ERIE 10-Q
Erie Indemnity Co (ERIE)
10-Q
2021-10-28
For: 2021-09-30
View Original
Added on
April 10, 2026
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2021
OR
For the transition period from___to___
Commission file number 0-24000
| (Exact name of registrant as specified in its charter) | ||||||||
| (State or other jurisdiction of | (IRS Employer | |||||||||||||
| incorporation or organization) | Identification No.) | |||||||||||||
| (Address of principal executive offices) | (Zip Code) | |||||||||||||||||||
| (Registrant’s telephone number, including area code) | |||||||||||
| Not applicable | ||||||||
| (Former name, former address and former fiscal year, if changed since last report) | ||||||||
Securities registered pursuant to Section 12(b) of the Act:
| stated value $0.0292 per share | |||||||||||||||||
| (Title of each class) | (Trading Symbol) | (Name of each exchange on which registered) | |||||||||||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
| ☒ | Accelerated filer | ☐ | Non-accelerated filer | ☐ | ||||||||||||||||||||||
| Smaller reporting company | Emerging growth company | |||||||||||||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares outstanding of the registrant’s Class A Common Stock as of the latest practicable date was 46,189,068 at October 22, 2021.
The number of shares outstanding of the registrant’s Class B Common Stock as of the latest practicable date was 2,542 at October 22, 2021.
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ERIE INDEMNITY COMPANY
STATEMENTS OF OPERATIONS (UNAUDITED)
(dollars in thousands, except per share data)
| Three months ended | Nine months ended | ||||||||||||||||||||||
| September 30, | September 30, | ||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| Operating revenue | |||||||||||||||||||||||
Management fee revenue - policy issuance and renewal services | $ | $ | $ | $ | |||||||||||||||||||
| Management fee revenue - administrative services | |||||||||||||||||||||||
| Administrative services reimbursement revenue | |||||||||||||||||||||||
| Service agreement revenue | |||||||||||||||||||||||
| Total operating revenue | |||||||||||||||||||||||
| Operating expenses | |||||||||||||||||||||||
| Cost of operations - policy issuance and renewal services | |||||||||||||||||||||||
| Cost of operations - administrative services | |||||||||||||||||||||||
| Total operating expenses | |||||||||||||||||||||||
| Operating income | |||||||||||||||||||||||
| Investment income | |||||||||||||||||||||||
| Net investment income | |||||||||||||||||||||||
| Net realized investment gains | |||||||||||||||||||||||
| Net impairment recoveries (losses) recognized in earnings | ( | ( | |||||||||||||||||||||
| Total investment income | |||||||||||||||||||||||
| Interest expense, net | |||||||||||||||||||||||
| Other expense | |||||||||||||||||||||||
| Income before income taxes | |||||||||||||||||||||||
| Income tax expense | |||||||||||||||||||||||
| Net income | $ | $ | $ | $ | |||||||||||||||||||
| Net income per share | |||||||||||||||||||||||
| Class A common stock – basic | $ | $ | $ | $ | |||||||||||||||||||
| Class A common stock – diluted | $ | $ | $ | $ | |||||||||||||||||||
| Class B common stock – basic and diluted | $ | $ | $ | $ | |||||||||||||||||||
Weighted average shares outstanding – Basic | |||||||||||||||||||||||
| Class A common stock | |||||||||||||||||||||||
| Class B common stock | |||||||||||||||||||||||
Weighted average shares outstanding – Diluted | |||||||||||||||||||||||
| Class A common stock | |||||||||||||||||||||||
| Class B common stock | |||||||||||||||||||||||
| Dividends declared per share | |||||||||||||||||||||||
| Class A common stock | $ | $ | $ | $ | |||||||||||||||||||
| Class B common stock | $ | $ | $ | $ | |||||||||||||||||||
See accompanying notes to Financial Statements. See Note 11, "Accumulated Other Comprehensive Income (Loss)", for amounts reclassified out of accumulated other comprehensive income (loss) into the Statements of Operations.
3
ERIE INDEMNITY COMPANY
STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in thousands)
| Three months ended | Nine months ended | ||||||||||||||||||||||
| September 30, | September 30, | ||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| Net income | $ | $ | $ | $ | |||||||||||||||||||
| Other comprehensive (loss) income, net of tax | |||||||||||||||||||||||
| Change in unrealized holding (losses) gains on available-for-sale securities | ( | ( | |||||||||||||||||||||
Amortization of prior service costs and net actuarial loss on pension and other postretirement plans | |||||||||||||||||||||||
| Total other comprehensive (loss) income, net of tax | ( | ||||||||||||||||||||||
| Comprehensive income | $ | $ | $ | $ | |||||||||||||||||||
See accompanying notes to Financial Statements. See Note 11, "Accumulated Other Comprehensive Income (Loss)", for amounts reclassified out of accumulated other comprehensive income (loss) into the Statements of Operations.
4
ERIE INDEMNITY COMPANY
STATEMENTS OF FINANCIAL POSITION
(dollars in thousands, except per share data)
| September 30, | December 31, | |||||||||||||
| 2021 | 2020 | |||||||||||||
| Assets | (Unaudited) | |||||||||||||
| Current assets: | ||||||||||||||
| Cash and cash equivalents | $ | $ | ||||||||||||
| Available-for-sale securities | ||||||||||||||
| Equity securities | ||||||||||||||
| Receivables from Erie Insurance Exchange and affiliates, net | ||||||||||||||
| Prepaid expenses and other current assets | ||||||||||||||
| Accrued investment income | ||||||||||||||
| Total current assets | ||||||||||||||
| Available-for-sale securities, net | ||||||||||||||
| Equity securities | ||||||||||||||
| Fixed assets, net | ||||||||||||||
| Agent loans, net | ||||||||||||||
| Deferred income taxes, net | ||||||||||||||
| Other assets | ||||||||||||||
| Total assets | $ | $ | ||||||||||||
| Liabilities and shareholders' equity | ||||||||||||||
| Current liabilities: | ||||||||||||||
| Commissions payable | $ | $ | ||||||||||||
| Agent bonuses | ||||||||||||||
| Accounts payable and accrued liabilities | ||||||||||||||
| Dividends payable | ||||||||||||||
| Contract liability | ||||||||||||||
| Deferred executive compensation | ||||||||||||||
| Current portion of long-term borrowings | ||||||||||||||
| Total current liabilities | ||||||||||||||
| Defined benefit pension plans | ||||||||||||||
| Long-term borrowings | ||||||||||||||
| Contract liability | ||||||||||||||
| Deferred executive compensation | ||||||||||||||
| Other long-term liabilities | ||||||||||||||
| Total liabilities | ||||||||||||||
| Shareholders’ equity | ||||||||||||||
Class A common stock, stated value $ | ||||||||||||||
Class B common stock, convertible at a rate of | ||||||||||||||
| Additional paid-in-capital | ||||||||||||||
| Accumulated other comprehensive loss | ( | ( | ||||||||||||
| Retained earnings | ||||||||||||||
| Total contributed capital and retained earnings | ||||||||||||||
Treasury stock, at cost; | ( | ( | ||||||||||||
| Deferred compensation | ||||||||||||||
| Total shareholders’ equity | ||||||||||||||
| Total liabilities and shareholders’ equity | $ | $ | ||||||||||||
See accompanying notes to Financial Statements.
5
ERIE INDEMNITY COMPANY
STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED)
Three and nine months ended September 30, 2021
(dollars in thousands, except per share data)
| Class A common stock | Class B common stock | Additional paid-in-capital | Accumulated other comprehensive (loss) income | Retained earnings | Treasury stock | Deferred compensation | Total shareholders' equity | |||||||||||||||||||
| Balance, December 31, 2020 | $ | $ | $ | $ | ( | $ | $ | ( | $ | $ | ||||||||||||||||
| Net income | ||||||||||||||||||||||||||
| Other comprehensive loss | ( | ( | ||||||||||||||||||||||||
| Dividends declared: | ||||||||||||||||||||||||||
Class A $ | ( | ( | ||||||||||||||||||||||||
Class B $ | ( | ( | ||||||||||||||||||||||||
Net purchase of treasury stock (1) | ||||||||||||||||||||||||||
| Deferred compensation | ( | |||||||||||||||||||||||||
Rabbi trust distribution (2) | ( | |||||||||||||||||||||||||
| Balance, March 31, 2021 | $ | $ | $ | $ | ( | $ | $ | ( | $ | $ | ||||||||||||||||
| Net income | ||||||||||||||||||||||||||
| Other comprehensive income | ||||||||||||||||||||||||||
| Dividends declared: | ||||||||||||||||||||||||||
Class A $ | ( | ( | ||||||||||||||||||||||||
Class B $ | ( | ( | ||||||||||||||||||||||||
Net purchase of treasury stock (1) | ||||||||||||||||||||||||||
| Deferred compensation | ( | |||||||||||||||||||||||||
Rabbi trust distribution (2) | ( | |||||||||||||||||||||||||
| Balance, June 30, 2021 | $ | $ | $ | $ | ( | $ | $ | ( | $ | $ | ||||||||||||||||
| Net income | ||||||||||||||||||||||||||
| Other comprehensive loss | ( | ( | ||||||||||||||||||||||||
| Dividends declared: | ||||||||||||||||||||||||||
Class A $ | ( | ( | ||||||||||||||||||||||||
Class B $ | ( | ( | ||||||||||||||||||||||||
Net purchase of treasury stock (1) | ||||||||||||||||||||||||||
| Deferred compensation | ( | |||||||||||||||||||||||||
| Balance, September 30, 2021 | $ | $ | $ | $ | ( | $ | $ | ( | $ | $ | ||||||||||||||||
(1)Net purchases of treasury stock in 2021 include the repurchase of our Class A common stock in the open market that were subsequently distributed to satisfy stock based compensation awards.
(2)Distributions of our Class A shares were made from the rabbi trust to a retired director and an incentive compensation deferral plan participant in 2021.
6
ERIE INDEMNITY COMPANY
STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED)
Three and nine months ended September 30, 2020
(dollars in thousands, except per share data)
| Class A common stock | Class B common stock | Additional paid-in-capital | Accumulated other comprehensive (loss) income | Retained earnings | Treasury stock | Deferred compensation | Total shareholders' equity | |||||||||||||||||||
| Balance, December 31, 2019 | $ | $ | $ | $ | ( | $ | $ | ( | $ | $ | ||||||||||||||||
| ( | ( | |||||||||||||||||||||||||
| Net income | ||||||||||||||||||||||||||
| Other comprehensive loss | ( | ( | ||||||||||||||||||||||||
| Dividends declared: | ||||||||||||||||||||||||||
Class A $ | ( | ( | ||||||||||||||||||||||||
Class B $ | ( | ( | ||||||||||||||||||||||||
Net purchase of treasury stock (2) | ||||||||||||||||||||||||||
| Deferred compensation | ( | |||||||||||||||||||||||||
| Balance, March 31, 2020 | $ | $ | $ | $ | ( | $ | $ | ( | $ | $ | ||||||||||||||||
| Net income | ||||||||||||||||||||||||||
| Other comprehensive income | ||||||||||||||||||||||||||
| Dividends declared: | ||||||||||||||||||||||||||
Class A $ | ( | ( | ||||||||||||||||||||||||
Class B $ | ( | ( | ||||||||||||||||||||||||
Net purchase of treasury stock (2) | ||||||||||||||||||||||||||
| Deferred compensation | ( | |||||||||||||||||||||||||
Rabbi trust distribution (3) | ( | |||||||||||||||||||||||||
| Balance, June 30, 2020 | $ | $ | $ | $ | ( | $ | $ | ( | $ | $ | ||||||||||||||||
| Net income | ||||||||||||||||||||||||||
| Other comprehensive income | ||||||||||||||||||||||||||
| Dividends declared: | ||||||||||||||||||||||||||
Class A $ | ( | ( | ||||||||||||||||||||||||
Class B $ | ( | ( | ||||||||||||||||||||||||
Net purchase of treasury stock (2) | ||||||||||||||||||||||||||
| Deferred compensation | ( | |||||||||||||||||||||||||
| Balance, September 30, 2020 | $ | $ | $ | $ | ( | $ | $ | ( | $ | $ | ||||||||||||||||
(1)The cumulative effect adjustment is related to the implementation of credit loss allowance accounting guidance effective January 1, 2020.
