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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended June 30, 2004 OR [   ] 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 applicableFormer name, former address and former fiscal year, if changed since last report
 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
[X]     No [   ] 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
[   ]     No [X] 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 August 13, 2004. 1




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INDEX ERIE FAMILY LIFE INSURANCE COMPANY PART I. FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (Unaudited)Statements of Financial Position - June 30, 2004 (Unaudited) and December 31, 2003Statements of Operations (Unaudited) - Three and six months ended June 30, 2004 and 2003Statements of Comprehensive Income (Unaudited) - Three and six months ended June 30, 2004 and 2003Statements of Cash Flows (Unaudited) - Six months ended June 30, 2004 and 2003Notes to Financial Statements - June 30, 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 4.
    
    Submission of Matters to a Vote of Security HoldersItem 6.
    
    Exhibits and Reports on Form 8-KSIGNATURESCertificationCertificationCertifications
 2




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PART I. FINANCIAL INFORMATION ERIE FAMILY LIFE INSURANCE COMPANY 
  (Dollars in thousands)June 30,
    
    December 31,ASSETS
    
    2004
    
    2003(Unaudited)
    
    (Restated)Investments:Fixed maturities at fair value (amortized cost
of $1,257,776 and $1,203,607, respectively)
    
    $
    1,290,791
    
    
    $
    1,280,327Equity securities at fair value
(cost of $60,137 and $56,608, respectively)
    
    
    64,370
    
    
    
    62,948Limited partnerships at fair value
(cost of $13,031 and $12,203, respectively)
    
    
    13,108
    
    
    
    12,241Real estate mortgage loans
    
    
    6,216
    
    
    
    6,305Real estate
    
    
    1,086
    
    
    
    1,127Policy loans
    
    
    10,371
    
    
    
    9,951Total investments
    
    
    1,385,942
    
    
    
    1,372,899Cash and cash equivalents
    
    
    70,115
    
    
    
    91,667Premiums receivable from policyholders
    
    
    6,933
    
    
    
    7,344Reinsurance recoverable
    
    
    1,584
    
    
    
    2,960Other receivables
    
    
    373
    
    
    
    137Accrued investment income
    
    
    15,456
    
    
    
    15,088Deferred policy acquisition costs
    
    
    114,812
    
    
    
    98,207Reserve credit for reinsurance ceded
    
    
    24,191
    
    
    
    20,758Prepaid federal income taxes
    
    
    1,216
    
    
    
    1,983Other assets
    
    
    6,755
    
    
    
    18,520Total assets
    
    $
    1,627,377
    
    
    $
    1,629,563
 See Notes to Financial Statements. 3




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ERIE FAMILY LIFE INSURANCE COMPANY
STATEMENTS OF FINANCIAL POSITION (Dollars in thousands)June 30,
    
    December 31,LIABILITIES AND SHAREHOLDERS EQUITY
    
    2004
    
    2003(Unaudited)
    
    (Restated)Liabilities:Policy Liabilities and Accruals:Future policy benefits
    
    $
    115,553
    
    
    $
    108,089Policy and contract claims
    
    
    3,023
    
    
    
    3,653Annuity deposits
    
    
    962,907
    
    
    
    932,553Universal life deposits
    
    
    157,057
    
    
    
    150,421Supplementary contracts not
including life contingencies
    
    
    718
    
    
    
    579Other policyholder funds
    
    
    4,910
    
    
    
    9,856Deferred income taxes
    
    
    37,275
    
    
    
    46,813Reinsurance premium due
    
    
    1,327
    
    
    
    1,875Securities lending collateral
    
    
    43,831
    
    
    
    65,495Accounts payable and accrued expenses
    
    
    9,383
    
    
    
    9,239Notes payable to Erie Indemnity Company
    
    
    40,000
    
    
    
    40,000Due to affiliates
    
    
    4,046
    
    
    
    3,442Dividends payable
    
    
    2,079
    
    
    
    1,985Total liabilities
    
    
    1,382,109
    
    
    
    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
    
    
    18,703
    
    
    
    44,603Retained earnings
    
    
    222,155
    
    
    
    206,550Total shareholders equity
    
    
    245,268
    
    
    
    255,563Total liabilities and shareholders equity
    
    $
    1,627,377
    
    
    $
    1,629,563
 See Notes to Financial Statements. 4




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ERIE FAMILY LIFE INSURANCE COMPANY 
  Three Months Ended
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003(Restated)
    
    
    
    
    
    (Restated)(Dollars in thousands, except per share data)Revenues:Net Policy Revenue:Life Premiums
    
    $
    13,789
    
    
    $
    13,529
    
    
    $
    26,901
    
    
    $
    25,771Group Life and Other Premiums
    
    
    836
    
    
    
    805
    
    
    
    1,703
    
    
    
    1,651Total Net Policy Revenue
    
    
    14,625
    
    
    
    14,334
    
    
    
