selling Shareholder Prior to the Offering Prior to the Offering be Sold After the Offering(1) After the Offering(1)
------------------- --------------------- --------------------- ------- --------------------- ---------------------
Black Interests 8,726,250 13.63% 4,000,000 4,726,250 7.38%
Limited
Partnership
------------------
(1) Assumes the option granted to the underwriters to purchase up to 600,000
shares is not exercised. If the option is exercised in full, the Selling
Shareholder will own 4,126,250 shares of Class A common stock, or 6.44%,
after the offering.
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DESCRIPTION OF CAPITAL STOCK
As of January 1, 2003, our authorized capital stock consisted of 74,996,930
shares of Class A common stock, of which 64,037,106 shares were outstanding, and
2,900 shares of Class B common stock, of which 2,900 shares were outstanding.
Our shares of Class A common stock do not have the right to vote on matters
submitted to a vote of shareholders, except in the instance where applicable law
permits shares of Class A common stock to vote as a class in regard to any
change in the rights, preferences and privileges of our Class A common stock.
If a dividend is declared and paid on our Class B common stock, each share
of Class A common stock is entitled to the declaration and payment of a
dividend, at the same time and on the same record date, in an amount at least
equal to 2/3 of 1% of the dividend per share paid on our Class B common stock.
In addition, shares of Class A common stock are entitled to receive dividends,
if declared by our board of directors out of funds legally available therefor,
without any requirement that a simultaneous dividend be declared on our Class B
common stock.
Holders of Class A common stock have the preemptive right to subscribe for
and purchase, pro rata according to the number of shares held, any shares of
Class A common stock we offer for sale for a cash consideration upon such terms
as are fixed by our board of directors. This preemptive right does not apply to
conversion of our Class B common stock into our Class A common stock. Our Class
B common stock is convertible into our Class A common stock at the rate of 2,400
shares of Class A common stock for each share of Class B common stock and cannot
be reissued following conversion or retirement.
In the event of our liquidation, dissolution or winding-up, holders of
Class A common stock and Class B common stock are entitled to share ratably in
any assets available for distribution to shareholders and, in such event, each
share of Class B common stock would be treated as if it had been converted into
2,400 shares of Class A common stock.
The ownership of more than a majority of our Class B common stock by the
H.O. Hirt Trusts, which by its terms authorize a change of control transaction
only if it is required to maintain the health of the Exchange, can be expected
to have the effect of preventing a change in control of us.
Our By-laws provide that each director shall perform his or her duties in
good faith, in a manner the director reasonably believes to be in our best
interests and with such care, including reasonable inquiry, skill and diligence,
as a person of ordinary prudence would use under similar circumstances. Our
By-laws further provide, as permitted by Pennsylvania law, that a director shall
not have any personal liability, as such, for monetary damages for any action
taken by the director unless (i) the director has breached or failed to perform
the director's duties as stated above and (ii) the breach or failure constitutes
self-dealing, willful
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misconduct or recklessness. This limitation on liability is not applicable to
the liability of a director pursuant to any criminal statute or for the payment
of taxes pursuant to local, state or federal law.
SHARES ELIGIBLE FOR FUTURE SALE
The market price of our Class A common stock could drop due to sales of a
large number of shares of our Class A common stock or the perception that such
sales could occur. These factors could also make it more difficult to raise
funds through future offerings of common stock.
After the offering described in this prospectus, 64,037,106 shares of Class
A common stock will be outstanding, which, except for any shares held by
"affiliates" of the Company as defined in Rule 144 under the Securities Act of
1933, are freely tradable without registration under the Securities Act of 1933.
Shares held by affiliates can be sold in compliance with Rule 144, pursuant to
another exemption from registration or by registering such shares for resale
under the Securities Act of 1933.
In general, under Rule 144 as currently in effect, any person who is an
affiliate or certain persons whose shares are aggregated with our affiliate, is
entitled to sell, within any three-month period, a number of shares that does
not exceed the greater of:
. 1% of the number of then-outstanding shares of Class A common stock;
and
. the average weekly trading volume in the Class A common stock during
the four calendar weeks preceding the date on which the notice of such sale
on Form 144 is filed with the Securities and Exchange Commission or, if on
such notice is required to be filed, the date of receipt of the order to
execute the transaction by the broker or the date of execution of the
transaction directly with a market maker.
In connection with this offering, the Company, certain of its directors and
officers, the Selling Shareholder and certain other shareholders have indicated
that they will enter into lock-up agreements under which they will generally
agree not to dispose of or hedge any of their shares or securities convertible
into or exchangeable for shares of common stock of the Company during the 90-day
period from the date of this prospectus without prior written approval of the
underwriters. Certain of our existing shareholders, however, have not indicated
that they will agree to enter into lock-up agreements, including Susan Hirt
Hagen, who is a member of our board of directors and a trustee and a beneficiary
of the H.O. Hirt Trusts and Thomas B. Hagen, who is Mrs. Hagen's husband. Also,
Laurel A. Hirt has indicated that she will not agree to enter into a lock-up
agreement. Ms. Hirt is a daughter of F. William Hirt, the chairman of our board
of directors. Mr. Hirt is also a trustee and a beneficiary of the H.O. Hirt
Trusts. Although we have not received any indication that Mr.
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and Mrs. Hagen or Laurel Hirt are planning to sell Class A shares during the
90-day period from the date of this prospectus, Mr. and Mrs. Hagen and Laurel
Hirt, if they do not execute lock-up agreements, may have available for sale up
to 31.76% of the outstanding Class A shares, assuming no further conversion of
Class B shares into Class A shares. Sales, or the availability for sale, by
these shareholders following the consummation of this offering of a substantial
number of shares of our Class A common stock that are not subject to lock-up
agreements may have an adverse effect on the market price of our Class A common
stock.
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UNDERWRITING
The Company, the selling shareholder and the underwriters named below have
entered into an underwriting agreement with respect to the shares being offered.
Subject to certain conditions, each underwriter has severally agreed to purchase
the number of shares indicated in the following table. Goldman, Sachs & Co.,
Credit Suisse First Boston Corporation, Advest, Inc., Cochran, Caronia
Securities LLC and Legg Mason Wood Walker, Incorporated are acting as the
representatives of the underwriters.
Underwriters Number of Shares
------------ ----------------
Goldman, Sachs & Co. ...............................
Credit Suisse First Boston Corporation .............
Advest, Inc. .......................................
Cochran, Caronia Securities LLC ....................
Legg Mason Wood Walker, Incorporated ...............
---------
Total ......................................... 4,000,000
=========
The underwriters are committed to take and pay for all of the shares being
offered, if any are taken, other than the shares covered by the option described
below, unless and until this option is exercised.
If the underwriters sell more than the total number set forth in the table
above, the underwriters have an option to buy an additional 600,000 shares of
Class A common stock from the selling shareholder. They may exercise that option
for 30 days. If any shares are purchased pursuant to this option, the
underwriters will severally purchase shares in approximately the same portion as
set forth in the above table.
The following table shows the per share and total underwriting discounts
and commissions to be paid to each underwriter by the Selling Shareholder. Such
amounts are shown assuming both no exercise and full exercise of the
underwriters' option to purchase 600,000 additional shares of Class A common
stock.
Paid by the Selling Shareholder No Exercise Full Exercise
------------------------------- ----------- -------------
Per Share .......................................... $ $
Total .............................................. $ $
Shares sold by the underwriters to the public will initially be offered at
the initial price to public set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $_____ per share from the initial price to
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the public. Any such securities dealers may resell any shares purchased from
underwriters to certain other brokers or dealers at a discount of up to $_____
per share from the initial price to the public. If all the shares are not sold
at the initial price to the public, the representatives may change the offering
price and the other selling terms.
The Company, certain of its directors and officers, the Selling Shareholder
and certain other shareholders have agreed not to dispose of or hedge any of
their shares or securities convertible into or exchangeable for shares of common
stock of the Company during the period from the date of this prospectus
continuing through the date 90 days after the date of this prospectus, except
with the prior written consent of Goldman, Sachs & Co. This agreement does not
apply to any existing employee benefit plans of the Company. See "Shares
Eligible for Future Sale" for a discussion of certain transfer restrictions and
shares not expected to be subject to lock-up agreements.
The Company's Class A common stock is quoted on the NASDAQ Stock Market(SM)
under the symbol "ERIE."
A prospectus in electronic form may be made available on the websites
maintained by one or more of the representatives of the underwriters of this
offering and may also be made available on websites maintained by other
underwriters. The underwriters may agree to allocate a number of shares to
underwriters for sale to their online brokerage account holders. Underwriters
may make Internet distributions on the same basis as other allocations.
In connection with this offering, the underwriters may purchase and sell
shares of the Class A common stock in the open market. These transactions may
include short sales, stabilizing transactions and purchases to cover positions
created by short sales. Shorts sales involve the sale by the underwriters of a
greater number of shares than they are required to purchase in the offering.
"Covered" short sales are sales made in an amount not greater than the
underwriters' option to purchase additional shares from the Selling Shareholder
in the offering. The underwriters may close out any covered short position by
either exercising their option to purchase additional shares or purchasing
shares in the open market. In determining the source of shares to close out the
covered short position, the underwriters will consider, among other things, the
price of shares available for purchase in the open market as compared to the
price at which they may purchase shares through the overallotment option.
"Naked" short sales are any sales in excess of such option. The underwriters
must close out any naked short position by purchasing shares in the open market.
A naked short position is more likely to be created if the underwriters are
concerned that there may be downward pressure on the price of the Class A common
stock in the open market after pricing that could adversely affect investors who
purchase in the offering. Stabilizing transactions consist of various bids for
or purchases of the Class A common stock made by the underwriters in the open
market prior to the completion of the offering.
-120-
The underwriters also may impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representatives have purchased shares sold
by or for the account of such underwriter in stabilizing or short covering
transaction.
Purchases to cover a short position and stabilizing transactions may have
the effect of preventing or retarding a decline in the market price of the
Company's Class A common stock, and together with the imposition of the penalty
bid, may stabilize, maintain or otherwise affect the market price of the common
stock. As a result, the price of the Class A common stock may be higher than the
price that otherwise might exist in the open market. If these activities are
commenced, they may be discontinued at any time. These transactions may be
effected on the NASDAQ National Market System, in the over-the-counter market or
otherwise.
Each underwriter has agreed that (i) it has not offered or sold, and prior
to the six months after the date of issue of the notes will not offer or sell
any securities to persons in the United Kingdom except to persons whose ordinary
activities involve them in acquiring, holding, managing or disposing of
investments (as principal or agent) for purposes of their businesses or
otherwise in circumstances which have not resulted and will not result in an
offer to the public in the United Kingdom within the meaning of the Public
Offers of Securities Regulations 1995; (ii) it has complied, and will comply
with, all applicable provisions of the Financial Services and Markets Act of
2000 of Great Britain ("FSMA") with respect to anything done by it in relation
to the securities in, from or otherwise involving the United Kingdom, and (iii)
it has only communicated or caused to be communicated and will only communicate
or cause to be communicated any invitation or indictment to engage in investment
activity (within the meaning of section 21 of the FSMA) received by it in
connection with the issue or sale of any securities in circumstances in which
section 21(l) of the FSMA does not apply to the issuer.
The securities have not been and will not be registered under the
Securities and Exchange Law of Japan. Each underwriter has represented and
agreed that it has not offered or sold, and it will not offer or sell, directly
or indirectly, any securities in Japan or to, or for the account or benefit of,
any resident of Japan or to, or for the account or benefit, of any resident of
reoffering or resale, directly or indirectly, in Japan, or to, or for the
account or benefit of, any resident of Japan except (i) pursuant to an exemption
from the registration requirements of, or otherwise in compliance with, the
Securities and Exchange Law of Japan and (ii) in compliance with the other
relevant laws and regulations of Japan.
No offer to sell the securities has been or will be made in the Hong Kong
Special Administrative Region of the Peoples Republic of China ("Hong Kong"), by
means of any document, other than to persons whose ordinary business is to buy
or sell shares or debentures, whether as principal or agent, except in
circumstances which do not constitute an offer to the public within the meaning
of the Companies Ordinance (Cap. 32) of Hong Kong,
-121-
and unless permitted to do so under the securities laws of Hong Kong, no person
has issued or had in its possession for the purposes of issue, and will not
issue or have in its possession for the purpose of issue, any advertisement,
document or invitation relating to the securities in Hong Kong other than with
respect to the securities intended to be disposed of to persons outside Hong
Kong or only to persons whose business involves the acquisition, disposal or
holding of securities whether as principal or agent.
This prospectus has not been registered as a prospectus with the Monetary
Authority of Singapore. Accordingly, this prospectus and any other document or
material in connection with the offer or sale, or invitation or subscription or
purchase, of the securities may not be circulated or distributed, nor may the
securities be offered or sold, or be made the subject of an invitation for
subscription or purchase, whether directly or indirectly, to persons in
Singapore other than under circumstances in which such offer, sale or invitation
does not constitute an offer or sale, or invitation for subscription or
purchase, of the securities to the public in Singapore.
The Selling Shareholder estimates that the total expenses of this offering,
excluding underwriting discounts and commissions, will be approximately $_____.
The Company and the Selling Shareholder have agreed to indemnify the
underwriters against certain liabilities, including liabilities under the
Securities Act of 1933.
-122-
VALIDITY OF COMMON STOCK
Certain legal matters with respect to the validity of the Class A common
stock will be passed upon for us by Duane Morris LLP, Philadelphia,
Pennsylvania. Certain legal matters with respect to the validity of the Class A
common stock will be passed upon for the underwriters by Sullivan & Cromwell
LLP, New York, New York, in reliance on the opinion of Duane Morris LLP with
respect to Pennsylvania law.
EXPERTS
The financial statements included in this Registration Statement have been
so included on the report of Malin, Bergquist & Company, LLP, independent
auditors, given on the authority of said firm as experts in auditing and
accounting.
The audit committee of our board of directors annually considers the
selection of our independent auditors. On September 10, 2002, the audit
committee selected Ernst & Young, LLP as our independent auditors for the fiscal
year ending December 31, 2003.
-123-
WHERE TO FIND MORE INFORMATION/INCORPORATION BY REFERENCE
We file reports, proxy statements and other information with the Securities
and Exchange Commission. Our SEC filings are also available over the Internet at
the SEC's web site at http://www.sec.gov. You may also read and copy any
document we file at the SEC's public reference room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for more
information about the public reference room.
The SEC allows us to "incorporate by reference" the information we file
with them, which means:
. incorporated documents are considered part of the prospectus;
. we can disclose important information to you by referring you to those
documents; and
. information that we file with the SEC will automatically update and
supersede the prospectus.
We are incorporating by reference the documents listed below that were
filed with the SEC under the Securities Exchange Act of 1934 under File No.
0-24000:
. Annual Report on Form 10-K for the year ended December 31, 2001;
. Definitive proxy statement filed under Section 14 of the Securities
Exchange Act of 1934 in connection with the shareholders' meetings held on
April 24, 2001 and April 30, 2002;
. Quarterly Reports on Form 10-Q for the quarters ended March 31, 2002,
June 30, 2002 and September 30, 2002; and
. Current Reports on Form 8-K filed January 23, 2002, May 8, 2002, July
24, 2002, September 13, 2002, December 11, 2002, December 23, 2002 and
January 7, 2003.
We also incorporate by reference each of the following documents that we
will file with the SEC after the date of the prospectus but before the end of
the offering:
. Reports filed under Sections 13(a) and (c) of the Securities Exchange
Act of 1934;
. Definitive proxy or information statements filed under Section 14 of
the Securities Exchange Act of 1934 in connection with any subsequent
shareholders' meeting; and
. Any reports filed under Section 15(d) of the Securities Exchange Act
of 1934.
