##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 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 September 30, 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 x     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 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
October 27, 2004.




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TABLE OF CONTENTS  Exhibit 31.1Exhibit 31.2Exhibit 32    Table of Contents  INDEX ERIE FAMILY LIFE INSURANCE COMPANY PART I. FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (Unaudited)Statements of Financial Position  September 30, 2004 and December 31, 2003Statements of Operations  Three and nine months ended September 30, 2004 and 2003Statements of Comprehensive Income  Three and nine months ended September 30, 2004 and 2003Statements of Cash Flows  Nine months ended September 30, 2004 and 2003Notes to Financial Statements  September 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 6.
    
    Exhibits and Reports on Form 8-KSIGNATURES
 2




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PART I. FINANCIAL INFORMATION 
 ERIE FAMILY LIFE INSURANCE COMPANY
STATEMENTS OF FINANCIAL POSITION (Dollars in thousands)September 30,
    
    December 31,2004
    
    2003(Unaudited)
    
    (Restated)ASSETSINVESTMENTSFixed maturities at fair value (amortized cost
of $1,273,788 and $1,203,607, respectively)
    
    $
    1,344,264
    
    
    $
    1,280,327Equity securities at fair value
(cost of $56,608 and $56,608, respectively)
    
    
    63,176
    
    
    
    62,948Limited partnerships, under equity method (cost of $11,410 and $12,203, respectively)
    
    
    11,390
    
    
    
    12,241Real estate mortgage loans
    
    
    6,171
    
    
    
    6,305Real estate
    
    
    1,065
    
    
    
    1,127Policy loans
    
    
    10,448
    
    
    
    9,951Total investments
    
    
    1,436,514
    
    
    
    1,372,899Cash and cash equivalents
    
    
    80,182
    
    
    
    91,667Premiums receivable from policyholders
    
    
    7,116
    
    
    
    7,344Reinsurance recoverable
    
    
    1,250
    
    
    
    2,960Other receivables
    
    
    368
    
    
    
    137Accrued investment income
    
    
    18,620
    
    
    
    15,088Deferred policy acquisition costs
    
    
    108,287
    
    
    
    98,207Reserve credit for reinsurance ceded
    
    
    26,150
    
    
    
    20,758Prepaid federal income taxes
    
    
    859
    
    
    
    1,983Other assets
    
    
    6,556
    
    
    
    18,520Total assets
    
    $
    1,685,902
    
    
    $
    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)September 30,
    
    December 31,2004
    
    2003(Unaudited)
    
    (Restated)LIABILITIES AND SHAREHOLDERS EQUITYLIABILITIESPolicy Liabilities and Accruals:Future policy benefits
    
    $
    119,495
    
    
    $
    108,089Policy and contract claims
    
    
    3,762
    
    
    
    3,653Annuity deposits
    
    
    972,475
    
    
    
    932,553Universal life deposits
    
    
    160,222
    
    
    
    150,421Supplementary contracts not
including life contingencies
    
    
    684
    
    
    
    579Other policyholder funds
    
    
    6,960
    
    
    
    9,856Deferred income taxes
    
    
    47,954
    
    
    
    46,813Reinsurance premium due
    
    
    1,263
    
    
    
    1,875Securities lending collateral
    
    
    33,104
    
    
    
    65,495Accounts payable and accrued expenses
    
    
    27,064
    
    
    
    9,239Notes payable to Erie Indemnity Company
    
    
    40,000
    
    
    
    40,000Due to affiliates
    
    
    2,197
    
    
    
    3,442Dividends payable
    
    
    4,158
    
    
    
    1,985Total liabilities
    
    
    1,419,338
    
    
    
    1,374,000SHAREHOLDERS EQUITYCommon 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
    
    
    39,158
    
    
    
    44,603Retained earnings
    
    
    222,996
    
    
    
    206,550Total shareholders equity
    
    
    266,564
    
    
    
    255,563Total liabilities and shareholders equity
    
    $
    1,685,902
    
    
    $
    1,629,563
 See Notes to Financial Statements. 4




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ERIE FAMILY LIFE INSURANCE COMPANY
STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended
    
    Nine Months EndedSeptember 30
    
    September 302004
    
    2003
    
    2004
    
    2003(Restated)
    
    
    
    (Restated)(Dollars in thousands, except per share data)RevenuesNet Policy Revenue:Life Premiums
    
    $
    13,458
    
    
    $
    12,757
    
    
    $
    40,359
    
    
    $
    38,528Group Life and Other Premiums
    
    
    819
    
    
    
    841
    
    
    
    2,522
    
    
    
    2,492Total Net Policy Revenue
    
    
    14,277
    
    
    
    13,598
    
    
    