    28,604
    
    
    
    27,422Net Investment Income
    
    
    19,752
    
    
    
    19,843
    
    
    
    38,507
    
    
    
    38,426Net Realized Gains on Investments
    
    
    5,556
    
    
    
    2,099
    
    
    
    8,404
    
    
    
    4,261Equity in Earnings of Limited Partnerships
    
    
    712
    
    
    
    120
    
    
    
    867
    
    
    
    400Other Income
    
    
    238
    
    
    
    217
    
    
    
    556
    
    
    
    396Total Revenues
    
    
    40,883
    
    
    
    36,613
    
    
    
    76,938
    
    
    
    70,905Benefits and Expenses:Death Benefits
    
    
    3,479
    
    
    
    2,761
    
    
    
    8,383
    
    
    
    6,602Interest on Annuity Deposits
    
    
    11,136
    
    
    
    10,605
    
    
    
    22,046
    
    
    
    20,540Interest on Universal Life Deposits
    
    
    1,751
    
    
    
    1,827
    
    
    
    3,487
    
    
    
    3,606Surrender and Other Benefits
    
    
    295
    
    
    
    448
    
    
    
    615
    
    
    
    723Increase in Future Life Policy Benefits
    
    
    1,784
    
    
    
    1,509
    
    
    
    4,031
    
    
    
    3,297Amortization of Deferred Policy Acquisition Costs
    
    
    (3,592
    )
    
    
    1,725
    
    
    
    (3,365
    )
    
    
    3,909Commissions
    
    
    1,043
    
    
    
    1,143
    
    
    
    1,585
    
    
    
    2,483General Expenses
    
    
    4,097
    
    
    
    3,915
    
    
    
    7,975
    
    
    
    8,337Taxes, Licenses and Fees
    
    
    1,023
    
    
    
    707
    
    
    
    1,857
    
    
    
    1,384Total Benefits and Expenses
    
    
    21,016
    
    
    
    24,640
    
    
    
    46,614
    
    
    
    50,881Income Before Income Taxes
    
    
    19,867
    
    
    
    11,973
    
    
    
    30,324
    
    
    
    20,024Provision for Federal Income Tax (Benefit):Current
    
    
    3,662
    
    
    
    4,194
    
    
    
    6,148
    
    
    
    7,919Deferred
    
    
    2,958
    
    
    
    (39
    )
    
    
    4,411
    
    
    
    (971
    )Total Provision for Federal Income Tax
    
    
    6,620
    
    
    
    4,155
    
    
    
    10,559
    
    
    
    6,948Net Income
    
    $
    13,247
    
    
    $
    7,818
    
    
    $
    19,765
    
    
    $
    13,076Net Income Per Share
    
    $
    1.40
    
    
    $
    0.83
    
    
    $
    2.09
    
    
    $
    1.38Dividends Declared Per Share
    
    $
    0.22
    
    
    $
    0.42
    
    
    $
    0.44
    
    
    $
    0.63
 See Notes to Financial Statements. 5




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ERIE FAMILY LIFE INSURANCE COMPANY 
  Three Months Ended
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003(Restated)
    
    
    
    
    
    (Restated)(Dollars in thousands)Net Income
    
    $
    13,247
    
    
    $
    7,818
    
    
    $
    19,765
    
    
    $
    13,076Unrealized (losses) gains on securities:Unrealized holding (losses) gains arising
during period, net of related offsets
    
    
    (57,315
    )
    
    
    41,296
    
    
    
    (31,442
    )
    
    
    54,650Less: gains included in net income
    
    
    (5,556
    )
    
    
    (2,099
    )
    
    
    (8,404
    )
    
    
    (4,261
    )Net unrealized holding (losses) gains
arising during period, net of related offsets
    
    
    (62,871
    )
    
    
    39,197
    
    
    
    (39,846
    )
    
    
    50,389Income tax benefit (expense) related to
unrealized (losses) gains
    
    
    22,005
    
    
    
    (13,719
    )
    
    
    13,946
    
    
    
    (17,636
    )Unrealized (deprecation) appreciation of
investments, net of tax
    
    
    (40,866
    )
    
    
    25,478
    
    
    
    (25,900
    )
    
    
    32,753Comprehensive (Loss) Income
    
    ($
    27,619
    )
    
    $
    33,296
    
    
    ($
    6,135
    )
    
    $
    45,829
 See Notes to Financial Statements. 6




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ERIE FAMILY LIFE INSURANCE COMPANY 
  Six Months Ended
    
    Six Months EndedJune 30, 2004
    
    June 30, 2003(Dollars in thousands)CASH FLOWS PROVIDED BY (USED IN)
OPERATING ACTIVITIES:Premiums collected
    
    $
    23,277
    
    
    $
    23,965Net investment income received
    
    
    40,323
    
    
    
    37,953Miscellaneous income
    
    
    556
    
    
    