-124-
You may request a copy of these filings, at no cost, by contacting us
at the following address or phone number:
Erie Indemnity Company
Attn: Jan R. Van Gorder,
Senior Executive Vice President,
Secretary and General Counsel
100 Erie Insurance Place
Erie, Pennsylvania 16530
Tel: (814) 870-2000
http://www.erieinsurance.com
You should rely only on the information incorporated by reference or
provided in this prospectus or any supplement. We have not authorized anyone
else to provide you with different information. The Selling Shareholder will not
make an offer of these shares in any state where the offer is not permitted. You
should not assume that the information in this prospectus or any supplement is
accurate as of any date other than the date on the front of these documents.
This prospectus is part of a Registration Statement on Form S-3 we filed
with the SEC (Registration No. 333-99943).
-125-
ERIE INDEMNITY COMPANY
INDEX TO FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report ...................................................... F-2
Consolidated Statements of Financial Position as of
December 31, 2001 and 2000 ...................................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 2001, 2000 and 1999 ................................................ F-5
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 2001, 2000 and 1999 .......................................... F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999 ................................................ F-8
Notes to Consolidated Financial Statements ........................................ F-10
Unaudited Consolidated Statement of Financial Position as of
September 30, 2002 .............................................................. F-52
Unaudited Consolidated Statements of Operations for the
nine-month periods ended September 30, 2002 and 2001 ............................ F-54
Unaudited Consolidated Statements of Comprehensive Income for the
nine-month periods ended September 30, 2002 and 2001 ............................ F-55
Unaudited Consolidated Statements of Cash Flows for the
nine-month periods ended September 30, 2002 and 2001 ............................ F-56
Notes to Unaudited Consolidated Financial Statements (Unaudited) .................. F-57
F-1
INDEPENDENT AUDITORS' REPORT
ON THE CONSOLIDATED FINANCIAL STATEMENTS
To the Board of Directors and Shareholders
Erie Indemnity Company
Erie, Pennsylvania
We have audited the accompanying Consolidated Statements of Financial Position
of Erie Indemnity Company and subsidiaries as of December 31, 2001 and 2000, and
the related Consolidated Statements of Operations, Shareholders' Equity, and
Cash Flows for each of the three years in the period ended December 31, 2001.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Erie Indemnity
Company and subsidiaries as of December 31, 2001 and 2000, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2001 in conformity with accounting principles generally
accepted in the United States of America.
Erie, Pennsylvania
February 7, 2002
MALIN, BERGQUIST & COMPANY LLP
F-2
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
As of December 31, 2001 and 2000
(Dollars in thousands)
ASSETS 2001 2000
------------ -------------
Investments:
Fixed maturities at fair value
(amortized cost of $543,423
and $524,172, respectively) $ 559,873 $ 531,546
Equity securities at fair value (cost of
$159,727 and $184,968, respectively) 193,798 204,446
Limited partnerships (cost of $79,668
and $60,661, respectively) 81,596 68,242
Real estate mortgage loans 5,700 6,581
------------ -------------
Total investments $ 840,967 $ 810,815
Cash and cash equivalents 88,213 38,778
Accrued investment income 9,138 9,087
Premiums receivable from Policyholders 186,175 156,269
Prepaid federal income taxes 14,056 3,604
Reinsurance recoverable from Erie Insurance Exchange
on unpaid losses 438,605 375,567
Ceded unearned premiums to Erie Insurance Exchange 52,450 36,483
Note receivable from Erie Family Life Insurance Company 15,000 15,000
Other receivables from Erie Insurance Exchange and affiliates 149,600 119,959
Reinsurance recoverable from non-affiliates 372 712
Deferred policy acquisition costs 17,018 13,202
Property and equipment 14,635 13,856
Equity in Erie Family Life Insurance Company 44,683 42,331
Other assets 64,654 44,936
------------ -------------
Total assets $ 1,935,566 $ 1,680,599
============ =============
See accompanying notes to consolidated financial statements.
F-3
ERIE INDEMNITY COMPANY
LIABILITIES AND SHAREHOLDERS' EQUITY 2001 2000
------------ ------------
LIABILITIES
Unpaid losses and loss adjustment expenses $ 557,278 $ 477,879
Unearned premiums 311,969 263,855
Commissions payable and accrued 110,121 96,823
Accounts payable and accrued expenses 46,164 30,476
Deferred income taxes 12,945 7,161
Dividends payable 10,930 9,839
Employee benefit obligations 20,904 15,551
----------- -----------
Total liabilities $ 1,070,311 $ 901,584
----------- -----------
SHAREHOLDERS' EQUITY
Capital stock
Class A common, stated value $.0292 per
share; authorized 74,996,930 shares; 67,032,000
shares issued; 63,836,323 and 64,056,323 shares
outstanding in 2001 and 2000, respectively $ 1,955 $ 1,955
Class B common, stated value $70 per
share; authorized 3,070 shares;
3,070 shares issued and outstanding 215 215
Additional paid-in capital 7,830 7,830
Accumulated other comprehensive income 35,222 23,182
Retained earnings 913,406 831,552
----------- -----------
Total contributed capital and retained earnings $ 958,628 $ 864,734
Treasury stock, at cost, 3,195,677 shares in
2001 and 2,975,677 in 2000 (93,373) (85,719)
----------- -----------
Total shareholders' equity $ 865,255 $ 779,015
----------- -----------
Total liabilities and shareholders' equity $ 1,935,566 $ 1,680,599
=========== ===========
See accompanying notes to consolidated financial statements.
F-4
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2001, 2000 and 1999
(Amounts in thousands, except per share data)
2001 2000 1999
------------ ------------ -----------
OPERATING REVENUE:
Management fee revenue $ 634,966 $ 551,646 $ 513,375
Premiums earned 137,648 123,708 117,224
Service agreement revenue 27,247 22,662 15,441
----------- ---------- -----------
Total operating revenue $ 799,861 $ 698,016 $ 646,040
----------- ---------- ----------
OPERATING EXPENSES:
Cost of management operations $ 477,645 $ 415,562 $ 380,298
Losses and loss adjustment expenses incurred 117,201 99,564 87,719
Policy acquisition and other underwriting expenses 40,910 34,546 33,044
----------- ---------- -----------
Total operating expenses $ 635,756 $ 549,672 $ 501,061
----------- ---------- ----------
OTHER INCOME AND EXPENSES:
Investment income, net of expenses $ 49,884 $ 48,401 $ 43,344
Net realized (losses) gains on investments (31,879) 16,968 14,746
Equity in (losses) earnings of limited partnerships (7) 4,733 641
----------- ---------- -----------
Total other income and expenses $ 17,998 $ 70,102 $ 58,731
----------- ---------- ----------
Income before income taxes and equity in earnings of
Erie Family Life Insurance Company $ 182,103 $ 218,446 $ 203,710
Less: Provision for income taxes 60,561 71,161 65,296
Equity in earnings of Erie Family Life Insurance
Company, net of tax 719 5,108 4,692
----------- ---------- -----------
NET INCOME $ 122,261 $ 152,393 $ 143,106
=========== ========== ===========
Net income per share $ 1.71 $ 2.12 $ 1.95
=========== ========== ===========
Weighted average shares outstanding 71,342 71,954 73,487
=========== ========== ===========
See accompanying notes to consolidated financial statements.
F-5
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
Total
Shareholders' Comprehensive Retained
Equity Income Earnings
--------------- ------------- --------------
Balance, January 1, 1999 $ 655,223 $ $ 605,045
Comprehensive income
Net income 143,106 $ 143,106 143,106
Unrealized depreciation of investments, net of tax (13,597) (13,597)
-----------
Comprehensive income $ 129,509
===========
Purchase of treasury stock (54,330)
Dividends declared:
Class A $.495 per share (32,575) (32,575)
Class B $74.25 per share (228) (228)
------------ -----------
Balance, December 31, 1999 $ 697,599 $ 715,348
------------ -----------
Comprehensive income
Net income 152,393 $ 152,393 152,393
Unrealized depreciation of investments, net of tax (3,399) (3,399)
-----------
Comprehensive income $ 148,994
===========
Purchase of treasury stock (31,389)
Dividends declared:
Class A $.5575 per share (35,932) (35,932)
Class B $83.625 per share (257) (257)
------------ -----------
Balance, December 31, 2000 $ 779,015 $ 831,552
------------ -----------
Comprehensive income
Net income 122,261 $ 122,261 122,261
Unrealized appreciation of investments, net of tax 14,890 14,890
Minimum pension liability adjustment, net of tax (2,850) (2,850)
-----------
Comprehensive income $ 134,301
===========
Purchase of treasury stock (7,654)
Dividends declared:
Class A $.6275 per share (40,119) (40,119)
Class B $94.125 per share (288) (288)
------------ ----------
Balance, December 31, 2001 $ 865,255 $ 913,406
============ ==========
F-6
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 2001, 2000 and 1999
(Dollars in thousands, except per share data)
Accumulated
Other
Comprehensive Class A Class B Additional Treasury
Income Common Common Paid-in-Capital Stock
--------------- ----------- ----------- ---------------- -----------
$ 40,178 $ 1,955 $ 215 $ 7,830 $ 0
(13,597)
(54,330)
------------ --------- --------- ----------- --------
$ 26,581 $ 1,955 $ 215 $ 7,830 ($54,330)
------------ --------- --------- ----------- --------
(3,399)
(31,389)
------------ --------- --------- ----------- --------
$ 23,182 $ 1,955 $ 215 $ 7,830 ($85,719)
------------ --------- --------- ----------- --------
14,890
(2,850)
(7,654)
------------ --------- --------- ----------- --------
$ 35,222 $ 1,955 $ 215 $ 7,830 ($93,373)
============ ========= ========= =========== ========
See accompanying notes to consolidated financial statements.
F-7
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2001, 2000 and 1999
(Dollars in thousands)
2001 2000 1999
----------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 122,261 $ 152,393 $ 143,106
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 2,350 2,745 1,766
Deferred income tax expense (benefit) 1,013 ( 2,112) ( 1,311)
Amortization of deferred policy acquisition costs 24,276 22,793 22,507
Realized loss (gain) on investments 31,879 ( 16,968) ( 14,746)
Equity in losses (income) from limited partnerships 7 ( 4,733) ( 641)
Net amortization of bond (discount) premium ( 199) ( 43) 80
Undistributed earnings of Erie Family Life 0 ( 4,020) ( 3,696)
Dividends received in excess of undistributed
earnings - Erie Family Life 821 0 0
Deferred compensation 294 642 1,212
Increase in accrued investment income ( 51) ( 1,089) ( 745)
Increase in receivables ( 138,213) ( 76,240) ( 6,274)
Policy acquisition costs deferred ( 28,092) ( 24,591) ( 23,049)
Increase in prepaid expenses and other assets ( 14,460) ( 939) ( 6,185)
Increase in accounts payable and
accrued expenses 16,362 8,068 3,343
Increase in commissions payable and accrued 13,298 3,950 7,868
Increase in income taxes recoverable ( 10,452) ( 629) ( 466)
Increase in loss reserves 79,398 44,984 6,730
Increase in unearned premiums 48,115 26,403 7,469
----------- ---------- ----------
Net cash provided by operating activities $ 148,607 $ 130,614 $ 136,968
----------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments:
Fixed maturities ($ 235,854) ($ 153,029) ($ 162,769)
Equity securities ( 67,549) ( 54,649) ( 71,637)
Mortgage loans 0 0 ( 66)
Limited partnership investments ( 28,380) ( 24,753) ( 20,667)
Sales/maturities of investments:
Fixed maturity sales 109,634 61,333 30,927
Fixed maturity calls/maturities 80,223 59,570 64,094
Equity securities 90,589 55,596 84,187
Mortgage loans 882 1,649 123
Limited partnership sales or distributions 6,634 6,227 1,368
Purchase of property and equipment ( 2,014) ( 308) ( 444)
Purchase of computer software ( 1,113) ( 1,032) ( 4,194)
Loans to agents ( 7,612) ( 1,781) ( 3,459)
Collections on agent loans 2,358 1,719 2,582
----------- ----------- -----------
Net cash used in investing activities ($ 52,202) ($ 49,458) ($ 79,955)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid to shareholders ($ 39,316) ($ 35,203) ($ 32,049)
Purchase of treasury stock ( 7,654) ( 31,389) ( 54,330)
----------- ----------- -----------
Net cash used in financing activities ($ 46,970) ($ 66,592) ($ 86,379)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents $ 49,435 $ 14,564 ($ 29,366)
Cash and cash equivalents at beginning of year 38,778 24,214 53,580
----------- ----------- -----------
Cash and cash equivalents at end of year $ 88,213 $ 38,778 $ 24,214
=========== =========== ===========
F-8
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the years ended December 31, 2001, 2000 and 1999 for income
taxes was $70,751, $74,286 and $67,495, respectively.
See accompanying notes to consolidated financial statements.
F-9
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 1. NATURE OF BUSINESS
Erie Indemnity Company (Company), formed in 1925, is the
attorney-in-fact for the Erie Insurance Exchange (Exchange), a
reciprocal insurance exchange. The Company earns a management fee for
management services provided to the Exchange and its affiliates. The
Exchange is a Pennsylvania domiciled property/casualty insurer rated
A++ Superior by A. M. Best. The Exchange is the 23/rd/ largest insurer
in the United States based on net premiums written for all lines of
business. See also Note 10.
The subscriber's agreement between each policyholder and the Exchange,
which is executed by each applicant when applying for insurance
coverage from the Exchange, permits us to retain up to 25% of the
direct written premiums of the Exchange in addition to the direct
written premiums of the other members of the Property and Casualty
Group, all of which are assumed by the Exchange under a pooling
agreement. The management fee rate is generally set by our board of
directors each December for the following year. In consideration for
this payment, the Company performs certain services for the Exchange
relating to the sales, underwriting and issuance of policies on behalf
of the Exchange. Each subscriber's agreement provides that the
remainder of the premium must be used by the Exchange for losses, loss
adjustment expenses, investment expenses, damages, legal expenses,
court costs, taxes, assessments, licenses, fees, any other governmental
fines and charges, establishment of reserves and surplus, and
reinsurance and may be used for dividends and other purposes to the
advantage of the policyholders of the Exchange. The provisions in the
subscriber's agreements executed by the policyholders regarding the
Company's appointment as attorney-in-fact are the sole agreements
governing the services performed by the Company for the Exchange. There
is no provision for termination of the Company's appointment as
attorney-in-fact and it is not affected by an insured's disability or
incapacity.
The Company's property/casualty insurance subsidiaries also share
proportionately in the results of all property/casualty insurance
underwriting operations of the Exchange. The Exchange, Erie Insurance
Company (EIC), a wholly-owned subsidiary of the Company, and the Erie
Insurance Company of New York (EINY), a wholly-owned subsidiary of the
EIC, are part of an intercompany pooling agreement. Under this
agreement, EIC and EINY cede
F-10
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 1 NATURE OF BUSINESS (CONTINUED)
100% of their property/casualty insurance business, including
property/casualty insurance operations assets and liabilities, to the
Exchange. The pooling arrangement expressly does not apply to
investment and other non-underwriting operations and income tax
obligations of the parties. The Exchange acts on behalf of EIC and EINY
to fulfill all obligations under ceded insurance policies and to adjust
and pay all related claims and underwriting expenses. Erie Insurance
Property & Casualty Company, a wholly-owned subsidiary of the Company,
and Flagship City Insurance Company, owned by the Exchange, participate
in a quota share agreement, where all insurance business is ceded to
the Exchange. The Exchange retrocedes to EIC and EINY a specified
percentage (5% for EIC and .5% for EINY during 2001, 2000 and 1999) of
all pooled property/casualty insurance business, including insurance
operations assets and liabilities. The specified percentages may only
be changed by each party executing a written amendment. Insurance ceded
by EIC, EINY, Erie Insurance Property & Casualty Company and Flagship
City Insurance Company, to the Exchange does not relieve EIC and EINY
from their primary liability as the original insurers. The intercompany
pooling agreement and the two quota share reinsurance agreements each
may be terminated by any party to the respective agreement as of the
end of any calendar year by providing not less than 90 days' advance
written notice. See also Note 12.
The Exchange, EIC and EINY together with the Erie Insurance Property &
Casualty Company and the Flagship City Insurance Company as well as the
Erie Family Life Insurance Company (EFL) operate collectively as the
"Erie Insurance Group (EIG)."