    42,881
    
    
    
    41,020Net Investment Income
    
    
    18,992
    
    
    
    18,932
    
    
    
    57,499
    
    
    
    57,358Net Realized Gains on Investments
    
    
    1,103
    
    
    
    4,908
    
    
    
    9,507
    
    
    
    9,170Equity in Earnings of Limited Partnerships
    
    
    203
    
    
    
    1,394
    
    
    
    1,070
    
    
    
    1,794Other Income
    
    
    203
    
    
    
    264
    
    
    
    759
    
    
    
    659Total Revenues
    
    
    34,778
    
    
    
    39,096
    
    
    
    111,716
    
    
    
    110,001BENEFITS AND EXPENSESDeath Benefits
    
    
    5,096
    
    
    
    4,456
    
    
    
    13,479
    
    
    
    11,058Interest on Annuity Deposits
    
    
    11,076
    
    
    
    10,957
    
    
    
    33,121
    
    
    
    31,496Interest on Universal Life Deposits
    
    
    1,775
    
    
    
    1,658
    
    
    
    5,262
    
    
    
    5,263Surrender and Other Benefits
    
    
    306
    
    
    
    236
    
    
    
    921
    
    
    
    960Increase in Future Life Policy Benefits
    
    
    1,982
    
    
    
    1,858
    
    
    
    6,014
    
    
    
    5,155Amortization of Deferred Policy Acquisition Costs
    
    
    1,942
    
    
    
    1,861
    
    
    
    (1,423
    )
    
    
    5,770Commissions
    
    
    15
    
    
    
    287
    
    
    
    1,601
    
    
    
    2,771General Expenses
    
    
    4,171
    
    
    
    2,273
    
    
    
    12,146
    
    
    
    10,610Taxes, Licenses and Fees
    
    
    798
    
    
    
    693
    
    
    
    2,655
    
    
    
    2,077Total Benefits and Expenses
    
    
    27,161
    
    
    
    24,279
    
    
    
    73,776
    
    
    
    75,160Income Before Income Taxes
    
    
    7,617
    
    
    
    14,817
    
    
    
    37,940
    
    
    
    34,841Provision for Federal Income Tax (Benefit):Current
    
    
    2,957
    
    
    
    3,207
    
    
    
    9,106
    
    
    
    11,126Deferred
    
    
    (339
    )
    
    
    1,933
    
    
    
    4,073
    
    
    
    962Total Provision for Federal Income Tax
    
    
    2,618
    
    
    
    5,140
    
    
    
    13,179
    
    
    
    12,088Net Income
    
    $
    4,999
    
    
    $
    9,677
    
    
    $
    24,761
    
    
    $
    22,753Net Income Per Share
    
    $
    0.53
    
    
    $
    1.02
    
    
    $
    2.62
    
    
    $
    2.41Dividends Declared Per Share
    
    $
    0.44
    
    
    $
    0.21
    
    
    $
    0.88
    
    
    $
    0.84
 See Notes to Financial Statements. 5




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ERIE FAMILY LIFE INSURANCE COMPANY
STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) Three Months Ended
    
    Nine Months EndedSeptember 30
    
    September 302004
    
    2003
    
    2004
    
    2003(Restated)
    
    
    
    (Restated)(Dollars in thousands)Net Income
    
    $
    4,999
    
    
    $
    9,677
    
    
    $
    24,761
    
    
    $
    22,753Unrealized gains (losses) on securities:Unrealized holding gains (losses) arising
during period, net of offsets to
shadow deferred acquisition costs
    
    
    32,572
    
    
    
    (16,731
    )
    
    
    1,131
    
    
    
    37,935Less: gains included in net income
    
    
    (1,103
    )
    
    
    (4,908
    )
    
    
    (9,507
    )
    
    
    (9,170
    )Net unrealized holding gains (losses)
arising during period, net of offsets
to shadow deferred acquisition costs
    
    
    31,469
    
    
    
    (21,639
    )
    
    
    (8,376
    )
    
    
    28,765Income tax (expense) benefit related to
unrealized gains (losses)
    
    
    (11,014
    )
    
    
    7,583
    
    
    
    2,932
    
    
    
    (10,068
    )Unrealized appreciation (deprecation) of
investments, net of tax
    
    
    20,455
    
    
    
    (14,056
    )
    
    
    (5,444
    )
    
    
    18,697Comprehensive Income (Loss)
    
    $
    25,454
    
    
    $
    (4,379
    )
    
    $
    19,317
    
    
    $
    41,450
 See Notes to Financial Statements. 6




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ERIE FAMILY LIFE INSURANCE COMPANY
STATEMENTS OF CASH FLOWS (Unaudited) Nine Months Ended
    
