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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q/A þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2004 OR o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______ to ______ Commission file number
2-39458 ERIE FAMILY LIFE INSURANCE COMPANY 
  PENNSYLVANIA
    
    25-1186315(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)100 Erie Insurance Place, Erie, Pennsylvania
    
    16530(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone
number, including area code (814) 870-2000 Not applicable 
  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 þ No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes o No þ Indicate the number of shares outstanding of each of the Registrants classes
of common stock, as of the latest practicable date: 9,450,000 shares of Common
Stock outstanding on May 10, 2004.    1




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INDEX ERIE FAMILY LIFE INSURANCE COMPANY PART I. FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (Restated)Statements of Financial Position  March 31, 2004 (Unaudited) and December 31, 2003Statements of Operations (Unaudited)  Three months ended March 31, 2004 and 2003Statements of Comprehensive Income (Unaudited)  Three months ended March 31, 2004 and 2003Statements of Cash Flows (Unaudited)  Three months ended March 31, 2004 and 2003Notes to Financial Statements  March 31, 2004Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3.
    
    Quantitative and Qualitative Disclosures About Market RiskItem 4.
    
    Controls and ProceduresPART II. OTHER INFORMATIONItem 6.
    
    Exhibits and Reports on Form 8-KSIGNATURESCertificationCertificationCertifications
  2




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PART I. FINANCIAL INFORMATION 
 ERIE FAMILY LIFE INSURANCE COMPANY
STATEMENTS OF FINANCIAL POSITION (Restated) (Dollars in thousands)March 31,
    
    December 31,ASSETS
    
    2004
    
    2003(Unaudited)Investments:Fixed maturities at fair value (amortized cost
of $1,245,569 and $1,203,607, respectively)
    
    $
    1,349,147
    
    
    $
    1,280,327Equity securities at fair value
(cost of $56,608 and $56,608, respectively)
    
    
    64,666
    
    
    
    62,948Limited partnerships at fair value
(cost of $11,609 and $12,203, respectively)
    
    
    11,711
    
    
    
    12,241Real estate mortgage loans
    
    
    6,261
    
    
    
    6,305Real estate
    
    
    1,106
    
    
    
    1,127Policy loans
    
    
    10,097
    
    
    
    9,951Total investments
    
    
    1,442,988
    
    
    
    1,372,899Cash and cash equivalents
    
    
    103,936
    
    
    
    91,667Premiums receivable from policyholders
    
    
    6,924
    
    
    
    7,344Reinsurance recoverable
    
    
    2,741
    
    
    
    2,960Other receivables
    
    
    352
    
    
    
    137Accrued investment income
    
    
    18,418
    
    
    
    15,088Deferred policy acquisition costs
    
    
    95,839
    
    
    
    98,207Reserve credit for reinsurance ceded
    
    
    22,209
    
    
    
    20,758Prepaid federal income taxes
    
    
    0
    
    
    
    1,983Other assets
    
    
    10,269
    
    
    
    18,520Total assets
    
    $
    1,703,676
    
    
    $
    1,629,563
 See Notes to Financial Statements. 3




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ERIE FAMILY LIFE INSURANCE COMPANY
STATEMENTS OF FINANCIAL POSITION (Restated) (Dollars in thousands)March 31,
    
    December 31,LIABILITIES AND SHAREHOLDERS EQUITY
    
    2004
    
    2003(Unaudited)Liabilities:Policy Liabilities and Accruals:Future policy benefits
    
    $
    111,786
    
    
    $
    108,089Policy and contract claims
    
    
    3,294
    
    
    
    3,653Annuity deposits
    
    
    948,061
    
    
    
    932,553Universal life deposits
    
    
    153,434
    
    
    
    150,421Supplementary contracts not
including life contingencies
    
    
    709
    
    
    
    579Other policyholder funds
    
    
    7,561
    
    
    
    9,856Federal income taxes payable
    
    
    522
    
    
    
    0Deferred income taxes
    
    
    56,325
    
    
    
    46,813Reinsurance premium due
    
    
    786
    
    
    
    1,875Securities lending collateral
    
    
    79,228
    
    
    
    65,495Accounts payable and accrued expenses
    
    
    22,840
    
    
    
    9,239Notes payable to Erie Indemnity Company
    
    
    40,000
    
    
    
    40,000Due to affiliates
    
    
    2,085
    
    
    
    3,442Dividends payable
    
    
    2,079
    
    
    
    1,985Total liabilities
    
    
    1,428,710
    
    
    
    1,374,000Shareholders Equity:Common stock, $.40 par value per share;
authorized 15,000,000 shares; 9,450,000
shares issued and outstanding
    
    
    3,780
    
    
    
    3,780Additional paid-in capital
    
    
    630
    
    
    
    630Accumulated other comprehensive income
    
    
    59,569
    
    
    
    44,603Retained earnings
    
    
    210,987
    
    
    
    206,550Total shareholders equity
    
    
    274,966
    
    
    
    255,563Total liabilities and shareholders equity
    
    $
    1,703,676
    
    
    $
    1,629,563
 See Notes to Financial Statements. 4




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ERIE FAMILY LIFE INSURANCE COMPANY
STATEMENTS OF OPERATIONS (Unaudited) (Restated) Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003(Dollars in thousands, except per share data)Revenues:Net Policy Revenue:Life premiums
    
    $
    13,112
    
    
    $
    12,242Group life and other premiums
    
    
    867
    
    
    
    847Total net policy revenue
    
    
    13,979
    
    
    
    13,089Net investment income
    
    
    18,755
    
    
    
    18,584Net realized gains on investments
    
    
    2,848
    
    
    
    2,162Equity in earnings of limited partnerships
    
    
    155
    
    
    
    280Other income
    
    
    318
    
    
    
    177Total revenues
    
    
    36,055
    
    
    
    34,292Benefits and Expenses:Death benefits
    
    
    4,904
    
    
    
    3,841Interest on annuity deposits
    
    
    10,910
    
    
    
    9,935Interest on universal life deposits
    
    
    1,736
    
    
    
    1,779Surrender and other benefits
    
    
    320
    
    
    
    273Increase in future life policy benefits
    
    
    2,247
    
    
    
    1,788Amortization of deferred policy
acquisition costs
    
    
    228
    
    
    
    2,184Commissions
    
    
    542
    
    
    
    1,341General expenses
    
    
    3,878
    
    
    
    4,422Taxes, licenses and fees
    
    
    834
    
    
    
    677Total benefits and expenses
    
    
    25,599
    
    
    
    26,240Income before income taxes
    
    
    10,456
    
    
    
    8,052Provision for federal income taxes (benefit):Current
    
    
    2,487
    
    
    
    3,725Deferred
    
    
    1,453
    
    
    
    (931
    )Total provision for federal income taxes
    
    
    3,940
    
    
    
    2,794Net income
    
    $
    6,516
    
    
    $
    5,258Net income per share
    
    $
    0.69
    
    
    $
    0.56Dividends declared per share
    
    $
    0.22
    
    
    $
    0.21
 See Notes to Financial Statements. 5




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ERIE FAMILY LIFE INSURANCE COMPANY
STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (Restated) Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003(Dollars in thousands)Net income
    