The property/casualty insurers of the Erie Insurance Group operate in
11 states and the District of Columbia. Business consists, to a large
extent, of private passenger and commercial automobile, homeowners and
workers' compensation insurance in Pennsylvania, Ohio, West Virginia,
Maryland and Virginia.
F-11
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
---------------------
The accompanying consolidated financial statements have been
prepared in conformity with accounting principles generally accepted
in the United States of America that differ from statutory
accounting practices (SAP) prescribed or permitted for insurance
companies by regulatory authorities. See also Note 13.
Principles of consolidation
---------------------------
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in
consolidation. The 21.6% equity ownership of EFL is not consolidated
but accounted for under the equity method of accounting.
Reclassifications
-----------------
Certain amounts reported in prior years have been reclassified to
conform to the current year's financial statement presentation.
Use of estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management 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.
Investments and cash equivalents
--------------------------------
Fixed maturities and marketable equity securities are classified as
available-for-sale. Equity securities consist primarily of common
and nonredeemable preferred stocks while fixed maturities consist of
bonds, notes and redeemable preferred stock. Available-for-sale
securities are stated at fair value, with the unrealized gains and
losses, net of deferred tax, reflected in shareholders' equity in
accumulated other comprehensive income. There are no securities
classified
F-12
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
as "trading" or "held-to-maturity." Realized gains and losses on
sales of investments, are recognized in income on the specific
identification method. Interest and dividend income is recorded as
earned.
Limited partnerships include U.S. and foreign private equity, real
estate and fixed income investments. The private equity limited
partnerships invest primarily in small- to medium-sized companies.
Limited partnerships are recorded using the equity method, which
approximates the Company's share of the carrying value of the
partnership. Unrealized gains and losses on private equity limited
partnerships are reflected in shareholders' equity in accumulated
other comprehensive income, net of deferred taxes. The Company has
not guaranteed any of the partnership liabilities.
When a decline in value of investments is considered to be
other-than-temporary by Company management, the investments are
written down to realizable value. The write down is made on an
individual security or limited partnership basis and is considered a
realized loss in the Consolidated Statements of Operations.
Mortgage loans on commercial real estate are recorded at unpaid
balances, adjusted for amortization of premium or discount. A
valuation allowance would be provided for impairment in net
realizable value based on periodic valuations as needed.
Cash equivalents are principally comprised of investments in bank
money market funds and approximate fair value.
Derivatives
-----------
Financial Accounting Standards Board Statement of Financial
Accounting Standards (FAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (FAS 133) became effective for
fiscal years beginning after June 15, 1999. Sections of FAS 133 were
subsequently amended by FAS 138 "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" (an amendment of FAS 133
which became effective for all fiscal quarters of all fiscal years
beginning after June 15, 2000). FAS 133 and FAS 138 establish
accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other
contracts, and for
F-13
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
hedging activities. The accounting for changes in the fair value of
a derivative, i.e. gains and losses, depends on the intended use of
the derivative and the resulting designation.
For derivatives not designated as a hedging instrument, the gain or
loss is recognized in earnings in the period of change. Credit risk
is managed by entering into transactions using a bank counterparty
with a high credit rating. See also Note 3.
Fair value of financial instruments
-----------------------------------
Fair values of available-for-sale securities are based on quoted
market prices, where available, or dealer quotations. The carrying
amounts reported in the Consolidated Statements of Financial
Position approximate fair value. The carrying value of receivables
and liabilities arising in the ordinary course of business
approximates fair value.
Deferred policy acquisition costs
---------------------------------
Commissions and other costs of acquiring insurance that vary with,
and are primarily related to, the production of new and renewal
business are deferred and amortized over the terms of the policies
or reinsurance treaties to which they relate. The amount of costs to
be deferred would be reduced to the extent future policy premiums
and anticipated investment income would not exceed related losses,
expenses and Policyholder dividends. There have been no reduction in
costs deferred in any of the years presented. Amortization expense,
which is included in policy acquisition and other underwriting
expenses of insurance underwriting operations, equaled $24,276,
$22,793 and $22,507 in 2001, 2000 and 1999, respectively.
Insurance liabilities
---------------------
Losses incurred refer to amounts paid or expected to be paid for
loss events which have occurred through the balance sheet date. The
cost of investigating, resolving and processing claims are referred
to as "loss adjustment expenses". A liability is established for the
total unpaid cost of losses and loss adjustment expenses, including
events occurring in current
F-14
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
and prior years. Losses are reported on the Consolidated Statements of
Operations in insurance underwriting operations.
The liability for losses and loss adjustment expenses includes an
amount determined from loss reports and individual cases and an
amount, based on past experience, for losses incurred but not
reported. Inflation is provided for in the reserving function through
analysis of costs, trends and reviews of historical reserving results.
Such liabilities are necessarily based on estimates and, while
management believes the amount is appropriate, the ultimate liability
may differ from the amounts provided. The methods for making such
estimates and for establishing the resulting liability are continually
reviewed, and any adjustments considered necessary are reflected in
current earnings. Loss reserves, as permitted by insurance department
statute, are set at full expected cost except for loss reserves for
workers' compensation which have been discounted at 2.5% in 2001 and
2000. Unpaid losses and loss adjustment expenses in the Consolidated
Statements of Financial Position were reduced by $2,390 and $1,509 at
December 31, 2001 and 2000, respectively, due to discounting. The
reserves for losses and loss adjustment expenses are reported net of
receivables for salvage and subrogation of $3,661 and $3,349 at
December 31, 2001 and 2000, respectively.
Environment-related claims
--------------------------
In establishing the liability for unpaid losses and loss adjustment
expenses related to environmental claims, management considers facts
currently known and the current state of the law and coverage
litigation. Liabilities are recognized for known claims (including the
cost of related litigation) when sufficient information has been
developed to indicate the involvement of a specific insurance policy,
and management can reasonably estimate its liability. In addition,
liabilities have been established to cover additional exposures on
both known and unasserted claims. Estimates of the liabilities are
reviewed and updated continually. The total amount of the Company's
property/casualty insurance subsidiaries' share of paid losses and
loss reserves pertaining to environment-related claims is immaterial.
F-15
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Liability for guaranty fund and other assessments
-------------------------------------------------
The Company's property/casualty insurance subsidiaries may be
required, under the solvency or guaranty laws of the various
states in which they are licensed, to pay assessments up to
prescribed limits to fund Policyholder losses or liabilities of
insolvent insurance companies. The liability for guaranty fund or
other assessments is recorded when the event obligating the
Company has occurred and the amount can be reasonably estimated.
The estimated liability for guaranty fund and other assessments
at December 31, 2001 and 2000 totaled $2,383 and $592,
respectively. During 2001, the Company received notification of
the insolvency of Reliance Insurance Company. It is expected this
insolvency will result in guaranty fund liabilities to be
assessed the Company's property/casualty insurance subsidiaries.
The Company has recorded an estimated liability that has been
charged to operations in the current period based on preliminary
data relating to this insolvency. The estimated liability for the
Reliance insolvency is $2,024 at December 31, 2001.
Certain states permit these assessments, or a portion thereof, to
be recovered as an offset to future premium taxes. When an
assessment can be recovered, an asset is established on a basis
consistent with the credits to be realized under applicable state
law. During 2001, the Company's property/casualty insurance
subsidiaries recorded an asset of $559 related to these
recoverable credits which will be recovered in accordance with
state law which ranges between a 5 and 10 year period. These
liabilities and corresponding recoverable assets are presented
gross on the Consolidated Statement of Financial Position.
Reinsurance
-----------
The insurance underwriting operations segment in the Consolidated
Statements of Operations is presented net of reinsurance
activities. Gross losses and expenses incurred are reduced for
amounts expected to be recovered under reinsurance agreements.
Reinsurance transactions are recorded gross on the Consolidated
Statements of Financial Position. Estimated reinsurance
recoverables and receivables for ceded unearned premiums are
recorded as assets with liabilities recorded for related unpaid
F-16
7
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
losses and expenses and unearned premiums. Reinsurance premiums are
recognized as revenue on a pro rata basis over the policy term.
Income taxes
------------
Provisions for income taxes include deferred taxes resulting from
changes in cumulative temporary differences between the tax bases
and financial statement bases of assets and liabilities. Deferred
taxes are provided on the liability method, whereby deferred tax
assets are recognized for deductible temporary differences and
deferred tax liabilities are recognized for taxable temporary
differences. Deferred tax assets and liabilities are adjusted for
the effects of changes in tax laws and rates on the date of
enactment.
Property and equipment
----------------------
Property and equipment are stated at cost. Improvements and
replacements are capitalized, while expenditures for maintenance and
repairs are charged to expense as incurred.
Depreciation of property and equipment is computed using straight
line and accelerated methods over the estimated useful lives of the
assets. The costs and accumulated depreciation and amortization of
property sold or retired are removed from the accounts and gains or
losses, if any, are reflected in earnings for the year.
Property and equipment as of December 31 is summarized as follows:
2001 2000
--------- ---------
Land $ 737 $ 737
Buildings 5,879 5,863
Leasehold improvements 518 322
Computer software 18,836 17,723
Computer equipment 5,416 3,706
Transportation equipment 544 450
--------- ---------
$ 31,930 $ 28,801
Less accumulated depreciation 17,295 14,945
--------- ---------
$ 14,635 $ 13,856
========= =========
F-17
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Software development costs, primarily salaries and benefits,
totaling $7,842 and $7,797, are included in property and equipment
at December 31, 2001 and 2000, respectively. Software development
costs capitalized during 2001 and 2000 amounted to $45 and $499,
respectively. These costs are amortized on a straight-line basis
over the expected life of the applications once the software is
ready for intended use. Software amortization related to these costs
totaled $2,007, $1,697 and $199 in 2001, 2000 and 1999,
respectively.
During 2001, the Company entered into various operating lease
agreements for computer equipment. These leases contain various
early termination provisions which allow the Company to cancel the
leases generally after three years from inception of the lease. The
total projected commitment for these leases at December 31, 2001,
approximates $10,051 through the year 2004. Of this total,
approximately $5,075 will be reimbursed to the Company from its
affiliates. The total rental expense for 2001 was $165.
Revenue recognition
-------------------
In 2000, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." SAB 101 states revenue should not be recognized until
it is realized or realizable and earned. Cited in SAB 101 are
certain criteria that generally should be met to determine when
revenue is realized or realizable and earned. The Company
periodically evaluates its revenue recognition practices in relation
to the requirements of SAB 101. Management believes the revenue
recognition practices are in compliance with the provisions of SAB
101.
Recognition of management fee revenue
-------------------------------------
A management fee is charged the Exchange by the Company for
management of the affairs of the Exchange. The fee is recorded as
revenue, calculated as a percentage of Exchange direct and
affiliated assumed premiums written. The management fees are
recognized upon policy issuance or renewal since all contractual
obligations for services to the Exchange have been performed or are
substantially completed at that time. The Exchange issues policies
with annual terms only. Certain activities are performed and related
costs are incurred by the Company
F-18
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
subsequent to policy issuance in connection with the services
provided to the Exchange. These activities are inconsequential or
perfunctory. The cost of these activities is immaterial to the
Company.
Recognition of service agreement revenue
----------------------------------------
Service agreement revenue includes service income received from the
Exchange as compensation for the management of voluntary assumed
reinsurance from non-affiliated insurers. The Company receives a
service fee, which is currently 7.0% of non-affiliated assumed
reinsurance premiums written. The service fee revenue is recognized
in the period in which the related premium is earned since our
services extend to that same period.
Also included in service agreement revenue are service charges the
Company collects from Policyholders for providing extended payment
terms on policies written by the Property and Casualty Group.
Service charges are recognized as revenue when the additional
billings are rendered.
Recognition of premium revenues and losses
------------------------------------------
Property and liability premiums are recognized as revenue on a pro
rata basis over the policy term. Unearned premiums represent the
unexpired portion of premiums written.
Losses and loss adjustment expenses are recorded as incurred.
Premiums earned and losses and loss adjustment expenses incurred are
reflected in the Consolidated Statements of Operations net of
amounts ceded to the Exchange. See also Note 12.
Agency contingency award estimates
----------------------------------
The estimate for the agent contingency awards is modeled on a
monthly basis using actual underwriting data by agency for the two
prior years combined with the current year to date actual data. The
Company uses projected underwriting data for the remainder of the
current year in order to model the 36-month underwriting results by
agency.
F-19
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Earnings per share
------------------
Earnings per share is based on the weighted average number of
Class A shares outstanding, giving effect to the conversion of
the weighted average number of Class B shares outstanding at a
rate of 2,400 Class A shares for one Class B share. The total
weighted average number of Class A equivalent shares outstanding
(including conversion of Class B shares) was 71,342,329,
71,954,402, and 73,486,572 during 2001, 2000 and 1999,
respectively.
F-20
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 3. INVESTMENTS
The following tables summarize the cost and market value of available-
for-sale securities at December 31, 2001 and 2000:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
December 31, 2001
-----------------
Fixed Maturities:
-----------------
U.S. treasuries &
government agencies $ 11,211 $ 502 $ 0 $ 11,713
States & political subdivisions 42,392 1,817 88 44,121
Special revenue 110,267 3,496 345 113,418
Public utilities 25,150 1,156 36 26,270
U. S. industrial &
miscellaneous 311,757 8,989 1,438 319,308
Foreign 26,634 859 17 27,476
----------- ----------- ----------- -----------
Total bonds $ 527,411 $ 16,819 $ 1,924 $ 542,306
Redeemable preferred stock 16,012 1,555 0 17,567
----------- ----------- ----------- -----------
Total fixed maturities $ 543,423 $ 18,374 $ 1,924 $ 559,873
----------- ----------- ----------- -----------
Equity Securities:
------------------
Common stock:
U. S. banks, trusts &
insurance companies $ 3,284 $ 814 $ 16 $ 4,082
U. S. industrial &
miscellaneous 28,718 31,570 579 59,709
Nonredeemable
preferred stock:
Public Utilities 2,370 12 3 2,379
U. S. banks, trusts &
insurance companies 14,685 938 58 15,565
U. S. industrial &
miscellaneous 91,185 2,573 2,111 91,647
Foreign 19,485 1,039 108 20,416
----------- ----------- ----------- -----------
Total equity securities $ 159,727 $ 36,946 $ 2,875 $ 193,798
----------- ----------- ----------- -----------
Total available-for-sale
securities $ 703,150 $ 55,320 $ 4,799 $ 753,671
=========== =========== =========== ===========
F-21
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 3 INVESTMENTS (CONTINUED)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ----------
December 31, 2000
-----------------
Fixed Maturities:
----------------
U.S. treasuries &
government agencies $ 11,216 $ 420 $ 24 $ 11,612
States & political subdivisions 50,337 1,656 34 51,959
Special revenue 110,855 3,779 68 114,566
Public utilities 23,221 550 207 23,564
U. S. industrial &
miscellaneous 267,231 4,770 5,940 266,061
Foreign 30,082 238 406 29,914
--------- --------- --------- ----------
Total bonds $ 492,942 $ 11,413 $ 6,679 $ 497,676
Redeemable preferred stock 31,230 3,341 701 33,870
--------- --------- --------- ----------
Total fixed maturities $ 524,172 $ 14,754 $ 7,380 $ 531,546
--------- --------- --------- ----------
Equity Securities:
-----------------
Common stock:
U. S. banks, trusts &
insurance companies $ 3,651 $ 422 $ 275 $ 3,798
U. S. industrial &
miscellaneous 63,662 38,286 15,343 86,605
Foreign 7,100 581 2,719 4,962
Nonredeemable
preferred stock:
U. S. banks, trusts &
insurance companies 22,094 97 66 22,125
U. S. industrial &
miscellaneous 62,266 1,987 3,119 61,134
Foreign 26,195 217 590 25,822
--------- --------- --------- ----------
Total equity securities $ 184,968 $ 41,590 $ 22,112 $ 204,446
--------- --------- --------- ----------
Total available-for-sale
securities $ 709,140 $ 56,344 $ 29,492 $ 735,992
========= ========= ========= ==========
F-22
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 3. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of fixed maturities at
December 31, 2001, by remaining contractual term to maturity, are
shown below.