    Nine Months EndedSeptember 30, 2004
    
    September 30, 2003(Dollars in thousands)CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:Premiums collected
    
    $
    39,359
    
    
    $
    36,584Net investment income received
    
    
    57,217
    
    
    
    54,258Other income
    
    
    759
    
    
    
    657Benefits to policyholders
    
    
    (51,818
    )
    
    
    (48,640
    )Commissions paid to agents
    
    
    (4,401
    )
    
    
    (11,551
    )Salaries and wages paid
    
    
    (9,212
    )
    
    
    (8,241
    )General operating expenses paid
    
    
    (12,164
    )
    
    
    (10,499
    )Taxes, licenses and fees paid
    
    
    (2,396
    )
    
    
    (2,190
    )Income taxes paid
    
    
    (7,982
    )
    
    
    (9,078
    )Net cash provided by operating activities
    
    
    9,362
    
    
    
    1,300CASH FLOWS USED IN INVESTING ACTIVITIES:Purchase of investments:Fixed maturities
    
    
    (198,238
    )
    
    
    (447,776
    )Equity securities
    
    
    (3,529
    )
    
    
    (10,774
    )Limited partnerships
    
    
    (963
    )
    
    
    (1,910
    )Sales/maturities of investments:Sales of fixed maturities
    
    
    139,824
    
    
    
    200,487Calls/maturities of fixed maturities
    
    
    24,773
    
    
    
    80,031Equity securities
    
    
    3,492
    
    
    
    20,468Limited partnerships
    
    
    2,864
    
    
    
    6,846(Decrease) increase in collateral from securities lending
    
    
    (32,391
    )
    
    
    28,389Net mortgage loans
    
    
    134
    
    
    
    391Net policy loans
    
    
    (497
    )
    
    
    (510
    )Net cash used in investing activities
    
    
    (64,531
    )
    
    
    (124,358
    )CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:Annuity and supplementary
contract deposits and interest
    
    
    92,615
    
    
    
    158,912Annuity and supplementary
contract surrenders and withdrawals
    
    
    (52,589
    )
    
    
    (40,330
    )Universal life deposits and interest
    
    
    14,761
    
    
    
    15,448Universal life surrenders
    
    
    (4,960
    )
    
    
    (3,836
    )Proceeds from issue of note payable
    
    
    0
    
    
    
    25,000Dividends paid to shareholders
    
    
    (6,143
    )
    
    
    (5,954
    )Net cash provided by financing activities
    
    
    43,684
    
    
    
    149,240Net (decrease) increase in cash and cash equivalents
    
    
    (11,485
    )
    
    
    26,182Cash and cash equivalents at beginning of period
    
    
    91,667
    
    
    
    97,022Cash and cash equivalents at end of period
    
    $
    80,182
    
    
    $
    123,204
 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 nine-month period ended September 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 nine months ended September 30, 2003,
and deferred policy acquisition costs and shareholders equity as of December
31, 2003 is as follows: Three Months Ended
    
    Nine Months EndedSeptember 30, 2003
    
    September 30, 2003(Dollars in thousands, except per share data)As originally reported:Net income
    
    $
    9,984
    
    
    $
    23,204Net income per share
    
    $
    1.05
    
    
    $
    2.45As restated:Net income
    
    $
    9,677
    
    
    $
    22,753Net income per share
    
    $
    1.02
    
    
    $
    2.41
 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 September 30, 2004 and December 31, 2003, marketable equity securities
consist of nonredeemable preferred stock while fixed maturities consist of
bonds, notes and redeemable preferred stock. Management classifies 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 (Loss) and Shareholders Equity. The following is a summary of available-for-sale securities: Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    EstimatedCost
    
    Gains
    
    Losses
    
    Fair ValueSeptember 30, 2004Fixed Maturities:Bonds:U.S. treasuries and
government agencies
    
    $
    65,139
    
    
    $
    1,189
    
    
    $
    18
    
    
    $
    66,310Public utilities
    
    
    151,477
    
    
    
    11,314
    
    
    
    279
    
    
    
    162,512U.S. banks, trusts
and insurance companies
    
    
    186,213
    
    
    
    10,279
    
    
    
    523
    
    
    
    195,969U.S. industrial and miscellaneous
    
    
    557,922
    
    
    
    35,857
    
    
    
    1,200
    
    
    
    592,579Mortgage-backed
    
    
    152,819
    
    
    
    3,904
    
    
    
    507
    
    
    
    156,216Asset-backed
    
    
    10,945
    
    
    
    404
    
    
    
    79
    
    
    
    11,270Foreign
    
    
    142,257
    
    
    
    11,284
    
    
    