(2)Net purchases of treasury stock in 2020 include the repurchase of our Class A common stock in the open market that were subsequently distributed to satisfy stock based compensation awards.
(3)Distributions of our Class A shares were made from the rabbi trust to a retired director in 2020.
See accompanying notes to Financial Statements.
7
ERIE INDEMNITY COMPANY
STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
| Nine months ended | ||||||||||||||
| September 30, | ||||||||||||||
| 2021 | 2020 | |||||||||||||
| Cash flows from operating activities | ||||||||||||||
| Management fee received | $ | $ | ||||||||||||
| Administrative services reimbursements received | ||||||||||||||
| Service agreement fee received | ||||||||||||||
| Net investment income received | ||||||||||||||
| Commissions paid to agents | ( | ( | ||||||||||||
| Agents bonuses paid | ( | ( | ||||||||||||
| Salaries and wages paid | ( | ( | ||||||||||||
| Employee benefits paid | ( | ( | ||||||||||||
| General operating expenses paid | ( | ( | ||||||||||||
| Administrative services expenses paid | ( | ( | ||||||||||||
| Income taxes paid | ( | ( | ||||||||||||
| Interest paid | ( | ( | ||||||||||||
| Net cash provided by operating activities | ||||||||||||||
| Cash flows from investing activities | ||||||||||||||
| Purchase of investments: | ||||||||||||||
| Available-for-sale securities | ( | ( | ||||||||||||
| Equity securities | ( | ( | ||||||||||||
| Other investments | ( | ( | ||||||||||||
| Proceeds from investments: | ||||||||||||||
| Available-for-sale securities sales | ||||||||||||||
| Available-for-sale securities maturities/calls | ||||||||||||||
| Equity securities | ||||||||||||||
| Other investments | ||||||||||||||
| Purchase of fixed assets | ( | ( | ||||||||||||
| Loans to agents | ( | ( | ||||||||||||
| Collections on agent loans | ||||||||||||||
| Net cash used in investing activities | ( | ( | ||||||||||||
| Cash flows from financing activities | ||||||||||||||
| Dividends paid to shareholders | ( | ( | ||||||||||||
| Net payments on long-term borrowings | ( | ( | ||||||||||||
| Net cash used in financing activities | ( | ( | ||||||||||||
| Net increase (decrease) in cash and cash equivalents | ( | |||||||||||||
| Cash and cash equivalents, beginning of period | ||||||||||||||
| Cash and cash equivalents, end of period | $ | $ | ||||||||||||
| Supplemental disclosure of noncash transactions | ||||||||||||||
| Transfer of investments from limited partnerships to equity securities | $ | $ | ||||||||||||
| Operating lease assets obtained in exchange for new operating lease liabilities | $ | $ | ||||||||||||
| Liability incurred to purchase fixed assets | $ | $ | ||||||||||||
See accompanying notes to Financial Statements.
8
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
Note 1. Nature of Operations
Erie Indemnity Company ("Indemnity", "we", "us", "our") is a publicly held Pennsylvania business corporation that has since its incorporation in 1925 served as the attorney-in-fact for the subscribers (policyholders) at the Erie Insurance Exchange ("Exchange"). The Exchange, which also commenced business in 1925, is a Pennsylvania-domiciled reciprocal insurer that writes property and casualty insurance.
Our primary function as attorney-in-fact is to perform policy issuance and renewal services on behalf of the subscribers at the Exchange. We also act as attorney-in-fact on behalf of the Exchange with respect to all claims handling and investment management services, as well as the service provider for all claims handling, life insurance, and investment management services for its insurance subsidiaries, collectively referred to as "administrative services". Acting as attorney-in-fact in these two capacities is done in accordance with a subscriber's agreement (a limited power of attorney) executed individually by each subscriber (policyholder), which appoints us as their common attorney-in-fact to transact certain business on their behalf. Pursuant to the subscriber's agreement for acting as attorney-in-fact in these two capacities, we earn a management fee calculated as a percentage of the direct and affiliated assumed premiums written by the Exchange.
The policy issuance and renewal services we provide to the Exchange are related to the sales, underwriting and issuance of policies. The sales related services we provide include agent compensation and certain sales and advertising support services. Agent compensation includes scheduled commissions to agents based upon premiums written as well as additional commissions and bonuses to agents, which are earned by achieving targeted measures. The underwriting services we provide include underwriting and policy processing. The remaining services we provide include customer service and administrative support. We also provide information technology services that support all the functions listed above. Included in these expenses are allocations of costs for departments that support these policy issuance and renewal functions.
By virtue of its legal structure as a reciprocal insurer, the Exchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. Claims handling services include costs incurred in the claims process, including the adjustment, investigation, defense, recording and payment functions. Life insurance management services include costs incurred in the management and processing of life insurance business. Investment management services are related to investment trading activity, accounting and all other functions attributable to the investment of funds. Included in these expenses are allocations of costs for departments that support these administrative functions. The amounts incurred for these services are reimbursed to Indemnity at cost in accordance with the subscriber's agreement and the service agreements. State insurance regulations require that intercompany service agreements and any material amendments be approved in advance by the state insurance department.
Our results of operations are tied to the growth and financial condition of the Exchange. If any events occurred that impaired the Exchange’s ability to grow or sustain its financial condition, including but not limited to reduced financial strength ratings, disruption in the independent agency relationships, significant catastrophe losses, or products not meeting customer demands, the Exchange could find it more difficult to retain its existing business and attract new business. A decline in the business of the Exchange almost certainly would have as a consequence a decline in the total premiums paid and a correspondingly adverse effect on the amount of the management fees we receive. We also have an exposure to a concentration of credit risk related to the unsecured receivables due from the Exchange for its management fee and cost reimbursements. See Note 12, "Concentrations of Credit Risk".
Coronavirus ("COVID-19") pandemic
9
Note 2. Significant Accounting Policies
Basis of presentation
The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by 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 months ended September 30, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021. For further information, refer to the financial statements and footnotes included in our Form 10-K for the year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.
Use of estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
10
Note 3. Revenue
The majority of our revenue is derived from the subscriber’s agreement between us and the subscribers (policyholders) at the Exchange. Pursuant to the subscriber’s agreement, we earn a management fee calculated as a percentage, not to exceed 25 %, of all direct and affiliated assumed written premiums of the Exchange. We allocate a portion of our management fee revenue, currently 25 % of the direct and affiliated assumed written premiums of the Exchange, between the two performance obligations we have under the subscriber’s agreement. The first performance obligation is to provide policy issuance and renewal services to the subscribers (policyholders) at the Exchange, and the second is to act as attorney-in-fact on behalf of the Exchange, as well as the service provider for its insurance subsidiaries, with respect to all administrative services.
The transaction price, including management fee revenue and administrative service reimbursement revenue, includes variable consideration and is allocated based on the estimated standalone selling prices developed using industry information and other available information for similar services. A constraining estimate of variable consideration exists related to the potential for management fees to be returned if a policy were to be cancelled mid-term. Management fees are returned to the Exchange when policyholders cancel their insurance coverage mid-term and premiums are refunded to them. The constraining estimate is determined using the expected value method, based on both historical and current information. The estimated transaction price, as reduced by the constraint, reflects consideration expected for performance of our services. We update the transaction price and the related allocation at least annually based upon the most recent information available or more frequently if there have been significant changes in any components considered in the transaction price.
The first performance obligation is to provide policy issuance and renewal services that result in executed insurance policies between the Exchange or one of its insurance subsidiaries and the subscriber (policyholder). The subscriber (policyholder), receives economic benefits when substantially all the policy issuance or renewal services are complete and an insurance policy is issued or renewed by the Exchange or one of its insurance subsidiaries. It is at the time of policy issuance or renewal that the allocated portion of revenue is recognized.
The following table disaggregates revenue by our two performance obligations:
| Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||
| (in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Management fee revenue - policy issuance and renewal services | $ | $ | $ | $ | |||||||||||||
| Management fee revenue - administrative services | |||||||||||||||||
| Administrative services reimbursement revenue | |||||||||||||||||
| Total administrative services | $ | $ | $ | $ | |||||||||||||
11
Note 4. Earnings Per Share
A reconciliation of the numerators and denominators used in the basic and diluted per-share computations is presented as follows for each class of common stock:
| Three months ended September 30, | ||||||||||||||||||||||||||||||||||||||
| 2021 | 2020 | |||||||||||||||||||||||||||||||||||||
| (dollars in thousands, except per share data) | Allocated net income (numerator) | Weighted shares (denominator) | Per-share amount | Allocated net income (numerator) | Weighted shares (denominator) | Per-share amount | ||||||||||||||||||||||||||||||||
| Class A – Basic EPS: | ||||||||||||||||||||||||||||||||||||||
| Income available to Class A stockholders | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Dilutive effect of stock-based awards | — | — | ||||||||||||||||||||||||||||||||||||
| Assumed conversion of Class B shares | — | — | ||||||||||||||||||||||||||||||||||||
| Class A – Diluted EPS: | ||||||||||||||||||||||||||||||||||||||
Income available to Class A stockholders on Class A equivalent shares | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Class B – Basic and diluted EPS: | ||||||||||||||||||||||||||||||||||||||
| Income available to Class B stockholders | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Nine months ended September 30, | ||||||||||||||||||||||||||||||||||||||
| 2021 | 2020 | |||||||||||||||||||||||||||||||||||||
| (dollars in thousands, except per share data) | Allocated net income (numerator) | Weighted shares (denominator) | Per-share amount | Allocated net income (numerator) | Weighted shares (denominator) | Per-share amount | ||||||||||||||||||||||||||||||||
| Class A – Basic EPS: | ||||||||||||||||||||||||||||||||||||||
| Income available to Class A stockholders | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Dilutive effect of stock-based awards | — | — | ||||||||||||||||||||||||||||||||||||
| Assumed conversion of Class B shares | — | — | ||||||||||||||||||||||||||||||||||||
| Class A – Diluted EPS: | ||||||||||||||||||||||||||||||||||||||
Income available to Class A stockholders on Class A equivalent shares | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Class B – Basic and diluted EPS: | ||||||||||||||||||||||||||||||||||||||
| Income available to Class B stockholders | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||
12
Note 5. Fair Value
Financial instruments carried at fair value
Our available-for-sale and equity securities are recorded at fair value, which is the price that would be received to sell the asset in an orderly transaction between willing market participants as of the measurement date.
Valuation techniques used to derive the fair value of our available-for-sale and equity securities are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources. Unobservable inputs reflect our own assumptions regarding fair market value for these securities. Financial instruments are categorized based upon the following characteristics or inputs to the valuation techniques:
•Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.
•Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
•Level 3 – Unobservable inputs for the asset or liability.
Estimates of fair values for our investment portfolio are obtained primarily from a nationally recognized pricing service. Our Level 1 securities are valued using an exchange traded price provided by the pricing service. Pricing service valuations for Level 2 securities include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data. Pricing service valuations for Level 3 securities are based upon proprietary models and are used when observable inputs are not available or in illiquid markets.
Although virtually all of our prices are obtained from third party sources, we also perform internal pricing reviews, including evaluating the methodology and inputs used to ensure that we determine the proper classification level of the financial instrument and reviewing securities with price changes that vary significantly from current market conditions or independent price sources. Price variances are investigated and corroborated by market data and transaction volumes. We have reviewed the pricing methodologies of our pricing service as well as other observable inputs and believe that the prices adequately consider market activity in determining fair value.
In limited circumstances we adjust the price received from the pricing service when, in our judgment, a better reflection of fair value is available based upon corroborating information and our knowledge and monitoring of market conditions such as a disparity in price of comparable securities and/or non-binding broker quotes. In other circumstances, certain securities are internally priced because prices are not provided by the pricing service.