Amortized Estimated
Cost Fair Value
----------- -----------
Due in one year or less $ 37,241 $ 37,787
Due after one year through five years 162,766 167,265
Due after five years through ten years 160,105 165,194
Due after ten years 183,311 189,627
----------- -----------
$ 543,423 $ 559,873
=========== ===========
Changes in unrealized gains (losses) consist of the following for the
years ended December 31:
2001 2000 1999
----------- ----------- -----------
Equity securities $ 14,593 $ (24,410) $ 11,061
Fixed maturities 9,076 11,246 (24,123)
Limited partnerships (5,651) 5,930 1,616
Equity in unrealized gains (losses)
of Erie Family Life
Insurance Company 4,890 2,005 (9,473)
Deferred federal income tax (liability)
benefit (8,018) 1,830 7,322
----------- ----------- -----------
Increase (decrease) in unrealized gains $ 14,890 $ (3,399) $ (13,597)
=========== =========== ===========
Sources of net investment income for the years ended December 31 are as
follows:
2001 2000 1999
----------- ----------- -----------
Fixed maturities $ 36,569 $ 34,445 $ 30,547
Equity securities 11,022 11,034 10,104
Cash equivalents and other 3,034 3,416 3,222
----------- ----------- -----------
Total investment income $ 50,625 $ 48,895 $ 43,873
Investment expense 741 494 529
----------- ----------- -----------
Net investment income $ 49,884 $ 48,401 $ 43,344
=========== =========== ===========
F-23
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 3. INVESTMENTS (CONTINUED)
Following are the components of net realized (loss) gain on investments as
reported on the Consolidated Statements of Operations. The securities impairment
charge in 2001 related primarily to preferred stocks in the equipment leasing
and agricultural industry segments. The limited partnership impairment charge
resulted from one private equity partnership that had investments of preferred
stock in the eCommerce industry and common stock in the customer relationship
software industry. The securities impairment charge in 2000 resulted from
preferred stocks in the financial services industry.
2001 2000 1999
--------- -------- --------
Fixed maturities:
----------------
Gross realized gains $ 4,216 $ 2,921 $ 712
Gross realized losses (7,941) (311) (87)
--------- -------- --------
Net realized (losses) gains ($ 3,725) $ 2,610 $ 625
--------- -------- --------
Equity securities:
-----------------
Gross realized gains $ 4,997 $ 18,070 $ 18,437
Gross realized losses and impairments (30,418) (3,712) (4,316)
--------- -------- --------
Net realized (losses) gains ($25,421) $ 14,358 $ 14,121
--------- -------- --------
Limited partnership impairment charge ($2,733) $ 0 $ 0
--------- -------- --------
Net realized (losses) gains on
investments ($31,879) $ 16,968 $ 14,746
========= ======== ========
The components of equity in (losses) earnings of limited partnerships
as reported on the Consolidated Statements of Operations for the years
ended December 31 are as follows:
2001 2000 1999
------- ------- -------
Private equity ($2,013) $ 1,464 ($354)
Real estate 1,424 1,926 905
Fixed income 582 1,343 90
------- ------- -------
Total equity in (losses) earnings of limited
partnerships ($7) $ 4,733 $ 641
======= ======= =======
See also Note 14 for investment commitments related to partnerships.
The Company participates in a securities lending program whereby
certain securities from its portfolio are loaned to other institutions
for short
F-24
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 3. INVESTMENTS (CONTINUED)
periods of time through a lending agent. The Company maintains control
over the securities. A fee is paid to the Company by the borrower.
Collateral, comprised of cash and government securities, that exceeds
the market value of the loaned securities is maintained by the lending
agent. The Company has an indemnification agreement with the lending
agent in the event a borrower becomes insolvent or fails to return
securities. The Company had loaned securities with a market value of
$46,771 and $31,776 and secured collateral of $48,804 and $33,468 at
December 31, 2001 and 2000, respectively. The borrower of the securities
is not permitted to sell or replace the security on loan. The Company
maintains the loaned securities on its Consolidated Statements of
Financial Position as part of its invested assets. The Company has
incurred no losses on the loan program since the program's inception.
During 2001, the Company entered into several foreign currency forward
contracts related to its limited partnership investments, which are by
definition derivatives. These contracts were not designated as hedges as
the primary purpose is to generate profits from short-term market
movements. The forward contracts have no cash requirements at the
inception of the arrangement. At December 31, 2001, the notional amount
of the contracts outstanding totaled $1,869. Changes in value, totaling
$8 in 2001, have been recognized currently in earnings as realized gains
in the Consolidated Statements of Operations.
F-25
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 4. COMPREHENSIVE INCOME
Comprehensive income is defined as any change in equity from
transactions and other events originating from nonowner sources. The
components of other comprehensive income follow for the years ended
December 31:
2001 2000 1999
------------- ------------ ------------
Unrealized holding (losses) gains on securities
arising during period ($ 8,971) $ 11,739 ($ 6,173)
Less: losses (gains) included in net income 31,879 ( 16,968) ( 14,746)
------------- ------------ ------------
Net unrealized holding gains (losses) arising
during period 22,908 ( 5,229) ( 20,919)
Income tax (liability) benefit related to unrealized
gains or losses ( 8,018) 1,830 7,322
------------- ------------ ------------
Net appreciation (depreciation) of
investments 14,890 ( 3,399) ( 13,597)
Minimum pension liability adjustment (See also Note 6) ( 4,384) 0 0
Tax asset related to pension liability
adjustment 1,534 0 0
------------- ------------ ------------
Net pension liability adjustment ( 2,850) 0 0
------------- ------------ ------------
Other comprehensive income (loss), net of tax $ 12,040 ($ 3,399) ($ 13,597)
============= ============ ============
F-26
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 5. EQUITY IN ERIE FAMILY LIFE INSURANCE COMPANY
The Company owns 21.6% of EFL's common shares outstanding, which is
accounted for using the equity method of accounting. EFL is a
Pennsylvania-domiciled life insurance company operating in ten states
and the District of Columbia.
The following represents condensed financial information for EFL on a
Generally Accepted Accounting Principles (GAAP) basis:
2001 2000 1999
----------- ----------- ------------
Investments $ 869,723 $ 881,069 $ 817,460
Total assets 1,120,483 1,020,343 954,532
Liabilities 914,724 824,623 783,429
Shareholders' equity 205,759 195,720 171,103
Revenues 89,514 115,373 102,924
Net income 2,738 25,390 23,325
Comprehensive income (loss) 17,410 31,421 ( 5,191)
Dividends paid to shareholders 7,229 6,662 6,096
The Company's share of EFL's net unrealized gains or (losses) on
securities, as reflected in shareholders' equity, is $3,983, $801 and
($502) at December 31, 2001, 2000 and 1999, respectively.
F-27
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS
Pension plans
-------------
The Company's pension plans consist of: (1) a noncontributory-defined
benefit pension plan covering substantially all Employees of the
Company, (2) an unfunded supplemental employee retirement plan (SERP)
for its executive management and division officers and (3) an
unfunded pension plan for its outside directors. Information about
the plans follows for the years ended December 31:
2001 2000
--------- ---------
Net periodic benefit cost:
Service cost $ 6,837 $ 6,329
Interest cost 8,325 7,705
Expected return on plan assets (13,709) (12,322)
Amortization of prior service cost 844 989
Recognized net actuarial gain (2,583) (2,303)
Amortization of unrecognized initial net asset (234) (234)
--------- ---------
Net periodic benefit cost $ 520 $ 164
========= =========
Change in benefit obligation:
Benefit obligation at January 1 $ 116,693 $ 104,588
Service cost 6,837 6,329
Interest cost 8,325 7,705
Amendments 55 611
Actuarial loss (gain) 14,523 (2,114)
Benefits paid (1,729) (426)
--------- ---------
Benefit obligation at December 31 $ 144,704 $ 116,693
========= =========
Change in plan assets:
Fair value of plan assets at January 1 $ 171,636 $ 160,385
Actual return on plan assets (31,413) 11,688
Employer contributions (refunds) 9,271 (12)
Benefits paid (1,729) (425)
--------- ---------
Fair value of plan assets at December 31 $ 147,765 $ 171,636
========= =========
Reconciliation of funded status:
Funded status at December 31 $ 3,061 $ 54,943
Unrecognized net actuarial loss (gain) 10,986 (51,342)
Unrecognized prior service cost 5,236 6,025
Unrecognized initial net asset (469) (701)
--------- ---------
Net amount recognized on Consolidated
Statements of Financial Position $ 18,814 $ 8,925
========= =========
Amounts recognized in the consolidated statements
of financial position consist of:
Prepaid benefit cost $ 25,451 $ 15,096
Accrued benefit liability (13,686) (8,656)
Intangible asset 2,665 2,485
Accumulated other comprehensive income 4,384 0
--------- ---------
Net amount recognized at year end $ 18,814 $ 8,925
========= =========
Weighted-average assumptions as of December 31:
Employee pension plan:
Discount rate 7.00% 7.50%
Expected return on plan assets 8.25 8.25
Rate of compensation increase 5.00 5.00
SERP:
Discount rate 7.00% 7.50%
Rate of compensation increase 6.00 - 7.25 5.00
F-28
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS (CONTINUED)
The amendment amounts relate primarily to two additional
participants being added to the SERP for each of the years 2001 and
2000.
The Employee pension plan has assets that include cash, treasury
bonds, corporate bonds, common and preferred stocks and mortgages.
An additional minimum pension liability of $4,384 resulted in 2001
due to changes in discount rates, the rate of compensation increase
and certain other assumptions of the SERP. The additional pension
liability was recorded as a reduction to shareholders' equity as
accumulated other comprehensive income, net of deferred income
taxes.
The Company's funding policy regarding the Employee pension plan is
to contribute amounts sufficient to meet ERISA funding requirements
plus such additional amounts as may be determined to be
appropriate.
The Employee pension plan purchases individual annuities
periodically from EFL to settle retiree benefit payments. Such
purchases equaled $4,513, $5,627 and $5,322 in 2001, 2000 and 1999,
respectively. These are non-participating annuity contracts under
which EFL has unconditionally contracted to provide specified
benefits to beneficiaries in return for a fixed premium from the
plan. However, the plan remains the primary obligor to the
beneficiaries and a contingent liability exists in the event EFL
could not honor the annuity contracts. The benefit obligation has
been reduced for these annuities purchased for retirees.
The projected benefit obligation, accumulated benefit obligation,
and fair value of plan assets for the pension plans with
accumulated benefit obligations in excess of plan assets (SERP and
the pension plan for outside directors) were $20,348, $13,686 and
$0 respectively, as of December 31, 2001, and $12,696, $8,656 and
$0, respectively, as of December 31, 2000.
Post-retirement benefits other than pensions
--------------------------------------------
The Company provides post-retirement medical coverage for eligible
retired Employees and eligible dependents. To be eligible for
benefits, an employee must be 60 years old and have 15 years of
continuous full-time service. The
F-29
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS (CONTINUED)
benefits are provided from retirement to age 65. The benefits are
unfunded as the Company pays the obligations when due. The cash
payments for such benefits were $379, $161 and $121 in 2001, 2000 and
1999, respectively. Actuarially determined costs are recognized over
the period the Employee provides service to the Company. Information
about this plan follows for the years ended December 31:
2001 2000
-------- --------
Net periodic benefit cost:
Service cost $ 400 $ 400
Interest cost 389 385
Amortization of prior service cost (36) (37)
Recognized net actuarial gain (50) (27)
-------- --------
Net periodic benefit cost $ 703 $ 721
======== ========
Change in benefit obligation:
Benefit obligation at January 1 $ 5,803 $ 4,745
Service cost 400 400
Interest cost 389 385
Actuarial loss 919 434
Benefits paid (379) (161)
-------- --------
Benefit obligation at December 31 $ 7,132 $ 5,803
======== ========
Reconciliation of Funded status:
Funded status at December 31 ($7,132) ($5,803)
Unrecognized net actuarial loss (gain) 244 (726)
Unrecognized prior service costs (330) (366)
-------- --------
Net liability recognized on Consolidated Statements
of Financial Position ($7,218) ($6,895)
======== ========
The weighted average discount rate used to measure the accumulated
post-retirement benefit obligation was 7.0% and 7.50% in 2001 and
2000, respectively. The December 31, 2001, accumulated benefit
obligation was based on a 10.0% increase in the cost of covered health
care benefits during 2001. The expected health care cost trend rate
assumption for 2002 is 10.0%. This rate is assumed to decrease
gradually to 5.5% per year in 2006 and to remain at that level
thereafter.
F-30
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS (CONTINUED)
2001 2000
------ ------
Effect on total of service and interest cost components:
1% Increase $ 126 $ 126
1% Decrease (106) (106)
Effect on post-retirement benefit obligation:
1% Increase $1,023 $ 814
1% Decrease (871) (695)
Employee savings plan
---------------------
The Company has an Employee Savings Plan for its Employees. Beginning
January 2001, the maximum percentage that eligible participants were
permitted to contribute to the plan was increased to 15%. The Company
match was also changed to 100% of the participant contributions up to
3% of compensation and 50% of participant contributions over 3% and up
to 5% of compensation. Additionally, regular part-time Employees are
eligible to participate in the plan. Prior to 2001, eligible
participants were permitted to make contributions of 1% to 8% of
compensation to the plan on a pre-tax salary reduction basis. The
Company matched one-half of the participant contributions up to 6% of
compensation. All full-time Employees were eligible to participate in
the plan. The Company's matching contributions to the plan in 2001,
2000 and 1999 were $5,329, $3,499 and $3,245, respectively. Employees
are permitted to invest a portion of employer contributions in the
Class A common stock of the Company. The plan acquires shares in the
open market necessary to meet the obligations of the plan.
Management incentive plans and deferred compensation
----------------------------------------------------
The Company has separate annual and long-term incentive plans for
executive management and division officers of the Company. The Company
also makes available several deferred compensation plans for executive
management, division officers and certain outside directors.
The annual incentive plan is a bonus plan that annually pays cash bonuses to
executive management and division officers of the Company. The incentives under
the plan are based on growth in written premiums and the underwriting results of
Erie's property casualty insurers compared to a peer group of property casualty
companies that write predominately personal lines insurance and that are also
rated A++ by
F-31
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS (CONTINUED)
A.M. Best. The cost of the plan is charged to operations as the
compensation is earned over the performance periods.
The long-term incentive plan (LTIP) of the Company is a restricted
stock awards plan designed to reward executive management and division
officers who can have a significant impact on the performance of the
Company with long-term compensation that is settled in Company stock.
Awards are determined based on the achievement of pre-determined
Company financial and personal performance objectives. According to
the plan, the Company cannot issue new stock or stock from treasury to
settle the compensation award obligations under the LTIP, but instead
must purchase its stock on the open market to settle all plan
obligations. Therefore, these stock awards do not cause net share
dilution. The restricted stock awards are granted at the end of a
three-year performance period. The stock awards vest over a three-year
period subsequent to the performance period. A liability is recorded
and compensation expense is recognized ratably over the performance
period. The effects of changes in the stock price are recognized as
compensation expense over the vesting period. At December 31, 2001,
2000 and 1999, the unvested outstanding restricted shares under the
LTIP totaled 77,748 shares, 67,284 shares and 32,449 shares,
respectively, with average grant prices of $ 33.16, $ 28.32 and $
29.77, respectively.
The deferred compensation plans are arrangements for executive
management and division officers of the Company whereby the
participants can elect to defer a portion of their compensation, until
separation from service to the Company. Those participating in the
plans select hypothetical investment funds for their deferrals and are
credited with the hypothetical returns generated. The Company also
matches a portion of some deferrals to the plans depending on the
amount of deferral and the election of the participant. The deferred
compensation plan for directors allows them to defer director and
meeting fees. Directors participating in the plan select hypothetical
investment funds for their deferrals and are credited with the
hypothetical returns generated. The Company does not match any
deferrals to the director plan.