    1,251
    
    
    
    152,290Total bonds
    
    
    1,266,772
    
    
    
    74,231
    
    
    
    3,857
    
    
    
    1,337,146Redeemable preferred stock
    
    
    7,016
    
    
    
    102
    
    
    
    0
    
    
    
    7,118Total fixed maturities
    
    
    1,273,788
    
    
    
    74,333
    
    
    
    3,857
    
    
    
    1,344,264Equity Securities:Nonredeemable preferred stock:Public utilities
    
    
    1,864
    
    
    
    102
    
    
    
    0
    
    
    
    1,966U.S. banks, trusts
and insurance companies
    
    
    16,909
    
    
    
    1,916
    
    
    
    0
    
    
    
    18,825U.S. industrial and miscellaneous
    
    
    17,119
    
    
    
    1,865
    
    
    
    17
    
    
    
    18,967Foreign
    
    
    20,716
    
    
    
    2,702
    
    
    
    0
    
    
    
    23,418Total equity securities
    
    
    56,608
    
    
    
    6,585
    
    
    
    17
    
    
    
    63,176Total fixed maturities and equity
securities
    
    $
    1,330,396
    
    
    $
    80,918
    
    
    $
    3,874
    
    
    $
    1,407,440
 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. 10




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ERIE FAMILY LIFE INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Continued) NOTE D  INVESTMENTS (Continued) The components of net realized gains on investments as reported in the
Statements of Operations are included below. Three Months Ended
    
    Nine Months EndedSeptember 30
    
    September 302004
    
    2003
    
    2004
    
    2003Fixed maturities:Gross realized gains
    
    $
    1,186
    
    
    $
    6,224
    
    
    $
    9,860
    
    
    $
    15,294Gross realized losses
    
    
    (45
    )
    
    
    (1,140
    )
    
    
    (358
    )
    
    
    (5,999
    )Net realized gains
    
    
    1,141
    
    
    
    5,084
    
    
    
    9,502
    
    
    
    9,295Equity securities:Gross realized gains
    
    
    5
    
    
    
    106
    
    
    
    102
    
    
    
    330Gross realized losses
    
    
    (43
    )
    
    
    (282
    )
    
    
    (97
    )
    
    
    (455
    )Net realized (losses) gains
    
    
    (38
    )
    
    
    (176
    )
    
    
    5
    
    
    
    (125
    )Net realized gains on investments
    
    $
    1,103
    
    
    $
    4,908
    
    
    $
    9,507
    
    
    $
    9,170
 The gross unrealized losses at September 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
    
    $
    (2,495
    )
    
    $
    156,449
    
    
    $
    153,954
    
    
    
    54Six to 12 months
    
    
    (375
    )
    
    
    8,803
    
    
    
    8,428
    
    
    
    312 to 18 months
    
    
    (984
    )
    
    
    32,177
    
    
    
    31,193
    
    
    
    15Greater than 18 months
    
    
    (20
    )
    
    
    4,158
    
    
    
    4,138
    
    
    
    2$
    (3,874
    )
    
    $
    201,587
    
    
    $
    197,713
    
    
    
    74
 No investments in an unrealized loss position at September 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 recorded, depending on evolving accounting
guidance in this area. 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 September 30,
2004 and 2003, related to this program totaled $18 and $28, respectively. For
the nine months ended September 30, 2004 and 2003, revenue received related to
this program totaled $72 and $76, respectively. 11




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##### Table of Contents



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 $32,170 and $64,082
and secured collateral of $33,104 and $65,495 at September 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 September 30, 2004 include U.S. and foreign real estate
and mezzanine debt investments. Real estate limited partnerships represent
91.9%, while mezzanine debt limited partnerships represent 8.1%, of the total
carrying value at September 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
    
    Nine Months EndedSeptember 30
    
    September 302004
    
    2003
    
    2004
    
    2003Mezzanine Debt
    
    $
    43
    
    
    $
    53
    
    
    $
    77
    
    
    $
    52Real Estate
    
    
    160
    
    
    
    1,341
    
    
    
    993
    
    
    
    1,742$
    203
    
    
    $
    1,394
    
    
    $
    1,070
    
    
    $
    1,794
 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. 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 &
    
    CorporateSeptember 30, 2004
    
    Life
    
    Life
    
    Annuities
    
    Other
    
    Account
    
    TotalTotal policy revenue, net of
reinsurance
    
    $
    9,983
    
    
    $
    3,475
    
    
    $
    0
    
    
    $
    819
    
    
    $
    0
    
    
    $
    14,277Total investment-related
and other income
    
    
    1,737
    
    
    
    2,294
    
    
    
    14,082
    
    
    
    48
    
    
    
