##### 



Exhibit 13

Selected Financial Data

Years ended December 31
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999(amounts in thousands, except per share data)Operating dataTotal net policy revenue
    
    $
    55,932
    
    
    $
    51,129
    
    
    $
    46,491
    
    
    $
    44,537
    
    
    $
    41,686Net investment and other income
    
    
    79,106
    
    
    
    70,765
    
    
    
    62,669
    
    
    
    63,876
    
    
    
    56,905Net realized gains (losses) on investments
    
    
    13,176
    
    
    
    (9,610
    )
    
    
    (19,646
    )
    
    
    6,960
    
    
    
    4,333Total revenues
    
    
    148,214
    
    
    
    112,284
    
    
    
    89,514
    
    
    
    115,373
    
    
    
    102,924Total benefits and expenses
    
    
    98,050
    
    
    
    98,747
    
    
    
    85,327
    
    
    
    76,550
    
    
    
    67,998Income before income taxes
    
    
    50,164
    
    
    
    13,537
    
    
    
    4,187
    
    
    
    38,823
    
    
    
    34,926Provision for federal income taxes
    
    
    15,818
    
    
    
    4,697
    
    
    
    1,449
    
    
    
    13,433
    
    
    
    11,601Net income
    
    $
    34,346
    
    
    $
    8,840
    
    
    $
    2,738
    
    
    $
    25,390
    
    
    $
    23,325Net income per share
    
    $
    3.63
    
    
    $
    0.94
    
    
    $
    0.29
    
    
    $
    2.69
    
    
    $
    2.47Financial positionTotal assets
    
    $
    1,635,230
    
    
    $
    1,389,619
    
    
    $
    1,169,442
    
    
    $
    1,020,343
    
    
    $
    954,532Notes payable to affiliate
    
    
    40,000
    
    
    
    15,000
    
    
    
    15,000
    
    
    
    15,000
    
    
    
    15,000Shareholders equity
    
    
    259,247
    
    
    
    224,447
    
    
    
    205,759
    
    
    
    195,720
    
    
    
    171,103Book value per share
    
    
    27.43
    
    
    
    23.75
    
    
    
    21.77
    
    
    
    20.71
    
    
    
    18.11Dividends declared per share
    
    
    0.84
    
    
    
    0.84
    
    
    
    0.78
    
    
    
    0.72
    
    
    
    0.66Average number of shares outstanding
    
    
    9,450
    
    
    
    9,450
    
    
    
    9,450
    
    
    
    9,450
    
    
    
    9,450


49



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##### 



Managements Discussion and Analysis of Financial Condition and Results of Operations



The following discussion and analysis should be read in conjunction with the
financial statements and related notes found on pages 34-53, as they contain
important information that is helpful in evaluating the Companys operating
results and
financial condition. Overview General Erie Family Life Insurance Company (the Company) is a Pennsylvania life
insurance company formed in 1967. The Company operates as one reportable life
insurance segment, offering a range of products and services. These products
include nonparticipating individual and group life insurance policies,
including fixed universal life. The Company also sells fixed individual and
group annuities and disability income policies. The Company markets its
products through independent agents throughout 10 states and the District of
Columbia. The Company is owned 21.6% by Erie Indemnity Company (EIC), 53.5% by
Erie Insurance Exchange (Exchange) and the remaining 24.9% by public
shareholders. The Company, EIC and the Exchange and its subsidiaries and
affiliates operate collectively under the name Erie Insurance Group. Revenues and expenses The Company earns premiums principally from the sale of individual life, group
life and disability income insurance products. The Company also generates a
significant amount of investment income from investing premiums and deposits
received on fixed annuity contracts. Operating expenses principally consist of
insurance benefits provided, interest credited on annuity and universal life
deposits, general business expenses, premium taxes and commissions and other
costs of selling and servicing the various products the Company sells. Financial stability The
Companys profitability depends principally on the ability to price and
manage risk on insurance products, the ability to attract and retain deposit
funds and the ability to manage expenses. Specific, drivers of the Companys
profitability include:  
    
    Developing and distributing competitive products;  
    
    Pricing insurance products at a competitive level while enabling the Company
to earn a margin over the cost of providing benefits;



    
    Controlling expenses of acquiring policyholders and administering insurance
products;  
    
    Mortality and morbidity experience on individual and group life insurance,
annuity and disability income products;  
    
    Persistency experience, which affects the recovery of the costs of acquiring
new business over the lives of the contracts;  
    
    Returns on investments, including maintaining interest rate spreads over the
amounts credited to deposit funds. In addition, external factors such as regulation, competition, interest rates,
taxes, securities market conditions and general economic conditions affect
profitability. Market Outlook According to the Life Insurance Marketing and Research Association, the 2004
growth in new premium for the industry is expected to be approximately 2%.
These reports also indicate that pricing in the primary life and life
reinsurance markets is holding firm or starting to climb, and underwriting
standards for the most part appear to be holding constant. In addition to these factors, the Companys production in 2004 will be affected
by our multi-line agents focus on property/casualty insurance underwriting
profitability and the absence of a companywide incentive program. Also,
beginning in 2004, ERIE will be rolling out the ERIEConnection® system to its
agents. This system will require a significant amount of time for agents to
become proficient in its use. The rollout of ERIEConnection® may have a
short-term impact on production. A rebounding stock market is also causing
equity products to have increased appeal when compared to fixed-rate annuity
products sold by the Company. Significant Transactions with Related Parties The Company, EIC and the Exchange share common facilities and services. The
costs of such common services are allocated to the Company based upon the
Companys usage. Additionally, EIC is the common paymaster for the Erie
Insurance Group. The Company reimburses EIC for operating expenses, including
salary and benefit costs. Operating expenses of the Company paid by EIC are
reimbursed on a monthly basis. The amount of these reimbursements totaled $26.1
million, $23.8 million and $18.5 million for 2003, 2002 and 2001, respectively.
No interest is charged or received on intercompany balances due to the timely
settlement terms and nature of the items.




50



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##### 





Employees performing services for the Company participate in the pension and
other employee benefit plans sponsored by EIC. Pension benefits are based on
years of service and salary. Pension costs are funded by EIC in amounts
sufficient to at least meet ERISA minimum funding requirements. The Company
reimburses EIC on a monthly basis for its share of pension costs. The Company,
through EIC, also participates in certain deferred compensation and
supplemental pension plans for certain executive and senior officers. The
amounts recorded by the Company for the deferred compensation and supplemental
pension plan are reimbursed to EIC as payments are made under these plans.
Amounts allocated to the Company from EIC for these pension and other employee
benefit plans, and included in the total reimbursements noted in the above
paragraph, totaled $1.2 million, $0.8 million and $0.5 million for 2003, 2002
and 2001, respectively. The Erie Insurance Group affiliated property/casualty insurance companies
periodically purchase annuities from the Company in connection with the
structured settlement of claims. The reserves held for structured settlement
annuities sold to the affiliated property/casualty insurance companies totaled
$201.9 million and $186.2 million at December 31, 2003 and 2002, respectively. The Erie Insurance Group Retirement Plan for employees purchases from the
Company individual annuities for some terminated vested employees or
beneficiaries receiving benefits. These are nonparticipating annuity contracts
under which the Company has unconditionally contracted to provide specified
benefits to beneficiaries in return for a fixed premium from the plan. Annuity
deposit balances outstanding relating to pension annuities sold to the Erie
Insurance Group Retirement Plan are $45.0 million and $47.3 million at December
31, 2003 and 2002, respectively. The Erie Insurance Group 401(k) plan for employees includes an investment
option in a Company group annuity. Annuity deposit balances outstanding
relating to 401(k) contributions from employees are $28.0 million and $25.1
million at December 31, 2003 and 2002, respectively. The Company has a $15.0 million surplus note payable to 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 approval of the Pennsylvania Insurance
Commissioner. The note will be payable on demand on or after December 31, 2005,
subject to approval by the Pennsylvania Insurance Commissioner. During 2003,
2002 and 2001, the Company paid interest to EIC totaling $1.0 million in each
year.


During the third quarter of 2003, the Company issued an additional $25.0
million surplus note to EIC in exchange for $25.0 million in cash. This surplus
note bears an annual interest rate of 6.70% and is scheduled to be paid
semi-annually, subject to approval of the Pennsylvania Insurance Commissioner.
The surplus note will be payable on demand on or after December 31, 2018,
subject to approval by the Pennsylvania Insurance Commissioner. The Company
paid interest totaling $0.6 million on this note in 2003. Critical Accounting Estimates The Company makes estimates and assumptions that can have a significant affect
on amounts and disclosures reported in the financial statements. The most
significant estimates relate to valuation of investments, policy acquisition
costs, reserves for policy liabilities and guaranty fund liability accruals.
While management believes its estimates are appropriate, the ultimate amounts
may differ from the estimates provided. The methods for making these estimates
are continually reviewed and any adjustments considered necessary are reflected
in current earnings. Investment valuation Management makes estimates concerning the valuation of all investments and the
timely recognition of other-than-temporary declines in value of these
investments. When the decline in value of an investment is considered by
management to be other-than-temporary, the investment is written down to its
market value. For all investments except limited partnerships, the impairment
charge is included as a realized loss on investments in the Statements of
Operations. For limited partnerships, the impairment charge is included as a
component of equity in earnings of limited partnerships. All investments are
individually monitored for other-than-temporary declines in value. Generally,
if an individual security has in managements opinion depreciated significantly
in value and has been in such unrealized loss
position for a significant period of time, management presumes there has been
an other-than-temporary decline in value. In making valuation judgements,
management considers the significance of the amount and timeframe when fair
value is below cost; financial condition of the issuer; a significant drop in
ratings by Standard & Poors or Moodys; specific events that occurred
affecting an investment; and specific industry or geographic events. Deferred policy acquisition cost (DAC) 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. At each balance sheet
date, the Company evaluates the historical and expected future gross premiums
and profits on its insurance and annuity products.




51



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##### 





The DAC on traditional life insurance products is amortized in relation to
gross premiums. Assumptions used for a specific year are locked-in;
therefore, amortization in subsequent years is not adjusted for changing
assumptions. Changes in estimated expected future gross profit on the annuity and universal
life products requires that the DAC amortization rate be revised retroactively
to the date of policy issuance. The cumulative difference related to prior
periods is recognized as a component of the current periods DAC amortization,
along with DAC amortization associated with the actual gross profits of the
current period. Lower actual gross profits in a period would typically result
in less DAC amortization expense in that period. The converse would also be
true. However, if lower gross profits were to continue into the future,
additional amortization of the existing DAC asset may occur. The Company periodically reviews the DAC asset to determine if it continues to
be recoverable 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 amount of DAC considered realizable would be reduced in
the near term if the estimate of ultimate or future gross premiums or profits
is reduced. The amount of DAC amortization would be revised if any of the
estimates discussed above are revised. Insurance liabilities Significant assumptions underlying estimates of reserves for policy liabilities
include a variety of factors such as anticipated mortality, morbidity,
withdrawals, lapses and investment yields. Liabilities for life insurance and
income-paying annuity future policy benefits are computed primarily by the
net level premium method. Disability income reserves are calculated as two-year
preliminary term mid-terminal reserves plus unearned premium reserves plus
claim reserves. Deferred annuity future policy benefit liabilities are
established at accumulated values without reduction for surrender charges.
Reserves for universal life and investment contracts are based on the contract
account balance, if future benefit payments in excess of the account balance
are not guaranteed, or the present value of future benefit payments when such
payments are guaranteed. Variations are inherent in such calculations due to
the estimates and assumptions necessary in the calculations.


Results of Operations Financial overview Net income increased to $34.3 million, or $3.63 per share, in 2003, from $8.8
million, or $0.94 per share, in 2002. Strong investment gains, improved spreads
on interest-sensitive products and solid premium growth contributed to the
financial results of 2003. Revenues Analysis of policy revenue Total net policy revenue increased by $4.8 million, or 9.4%, to $55.9 million
in 2003. Total policies in force grew 7.7% to 290,290 at December 31, 2003,
from 269,632 at December 31, 2002. Net premiums collected on traditional life
insurance policies increased $3.0 million, or 8.5%, to $37.8 million in 2003,
from $34.8 million in 2002. Renewal premiums collected increased 9.9% and
contributed $2.9 million to the growth in 2003. The Companys ERIE Flagship
Termssm2 and ERIE Target Termsm products, introduced in late 2001, continued
to achieve exceptional growth by Company standards in 2003. Policies in force
on traditional products increased 7.5% to 201,492 in 2003, from 187,449 in
2002. Life insurance in force continues to grow, totaling $27.1 billion at
December 31, 2003, an increase of $3.9 billion, or 16.7%, over 2002. Life
insurance in force after consideration of reinsurance ceded increased 7.0% to
$17.3 billion at December 31, 2003. The Companys new generation of products are heavily reinsured, which allows
the Company to price the products more competitively and reduces underwriting
volatility. Under the reinsurance treaty for the ERIE Target Termsm product,
the reinsurer assumes 90% of mortality risk up to $3.0 million (the Companys
retention limit is $300,000) and assumes all mortality risk above that amount.
The reinsurance treaty for the ERIE Flagship Termsm2 product provides that the
reinsurer assumes 50% of mortality risk up to $600,000 (the Companys retention
limit is $300,000) and assumes all mortality risk above that amount. Premiums on a direct and ceded basis for the years ended December 31 are
reflected below. (dollars in thousands)
    
    2003
    
    2002
    
    2001Direct premiums
    
    $
    72,947
    
    
    $
    63,426
    
    
    $
    54,549Ceded premiums
    
    
    17,015
    
    
    
    12,297
    
    
    
    8,058Net premiums
    
    $
    55,932
    
    
    $
    51,129
    
    
    $
    46,491
 The increase in ceded premiums resulted from higher sales of the ERIE Target
Termsm and ERIE Flagship Termsm2 plans. The reinsurance premiums ceded on the
Flagship and Target Term life insurance products alone amounted to $12.8
million and $8.7 million in 2003 and 2002, respectively.