    $
    6,516
    
    
    $
    5,258Unrealized gains on securities:Unrealized holding gains arising
during period, net of related offsets
    
    
    25,873
    
    
    
    13,354Less: Gains included in net income
    
    
    (2,848
    )
    
    
    (2,162
    )Net unrealized holding gains arising
during period, net of related offsets
    
    
    23,025
    
    
    
    11,192Income tax expense related to
unrealized gains
    
    
    8,059
    
    
    
    3,917Unrealized appreciation of
investments, net of taxes
    
    
    14,966
    
    
    
    7,275Comprehensive income
    
    $
    21,482
    
    
    $
    12,533
 See Notes to Financial Statements. 6




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ERIE FAMILY LIFE INSURANCE COMPANY
STATEMENTS OF CASH FLOWS (Unaudited) Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003(Dollars in thousands)CASH FLOWS USED IN OPERATING ACTIVITIES:Premiums collected
    
    $
    10,790
    
    
    $
    10,341Net investment income received
    
    
    16,480
    
    
    
    14,478Miscellaneous income
    
    
    318
    
    
    
    177Benefits to policyholders
    
    
    (18,870
    )
    
    
    (16,031
    )Commissions paid to agents
    
    
    (1,340
    )
    
    
    (3,948
    )Salaries and wages paid
    
    
    (3,326
    )
    
    
    (3,038
    )General operating expenses paid
    
    
    (4,183
    )
    
    
    (3,883
    )Taxes, licenses and fees paid
    
    
    (1,291
    )
    
    
    (1,175
    )Income taxes recovered (paid)
    
    
    19
    
    
    
    (14
    )Net cash used in operating activities
    
    
    (1,403
    )
    
    
    (3,093
    )CASH FLOWS USED IN INVESTING ACTIVITIES:Purchase of investments:Fixed maturities
    
    
    (70,733
    )
    
    
    (182,931
    )Equity securities
    
    
    0
    
    
    
    (5,590
    )Limited partnerships
    
    
    (5
    )
    
    
    (650
    )Sales/maturities of investments:Sales of fixed maturities
    
    
    49,784
    
    
    
    76,777Calls/maturities of fixed maturities
    
    
    3,530
    
    
    
    29,032Equity securities
    
    
    0
    
    
    
    3,154Limited partnerships
    
    
    800
    
    
    
    1,617Increase in collateral from securities lending
    
    
    13,733
    
    
    
    32,519Net mortgage loans
    
    
    44
    
    
    
    300Net policy loans
    
    
    (146
    )
    
    
    (54
    )Net cash used in investing activities
    
    
    (2,993
    )
    
    
    (45,826
    )CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:Annuity and supplementary
contract deposits and interest
    
    
    33,603
    
    
    
    72,153Annuity and supplementary
contract surrenders and withdrawals
    
    
    (17,966
    )
    
    
    (12,318
    )Universal life deposits and interest
    
    
    4,820
    
    
    
    5,093Universal life surrenders
    
    
    (1,807
    )
    
    
    (1,251
    )Dividends paid to shareholders
    
    
    (1,985
    )
    
    
    (1,985
    )Net cash provided by financing activities
    
    
    16,665
    
    
    
    61,692Net increase in cash and cash equivalents
    
    
    12,269
    
    
    
    12,773Cash and cash equivalents at beginning of period
    
    
    91,667
    
    
    
    97,022Cash and cash equivalents at end of period
    
    $
    103,936
    
    
    $
    109,795
 See Notes to Financial Statements. 7




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited)
(All dollar amounts are in thousands) NOTE A  BASIS OF PRESENTATION The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and in conformity with the instructions to Form 10-Q and Rule 10-01
of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles 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 three-month period ended March 31,
2004 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2004. For further information, refer to the financial
statements and footnotes thereto included in the Companys Annual Report on
Form 10-K/A for the year ended December 31, 2003 as filed with the Securities and
Exchange Commission on August 20, 2004. NOTE B  RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS During the second quarter of 2004, the Company completed a comprehensive
analysis of its deferred policy acquisition cost (DAC) asset in response to a
material weakness in internal control. The analysis indicated that amounts
previously reported as deferred policy acquisition costs and related
amortization were incorrectly calculated. Accordingly, the Company has restated
its previously issued financial statements. The impact of the restatement to
net income and net income per share for the quarters ended March 31, 2003 and
2004, and deferred policy acquisition costs and shareholders equity as of December 31, 2003 and March 31, 2004 is as
follows: Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003(Dollars in thousands, except per share data)As originally reported:Net income
    
    $
    5,830
    
    
    $
    5,406Net income per share
    
    $
    0.62
    
    
    $
    0.57As restated:Net income
    
    $
    6,516
    
    
    $
    5,258Net income per share
    
    $
    0.69
    
    
    $
    0.56
 March 31,
    
    December 31,2004
    
    2003(Dollars in thousands)As originally reported:Deferred policy acquisition costs
    
    $
    100,553
    
    
    $
    103,874Shareholders equity
    
    $
    278,030
    
    
    $
    259,247As restated:Deferred policy acquisition costs
    
    $
    95,839
    
    
    $
    98,207Shareholders equity
    
    $
    274,966
    
    
    $
    255,563
 In connection with the above
described restatement, the following footnotes have been revised to
reflect restatements: A, D, E, F, and H. NOTE C  INVESTMENTS At March 31, 2004 and 2003, marketable equity securities consist of
nonredeemable preferred stock while fixed maturities consist of bonds, notes
and redeemable preferred stock. Management considers all fixed maturities as
available-for-sale. Management determines the appropriate classification of
fixed maturities at the time of purchase and reevaluates such designation as of
each statement of financial position date. Available-for-sale securities are
stated at fair value, with the unrealized gains and losses, net of deferred
federal income taxes, reported as a separate component of Comprehensive Income
and Shareholders Equity. 8




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE C  INVESTMENTS (Continued) The following is a summary of available-for-sale securities: Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    EstimatedCost
    
    Gains
    
    Losses
    
    Fair ValueMarch 31, 2004Fixed Maturities:Bonds:U.S. treasuries and
government agencies
    
    $
    67,161
    
    
    $
    2,697
    
    
    $
    0
    
    
    $
    69,858Public utilities
    
    
    147,103
    
    
    
    13,532
    
    
    
    73
    
    
    
    160,562U.S. banks, trusts
and insurance companies
    
    
    168,522
    
    
    
    13,361
    
    
    
    148
    
    
    
    181,735U.S. industrial and miscellaneous
    
    
    540,176
    
    
    
    51,226
    
    
    
    163
    
    
    
    591,239Mortgage-backed
    
    
    158,604
    
    
    
    6,360
    
    
    
    79
    
    
    
    164,885Asset-backed
    
    
    8,023
    
    
    
    478
    
    
    
    0
    
    
    
    8,501Foreign
    
    
    148,964
    
    
    
    16,194
    
    
    
    147
    
    
    
    165,011Total bonds
    
    
    1,238,553
    
    
    
    103,848
    
    
    