    395Benefits to policyholders
    
    
    (34,654
    )
    
    
    (32,140
    )Commissions paid to agents
    
    
    (3,252
    )
    
    
    (7,986
    )Salaries and wages paid
    
    
    (6,501
    )
    
    
    (5,582
    )General operating expenses paid
    
    
    (7,092
    )
    
    
    (6,969
    )Taxes, licenses and fees paid
    
    
    (2,024
    )
    
    
    (1,814
    )Income taxes paid
    
    
    (5,382
    )
    
    
    (8,675
    )Net cash provided by (used in) operating activities
    
    
    5,251
    
    
    
    (853
    )CASH FLOWS USED IN INVESTING ACTIVITIES:Purchase of investments:Fixed maturities
    
    
    (166,147
    )
    
    
    (317,047
    )Equity securities
    
    
    (3,529
    )
    
    
    (8,598
    )Limited partnerships
    
    
    (810
    )
    
    
    (1,910
    )Sales/maturities of investments:Sales of fixed maturities
    
    
    116,770
    
    
    
    115,837Calls/maturities of fixed maturities
    
    
    14,954
    
    
    
    58,331Equity securities
    
    
    0
    
    
    
    7,071Limited partnerships
    
    
    890
    
    
    
    3,113(Decrease) increase in collateral from securities lending
    
    
    (21,664
    )
    
    
    27,010Net mortgage loans
    
    
    89
    
    
    
    345Net policy loans
    
    
    (420
    )
    
    
    (266
    )Net cash used in investing activities
    
    
    (59,867
    )
    
    
    (116,114
    )CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:Annuity and supplementary
contract deposits and interest
    
    
    66,254
    
    
    
    124,747Annuity and supplementary
contract surrenders and withdrawals
    
    
    (35,761
    )
    
    
    (26,344
    )Universal life deposits and interest
    
    
    9,891
    
    
    
    10,425Universal life surrenders
    
    
    (3,256
    )
    
    
    (2,560
    )Dividends paid to shareholders
    
    
    (4,064
    )
    
    
    (3,969
    )Net cash provided by financing activities
    
    
    33,064
    
    
    
    102,299Net decrease in cash and cash equivalents
    
    
    (21,552
    )
    
    
    (14,668
    )Cash and cash equivalents at beginning of period
    
    
    91,667
    
    
    
    97,022Cash and cash equivalents at end of period
    
    $
    70,115
    
    
    $
    82,354
 See Notes to Financial Statements. 7




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ERIE FAMILY LIFE INSURANCE COMPANY 
 
 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 six-month period ended June 30, 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 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 three and six months ended June 30, 2003, and
deferred policy acquisition costs and shareholders' equity as of December 31, 2003 is as follows: Three Months Ended
    
    Six Months EndedJune 30, 2003
    
    June 30, 2003(Dollars in thousands, except per share data)As originally reported:Net income
    
    $
    7,814
    
    
    $
    13,220Net income per share
    
    $
    0.83
    
    
    $
    1.40As restated:Net income
    
    $
    7,818
    
    
    $
    13,076Net income per share
    
    $
    0.83
    
    
    $
    1.38
 December 31,2003(Dollars in thousands)As originally reported:Deferred policy acquisition costs
    
    $
    103,874Shareholders equity
    
    $
    259,247As restated:Deferred policy acquisition costs
    
    $
    98,207Shareholders' equity
    
    $
    255,563
 NOTE C  EARNINGS PER SHARE Earnings per share amounts are based on the weighted average number of common
shares outstanding during each of the respective periods. 8




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited)
(All dollar amounts are in thousands) NOTE D  INVESTMENTS At June 30, 2004 and 2003, marketable equity securities consist of common
and 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 (Loss) Income and Shareholders Equity. The following is a summary of available-for-sale securities: Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    EstimatedCost
    
    Gains
    
    Losses
    
    Fair ValueJune 30, 2004Fixed Maturities:Bonds:U.S. treasuries and
government agencies
    
    $
    67,151
    
    
    $
    654
    
    
    $
    573
    
    
    $
    67,232Public utilities
    
    
    153,680
    
    
    
    7,049
    
    
    
    1,702
    
    
    
    159,027U.S. banks, trusts
and insurance companies
    
    
    177,450
    
    
    
    6,435
    
    
    
    3,010
    
    
    
    180,875U.S. industrial and miscellaneous
    
    
    546,705
    
    
    
    23,625
    
    
    
    4,159
    
    
    
    566,171Mortgage-backed
    
    
    154,412
    
    
    
    2,069
    
    
    
    2,464
    
    
    
    154,017Asset-backed
    
    
    8,023
    
    
    
    225
    
    
    
    202
    
    
    
    8,046Foreign
    
    
    143,339
    
    
    
    7,987
    
    
    
    2,974
    
    
    
    148,352Total bonds
    
    
    1,250,760
    
    
    
    48,044
    
    
    