    2,340
    
    
    
    20,501Total revenues
    
    
    11,720
    
    
    
    5,769
    
    
    
    14,082
    
    
    
    867
    
    
    
    2,340
    
    
    
    34,778Less: Total benefits and
expenses
    
    
    10,122
    
    
    
    3,768
    
    
    
    12,250
    
    
    
    1,021
    
    
    
    0
    
    
    
    27,161Income (loss) before taxes
    
    $
    1,598
    
    
    $
    2,001
    
    
    $
    1,832
    
    
    $
    (154
    )
    
    $
    2,340
    
    
    $
    7,617Nine Months EndedSeptember 30, 2004Total policy revenue, net of
reinsurance
    
    $
    29,940
    
    
    $
    10,419
    
    
    $
    1
    
    
    $
    2,521
    
    
    $
    0
    
    
    $
    42,881Total investment-related
and other income
    
    
    5,756
    
    
    
    7,617
    
    
    
    46,981
    
    
    
    158
    
    
    
    8,323
    
    
    
    68,835Total revenues
    
    
    35,696
    
    
    
    18,036
    
    
    
    46,982
    
    
    
    2,679
    
    
    
    8,323
    
    
    
    111,716Less: Total benefits and
expenses
    
    
    29,989
    
    
    
    4,770
    
    
    
    37,056
    
    
    
    1,961
    
    
    
    0
    
    
    
    73,776Income before taxes
    
    $
    5,707
    
    
    $
    13,266
    
    
    $
    9,926
    
    
    $
    718
    
    
    $
    8,323
    
    
    $
    37,940
 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 in 2004, DAC was increased and the
amortization of DAC was decreased by $5.2 million and $0.7 million for
universal life and fixed annuities, 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 &
    
    CorporateSeptember 30, 2003
    
    Life
    
    Life
    
    Annuities
    
    Other
    
    Account
    
    Total(Restated)Total policy revenue, net of
reinsurance
    
    $
    9,414
    
    
    $
    3,343
    
    
    $
    3
    
    
    $
    838
    
    
    $
    0
    
    
    $
    13,598Total investment-related
and other income
    
    
    2,068
    
    
    
    2,711
    
    
    
    16,539
    
    
    
    42
    
    
    
    4,138
    
    
    
    25,498Total revenues
    
    
    11,482
    
    
    
    6,054
    
    
    
    16,542
    
    
    
    880
    
    
    
    4,138
    
    
    
    39,096Less: Total benefits and
expenses
    
    
    7,942
    
    
    
    2,788
    
    
    
    12,504
    
    
    
    1,045
    
    
    
    0
    
    
    
    24,279Income (loss) before taxes
    
    $
    3,540
    
    
    $
    3,266
    
    
    $
    4,038
    
    
    $
    (165
    )
    
    $
    4,138
    
    
    $
    14,817Nine Months EndedSeptember 30, 2003(Restated)Total policy revenue, net of
reinsurance
    
    $
    28,566
    
    
    $
    9,962
    
    
    $
    5
    
    
    $
    2,487
    
    
    $
    0
    
    
    $
    41,020Total investment-related
and other income
    
    
    5,938
    
    
    
    7,638
    
    
    
    47,278
    
    
    
    126
    
    
    
    8,001
    
    
    
    68,981Total revenues
    
    
    34,504
    
    
    
    17,600
    
    
    
    47,283
    
    
    
    2,613
    
    
    
    8,001
    
    
    
    110,001Less: Total benefits and
expenses
    
    
    25,009
    
    
    
    11,008
    
    
    
    36,938
    
    
    
    2,205
    
    
    
    0
    
    
    
    75,160Income before taxes
    
    $
    9,495
    
    
    $
    6,592
    
    
    $
    10,345
    
    
    $
    408
    
    
    $
    8,001
    
    
    $
    34,841
 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 September 30, 2004
and 2003, $11.2 billion and $8.7 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 September 30, 2004,
the amount of in-force life insurance ceded to Generali totaled approximately
$6.3 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
    
    Nine Months EndedSeptember 30
    
    September 302004
    
    2003
    
    2004
    
    2003(Restated)
    
    
    
    (Restated)Revenues:Direct policy revenue
    
    $
    19,498
    
    
    $
    17,589
    
    
    $
    57,172
    
    
    $
    52,416Policy revenue ceded
    
    
    (5,221
    )
    
    
    (3,991
    )
    
    
    (14,291
    )
    
    
    (11,396
    )Net policy revenue
    
    
    14,277
    
    
    
    13,598
    
    
    
    42,881
    
    
    
    41,020Net investment income
    
    
    18,992
    
    
    
    18,932
    
    
    
    57,499
    
    
    