    610
    
    
    
    1,341,791Redeemable preferred stock
    
    
    7,016
    
    
    
    340
    
    
    
    0
    
    
    
    7,356Total fixed maturities
    
    
    1,245,569
    
    
    
    104,188
    
    
    
    610
    
    
    
    1,349,147Equity Securities:Nonredeemable preferred stock:Public utilities
    
    
    1,864
    
    
    
    121
    
    
    
    0
    
    
    
    1,985U.S. banks, trusts
and insurance companies
    
    
    13,909
    
    
    
    2,361
    
    
    
    0
    
    
    
    16,270U.S. industrial and miscellaneous
    
    
    17,119
    
    
    
    2,321
    
    
    
    0
    
    
    
    19,440Foreign
    
    
    23,716
    
    
    
    3,255
    
    
    
    0
    
    
    
    26,971Total equity securities
    
    
    56,608
    
    
    
    8,058
    
    
    
    0
    
    
    
    64,666Total available-for-sale securities
    
    $
    1,302,177
    
    
    $
    112,246
    
    
    $
    610
    
    
    $
    1,413,813
 9




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE C  INVESTMENTS (Continued) Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    EstimatedCost
    
    Gains
    
    Losses
    
    Fair ValueDecember 31, 2003Fixed Maturities:Bonds:U.S. treasuries and
government agencies
    
    $
    61,176
    
    
    $
    1,543
    
    
    $
    37
    
    
    $
    62,682Public utilities
    
    
    141,154
    
    
    
    10,377
    
    
    
    528
    
    
    
    151,003U.S. banks, trusts
and insurance companies
    
    
    158,731
    
    
    
    9,358
    
    
    
    836
    
    
    
    167,253U.S. industrial and miscellaneous
    
    
    547,363
    
    
    
    41,077
    
    
    
    776
    
    
    
    587,664Mortgage-backed
    
    
    145,394
    
    
    
    3,622
    
    
    
    182
    
    
    
    148,834Asset-backed
    
    
    5,032
    
    
    
    330
    
    
    
    0
    
    
    
    5,362Foreign
    
    
    137,741
    
    
    
    13,314
    
    
    
    933
    
    
    
    150,122Total bonds
    
    
    1,196,591
    
    
    
    79,621
    
    
    
    3,292
    
    
    
    1,272,920Redeemable preferred stock
    
    
    7,016
    
    
    
    391
    
    
    
    0
    
    
    
    7,407Total fixed maturities
    
    
    1,203,607
    
    
    
    80,012
    
    
    
    3,292
    
    
    
    1,280,327Equity Securities:Nonredeemable preferred stock:Public utilities
    
    
    1,864
    
    
    
    136
    
    
    
    0
    
    
    
    2,000U.S. banks, trusts
and insurance companies
    
    
    13,909
    
    
    
    1,921
    
    
    
    0
    
    
    
    15,830U.S. industrial and miscellaneous
    
    
    17,119
    
    
    
    1,775
    
    
    
    20
    
    
    
    18,874Foreign
    
    
    23,716
    
    
    
    2,528
    
    
    
    0
    
    
    
    26,244Total equity securities
    
    
    56,608
    
    
    
    6,360
    
    
    
    20
    
    
    
    62,948Total available-for-sale securities
    
    $
    1,260,215
    
    
    $
    86,372
    
    
    $
    3,312
    
    
    $
    1,343,275
 Realized gains and losses on the sales of investments are recognized in income
using the specific identification method. Investments that have declined in
value below cost and for which the decline is considered to be
other-than-temporary by management are written down to estimated realizable
value.
The impairments are made on an individual security basis and are recorded as a
component of net realized gains on investments in the Statements of Operations. The components of net realized gains on investments as reported in the
Statements of Operations are included below. There were no impairment charges
recorded in the first quarter of 2004. Included in the first quarter of 2003 gross realized losses are impairment
charges of $3.5 million related to fixed maturities. 10




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE C  INVESTMENTS (Continued) Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003Fixed maturities:Gross realized gains
    
    $
    2,930
    
    
    $
    7,004Gross realized losses
    
    
    (93
    )
    
    
    (4,833
    )Net realized gains
    
    
    2,837
    
    
    
    2,171Equity securities:Gross realized gains
    
    
    11
    
    
    
    0Gross realized losses
    
    
    0
    
    
    
    (9
    )Net realized gains (losses)
    
    
    11
    
    
    
    (9
    )Net realized gains
on investments
    
    $
    2,848
    
    
    $
    2,162
 The gross unrealized losses at March 31, 2004 span the various investment
categories of fixed
maturities and equity securities. The gross unrealized losses are aged as
follows: Estimated
    
    NumberUnrealized
    
    Amortized
    
    Fair
    
    ofLoss
    
    Cost
    
    Value
    
    HoldingsSix months or less
    
    
    ($70
    )
    
    $
    23,231
    
    
    $
    23,161
    
    
    
    9Six to 12 months
    
    
    (498
    )
    
    
    34,710
    
    
    
    34,212
    
    
    
    15Greater than 18 months
    
    
    (42
    )
    
    
    4,711
    
    
    
    4,669
    
    
    
    2($610
    )
    
    $
    62,652
    
    
    $
    62,042
    
    
    
    26
 No investments in an unrealized loss position at
March 31, 2004 had a decline in market value that was considered by management to be
other-than-temporary, thereby causing the investment to be impaired based on Company policy.
There were no market conditions, industry characteristics or fundamental operating results
of a specific issuer that suggested impairment of any of the listed investments. The Company participates in a securities lending program whereby certain
securities from its portfolio are loaned to other institutions for short
periods of time. A fee is paid to the Company by the borrower. Company policy
requires collateral equal to 102% of the fair value of the loaned securities.
The Company maintains full ownership rights to the securities loaned and
continues to earn interest on them. In addition, the Company has the ability
to sell the securities while they are on loan. The Company has an
indemnification agreement with the lending agent in the event a borrower
becomes insolvent or fails to return securities. Securities lending collateral
is recorded by the Company as a liability. The proceeds from the collateral
are invested in cash and short-term investments and are reported on the
Statements of Financial Position as cash and cash equivalents. The Company
shares a portion of the interest received on these short-term investments with
the lending agent. Revenue received for the three months ended March 31, 2004
and 2003, related to this program totaled $28 and $21, respectively. The Company had loaned securities with a market value of $77.5 million and
$64.1 million and secured collateral of $79.2 million and $65.5 million at
March 31, 2004 and December 31, 2003, respectively. The Company records the
loaned securities on its Statements of Financial Position as part of its
invested assets. The Company has incurred no losses on the loan program since
the programs inception. 11




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE C  INVESTMENTS (Continued) Limited partnerships at March 31, 2004 include U.S. and foreign real estate and
mezzanine debt investments. Real estate limited partnerships represent 91.0%,
while mezzanine debt limited partnerships represent 9.0%, of the total carrying
value at March 31, 2004. These partnerships are recorded at fair value using
the equity method. The Company has not guaranteed any of the partnership
liabilities. The components of equity in earnings of limited partnerships as reported in the
Statements of Operations are as follows: Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003Mezzanine debt
    