    15,084
    
    
    
    1,283,720Redeemable preferred stock
    
    
    7,016
    
    
    
    55
    
    
    
    0
    
    
    
    7,071Total fixed maturities
    
    
    1,257,776
    
    
    
    48,099
    
    
    
    15,084
    
    
    
    1,290,791Equity Securities:Common stock:U.S. industrial and miscellaneous
    
    
    529
    
    
    
    0
    
    
    
    85
    
    
    
    444Nonredeemable preferred stock:Public utilities
    
    
    1,864
    
    
    
    54
    
    
    
    0
    
    
    
    1,918U.S. banks, trusts
and insurance companies
    
    
    16,909
    
    
    
    1,579
    
    
    
    0
    
    
    
    18,488U.S. industrial and miscellaneous
    
    
    17,119
    
    
    
    1,484
    
    
    
    159
    
    
    
    18,444Foreign
    
    
    23,716
    
    
    
    1,435
    
    
    
    75
    
    
    
    25,076Total equity securities
    
    
    60,137
    
    
    
    4,552
    
    
    
    319
    
    
    
    64,370Total fixed maturities and equity
securities
    
    $
    1,317,913
    
    
    $
    52,651
    
    
    $
    15,403
    
    
    $
    1,355,161
 9




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE D  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 fixed maturities and equity
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. 10




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE D  INVESTMENTS (Continued) Three Months Ended
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003Fixed maturities:Gross realized gains
    
    $
    5,744
    
    
    $
    2,258
    
    
    $
    8,674
    
    
    $
    9,263Gross realized losses
    
    
    (220
    )
    
    
    (141
    )
    
    
    (313
    )
    
    
    (4,974
    )Net realized gains
    
    
    5,524
    
    
    
    2,117
    
    
    
    8,361
    
    
    
    4,289Equity securities:Gross realized gains
    
    
    32
    
    
    
    29
    
    
    
    43
    
    
    
    29Gross realized losses
    
    
    0
    
    
    
    (47
    )
    
    
    0
    
    
    
    (57
    )Net realized gains (losses)
    
    
    32
    
    
    
    (18
    )
    
    
    43
    
    

    
    (28
    )Net realized gains on investments
    
    $
    5,556
    
    
    $
    2,099
    
    
    $
    8,404
    
    
    $
    4,261
 The gross unrealized losses at June 30, 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
    
    ($
    12,947
    )
    
    $
    473,859
    
    
    $
    460,912
    
    
    
    167Six to 12 months
    
    
    (2,337
    )
    
    
    31,685
    
    
    
    29,348
    
    
    
    1412 to 18 months
    
    
    (70
    )
    
    
    1,412
    
    
    
    1,342
    
    
    
    1Greater than 18 months
    
    
    (49
    )
    
    
    4,437
    
    
    
    4,388
    
    
    
    2($
    15,403
    )
    
    $
    511,393
    
    
    $
    495,990
    
    
    
    184
 No investments in an unrealized loss position at June 30, 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. However, as interest rates rise, declines in value of
the Companys substantial fixed income portfolio could occur,
which may require impairment charges to be made. 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 June 30, 2004
and 2003, related to this program totaled $26 and $27, respectively. For the
six months ended June 30, 2004 and 2003, revenue received related to this
program totaled $54 and $48, respectively. 11




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE D  INVESTMENTS (Continued) The Company had loaned securities with a market value of $43.0 million and
$64.1 million and secured collateral of $43.8 million and $65.5 million at June
30, 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. Limited partnerships at June 30, 2004 include U.S. and foreign real estate and
mezzanine debt investments. Real estate limited partnerships represent 92.5%,
while mezzanine debt limited partnerships represent 7.5%, of the total carrying
value at June 30, 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
    
    Six Months EndedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003Mezzanine Debt
    
    $
    15
    
    
    $
    86
    
    
    $
    35
    
    
    ($
    1
    )Real Estate
    
    
    697
    
    
    
    34
    
    
    
    832
    
    
    
    401$
    712
    
    
    $
    120
    
    
    $
    867
    
    
    $
    400
 NOTE E  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 second quarter 2004 evaluation, the
Company modified certain assumptions related to lapse, mortality, interest
rates, surrender rates and other factors causing an unlocking as provided under
accounting guidance. As a result of unlocking assumptions, DAC as of June 30,
2004 increased by $5.9 million and net income for the second quarter 2004
increased by $3.9 million. 12




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##### Table of Contents



ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE F  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 &
    
    CorporateJune 30, 2004
    
    Life
    
    Life
    
    Annuities
    
    Other
    
    Account
    
    TotalTotal policy revenue, net of
reinsurance
    
    $
    10,313
    
    
    $
    3,476
    
    
    $
    1
    
    
    $
    835
    
    
    $
    0
    
    
    $
    14,625Total investment-related
and other income
    
    
    2,169
    
    
    
    2,849
    
    
    