    57,358Net realized gains
on investments
    
    
    1,103
    
    
    
    4,908
    
    
    
    9,507
    
    
    
    9,170Equity in earnings of limited
partnerships
    
    
    203
    
    
    
    1,394
    
    
    
    1,070
    
    
    
    1,794Other income
    
    
    203
    
    
    
    264
    
    
    
    759
    
    
    
    659Total revenues
    
    $
    34,778
    
    
    $
    39,096
    
    
    $
    111,716
    
    
    $
    110,001Benefits and expenses:Death benefits
    
    $
    6,790
    
    
    $
    5,419
    
    
    $
    17,836
    
    
    $
    14,137Reinsurance recoveries
    
    
    (1,694
    )
    
    
    (963
    )
    
    
    (4,357
    )
    
    
    (3,079
    )Net death benefits
    
    
    5,096
    
    
    
    4,456
    
    
    
    13,479
    
    
    
    11,058Interest on deposits and
other policyholder benefits
    
    
    13,157
    
    
    
    12,851
    
    
    
    39,304
    
    
    
    37,719Increases in future life policy
benefits
    
    
    3,941
    
    
    
    3,365
    
    
    
    11,406
    
    
    
    9,659Reinsurance reserve credits
    
    
    (1,959
    )
    
    
    (1,507
    )
    
    
    (5,392
    )
    
    
    (4,504
    )Net increases in future life
policy benefits
    
    
    1,982
    
    
    
    1,858
    
    
    
    6,014
    
    
    
    5,155Amortization of deferred policy
acquisition costs
    
    
    1,942
    
    
    
    1,861
    
    
    
    (1,423
    )
    
    
    5,770Commissions
    
    
    2,126
    
    
    
    2,153
    
    
    
    7,234
    
    
    
    7,875Reinsurance commission allowance
    
    
    (2,111
    )
    
    
    (1,866
    )
    
    
    (5,633
    )
    
    
    (5,104
    )Net commissions
    
    
    15
    
    
    
    287
    
    
    
    1,601
    
    
    
    2,771General expenses, taxes,
licenses and fees
    
    
    4,969
    
    
    
    2,966
    
    
    
    14,801
    
    
    
    12,687Total benefits and expenses
    
    $
    27,161
    
    
    $
    24,279
    
    
    $
    73,776
    
    
    $
    75,160Income before income taxes
    
    $
    7,617
    
    
    $
    14,817
    
    
    $
    37,940
    
    
    $
    34,841
 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 by 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 third 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 by 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 and $0.2 million on this note during the third quarter of 2004 and
2003, respectively. NOTE I  SUPPLEMENTARY DATA ON CASH FLOWS A reconciliation of net income to net cash provided by operating activities as
presented in the Statements of Cash Flows is as follows: Nine Months Ended
    
    Nine Months EndedSeptember 30, 2004
    
    September 30, 2003(Restated)CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:Net income
    
    $
    24,761
    
    
    $
    22,753Adjustments to reconcile net income to net cash
provided by operating activities:Amortization of deferred policy acquisition costs
    
    
    (1,423
    )
    
    
    5,770Other amortization
    
    
    764
    
    
    
    535Deferred federal income tax expense
    
    
    4,073
    
    
    
    962Realized gains on investments
    
    
    (9,507
    )
    
    
    (9,170
    )Equity in earnings of limited partnerships
    
    
    (1,070
    )
    
    
    (1,794
    )(Increase) decrease in premium and other receivables
    
    
    (3
    )
    
    
    777Increase in accrued investment income
    
    
    (3,532
    )
    
    
    (5,053
    )Policy acquisition costs deferred
    
    
    (10,960
    )
    
    
    (14,607
    )Increase in other assets
    
    
    (101
    )
    
    
    0Increase in reinsurance recoverables and reserve credits
    
    
    (3,682
    )
    
    
    (3,501
    )Decrease in prepaid federal income taxes
    
    
    1,124
    
    
    
    2,047Increase in future policy benefits and claims
    
    
    11,514
    
    
    
    9,571Decrease in other policyholder funds
    
    
    (2,896
    )
    
    
    (4,382
    )Decrease in reinsurance premium due
    
    
    (612
    )
    
    
    (796
    )Increase (decrease) in accounts payable and due to affiliates
    
    
    912
    
    
    