    $
    20
    
    
    
    ($88
    )Real estate
    
    
    135
    
    
    
    368$
    155
    
    
    $
    280
 NOTE D  DEFERRED POLICY ACQUISITION COST ASSET The Company incurs significant costs in connection with acquiring new business.
Many of these acquisition costs, which vary with and are primarily related to
the production of new business, are deferred as an asset and are then amortized
over a period of time. The Company periodically reviews the DAC asset to
assess recoverability from future income. If less than the full amount of DAC
is determined to be recoverable, a portion of such costs are expensed at the
time of determination. The DAC on traditional life insurance products is amortized in relation to
estimated gross premiums in accordance with Statement of Financial Accounting
Standard No. 60, Accounting and Reporting by Insurance Enterprises. The DAC on
the annuity and universal life products is amortized in relation to estimated
gross profits in accordance with Statement of Financial Accounting Standard No.
97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration
Contracts and for Realized Gains and Losses from the Sale of Investments (FAS
97). During the second quarter of 2004, the Company completed a comprehensive
analysis of its deferred acquisition cost asset. As described further in Note
B, this analysis resulted in a restatement of previously issued financial
statements. In accordance with FAS 97, the Company periodically evaluates certain
assumptions in use to determine DAC and amortization related to its interest
sensitive products. In the first quarter 2004 evaluation, the Company modified
certain assumptions related to interest rate spreads causing an unlocking as
provided under accounting guidance. As a result of unlocking assumptions, DAC
as of March 31, 2004 increased by $1.7 million and net income for the first
quarter 2004 increased by $1.1 million. 12




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE E  SEGMENT INFORMATION The Company offers a range of products and services, but operates as one
reportable life insurance segment. The Companys Traditional Life insurance
line includes permanent life, endowment life, term life and whole life
policies. The Universal Life line includes all fixed universal life products
sold by the Company. The Company does not sell variable universal life
products. The Fixed Annuities line includes fixed ordinary deferred annuities,
tax advantaged deferred annuities, annuities in pay-out and structured
settlements. Neither variable nor equity indexed annuity products are sold by
the Company. The Group Life and Other line includes group life insurance and
disability income products. The Corporate Account line includes investment
income earned from surplus not specifically allocable to any one product type.
Investment-related income is allocated based on the assumption that the fixed
maturities and preferred stock portfolios support the insurance product lines
and the limited partnership and remaining fixed maturity investments support
the Corporate Account. GroupThree Months Ended
    
    Traditional
    
    Universal
    

Fixed
    
    Life &
    
    CorporateMarch 31, 2004
    
    Life
    
    Life
    
    Annuities
    
    Other
    
    Account
    
    Total(Restated)Total policy revenue, net of
reinsurance
    
    $
    9,644
    
    
    $
    3,468
    
    
    $
    0
    
    
    $
    867
    
    
    $
    0
    
    
    $
    13,979Total investment-related
and other income
    
    
    1,850
    
    
    
    2,474
    
    
    
    15,208
    
    
    
    51
    
    
    
    2,493
    
    
    
    22,076Total revenues
    
    
    11,494
    
    
    
    5,942
    
    
    
    15,208
    
    
    
    918
    
    
    
    2,493
    
    
    
    36,055Less: Total benefits and
expenses
    
    
    10,295
    
    
    
    2,803
    
    
    
    12,011
    
    
    
    490
    
    
    
    0
    
    
    
    25,599Income before taxes
    
    $
    1,199
    
    
    $
    3,139
    
    
    $
    3,197
    
    
    $
    428
    
    
    $
    2,493
    
    
    $
    10,456Three Months Ended
March 31, 2003(Restated)Total policy revenue, net of
reinsurance
    
    $
    8,963
    
    
    $
    3,279
    
    
    $
    1
    
    
    $
    846
    
    
    $
    0
    
    
    $
    13,089Total investment-related
and other income
    
    
    1,892
    
    
    
    2,386
    
    
    
    14,846
    
    
    
    41
    
    
    
    2,038
    
    
    
    21,203Total revenues
    
    
    10,855
    
    
    
    5,665
    
    
    
    14,847
    
    
    
    887
    
    
    
    2,038
    
    
    
    34,292Less: Total benefits and
expenses
    
    
    8,946
    
    
    
    4,444
    
    
    
    12,040
    
    
    
    810
    
    
    
    0
    
    
    
    26,240Income before taxes
    
    $
    1,909
    
    
    $
    1,221
    
    
    $
    2,807
    
    
    $
    77
    
    
    $
    2,038
    
    
    $
    8,052
 13




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE F  REINSURANCE The Company has entered into various reinsurance treaties for the purpose of
ceding the excess of life insurance face amounts over Company established
retention limits. Reinsurance contracts do not relieve the Company from its
obligations to policyholders. Failure of reinsurers to honor their obligations
could result in losses to the Company. The Company considers all of its
reinsurance assets to be collectible; therefore, no allowance has been
established for uncollectible amounts. Generally, the Companys retention limit is $300 per life for individual
coverage. For its two newest products, ERIE Flagship Term2 and ERIE Target
Term, the Company has first dollar quota share treaties with several
unaffiliated reinsurers. The Company reinsures 50% and 90% of the ERIE
Flagship Term2 and Erie Target Term products, respectively, subject to the
Companys $300 retention limit. For its disability income product, the Company
has a 50% quota share agreement with its reinsurer. As of March 31, 2004 and
2003, $10.0 billion and $7.4 billion, respectively, of life insurance in force
was ceded to other companies. The Companys most significant reinsurance
business is with Generali USA Reassurance Company, which reinsures a portion of
the Companys life and accident and health business. At March 31, 2004, the
amount of in-force life insurance ceded to Generali totaled approximately $5.8
billion. 14




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE F  REINSURANCE (Continued) The effect of ceded reinsurance in the Statements of Operations is as follows: Three Months Ended
    
    Three Months Ended(Restated)
    
    March 31, 2004
    
    March 31, 2003Revenues:Direct policy revenue
    
    $
    18,023
    
    
    $
    16,400Policy revenue ceded
    
    
    (4,044
    )
    
    
    (3,311
    )Net policy revenue
    
    
    13,979
    
    
    
    13,089Net investment income
    
    
    18,755
    
    
    
    18,584Net realized gains on investments
    
    
    2,848
    
    
    
    2,162Equity in earnings of limited
partnerships
    
    
    155
    
    
    
    280Other income
    
    
    318
    
    
    
    177Total revenues
    
    $
    36,055
    
    
    $
    34,292Benefits and expenses:Death benefits
    
    $
    6,626
    
    
    $
    5,207Reinsurance recoveries
    
    
    (1,722
    )
    
    
    (1,366
    )Net death benefits
    
    
    4,904
    
    
    
    3,841Interest on deposits and
other policyholder benefits
    
    
    12,966
    
    
    
    11,987Increases in future life policy benefits
    
    
    3,698
    
    
    
    3,126Reinsurance reserve credits
    
    
    (1,451
    )
    