    17,691
    
    
    
    926
    
    
    
    2,623
    
    
    
    26,258Total revenues
    
    
    12,482
    
    
    
    6,325
    
    
    
    17,692
    
    
    
    1,761
    
    
    
    2,623
    
    
    
    40,883Less: Total benefits and
expenses
    
    
    9,571
    
    
    
    (1,801
    )
    
    
    12,795
    
    
    
    451
    
    
    
    0
    
    
    
    21,016Income before taxes
    
    $
    2,911
    
    
    $
    8,126
    
    
    $
    4,897
    
    
    $
    1,310
    
    
    $
    2,623
    
    
    $
    19,867
 Six Months EndedJune 30, 2004Total policy revenue, net of
reinsurance
    
    $
    19,957
    
    
    $
    6,944
    
    
    $
    1
    
    
    $
    1,702
    
    
    $
    0
    
    
    $
    28,604Total investment-related
and other income
    
    
    4,019
    
    
    
    5,323
    
    
    
    32,899
    
    
    
    977
    
    
    
    5,116
    
    
    
    48,334Total revenues
    
    
    23,976
    
    
    
    12,267
    
    
    
    32,900
    
    
    
    2,679
    
    
    
    5,116
    
    
    
    76,938Less: Total benefits and
expenses
    
    
    19,866
    
    
    
    1,002
    
    
    
    24,806
    
    
    
    940
    
    
    
    0
    
    
    
    46,614Income before taxes
    
    $
    4,110
    
    
    $
    11,265
    
    
    $
    8,094
    
    
    $
    1,739
    
    
    $
    5,116
    
    
    $
    30,324
 During the second quarter of 2004, the Company unlocked certain assumptions
related to determination of DAC for its universal life and fixed
annuities. As a result of unlocking these assumptions, DAC was increased and
the amortization of DAC was decreased by $5.2 million and $0.7 million for
universal life and fixed annuities for the second quarter of 2004,
respectively. 13




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##### Table of Contents



ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE F  SEGMENT INFORMATION (Continued) GroupThree Months Ended
    
    Traditional
    
    Universal
    
    Fixed
    
    Life &
    
    CorporateJune 30, 2003
    
    Life
    
    Life
    
    Annuities
    
    Other
    
    Account
    
    Total(Restated)Total policy revenue, net of
reinsurance
    
    $
    10,189
    
    
    $
    3,340
    
    
    $
    1
    
    
    $
    804
    
    
    $
    0
    
    
    $
    14,334Total investment-related
and other income
    
    
    1,978
    
    
    
    2,541
    
    
    
    15,893
    
    
    
    42
    
    
    
    1,825
    
    
    
    22,279Total revenues
    
    
    12,167
    
    
    
    5,881
    
    
    
    15,894
    
    
    
    846
    
    
    
    1,825
    
    
    
    36,613Less: Total benefits and
expenses
    
    
    8,121
    
    
    
    3,775
    
    
    
    12,394
    
    
    
    350
    
    
    
    0
    
    
    
    24,640Income before taxes
    
    $
    4,046
    
    
    $
    2,106
    
    
    $
    3,500
    
    
    $
    496
    
    
    $
    1,825
    
    
    $
    11,973
 Six Months EndedJune 30, 2003(Restated)Total policy revenue, net of
reinsurance
    
    $
    19,152
    
    
    $
    6,619
    
    
    $
    2
    
    
    $
    1,649
    
    
    $
    0
    
    
    $
    27,422Total investment-related
and other income
    
    
    3,870
    
    
    
    4,927
    
    
    
    30,739
    
    
    
    84
    
    
    
    3,863
    
    
    
    43,483Total revenues
    
    
    23,022
    
    
    
    11,546
    
    
    
    30,741
    
    
    
    1,733
    
    
    
    3,863
    
    
    
    70,905Less: Total benefits and
expenses
    
    
    17,067
    
    
    
    8,219
    
    
    
    24,435
    
    
    
    1,160
    
    
    
    0
    
    
    
    50,881Income before taxes
    
    $
    5,955
    
    
    $
    3,327
    
    
    $
    6,306
    
    
    $
    573
    
    
    $
    3,863
    
    
    $
    20,024
 NOTE G  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 June 30, 2004 and
2003, $10.6 billion and $8.2 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 June 30, 2004, the
amount of in-force life insurance ceded to Generali totaled approximately $6.1
billion. 14




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##### Table of Contents



ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE G  REINSURANCE (Continued) The effect of ceded reinsurance in the Statements of Operations is as follows: Three Months Ended
    
    Six Months Ended(Restated)
    
    June 30
    
    June 302004
    
    2003
    
    2004
    
    2003Revenues:Direct policy revenue
    
    $
    19,651
    
    
    $
    18,427
    
    
    $
    37,674
    
    
    $
    34,827Policy revenue ceded
    
    
    (5,026
    )
    
    
    (4,093
    )
    