52



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##### 





Universal life products generated premium, net of reinsurance, of $13.4
million, $12.2 million and $11.0 million in 2003, 2002 and 2001, respectively.
Reinsurance premiums ceded on universal life policies totaled $1.2 million,
$1.1 million and $1.1 million in 2003, 2002 and 2001, respectively. Policies in
force on universal life products increased 5.3% to 50,306 in 2003 from 47,769
in 2002. Reinsurance arrangements for universal life products did not change in
2002 or 2003. Total annuity and universal life deposits, which do not appear as revenue on
the Statements of Operations, were $157.5 million, $187.7 million and $82.0
million in 2003, 2002 and 2001, respectively. First-year and single premium
annuity deposits, excluding deposits for structured settlements and deposits
for the Erie Insurance Group Retirement Plan, decreased $39.9 million to $100.7
million in 2003, from $140.6 million in 2002. 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 slowed during the
second half of 2003 as the Company lowered its credited interest rates
and the equity market improved. For 2003, deposits through July averaged $14.3
million per month, compared to $4.1 million per month from August through
December. Analysis of investment-related income Net investment income increased $10.7 million, or 16.1%, in 2003 and $5.1
million, or 8.3%, in 2002. The increase in net investment income for both 2003
and 2002 was due to higher-invested balances in fixed maturities partially
offset by lower yields. The higher-invested balances were a direct result of
significant annuity sales in 2003 and 2002. The Company recognized net realized gains on investments of $13.2 million in
2003, and net realized losses of $9.6 million and $19.6 million in 2002 and
2001, respectively. Fewer impairments in 2003 contributed to the 2003 increase
in net realized gains. The Company recorded impairments on fixed maturity and
equity security investments of $3.4 million and $25.8 million in 2003 and 2002,
respectively. The Companys Equity in Earnings of Limited Partnerships decreased to $1.3
million in 2003, from $3.7 million in 2002. The Company recognized impairment
charges relating to mezzanine debt limited partnerships of $2.0 million and
$1.0 million in 2003 and 2002, respectively, driving the decrease in the
earnings of the limited partnerships.


Benefits and expenses Analysis of policy-related benefits and expenses Net death benefits on life insurance policies decreased slightly in 2003 to
$15.2 million, compared to $15.5 million in 2002 and $13.3 million in 2001.
These benefits are net of reinsurance recoveries of $4.7 million, $2.9 million
and $2.5 million in 2003, 2002 and 2001, respectively. As noted previously in
the Analysis of Policy Revenue section, the Companys primary term products
are substantially reinsured. Random fluctuations in death benefits incurred can
be expected when mortality results are measured over a short time period due to
the small number of claims involved. These short-term fluctuations can
influence quarterly or annual results without impacting long-term
profitability. Management believes that its underwriting philosophy and
practices are sound. Interest expense incurred on deposits increased $2.2 million, or 4.6%, in 2003
and $4.8 million, or 11.4%, in 2002. This increase can be attributed to the
growth of annuities on deposit. At December 31, 2003, the balance of annuity
deposits totaled $932.6 million, compared to $803.7 million at December 31,
2002, an increase of 16.0%. The Company has lowered its credited interest rates
in both 2003 and 2002 to reflect the current market conditions. Interest was
credited on annuity and universal life deposits in 2003 and 2002 at the
following rates: Annuity
    
    Universal lifedeposits
    
    depositsJan. 1, 2002-Feb. 19, 2002
    
    
    5.00%-6.00
    %
    
    
    6.00%-6.75
    %Feb. 20, 2002-Oct. 7, 2002
    
    
    4.75%-5.50
    %
    
    
    5.50%-6.25
    %Oct. 8, 2002-Dec. 2, 2002
    
    
    4.25%-5.00
    %
    
    
    5.25%-6.00
    %Dec. 3, 2002-Feb. 24, 2003
    
    
    4.00%-4.80
    %
    
    
    5.25%-6.00
    %Feb. 25, 2003-March 10, 2003
    
    
    3.75%-4.70
    %
    
    
    5.25%-6.00
    %March 11, 2003-May 14, 2003
    
    
    3.75%-4.70
    %
    
    
    5.00%-5.75
    %May 15, 2003-June 1, 2003
    
    
    3.50%-4.70
    %
    
    
    5.00%-5.75
    %June 2, 2003-July 9, 2003
    
    
    3.50%-4.70
    %
    
    
    4.75%-5.50
    %July 10, 2003-Dec. 31, 2003
    
    
    3.00%-4.70
    %
    
    
    4.25%-5.00
    %
 Surrender and other benefits decreased by $0.5 million to $1.3 million in 2003
and decreased by $0.5 million to $1.8 million in 2002. Surrender and other
benefits include life surrender benefits, matured endowments, disability
benefits and interest on death benefits. The decrease in surrender and other
benefits in 2003 resulted from changes in the Companys share of the
Pennsylvania Employees Group Life Insurance (PEGLI) pool. PEGLI is a voluntary
reinsurance pool that provides reinsurance coverage to primary insurers who
insure Commonwealth of Pennsylvania employees upon their retirement. The
Companys share of the PEGLI pool benefit expense was minimal in 2003, $0.6
million in 2002 and $1.0 million in 2001. The change in the Companys share of
the PEGLI pool is subject to fluctuations inherent in the underwriting of life
insurance products. Beginning July 1,




53



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##### 





2000, the Company stopped receiving new business from the PEGLI pool. Assets
recognized by the Company for its share of the PEGLI pool amounts to $2.6
million at December 31, 2003 The liability for future life policy benefits is computed considering various
factors such as anticipated mortality, future investment yields, withdrawals
and anticipated credit for reinsurance. The increase in future life policy
benefit expense increased $0.6 million, or 9.9%, in 2003 and increased $0.8
million, or 14.2%, in 2002. The required reserves increased with the success of
the newest traditional life insurance products, ERIE Target Termsm and ERIE
Flagship Termsm2, and with the increase in the Companys life insurance in
force after consideration of reinsurance ceded of 7.0% in 2003. The amortization of deferred policy acquisition costs decreased $1.9 million,
or 22.6%, in 2003 and increased $2.6 million, or 44.8%, in 2002. In 2003, the
Companys recoverability testing indicated the DAC asset is fully recoverable
at December 31, 2003. In 2002, the actual expenses on the Companys new term
plans exceeded the amount of expenses considered to be recoverable from future
gross premiums. As a result, an adjustment to increase DAC amortization of
approximately $2.0 million, or $0.14 per share after taxes, was made in the
fourth quarter of 2002, which reduced the DAC asset. Analysis of other expenses General expenses and commissions, net of DAC additions, decreased $0.6 million,
or 4.0%, to $15.7 million in 2003, compared to $16.3 million in 2002 and $13.8
million in 2001. General expenses include wages and salaries, employee
benefits, data processing expenses, occupancy expenses and other office and
general administrative expenses of the Company. General expenses of the Company
related to the acquisition and underwriting of new policies are deferred as


DAC. Commissions, medical inspection and exam fees related to new business
production and wages, salaries and employee benefits of underwriting personnel
are all deferrable. Direct commissions to independent agents include new and renewal commissions,
production bonuses and promotional incentives to agents. 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. Commission expense, net of DAC, decreased $1.1 million, or 29.6%, to $2.7
million in 2003, from $3.8 million in 2002. Part of this decrease is due to a
$0.5 million credit to commission expense for the overaccrual of sales contest
expenses. In addition, the portion of commissions on single premium deferred
annuities, not capitalized as DAC, decreased from $1.7 million in 2002 to $0.7
million in 2003 due to a decrease in single premium deferred annuity sales in
2003. 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.




Distribution of Invested Assets
Carrying Value at December 31(dollars in thousands)

2003
    
    %
    
    2002
    
    %Fixed maturities available-for-sale
    
    $
    1,280,327
    
    
    
    93.3
    
    
    $
    1,039,367
    
    
    
    91.0Preferred stock
    
    
    62,948
    
    
    
    4.6
    
    
    
    68,749
    
    
    
    6.0Limited partnerships
    
    
    12,241
    
    
    
    0.9
    
    
    
    16,053
    
    
    
    1.4Other invested assets
    
    
    17,383
    
    
    
    1.2
    
    
    
    17,901
    
    
    
    1.6Total
invested assets
    
    $
    1,372,899
    
    
    
    100.0
    
    
    $
    1,142,070
    
    
    
    100.0


54



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##### 





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. In 2003, impairment charges
on fixed maturity securities totaled $3.4 million. At December 31, 2003, the Companys investment in fixed maturities totaled $1.3
billion, or 93.3%, of total invested assets. These resources provide the
liquidity the Company requires to meet known and unforeseen demands on its
funds. Limited partnerships, real estate, policy loans and real estate mortgage
loans comprised the remaining 2.2% of total invested assets. The Companys performance of its fixed maturities and equity securities
compared to market indices is presented below. Two years endedDecember 31, 2003(Pre-tax annualized returns) (1)Fixed maturities
    
    
    9.63
    %Preferred stock
    
    
    13.53
    %Other indices:Lehman Brothers Global Aggregate
Bond Index-Unhedged
    
    
    14.50
    %(2)Lehman Brothers Global Aggregate
Bond Index-Hedged
    
    
    5.75
    %
   (1)
    
    Includes income, realized and unrealized gains and losses.(2)
    
    Unhedged global bond index returns include the effects of currency
fluctuations.


Fixed maturities The Companys fixed maturities at December 31, 2003, consist of investments in
bonds, redeemable preferred stock and notes. It is the Companys objective that
the fixed maturity portfolio be of very high quality and well-diversified
within each market sector. The Company only purchases investment-grade
securities. Non-investment-grade issues held by the Company are the result of
downgrades of securities previously rated investment grade. The portfolio is
managed with the goal of achieving reasonable returns while limiting exposure
to risk. The Companys fixed maturity investments include 97.0%, or $1.2 billion, of
high-quality, marketable bonds and redeemable preferred stock, all of which
were rated at investment-grade levels (above Ba1/BB+) at December 31, 2003. The
below-investment-grade category consists of $25.8 million of bonds rated
Ba1/BB+ and $12.1 million of bonds rated below Ba1/BB+. Generally, the
fixed-maturity securities in the Companys portfolio are rated by external
rating agencies. If not externally rated, they are rated by the Company on a
basis consistent with the basis used by the rating agencies. Management believes that having all fixed maturities classified as
available-for-sale securities will allow the Company to meet its liquidity
needs and provide greater flexibility for its investment managers to respond to
changes in market conditions or strategic direction. Securities classified as
available-for-sale are carried at market value with unrealized gains and losses
included in shareholders equity. At December 31, 2003 and 2002, net unrealized
gains on fixed maturities available-for-sale amounted to $49.9 million and
$34.6 million, respectively, net of deferred taxes. Equity securities Equity securities at December 31, 2003, consist of nonredeemable preferred
stock carried on the Statements of Financial Position at market value. At
December 31, 2003 and 2002, nonredeemable preferred stock held by the Company
had net unrealized gains of $4.1 million and $1.7 million, respectively, net of
deferred taxes. As with the fixed maturities portfolio, the Companys
nonredeemable preferred stock portfolio provides a source of highly predictable
current income. These securities are diversified within each market sector and
support the investment return provided to policyholders. The nonredeemable
preferred stock consist of $55.1 million of high quality positions rated
investment-grade level (above Ba1/BB+) at December 31, 2003. The
below-investment-grade (below Ba1/BB+) category consists of $7.9 million of
nonredeemable preferred stock investments.




55



---



##### 





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. Quantitative and Qualitative Disclosures About Market Risk The Company is exposed to potential loss from various market risks, including
changes in interest rates, credit risk and, to a lesser extent, equity prices. Interest rate risk The Companys exposure to interest rates is concentrated in the fixed
maturities portfolio. The fixed maturities portfolio comprises 93.3% and 91.0%
of invested assets at December 31, 2003 and 2002, respectively. The Company
does not hedge its exposure to interest rate risk since it has the capacity and
intention to hold the fixed maturity positions until maturity. The Company
calculates the duration and convexity of the fixed maturities portfolio each
month to measure the price sensitivity of the portfolio to interest rate
changes. Duration measures the relative sensitivity of the fair value of an
investment to changes in interest rates. Convexity measures the rate of change
of duration with respect to changes in interest rates. These factors are
analyzed monthly to ensure that both the duration and convexity remain in the
targeted ranges established by management. Principal cash flows and related weighted-average interest rates by expected
maturity dates for financial instruments sensitive to interest rates are as
follows: December 31, 2003
    
    Principal
    
    Weighted-average(dollars in thousands)
    
    cash flows
    
    interest rateFixed maturities:2004
    
    $
    22,984
    
    
    
    5.2
    %2005
    
    
    30,200
    
    
    
    5.92006
    
    
    42,089
    
    
    
    5.22007
    
    
    57,000
    
    
    
    5.52008
    
    
    57,201
    
    
    
    5.3Thereafter
    
    
    1,001,955
    
    
    
    6.3Total
    
    $
    1,211,429Market value
    
    $
    1,280,327


December 31, 2002
    
    Principal
    
    Weighted-average(dollars in thousands)
    
    cash flows
    
    interest rateFixed maturities:2003
    
    $
    38,890
    
    
    
    6.6
    %2004
    
    
    24,434
    
    
    
    6.72005
    
    
    50,201
    
    
    
    6.22006
    
    
    50,190
    
    
    
    6.62007
    
    
    63,932
    
    
    
    5.7Thereafter
    
    
    763,010
    
    
    
    6.9Total
    
    $
    990,657Market value
    
    $
    1,039,367
 Actual cash flows may differ from those stated as a result of calls,
prepayments and defaults. A sensitivity analysis is used to measure the potential loss in future
earnings, fair values or cash flows of market sensitive instruments resulting
from one or more selected hypothetical changes in interest rates and other
market rates or prices over a selected period. In the Companys sensitivity
analysis model, a hypothetical change in market rates is selected that is
expected to reflect reasonably possible changes in those rates. The following
pro forma information is presented assuming a 100 basis point increase in
interest rates at December 31 of each year, and reflects the estimated effect
on the fair value of the Companys fixed maturity investment portfolio. The
Company used the modified duration of its fixed maturity
investment portfolio to model the pro forma effect of a change in interest
rates at December 31, 2003 and 2002. Fixed maturity interest rate sensitivity analysis As of December 31(dollars in thousands)
    
    2003
    
    2002Market value
    
    $
    1,280,327
    
    
    $
    1,039,367Change in market value (1)
    
    
    (75,266
    )
    
    
    (58,665
    )Pro forma market value
    
    
    1,205,061
    
    
    
    980,702Modified duration (2)
    
    
    6.0
    
    
    
    5.6
   (1)
    
    The change in market value is calculated by taking the negative of the
product obtained by multiplying (i) modified duration by (ii) change in
interest rates by (iii) market value of the portfolio.(2)
    
    Modified duration is a measure of a portfolios sensitivity to changes in
interest rates. It is interpreted as the approximate percentage change in
the market value of a portfolio for a certain basis point change in
interest rates. The risks associated with interest rate guarantees on the Companys universal
life and annuity products are discussed in the Factors That May Affect Future
Results section of this report.