    
    (1,338
    )Net increases in future life policy
benefits
    
    
    2,247
    
    
    
    1,788Amortization of deferred policy
acquisition costs
    
    
    228
    
    
    
    2,184Commissions
    
    
    2,163
    
    
    
    2,895Reinsurance commission allowance
    
    
    (1,621
    )
    
    
    (1,554
    )Net commissions
    
    
    542
    
    
    
    1,341General expenses, taxes, licenses
and fees
    
    
    4,712
    
    
    
    5,099Total benefits and expenses
    
    $
    25,599
    
    
    $
    26,240Income before income taxes
    
    $
    10,456
    
    
    $
    8,052
 15




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE G  NOTES PAYABLE TO ERIE INDEMNITY COMPANY The Company has a $15,000 surplus note payable to Erie Indemnity Company (EIC).
This note bears an annual interest rate of 6.45%. Interest on the surplus
note is scheduled to be paid semi-annually, subject to prior approval of the
Pennsylvania Insurance Commissioner. The note is payable on demand on or after
December 31, 2005, subject to prior approval by the Pennsylvania Insurance
Commissioner. The Company accrued interest of $0.2 million on this note during
the first quarter of 2004 and 2003. During the third quarter of 2003, the Company issued a $25,000 surplus note to
EIC in exchange for $25,000 in cash. This surplus note bears an annual
interest rate of 6.70% and is scheduled to be paid semi-annually, subject to
prior approval of the Pennsylvania Insurance Commissioner. The surplus note is
payable on demand on or after December 31, 2018, subject to prior approval by
the Pennsylvania Insurance Commissioner. The Company accrued interest of $0.4
million on this note during the first quarter of 2004. NOTE H  SUPPLEMENTARY DATA ON CASH FLOWS (Restated) A reconciliation of net income to net cash used in operating activities as
presented in the Statements of Cash Flows is as follows: Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003CASH FLOWS USED IN OPERATING ACTIVITIES:Net income
    
    $
    6,516
    
    
    $
    5,258Adjustments to reconcile net income to net cash
used in operating activities:Amortization of deferred policy acquisition costs
    
    
    228
    
    
    
    2,184Other amortization
    
    
    246
    
    
    
    120Deferred federal income tax expense (benefit)
    
    
    1,453
    
    
    
    (931
    )Realized gains on investments
    
    
    (2,848
    )
    
    
    (2,162
    )Equity in earnings of limited partnerships
    
    
    (155
    )
    
    
    (280
    )Decrease in premium and other receivables
    
    
    204
    
    
    
    1,028Increase in accrued investment income
    
    
    (3,330
    )
    
    
    (4,654
    )Policy acquisition costs deferred
    
    
    (3,476
    )
    
    
    (4,564
    )Increase in other assets
    
    
    (95
    )
    
    
    0Increase in reinsurance recoverables and reserve credits
    
    
    (1,232
    )
    
    
    (958
    )Decrease in prepaid federal income taxes
    
    
    2,506
    
    
    
    3,711Increase in future policy benefits and claims
    
    
    3,338
    
    
    
    3,323Decrease in other policyholder funds
    
    
    (2,296
    )
    
    
    (2,768
    )Decrease in reinsurance premium due
    
    
    (1,089
    )
    
    
    (985
    )Decrease in accounts payable and due to affiliates
    
    
    (1,373
    )
    
    
    (1,415
    )Net cash used in operating activities
    
    
    ($1,403
    )
    
    
    ($3,093
    )
 NOTE I  COMMITMENTS The Company has outstanding commitments to invest up to $1.5 million in real
estate limited partnerships at March 31, 2004. These commitments will be
funded as required through the end of the respective investment periods, which
typically span 3 to 5 years. 16




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##### Table of Contents



ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE J  STATUTORY INFORMATION The minimum statutory capital and surplus requirements under Pennsylvania law
for stock life insurance companies (Section 386 of the Pennsylvania Insurance
Company Law) amounts to $1,650. In addition, the Company is subject to certain
risk based capital surplus requirements. The Companys total statutory capital
and surplus significantly exceed these minimum requirements. 17




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF FINANCIAL OPERATIONS The following discussion and analysis should be read in conjunction with the
historical financial information and related notes found on pages 3 through 17,
and Managements Discussion and Analysis of Financial Condition and Results of
Operations contained in the Companys Annual Report on Form 10-K/A for the year
ended December 31, 2003, as filed with the Securities and Exchange Commission
on August 20, 2004. As further described in Note B, the Company has restated its financial statements. FINANCIAL OVERVIEW Net income increased to $6.5 million, or $0.69 per share, in the first quarter
of 2004, compared to $5.3 million, or $0.56 per share, for the first quarter of
2003. An increase in policy revenues was principally responsible for this
growth. REVENUES Analysis of Policy Revenue Total net policy revenue increased 6.8% to $14.0 million in the first quarter
of 2004 from $13.1 million during the same period in 2003. Contributing to
this growth was an increase in net premiums on traditional life insurance
products. Net premiums on traditional life insurance policies increased $0.9
million, or 9.5%, to $10.3 million for the quarter ended March 31, 2004. Total
policies in force on traditional life insurance products increased 6.6% to
203,840 at March 31, 2004, compared to 191,257 at March 31, 2003. Although total net premiums are up in 2004, sales of new traditional policies
declined in the first quarter of 2004 when compared to the same period in 2003.
Direct new premiums on traditional life insurance policies were down 10.5% to
$2.4 million for the quarter ended March 31, 2004, from $2.7 million for the
quarter ended March 31, 2003. The decline in new premiums was offset by a
significant increase in direct renewal premiums. Direct renewal premiums on
traditional life insurance policies increased 19.7%, to $11.5 million for the
quarter ended March 31, 2004 from $9.6 million during the same period in 2003 Analysis of Investment-related Income Net investment income increased $0.2 million to $18.8 million in the first
quarter of 2004 from $18.6 million for the same period in 2003. The slight
increase in net investment income for the first quarter of 2004 compared to the
same period in 2003 is due in part to lower yielding fixed income securities.
Net realized capital gains on investments were $2.8 million in the first
quarter of 2004, compared to net realized capital gains of $2.2 million in the
first quarter of 2003. There were no impairment charges included in net
realized gains in the first quarter of 2004. In the first quarter of 2003, the
Company recognized impairment charges of $3.5 million for write-downs of fixed
maturity investments deemed to have incurred other-than-temporary impairments
in value. 18




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF FINANCIAL OPERATIONS (Continued) The Companys performance of its fixed maturities and preferred stock compared
to market indices is presented below: Two year period endedMarch 31, 2004(Pre-tax annualized returns) (1)Erie Family Life Insurance Company indices:Fixed maturities
    