F-32
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 6. BENEFIT PLANS (CONTINUED)
The awards, payments, deferrals and liabilities under the plans were
as follows for the years ended December 31:
2001 2000 1999
-------- -------- --------
Awards, match and hypothetical earnings:
Long-term incentive plan awards $ 1,843 $ 1,300 $ 1,380
Annual incentive plan awards 2,169 2,291 1,276
Deferred compensation plan, match and hypothetical earnings (412) 90 725
-------- -------- --------
Total plan awards and earnings $ 3,600 $ 3,681 $ 3,381
======== ======== ========
Total plan awards paid $ 2,441 $ 1,590 $ 1,426
======== ======== ========
Compensation deferred under the plans $ 1,060 $ 895 $ 698
======== ======== ========
Distributions from the deferred compensation plans $ (355) $ (341) $ (211)
======== ======== ========
Outstanding plan liabilities at December 31, $ 12,485 $ 10,621 $ 7,976
======== ======== ========
Health and dental benefits
--------------------------
The Company has self-funded health and dental care plans for all of
its Employees and eligible dependents. Estimated unpaid claims
incurred are accrued as a liability at December 31, 2001 and 2000.
Operations were charged $19,826, $17,456 and $14,756 in 2001, 2000 and
1999, respectively, for the cost of health and dental care provided
under these plans.
All liabilities for the above mentioned plans are presented in this
note in total for all employees of the Erie Insurance Group. The gross
liability is presented in the Consolidated Statements of Financial
Position as employee benefit obligations with amounts expected to be
recovered from the Company's affiliates included in other assets.
F-33
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 7. INCOME TAXES
The provision for income taxes consists of the following for the years
ended December 31:
2001 2000 1999
-------- -------- --------
Federal income taxes:
Currently due $ 59,602 $ 73,657 $ 66,960
Deferred 959 (2,496) (1,664)
-------- -------- --------
Total $ 60,561 $ 71,161 $ 65,296
======== ======== ========
A reconciliation of the provision for income taxes with amounts
determined by applying the statutory federal income tax rates to
pre-tax income is as follows:
2001 2000 1999
----------- ----------- ------------
Income tax at statutory rates $ 64,007 $ 78,378 $ 73,051
Tax-exempt interest (2,729) (3,046) (3,229)
Dividends received deduction (2,398) (2,160) (2,064)
Other 1,681 (2,011) (2,462)
---------- ---------- ----------
Provision for income taxes $ 60,561 $ 71,161 $ 65,296
========== ========== ==========
Temporary differences and carryforwards, which give rise to deferred
tax assets and liabilities, are as follows for the years ended
December 31:
2001 2000
------- -------
DEFERRED TAX ASSETS:
Loss reserve discount $ 4,580 $ 3,965
Unearned premiums 4,960 4,286
Employee benefit plan obligations 4,800 4,111
Severance benefits 3,801 0
Write downs of securities 1,606 443
Other 1,525 1,212
------- -------
Total deferred tax assets $21,272 $14,017
------- -------
DEFERRED TAX LIABILITIES:
Deferred policy acquisition costs $ 5,956 $ 4,621
Unrealized gains 16,822 12,051
Pension and other benefits 7,021 2,438
Other 4,418 2,068
------- -------
Total deferred tax liabilities $34,217 $21,178
------- -------
Net deferred income tax liability $12,945 $ 7,161
======= =======
F-34
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
The Company, as a corporate attorney-in-fact for a reciprocal insurer,
is not subject to state corporate taxes.
F-35
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 8. CAPITAL STOCK
Class A and B shares
--------------------
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 for each Class
B share. There is no provision for conversion of Class A shares to
Class B shares and Class B shares surrendered for conversion cannot be
reissued. 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% of any
dividend declared on each share of Class B common stock. The Company
may declare and pay a dividend in respect of Class A common stock
without any requirement that any dividend be declared and paid in
respect of Class B common stock. Sole voting power is vested in Class
B common stock except insofar as any applicable law shall permit Class
A common stock to vote as a class in regards to any changes in the
rights, preferences and privileges attaching to Class A common stock.
Stock repurchase plan
---------------------
Beginning in 1999, the Company established a stock repurchase program.
The Company may repurchase as much as $120 million of its outstanding
Class A common stock through December 31, 2002. Treasury shares are
recorded on the Consolidated Statements of Financial Position at cost.
In 2001 there were 220,000 shares repurchased at a total cost of
$7,654, or an average price per share of $34.79. Since its inception,
3,195,677 shares have been repurchased at a total cost of $93,373, or
an average price per share of $29.22. The Company may purchase the
shares from time to time in the open market or through privately
negotiated transactions, depending on prevailing market conditions and
alternative uses of the Company's capital.
F-36
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 9. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of beginning and ending
loss and loss adjustment expense liability balances for the Company's
wholly-owned property/casualty insurance subsidiaries:
2001 2000 1999
-------- -------- --------
Total unpaid losses and loss
adjustment expenses at January 1, gross $477,879 $432,895 $426,165
Less reinsurance recoverables 375,567 337,911 334,708
-------- -------- --------
Net balance at January 1 102,312 94,984 91,457
Incurred related to:
Current accident year 111,258 93,416 88,422
Prior accident years 5,943 6,148 (703)
-------- -------- --------
Total incurred 117,201 99,564 87,719
Paid related to:
Current accident year 59,637 53,251 50,560
Prior accident years 41,203 38,985 33,632
-------- -------- --------
Total paid 100,840 92,236 84,192
-------- -------- --------
Net balance at December 31 118,673 102,312 94,984
Plus reinsurance recoverables 438,605 375,567 337,911
-------- -------- --------
Total unpaid losses and loss adjustment
expenses at December 31, gross $557,278 $477,879 $432,895
======== ======== ========
Included in the 2001 losses and loss adjustment expenses incurred
related to current accident year of $111,258 are the Company's share
of estimated incurred losses of the Erie Insurance Group's reinsurance
business stemming from the September 11th attack on the World Trade
Center of $8,250. Partially offsetting these losses is an aggregate
excess of loss reinsurance agreement between the Exchange and the
Company's property/casualty insurance subsidiaries. See also Note 12.
This agreement reduces the net retention of these losses recorded by
the Company to $5,839. Current loss estimates are based on the
assumption that the attack will be considered one event. If the attack
comes to be considered two events, the total potential exposure for
EIG would increase between $50,000 and $75,000. The effect on the
Company
F-37
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 9. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
would be additional losses between $2,750 and $4,125. Taking into
consideration the excess of loss reinsurance agreement, the net impact
of such potential additional losses would be minimal to the Company.
The property/casualty insurers are exposed to both direct and
reinsurance losses arising from possible future terrorist actions and
other catastrophic events.
The 2001 incurred losses related to prior accident years of $5,943 are
due primarily to adverse development of losses in the private
passenger auto liability and workers' compensation lines of business
and are generally the result of ongoing analysis of recent loss
development trends. These losses are reflected in the insurance
underwriting operations segment of the Consolidated Statements of
Operations.
The 2000 incurred losses related to prior accident years of $6,148 are
due to adverse development of reinsurance losses from the catastrophic
storms in Europe in December 1999, combined with increased loss
severity in private passenger automobile and in commercial lines of
business.
NOTE 10. RELATED PARTY TRANSACTIONS
Management fee
--------------
A management fee is charged to the Exchange for management services
provided by the Company under the subscriber's agreement. The fee is a
percentage of Exchange direct and affiliated assumed premiums written.
The percentage rate is adjusted periodically within specified limits
by the Company's Board of Directors. The management fee charged the
Exchange was 25% for each year from 1999 to 2001. The provisions in
the subscriber's agreements executed by the policyholders regarding
the Company's appointment as attorney-in-fact are the sole agreements
governing the services performed by the Company for the Exchange.
There is no provision for termination of the Company's appointment as
attorney-in-fact and it is not affected by an insured's disability or
incapacity.
In December 2001, the Board of Directors elected to maintain the 25%
management fee rate for all of 2002. The Company's Board of Directors
may change the management fee rate at its discretion, but it may not
exceed 25%.
F-38
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 10. RELATED PARTY TRANSACTIONS (CONTINUED)
eCommerce Program and Related Information Technology Infrastructure
-------------------------------------------------------------------
During 2001, the Erie Insurance Group undertook a series of
initiatives to develop its eCommerce capabilities. In connection with
this program, the Company and the property/casualty insurance
Companies of the Erie Insurance Group entered into a Cost Sharing
Agreement for Information Technology Development (Agreement). The
Agreement describes how member companies of the Erie Insurance Group
will share the costs to be incurred for the development of new
Internet enabled property/casualty policy administration and customer
relationship management systems. The Agreement provides that the cost
of the systems and the related enabling technology costs, such as
required infrastructure and architectural tools, will be shared among
the property/casualty insurance companies in a manner consistent with
the sharing of insurance transactions under the existing intercompany
pooling agreement. See also Note 12. These costs are included in the
policy acquisition and other underwriting expenses in the Consolidated
Statements of Operations. The Company's share of these costs, incurred
by the Company's property/casualty insurance subsidiaries totaled
$1,315 for the year ended December 31, 2001.
Certain other costs of the eCommerce Program are related to
information technology hardware and are not included under the
Agreement. These costs are included in the cost of management
operations in the Consolidated Statement of Operations. The Company's
share of these infrastructure costs amounted to $1,589 for the year
ended December 31, 2001.
Service agreement revenue
-------------------------
A service agreement fee is charged to the Exchange to compensate the
Company for its management of non-affiliated assumed reinsurance
business on behalf of the Exchange. The Company receives a fee of 7%
of voluntary reinsurance premiums assumed from non-affiliated insurers
and is responsible for accounting, underwriting, and operating
expenses in connection with the administration of this business.
Service agreement fee revenue amounted to $11,251, $10,149 and $8,158
in 2001, 2000 and 1999, respectively.
Also included in service agreement revenue are service charges
collected from Policyholders for providing extended payment terms on
policies written by the insurers managed by the Company. In June 2000,
this administrative fee
F-39
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 10. RELATED PARTY TRANSACTIONS (CONTINUED)
collected from Policyholders increased from $2 to $3 per installment
for policies renewing in most states. Service charge revenue amounted
to $15,996, $12,513 and $7,283 in 2001, 2000 and 1999, respectively.
Expense allocations
-------------------
The claims handling function of the Exchange is established and its
services are performed by personnel who are entirely dedicated to and
paid for by the Exchange from its own policyholder revenues. The
Exchange's claims function and its management and administration are
exclusively the responsibility of the Exchange and not a part of the
services the Company provides under the subscriber's agreement.
Likewise, personnel who perform activities within the life insurance
operations of Erie Family Life are paid for by Erie Family Life from
its own policyholder revenues. However, the Company is the legal
entity that employs personnel on behalf of the Exchange and Erie
Family Life and functions as a common paymaster for all employees.
Common overhead expenses included in the expenses paid for by the
Company are allocated based on appropriate utilization statistics
(employee count, square footage, vehicle count, project hours, etc.)
specifically measured to accomplish proportional allocations.
Executive compensation is allocated based on each executive's primary
responsibilities (management services, property and casualty claims
operations, EFL operations and investment operations). Management
believes the methods used to allocate common overhead expenses among
the affiliated entities are reasonable.
Payments on behalf of related entities
--------------------------------------
The Company makes certain payments for the account of Erie Insurance
Group related entities. The Company, in making these payments is
acting as the common paymaster. Cash transfers are settled monthly.
The amounts of these cash settlements for Company payments made for
the account of related entities were as follows for the years ended
December 31:
2001 2000 1999
-------- -------- --------
Erie Insurance Exchange $162,549 $142,519 $136,045
Erie Family Life 18,545 18,631 14,740
-------- -------- --------
Total $181,094 $161,150 $150,785
======== ======== ========
F-40
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 10. RELATED PARTY TRANSACTIONS (CONTINUED)
Office leases
-------------
The Company occupies certain office facilities owned by the Exchange
and EFL. The Company leases office space on a year-to-year basis from
the Exchange. Rent expenses under these leases totaled $10,842,
$10,703 and $10,320 in 2001, 2000 and 1999, respectively. The Company
has a lease commitment until 2008 with EFL for a branch office.
Rentals paid to EFL under this lease totaled $311 in 2001, $309 in
2000 and $303 in 1999.
Note receivable from EFL
------------------------
The Company is due $15 million from EFL in the form of a surplus note.
The note bears an annual interest rate of 6.45% and all payments of
interest and principal of the note may be repaid only out of
unassigned surplus of EFL and are subject to prior approval of the
Pennsylvania Insurance Commissioner. Interest on the surplus note is
scheduled to be paid semi-annually. The note will be payable on demand
on or after December 31, 2005. During 2001, 2000 and 1999, EFL paid
interest to the Company totaling $968 each year.
Structured settlements with EFL
-------------------------------
The Erie Insurance Group affiliated property/casualty insurance
companies periodically purchase annuities from EFL in connection with
the structured settlement of claims. The Company's pro-rata share
(5.5%) of such annuities purchased equaled $708, $889 and $1,282 in
2001, 2000 and 1999, respectively.
NOTE 11. RECEIVABLES FROM ERIE INSURANCE EXCHANGE AND CONCENTRATIONS OF CREDIT
RISK
Financial instruments, which potentially expose the Company to
concentrations of credit risk, include unsecured receivables from the
Exchange. Most all of the Company's revenue and receivables are from
the Exchange and affiliates.
Management fee and expense allocation amounts due from the Exchange
were $147,344 and $117,962 in 2001 and 2000, respectively. A
receivable from EFL for expense allocation amounts totaled $2,256 at
December 31, 2001 compared to $1,997 at December 31, 2000. The Company
also has a receivable due from the Exchange for reinsurance
recoverable from losses and unearned premium
F-41
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 11. RECEIVABLES FROM ERIE INSURANCE EXCHANGE AND CONCENTRATIONS OF CREDIT
RISK (CONTINUED)
balances ceded to the pool totaling $491,055 and $412,050 in 2001 and
2000, respectively.
Premiums receivable from Policyholders at December 31, 2001 and 2000
equaled $186,175 and $156,269, respectively. A significant amount of
these receivables are ceded to the Exchange as part of the
intercompany pooling agreement. At December 31, 2001, the Exchange's
statutory total assets totaled almost $7 billion and Policyholders'
surplus totaled $3 billion.
NOTE 12. REINSURANCE
EIC and EINY have an intercompany reinsurance pooling agreement with
the Exchange, whereby EIC and EINY cede all of their direct
property/casualty insurance to the Exchange, except for the annual
premium under the all-lines aggregate excess of loss reinsurance
agreement discussed below. EIC and EINY then assume 5% and 0.5%,
respectively, of the total of the Exchange's insurance business
(including the business assumed from EIC and EINY). The companies
settle accounts between them by payment of amounts due within 30 days
after the end of each quarterly accounting period. The purpose of the
pooling agreement is to spread the risks of the members of the
Property and Casualty Group by the different lines of business they
underwrite and geographic regions in which each operates. The pooling
agreement may be terminated by any party to the agreement as of the
end of any calendar year by providing not less than 90 days' advance
written notice.
EIC and EINY have in effect an all-lines aggregate excess of loss
reinsurance agreement with the Exchange. The purpose of the excess of
loss agreement is to mitigate catastrophic loss exposure and thereby
reduce the adverse effects on the results of operations of EIC and
EINY in a given year if the frequency or severity of claims were
substantially higher than historical averages because of a
catastrophic event or series of events. Under this agreement, EIC and
EINY reinsure their net retained share of the intercompany reinsurance
pool such that once EIC and EINY have sustained ultimate net losses in
any applicable accident year that exceed an amount equal to 72.5% of
EIC and EINY's net premiums earned in that period, the Exchange will
be liable for 95% of the amount of such excess, up to but not
exceeding, an amount equal to 95% of 15% of EIC and EINY's net premium
earned. Losses equal to 5% of the net ultimate
F-42
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 12. INSURANCE (CONTINUED)
net loss in excess of the retention under the contract are retained
net by EIC and EINY. The annual premium is subject to a minimum
premium of $950. This reinsurance treaty is excluded from the
intercompany pooling agreement. The annual premium paid to the
Exchange for the agreement totaled $1,423, $1,268 and $1,199 in 2001,
2000 and 1999 respectively. Recoveries during 2001 amounted to $7,241,
of which $6,506 relates to the 2001 accident year. The balance of the
recoveries under this agreement recorded in 2001 related to the 1999
accident year. There were no loss recoveries by EIC or EINY under the
agreement for 2000 or 1999.