56



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##### 





Credit risk The Companys portfolios of fixed maturity securities, nonredeemable preferred
stock, mortgage loans and, to a lesser extent, short-term investments are
subject to credit risk. This risk is defined as the potential loss in market
value resulting from adverse changes in the borrowers ability to repay the
debt. The Company manages this risk by performing underwriting analysis prior
to purchase and ongoing reviews of credit quality by position and for the fixed
maturity portfolio in total. The Company does not currently hedge credit risk
inherent in its fixed maturity investments. The Company has entered into various reinsurance treaties for the purpose of
ceding life insurance in force that exceeds the Companys desired retention
limits. Failure of reinsurers to honor their obligations could result in losses
to the Company. The Companys most significant reinsurance relationship is with
Generali USA Reassurance Company (Generali) (formerly Business Mens Assurance
Company of America), which reinsures a portion of the Companys life and
accident and health business. At December 31, 2003, the amount of life
insurance in force ceded to Generali totaled approximately $5.6 billion, which
represents 20.6% of EFLs total life insurance in force at that date. Equity price risk The Companys portfolio of marketable equity securities, which is carried on
the Statements of Financial Position at estimated fair value, has exposure to
price risk. Price risk is the risk of potential loss in estimated fair value
resulting from an adverse change in prices. The Companys objective is to earn
competitive relative returns by investing in a diverse portfolio of liquid
securities. The Companys equity securities at December 31, 2003 and 2002, were
made up entirely of nonredeemable preferred stocks. In 2002, the Company sold
its remaining common stock portfolio to increase its overall earnings stream
and reduce the impact of equity price risk.


Liquidity and Capital Resources General considerations and analysis 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 commission 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
in 2003 was $11.4 million compared to $22.8 million in 2002 and $18.0 million
in 2001. Cash flow sources from investing activities includes proceeds from the sales,
calls and maturities of fixed maturity positions. These proceeds totaled $340.0
million, $267.6 million and $293.0 million in 2003, 2002 and 2001,
respectively. Market interest rates declined in 2003 and 2002, causing greater
levels of calls. Also, record numbers of credit quality downgrades and defaults
occurred in the bond markets in 2002 and 2001. The Company sold many of these
issues in order to improve the overall credit quality of the fixed income
portfolio. Annuity and universal life deposits, which do not appear as revenue on the
financial statements, are a source of funds from financing activities. Net cash
provided by annuity and universal life deposits in 2003 were $128.8 million and
$14.9 million, respectively. 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. Another source of funds from financing in 2003 was the issuance of a $25.0
million surplus note to EIC, which improved the risk-based capital position of
EFL for rating agency purposes. Cash outflow requirements are primarily for policy death benefits, policy
surrenders and withdrawals, commissions, general operating expenses, federal
income taxes, dividends to shareholders and purchases of investments. Interest rate fluctuations can affect the timing of cash flows associated with
the insurance and annuity liabilities as well as the value of the assets
supporting these obligations. Changes in interest rates and other market
conditions can also expose the Company to the risk of accelerated surrenders as
policyholders and contract holders are attracted to alternative products. The
Company seeks to maintain an




57



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##### 





appropriate match between assets and liabilities to satisfy the changing cash
flow requirements associated with interest rate fluctuations. In response to
interest rate changes, the Company adjusts credited interest rates to the
extent permitted by contracts. The Company uses surrender charges to mitigate the extent, timing and
profitability impact of withdrawals of funds from annuity contracts. The
following table sets forth withdrawal characteristics of annuity reserves and
deposit liabilities: 2003
    
    2002As of December 31
    
    
    
    
    
    % of
    
    
    
    
    
    % of(dollars in thousands)
    
    Amount
    
    Total
    
    Amount
    
    TotalNot subject to
discretionary withdrawal
provisions
    
    $
    269,156
    
    
    
    28.9
    %
    
    $
    255,300
    
    
    
    31.8
    %Subject to discretionary
withdrawal, with
adjustment:With market value
adjustment
    
    
    28,034
    
    
    
    3.0
    %
    
    
    25,081
    
    
    
    3.1
    %At contract value,
less surrender charge
of 5% or more
    
    
    224,776
    
    
    
    24.1
    %
    
    
    162,512
    
    
    
    20.2
    %Subtotal
    
    
    521,966
    
    
    
    56.0
    %
    
    
    442,893
    
    
    
    55.1
    %Subject to discretionary
withdrawal at contract
value with no surrender
charge or surrender
charge of less than 5%
    
    
    410,587
    
    
    
    44.0
    %
    
    
    360,782
    
    
    
    44.9
    %Total annuity reserves
and deposit liabilities
    
    $
    932,553
    
    
    
    100.0
    %
    
    $
    803,675
    
    
    
    100.0
    %
 The Companys liquidity position remains strong as invested assets and cash and
cash equivalents increased 18.2% to $1.5 billion at December 31, 2003. As an
added measure of liquidity, the Company has arranged for a $10.0 million line
of credit with a commercial bank. There were no borrowings under this credit
line in 2003, 2002 or 2001. Management believes its cash flow from operations
and its liquid assets and marketable securities will enable the Company to meet
foreseeable cash requirements. The continued adequacy of the liquidity depends
upon factors including future securities market conditions, changes in interest
rate levels and policyholder perceptions of the Companys strength, which could
lead to reduced cash inflows or increased cash outflows.


Non-insurance contractual obligations The following table presents the Companys contractual cash flow commitments on
long-term debt and purchase obligations. See Notes 11 and 14 to the Financial
Statements for additional information on the long-term debt and purchase
obligations. This table does not reflect obligations under insurance and
annuity contracts. Payments Due by PeriodLess than
    
    1-3
    
    3-5
    
    After(dollars in thousands)
    
    Total
    
    1 Year
    
    Years
    
    Years
    
    5 YearsLong-term
debt obligations
    
    $
    40,000
    
    
    $
    0
    
    
    $
    15,000
    
    
    $
    0
    
    
    $
    25,000Purchase
obligations
    
    
    1,500
    
    
    
    0
    
    
    
    1,500
    
    
    
    0
    
    
    
    0Total
    
    $
    41,500
    
    
    $
    0
    
    
    $
    16,500
    
    
    $
    0
    
    
    $
    25,000
 Financial ratings In
2003, the Companys A.M. Best Company rating was lowered from A+ (Superior)
to A (Excellent). Life company affiliates of property and casualty groups are
typically rated one financial strength category lower than the property/casualty affiliates by A.M. Best Company. The A 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. Financial
strength ratings continue to be an important factor in evaluating the
competitive position of insurance companies. Regulatory considerations The Commonwealth of Pennsylvania follows the statutory accounting practices
related to minimum Risk-Based Capital (RBC) requirements for domestic insurance
companies that were developed by the NAIC. The NAIC standard set for measuring
RBC is a method of calculating the minimum amount of capital appropriate for an
insurance company to support its overall business operations in consideration
of its size and risk profile. The RBC formula is used by the state insurance
regulators as an early warning tool to identify, for the purpose of initiating
regulatory action, insurance companies that potentially are inadequately
capitalized. In addition, the formula defines minimum capital standards that
will supplement the current system of low fixed minimum capital and surplus
requirements on a state-by-state basis. At December 31, 2003, the Company
substantially
exceeded the minimum risk-based capital levels that require regulatory action.




58



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##### 





Factors That May Affect Future Results Agent compensation In 2003, management of the Erie Insurance Group made a commitment to focus on
property/casualty underwriting profitability. One of the changes made to
accomplish this goal was to revamp the agency compensation program, including
making several changes to the Companys commission and bonus structure.
Effective December 16, 2003, the Company implemented a reduction in the
commission paid on annuities and the restructuring of the bonus program,
including life insurance bonuses. These bonuses, which had been in place for nearly 20 years, were designed to
incent agents to sell the Companys products when the life insurance product
portfolio was limited and less competitive with industry leaders. Today, with
the introduction of new products, the Companys portfolio is more competitive
and flexible. The Company believes the new commission structure provides
competitive levels of compensation and will recognize and reward superior life
production. While the level of paid commissions may vary in the short-term,
management does not expect the commission expense levels to vary materially
since the majority of these expenses are capitalized as deferred policy
acquisition costs. Changes in the life commission and bonus structures could
affect the growth in sales of life and annuity products by ERIE agencies. 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 recently 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 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
    
    Rate
    
    Interest Rate
    
    Liabilities(dollars in thousands)1-5
    
    4.5
    %
    
    4.5
    %
    
    $270,0206-10
    
    4.5
    
    
    4.0
    
    
    112,098Over 10
    
    4.5
    
    
    3.5
    
    
    159, 218All Years
    
    3.0
    
    
    3.0
    
    
    31,102All Years
    
    1.5
    
    
    1.5
    
    
    9,660
 The Company has some ability in its universal life and annuity policy contracts
to restrict new deposits on existing contracts. New deposits are 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 December 31, 2003, have an annualized planned premium of
$31.7 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 23,162 FPDA contracts
in force, of which 20,710 have guarantees in excess of 3.0%. No additional
payments are permitted on single premium deferred annuity contracts. During 2003, the average rate credited on flexible premium deferred annuity and
universal life account values was 4.33% and 4.58%, respectively. The current
coupon yield on fixed maturities matched against universal life and annuity
products at December 31, 2003, is 6.1%. 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.




59



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##### 





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 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. In August 2002, the eCommerce program took advantage of a significant business
opportunity to work with a well-known provider of information technology
services and solutions to develop the Erie Insurance Groups eCommerce system
called ERIEConnection®. 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, new business production is expected to be curtailed over the short
term. The amount of lost production will correlate to the timing and duration
of the rollout effort as well as the number and types of issues encountered.
Precise measurement of this impact on production is not estimable.   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 2003 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.


Market for the Registrants Common Stock and Related Shareholder Matters Dividends The Companys common stock is traded on the OTC Bulletin Board (OTCBB) under
the symbol ERIF The Company had 913 shareholders of record of common stock on
December 31, 2003. Date dividends declared
    
    Dividends declared per shareFebruary 25, 2003
    
    $
    0.210April 29, 2003
    
    
    0.210June 10, 2003
    
    
    0.210September 19, 2003
    
    
    0.210Total
    
    $
    0.840March 5, 2002
    
    $
    0.210April 30, 2002
    
    
    0.210June 12, 2002
    
    
    0.210September 9, 2002
    
    
    0.210Total
    
    $
    0.840
 The amount of dividends the Company can pay to its shareholders without the
prior approval of the Pennsylvania Insurance Commissioner is limited by statute
to the greater of: (a) 10% of its statutory surplus as regards policyholders
as shown on its last annual statement on file with the commissioner, or (b) the
net income as reported for the period covered by such annual statement, but
shall not include pro rata distribution of any class of the insurers own
securities. Accordingly, the maximum dividend payout that may be made in 2004
without prior Pennsylvania Commissioner approval is $15.4 million. High/low closing price of common stock 2003
    
    2002Low
    
    high
    
    Low
    
    highFirst quarter
    
    $
    18
    1/2
    
    $
    22
    
    
    $
    20
    
    
    $
    21
    3/4Second quarter
    
    
    22
    
    
    
    23
    1/2
    
    
    20
    1/4
    
    
    22
    5/8Third quarter
    
    
    19
    1/4
    
    
    23
    1/2
    
    
    21
    1/4
    
    
    22
    1/8Fourth quarter
    
    
    22
    5/8
    
    
    29
    3/4
    
    
    21
    1/5
    
    
    22
    1/2




60



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##### 



Index to Graphs included in the Investment Section
of The Managements Discussion and Analysis

Graph #1
    
    LIFE INSURANCE IN FORCE (BILLIONS)


2003 Gross
    
    $
    27.12003 Net
    
    $
    17.32002 Gross
    
    $
    23.22002 Net
    
    $
    16.22001 Gross
    
    $
    18.92001 Net
    
    $
    14.8


Graph #2
    
    DIVERSIFICATION OF FIXED MATURITIESAT DECEMBER 31, 2003  CARRYING/MARKET VALUE


U.S. Industrial & Miscellaneous
    
    
    46
    %U.S. Banks, Trusts and Insurance Companies
    
    
    13
    %Public Utilities
    
    
    12
    %Mortgage & Asset-backed
    
    
    12
    %Foreign
    
    
    12
    %U.S. Treasuries
    
    
    5
    %


Graph #3
    
    QUALITY* OF FIXED MATURITY PORTFOLIOAT DECEMBER 31, 2003  CARRYING/MARKET VALUE


Aaa/AAA
    
    
    20
    %Aa/AA
    
    
    6
    %A
    
    
    34
    %Baa/BBB
    
    
    37
    %Ba/BB or lower
    
    
    3
    %


* As rated by Standard & Poors or Moodys Investors
Service, Inc.Graph #4
    
    DIVERSIFICATION OF EQUITY SECURITIESAT DECEMBER 31, 2003  CARRYING/MARKET VALUE


Foreign Banks & Insurance
    
    
    36
    %U.S. Industrial & Miscellaneous
    
    
    30
    %U.S. Banks & Insurance
    
    
    25
    %Foreign Industrial & Miscellaneous
    
    
    6
    %Public Utilities
    
    
    3
    %


61



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##### 



Report of Management

The management of Erie Family Life Insurance Company is responsible for the
preparation of information included in the financial statements in this Annual
Report to Shareholders. The financial statements have been prepared in
conformity with Generally Accepted Accounting Principles. The balances in the
financial statements are developed from the financial records of the Company
and reflect estimates using judgment where amounts cannot be measured
precisely or for transactions not yet complete.