    (1,812
    )Net cash provided by operating activities
    
    $
    9,362
    
    
    $
    1,300
 NOTE J  COMMITMENTS The Company has outstanding commitments to invest up to $3.6 million in real
estate limited partnerships at September 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 restated its
financial statements for periods prior to thee second quarter 2004. FINANCIAL OVERVIEW Net income decreased to $5.0 million, or $0.53 per share, in the third quarter
of 2004, compared to $9.7 million, or $1.02 per share, for the third quarter of
2003. This decrease was partially the result of a decrease in net realized
capital gains to $1.1 million in the third quarter of 2004 from net realized
capital gains of $4.9 million recorded during the same period in 2003. For the
nine months ended September 30, 2004, net income increased to $24.8 million, or
$2.62 per share, compared to $22.8 million, or $2.41 per share for the same
period in 2003. The increase in year to date net income resulted from increased
net policy revenue and the unlocking of DAC which was partially offset by
increases in life insurance benefits, interest on annuity deposits and general
operating expenses. REVENUES Analysis of Policy Revenue Total net policy revenue increased 5.0%, to $14.3 million in the third quarter
of 2004 from $13.6 million during the same period in 2003. Although total net
premiums are up in 2004, sales of new traditional policies declined in the
third quarter of 2004 when compared to the same period in 2003. Direct new
premiums on traditional life insurance policies decreased 4.5% to $2.5 million
for the quarter ended September 30, 2004, from $2.6 million for the quarter
ended September 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 more heavily on underwriting profitability,
new property and casualty production and traditional life policy production
have declined. Total net policy revenue increased $1.9 million, or 4.5%, to
$42.9 million for the nine months ended September 30, 2004. Analysis of Investment-related Income Net investment income increased $0.1 million to $19.0 million in the third
quarter of 2004 when compared to the same period in 2003. The slight increase
in net investment income for the third quarter of 2004 compared to the same
period in 2003 is due in part to a moderate increase in the size of the
investment portfolio and relatively unchanged yields. Net realized capital gains on investments were $1.1 million in the third
quarter of 2004, compared to net realized capital gains of $4.9 million in the
third quarter of 2003. This $3.8 million decrease is due to gains generated on
the sale of fixed income securities in the third quarter of 2003 in light of
favorable market conditions. Equity in earnings of limited partnerships was $0.2 million in the third
quarter of 2004 compared to $1.4 million in the third quarter of 2003. This
decrease is due to gains of $1.0 million in the third quarter of 2003 which
were the result of the liquidation of a real estate limited partnership. 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 endedSeptember 30, 2004(Pre-tax annualized returns) (1)Erie Family Life Insurance Company indices:Fixed maturities
    
    
    8.09
    %Preferred stock
    
    
    10.96Other indices:Lehman Brothers U.S. Aggregate
    
    
    4.54
    %
 (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 14.4% in the third
quarter of 2004 to $5.1 million. For the nine months ended September 30, 2004,
net death benefits on life insurance policies increased $2.4 million, or 21.9%,
to $13.5 million, from $11.1 million during the same period in 2003. As the
Companys life insurance inforce continues to grow, death benefits can be
expected to increase. Net life insurance inforce has grown from $16.5 billion
at September 30, 2003 to $17.1 billion at September 30, 2004, an increase of
3.8%. Interest expense incurred on deposits increased 1.9%, to $12.9 million in the
third quarter of 2004 from $12.6 million in the third quarter of 2003. For the
nine months ended September 30, 2004, interest expense incurred on deposits
increased 4.4%, to $38.4 million, from $36.8 million for the same period in
2003. This increase can be attributed to the growth of annuities on deposit
partially offset by lower crediting rates. At September 30, 2004, the balance
of annuity deposits totaled $972.5 million, compared to $922.3 million at
September 30, 2003, an increase of 5.4%. 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  July 31, 2004
    
    
    3.00     - 4.70
    
    
    