To the extent the Exchange assumes reinsurance business from
nonaffiliated sources, the Company participates because of its pooling
agreement with the Exchange. Similarly, the Company also participates
in the business ceded from the Exchange. Reinsurance premiums,
commissions, expense reimbursements and reserves related to
reinsurance business are accounted for on bases consistent with those
used in accounting for the original policies issued and the terms of
the reinsurance contracts. Premiums ceded to the Exchange have been
reported as a reduction of premium income. The Company's property and
liability reinsurance assumed from foreign insurance companies is
accounted for using the periodic method, whereby premiums are
recognized as revenue over the policy term, and claims, including an
estimate of claims incurred but not reported, are recognized as they
occur. The amount of reinsurance business assumed from foreign
insurance companies is not significant.
Reinsurance contracts do not relieve the Company from its primary
obligations to Policyholders. A contingent liability exists with
respect to reinsurance receivables in the event reinsurers are unable
to meet their obligations under the reinsurance agreements. All
reinsurance agreements are accounted for under SFAS 113-Accounting and
Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts.
F-43
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 12. INSURANCE (CONTINUED)
The following summarizes insurance and reinsurance activities for the
Company:
2001 2000 1999
-------------- ------------- --------------
Premiums Earned:
Direct $ 432,307 $ 377,570 $ 351,228
Assumed nonaffiliates 7,391 4,824 5,380
Ceded to Erie Insurance Exchange (439,698) (382,394) (356,608)
Assumed from Erie Insurance Exchange 137,648 123,708 117,224
------------- ------------ -------------
Net $ 137,648 $ 123,708 $ 117,224
============ ============ =============
Losses and Loss Adjustment Expenses
Incurred:
Direct $ 374,440 $ 325,644 $ 264,177
Assumed nonaffiliates 14,262 3,956 6,512
Ceded to Erie Insurance Exchange (388,702) (329,600) (270,689)
Assumed from Erie Insurance Exchange 117,201 99,564 87,719
------------- ------------ -------------
Net $ 117,201 $ 99,564 $ 87,719
============= ============ =============
NOTE 13. STATUTORY INFORMATION
The statutory financial statements of Erie Insurance Property &
Casualty Company and EIC are prepared in accordance with accounting
practices prescribed by the Pennsylvania Insurance Department. EINY
prepares its statutory financial statements in accordance with
accounting practices prescribed by the New York Insurance Department.
Prescribed SAP include state laws, regulations, and general
administration rules, as well as a variety of publications from the
National Association of Insurance Commissioners (NAIC). The NAIC
adopted the Codification of Statutory Accounting Practices
(Codification), effective January 1, 2001, as the NAIC-supported basis
of accounting. The Codification was approved with a provision allowing
for prescribed or permitted accounting practices to be determined by
each state's insurance commissioner. Accordingly, such discretion will
continue to allow prescribed or permitted accounting practices that
may differ from state to state. The New York State Insurance
Department did not adopt the deferred tax provisions of Codification,
thus no deferred taxes are recorded on the EINY statutory financial
statements.
F-44
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 13. STATUTORY INFORMATION (CONTINUED)
Codification resulted in changes to the Company's
statutory-basis financial statements, the most significant of
which was the recording of statutory deferred taxes for EIC
and Erie Insurance Property & Casualty Company. The total
cumulative adjustment increased the surplus of the Company's
property/casualty insurance subsidiaries by $4,446 as of
January 1, 2001.
Accounting principles used to prepare statutory financial
statements differ from those used to prepare financial
statements on the basis of generally accepted accounting
principles. Consolidated balances including amounts reported
by the property/casualty insurance subsidiaries on the
statutory basis would be as follows:
2001 2000 1999
----------- ----------- ------------
Shareholders' equity at December 31, $ 854,003 $ 767,894 $ 688,802
Net income for the year ended December 31, 118,475 150,942 142,615
The amount of dividends the Company's Pennsylvania-domiciled
property/casualty subsidiaries, EIC and Erie Insurance
Property & Casualty Company, can pay without the prior
approval of the Pennsylvania Insurance Commissioner is limited
by Pennsylvania regulation to not more than the greater of:
(a) 10% of its statutory surplus as reported on its last
annual statement, or (b) the net income as reported on its
last annual statement. The amount of dividends that the Erie
Insurance Company's New York-domiciled property/casualty
subsidiary, EINY, can pay without the prior approval of the
New York Superintendent of Insurance is limited to the lesser
of: (a) 10% of its statutory surplus as reported on its last
annual statement, or (b) 100% of its adjusted net investment
income during such period. At December 31, 2001, the maximum
dividend the Company could receive from its property/casualty
insurance subsidiaries was $5,491. No dividends were paid to
the Company from its property/casualty insurance subsidiaries
in 2001 or 2000.
The amount of dividends EFL, a Pennsylvania-domiciled life
insurer, can pay to its shareholders without the prior
approval of the Pennsylvania Insurance Commissioner is limited
by statute to the greater of: (a) 10% of its statutory surplus
as regards Policyholders as shown on its last annual statement
on file with the commissioner, or (b) the net income as
reported for the period
F-45
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 13. STATUTORY INFORMATION (CONTINUED)
covered by such annual statement, but shall not include pro rata
distribution of any class of the insurer's own securities.
Accordingly, the Company's share of the maximum dividend payout which
may be made in 2002 without prior Pennsylvania Commissioner approval
is $2,295. Dividends to the Company totaled $1,594 in 2001 and $1,472
in 2000.
NOTE 14. COMMITMENTS
The Company has outstanding commitments to invest up to $124,000 in
limited partnerships at December 31, 2001. These commitments will be
funded as required through the end of the respective investment
periods, which typically span 3 to 5 years expiring in 2005. At
December 31, 2001, the total commitment to fund limited partnerships
that invest in private equity securities is $87,000, real estate
activities $22,000 and fixed income securities $15,000. At December
31, 2001, no one partnership commitment exceeded $7.5 million, or 6%,
of the outstanding commitment amount.
During 2001, the Company entered into contracts to provide services
related to the eCommerce program with various external vendors. The
total outstanding commitment for these contracts at December 31, 2001,
was $16,146, of which approximately $12,943 will be reimbursed to the
Company by the Exchange. The majority of these committed services at
December 31, 2001, are expected to be performed in 2002.
NOTE 15. SEGMENT INFORMATION
The Company operates its business as three reportable segments -
management operations, property/casualty insurance operations and
investment operations. Accounting policies for segments are the same
as those described in the summary of significant accounting policies.
See also Note 2. Assets are not allocated to the segments and are
reviewed in total by management for purposes of decision making. No
single customer or agent provides 10% or more of revenues for the
Exchange.
The Company's principal operations consist of serving as
attorney-in-fact for the Exchange, which constitute its management
operations. The Company's property/casualty insurance operations arise
through direct business of its
F-46
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 15. SEGMENT INFORMATION (CONTINUED)
subsidiaries and by virtue of the pooling agreement between its
subsidiaries and the Exchange, which includes assumed reinsurance from
nonaffiliated domestic and foreign sources. Insurance provided in the
property/casualty operations consists of personal and commercial lines
and is sold by independent agents. Personal lines are marketed to
individuals and commercial lines are marketed to small and
medium-sized businesses. The performance of the personal lines and
commercial lines is evaluated based upon the underwriting results as
determined under SAP for the total pooled business of the Group.
F-47
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 15. SEGMENT INFORMATION (CONTINUED)
Summarized financial information for these operations is presented
below.
2001 2000 1999
------------ ------------ ------------
Management operations:
---------------------
OPERATING REVENUE:
Management fee revenue $ 634,966 $ 551,646 $ 513,375
Service agreement revenue 27,247 22,662 15,441
------------ ------------ ------------
Total operating revenue $ 662,213 $ 574,308 $ 528,816
------------ ------------ ------------
Cost of management operations 477,645 415,562 380,298
Income before income taxes $ 184,568 $ 158,746 $ 148,518
============ ============ ============
Net income from management operations $ 123,187 $ 107,032 $ 100,913
============ ============ ============
Insurance underwriting operations:
---------------------------------
OPERATING REVENUE:
Premiums earned:
Commercial lines $ 34,970 $ 28,456 $ 25,147
Personal lines 97,078 89,369 87,334
Reinsurance 8,866 7,880 6,185
------------ ------------ ------------
Total premiums earned (SAP) 140,914 125,705 118,666
GAAP adjustments (3,266) (1,997) (1,442)
------------ ------------ ------------
Total premiums earned (GAAP) $ 137,648 $ 123,708 $ 117,224
------------ ------------ ------------
OPERATING EXPENSES:
Losses and expenses:
Commercial lines $ 41,417 $ 31,914 $ 26,726
Personal lines 107,851 92,012 85,512
Reinsurance 12,970 12,203 9,225
------------ ------------ ------------
Total losses and expenses (SAP) 162,238 136,129 121,463
GAAP adjustments (4,127) (2,019) (700)
------------ ------------ ------------
Total losses and expenses (GAAP) $ 158,111 $ 134,110 $ 120,763
------------ ------------ ------------
Loss before income taxes ($20,463) ($10,402) ($3,539)
============ ============ ============
Net loss from insurance underwriting
operations ($13,658) ($7,013) ($2,405)
============ ============ ============
Investment operations:
---------------------
Net investment income $ 49,884 $ 48,401 $ 43,344
Net realized (loss) income on investments (31,879) 16,968 14,746
Equity in (losses) earnings of
limited partnerships (7) 4,733 641
------------ ------------ ------------
Income before income taxes and
equity in earnings of EFL $ 17,998 $ 70,102 $ 58,731
============ ============ ============
Net income from investment operations $ 12,732 $ 52,374 $ 44,598
============ ============ ============
Profitability of the Management Operations segment is evaluated
principally based on the gross margin from management operations
while profitability of the
F-48
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 15. SEGMENT INFORMATION (CONTINUED)
Property Casualty Operations segment is evaluated principally based on
the combined ratio. Investment operations performance is evaluated
based on appreciation of assets, rate of return and overall return.
F-49
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
First Second Third Fourth
Quarter Quarter Quarter Quarter
---------- ---------- ---------- ----------
2001
----
Operating revenue $ 184,255 $ 208,583 $ 209,163 $ 197,860
Operating expenses (144,593) (157,265) (164,708) (169,190)
Other income and expenses 11,452 17,289 6,667 (17,410)
---------- ---------- ---------- ----------
Income before income taxes and equity in
earnings of EFL 51,114 68,607 51,122 11,260
========== ========== ========== ==========
Net income $ 34,785 $ 47,129 $ 34,430 $ 5,917
========== ========== ========== ==========
Net income per share $ 0.49 $ 0.66 $ 0.48 $ 0.08
========== ========== ========== ==========
Comprehensive income $ 36,407 $ 45,414 $ 31,081 $ 21,399
========== ========== ========== ==========
2000
----
Operating revenue $ 164,223 $ 182,787 $ 183,466 $ 167,540
Operating expenses (130,808) (141,067) (141,791) (136,006)
Other income and expenses 18,108 19,386 17,682 14,926
---------- ---------- ---------- ----------
Income before income taxes and equity in
earnings of EFL 51,523 61,106 59,357 46,460
========== ========== ========== ==========
Net income $ 36,185 $ 42,518 $ 41,192 $ 32,498
========== ========== ========== ==========
Net income per share $ 0.50 $ 0.59 $ 0.58 $ 0.45
========== ========== ========== ==========
Comprehensive income $ 50,036 $ 35,093 $ 41,565 $ 22,300
========== ========== ========== ==========
1999
----
Operating revenue $ 154,171 $ 170,724 $ 169,038 $ 152,107
Operating expenses (120,411) (129,025) (128,672) (122,953)
Other income and expenses 13,714 14,906 14,994 15,117
---------- ---------- ---------- ----------
Income before income taxes and equity in
earnings of EFL 47,474 56,605 55,360 44,271
========== ========== ========== ==========
Net income $ 33,407 $ 39,225 $ 38,425 $ 32,049
========== ========== ========== ==========
Net income per share $ 0.45 $ 0.53 $ 0.53 $ 0.44
========== ========== ========== ==========
Comprehensive income $ 31,897 $ 32,180 $ 26,295 $ 39,137
========== ========== ========== ==========
F-50
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share data
NOTE 16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (CONTINUED)
During the fourth quarter of 2001, the Company realized net losses on the sale
of impaired securities and realized charges for other-than-temporary impairments
of equity securities and limited partnerships totaling $29,153. Realized losses
resulted in an after-tax earnings per share reduction of $0.27. The investment
sales were part of a proactive year-end tax planning strategy and will produce
the recovery of approximately $9.6 million of federal income taxes paid in 1998,
1999 and 2000. Also contributing to the fourth quarter 2001 decline in net
income per share were charges for a severance benefit stemming from the
retirement of the president and CEO of the Erie Insurance Group. The Company's
share of charges related to this severance were approximately $0.10 per share,
after taxes.
F-51
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(Dollars in thousands)
September 30, December 31
ASSETS 2002 2001
---- ----
(Unaudited)
INVESTMENTS
Fixed maturities at fair value
(amortized cost of $620,274 and $543,423, respectively) $ 646,172 $ 559,873
Equity securities at fair value (cost of $165,772 and $159,727, respectively) 181,919 193,798
Limited partnerships (cost of $93,197 and $79,668, respectively) 88,952 81,596
Real estate mortgage loans 5,601 5,700
--------------- ---------------
TOTAL INVESTMENTS $ 922,644 $ 840,967
Cash and cash equivalents 76,190 88,213
Accrued investment income 12,496 9,138
Premiums receivable from Policyholders 240,448 186,175
Prepaid federal income tax 4,383 14,056
Reinsurance recoverable from Erie Insurance Exchange 506,012 438,605
Ceded unearned premium to Erie Insurance Exchange 64,116 52,450
Note receivable from Erie Family Life Insurance Company on unpaid losses 15,000 15,000
Other receivables from Erie Insurance Exchange and affiliates 191,167 149,600
Reinsurance recoverable non-affiliates 273 372
Deferred policy acquisition costs 21,635 17,018
Property and equipment 13,419 14,635
Equity in Erie Family Life Insurance Company 47,254 44,683
Prepaid pension 40,017 25,451
Other assets 39,636 39,203
--------------- ---------------
Total assets $ 2,194,690 $ 1,935,566
=============== ===============
(Continued)
See Notes to Consolidated Financial Statements.
F-52
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(Dollars in thousands)
September 30, December 31
LIABILITIES AND SHAREHOLDERS' EQUITY 2002 2001
---- ----
(Unaudited)
LIABILITIES
Unpaid losses and loss adjustment expenses $ 629,618 $ 557,278
Unearned premiums 390,639 311,969
Commissions payable and accrued 137,383 110,121
Accounts payable and accrued expenses 41,044 46,164
Deferred income taxes 10,054 12,945
Dividends payable 10,895 10,930
Employee benefit obligations 16,783 20,904
--------------- ---------------
TOTAL LIABILITIES $ 1,236,416 $ 1,070,311
--------------- ---------------
SHAREHOLDERS' EQUITY
Capital Stock
Class A common, stated value $0.292 per share; authorized 74,996,930
shares; 67,080,000 shares issued in 2002; 63,677,106 and 63,836,323
shares outstanding in 2002
and 2001, respectively $ 1,957 $ 1,955
Class B common, stated value $70 per
share; authorized 3,070 shares;
3,050 shares issued and outstanding in 2002 and
3,070 shares issued and outstanding in 2001 213 215
Additional paid-in capital 7,830 7,830
Accumulated other comprehensive income 31,266 35,222
Retained earnings 1,018,868 913,406
--------------- ---------------
Total contributed capital and retained earnings $ 1,060,134 $ 958,628
Treasury stock, at cost 3,402,894 shares
in 2002 and 3,195,677 shares in 2001 (101,860) (93,373)
--------------- ---------------
TOTAL SHAREHOLDERS' EQUITY $ 958,274 $ 865,255
--------------- ---------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,194,690 $ 1,935,566
=============== ===============
See Notes to Consolidated Financial Statements.