    
    11.59
    %Preferred stock
    
    
    15.33Other indices:Lehman Brothers U.S. Aggregate
    
    
    8.50
    %
 (1) Includes income, realized and unrealized gains and losses. BENEFITS AND EXPENSES Analysis of Policy-related Benefits and Expenses Net death benefits on life insurance policies increased $1.1 million or 27.7%
in the first quarter of 2004 to $4.9 million. Random fluctuations in death
benefits incurred can be expected when mortality results are measured over a
short time period due to the small number of claims involved. These short-term
fluctuations can influence quarterly or annual results without impacting
long-term profitability. Management believes its underwriting philosophy and
practices are sound. Interest expense incurred on deposits increased $0.9 million, or 8.0%, to $12.6
million in the first quarter of 2004 from $11.7 million in the first quarter of
2003. This increase can be attributed to the growth of annuities on deposit.
At March 31, 2004, the balance of annuity deposits totaled $948.1 million,
compared to $863.5 million at March 31, 2003, an increase of 9.8%. The Company
has lowered its credited interest rates during the last two years to reflect
the current market conditions. Interest was credited on annuity and universal
life deposits in 2004 and 2003 at the following rates: Annuity
    
    Universal LifeDeposits
    
    DepositsJanuary 1, 2003  February 24, 2003
    
    
    4.00% - 4.80
    %
    
    
    5.25% - 6.00
    %February 25, 2003  March 10, 2003
    
    
    3.75    - 4.70
    
    
    
    5.25    - 6.00March 11, 2003  May 14, 2003
    
    
    3.75    - 4.70
    
    
    
    5.00    - 5.75May 15, 2003  June 1, 2003
    
    
    3.50    - 4.70
    
    
    
    5.00    - 5.75June 2, 2003  July 9, 2003
    
    
    3.50    - 4.70
    
    
    
    4.75    - 5.50July 10, 2003  March 31, 2004
    
    
    3.00    - 4.70
    
    
    
    4.25    - 5.00
 The liability for future life policy benefits is computed considering various
factors such as anticipated mortality, future investment yields, withdrawals
and anticipated credit for reinsurance ceded. Increase in future life policy
benefits net of reinsurance ceded totaled $2.2 million in the first quarter of
2004, compared to $1.8 million in the first quarter of 2003, an increase of
25.6%. The increase in reserves is a result of the success of the Companys
newest traditional life insurance products, ERIE Target Term and ERIE Flagship
Term2. These products are largely responsible for the growth in life insurance
in force which, at March 31, 2004, has grown to $27.7 billion, compared to
approximately $24.3 billion at March 31, 2003. 19




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF FINANCIAL OPERATIONS (Continued) Amortization of deferred policy acquisition costs (DAC) decreased $2.0 million
to $0.2 million in the first quarter of 2004 when compared to the same period
in 2003. During the first quarter of 2004, the Company unlocked certain
assumptions in accordance with Statement of Financial Accounting Standards No.
97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration
Contracts and for Realized Gains and Losses from the Sale of Investments
related to interest rate spreads on its interest sensitive products. As a
result of unlocking these assumptions, DAC was increased and the amortization
of DAC was decreased by $1.7 million during the first quarter of 2004. Analysis of Other Expenses Direct commissions to independent agents include new and renewal commissions,
production bonuses and promotional incentives. These direct commission
expenses are reported on the Statements of Operations net of commissions
received from reinsurers. The reported expense is also affected by the amount
of commission expenses capitalized as DAC. Commissions, which vary with and
are related primarily to the production of new business, are deferrable as DAC.
Most first-year and incentive commissions and some second-year commissions
qualify for deferral as DAC. For the first quarter of 2004, net commission
expense decreased $0.8 million to $0.5 million, compared to $1.3 million for
the first quarter of 2003. This decrease is primarily attributable to the
decline in annuity sales. Annuity premiums for the quarter ended March 31, 2004
were $14.3 million, compared to $55.7 million for the same period in 2003.
Commissions and bonuses on these premiums, net of DAC, were $0.3 million and
$0.7 million for the periods ended March 31, 2004 and 2003, respectively. General expenses, net of DAC, decreased $0.5 million, to $3.9 million for the
first quarter of 2004. The decrease is the result of a contribution made to the
supplemental employee retirement plan for a recently retired executive of the
Company in the first quarter of 2003. General expenses include wages and
salaries, employee benefits, data processing expenses, occupancy expenses and
other office and general administrative expenses of the Company. Certain
general expenses of the Company related to the acquisition and underwriting of
new policies are deferred as DAC. Such expenses include medical inspection and
exam fees related to new business production and wages, salaries and employee
benefits of underwriting personnel. FINANCIAL CONDITION Investments The Companys investment strategies provide that portfolios are structured to
match the features of the life insurance and annuity products sold by the
Company. Annuities and life insurance policies are long-term products;
therefore, the Companys investment strategy takes a long-term perspective
emphasizing investment quality, diversification and superior investment
returns. The Companys investments are managed on a total return approach that
focuses on current income and capital appreciation. The Companys invested assets are sufficiently liquid to meet commitments to
its policyholders. At March 31, 2004, the Companys investment portfolio
consisting of cash, investment grade bonds and investment grade preferred
stock, totaled more than $1.5 billion, or 86.6% of total assets. These
resources provide the liquidity the Company requires to meet known and
unforeseen demands on its funds. The Company continually reviews the investment portfolio to evaluate positions
that might incur other-than-temporary declines in value. For investment
holdings, general economic conditions and/or conditions specifically affecting
the underlying issuer or its industry, including downgrades by the major rating
agencies, are considered in evaluating impairment in value. In addition to
specific factors, other factors considered in the Companys review of
investment valuation are the length of time the market value is below cost and
the amount the market value is below cost. 20




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF FINANCIAL OPERATIONS (Continued) For fixed maturity and preferred stock investments, the Company individually
analyzes all positions with emphasis on those that, in managements opinion,
have declined significantly below cost. The Company considers market
conditions, industry characteristics and the fundamental operating results of
the issuer to determine if declines in value are due to changes in interest
rates, changes relating to a decline in credit quality, or other issues
affecting the investment. Positions that have incurred significant market price
declines for extended periods, in which the creditworthiness of the issuer or
other factors indicate a decline that is other-than-temporary, are recognized
as impaired and reflected as a charge to the Companys operations. If the Companys policy for determining the recognition of impaired positions
were different, the Companys Results of Operations could be significantly
impacted. Management believes its investment valuation philosophy and
accounting practices result in appropriate and timely measurement of value and
recognition of impairment. The Companys investments are subject to certain risks, including interest rate
price risk and credit risk. The Company monitors exposure to interest rate risk
through periodic reviews of asset and liability positions. Estimates of cash
flows and the impact of interest rate fluctuations relating to the investment
portfolio are monitored regularly. The Companys objective is to earn
competitive relative returns by investing in a diverse portfolio of
high-quality, liquid securities. Portfolio characteristics are analyzed
regularly and market risk is actively managed through a variety of techniques.
Portfolio holdings are diversified across industries, and concentrations in any
one company or industry are limited by parameters established by Company
management and the Board of Directors. Reserve Liabilities The Companys primary commitment is its obligation to meet the payment of
future policy benefits
under the terms of its life insurance and annuity contracts. To meet these
future obligations, the Company establishes life insurance reserves based upon
the type of policy, the age of the insured and the number of years the policy
has been in force. The Company also establishes annuity and universal life
reserves based on the amount of policyholder deposits (less applicable
insurance and expense charges) plus interest earned on those deposits. Life
insurance and annuity reserves are supported primarily by the Companys
long-term, fixed-income investments as the underlying policy reserves are
generally also of a long-term nature. LIQUIDITY AND CAPITAL RESOURCES Liquidity is a measure of the Companys ability to secure enough cash to meet
its contractual obligations and operating needs. Generally, insurance premiums
are collected prior to claims and benefit disbursements and these funds are
invested to provide necessary cash flows in future years. The Companys major
sources of cash from operations are life insurance premiums and investment
income. Major cash outflows from operations are for benefits to policyholders
and commissions to agents. The Companys liquidity position remains strong as
investments and cash and cash equivalents increased by $82.4 million during the
first three months of 2004 to $1.5 billion. Annuity and universal life deposits, which do not appear as revenue on the
Statement of Operations, are a source of funds. These deposits do not involve
a mortality or morbidity risk and are accounted for using methods applicable to
comparable interest-bearing obligations of other types of financial
institutions. This
method of accounting records deposits as a liability rather than as revenue.
Annuity and universal life deposits were $25.8 million in the first quarter of
2004 and $65.5 million in the first quarter of 2003. The Companys ability to
attract deposits depends in large part on the relative attractiveness of its
products compared to other investment alternatives. Annuity deposits began to
slow during the second half of 2003 as the Company lowered its credited
interest rates and the equity market improved. 21