The Companys system of internal control is designed to safeguard Company
assets from unauthorized use or disposition and to provide for proper
authorization, execution and recording of Company transactions. Company
personnel design, maintain and monitor internal control on an ongoing basis.
In addition, the Companys internal auditors review and report on the
functioning of various aspects of internal control.

The Audit Committee of the Board of Directors, composed of outside directors,
meets periodically with the Companys management, internal auditors and
independent auditors to review the work of each and to inquire as to their
assessment of the performance of Company financial personnel. The independent
auditors and internal auditors have full and free access to the Audit
Committee, without the presence of management, to discuss results of work
performed and communicate other appropriate matters.

/s/
    
    Jeffrey A. LudrofPresident andChief Executive OfficerFebruary 17, 2004/s/
    
    Philip A. GarciaExecutive Vice President andChief Financial OfficerFebruary 17, 2004/s/
    
    Timothy G. NeCastroSenior Vice President and ControllerFebruary 17, 2004


62



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##### 



Independent Auditors Report

To the Board of Directors and Shareholders
Erie Family Life Insurance Company
Erie, Pennsylvania

We have audited the accompanying Statements of Financial Position of Erie
Family Life Insurance Company as of December 31, 2003, and the related
Statements of Operations, Shareholders Equity and Cash Flows for the year
then ended. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial
statements based on our audit. The financial statements of the Company as of
December 31, 2002, and for the two years then ended, were audited by other
auditors whose report dated February 7, 2003, expressed an unqualified opinion
on those statements.

We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Erie Family Life Insurance
Company as of December 31, 2003, and the results of its operations and its
cash flows for the year then ended, in conformity with accounting principles
generally accepted in the United States of America.

/s/
    
    Ernst & Young LLPCleveland, OhioFebruary 17, 2004


63



---



##### 



Statements of Operations

Years ended December 31
    
    2003
    
    2002
    
    2001(dollars in thousands, except per share data)RevenuesNet policy revenue:Life premiums
    
    $
    52,045
    
    
    $
    48,070
    
    
    $
    43,693Group life and other premiums
    
    
    3,887
    
    
    
    3,059
    
    
    
    2,798Total net policy revenue
    
    
    55,932
    
    
    
    51,129
    
    
    
    46,491Net investment income
    
    
    76,966
    
    
    
    66,286
    
    
    
    61,181Net realized gains (losses) on investments
    
    
    13,176
    
    
    
    (9,610
    )
    
    
    (19,646
    )Equity in earnings of limited partnerships
    
    
    1,296
    
    
    
    3,664
    
    
    
    736Other income
    
    
    844
    
    
    
    815
    
    
    
    752Total revenues
    
    
    148,214
    
    
    
    112,284
    
    
    
    89,514Benefits and expensesDeath benefits
    
    
    15,197
    
    
    
    15,547
    
    
    
    13,338Interest on annuity deposits
    
    
    42,178
    
    
    
    39,720
    
    
    
    35,284Interest on universal life deposits
    
    
    6,959
    
    
    
    7,249
    
    
    
    6,889Surrender and other benefits
    
    
    1,263
    
    
    
    1,785
    
    
    
    2,263Increase in future life policy benefits
    
    
    7,211
    
    
    
    6,563
    
    
    
    5,748Amortization of deferred policy acquisition costs
    
    
    6,526
    
    
    
    8,427
    
    
    
    5,818Commissions
    
    
    2,679
    
    
    
    3,806
    
    
    
    2,425General expenses
    
    
    12,973
    
    
    
    12,494
    
    
    
    11,417Taxes, licenses and fees
    
    
    3,064
    
    
    
    3,156
    
    
    
    2,145Total benefits and expenses
    
    
    98,050
    
    
    
    98,747
    
    
    
    85,327Income before income taxes
    
    
    50,164
    
    
    
    13,537
    
    
    
    4,187Provision for federal income taxes
    
    
    15,818
    
    
    
    4,697
    
    
    
    1,449Net income
    
    $
    34,346
    
    
    $
    8,840
    
    
    $
    2,738Net income per share
    
    $
    3.63
    
    
    $
    0.94
    
    
    $
    0.29


See accompanying notes to financial statements.

64



---



##### 



Statements of Financial Position

As of December 31
    
    2003
    
    2002(dollars in thousands)AssetsInvested assetsFixed maturities at fair value (amortized cost of $1,203,607
and $986,137, respectively)
    
    $
    1,280,327
    
    
    $
    1,039,367Equity securities at fair value (cost of $56,608 and $66,072, respectively)
    
    
    62,948
    
    
    
    68,749Limited partnerships (cost of $12,203 and $16,352, respectively)
    
    
    12,241
    
    
    
    16,053Real estate mortgage loans
    
    
    6,305
    
    
    
    7,175Real estate
    
    
    1,127
    
    
    
    1,210Policy loans
    
    
    9,951
    
    
    
    9,516Total invested assets
    
    
    1,372,899
    
    
    
    1,142,070Cash and cash equivalents
    
    
    91,667
    
    
    
    97,022Premiums receivable from policyholders
    
    
    7,344
    
    
    
    6,225Reinsurance recoverable
    
    
    2,960
    
    
    
    1,713Other receivables
    
    
    137
    
    
    
    1,486Accrued investment income
    
    
    15,088
    
    
    
    13,353Deferred policy acquisition costs
    
    
    103,874
    
    
    
    104,065Reserve credit for reinsurance ceded
    
    
    20,758
    
    
    
    14,123Prepaid federal income taxes
    
    
    1,983
    
    
    
    2,674Other assets
    
    
    18,520
    
    
    
    6,888Total assets
    
    $
    1,635,230
    
    
    $
    1,389,619Liabilities and shareholders equityLiabilitiesPolicy liabilities and accruals:Future policy benefits
    
    $
    108,089
    
    
    $
    94,243Policy and contract claims
    
    
    3,653
    
    
    
    2,362Annuity deposits
    
    
    932,553
    
    
    
    803,675Universal life deposits
    
    
    150,421
    
    
    
    135,551Supplementary contracts not including life contingencies
    
    
    579
    
    
    
    625Other policyholder funds
    
    
    9,856
    
    
    
    14,335Deferred income taxes
    
    
    48,796
    
    
    
    41,577Reinsurance premium due
    
    
    1,875
    
    
    
    1,591Securities lending collateral
    
    
    65,495
    
    
    
    41,669Accounts payable and accrued expenses
    
    
    9,239
    
    
    
    9,673Notes payable to Erie Indemnity Company
    
    
    40,000
    
    
    
    15,000Due to affiliates
    
    
    3,442
    
    
    
    2,886Dividends payable
    
    
    1,985
    
    
    
    1,985Total liabilities
    
    
    1,375,983
    
    
    
    1,165,172Shareholders 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
    
    
    44,537
    
    
    
    36,145Retained earnings
    
    
    210,300
    
    
    
    183,892Total shareholders equity
    
    
    259,247
    
    
    
    224,447Total liabilities and shareholders equity
    
    $
    1,635,230
    
    
    $
    1,389,619


See accompanying notes to financial statements.

65



---



##### 



Statements of Cash Flows

Years ended December 31
    
    2003
    
    2002
    
    2001(dollars in thousands)Cash
flows from operating activitiesPremiums collected
    
    $
    51,942
    
    
    $
    55,077
    
    
    $
    50,258Net investment income received
    
    
    78,295
    
    
    
    68,096
    
    
    
    64,439Miscellaneous income
    
    
    844
    
    
    
    814
    
    
    
    751Benefits to policyholders
    
    
    (65,485
    )
    
    
    (63,548
    )
    
    
    (59,611
    )Commissions paid to agents
    
    
    (14,300
    )
    
    
    (12,398
    )
    
    
    (8,002
    )Salaries and wages paid
    
    
    (11,408
    )
    
    
    (11,485
    )
    
    
    (9,127
    )General operating expenses paid
    
    
    (13,115
    )
    
    
    (11,782
    )
    
    
    (9,101
    )Taxes, licenses and fees paid
    
    
    (2,934
    )
    
    
    (3,300
    )
    
    
    (1,909
    )Income taxes (paid) recovered
    
    
    (12,426
    )
    
    
    1,329
    
    
    
    (9,701
    )Net cash provided by operating activities
    
    
    11,413
    
    
    
    22,803
    
    
    
    17,997Cash flows from investing activitiesPurchase of investments:Fixed maturities
    
    
    (554,355
    )
    
    
    (551,582
    )
    
    
    (329,244
    )Equity securities
    
    
    (13,675
    )
    
    
    (31,246
    )
    
    
    (23,172
    )Limited partnerships
    
    
    (2,560
    )
    
    
    (6,199
    )
    
    
    (9,513
    )Sales/maturities of investments:Sales of fixed maturities
    
    
    228,277
    
    
    
    152,474
    
    
    
    218,548Calls/maturities of fixed maturities
    
    
    111,713
    
    
    
    115,099
    
    
    
    74,480Equity securities
    
    
    20,841
    
    
    
    59,963
    
    
    
    55,563Limited partnerships
    
    
    7,965
    
    
    
    10,952
    
    
    
    28,206Increase (decrease) in collateral from securities lending
    
    
    23,826
    
    
    
    (7,290
    )
    
    
    48,959Net mortgage loans
    
    
    871
    
    
    
    182
    
    
    
    927Net policy loans
    
    
    (435
    )
    
    
    (637
    )
    
    
    (1,113
    )Net cash (used in) provided by investing activities
    
    
    (177,532
    )
    
    
    (258,284
    )
    
    
    63,641Cash flows from financing activitiesAnnuity and supplementary contract deposits and interest
    
    
    186,379
    
    
    
    215,255
    
    
    
    105,138Annuity and supplementary contract surrenders and withdrawals
    
    
    (57,547
    )
    
    
    (48,410
    )
    
    
    (52,408
    )Universal life deposits and interest
    
    
    20,285
    
    
    
    19,426
    
    
    
    19,127Universal life surrenders
    
    
    (5,415
    )
    
    
    (5,434
    )
    
    
    (4,759
    )Proceeds from issuance of long-term debt
    
    
    25,000
    
    
    
    0
    
    
    
    0Dividends paid to shareholders
    
    
    (7,938
    )
    
    
    (7,796
    )
    
    
    (7,229
    )Net cash provided by financing activities
    
    
    160,764
    
    
    
    173,041
    
    
    
    59,869Net (decrease) increase in cash and cash equivalents
    
    
    (5,355
    )
    
    
    (62,440
    )
    
    
    141,507Cash and cash equivalents at beginning of year
    
    
    97,022
    
    
    
    159,462
    
    
    
    17,955Cash and cash equivalents at end of year
    
    $
    91,667
    
    
    $
    97,022
    
    
    $
    159,462


See accompanying notes to financial statements.

66



---



##### 



Statements of Shareholders Equity

AccumulatedTotal
    
    
    
    
    
    
    
    
    
    other
    
    
    
    
    
    Additional(dollars in thousands,
    

shareholders
    
    Comprehensive
    
    Retained
    
    comprehensive
    
    Common
    
    paid-inexcept per share data)
    
    equity
    
    income
    
    earnings
    
    income
    
    stock
    
    capitalBalance, January 1, 2001
    
    $
    195,720
    
    
    
    
    
    
    $
    187,623
    
    
    $
    3,687
    
    
    $
    3,780
    
    
    $
    630Comprehensive income:Net income
    
    
    2,738
    
    
    $
    2,738
    
    
    
    2,738Unrealized appreciation
of investments, net of tax
    
    
    14,672
    
    
    
    14,672
    
    
    
    
    
    
    
    14,672Comprehensive income
    
    
    
    
    
    $
    17,410Dividends declared,
$0.78 per share
    
    
    (7,371
    )
    
    
    
    
    
    
    (7,371
    )Balance, December 31, 2001
    
    
    205,759
    
    
    
    
    
    
    
    182,990
    
    
    
    18,359
    
    
    
    3,780
    
    
    
    630Comprehensive income:Net income
    
    
    8,840
    
    
    $
    8,840
    
    
    
    8,840Unrealized appreciation
of investments, net of tax
    
    
    17,786
    
    
    
    17,786
    
    
    
    
    
    
    
    17,786Comprehensive income
    
    
    
    
    
    $
    26,626Dividends declared,
$0.84 per share
    
    
    (7,938
    )
    
    
    
    
    
    
    (7,938
    )Balance, December 31, 2002
    
    
    224,447
    
    
    
    
    
    
    
    183,892
    
    
    
    36,145
    
    
    
    3,780
    
    
    
    630Comprehensive income:Net income
    
    
    34,346
    
    
    $
    34,346
    
    
    
    34,346Unrealized appreciation
of investments, net of tax
    
    
    8,392
    
    
    
    8,392
    
    
    
    
    
    
    
    8,392Comprehensive income
    
    
    
    
    
    $
    42,738Dividends declared,
$0.84 per share
    
    
    (7,938
    )
    
    
    
    
    
    
    (7,938
    )Balance, December 31, 2003
    
    $
    259,247
    
    
    
    
    
    
    $
    210,300
    
    
    $
    44,537
    
    
    $
    3,780
    
    
    $
    630


See accompanying notes to financial statements.