When a price from the pricing service is not available, values are determined by obtaining broker/dealer quotes and/or market comparables. When available, we obtain multiple quotes for the same security. The ultimate value for these securities is determined based upon our best estimate of fair value using corroborating market information. As of September 30, 2021, nearly all of our available-for-sale and equity securities were priced using a third party pricing service.
13
The following tables present our fair value measurements on a recurring basis by asset class and level of input as of:
| September 30, 2021 | ||||||||||||||||||||||||||
| (in thousands) | Total | Level 1 | Level 2 | Level 3 | ||||||||||||||||||||||
| Available-for-sale securities: | ||||||||||||||||||||||||||
| Corporate debt securities | $ | $ | $ | $ | ||||||||||||||||||||||
| Collateralized debt obligations | ||||||||||||||||||||||||||
| Commercial mortgage-backed securities | ||||||||||||||||||||||||||
| Residential mortgage-backed securities | ||||||||||||||||||||||||||
| Other debt securities | ||||||||||||||||||||||||||
| U.S. Treasury | ||||||||||||||||||||||||||
| Total available-for-sale securities | ||||||||||||||||||||||||||
| Equity securities - nonredeemable preferred and common stock: | ||||||||||||||||||||||||||
| Financial services sector | ||||||||||||||||||||||||||
| Utilities sector | ||||||||||||||||||||||||||
| Energy sector | ||||||||||||||||||||||||||
| Consumer sector | ||||||||||||||||||||||||||
| Communications sector | ||||||||||||||||||||||||||
| Industrial sector | ||||||||||||||||||||||||||
| Total equity securities | ||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||||
| (in thousands) | Total | Level 1 | Level 2 | Level 3 | ||||||||||||||||||||||
| Available-for-sale securities: | ||||||||||||||||||||||||||
| Corporate debt securities | $ | $ | $ | $ | ||||||||||||||||||||||
| Collateralized debt obligations | ||||||||||||||||||||||||||
| Commercial mortgage-backed securities | ||||||||||||||||||||||||||
| Residential mortgage-backed securities | ||||||||||||||||||||||||||
| Other debt securities | ||||||||||||||||||||||||||
| Total available-for-sale securities | ||||||||||||||||||||||||||
| Equity securities - nonredeemable preferred and common stock: | ||||||||||||||||||||||||||
| Financial services sector | ||||||||||||||||||||||||||
| Utilities sector | ||||||||||||||||||||||||||
| Energy sector | ||||||||||||||||||||||||||
| Consumer sector | ||||||||||||||||||||||||||
| Communications sector | ||||||||||||||||||||||||||
| Industrial sector | ||||||||||||||||||||||||||
| Total equity securities | ||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||
14
Level 3 Assets – 2021 Quarterly Change:
(in thousands) | Beginning balance at June 30, 2021 | Included in earnings(1) | Included in other comprehensive income | Purchases | Sales | Transfers into Level 3(2) | Transfers out of Level 3(2) | Ending balance at September 30, 2021 | ||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale securities: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Corporate debt securities | $ | $ | $ | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||||||||||
| Collateralized debt obligations | ( | |||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial mortgage-backed securities | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||
| Residential mortgage-backed securities | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||
| Other debt securities | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||
| Total available-for-sale securities | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||
| Nonredeemable preferred stock | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total Level 3 securities | $ | $ | ( | $ | ( | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||||||||
Level 3 Assets – 2021 Year-to-Date Change:
| (in thousands) | Beginning balance at December 31, 2020 | Included in earnings(1) | Included in other comprehensive income | Purchases | Sales | Transfers into Level 3(2) | Transfers out of Level 3(2) | Ending balance at September 30, 2021 | ||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale securities: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Corporate debt securities | $ | $ | $ | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||||||||||
| Collateralized debt obligations | ( | |||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial mortgage-backed securities | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||
| Residential mortgage-backed securities | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||
| Other debt securities | ( | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||||
| Total available-for-sale securities | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||
| Nonredeemable preferred stock | ( | |||||||||||||||||||||||||||||||||||||||||||||||||
| Total Level 3 securities | $ | $ | ( | $ | ( | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||||||||
15
Level 3 Assets – 2020 Quarterly Change:
| (in thousands) | Beginning balance at June 30, 2020 | Included in earnings(1) | Included in other comprehensive income | Purchases | Sales | Transfers into Level 3(2) | Transfers out of Level 3(2) | Ending balance at September 30, 2020 | ||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale securities: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Corporate debt securities | $ | $ | $ | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||||||||||
| Collateralized debt obligations | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial mortgage-backed securities | ( | |||||||||||||||||||||||||||||||||||||||||||||||||
| Residential mortgage-backed securities | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total available-for-sale securities | ( | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||||
| Nonredeemable preferred stock | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total Level 3 securities | $ | $ | $ | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||||||||||
Level 3 Assets – 2020 Year-to-Date Change:
| (in thousands) | Beginning balance at December 31, 2019 | Included in earnings(1) | Included in other comprehensive income | Purchases | Sales | Transfers into Level 3(2) | Transfers out of Level 3(2) | Ending balance at September 30, 2020 | ||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale securities: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Corporate debt securities | $ | $ | $ | ( | $ | $ | ( | $ | $ | ( | $ | |||||||||||||||||||||||||||||||||||||||
| Collateralized debt obligations | ( | |||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial mortgage-backed securities | ( | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||||
| Residential mortgage-backed securities | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total available-for-sale securities | ( | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||||
| Nonredeemable preferred stock | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total Level 3 securities | $ | $ | $ | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||||||||||
(1)These amounts are reported as net investment income and net realized investment gains (losses) for each of the periods presented above.
(2)Transfers into and/or (out) of Level 3 are primarily attributable to the availability of market observable information and the re-evaluation of the observability of pricing inputs.
Financial instruments not carried at fair value
The following table presents the carrying values and fair values of financial instruments categorized as Level 3 in the fair value hierarchy that are recorded at carrying value as of:
| September 30, 2021 | December 31, 2020 | |||||||||||||||||||||||||
| (in thousands) | Carrying value | Fair value | Carrying value | Fair value | ||||||||||||||||||||||
Agent loans (1) | $ | $ | $ | $ | ||||||||||||||||||||||
Long-term borrowings (2) | ||||||||||||||||||||||||||
(1)The discount rate used to calculate fair value at September 30, 2021 is reflective of a decrease in the BB+ financial yield curve.
16
Note 6. Investments
Available-for-sale securities
See Note 5, "Fair Value" for additional fair value disclosures. The following tables summarize the cost and fair value, net of credit loss allowance, of our available-for-sale securities as of:
| September 30, 2021 | ||||||||||||||||||||||||||
| (in thousands) | Amortized cost | Gross unrealized gains | Gross unrealized losses | Estimated fair value | ||||||||||||||||||||||
| Corporate debt securities | $ | $ | $ | $ | ||||||||||||||||||||||
| Collateralized debt obligations | ||||||||||||||||||||||||||
| Commercial mortgage-backed securities | ||||||||||||||||||||||||||
| Residential mortgage-backed securities | ||||||||||||||||||||||||||
| Other debt securities | ||||||||||||||||||||||||||
| U.S. Treasury | ||||||||||||||||||||||||||
| Total available-for-sale securities, net | $ | $ | $ | $ | ||||||||||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||||
| (in thousands) | Amortized cost | Gross unrealized gains | Gross unrealized losses | Estimated fair value | ||||||||||||||||||||||
| Corporate debt securities | $ | $ | $ | $ | ||||||||||||||||||||||
| Collateralized debt obligations | ||||||||||||||||||||||||||
| Commercial mortgage-backed securities | ||||||||||||||||||||||||||
| Residential mortgage-backed securities | ||||||||||||||||||||||||||
| Other debt securities | ||||||||||||||||||||||||||
| Total available-for-sale securities, net | $ | $ | $ | $ | ||||||||||||||||||||||
The amortized cost and estimated fair value of available-for-sale securities at September 30, 2021 are shown below by remaining contractual term to maturity. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| September 30, 2021 | ||||||||||||||
| Amortized | Estimated | |||||||||||||
| (in thousands) | cost | fair value | ||||||||||||
| Due in one year or less | $ | $ | ||||||||||||
| Due after one year through five years | ||||||||||||||
| Due after five years through ten years | ||||||||||||||
| Due after ten years | ||||||||||||||
| Total available-for-sale securities | $ | $ | ||||||||||||
17
The below securities have been evaluated and determined to be temporary declines in fair value for which we expect to recover our entire principal plus interest. The following tables present available-for-sale securities based on length of time in a gross unrealized loss position as of:
| September 30, 2021 | ||||||||||||||||||||||||||||||||||||||||||||
| Less than 12 months | 12 months or longer | Total | ||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Fair value | Unrealized losses | Fair value | Unrealized losses | Fair value | Unrealized losses | No. of holdings | |||||||||||||||||||||||||||||||||||||
| Corporate debt securities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
| Collateralized debt obligations | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial mortgage-backed securities | ||||||||||||||||||||||||||||||||||||||||||||
| Residential mortgage-backed securities | ||||||||||||||||||||||||||||||||||||||||||||
| Other debt securities | ||||||||||||||||||||||||||||||||||||||||||||
| U.S. Treasury | ||||||||||||||||||||||||||||||||||||||||||||
| Total available-for-sale securities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
| Quality breakdown of available-for-sale securities: | ||||||||||||||||||||||||||||||||||||||||||||
| Investment grade | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
| Non-investment grade | ||||||||||||||||||||||||||||||||||||||||||||
| Total available-for-sale securities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||||||||||||||||||||||
| Less than 12 months | 12 months or longer | Total | ||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Fair value | Unrealized losses | Fair value | Unrealized losses | Fair value | Unrealized losses | No. of holdings | |||||||||||||||||||||||||||||||||||||
| Corporate debt securities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
| Collateralized debt obligations | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial mortgage-backed securities | ||||||||||||||||||||||||||||||||||||||||||||
| Residential mortgage-backed securities | ||||||||||||||||||||||||||||||||||||||||||||
| Other debt securities | ||||||||||||||||||||||||||||||||||||||||||||
| Total available-for-sale securities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
| Quality breakdown of available-for-sale securities: | ||||||||||||||||||||||||||||||||||||||||||||
| Investment grade | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
| Non-investment grade | ||||||||||||||||||||||||||||||||||||||||||||
| Total available-for-sale securities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
Credit loss allowance on investments
As of September 30, 2021, the current expected credit loss allowance on agent loans was $1.0 million compared to $1.1 million at December 31, 2020. The current expected credit loss on available-for-sale securities was less than $0.1 million at September 30, 2021, and $0.2 million at December 31, 2020.
Net investment income
Investment income (loss), net of expenses, was generated from the following portfolios:
| Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||||||||
| (in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||
| Available-for-sale securities | $ | $ | $ | $ | |||||||||||||||||||||||||
| Equity securities | |||||||||||||||||||||||||||||
Limited partnerships (1) | ( | ||||||||||||||||||||||||||||
| Cash equivalents and other | |||||||||||||||||||||||||||||
| Total investment income | |||||||||||||||||||||||||||||
| Less: investment expenses | |||||||||||||||||||||||||||||
| Investment income, net of expenses | $ | $ | $ | $ | |||||||||||||||||||||||||
(1)Equity in earnings (losses) of limited partnerships includes both realized gains (losses) and unrealized valuation changes. Our limited partnership investments are included in the line item "Other assets" in the Statements of Financial Position. We have made no new limited partnership commitments since 2006, and the balance of limited partnership investments is expected to decline over time as additional distributions are received.