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF FINANCIAL OPERATIONS (Continued) The Companys current commitments for expenditures as of March 31, 2004 are
primarily for policy death benefits, policy surrenders and withdrawals, general
operating expenses, federal income taxes, and dividends to shareholders. In
addition, the Company has outstanding commitments to invest up to $1.5 million
in real estate limited partnerships at March 31, 2004. All Company commitments
are met by cash flows from policy revenue, annuity and universal life deposits
and investment income. Management believes its cash flow from operations and
its liquid assets and marketable securities will also enable the Company to
meet any foreseeable cash requirements. Also available as a source of funds to
the Company is a $10.0 million committed line of credit and letter agreement
with PNC Bank, N.A. The Company may use extensions of credit from the bank to
fund working capital needs of the Company and for other general corporate
purposes. At March 31, 2004 and December 31, 2003, securities held as
collateral on the committed line of credit totaled $15.2 million and $15.1
million, respectively. At March 31, 2004 and December 31, 2003, there were no
borrowings on this line of credit. For a complete discussion of the fixed contractual obligations see Managements
Discussion and Analysis of Financial Condition and Results of Operations
contained in the Companys amended Annual Report on Form 10-K/A for the year
ended December 31, 2003 as filed with the Securities and Exchange Commission on
August 20, 2004. FACTORS THAT MAY AFFECT FUTURE RESULTS Agent Compensation In 2003, management of the Erie Insurance Group made a commitment to focus on
property/casualty underwriting profitability. One of the changes made to
accomplish this goal was to revamp the agency compensation program, including
making several changes to the Companys commission and bonus structure.
Effective December 16, 2003, the Company implemented a reduction in the
commissions paid on annuities and restructured the bonus program, including
life insurance bonuses. These bonuses, which had been in place for nearly 20 years, were designed to
incent agents to sell the Companys products when the life insurance product
portfolio was limited and less competitive with industry leaders. Today, with
the introduction of new products, the Companys portfolio is more competitive
and flexible. The Company believes the new commission structure provides
competitive levels of compensation and will recognize and reward superior life
insurance production. While the level of paid commissions may vary in the
short-term, management does not expect the commission expense levels to vary
materially since the majority of these expenses are capitalized as deferred
policy acquisition costs. Changes in the life commission and bonus structures
could affect the growth in sales of life and annuity products by ERIE agencies. 22




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF FINANCIAL OPERATIONS (Continued) Products with Interest Rate Guarantees Several of the Companys annuity and universal life products offer guaranteed
interest rates to policyholders. In response to the current interest rate
environment, the Company has reduced the credited interest rates to
historically low levels. Certain products are now at the minimum interest rates
guaranteed under these policy forms. If the interest rates on fixed income securities continue to decline, the
interest rates available in the marketplace may be insufficient to produce
target profit margins or, in extreme situations, could produce negative profit
margins on annuity and universal life deposits. Effective July 10, 2003, the Company revised its current deferred annuity
products to lower interest rate guarantees on newly issued policies to 1.5% in
all policy years. This change has been approved in all states in which the
Company operates. Annuity contracts issued between February 25, 2003 and July 9, 2003 have a
guaranteed interest rate of 3.0%. Contract forms issued before February 2003
have a stepped-down guaranteed interest rate structure. The guaranteed
interest rates and approximate current deposit liabilities for deferred annuity
products with credited interest rates subject to change by the Company are as
follows: Initial
    
    CurrentPolicy
    
    Guaranteed
    
    Guaranteed
    
    DepositYears
    
    Interest Rate
    
    Interest Rate
    
    Liabilities(in thousands)1-5
    
    
    4.5
    %
    
    
    4.5
    %
    
    $
    312,2856-10
    
    
    4.5
    
    
    
    4.0
    
    
    
    111,840Over 10
    
    
    4.5
    
    
    
    3.5
    
    
    
    119,931All Years
    
    
    3.0
    
    
    
    3.0
    
    
    
    31,740All Years
    
    
    1.5
    
    
    
    1.5
    
    
    
    13,852
 The Company has some ability to restrict new deposits on its universal life and
annuity policy contracts. New deposits can be limited under the terms of the
Companys universal life and annuity contracts as follows:  
    
    Universal life products provide for planned premium amounts.
Additional unplanned premium payments may be made at any time during
the insureds lifetime and before the end of the payment period. The
amounts of such payments must be acceptable to the Company and be
within IRS guidelines. Policies in force at March 31, 2004 have an
annualized planned premium of $30.2 million.
    
    Flexible premium deferred annuity (FPDA) contracts allow the
Company to limit deposits to a maximum of $25,000 per year. The
Company began limiting deposits to the contractual maximum effective
July 10, 2003 on products with interest rate guarantees exceeding
3.0% to insure that overall product interest spreads are maintained.
Currently, there are 23,263 FPDA contracts in force, of which 20,433
have guarantees in excess of 3.0%. No additional payments are
permitted on single premium deferred annuity contracts. 23