67



---



##### 



Notes to Financial Statements



Note 1. Nature of Business Erie Family Life Insurance Company (the Company), a Pennsylvania-domiciled life
insurer, is engaged in the business of underwriting and selling
nonparticipating individual and group life insurance policies, including
universal life, annuity products and disability income products. The Company
markets its products through independent agents in 10 states and the District
of Columbia and is subject to supervision and regulations of the states in
which it operates. A majority of the Companys business is written in
Pennsylvania, Ohio, Maryland and Virginia. See also Note 15. The Company is owned 21.6% by the Erie Indemnity Company (EIC), 53.5% by the
Erie Insurance Exchange (Exchange) and the remaining 24.9% by public
shareholders. EIC is a Pennsylvania business corporation formed in 1925 to be
the attorney-in-fact for policyholders of Erie Insurance Exchange, a
Pennsylvania-domiciled reciprocal insurance exchange. As attorney-in-fact for
the Exchange, EIC has a fiduciary duty to protect the policyholders of the
Exchange in addition to its fiduciary duty to protect the interests of its
shareholders. EIC operates predominantly as a provider of certain management
services to the Exchange. EIC also is engaged in the property/casualty
insurance business through its wholly-owned subsidiaries, Erie Insurance
Company, Erie Insurance Property and Casualty Company, and Erie Insurance
Company of New York and through a subsidiary of the Exchange, Flagship City
Insurance Company. The Company, EIC, the Exchange and their subsidiaries and
affiliates operate collectively under the name Erie Insurance Group. Note 2. Recent Accounting Pronouncements In June 2002, the Financial Accounting Standards Board (FASB), issued Statement
of Financial Accounting Standards (FAS) 146, Accounting for Costs Associated
with Exit or Disposal Activities, which supercedes Emerging Issues Task Force
(EITF) Issue 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred
in a Restructuring). The provisions of this Statement are effective for exit
and disposal activities initiated after December 31, 2002. FAS 146 requires
recognition of a liability for costs associated with an exit or disposal
activity when the liability is incurred, rather than when the entity commits to
an exit plan under EITF Issue 94-3. The Company has not exited or disposed of
any portion of its business. In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, which became effective for
financial statements of interim or annual periods ending after December 15,
2002. This Interpretation provides


guidance on disclosures to be made by a
guarantor about its obligations under certain guarantees and clarifies that a
guarantor is required to recognize a liability for the fair value of the
obligation undertaken in issuing the guarantee. The Company has no guarantee
contracts that are covered by this Interpretation. The Financial Accounting Standard Board (FASB) issued FASB Interpretation No.
46 (FIN 46), Consolidation of Variable Interest Entities, in January 2003 and
made certain revisions to FIN 46 in December 2003. This Interpretation provides
guidance on the identification of entities for which control is achieved
through means other than through voting rights, so called variable interest
entities (VIEs), and how to determine when and which business enterprises
should consolidate variable interest entities. If an entity is identified as
the variable interest entitys primary beneficiary, the entity is required to
consolidate the variable interest entity. For public entities that are not
small business issuers, FIN 46 is effective no later than the first reporting
period that ends after March 15, 2004. Management has evaluated its limited partnership investments comprised of four
real estate partnerships valued at $11,250 and one mezzanine debt partnership
valued at $991 to determine if they are VIEs. All but one of the partnerships
qualify as VIEs. However, the Company does not qualify as the primary
beneficiary for any of the partnerships. The Company does not hold a
significant interest in any of the limited partnerships; therefore,
consolidation of the partnerships with the financial statements of the Company
is not required. In July 2003, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 03-1, Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate
Accounts. This SOP is not applicable to the Company since the Company does not
issue the products addressed in the SOP. Note 3. Significant Accounting Policies Basis of presentation The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles (GAAP) that differ from statutory
accounting practices (SAP) prescribed or permitted for insurance companies by
state regulatory authorities. For differences between GAAP and SAP, see Note
16. Use of estimates The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of




All dollar amounts are in thousands, except per share data.

68



---



##### 



Notes to Financial Statements



revenues and expenses during the reporting period. The most significant
estimates relate to valuation of investments, policy acquisition costs and
reserves for policy liabilities. While management believes its estimates are
appropriate, the ultimate amounts may differ from the estimates provided. The
methods for making these estimates are continually reviewed and any adjustments
considered necessary are reflected in current earnings. Investments Fixed maturities and marketable equity securities are classified as
available-for-sale. At December 31, 2003, equity securities consist of
nonredeemable preferred stock while fixed maturities consist of bonds, notes
and redeemable preferred stock. Available-for-sale securities are stated at
fair value, with the unrealized gains and losses, net of tax, reported as a
separate component of Comprehensive Income and Shareholders Equity. There are
no securities classified as trading securities or held-to-maturity
securities. Limited partnerships include U.S. and foreign real estate and fixed income
investments. These partnerships are recorded using the equity method, which
approximates the Companys share of the carrying value of the partnership. The
Company has not guaranteed any of the partnership liabilities. Mortgage loans on commercial real estate are recorded at unpaid balances,
adjusted for amortization of premium or discount. Valuation allowances, if
needed, are provided for impairment in net realizable value based on periodic
valuations. Policy loans are recorded at unpaid balances. Interest and dividend income is recorded as earned. Realized gains and losses
on sales of investments are recognized in income on the specific identification
method. The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is included
in investment income. For the mortgage-backed bond portion of the fixed maturity securities
portfolio, the Company recognizes income using a constant effective yield
method based on anticipated prepayments and the estimated economic life of the
securities. When actual prepayments differ significantly from anticipated
prepayments, the effective yield is recalculated to reflect actual payment to
date and anticipated future payments. The net investment in the security is
adjusted to the amount that would have existed had the new effective yield been
applied since the acquisition of the security, with the corresponding
adjustment included as part of investment income. 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 greater emphasis on those that have in
managements
opinion, 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, where 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. Impairment charges made on securities are considered a realized loss in the
Statements of Operations. Impairment charges on limited partnerships are
recorded as a loss in Equity in Earnings of Limited Partnerships in the
Statements of Operations. Cash equivalents The Company considers all highly liquid investments with an original maturity
of three months or less when purchased to be cash equivalents. Cash equivalents
total $31,036 and $58,190 at December 31, 2003 and 2002, respectively, and are
comprised of investments in bank money market funds and short-term bonds. Deferred policy acquisition costs (DAC) 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. At each balance sheet
date, the Company evaluates the historical and expected future gross premiums
and profits on its insurance and annuity products. The DAC on traditional life insurance products are amortized in relation to
gross premiums. Assumptions used for a specific year are locked-in;
therefore, amortization in subsequent years is not adjusted for changing
assumptions. Changes in estimated expected future gross profit on the annuity and universal
life products requires that the DAC amortization rate be revised retroactively
to the date of policy issuance. The cumulative difference related to prior
periods is recognized as a component of the current periods




All dollar amounts are in thousands, except per share data.

69



---



##### 



Notes to Financial Statements



DAC amortization, along with DAC amortization associated with the actual gross
profits of the current period. Lower actual gross profits in a period would
typically result in less DAC amortization expense in that period. The converse
would also be true. However, if lower gross profits were to continue into the
future, additional amortization of the existing DAC asset may occur. The Company periodically reviews the DAC asset to determine if it continues to
be recoverable 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 amount of DAC considered realizable would be reduced in
the near term if the estimate of ultimate or future gross premiums or profits
is reduced. The amount of DAC amortization would be revised if any of the
estimates discussed above are revised. The DAC is adjusted for the impact of unrealized gains or losses on investments
as if these gains or losses had been realized, with corresponding credits or
charges included in Accumulated Other Comprehensive Income (Loss). Insurance liabilities Liabilities for life insurance and income-paying annuity future policy benefits
are computed primarily by the net level premium method with assumptions as to
anticipated mortality, withdrawals, lapses and investment yields. Disability
income reserves are calculated as two-year preliminary term mid-terminal
reserves plus unearned premium reserves plus claim reserves. Deferred annuity
future policy benefit liabilities are established at accumulated values without
reduction for surrender charges. Reserves for universal life and investment
contracts are based on the contract account balance, if future benefit payments
in excess of the account balance are not guaranteed, or the present value of
future benefit payments when such payments are guaranteed. Variations are
inherent in such calculations due to the estimates and assumptions necessary in
the calculations. Interest rate assumptions for noninterest-sensitive life
insurance range from 3.50% to 4.00% on policies issued in 1980 and prior years
and 5.00% to 7.25% on policies issued in 1981 and subsequent years. Mortality
and withdrawal assumptions are based on tables typically used in the industry,
modified to reflect actual experience where appropriate. Universal life and annuity deposits are credited with varying interest rates
determined at the discretion of the Company subject to certain minimums.
Interest rates credited on deposits during the year were as follows: 2003
    
    2002
    
    2001Annuity
    
    
    3.00%-4.80
    %
    
    
    4.00%-6.00
    %
    
    
    5.00%-6.25
    %Universal Life
    
    
    4.25%-6.00
    %
    
    
    5.25%-6.75
    %
    
    
    6.00%-6.75
    %


Liability for guaranty fund assessments The Company may be required, under the solvency or guaranty laws of the various
states in which it is licensed, to pay assessments up to prescribed limits to
fund policyholder losses or liabilities of insolvent life insurance companies.
Certain states permit these assessments, or a portion thereof, to be recovered
as an offset to future premium taxes. Assessments are recognized as incurred when an event obligating the Company has
occurred and the amount can be reasonably estimated. The Company commonly
becomes aware of insolvencies prior to obtaining specific assessment amounts
from state guaranty associations to estimate its share of the liability. The
Company estimates its liability based on information received from the National
Organization of Life and Health Insurance Guaranty Associations (NOLHGA). The
information provided by NOLHGA is obtained from a variety of sources and is
only an estimate. When the assessment is subject to credit against future
premium taxes, and such credits are likely to be recoverable, an asset is
established. The asset is reduced when the credits are realized under
applicable state law. The Companys estimated liability for guaranty fund and other assessments was
$729 and $645 at December 31, 2003 and 2002, respectively. The estimated asset
for credit against future premium taxes was $512 and $506 at December 31, 2003
and 2002, respectively. Recognition of premium revenues and losses Premiums on traditional life insurance contracts are reported as earned revenue
when due. Reserves for future policy benefits are established as premiums are
earned. For universal life and annuity contracts, deposits are recorded as a
liability. Revenue is recognized as amounts are assessed against the
policyholders account for mortality coverage and contract expenses. The
primary source of revenue on annuity deposits is derived from the interest
spread earned by the Company which is reflected in net investment income and
interest on annuity deposits. Disability income premiums are recognized as
revenue pro rata over the terms of the contracts. Reinsurance Reinsurance premiums, commissions and expense reimbursements on reinsurance
ceded are accounted for on a basis consistent with those used in accounting for
the original policies issued. Premiums and benefits to policyholders ceded to
other companies have been reported as a reduction of Policy Revenue and
Increase in Future Policy Benefits on the Statements of Operations.




All dollar amounts are in thousands, except per share data.

70



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##### 



Notes to Financial Statements



Expense reimbursements received in connection with reinsurance ceded have been
accounted for as a reduction of the related policy acquisition costs. Amounts
recoverable from reinsurers for future policy benefits are estimated in a
manner consistent with the assumptions used for the underlying policy benefits
and are recorded as an asset under Reserve Credit for Reinsurance Ceded on
the Statements of Financial Position. Income taxes Provisions for income taxes include deferred taxes resulting from changes in
cumulative temporary differences between the tax bases and financial statement
bases of assets and liabilities. Deferred taxes are provided on a liability
method whereby deferred tax assets are recognized for deductible temporary
differences and deferred tax liabilities are recognized for taxable temporary
differences. Deferred tax assets and liabilities are adjusted for the effects
of changes in tax laws and rates on the date of enactment.


Software development costs Software development costs have been capitalized and included in other assets.
Total software development costs are being amortized on a straight-line basis
over the expected useful life of the asset. The carrying value of this asset at
December 31, 2003 and 2002, was $1,434 and $1,684, respectively. Earnings per share Earnings per share amounts are based on the weighted average number of common
shares outstanding during each of the respective years. Reclassifications Certain amounts previously reported in the 2002 financial statements have been
reclassified to conform to the current periods presentation. Such
reclassifications did not impact earnings or total shareholders equity.




Note 4. Investments

The following tables summarize the cost and market value of available-for-sale
securities at December 31, 2003 and 2002:

Gross
    
    GrossAmortized
    
    unrealized
    
    unrealized
    
    EstimatedDecember 31, 2003
    
    cost
    
    gains
    
    losses
    
    fair valueFixed maturitiesBonds: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 securitiesNonredeemable 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


All dollar amounts are in thousands, except per share data.