18
Realized investment gains (losses)
Realized gains (losses) on investments were as follows:
| Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||||||||
| (in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||
| Available-for-sale securities: | |||||||||||||||||||||||||||||
| Gross realized gains | $ | $ | $ | $ | |||||||||||||||||||||||||
| Gross realized losses | ( | ( | ( | ( | |||||||||||||||||||||||||
| Net realized gains on available-for-sale securities | |||||||||||||||||||||||||||||
| Equity securities | ( | ||||||||||||||||||||||||||||
| Miscellaneous | |||||||||||||||||||||||||||||
| Net realized investment gains | $ | $ | $ | $ | |||||||||||||||||||||||||
The portion of net unrealized gains and losses recognized during the reporting period related to equity securities held at the reporting date is calculated as follows:
| Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||||||||
| (in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||
| Equity securities: | |||||||||||||||||||||||||||||
| Net (losses) gains recognized during the period | $ | ( | $ | $ | $ | ||||||||||||||||||||||||
| Less: net (losses) gains recognized on securities sold | ( | ( | |||||||||||||||||||||||||||
| Net unrealized (losses) gains recognized on securities held at reporting date | $ | ( | $ | $ | $ | ||||||||||||||||||||||||
Net impairment recoveries (losses) recognized in earnings
Impairments on available-for-sale securities and agent loans were as follows:
| Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||||||||
| (in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||
| Available-for-sale securities: | |||||||||||||||||||||||||||||
| Intent to sell | $ | ( | $ | ( | $ | ( | $ | ( | |||||||||||||||||||||
| Credit (impaired) recovered | ( | ( | ( | ||||||||||||||||||||||||||
| Total available-for-sale securities | ( | ( | ( | ||||||||||||||||||||||||||
| Agent loans - expected credit recoveries (losses) | ( | ||||||||||||||||||||||||||||
| Net impairment recoveries (losses) recognized in earnings | $ | $ | ( | $ | $ | ( | |||||||||||||||||||||||
19
Note 7. Borrowing Arrangements
Bank line of credit
As of September 30, 2021, we have access to a $100 million bank revolving line of credit with a $25 million letter of credit sublimit that expires on October 30, 2023. As of September 30, 2021, a total of $99.1 million remains available under the facility due to $0.9 million outstanding letters of credit, which reduce the availability for letters of credit to $24.1 million. We had no borrowings outstanding on our line of credit as of September 30, 2021. Investments with a fair value of $122.6 million were pledged as collateral on the line at September 30, 2021. The investments pledged as collateral have no trading restrictions and are reported as available-for-sale securities and cash and cash equivalents as of September 30, 2021. The banks require compliance with certain covenants, which include leverage ratios and debt restrictions, for our line of credit. We are in compliance with all covenants at September 30, 2021.
Term loan credit facility
In 2016, we entered into a credit agreement for a $100 million senior secured draw term loan credit facility ("Credit Facility") for the acquisition of real property and construction of an office building that now serves as part of our principal headquarters. On January 1, 2019, the Credit Facility converted to a fully-amortized term loan with monthly payments of principal and interest at a fixed rate of 4.35 % over a period of 28 years. Investments with a fair value of $121.9 million were pledged as collateral for the facility and are reported as available-for-sale securities and cash and cash equivalents as of September 30, 2021. The bank requires compliance with certain covenants, which include leverage ratios, debt restrictions and minimum net worth, for our Credit Facility. We are in compliance with all covenants at September 30, 2021.
The remaining unpaid balance from the Credit Facility is reported at carrying value, net of unamortized loan origination and commitment fees, as long-term borrowings on our Statements of Financial Position. See Note 5, "Fair Value" for the estimated fair value of these borrowings.
Annual principal payments
The following table sets forth future principal payments:
| (in thousands) | ||||||||
| Year | Principal payments | |||||||
| 2021 | $ | |||||||
| 2022 | ||||||||
| 2023 | ||||||||
| 2024 | ||||||||
| 2025 | ||||||||
| Thereafter | ||||||||
20
Note 8. Postretirement Benefits
Pension plans
Our pension plans consist of a noncontributory defined benefit pension plan covering substantially all employees and an unfunded supplemental employee retirement plan for certain members of executive and senior management. Although we are the sponsor of these postretirement plans and record the funded status of these plans, the Exchange and its subsidiaries reimburse us for approximately 58 % of the annual benefit expense of these plans, which represents pension benefits for employees performing administrative services and their allocated share of costs for employees in departments that support the administrative functions.
The cost of our pension plans are as follows:
| Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||||
| (in thousands) | 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||||
| Service cost for benefits earned | $ | $ | $ | $ | ||||||||||||||||||||||
| Interest cost on benefits obligation | ||||||||||||||||||||||||||
| Expected return on plan assets | ( | ( | ( | ( | ||||||||||||||||||||||
| Prior service cost amortization | ||||||||||||||||||||||||||
| Net actuarial loss amortization | ||||||||||||||||||||||||||
Pension plan cost (1) | $ | $ | $ | $ | ||||||||||||||||||||||
(1)The components of pension plan costs other than the service cost component are included in the line item "Other expense" in the Statements of Operations after reimbursements from the Exchange and its subsidiaries.
Note 9. Income Taxes
Note 10. Capital Stock
Class A and B common stock
Holders of Class B shares may, at their option, convert their shares into Class A shares at the rate of 2,400 Class A shares per Class B share. There were no
Stock repurchases
In 2011, our Board of Directors approved a continuation of the current stock repurchase program of $150 million, with no time limitation. There were no 17.8 million of repurchase authority remaining under this program at September 30, 2021.
21
Note 11. Accumulated Other Comprehensive Income (Loss)
Changes in accumulated other comprehensive income ("AOCI") (loss) by component, including amounts reclassified to other comprehensive income ("OCI") (loss) and the related line item in the Statements of Operations where net income is presented, are as follows:
| Three months ended | Three months ended | |||||||||||||||||||||||||
| September 30, 2021 | September 30, 2020 | |||||||||||||||||||||||||
| (in thousands) | Before Tax | Income Tax | Net | Before Tax | Income Tax | Net | ||||||||||||||||||||
| Investment securities: | ||||||||||||||||||||||||||
| AOCI, beginning of period | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||
| OCI (loss) before reclassifications | ( | ( | ( | |||||||||||||||||||||||
| Realized investment gains | ( | ( | ( | ( | ( | ( | ||||||||||||||||||||
| Impairment losses | ||||||||||||||||||||||||||
| OCI (loss) | ( | ( | ( | |||||||||||||||||||||||
| AOCI, end of period | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||
| Pension and other postretirement plans: | ||||||||||||||||||||||||||
| AOCI (loss), beginning of period | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||||||||||
| Amortization of prior service costs | ||||||||||||||||||||||||||
| Amortization of net actuarial loss | ||||||||||||||||||||||||||
| OCI | ||||||||||||||||||||||||||
| AOCI (loss), end of period | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||||||||||
| Total | ||||||||||||||||||||||||||
| AOCI (loss), beginning of period | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||||||||||
| Investment securities | ( | ( | ( | |||||||||||||||||||||||
| Pension and other postretirement plans | ||||||||||||||||||||||||||
| OCI (loss) | ( | ( | ( | |||||||||||||||||||||||
| AOCI (loss), end of period | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||||||||||
| Nine months ended | Nine months ended | |||||||||||||||||||||||||
| September 30, 2021 | September 30, 2020 | |||||||||||||||||||||||||
| (in thousands) | Before Tax | Income Tax | Net | Before Tax | Income Tax | Net | ||||||||||||||||||||
| Investment securities: | ||||||||||||||||||||||||||
| AOCI, beginning of period | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||
| OCI (loss) before reclassifications | ( | ( | ( | |||||||||||||||||||||||
| Realized investment gains | ( | ( | ( | ( | ( | ( | ||||||||||||||||||||
| Impairment (recoveries) losses | ( | ( | ( | |||||||||||||||||||||||
| OCI (loss) | ( | ( | ( | |||||||||||||||||||||||
| AOCI, end of period | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||
| Pension and other postretirement plans: | ||||||||||||||||||||||||||
| AOCI (loss), beginning of period | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||||||||||
| Amortization of prior service costs | ||||||||||||||||||||||||||
| Amortization of net actuarial loss | ||||||||||||||||||||||||||
| OCI | ||||||||||||||||||||||||||
| AOCI (loss), end of period | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||||||||||
| Total | ||||||||||||||||||||||||||
| AOCI (loss), beginning of period | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||||||||||
| Investment securities | ( | ( | ( | |||||||||||||||||||||||
| Pension and other postretirement plans | ||||||||||||||||||||||||||
| OCI | ||||||||||||||||||||||||||
| AOCI (loss), end of period | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | $ | ( | ||||||||||||||
22
Note 12. Concentrations of Credit Risk
Note 13. Commitments and Contingencies
In 2020, we entered into an agreement with a bank for the establishment of a loan participation program for agent loans. The maximum amount of loans to be funded through this program is $100 million. We have committed to fund a minimum of 30 % of each loan executed through this program. As of September 30, 2021, the total loans executed under this agreement totaled $25.8 million, of which our portion of the loans is $9.6 million. Additionally, we have agreed to guarantee a portion of the funding provided by the other participants in the program in the event of default. As of September 30, 2021, our maximum potential amount of future payments on the guaranteed portion is $3.0 million. All loan payments under the participation program are current as of September 30, 2021.
We are involved in litigation arising in the ordinary course of conducting business. In accordance with current accounting standards for loss contingencies and based upon information currently known to us, we establish reserves for litigation when it is probable that a loss associated with a claim or proceeding has been incurred and the amount of the loss or range of loss can be reasonably estimated. When no amount within the range of loss is a better estimate than any other amount, we accrue the minimum amount of the estimable loss. To the extent that such litigation against us may have an exposure to a loss in excess of the amount we have accrued, we believe that such excess would not be material to our financial condition, results of operations, or cash flows. Legal fees are expensed as incurred. We believe that our accruals for legal proceedings are appropriate and, individually and in the aggregate, are not expected to be material to our financial condition, results of operations, or cash flows.
We review all litigation on an ongoing basis when making accrual and disclosure decisions. For certain legal proceedings, we cannot reasonably estimate losses or a range of loss, if any, particularly for proceedings that are in their early stages of development or where the plaintiffs seek indeterminate damages. Various factors, including, but not limited to, the outcome of potentially lengthy discovery and the resolution of important factual questions, may need to be determined before probability can be established or before a loss or range of loss can be reasonably estimated. If the loss contingency in question is not both probable and reasonably estimable, we do not establish an accrual and the matter will continue to be monitored for any developments that would make the loss contingency both probable and reasonably estimable. In the event that a legal proceeding results in a substantial judgment against, or settlement by, us, there can be no assurance that any resulting liability or financial commitment would not have a material adverse effect on the financial condition, results of operations, or cash flows.
Note 14. Subsequent Events
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of financial condition and results of operations highlights significant factors influencing Erie Indemnity Company ("Indemnity", "we", "us", "our"). This discussion should be read in conjunction with the historical financial statements and the related notes thereto included in Part I, Item 1. "Financial Statements" of this Quarterly Report on Form 10-Q, and with Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" for the year ended December 31, 2020, as contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 25, 2021.