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF FINANCIAL OPERATIONS (Continued) During the first quarter of 2004, the average rate credited on flexible premium
deferred annuity and universal life account values was 4.18% and 4.58%,
respectively. The current coupon yield on fixed maturities matched against
universal life and annuity products at March 31, 2004, is 6.0%. Market Conditions for Competing Products The Companys deposit-type products compete with a wide variety of investment
options. Among other factors affecting the investment decisions of
policyholders and potential policyholders are general investment market
conditions, particularly the market interest rate environment and the
performance of the equity markets. Changes in interest rates affect pricing
and the relative attractiveness of interest-sensitive investment options, which
bears directly on the ability of the Company to attract new policyholders and
retain existing holders of annuity, universal life and certain permanent life
insurance products. Financial Ratings The combination of Company growth and declines in investment returns exposes
the Company to reduced statutory surplus levels. Surplus levels are an
important element of the rating process used by such agencies as A.M. Best and
Standard & Poors, which are industry-accepted measures of an insurance
companys financial health and ability to meet ongoing obligations to
policyholders. These ratings are a factor in establishing the competitive
position of insurance companies. If the Company were to incur reductions in statutory surplus for an extended
period of time, the ratings of the Company may be downgraded. Future downgrades
in these or other ratings would reduce the competitive position of the Company
by making it more difficult to attract business in the highly competitive life
insurance industry. In such circumstances, the Company may need to take
measures to increase surplus levels in order to maintain adequate ratings. The
Company may increase surplus through a variety of means, including the issuance
of additional surplus notes. Introduction of ERIEConnection® In 2001, the Erie Insurance Group, including the Company, began the development
of several eCommerce initiatives in support of the Groups business model of
distributing insurance products exclusively through independent agents. These
initiatives include customer interaction systems that are intended to improve
service and efficiency, as well as result in increased sales. The implementation of the new system will require a significant investment in
training and orientation for the independent agency force. During
implementation, as agency resources are dedicated to learning the new system,
sales of new business could be adversely affected over the short term. The
amount of lost sales will correlate to the timing and duration of the systems
rollout effort as well as the number and types of system issues encountered.
Precise measurement of the impact on sales is not estimable. 24




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Companys 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 and interest rates are included in
Item 7A in the Companys 2003 Annual Report on Form 10-K/A. The risks associated
with interest rate guarantees on the Companys universal life and annuity
products are discussed in the Companys Annual Report on Form 10-K/A for 2003 in
Factors That May Affect Future Results. The information contained in the
Investments section of Managements Discussion and Analysis of Financial
Condition and Results of Operations in the Companys 2003 Annual Report on Form
10-K/A is incorporated herein by reference. The Company also has exposure to credit risk through its portfolios of fixed
maturity securities, preferred stock, mortgage loans, and to a lesser extent,
short-term investments. This risk is defined as the potential loss in market
value resulting from adverse changes in the borrowers ability to repay the
debt. The Companys objective is to earn competitive returns by investing in a
diversified portfolio of securities. The Company manages this risk by
performing up front underwriting analysis and regular reviews by its investment
staff. The fixed maturity investments are also maintained between minimum and
maximum percentages of invested assets.  Safe Harbor Statement Under the Private Securities Litigation Reform Act of
1995:Certain forward-looking statements contained herein involve risks and
uncertainties. These statements include certain discussions relating to
underwriting, premium and investment income volume, business strategies,
profitability and business relationships and the Companys other business
activities during 2004 and beyond. In some cases, you can identify
forward-looking statements by terms such as may, will, should, could,
would, expect, plan, intend, anticipate, believe, estimate,
project, predict, potential and similar expressions. These
forward-looking statements reflect the Companys current views about future
events, are based on assumptions and are subject to known and unknown risks and
uncertainties that may cause results to differ materially from those
anticipated in those statements. Many of the factors that will determine
future events or achievements are beyond our ability to control or predict. 25




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ITEM 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures In its Form 10-K Annual Report for 2003, the Company reported a weakness in
internal control over the processes used to determine the recorded amount of
deferred acquisition costs (DAC) and related DAC amortization. The Companys
independent auditors, Ernst & Young, LLP, in conjunction with their audit of
the Companys 2003 financial statements, characterized this weakness as a
material weakness, as defined in Statement on Auditing Standards No. 60. The
material weakness was communicated to the Companys management and the Audit
Committee of the Board of Directors. As of March 31, 2004, the Company conducted an evaluation, under the
supervision and with the participation of the Companys management, including
its Chief Executive Officer and its Chief Financial Officer, of the
effectiveness of the design and operation of the Companys disclosure controls
and procedures [as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 (the Exchange Act)]. Based on this
evaluation, the Companys Chief Executive Officer and Chief Financial Officer
concluded that, as of May 14, 2004, the date the Company filed its original
Form 10-Q (the Original Filing) for the quarter ended March 31, 2004, except
for the previously disclosed material weakness relating to the Companys
accounting for DAC, the Companys disclosure controls and procedures as of
March 31, 2004 were effective for gathering, analyzing and disclosing the
information the Company is required to disclose in reports it files under the
Exchange Act within the time periods specified in the Securities and Exchange
Commissions (the SEC) rules and forms. As reported in its Original Filing, management developed a plan in
collaboration with the Audit Committee of the Board to correct this weakness in
internal control during 2004. The plan entails implementation of improved
procedures and controls over periodic DAC computations and balances, ongoing
evaluation of underlying assumptions, monitoring of DAC trends and ratios and
the installation of improved valuation systems. The plan was reviewed with,
and progress is being monitored by, the Audit Committee of the Board and
Company management, including its Chief Executive Officer and its Chief
Financial Officer. The Original Filing also disclosed that, depending on the
outcome of the evaluation when it was completed, a reinstatement of previously
issued financial statements may be warranted. The Company made substantive progress in correcting the weakness in control
during the first quarter of 2004. Under the plan, an independent consulting
actuary was engaged to provide oversight over the team of internal actuarial
and accounting personnel performing the evaluation. This independent
consulting actuary provided direction and guidance in evaluating past practices
and in implementing procedures and controls regarding actuarial functions. As of May 14, 2004, the Company had effected certain improvements to its DAC
accounting procedures as described in Item 4 of the Original Filing. Subsequent to the Original Filing the Company completed its evaluation of DAC
accounting issues and has identified adjustments to its previously issued
financial statements that require restatement. As described further in the
footnotes to its financial statements, the Company has recorded these
adjustments and is hereby amending the Original Filing by filing this Form
10-Q/A. Based on managements evaluation and improvements in DAC and other processes
made through the date of filing of this Form 10-Q/A, the Companys Chief
Executive Officer and Chief Financial Officer have concluded that the Companys
disclosure controls and procedures are effective for gathering, analyzing and
disclosing the information the Company is required to disclose in the reports
it files under the Exchange Act within the time periods specified in the SECs
rules and forms. Other than the improvements made to the Companys processes
and controls over accounting for DAC, there have been no significant changes in
the Companys internal controls or in other factors that could significantly
affect internal controls subsequent to the date of managements evaluation. 26




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PART II. OTHER INFORMATION 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K Exhibits ExhibitNumber
    
    Description of Exhibit31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232
    
    Statements of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
 Reports on Form 8-K On February 25, 2004, the Company filed a report on Form 8-K, reporting under
Item 12, that a press release had been issued reporting the Companys earnings
for the quarter and year ended December 31, 2003. On March 5, 2004, the Company filed a report on Form 8-K, reporting under Item
5, that a dividend had been declared at its March 2, 2004 board meeting. 27




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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 Family Life Insurance Company(Registrant)Date: August 20, 2004
    /s/ Jeffrey A. Ludrof(Jeffrey A. Ludrof, President & CEO)/s/ Philip A. Garcia(Philip A. Garcia, Executive Vice President & CFO) 28