    4.25     - 5.00August 1, 2004  September 30, 2004
    
    
    3.50     - 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 increased 4.3% to $1.9
million in the third quarter of 2004 when compared to the same period in 2003.
For the nine months ended September 30, 2004, negative amortization of DAC was
$1.4 million compared to amortization of $5.8 million for the comparable 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
unlocked certain assumptions concerning lapse, mortality, interest rates,
surrender rates and other factors on its interest sensitive products. As a
result of unlocking these assumptions, the DAC asset was increased and the
amortization of DAC was decreased by $5.9 million in the second quarter of 2004
and $1.7 million in 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 renewal commissions qualify for
deferral as DAC. For the third quarter of 2004, the commission expense totaled
less than $0.1 million, compared to $0.3 million for the third quarter of 2003.
During the third quarter of 2004 an adjustment of $0.3 was made to adjust the
over accrual of bonuses incurred during the second quarter of 2004. For the
nine months ended September 30, 2004, commission expense decreased $1.2 million
to $1.6 million. This decrease is primarily attributable to the decline in
annuity sales. This decrease in annuity sales is also reflected in the
Statements of Cash Flows, where commissions paid to agents decreased $7.2
million in 2004 when compared to 2003. Annuity premiums for the period ended
September 30, 2004 were $41.4 million, compared to $107.8 million for the same
period in 2003. Commissions and bonuses on these premiums, net of DAC, were
$0.6 million and $2.1 million for the periods ended September 30, 2004 and
2003, respectively. General expenses, net of DAC, increased $1.9 million, to $4.2 million for the
third quarter of 2004, compared to $2.3 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 internal accounting controls,
increases in information technology costs and costs associated with the
implementation of a new traditional life product valuation system.
Additionally, fewer general expenses were capitalized as DAC in the third
quarter 2004. Approximately $1.2 million less in general expenses were
capitalized in the third quarter 2004 compared to the third quarter 2003 as a
result of the continued refinements of DAC accounting processes. 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 September 30, 2004, the Companys investment portfolio
consisting of cash, investment grade bonds and investment grade preferred
stock, totaled more than $1.4 billion, or 83.4% 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 changed, 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 nine months ended September 30, 2004 was $9.4 million. The Companys
liquidity position remains strong as investments and cash and cash equivalents
increased by $52.1 million during the first nine 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 $18.4 million in the
third quarter of 2004 and $26.6 million in the third 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 September 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 September 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 The Companys annuity and universal life contracts contain provisions that
guarantee interest rates will not decrease below certain levels. If the
interest rates on fixed income securities decline further, the interest earned
on the Companys investments portfolio 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
    %
    
    $
    258.76-10
    
    
    4.5
    
    
    
    4.0
    
    
    
    113.6Over 10
    
    
    4.5
    
    
    
    3.5
    
    
    
    177.1All Years
    
    
    3.0
    
    
    
    3.0
    
    
    
    32.4All Years
    
    
    1.5
    
    
    
    1.5
    
    
    
    27.1
 The Company has some ability to restrict new deposits on its universal life and
annuity 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 September 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 23,961 FPDA contracts in force, of which 19,979
have guarantees in excess of 3.0%. No additional payments are
permitted on single premium deferred annuity contracts. During the third quarter of 2004, the average rate credited on flexible premium
deferred annuity and universal life account values was 4.2% and 4.6%,
respectively. The current coupon yield on fixed maturities matched against
universal life and annuity products at September 30, 2004, is 5.9%. 23




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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. The Companys rating
from A.M. Best is A (Excellent). The A (Excellent) rating continues
to affirm the Companys strong financial position indicating that
the Company has an excellent ability to meet its ongoing obligations
to policyholders. The Company is also rated by Standard &
Poors, but this rating is based solely on public information.
Standard & Poors rates the Companys Api,
strong. The Company also has a rating of B (Good) from
Weiss Ratings, Inc. According to Weiss Ratings, the B rating
indicates that the Company offers good financial security and has the
resources necessary to deal with a variety of adverse conditions. 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. As of September 30, 2004, the Company had deployed ErieConnection, the
insurance application and policy processing system being developed in the
eCommerce program, to approximately 48 agencies in Ohio, Illinois, Indiana and
Wisconsin and a total of about 1,000 Erie employees in the home and branch
office locations. The system has generally not met Company or agency
expectations for functionality or performance. Management is taking action to
enhance ErieConnection, to correct deficiencies and improve usability and will
not continue deployment beyond the current installed base until such remedial
actions are suitably completed. The cost and timing of such actions are not
determinable at this time. In addition to the cost impact of eCommerce, the implementation of this 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, new business sales may decline over the
short term. The amount of lost sales will correlate to the timing and duration
of the rollout effort as well as the number and types of issues encountered.
Measurement of this impact on sales can not yet be estimated. Reinsurance During the third quarter of 2004 the Company was notified by one of its
reinsurers that it intends to significantly reduce the expense allowance
provided to the Company to cover costs associated with underwriting the
Companys Target Term policies ceded to the reinsurer. This change could have a 24




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF FINANCIAL OPERATIONS (Continued) significant impact on the profitability of the ceded products if the Company
continues to cede new policies to this reinsurer. The change applies to new
business only and is scheduled to be effective January 1, 2005. The Company
expects to be able to place new business on Target Term policies normally ceded to this
reinsurer with another reinsurer offering contract terms and conditions similar
to its current contract. 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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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. 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 and has effected certain improvements to its DAC accounting procedures. 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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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 The Company did not file any reports on Form 8-K during the three-month period
ended September 30, 2004. 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: October 27, 2004
    
    /s/ Jeffrey A. Ludrof(Jeffrey A. Ludrof, President & CEO)/s/ Philip A. Garcia(Philip A. Garcia, Executive Vice President & CFO)
 29