INDEX
| Page Number | |||||
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995:
Statements contained herein that are not historical fact are forward-looking statements and, as such, are subject to risks and uncertainties that could cause actual events and results to differ, perhaps materially, from those discussed herein. Forward-looking statements relate to future trends, events or results and include, without limitation, statements and assumptions on which such statements are based that are related to our plans, strategies, objectives, expectations, intentions, and adequacy of resources. Examples of forward-looking statements are discussions relating to premium and investment income, expenses, operating results, and compliance with contractual and regulatory requirements. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Among the risks and uncertainties, in addition to those set forth in our filings with the Securities and Exchange Commission, that could cause actual results and future events to differ from those set forth or contemplated in the forward-looking statements include the following:
•dependence upon our relationship with the Erie Insurance Exchange ("Exchange") and the management fee under the agreement with the subscribers at the Exchange;
•dependence upon our relationship with the Exchange and the growth of the Exchange, including:
◦general business and economic conditions;
◦factors affecting insurance industry competition;
◦dependence upon the independent agency system; and
◦ability to maintain our reputation for customer service;
•dependence upon our relationship with the Exchange and the financial condition of the Exchange, including:
◦the Exchange's ability to maintain acceptable financial strength ratings;
◦factors affecting the quality and liquidity of the Exchange's investment portfolio;
◦changes in government regulation of the insurance industry;
◦litigation and regulatory actions;
◦emerging claims and coverage issues in the industry; and
◦severe weather conditions or other catastrophic losses, including terrorism;
•potential impacts of the COVID-19 pandemic on the growth and financial condition of the Exchange;
•costs of providing policy issuance and renewal services to the Exchange under the subscriber's agreement;
•ability to attract and retain talented management and employees;
•ability to ensure system availability and effectively manage technology initiatives;
•difficulties with technology or data security breaches, including cyber attacks;
•ability to maintain uninterrupted business operations;
•outcome of pending and potential litigation;
•potential impacts of the COVID-19 pandemic on our operations, the business operations of our customers and/or independent agents, or our third-party vendor operations;
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•factors affecting the quality and liquidity of our investment portfolio; and
•our ability to meet liquidity needs and access capital.
A forward-looking statement speaks only as of the date on which it is made and reflects our analysis only as of that date. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changes in assumptions, or otherwise.
OPERATING OVERVIEW
Overview
We serve as the attorney-in-fact for the subscribers (policyholders) at the Exchange, a reciprocal insurer that writes property and casualty insurance. Our primary function as attorney-in-fact is to perform policy issuance and renewal services on behalf of the subscribers at the Exchange. We also act as attorney-in-fact on behalf of the Exchange, as well as the service provider for its insurance subsidiaries, with respect to all administrative services.
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 the Exchange signs a subscriber's agreement, which contains an appointment of Indemnity as their attorney-in-fact to transact the business of the Exchange on their behalf. Pursuant to the subscriber’s agreement for acting as attorney-in-fact in these two capacities, we earn a management fee calculated as a percentage of the direct and affiliated assumed premiums written by the Exchange.
Our earnings are primarily driven by the management fee revenue generated for the services we provide to the Exchange. The policy issuance and renewal services we provide to the Exchange are related to the sales, underwriting and issuance of policies. The sales related services we provide include agent compensation and certain sales and advertising support services. Agent compensation includes scheduled commissions to agents based upon premiums written as well as additional commissions and bonuses to agents, which are earned by achieving targeted measures. Agent compensation generally comprises approximately two-thirds of our policy issuance and renewal expenses. The underwriting services we provide include underwriting and policy processing. The remaining services we provide include customer service and administrative support. We also provide information technology services that support all the functions listed above. Included in these expenses are allocations of costs for departments that support these policy issuance and renewal functions.
By virtue of its legal structure as a reciprocal insurer, the Exchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. Claims handling services include costs incurred in the claims process, including the adjustment, investigation, defense, recording and payment functions. Life insurance management services include costs incurred in the management and processing of life insurance business. Investment management services are related to investment trading activity, accounting and all other functions attributable to the investment of funds. Included in these expenses are allocations of costs for departments that support these administrative functions. The amounts incurred for these services are reimbursed to Indemnity at cost in accordance with the subscriber's agreement and the service agreements. State insurance regulations require that intercompany service agreements and any material amendments be approved in advance by the state insurance department.
Our results of operations are tied to the growth and financial condition of the Exchange as the Exchange is our sole customer, and our earnings are largely generated from management fees based on the direct and affiliated assumed premiums written by the Exchange. The Exchange generates revenue by insuring preferred and standard risks, with personal lines comprising 71% of the 2020 direct and affiliated assumed written premiums and commercial lines comprising the remaining 29%. The principal personal lines products are private passenger automobile and homeowners. The principal commercial lines products are commercial multi-peril, commercial automobile and workers compensation.
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Coronavirus ("COVID-19") pandemic
In March 2020, the outbreak of the coronavirus ("COVID-19") was declared a global pandemic. The uncertainty resulting from the COVID-19 pandemic continues to evolve and the pandemic’s ultimate impact and duration remain uncertain at this time.
The impact the COVID-19 pandemic has on the premiums written by the Exchange, our sole customer, affects our management fee revenue. The uncertainty of the ongoing impacts of the COVID-19 pandemic will likely continue until such time as the spread of the virus is contained. In response to reduced driving conditions in 2020 resulting from the COVID-19 pandemic, the Exchange implemented $200 million in personal and commercial auto rate reductions on policies written between July 1, 2020 and June 30, 2021. For the nine months ended September 30, 2021, these rate reductions resulted in a decrease to Exchange's written premiums of approximately $110 million and a corresponding decrease in our management fee revenue of approximately $28 million. There may also be other market and/or regulatory pressures that could impact the Exchange’s operations. While financial markets remained generally strong in the first nine months of 2021, we could experience future losses and/or impairments to the portfolio if future development of the pandemic impacts market conditions. Additionally, we continued to incur increased agent incentive costs as claim frequency, while increasing in 2021, remains lower than pre-pandemic levels resulting in improved agent profitability the first nine months of 2021. We have provided additional disclosure of these impacted areas throughout our Management’s Discussion and Analysis that follows. A broader discussion of the potential future impacts has also been disclosed in Financial Condition and Liquidity and Capital Resources contained within this report, as well as Part I. Item 1A. "Risk Factors" related to COVID-19 as included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.
We have a dedicated internal committee comprised of management from various finance disciplines reviewing our risk positions and emerging trends on an ongoing basis as circumstances are evolving. The committee is reviewing risk scenarios and performing stress tests, including the review of cash flow trends, liquidity requirements and other forms of risk quantification. This provides tools for management, as well as our Risk Committee of the Board of Directors, to assess risks and prioritize key issues.
While we were not required to close our physical locations under the state mandated closure of nonessential services, out of concern for the health and safety of our employees, over 90% of our workforce has been working remote since March 2020. We have had no significant interruption to our core business processes or systems to date. We have had no significant changes to our financial close or reporting processes or related internal controls, nor do we anticipate any significant future challenges at this time. We have a dedicated team responsible for the development and implementation of a return to office plan. We began returning some employees to our offices in July 2021, but paused as a result of the national increase in infections. We plan to resume returning employees to our offices in phases when we consider it appropriate.
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Financial Overview
| Three months ended September 30, | Nine months ended September 30, | |||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands, except per share data) | 2021 | 2020 | % Change | 2021 | 2020 | % Change | ||||||||||||||||||||||||||||||||||||||
| (Unaudited) | (Unaudited) | |||||||||||||||||||||||||||||||||||||||||||
| Operating income | $ | 95,103 | $ | 96,225 | (1.2) | % | $ | 256,263 | $ | 273,105 | (6.2) | % | ||||||||||||||||||||||||||||||||
| Total investment income | 20,598 | 16,438 | 25.3 | 55,004 | 18,796 | NM | ||||||||||||||||||||||||||||||||||||||
| Interest expense, net | 1,034 | 3 | NM | 3,082 | 8 | NM | ||||||||||||||||||||||||||||||||||||||
| Other expense | 541 | 964 | (43.7) | 1,608 | 1,588 | 1.3 | ||||||||||||||||||||||||||||||||||||||
| Income before income taxes | 114,126 | 111,696 | 2.2 | 306,577 | 290,305 | 5.6 | ||||||||||||||||||||||||||||||||||||||
| Income tax expense | 23,903 | 22,480 | 6.3 | 63,759 | 59,786 | 6.6 | ||||||||||||||||||||||||||||||||||||||
| Net income | $ | 90,223 | $ | 89,216 | 1.1 | % | $ | 242,818 | $ | 230,519 | 5.3 | % | ||||||||||||||||||||||||||||||||
| Net income per share – diluted | $ | 1.72 | $ | 1.71 | 1.1 | % | $ | 4.64 | $ | 4.41 | 5.3 | % | ||||||||||||||||||||||||||||||||
NM = not meaningful
Operating income decreased in both the third quarter and nine months ended September 30, 2021, compared to the same periods in 2020, as growth in operating expenses outpaced the growth in operating revenues. Management fee revenue for policy issuance and renewal services increased 4.2% to $504.9 million in the third quarter of 2021 and 3.6% to $1.5 billion for the nine months ended September 30, 2021, respectively. Management fee revenue is based upon the management fee rate we charge, and the direct and affiliated assumed premiums written by the Exchange. The management fee rate was 25% for both 2021 and 2020. The direct and affiliated assumed premiums written by the Exchange increased 3.8% to $2.1 billion in the third quarter of 2021 and increased 3.0% to $6.0 billion for the nine months ended September 30, 2021 compared to the same periods in 2020.
Cost of operations for policy issuance and renewal services increased 5.1% to $430.3 million and 5.5% to $1.3 billion in the third quarter and nine months ended September 30, 2021, compared to the same periods in 2020, due to higher commissions driven by direct and affiliated assumed written premium growth, technology investments and personnel costs.
Management fee revenue for administrative services decreased 2.9% to $14.5 million and 1.1% to $44.0 million in the third quarter and nine months ended September 30, 2021, compared to the same periods in 2020. The administrative services reimbursement revenue and corresponding cost of operations increased both total operating revenue and total operating expenses by $162.4 million in the third quarter of 2021 and $473.1 million for the nine months ended September 30, 2021, but had no net impact on operating income.
Total investment income increased $4.2 million and $36.2 million in the third quarter and nine months ended September 30, 2021, compared to the same periods in 2020. The results from both periods were primarily due to increases in net investment income which were driven by favorable results in our limited partnership portfolio.
General Conditions and Trends Affecting Our Business
Economic conditions
Unfavorable changes in economic conditions, including declining consumer confidence, inflation, high unemployment, and the threat of recession, among others, may lead the Exchange’s customers to modify coverage, not renew policies, or even cancel policies, which could adversely affect the premium revenue of the Exchange, and consequently our management fee. As the COVID-19 pandemic continues to evolve, the extent and duration of the impacts to economic conditions remain uncertain. See Financial Condition and Liquidity and Capital Resources contained within this report, as well as Part I. Item 1A. "Risk Factors" related to COVID-19 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021 for a discussion of the potential impacts of the COVID-19 pandemic on our operations.
Financial market volatility
Our portfolio of fixed maturity and equity security investments is subject to market volatility especially in periods of instability in the worldwide financial markets. Over time, net investment income could also be impacted by volatility and by the general level of interest rates, which impact reinvested cash flow from the portfolio and business operations. Depending upon market conditions, which are unpredictable and remain uncertain, considerable fluctuation could exist in the fair value of our investment portfolio and reported total investment income, which could have an adverse impact on our financial condition, results of operations, and cash flows. Significant volatility was seen in the global financial markets at the onset of the COVID-19 pandemic and pandemic related events may create future volatility. The extent of the impact on our invested assets cannot be estimated with a high degree of certainty at this time given the ongoing developments of this pandemic and the related impacts on the financial markets.
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RESULTS OF OPERATIONS
Management fee revenue
We have two performance obligations in the subscriber’s agreement, providing policy issuance and renewal services and acting as attorney-in-fact for the Exchange, as well as the service provider for its insurance subsidiaries, with respect to all administrative services. We earn management fees for acting as the attorney-in-fact for the subscribers at the Exchange in these two capacities, and allocate our revenues between our performance obligations.
The management fee is calculated by multiplying all direct and affiliated assumed premiums written by the Exchange by the management fee rate, which is determined by our Board of Directors at least annually. The management fee rate was set at 25%, the maximum rate, for both 2021 and 2020. Changes in the management fee rate can affect our revenue and net income significantly. The transaction price, including management fee revenue and administrative service reimbursement revenue, includes variable consideration and is allocated based on the estimated standalone selling prices developed using industry information and other available information for similar services. We update the transaction price and the related allocation at least annually based upon the most recent information available or more frequently if there have been significant changes in any components considered in the transaction price. Our current transaction price allocation review resulted in a minor change in the allocation percentages between the two performance obligations. The change in allocation will not have a material impact on our financial statements.