71



---



##### 



Notes to Financial Statements

Gross
    
    GrossAmortized
    
    unrealized
    
    unrealized
    
    EstimatedDecember 31, 2002
    
    cost
    
    gains
    
    losses
    
    fair valueFixed maturitiesBonds:U. S. treasuries and government agencies
    
    $
    48,234
    
    
    $
    2,604
    
    
    $
    0
    
    
    $
    50,838Public utilities
    
    
    120,871
    
    
    
    6,121
    
    
    
    1,491
    
    
    
    125,501U. S. banks, trusts and insurance companies
    
    
    101,022
    
    
    
    7,591
    
    
    
    114
    
    
    
    108,499U. S. industrial and miscellaneous
    
    
    491,719
    
    
    
    31,497
    
    
    
    4,749
    
    
    
    518,467Mortgage-backed
    
    
    75,217
    
    
    
    3,605
    
    
    
    0
    
    
    
    78,822Asset-backed
    
    
    4,500
    
    
    
    495
    
    
    
    0
    
    
    
    4,995Foreign
    
    
    135,743
    
    
    
    9,640
    
    
    
    2,273
    
    
    
    143,110Total bonds
    
    
    977,306
    
    
    
    61,553
    
    
    
    8,627
    
    
    
    1,030,232Redeemable preferred stock
    
    
    8,831
    
    
    
    304
    
    
    
    0
    
    
    
    9,135Total fixed maturities
    
    
    986,137
    
    
    
    61,857
    
    
    
    8,627
    
    
    
    1,039,367Equity securitiesNonredeemable preferred stock:U. S. banks, trusts and insurance companies
    
    
    7,016
    
    
    
    211
    
    
    
    0
    
    
    
    7,227U. S. industrial and miscellaneous
    
    
    11,872
    
    
    
    773
    
    
    
    0
    
    
    
    12,645Foreign
    
    
    47,184
    
    
    
    2,496
    
    
    
    803
    
    
    
    48,877Total equity securities
    
    
    66,072
    
    
    
    3,480
    
    
    
    803
    
    
    
    68,749Total fixed maturities and equity securities
    
    $
    1,052,209
    
    
    $
    65,337
    
    
    $
    9,430
    
    
    $
    1,108,116




Components of net investment income follow for the years ended December 31: 2003
    
    2002
    
    2001Fixed maturities
    
    $
    72,139
    
    
    $
    58,933
    
    
    $
    53,172Equity securities
    
    
    5,323
    
    
    
    5,999
    
    
    
    6,815Other
    
    
    2,051
    
    
    
    3,296
    
    
    
    3,109Total investment income
    
    
    79,513
    
    
    
    68,228
    
    
    
    63,096Investment expense
    
    
    2,547
    
    
    
    1,942
    
    
    
    1,915Net investment income
    
    $
    76,966
    
    
    $
    66,286
    
    
    $
    61,181
 Components of realized gains and losses on investments reflected in operations
for the years ended December 31 are included below. Included in 2003 gross
realized losses of fixed maturities are impairment charges totaling $3,445.
These charges relate primarily to investments in the communications, energy and
finance segments. Included in 2002 gross realized losses of fixed maturities
and equity securities are impairment charges totaling


$25,806. These charges relate primarily to investments in the communications,
energy and finance segments. In 2001, an equity securities impairment charge
totaling $27 related to one position in the computer and office equipment
segment. 2003
    
    2002
    
    2001Fixed maturities:Gross realized gains
    
    $
    19,411
    
    
    $
    10,008
    
    
    $
    8,616Gross realized losses
    
    
    ( 6,081
    )
    
    
    ( 26,400
    )
    
    
    (13,502
    )Net realized gains (losses)
    
    
    13,330
    
    
    
    (16,392
    )
    
    
    ( 4,886
    )Equity securities:Gross realized gains
    
    
    379
    
    
    
    13,308
    
    
    
    1,657Gross realized losses
    
    
    ( 533
    )
    
    
    ( 5,276
    )
    
    
    (17,561
    )Net realized (losses) gains
    
    
    (154
    )
    
    
    8,032
    
    
    
    (15,904
    )Limited partnerships:Gross realized gains
    
    
    0
    
    
    
    452
    
    
    
    4, 715Gross realized losses
    
    
    0
    
    
    
    (1,702
    )
    
    
    ( 3,571
    )Net realized (losses) gains
    
    
    0
    
    
    
    (1,250
    )
    
    
    1,144Net realized gains
(losses) on investments
    
    $
    13,176
    
    
    $
    (9,610
    )
    
    $
    (19,646
    )




All dollar amounts are in thousands, except per share data.

72



---



##### 



Notes to Financial Statements



Investments at carrying value in limited partnerships consisted of the
following at December 31: 2003
    
    2002Real estate
    
    $
    11,250
    
    
    $
    13,551Mezzanine debt
    
    
    991
    
    
    
    2,502Total limited partnerships
    
    $
    12,241
    
    
    $
    16,053
 The components of equity in earnings of limited partnerships reported for the
years ended December 31 are reflected below. Impairment charges of $2,026 and
$953 in 2003 and 2002, respectively, are included in the equity in earnings of
limited partnerships. 2003
    
    2002
    
    2001Private equity
    
    $
    0
    
    
    $
    0
    
    
    $
    (1,093
    )Real estate
    
    
    2,790
    
    
    
    4,136
    
    
    
    1,390Mezzanine debt
    
    
    (1,494
    )
    
    
    (472
    )
    
    
    439Equity in earnings
of limited partnerships
    
    $
    1,296
    
    
    $
    3,664
    
    
    $
    736
 The following is a summary of fixed maturities by remaining term to contractual
maturity. Mortgage-backed securities are allocated based on their stated
maturity dates. Actual cash flows may differ from those stated as a result of
calls, prepayments or defaults. As of December 31, 2003
    
    Amortized cost
    
    Estimated fair valueDue in one year or less
    
    $
    17,678
    
    
    $
    19,432Due after one year through five years
    
    
    184,637
    
    
    
    196,157Due after five years through 10 years
    
    
    567,715
    
    
    
    605,695Due after 10 years through 20 years
    
    
    207,239
    
    
    
    215,483Due after 20 years
    
    
    225,328
    
    
    
    242,220Bonds in default
    
    
    1,010
    
    
    
    1,340Total fixed maturities
    
    $
    1,203,607
    
    
    $
    1,280,327
 The gross unrealized losses at December 31, 2003, span the various investment
categories of fixed maturities and equity securities. The gross unrealized
losses are aged as follows: Unrealized
    
    Amortized
    
    Estimated
    
    Number ofloss
    
    cost
    
    fair value
    
    holdingsSix months or less
    
    $
    ( 3,204
    )
    
    $
    174,749
    
    
    $
    171,545
    
    
    
    64Six to 12 months
    
    
    ( 59
    )
    
    
    3,441
    
    
    
    3,382
    
    
    
    112 to 18 months
    
    
    ( 28
    )
    
    
    2, 058
    
    
    
    2,030
    
    
    
    1Greater than 18 months
    
    
    ( 21
    )
    
    
    3,178
    
    
    
    3,157
    
    
    
    2$
    (3,312
    )
    
    $
    183,426
    
    
    $
    180,114
    
    
    
    68


No investments in an unrealized loss position at December 31, 2003 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. Net unrealized gains and losses on investments are credited or charged directly
to Accumulated Other Comprehensive Income. At December 31, 2003, net
unrealized gains on investments of $44,537 consisted of $86,410 in gross
unrealized gains, less $3,312 in gross unrealized losses, less $14,579 in other
related offsets (see Note 5) and deferred taxes of $23,982. Changes in net unrealized gains include the following for the years ended
December 31: 2003
    
    2002
    
    2001Unrealized gains (losses) from:Equity securities
    
    $
    3,663
    
    
    $
    (14,240
    )
    
    $
    6,388Fixed maturities
    
    
    23,490
    
    
    
    41,460
    
    
    
    23,197Limited partnerships
    
    
    338
    
    
    
    143
    
    
    
    (7,013
    )Deferred policy acquisition costs
    
    
    (14,579
    )
    
    
    0
    
    
    
    0Deferred federal income tax expense
    
    
    ( 4,520
    )
    
    
    ( 9,577
    )
    
    
    ( 7,900
    )Increase in net unrealized gains
    
    $
    8,392
    
    
    $
    17,786
    
    
    $
    14,672
 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 in return.
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 years ended December 31, 2003 and
2002, related to this program, totaled $103 and $97, respectively. The Company had loaned securities with a market value of $64,082 and $40,732
and secured collateral of $65,495 and $41,669 at December 31, 2003 and 2002,
respectively. The




All dollar amounts are in thousands, except per share data.

73



---



##### 



Notes to Financial Statements



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. Bonds having a fair value of $2,215 at December 31, 2003, were on deposit with
various regulatory authorities as required by law. Bonds having a fair value of
$15,057 are pledged as collateral on a $10,000 line of credit with a bank.
There were no borrowings on the line during 2003 and 2002. See Note 6 for fair value basis of investments. Note 5. Deferred Policy Acquisition Costs Deferred policy acquisition costs are summarized as follows: 2003
    
    2002
    
    2001Balance at beginning of year
    
    $
    104,065
    
    
    $
    92,015
    
    
    $
    84,723Additions:Commissions
    
    
    9,448
    
    
    
    10,894
    
    
    
    5,543General expenses
    
    
    11,411
    
    
    
    9,365
    
    
    
    7,364Taxes, licenses and fees
    
    
    55
    
    
    
    218
    
    
    
    20320,914
    
    
    
    20,477
    
    
    
    13,110Amortization
    
    
    (6,526
    )
    
    
    (8,427
    )
    
    
    (5,818
    )Change in unrealized investment gains
    
    
    (14,579
    )
    
    
    0
    
    
    
    0Balance at end of year
    
    $
    103,874
    
    
    $
    104,065
    
    
    $
    92,015
 The 2003 and 2002 annuity deposits were significantly higher than 2001,
resulting in an increase in commission amounts capitalized in DAC. Additions to
DAC relating to annuities were $4,432, $6,932 and $1,880 in 2003, 2002 and
2001, respectively. At December 31, 2003, the Companys recoverability testing indicated the DAC
asset was fully recoverable. This in turn allowed the Company to capitalize a
larger portion of general expenses as DAC in 2003 when compared to 2002. In
2002, the Company determined that the estimated future gross premiums on its
term products issued in 2002 were insufficient to cover actual deferred
acquisition costs. Thus, an adjustment to increase amortization by
approximately $2,000, or $0.14 per share, after taxes, was recorded in the
fourth quarter of 2002. In 2003, the Company began adjusting the unamortized balance of DAC for the
impact on estimated future gross profits as if net unrealized appreciation and
depreciation on investments had been realized as of the balance sheet date. The
impact of this adjustment, net of tax, is included in Accumulated Other
Comprehensive Income in Shareholders Equity. As of December 31, 2003, the
adjustment to DAC resulting from this change in unrealized investment gains was
$14.6 million. The amount charged to Accumulated Other Comprehensive Income
was $9.5 million, net of $5.1 million of tax.


Note 6. Fair Value of Financial Instruments Estimated fair value amounts of financial instruments have been determined
using available market information and appropriate valuation methodologies.
However, considerable judgment is required in developing the estimates of fair
value. Accordingly, these estimates are not necessarily indicative of the
amounts that could be realized in a current market exchange. Certain financial
instruments, including insurance contracts other than financial guarantees and
investment contracts, are exempt from fair value disclosure requirements. The
following methods and assumptions were used by the Company in estimating the
fair value of each class of financial instrument for which it is practicable to
estimate that value. Cash and cash equivalents:The carrying amounts approximate their fair value. Fixed maturities and equity securities:Fair values were based on quoted market
prices, where available, or dealer quotations. See Note 4 for fair value
disclosures. Limited partnerships:Fair values of the mezzanine debt limited partnerships
were provided to the Company by the partnership. Real estate limited
partnership fair values approximate carrying value. Policy loans and real estate mortgage loans:For policy loans and real estate
mortgage loans, carrying value is representative of estimated fair value. Trading assets and trading liabilities:The carrying value of these assets and
liabilities arising in the ordinary course of business approximates their fair
values. Annuity deposits:Included in this category are annuity deposit contracts. The
Company retains the right to change interest rates subject to a one-year
guaranteed interest rate and a minimum interest rate provided in the policy. As
a result, the carrying value of these contracts approximates their fair value.
These annuity deposits totaled $759,337 and $643,941 at December 31, 2003 and
2002, respectively. Annuity deposits include structured settlements, contracts that the
policyholder cannot surrender at any time and for which the policyholder is
locked into an interest rate for the duration of the contract. Fair values of
these contracts were estimated using discounted projected cash flows based upon
interest rates currently being offered for similar contracts with the same
remaining maturities. At December 31, 2003 and 2002, the carrying value of
structured settlements totaled $173,216 and $159,734, respectively, while the
estimated fair value of these contracts totaled $189,440 and $178,609,
respectively. Universal life deposits:The Company retains the right to change interest rates
on its universal life deposits subject to a minimum interest rate provided in
the policy. As a result, the carrying value of these contracts approximates
their fair value.




All dollar amounts are in thousands, except per share data.

74



---



##### 



Notes to Financial Statements

Note 7. Comprehensive Income



Comprehensive income is composed of net income and other comprehensive income,
which includes unrealized appreciation of investments, net of tax. The components of other comprehensive income for the years ended December 31
are as follows: 2003
    
    2002
    
    2001Unrealized holding gains arising during period, net of related offsets
    
    $
    26,088
    
    
    $
    17,753
    
    
    $
    2,926Less: (gains) losses included in net income
    
    
    (13,176
    )
    
    
    9,610
    
    
    
    19,646Net unrealized holding gains arising during period, net of related offsets
    
    
    12,912
    
    
    
    27,363
    
    
    
    22,572Income tax expense related to unrealized gains
    
    
    ( 4,520
    )
    
    
    ( 9,577
    )
    
    
    ( 7,900
    )Other comprehensive income, net of tax
    
    $
    8,392
    
    
    $
    17,786
    
    
    $
    14,672
 The Accumulated Other Comprehensive Income balances of $44,537 and $36,145 as
of December 31, 2003 and 2002, respectively, relate entirely to the unrealized
appreciation of investments, net of tax. Note 8. Liability for Unpaid Policy and Contract Claims Activity in the liability for unpaid policy and contract claims is as follows: 2003
    
    2002
    
    2001Balance at January 1
    
    $
    2,362
    
    
    $
    1,950
    
    
    $
    2,473Less reinsurance recoverables
    
    
    ( 915
    )
    
    
    (1,022
    )
    
    
    (168
    )Net balance at January 1
    
    
    1,447
    
    
    
    928
    
    
    
    2,305Total death claims incurred
    
    
    15,197
    
    
    
    15,547
    
    
    
    13,338Total death claims paid, net
of reinsurance recoveries
    
    
    15,097
    
    
    
    15,027
    
    
    
    14,715Net balance at December 31
    
    
    1,547
    
    
    
    1,448
    
    
    
    928Plus reinsurance recoverables
    
    
    2,106
    
    
    
    914
    
    
    
    1,022Balance at December 31
    
    $
    3,653
    
    
    $
    2,362
    
    
    $
    1,950
 Included in the 2002 total death claims paid is payment of a claim related to a
former president and CEO of the Company totaling $739, net of reinsurance
recoveries.