    
    (9,070
    )
    
    
    (7,405
    )Net policy revenue
    
    
    14,625
    
    
    
    14,334
    
    
    
    28,604
    
    
    
    27,422Net investment income
    
    
    19,752
    
    
    
    19,843
    
    
    
    38,507
    
    
    
    38,426Net realized gains
on investments
    
    
    5,556
    
    
    
    2,099
    
    
    
    8,404
    
    
    
    4,261Equity in earnings of limited
partnerships
    
    
    712
    
    
    
    120
    
    
    
    867
    
    
    
    400Other income
    
    
    238
    
    
    
    217
    
    
    
    556
    
    
    
    396Total revenues
    
    $
    40,883
    
    
    $
    36,613
    
    
    $
    76,938
    
    
    $
    70,905Benefits and expenses:Death benefits
    
    $
    4,420
    
    
    $
    3,511
    
    
    $
    11,046
    
    
    $
    8,718Reinsurance recoveries
    
    
    (941
    )
    
    
    (750
    )
    
    
    (2,663
    )
    
    
    (2,116
    )Net death benefits
    
    
    3,479
    
    
    
    2,761
    
    
    
    8,383
    
    
    
    6,602Interest on deposits and
other policyholder benefits
    
    
    13,182
    
    
    
    12,880
    
    
    
    26,148
    
    
    
    24,869Increases in future life policy
benefits
    
    
    3,766
    
    
    
    3,168
    
    
    
    7,464
    
    
    
    6,294Reinsurance reserve credits
    
    
    (1,982
    )
    
    
    (1,659
    )
    
    
    (3,433
    )
    
    
    (2,997
    )Net increases in future life
policy benefits
    
    
    1,784
    
    
    
    1,509
    
    
    
    4,031
    
    
    
    3,297Amortization of deferred policy
acquisition costs
    
    
    (3,592
    )
    
    
    1,725
    
    
    
    (3,365
    )
    
    
    3,909Commissions
    
    
    2,945
    
    
    
    2,827
    
    
    
    5,108
    
    
    
    5,721Reinsurance commission allowance
    
    
    (1,902
    )
    
    
    (1,684
    )
    
    
    (3,523
    )
    
    
    (3,238
    )Net commissions
    
    
    1,043
    
    
    
    1,143
    
    
    
    1,585
    
    
    
    2,483General expenses, taxes,
licenses and fees
    
    
    5,120
    
    
    
    4,622
    
    
    
    9,832
    
    
    
    9,721Total benefits and expenses
    
    $
    21,016
    
    
    $
    24,640
    
    
    $
    46,614
    
    
    $
    50,881Income before income taxes
    
    $
    19,867
    
    
    $
    11,973
    
    
    $
    30,324
    
    
    $
    20,024
 15




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##### Table of Contents



ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE H  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 paid interest of $0.5 million on this note during
the second 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 paid interest of $0.8
million on this note during the second quarter of 2004. NOTE I  SUPPLEMENTARY DATA ON CASH FLOWS A reconciliation of net income to net cash provided by (used in) operating
activities as presented in the Statements of Cash Flows is as follows: Six Months Ended
    
    Six Months EndedJune 30, 2004
    
    June 30, 2003(Restated)CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:Net income
    
    $
    19,765
    
    
    $
    13,076Adjustments to reconcile net income to net cash
provided by (used in) operating activities:Amortization of deferred policy acquisition costs
    
    
    (3,365
    )
    
    
    3,909Other amortization
    
    
    528
    
    
    
    318Deferred federal income tax expense (benefit)
    
    
    4,410
    
    
    
    (971
    )Realized gains on investments
    
    
    (8,404
    )
    
    
    (4,261
    )Equity in earnings of limited partnerships
    
    
    (867
    )
    
    
    (400
    )Decrease in premium and other receivables
    
    
    176
    
    
    
    769Increase in accrued investment income
    
    
    (369
    )
    
    
    (1,610
    )Policy acquisition costs deferred
    
    
    (7,316
    )
    
    
    (9,435
    )Increase in other assets
    
    
    (104
    )
    
    
    0Increase in reinsurance recoverables and reserve credits
    
    
    (2,057
    )
    
    
    (2,786
    )Decrease (increase) in prepaid federal income taxes
    
    
    767
    
    
    
    (756
    )Increase in future policy benefits and claims
    
    
    6,834
    
    
    
    6,194Decrease in other policyholder funds
    
    
    (4,946
    )
    
    
    (3,671
    )Decrease in reinsurance premium due
    
    
    (548
    )
    
    
    (519
    )Increase (decrease) in accounts payable and due to affiliates
    
    
    747
    
    
    