The following table presents the allocation and disaggregation of revenue for our two performance obligations:
| Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | % Change | 2021 | 2020 | % Change | |||||||||||||||||||||||
| (Unaudited) | (Unaudited) | ||||||||||||||||||||||||||||
| Policy issuance and renewal services | |||||||||||||||||||||||||||||
Direct and affiliated assumed premiums written by the Exchange | $ | 2,075,745 | $ | 1,999,074 | 3.8 | % | $ | 6,024,484 | $ | 5,849,505 | 3.0 | % | |||||||||||||||||
| Management fee rate | 24.3 | % | 24.2 | % | 24.3 | % | 24.2 | % | |||||||||||||||||||||
| Management fee revenue | 504,406 | 483,776 | 4.3 | 1,463,950 | 1,415,580 | 3.4 | |||||||||||||||||||||||
Change in estimate for management fee returned on cancelled policies (1) | 485 | 775 | (37.2) | (1,070) | (3,484) | 69.3 | |||||||||||||||||||||||
| Management fee revenue - policy issuance and renewal services | $ | 504,891 | $ | 484,551 | 4.2 | % | $ | 1,462,880 | $ | 1,412,096 | 3.6 | % | |||||||||||||||||
| Administrative services | |||||||||||||||||||||||||||||
Direct and affiliated assumed premiums written by the Exchange | $ | 2,075,745 | $ | 1,999,074 | 3.8 | % | $ | 6,024,484 | $ | 5,849,505 | 3.0 | % | |||||||||||||||||
| Management fee rate | 0.7 | % | 0.8 | % | 0.7 | % | 0.8 | % | |||||||||||||||||||||
| Management fee revenue | 14,530 | 15,993 | (9.1) | 42,171 | 46,796 | (9.9) | |||||||||||||||||||||||
Change in contract liability (2) | (67) | (1,064) | 93.6 | 1,808 | (2,247) | NM | |||||||||||||||||||||||
Change in estimate for management fee returned on cancelled policies (1) | 8 | (19) | NM | 6 | (55) | NM | |||||||||||||||||||||||
| Management fee revenue - administrative services | 14,471 | 14,910 | (2.9) | 43,985 | 44,494 | (1.1) | |||||||||||||||||||||||
Administrative services reimbursement revenue | 162,410 | 147,710 | 10.0 | 473,133 | 451,229 | 4.9 | |||||||||||||||||||||||
Total revenue from administrative services | $ | 176,881 | $ | 162,620 | 8.8 | % | $ | 517,118 | $ | 495,723 | 4.3 | % | |||||||||||||||||
NM = not meaningful
(1)A constraining estimate of variable consideration exists related to the potential for management fees to be returned if a policy were to be cancelled mid-term. Management fees are returned to the Exchange when policies are cancelled mid-term and unearned premiums are refunded.
(2)Management fee revenue - administrative services is recognized over time as the services are provided. See Part I, Item 1. "Financial Statements - Note 3, Revenue, of Notes to Financial Statements" contained within this report.
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Direct and affiliated assumed premiums written by the Exchange
Direct and affiliated assumed premiums include premiums written directly by the Exchange and premiums assumed from its wholly owned property and casualty subsidiaries. Direct and affiliated assumed premiums written by the Exchange increased 3.8% to $2.1 billion in the third quarter of 2021 compared to the third quarter of 2020, primarily driven by increases in homeowners and commercial multi-peril premiums written. Year-over-year policies in force for all lines of business increased 3.2% in the third quarter of 2021 compared to 1.7% in the third quarter of 2020. The year-over-year average premium per policy for all lines of business decreased 0.7% at September 30, 2021 compared to an increase of 0.8% at September 30, 2020. The year-over-year average premium per policy at September 30, 2021 was impacted by the rate reductions for our personal and commercial auto policies written between July 1, 2020 and June 30, 2021, in response to lower driving activity as a result of the COVID-19 pandemic.
Premiums generated from new business decreased 2.4% to $239 million in the third quarter of 2021. While year-over-year average premium per policy on new business increased 2.0% at September 30, 2021, new business policies written decreased 8.9% in the third quarter of 2021. Premiums generated from new business increased 10.4% to $244 million in the third quarter of 2020. While year-over-year average premium per policy on new business decreased 4.6% at September 30, 2020, new business policies written increased 19.7% in the third quarter of 2020. Premiums generated from renewal business increased 4.7% to $1.8 billion in the third quarter of 2021 compared to the third quarter of 2020. Underlying the trend in renewal business premiums was steady policy retention ratios, partially offset by a 1.0% decrease in year-over-year average premium per policy at September 30, 2021, compared to an increase of 1.5% at September 30, 2020.
Personal lines – Total personal lines premiums written increased 2.6% to $1.5 billion in the third quarter of 2021, compared to 1.8% in the third quarter of 2020. While total personal lines year-over-year average premium per policy decreased 1.5% at September 30, 2021, total personal lines policies in force increased 3.1% in the third quarter of 2021.
Commercial lines – Total commercial lines premiums written increased 7.2% to $582 million in the third quarter of 2021, compared to 2.5% in the third quarter of 2020, driven by a 3.7% increase in total commercial lines policies in force and a 0.9% increase in total commercial lines year-over-year average premium per policy.
Future trends-premium revenue – Through a careful agency selection process, the Exchange plans to continue its effort to expand the size of its agency force to increase market penetration in existing operating territories to contribute to future growth.
Changes in premium levels attributable to the growth in policies in force and rate changes directly affect the profitability of the Exchange and have a direct bearing on our management fee. Future premiums could be impacted by changes resulting from the COVID-19 pandemic, including potential regulatory changes and inflationary trends, among others. Longer-term, increased driving activity may result in future rate increases due to higher claims frequencies and severity. See also Part I. Item 1A. "Risk Factors" related to COVID-19 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.
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Policy issuance and renewal services
| Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | % Change | 2021 | 2020 | % Change | |||||||||||||||||||||||
| (Unaudited) | (Unaudited) | ||||||||||||||||||||||||||||
| Management fee revenue - policy issuance and renewal services | $ | 504,891 | $ | 484,551 | 4.2 | % | $ | 1,462,880 | $ | 1,412,096 | 3.6 | % | |||||||||||||||||
| Service agreement revenue | 6,067 | 6,310 | (3.9) | 18,048 | 19,418 | (7.1) | |||||||||||||||||||||||
| 510,958 | 490,861 | 4.1 | 1,480,928 | 1,431,514 | 3.5 | ||||||||||||||||||||||||
Cost of policy issuance and renewal services | 430,326 | 409,546 | 5.1 | 1,268,650 | 1,202,903 | 5.5 | |||||||||||||||||||||||
Operating income - policy issuance and renewal services | $ | 80,632 | $ | 81,315 | (0.8) | % | $ | 212,278 | $ | 228,611 | (7.1) | % | |||||||||||||||||
Policy issuance and renewal services
The management fee revenue allocated for providing policy issuance and renewal services was 24.3% and 24.2% of the direct and affiliated assumed premiums written by the Exchange for both the three and nine months ended September 30, 2021 and 2020, respectively. This portion of the management fee is recognized as revenue when the policy is issued or renewed because it is at that time that the services we provide are substantially complete and the executed insurance policy is transferred to the customer. The increase in management fee revenue for policy issuance and renewal services was driven by the increase in the direct and affiliated assumed premiums written by the Exchange discussed previously.
Service agreement revenue
Service agreement revenue includes service charges we collect from subscribers/policyholders for providing extended payment terms on policies written and assumed by the Exchange, and late payment and policy reinstatement fees. The service charges are fixed dollar amounts per billed installment. The decrease in service agreement revenue reflects the continued shift to payment plans that do not incur service charges or offer a premium discount for certain payment methods.
Cost of policy issuance and renewal services
| Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | % Change | 2021 | 2020 | % Change | |||||||||||||||||||||||
| (Unaudited) | (Unaudited) | ||||||||||||||||||||||||||||
| Commissions: | |||||||||||||||||||||||||||||
| Total commissions | $ | 288,046 | $ | 273,184 | 5.4 | % | $ | 842,647 | $ | 803,658 | 4.9 | % | |||||||||||||||||
| Non-commission expense: | |||||||||||||||||||||||||||||
| Underwriting and policy processing | $ | 40,731 | $ | 40,674 | 0.1 | % | $ | 124,500 | $ | 121,917 | 2.1 | % | |||||||||||||||||
| Information technology | 46,693 | 42,940 | 8.7 | 139,174 | 128,253 | 8.5 | |||||||||||||||||||||||
| Sales and advertising | 13,422 | 12,111 | 10.8 | 38,955 | 39,356 | (1.0) | |||||||||||||||||||||||
| Customer service | 8,980 | 8,650 | 3.8 | 26,909 | 25,860 | 4.1 | |||||||||||||||||||||||
| Administrative and other | 32,454 | 31,987 | 1.5 | 96,465 | 83,859 | 15.0 | |||||||||||||||||||||||
| Total non-commission expense | 142,280 | 136,362 | 4.3 | 426,003 | 399,245 | 6.7 | |||||||||||||||||||||||
Total cost of policy issuance and renewal services | $ | 430,326 | $ | 409,546 | 5.1 | % | $ | 1,268,650 | $ | 1,202,903 | 5.5 | % | |||||||||||||||||
Commissions – Commissions increased $14.9 million in the third quarter of 2021 and $39.0 million for the nine months ended September 30, 2021 compared to the same periods in 2020, primarily driven by the growth in direct and affiliated assumed written premium, primarily in lines of business that pay a higher commission rate. To a lesser extent, there was also an increase in agent incentive compensation for the third quarter and nine months ended September 30, 2021 compared to the third quarter and nine months ending September 30, 2020. The estimated agent incentive payouts at September 30, 2021 are based on actual underwriting results for the two prior years and current year-to-date actual results and forecasted results for the remainder of 2021. For the nine months ended September 30, 2020, lower claims frequency and related loss expense due to the COVID-19 pandemic impacted agent compensation related to the profitability component.
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Non-commission expense – Non-commission expense increased $5.9 million in the third quarter of 2021 compared to the third quarter of 2020. Information technology costs increased $3.8 million primarily due to increased hardware and software costs as well as increased personnel costs. Sales and advertising increased $1.3 million primarily due to personnel costs. Administrative and other costs increased $0.5 million primarily driven by increased building and equipment depreciation compared to the same period in 2020. Personnel costs in all expense categories for the third quarter of 2021 were impacted by higher medical costs compared to the prior year as the COVID-19 pandemic reduced elective procedures in 2020 and higher incentive plan award accruals due to increased direct written premium growth.
Non-commission expense increased $26.8 million in the nine months ended September 30, 2021 compared to the same period of 2020. Underwriting and policy processing expense increased $2.6 million primarily due to increased personnel costs and underwriting report costs. Information technology costs increased $10.9 million primarily due to increased hardware and software costs and personnel costs. Administrative and other costs increased $12.6 million primarily driven by increased building and equipment depreciation, professional fees and personnel costs compared to the same period in 2020. Personnel costs in all expense categories were impacted by higher medical costs compared to the prior year as the COVID-19 pandemic reduced elective procedures in 2020 and higher incentive plan award accruals due to increased direct written premium growth.