F-53
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Nine Months Ended
September 30
--------------------------------------
2002 2001
--------------------------------------
(Amount in thousands, except per share
data)
OPERATING REVENUE:
Management fee revenue $ 593,895 $ 480,805
Premiums earned 119,824 100,857
Service agreement revenue 16,310 20,339
------------ -----------
Total operating revenue $ 730,029 $ 602,001
------------ -----------
OPERATING EXPENSES:
Cost of management operations $ 421,097 $ 349,796
Losses and loss adjustment expenses incurred 98,431 88,074
Policy acquisition and other underwriting expenses 37,343 28,696
------------ -----------
Total operating expenses $ 556,871 466,566
------------ -----------
OTHER INCOME AND EXPENSES:
Net investment income $ 40,705 $ 36,855
Net realized loss on investments (8,628) (2,726)
Equity in earnings of limited partnerships 1,110 1,279
------------ -----------
Total other income and expenses $ 33,187 $ 35,408
------------ -----------
Income before income taxes and equity in earnings
of Erie Family Life Insurance Company $ 206,345 $ 170,843
Less: Provision for income taxes 69,171 56,835
Equity in earnings of Erie Family
Life Insurance Company, net of tax $ 1,015 $ 2,337
------------ -----------
Net income $ 138,189 $ 116,345
============ ===========
Net income per share $ 1.94 $ 1.63
============ ===========
Weighted average shares outstanding 71,109 71,380
Dividends declared per share:
Class A $ 0.51 $ 0.4575
Class B 76.50 68.625
See Notes to Consolidated Financial Statements.
F-54
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Nine Months Ended
September 30
-------------------------------------
2002 2001
---------------- --------------
(Dollars in thousands)
NET INCOME $ 138,189 $ 116,345
--------------- ---------------
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising
during period (19,030) (8,021)
Less: Losses included in net income 8,628 2,726
--------------- ---------------
Net unrealized holding gains (losses)
arising during period (10,402) (5,295)
Income tax (expense) benefit related to
unrealized gains (losses) 3,641 1,853
--------------- ---------------
Net appreciation (depreciation) of investments (6,761) (3,442)
Minimum pension liability adjustment 4,315 0
Less: Tax asset related to pension
liability adjustment (1,510) 0
--------------- ---------------
Net pension liability adjustment 2,805 0
--------------- ---------------
Other comprehensive income loss, net of tax (3,956) (3,442)
COMPREHENSIVE INCOME $ 134,233 $ 112,903
=============== ===============
See Notes to Consolidated Financial Statements.
F-55
ERIE INDEMNITY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended
September 30
-------------------------------------
2002 2001
---------------- ---------------
(Amount in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
NET INCOME $ 138,189 $ 116,345
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 2,909 2,306
Deferred income tax expense 726 3,820
Amortization of deferred policy acquisition costs 21,516 17,852
Equity in income of limited partnerships (1,110) (1,279)
Realized loss on investments 8,628 2,726
Net amortization of bond discount (318) (156)
Undistributed losses (earnings of Erie Family Life
Insurance Company) 196 (1,317)
Deferred compensation 341 119
Increase in accrued investment income (3,358) (1,231)
Increase in receivables (174,815) (148,346)
Policy acquisition costs deferred (26,133) (21,283)
Increase in prepaid expenses and other assets (14,476) (11,497)
(Decrease) increase in accounts payable and accrued
expenses (5,265) 5,698
Increase in commissions payable and accrued 27,262 11,803
Increase in income taxes payable 9,673 22,313
Increase in loss reserves 72,340 54,383
Increase in unearned premiums 78,669 48,331
----------------- ---------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 134,974 $ 100,587
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments:
Fixed maturities $ (248,428) $ (161,360)
Equity securities (41,655) (43,267)
Limited partnership investments (34,448) (20,488)
Sales/maturities of investments:
Fixed maturity sales 83,978 79,485
Fixed maturity calls/maturities 80,950 61,249
Equity securities 33,949 39,881
Mortgage Loans 99 850
Limited partnership sales or distributions 22,028 5,687
Purchase of property and equipment (1,334) (1,821)
Purchase of computer software (359) (818)
Loans to agents (2,527) (6,903)
Collections on agent loans 2,000 1,788
----------------- ---------------
NET CASH USED IN INVESTING ACTIVITIES $ (105,747) $ (45,717)
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid to shareholders $ (32,763) $ (29,507)
Purchase of treasury stock (8,487) (6,687)
----------------- ---------------
NET CASH USED IN FINANCING ACTIVITIES $ (41,250) $ (36,194)
----------------- ---------------
Net (decrease) increase in cash and cash equivalents (12,023) 18,676
Cash and cash equivalents at beginning of period 88,213 38,778
----------------- ---------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 76,190 $ 57,454
================= ===============
Supplemental disclosures of cash flow information:
Income tax payments $ 69,326 $ 31,571
See Notes to Consolidated Financial Statements.
F-56
ERIE INDEMNITY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
All dollar amounts are in thousands except per share data
NOTE A -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements, which include the
accounts of the Erie Indemnity Company and its wholly owned property and
casualty insurance subsidiaries, Erie Insurance Company (EIC), Erie Insurance
Company of New York (EINY) and Erie Insurance Property & Casualty Company, have
been prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles (GAAP) for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the nine-month period ended September 30, 2002 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2002. For further information, refer to the consolidated financial statements
and footnotes thereto included in the Company's Form 10-K for the year ended
December 31, 2001 as filed with the Securities and Exchange Commission on March
12, 2002.
NOTE B -- RECLASSIFICATIONS
Certain amounts previously reported in the 2001 financial statements have been
reclassified to conform to the current period's presentation. Such
reclassifications were minor in nature and did not impact earnings.
NOTE C -- EARNINGS PER SHARE
Earnings per share is based on the weighted average number of Class A shares
outstanding (63,789,404 and 64,011,614 at September 30, 2002 and 2001,
respectively), giving effect to the conversion of the weighted average number of
Class B shares outstanding (3,050 in 2002 and 3,070 in 2001) at a rate of 2,400
Class A shares for one Class B share. In August 2002, 20 shares of Class B
voting stock were converted to 48,000 non voting shares of Class A common stock.
For the nine months ended September 30, 2002 weighted average equivalent shares
outstanding were 71,109,404 compared to 71,379,614 for the nine months ended
September 30, 2001.
NOTE D -- INVESTMENTS
Marketable equity securities consist primarily of common and non redeemable
preferred stocks while fixed maturities consist of bonds, notes and redeemable
preferred stock. Management considers all fixed maturities and marketable equity
securities available-for-sale. Management determines the appropriate
classification of fixed maturities at the time of purchase and
F-57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE D -- INVESTMENTS (CONTINUED)
reevaluates such designation as of each statement of financial position date.
Available-for-sale securities are stated at fair value, with the unrealized
gains and losses, net of deferred tax, reported as a separate component of
accumulated other comprehensive income in shareholders' equity. When a decline
in the value of investments is considered to be other-than-temporary by
management, the investments are written down to their estimated realizable
value. Investment impairments are evaluated on an individual security basis and
investments considered impaired are recorded as realized losses on investments
in the Consolidated Statements of Operations. In the first nine months of 2002
and 2001 the Company recognized impairment charges totaling $17,668 and $5,736,
respectively.
F-58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE D -- INVESTMENTS (CONTINUED)
The following is a summary of available-for-sale securities:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ------------ ------------- -------------
September 30, 2002
------------------
FIXED MATURITIES:
----------------
U.S. treasuries & government
agencies $ 8,281 $ 727 $ 82 $ 8,926
States & political subdivisions 52,071 3,371 0 55,442
Special revenue 96,068 5,506 0 101,574
Public utilities 42,820 1,524 988 43,356
U.S. industrial & miscellaneous 360,806 24,573 8,997 376,382
Foreign 47,177 2,070 2,691 46,556
------------ ------------ ------------- -------------
Total bonds $ 607,223 $ 37,771 $ 12,758 $ 632,236
Redeemable preferred stock 13,051 885 0 13,936
------------ ------------ ------------- -------------
Total fixed maturities $ 620,274 $ 38,656 $ 12,758 $ 646,172
------------ ------------ ------------- -------------
EQUITY SECURITIES:
-----------------
Common stock:
U.S. banks, trusts &
insurance companies $ 1,846 $ 784 $ 484 $ 2,146
U.S. industrial & miscellaneous 19,777 14,023 1,632 32,168
Foreign 417 233 0 650
Non redeemable preferred stock:
Public utilities 11,902 125 114 11,913
U.S. banks, trusts &
insurance companies 22,189 1,478 486 23,181
U.S. industrial & miscellaneous 89,166 4,651 3,785 90,032
Foreign 20,475 1,404 50 21,829
------------ ------------ ------------- -------------
Total equity securities $ 165,772 $ 22,698 $ 6,551 $ 181,919
------------ ------------ ------------- -------------
Total available-for-sale
securities $ 786,046 $ 61,354 $ 19,309 $ 828,091
============ ============ ============= =============
F-59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE D -- INVESTMENTS (CONTINUED)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ------------ ------------- -------------
December 31, 2001
-----------------
FIXED MATURITIES:
----------------
U.S. treasuries & government
agencies $ 11,211 $ 502 $ 0 $ 11,713
States & political subdivisions 42,392 1,817 88 44,121
Special revenue 110,267 3,496 345 113,418
Public utilities 25,150 1,156 36 26,270
U.S. industrial & miscellaneous 311,757 8,989 1,438 319,308
Foreign 26,634 859 17 27,476
------------ ------------ ------------- -------------
Total bonds $ 527,411 $ 16,819 $ 1,924 $ 542,306
Redeemable preferred stock 16,012 1,555 0 17,567
------------ ------------ ------------- -------------
Total fixed maturities $ 543,423 $ 18,374 $ 1,924 $ 559,873
------------ ------------ ------------- -------------
EQUITY SECURITIES:
Common stock:
U.S. banks, trusts &
insurance companies $ 3,284 $ 814 $ 16 $ 4,082
U.S. industrial & miscellaneous 28,718 31,570 579 59,709
Nonredeemable
preferred stock:
Public utilities 2,370 12 3 2,379
U.S. banks, trusts &
insurance companies 14,685 938 58 15,565
U.S. industrial & miscellaneous 91,185 2,573 2,111 91,647
Foreign 19,485 1,039 108 20,416
------------ ------------ ------------- -------------
Total equity securities $ 159,727 $ 36,946 $ 2,875 $ 193,798
------------ ------------ ------------- -------------
Total available-for-sale
securities $ 703,150 $ 55,320 $ 4,799 $ 753,671
============ ============ ============= =============
F-60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE D - INVESTMENTS (CONTINUED)
The Company participates in a securities lending program whereby certain
securities from its portfolio are loaned to other institutions through a lending
agent. A fee is paid to the Company by the borrower. Collateral, comprised of
cash and government securities, that exceeds the market value of the loaned
securities is maintained by the lending agent in the event a borrower becomes
insolvent or fails to return securities. The Company had loaned securities with
a market value of $37,396 and $38,503 secured by collateral of $39,067 and
$39,645 at September 30, 2002 and 2001, respectively. The Company maintains the
loaned securities on its Consolidated Statements of Financial Position as part
of its invested assets. The Company has incurred no losses on the loan program
since the program's inception.
The components of net realized loss on investments as reported on the
Consolidated Statements of Operations are included below. The securities that
were recognized as impaired during the first nine months of 2002 were in the
telecommunications and energy industry segment. Impairment charges taken in the
first nine months of 2001 related to the internet, telecommunications equipment,
semi-conductor and software development industry segments.
Nine Months Ended
September 30
---------------------------------
2002 2001
-------------- -------------
Fixed maturities:
----------------
Gross realized gains $ 5,515 $ 3,697
Gross realized losses and impairments (15,425) (503)
-------------- --------------
Net realized (loss) gain ($9,910) $ 3,194
-------------- --------------
Equity securities:
-----------------
Gross realized gains $ 7,989 $ 4,045
Gross realized losses and impairments (6,707) (9,965)
-------------- --------------
Net realized gain (loss) $ 1,282 ($5,920)
-------------- --------------
Net realized loss on
investments ($8,628) ($2,726)
============== ==============
F-61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE D - INVESTMENTS (CONTINUED)
Limited partnerships include U.S. and foreign private equity, real estate and
fixed income investments. The private equity limited partnerships invest in
small-to medium-sized companies. Limited partnerships are recorded using the
equity method, which approximates the Company's share of the carrying value of
the partnership. Unrealized gains and losses on private equity limited
partnerships are reflected in shareholders' equity in accumulated other
comprehensive income, net of deferred taxes. The Company has not guaranteed any
of the partnership liabilities.
Limited partnerships that have declined in value below cost and for which the
decline is considered to be other-than-temporary by management are written down
to realizable value. These impairments are made directly on an individual
limited partnership basis and are considered a loss in the Equity in Earnings of
Limited Partnerships on the Consolidated Statements of Operations. The
components of Equity in Earnings of Limited Partnerships as reported on the
Consolidated Statements of Operations are included below. For the nine months
ended September 30, 2002 impairment charges related to limited partnerships were
$1,381. There were no impairments recognized during the nine month period ended
September 30, 2001.
Nine Months Ended
September 30
--------------------------
2002 2001
----------- ------------
Private equity ($2,734) ($ 373)
Real estate 3,712 1,318
Fixed income 132 334
----------- ------------
Total equity in earnings (losses)
of limited partnerships $ 1,110 $ 1,279
=========== ============
F-62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE D -- INVESTMENTS (CONTINUED)
During 2001, the Company entered into several foreign currency forward contracts
which are by definition derivatives. The purpose of these contracts is to hedge
future capital calls related to the Company's limited partnership commitments.
However, under accounting rules, these contracts are not considered hedges. The
forward contracts have no cash requirements at the inception of the arrangement.
At September 30, 2002 there were no contracts outstanding. For the nine months,
gains on these contracts totaled $214 for 2002 and $50 in 2001.
NOTE E -- SUMMARIZED FINANCIAL STATEMENT INFORMATION OF AFFILIATE
The Company owns 21.6% of Erie Family Life Insurance Company (EFL) common shares
outstanding and accounts for this investment using the equity method of
accounting. EFL is a Pennsylvania domiciled life insurance company operating in
10 states and the District of Columbia. Dividends paid to the Company for the
nine months ended September 30, 2002 and 2001 totaled $1,257 and $1,163,
respectively.
The following represents unaudited condensed financial statement information for
EFL on a GAAP basis:
Nine Months Ended Nine Months Ended
September 30, 2002 September 30, 2001
------------------ ------------------
Revenues $ 79,598 $ 79,066
Benefits and expenses 70,604 61,302
----------- -----------
Income before income taxes 8,994 17,764
Income taxes 3,112 6,147
----------- -----------
Net income $ 5,882 $ 11,617
=========== ===========
Comprehensive income $ 18,675 $ 22,285
=========== ===========
Dividends paid to shareholders $ 5,812 $ 5,387
=========== ===========
Net unrealized appreciation on investment
securities at September 30, net of deferred taxes $ 31,152 $ 14,355
=========== ===========
F-63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE F -- NOTE RECEIVABLE FROM ERIE FAMILY LIFE INSURANCE COMPANY
The Company is due $15,000 from EFL in the form of a surplus note. The note
bears an annual interest rate of 6.45% and all payments of interest and
principal on the note may be repaid only out of unassigned surplus of EFL and
are subject to prior approval by the Pennsylvania Insurance Commissioner.
Interest on the surplus note is scheduled to be paid semi-annually. The note
will be payable on demand on or after December 31, 2005. EFL paid $968 in the
first nine months of 2002 and 2001 to the Company. EFL also accrued interest of
$242 in the third quarters of 2002 and 2001 which is payable to the Company.