    (710
    )Net cash provided by (used in) operating activities
    
    $
    5,251
    
    
    ($
    853
    )
 NOTE J  COMMITMENTS The Company has outstanding commitments to invest up to $3.7 million in real
estate limited partnerships at June 30, 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 K  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 $13.2 million, or $1.40 per share, in the second
quarter of 2004, compared to $7.8 million, or $0.83 per share, for the second
quarter of 2003. For the six months ended June 30, 2004, net income increased
to $19.8 million, or $2.09 per share, compared to $13.1 million, or $1.38 per
share for the same period in 2003. Increases in investment related earnings
combined with the unlocking of deferred policy acquisition costs resulted in
the large increase in earnings. REVENUES Analysis of Policy Revenue Total net policy revenue increased to $14.6 million in the second quarter of
2004 from $14.3 million during the same period in 2003. Although total net
premiums are up in 2004, sales of new traditional policies declined in the
second quarter of 2004 when compared to the same period in 2003. Direct new
premiums on traditional life insurance policies decreased 4.0% to $2.5 million
for the quarter ended June 30, 2004, from $2.6 million for the quarter ended
June 30, 2003. In 2003, management of the Erie Insurance Group enhanced its
focus on property/casualty underwriting profitability. As the
Companys independent agents focus on underwriting
profitability, new property and casualty production and traditional
life policy production have declined. In addition, effective December
16, 2003, the Company restructured its bonus program. Changes
in the bonus program may be affecting the growth in
sales of life and annuity products by ERIE agencies. Total net policy revenue
increased $1.2 million, or 4.3%, to $28.6 million for the six months ended June
30, 2004. Analysis of Investment-related Income Net investment income decreased $0.1 million to $19.8 million in the second
quarter of 2004 when compared to the same period in 2003. The slight decrease
in net investment income for the second 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 $5.6 million in the second
quarter of 2004, compared to net realized capital gains of $2.1 million in the
second quarter of 2003. Included in the second quarter of 2004 was a gain of
$1.4 million from the maturity of a bond that had been recognized as impaired
in 2002. 18




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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 performance of its fixed maturities and preferred stock compared
to market indices is presented below: Two year period endedJune 30, 2004(Pre-tax annualized returns) (1)Erie Family Life Insurance Company indices:Fixed maturities
    
    
    8.07
    %Preferred stock
    
    
    10.69Other indices:Lehman Brothers U.S. Aggregate
    
    
    5.24
    %
 (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 $0.7 million or 26.0%
in the second quarter of 2004 to $3.5 million. For the six months ended June
30, 2004, net death benefits on life insurance policies increased $1.8 million,
or 27.0%, to $8.4 million, from $6.6 million during the same period in 2003.
Net life insurance inforce has grown from $16.9 billion at June 30, 2003 to
$17.8 billion at June 30, 2004, an increase of 5.3%. In addition, 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. 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 $0.5 million, or 3.7%, to $12.9
million in the second quarter of 2004 from $12.4 million in the second quarter
of 2003. This increase can be attributed to the growth of annuities on
deposit. At June 30, 2004, the balance of annuity deposits totaled $962.9
million, compared to $902.1 million at June 30, 2003, an increase of 6.7%. The
Company has lowered its credited interest rates during the last two years to
reflect 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  June 30, 2004
    
    
    3.00 - 4.70
    
    
    
    4.25 - 5.00
 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) was a negative $3.6
million in the second quarter of 2004 compared to amortization of $1.7 million
for the same period in 2003. In accordance with FAS 97, the Company
periodically evaluates certain assumptions in use to determine DAC and related
amortization related to its interest sensitive products. During the second
quarter 2004, the Company modified certain assumptions concerning lapse,
mortality, interest rates, surrender rates and other factors. As a result of
unlocking these assumptions, DAC was increased and the amortization of DAC was
decreased by $5.9 million during the second 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 second quarter of 2004, net commission
expense decreased $0.1 million to $1.0 million, compared to $1.1 million for
the second quarter of 2003. This decrease is primarily attributable to the
decline in annuity sales. Annuity premiums for the quarter ended June 30, 2004
were $15.2 million, compared to $36.1 million for the same period in 2003.
Commissions and bonuses on these premiums, net of DAC, were $0.2 million and
$0.7 million for the periods ended June 30, 2004 and 2003, respectively. For
the six months ended June 30, 2004, commission expense decreased $0.9 million
to $1.6 million, which is attributable to the reduction in annuity sales. General expenses, net of DAC, increased $0.2 million, or 4.6%, to $4.1 million
for the second quarter of 2004, compared to $3.9 million for the same period in
2003. General expenses include wages and salaries, employee benefits, data
processing expenses, professional fees, 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. The increase
in general expenses includes professional consulting fees related to the
strengthening of controls and increases in allocated information technology
costs of Company projects. 20




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF FINANCIAL OPERATIONS (Continued) 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 June 30, 2004, the Companys investment portfolio
consisting of cash, investment grade bonds and investment grade preferred
stock, totaled more than $1.3 billion, or 82.6% 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. 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. 21