Administrative services
| Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | % Change | 2021 | 2020 | % Change | |||||||||||||||||||||||
| (Unaudited) | (Unaudited) | ||||||||||||||||||||||||||||
| Management fee revenue - administrative services | $ | 14,471 | $ | 14,910 | (2.9) | % | $ | 43,985 | $ | 44,494 | (1.1) | % | |||||||||||||||||
Administrative services reimbursement revenue | 162,410 | 147,710 | 10.0 | 473,133 | 451,229 | 4.9 | |||||||||||||||||||||||
Total revenue allocated to administrative services | 176,881 | 162,620 | 8.8 | 517,118 | 495,723 | 4.3 | |||||||||||||||||||||||
Administrative services expenses | |||||||||||||||||||||||||||||
Claims handling services | 140,100 | 127,055 | 10.3 | 407,762 | 390,832 | 4.3 | |||||||||||||||||||||||
Investment management services | 9,884 | 9,373 | 5.4 | 29,287 | 26,783 | 9.3 | |||||||||||||||||||||||
Life management services | 12,426 | 11,282 | 10.1 | 36,084 | 33,614 | 7.3 | |||||||||||||||||||||||
Operating income - administrative services | $ | 14,471 | $ | 14,910 | (2.9) | % | $ | 43,985 | $ | 44,494 | (1.1) | % | |||||||||||||||||
Administrative services
The management fee revenue allocated to administrative services was 0.7% and 0.8% of the direct and affiliated assumed premiums written by the Exchange for both the three and nine months ended September 30, 2021 and 2020, respectively. This portion of the management fee is recognized as revenue over a four-year period representing the time over which the services are provided. We also report reimbursed costs as revenues, which are recognized monthly as services are provided. The administrative services expenses we incur and the related reimbursements we receive are recorded gross in the Statements of Operations.
Cost of administrative services
By virtue of its legal structure as a reciprocal insurer, the Exchange does not have any employees or officers. Therefore, it enters into contractual relationships by and through an attorney-in-fact. Indemnity serves as the attorney-in-fact on behalf of the Exchange with respect to its administrative services in accordance with the subscriber's agreement. The Exchange's insurance subsidiaries also utilize Indemnity for these services in accordance with the service agreements between each of the subsidiaries and Indemnity. The amounts incurred for these services are reimbursed to Indemnity at cost in accordance with the subscriber's agreement and the service agreements. We record these reimbursements due from the Exchange and its insurance subsidiaries as a receivable.
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Total investment income
A summary of the results of our investment operations is as follows:
| Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | % Change | 2021 | 2020 | % Change | |||||||||||||||||||||||||||||||||||
| (Unaudited) | (Unaudited) | ||||||||||||||||||||||||||||||||||||||||
| Net investment income | $ | 18,858 | $ | 10,645 | 77.2 | % | $ | 49,605 | $ | 20,353 | NM | ||||||||||||||||||||||||||||||
| Net realized investment gains | 1,610 | 5,915 | (72.8) | % | 5,183 | 1,635 | NM | ||||||||||||||||||||||||||||||||||
| Net impairment recoveries (losses) recognized in earnings | 130 | (122) | NM | 216 | (3,192) | NM | |||||||||||||||||||||||||||||||||||
| Total investment income | $ | 20,598 | $ | 16,438 | 25.3 | % | $ | 55,004 | $ | 18,796 | NM | ||||||||||||||||||||||||||||||
NM = not meaningful
Net investment income
Net investment income includes interest and dividends on our fixed maturity and equity security portfolios and the results of our limited partnership investments, net of investment expenses. Net investment income increased $8.2 million in the third quarter of 2021 and $29.3 million for the nine months ended September 30, 2021, compared to the same periods in 2020. The results from both periods were primarily due to equity in earnings of limited partnerships of $11.5 million and $26.7 million for the three and nine months ended September 30, 2021, respectively, compared to equity in earnings of limited partnerships of $3.6 million and equity in losses of limited partnerships $2.4 million, respectively, for the same periods in 2020. We have made no new limited partnership commitments since 2006, and the balance of limited partnership investments is expected to decline over time as additional distributions are received.
Net realized investment gains (losses)
A breakdown of our net realized investment gains (losses) is as follows:
| Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||||||||||||
| (in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||||||||
| Securities sold: | (Unaudited) | (Unaudited) | |||||||||||||||||||||||||||
| Available-for-sale securities | $ | 2,189 | $ | 137 | $ | 4,069 | $ | 1,107 | |||||||||||||||||||||
| Equity securities | (267) | 1,796 | 5 | (1,009) | |||||||||||||||||||||||||
| Equity securities change in fair value | (312) | 3,981 | 1,108 | 1,534 | |||||||||||||||||||||||||
| Miscellaneous | 0 | 1 | 1 | 3 | |||||||||||||||||||||||||
| Net realized investment gains | $ | 1,610 | $ | 5,915 | $ | 5,183 | $ | 1,635 | |||||||||||||||||||||
Net realized gains during the three and nine months ended September 30, 2021 were primarily due to disposals of available-for-sale securities. Net realized gains during the three and nine months ended September 30, 2020 were primarily due to market value adjustments on equity securities.
Net impairment recoveries (losses) recognized in earnings
Net impairment recoveries during the three and nine months ended September 30, 2021 were primarily a result of the change in the current expected credit loss allowance related to our agent loans. Net impairment losses for the nine months ended September 30, 2020 were primarily due to the COVID-19 pandemic's impact on financial markets on our available-for-sale securities.
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Financial condition of Erie Insurance Exchange
Serving in the capacity of attorney-in-fact for the Exchange, we are dependent on the growth and financial condition of the Exchange, who is our sole customer. The strength of the Exchange and its wholly owned subsidiaries is rated annually by A.M. Best Company through assessing its financial stability and ability to pay claims. The ratings are generally based upon factors relevant to policyholders and are not directed toward return to investors. The Exchange and each of its property and casualty subsidiaries are rated A+ "Superior", the second highest financial strength rating, which is assigned to companies that have achieved superior overall performance when compared to the standards established by A.M. Best and have a superior ability to meet obligations to policyholders over the long term. On July 27, 2021, the outlook for the financial strength rating was affirmed as stable. As of December 31, 2020, only approximately 12% of insurance groups, in which the Exchange is included, are rated A+ or higher.
The financial statements of the Exchange are prepared in accordance with statutory accounting principles prescribed by the Commonwealth of Pennsylvania. Financial statements prepared under statutory accounting principles focus on the solvency of the insurer and generally provide a more conservative approach than under U.S. generally accepted accounting principles. Statutory direct written premiums of the Exchange and its wholly owned property and casualty subsidiaries grew 3.0% to $6.0 billion in the first nine months of 2021 compared to the first nine months of 2020. These premiums, along with investment income, are the major sources of cash that support the operations of the Exchange. Policyholders’ surplus determined under statutory accounting principles was $11.7 billion at September 30, 2021, $10.7 billion at December 31, 2020, and $10.0 billion at September 30, 2020. The Exchange and its wholly owned property and casualty subsidiaries' year-over-year policy retention ratio continues to be high at 90.0% at September 30, 2021 and 89.9% at both December 31, 2020 and September 30, 2020.
We have prepared our financial statements considering the financial strength of the Exchange based on its A.M. Best rating and strong level of surplus. We are monitoring risks related to the COVID-19 pandemic on an ongoing basis and believe that the Exchange falls within defined risk tolerances. However, see Part I. Item 1A. "Risk Factors" related to COVID-19 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021 for possible outcomes that could impact that determination.
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FINANCIAL CONDITION
Investments
Our investment portfolio is managed with the objective of maximizing after-tax returns on a risk-adjusted basis. The following table presents the carrying value of our investments as of:
| (dollars in thousands) | September 30, 2021 | % to total | December 31, 2020 | % to total | ||||||||||||||||||||||
| (Unaudited) | ||||||||||||||||||||||||||
| Fixed maturities | $ | 937,504 | 83 | % | $ | 928,236 | 84 | % | ||||||||||||||||||
| Equity securities: | ||||||||||||||||||||||||||
| Preferred stock | 86,270 | 8 | 94,071 | 9 | ||||||||||||||||||||||
| Common stock | 10 | 0 | 19 | 0 | ||||||||||||||||||||||
Agent loans (1) | 67,789 | 6 | 69,212 | 6 | ||||||||||||||||||||||
| Other investments | 40,009 | 3 | 14,325 | 1 | ||||||||||||||||||||||
| Total investments | $ | 1,131,582 | 100 | % | $ | 1,105,863 | 100 | % | ||||||||||||||||||
(1)The current portion of agent loans is included with prepaid expenses and other current assets in the Statements of Financial Position.
Fixed maturities
Under our investment strategy, we maintain a fixed maturity portfolio that is of high quality and well diversified within each market sector. This investment strategy also achieves a balanced maturity schedule. Our fixed maturity portfolio is managed with the goal of achieving reasonable returns while limiting exposure to risk.
Fixed maturities are carried at fair value with unrealized gains and losses, net of deferred taxes, included in shareholders’ equity. Net unrealized gains on fixed maturities, net of deferred taxes, totaled $13.5 million at September 30, 2021, compared to net unrealized gains of $23.3 million at December 31, 2020.
The following table presents a breakdown of the fair value of our fixed maturity portfolio by industry sector and rating as of:
| (in thousands) | September 30, 2021 (1) | |||||||||||||||||||||||||||||||||||||
| AAA | AA | A | BBB | Non- investment grade | Fair value | |||||||||||||||||||||||||||||||||
(Unaudited) | ||||||||||||||||||||||||||||||||||||||
| Basic materials | $ | 0 | $ | 0 | $ | 3,206 | $ | 0 | $ | 8,930 | $ | 12,136 | ||||||||||||||||||||||||||
| Communications | 0 | 8,742 | 8,456 | 17,550 | 18,715 | 53,463 | ||||||||||||||||||||||||||||||||
| Consumer | 0 | 3,180 | 20,079 | 69,040 | 42,643 | 134,942 | ||||||||||||||||||||||||||||||||
| Diversified | 0 | 0 | 0 | 1,033 | 1,004 | 2,037 | ||||||||||||||||||||||||||||||||
| Energy | 0 | 4,160 | 7,835 | 18,554 | 11,863 | 42,412 | ||||||||||||||||||||||||||||||||
| Financial | 0 | 1,015 | 67,054 | 113,215 | 16,850 | 198,134 | ||||||||||||||||||||||||||||||||
| Industrial | 0 | 0 | 10,009 | 16,435 | 24,128 | 50,572 | ||||||||||||||||||||||||||||||||
Structured securities (2) | 151,952 | 164,822 | 30,168 | 16,846 | 0 | 363,788 | ||||||||||||||||||||||||||||||||
| Technology | 5,213 | 0 | 7,814 | 22,137 | 13,317 | 48,481 | ||||||||||||||||||||||||||||||||
| U.S. Treasury | 0 | 5,749 | 0 | 0 | 0 | 5,749 | ||||||||||||||||||||||||||||||||
| Utilities | 0 | 0 | 3,800 | 17,045 | 4,945 | 25,790 | ||||||||||||||||||||||||||||||||
Total | $ | 157,165 | $ | 187,668 | $ | 158,421 | $ | 291,855 | $ | 142,395 | $ | 937,504 | ||||||||||||||||||||||||||
(1)Ratings are supplied by S&P, Moody’s, and Fitch. The table is based upon the lowest rating for each security.
(2)Structured securities include residential and commercial mortgage-backed securities, collateralized debt obligations, and asset-backed securities.
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Equity securities
Equity securities consist of nonredeemable preferred and common stock and are carried at fair value in the Statements of Financial Position with all changes in unrealized gains and losses reflected in the Statements of Operations.
The following table presents an analysis of the fair value of our nonredeemable preferred and common stock securities by sector as of:
| (in thousands) | September 30, 2021 | December 31, 2020 | ||||||||||||||||||||||||
| Preferred stock | Common stock | Preferred stock | Common stock | |||||||||||||||||||||||
| (Unaudited) | ||||||||||||||||||||||||||
| Communications | $ | 1,013 | $ | 0 | $ | 2,699 | $ | 0 | ||||||||||||||||||
| Consumer | 2,218 | 0 | 3,068 | 0 | ||||||||||||||||||||||
| Energy | 5,306 | 10 | 2,187 | 19 | ||||||||||||||||||||||
| Financial services | 70,432 | 0 | 76,575 | 0 | ||||||||||||||||||||||
| Industrial | 255 | 0 | 800 | 0 | ||||||||||||||||||||||
| Utilities | 7,046 | 0 | 8,742 | 0 | ||||||||||||||||||||||
Total | $ | 86,270 | $ | 10 | $ | 94,071 | $ | 19 | ||||||||||||||||||
35
LIQUIDITY AND CAPITAL RESOURCES
We continue to monitor the sufficiency of our liquidity and capital resources given the potential impact of the COVID-19 pandemic. We did not see a significant impact on our sources or uses of cash in the first nine months of 2021. However, we may experience future reductions in our management fee revenue if the Exchange’s premium growth is constrained. Also, future disruptions in the markets could occur which may affect our liquidity position. If our normal operating and investing cash activities were to become insufficient to meet future funding requirements, we believe we have sufficient access to liquidity through our cash position, liquid marketable securities and our $100 million line of credit that does not expire until October 2023. See broader discussions of potential risks to our operations in the Operating Overview contained within this report and Part I. Item 1A. "Risk Factors" related to COVID-19 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.