Note 9. Annuity and Universal Life Deposits The Company offers, among other products, annuity and universal life insurance.
The amount received as deposits for each of the years ended December 31 are as
follows: 2003
    
    2002
    
    2001Deposits:Universal life
    
    $
    13,326
    
    
    $
    12,176
    
    
    $
    12,238Annuity
    
    
    144,202
    
    
    
    175,509
    
    
    
    69,754Total
    
    $
    157,528
    
    
    $
    187,685
    
    
    $
    81,992
 For information related to annuity products sold to affiliates, see Note 11,
Related Party Transactions. Note 10. Federal Income Taxes The provision for federal income taxes consists of the following for the years
ended December 31: 2003
    
    2002
    
    2001Currently due
    
    $
    13,118
    
    
    $
    4,504
    
    
    $
    1,361Deferred
    
    
    2,700
    
    
    
    193
    
    
    
    88Total
    
    $
    15,818
    
    
    $
    4,697
    
    
    $
    1,449
 A reconciliation of the provision for income taxes with amounts determined by
applying the statutory federal income tax rates to pretax income is as follows: 2003
    
    2002
    
    2001Federal income taxes at statutory rates
    
    $
    17,557
    
    
    $
    4,738
    
    
    $
    1,465Dividends received deduction and tax-exempt interest
    
    
    (3
    )
    
    
    (18
    )
    
    
    (33
    )Other
    
    
    (1,736
    )
    
    
    ( 23
    )
    
    
    17Provision for federal income taxes
    
    $
    15,818
    
    
    $
    4,697
    
    
    $
    1,449
 The Company recorded an adjustment to deferred income taxes during the fourth
quarter of 2003. Deferred tax liabilities established in previous years to
reflect potential income tax exposures were determined to be unnecessary and
the amounts provided were reversed during the fourth quarter. The one-time
non-cash reduction in deferred taxes of $1.3 million, increased fourth quarter
earnings by $0.14 per share.




All dollar amounts are in thousands, except per share data.

75



---



##### 



Notes to Financial Statements



Temporary differences between the financial statement carrying amounts and tax
bases of assets and liabilities that give rise to deferred income tax assets
and liabilities for the years ended December 31 are as follows: 2003
    
    2002Deferred tax assets:Liability for future life and annuity policy benefits
    
    $
    (9,656
    )
    
    $
    (8,032
    )Write-down of investments
    
    
    ( 2, 242
    )
    
    
    (1, 736
    )Deferred compensation
    
    
    (1,245
    )
    
    
    ( 962
    )Total deferred tax assets
    
    
    (13,143
    )
    
    
    (10,730
    )Deferred tax liabilities:Deferred policy acquisition costs
    
    
    35,700
    
    
    
    31,399Unrealized gains on investment
    
    
    23,982
    
    
    
    19,462Other
    
    
    2,257
    
    
    
    1,446Total deferred tax liabilities
    
    
    61,939
    
    
    
    52,307Net
deferred income tax liability
    
    $
    48,796
    
    
    $
    41,577
 Note 11. Related Party Transactions Expense allocations Allocations from EIC for operating expenses paid on behalf of the Company are
made on a monthly basis. The Company reimburses EIC when the expenses are paid.
The amount of these cash settlements for the Company totaled $26,081, $23,784
and $18,545 in 2003, 2002 and 2001, respectively. The employees of the Company participate in the pension and other employee
benefit plans of EIC. The pension benefits are based on years of service and
salary. Pension costs are funded by EIC in amounts sufficient to at least meet
ERISA minimum funding requirements. The Company, through EIC, also participates
in certain deferred compensation and supplemental pension plans for certain
executive and senior officers. The amounts recorded by the Company for the
deferred compensation and supplemental pension plan totaled $1,039, $748 and
$553 at December 31, 2003, 2002 and 2001, respectively, which will be settled
in cash to EIC as payments are made under these plans. The pension and related
benefit costs allocated to the Company from EIC equaled $191, $6 and ($96) in
2003, 2002 and 2001, respectively. Notes payable to EIC The Company has a $15,000 surplus note payable to EIC. This note bears an
annual interest rate of 6.45%. Interest on the surplus note is scheduled to be
paid semiannually, subject to approval of the Pennsylvania Insurance
Commissioner. The note will be payable on demand on or after December 31, 2005,
subject to approval by the Pennsylvania Insurance Commissioner. Interest paid
on this note totaled $968 in 2003, 2002 and 2001.


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 semiannually, subject to approval of
the Pennsylvania Insurance Commissioner. The surplus note will be payable on
demand on or after December 31, 2018, subject to approval by the Pennsylvania
Insurance Commissioner. The Company paid interest totaling $582 on this note in
2003. Real estate The Company owns certain real estate it leases to EIC. The real estate is
recorded net of accumulated depreciation of $1,694 and $1,611 at December 31,
2003 and 2002, respectively. Rentals paid by EIC to the Company totaled $320,
$318 and $312 in 2003, 2002 and 2001, respectively. Future minimum rentals
under this agreement are as follows: 2004
    
    $
    3282005
    
    
    3312006
    
    
    3372007
    
    
    3412008
    
    
    113Total
    
    $
    1,450
 Software and equipment EIC purchased certain software and equipment for use by the Company.
Depreciation and applicable interest are charged to the Company throughout the
estimated useful life of the asset and is included in general expenses.
Depreciation and interest charged the Company in 2003, 2002 and 2001 amounted
to $679, $672 and $701, respectively. Annuities sold to affiliates The Erie Insurance Group Retirement Plan for employees purchases from the
Company individual annuities for some terminated vested employees or
beneficiaries receiving benefits. These are nonparticipating annuity contracts
under which the Company has unconditionally contracted to provide specified
benefits to beneficiaries in return for a fixed premium from the plan. Due to
the current interest rate environment, the Erie Insurance Group Retirement Plan
for employees did not purchase any annuities from the Company in 2003. Annuity
deposits in 2002 and 2001 included $149 and $4,513, respectively, of deposits
on annuity contracts purchased by the Erie Insurance Group Retirement Plan for
employees. Annuity deposit balances outstanding relating to pension annuities
sold to the Erie Insurance Group Retirement Plan are $45,011 and $47,331 at
December 31, 2003 and 2002, respectively.




All dollar amounts are in thousands, except per share data.

76



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##### 



Notes to Financial Statements



The Erie Insurance Group 401(k) plan for employees includes an investment
option in a Company annuity. Annuity deposits in 2003, 2002 and 2001 included
$2,580, $2,182 and $1,912, respectively, of deposits on annuity contracts
purchased by Erie Insurance Group employees through the 401(k) plan. Annuity
deposit balances outstanding relating to 401(k) annuities sold to employees
are $28,034 and $25,081 at December 31, 2003 and 2002, respectively. The Erie Insurance Group affiliated property/casualty insurance companies
periodically purchase annuities from the Company in connection with the
structured settlement of claims. Considerations recorded in annuity deposits in
the Statements of Financial Position from structured settlement annuities sold
to affiliated property/casualty companies of the Erie Insurance Group totaled
$20,884, $18,564 and $12,879 in 2003, 2002 and 2001, respectively. The reserves
held for structured settlement annuities sold to the affiliated
property/casualty insurance companies equal $201,941 and $186,180 at December
31, 2003 and 2002, respectively. Note 12. Reinsurance The Company has entered into various reinsurance treaties for the purpose of
ceding the excess of life insurance over the Companys 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 disability income product, the Company has a 50%
coinsurance agreement with its reinsurer. As of December 31, 2003 and 2002,
$9.8 billion and $7.0 billion, respectively, of life insurance in force was
ceded to other companies. The Companys most significant reinsurance
relationship is with Generali USA Reassurance Company (Generali) (formerly
Business Mens Assurance Company of America), which reinsures a portion of the
Companys life and accident and health business. At December 31, 2003, the
amount of in-force life insurance ceded to Generali totaled approximately $5.6
billion. The Companys newest products,
ERIE Flagship TermSM2 and ERIE Target TermSM
are reinsured 50% and 90%, respectively, with nonaffiliated reinsurers. Sales
of ERIE Flagship Term, ERIE Flagship TermSM2 and the ERIE
Target TermSM
continue to result in increased ceded reinsurance balances. Policy revenue
ceded to Generali totaled $7,234, $5,816 and $3,956 for the years ended
December 31, 2003, 2002 and 2001, respectively.


The effect of ceded reinsurance in the Statements of
Operations is as follows: 2003
    
    2002
    
    2001RevenuesDirect policy revenue
    
    $
    72,947
    
    
    $
    63,426
    
    
    $
    54,549Policy revenue ceded
    
    
    (17,015
    )
    
    
    (12,297
    )
    
    
    (8,058
    )Net policy revenue
    
    
    55,932
    
    
    
    51,129
    
    
    
    46,491Net investment income
    
    
    76,966
    
    
    
    66,286
    
    
    
    61,181Net realized gains (losses)
on investments
    
    
    13,176
    
    
    
    (9,610
    )
    
    
    (19,646
    )Equity in earnings of
limited partnerships
    
    
    1,296
    
    
    
    3,664
    
    
    
    736Other income
    
    
    844
    
    
    
    815
    
    
    
    752Total revenues
    
    
    148,214
    
    
    
    112,284
    
    
    
    89,514Benefits and expensesDeath benefits
    
    
    19,933
    
    
    
    18,462
    
    
    
    15,833Reinsurance recoveries
    
    
    (4,736
    )
    
    
    (2,915
    )
    
    
    (2,495
    )Net death benefits
    
    
    15,197
    
    
    
    15,547
    
    
    
    13,338Interest on deposits and
other policyholder benefits
    
    
    50,400
    
    
    
    48,754
    
    
    
    44,436Increase in future life
policy benefits
    
    
    13,846
    
    
    
    8,566
    
    
    
    8,792Reinsurance reserve credits
    
    
    (6,635
    )
    
    
    (2,003
    )
    
    
    (3,044
    )Net increase in future life
policy benefits
    
    
    7,211
    
    
    
    6,563
    
    
    
    5,748Amortization of deferred
policy acquisition costs
    
    
    6,526
    
    
    
    8,427
    
    
    
    5,818Commissions
    
    
    10,316
    
    
    
    10,839
    
    
    
    6,311Reinsurance commission
allowance
    
    
    (7,637
    )
    
    
    (7,033
    )
    
    
    (3,886
    )Net commissions
    
    
    2,679
    
    
    
    3,806
    
    
    
    2,425General expenses, taxes,
licenses and fees
    
    
    16,037
    
    
    
    15,650
    
    
    
    13,562Total benefits and expenses
    
    
    98,050
    
    
    
    98,747
    
    
    
    85,327Income before income taxes
    
    $
    50,164
    
    
    $
    13,537
    
    
    $
    4,187




All dollar amounts are in thousands, except per share data.

77



---



##### 



Notes to Financial Statements

Note 13. 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 for the years ended December 31 is as
follows: 2003
    
    2002
    
    2001Cash flows from operating activitiesNet Income
    
    $
    34, 346
    
    
    $
    8, 840
    
    
    $
    2,738Adjustments to reconcile net income to
net cash provided by operating activities:Amortization of deferred policy acquisition costs
    
    
    6,526
    
    
    
    8,427
    
    
    
    5,818Other amortization
    
    
    791
    
    
    
    311
    
    
    
    576Deferred federal income tax expense
    
    
    2,700
    
    
    
    193
    
    
    
    88Realized (gains) losses on investments
    
    
    (13,176
    )
    
    
    9,610
    
    
    
    19,646Equity in earnings of limited partnerships
    
    
    (1,296
    )
    
    
    (3,664
    )
    
    
    (736
    )Increase in premiums receivable
    
    
    (1,120
    )
    
    
    (1,135
    )
    
    
    (480
    )Decrease (increase) in other receivables
    
    
    1,351
    
    
    
    (1,114
    )
    
    
    18(Increase) decrease in accrued investment income
    
    
    (1,735
    )
    
    
    (1,833
    )
    
    
    518Policy acquisition costs deferred
    
    
    (20,915
    )
    
    
    (20,477
    )
    
    
    (13,110
    )Decrease in other assets
    
    
    69
    
    
    
    1,719
    
    
    
    597Decrease (increase) in prepaid federal income taxes
    
    
    692
    
    
    
    5,834
    
    
    
    ( 8,341
    )Increase in reinsurance recoverables and reserve credits
    
    
    ( 8,041
    )
    
    
    (1,941
    )
    
    
    ( 4,207
    )Increase in future policy benefits and claims
    
    
    15,296
    
    
    
    8,983
    
    
    
    8,271(Decrease) increase in other policyholder funds
    
    
    (4,479
    )
    
    
    6,361
    
    
    
    3,359Increase (decrease) in reinsurance premium due
    
    
    283
    
    
    
    (150
    )
    
    
    847Increase in accounts payable and due to affiliates
    
    
    121
    
    
    
    2,839
    
    
    
    2,395Net cash provided by operating activities
    
    $
    11,413
    
    
    $
    22,803
    
    
    $
    17,997


Note 14. Commitments and Contingencies Commitments The Company has outstanding commitments to invest up to $1.5 million in limited
partnerships at December 31, 2003. These commitments will be funded as required
through the end of the respective investment periods, which typically span 3 to
5 years. Contingencies The Company is involved in litigation arising in the ordinary course of
business. In the opinion of management, the effects, if any, of such litigation
are not expected to be material to the Companys financial condition. Note 15. 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.
Variable universal life products are not sold by the Company. 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 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 common stock,
limited partnership and remaining fixed maturity investments support the
Corporate Account. Because the Company sold its entire common stock portfolio
at the end of 2002, relatively more of the fixed maturity portfolio will
support the Corporate Account in future periods. The loss recorded in the Fixed Annuities line for the year ended December 31,
2002, is a direct result of the $24,697 of impairment charges recognized on
fixed maturity investments during 2002. The 2002 increase in investment-related
and other income in the Corporate Account is a result of $8,683 in net realized
gains on the sale of common stock in 2002. The 2001 results in the Corporate
Account investment-related income were due to realized losses on common stock
totaling $16,356.