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF FINANCIAL OPERATIONS (Continued) 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 net positive cash flow from operations is used
to fund Company commitments and to build the investment portfolio, thereby
increasing future investment returns. Net cash provided by operating activities
for the three months ended June 30, 2004 was $5.3 million. The Companys
liquidity position remains strong. Investments and cash and cash equivalents
totaled $1.5 billion at June 30, 2004. 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 $24.8 million in the
second quarter of 2004 and $45.5 million in the second 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. 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 June 30, 2004 and December 31, 2003, securities
held as collateral on the committed line of credit totaled $14.6 million and
$15.1 million, respectively. At June 30, 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 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. 22




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF FINANCIAL OPERATIONS (Continued) FACTORS THAT MAY AFFECT FUTURE RESULTS 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
    %
    
    $
    263,1566-10
    
    
    4.5
    
    
    
    4.0
    
    
    
    112,689Over 10
    
    
    4.5
    
    
    
    3.5
    
    
    
    171,526All Years
    
    
    3.0
    
    
    
    3.0
    
    
    
    32,089All Years
    
    
    1.5
    
    
    
    1.5
    
    
    
    20,677
 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 June 30, 2004 have an
annualized planned premium of $30.4 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 23,833 FPDA contracts in force, of which 20,206
have guarantees in excess of 3.0%. No additional payments are
permitted on single premium deferred annuity contracts. During the second quarter of 2004, the average rate credited on flexible
premium deferred annuity and universal life account values was 4.1% and 4.6%,
respectively. The current coupon yield on fixed maturities matched against
universal life and annuity products at June 30, 2004, is 5.9%. 23




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF FINANCIAL OPERATIONS (Continued) 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. 24




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF FINANCIAL OPERATIONS (Continued) 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. 25




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##### Table of Contents



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. 26




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##### Table of Contents



ITEM 4. CONTROLS AND PROCEDURES In its Form 10-K Annual
Report for 2003 as originally filed with the Securities and Exchange Commission
(the SEC) on March 8, 2004, as amended on April 1, 2004 (the
Original Filing), 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 reported in the 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 evaluation of DAC accounting issues, 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 has been reviewed with,
and progress is being monitored by, the Audit Committee of the Board and Company
management, including the Chief Executive Officer and the Chief Financial
Officer. Subsequent to the Original
Filing and pursuant to the plan, the Company completed its evaluation of DAC
accounting issues and identified adjustments to its previously issued financial
statements that required restatement (the Restatement). For
additional discussion of the Restatement, see the Companys Form 10-K/A
filed August 20, 2004. The Company has made
substantive progress in correcting the material weakness through the date of the
filing of this Form 10-Q. An independent consulting actuary engaged by the
Company is providing oversight over the team of internal actuarial and
accounting personnel implementing the plan, and providing direction and guidance
in evaluating past practices and in implementing procedures and controls
regarding actuarial functions. The Company has effected
certain improvements to its DAC accounting procedures. For example, actuarial
and financial personnel have developed management reports to enable management
to better monitor DAC trends and ratios which increase transparency in
understanding the periodic results of operations. The Company has also purchased
a new valuation system. Installation of this new system began in the second
quarter of 2004 and is expected to extend through year-end. As of the end of the period
covered by this Form 10-Q, the Company carried out an evaluation, under the
supervision and with the participation of the Companys Chief Executive
Officer and Chief Financial Officer, pursuant to Rule 13a-15 promulgated under
the Securities Exchange Act of 1934, as amended (the Exchange Act),
of the effectiveness of the design and operation of the Companys
disclosure controls and procedures. In making the evaluation described above,
the Company considered matters relating to the Restatement including the above
described control weakness. Based on managements
evaluation, the Companys Chief Executive Officer and Chief Financial
Officer have concluded that, except for the material weakness described above,
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. 27




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##### Table of Contents



PART II. OTHER INFORMATION 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On April 27, 2004, the Registrant held its Annual Meeting of Shareholders:  The following directors were elected for a one-year term and until a
successor is elected and qualified: Kaj Ahlmann
    
    C. Scott HartzJohn T. Baily
    
    F. William HirtSamuel P. Black, III
    
    Samuel P. KatzJ. Ralph Borneman, Jr.
    
    Claude C. Lilly, IIIWilson C. Cooney
    
    Jeffrey A. LudrofPatricia Garrison-Corbin
    
    Jan R. Van Gorder, Esq.John R. Graham
    
    Robert C. WilburnSusan Hirt Hagen
 
 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 May 27, 2004, the Company filed a report on Form 8-K reporting under Item 5,
the resignation, effective immediately, of Samuel P. Katz, President,
Wynnefield Capital Advisors, Inc. from the Companys Board of Directors for
personal reasons. The Nominating and Governance Committee has initiated the
process to determine whether to fill the vacated position prior to the 2005
Annual Shareholders Meeting or reduce the number of directors from 15 to 14. 28




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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)
 29