Sources and Uses of Cash
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet the short- and long-term cash requirements of its business operations and growth needs. Our liquidity requirements have been met primarily by funds generated from management fee revenue and income from investments. Cash provided from these sources is used primarily to fund the costs of our management operations including commissions, salaries and wages, pension plans, share repurchases, dividends to shareholders, and the purchase and development of information technology. We expect that our operating cash needs will be met by funds generated from operations.
Volatility in the financial markets presents challenges to us as we do occasionally access our investment portfolio as a source of cash. Some of our fixed income investments, despite being publicly traded, may be illiquid. Volatility in these markets could impair our ability to sell certain fixed income securities or cause such securities to sell at deep discounts. We believe we have sufficient liquidity to meet our needs from sources other than the liquidation of securities, even if market volatility persists throughout 2021 and beyond.
Cash flow activities
The following table provides condensed cash flow information for the nine months ended September 30:
| (in thousands) | 2021 | 2020 | ||||||||||||
| (Unaudited) | (Unaudited) | |||||||||||||
| Net cash provided by operating activities | $ | 264,038 | $ | 234,478 | ||||||||||
| Net cash used in investing activities | (43,158) | (218,571) | ||||||||||||
| Net cash used in financing activities | (146,124) | (136,291) | ||||||||||||
| Net increase (decrease) in cash and cash equivalents | $ | 74,756 | $ | (120,384) | ||||||||||
Net cash provided by operating activities was $264.0 million in the first nine months of 2021, compared to $234.5 million in the first nine months of 2020. Increased cash provided by operating activities in the first nine months of 2021 was primarily due to an increase in management fees received driven by growth in direct and affiliated assumed premiums written by the Exchange of $62.3 million and an increase in administrative service reimbursements received of $39.3 million. Partially offsetting the increase in cash provided by operating activities was an increase in cash paid for agent commissions of $30.0 million, due to higher scheduled commission driven by premium growth, an increase in agent bonuses of $15.5 million and increases in administrative services expenses paid of $31.0 million, in the first nine months of 2021 compared to the same period in 2020.
Net cash used in investing activities was $43.2 million in the first nine months of 2021, compared to $218.6 million in the same period in 2020. In the first nine months of 2021, net cash used in investing activities was primarily driven by fixed asset purchases, as purchases of investments were offset by proceeds from sales and maturities/calls of investments. Net cash used in investing activities in the first nine months of 2020 was primarily due to purchases of available-for-sale securities exceeding the proceeds generated from investment sales and maturities/calls of available-for-sale securities.
Net cash used in financing activities totaled $146.1 million in the first nine months of 2021, compared to $136.3 million in the first nine months of 2020. The increase in cash used in the first nine months of 2021, compared to the same period in 2020, was due to dividends paid to shareholders. We increased both our Class A and Class B shareholder regular quarterly dividends by 7.3% for 2021, compared to 2020. There are no regulatory restrictions on the payment of dividends to our shareholders.
36
There were no repurchases of our Class A nonvoting common stock in the first nine months of 2021 and 2020 in conjunction with our stock repurchase program. In 2011, our Board of Directors approved a continuation of the current stock repurchase program of $150 million with no time limitation. This repurchase authority includes, and is not in addition to, any unspent amounts remaining under the prior authorization. We had approximately $17.8 million of repurchase authority remaining under this program at September 30, 2021, based upon trade date.
During the nine months ended September 30, 2021, we purchased 25,065 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $5.0 million. Of this amount, we purchased 978 shares for $0.2 million, or $242.01 per share, for stock-based awards in conjunction with our equity compensation plan. We purchased 3,939 shares for $0.8 million, or $212.69 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The remaining 20,148 shares were purchased at a total cost of $4.0 million, or $196.25 per share, to fund the rabbi trust for the incentive compensation deferral plan. All shares were delivered as of September 30, 2021.
During the nine months ended September 30, 2020, we purchased 28,155 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $5.0 million. Of this amount, we purchased 1,787 shares for $0.3 million, or $165.82 per share, for stock-based awards in conjunction with our equity compensation plan. We purchased 4,785 shares for $0.9 million, or $178.98 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The remaining 21,583 shares were purchased at a total cost of $3.8 million, or $178.62 per share, to fund the rabbi trust for the incentive compensation deferral plan. All shares were delivered as of September 30, 2020.
Capital Outlook
We regularly prepare forecasts evaluating the current and future cash requirements for both normal and extreme risk events, including the current COVID-19 pandemic. Should an extreme risk event result in a cash requirement exceeding normal cash flows, we have the ability to meet our future funding requirements through various alternatives available to us.
Outside of our normal operating and investing cash activities, future funding requirements could be met through: 1) cash and cash equivalents, which total approximately $236.0 million at September 30, 2021, 2) a $100 million bank revolving line of credit, and 3) liquidation of unpledged assets held in our investment portfolio, including preferred stock and investment grade bonds, which totaled approximately $644.2 million at September 30, 2021. Volatility in the financial markets could impair our ability to sell certain fixed income securities or cause such securities to sell at deep discounts. Additionally, we have the ability to curtail or modify discretionary cash outlays such as those related to shareholder dividends and share repurchase activities.
As of September 30, 2021, we have access to a $100 million bank revolving line of credit with a $25 million letter of credit sublimit that expires on October 30, 2023. As of September 30, 2021, a total of $99.1 million remains available under the facility due to $0.9 million outstanding letters of credit, which reduce the availability for letters of credit to $24.1 million. We had no borrowings outstanding on our line of credit as of September 30, 2021. Investments with a fair value of $122.6 million were pledged as collateral on the line at September 30, 2021. The investments pledged as collateral have no trading restrictions and are reported as available-for-sale securities and cash and cash equivalents in the Statements of Financial Position. The banks require compliance with certain covenants, which include leverage ratios and debt restrictions. We were in compliance with our bank covenants at September 30, 2021.
Off-Balance Sheet Arrangements and Contractual Obligations
Off-balance sheet arrangements include those with unconsolidated entities that may have a material current or future effect on our financial condition or results of operations, including material variable interests in unconsolidated entities that conduct certain activities. We have no material off-balance sheet obligations. As of September 30, 2021, there were no material changes to our future contractual obligations as previously reported in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.
37
CRITICAL ACCOUNTING ESTIMATES
We make estimates and assumptions that have a significant effect on the amounts and disclosures reported in the financial statements. The most significant estimates relate to investment valuation and retirement benefit plans for employees. While management believes its estimates are appropriate, the ultimate amounts may differ from estimates provided. Our most critical accounting estimates are described in Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" for the year ended December 31, 2020 of our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 25, 2021. See Part I, Item 1. "Financial Statements - Note 5, Fair Value, of Notes to Financial Statements" contained within this report for additional information on our valuation of investments.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is primarily related to fluctuations in prices and interest rates. Quantitative and qualitative disclosures about market risk resulting from changes in prices, interest rates, and other risk exposures for the year ended December 31, 2020 are included in Item 7A. "Quantitative and Qualitative Disclosures About Market Risk", of our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 25, 2021.
Significant volatility was seen in the global financial markets at the onset of the COVID-19 pandemic and pandemic related events may create future volatility; however, there have been no material changes that impact our portfolio or reshape our periodic investment reviews of asset allocations during the nine months ended September 30, 2021. For a recent discussion of conditions surrounding our investment portfolio, see the "Operating Overview", "Results of Operations", and "Financial Condition" discussions contained in Part I, Item 2. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" contained within this report.
ITEM 4. CONTROLS AND PROCEDURES
We carried out an evaluation, with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.
Our management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, any change in our internal control over financial reporting and determined there has been no change in our internal control over financial reporting during the nine months ended September 30, 2021 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Erie Indemnity Company (“Indemnity”) was named as a defendant in a complaint filed on August 24, 2021, by alleged subscribers of the Erie Insurance Exchange (the “Exchange”) in the Court of Common Pleas Civil Division of Allegheny County, Pennsylvania captioned TROY STEPHENSON, CHRISTINA STEPHENSON, SUSAN RUBEL, and STEVEN BARNETT, individually and on behalf of all others similarly situated (Plaintiffs) v. Erie Indemnity Company (Defendant).
The complaint seeks relief for alleged breaches of fiduciary duty by Indemnity in connection with the setting of the management fee it receives, pursuant to the terms of the Subscribers Agreement executed between Indemnity and all policyholders of the Exchange, as compensation for acting as the attorney-in-fact in the management of the Exchange. The relief sought is for the period beginning two years prior to the date of the filing of the complaint and continuing through 2021.
The complaint seeks (i) a finding that Indemnity has breached its fiduciary duties; (ii) an award of damages in an amount to be determined at trial; and (iii) such other relief, including disgorgement of profits or other injunctive relief, that the Court deems just and proper.
Service of the complaint was effectuated on September 20, 2021. A Notice of Removal to the United States District Court for the Western District of Pennsylvania was filed on October 20, 2021. Indemnity intends to vigorously defend against all of the allegations and requests for relief in the complaint.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 as filed with the Securities and Exchange Commission on February 25, 2021.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
In 2011, our Board of Directors approved a continuation of the current stock repurchase program, authorizing repurchases for a total of $150 million with no time limitation. This repurchase authority included, and was not in addition to, any unspent amounts remaining under the prior authorization. There were no repurchases of our Class A common stock under this program during the nine months ending September 30, 2021. We had approximately $17.8 million of repurchase authority remaining under this program at September 30, 2021.
During the quarter ending September 30, 2021, we purchased 1,507 shares of our outstanding Class A nonvoting common stock outside of our publicly announced share repurchase program at a total cost of $0.3 million. We purchased 171 shares for $0.1 million, or $184.70 per share, in August 2021 to fund the rabbi trust for the incentive compensation deferral plan. The shares were transferred to the rabbi trust in August 2021. The remaining 1,336 shares were purchased in August 2021 at a total cost of $0.2 million, or $184.70 per share, to fund the rabbi trust for the outside director deferred stock compensation plan. The shares were transferred to the rabbi trust in August 2021.
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ITEM 6. EXHIBITS
| Exhibit | ||||||||
| Number | Description of Exhibit | |||||||
| 10.1* | ||||||||
| 10.2* | ||||||||
| 10.3* | ||||||||
| 31.1* | ||||||||
| 31.2* | ||||||||
| 32* | ||||||||
| 101.INS* | Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | |||||||
| 101.SCH* | Inline XBRL Taxonomy Extension Schema Document. | |||||||
| 101.CAL* | Inline XBRL Taxonomy Extension Calculation Linkbase Document. | |||||||
| 101.DEF* | Inline XBRL Taxonomy Extension Definition Linkbase Document. | |||||||
| 101.LAB* | Inline XBRL Taxonomy Extension Label Linkbase Document. | |||||||
| 101.PRE* | Inline XBRL Taxonomy Extension Presentation Linkbase Document. | |||||||
| 104* | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). | |||||||
* Filed herewith.
40
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Erie Indemnity Company | ||||||||||||||
| (Registrant) | ||||||||||||||
| Date: | October 28, 2021 | By: | /s/ Timothy G. NeCastro | |||||||||||
| Timothy G. NeCastro, President & CEO | ||||||||||||||
| By: | /s/ Gregory J. Gutting | |||||||||||||
| Gregory J. Gutting, Executive Vice President & CFO | ||||||||||||||
41