All dollar amounts are in thousands, except per share data.

78



---



##### 



Notes to Financial Statements

Traditional
    
    Universal
    
    Fixed
    
    Group life
    
    Corporatelife
    
    life
    
    annuities
    
    & other
    
    account
    
    Total2003Total policy revenue, net of reinsurance
    
    $
    38,695
    
    
    $
    13,350
    
    
    $
    5
    
    
    $
    3,882
    
    
    $
    0
    
    
    $
    55,932Total net investment income and other income
    
    
    6,857
    
    
    
    8,897
    
    
    
    54,329
    
    
    
    168
    
    
    
    8,855
    
    
    
    79,106Net realized capital gains
    
    
    1,191
    
    
    
    1,421
    
    
    
    9,417
    
    
    
    29
    
    
    
    1,118
    
    
    
    13,176Total revenues
    
    
    46,743
    
    
    
    23,668
    
    
    
    63,751
    
    
    
    4,079
    
    
    
    9,973
    
    
    
    148,214Less: Total benefits and expenses
    
    
    32,972
    
    
    
    15,679
    
    
    
    46,155
    
    
    
    3,244
    
    
    
    0
    
    
    
    98,050Income before income taxes
    
    $
    13,771
    
    
    $
    7,989
    
    
    $
    17,596
    
    
    $
    835
    
    
    $
    9,973
    
    
    $
    50,1642002Total policy revenue, net of reinsurance
    
    $
    35,860
    
    
    $
    12,209
    
    
    $
    3
    
    
    $
    3,057
    
    
    $
    0
    
    
    $
    51,129Total net investment income and other income
    
    
    6,381
    
    
    
    8,227
    
    
    
    46,294
    
    
    
    157
    
    
    
    9,706
    
    
    
    70,765Net realized capital (losses) gains
    
    
    (1,547
    )
    
    
    (1,819
    )
    
    
    (11,198
    )
    
    
    (38
    )
    
    
    4,992
    
    
    
    (9,610
    )Total revenues
    
    
    40,694
    
    
    
    18,617
    
    
    
    35,099
    
    
    
    3,176
    
    
    
    14,698
    
    
    
    112,284Less: Total benefits and expenses
    
    
    35,106
    
    
    
    17,246
    
    
    
    44,115
    
    
    
    2,280
    
    
    
    0
    
    
    
    98,747Income (loss) before income taxes
    
    $
    5,588
    
    
    $
    1,371
    
    
    $
    (9,016
    )
    
    $
    896
    
    
    $
    14,698
    
    
    $
    13,5372001Total policy revenue, net of reinsurance
    
    $
    32,685
    
    
    $
    11,008
    
    
    $
    3
    
    
    $
    2,795
    
    
    $
    0
    
    
    $
    46,491Total net investment income and other income
    
    
    6,446
    
    
    
    7,899
    
    
    
    42,914
    
    
    
    164
    
    
    
    5,246
    
    
    
    62,669Net realized capital losses
    
    
    (471
    )
    
    
    (527
    )
    
    
    (3,128
    )
    
    
    (12
    )
    
    
    (15,508
    )
    
    
    (19,646
    )Total revenues
    
    
    38,660
    
    
    
    18,380
    
    
    
    39,789
    
    
    
    2,947
    
    
    
    (10,262
    )
    
    
    89,514Less: Total benefits and expenses
    
    
    28,764
    
    
    
    15,040
    
    
    
    38,009
    
    
    
    3,514
    
    
    
    0
    
    
    
    85,327Income (loss) before income taxes
    
    $
    9,896
    
    
    $
    3,340
    
    
    $
    1,780
    
    
    $
    (567
    )
    
    $
    (10,262
    )
    
    $
    4,187


Note 16. Statutory Information



The Company prepares its statutory financial statements in accordance with
accounting practices prescribed by the Pennsylvania Insurance Department.
Prescribed Statutory Accounting Practices (SAP) include state laws, regulations
and general administrative rules, as well as a variety of publications from the
National Association of Insurance Commissioners (NAIC). Accounting principles
used to prepare statutory financial statements differ from financial statements
prepared on the basis of generally accepted accounting principles. A reconciliation of net income as filed with regulatory authorities to net
income reported in the accompanying financial statements for the years ended
December 31, 2003, 2002 and 2001, follows:


2003
    
    2002
    
    2001Statutory net income (loss)
    
    $
    15,404
    
    
    $
    (8,625
    )
    
    $
    (5,065
    )Reconciling items:Policy liabilities and accruals
    
    
    1,224
    
    
    
    3,568
    
    
    
    831Deferred policy acquisition
costs, net of amortization
    
    
    14,388
    
    
    
    12,050
    
    
    
    7,292Investment valuation
differences
    
    
    6,747
    
    
    
    3,372
    
    
    
    2,084GAAP deferred taxes
    
    
    (2,700
    )
    
    
    (193
    )
    
    
    (88
    )Deferred and uncollected
premiums
    
    
    (1,764
    )
    
    
    (2,034
    )
    
    
    (1,557
    )Limited partnership income
    
    
    1,295
    
    
    
    950
    
    
    
    (500
    )Other
    
    
    (248
    )
    
    
    (248
    )
    
    
    (259
    )GAAP net income
    
    $
    34,346
    
    
    $
    8,840
    
    
    $
    2,738




All dollar amounts are in thousands, except per share data.

79



---



##### 



Notes to Financial Statements



A reconciliation of shareholders equity as filed with regulatory authorities
to shareholders equity reported in the accompanying financial statements as of
December 31, 2003 and 2002, follows: 2003
    
    2002Statutory shareholders equity
    
    $
    124,633
    
    
    $
    93,319Reconciling items:Asset valuation and interest
maintenance reserves
    
    
    30,836
    
    
    
    21,990Investment
valuation differences
    
    
    83,060
    
    
    
    56,010Deferred policy acquisition costs
    
    
    103,874
    
    
    
    104,065Surplus note
    
    
    (40,000
    )
    
    
    (15,000
    )Policy
liabilities and accruals
    
    
    18,848
    
    
    
    17,624Difference between statutory
and GAAP deferred taxes
    
    
    (50,742
    )
    
    
    (44,312
    )Deferred
and uncollected premiums
    
    
    (12,697
    )
    
    
    (10,933
    )Capitalized salaries and
benefits, net of amortization
    
    
    1,435
    
    
    
    1,684GAAP shareholders equity
    
    $
    259,247
    
    
    $
    224,447


The minimum statutory capital and surplus requirements
under Pennsylvania law for stock life insurance companies
(Section 386 of the PA Insurance Code) amounts to $1,650.
The Companys total statutory capital and surplus well
exceeded these minimum requirements. The amount of dividends the Company can pay to its
shareholders without the prior approval of the Pennsylvania
Insurance Commissioner is limited by statute to the greater
of: (a) 10% of its statutory surplus as regards policyholders
as shown on its last annual statement on file with the
commissioner, or (b) the net income as reported for the period
covered by such annual statement, but shall not include pro
rata distribution of any class of the insurers own securities.
Accordingly, the maximum dividend payout which may be
made in 2004 without prior Pennsylvania Commissioner
approval is $15,404. Dividends declared to shareholders
totaled $7,938 in both 2003 and 2002. Bonds having a carrying value of $2,113 at December 31,
2003, were on deposit with various regulatory authorities as
required by law. The carrying value of these bonds are not
material for separate disclosure on the Companys Statements
of Financial Position and are included with fixed maturities.




Note 17. Quarterly Results of Operations (Unaudited)

The following results are unaudited. In the opinion of the Companys
management, all adjustments-consisting only of normal recurring
accruals-necessary for a fair presentation of the interim periods presented
have been included.

First
    
    Second
    
    Third
    
    Fourthquarter
    
    quarter
    
    quarter
    
    quarter2003Total net policy revenue
    
    $
    13,089
    
    
    $
    14,334
    
    
    $
    13,598
    
    
    $
    14,911Net investment income
    
    
    18,584
    
    
    
    19,843
    
    
    
    18,932
    
    
    
    19,607Net realized gains on investments
    
    
    2,162
    
    
    
    2,099
    
    
    
    4,908
    
    
    
    4,007Equity in earnings (losses) of limited partnerships
    
    
    280
    
    
    
    120
    
    
    
    1,394
    
    
    
    (498
    )Other income
    
    
    177
    
    
    
    217
    
    
    
    264
    
    
    
    186Total revenues
    
    
    34,292
    
    
    
    36,613
    
    
    
    39,096
    
    
    
    38,213Total benefits and expenses
    
    
    26,013
    
    
    
    24,647
    
    
    
    23,806
    
    
    
    23,584
    (1)Income before income taxes
    
    
    8,279
    
    
    
    11,966
    
    
    
    15,290
    
    
    
    14,629Provision for federal income taxes
    
    
    2,873
    
    
    
    4,152
    
    
    
    5,306
    
    
    
    3,487
    (2)Net income
    
    $
    5,406
    
    
    $
    7,814
    
    
    $
    9,984
    
    
    $
    11,142Net income per share
    
    $
    0.57
    
    
    $
    0.83
    
    
    $
    1.05
    
    
    $
    1.18Comprehensive income (loss)
    
    $
    15,500
    
    
    $
    38,815
    
    
    $
    (18,304
    )
    
    $
    6,727


All dollar amounts are in thousands, except per share data.

80



---



##### 



Notes to Financial Statements

First
    
    Second
    
    Third
    
    Fourthquarter
    
    quarter
    
    quarter
    
    quarter2002Total net policy revenue
    
    $
    12,329
    
    
    $
    13,518
    
    
    $
    12,311
    
    
    $
    12,971Net investment income
    
    
    14,510
    
    
    
    16,998
    
    
    
    16,517
    
    
    
    18,261Net realized gains (losses) on investments
    
    
    2,054
    
    
    
    (7,698
    )
    
    
    (5,235
    )
    
    
    1,269Equity in earnings (losses) of limited partnerships
    
    
    1,069
    
    
    
    2,513
    
    
    
    151
    
    
    
    (69
    )Other income
    
    
    244
    
    
    
    177
    
    
    
    139
    
    
    
    255Total revenues
    
    
    30,206
    
    
    
    25,508
    
    
    
    23,883
    
    
    
    32,687Total benefits and expenses
    
    
    23,500
    
    
    
    23,970
    
    
    
    23,133
    
    
    
    28,144Income before income taxes
    
    
    6,706
    
    
    
    1,538
    
    
    
    750
    
    
    
    4,543Provision for federal income taxes
    
    
    2,320
    
    
    
    532
    
    
    
    260
    
    
    
    1,585Net income
    
    $
    4,386
    
    
    $
    1,006
    
    
    $
    490
    
    
    $
    2,958Net income per share
    
    $
    0.46
    
    
    $
    0.11
    
    
    $
    0.05
    
    
    $
    0.32Comprehensive (loss) income
    
    $
    (5,973
    )
    
    $
    7,964
    
    
    $
    16,683
    
    
    $
    7,9522001Total net policy revenue
    
    $
    10,997
    
    
    $
    11,861
    
    
    $
    11,295
    
    
    $
    12,338Net investment income
    
    
    14,709
    
    
    
    15,865
    
    
    
    14,744
    
    
    
    15,863Net realized gains (losses) on investments
    
    
    594
    
    
    
    (1,067
    )
    
    
    (2,034
    )
    
    
    (17,139
    )(3)Equity in (losses) earnings of limited partnerships
    
    
    (965
    )
    
    
    1,767
    
    
    
    614
    
    
    
    (680
    )Other income
    
    
    191
    
    
    
    178
    
    
    
    317
    
    
    
    66Total revenues
    
    
    25,526
    
    
    
    28,604
    
    
    
    24,936
    
    
    
    10,448Total benefits and expenses
    
    
    20,265
    
    
    
    19,962
    
    
    
    21,075
    
    
    
    24,025Income (loss) before income taxes
    
    
    5,261
    
    
    
    8,642
    
    
    
    3,861
    
    
    
    (13,577
    )Provision for federal income taxes (benefit)
    
    
    1,820
    
    
    
    2,985
    
    
    
    1,342
    
    
    
    (4,698
    )Net income (loss)
    
    $
    3,441
    
    
    $
    5,657
    
    
    $
    2,519
    
    
    $
    (8,879
    )Net income (loss) per share
    
    $
    0.36
    
    
    $
    0.60
    
    
    $
    0.27
    
    
    $
    (0.94
    )Comprehensive income (loss)
    
    $
    9,136
    
    
    $
    7,295
    
    
    $
    5,854
    
    
    $
    (4,875
    )




(1)
 
 The DAC amortization recorded during each of the first three quarters of
2003 was affected by a $700 charge for additional amortization related to
DAC recoverability issues. These charges were subsequently reversed in the
fourth quarter of 2003 after recoverability testing indicated the DAC
asset was fully recoverable.  (2)
 
 The Company recorded an adjustment to deferred income taxes during the fourth
quarter of 2003. Deferred tax liabilities established in previous years to
reflect potential


income tax exposures were determined to be unnecessary and the amounts
provided were reversed during the fourth quarter. The one-time non-cash
reduction in deferred taxes increased fourth quarter earnings by $0.14 per
share.  (3)
 
 Net realized losses on investments in the fourth quarter of 2001 resulted
primarily from sales of fixed maturities and common stock as part of a
proactive year-end tax-planning strategy.




All dollar amounts are in thousands, except per share data.

81