NOTE G -- TREASURY STOCK
The Company has in place a stock repurchase plan, under which the Company may
repurchase as much as $120,000 of its outstanding Class A common stock through
December 31, 2002. Treasury shares are recorded in the Consolidated Statements
of Financial Position at cost. The Company filed a registration statement on
Form S-3 with the Securities and Exchange Commission on September 30, 2002. The
Company has suspended share repurchases under this plan until the secondary
offering had been completed.
NOTE H -- COMMITMENTS
The Company has contractual commitments to invest up to $116,000 related to its
limited partnership investments at September 30, 2002. These commitments will be
funded as required by the partnership's agreements through September 2007. At
September 30, 2002, the total commitment to fund limited partnerships that
invest in private equity securities is $80,000, real estate activities $20,000
and fixed income securities $16,000. The Company expects to have sufficient cash
flows from operations to meet these partnership commitments.
NOTE I -- SEGMENT INFORMATION
The Company operates its business as three reportable segments - management
operations, property and casualty insurance underwriting and investment
operations. The Company's principal operations consist of serving as
attorney-in-fact for the Erie Insurance Exchange (the Exchange). In its capacity
as attorney-in-fact, the Company sells, underwrites and issues property and
casualty insurance policies for the Exchange. These activities constitute the
Company's management operations. The Company's property and casualty insurance
underwriting operations arise through direct business of its insurance
subsidiaries and by virtue of the intercompany pooling agreement between its
subsidiaries and the Exchange which includes assumed
F-64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE I -- SEGMENT INFORMATION (CONTINUED)
reinsurance from non-affiliated domestic and foreign sources. The performance of
the management operations segment is evaluated principally based on revenue
growth and the profitability as measured by the gross margin from management
operations while profitability of the property and casualty insurance operations
segment is evaluated principally based on the combined ratio. Investment
operations performance is evaluated based on appreciation of asset, rate of
return and overall return. Net income from investment operations includes equity
in earnings of EFL, net of tax. Accounting policies for segments are the same as
described in the summary of significant accounting policies Note 2, of the
Company's Annual Report on Form 10-K for the year ended December 31, 2001 as
filed with the Securities and Exchange Commission on March 12, 2002.
The Exchange and its property and casualty subsidiary, Flagship City Insurance
Company, combined with the Company's property and casualty insurance
subsidiaries (collectively, the Property and Casualty Group) provide personal
and commercial lines insurance through independent agents. The performance of
the personal and commercial lines is evaluated based upon the underwriting
results as determined under SAP for the total pooled business of the Property
and Casualty Group. Assets are not allocated to segments and are reviewed in
total by management for purposes of decision making. No single customer or agent
provides 10% or more of revenues for the Property and Casualty Group.
F-65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE I -- SEGMENT INFORMATION (CONTINUED)
Summarized financial information for these operations is presented below:
Nine Months Ended
September 30
------------------------
2002 2001
--------- ----------
MANAGEMENT OPERATIONS:
---------------------
OPERATING REVENUE:
Management fee revenue $ 593,895 $ 480,805
Service agreement revenue 16,310 20,339
--------- ---------
Total operating revenue $ 610,205 $ 501,144
========= =========
Cost of management operations $ 421,097 $ 349,796
Income before income taxes $ 189,108 $ 151,348
========= =========
Net income from management
operations $ 125,715 $ 100,998
========= =========
INSURANCE UNDERWRITING OPERATIONS:
---------------------------------
OPERATING REVENUE:
Premiums earned:
Commercial lines $ 33,890 $ 25,627
Personal lines 83,461 72,137
Reinsurance 5,724 5,024
--------- ---------
Total premiums earned (SAP) 123,075 102,788
GAAP adjustments (3,251) (1,931)
--------- ---------
Total premiums earned (GAAP) $ 119,824 $ 100,857
--------- ---------
OPERATING EXPENSES:
Losses and expenses:
Commercial lines $ 37,351 $ 28,554
Personal lines 97,775 79,434
Reinsurance 5,265 12,213
--------- ---------
Total losses and expenses
(SAP) 140,391 120,201
GAAP adjustments (4,617) (3,431)
--------- ---------
Total losses and expenses
(GAAP) $ 135,774 $ 116,770
========= =========
Loss before income taxes ($ 15,950) ($ 15,913)
========= =========
Net loss from insurance
underwriting operations ($ 10,603) ($ 10,619)
========= =========
F-66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE I -- SEGMENT INFORMATION (CONTINUED)
INVESTMENT OPERATIONS:
---------------------
Net investment income $ 40,705 $ 36,855
Net realized loss on investments (8,628) (2,726)
Equity in earnings of
limited partnerships 1,110 1,279
--------- ---------
Income before income taxes and
equity in earnings of EFL $ 33,187 $ 35,408
========= =========
Net income from investment
operations $ 23,077 $ 25,966
========= =========
The following table presents the management fee revenue by line of business:
Nine Months Ended %
September 30 Change
--------------------------------
2002 2001
-------- --------
Private passenger auto $313,786 $262,901 19.4%
Commercial auto 50,884 39,963 27.3
Homeowner 92,017 76,373 20.5
Commercial multi-peril 62,371 44,619 39.8
Workers' compensation 52,173 38,829 34.3
All other lines of business 22,664 18,120 25.1
-------- -------- ----
Total $593,895 $480,805 23.5%
======== ======== ====
F-67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE I -- SEGMENT INFORMATION (CONTINUED)
The growth rate of policies in force and policy retention trends (the percentage
of current Policyholders who have renewed their policies) directly impact the
Company's management and property and casualty insurance subsidiaries operating
segments. Below is a summary of each by line of business for the Property and
Casualty Group's insurance business.
Growth rate of policies in force for Property and Casualty Group insurance
--------------------------------------------------------------------------
operations:
----------
Private 12-mth. 12-mth. All other 12-mth. Total
passenger growth growth personal lines growth Personal
Date auto rate Homeowner rate of business rate Lines
------------ --------- ------ --------- ------ -------------- ------- --------
12/31/2000 1,337,280 4.9% 986,654 7.5% 192,909 10.3% 2,516,843
03/31/2001 1,356,651 5.3 1,003,517 7.7 197,849 10.7 2,558,017
06/30/2001 1,382,419 5.9 1,029,339 8.1 204,614 10.9 2,616,372
09/30/2001 1,408,092 6.3 1,053,014 8.4 210,220 11.4 2,671,326
12/31/2001 1,432,747 7.1 1,075,816 9.0 215,134 11.5 2,723,697
03/31/2002 1,469,617 8.3 1,104,806 10.1 222,061 12.2 2,796,484
06/30/2002 1,512,335 9.4 1,146,639 11.4 231,951 13.4 2,890,925
09/30/2002 1,554,425 10.4 1,190,651 13.1 240,410 14.4 2,985,486
12-mth. 12-mth. 12-mth. All other 12-mth. Total
CML* growth CML* growth Workers' growth CML* lines growth Commercial
Date auto rate multi-peril rate comp. rate of business rate Lines
------------ ------ ------ ----------- ------ -------- ------ ----------- ------ ----------
12/31/2000 87,567 5.8% 148,910 10.1% 47,156 8.4% 65,077 7.1% 348,710
03/31/2001 89,388 7.0 152,260 10.6 48,104 8.7 66,309 8.0 356,061
06/30/2001 91,794 7.9 157,804 10.8 49,711 9.5 67,964 8.9 367,273
09/30/2001 94,204 8.8 162,246 11.1 50,984 9.6 70,048 9.0 377,482
12/31/2001 96,100 9.7 166,214 11.6 52,033 10.3 71,539 9.9 385,886
03/31/2002 98,926 10.7 171,283 12.5 53,320 10.8 73,392 10.7 396,921
06/30/2002 102,447 11.6 179,761 13.9 55,607 11.9 75,884 11.7 413,699
09/30/2002 105,353 11.8 185,608 14.4 57,375 12.5 78,131 11.5 426,467
F-68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE I -- SEGMENT INFORMATION (CONTINUED)
Policy retention trends for Property and Casualty Group insurance operations:
----------------------------------------------------------------------------
Private All other
passenger CML* CML* Workers' Lines of
Date auto auto Homeowner multi-peril comp. business Total
-------------- ----------- ----------- --------- ------------ --------- -------- ---------
12/31/2000 92.31% 89.80% 90.70% 87.92% 88.48% 87.89% 91.01%
03/31/2001 92.24 90.29 90.66 88.58 89.06 88.03 91.03
06/30/2001 92.25 90.35 90.63 88.36 88.76 88.18 91.01
09/30/2001 92.22 90.16 90.38 88.18 88.53 88.16 90.89
12/31/2001 92.24 90.53 90.24 88.03 88.43 88.15 90.85
03/31/2002 92.26 90.86 90.24 88.77 89.34 88.11 90.91
06/30/2002 92.35 91.12 90.35 88.95 89.46 88.30 91.02
09/30/2002 92.50 90.79 90.54 88.69 89.51 88.15 91.12
*CML = Commercial
F-69
================================================================================
No dealer, salesperson or other person is authorized to give any
information or to represent anything not contained in this prospectus. You must
not rely on any unauthorized information or representations. This prospectus is
an offer to sell only the shares offered hereby, but only under circumstances
and in jurisdictions where it is lawful to do so. The information contained in
this prospectus is current as of its date.
___________
TABLE OF CONTENTS
Page
----
Prospectus Summary ................................................... 2
Risk Factors ......................................................... 11
Cautionary Note Regarding
Forward-Looking Statements ......................................... 30
Price Range of Our Class A Common
Stock and Dividend History ......................................... 31
Capitalization ....................................................... 32
Selected Historical Financial
Information of the Company ......................................... 33
Selected Historical Financial
Information of the Exchange ........................................ 34
Management's Discussion and
Analysis of Financial Condition
and Results of Operations .......................................... 35
Business ............................................................. 59
Erie Insurance Exchange .............................................. 94
Erie Family Life Insurance Company ................................... 103
Management ........................................................... 104
Certain Relationships and
Related Transactions ............................................... 108
Principal Shareholders ............................................... 109
Selling Shareholder .................................................. 115
Description of Capital Stock ......................................... 116
Shares Eligible for Future Sale ...................................... 117
Underwriting ......................................................... 119
Validity of Common Stock ............................................. 123
Experts .............................................................. 123
Where To Find More Information/
Incorporation by Reference ......................................... 124
Index to Financial Statements ........................................ F-1
Shares
Erie Indemnity Company
Class A Common Stock
--------------
PROSPECTUS
--------------
GOLDMAN, SACHS & CO.
CREDIT SUISSE FIRST BOSTON
ADVEST, INC.
COCHRAN, CARONIA SECURITIES LLC
LEGG MASON WOOD WALKER,
INCORPORATED
Representatives of the Underwriters
================================================================================
PART II
Item 14. Other Expenses Of Issuance And Distribution.
------- -------------------------------------------
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the registrant in connection
with the sale of the Class A common stock being registered. All amounts are
estimates except the registration fee.
Commission registration fee $ 18,238
NASD filing fee 20,324
Printing and engraving costs 110,000
Legal fees and expenses 500,000
Accounting fees and expenses 150,000
Blue sky filing fees and expenses 0
Transfer agent and registrar fees and expenses 1,000
Miscellaneous expenses 25,000
------------
$ 824,562
============
All expenses other than the Commission registration fee are estimated. The
selling shareholder identified in this registration statement is obligated to
reimburse the registrant for the above listed expenses.
Item 15. Indemnification of Directors and Officers.
------- -----------------------------------------
Pennsylvania law provides that a Pennsylvania corporation may indemnify
directors, officers, employees and agents of the corporation against liabilities
they may incur in such capacities for any action taken or any failure to act,
whether or not the corporation would have the power to indemnify the person
under any provision of law, unless such action or failure to act is determined
by a court to have constituted recklessness or willful misconduct. Pennsylvania
law also permits the adoption of a bylaw amendment, approved by shareholders,
providing for the elimination of a director's liability for monetary damages for
any action taken or any failure to take any action unless (i) the director has
breached or failed to perform the duties of his office and (ii) the breach or
failure to perform constitutes self-dealing, willful misconduct or recklessness.
The Bylaws of the registrant provide for (i) indemnification of directors,
officers, employees and agents of the registrant and its subsidiaries and (ii)
the elimination of a director's liability for monetary damages, to the fullest
extent permitted by Pennsylvania law.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers or controlling persons of the
registrant pursuant to the foregoing provisions, the registrant has been
informed that, in the opinion of the Securities
II-1
and Exchange Commission, such indemnification is against public policy as
expressed in the Securities Act of 1933 and is therefore unenforceable.
Item 16. Exhibits.
------- --------
Exhibit No. Exhibit Description
----------- -----------------------------------------------------------
1**** Form of Underwriting Agreement
4.1* Form of Registrant's Class A Common Stock Certificate
4.2* Form of Registrant's Class B Common Stock Certificate
5**** Opinion of Duane Morris LLP
23.1 Consent of Malin, Bergquist & Company LLP
23.2*** Consent of Ward Group
23.3**** Consent of Duane Morris LLP (Included in Exhibit 5)
24** Powers of Attorney
--------------------
* Such exhibit is incorporated by reference to the like numbered exhibit
in Registrant's Form 10 Registration Statement Number 0-24000 filed with
the Securities and Exchange Commission on May 2, 1994.
** Such exhibit is incorporated by reference to the like numbered exhibit
in Registrant's Form S-3 Registration Statement, Commission File No.
333-99943.
*** Such exhibit is incorporated by reference to the like numbered exhibit
in Registrant's Amendment No. 1 to Form S-3 Registration Statement,
Commission File No. 333-99943.
**** Such exhibit is incorporated by reference to the like numbered exhibit
in Registrant's Amendment No. 2 to Form S-3 Registration Statement,
Commission File No. 333-99943.
Item 17. Undertakings.
------- ------------
II-2
The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 that is incorporated by reference in the Registration
Statement shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Commission, such indemnification is
against public policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act of 1933 and will be governed by the
final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
II-3
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Amendment No. 3 to
this registration statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Erie, Commonwealth of Pennsylvania, on
January 7, 2003.
ERIE INDEMNITY COMPANY
By: /s/ Jeffrey A. Ludrof
--------------------------------------
Jeffrey A. Ludrof,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 3 to this registration statement has been signed by the following persons in
the capacities and on the dates indicated.
Signature Title Date
-------------------------------- ------------------------------------------------ ---------------
/s/ Jeffrey A. Ludrof President, Chief Executive Officer and Director January 7, 2003
-------------------------------- (principal executive officer)
Jeffrey A. Ludrof
/s/ Philip A. Garcia Executive Vice President and Chief Financial January 7, 2003
-------------------------------- Officer (principal financial officer)
Philip A. Garcia
/s/ Timothy G. NeCastro Senior Vice President and Controller (principal January 7, 2003
-------------------------------- accounting officer)
Timothy G. NeCastro
* Director January 7, 2003
--------------------------------
Samuel P. Black, III
* Director January 7, 2003
--------------------------------
J. Ralph Borneman, Jr.
II-4
* Director January 7, 2003
--------------------------------
Patricia A. Garrison-Corbin
________________________________ Director January ____, 2003
Susan Hirt Hagen
* Chairman of the Board and Director January 7, 2003
--------------------------------
F. William Hirt
* Director January 7, 2003
--------------------------------
Samuel P. Katz
* Director January 7, 2003
--------------------------------
Claude C. Lilly, III
* Director January 7, 2003
--------------------------------
Henry N. Nassau
* Director January 7, 2003
--------------------------------
John M. Petersen
/s/ Jan R. Van Gorder Senior Executive Vice President, Secretary, January 7, 2003
-------------------------------- General Counsel and Director
Jan R. Van Gorder
* Director January 7, 2003
--------------------------------
Robert C. Wilburn
*By: /s/ Jan R. Van Gorder
---------------------------
Jan R. Van Gorder,
Attorney-in-Fact
II-5